-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, ChnM0kx9qoam42zjfxPNtTQ24/Zd/Ftwfvy4p3YA9tjQ9Ldj7AKCLpYKG4za3mU6 kqQ0vd+6VAN+vPYIqjzWmQ== 0000893220-03-001312.txt : 20030730 0000893220-03-001312.hdr.sgml : 20030730 20030730172257 ACCESSION NUMBER: 0000893220-03-001312 CONFORMED SUBMISSION TYPE: S-1/A PUBLIC DOCUMENT COUNT: 10 FILED AS OF DATE: 20030730 FILER: COMPANY DATA: COMPANY CONFORMED NAME: MERCER INSURANCE GROUP INC CENTRAL INDEX KEY: 0001050690 STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331] IRS NUMBER: 232939601 STATE OF INCORPORATION: PA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: S-1/A SEC ACT: 1933 Act SEC FILE NUMBER: 333-104897 FILM NUMBER: 03812379 BUSINESS ADDRESS: STREET 1: 10 NORTH HIGHWAY ONE CITY: PENNINGTON STATE: NJ ZIP: 08534 BUSINESS PHONE: 6097370426 MAIL ADDRESS: STREET 1: 10 N HWY 1 CITY: PENNINGTON STATE: NJ ZIP: 08534 S-1/A 1 e85343a2sv1za.txt MERCER MUTUAL INSURANCE COMPANY S-1 AMENDMENT #2 AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JULY 30, 2003. REGISTRATION NO. 333-104897 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 --------------------- PRE-EFFECTIVE AMENDMENT NO. 2 TO FORM S-1 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 --------------------- MERCER INSURANCE GROUP, INC. (Exact name of registrant as specified in its charter) PENNSYLVANIA 6331 23-2934601 (State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer incorporation or organization) Classification Code Number) Identification Number)
10 NORTH HIGHWAY 31 PENNINGTON, NEW JERSEY 08534 (609) 737-0426 (Address, including zip code, and telephone number, including area code, of registrant's principal executive offices) ANDREW R. SPEAKER PRESIDENT AND CHIEF EXECUTIVE OFFICER MERCER INSURANCE GROUP, INC. 10 NORTH HIGHWAY 31 P.O. BOX 278 PENNINGTON, NEW JERSEY 08534 (609) 737-0426 (Name, address, including zip code, and telephone number, including area code, of agent for service) COPIES TO: JEFFREY P. WALDRON, ESQUIRE JOHN S. CHAPMAN, ESQUIRE EDWARD C. HOGAN, ESQUIRE J. BRETT PRITCHARD, ESQUIRE STEVENS & LEE LORD, BISSELL & BROOK 620 FREEDOM BUSINESS CENTER 115 SOUTH LASALLE STREET SUITE 200 CHICAGO, ILLINOIS 60603 P.O. BOX 62330 (312) 443-0700 KING OF PRUSSIA, PENNSYLVANIA 19406 (610) 478-2000
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as practicable after this Registration Statement becomes effective. If any of the securities being registered on this form are to be offered on a delayed or continuous basis pursuant to Rule 415 of the Securities Act of 1933, check the following box: [X] If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act of 1933, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] - --------------- If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act of 1933, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] - --------------- If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box. [ ] CALCULATION OF REGISTRATION FEE
- -------------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------------- PROPOSED MAXIMUM PROPOSED MAXIMUM AMOUNT OF TITLE OF EACH CLASS OF AMOUNT TO BE OFFERING AGGREGATE REGISTRATION SECURITIES TO BE REGISTERED REGISTERED(1) PRICE PER UNIT(2) OFFERING PRICE FEE(3) - -------------------------------------------------------------------------------------------------------------------------- Common Stock, no par value............ 6,849,391 $10.00 $68,493,910 $5,541 - -------------------------------------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------------------------------------
(1) Includes shares to be offered to eligible policyholders, directors, officers and employees of Mercer Mutual Insurance Company, Mercer Mutual's employee stock ownership plan, and the general public, pursuant to Mercer Mutual's Plan of Conversion from Mutual to Stock Form, and shares to be offered to Franklin Mutual Insurance Company and the shareholders of Franklin Holding Company pursuant to certain contractual rights. (2) Estimated solely for the purpose of calculating the registration fee. (3) Registration fee has been previously paid. --------------------- THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A), MAY DETERMINE. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- PROSPECTUS [LOGO TO COME] MERCER INSURANCE GROUP, INC. (PROPOSED HOLDING COMPANY FOR MERCER MUTUAL INSURANCE COMPANY) 6,261,111 SHARES OF COMMON STOCK Mercer Mutual Insurance Company is converting from the mutual to the stock form of organization. As part of the conversion, Mercer Insurance Group, Inc. is offering 6,261,111 shares of its common stock at a purchase price of $10.00 per share, and will use a portion of the proceeds from this offering to purchase all of the authorized capital stock of Mercer Mutual Insurance Company. As a result, Mercer Mutual Insurance Company will become a wholly owned subsidiary of Mercer Insurance Group, Inc. Applicable law requires Mercer Insurance Group, Inc. to sell an amount of its common stock equal to the estimated pro forma market value of Mercer Mutual Insurance Company, as determined by an independent valuation. The common stock will be listed on the Nasdaq National Market under the symbol "MIGP." --------------------- TERMS OF THE OFFERING PRICE: $10.00 PER SHARE
MINIMUM MAXIMUM ----------- ----------- Number of shares offered.................................... 4,165,000 6,261,111 Gross proceeds.............................................. $41,650,000 $62,611,110 Less: Proceeds from ESOP shares (1)......................... 4,165,000 6,261,110 Estimated offering expenses, including underwriting commissions............................................... $ 2,937,710 $ 3,201,820 Net proceeds................................................ $34,547,290 $53,148,180 Net proceeds per share...................................... $ 8.29 $ 8.49
- --------------- (1) The calculation of net proceeds from this offering does not include the shares being purchased by our employee stock ownership plan (ESOP) because the ESOP is not paying cash for these shares, but is instead purchasing them with the proceeds of a loan from Mercer Insurance Group, Inc. The ESOP is purchasing 10% of the shares sold in the conversion. In the conversion, we are offering a maximum of 5,635,000 shares in the following order of priority: first, to eligible policyholders (persons who, on December 13, 2002, were named insureds under policies issued by Mercer Mutual); second, to directors, officers and employees of Mercer Mutual or its affiliates; and third, to the general public. If eligible policyholders, directors, officers and employees of Mercer Mutual and the general public subscribe for the maximum of 5,635,000 shares in the conversion, the ESOP will purchase an additional 626,111 shares, bringing the total shares sold in the conversion to 6,261,111 shares. The offering expires on [September 8, 2003]. We may extend the offering to a date no later than [October 27, 2003] upon written notice to all subscribers. Orders are irrevocable unless the offering is terminated or extended beyond [September 8, 2003]. If the offering is extended beyond [September 8, 2003], subscribers will have the right to modify or rescind their orders. If by the expiration date, we do not receive orders for at least 4,165,000 shares (including the 10% being purchased by the ESOP), we may sell additional shares in a syndicated community offering using a syndicate of registered broker/dealers managed by Sandler O'Neill & Partners, L.P. This syndicated community offering must be completed or terminated by [December 9, 2003.] The minimum number of shares that you may purchase is 25, and the maximum is 100,000, subject to availability. Your funds will be held in an escrow account at Wilmington Trust Company until completion or termination of the offering. If the offering is terminated, we will return your funds promptly, without interest. Mercer Mutual has engaged Sandler O'Neill & Partners, L.P. to assist with the conversion. Sandler O'Neill & Partners, L.P. is not required to sell any specific number or dollar amount of shares, but will use its best efforts to sell the common stock offered. For more information, please call our Stock Processing Center, toll-free, at 1-866-818-9961. In addition to the shares offered by this prospectus, we are concurrently offering a total of 588,280 shares in separate offerings that are not part of the conversion. These offerings are described under the section of this prospectus entitled "Additional Shares Being Issued After the Conversion." An investment in our common stock involves risks. See the section entitled "Risk Factors" that begins on page 18. Mercer Mutual is converting to stock form pursuant to a Plan of Conversion adopted by Mercer Mutual's Board of Directors and approved by the Pennsylvania Insurance Commissioner. The Pennsylvania Insurance Commissioner's approval of the Plan of Conversion does not constitute or imply endorsement of the conversion, and does not constitute investment advice or a recommendation by the Pennsylvania Insurance Commissioner or the Pennsylvania Insurance Department to purchase our common stock. Neither the Securities and Exchange Commission nor any state insurance department or securities regulator has approved or disapproved these securities or determined if this prospectus is accurate or complete. Any representation to the contrary is a criminal offense. SANDLER O'NEILL & PARTNERS, L.P. The date of this Prospectus is August , 2003 TABLE OF CONTENTS
PAGE ---- Prospectus Summary.......................................... 1 Selected Consolidated Financial Data........................ 15 Risk Factors................................................ 18 Forward-looking Information................................. 28 Use of Proceeds............................................. 30 Capitalization.............................................. 32 Pro Forma Data.............................................. 34 Management's Discussion and Analysis of Financial Condition and Results of Operations................................. 42 Market for the Common Stock................................. 57 Dividend Policy............................................. 57 Business.................................................... 59 The Conversion.............................................. 83 Background and Reasons for the Conversion................. 83 Conversion Process........................................ 86 Offering of Common Stock.................................. 86 Effect of Conversion on Policyholders..................... 87 Continuity of Insurance Coverage and Business Operations............................................. 87 Voting Rights............................................. 87 Policyholder Dividends.................................... 88 Rights Upon Dissolution After Conversion.................. 88 Subscription Offering..................................... 88 Community Offering........................................ 89 Syndicated Community Offering............................. 90 Limitations on Purchases of Common Stock.................. 91 Stock Pricing and Number of Shares to be Issued........... 92 If Subscriptions Received in the Subscription Offering Meet or Exceed the Maximum Number of Shares Offered....... 94 If Subscriptions Received in the Subscription Offering Meet or Exceed the Required Minimum....................... 94 If Subscriptions Received in the Subscription Offering Do Not Meet or Exceed Require Minimum........................ 94 If Subscriptions Received in All of the Offerings Do Not Meet the Required Minimum.............................. 94 The Valuation............................................. 95 Tax Effects Generally..................................... 99 Tax Consequences of Subscription Rights................... 100 Termination Dates of the Subscription and Community Offerings.............................................. 100 Use of Order Forms in this Offering....................... 101 Payment for Shares........................................ 102 Delivery of Certificates.................................. 102 Marketing and Underwriting Arrangements................... 102 Proposed Management Purchases............................. 103 Limitations on Resales.................................... 104 Interpretation and Amendment of the Plan of Conversion.... 104
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PAGE ---- Termination............................................... 105 Conditions................................................ 105 Additional Shares Being Issued after the Conversion......... 105 Management.................................................. 106 Restrictions on Acquisition of the Holding Company.......... 114 Description of Capital Stock................................ 120 Transfer Agent and Registrar................................ 121 Legal Matters............................................... 121 Experts..................................................... 121 Registration Requirements................................... 121 Where You Can Find Additional Information................... 122 Index to Consolidated Financial Statements.................. F-1
You should rely only on the information contained in this prospectus. We have not, and Sandler O'Neill & Partners, L.P. has not, authorized any other person to provide you with different information. If anyone provides you with different or inconsistent information, you should not rely on it. We are not, and Sandler O'Neill & Partners, L.P. is not, making an offer to sell these securities to any person in any jurisdiction where the offer or sale is not permitted. You should assume that the information appearing in this prospectus is accurate only as of the date on the front cover of this prospectus. Our business, financial condition, results of operations and prospects may have changed since that date. Information contained on our web site is not part of this prospectus. Until , 2003, all dealers effecting transactions in these securities, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the obligation of dealers to deliver a prospectus when acting as underwriters. ii PROSPECTUS SUMMARY This summary highlights selected information from this document and may not contain all of the information that is important to you. To understand the offering fully, you should carefully read this entire prospectus, including the financial statements and related notes and the risks of investing in our common stock discussed under "Risk Factors." Throughout this document the use of the words "we", "our" and "us" refer to either Mercer Insurance Group, Inc., Mercer Mutual Insurance Company, or both as the context may require. OVERVIEW We are a provider of a wide array of property and casualty insurance products designed to meet the insurance needs of consumers and small and medium-sized businesses throughout New Jersey and Pennsylvania. We have three operating segments: commercial lines insurance, personal lines insurance and our investment function. Our products include homeowners, commercial multi-peril, other liability, personal automobile, workers compensation, fire and inland marine and commercial automobile coverages. We market our products through a network of over 300 independent producers in New Jersey and Pennsylvania. While traditionally focusing on personal lines for New Jersey customers, over the past six years we have moved aggressively to expand our commercial and casualty premium volume and geographically diversify our writings into Pennsylvania. In order to attract and retain commercial and casualty business, we have developed programs specifically tailored to meet the needs of particular types of businesses. In 2002, homeowners insurance represented 26.9% of our direct premiums written compared to 43.3% in 1998 and commercial writings represented 54.1%, up from 45.0% in 1998. This significant shift in the mix of our writings occurred despite our acquisition in 2001 of a 49% interest in Franklin Insurance Company, the business of which consists entirely of personal lines policies. Our principal office is located at 10 North Highway 31, Pennington, New Jersey 08534. Our telephone number is (800) 223-0534. OUR BUSINESS STRATEGIES We continually strive to improve our profitability and reduce the impact of losses on our business. One of our principal objectives is to become a geographically diverse property and casualty insurer with at least 75% of our direct written premiums consisting of commercial and casualty business that meets our disciplined underwriting standards. By doing so, we believe that our profits from operations will increase and we will be less susceptible to property insurance losses. Our principal strategies to achieve our goals are to: - Increase our commercial writings. Our commercial lines have been more profitable than our personal lines, with a combined ratio for the three months ended March 31, 2003 of 81.3% for commercial lines compared to 125.5% for personal lines, and a combined ratio in 2002 of 86.0% for commercial lines compared to 102.8% for personal lines. Commercial lines growth as a percentage of total writings would lessen the impact that personal lines losses would have on us. - Diversify our business geographically. We intend to increase our business outside New Jersey by expanding our existing producer relationships and by selectively acquiring other insurance companies. Geographic diversification of our aggregate risk would reduce the impact that weather-related property losses have on us. Other than the acquisition of the shares of Franklin Holding Company, Inc. that we do not already own (see "Additional Shares to be Issued After the Conversion"), at the present time we do not have any letter of intent or agreement to acquire any other company. - Attract and retain high-quality insurance producers with diverse customer bases. We intend to implement this strategy through increased marketing activities in targeted growth markets and the development and tailoring of commercial programs to meet the needs of our producers and their customers. 1 - Reduce our ratio of expenses to net premiums earned. We are committed to improving our profitability by reducing expenses through the use of technology and by increasing our premium writings through the strategic deployment of our capital. - Reduce our reliance on reinsurance. We intend to increase the risk our insurance companies retain on individual policies, which will increase net premium volume. The additional capital generated by the conversion will permit us to accelerate these strategies and the holding company structure will provide flexibility to facilitate the achievement of our goals. THE COMPANIES Mercer Insurance Group, Inc. was formed to become the holding company for Mercer Mutual Insurance Company upon completion of Mercer Mutual's conversion from mutual to stock form. In this document, we refer to Mercer Insurance Group, Inc. as the Holding Company. The Holding Company currently has no significant assets or liabilities and no operations. After the conversion, the Holding Company's primary assets will be the outstanding capital stock of Mercer Mutual and a portion of the net proceeds of the conversion. Mercer Mutual is a Pennsylvania mutual insurance company that began operations in 1844. Upon completion of the conversion, the name of Mercer Mutual will be Mercer Insurance Company. It owns 100% of Queenstown Holding Company, Inc., a New Jersey corporation that owns 100% of Mercer Insurance Company of New Jersey, Inc., a New Jersey stock insurance company. Mercer Insurance Company of New Jersey, Inc. began operations in 1982 and offers only workers' compensation insurance to businesses located in New Jersey. Mercer Mutual also owns 49% of Franklin Holding Company, Inc., a Delaware corporation that owns 100% of Franklin Insurance Company. Mercer Mutual controls Franklin Insurance Company through majority positions on the board of directors of Franklin Holding, control of management and other features. Franklin Insurance Company is a Pennsylvania stock insurance company that began operations in 1998, and offers private passenger automobile and homeowners' insurance to Pennsylvania residents. Mercer Mutual also owns 100% of BICUS Services Corporation, a provider of management services to Mercer Mutual and its subsidiaries. FINANCIAL CONDITION AND RESULTS OF OPERATIONS Mercer Mutual has been profitable in each of the past five years, due in large part to our disciplined underwriting approach. One industry measurement of a company's underwriting success is the combined ratio, which is the sum of a company's loss and loss adjustment expense ratio and its underwriting expense ratio. A combined ratio of less than 100% means a company is making an underwriting profit. Although harsh weather conditions adversely affected our first quarter 2003 results, our statutory combined ratios of 93.4% in 1998, 92.7% in 1999, 92.9% in 2000 and 93.4% in 2001 out-performed the industry averages of 103.9%, 106.3%, 108.7% and 115.1% for those years, respectively. Our statutory combined ratio for 2002 was 94.7% and industry data for that year is not yet available. Our insurance companies have been assigned an "A" (Excellent) rating by A.M. Best. An "A" rating is the third highest rating out of 16 possible ratings by A.M. Best. For the three months ended March 31, 2003 and the year ended December 31, 2002, we had: - direct written premiums of $13.0 million and $50.9 million, respectively; - consolidated revenues of $11.7 million and $42.6 million, respectively; and, - net income of $233,000 and $2.2 million, respectively. 2 At March 31, 2003, we had: - consolidated assets of $104.3 million; - total equity of $36.9 million; and - over 51,000 property and casualty policies in force. Our net income for the three months ended March 31, 2003, declined by 69.8% compared to the net income for the three months ended March 31, 2002. The underwriting gain from our commercial lines segment increased from the prior comparable period by $464,000 to $1.1 million; however, our personal lines segment incurred a loss of $1.4 million, which represented a decrease of $1.2 million from the prior comparable period. In addition, segment income from our investment function decreased in the three months ended March 31, 2003, by $71,000 to $576,000 compared to the same period in 2002. For the year ended December 31, 2002, Mercer Mutual's net income of $2.2 million was 33.3% less than its net income of $3.3 million for the year ended December 31, 2001. Although the underwriting gain from our commercial lines segment in 2002 increased from the prior year by $1.4 million to $2.9 million, our personal lines segment incurred an underwriting loss of $1.4 million, which represented a decrease of $1.9 million from the prior year. In addition, segment income from our investment function decreased in 2002 by $600,000 to $1.8 million, due in part to a net realized investment loss for the year of $220,000. THE CONVERSION We are converting to a stock company because we view it as a critical component of our strategic plan. We believe the conversion will help us realize our goals by providing us with: - capital to be used to support our current operations, expand and strengthen our producer network and reduce our reliance on reinsurance; - the ability to issue stock to make acquisitions and to access capital markets to satisfy future capital needs; and - the opportunity for our policyholders, directors, officers and employees to acquire stock in the Holding Company, which will provide additional incentive for their performance and enable them to participate in our success. For additional discussion, see the subsection entitled "Background and Reasons for the Conversion" under the heading "The Conversion." RESULT OF THIS OFFERING AND THE CONVERSION After this offering and the conversion are completed, the Holding Company will be a publicly held company that owns all of the stock of Mercer Mutual. If you purchase stock in the conversion, you will become a shareholder of the Holding Company when the conversion becomes effective. If you do not purchase stock in the offering, you will have no interest in Mercer Mutual or the Holding Company after the conversion. THE INSURANCE COVERAGE UNDER ANY MERCER MUTUAL POLICY THAT YOU OWN WILL NOT BE AFFECTED BY THE CONVERSION OR BY YOUR RESPONSE TO THE OFFERING. For additional details, see the subsection entitled "Effect of Conversion on Policyholders" under the heading "The Conversion." SUBSCRIPTION RIGHTS Each person who was a named insured at the close of business on December 13, 2002, under an existing insurance policy issued by Mercer Mutual (we refer to these policyholders as "eligible policyholders") has the right to purchase up to 100,000 shares of the Holding Company's common stock in this offering (subject to reduction in the event of over-subscription). We refer to these rights as "subscription rights." In addition to eligible policyholders, our Employee Stock Ownership Plan (ESOP) and the directors, officers and employees of Mercer Mutual and its affiliates also have the right to purchase Holding Company 3 common stock in this offering. The ESOP has the right to purchase an amount equal to up to 10% of the total shares of common stock to be issued in the conversion. The ESOP is permitted to exercise this right in full even if there is an oversubscription by eligible policyholders. Each director, officer and employee also has the right to purchase up to 100,000 shares of common stock. However, these rights are secondary to the subscription rights of eligible policyholders. Therefore, these rights may be exercised only if eligible policyholders subscribe for less than 5,635,000 shares of common stock. Over 25% of the directors, officers and employees are eligible policyholders and will have the right to subscribe for stock in that capacity. Except for Mercer Mutual's eligible policyholders, the directors, officers and employees of Mercer Mutual and its affiliates, and the ESOP, no other person or entity has any right to purchase common stock in this offering. DETERMINATION OF OFFERING PRICE AND TOTAL NUMBER OF SHARES OFFERED IN THE CONVERSION Griffin Financial Group, LLC has determined that as of May 30, 2003, the consolidated pro forma market value of Mercer Mutual as a subsidiary of the Holding Company was between $41,650,000 and 56,350,000. The total number of shares offered in the conversion was obtained by taking the high end of that valuation range and dividing that amount by the $10.00 per share offering price, for a total of 5,635,000 shares. We then added to the 5,635,000 total 626,111 shares to allow for the purchase by the ESOP of 10% of the shares of common stock to be issued in the conversion in the event that the other subscribers purchase all of the 5,635,000 shares offered. We determined the $10.00 per share offering price in consultation with Sandler O'Neill & Partners, L.P. and Griffin Financial Group, LLC. See the subsection entitled "Risk Factors Relating to the Ownership of Mercer Insurance Group Stock" under the section entitled "Risk Factors." On the last day of the offering, Griffin Financial Group will submit to the Pennsylvania Insurance Department and us an updated valuation of the pro forma fair market value of Mercer Mutual as a subsidiary of the Holding Company as of that date. If this updated valuation falls within the valuation range described in this prospectus, and the other conditions (described below) to the completion of the offering are satisfied, the offering will be completed promptly. The updated valuation will be filed with the SEC. If this updated valuation does not fall within the valuation range described in this prospectus, then we will either cancel the offering or extend the offering to a date no later than [October 27, 2003] using the updated valuation range. If we extend this offering, we will give written notice of the extension to all subscribers on or promptly after [September 8, 2003], and each subscriber must confirm his or her subscription by the extended termination date. The method for confirming a subscription and the updated valuation will be described in our notice of extension. This notice, which will be in the form of a supplement to this prospectus, will be filed with SEC. See "Where You Can Find Additional Information." If, after a subscriber's receipt of that notice, the subscriber does not confirm his or her subscription in writing, his or her subscription will be returned without interest. If we elect to extend the offering and also elect to proceed with the syndicated community offering, confirming subscribers' funds will remain in the escrow account until no later than [December 9, 2003.] USE OF PROCEEDS The Holding Company expects to contribute 50% of the net proceeds from the offering to Mercer Mutual. In exchange, the Holding Company will receive all of the authorized capital stock of Mercer Mutual. On a short-term basis, the remaining net proceeds will be invested primarily in U.S. government securities and other federal agency securities. These net proceeds will be available for a variety of corporate purposes, including additional capital contributions to our insurance subsidiaries and future acquisitions. We also may use a portion of these net proceeds to fund the purchase by us in the open market of some or all of the shares that would be used to make restricted stock awards, or issued upon the exercise of stock options, under our proposed stock-based incentive plan, if we receive the prior approval of the Pennsylvania Insurance Department to do so. 4 The proceeds contributed to Mercer Mutual will become part of Mercer Mutual's capital, and will help Mercer Mutual expand its underwriting capacity, diversify its business and reduce its reliance on reinsurance. Mercer Mutual may contribute a portion of these funds to its subsidiaries if necessary to support their operations. Except for the foregoing, we currently have no specific plans, intentions, arrangements or understandings regarding the proceeds of the offering. THE SUBSCRIPTION AND COMMUNITY OFFERINGS In the subscription and community offerings, shares of common stock are being offered to eligible subscribers in the following order of priority: - First: To eligible policyholders; - Second: To directors, officers and employees of Mercer Mutual or its affiliates; and - Third: To members of the general public with preference given to: (i) natural persons and trusts of natural persons (including individual retirement and Keogh retirement accounts and personal trusts in which such natural persons have substantial interests) who are residents of the states of Pennsylvania or New Jersey; (ii) principals of corporations, partnerships, limited liability companies or other similar entities that are eligible policyholders; (iii) licensed insurance agencies that have been appointed by Mercer Mutual to market and distribute policies of insurance, and their affiliates; (iv) named insureds under policies of insurance issued by Mercer Mutual after December 13, 2002; and (v) providers of goods or services to Mercer Mutual. The eligible policyholders of Mercer Mutual and the directors, officers and employees of Mercer Mutual and its affiliates have the right to purchase shares of common stock in the conversion based on these priorities. Our ESOP also has the right to purchase shares in this offering in an amount equal to 10% of the shares sold in the conversion. We call the offering of common stock to these constituents the "subscription offering." We refer to the offering of common stock to the general public as the "community offering." Unlike the subscription offering, subscribers in the community offering do not have any right to purchase shares in the offering, and their subscriptions are subject to the rights of the eligible subscribers in the subscription offering. Any of the 5,635,000 offered shares of common stock not subscribed for in the subscription offering may be sold in the community offering. However, the Holding Company reserves the absolute right to accept or reject any orders in the community offering, in whole or in part. THE SYNDICATED COMMUNITY OFFERING If participants in the subscription and community offerings, other than the ESOP, subscribe for fewer than 5,635,000 shares, the Holding Company, in its sole discretion, may sell additional shares on a best efforts basis using a syndicate of registered broker dealers managed by Sandler O'Neill & Partners, L.P. For a comparison of the subscription, community and syndicated community offerings, as well as other offerings of common stock being made by the Holding Company, see the table on page 14. HOW DO I BUY STOCK IN THE OFFERING? To buy common stock in the offering, sign and complete the stock order form that accompanies this prospectus and send it to us with your payment in the envelope provided so that it is received no later than [September 8, 2003]. Payment may be made by check or money order payable to "Wilmington Trust Company, as escrow agent for Mercer Insurance Group, Inc." We may reject an incomplete or late stock order. Your funds will be held in an escrow account with Wilmington Trust Company. You have no right to 5 modify your investment or withdraw your funds without our consent, unless we extend the offering to a date later than [September 8, 2003]. Our consent to any modification or withdrawal request may or may not be given in our sole discretion. If we extend the offering to a date later than [September 8, 2003], you must confirm your subscription by the later of the extended expiration date or the date the syndicated community offering is completed or terminated, or your money will be refunded without interest. The subscription and community offerings may not be extended to a date later than [October 27, 2003] and the syndicated community offering must be completed or terminated by [December 9, 2003.] If we extend this offering, we will give written notice of the extension to all subscribers on or promptly after [September 8, 2003], and each subscriber must confirm his or her subscription by the extended termination date. The method for confirming a subscription will be described in our notice of extension. This notice, which will be in the form of a supplement to this prospectus, will be filed with SEC. LIMITS ON YOUR PURCHASE OF THE COMMON STOCK If you elect to purchase common stock in this offering, you must purchase at least 25 shares of common stock ($250). You may not, either by yourself or together with any of the following persons, purchase more than 100,000 shares ($1 million): (1) any corporation or organization (other than an affiliate of Mercer Mutual) of which you are an officer or partner or the beneficial owner of 10% or more of any class of equity securities; (2) any trust or other estate in which you have a substantial beneficial interest or as to which you serve as trustee or in a similar fiduciary capacity; (3) any of your relatives or your spouse, or any relative of your spouse, who lives at home with you; (4) any person or entity who you control, who controls you, or who together with you is controlled by the same third party; (5) any person or entity who is knowingly participating with you in an effort to purchase common stock in this offering, or who is engaging with you in interdependent conscious parallel action toward acquiring common stock in this offering; or (6) any person or entity with whom you are combining or pooling voting or other interests in the securities of an issuer for a common purpose pursuant to any agreement or relationship. Mercer Mutual's Employee Stock Ownership Plan (ESOP) may purchase up to 10% of the shares of common stock to be issued in the conversion and is expected to do so. OVERSUBSCRIPTION If you are an eligible policyholder of Mercer Mutual, or a director, officer or employee of Mercer Mutual or its affiliates, and we receive in the subscription offering subscriptions for more than 5,635,000 shares, which is the maximum number being offered to eligible policyholders, directors, officers and employees, your subscription may be reduced. In that event, no shares will be sold in the community offering, and the shares of common stock will be allocated first to eligible policyholders and then to directors, officers and employees. The maximum number of shares being offered will be increased to the extent necessary to allow the ESOP to purchase 10% of the total shares issued in the conversion. If eligible policyholders subscribe for more than 5,635,000 shares, no shares of common stock will be sold to directors, officers and employees of Mercer Mutual or its affiliates (except in their capacity as eligible policyholders). The shares of common stock will be allocated so as to permit each subscriber to purchase up to 1,000 shares (unless the magnitude of subscriptions does not permit such an allocation). Any remaining shares will be allocated among the eligible policyholders who subscribe for more than 1,000 shares based on the number of shares for which they subscribe. Therefore, prior to subscribing, every eligible policyholder has the exact same right to acquire the same number of shares in the conversion, notwithstanding differences in their premiums or coverages. For a more complete description of the allocation procedures in the event of an 6 oversubscription by eligible policyholders, see the subsection of the prospectus entitled "Subscription Offering" under the section of the prospectus entitled "The Conversion." If eligible policyholders subscribe for less than 5,635,000 shares, but together with directors, officers and employees of Mercer Mutual and its affiliates, subscribe for more than 5,635,000 shares, each eligible policyholder will be allowed to purchase the full amount of shares for which he or she subscribed, and the remaining shares of common stock will be allocated among the directors, officers and employees on the basis of a point system. One point will be assigned for each year of service to Mercer Mutual and its affiliates, one point for each then current annual salary increment of $5,000, and one point for each office held in Mercer Mutual or its affiliates. The remaining shares then will be distributed on a pro-rata basis using the point system. If we receive in the subscription offering subscriptions for less than 5,635,000 shares of common stock, but in the subscription and community offerings together we receive subscriptions for more than 5,635,000 shares, we will sell to participants in the subscription offering the number of shares sufficient to satisfy their subscriptions in full, and then may accept subscriptions in the community offering, and if necessary, the syndicated community offering, provided that the total number of shares sold in all three offerings does not exceed 5,635,000 shares (not including the shares sold to the ESOP). UNDERSUBSCRIPTION If, after completion of the subscription and community offerings and any syndicated community offering, the number of shares subscribed for in the conversion is less than 4,165,000, then we will cancel the offering. All subscription funds will be returned promptly to subscribers without interest. After the return of those funds, we may cause a new valuation of the consolidated pro forma market value of Mercer Mutual, as a subsidiary of the Holding Company, to be performed, and based on this valuation commence a new offering of the common stock. ADDITIONAL SHARES BEING ISSUED AFTER THE CONVERSION In connection with the settlement of litigation between Mercer Mutual and Franklin Mutual Insurance Company, a New Jersey corporation, Mercer Mutual has granted to Franklin Mutual the right to purchase, at a purchase price of $10.00 per share, the same number of shares of the Holding Company common stock that an eligible policyholder can purchase under the Plan of Conversion. Therefore, Franklin Mutual may purchase up to 100,000 shares (subject to reduction, to the same extent as an eligible policyholder subscribing for 100,000 shares, in the event of an oversubscription by eligible policyholders). These shares are being offered concurrently with the shares being offered in the conversion. We do not know whether and, if so, to what extent Franklin Mutual will exercise its right and purchase stock. We also are offering shares of common stock to shareholders of Franklin Holding, a Delaware corporation that owns 100% of the capital stock of Franklin Insurance Company, a Pennsylvania property and casualty insurance company. (Franklin Holding and its subsidiary, Franklin Insurance Company, are not affiliated in any way with Franklin Mutual.) As part of Mercer Mutual's acquisition of a 49% interest in Franklin Holding in 2001, the parties agreed that in the event of a conversion of Mercer Mutual, the eight holders of the capital stock of Franklin Holding would have the right to exchange their Franklin Holding shares for shares of Holding Company common stock. The number of shares of Holding Company common stock to be exchanged is equal to the value of each holder's Franklin Holding capital stock divided by $10.00 (the purchase price of the Holding Company common stock in this offering). This value was negotiated by us and the eight holders of Franklin Holding capital stock in 2001 on an arms-length basis; no party obtained an independent valuation of Franklin Holding in connection with this negotiation. These shares are being offered concurrently with the shares being offered in the conversion and will be issued immediately after completion of the conversion. If any of the eight shareholders do not exercise their exchange rights, Mercer Mutual has the right to require them to exchange their shares on the same terms and we expect that we would exercise that right. Accordingly, upon completion of the share exchange, Mercer Mutual will own 100% of the outstanding capital stock of Franklin Holding. 7 In the share exchange, 488,280 shares of Holding Company common stock will be issued to the shareholders of Franklin Holding. Of this amount, 251,715 shares will be issued to H. Thomas Davis, Jr. the founder of Franklin Holding and a current director and officer of the Holding Company and Mercer Mutual. Mr. Davis also intends to purchase 100,000 shares of Holding Company common stock in the conversion. Therefore, after the share exchange and the conversion, he will own between 5.1% and 7.4% of the outstanding shares of Holding Company common stock. For an additional description of Mercer Mutual's acquisition of Franklin Holding and Franklin Insurance Company, see the subsection entitled "Our Insurance Companies" under the heading "Business." You should also read the risk factor entitled "Shares issued to the ESOP, to Franklin Holding, to Franklin Mutual and under the stock-based incentive plan will dilute the equity interests of shareholders" in the "Risk Factors" section of this prospectus. For a comparison of these offerings with the subscription, community and syndicated community offerings, see the table on page 14. SHARES OUTSTANDING IMMEDIATELY AFTER THE OFFERING After the offering, there will be a minimum of 4,753,280 shares and a maximum of 6,849,391 shares issued and outstanding. These amounts include the shares that will be issued in the conversion to the ESOP and the 488,280 shares that will be issued after the conversion to the shareholders of Franklin Holding. These amounts also assume that Franklin Mutual will purchase 100,000 shares in this offering. MANAGEMENT PURCHASES OF STOCK All of the directors and executive officers of the Holding Company and Mercer Mutual, except for one director and one officer, are eligible policyholders. The management group, together with their associates, proposes to purchase approximately 336,300 shares of common stock in the conversion. (For a definition of "associates" see The Conversion -- "Limitations on the Purchase of Stock.")This amount does not include any of the shares of common stock to be purchased by the ESOP. The shares purchased by those members of the management group who are eligible policyholders will be purchased in that capacity and not in their capacity as a director or officer. The total shares purchased by the management group and their associates are not permitted to exceed 33% of the shares issued in the conversion. For additional discussion, see "The Conversion -- Proposed Management Purchases." In addition to these shares, 251,715 shares will be issued to H. Thomas Davis, Jr. the founder of Franklin Holding and a current director and officer of the Holding Company and Mercer Mutual, in exchange for the shares of Franklin Holding common stock that he owns. BENEFITS TO MANAGEMENT The directors and executive officers of the Holding Company currently have no ownership interest in Mercer Mutual or any of its subsidiaries (with the exception of Franklin Holding), and it is not anticipated that they will have any ownership interest at any time prior to the conversion. H. Thomas Davis, Jr., the founder of Franklin Insurance Company and an officer and director of Mercer Mutual, is the owner of 51% of the outstanding common stock of Franklin Holding. He also owns options to acquire 226,100 non-voting shares of common stock of Franklin Holding. The Holding Company's directors and executive officers and their associates intend to purchase in the conversion approximately 336,300 shares of the Holding Company common stock. If they purchase the number of shares they intend to purchase in the conversion, immediately after the completion of the conversion the Holding Company's directors and executive officers and their associates will own the following: - 12.6% of the outstanding shares of common stock, assuming the minimum of 4,165,000 shares are sold in the offering and 488,280 shares are issued to shareholders of Franklin Holding (251,715 shares of which Mr. Davis is receiving in exchange for his shares of and options to acquire Franklin Holding stock), or - 8.7% of the outstanding shares of common stock, assuming the maximum of 6,261,111 shares are sold in the offering and 488,280 shares are issued to shareholders of Franklin Holding. 8 These assumptions do not reflect any of the following: - The 100,000 additional shares that may be issued to Franklin Mutual (see "Additional Shares Being Issued After the Conversion"); - The executive officers' proportionate share of the shares that will be allocated to employees under the ESOP (See "Management -- Benefit Plans and Agreements"); and - The shares that would be issuable upon the exercise of options or the vesting of restricted stock awards granted under our proposed stock-based incentive plan (See "Management -- Benefit Plans and Agreements"). Upon completion of the conversion, the ESOP, a tax-qualified benefit plan, will own 10% of the total shares of common stock issued in the conversion. The ESOP will use funds borrowed under the terms of a ten-year loan from the Holding Company to finance this purchase. These shares will be allocated to accounts maintained for the benefit of the employees of the Holding Company or its affiliates, including their executive officers, as the loan is repaid. Allocation of shares to employee accounts is not discretionary but rather is governed by an ESOP plan document that must comply with Internal Revenue Service regulations. Allocations generally are based upon the wages of each plan participant relative to the wages of all plan participants, subject to specific limitations regarding allocations to highly compensated individuals. The Board of Directors of the Holding Company also has adopted a stock-based incentive plan for the Holding Company's management. This benefit plan will be submitted to the Holding Company's shareholders for approval. However, under applicable law, it cannot be proposed to shareholders until at least six months after the conversion has been completed. Under the proposed stock-based incentive plan, the Holding Company may grant options to purchase common stock, stock appreciation rights or restricted stock to employees and directors. The exercise price of stock options granted will be the fair market value of the common stock on the date of the option grant. Restricted stock awards will vest over a five-year period as consideration for services. A number of shares equal to 10% of the shares issued in the conversion (including shares issued to the ESOP but excluding shares issued to Franklin Mutual or Franklin Holding shareholders) will be reserved for future issuance by the Holding Company upon the exercise of stock options and a number of shares equal to 4% of the shares issued in the conversion (including shares issued to the ESOP but excluding shares issued to Franklin Mutual or the Franklin Holding shareholders) will be reserved for future issuance by the Holding Company upon the grant of restricted stock awards. No decisions concerning the number of shares to be awarded or options to be granted to any director or officer have been made at this time. The following table presents information regarding the participants in each benefit plan, and the total amount, the percentage, and the dollar value of the stock that we intend to set aside for our ESOP and stock-based incentive plan. No options or restricted shares will be issued under the stock-based incentive plan until at least six months after the completion of the conversion. The table assumes the following: - that 4,900,000 shares will be sold in the conversion (which shares do not include shares issued to Franklin Mutual or the Franklin Holding shareholders), - that shares issued pursuant to restricted stock awards under the stock-based incentive plan will be issued from shares issued in the conversion and repurchased by the Company in the open-market, - that shares issued pursuant to the exercise of stock options granted under the stock-based incentive plan will be issued from authorized but unissued common stock, and - that the value of the stock in the table is $10.00 per share. 9 Options are assigned no value because their exercise price will be equal to the fair market value of the stock on the day the options are granted. As a result, anyone who receives an option will benefit from the option only if the price of the stock rises above the exercise price and the option is exercised.
PERCENTAGE OF ESTIMATED TOTAL SHARES VALUE NUMBER ISSUED IN THE PARTICIPANTS OF SHARES OF SHARES CONVERSION(1) ----------------------- ---------- --------- ------------- Employee Stock Ownership Plan.... Employees $4,900,000 490,000 10.0% Stock-Based Incentive Plan: Restricted Stock Awards........ Employees and Directors $1,960,000 196,000 4.0%(2) Stock Options.................. Employees and Directors -- 490,000 9.1%(3) ---------- --------- ---- Total.......................... $6,860,000 1,176,000 23.1% ========== ========= ====
- --------------- (1) Total shares issued in the conversion does not include the 488,280 shares to be issued to the shareholders of Franklin Holding in exchange for their shares of Franklin Holding stock, or the 100,000 shares offered to Franklin Mutual. The shares issuable under the ESOP and the stock-based incentive plan, assuming the sale of 4,900,000 shares in the conversion, would constitute the following percentages of the total shares issued in the conversion plus the shares issuable to the Franklin Holding shareholders and Franklin Mutual: ESOP shares, 8.9%; restricted stock awards, 3.6%; and shares issuable under stock options, 8.2%. (2) Assumes the purchase by Mercer Insurance Group, prior to the awards, of 196,000 shares of common stock in the open market. (3) Percentage is on a fully diluted basis assuming the exercise of options to purchase 490,000 shares. DEADLINES FOR PURCHASING STOCK The subscription and community offerings will terminate at 3:00 p.m., Eastern Time, on [September 8, 2003], unless extended. They may be extended to a date no later than [October 27, 2003]. The syndicated offering, if that offering is conducted, may terminate at any time without notice but no later than 45 days after the termination of the subscription and community offerings. CONDITIONS THAT MUST BE SATISFIED BEFORE WE CAN COMPLETE THE OFFERING AND ISSUE THE STOCK Before we can complete the offering and issue our stock: - [We must receive the approval of Mercer Insurance Group's acquisition of Queenstown Holding Company, Inc. and Mercer Insurance Company of New Jersey, Inc. from the New Jersey Department of Banking and Insurance]; - Mercer Mutual's eligible policyholders must approve the Plan of Conversion; and - We must sell at least the minimum number of shares offered. TERMINATION OF THE OFFERING We have the right to terminate the offering and cancel the conversion. If we terminate the offering or cancel the conversion, your money will be promptly refunded, without interest. Any interest accrued on your funds will be retained by us to help defray the costs of the conversion. DIVIDEND POLICY We currently do not intend to pay dividends to shareholders of the Holding Company. In addition, as a condition to the order of the Pennsylvania Insurance Department approving the conversion and granting an exemption with respect to the Holding Company's acquisition of Mercer Mutual, during the three-year period immediately following the conversion, the payment of any dividends from the Holding Company to its 10 shareholders and from Mercer Mutual to the Holding Company requires the prior approval of the Pennsylvania Insurance Department. HOW YOU MAY OBTAIN ADDITIONAL INFORMATION REGARDING THE CONVERSION If you have any questions regarding the conversion, please call the Stock Processing Center, toll-free, at (866) 818-9961, Monday through Friday between 10:00 a.m. and 4:00 p.m., Eastern Time. The Stock Processing Center will be closed for national holidays. OUR CORPORATE STRUCTURE The following corporate organization charts show our organizational structure before and after the conversion: 11 MUTUAL INSURANCE COMPANY PRE-CONVERSION ORGANIZATION CHART (PRE-CONVERSION ORGANIZATION FLOW CHART) * The members of the Board of Directors of each of these corporations are identical. Mercer Insurance Group, Inc. has not issued any of its authorized common stock and does not intend to do so prior to the completion of the conversion. It also does not own or have any ownership interest in the capital stock of any other corporation. 12 MERCER INSURANCE GROUP, INC. POST-CONVERSION ORGANIZATION CHART (POST-CONVERSION ORGANIZATION FLOW CHART) 13 COMPARISON OF STOCK OFFERINGS The following chart sets forth a comparison of the offerees, duration and size of the subscription offering, the community offering, the syndicated community offering, the offering to Franklin Mutual and the offering to shareholders of Franklin Holding. For additional information concerning these offerings, see the sections of the prospectus entitled "The Conversion" and "Additional Shares Being Issued after the Conversion."
DATES OF THE DOLLAR AMOUNT OF COMMISSIONS AND OFFERING TYPE OF OFFEREES OFFERING SHARES OFFERED SELLING CONCESSIONS - --------------------- ---------------- ------------ ---------------- ------------------- Subscription Eligible [August 4, 2003 $62,611,110 $0.14 per share Offering policyholders of until September sold to non- Mercer Mutual, 8, 2003; may be affiliates (up to a directors, extended until no maximum of $742,000 officers and later than if 6,261,111 shares employees of October 27, 2003] are sold in this Mercer Mutual and offering) its affiliates, and the ESOP Community The general [August 4, 2003 The difference $0.14 per share Offering public, with until September between sold to non- preferences given 8, 2003; may be $62,611,110 and affiliates (up to a to defined extended until no the dollar amount maximum of $742,000 classes of later than sold in the less the subscribers October 27, 2003] Subscription commissions and Offering selling commissions paid with respect to the Subscription Offering) Syndicated The general [Will commence The difference $0.70 per share Community public after completion between sold to non- Offering of the $62,611,110 and affiliates up to a subscription and the dollar amount maximum of community sold in the $3,712,000 offerings and Subscription and will be completed Community within 45 days, Offerings but no later than December 9, 2003] Franklin Mutual Franklin Mutual [August 4, 2003 $1,000,000 None Offering Insurance Company until September 8, 2003; may be extended until no later than October 27, 2003] Franklin Holding Shareholders of [August 4, 2003 $4,882,800 None Offering Franklin Holding until September Company (except 3, 2003] Mercer Mutual)
14 SELECTED CONSOLIDATED FINANCIAL DATA The following table sets forth selected consolidated financial data for Mercer Mutual prior to the conversion. You should read this data in conjunction with Mercer Mutual's consolidated financial statements and accompanying notes, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and other financial information included elsewhere in this prospectus. The consolidated statement of income data for each of the years in the three-year period ended December 31, 2002, and the consolidated balance sheet data at December 31, 2002 and December 31, 2001 is derived from the audited consolidated financial statements of Mercer Mutual and its subsidiaries beginning on page F-2. The consolidated statement of income data for the years ended December 31, 1999 and 1998, and the consolidated balance sheet data at December 31 of each of the years in the three-year period ended December 31, 2000, is derived from audited consolidated financial statements of Mercer Mutual and its subsidiaries that are not included in this prospectus. The consolidated statement of income data for the three months ended March 31, 2003 and 2002 and the consolidated balance sheet data at March 31, 2003 and 2002 are derived from the unaudited consolidated financial statements of Mercer Mutual and its subsidiaries and include all adjustments (consisting only of normal recurring accruals) that we consider necessary for a fair presentation of such financial information for such periods. MERCER MUTUAL SELECTED CONSOLIDATED FINANCIAL DATA
THREE MONTHS ENDED MARCH 31, (UNAUDITED) YEAR ENDED DECEMBER 31, ------------------------- -------------------------------------------------- 2003 2002 2002 2001 2000 1999 1998 ----------- ----------- ---------- ------- ------- ------- ------- (IN THOUSANDS) Revenue Data: Direct premiums written..... $ 13,019 $11,515 $ 50,858 $41,497 $31,782 $30,394 $30,106 Net premiums written........ 11,259 10,023 44,471 34,710 28,049 27,068 27,067 Statement of Income Data: Net premiums earned......... 11,056 9,444 40,454 30,728 27,635 26,839 23,609 Investment income, net of expenses.................. 427 529 2,061 2,425 2,517 2,384 2,212 Net realized investment gains (losses)............ 149 118 (220) 42 (288) 408 539 Other revenue............... 80 76 329 250 167 170 176 ---------- ------- ---------- ------- ------- ------- ------- Total revenue............. 11,712 10,167 42,624 33,445 30,031 29,801 26,536 ---------- ------- ---------- ------- ------- ------- ------- Expenses: Loss and loss adjustment expenses.................. 6,514 4,634 20,067 14,534 13,711 13,109 11,942 Amortization of deferred policy acquisition costs..................... 2,973 2,643 10,953 8,137 7,478 7,350 6,556 Other expenses.............. 1,849 1,697 7,974 6,103 4,575 4,336 4,192 Stock conversion expenses(1)............... 12 -- 95 -- -- -- -- Expenses from conversion attempt(2)................ -- -- -- -- -- 2,170 -- ---------- ------- ---------- ------- ------- ------- ------- Total expenses............ 11,348 8,974 39,089 28,744 25,764 26,965 22,690 ---------- ------- ---------- ------- ------- ------- ------- Income before income taxes and minority interest in income of subsidiary............... 364 1,193 3,535 4,671 4,267 2,836 3,846 ---------- ------- ---------- ------- ------- ------- -------
15
THREE MONTHS ENDED MARCH 31, (UNAUDITED) YEAR ENDED DECEMBER 31, ------------------------- -------------------------------------------------- 2003 2002 2002 2001 2000 1999 1998 ----------- ----------- ---------- ------- ------- ------- ------- (IN THOUSANDS) Income taxes.................. 88 418 1,155 1,271 1,199 744 1,211 ---------- ------- ---------- ------- ------- ------- ------- Income before minority interest in income of subsidiary.................. 276 775 2,380 3,400 3,068 2,092 2,635 Minority interest in income of subsidiary.................. (43) (4) (138) (100) -- -- -- ---------- ------- ---------- ------- ------- ------- ------- Net income.................... $ 233 $ 771 $ 2,242 $ 3,300 $ 3,068 $ 2,092 $ 2,635 ========== ======= ========== ======= ======= ======= ======= Selected Balance Sheet Data (at period end): Total investments and cash...................... $ 74,116 $71,754 $ 76,780 $73,166 $69,055 $62,300 $59,932 Total assets................ 104,346 97,718 105,848 97,119 84,857 78,983 80,728 Reserves for loss and loss adjustment expenses....... 32,920 31,605 31,348 31,059 28,766 29,471 30,948 Unearned premiums........... 25,057 21,108 24,923 20,548 16,344 15,794 15,436 Total liabilities........... 64,328 58,943 65,719 59,796 51,945 51,054 52,389 Minority interest in subsidiary................ 3,149 2,968 3,112 1,926 -- -- -- Total equity................ 36,869 35,806 37,017 35,397 32,912 27,928 27,889 GAAP Ratios: Loss and loss adjustment expense ratio(3).......... 58.9% 49.1% 49.6% 47.3% 49.6% 48.8% 50.6% Underwriting expense ratio(4).................. 43.6% 46.0% 46.8% 46.3% 43.6% 43.6% 45.5% Combined ratio(5)........... 102.5% 95.1% 96.4% 93.6% 93.2% 92.4% 96.1% Statutory Data: Statutory loss and loss adjustment expense ratio..................... 58.9% 49.1% 49.6% 48.9% 49.7% 48.9% 50.6% Statutory underwriting expense ratio............. 42.7% 42.9% 45.1% 44.5% 43.2% 43.8% 42.7% Statutory combined ratio.... 101.6% 92.0% 94.7% 93.4% 92.9% 92.7% 93.4% Surplus..................... $ 28,424 $32,354 $ 28,877 $31,655 $29,046 $25,745 $23,129 Ratio of net premiums written to statutory surplus................... 1.58x(8) 1.24x(8) 1.51x 1.05x 0.97x 1.05x 1.17x Industry Statutory Data(6) Loss and loss adjustment expense ratio............. N/A N/A N/A 88.4% 81.1% 78.4% 76.3% Underwriting expense ratio..................... N/A N/A N/A 26.7% 27.6% 27.9% 27.6% Combined ratio.............. N/A N/A N/A 115.1% 108.7% 106.3% 103.9% Pro Forma Data(7): Net income.................. $ 215 $ 2,167 Net income per share of common stock.............. $ 0.05 $ 0.50 Weighted average number of shares of common stock outstanding............... 4,383,636 4,357,605
- --------------- (1) Costs and expenses related to the stock conversion incurred in the year ended December 31, 2002. These costs and expenses are reported separately in our consolidated income statements within income from continuing operations before income taxes. Stock conversion expenses consist primarily of the costs of engaging independent accounting, valuation, legal and other consultants to advise us and our insurance regulators as to the stock conversion process and related matters, as well as printing and postage costs relating to our communications with our policyholders. These costs and expenses are reported in accordance with the American Institute of Certified Public Accountants Statement of Position ("SOP") 00-3, "Accounting by Insurance Enterprises for Demutualizations and Formations of Mutual Insurance Holding Companies and for Certain Long-Duration Participating Contracts." SOP 00-3 16 addresses financial statement presentation and accounting for stock conversion expenses and accounting for retained earnings and other comprehensive income at the date of the stock conversion. (2) Costs and expenses relating to the previous attempt to convert to a stock company. (3) Calculated by dividing losses and loss adjustment expenses by net premiums earned. (4) Calculated by dividing other underwriting expenses by net premiums earned. (5) The sum of the loss and loss adjustment expense ratio and the underwriting expense ratio. A combined ratio of less than 100% means a company is making an underwriting profit. (6) As reported by A.M. Best Company, Inc., an independent insurance rating organization, for 940 property and casualty insurance organizations (excluding state funds) representing 2,412 companies. Data for the quarters ended March 31, 2003 and 2002 and for the year ended December 31, 2002, is not available. (7) Information excerpted from Mercer Mutual's unaudited pro forma condensed consolidated statements of income for the three months ended March 31, 2003 and the year ended December 31, 2002. This pro forma data does not reflect any income from the investment of the net proceeds of the offering available for investment. This income is not "factually supportable" as that term is used in the Securities and Exchange Commission's rules and regulations. However, this data does reflect the pro forma adjustment to recognize compensation expense under the ESOP for shares of common stock committed to be released to participants as the $4.2 million loan from the Holding Company to the ESOP is repaid over a ten-year term. See the footnotes under "Pro Forma Data" commencing on page 34. (8) Calculated by annualizing net written premiums. 17 RISK FACTORS Before you invest in the common stock, you should carefully consider the following risk factors. You should also refer to the other information in this prospectus, including the financial statements and accompanying notes included elsewhere in this prospectus. Any of the risks described below could result in a significant or material adverse effect on our results of operations or financial condition, and a corresponding decline in the market price of our common stock and the value of your investment. RISKS RELATED TO OUR BUSINESS Catastrophic or other significant natural losses may negatively affect our financial and operating results. As a property and casualty insurer, we are subject to claims from catastrophes that may have a significant negative impact on operating and financial results. We have experienced catastrophe losses, and can be expected to experience catastrophe losses in the future. Catastrophe losses can be caused by various events, including coastal storms, snow storms, ice storms, freezing, hurricanes, earthquakes, tornadoes, wind, hail, fires, and other natural or man-made disasters. We also face exposure to losses resulting from acts of war, acts of terrorism and political instability. The frequency, number and severity of these losses are unpredictable. The extent of losses from a catastrophe is a function of both the total amount of insured exposure in the area affected by the event and the severity of the event. We attempt to mitigate catastrophe risk by reinsuring a portion of our exposure. In the future, we intend to reduce our reliance on reinsurance by increasing the maximum exposure retained by our insurance companies on individual property and casualty risks, and instead rely on the capital raised in the conversion and contributed or available for contribution to our insurance subsidiaries to cover that portion of our losses. However, in the event that we experience catastrophe losses, we cannot assure you that the capital raised in the offering and our unearned premium, loss reserves and reinsurance will be adequate to cover these risks. In addition, because accounting regulations do not permit insurers to reserve for catastrophic events until they occur, claims from catastrophic events could cause substantial volatility in our financial results for any fiscal quarter or year and could have a material adverse affect on our financial condition or results of operations. Our ability to write new business also could be adversely affected. Our financial condition and results of operations also are affected periodically by losses caused by natural perils that are not deemed a catastrophe. If a number of these events occurred in a short time period, it may materially affect our financial condition and results of operations. Due to the geographic concentration of our business, catastrophe and natural peril losses may have a greater adverse effect on us than they would on a more geographically diverse property and casualty insurer. Our limited operating region may affect our business significantly. All direct premiums that we receive are generated in New Jersey and Pennsylvania. For the three months ended March 31, 2003, 75.0% of our direct premiums were generated in New Jersey and 25.0% were generated in Pennsylvania. For the year ended December 31, 2002, New Jersey direct premiums accounted for 78.6% of our writings with the remaining 21.4% generated in Pennsylvania. We could be significantly affected by legislative, judicial, economic, regulatory, demographic and other events and conditions in these states. In addition, we have significant exposure to property losses caused by severe weather that affects either or both of these states. Those losses could adversely affect our results. We may enter new markets and there can be no assurance that our diversification strategy will be effective. We intend to use a portion of the capital raised in this offering to attract new insurance producers and acquire other insurance companies outside New Jersey. We are considering producers and companies located in the mid-Atlantic and mid-Western regions, with emphasis on those located in the states of Maryland, Ohio and Pennsylvania. However, we also will evaluate potential business combinations in other jurisdictions to determine whether factors exist that would make such a combination beneficial to us. The success of our diversification strategy will depend largely on our ability to identify suitable acquisition candidates that may be acquired at a reasonable cost. Our limited experience in these areas may make it difficult to successfully acquire these candidates and more difficult for our strategy to succeed. It also will be 18 important to attract new producers and successfully market to them. We cannot assure you that we will be successful in implementing our diversification strategy. This diversification strategy may present special risks: - Our prior success has been achieved by taking a disciplined approach to underwriting and pricing. We also have expanded our exposure to commercial and casualty risks and proportionally reduced our personal and property risks as a percentage of our entire business. We may not be able to successfully implement our underwriting, pricing and product strategies in the companies we acquire or over a larger operating region. - Due to our limited acquisition experience and for other reasons, we may not be able to efficiently combine an acquired company with our present operations. - We believe that in the states of Maryland, Ohio and Pennsylvania, commercial lines insurers generally are permitted to manage risk selection and pricing without undue regulatory interference. However, there is no guarantee that we will not encounter undue regulatory interference in these states that could impact our desire and ability to expand. - An acquisition could dilute the book value and earnings per share of our common stock. - We may not be able to attract and retain qualified personnel needed for expanded operations. - Internal monitoring and control systems may prove inadequate. The property and casualty insurance market in which we operate is highly competitive. Competition in the property and casualty insurance business is based on many factors. These factors include the perceived financial strength of the insurer, premiums charged, policy terms and conditions, services provided, reputation, financial ratings assigned by independent rating agencies and the experience of the insurer in the line of insurance to be written. We compete with stock insurance companies, mutual companies, local cooperatives and other underwriting organizations. Many of these competitors have substantially greater financial, technical and operating resources than we have. Many of the lines of insurance we write are subject to significant price competition. If our competitors price their products aggressively, our ability to grow or renew our business may be adversely affected. We pay producers on a commission basis to produce business. Some of our competitors may offer higher commissions or insurance at lower premium rates through the use of salaried personnel or other distribution methods that do not rely on independent producers. Increased competition could adversely affect our ability to attract and retain business and thereby reduce our profits from operations. Our revenues may fluctuate with our investment results and changes in interest rates. Our investment portfolio contains a significant amount of fixed-income securities, including bonds, mortgage-backed securities (MBSs) and other securities. The market values of all of our investments fluctuate depending on economic conditions and other factors. The market values of our fixed-income securities are particularly sensitive to changes in interest rates. For example, if interest rates rise, fixed-income investments generally will decrease in value. If interest rates decline, these investments generally will increase in value except for MBSs, which may decline due to higher prepayments on the mortgages underlying the securities. During the three months ended March 31, 2003, and the year ended December 31, 2002, interest rates declined and as a result, net investment income decreased $102,000, or 19.3%, and $364,000, or 15.0%, respectively, over the comparable prior periods. Net realized investment gains also decreased by $262,000 for the year ended December 31, 2002, to a loss of $220,000. This net realized loss was largely attributable to the writedown of $647,000 relating to equity securities that we determined were other than temporarily impaired. We also sustained a net realized investment loss of $288,000 for the year ended December 31, 2000 due to writedowns of securities that we determined were other than temporarily impaired. Charges relating to securities that we determine are other than temporarily impaired are measured by comparing the market value of the security at the time of determination versus the book value of the security. These charges are included in net realized investment gains or losses. 19 Our equity securities include securities with $1,750,000 in unrealized losses at March 31, 2003. All of our equity securities are listed as available for sale. We evaluate securities for impairment on a quarterly basis and specifically determine on an individual security basis whether or not the decline in value is other than temporary. Equity securities with unrealized losses at March 31, 2003 in general were determined to have temporary declines in value due to geopolitical rather than fundamental reasons. Certain of these equity securities were determined to have temporary declines in value as a reaction to their particular industry rather than specifically to the issuer of those securities. We believe it is more likely than not that those securities will appreciate in value. If our assessment of those securities subsequently changes and we conclude that the declines in value are other than temporary, future earnings will be negatively affected. MBSs, including collateralized mortgage obligations (CMOs), are subject to prepayment risks that vary with, among other things, interest rates. During periods of declining interest rates, MBSs generally prepay faster as the underlying mortgages are prepaid and/or refinanced by the borrowers in order to take advantage of the lower rates. MBSs that have an amortized cost that is greater than par (i.e., purchased at a premium) may incur a reduction in yield or a loss as a result of prepayments. In addition, during such periods, we generally will be unable to reinvest the proceeds of any prepayment at comparable yields. Conversely, during periods of rising interest rates, the frequency of prepayments generally decreases. MBSs that have an amortized value that is less than par (i.e., purchased at a discount) may incur a decrease in yield or a loss as a result of slower prepayments. We may not be able to prevent or minimize the negative impact of interest rate changes. Additionally, we may, from time to time, for business, regulatory or other reasons, elect or be required to sell certain of our invested assets at a time when their market values are less than their original cost, resulting in realized capital losses, which would reduce net income. New Jersey "retaliatory tax" laws could possibly have an adverse impact on our results of operations. Mercer Mutual was organized under the laws of the State of New Jersey and operated as a New Jersey mutual insurance company until October 16, 1997, when it changed its state of domicile from New Jersey to Pennsylvania. For the years prior to and after its redomestication to Pennsylvania, Mercer Mutual has paid an annual tax to New Jersey in an amount equal to 2.1% of 12.5% of the total net direct premiums collected by Mercer Mutual on all policies of insurance wherever issued and an annual tax to Pennsylvania in an amount equal to 2.0% of the total net direct premiums collected by Mercer Mutual on all policies of insurance issued to policyholders located in Pennsylvania. However, New Jersey has a retaliatory tax provision that allows New Jersey to tax out-of-state insurance companies at the same rate as New Jersey insurance companies are taxed in the state in which such out-of-state company is domiciled. Because Mercer Mutual is a Pennsylvania-domiciled insurance company, this provision could be interpreted by the New Jersey taxing authority to require Mercer Mutual to pay, for all or a portion of 1997 and each year thereafter, as well as for all future years, a tax to New Jersey equal to 2.0% of the total net direct premiums collected by Mercer Mutual (which is Pennsylvania's tax rate) on all policies of insurance issued to policyholders located in New Jersey. For example, under this interpretation Mercer Mutual would have been required to pay approximately $714,000 in taxes to New Jersey for the year ended December 31, 2002, $611,000 more than the amount that was paid for that year. Since 1997, Mercer Mutual has accrued its New Jersey tax liability at the higher rate but has paid its New Jersey tax liability at the lower rate because it disagrees with this interpretation. As a result, Mercer Mutual's financial statements reflect a reserve account in the amount of $2.2 million. This amount would be sufficient to satisfy the liability for accrued taxes at the retaliatory rate and substantially all interest that could be assessed by New Jersey. The New Jersey taxing authority is being challenged by another insurer in an action initiated in New Jersey state court, based on the authority's interpretation of the retaliatory tax provision in a manner similar to that contemplated above. Despite this pending legal challenge, the New Jersey taxing authority recently asserted the retaliatory tax against Mercer Mutual with respect to the 1999 tax year (the 1997 and 1998 tax years are closed). Mercer elected to pay the asserted tax under protest and expects to seek a refund under New Jersey's administrative tax appeal process. 20 If the New Jersey taxing authority position is upheld, either as a result of the state court action or Mercer Mutual's proposed administrative proceeding, Mercer Mutual can avoid the tax in future periods by renewing Mercer Mutual policies in Mercer Insurance Company of New Jersey, Inc., its New Jersey domestic insurance company subsidiary, subject to regulatory approval. This company would not be subject to the retaliatory tax because it is domiciled in New Jersey. Mercer Mutual had not previously renewed Mercer Mutual policies in its New Jersey subsidiary because only Mercer Mutual policyholders would have subscription and voting rights upon a conversion of Mercer Mutual. Therefore, renewal of Mercer Mutual policies in the New Jersey subsidiary would have disenfranchised policyholders and denied them subscription rights. Our results may be adversely affected if our actual losses exceed our loss reserves. We maintain reserves to cover amounts we estimate will be needed to pay for insured losses and for the expenses necessary to settle claims. Estimating loss and loss expense reserves is a difficult and complex process involving many variables and subjective judgments. We regularly review our reserving techniques and our overall amount of reserves. We review historical data and consider the impact of various factors such as: - trends in claim frequency and severity; - information regarding each claim for losses; - legislative enactments, judicial decisions and legal developments regarding damages; and - trends in general economic conditions, including inflation. Our actual losses could exceed our reserves. As part of our business strategy, we intend to reduce our reliance on reinsurance by increasing the maximum exposure retained by our insurance companies on individual property and casualty risks. See the subsection "Our Business Strategies" in the "Business" section of this prospectus. However, this increase in exposure may make it more likely that, if adverse events occur, our loss reserves could be inadequate. If we determine that our loss reserves are inadequate, we will have to increase them. This adjustment would reduce income during the period in which the adjustment is made, which could have a material adverse impact on our financial condition and results of operation. For additional information, see "Business -- Loss and LAE Reserves." Our exposure to terrorism related risks has increased. The tragic events of September 11, 2001, changed the way the property and casualty insurance industry views catastrophic risk. Numerous classes of business have become exposed to terrorism related catastrophic risks in addition to the catastrophic risks related to natural occurrences. As a result, we have changed our underwriting protocols to address terrorism and the limited availability of terrorism reinsurance. However, given the uncertainty of the potential threats, we cannot be sure that we have addressed all the possibilities. If another major terrorist event occurs in the United States, it could have a material adverse effect on our business. As a result of the substantial losses incurred by reinsurers, the cost of reinsurance in the marketplace has increased significantly and reinsurance capacity for certain coverages, such as terrorism, is limited. A shortage of reinsurance capacity could constrain our ability to respond to business opportunities and could make our future operating results more volatile. In response to the tightening of supply in certain insurance and reinsurance markets resulting from, among other things, the World Trade Center tragedy, the Terrorism Risk Insurance Act of 2002 (TRIA) was adopted. This law establishes a federal assistance program through the end of 2005 to help the commercial property and casualty insurance industry cover claims related to future terrorism related losses and regulates the terms of insurance relating to certain terrorism coverage. TRIA requires that coverage be made available for terrorist acts and imposes policyholder notice obligations. This law could adversely affect our business by increasing underwriting capacity for our larger competitors as well as by requiring that our insurance companies offer coverage for terrorist acts. We are in the process of evaluating the likely impact of this law on our future operations. We currently are unable to predict the extent to which this legislation will affect the demand for our products or the risks that may be available for us to consider underwriting. We also are unable 21 to predict whether, in what form or in what jurisdictions any other regulatory proposals might be adopted or their effect on our insurance companies. Our operating results can fluctuate significantly due to the nature of our industry. The operating results of property and casualty insurers are subject to significant fluctuation. Factors influencing results include extreme weather conditions and natural disasters, regulation, competition, judicial trends, changes in the investment and interest rate environment and general economic conditions. Our operating results also may be affected by changes in the supply and the pricing of property and casualty insurance and reinsurance. The property and casualty insurance industry has historically been highly cyclical. The unpredictability of claims experience and the competitive nature of the industry have contributed historically to significant fluctuation in results. Because of these and other factors, our historic results of operations may not be indicative of our future operations. Our results of operations may be adversely affected by any loss of business from key producers. Our products are marketed by independent producers. Other insurance companies compete with us for the services and allegiance of these producers. These producers may choose to direct business to our competitors, or may direct less desirable risks to us. Our two largest producers, Davis Insurance Agency and Brown & Brown, Inc., accounted for approximately 13.7% and 8.4%, respectively, of our direct premiums written for the three months ended March 31, 2003 and approximately 13.9% and 9.1%, respectively, of our direct premiums written for the year ended December 31, 2002. H. Thomas Davis, Jr., a director and executive officer of the Company, is the owner of the Davis Insurance Agency. Our 10 largest producers accounted for 38.7% and 39.8% of direct premiums written for the same respective periods. If we experienced a significant decrease in business from, or lost entirely, either of our two largest producers or several of our other large producers, it would have a material adverse effect on us. If we fail to comply with insurance industry regulations, or if those regulations become more burdensome, we may not be able to operate profitably. Our insurance companies are regulated by government agencies in the states in which we do business, as well as by the federal government. Most insurance regulations are designed to protect the interests of policyholders rather than shareholders and other investors. These regulations, generally administered by a department of insurance in each state in which we do business, relate to, among other things: - approval of policy forms and premium rates; - standards of solvency, including establishing statutory and risk-based capital requirements for statutory surplus; - classifying assets as admissible for purposes of determining statutory surplus; - licensing of insurers and their producers; - advertising and marketing practices; - restrictions on the nature, quality and concentration of investments; - assessments by guaranty associations; - restrictions on the ability of our insurance company subsidiaries to pay dividends to us; - restrictions on transactions between our insurance company subsidiaries and their affiliates; - restrictions on the size of risks insurable under a single policy; - requiring deposits for the benefit of policyholders; - requiring certain methods of accounting; - periodic examinations of our operations and finances; - claims practices; - prescribing the form and content of records of financial condition required to be filed; and 22 - requiring reserves for unearned premium, losses and other purposes. State insurance departments also conduct periodic examinations of the affairs of insurance companies and require the filing of annual and other reports relating to financial condition, holding company issues and other matters. These regulatory requirements may adversely affect or inhibit our ability to achieve some or all of our business objectives. In addition, regulatory authorities have relatively broad discretion to deny or revoke licenses for various reasons, including the violation of regulations. In some instances, we follow practices based on our interpretations of regulations or practices that we believe may be generally followed by the industry. These practices may turn out to be different from the interpretations of regulatory authorities. If we do not have the requisite licenses and approvals or do not comply with applicable regulatory requirements, insurance regulatory authorities could preclude or temporarily suspend us from carrying on some or all of our activities or otherwise penalize us. This could adversely affect our ability to operate our business. Further, changes in the level of regulation of the insurance industry or changes in laws or regulations themselves or interpretations by regulatory authorities could adversely affect our ability to operate our business. We are subject to various accounting and financial requirements established by the National Association of Insurance Commissioners (NAIC). If we fail to comply with these laws, regulations and requirements, it could result in consequences ranging from a regulatory examination to a regulatory takeover of one or more of our insurance companies. This would make our business less profitable. In addition, state regulators and the NAIC continually re-examine existing laws and regulations, with an emphasis on insurance company solvency issues and fair treatment of policyholders. Insurance laws and regulations could change or additional restrictions could be imposed that are more burdensome and make our business less profitable. Because these laws and regulations are for the protection of policyholders, any changes may not be in your best interest as a shareholder. See "Business -- Regulation." Our ability to manage our exposure to underwriting risks depends on the availability and cost of reinsurance coverage. Reinsurance is the practice of transferring part of an insurance company's liability and premium under an insurance policy to another insurance company. We use reinsurance arrangements to limit and manage the amount of risk we retain, to stabilize our underwriting results and to increase our underwriting capacity. The availability and cost of reinsurance are subject to current market conditions and may vary significantly over time. The insurance industry is currently experiencing a hard market cycle during which price competition is less significant than during a soft market cycle. Therefore, during a hard market cycle insurers, including reinsurers, are able to increase premiums and realize a larger profit margin. While a hard market typically has a positive effect on premium growth, it typically has a negative effect on reinsurance costs. This hard market cycle has caused the Company's reinsurance costs, as a percentage of direct premiums written, to increase from 14.2% for the three months ended March 31, 2002 to 15.6% for the three months ended March 31, 2003. Should this hard market cycle continue, reinsurance costs would continue to rise, reinsurance could become more difficult to obtain, and the Company may have to further increase its retention levels. Any increase in our retention levels will increase our risk of loss. We may be unable to maintain our desired reinsurance coverage or to obtain other reinsurance coverage in adequate amounts and at favorable rates. If we are unable to renew our expiring coverage or obtain new coverage, it will be difficult for us to manage our underwriting risks and operate our business profitably. It is also possible that the losses we experience on risks we have reinsured will exceed the coverage limits on the reinsurance. If the amount of our reinsurance coverage is insufficient, our insurance losses could increase substantially. If our reinsurers do not pay our claims in a timely manner, we may incur losses. We are subject to loss and credit risk with respect to the reinsurers with whom we deal because buying reinsurance does not relieve us of our liability to policyholders. If our reinsurers are not capable of fulfilling their financial obligations to us, our insurance losses would increase. 23 A reduction in our A.M. Best rating could affect our ability to write new business or renew our existing business. Ratings assigned by the A.M. Best Company, Inc. are an important factor influencing the competitive position of insurance companies. A.M. Best ratings represent independent opinions of financial strength and ability to meet obligations to policyholders and are not directed toward the protection of investors. Therefore, our A.M. Best rating should not be relied upon as a basis for an investment decision to purchase our common stock. Our operating subsidiaries hold a financial strength rating of "A" (Excellent) by A.M. Best, the third highest rating out of 15 rating classifications. Financial strength ratings are used by producers and customers as a means of assessing the financial strength and quality of insurers. If our financial position deteriorates, we may not maintain our favorable financial strength rating from A.M. Best. A downgrade of our rating could severely limit or prevent us from writing desirable business or from renewing our existing business. See "Business -- A.M. Best Rating." We could be adversely affected by the loss of our key personnel. The success of our business is dependent, to a large extent, on the efforts of certain key management personnel, in particular Andrew R. Speaker, our President and Chief Executive Officer; H. Thomas Davis, Jr., Senior Vice President; and Paul D. Ehrhardt, Senior Vice President. We maintain a key man life insurance policy on each of Mr. Speaker and Mr. Davis, with face value benefits of $5.5 million and $2.5 million, respectively. The proceeds of these policies are payable to us. However, we do not maintain any key man insurance on Mr. Ehrhardt or any other executive. We have employment agreements with each of Messrs. Speaker, Davis and Ehrhardt. The loss of key personnel could prevent us from fully implementing our business strategy and could significantly and negatively affect our financial condition and results of operations. As we continue to grow, we will need to recruit and retain additional qualified management personnel, and our ability to do so will depend upon a number of factors, such as our results of operations and prospects and the level of competition then prevailing in the market for qualified personnel. Presently, competition to attract and retain key personnel is intense. See "Directors and Officers" under the section entitled "Management." We may not be able to successfully implement our technology initiative. We are changing our information system from an outside service bureau platform to one using an internal software package. Our new platform will allow a producer to produce business through the Internet or through the method he or she has historically used. Business processed and maintained in this system through the Internet will provide efficiency because information for all users is entered only once. Full conversion to the new platform is scheduled to be completed by December 31, 2004. We may not be able to successfully re-engineer our internal processes to allow for implementation of this new system to the extent we desire. Further, during the transition period our producers' ability to transact business with us may be interrupted, and we and our producers may not be able to provide our customers with the level of service to which they are accustomed. We believe that the ability to produce business through the Internet will increase our revenues by making it easier for us and our producers to exchange information, and should lower expenses by increasing ease of use. However, our producers may not be willing to use the Internet feature of this system. In addition, our short-term expenses have increased because of costs associated with the implementation of the new system and the need to maintain two systems during the transition. RISK FACTORS RELATING TO THE OWNERSHIP OF MERCER INSURANCE GROUP COMMON STOCK The price of our common stock may decrease after the conversion. Upon completion of the conversion, subscribers receiving our common stock in the offering will become shareholders of the Holding Company. Our common stock could decline in value after the conversion. The market value of the common stock will fluctuate based upon general market and economic conditions, the financial condition and results of operations of our business, our prospects and other factors. You may not be able to sell your shares at or above the price you pay to purchase them. 24 You may find it difficult to sell your shares if an active trading market does not develop. This is the first time the Holding Company has issued common stock. Therefore, no market currently exists for our shares. The Holding Company has received approval to have the common stock quoted on the Nasdaq National Market under the symbol "MIGP," following completion of the conversion. However, even if our stock is listed on the Nasdaq National Market, an active trading market may not develop and the stock may not be followed by market analysts or the investment community. This may reduce the amount of market activity in our stock and make it more difficult for you to sell your shares. The broad valuation range could reduce your percentage ownership of the Holding Company. The number of shares offered in the conversion is based on Griffin Financial Group's valuation of the consolidated pro forma market value of Mercer Mutual as a subsidiary of the Holding Company. This value has initially been determined to be an estimated valuation range of between $41,650,000 and $56,350,000. Immediately prior to the completion of the conversion, Griffin Financial will update its valuation to confirm that it is within the estimated valuation range. If it is within the estimated valuation range, the conversion can be completed. If it is not within the estimated valuation range, then we will either cancel the offering or extend the offering using the updated estimated valuation. There is a difference of approximately $14.7 million between the minimum and the maximum of the estimated valuation range. The aggregate dollar value of the shares sold in the conversion must be within the estimated valuation range, with one exception. The aggregate dollar value of the shares issued in the conversion can exceed the range if necessary to permit the ESOP to purchase 10% of the total amount of common stock issued in the conversion. As a result, the percentage interest in the Holding Company that a subscriber acquires can vary widely based upon the number of shares sold in the conversion. A subscriber for a fixed number of shares of common stock will have approximately a 25% smaller ownership interest at the maximum level of the range than at the minimum level. Shares issued to the ESOP, to Franklin Holding, to Franklin Mutual and under the stock-based incentive plan will dilute the equity interests of shareholders. The ESOP will purchase in the conversion a number of shares of common stock equal to 10% of the shares sold in the conversion. The shareholders of Franklin Holding will receive 488,280 shares of our common stock after the conversion in exchange for their shares of Franklin Holding stock. Franklin Mutual has the right to purchase up to 100,000 shares of our common stock after the conversion at a price of $10.00 per share. Under our stock-based incentive plan, if approved, we may issue a number of shares equal to 10% of the shares sold in the conversion upon the exercise of stock options and a number of shares equal to 4% of the shares sold in the conversion in the form of restricted stock. Shares of common stock issued by the Holding Company to the ESOP, to the shareholders of Franklin Holding and to Franklin Mutual will consist of authorized but unissued shares of common stock. These newly issued shares will dilute the interests of those subscribers who purchase stock in the conversion. The shares of our common stock issued under the stock-based incentive plan also may consist of authorized but unissued shares of common stock. If so, the issuance of these shares would dilute the equity interests of the then-existing shareholders. RISK FACTORS RELATING TO THE CONVERSION We Believe that Subscription Rights Have No Value, But the Internal Revenue Service May Disagree. We have obtained a private letter ruling from the Internal Revenue Service to the effect that: - any gain realized by an eligible policyholder as a result of the receipt of subscription rights with a fair market value must be recognized, whether or not such rights are exercised; and - the amount of gain recognized by each eligible policyholder should equal the fair market value of subscription rights received by the eligible policyholder. Griffin Financial has advised us that it believes the subscription rights will have no fair market value. Griffin Financial has noted that the subscription rights will be granted at no cost to recipients, will be legally nontransferable and of short duration, and will provide the recipient with the right only to purchase shares of common stock at the same price to be paid by members of the general public in the community offering. 25 Griffin Financial cannot assure us, however, that the Internal Revenue Service will not challenge Griffin's determination, and if they do, that such challenge would not be successful. If the Internal Revenue Service were to assert successfully that the nontransferable subscription rights have an ascertainable fair market value, eligible policyholders would be required to include in gross income any gain they realize as a result of the receipt of subscription rights, whether or not such rights are exercised. See the subsection entitled "Tax Consequences of Subscription Rights" under the heading "The Conversion." Management could effectively control certain situations that may be viewed as contrary to your interests. The extent of management's control over the Holding Company is related to the following factors: - Management of the Holding Company and their associates expect to subscribe for approximately 336,300 shares of the common stock to be issued in the conversion, including 100,000 shares to be purchased by H. Thomas Davis, Jr., the founder of Franklin Holding and a director and officer of Mercer Mutual. - Mr. Davis also will acquire 251,715 shares as a result of the exchange of his shares in Franklin Holding for shares of Holding Company common stock. (For a description, see the section entitled "Additional Shares Being Issued After the Conversion.") - The ESOP will purchase 10% of the shares to be issued in the conversion. The shares held by the ESOP will be voted in the manner directed by our employees. - Following the conversion, and subject to shareholder approval, the Holding Company intends to implement the stock-based incentive plan pursuant to which shares of restricted stock and stock options will be issued to our directors, officers and employees. - Certain statutory and regulatory provisions, as well as provisions in the Holding Company's articles of incorporation and bylaws, may make it easier for existing management to retain their positions with the Holding Company and discourage certain acquisition proposals. As a result of these factors, management could acquire, directly or indirectly, a substantial equity interest in the Holding Company. If all members of management were to act together as a group, they could have significant influence over the outcome of the election of directors and any other shareholder vote. Therefore, management might have the power to take actions that non-affiliated investors may deem to be contrary to the investors' best interests. Statutory provisions and our articles and bylaws may serve to entrench management and also may discourage takeover attempts to acquire the Holding Company that you may believe are in your best interests. The Holding Company is subject to provisions of Pennsylvania corporate and insurance law that hinder a change of control. Pennsylvania law requires the Pennsylvania Insurance Department's prior approval of a change of control of an insurance holding company. Under Pennsylvania law, the acquisition of 10% or more of the outstanding capital stock of an insurer or its holding company is presumed to be a change in control. Approval by the Insurance Department may be withheld even if the transaction would be in the shareholders' best interest if the Insurance Department determines that the transaction would be detrimental to policyholders. The Holding Company's Articles of Incorporation and Bylaws contain provisions that may discourage a change in control of the Holding Company. These provisions include: - the prohibition of ownership and voting of shares having in excess of 10% of the total voting power of the outstanding stock of the Holding Company; - a classified board of directors divided into three classes serving for successive terms of three years each; - the prohibition of cumulative voting in the election of directors; - the requirement that nominations for the election of directors made by shareholders and any shareholder proposals for the agenda at any annual meeting generally must be made by notice (in writing) delivered or mailed to us not less than 90 days prior to the meeting; 26 - the requirement that any merger, consolidation, sale of assets or similar transaction involving the Holding Company requires the affirmative vote of shareholders entitled to cast at least 80% of the votes which all shareholders are entitled to cast, unless the transaction is approved in advance by 66 2/3% of the members of the board of directors; - the requirement that a person must be a shareholder of the Holding Company for the lesser of three years or the time that has elapsed since the completion of the conversion, before he or she can be elected to the board of directors; - the requirement that any person or entity that acquires stock of the Holding Company with a combined voting power of 25% or more of the total voting power of outstanding capital stock, must offer to purchase, for cash, all outstanding shares of the Holding Company's voting stock at a price equal to the highest price paid for that stock within the preceding twelve months by that person or entity; - the prohibition of shareholder action without a meeting and the prohibition of shareholders being able to call a special meeting; - the provision that certain provisions of the Holding Company's articles of incorporation can only be amended by an affirmative vote of shareholders entitled to cast at least 80% of all votes which shareholders are entitled to cast, unless approved by an affirmative vote of at least 80% of the members of the Board of Directors; and - the provision that certain provisions of the Holding Company's bylaws can only be amended by an affirmative vote of shareholders entitled to cast at least 66 2/3% or 80% of all votes which shareholders are entitled to cast, unless approved by an affirmative vote of at least 80% of the members of the Board of Directors. These provisions may serve to entrench management and may discourage a takeover attempt that you may consider to be in your best interest or in which you would receive a substantial premium over the current market price. These provisions may make it extremely difficult for any one person or group of affiliated persons to acquire voting control of the Holding Company, with the result that it may be extremely difficult to bring about a change in the board of directors or management. Some of these provisions also may tend to perpetuate present management because of the additional time required to cause a change in the control of the board. Other provisions render it difficult for shareholders owning less than a majority of the voting stock to be able to elect even a single director. See the subsections entitled "Certain Benefit Plans and Agreements" in the "Management" section and "Regulation" in the "Business" section, and the section entitled "Description of the Capital Stock." A challenge to the Pennsylvania Insurance Commissioner's approval of the Plan of Conversion could put the terms of the conversion in question and reduce the market price of common stock. The Pennsylvania Insurance Commissioner issued an order approving the Plan of Conversion on July 8, 2003. The Pennsylvania law governing the conversion (the Conversion Act) provides that any action challenging the validity of or arising out of the acts taken or proposed to be taken under the Conversion Act must be commenced no later than 30 days after the later of the approval of the plan of conversion by the Pennsylvania Insurance Commissioner or the adoption of the plan by a vote of the eligible policyholders. Any list of possible challenges that could be brought with respect to the Mercer Mutual conversion is necessarily speculative. In prior mutual-to-stock conversion transactions, complaints and petitions have been filed claiming, among other things, that (i) the applicable conversion statute or portions of the statute are unconstitutional, (ii) disclosures to policyholders were inadequate, (iii) consideration was improperly distributed to or allocated among policyholders, and (iv) the insurance commissioner abused his or her authority or committed errors of law in reviewing and approving the transaction or that his or her findings were not supported by substantial evidence. Complaints have sought both injunctive relief and damages, and parties to the lawsuits have included policyholder plaintiffs (individually or representing a purported class) and, as defendants, the converting company and the insurance commissioner. The existence of any such challenges could reduce the market price of the common stock. In the event that the Plan or the Pennsylvania Insurance Commissioner's order approving the Plan is challenged, a 27 successful challenge could result in monetary damages, a modification of the Plan or the Insurance Commissioner's approval of the Plan being set aside. In addition, a successful challenge would likely result in substantial uncertainty relating to the terms and effectiveness of the Plan, and an extended period of time might be required to reach a final determination. Such an outcome may reduce the market price of the common stock. If the insurance companies are not sufficiently profitable, the Holding Company's ability to pay dividends will be limited. The Holding Company is a separate entity with no operations of its own other than holding the stock of Mercer Mutual. The Holding Company will depend primarily on dividends paid by its insurance company subsidiaries and proceeds from the offering retained by the Holding Company. The Holding Company will receive dividends only after all of its subsidiaries' obligations and regulatory requirements have been satisfied. Pursuant to the Pennsylvania Insurance Department's order approving the conversion, both the Holding Company and Mercer Mutual are prohibited from declaring or paying any dividends without the approval of the Insurance Department for a period of three years following the effective date of the conversion. The Holding Company presently does not intend to pay dividends to its shareholders. If Mercer Mutual and the other insurance company subsidiaries are not sufficiently profitable, our ability to pay dividends to you in the future will be limited. FORWARD-LOOKING INFORMATION This prospectus contains forward-looking statements. You can find many of these statements by looking for words such as "believes," "intends," "expects," "plans," "anticipates," "seeks," "estimates," "projects," or similar expressions in this prospectus. The forward-looking statements are subject to numerous assumptions, risks and uncertainties. We have identified several important factors that could cause actual results to differ materially from any results discussed, contemplated, projected, forecast, estimated or budgeted in the forward-looking information. All of these factors are difficult to predict and many are beyond our control. These important factors include those discussed under "Risk Factors" and those listed below: - future economic conditions in the regional and national markets in which the companies compete which are less favorable than expected; - the effects of weather-related and other catastrophic events; - the effect of legislative, judicial, economic, demographic and regulatory events in the two states in which we do business; - the ability to enter new markets successfully and capitalize on growth opportunities either through acquisitions or the expansion of our producer network; - financial market conditions, including, but not limited to, changes in interest rates and the stock markets causing a reduction of investment income or investment gains, an acceleration of the amortization of deferred policy acquisition costs, reduction in the value of our investment portfolio or a reduction in the demand for our products; - the impact of acts of terrorism and acts of war; - the effects of terrorist related insurance legislation and laws; - inflation; - the cost, availability and collectibility of reinsurance; - estimates and adequacy of loss reserves and trends in losses and loss adjustment expenses; - heightened competition, including specifically the intensification of price competition, the entry of new competitors and the development of new products by new and existing competitors; 28 - changes in the coverage terms selected by insurance customers, including higher deductibles and lower limits; - our inability to obtain regulatory approval of, or to implement, premium rate increases; - the potential impact on our reported net income that could result from the adoption of future accounting standards issued by the Financial Accounting Standards Board or other standard-setting bodies; - inability to carry out marketing and sales plans, including, among others, development of new products or changes to existing products and acceptance of the new or revised products in the market; - unanticipated changes in industry trends and ratings assigned by nationally recognized rating organizations; - adverse litigation or arbitration results; - the ability to carry out our business plans; and - adverse changes in applicable laws, regulations or rules governing insurance holding companies and insurance companies, and environmental, tax or accounting matters including limitations on premium levels, increases in minimum capital and reserves, and other financial viability requirements, and changes that affect the cost of, or demand for our products. Because forward-looking information is subject to various risks and uncertainties, actual results may differ materially from that expressed or implied by the forward-looking information. Therefore, we caution you not to place undue reliance on this forward-looking information, which speaks only as of the date of this prospectus. All subsequent written and oral forward-looking information attributable to the Holding Company or Mercer Mutual or any person acting on our behalf is expressly qualified in its entirety by the cautionary statements contained or referred to in this section. We do not undertake any obligation to publicly release any revisions that may be made to any forward-looking statements to reflect events or circumstances occurring after the date of this prospectus. 29 USE OF PROCEEDS The Holding Company expects to contribute at least 50% of net proceeds from the offering to Mercer Mutual in exchange for all of its capital stock. The Holding Company will retain the balance of the net proceeds. On a short-term basis, the retained net proceeds will be invested primarily in U.S. government securities and other federal agency securities. These net proceeds will be available for a variety of corporate purposes. These purposes include additional capital contributions to our subsidiaries and future acquisitions. We also may use a portion of these net proceeds to fund the purchase of some or all of the shares to be acquired by our stock-based incentive plan and used to make restricted stock awards, if we receive the prior approval to do so from the Pennsylvania Insurance Department. These shares would be acquired in the open market. The stock-based incentive plan requires shareholder approval. We expect to seek approval at the first annual meeting of shareholders, to be held no earlier than six months following the conversion. See the subsection entitled "Certain Benefit Plans and Agreements" under the heading "Management." The net proceeds used to acquire the stock of Mercer Mutual will become part of Mercer Mutual's capital. This increase in capital will expand Mercer Mutual's underwriting capacity, permit it to reduce its reliance on reinsurance and permit geographic diversification of its business. In addition, Mercer Mutual may contribute a portion of the capital received from the Holding Company to its subsidiaries if necessary to support their operations. Any payment of dividends by our insurance companies, including those from Mercer Mutual to the Holding Company, may be limited by state law. In addition, the order of the Pennsylvania Insurance Department approving the conversion transaction requires the Insurance Department's prior approval of the payment of any dividends by Mercer Mutual to the Holding Company or by the Holding Company to its shareholders, during the three year period following the conversion. Except for the capital contributions to Mercer Mutual and its subsidiaries and the possible purchase of stock for restricted stock awards, we currently have no specific plans, arrangements or understandings regarding the use of the net proceeds from this offering. The amount of proceeds from the sale of common stock in the offering will depend on a few factors. These factors are the total number of shares actually sold, the relative percentages of common stock sold in each of the subscription, community and syndicated community offerings and the actual expenses of the conversion. As a result, the net proceeds from the sale of common stock cannot be determined until the conversion is completed. 30 The table below shows the estimated net proceeds we would receive, assuming the sale of various amounts of the common stock. The estimates are based upon the following assumptions: - 10% of the shares will be sold to the ESOP and 336,300 shares will be sold in the subscription offering to the directors, officers and employees of Mercer Mutual or its affiliates, with no commission paid to Sandler O'Neill & Partners, L.P. on any of these shares. - The Holding Company will not receive any cash proceeds from the ESOP's purchase of 10% of the shares of common stock sold in the conversion. Instead, the Holding Company will record on its financial statements a loan to the ESOP (on the terms described under "Management -- Certain Benefit Plans and Agreements -- Employee Stock Ownership Plan") in the amount of the purchase price for those shares. - The shares to be issued to the shareholders of Franklin Holding are not included in the table because the Holding Company will not receive any cash proceeds from the issuance of these shares. - Other conversion expenses, not including sales commissions, will be approximately $2.5 million. - No shares will be sold in a syndicated community offering. - Immediately after the conversion, Franklin Mutual will purchase 100,000 shares of common stock from the Holding Company at a purchase price of $10.00 per share.
REQUIRED MINIMUM MAXIMUM OF 4,165,000 4,900,000 5,635,000 OF 6,261,111 SHARES SHARES SHARES SHARES AT $10.00 AT $10.00 AT $10.00 AT $10.00 PER SHARE PER SHARE PER SHARE PER SHARE ------------ --------- --------- ------------ Gross proceeds of offering................ $41,650 $49,000 $56,350 $62,611 Proceeds from shares sold to Franklin Mutual.................................. 1,000 1,000 1,000 1,000 Less: Estimated expenses, including underwriting expenses................... (2,938) (3,030) (3,123) (3,202) ------- ------- ------- ------- Estimated net proceeds.................... 39,712 46,970 54,227 60,409 Less: Common Stock to be acquired by ESOP..... (4,165) (4,900) (5,635) (6,261) ------- ------- ------- ------- Estimated net proceeds, as adjusted(1).... $35,547 $42,070 $48,592 $54,148 ======= ======= ======= =======
- --------------- (1) Does not include any adjustment for the portion of the estimated net proceeds that may be used to fund the purchase of shares in the open market to be used for restricted stock awards or stock option exercises pursuant to our stock-based incentive plan. These shares are not included because the stock-based incentive plan is subject to shareholder approval, and for a period of three years after the conversion any open market purchase of these shares by the Holding Company requires the prior approval of the Pennsylvania Insurance Department. Implementation of the stock-based incentive plan will not occur until at least six months after the completion of the conversion. Therefore, we are unable to predict the market price of the common stock at that time. We may fund all or a portion of the purchase from cash flow or we may issue new shares directly from the Holding Company's authorized but unissued shares in lieu of purchasing shares in the open market. 31 CAPITALIZATION The following table displays information regarding the consolidated historical capitalization of Mercer Mutual and its subsidiaries at March 31, 2003. The table also displays the pro forma consolidated capitalization of the Holding Company. The pro forma information gives effect to the sale of common stock at the minimum, midpoint, and maximum of the estimated range of the consolidated pro forma market value of Mercer Mutual as a subsidiary of the Holding Company, as determined by the independent valuation of Griffin Financial Group, LLC. The pro forma information also is displayed at the maximum of the estimated valuation range plus shares issuable to the ESOP. The pro forma information at each of the four assumed levels of common stock sales also gives effect to the issuance of 100,000 shares immediately after the conversion to Franklin Mutual and the issuance of 488,280 shares to the shareholders of Franklin Holding. The various capital positions are displayed based upon the assumptions set forth under "Use of Proceeds." For additional financial information regarding Mercer Mutual, see our consolidated financial statements and related notes beginning on page F-1 of this prospectus. The total number of shares to be issued in the conversion plus the shares to be issued to Franklin Mutual and the shareholders of Franklin Holding will range from 4,753,280 shares to 6,849,391 shares. The exact number will depend on market and financial conditions. See "Use of Proceeds" and the subsection entitled "Stock Pricing and Number of Shares to be Issued" under the heading "The Conversion."
PRO FORMA CONSOLIDATED CAPITALIZATION OF THE HOLDING COMPANY BASED ON THE ISSUANCE OF ----------------------------------------------------------- HISTORICAL 6,223,280 CONSOLIDATED SHARES CAPITALIZATION 4,753,280 5,488,280 6,223,280 AT $10.00 OF MERCER SHARES SHARES SHARES PER SHARE PLUS MUTUAL AT AT $10.00 AT $10.00 AT $10.00 626,111 ESOP MARCH 31, 2003 PER SHARE(1) PER SHARE(1) PER SHARE(1) SHARES(1)(2) ----------------- ------------ ------------ ------------ -------------- (IN THOUSANDS) Long term debt Shareholders' equity(3): Preferred stock, authorized 5,000,000 shares; 0 shares outstanding Common stock, no par value per share; authorized 15,000,000 shares; shares to be outstanding -- as shown(4)(5)................ $44,595 $51,853 $59,110 $65,292 Retained earnings............. $34,263 34,263 34,263 34,263 34,263 Unrealized gains.............. 2,606 2,606 2,606 2,606 2,606 Less: Common stock to be acquired by ESOP(2)(6)................. (4,165) (4,900) (5,635) (6,261) ------- ------- ------- ------- ------- Total...................... $36,869 $77,299 $83,822 $90,344 $95,900 ======= ======= ======= ======= =======
- --------------- (1) Includes shares issuable after the conversion to Franklin Mutual Insurance Company and the shareholders of Franklin Holding, assuming that Franklin Mutual will purchase all of the shares that it has the right to purchase in this offering, and that 488,280 shares will be issued to the shareholders of Franklin Holding. Franklin Mutual may purchase up to 100,000 shares; however, Franklin Mutual has not indicated to us whether it will purchase any shares in the offering. (2) If 5,635,000 shares are sold in the conversion to subscribers other than the ESOP, the ESOP will purchase an additional 626,111 shares in the conversion. (3) Pro forma shareholders' equity is not intended to represent the fair market value of the common stock or the net fair market value of the Holding Company's assets and liabilities. The amounts indicated also are not intended to represent what would be available for distribution to shareholders, if any, in the event of 32 liquidation. The pro forma data may be materially affected by a change in the number of shares to be sold in the conversion and by other factors. (4) These pro forma amounts include the net proceeds from the conversion, the 488,280 shares (valued at $10.00 per share) that will be issued after the conversion to the shareholders of Franklin Holding in exchange for their shares of Franklin Holding stock, and 100,000 shares issuable after the conversion at a purchase price of $10.00 per share to Franklin Mutual. Franklin Mutual has not indicated to us whether it will purchase any shares in the offering. (5) Does not reflect additional shares of common stock that could be issued pursuant to our stock-based incentive plan. The aggregate amount of common stock issuable under this plan is equal to 14% of the shares issued in the conversion, or 583,100 shares if 4,165,000 shares are issued, 686,000 shares if 4,900,000 shares are issued, 788,900 shares if 5,635,000 shares are issued and 876,556 shares if 6,261,111 shares are issued (shares issued in the conversion do not include shares issued to Franklin Mutual or the shareholders of Franklin Holding, which are being issued immediately after the conversion). An undetermined portion of the stock issued under the stock-based incentive plan may be issued from the Holding Company's authorized but unissued shares and an undetermined portion of the shares may be issued from any treasury shares purchased by the Holding Company in the open market. Each of these methods and amounts would have different and varying effects on the Holding Company's shareholders' equity. Implementation of the stock-based incentive plan requires shareholder approval, which we expect to seek at our first annual meeting of shareholders held after the conversion. See the subsection entitled "Certain Benefit Plans and Agreements" under the heading "Management." (6) Assumes that the funds used to purchase these shares will be borrowed from the Holding Company. Under generally accepted accounting principles (GAAP), the aggregate purchase price of shares of common stock to be purchased by the ESOP in the offering represents unearned compensation and is, accordingly, reflected as a reduction of capital. As the ESOP loan is repaid, shares are released and allocated to ESOP participants' accounts, and a corresponding reduction in the charge against capital will occur. See the subsection entitled "Certain Benefit Plans and Agreements" under the heading "Management." 33 PRO FORMA DATA The following pro forma condensed consolidated balance sheet as of March 31, 2003, gives effect to the conversion, including implementation of the ESOP and the issuance of Holding Company common stock to the shareholders of Franklin Holding and to Franklin Mutual, as if they had occurred as of March 31, 2003. The data is based on the assumption that 4,165,000 shares of common stock (the minimum number of shares required to be sold in the conversion) are sold to eligible policyholders, directors, officers, employees and the ESOP in the subscription offering, that 488,280 shares are issued to the shareholders of Franklin Holding in exchange for their Franklin Holding stock, and that 100,000 shares are sold to Franklin Mutual at a purchase price of $10.00 per share pursuant to our contractual obligation. The following pro forma condensed consolidated statements of income for the year ended December 31, 2002, and the three months ended March 31, 2003, present our consolidated operating results as if the conversion and implementation of the ESOP had occurred as of January 1, 2002. Under our Plan of Conversion, Mercer Mutual will convert from a Pennsylvania-chartered mutual insurance company to a Pennsylvania-chartered stock insurance company. Mercer Mutual will issue shares of its capital stock to the Holding Company in exchange for a portion of the net proceeds from the sale of common stock in this offering. The conversion will be accounted for as a simultaneous reorganization, recapitalization and share offering. The conversion will not change the historical accounting basis of Mercer Mutual's consolidated financial statements. Completion of the conversion is contingent on the sale of a minimum of 4,165,000 shares of common stock in the conversion. If less than 4,165,000 shares of common stock are subscribed for in the subscription and community offerings, the remaining shares, up to a maximum of 5,635,000 shares (not including shares sold to the ESOP), will be offered in the syndicated community offering. The unaudited pro forma information does not claim to represent what our consolidated financial position or results of operations would have been had the conversion occurred on the dates indicated. This information is not intended to project our consolidated financial position or results of operations for any future date or period. The pro forma adjustments are based on available information and certain assumptions that we believe are factually supportable and reasonable under the circumstances. The unaudited pro forma consolidated financial information should be read in conjunction with the accompanying notes, and the other consolidated financial information pertaining to Mercer Mutual included elsewhere in this prospectus. The pro forma adjustments and pro forma consolidated amounts are provided for informational purposes only. Our consolidated financial statements will reflect the effects of the conversion only from the date it occurs. 34 UNAUDITED PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET AS OF MARCH 31, 2003
HISTORICAL PRO FORMA CONSOLIDATED ADJUSTMENTS CONSOLIDATED(1) ------------ ----------- --------------- (IN THOUSANDS) ASSETS Investments: Fixed income securities............................. $ 45,062 $35,547 (2) $ 80,609 Equity securities................................... 18,651 18,651 -------- ------- -------- Total investments................................... 63,713 35,547 99,260 Cash and cash equivalents............................. 10,403 10,403 Receivables........................................... 11,033 11,033 Prepaid reinsurance premiums.......................... 1,078 1,078 Property and equipment, net........................... 6,027 6,027 Deferred policy acquisition costs..................... 5,805 5,805 Goodwill.............................................. 2,876 1,734 (3) 4,610 Other assets.......................................... 3,411 3,411 -------- ------- -------- Total assets.......................................... $104,346 $37,281 $141,627 ======== ======= ======== LIABILITIES Losses and loss adjustment expenses................... $ 32,920 $ 32,920 Unearned premiums..................................... 25,057 25,057 Other liabilities..................................... 6,351 6,351 -------- -------- Total liabilities..................................... 64,328 64,328 Minority interest in subsidiary....................... 3,149 (3,149)(3) -- Shareholders' equity Common stock........................................ -- 44,595 (4) 44,595 Unearned employee stock ownership plan compensation..................................... -- (4,165)(5) (4,165) Retained earnings................................... 34,263 34,263 Unrealized gains in investments net of deferred income taxes..................................... 2,606 2,606 -------- ------- -------- Total shareholders' equity............................ $ 36,869 $40,430 $ 77,299 -------- ------- -------- Total liabilities and shareholders' equity............ $104,346 $37,281 $141,627 ======== ======= ======== Pro forma shareholders' equity per share.............. $ 16.26
35 NOTES TO UNAUDITED PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) (1) The unaudited pro forma condensed consolidated balance sheet, as prepared, gives effect to the sale of common stock at the minimum of the estimated range of the consolidated pro forma market value of Mercer Mutual as a subsidiary of the Holding Company, as determined by the independent valuation of Griffin Financial Group, LLC. The unaudited pro forma condensed consolidated balance sheet also includes the shares to be issued immediately after the conversion to Franklin Mutual and the shareholders of Franklin Holding, and is based upon the assumptions set forth under "Use of Proceeds." For comparison with the above, the following table provides the net proceeds, pro forma shareholders' equity and pro forma shareholders' equity per share at the midpoint and maximum of the estimated valuation range and at the maximum of the range plus the shares to be issued to the ESOP in the amount equal to 10% of the shares issuable in the conversion. Each of these columns also includes the shares issuable to Franklin Mutual and the shareholders of Franklin Holding. Pro forma shareholders' equity equals the net proceeds from the conversion, plus the assumed value (at $10.00 per share) of the shares to be issued to the shareholders of Franklin Holding, plus the gross proceeds from the sale of all 100,000 shares offered to Franklin Mutual, plus the historical retained earnings of Mercer Mutual and plus unrealized gains in investments net of deferred income taxes.
5,488,280 6,223,280 6,849,391 SHARES SHARES SHARES --------- --------- --------- Net proceeds from conversion........................ $ 45,970 $ 53,227 $ 59,409 Less: common stock to be acquired by ESOP......... (4,900) (5,635) (6,261) Plus: common stock to be purchased by Franklin Mutual......................................... 1,000 1,000 1,000 --------- --------- --------- Net investable proceeds............................. $ 42,070 $ 48,592 $ 54,148 Pro forma shareholders' equity...................... $ 83,822 $ 90,344 $ 95,900 Pro forma shareholders' equity per share............ $ 15.27 $ 14.52 $ 14.00
(2) The pro forma adjustment to reflect the conversion and the sale of shares to Franklin Mutual is as follows (in thousands):
Issuance of 4,165,000 shares at $10.00/share................ $41,650 Estimated conversion expenses............................... (2,938) ------- Net proceeds from conversion................................ 38,712 ------- Less: common stock to be purchased by ESOP.................. 4,165 Plus: common stock purchased by Franklin Mutual at $10.00/share.............................................. 1,000 ------- Net investable proceeds..................................... $35,547
(3) As a result of the 488,280 shares to be issued to the shareholders of Franklin Holding in exchange for all of the outstanding capital stock of Franklin Holding not owned by Mercer Mutual, Mercer Mutual minority interest will be eliminated and additional goodwill will be recorded. The allocation of the purchase price is preliminary. See "Additional Shares Being Issued after the Conversion." (4) Pro forma common stock includes the net proceeds from the conversion, the assumed value of the shares to be issued to the shareholders of Franklin Holding (valued at $10.00 per share) in exchange for their 36 Franklin Holding shares, and the gross proceeds from the sale of all 100,000 shares offered to Franklin Mutual, as follows: Sale of 4,165,000 shares at $10.00/share.................... $41,650 Exchange of Franklin Holding shares......................... 4,883 Sale of 100,000 shares to Franklin Mutual at $10.00/share... 1,000 Estimated conversion expenses............................... (2,938) ------- Pro-forma common stock...................................... $44,595
(5) Reflects the $4,165 loan from the Holding Company to the ESOP, the proceeds of which will be used to purchase 10% of the common stock issued in the conversion at a purchase price of $10.00 per share. The amount of this borrowing has been reflected as a reduction from gross proceeds to determine the estimated net funds available for investment. The amount of the ESOP Loan will increase to $4,900,000, $5,635,000 and $6,261,111 if 4,900,000, 5,635,000 and 6,261,111 shares, respectively, are sold in the conversion. The ESOP loan will bear interest at an annual rate equal to the prime rate as published in The Wall Street Journal on the closing date of the conversion. The prime rate on June 26, 2003 was 4.25%. The ESOP loan will require annual payments of approximately $512 for a term of 10 years. The Holding Company intends to make contributions to the ESOP at least equal to the principal and interest requirement of the ESOP loan. As the ESOP loan is repaid, shareholders' equity will be increased. The ESOP expense reflects adoption of Statement of Position (SOP) 93-6, which requires recognition of expense based upon shares committed to be allocated under the ESOP, and the exclusion of unallocated shares from earnings per share computations. The valuation of shares committed to be allocated under the ESOP would be based upon the average market value of the shares during the year. For purposes of this calculation, the average market value was assumed to be equal to $10.00 per share. See the subsection entitled "Certain Benefit Plans and Agreements" under the heading "Management." 37 UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF INCOME YEAR ENDED DECEMBER 31, 2002 (IN THOUSANDS, EXCEPT SHARE DATA)
HISTORICAL PRO FORMA CONSOLIDATED ADJUSTMENTS(1) CONSOLIDATED(2) ------------ -------------- --------------- (IN THOUSANDS) Revenue: Net premiums earned............................... $40,454 $ 40,454 Investment income, net of expenses................ 2,061 2,061 Net realized investment losses.................... (220) (220) Other revenue..................................... 329 329 ------- ----- ---------- Total revenue.................................. 42,624 42,624 ------- ----- ---------- Expenses: Losses and loss adjustment expenses............... 20,067 20,067 Amortization of deferred policy acquisition costs.......................................... 10,953 10,953 Operating expenses................................ 7,974 417 (3) 8,391 Stock conversion expenses......................... 95 (95)(4) -- ------- ----- ---------- Total expenses................................. 39,089 322 39,411 ------- ----- ---------- Income before taxes and minority interest in income of subsidiary..................................... 3,535 (322) 3,213 Income taxes........................................ 1,155 (109)(5) 1,046 ------- ----- ---------- Income before minority interest in income of subsidiary........................................ 2,380 (213) 2,167 Minority interest in income of subsidiary........... (138) 138 -- ------- ----- ---------- Net income.......................................... $ 2,242 $ (75) $ 2,167 ======= ===== ========== Earnings per share data: Net income per share of common stock.............. $ .50 Weighted average number of shares of common stock outstanding.................................... 4,357,605(6)
See accompanying Notes to Unaudited Pro Forma Condensed Consolidated Statement of Income. 38 UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF INCOME THREE MONTHS ENDED MARCH 31, 2003 (IN THOUSANDS, EXCEPT SHARE DATA)
HISTORICAL PRO FORMA CONSOLIDATED ADJUSTMENTS(1) CONSOLIDATED(2) ------------ -------------- --------------- (IN THOUSANDS) Revenue: Net premiums earned............................... $11,056 $ 11,056 Investment income, net of expenses................ 427 427 Net realized investment gains..................... 149 149 Other revenue..................................... 80 80 ------- ---- ---------- Total revenue.................................. 11,712 11,712 ------- ---- ---------- Expenses: Losses and loss adjustment expenses............... 6,514 6,514 Amortization of deferred policy acquisition costs.......................................... 2,973 2,973 Operating expenses................................ 1,849 104 (3) 1,953 Stock conversion expenses......................... 12 (12)(4) -- ------- ---- ---------- Total expenses................................. 11,348 92 11,440 ------- ---- ---------- Income before taxes and minority interest in income of subsidiary..................................... 364 (92) 272 Income taxes........................................ 88 (31)(5) 57 ------- ---- ---------- Income before minority interest in income of subsidiary........................................ 276 (61) 215 Minority interest in income of subsidiary........... (43) 43 -- ------- ---- ---------- Net income.......................................... $ 233 $(18) $ 215 ======= ==== ========== Earnings per share data: Net income per share of common stock.............. $ .05 Weighted average number of shares of common stock outstanding.................................... 4,383,636(6)
See accompanying Notes to Unaudited Pro Forma Condensed Consolidated Statement of Income. 39 NOTES TO UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF INCOME (IN THOUSANDS, EXCEPT SHARE DATA) (1) Does not reflect any income from the investment of net proceeds available for investment and assumed to be received as of January 1, 2002. This income is not "factually supportable" as that term is used in the Securities and Exchange Commission's rules and regulations. On a short-term basis, these proceeds will be invested primarily in U.S. government securities and other federal agency securities. The average of the three-month U.S. Treasury bill rate in effect on each of December 31, 2001, March 31, 2002, June 30, 2002, and September 30, 2002, was 1.69% per annum. If these proceeds were invested at 1.69% for the year ended December 31, 2002 and the three months ended March 31, 2003, pro forma net income (after tax), as reported in these pro forma financial statements, would have increased by $396 and $99 for the year ended December 31, 2002 and the three months ended March 31, 2003, respectively. Pro forma net income per share, as reported herein, would have increased by $0.09 for the year ended December 31, 2002 and by $0.02 for the three months ended March 31, 2003. (2) The unaudited pro forma condensed consolidated statements of income, as prepared, give effect to the sale of common stock at the minimum of the estimated range of the consolidated pro forma market value of Mercer Mutual as a subsidiary of the Holding Company, as determined by the independent valuation of Griffin Financial Group, LLC. The unaudited pro forma condensed consolidated statements of income also give effect to the shares to be issued immediately after the conversion to Franklin Mutual and the shareholders of Franklin Holding, and are based upon the assumptions set forth under "Use of Proceeds." The following table provides a comparison between the sale of common stock at the minimum and maximum of the estimated valuation range, and at the maximum of the range plus the shares to be issued to the ESOP in the amount equal to 10% of the shares issuable in the conversion.
MARCH 31, 2003 DECEMBER 31, 2002 ------------------------------------ ------------------------------------ 4,165,000 5,635,000 6,261,111 4,165,000 5,635,000 6,261,111 SHARES SHARES SHARES SHARES SHARES SHARES ---------- ---------- ---------- ---------- ---------- ---------- ESOP compensation expense................. $ 104 $ 141 $ 157 $ 417 $ 564 $ 626 Net income................ $ 215 $ 191 $ 180 $ 2,167 $ 2,070 $ 2,030 Net income per share of common stock............ $ .05 $ .03 $ .03 $ .50 $ .36 $ .32 Weighted average number of shares of common stock outstanding(a).......... 4,383,636 5,723,174 6,293,717 4,357,605 5,687,955 6,254,586
- --------------- (a) Includes shares issued to Franklin Mutual and the shareholders of Franklin Holding. (3) Pro forma adjustment to recognize compensation expense under the ESOP for shares of common stock committed to be released to participants as the principal and interest of the $4,165 loan from the Holding Company to the ESOP is repaid. The pro forma adjustment reflects the amounts repaid on the ESOP loan based on 10 equal annual installments. (4) Costs and expenses related to the stock conversion are treated as non-recurring after completion of the conversion. (5) Adjustment to reflect the federal income tax effects of (3) (4) above. 40 (6) Calculation of weighted average number of shares outstanding:
LESS UNALLOCATED TOTAL SHARES ESOP SHARES WEIGHTED ISSUED(A) SHARES OUTSTANDING AVERAGE(B) ------------ ----------- ----------- ---------- January 1, 2002........................ 4,753,280 (416,500) 4,336,780 Shares allocated....................... -- 41,650 41,650 --------- -------- --------- December 31, 2002...................... 4,753,280 (374,850) 4,378,430 4,357,605 --------- -------- --------- --------- Shares allocated....................... 10,413 10,413 --------- -------- --------- March 31, 2003......................... 4,753,280 (364,437) 4,388,843 4,383,636 ========= ======== ========= =========
- --------------- (a) Includes 4,165,000 shares issued in the conversion plus shares issuable after the conversion to Franklin Mutual and the shareholders of Franklin Holding, assuming that Franklin Mutual will purchase all of the shares that they have the right to purchase in this offering, and that 488,280 shares will be issued to the shareholders of Franklin Holding. Franklin Mutual may purchase up to 100,000 shares; however, Franklin Mutual has not indicated to us whether it will purchase any shares in the offering. (b) ESOP shares are allocated evenly to plan participants throughout the period and therefore the weighted average number of shares outstanding is determined by adding beginning of period and end of period shares outstanding and dividing the sum by two. 41 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following presents management's discussion and analysis of our financial condition and results of operations as of the dates and for the periods indicated. You should read this discussion in conjunction with the consolidated financial statement and notes thereto included in this prospectus and the information under the caption "Risk Factors". This discussion contains forward-looking information that involves risks and uncertainties. Actual results could differ significantly from these forward-looking statements. See "Forward-Looking Information". OVERVIEW Mercer Mutual is a Pennsylvania mutual insurance company that underwrites property and casualty insurance in New Jersey and Pennsylvania. Our consolidated operating insurance company subsidiaries are: - Mercer Insurance Company of New Jersey, Inc., a New Jersey property and casualty stock insurance corporation that currently offers only workers' compensation insurance to businesses located in New Jersey; and - Franklin Insurance Company, a property and casualty stock insurance company offering private passenger automobile and homeowners insurance to individuals located in Pennsylvania. On the effective date of the conversion, Mercer Mutual will become a wholly owned subsidiary of the Holding Company. The consolidated financial statements of Mercer Mutual prior to the conversion will become the Holding Company's consolidated financial statements upon completion of the conversion. We report our operating results in three operating segments: commercial lines insurance, personal lines insurance and the investment function. See Note 9 of the notes to our consolidated financial statements included in this prospectus. However, assets are not allocated to segments and are reviewed in the aggregate for decision-making purposes. Our commercial lines business consists primarily of multi-peril and general liability and related coverages. Our personal lines business consists primarily of homeowners and private passenger automobile insurance. We market both the commercial and personal lines through independent producers. 42 MERCER INSURANCE GROUP, INC. MD & A SELECTED FINANCIAL DATA
THREE MONTHS ENDED MARCH 31, (UNAUDITED) YEAR ENDED DECEMBER 31, ------------------------------ ----------------------------------------------------- PERCENTAGE PERCENTAGE PERCENTAGE 2003 CHANGE 2002 2002 CHANGE 2001 CHANGE 2000 ------- ---------- ------- ------- ---------- ------- ---------- ------- (IN THOUSANDS) Revenue Data: Direct premiums written... $13,019 13.1% $11,515 $50,858 22.6% $41,497 30.6% $31,782 Assumed premiums written................. 273 97.8 138 808 (45.2) 1,474 357.8 322 Ceded premiums written.... (2,033) 24.7 (1,630) (7,195) (12.9) (8,261) 103.7 (4,055) ------- ----- ------- ------- ------ ------- ------ ------- Net premiums written...... 11,259 12.3 10,023 44,471 28.1 34,710 23.7 28,049 Change in unearned premiums................ (203) (579) (4,017) (3,982) (414) ------- ----- ------- ------- ------ ------- ------ ------- Net premiums earned....... 11,056 17.1 9,444 40,454 31.7 30,728 11.2 27,635 Net investment income..... 427 (19.3) 529 2,061 (15.0) 2,425 (3.7) 2,517 Net realized investment gains (losses).......... 149 26.3 118 (220) (623.8) 42 (114.6) (288) Other revenue............. 80 5.3 76 329 31.6 250 49.7 167 ------- ----- ------- ------- ------ ------- ------ ------- Total revenue.... 11,712 15.2 10,167 42,624 27.4 33,445 11.4 30,031 ------- ----- ------- ------- ------ ------- ------ ------- Losses and expenses: Loss and loss adjustment expenses.............. 6,514 40.6 4,634 20,067 38.1 14,534 6.0 13,711 Other expenses.......... 4,834 11.4 4,340 19,022 33.6 14,240 18.1 12,053 ------- ----- ------- ------- ------ ------- ------ ------- Total expenses... 11,348 26.5 8,974 39,089 35.8 28,774 11.7 25,764 ------- ----- ------- ------- ------ ------- ------ ------- Income before income taxes and minority interest in income of subsidiary.... 364 (69.5) 1,193 3,535 (24.3) 4,671 9.5 4,267 Income taxes.............. 88 (80.4) 418 1,155 (9.1) 1,271 6.0 1,199 ------- ----- ------- ------- ------ ------- ------ ------- Income before minority interest in income of subsidiary.............. 276 (64.4) 775 2,380 (30.0) 3,400 10.8 3,068 Minority interest in income of subsidiary.... (43) 975.0 (4) (138) 38.0 (100) -- -- ------- ----- ------- ------- ------ ------- ------ ------- Net income................ $ 233 (69.8)% $ 771 $ 2,242 (32.1)% $ 3,300 7.6% $ 3,068 ======= ===== ======= ======= ====== ======= ====== ======= Loss and loss adjustment expense ratio........... 58.9% 49.1% 49.6% 47.3% 49.6% Expense ratio............. 43.6% 46.0% 46.8% 46.3% 43.6% Combined ratio............ 102.5% 95.1% 96.4% 93.6% 93.2%
CRITICAL ACCOUNTING POLICIES General. We are required to make estimates and assumptions in certain circumstances that affect amounts reported in our consolidated financial statements and related footnotes. We evaluate these estimates and assumptions on an on-going basis based on historical developments, market conditions, industry trends and other information that we believe to be reasonable under the circumstances. There can be no assurance that actual results will conform to our estimates and assumptions, and that reported results of operation will not be materially adversely affected by the need to make accounting adjustments to reflect changes in these estimates and assumptions from time to time. We believe the following policies are the most sensitive to estimates and judgments. 43 Liabilities for Loss and Loss Adjustment Expenses. The liability for losses and loss adjustment expenses represents estimates of the ultimate unpaid cost of all losses incurred, including losses for claims that have not yet been reported to our insurance companies. The amount of loss reserves for reported claims is based primarily upon a case-by-case evaluation of the type of risk involved, knowledge of the circumstances surrounding each claim and the insurance policy provisions relating to the type of loss. The amounts of loss reserves for unreported claims and loss adjustment expense reserves are determined using historical information by line of insurance as adjusted to current conditions. Inflation is implicitly provided for in the reserving function through analysis of costs, trends and reviews of historical reserving results. Reserves are closely monitored and are recomputed periodically using the most recent information on reported claims and a variety of statistical techniques. Specifically, on a quarterly basis, we review, by line of business, existing reserves, new claims, changes to existing case reserves, and paid losses with respect to the current and prior accident years. We use historical paid losses and accident year data to derive expected ultimate loss and loss adjustment expense ratios by line of business. We then apply these expected loss and loss adjustment expense ratios to in-force business to derive a reserve level for each line of business. This amount, together with reserves required by new reported claims and changes to existing case reserves, is compared to existing reserves to establish the addition to reserves that is required. In connection with the determination of the reserves, we also consider other specific factors such as recent weather-related losses, trends in historical paid losses, and legal and judicial trends with respect to theories of liability. Because of the nature of Mercer's business, which generally provides coverage for short-term risks, loss development is comparatively rapid and historical paid losses have been a reliable predictive measure of future losses. Nevertheless, reserves are estimates because there are uncertainties inherent in the estimates of ultimate losses. Court decisions, regulatory changes and economic conditions can affect the ultimate cost of claims that occurred in the past as well as create uncertainties regarding future loss cost trends. Accordingly, the ultimate liability for unpaid losses and loss settlement expenses will likely differ from the amount recorded at March 31, 2003. Changes in estimates or differences between estimates and amounts ultimately paid are reflected in current operations. Loss reserving techniques and assumptions have been consistently applied during the periods presented. The property and casualty industry has incurred substantial aggregate losses from claims related to asbestos-related illnesses, environmental remediation, product and construction defect liability, mold, and other uncertain exposures. Mercer has not experienced significant losses from these types of claims. In the discussions that follow, we use the term "loss development", which refers to the calendar year income statement impact of changes in the provision for loss and loss adjustment expenses incurred in prior accident years. 44 The table below summarizes loss and loss adjustment reserves by major line of business:
DECEMBER 31, MARCH 31, ----------------- 2003 2002 2001 --------- ------- ------- (IN THOUSANDS) Commercial lines: Commercial multi-peril................................ $ 5,823 $ 6,017 $ 5,098 Other liability....................................... 6,547 6,390 7,927 Workers' compensation................................. 4,396 4,224 3,935 Commercial automobile................................. 1,839 1,886 1,763 Fire, allied, inland marine........................... 190 119 1,149 ------- ------- ------- 18,795 18,636 19,872 ------- ------- ------- Personal lines: Homeowners............................................ 9,891 8,896 7,801 Personal automobile................................... 2,334 2,070 1,343 Fire, allied, inland marine........................... 618 477 736 Other liability....................................... 1,247 1,201 1,257 Workers' compensation................................. 35 68 50 ------- ------- ------- 14,125 12,712 11,187 ------- ------- ------- Total................................................... $32,920 $31,348 $31,059 ======= ======= =======
Investments. Unrealized investment gains or losses on investments carried at fair value, net of applicable income taxes, are reflected directly in shareholders' equity as a component of comprehensive income and, accordingly, have no effect on net income. A decline in fair value of an investment below its cost that is deemed other than temporary is charged to earnings. We monitor our investment portfolio and review investments that have experienced a decline in fair value below cost to evaluate whether the decline is other than temporary. These evaluations involve judgment and consider the magnitude and reasons for a decline and the prospects for the fair value to recover in the near term. In the years ended December 31, 2002, 2001 and 2000, we recorded a pre-tax charge to earnings of $647,000, $185,000 and $219,000, respectively, primarily with respect to equity securities that we determined were other than temporarily impaired. Adverse investment market conditions, or poor operating results of underlying investments, could result in impairment charges in the future. We generally apply the following standards in determining whether the decline in fair value of an investment is other than temporary: Equities -- If an equity security has a market value below 50% of cost or remains below 80% of cost for more than three months, a review of the financial condition and prospects of the company is performed by the Investment Committee of the Board of Directors to determine if the decline in market value is other than temporary. A specific determination is made for any such security. Other equity securities in an unrealized loss position not meeting these quantitative thresholds are evaluated considering, among other things, the magnitude and reasons for the decline and the prospects for the fair value of the securities to recover in the near term. If it is determined that the decline in market value is judged to be "other than temporary" then the cost basis of the security is written down to "realizable value" and the amount of the write down accounted for as a realized loss. "Realizable value" is defined as the quoted market price of the security. Write-down to a value other than the market price requires objective evidence in support of that value. All write downs during 2002, 2001 and 2000 have been to quoted market prices. Fixed Income Securities -- A fixed maturity security generally is written down if we are unable to hold or otherwise intend to sell a security with an unrealized loss, or if it is probable that we will be unable to collect all amounts due according to the contracted terms of a debt security not impaired at acquisition. 45 A fixed maturity security review for collectibility is done if any of the following situations occur: - A review of the financial condition and prospects of the company performed by the Investment Committee indicates that the security should be evaluated. - Moody's or S&P rate the security below investment grade. - The security has a market value below 70% of amortized cost at quarter end due to deterioration in credit quality. We have one material non-traded security, non-voting common stock in Excess Reinsurance Company, which is carried at $1.2 million. Its fair value is estimated at the statutory book value as reported to the NAIC. Other non-traded securities, which are not material in the aggregate, are carried at cost. Policy Acquisition Costs. We defer policy acquisition costs, such as commissions, premium taxes and certain other underwriting expenses that vary with and are directly related to the production of business. These costs are amortized over the effective period of the related insurance policies. The method followed in computing deferred policy acquisition costs limits the amount of deferred costs to their estimated realizable value, which gives effect to the premium to be earned, related investment income, loss and loss adjustment expenses, and certain other costs expected to be incurred as the premium is earned. Future changes in estimates, the most significant of which is expected loss and loss adjustment expenses, may require acceleration of deferred policy acquisition costs. Reinsurance. Amounts recoverable from property and casualty reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policy. Amounts paid for reinsurance contracts are expensed over the contract period during which insured events are covered by the reinsurance contracts. Ceded unearned premiums and reinsurance balances recoverable on paid and unpaid loss and loss adjustment expenses are reported separately as assets, instead of being netted with the appropriate liabilities, because reinsurance does not relieve us of our legal liability to our policyholders. Reinsurance balances recoverable are subject to credit risk associated with the particular reinsurer. Additionally, the same uncertainties associated with estimating unpaid loss and loss adjustment expenses affect the estimates for the ceded portion of these liabilities. We continually monitor the financial condition of our reinsurers. Income Taxes. We use the asset and liability method of accounting for income taxes. Deferred income taxes arise from the recognition of temporary differences between financial statement carrying amounts and the tax bases of our assets and liabilities. A valuation allowance is provided when it is more likely than not that some portion of the deferred tax asset will not be realized. The effect of a change in tax rates is recognized in the period of the enactment date. RESULTS OF OPERATIONS Our results of operations are influenced by factors affecting the property and casualty insurance industry in general. The operating results of the United States property and casualty insurance industry are subject to significant variations due to competition, weather, catastrophic events, regulation, general economic conditions, judicial trends, fluctuations in interest rates and other changes in the investment environment. Our premium growth and underwriting results have been, and continue to be, influenced by market conditions. Pricing in the property and casualty insurance industry historically has been cyclical. During a soft market cycle, price competition makes it difficult to attract and retain properly priced personal and commercial lines business. Our policy is to maintain our disciplined underwriting and pricing standards during soft markets, even at the expense of premium growth. The insurance industry is currently experiencing a hard market cycle during which price competition is less significant than during a soft market cycle. Therefore, during a hard market cycle insurers are able to increase premiums and receive a more acceptable profit margin. A hard market typically has a positive effect on premium growth. 46 On June 1, 2001, we acquired 49% of the outstanding shares of common stock of Franklin Holding and thereafter consolidated the financial condition and results of operations of Franklin Holding with Mercer Mutual. For the period between June 1, 2001 and March 31, 2003, we allocated a portion of Franklin Holding's net income or loss to the minority interest in Franklin Holding. This resulted in allocations of income to minority interest of $43,000 for the three months ended March 31, 2003, $138,000 for the year ended December 31, 2002, and $100,000 for the year ended December 31, 2001. Immediately after the completion of the conversion, we will acquire the remaining outstanding shares of common stock of Franklin Holding in exchange for 488,280 shares of Holding Company common stock. As a result of our purchase of these remaining shares, Franklin Holding will be a wholly owned subsidiary of Mercer Mutual. For more information on this exchange of shares, see the section entitled "Additional Shares Being Issued After the Conversion." THREE MONTHS ENDED MARCH 31, 2003 COMPARED TO THREE MONTHS ENDED MARCH 31, 2002 For the three months ended March 31, 2003, Mercer Mutual had net income of $233,000 compared to $771,000 for the three months ended March 31, 2002, a decline of 69.8%. Although the underwriting gain from our commercial lines segment for the three months ended March 31, 2003, increased from the prior comparable period by $464,000 to $1.1 million, our personal lines segment incurred a loss of $1.4 million, which represented a decrease of $1.2 million from the prior comparable period. See note 3 of the notes to our condensed consolidated financial statements for the three months ended March 31, 2003 and 2002 included in this prospectus for a reconciliation of underwriting gain (loss) by segment to consolidated amounts determined in accordance with GAAP. In addition, segment income from our investment function decreased in the three months ended March 31, 2003, by $71,000 to $576,000 compared to the same period in 2002. Total revenues for the three months ended March 31, 2003, were $11.7 million, which were $1.5 million or 15.2%, greater than revenues of $10.2 million for the three months ended March 31, 2002. This increase was due to a $1.6 million increase in net premiums earned for the three months ended March 31, 2003, compared to the three months ended March 31, 2002, which is described below. Direct premiums written increased by 13.1% to $13.0 million for the three months ended March 31, 2003, from $11.5 million for the three months ended March 31, 2002, and consisted of $7.4 million of commercial lines premiums and $5.6 million of personal lines premiums for the three months ended March 31, 2003, compared to $6.4 million in commercial lines premiums and $5.1 million in personal lines premiums for the same period in 2002. Net premiums earned increased by 17.1% to $11.1 million from $9.4 million for the comparable period. Commercial lines comprised $5.8 million and personal lines comprised $5.3 million of net premiums earned in the three months ended March 31, 2003, compared to $4.4 million and $5.0 million, respectively, in the three months ended March 31, 2002. The overall increases in direct premiums written and net premiums earned are generally attributable to firmer pricing but also represent continued strong growth in our commercial lines business. Consistent with our goal of increasing commercial business, we increased direct commercial multi-peril premiums written, the largest component of our commercial lines segment, by 24.0% to $3.6 million for the three months ended March 31, 2003, compared to $2.9 million for the comparable prior period, and increased commercial multi-peril net premiums earned by 33.6% to $2.8 million for the three months ended March 31, 2003, compared to $2.1 million for the three months ended March 31, 2002. We expect this trend of increasing commercial writings to continue. For the same comparative periods, net premiums earned for our homeowners insurance, the largest component of our personal lines segment, increased 2.3% to $3.1 million for the three months ended March 31, 2003, compared to $3.0 million for the comparable period in 2002, while the increase in homeowners direct premiums written increased 10.0% to $3.0 million for the three months ended March 31, 2003, from $2.7 million for the three months ended March 31, 2002. The growth rate for homeowners insurance reflects the reclassification of certain homeowners risks from our preferred program to our standard program. Premiums are higher for the standard program compared to the preferred program. Personal automobile direct written premiums, written exclusively in Pennsylvania, increased 17.9% to $2.0 million for 47 the three months ended March 31, 2003, compared to $1.7 million for the same period in 2002. Net earned premiums for personal automobile increased by 14.8% to $1.6 million for the three months ended March 31, 2003, from $1.4 million for the three months ended March 31, 2002. Despite the increases in personal lines premiums, we will continue to principally focus on commercial lines growth. Net investment income decreased $102,000, or 19.3%, to $427,000 for the three months ended March 31, 2003, compared to the same period in 2002 due to declining interest rates. Net realized investment gains increased by $31,000 for the three months ended March 31, 2003, to $149,000 compared to $118,000 for the three months ended March 31, 2002. For the three months ended March 31, 2003, we had a combined ratio of 102.5%, a loss and loss adjustment expense ratio of 58.9% and an underwriting expense ratio of 43.6%, compared to a combined ratio of 95.1%, a loss and loss adjustment expense ratio of 49.1% and an underwriting expense ratio of 46.0% for the three months ended March 31, 2002. In the commercial lines segment for the three months ended March 31, 2003, we had an underwriting gain of $1.1 million, a combined ratio of 81.3%, a loss and loss adjustment expense ratio of 34.1% and an underwriting expense ratio of 47.2%, compared to an underwriting gain of $611,000, a combined ratio of 86.0%, a loss and loss adjustment expense ratio of 33.9% and an underwriting expense ratio of 52.1% for the three months ended March 31, 2002. In the personal lines segment for the three months ended March 31, 2003, we had an underwriting loss of $1.4 million, a combined ratio of 125.5%, a loss and loss adjustment expense ratio of 85.7% and an underwriting expense ratio of 39.8%, compared to an underwriting loss of $141,000, a combined ratio of 102.8%, a loss and loss adjustment expense ratio of 62.1% and an underwriting expense ratio of 40.7% for the three months ended March 31, 2002. Net loss and loss adjustment expenses incurred increased overall by $1.9 million, or 40.6%, to $6.5 million for the three months ended March 31, 2003, from the same period in 2002. The increase in loss and loss adjustment expenses reflects the increase in commercial and personal lines volume and an increase in the frequency of personal lines losses. The increase in personal lines losses is attributable to harsher weather conditions for the three months ended March 31, 2003, compared to the same period in 2002. After a number of winters with relatively mild weather conditions in our operating region, we experienced one of the coldest winters in recent history. In addition, there was considerably more snow for the three months ended March 31, 2003, compared to the same period in 2002. These conditions lead to losses from frozen pipes, structure collapses and more frequent automobile losses. The increase in these losses is evidenced by the increase in the homeowners loss and loss expense ratio to 88.2% for the three months ended March 31, 2003, compared to 71.2% for the three months ended March 31, 2002, and an increase in the personal automobile loss and loss expense ratio to 78.9% for the three months ended March 31, 2003, compared to 67.2% for the three months ended March 31, 2002. Loss development of prior year net loss and loss adjustment expense reserves was a favorable $123,000, was spread among all lines of business and accident years and resulted primarily from the normal claims review process and not from any change in key assumptions or changes in reserving philosophy. Underwriting expenses increased by $494,000, or 11.3%, to $4.8 million for the three months ended March 31, 2003, from the same period in 2002. This increase was principally attributable to an increase in expenses due to higher amortization of deferred policy acquisition costs resulting from higher premium volume. We are currently in the process of converting our information system. When completed, we expect some costs to moderate as conversion costs and costs associated with operating dual systems end. These reduced costs will be offset by some higher staffing costs, but we also should be positioned to expand premium volume without material incremental expense because of increased processing capacity. We also expect underwriting expenses to moderate in future periods because we intend to significantly reduce the amount of business written in Mercer Mutual, the New Jersey assets of which became subject to New Jersey's retaliatory premium tax when Mercer Mutual redomesticated to Pennsylvania in 1997. We plan to do this by renewing, to the extent possible, Mercer Mutual premium volume in Mercer Insurance Company of New Jersey, Inc., a New Jersey domestic insurer that is not subject to this retaliatory tax. We have not previously renewed policies in our New Jersey subsidiary because only policyholders of Mercer Mutual, domiciled in Pennsylvania, have subscription and voting rights. Therefore, renewing policies in the New Jersey subsidiary before adoption of the Plan of Conversion would have denied subscription rights to our 48 policyholders and disenfranchised them. The cost of the additional premium tax was $150,000 for the three months ended March 31, 2003, and $135,000 for the three months ended March 31, 2002. Federal income tax expense was $88,000 for the three months ended March 31, 2003, an effective rate of 24.2%, compared to $418,000, an effective rate of 35.0%, in 2002. The decrease in the effective tax rate for the three months ended March 31, 2003, is attributable to tax-exempt investment income being a larger percentage of taxable income. YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001 For the year ended December 31, 2002, Mercer Mutual had net income of $2.2 million compared to $3.3 million for the year ended December 31, 2001, a decline of 33.3%. Although the underwriting gain from our commercial lines segment in 2002 increased from the prior year by $1.4 million to $2.9 million, our personal lines segment incurred an underwriting loss of $1.4 million, which represented a decrease of $1.9 million from the prior year. See note 9 of the notes to our consolidated financial statements included in this prospectus for a reconciliation of underwriting gain (loss) by segment to consolidated amounts determined in accordance with GAAP. In addition, segment income from our investment function decreased in 2002 by $600,000 to $1.8 million. Total revenues for 2002 were $42.6 million, which were $9.2 million or 27.4%, greater than 2001 revenues of $33.4 million. This increase was due to a $9.7 million increase in net premiums earned from 2001 to 2002, which is described below. Direct premiums written increased by 22.6% to $50.9 million in 2002, from $41.5 million in 2001 and consisted of $27.5 million of commercial lines premiums and $23.4 million of personal lines premiums in 2002, compared to $20.3 million in commercial lines premiums and $21.2 million in personal lines premiums in 2001. Net premiums earned increased by 31.7% to $40.5 million from $30.7 million in 2001. Commercial lines comprised $20.1 million and personal lines comprised $20.4 million of net premiums earned in 2002, compared to $15.1 million and $15.6 million, respectively, in 2001. The overall increases in direct premiums written and net premiums earned reflect continued strong growth in our commercial lines business and firmer pricing, as well as a full year of operations of Franklin Holding. Our controlling interest in Franklin Holding was acquired on June 1, 2001, and thus only seven months of operations for Franklin Holding were consolidated in the 2001 results. Consistent with our goal of increasing commercial business, we increased direct commercial multi-peril premiums written, the largest component of our commercial lines segment, by 39.2% to $13.5 million in 2002, compared to $9.7 million in 2001, and increased commercial multi-peril net premiums earned by 35.2% to $9.6 million in 2002, compared to $7.1 million in 2001. We expect this trend of increasing commercial writings to continue. For the same comparative periods, net premiums earned for our homeowners insurance, the largest component of our personal lines segment, increased 8.2% to $11.9 million in 2002 compared to $11.0 million in 2001 while the increase in homeowners premiums written increased a smaller 3.0% to $13.7 million in 2002 from $13.3 million in 2001. The declining growth rate for homeowners insurance reflects our strategy of focusing on commercial lines and decreasing our personal lines exposure. We expect this declining growth rate to be reflected in homeowners net premiums earned in future periods. Notably, for the first time in our history, commercial multi-peril premiums written in 2002 were approximately equal to homeowners premiums written in the same period. Although our focus is on commercial lines premium growth, Franklin Holding's business model, which uses Internet-based technology to process commodity personal lines business, made it an attractive acquisition candidate. The acquisition of Franklin Holding actually reversed a declining trend in homeowners premiums written that existed from 1998 to 2000 and added a meaningful book of Pennsylvania personal automobile business that totaled $6.9 million in written premiums in 2002 and $4.9 million in written premiums in 2001. Net investment income decreased $364,000, or 15.0%, to $2.1 million for the year ended December 31, 2002, compared to the same period in 2001 due to declining interest rates. Net realized investment gains decreased by $262,000 for the year ended December 31, 2002, to a loss of $220,000 compared to a gain of 49 $42,000 for the year ended December 31, 2001. This net realized loss was largely attributable to the writedown of $647,000 relating to equity securities that we determined were other than temporarily impaired compared to a writedown in 2001 of $185,000. Charges relating to securities that we determined were other than temporarily impaired are measured by comparing the market value of the security at the time of determination versus the book value of the security. These charges are included in net realized investment gains or losses. No facts or circumstances relating to these charges are expected to have any impact on any other material investment securities held. The following table summarizes securities with unrealized losses at December 31, 2002:
FAIR UNREALIZED VALUE LOSSES ------- ---------- (IN THOUSANDS) Fixed income securities: U.S. Government and Government agencies................... $ 8,898 $ 53 Obligations of states and political subdivisions.......... 929 3 Industrial and miscellaneous.............................. 1,180 25 ------- ------ $11,007 $ 81 ======= ====== Equity securities........................................... $ 5,426 $1,370 ======= ======
All securities are listed as available for sale. We evaluate securities for impairment on a quarterly basis and specifically determine on an individual security basis whether or not the decline in value is other than temporary. Equity securities with unrealized losses at December 31, 2002 in general were determined to have temporary declines in value due to geopolitical rather than fundamental reasons. Certain other equity securities also were determined to have temporary declines in value as a reaction to their particular industry rather than specifically to those companies. We believe it is more likely than not that those securities will appreciate in value. If it is subsequently determined that our assessment of those companies is erroneous and we conclude that the declines in value are other than temporary, future earnings will be negatively affected. The following table summarizes the length of time equity securities with unrealized losses at December 31, 2002 have been in an unrealized loss position:
LENGTH OF UNREALIZED LOSS ----------------------------- FAIR UNREALIZED LESS THAN 6 TO 12 OVER 12 VALUE LOSSES 6 MONTHS MONTHS MONTHS ------ ---------- --------- ------- ------- (IN THOUSANDS) Equity securities....................... $5,426 $1,370 $208 $995 $167 ====== ====== ==== ==== ====
At December 31, 2002, our bond portfolio was concentrated in U.S. government and government agency bonds with 80.2% of the bond portfolio in such bonds. None of the unrealized loss at December 31, 2002, pertained to bonds below investment grade or in securities not rated. Nearly all bonds were of investment grade and only 0.1% of bonds were below investment grade. The one below investment grade bond is carried at a fair value in excess of its cost because it had been written down in value in 2000. At December 31, 2002, our equity portfolio had a concentration in the financial services sector with 40% of equities invested in such securities. No other industry accounted for more than 10% of our equity portfolio. For the year ended December 31, 2002, the realized investment losses of $220,000 were comprised of gains of $703,000 offset by other than temporary writedowns of $647,000 and losses from the sale of securities of $276,000. The losses from the sale of securities were comprised of $8,000 from the sale of bonds and 50 $268,000 from the sale of equities. The following table summarizes the period of time that equity securities sold at a loss during the year ended December 31, 2002, had been in a continuous unrealized loss position:
FAIR PERIOD OF TIME IN AN VALUE ON REALIZED UNREALIZED LOSS POSITION SALE DATE LOSS - ------------------------ --------- -------- (IN THOUSANDS) 0-6 months.................................................. $ 95 $ 26 7-12 months................................................. 115 84 More than 12 months......................................... 417 158 ---- ---- Total....................................................... $627 $268 ==== ====
Of the $268,000 in realized losses from equity securities sold during the year ended December 31, 2002, realized losses of $11,000 were from a security that had been written down in 2001. Realized losses of $257,000 were from securities that had been expected to appreciate in value but after reevaluation were sold so that sale proceeds could be reinvested. Securities were sold due to a desire to reduce exposure to certain issuers and industries or in light of changing economic conditions. The following table summarizes our rate of return on invested assets compared to industry averages:
LEHMAN BROTHERS BOND MEASUREMENT INDICES S & P 500 MERCER - ----------- -------- --------- ------ Municipal bond index...................................... 9.6% -- 9.3% Mortgage-backed securities index.......................... 8.8% -- 9.1% Intermediate term treasury index.......................... 9.3% -- 8.8% Equities.................................................. -- (22.1)% (29.9)%
For the year ended December 31, 2002, we had a combined ratio of 96.4%, a loss and loss adjustment expense ratio of 49.6% and an underwriting expense ratio of 46.8%, compared to a combined ratio of 93.6%, a loss and loss adjustment expense ratio of 47.3% and an underwriting expense ratio of 46.3% for the year ended December 31, 2001. In the commercial lines segment in 2002, we had an underwriting gain of $2.9 million, a combined ratio of 85.6%, a loss and loss adjustment expense ratio of 36.3% and an underwriting expense ratio of 49.3%, compared to an underwriting gain of $1.5 million, a combined ratio of 90.4%, a loss and loss adjustment expense ratio of 42.5% and an underwriting expense ratio of 47.9% for 2001. In the personal lines segment in 2002, we had an underwriting loss of $1.4 million, a combined ratio of 107.0%, a loss and loss adjustment expense ratio of 62.8% and an underwriting expense ratio of 44.2%, compared to an underwriting gain of $500,000, a combined ratio of 96.8%, a loss and loss adjustment expense ratio of 52.0% and an underwriting expense ratio of 44.8% for 2001. Net loss and loss adjustment expenses incurred increased overall by $5.5 million, or 38.1%, to $20.1 million for the year ended December 31, 2002, from the same period in 2001. The increase in loss and loss adjustment expenses reflects the increase in commercial and personal lines volume, a full year of Franklin Holding business, an increase in our reinsurance retention, and a slightly higher frequency of losses. The loss and loss adjustment expense ratio increase was largely attributable to the acquisition of Franklin Holding, resulting in increased personal lines business that carries a significantly higher loss ratio (62.8% versus a 36.3% commercial lines loss and loss adjustment ratio), an increase in our reinsurance retention from $250,000 to $300,000 per policy and the fact that 2002 witnessed a slightly higher frequency of smaller, mostly personal lines losses, none of which pierced this higher retention level. For the year ended December 31, 2002, loss and loss adjustment expense reserves for accident years 2001 and prior demonstrated favorable development of $2.1 million. This favorable development was attributable to 51 a variety of lines of business and accident years. Homeowners accident year 1996 showed favorable loss development of $211,000 due to lower payouts on losses from a pooling agreement with other insurance carriers which was terminated in 1997 as well as lower payouts on Mercer's losses. Homeowners accident year 2000 showed favorable development of $119,000 as reported losses for that accident year were lower than the provision established for claims incurred but not reported. Personal lines fire, allied and marine loss and loss adjustment expenses for accident year 2001 showed favorable development of $207,000 as Mercer's share of mandatory residual market losses and loss expense were lower than expected as well as lower payouts on our own loss and loss expenses. Commercial multi-peril accident year 1998 showed favorable development of $114,000 due to settlement of losses at better than expected terms. Commercial multi-peril accident year 2001 showed favorable development of $424,000 as reported losses for that accident year were lower than the provision established for claims incurred but not reported. Provisions for such losses were established after consideration of industry trends, however, subsequent analysis indicated that Mercer's book of business was performing better than the industry, largely because of strong underwriting and the absence of certain long tail exposures such as asbestos and environmental liabilities. Commercial general liability accident year 1998 showed favorable development of $322,000 as reported losses for that accident year were lower than the provision established for claims incurred but not reported. The reporting of losses for commercial general liability occurs sometimes long after the actual loss and thus estimated reserves are established for these incurred but not reported losses. A reevaluation of commercial general liability loss reserves for the 1998 accident year indicated that loss and loss expenses are expected to be lower than originally estimated. The remaining favorable loss development was spread among all lines of business and accident years. In all cases, the favorable development resulted primarily from our normal claims review process during 2002 and not from any change in trends relating to the number of incurred or outstanding claims or settlement amounts, key assumptions or reserving philosophy. Multiple small changes in estimates occurred across all lines of business in 2002 as part of the normal review process, and there was no specific material change in estimate that should have been recognized in a prior period. Underwriting expenses increased by $4.7 million, or 32.9%, to $18.9 million for the year ended December 31, 2002, from the same period in 2001. This increase was attributable to an increase in expenses due to higher amortization of deferred policy acquisition costs resulting from higher premium volume, ongoing conversion of our information systems and the associated cost of maintaining two data processing systems during the transition period, a full year of Franklin Holding operations and the establishment of underwriting and marketing teams for future production in Pennsylvania. The increase in expenses also reflects our strategy of paying higher profit sharing commissions to our producers for good loss experience. The system conversion is scheduled to be completed by December 31, 2004. When completed, we expect some costs to moderate as conversion costs and costs associated with operating dual systems end. These reduced costs will be offset by some higher staffing costs, but we also should be positioned to expand premium volume without material incremental expense because of increased processing capacity. We also expect underwriting expenses to moderate in future periods because we intend to significantly reduce the amount of business written in Mercer Mutual, the New Jersey assets of which became subject to New Jersey's retaliatory premium tax when Mercer Mutual redomesticated to Pennsylvania in 1997. We will do this by renewing, to the extent possible, Mercer Mutual premium volume in Mercer Insurance Company of New Jersey, Inc., a New Jersey domestic insurer that is not subject to this retaliatory tax. We have not previously renewed policies in our New Jersey subsidiary because only policyholders of the Pennsylvania mutual company have subscription and voting rights. Therefore, renewing policies in the New Jersey subsidiary before adoption of the Plan of Conversion would have denied subscription rights to our policyholders and disenfranchised them. The cost of the additional premium tax was $611,000 and $532,000 in 2002 and 2001, respectively. Federal income tax expense was $1.2 million in 2002, an effective rate of 32.7%, compared to $1.3 million, an effective rate of 27.2%, in 2001. The increase in the effective tax rate during 2002 is attributable to less tax-exempt investment income as well as an increase in certain expenses not deductible for income tax purposes. 52 YEAR END DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000. For the year ended December 31, 2001, Mercer Mutual had net income of $3.3 million compared to $3.1 million for the year ended December 31, 2000, an increase of 7.6%. This increase was largely attributable to a $200,000 increase in segment income from investments (from $2.3 million in 2000 to $2.5 million in 2001), as a $969,000 increase in the underwriting gain from personal lines (from ($469,000) in 2000 to $500,000 in 2001) was mostly offset by an $800,000 reduction in the underwriting gain from commercial lines (from $2.3 million in 2000 to $1.5 million on 2000). Total revenues for 2001 were $33.4 million, which were $3.4 million or 11.4%, greater than 2000. This was due in large part to a $3.1 million increase in net premiums earned, which is described below. Direct premiums written increased by 30.6% to $41.5 million in 2001 from $31.8 million in 2000, and consisted of $20.3 million of commercial lines premiums and $21.2 million of personal lines premiums in 2001, compared to $16.6 million in commercial lines premiums and $15.2 million in personal lines premiums in 2000. Net premiums earned increased by 11.2% to $30.7 million from $27.6 million in 2000. Commercial lines comprised $15.1 million and personal lines comprised $15.6 million of net premiums earned in 2001, compared to $13.7 million and $13.9 million, respectively, in 2000. The overall increases in direct premiums written and net premiums earned reflect our strategy of increasing commercial business as well as the acquisition of a controlling interest in Franklin Holding in 2001. Commercial multi-peril premiums written increased 26.0% to $9.7 in million in 2001 from $7.7 million in 2000 and commercial multi-peril premiums earned increased to $7.1 million in 2001 from $6.9 million in 2000. The period from 2000 to 2001 began the significant increase in commercial premium volume and the increased written premium volume in 2001 was the basis for the significant earned premium gain in 2002. By contrast, homeowners written premiums increased 10.8% from $12.0 million in 2000 to $13.3 million in 2001, but earned premium volume was essentially unchanged from 2000 to 2001, decreasing $48,000. The increase in homeowners written premium volume was largely attributable to the acquisition of Franklin Holding. 2001 also marked the initial contribution of Pennsylvania personal automobile premium volume to earned and written premiums because of the acquisition of Franklin Holding. Net investment income decreased $92,000, or 3.7%, to $2.4 million for the year ended December 31, 2001, as compared to the same period in 2000 due to the declining interest rate environment. Net realized investment gains increased by $330,000 for the year ended December 31, 2001, to a gain of $42,000 from a loss of $288,000 for the year ended December 31, 2000, mostly as a result of reduced writedowns of securities that we determined were other than temporarily impaired. For the year ended December 31, 2001, we had a combined ratio of 93.6%, a loss and loss adjustment expense ratio of 47.3% and an underwriting expense ratio of 46.3%, compared to a combined ratio of 93.2%, a loss and loss adjustment expense ratio of 49.6% and an underwriting expense ratio of 43.6% for the year ended December 31, 2000. In the commercial lines segment in 2001, we had an underwriting gain of $1.5 million, a combined ratio of 90.4%, a loss and loss adjustment expense ratio of 42.5% and an underwriting expense ratio of 47.9%, compared to an underwriting gain of $2.3 million, a combined ratio of 82.9%, a loss and loss adjustment expense ratio of 37.7% and an underwriting expense ratio of 45.2% for 2000. In the personal lines segment in 2001, we had an underwriting gain of $500,000, a combined ratio of 96.8%, a loss and loss adjustment expense ratio of 52.0% and an underwriting expense ratio of 44.8%, compared to an underwriting loss of $469,000, a combined ratio of 103.4%, a loss and loss adjustment expense ratio of 61.3% and an underwriting expense ratio of 42.1% for 2000. Net loss and loss adjustment expenses increased overall by $823,000, or 6.0%, to $14.5 million for the year ended December 31, 2001, from the same period in 2000. These underwriting results reflect our disciplined approach to underwriting and pricing, and the better mix of our product lines and significantly improved loss experience in the personal lines segment. Our loss and loss expense ratio decreased 230 basis points largely due to favorable loss experience across most of our principal product lines. 53 For the year ended December 31, 2001, loss and loss adjustment expense reserves for accident years 2001 and prior demonstrated favorable development of $3.3 million. This favorable development was attributable to a variety of lines of business and accident years. Homeowners accident year 2000 showed favorable development of $627,000 because reported losses and loss adjustment expenses for that accident year were lower than the provision established for claims incurred but not reported and the related loss adjustment expenses. A reevaluation of casualty related losses for homeowners accident year 2000 indicated that these losses would be lower than originally anticipated. Commercial multi-peril accident year 1997 showed favorable development of $182,000 due to settlement of multiple losses at better than expected terms. Commercial multi-peril accident year 1999 showed favorable development of $272,000 and commercial multi-peril accident year 2000 showed favorable development of $520,000 because reported losses and related loss adjustment expenses for those accident years were lower than the provision established for claims incurred but not reported. A reevaluation of casualty related losses for commercial multi-peril accident years 1999 and 2000 indicated that Mercer's book of business was performing better than the industry, primarily because of strong underwriting and the absence of long tail exposures such as asbestos and environmental liability. Workers' compensation accident years 1998, 1999 and 2000 showed favorable development of $171,000, $116,000 and $144,000, respectively. A reevaluation of workers' compensation loss and loss adjustment expense reserves indicated that Mercer's workers' compensation book of business, which is largely low to moderate risk in nature, was not experiencing the national trend of poorer loss experience, thus resulting in the favorable development. Commercial automobile accident year 2000 showed favorable development of $346,000 because reported losses and related loss adjustment expenses were lower than the provision established for claims incurred but not reported. The remaining favorable loss development was spread among all lines of business and accident years. In all cases, the favorable development resulted primarily from our normal claims review process during 2001 and not from any change in trends relating to the number of incurred or outstanding claims or settlement amounts, key assumptions or reserving philosophy. Multiple small changes in estimates occurred across all lines of business in 2001 as part of the normal review process, and there was no specific material change in estimate that should have been recognized in a prior period. Underwriting expenses increased by $2.2 million, or 18.1%, to $14.2 million for the year ended December 31, 2001, from the same period in 2000. This increase was largely attributable to an increase in expenses due to our acquisition of Franklin Holding, as well as an increase in net commissions caused by our payment of higher profit sharing commissions to our producers due to good loss experience. In addition, ceded commissions were lower as a result of changes in the reinsurance program relating to retention levels and type of reinsurance coverage. Federal income tax expense was $1.3 million in 2001, an effective rate of 27.2%, compared to $1.2 million, an effective rate of 28.1%, in 2000. EFFECT OF CONVERSION ON OUR FUTURE FINANCIAL CONDITION AND RESULTS OF OPERATIONS Our future financial condition and results of operations will be affected by the conversion and related transactions. Upon completion of the conversion, our consolidated shareholders' equity will be between $77.3 million and $95.9 million, an increase of approximately 109.7% to 160.1% over the consolidated surplus of Mercer Mutual at March 31, 2003. See "Use of Proceeds," "Capitalization" and "Pro Forma Data." This increased capitalization should permit us to (i) increase direct premium volume to the extent competitive conditions permit, (ii) increase net premium volume by decreasing our reliance on reinsurance (see "Business -- Strategy -- Reduced Reliance on Reinsurance"), and (iii) enhance investment income by increasing our investable capital. ESOP In connection with the conversion, the ESOP intends to finance the purchase of 10% of the common stock issued in the conversion with the proceeds of a loan from the Holding Company, and Mercer Mutual will make annual contributions to the ESOP sufficient to repay that loan, which we estimate will total, on a pre-tax basis, between $512,000 and $770,000 annually. See "Management -- Certain Benefit Plans and Agreements -- Employee Stock Ownership Plan." 54 HOLDING COMPANY PURCHASE OF COMMON STOCK The stock-based incentive plan may issue a total number of shares equal to 14% of the shares of common stock that were issued in the conversion. Of this amount, an amount equal to 4% of the shares of common stock issued in the conversion may be used to make restricted stock awards under the stock-based incentive plan. Following the completion of the conversion and the implementation of the stock-based incentive plan, the Holding Company intends to purchase shares of its common stock in the open market and contribute those shares to the stock-based incentive plan for use in making restricted stock awards under that plan. Such purchase will require the prior approval of the Pennsylvania Insurance Department. The fair market value of any common stock used for restricted stock awards will represent unearned compensation. As the Holding Company accrues compensation expense to reflect the vesting of such shares, unearned compensation will be reduced accordingly. This compensation expense will be deductible for federal income tax purposes. Implementation of the stock-based incentive plan is subject to shareholder approval. See the subsection entitled "Certain Benefit Plans and Agreements" under the heading "Management." LIQUIDITY AND CAPITAL RESOURCES Our insurance companies generate sufficient funds from their operations and maintain a high degree of liquidity in their investment portfolios. The primary source of funds to meet the demands of claim settlements and operating expenses are premium collections, investment earnings and maturing investments. As of March 31, 2003, Mercer Mutual has plans to spend $2.5 million for the expansion of its existing facilities in Pennington, New Jersey. We are also in the process of building an information system platform that will allow our producers to conduct their business through the Internet or through the method they have historically used. As of March 31, 2003, we have spent $1.6 million on the development of this platform, which includes license fees for software used in the platform. It should be completed by 2004 at an additional cost of $1.2 million. As they are incurred, these costs are capitalized and amortized over a five-year period once the corresponding asset is placed in service. Mercer Mutual possesses sufficient resources for these future expenditures without incurring any debt. Our insurance companies maintain investment and reinsurance programs that are intended to provide sufficient funds to meet their obligations without forced sales of investments. They maintain a portion of their investment portfolio in relatively short-term and highly liquid assets to ensure the availability of funds. The principal source of liquidity for the Holding Company will be dividend payments and other fees received from Mercer Mutual. For a period of three years after the conversion, Mercer Mutual may not declare or pay any dividend to the Holding Company without the approval of the Pennsylvania Insurance Department. After this three-year period, Mercer Mutual will be restricted by the insurance laws of Pennsylvania as to the amount of dividends or other distributions it may pay to the Holding Company. Under Pennsylvania law, there is a maximum amount that may be paid by Mercer Mutual during any twelve-month period after notice to, but without prior approval of, the Pennsylvania Insurance Department. This limit is the greater of 10% of Mercer Mutual's statutory surplus as reported on its most recent annual statement filed with the Pennsylvania Insurance Department, or the net income of Mercer Mutual for the period covered by such annual statement. If the dividend restrictions related to the conversion were not in effect, then as of December 31, 2002, the amounts available for payment of dividends from Mercer Mutual in 2002, without the prior approval of the Pennsylvania Insurance Department would have been approximately $2.9 million. Prior to its payment of any dividends, Mercer Insurance Company of New Jersey, Inc. is required to provide notice of the dividends to the New Jersey Department of Banking and Insurance. The New Jersey Department has the power to limit or prohibit dividend payments if certain conditions exist. These restrictions or any subsequently imposed restrictions may affect our future liquidity. QUANTITATIVE AND QUALITATIVE INFORMATION ABOUT MARKET RISK General. Market risk is the risk that we will incur losses due to adverse changes in market rates and prices. We have exposure to three principal types of market risk through our investment activities: interest rate 55 risk, credit risk and equity risk. Our primary market risk exposure is to changes in interest rates. We have not entered, and do not plan to enter, into any derivative financial instruments for trading or speculative purposes. Interest Rate Risk. Interest rate risk is the risk that we will incur economic losses due to adverse changes in interest rates. Our exposure to interest rate changes primarily results from our significant holdings of fixed rate investments. Fluctuations in interest rates have a direct impact on the market valuation of these securities. The average maturity of our fixed income investment portfolio is 8.14 years. Our fixed maturity investments include U.S. and foreign government bonds, securities issued by government agencies, obligations of state and local governments and governmental authorities, corporate bonds and mortgage-backed securities, most of which are exposed to changes in prevailing interest rates. We carry these investments as available for sale. This allows us to manage our exposure to risks associated with interest rate fluctuations through active review of our investment portfolio by our management and board of directors and consultation with our financial advisor. Fluctuations in near-term interest rates could have an impact on the results of operations and cash flows. Certain of these fixed income securities have call features. In a declining interest rate environment, these securities may be called by their issuer and replaced with securities bearing lower interest rates. In a rising interest rate environment, we may sell these securities (rather than holding to maturity) and receive less than we paid for them. As a general matter, we do not attempt to match the durations of our assets with the durations of our liabilities. Our goal is to maximize the total return on all of our investments. An important strategy that we employ to achieve this goal is to try to hold enough in cash and short-term investments in order to avoid liquidating longer-term investments to pay claims. The tables below show the interest rate sensitivity of our fixed income financial instruments measured in terms of market value (which is equal to the carrying value for all our securities) for the periods indicated.
AS OF DECEMBER 31, 2002 MARKET VALUE ---------------------------------------- -100 BASIS AS OF +100 BASIS POINT CHANGE 12/31/2002 POINT CHANGE ------------ ---------- ------------ ($ IN THOUSANDS) Bonds and preferred stocks....................... $57,260 $53,909 $50,847 Cash and cash equivalents........................ 7,201 7,201 7,201 ------- ------- ------- Total............................................ $64,461 $61,110 $58,048
Credit Risk. The quality of our interest-bearing investments is generally good. Except for one defaulted bond with a face amount of $100,000 that we have written down to $25,000, we hold no other interest-bearing investments having a substantial risk of non-payment. Equity Risk. Equity price risk is the risk that we will incur economic losses due to adverse changes in equity prices. Our exposure to changes in equity prices primarily results from our holdings of common stocks, mutual funds and other equities. Our portfolio of equity securities is carried on the balance sheet at fair value. Therefore, an adverse change in market prices of these securities would result in losses. Portfolio characteristics are analyzed regularly and market risk is actively managed through a variety of techniques. In accordance with accounting principles generally accepted in the United States of America, when an equity security becomes other than temporarily impaired, we record this impairment as a charge against earnings. For the year ended December 31, 2002, we recorded a pre-tax charge of $647,000 with respect to certain equity securities that we have concluded are other than temporarily impaired. Company and industry concentrations are established by the Board of Directors. At December 31, 2002, Mercer Mutual's equity portfolio made up 26.5% of Mercer Mutual's total investment portfolio, and was relatively concentrated in terms of the number of issuers and industries. At December 31, 2002, Mercer Mutual's top ten equity holdings represented $6.7 million or 32.8% of the equity portfolio. Investments in the 56 financial sectors represented 40.0% while investments in pharmaceutical companies, conglomerates and information technology companies represented 9.2%, 7.8% and 7.6%, respectively, of the equity portfolio at December 31, 2002. Such concentration can lead to higher levels of short-term price volatility. Due to our long-term investment focus, we are not as concerned with short-term volatility as long as our insurance subsidiaries' ability to write business is not impaired. The table below summarizes Mercer Mutual's equity price risk and shows the effect of a hypothetical 20% increase and a 20% decrease in market prices as of December 31, 2002. The selected hypothetical changes do not indicate what could be the potential best or worst case scenarios.
ESTIMATED ESTIMATED HYPOTHETICAL FAIR VALUE OF FAIR VALUE AFTER PERCENTAGE INCREASE EQUITY SECURITIES HYPOTHETICAL HYPOTHETICAL (DECREASE) IN AT 12/31/02 PRICE CHANGE CHANGE IN PRICES SURPLUS(1) - ----------------- ------------ ---------------- ------------------- (IN THOUSANDS) $20,332 20% increase $24,399 7.3% $20,332 20% decrease $16,266 (7.3)%
- --------------- (1) Net of tax IMPACT OF INFLATION Inflation increases consumers' needs for property and casualty insurance coverage. Inflation also increases claims incurred by property and casualty insurers as property repairs, replacements and medical expenses increase. These cost increases reduce profit margins to the extent that rate increases are not implemented on an adequate and timely basis. We establish property and casualty insurance premiums levels before the amount of losses and loss expenses, or the extent to which inflation may impact these expenses, are known. Therefore, our insurance companies attempt to anticipate the potential impact of inflation when establishing rates. Because inflation has remained relatively low in recent years, financial results have not been significantly impacted by inflation. MARKET FOR THE COMMON STOCK The common stock has been approved for quotation on the Nasdaq National Market under the symbol "MIGP," subject to the completion of the conversion. The Holding Company has never issued any capital stock. Consequently, there is no established market for the common stock. The development of a public market having the desirable characteristics of depth, liquidity and orderliness depends upon the presence in the marketplace of a sufficient number of willing buyers and sellers at any given time. Neither we nor any market maker has any control over the development of such a public market. Accordingly, we cannot assure you that an established and liquid market for the common stock will develop, or if one develops, that it will continue. Sandler O'Neill & Partners, L.P. has advised us that it intends to make a market in the common stock following the conversion, but it is under no obligation to do so. One of the requirements for continued quotation of the common stock on the Nasdaq National Market is that there be at least two market makers for the common stock. We cannot assure you that there will be two or more market makers for the common stock. Furthermore, we cannot assure you that you will be able to resell your shares of common stock for a price at or above $10.00 per share, or that quotations will be available on the Nasdaq National Market, as contemplated. DIVIDEND POLICY Payment of dividends on the common stock is subject to determination and declaration by the Holding Company's Board of Directors. Our dividend policy will depend upon our financial condition, results of operations and future prospects. Additionally, the Holding Company is prohibited from declaring or paying any dividends during the three years following the conversion, unless such dividends are approved by the Pennsylvania Insurance Department. At present, we have no intention to pay dividends to our shareholders. 57 We cannot assure you that dividends will be paid, or if and when paid, that they will continue to be paid in the future. The Holding Company initially will have no significant source of income other than dividends from Mercer Mutual and earnings from the repayment of the Holding Company's loan to the ESOP and the investment of the net proceeds of the conversion retained by the Holding Company. Therefore, the payment of dividends by the Holding Company will depend significantly upon receipt of dividends from Mercer Mutual. Mercer Mutual also is prohibited from declaring or paying any dividends during the three years following the Conversion, unless such dividends are approved by the Pennsylvania Insurance Department. We cannot assure you that the Pennsylvania Insurance Department would approve the declaration or payment by Mercer Mutual of any dividends to the Holding Company. See the subsection entitled "Regulation" under the heading "Business." Except as described above, the Holding Company is not subject to regulatory restrictions on the payment of dividends to shareholders. The Holding Company is subject to the requirements of the Pennsylvania Business Corporation Law of 1988. This law generally permits dividends or distributions to be paid as long as, after making the dividend or distribution, the Holding Company will be able to pay its debts in the ordinary course of business and the Holding Company's total assets will exceed its total liabilities plus the amount that would be needed to satisfy the preferential rights upon dissolution of holders of stock with senior liquidation rights if the Holding Company were to be dissolved at the time the dividend or distribution is paid. 58 BUSINESS OVERVIEW We are a provider of a wide array of property and casualty insurance products designed to meet the insurance needs of consumers and small and medium-sized businesses throughout New Jersey and Pennsylvania. We report our operating results in three segments: commercial lines insurance, personal lines insurance and the investment function. However, assets are not allocated to segments and are reviewed in the aggregate for decision-making purposes. Our insurance products include homeowners, commercial multi-peril, other liability, personal automobile, workers compensation, fire and inland marine and commercial automobile coverages. We market our products through a network of over 300 independent producers in New Jersey and Pennsylvania. Substantially all producers market both commercial and personal lines products. Prior to 1997, our business was primarily focused on providing personal lines for New Jersey customers. However, over the past six years we have moved aggressively to expand our commercial and casualty premium volume and geographically diversify our writings into Pennsylvania. In order to attract and retain commercial and casualty business, we have developed insurance programs specifically tailored to meet the needs of particular types of businesses. In 2002, homeowners insurance represented 26.9% of our direct premiums written compared to 43.3% in 1998 and commercial writings represented 54.1%, up from 45.0% in 1998. This significant shift in the mix of our writings occurred despite our acquisition in 2001 of 49% interest in Franklin Insurance Company whose business consisted entirely of personal lines policies. We have been profitable in each of the past five years, due in large part to our disciplined underwriting approach. One industry measurement of a company's underwriting success is the combined ratio, which is the sum of a company's loss and loss adjustment expense ratio and its underwriting expense ratio. A combined ratio of less than 100% means a company is making an underwriting profit. Although harsh weather affected first quarter 2003 results, our statutory combined ratios of 93.4% in 1998, 92.7% in 1999, 92.9% in 2000, and 93.4% in 2001 out-performed the industry averages of 103.9%, 106.3%, 108.7%, and 115.1% for those years, respectively. Our statutory combined ratio for 2002 was 94.7% and industry data for 2002 is not yet available. Our insurance companies have been assigned an "A" (excellent) rating by A.M. Best. An "A" rating is the third highest rating out of A.M. Best's 16 possible rating categories. We are managed by an experienced group of executives led by Andrew R. Speaker, the President and Chief Executive Officer. Mr. Speaker has served in his current position since March 2000, and in various other positions with Mercer Mutual and its subsidiaries since 1990. Through Mercer Mutual's acquisition of Franklin Holding in 2001, H. Thomas Davis, Jr., the founder of Franklin Insurance Company, became a senior vice president of Mercer Mutual. As a group, our executive officers have on average more than 26 years of experience in the property and casualty insurance industry. OUR BUSINESS STRATEGIES We continually strive to improve our profitability and reduce the impact of losses on our business. One of our principal objectives for the future is to become a geographically diverse property and casualty insurer with at least 75% of our direct written premiums consisting of commercial and casualty business that meets our disciplined underwriting standards. By doing so, we believe that our results of operations will improve and we will lessen the impact of property insurance losses on our results. The following discussion describes the strategies we intend to use to achieve our goals. Increase our commercial and casualty writings. Over the last six years we have taken, and will continue to take, steps to increase commercial and casualty premium volume. Growth in commercial and casualty lines reduces our personal lines exposure as a percentage of direct written premiums. This reduces the relative adverse impact that weather-related property losses can have on us. Increased commercial lines business also benefits us because we have greater flexibility in establishing rates for these lines. In order to attract and retain commercial and casualty insurance business, we have developed insurance programs specifically tailored to meet the needs of particular types of businesses. These programs are 59 continually refined and, if successful, expanded based on input from our producers and our marketing personnel. We have a program that is available for churches, synagogues and other religious institutions. This program includes many preferred coverages and special pricing, and we have policy forms tailored for these institutions. We use this program to attract producers that have substantial books of business with religious institutions. At December 31, 2002, we had approximately 500 religious institution policies in force with direct written premiums of $2.5 million. We did not perform a complete loss ratio calculation for this product separately, but, based upon available data regarding known claims, we believe that the loss ratio for religious institution policies is better than our favorable loss experience in the commercial segment generally. In order to complement our existing commercial accounts, we offer a two-tiered pricing approach for commercial automobile insurance covering light to medium weight trucks and business-owned private passenger-type vehicles used for commercial purposes. In addition to a standard rate, we offer a preferred rate for risks meeting specified underwriting standards. We believe that there is an opportunity to increase our volume of casualty business by: (1) marketing casualty coverages to existing producers who have witnessed the establishment and growth of our commercial lines, and (2) forming and developing relationships with new producers that focus on commercial and casualty business. We believe an increasing share of this market is desirable and attainable given our existing relationships with our producers and our insureds, as well as the extensive experience and producer relationships of our commercial business management personnel. Capital raised in the conversion will be available to supply additional surplus to our insurance companies to support an increase in premium volume resulting from this continued diversification of our business lines. Diversify our business geographically. For the year ended December 31, 2002, 76.8% of our business was written in New Jersey. We intend to geographically diversify our risk by increasing our business outside New Jersey. We intend to explore opportunities that may arise in Maryland, Ohio, Pennsylvania and other states within the Mid-Atlantic and Midwestern United States that have reduced or different weather-related property loss exposure, and where we believe commercial lines insurers generally are permitted to manage risk selection and pricing without undue regulatory interference. We also will evaluate potential business opportunities that are called to our attention in other jurisdictions to determine whether factors exist that would make such opportunities beneficial to us. If so, we may explore those opportunities as well. We expect to accomplish our geographic diversification through the expansion of our existing producer relationships in Pennsylvania and through selective strategic acquisitions. Other than the acquisition of the remaining shares of Franklin Holding Company, Inc. that we do not already own (see "Additional Shares to be Issued After the Conversion"), we do not have any letter of intent or agreement to acquire any other company. Attract and retain high-quality producers with diverse customer bases. We believe our insurance companies have a strong reputation for personal attention and prompt, efficient service to producers and insureds. This reputation has allowed us to grow and foster our relationships with many high volume producers. Several of these producers focus primarily on commercial business and are located in areas we have targeted as growth opportunities within Pennsylvania and New Jersey. We intend to focus our marketing efforts on maintaining and improving our relationships with these producers, as well as on attracting new high-quality producers in areas with a substantial potential for growth, particularly in Pennsylvania. We also intend to continue to develop and tailor our commercial programs to enable our products to meet the needs of the customers served by our producers. Our religious institutions, "main street" business and commercial automobile programs are successful examples of this effort. Reduce our ratio of expenses to net premiums earned. We are committed to improving our profitability by reducing expenses through the use of enhanced technology and by increasing our premium writings through the strategic deployment of our capital. Currently, we are in the process of converting our information systems 60 from an outside service bureau to an internally staffed system. We expect that this project will be completed by December 31, 2004. When completed, we will be able to eliminate the cost of the outside service bureau. In addition, the additional capital raised in the conversion will allow us to expand our premium writings while maintaining appropriate premium to surplus ratios. We anticipate that this increase in writings can be achieved without a commensurate increase in expenses, and will therefore help to reduce our expense ratio. Reduce our reliance on reinsurance. We intend to reduce our reliance on reinsurance by increasing the maximum exposure retained by our insurance companies on individual property and casualty risks. The capital raised in the conversion and contributed or available for contribution to our insurance subsidiaries will be available to cover losses. Therefore, this capital will enable us to retain higher maximum exposure amounts under our reinsurance agreements. We will determine the appropriate increase in our maximum exposure based on a number of factors, which include: - the amount of capital raised in the conversion; - our evaluation of our ability to incur multiple losses; and - the revised terms and limits that we establish with our reinsurers. A decrease in reinsurance would result in a decrease in ceded premiums and a corresponding increase in net premium income, but would increase our risk of loss. OUR INSURANCE COMPANIES Mercer Mutual is a Pennsylvania mutual insurance company that was originally incorporated under a special act of the legislature of the State of New Jersey in 1844. Mercer Mutual commenced operations under the name Mercer County Mutual Fire Insurance Company, which was changed to its current name in 1958. On October 16, 1997, Mercer Mutual filed Articles of Domestication with Pennsylvania thereby changing its state of domicile from New Jersey to Pennsylvania. Mercer Mutual owns all of the issued and outstanding capital stock of Queenstown Holding Company, Inc., which owns all of the issued and outstanding capital stock of Mercer Insurance Company of New Jersey, Inc. Mercer Mutual has a controlling interest in Franklin Holding, which owns all of the issued and outstanding capital stock of Franklin Insurance Company. Mercer Mutual is a property and casualty insurer of small and medium-sized businesses and property owners located in New Jersey and Pennsylvania. Mercer Mutual markets commercial multi-peril and homeowners policies, as well as other liability, workers' compensation, fire, allied, inland marine and commercial automobile coverages through over 200 independent producers. Mercer Mutual does not market private passenger automobile coverage. Mercer Mutual is subject to examination and comprehensive regulation by the Pennsylvania Insurance Department. See "Business -- Regulation." Mercer Insurance Company of New Jersey, Inc. is a property and casualty stock insurance company that was incorporated in 1981. It offers only workers' compensation insurance to businesses located in New Jersey. However, Mercer Insurance Company of New Jersey, Inc. also is authorized to write the same types of insurance offered by Mercer Mutual. Mercer Insurance Company of New Jersey, Inc. is subject to examination and comprehensive regulation by the New Jersey Department of Banking and Insurance. See "Business -- Regulation." Franklin Insurance Company is a property and casualty stock insurance company that was incorporated in 1997. Mercer Mutual acquired 49% of the common stock of Franklin Holding, which owns 100% of Franklin Insurance Company, on June 1, 2001. Mercer Mutual controls Franklin Holding and Franklin Insurance Company pursuant to, among other things, a shareholders' agreement among Mercer Mutual, Franklin Holding and H. Thomas Davis, Jr., the founder of Franklin Insurance Company and the owner of the remaining 51% of the outstanding Franklin Holding common stock. (Mr. Davis also is an officer and director of Mercer Mutual.) Under this agreement, Mr. Davis has agreed to elect and maintain a board of directors for Franklin Holding and Franklin Insurance Company consisting of Mercer Mutual's seven directors, Mr. Davis and one other director selected by Mr. Davis. Mercer Mutual has agreed that for so long as Mr. Davis and 61 Mercer each continue to own shares of Franklin Holding, Mercer Mutual will use its best efforts to cause Mr. Davis to be elected to the Board of Directors of Mercer Mutual and each of its subsidiaries. This shareholders' agreement also restricts Mr. Davis from transferring any of his shares in Franklin Holding to any person other than Mercer Mutual unless he has received a bona fide offer from a third party to purchase such shares. If so, Mercer Mutual has the right of first refusal to purchase Mr. Davis' shares on terms and conditions, including price, that are no less favorable to Mercer Mutual than those which the third party has proposed to Mr. Davis. Mr. Davis also has the right to require Mercer Mutual to purchase his Franklin Holding shares at any time after September 3, 2007, or prior to such date in the event of his death or disability, the expiration of his employment agreement or the acquisition, merger, consolidation or reorganization of Mercer Mutual. The purchase price is determined pursuant to a formula set forth in the agreement that is based on the greater of Mercer Mutual's aggregate return on its investment in Franklin Holding since June 1, 2001, or Mercer Mutual's aggregate return on equity since June 1, 2001. This purchase price cannot be less than $1.97 million. This is the same formula that is being used to determine the number of shares of Holding Company common stock that will be delivered to Mr. Davis in exchange for his Franklin Holding stock immediately after completion of the conversion. Mercer Mutual has a corresponding right to purchase these shares at that same price at any time after September 3, 2007 or in the event Mr. Davis resigns his employment prior to June 1, 2004 without good reason. Because all shares of capital stock of Franklin Holding will be exchanged for Holding Company common stock immediately after the conversion, we will own all the capital stock of Franklin Holding and the shareholder agreement will terminate. Currently, Franklin Insurance Company offers private passenger automobile and homeowners insurance to individuals located in Pennsylvania. Franklin Insurance Company is represented by approximately 50 independent producers. All transactions conducted between Franklin Insurance Company and its producers are performed electronically. Franklin Insurance Company is subject to examination and comprehensive regulation by the Pennsylvania Insurance Department. See the subsection entitled "Regulation" under the heading "Business." THE HOLDING COMPANY We incorporated the Holding Company so that it could acquire all of Mercer Mutual's capital stock in the conversion. Because the Holding Company and Mercer Mutual already are under common control, the acquisition by the Holding Company of the stock of Mercer Mutual is not treated as a change in control of Mercer Mutual that requires further regulatory approval. Prior to the conversion, the Holding Company has not engaged and will not engage in any significant operations. After the conversion, the Holding Company's primary assets will be the outstanding capital stock of Mercer Mutual and a portion of the net proceeds of the conversion. We believe that the holding company structure will give us greater flexibility to expand our operations and the products and services we offer, although presently there are no definitive plans or arrangements for any expansion. We will be able to diversify our business through existing or newly formed subsidiaries or through the issuance of capital stock to make acquisitions or to obtain additional financing in the future. The portion of the net proceeds from the sale of common stock in the conversion that the Holding Company will contribute to Mercer Mutual will increase Mercer Mutual's surplus. This increase in surplus will enhance policyholder protection and increase the amount of funds available to support both current operations and future growth. After the conversion, the Holding Company will be subject to regulation by the Pennsylvania Insurance Department and the New Jersey Department of Banking and Insurance as its primary regulators because it will be the holding company for Mercer Mutual, Mercer Insurance Company of New Jersey, Inc. and its holding company, Queenstown Holding Company, Inc., Franklin Holding, and Franklin Insurance Company. 62 COMMERCIAL LINES PRODUCTS The following tables set forth the direct premiums written, net premiums earned, net loss ratios, expense ratios and combined ratios of our commercial lines products on a consolidated basis for the periods indicated:
THREE MONTHS ENDED MARCH 31, YEAR ENDED DECEMBER 31, --------------- --------------------------- 2003 2002 2002 2001 2000 ------ ------ ------- ------- ------- (DOLLARS IN THOUSANDS) Direct Premiums Written: Commercial multi-peril.................... $3,602 $2,905 $13,485 $ 9,689 $ 7,723 Other liability........................... 1,790 1,468 6,641 4,760 4,277 Workers' compensation..................... 1,022 974 3,665 2,943 2,251 Commercial automobile..................... 742 899 2,787 2,239 1,874 Fire, allied, inland marine............... 207 188 910 675 503 ------ ------ ------- ------- ------- Total................................... 7,363 6,434 $27,489 $20,306 $16,628 ====== ====== ======= ======= ======= Net Premiums Earned: Commercial multi-peril.................... 2,832 2,119 9,631 7,101 6,916 Other liability........................... 1,358 1,033 4,810 3,727 3,134 Workers' compensation..................... 753 569 2,735 2,015 1,687 Commercial automobile..................... 669 539 2,478 1,967 1,588 Fire, allied, inland marine............... 124 111 434 309 360 ------ ------ ------- ------- ------- Total................................... $5,736 $4,371 $20,088 $15,119 $13,685 ====== ====== ======= ======= ======= Net Loss Ratios: Commercial multi-peril.................... 23.8% 36.8% 40.7% 34.8% 38.2% Other liability........................... 18.1 25.1 21.5 44.5 17.3 Workers' compensation..................... 44.6 34.1 38.4 45.8 48.3 Commercial automobile..................... 97.3 42.9 49.9 58.9 68.6 Fire, allied, inland marine............... 37.0 17.6 9.3 69.9 22.3 ------ ------ ------- ------- ------- Total................................... 34.1% 33.9% 36.3% 42.5% 37.7% ====== ====== ======= ======= ======= Expense Ratio Commercial multi-peril.................... 50.9% 54.7% 54.3% 51.6% 45.7% Other liability........................... 46.3 50.2 47.7 45.3 47.2 Workers' compensation..................... 41.4 44.1 38.4 45.2 42.9 Commercial automobile..................... 38.0 51.2 42.0 39.3 41.0 Fire, allied, inland marine............... 54.7 65.0 68.9 66.3 46.7 ------ ------ ------- ------- ------- Total................................... 47.2% 52.1% 49.3% 47.9% 45.2% ====== ====== ======= ======= =======
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THREE MONTHS ENDED MARCH 31, YEAR ENDED DECEMBER 31, --------------- --------------------------- 2003 2002 2002 2001 2000 ------ ------ ------- ------- ------- (DOLLARS IN THOUSANDS) Combined Ratios(1): Commercial multi-peril.................... 74.7% 91.5% 95.0% 86.4% 83.9% Other liability........................... 64.4 75.3 69.2 59.8 64.5 Workers' compensation..................... 86.0 78.2 76.8 91.0 91.2 Commercial automobile..................... 135.3 94.1 91.9 98.2 109.6 Fire, allied, inland marine............... 91.7 82.6 78.2 136.2 69.0 ------ ------ ------- ------- ------- Total................................... 81.3% 86.0% 85.6% 90.4% 82.9% ====== ====== ======= ======= =======
- --------------- (1) A combined ratio over 100% means that an insurer's underwriting operations are not profitable. Commercial Multi-Peril. We write a number of multi-peril policies in New Jersey and Pennsylvania providing property and liability coverage. These policies include larger apartment risks, condominium associations and 3-4 family dwelling policies. Various other risk classes also are written on this policy. As of March 31, 2003, approximately 1,200 multi-peril policies were in force. We are working to increase market penetration for this product because it includes commercial liability risks that have more flexible and profitable rate structures. One of these marketing initiatives relates to certain habitational classes of business. Due to recent market conditions, we have targeted our business generation efforts toward condominium associations and garden style apartment complexes. Because pricing has returned to more supportable levels, we have taken this opportunity to underwrite many of these businesses. Many national insurance carriers have decided not to underwrite condominium associations and garden style apartment complexes because of a perceived inability to underwrite such business profitably. This practice of avoiding a class of business due to such an underwriting perception is known as "class underwriting." Class underwriting is often implemented by carriers in hard market cycles, which the insurance industry is currently experiencing. Condominium associations and garden style apartment complexes as a class have been determined to be unprofitable by many national carriers because the pricing of this business has been driven to inefficient levels during the soft market cycle. Therefore, they are avoiding this class of business entirely, and ignoring any individual risks within the class that can be underwritten profitably. This approach has allowed Mercer Mutual greater ability to underwrite and price these risks at appropriate levels. We also have a business owners policy that provides property and liability coverages to small businesses. This product is marketed to several distinct groups: (i) apartment building owners with 75 or fewer units; (ii) condominium associations; (iii) business owners who lease their buildings to tenants; (iv) mercantile business owners, such as florists, delicatessens, and beauty parlors; and (v) offices with owner or tenant occupancies. As of March 31, 2003, approximately 4,200 business owners policies were in force. We also offer a specialized multi-peril policy specifically designed for religious institutions. This enhanced product includes directors and officers coverage, religious counseling coverage and systems breakdown coverage (through a reinsurance arrangement). Coverage for child care centers and schools also is available. As of March 31, 2003, approximately 500 commercial multi-peril policies written for religious institutions were in force. Other Liability. We write liability coverage for insureds who do not have property exposure or whose property exposure is insured elsewhere. The majority of these policies are written for small contractors such as carpenters, painters or electricians, who choose to self-insure small property exposures. Coverage for both premises and a limited amount of products liability exposures are regularly provided. Coverage is provided for other exposures such as vacant land and habitational risks. Approximately 1,800 commercial general liability policies were in force as of March 31, 2003. Commercial umbrella coverage is available for insureds who insure their primary general liability exposures with Mercer Mutual through a business owners, commercial multi-peril, religious institution or 64 commercial general liability policy. This coverage typically has limits of $1,000,000 to $5,000,000, but higher limits are available if needed. To improve processing efficiencies and maintain underwriting standards, we prefer to offer this coverage as an endorsement to the underlying liability policy rather than as a separate stand-alone policy. Workers' Compensation. We write workers' compensation policies in conjunction with an otherwise eligible business owners, commercial multi-peril, religious institution, commercial property or general liability policy. As of March 31, 2003, most of our workers' compensation insureds have other policies with us. There were approximately 2,300 workers' compensation policies in effect as of December 31, 2002. Commercial Automobile. This product is designed to cover light and medium weight trucks used in business, as well as company-owned private passenger type vehicles. Other specialty classes such as church vans and funeral director vehicles also can be covered. The policy is marketed as a companion offering to our business owners, commercial multi-peril, religious institution, commercial property or general liability policies. Approximately 800 commercial automobile policies were in force as of March 31, 2003. Fire, Allied Lines and Inland Marine. Fire and allied lines insurance generally covers fire, lightning, and removal and extended coverage. Inland marine coverage insures merchandise or cargo in transit and business and personal property. We offer these coverages for property exposures in cases where it is not insuring the companion liability exposures. Generally, the rates charged on these policies are higher than those for the same property exposures written on a multi-peril or business owners policy. PERSONAL LINES PRODUCTS The following tables set forth the direct premiums written, net premiums earned, net loss ratios, expense ratios and combined ratios of our personal lines products on a consolidated basis for the periods indicated:
THREE MONTHS ENDED YEAR ENDED MARCH 31, DECEMBER 31, ------------------ --------------------------- 2003 2002 2002 2001 2000 ------- ------- ------- ------- ------- (IN THOUSANDS) Direct Premiums Written: Homeowners...................... $3,015 $2,740 $13,698 $13,282 $12,031 Personal automobile............. 2,004 1,700 6,865 4,926 -- Fire, allied, inland marine..... 504 510 2,227 2,349 2,475 Other liability................. 123 121 528 554 567 Workers' compensation........... 10 11 51 79 81 ------ ------ ------- ------- ------- Total......................... $5,656 $5,082 $23,369 $21,191 $15,154 ====== ====== ======= ======= ======= Net Premiums Earned: Homeowners...................... $3,082 $3,012 $11,874 $10,951 $10,999 Personal automobile............. 1,611 1,403 5,948 1,897 -- Fire, allied, inland marine..... 531 550 2,162 2,343 2,494 Other liability................. 85 90 322 348 382 Workers' compensation........... 11 18 60 70 75 ------ ------ ------- ------- ------- Total......................... $5,320 $5,073 $20,366 $15,609 $13,950 ====== ====== ======= ======= =======
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THREE MONTHS ENDED YEAR ENDED MARCH 31, DECEMBER 31, ------------------ --------------------------- 2003 2002 2002 2001 2000 ------- ------- ------- ------- ------- (IN THOUSANDS) Net Loss Ratios: Homeowners...................... 88.2% 71.2% 68.1% 49.5% 68.4% Personal automobile............. 78.9 67.2 67.8 78.4 -- Fire, allied, inland marine..... 62.9 9.2 14.8 42.8 32.2 Other liability................. 279.0 13.5 102.7 57.5 57.5 Workers' compensation........... 3.3 8.1 29.3 0.0 0.2 ------ ------ ------- ------- ------- Total......................... 85.7% 62.1% 62.8% 52.0% 61.3% ====== ====== ======= ======= ======= Expense Ratio Homeowners...................... 40.2% 42.4% 46.5% 44.6% 42.3% Personal automobile............. 38.4 36.0 39.6 49.8 -- Fire, allied, inland marine..... 42.3 45.1 45.6 42.9 41.8 Other liability................. 36.6 33.1 41.4 40.8 38.3 Workers' compensation........... 24.8 16.6 24.7 40.3 39.0 ------ ------ ------- ------- ------- Total......................... 39.8% 40.7% 44.2% 44.8% 42.1% ====== ====== ======= ======= ======= Combined Ratios(1): Homeowners...................... 128.4% 113.6% 114.6% 94.1% 110.7% Personal automobile............. 117.3 103.2 107.4 128.2 -- Fire, allied, inland marine..... 105.2 54.3 60.4 85.7 74.0 Other liability................. 315.6 46.6 144.1 98.3 95.8 Workers' compensation........... 28.1 24.7 54.0 40.3 39.2 ------ ------ ------- ------- ------- Total......................... 125.5% 102.8% 107.0% 96.8% 103.4% ====== ====== ======= ======= =======
Homeowners. Our homeowners policy is a multi-peril policy providing property and liability coverages and optional inland marine coverage. The homeowners policy is sold to provide coverage for an insured's residence. We market both a standard and a preferred homeowner product. The preferred product is offered at a discount to our standard rates to our customers who have a lower risk of loss. As of March 31, 2003, we had approximately 25,000 homeowners policies in force, with 33.9% of those being the preferred product. Personal Automobile. We write comprehensive personal automobile coverage including liability, property damage and all state required insurance minimums for individuals domiciled in Pennsylvania. This product is multi-tiered with an emphasis placed on individuals with lower than average risk profiles. As of March 31, 2003, we had approximately 8,200 personal automobile policies in force. We do not write any private passenger automobile products in New Jersey. Combination Dwelling Policy. Our combination dwelling product is a flexible, multi-line package of insurance coverage. It is targeted to be written on an owner or tenant occupied dwelling of no more than two families. The dwelling policy combines property and liability insurance but also may be written on a monoline basis. The property portion is considered a fire, allied lines and inland marine policy, and the liability portion is considered an other liability policy. Approximately 3,700 combination dwelling policies were in force as of March 31, 2003. Other Liability. We write personal line excess liability, or "umbrella," policies covering personal liabilities in excess of amounts covered under Mercer Mutual's homeowners policies. These policies are available generally with limits of $1 million to $5 million. We do not market excess liability policies to individuals unless we also write an underlying primary liability policy. 66 Workers' Compensation. A small portion of our workers' compensation premiums are considered personal lines insurance because our New Jersey homeowners policy is required to include workers' compensation coverage for domestic employees. MARKETING We market our insurance products in New Jersey and Pennsylvania exclusively through independent producers. All of these producers represent multiple carriers and are established businesses in the communities in which they operate. They generally market and write the full range of our insurance companies' products. We consider our relationships with our producers to be good. Our insurance companies manage their producers through quarterly business reviews (with underwriter participation) and establishment of benchmarks/goals for premium volume and profitability. Our insurance companies in recent years have eliminated a number of low volume or unprofitable producers. For the three months ended March 31, 2003 and the year ended December 31, 2002, our two largest producers accounted for approximately 22.0% and 23.0% of our direct premiums written, respectively. One of these agencies is the Davis Insurance Agency which is owned by H. Thomas Davis, Jr., a director and employee of Mercer Mutual and the founder of Franklin Insurance Company. Mercer Mutual has an option to acquire the Davis Insurance Agency. The other top producer is Brown & Brown, Inc., which is not affiliated with us. No other producer accounted for more than 5% of our direct premiums written. For the three months ended March 31, 2003 and the year ended December 31, 2002, our top 10 producers accounted for 38.7% and 39.8%, respectively, of direct premiums written, with the largest producer generating approximately $2.9 million and $7.1 million of our premium revenue, respectively. We emphasize personal contact between our producers and the policyholders. We believe that our producers' fast and efficient service and name recognition, as well as our policyholders' loyalty to and satisfaction with producer relationships are the principal sources of new customer referrals, cross-selling of additional insurance products and policyholder retention. Our insurance companies depend upon their producer force to produce new business and to provide customer service. The network of independent producers also serves as an important source of information about the needs of the communities served by our insurance companies. This information is utilized by us to develop new products and new product features. Producers are compensated through a fixed base commission with an opportunity for profit sharing depending on the producer's premiums earned and loss experience. They are monitored and supported by our marketing representatives, who are employees of BICUS Services Corporation, a wholly owned subsidiary of Mercer Mutual. These representatives also have principal responsibility for recruiting and training new producers. We periodically hold seminars for producers and conduct training programs that provide both technical training about products and sales training on how to market our products. We also provide personal computer software to producers that allows them to quote rates on various policies. Our marketing efforts are further supported by our claims philosophy, which is designed to provide prompt and efficient service, resulting in a positive experience for producers and policyholders. We believe that these positive experiences are then conveyed by producers and policyholders to many potential customers. UNDERWRITING Our insurance companies write their personal and commercial lines by evaluating each risk with consistently applied standards. We maintain information on all aspects of our business that is regularly reviewed to determine product line profitability. We also employ numerous underwriters, who generally specialize in either personal or commercial lines, and have many years of experience as underwriters. Specific information is monitored with regard to individual insureds to assist us in making decisions about policy renewals or modifications. 67 We rely on information provided by our independent producers. Subject to certain guidelines, producers also pre-screen policy applicants. The producers have the authority to sell and bind insurance coverages in accordance with pre-established guidelines. Producers' results are continuously monitored. On occasion, producers with historically poor loss ratios have had their binding authority removed until more profitable underwriting results were achieved. CLAIMS Claims on insurance policies are received directly from the insured or through our independent producers. Claims are then assigned to either an in-house adjuster or an independent adjuster, depending upon the size and complexity of the claim. The adjuster investigates and settles the claim. As of March 31, 2003, we had eight in-house adjusters and worked with numerous independent adjusters. Claims settlement authority levels are established for each claims adjuster based upon his or her level of experience. Multi-line teams exist to handle all claims. The claims department is responsible for reviewing all claims, obtaining necessary documentation, estimating the loss reserves and resolving the claims. We attempt to minimize claims costs by encouraging the use of alternative dispute resolution procedures. Less than 17.0% of all open claims under our policies have resulted in litigation. Litigated claims are assigned to outside counsel. TECHNOLOGY When Mercer Mutual was evaluating its acquisition of Franklin Holding and its subsidiary, Franklin Insurance Company, one of Franklin's attractive features was its information system. Franklin Insurance was formed in 1997 with the idea that, by building an efficient information system, it could reduce expenses for both the producer and the company. Because homeowners' and private passenger automobile insurance are largely commodity businesses, low cost product delivery is crucial, especially for small companies that do not otherwise enjoy economies of scale. Franklin Insurance licensed a flexible insurance software package and internally built a front-end Internet based interface to the system. All business generated by Franklin Insurance's producers is processed and maintained in this system through the Internet, and these producers have access to their books of business through the Internet. This system provides efficiency because information for all users is entered only one time. Prior to the commencement of our acquisition discussions with Franklin Holding, we had been analyzing the possibility of purchasing a license to use the flexible insurance software package used by Franklin Insurance. At the same time that we were performing due diligence in connection with the acquisition of Franklin Insurance, we made a strategic decision to move from a service bureau platform to that software package. However, because Mercer Mutual is an established carrier with an established means of processing business with our producers, we decided that we could not simply require our producers to process business through the Internet. Instead, we decided to build a platform that would allow a producer to produce his business through the Internet or through the method he or she has historically used. This platform should be completed by 2004. Because of the experience and knowledge of the Franklin Insurance staff with the software package, all internal programming is and will continue to be conducted at our branch office in Lock Haven, Pennsylvania. In addition to the expert knowledge of this staff, we are able to hire and maintain staff at a more efficient cost level than at the home office location in Pennington, New Jersey due to differences in the cost of living in the respective areas. The focus of our ongoing information technology effort is: - to continue to re-engineer our internal processes to allow for more efficient operations; - to improve our producers' ability to transact business with us; and - to enable our producers to efficiently provide their clients with a high level of service. 68 We believe that our technology initiative will increase revenues by making it easier for our insurance companies and producers to exchange information. Increased ease of use also should lower expenses. However, our short-term expenses have increased because of costs associated with the implementation of the new system and the need to maintain two systems during the transition. We have not taken any steps to legally protect our intellectual property under any statutory scheme. We believe our intellectual property is a trade secret that is protected under common law and provides us with some competitive advantage in the near term, but we believe Internet-based producer/company interfaces will become commonplace and commercially available interfaces will dominate the market. Therefore, we do not believe that taking costly steps to protect our intellectual property is justified. REINSURANCE Reinsurance Ceded. In accordance with insurance industry practice, our insurance companies reinsure a portion of their exposure and pay to the reinsurers a portion of the premiums received on all policies reinsured. Insurance policies written by our companies are reinsured with other insurance companies principally to: - reduce net liability on individual risks; - mitigate the effect of individual loss occurrences (including catastrophic losses); - stabilize underwriting results; - decrease leverage; and - increase our insurance companies' underwriting capacity. Reinsurance can be facultative reinsurance or treaty reinsurance. Under facultative reinsurance, each policy or portion of a risk is reinsured individually. Under treaty reinsurance, an agreed-upon portion of a class of business is automatically reinsured. Reinsurance also can be classified as quota share reinsurance, pro-rata insurance or excess of loss reinsurance. Under quota share reinsurance and pro-rata insurance, the ceding company cedes a percentage of its insurance liability to the reinsurer in exchange for a like percentage of premiums less a ceding commission The ceding company in turn recovers from the reinsurer the reinsurer's share of all losses and loss adjustment expenses incurred on those risks. Under excess reinsurance, an insurer limits its liability to all or a particular portion of the amount in excess of a predetermined deductible or retention. Regardless of type, reinsurance does not legally discharge the ceding insurer from primary liability for the full amount due under the reinsured policies. However, the assuming reinsurer is obligated to reimburse the ceding company to the extent of the coverage ceded. We determine the amount and scope of reinsurance coverage to purchase each year based on a number of factors. These factors include the evaluation of the risks accepted, consultations with reinsurance representatives and a review of market conditions, including the availability and pricing of reinsurance. Our reinsurance arrangements are placed with non-affiliated reinsurers, and are generally renegotiated annually. For the three months ended March 31, 2003, our insurance companies ceded to reinsurers $2.0 million of written premiums, compared to $1.6 million of written premiums for the three months ended March 31, 2002. For the year ended December 31, 2002, our insurance companies ceded to reinsurers $7.2 million of written premiums, compared to $8.3 million of written premiums for the year ended December 31, 2001. The largest exposure that we retain on any one individual property risk is $300,000. Individual property risks in excess of $300,000 are covered on an excess of loss basis pursuant to various reinsurance treaties. All property lines of business, including commercial automobile physical damage, are reinsured under the same treaties. Except for umbrella liability, individual casualty risks that are in excess of $300,000 are covered on an excess of loss basis up to $1.0 million per occurrence, pursuant to various reinsurance treaties. Casualty losses in excess of $1.0 million arising from workers' compensation claims are reinsured up to $10.0 million on a per occurrence and per person treaty basis by various reinsurers. Umbrella liability losses are reinsured on a 90% quota share basis up to $1.0 million and a 100% quota share basis in excess of $1.0 million up to $5.0 million. 69 We also purchase casualty contingency loss excess reinsurance providing $3.0 million of coverage in excess of $1.0 million. Catastrophic reinsurance protects the ceding insurer from significant aggregate loss exposure. Catastrophic events include windstorms, hail, tornadoes, hurricanes, earthquakes, riots, blizzards, terrorist activities and freezing temperatures. We purchase layers of excess treaty reinsurance for catastrophic property losses. We reinsure 100% of any catastrophic losses per occurrence in an amount between $1.0 million and up to $2.0 million, and 97.5% of losses per occurrence in excess of $2.0 million, up to a maximum of $32.0 million per occurrence. The insolvency or inability of any reinsurer to meet its obligations to us could have a material adverse effect on our results of operations or financial condition. As of March 31, 2003, our five largest reinsurers based on percentage of ceded premiums are set forth in the following table:
PERCENTAGE OF CEDED A.M. BEST NAME PREMIUMS RATING - ---- ---------- --------- 1. Motors Insurance Corporation............................ 23.5% A 2. American Re-Insurance Co. .............................. 17.5% A+ 3. SCOR Reinsurance Company................................ 19.2% A- 4. Arch Reinsurance Company................................ 5.5% A- 5. Hartford Steam Boiler................................... 4.3% A+
The following table sets forth the five largest amounts of loss and loss expenses recoverable from reinsurers on unpaid claims as of March 31, 2003.
LOSS AND LOSS EXPENSES RECOVERABLE ON A.M. BEST NAME UNPAID CLAIMS RATING - ---- -------------- --------- (IN THOUSANDS) 1. American Re-Insurance Co. .............................. $1,175 A+ 2. Motors Insurance Corporation............................ 1,022 A 3. SCOR Reinsurance Company................................ 788 A- 4. Excess Reinsurance Company.............................. 202 A- 5. PMA Capital Insurance Co. .............................. 197 A-
The A+, A and A- ratings are the second, third and fourth highest of A.M. Best's 16 ratings. According to A.M. Best, companies with a rating of "A-" or better "have an excellent ability to meet their ongoing obligations to policyholders." We monitor the solvency of reinsurers through regular review of their financial statements and, if available, their A.M. Best ratings. We have experienced no significant difficulties collecting amounts due from reinsurers. Reinsurance Assumed. We generally do not assume risks from other insurance companies. However, we are required by statute to participate in certain residual market pools. This participation requires us to assume business for workers' compensation and for property exposures that are not insured in the voluntary marketplace. We participate in these residual markets pro rata on a market share basis, and as of March 31, 2003, our participation is not material. LOSS AND LAE RESERVES Our insurance companies are required by applicable insurance laws and regulations to maintain reserves for payment of losses and loss adjustment expenses (LAE). These reserves are established for both reported claims and for claims incurred but not reported (IBNR), arising from the policies they have issued. The laws and regulations require that provision be made for the ultimate cost of those claims without regard to how long it takes to settle them or the time value of money. The determination of reserves involves actuarial and statistical projections of what our insurance companies expect to be the cost of the ultimate settlement and 70 administration of such claims. The reserves are set based on facts and circumstances then known, estimates of future trends in claims severity, and other variable factors such as inflation and changing judicial theories of liability. Estimating the ultimate liability for losses and LAE is an inherently uncertain process. Therefore, the reserve for losses and LAE does not represent an exact calculation of that liability. Our reserve policy recognizes this uncertainty by maintaining reserves at a level providing for the possibility of adverse development relative to the estimation process. We do not discount our reserves to recognize the time value of money. When a claim is reported to us, our claims personnel establish a "case reserve" for the estimated amount of the ultimate payment. This estimate reflects an informed judgment based upon general insurance reserving practices and on the experience and knowledge of the estimator. The individual estimating the reserve considers the nature and value of the specific claim, the severity of injury or damage, and the policy provisions relating to the type of loss. Case reserves are adjusted by our claims staff as more information becomes available. It is our policy to settle each claim as expeditiously as possible. We maintain IBNR reserves to provide for already incurred claims that have not yet been reported and developments on reported claims. The IBNR reserve is determined by estimating our insurance companies' ultimate net liability for both reported and IBNR claims and then subtracting the case reserves for reported claims. Each quarter, we compute our estimated ultimate liability using principles and procedures applicable to the lines of business written. However, because the establishment of loss reserves is an inherently uncertain process, we cannot assure you that ultimate losses will not exceed the established loss reserves. Adjustments in aggregate reserves, if any, are reflected in the operating results of the period during which such adjustments are made. We do not believe our insurance companies are subject to any material potential asbestos or environmental liability claims. The following table provides a reconciliation of beginning and ending consolidated loss and LAE reserve balances of Mercer Mutual and its subsidiaries for the three months ended March 31, 2003 and 2002 and the years ended December 31, 2002, 2001 and 2000, prepared in accordance with GAAP. RECONCILIATION OF RESERVE FOR LOSSES AND LOSS ADJUSTMENT EXPENSES
THREE MONTHS ENDED MARCH 31, YEAR ENDED DECEMBER 31, ------------------- --------------------------- 2003 2002 2002 2001 2000 -------- -------- ------- ------- ------- (IN THOUSANDS) Reserves for losses and loss adjustment expenses at the beginning of period........ $31,348 $31,059 $31,059 $28,766 $29,471 Less: Reinsurance recoverable and receivables................................ (4,150) (5,425) (5,425) (4,675) (5,828) ------- ------- ------- ------- ------- Net reserves for losses and loss adjustment expenses at beginning of period............ 27,198 25,634 25,634 24,091 23,643 ------- ------- ------- ------- ------- Add: Provision for losses and loss adjustment expenses for claims occurring in: The current year........................... 6,637 5,354 22,211 17,813 17,665 Prior years................................ (123) (720) (2,144) (3,279) (3,954) ------- ------- ------- ------- ------- Total incurred losses and loss adjustment expenses................................ 6,514 4,634 20,067 14,534 13,711 ------- ------- ------- ------- ------- Less: Loss and loss adjustment expenses payments for claims occurring in: The current year........................... 1,942 1,260 11,128 7,265 7,421 Prior years................................ 3,265 2,619 7,735 5,726 5,842 ------- ------- ------- ------- -------
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THREE MONTHS ENDED MARCH 31, YEAR ENDED DECEMBER 31, ------------------- --------------------------- 2003 2002 2002 2001 2000 -------- -------- ------- ------- ------- (IN THOUSANDS) Total losses and loss adjustment expenses paid....................................... 5,207 3,879 18,503 12,991 13,263 ------- ------- ------- ------- ------- Net reserves for losses and loss adjustment expenses at end of period.................. 28,505 26,389 27,198 25,634 24,091 Add: Reinsurance recoverables and receivables................................ 4,415 4,676 4,150 5,425 4,675 ------- ------- ------- ------- ------- Reserves for losses and loss adjustment expenses at end of period.................. $32,920 $31,065 $31,348 $31,059 $28,766 ======= ======= ======= ======= =======
The following table shows the development of our consolidated reserves for unpaid losses and LAE from 1992 through 2002 on a GAAP basis. The top line of the table shows the liabilities at the balance sheet date, including losses incurred but not yet reported. The upper portion of the table shows the cumulative amounts subsequently paid as of successive years with respect to the liability. The lower portion of the table shows the reestimated amount of the previously recorded liability based on experience as of the end of each succeeding year. The estimates change as more information becomes known about the frequency and severity of claims for individual years. The redundancy (deficiency) exists when the reestimated liability at each December 31 is less (greater) than the prior liability estimate. The "cumulative redundancy (deficiency)" depicted in the table, for any particular calendar year, represents the aggregate change in the initial estimates over all subsequent calendar years.
YEAR ENDED DECEMBER 31, --------------------------------------------------------- 1992 1993 1994 1995 1996 1997 ------- ------- ------- ------- ------- ------- (IN THOUSANDS) Liability for unpaid losses and LAE net of reinsurance recoverable.... $20,067 $18,995 $18,298 $19,357 $20,074 $19,851 Cumulative amount of liability paid through: One year later.................... 6,329 6,023 6,935 6,368 6,042 4,536 Two years later................... 9,940 9,786 10,272 9,554 8,829 7,537 Three years later................. 12,723 12,144 12,336 11,539 11,143 9,738 Four years later.................. 14,160 13,590 13,228 12,819 12,472 10,975 Five years later.................. 14,852 14,350 13,749 13,690 13,422 11,550 Six years later................... 15,220 14,832 14,079 14,196 13,826 Seven years later................. 15,526 15,059 14,373 14,450 Eight years later................. 15,654 15,331 14,605 Nine years later.................. 15,819 15,466 Ten years later................... 15,943 Liability estimated as of: One year later.................... 18,246 17,746 17,344 17,712 19,018 17,874 Two years later................... 17,603 17,088 16,860 17,247 17,634 16,440 Three years later................. 16,985 16,779 16,495 16,568 16,987 14,711 Four years later.................. 16,490 16,244 15,810 16,208 15,905 14,204 Five years later.................. 16,225 16,026 15,641 15,680 15,769 13,914 Six years later................... 16,191 16,009 15,376 15,584 15,483 Seven years later................. 16,273 15,929 15,358 15,573 Eight years later................. 16,272 15,948 15,424 Nine years later.................. 16,253 16,003 Ten years later................... 16,306
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YEAR ENDED DECEMBER 31, --------------------------------------------------------- 1992 1993 1994 1995 1996 1997 ------- ------- ------- ------- ------- ------- (IN THOUSANDS) Cumulative total redundancy (deficiency)...................... 3,761 2,992 2,874 3,783 4,590 5,937 Gross liability -- end of year...... 38,472 33,308 35,531 36,176 35,221 31,872 Reinsurance recoverables............ 18,405 14,313 17,233 16,819 15,147 12,021 ------- ------- ------- ------- ------- ------- Net liability -- end of year........ $20,067 $18,995 $18,298 $19,357 $20,074 $19,851 ======= ======= ======= ======= ======= ======= Gross reestimated liability -- latest............... 32,873 27,658 27,905 27,311 25,186 21,878 Reestimated reinsurance recoverables -- latest............ 16,567 11,655 12,481 11,738 9,703 7,964 ------- ------- ------- ------- ------- ------- Net reestimated liability -- latest............... 16,306 16,003 15,424 15,573 15,483 13,914 ======= ======= ======= ======= ======= ======= Gross cumulative redundancy (deficiency)...................... 5,599 5,650 7,626 8,865 10,035 9,994 ======= ======= ======= ======= ======= =======
YEAR ENDED DECEMBER 31, ----------------------------------------------- 1998 1999 2000 2001 2002 ------- ------- ------- ------- ------- (IN THOUSANDS) Liability for unpaid losses and LAE net of reinsurance recoverable.................... $22,565 $23,643 $24,091 $25,634 $27,198 Cumulative amount of liability paid through: One year later............................. 5,525 5,842 5,725 2,376 -- Two years later............................ 8,655 8,627 9,428 Three years later.......................... 10,605 11,237 Four years later........................... 11,893 Five years later........................... Six years later............................ Seven years later.......................... Eight years later.......................... Nine years later........................... Ten years later............................ Liability estimated as of: One year later............................. 19,909 19,689 20,810 23,490 -- Two years later............................ 17,478 18,506 19,539 Three years later.......................... 16,625 17,483 Four years later........................... 15,826 Five years later........................... Six years later............................ Seven years later.......................... Eight years later.......................... Nine years later........................... Ten years later............................ Cumulative total redundancy (deficiency)..... 6,740 6,160 4,551 2,144 -- Gross liability -- end of year............... 30,948 29,471 28,766 31,059 31,348 Reinsurance recoverables..................... 8,383 5,828 4,675 5,425 4,150 ------- ------- ------- ------- ------- Net liability -- end of year................. $22,565 $23,643 $24,091 $25,634 $27,198 ======= ======= ======= ======= =======
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YEAR ENDED DECEMBER 31, ----------------------------------------------- 1998 1999 2000 2001 2002 ------- ------- ------- ------- ------- (IN THOUSANDS) Gross reestimated liability -- latest........ 20,991 22,003 23,376 28,113 Reestimated reinsurance recoverables -- latest..................... 5,165 4,520 3,837 4,623 ------- ------- ------- ------- Net reestimated liability -- latest.......... 15,826 17,483 19,539 23,490 ======= ======= ======= ======= Gross cumulative redundancy (deficiency)..... 9,957 7,468 5,390 2,946 ======= ======= ======= =======
INVESTMENTS On a consolidated basis, all of our investment securities are classified as available for sale and are carried at fair market value. An important component of our consolidated operating results has been the return on invested assets. Our investment objectives are (i) to maximize current yield, (ii) to maintain safety of capital through a balance of high quality, diversified investments that minimize risk, (iii) to maintain adequate liquidity for our insurance operations, (iv) to meet regulatory requirements, and (v) to increase surplus through appreciation. However, in order to enhance the yield on our fixed income securities, our investments generally have a longer duration than the life of our liabilities. See the section of this prospectus entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations" under the subsection entitled "Quantitative and Qualitative Information about Market Risk." Our investment policy requires that investments be made in a portfolio consisting of bonds, common stock and short-term money market instruments. Our equity investments are concentrated in companies with larger capitalizations. However, our single largest equity holding, valued at $1.2 million, is our investment in the common stock of Excess Reinsurance Company, which is a privately held, illiquid security. The policy does not permit investment in unincorporated businesses, private placements or direct mortgages, foreign denominated securities, financial guarantees or commodities. The Board of Directors of Mercer Mutual has developed this investment policy and reviews it periodically. The following table sets forth consolidated information concerning our investments. The table reflects our decision during 2002, after a review of our state and municipal bond portfolio, to sell those bonds that in our opinion had a strong likelihood to be redeemed in the near future in order to re-deploy the proceeds.
AT MARCH 31, 2003 AT DECEMBER 31, 2002 AT DECEMBER 31, 2001 -------------------- -------------------- -------------------- COST(2) FAIR VALUE COST(2) FAIR VALUE COST(2) FAIR VALUE ------- ---------- ------- ---------- ------- ---------- (IN THOUSANDS) Fixed income securities(1): United states government and government agencies............ $36,778 $37,319 $38,802 $39,499 $20,337 $19,964 Obligations of states and Political subdivisions........ 4,678 4,806 5,976 6,149 19,846 19,577 Industrial and miscellaneous....... 2,637 2,655 3,216 3,259 3,674 3,628 Mortgage-backed securities.......... 280 282 336 340 918 909 ------- ------- ------- ------- ------- ------- Total fixed income securities........ 44,373 45,062 48,330 49,247 44,775 44,078 Equity securities...... 15,346 18,651 16,697 20,332 14,486 20,653 ------- ------- ------- ------- ------- ------- Total............... $59,719 63,713 $65,027 $69,579 $59,261 $64,731 ======= ======= ======= ======= ======= =======
74 - --------------- (1) In our consolidated financial statements, investments are carried at fair value as established by quoted market prices on secondary markets. (2) Original cost of equity securities; original cost of fixed income securities adjusted for amortization of premium and accretion of discount. The table below contains consolidated information concerning the investment ratings of our fixed maturity investments at March 31, 2003.
AMORTIZED TYPE/RATINGS OF INVESTMENT(1) COST FAIR VALUE PERCENTAGES(2) - ----------------------------- --------- ---------- -------------- (IN THOUSANDS) U.S. Government and agencies....................... $36,778 $37,319 82.8% AAA................................................ 1,961 2,039 4.5% AA................................................. 1,507 1,536 3.4% A.................................................. 3,589 3,622 8.0% BBB................................................ 516 522 1.2% In default......................................... 22 24 0.1% ------- ------- ----- Total............................................ $44,373 $45,062 100.0% ======= ======= =====
- --------------- (1) The ratings set forth in this table are based on the ratings assigned by Standard & Poor's Corporation (S&P). If S&P's ratings were unavailable, the equivalent ratings supplied by Moody's Investors Services, Inc., Fitch Investors Service, Inc. or the NAIC were used where available. (2) Represents percent of fair value for classification as a percent of total for each portfolio. The table below sets forth the maturity profile of our consolidated fixed maturity investments as of March 31, 2003:
AMORTIZED MATURITY COST(1) FAIR VALUE PERCENTAGES(2) - -------- --------- ---------- -------------- (IN THOUSANDS) 1 year or less..................................... $ 251 $ 259 0.6% More than 1 year through 5 years................... 4,222 4,243 9.4% More than 5 years through 10 years................. 23,869 24,314 54.0% More than 10 years................................. 15,751 15,964 35.4% Mortgage-backed securities(3)...................... 280 282 0.6% ------- ------- ----- Total............................................ $44,373 $45,062 100.0% ======= ======= =====
- --------------- (1) Fixed maturities are carried at fair value in our consolidated financial statements beginning on page F-1. (2) Represents percent of fair value of the classification as a percent of the total. (3) Mortgage-backed securities consist of mortgage pass-through holdings and securities collateralized by home equity loans. These securities are presented separately in the maturity schedule due to the inherent risk associated with prepayment or early amortization. The average duration of this portfolio is 1.2 years. Prepayment rates are influenced by a number of factors that cannot be predicted with certainty, including: the relative sensitivity of the underlying mortgages or other collateral to changes in interest rates; a variety of economic, geographic and other factors; and the repayment priority of the securities in the overall securitization structures. The average duration of our fixed maturity investments, excluding mortgage backed securities that are subject to prepayment, was approximately 6.7 years as of March 31, 2003. As a result, the market value of our investments may fluctuate significantly in response to changes in interest rates. In addition, we may experience investment losses to the extent our liquidity needs require the disposition of fixed maturity securities in unfavorable interest rate environments. 75 Our consolidated average cash and invested assets, net investment income and return on average cash and invested assets for the three months ended March 31, 2003 and 2002 and the years ended December 31, 2002, 2001 and 2000 were as follows:
THREE MONTHS ENDED MARCH 31, YEAR ENDED DECEMBER 31, ------------------- --------------------------- 2003 2002 2002 2001 2000 -------- -------- ------- ------- ------- (IN THOUSANDS) Average cash and invested assets..... $75,448 $72,460 $74,973 $71,111 $65,678 Net investment income................ 427 529 2,061 2,425 2,517 Return on average cash and invested assets............................. 2.3% 2.9% 2.7% 3.4% 3.8%
A.M. BEST RATING A.M. Best rates insurance companies based on factors of concern to policyholders. A.M. Best currently assigns an "A" (Excellent) rating to our insurance companies as a group. This rating is the third highest out of 16 rating classifications. According to the A.M. Best guidelines, A.M. Best assigns "A" ratings to companies that have, on balance, excellent balance sheet strength, operating performance and business profiles. Companies rated "A" are considered by A.M. Best to have "an excellent ability to meet their ongoing obligations to policyholders." In evaluating a company's financial and operating performance, A.M. Best reviews: - the company's profitability, leverage and liquidity; - its book of business; - the adequacy and soundness of its reinsurance; - the quality and estimated market value of its assets; - the adequacy of its reserves and surplus; - its capital structure; - the experience and competence of its management; and - its marketing presence. COMPETITION The property and casualty insurance market is highly competitive. Our insurance companies compete with stock insurance companies, mutual companies, local cooperatives and other underwriting organizations. Certain of these competitors have substantially greater financial, technical and operating resources than our insurance companies. Our ability to compete successfully in our principal markets is dependent upon a number of factors, many of which are outside our control. These factors include market and competitive conditions. Many of our lines of insurance are subject to significant price competition. Some companies may offer insurance at lower premium rates through the use of salaried personnel or other distribution methods, rather than through independent producers paid on a commission basis (as our insurance companies do). In addition to price, competition in our lines of insurance is based on quality of the products, quality and speed of service, financial strength, ratings, distribution systems and technical expertise. 76 REGULATION General. Insurance companies are subject to supervision and regulation in the states in which they do business. State insurance authorities have broad administrative powers to administer statutes and regulations with respect to all aspects of the insurance business including: - approval of policy forms and premium rates; - standards of solvency, including establishing statutory and risk-based capital requirements for statutory surplus; - classifying assets as admissible for purposes of determining statutory surplus; - licensing of insurers and their producers; - advertising and marketing practices; - restrictions on the nature, quality and concentration of investments; - assessments by guaranty associations; - restrictions on the ability of our insurance company subsidiaries to pay dividends to us; - restrictions on transactions between our insurance company subsidiaries and their affiliates; - restrictions on the size of risks insurable under a single policy; - requiring deposits for the benefit of policyholders; - requiring certain methods of accounting; - periodic examinations of our operations and finances; - claims practices; - prescribing the form and content of records of financial condition required to be filed; and - requiring reserves for unearned premium, losses and other purposes. State insurance laws and regulations require our insurance companies to file financial statements with insurance departments everywhere they do business, and the operations of our insurance companies and accounts are subject to examination by those departments at any time. Our insurance companies prepare statutory financial statements in accordance with accounting practices and procedures prescribed or permitted by these departments. Examinations. Examinations are conducted by the Pennsylvania Insurance Department and the New Jersey Department of Banking and Insurance every three to five years. The Pennsylvania Insurance Department's last examination of Mercer Mutual was as of December 31, 1999. Their last examination of Franklin Insurance Company also was as of December 31, 1999. The New Jersey Department of Banking and Insurance's last completed examination of Mercer Mutual and Mercer Insurance Company of New Jersey, Inc. was as of December 31, 1995. These examinations did not result in any adjustments to the financial position of any of our insurance companies. In addition, there were no substantive qualitative matters indicated in the examination reports that had a material adverse impact on the operations of our insurance companies. The Pennsylvania Insurance Department is currently conducting an examination of Franklin Insurance Company as of December 31, 2001. The New Jersey Department of Banking and Insurance is currently conducting an examination of Mercer Insurance Company of New Jersey, Inc. as of December 31, 2000. NAIC Risk-Based Capital Requirements. In 1990, the National Association of Insurance Commissioners (the "NAIC") began an accreditation program to ensure that states have adequate procedures in place for effective insurance regulation, especially with respect to financial solvency. The accreditation program requires that a state meet specific minimum standards in over five regulatory areas to be considered for accreditation. 77 The accreditation program is an ongoing process and once accredited, a state must enact any new or modified standards approved by the NAIC within two years following adoption. As of March 31, 2003, Pennsylvania and New Jersey, the states in which our insurance company subsidiaries are domiciled, were accredited. Pennsylvania and New Jersey both impose the NAIC's risk-based capital requirements that require insurance companies to calculate and report information under a risk-based formula. These risk-based capital requirements attempt to measure statutory capital and surplus needs based on the risks in a company's mix of products and investment portfolio. Under the formula, a company first determines its "authorized control level" risk-based capital. This authorized control level takes into account (i) the risk with respect to the insurer's assets; (ii) the risk of adverse insurance experience with respect to the insurer's liabilities and obligations, (iii) the interest rate risk with respect to the insurer's business; and (iv) all other business risks and such other relevant risks as are set forth in the RBC instructions. A company's "total adjusted capital" is the sum of statutory capital and surplus and such other items as the risk-based capital instructions may provide. The formula is designed to allow state insurance regulators to identify weakly capitalized companies. The requirements provide for four different levels of regulatory attention. The "company action level" is triggered if a company's total adjusted capital is less than 2.0 times its authorized control level but greater than or equal to 1.5 times its authorized control level. At the company action level, the company must submit a comprehensive plan to the regulatory authority that discusses proposed corrective actions to improve the capital position. The "regulatory action level" is triggered if a company's total adjusted capital is less than 1.5 times but greater than or equal to 1.0 times its authorized control level. At the regulatory action level, the regulatory authority will perform a special examination of the company and issue an order specifying corrective actions that must be followed. The "authorized control level" is triggered if a company's total adjusted capital is less than 1.0 times but greater than or equal to 0.7 times its authorized control level; at this level the regulatory authority may take action it deems necessary, including placing the company under regulatory control. The "mandatory control level" is triggered if a company's total adjusted capital is less than 0.7 times its authorized control level; at this level the regulatory authority is mandated to place the company under its control. The capital levels of our insurance companies have never triggered any of these regulatory capital levels. We cannot assure you, however, that the capital requirements applicable to the business of our insurance companies will not increase in the future. NAIC Ratios. The NAIC also has developed a set of 11 financial ratios referred to as the Insurance Regulatory Information System or (IRIS). On the basis of statutory financial statements filed with state insurance regulators, the NAIC annually calculates these IRIS ratios to assist state insurance regulators in monitoring the financial condition of insurance companies. The NAIC has established an acceptable range for each of the IRIS financial ratios. If four or more of its IRIS ratios fall outside the range deemed acceptable by the NAIC, an insurance company may receive inquiries from individual state insurance departments. Our insurance companies' IRIS ratios for the year ended December 31, 2002 have not yet been determined. During each of the years ended December 31, 2001 and 2000, Mercer Mutual and Mercer Insurance Company of New Jersey, Inc. did not produce results outside the acceptable range for four or more IRIS tests, and Franklin Insurance Company produced results outside the acceptable range for four or more IRIS tests only in 2001 (the change in net writings, two-year overall operating ratio, the investment yield and liabilities to liquid assets tests). The results for the change in net writings and liabilities to liquid assets tests were the result of its reinsurance arrangement with Mercer Mutual that was put in place in 2001. The results for the two-year overall operating ratio and the investment yield are the result of Franklin Insurance Company's relatively short existence. Franklin Insurance Company has not received any inquiry from the Pennsylvania Insurance Department with respect its 2001 results. Market Conduct Regulation. State insurance laws and regulations include numerous provisions governing trade practices and the marketplace activities of insurers, including provisions governing the form and content of disclosure to consumers, illustrations, advertising, sales practices and complaint handling. State regulatory authorities generally enforce these provisions through periodic market conduct examinations. To our knowledge, we are currently in compliance with these provisions. 78 Property and Casualty Regulation. Our property and casualty operations are subject to rate and policy form approval. All of the rates and policy forms that we use that require regulatory approval have been filed with and approved by the appropriate insurance regulator. Our operations are also subject to laws and regulations covering a range of trade and claim settlement practices. To our knowledge, we are currently in compliance with these laws and regulations. State insurance regulatory authorities have broad discretion in approving an insurer's proposed rates. The extent to which a state restricts underwriting and pricing of a line of business may adversely affect an insurer's ability to operate that business profitably in that state on a consistent basis. State insurance laws and regulations require us to participate in mandatory property-liability "shared market," "pooling" or similar arrangements that provide certain types of insurance coverage to individuals or others who otherwise are unable to purchase coverage voluntarily provided by private insurers. Shared market mechanisms include assigned risk plans; fair access to insurance requirement or "FAIR" plans; and reinsurance facilities, such as the New Jersey Unsatisfied Claim and Judgment Fund. In addition, some states require insurers to participate in reinsurance pools for claims that exceed specified amounts. Our participation in these mandatory shared market or pooling mechanisms generally is related to the amounts of our direct writings for the type of coverage written by the specific arrangement in the applicable state. For the three years ended December 31, 2002, 2001 and 2000, we received earned premium from these arrangements in the amounts of $666,000, $355,000 and $343,000, respectively, and incurred losses and loss expenses from these arrangements in the amounts of $415,000, $342,000 and $169,000, respectively. Because we do not have a significant amount of direct writings in the coverages written under these arrangements, we do not anticipate that these arrangements will have a material effect on us in the future. However, we cannot predict the financial impact of our participation in any shared market or pooling mechanisms that may be implemented in the future by the states in which we do business. See the risk factor entitled "If we fail to comply with insurance industry regulations, or if those regulations become more burdensome, we may not be able to operate profitably." Guaranty Fund Laws. Many states have guaranty fund laws under which insurers doing business in the state can be assessed to fund policyholder liabilities of insolvent insurance companies. New Jersey and Pennsylvania, the states in which our insurance companies do business, have such laws. Under these laws, an insurer is subject to assessment depending upon its market share in the state of a given line of business. For the years ended December 31, 2002, 2001 and 2000, we incurred approximately $99,000, $102,000 and $15,000, respectively, in assessments pursuant to state insurance guaranty association laws. We establish reserves relating to insurance companies that are subject to insolvency proceedings when we are notified of assessments by the guaranty associations. We cannot predict the amount and timing of any future assessments on our insurance companies under these laws. Sarbanes-Oxley Act of 2002. On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002, or the SOA. The stated goals of the SOA are to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws. The SOA is the most far-reaching U.S. securities legislation enacted in some time. The SOA generally applies to all companies, both U.S. and non-U.S., that file or are required to file periodic reports with the Securities and Exchange Commission, or the SEC, under the Securities Exchange Act of 1934, or the Exchange Act. Given the extensive SEC role in implementing rules relating to many of the SOA's new requirements, the final scope of these requirements remains to be determined. The SOA includes very specific additional disclosure requirements and new corporate governance rules, requires the SEC and securities exchanges to adopt extensive additional disclosure, corporate governance and other related rules and mandates further studies of specified issues by the SEC and the Comptroller General. The SOA represents significant federal involvement in matters traditionally left to state regulatory systems, such as the regulation of the accounting profession, and to state corporate law, such as the relationship between a board of directors and management and between a board of directors and its committees. 79 The SOA addresses, among other matters: - audit committees; - certification of financial statements by the chief executive officer and the chief financial officer; - the forfeiture of bonuses or other incentive-based compensation and profits from the sale of an issuer's securities by directors and senior officers in the twelve month period following initial publication of any financial statements that later require restatement; - a prohibition on insider trading during pension plan black out periods; - disclosure of off-balance sheet transactions; - a prohibition on personal loans to directors and officers; - expedited filing requirements for Form 4 statements of changes of beneficial ownership of securities required to be filed by officers, directors and 10% shareholders; - disclosure of whether or not a company has adopted a code of ethics; - "real time" filing of periodic reports; - auditor independence; and - various increased criminal penalties for violations of securities laws. The SEC has been delegated the task of enacting rules to implement various provisions with respect to, among other matters, disclosure in periodic filings pursuant to the Exchange Act. To date, the SEC has implemented some of the provisions of the SOA. However, the SEC continues to issue final rules, reports, and press releases. As the SEC provides new requirements, we review those rules and comply as required. In addition, the common stock will trade on the Nasdaq National Market. NASDAQ also has provided proposed corporate governance rules that require additional compliance and supplement the SEC requirements under the SOA. We expect that these rules will not become effective until 2004. Terrorism Risk Insurance Act of 2002. On November 26, 2002, President Bush signed the Terrorism Risk Insurance Act of 2002. Under this law, coverage provided by an insurer for losses caused by certified acts of terrorism is partially reimbursed by the United States under a formula under which the government pays 90% of covered terrorism losses, exceeding a prescribed deductible. Therefore, the act limits an insurer's exposure to certified terrorist acts (as defined by the act) to the deductible formula. The deductible is based upon a percentage of direct earned premium for commercial property and casualty policies. Coverage under the act must be offered to all property, casualty and surety insureds. The immediate effect was to nullify terrorism exclusions previously permitted by state regulators to the extent they exclude losses that would otherwise be covered under the act. The act further states that until December 31, 2003, rates and forms for terrorism risk insurance covered by the act are not subject to prior approval or a waiting period under any applicable state law. Rates and forms of terrorism exclusions and endorsements are subject to subsequent review. We are currently unable to predict the extent to which this legislation may affect the demand for our products or the risks that will be available for us to consider underwriting. We are currently providing the coverage required by this act at no charge to our policyholders until we can develop and implement an appropriate pricing structure. We do not know the extent to which insureds will elect to purchase this coverage. Financial Services Modernized. The Gramm-Leach-Bliley Act was signed into law by President Clinton on November 12, 1999. The principal focus of the act is to facilitate affiliations among banks, securities firms and insurance companies. The ability of banks and securities firms to affiliate with insurers may increase the number, size and financial strength of our potential competitors. 80 Privacy. As mandated by the Gramm-Leach-Bliley Act, states continue to promulgate and refine laws and regulations that require financial institutions, including insurance companies, to take steps to protect the privacy of certain consumer and customer information relating to products or services primarily for personal, family or household purposes. A recent NAIC initiative that affected the insurance industry was the adoption in 2000 of the Privacy of Consumer Financial and Health Information Model Regulation, which assisted states in promulgating regulations to comply with the Gramm-Leach-Bliley Act. In 2002, to further facilitate the implementation of the Gramm-Leach-Bliley Act, the NAIC adopted the Standards for Safeguarding Customer Information Model Regulation. Several states have now adopted similar provisions regarding the safeguarding of customer information. Our insurance subsidiaries have implemented procedures to comply with the Gramm-Leach-Bliley Act's related privacy requirements. OFAC. The Treasury Department's Office of Foreign Asset Control (OFAC) maintains a list of "Specifically Designated Nationals and Blocked Persons" (the SDN List). The SDN List identifies persons and entities that the government believes are associated with terrorists, rogue nations or drug traffickers. OFAC's regulations prohibit insurers, among others, from doing business with persons or entities on the SDN List. If the insurer finds and confirms a match, the insurer must take steps to block or reject the transaction, notify the affected person and file a report with OFAC. The focus on insurers' responsibilities with respect to the SDN List has increased significantly since September 11, 2001. New and Proposed Legislation and Regulations. The property and casualty insurance industry has recently received a considerable amount of publicity because of rising insurance costs and the unavailability of insurance. New regulations and legislation are being proposed to limit damage awards, to control plaintiffs' counsel fees, to bring the industry under regulation by the federal government and to control premiums, policy terminations and other policy terms. We are unable to predict whether, in what form, or in what jurisdictions, any regulatory proposals might be adopted or their effect, if any, on our insurance companies. Dividends. Our insurance companies are restricted by the insurance laws of their respective states of domicile regarding the amount of dividends or other distributions they may pay without notice to or the prior approval of the state regulatory authority. The Pennsylvania Insurance Department's approval of Mercer Mutual's conversion to stock form is subject to, among other things, the condition that for a period of three years following the conversion, Mercer Mutual may not declare or pay a dividend to the Holding Company without the approval of the Pennsylvania Insurance Department. After this three-year period has expired, Mercer Mutual's ability to declare and pay dividends to the Holding Company will be subject to Pennsylvania law. Pennsylvania law sets the maximum amount of dividends that may be paid by Mercer Mutual and Franklin Insurance Company during any twelve-month period after notice to, but without prior approval of, the Pennsylvania Insurance Department. With respect to each insurance company, this amount cannot exceed the greater of 10% of the company's statutory surplus as reported on the most recent annual statement filed with the Pennsylvania Insurance Department, or the company's net income for the period covered by the annual statement. If the dividend restrictions contained in the Pennsylvania Insurance Department's approval of the conversion were not in effect, then as of December 31, 2002, the amount available for payment of dividends by Mercer Mutual to the Holding Company in 2003 without the prior approval of the Pennsylvania Insurance Department would be approximately $2.9 million. As of December 31, 2002, the amount available for payment of dividends by Franklin Insurance Company to its shareholders in 2003 without the prior approval of the Pennsylvania Insurance Department would be approximately $355,000. Until the post-conversion share exchange with H. Thomas Davis, Jr., holder of 51% of the common stock of Franklin Holding, is completed, Mercer Mutual is only entitled to 49% of any dividend declared by Franklin Holding on its common stock. New Jersey law sets the maximum amount of dividends that may be paid by Mercer Insurance Company of New Jersey, Inc. during any twelve-month period after notice to, but without prior approval of, the New Jersey Department of Banking and Insurance. This amount cannot exceed the greater of 10% of Mercer Insurance Company of New Jersey, Inc.'s statutory surplus as reported on the most recent annual statement filed with New Jersey, or the net income, not including realized capital gains, of Mercer Insurance Company 81 of New Jersey, Inc. for the period covered by the annual statement. As of December 31, 2002, the amount available for payment of dividends by Mercer Insurance Company of New Jersey, Inc. to Mercer Mutual in 2003 without the prior approval of New Jersey Department of Banking and Insurance would be approximately $887,000. Holding Company Laws. Most states have enacted legislation that regulates insurance holding company systems. Each insurance company in a holding company system is required to register with the insurance supervisory agency of its state of domicile and furnish certain information. This includes information concerning the operations of companies within the holding company system that may materially affect the operations, management or financial condition of the insurers within the system. Pursuant to these laws, the respective insurance departments may examine our insurance companies and their holding companies at any time, require disclosure of material transactions by our insurance companies and their holding companies and require prior notice of approval of certain transactions, such as "extraordinary dividends" distributed by our insurance companies. All transactions within the holding company system affecting our insurance companies and their holding companies must be fair and equitable. Notice of certain material transactions between our insurance companies and any person or entity in our holding company system will be required to be given to the applicable insurance commissioner. In some states, certain transactions cannot be completed without the prior approval of the insurance commissioner. Approval of the state insurance commissioner is required prior to any transaction affecting the control of an insurer domiciled in that state. In New Jersey and Pennsylvania, the acquisition of 10% or more of the outstanding capital stock of an insurer or its holding company is presumed to be a change in control. Pennsylvania law also prohibits any person from (i) making a tender offer for, or a request or invitation for tenders of, or seeking to acquire or acquiring any voting security of a Pennsylvania insurer if, after the acquisition, the person would be in control of the insurer, or (ii) effecting or attempting to effect an acquisition of control of or merger with a Pennsylvania insurer, unless the offer, request, invitation, acquisition, effectuation or attempt has received the prior approval of the Pennsylvania Insurance Department. Under Pennsylvania law, from the time a mutual insurance company files with the Pennsylvania Insurance Department an application to convert to a stock company, until the effective date of the conversion, any offer to acquire, announcement of an offer to acquire or acquisition of the converting company is prohibited. Any offer, announcement or acquisition would constitute a violation of the Pennsylvania Mutual-to Stock Conversion Act as well as the Pennsylvania holding company law described above. LEGAL PROCEEDINGS General. Our insurance companies are parties to litigation in the normal course of business. Based upon information presently available to us, we do not consider any litigation to be material. However, given the uncertainties attendant to litigation, we cannot assure you that our results of operations and financial condition will not be materially adversely affected by any litigation. Franklin Mutual Litigation. On March 8, 2000, Franklin Mutual Insurance Company, which is unrelated to Franklin Holding and Franklin Insurance Company, initiated litigation against Mercer Mutual's directors alleging that they manipulated the date of Mercer Mutual's annual meetings in an attempt to disenfranchise Franklin Mutual and unlawfully terminated Franklin Mutual's policies of insurance. (Mercer Mutual had terminated Franklin Mutual's policies because they did not conform to Mercer Mutual's pre-existing underwriting guidelines; Franklin Mutual appealed this termination to the New Jersey Department of Banking and Insurance, which upheld the termination.) This litigation was settled in August 2002. Pursuant to the settlement agreement, among other things, Mercer Mutual granted to Franklin Mutual the right to purchase, after the conversion, the same number of shares of the Holding Company common stock that an eligible policyholder can purchase under the Plan of Conversion. Mercer Mutual did not grant any other policyholder rights to Franklin Mutual. 82 INTERCOMPANY AGREEMENTS Effective January 1, 2002, our insurance companies are parties to a Reinsurance Pooling Agreement and related Loss Portfolio Transfer Reinsurance Agreements. Under these agreements, all premiums, losses and underwriting expenses of our insurance companies are combined and subsequently shared based on each individual company's statutory surplus from the most recently filed statutory annual statement. Mercer Mutual and all of its subsidiaries are parties to a Services Allocation Agreement, effective as of July 1, 2001. Pursuant to this agreement, any and all employees of Mercer Mutual and each of its subsidiaries (other than BICUS Services Corporation, a wholly owned subsidiary of Mercer Mutual) were transferred to, and became employees of, BICUS. BICUS has agreed to perform all necessary functions and services required by Mercer Mutual and each of its subsidiaries in conducting their respective operations. In turn, Mercer Mutual and each of its subsidiaries has agreed to reimburse BICUS for its costs and expenses incurred in rendering such functions and services in an amount determined by the parties. Mercer Mutual, Mercer Insurance, BICUS and Queenstown are parties to a consolidated tax allocation agreement that allocates each company a pro rata share of the consolidated income tax expense based upon its contribution of taxable income to the consolidated group. PROPERTIES Our main office is located at 10 North Highway 31, Pennington, New Jersey in a 14,357 square foot facility owned by Mercer Mutual. Mercer Mutual has received the necessary municipal approvals to construct an 11,012 square foot addition to its main office. The addition is expected to be completed in 2003 at an estimated cost of $2.5 million. We also own a tract of land adjacent to our main office property. Mercer Mutual also owns a 32,000 square foot office facility in Lock Haven, Pennsylvania. Mercer Mutual sub-leases a portion of this facility. Recent renovations to this facility were completed in December 2002 at a cost of $2.1 million. EMPLOYEES All of our employees are employed directly by BICUS Services Corporation, a wholly owned subsidiary of Mercer Mutual. Our insurance companies do not have any employees. BICUS provides management services to all of our insurance companies. As of March 31, 2003, the total number of full-time equivalent employees of BICUS was 87. None of these employees are covered by a collective bargaining agreement and BICUS believes that its employee relations are good. THE CONVERSION The plan has been approved by the Pennsylvania Insurance Department, subject to the plan's approval by the eligible policyholders of Mercer Mutual. Other conditions set by the Pennsylvania Insurance Department also must be satisfied. Approval by the Pennsylvania Insurance Department is not a recommendation or endorsement of the plan. BACKGROUND AND REASONS FOR THE CONVERSION The Plan of Conversion adopted by Mercer Mutual on December 13, 2002, as amended and restated on March 19, 2003, April 15, 2003, and on June 18, 2003, is the second plan of conversion adopted by Mercer Mutual in our history. We adopted our first plan of conversion in October 1997. We did so at that time because we believed then, and continue to believe today, that growth is critical to Mercer Mutual's success. However, due in large part to an extensive proxy contest waged by Franklin Mutual Insurance Company, a policyholder of Mercer Mutual at the time, Mercer Mutual's policyholders did not approve the 1997 plan by a sufficient margin, and the 1997 plan was terminated. Franklin Mutual engaged in that proxy contest after its unsolicited offer to acquire Mercer Mutual was unanimously rejected by Mercer Mutual's board of directors. 83 Despite Franklin Mutual's efforts, the 1997 plan was approved by approximately 57% of the votes cast. However, that amount was less than the 66 2/3% of votes cast required by Pennsylvania law. Despite the inability to convert to a stock institution, Mercer Mutual has been able to generate significant internal growth since 1997. This success has been built by taking a disciplined approach to underwriting and pricing and by better mixing our product base. However, continued growth remains an essential part of our strategic plan. We would like to grow geographically because we believe we can successfully implement our underwriting, pricing and product strategy over a larger operating region. We also are aware of how severe weather conditions can affect underwriting results, and how our limited geographic operating region increases our exposure to that risk. To expand our operating region and reduce our risk to catastrophe, our strategic plan depends on geographic diversification. Because geographic growth remains one of our critical corporate objectives, improving our access to capital continues to be a component of our strategic plan. We believe the geographic diversification that can be achieved as a mutual insurance company is limited. We have determined that the fastest and most effective method to achieve our goals is through a conversion to a stock company. The ability to issue stock and the additional capital generated by a conversion would allow us to seek and finance the acquisition of companies in other geographic areas. The capital from a conversion also would provide additional underwriting capacity that we could use to expand writings in Pennsylvania and other added markets. Although conversion from mutual to stock form has remained one of our objectives, obstacles to achievement of this goal existed until recently. First, we believed that a respite from the Franklin Mutual controversy regarding the 1997 plan was necessary to maintain sound customer and producer relationships. A second obstacle to conversion was that Franklin Mutual initiated litigation in March 2000 against Mercer Mutual's directors alleging that they manipulated the date of Mercer Mutual's annual meetings in an attempt to disenfranchise Franklin Mutual and unlawfully terminated Franklin Mutual's policies of insurance. (We had terminated Franklin Mutual's policies because they did not conform to Mercer Mutual's pre-existing underwriting guidelines; Franklin Mutual appealed this termination to the New Jersey Department of Banking and Insurance, which upheld the termination.) This litigation was settled in August 2002. As a result of that settlement, we agreed to grant Franklin Mutual the right to buy stock after the conversion on the same basis as if Franklin Mutual were an eligible policyholder. However, we did not grant Franklin any other policyholder rights. After this last obstacle to conversion was removed, we engaged Griffin Financial Group as our financial advisor, and Stevens & Lee as our counsel, to assist the Board in connection with a review of our strategic alternatives. Griffin Financial Group is a wholly owned subsidiary of Stevens & Lee. A presentation concerning strategic alternatives was made to the Board of Directors on September 30, 2002, as the first step in its decision-making process. A number of strategic options were considered at the September 30, 2002, meeting, including remaining a mutual, a mutual to stock conversion, the formation of a mutual holding company, a public offering of the stock of a subsidiary, and a mutual-to-mutual merger. With respect to a mutual to stock conversion, three alternatives were considered: - a conversion similar to the 1997 plan that would use the subscription rights model provided for in the Pennsylvania Mutual-to-Stock Conversion Act; - a conversion in which all of the surplus of the company would be distributed to policyholders and a concurrent public offering would be effected; and - a subscription rights conversion in which a partial distribution of surplus would be made to policyholders in one of several possible methods. The presentation also included a preliminary analysis of the potential appraised value of Mercer Mutual in a subscription rights conversion. The Board of Directors carefully reviewed its options and requested that additional analysis be prepared and discussed at a meeting scheduled for October 10, 2002. At the October 10, 2002 meeting, the Board of Directors unanimously directed counsel to prepare the Plan of Conversion using the same subscription rights conversion model contained in the 1997 plan and 84 provided for in the Mutual-to-Stock Conversion Act. Each of the other strategic options was rejected for the following reasons: - The option of remaining a mutual was rejected because it was inconsistent with the long-term strategic vision of the Board of Directors. For similar reasons, a merger with another mutual was rejected as inconsistent with our strategic plan and also because of an absence of attractive candidates. - The conversion from mutual to stock form in connection with the formation of a mutual holding company, followed by a public offering by the converted company, as well as a "downstream" public offering of a stock subsidiary, were both eliminated as options because neither transaction is attractive to the capital markets, especially because of the relatively small size of the ultimate public company. In addition, the Board believes that the mutual holding company structure is not favored by insurance regulators because it allows management, through the mutual holding company, to retain control over a majority of the outstanding voting capital stock of the converted company. - Of the mutual to stock conversion options examined, the Board concluded that, unlike the transactions typically undertaken by large life insurance companies, distributing surplus to policyholders coupled with a public offering is not economically feasible for the vast majority of smaller property and casualty insurance companies, including Mercer Mutual, because it results in a depletion of the converting company's capital. - The Board examined a subscription rights conversion coupled with a partial distribution of surplus to policyholders. The Board concluded that a transaction of this nature would be complicated, which could result in increased conversion costs, and would raise less capital than a standard subscription rights conversion. Based on its review of strategic options, the Board of Directors of Mercer Mutual concluded that the Plan of Conversion using the subscription rights model is the most appropriate course for the company. The Board of Directors of Mercer Mutual believes it is important to attract new capital in order to: (i) fund geographic expansion both through acquisition and increased producer representation, (ii) increase statutory surplus (and thereby strengthen policyholder protection), (iii) reduce reliance on reinsurance, (iv) support current operations, (v) achieve diversification of risk through product growth, (vi) provide increased opportunities for existing employees, and (vii) create new jobs. The Board of Directors also believes that reorganizing Mercer Mutual as a wholly-owned subsidiary of the Holding Company will enhance and improve operational flexibility and will facilitate product expansion and acquisitions. This will result in diversification of risk and enable Mercer Mutual to compete more effectively with other insurance companies. On December 13, 2002, the Board of Directors of Mercer Mutual unanimously adopted the Plan of Conversion, subject to approval by the Pennsylvania Insurance Department and the policyholders of Mercer Mutual. The plan was amended and restated on March 19, 2003, April 15, 2003 and on June 18, 2003. An application with respect to the conversion was filed by Mercer Mutual with the Pennsylvania Insurance Department on January 13, 2003. Notice of the filing and the opportunity to comment on and to request and receive a copy of the Plan was mailed on January 13, 2003, to all eligible policyholders, as required by law. The Pennsylvania Insurance Department held an informational public hearing regarding the Conversion on May 15, 2003. By order dated July 8, 2003, the plan was approved by the Pennsylvania Insurance Department. In addition, because the Holding Company and Mercer Mutual already are under common control, the acquisition by the Holding Company of the stock of Mercer Mutual is not treated as a change in control of Mercer Mutual that requires further regulatory approval. An application for approval of the Holding 85 Company's acquisition of control of Mercer Insurance Company of New Jersey, Inc. was approved by the New Jersey Department of Banking and Insurance on July , 2003. The Plan of Conversion is subject to the approval of the eligible policyholders at the special meeting to be held on , 2003. CONVERSION PROCESS The conversion will be accomplished by the filing of amended and restated articles of incorporation for Mercer Mutual with the Pennsylvania Department of State. These amended and restated articles will, among other things, create and authorize the issuance of shares of capital stock of the converted company. The Holding Company has received the approval of the Pennsylvania Insurance Department to contribute 50% of the net proceeds of the offering to Mercer Mutual in exchange for all of the capital stock of Mercer Mutual to be issued in the conversion. See "Use of Proceeds." After issuance of the shares of capital stock to the Holding Company, Mercer Mutual will become a wholly owned stock subsidiary of the Holding Company. The conversion will be effected only if subscriptions are received for at least 4,165,000 shares of common stock. The conversion will be accounted for as a simultaneous reorganization, recapitalization and share offering that will not change the historical accounting basis of Mercer Mutual's financial statements. The total purchase price of the common stock to be issued in the conversion will be within the estimated valuation range of between $41,650,000 and $56,350,000. This range is based upon an independent valuation of the consolidated pro forma market value of Mercer Mutual as of May 30, 2003, prepared by Griffin Financial Group. All shares of common stock to be issued and sold in the conversion will be sold at the same price of $10.00 per share. Griffin Financial Group's independent valuation will be affirmed or, if necessary, updated, prior to the completion of the conversion. Griffin Financial Group is a consulting firm experienced in corporate valuations and is a subsidiary of Stevens & Lee, P.C., counsel to Mercer Mutual. For additional information, see "Stock Pricing and Number of Shares to be Issued" herein. A copy of the Plan of Conversion is available for inspection at the Holding Company's principal executive offices located at 10 North Highway 31, Pennington, New Jersey and on our Internet web site at www.mercerins.com. A copy of the plan also was sent to each eligible policyholder along with the notice of the special meeting. The plan also is filed as an exhibit to the registration statement of which this prospectus is a part. Copies of the registration statement and attachments may be obtained from the SEC. See "Available Information." OFFERING OF COMMON STOCK In the conversion, we are offering shares of common stock to eligible policyholders of Mercer Mutual, the ESOP, directors, officers and employees of Mercer Mutual or its affiliates, and the general public. The offering to eligible policyholders, the ESOP, directors, officers and employees is referred to as the subscription offering because each of those constituents has the right to subscribe for and purchase common stock in the following order of priority: First, eligible policyholders of Mercer Mutual; and Second, directors, officers and employees of Mercer Mutual or its affiliates. Our ESOP also has the right to subscribe for and purchase shares in this offering in an amount equal to 10% of the shares sold in the conversion. Subscription rights received by the directors, officers and employees are secondary to the subscription rights of the eligible policyholders and the ESOP. All but two of Mercer Mutual's directors and officers will be purchasing stock in their capacity as eligible policyholders and not in their capacity as directors or officers. See the subsection of this section entitled "Proposed Management Purchases." The Holding Company's offering of common stock to the general public is referred to as the community offering. If all available shares in the subscription and community offerings are not subscribed for, we expect 86 to offer the remaining available shares to the general public in a syndicated community offering managed by Sandler O'Neill & Partners, L.P. on a best efforts basis. The completion of this offering is subject to market conditions and other factors beyond our control. If the conversion is not completed, Mercer Mutual will remain a mutual insurance company and all subscription funds will be promptly returned to subscribers without interest. EFFECT OF CONVERSION ON POLICYHOLDERS Each policyholder in a mutual insurance company, such as Mercer Mutual, has certain interests in the insurance company issuing the policy, including the contractual right to insurance coverage, the right to vote for the election of directors and certain other corporate transactions, and the right to receive dividends if, as and when declared by the board of directors of the company. Mutual policyholders also may have rights in the unlikely event of a solvent dissolution of a mutual insurance company, although the scope of these rights under Pennsylvania law is unclear. A statute specifically applicable to mutual insurance companies states that any surplus of a mutual insurance company remaining after satisfaction of all claims and liabilities, which may not be properly credited to policyholders and members, escheats to the Commonwealth of Pennsylvania. To our knowledge, the meaning of the phrase "which may not be properly credited to policyholders and members" has never been construed by a Pennsylvania court. Therefore, whether policyholders of Mercer would be entitled to any distribution of surplus upon a solvent dissolution of the company is unclear. A policyholder of a mutual insurance company, must have an effective insurance policy issued by that mutual company in order to be a member of that company. However, this membership interest has no market value because it cannot be separated from the underlying policy and in any event is not transferable. A policyholder whose policy is terminated loses the membership interest. As of the completion of the conversion, all policyholder interests in Mercer Mutual, except contract rights under policies of insurance, will terminate. If the Plan of Conversion is not approved by Mercer Mutual's eligible policyholders or if the conversion fails to be completed for any other reason, Mercer Mutual will continue as a mutual insurance company. In this case, eligible policyholders will retain the rights described above. CONTINUITY OF INSURANCE COVERAGE AND BUSINESS OPERATIONS Mercer Mutual's conversion to stock form will not change the insurance protection or premiums under individual insurance policies with Mercer Mutual. During and after the conversion, the normal business of issuing insurance policies will continue without change or interruption. After the conversion, Mercer Mutual will continue to provide services to policyholders under current policies. The Board of Directors of Mercer Mutual at the time of the conversion will continue to serve as the Board of Directors of Mercer Mutual after the conversion. The Board of Directors of the Holding Company will consist of the following persons, each of whom is an existing director of Mercer Mutual: Roland D. Boehm, H. Thomas Davis, Jr., William V. R. Fogler, William C. Hart, George T. Hornyak, Jr., Samuel J. Malizia, Richard U. Niedt, Andrew R. Speaker and Richard G. Van Noy. See "Management of the Holding Company -- Directors." All officers of Mercer Mutual at the time of the conversion will retain their positions with Mercer Mutual after the conversion. VOTING RIGHTS After the conversion, the voting rights of all policyholders in Mercer Mutual will cease. Policyholders will no longer have the right to elect the directors of Mercer Mutual or approve transactions involving Mercer Mutual. Instead, voting rights in Mercer Mutual will be held by the Holding Company, which will own all the capital stock of Mercer Mutual. Voting rights in the Holding Company will be held by the shareholders of the Holding Company. Each holder of common stock will be entitled to vote on any matter to be considered by the shareholders of the Holding Company, subject to the terms of the Holding Company's articles of 87 incorporation and bylaws and to the provisions of Pennsylvania and federal law. See the description of the common stock in the section entitled "Description of the Capital Stock." POLICYHOLDER DIVIDENDS The conversion will not affect the reasonable expectation of a policyholder to receive dividends from Mercer Mutual. The terms of the current policies of insurance provide that dividends will be paid only if, as and when declared by the Board of Directors of Mercer Mutual. Mercer Mutual has never declared a policyholder dividend. Regarding the Holding Company, its shareholders will have the exclusive right to receive any dividends paid by the Holding Company. See "Dividend Policy" or "Description of Capital Stock -- Common Stock." RIGHTS UPON DISSOLUTION AFTER CONVERSION After the conversion, policyholders will have no right to receive a pro rata distribution of any remaining surplus of Mercer Mutual. Instead, this right will vest in the Holding Company as the sole shareholder of Mercer Mutual. In the event of a liquidation, dissolution or winding up of the Holding Company, shareholders of the Holding Company would be entitled to receive, after payment of all debts and liabilities of the Holding Company, a pro rata portion of all assets of the Holding Company. See "Description of the Capital Stock -- Common Stock." SUBSCRIPTION OFFERING Eligible policyholders of Mercer Mutual, the ESOP, and directors, officers and employees of Mercer Mutual or its affiliates have the right to purchase shares of common stock in this offering. They did not pay any money or other consideration for these subscription rights, which cannot be transferred. The amount of common stock that these parties may purchase will be determined, in part, by the total number of shares of common stock subscribed for in this offering. Preference categories have been established for the allocation of common stock to the extent that shares are available. These categories are as follows: - Subscription Category No. 1. is reserved for eligible policyholders of Mercer Mutual. Eligible policyholders are those persons who are named insureds at the close of business on December 13, 2002 under an existing insurance policy issued by Mercer Mutual. Each eligible policyholder has the right to purchase, at $10.00 per share, up to 100,000 shares of common stock (except in the case of an oversubscription). The maximum number of shares that may be purchased by eligible policyholders in the aggregate is 5,635,000 shares. If there is an oversubscription, shares of common stock will be allocated among subscribing eligible policyholders in the following manner: - First, shares of common stock will be allocated among subscribing eligible policyholders to permit each of them, to the extent possible, to purchase the lesser of 1,000 shares, or the number of shares ordered. If the level of oversubscription prevents this initial allocation, then the common stock will be allocated pro-rata based on the number of shares for which each individual subscribed as compared to the total number of shares for which subscriptions were received from all eligible policyholders. - Second, any shares of common stock remaining after the initial allocation will be allocated among the subscribing eligible policyholders whose subscriptions remain unsatisfied. This allocation will be in the proportion to which each eligible policyholder's unsatisfied subscription bears to the total number of unsatisfied subscriptions. No fractional shares of common stock will be issued in the conversion. 88 Therefore, prior to sending in their subscriptions, every eligible policyholder has the exact same right to acquire the same number of shares in the conversion, notwithstanding differences in their premiums or coverage. The following table shows examples of various subscription scenarios:
NUMBER OF ELIGIBLE PERCENTAGE OF ELIGIBLE MAXIMUM NUMBER OF POLICYHOLDERS POLICYHOLDERS SHARES EACH SUBSCRIBING FOR SUBSCRIBING FOR SUBSCRIBER COULD 100,000 SHARES(1) 100,000 SHARES(1) PURCHASE(1) - ------------------ ---------------------- ----------------- 37,022...... 100% 152 27,767...... 75% 202 18,511...... 50% 304 9,256....... 25% 608
- --------------- (1) Assumes that all subscribing eligible policyholders subscribe for 100,000 shares. - Subscription Category No. 2 is reserved for the ESOP. The ESOP has the right to purchase an amount equal to up to 10% of the total shares of common stock to be issued in the conversion. This right is not subject to or subordinate to the subscription rights of eligible policyholders. The ESOP is permitted to exercise this right in full even if there is an oversubscription by eligible policyholders. The ESOP is expected to exercise this right in full and purchase 10% of the total shares of common stock issued in the conversion. Therefore, the number of shares to be purchased by the ESOP would range from 416,500 if the minimum number of shares were sold in the conversion to 626,111 if the maximum number of shares were sold. For a description of the ESOP, see the subsection entitled "Certain Benefit Plans and Agreements" in the section entitled "Management". - Subscription Category No. 3 is reserved for directors, officers and employees of Mercer Mutual or its affiliates. Each director, officer and employee has the right to purchase, at $10.00 per share, up to 100,000 shares of common stock. However, these subscription rights are secondary to the subscription rights received by the eligible policyholders and the ESOP. These rights may be exercised only if eligible policyholders subscribe for less than 5,635,000 shares of common stock. If there is an oversubscription among the directors, officers and employees, shares of common stock will be allocated among them on the basis of a point system. Each director, officer and employee will be assigned one point for each year of service to Mercer Mutual or its affiliates, one point for each current annual salary increment of $5,000, and one point for each office held in Mercer Mutual or its affiliates. Each subscribing director, officer or employee will then receive that number of shares of common stock equal to the remaining unallocated shares of common stock multiplied by a fraction the numerator of which is the number of points held by such director, officer or employee and the denominator of which is the total number of points held by all subscribing directors, officers and employees. Directors, officers or employees who subscribe to purchase shares of common stock and are eligible policyholders will be deemed to purchase common stock in their capacity as an eligible policyholder and not in their capacity as a director, officer or employee. A director, officer or employee who is an eligible policyholder cannot purchase more shares than the maximum number that an eligible policyholder is entitled to purchase. All but two of the Holding Company's directors and executive officers are eligible policyholders and will purchase all of their shares as eligible policyholders and not under Subscription Category No. 3. See the subsection of this section entitled "Proposed Management Purchases." COMMUNITY OFFERING Concurrently with the subscription offering, the Holding Company is offering shares of the common stock to the general public in a community offering. Unlike in the subscription offering, subscribers in the community offering have no statutory right to purchase stock in the offering. The ability to purchase stock in 89 the community offering is created only by the Plan of Conversion and is therefore subject to the limitations contained in the Plan. Preference in the community offering will be given to the following: - Natural persons and trusts of natural persons who are permanent residents of the State of New Jersey or the Commonwealth of Pennsylvania. The term "resident" means any natural person who occupies a dwelling located in either state and has an intention to remain in the state for a period of time. We may use policyholder records or other evidence provided to us to determine whether a person is a resident of New Jersey or Pennsylvania. In the case of a corporation or other business entity, the entity will be deemed to be a resident of New Jersey or Pennsylvania if its principal place of business or headquarters is located in either state. All residency determinations will be made in our sole and absolute discretion. - Principals of corporations, partnerships, limited liability companies or other entities that are eligible policyholders. - Licensed insurance producers who have been appointed by Mercer Mutual to market and distribute insurance products, and their affiliates. - Named insureds under policies of insurance issued by Mercer Mutual after December 13, 2002. - Providers of goods or services to Mercer Mutual. No one class of subscriber described above has priority over any other class. Acceptance of subscriptions for common stock received from members of the general public in the community offering will be subject to availability of shares. Shares may be available after satisfaction of all subscriptions in the subscription offering, subject to the maximum and minimum purchase limitations set forth in the Plan of Conversion. If 5,635,000 or more shares of the common stock are subscribed for in the subscription offering, no shares will be sold in the community offering. If more than 4,165,000 but less than 5,635,000 shares of the common stock are subscribed for in the subscription offering, we, in our sole discretion, will determine whether to accept subscriptions for shares in the community offering. In the event of oversubscription in the community offering, shares will be allocated among the subscribers in that offering in any manner we determine in our sole discretion. Furthermore, the right of any person to purchase shares in the community offering, including the preferred subscribers described above, is subject to our absolute right to accept or reject community offering subscriptions in whole or in part. SYNDICATED COMMUNITY OFFERING As a final step in the conversion, if there are any shares of common stock not purchased in the subscription and community offerings, they may be offered for sale to the public in a syndicated community offering. This syndicated offering would be commenced at our sole discretion. A syndicated community offering would be made through a group of registered broker-dealers to be formed and managed by Sandler O'Neill & Partners, L.P. on our behalf. We would reserve the right to reject orders in whole or part in our sole discretion in a syndicated community offering. Sandler O'Neill & Partners, L.P. would not have any obligation to take or purchase any shares of the common stock in the syndicated community offering. However, Sandler O'Neill & Partners, L.P. has agreed to use its best efforts in the sale of shares in any syndicated community offering. The price at which common stock would be sold in the syndicated community offering would be $10.00 per share. Shares of common stock purchased in the syndicated community offering would be combined with purchases in the subscription and community offerings for purposes of this offering's maximum purchase limitation of 100,000 shares. If shares are sold in a syndicated community offering, certificates representing shares of common stock, together with any refund due, would be mailed to purchasers at the address specified in the stock order form as soon as practicable following the sale of the common stock. Any certificates returned as undeliverable would be disposed of in accordance with applicable law. A syndicated community offering would terminate no more than 45 days following the termination date of the subscription and community offerings. 90 LIMITATIONS ON PURCHASES OF COMMON STOCK The Plan of Conversion provides for certain limitations on the purchase of shares in the conversion: - No person may purchase fewer than 25 shares of common stock in the conversion. - No purchaser, together with purchaser's affiliates and associates or a group acting in concert, may purchase more than 100,000 shares of common stock ($1 million). Therefore, if any of the following persons purchases stock, that purchase, when combined with your purchases, cannot exceed 100,000 shares: (1) any corporation or organization (other than an affiliate of Mercer Mutual) of which you are an officer or partner or the beneficial owner of 10% or more of any class of equity securities; (2) any trust or other estate in which you have a substantial beneficial interest or as to which you serve as trustee or in a similar fiduciary capacity; (3) any of your relatives or your spouse, or any relative of your spouse, who lives at home with you; (4) any person or entity who you control, who controls you, or who together with you is controlled by the same third party; (5) any person or entity who is knowingly participating with you in a joint activity or interdependent conscious parallel action toward a common goal; or (6) any person or entity with whom you are combining or pooling voting or other interests in the securities of an issuer for a common purpose pursuant to any agreement or relationship. The 100,000 share purchase limit does not apply to the ESOP, which intends to purchase 10% of the total number of shares of common stock issued in the conversion. There are 37,022 eligible policyholders. If subscriptions by eligible policyholders for common stock exceed the maximum of the estimated valuation range set forth in Griffin Financial Group's valuation, the Holding Company will be obligated to sell to eligible policyholders the maximum number of shares offered. If each eligible policyholder subscribed for 100,000 shares of common stock, then each eligible policyholder would receive only approximately 152 shares. Except as set forth below under "Proposed Management Purchases," the Holding Company is unable to predict the number of eligible policyholders that may participate in the subscription offering or the extent of any participation. Shares of common stock to be purchased and held by the ESOP and allocated to a participant will not be aggregated with shares of common stock purchased by the participant or any other purchase of common stock in the conversion for purposes of the purchase limitations discussed above. Officers and directors of Mercer Mutual and the Holding Company, together with their associates, may not purchase, in total, more than thirty-three percent (33%) of the shares of common stock issued in the conversion. An associate is defined as: (1) any corporation or organization (other than an affiliate of Mercer Mutual) of which the officer or director is an officer or partner or the beneficial owner of 10% or more of any class of equity securities; (2) any trust or other estate in which the officer or director has a substantial beneficial interest or as to which he or she serves as trustee or in a similar fiduciary capacity; or (3) any of the officer's or director's relatives or his or her spouse, or any relative of the spouse, who lives at home with the officer or director. Directors of the Holding Company and of Mercer Mutual will not be deemed to be associates of one another or a group acting in concert with other directors solely as a result of membership on the Board of Directors of the Holding Company, Mercer Mutual or any subsidiary of Mercer Mutual. 91 Subject to any required regulatory approval and the requirements of applicable law, we may increase or decrease any of the purchase limitations at any time. If the individual purchase limitation is increased, we will permit any person who subscribed for the maximum number of shares of common stock to purchase an additional number of shares up to the revised maximum. These additional shares will be subject to the rights and preferences of any person who has priority subscription rights. If the individual purchase limitation or the number of shares of common stock to be sold is decreased, the order of any person who subscribed for the maximum number of shares will be decreased to the new maximum. Each person purchasing common stock in the conversion will be deemed to confirm that the purchase does not conflict with the purchase limitations under the Plan of Conversion or otherwise imposed by law. If any person violates the purchase limitations, we have the right to purchase from that person, at the purchase price of $10.00 per share, all shares acquired by the person in excess of the purchase limitation, provided that we receive the prior approval to do so from the Pennsylvania Insurance Department. If the person has sold these excess shares, we are entitled to receive the difference between the aggregate purchase price paid by the person for the excess shares and the proceeds received by the person from the sale of the excess shares. This right of the Holding Company to purchase excess shares is assignable. We have the right in our absolute discretion and without liability to any subscriber, purchaser, underwriter or any other person to determine which subscriptions, if any, to accept in the community offering or in the syndicated community offering. We have the right to accept or reject any subscription in whole or in part for any reason or for no reason. We also have the right to determine whether and to what extent shares of common stock are to be offered or sold in a syndicated community offering. STOCK PRICING AND NUMBER OF SHARES TO BE ISSUED The Plan of Conversion requires that the purchase price of the common stock be based on a valuation of the consolidated pro forma market value of Mercer Mutual as a subsidiary of the Holding Company. The valuation must be in the form of a range consisting of a midpoint valuation, a valuation fifteen percent (15%) above the midpoint valuation and a valuation fifteen percent (15%) below the midpoint valuation. Griffin Financial Group has determined that, as of May 30, 2003, the estimated consolidated pro forma market value of Mercer Mutual as a subsidiary of the Holding Company is between $41.7 million and $56.4 million. Under the Plan of Conversion, the total purchase price of the common stock to be offered in the conversion must equal the consolidated pro forma market value of Mercer Mutual as a subsidiary of the Holding Company. Under the Pennsylvania Mutual-to-Stock Conversion Act, we are permitted to require a minimum subscription of 25 shares of common stock so long as the minimum subscription amount is no more than $500. Based on these minimum subscription parameters, the maximum price at which the Holding Company could offer shares of common stock in the conversion would be $20 per share. However, at a purchase price of $20 per share, the maximum number of shares of Common Stock that could be offered in the conversion would be 2,817,500. This compares with a maximum of 5,635,000 shares that are being offered at $10 per share. Therefore, we determined to offer the common stock in the conversion at the price of $10 per share to increase the number of shares available for purchase by policyholders. In addition, Sandler O'Neill & Partners, L.P. and Griffin Financial Group each advised us that the $10 per share offering price is commonly used in mutual-to-stock conversions of savings banks and associations that use the subscription rights model. These were the only factors considered by the Board of Directors of the Holding Company in determining to offer shares of common stock at $10 per share. The purchase price will be $10 per share regardless of any change in the consolidated pro forma market value of Mercer Mutual as a subsidiary of the Holding Company, as determined by Griffin Financial Group. The Holding Company plans to issue between 4,165,000 and 5,635,000 shares (exclusive of purchases by the ESOP) of the common stock in the conversion. This range was determined by dividing the $10 price per share into the range of Griffin Financial Group's valuation. The Holding Company also will issue in the conversion between 416,500 and 626,111 shares of common stock to the ESOP. Immediately after the conversion, the Holding Company will issue up to an additional 488,280 shares to the shareholders of Franklin 92 Holding pursuant to a pre-existing agreement, and up to an additional 100,000 shares to Franklin Mutual Insurance Company, also pursuant to a pre-existing agreement. At the completion of the subscription and community offerings, Griffin will submit an updated valuation of the consolidated pro forma market value of Mercer Mutual after the conversion as a subsidiary of the Holding Company. Griffin will take into account factors similar to those it considered in its valuation described in this prospectus. If the updated valuation is within the estimated valuation range, we will close the offering, assuming the satisfaction of all other conditions. If the updated valuation is not within the estimated valuation range, we may cancel this offering and terminate the Plan of Conversion. If we proceed with this offering using an updated valuation that is not within the estimated valuation range, subscribers will be promptly notified by mail of the updated valuation. This notice, which will be in the form of a supplement to this prospectus, also will be filed with the SEC pursuant to Rule 424 under the Securities Act of 1933. In this notice, subscribers will be requested to confirm or modify their orders. The funds of any subscribers who do not confirm their orders will be returned promptly without interest. Subscription orders may not be withdrawn for any reason if the updated valuation is within the estimated valuation range described in this prospectus. Because we may complete the conversion if the final valuation is within the estimated valuation range, the final valuation may be materially more or less than the total amount of subscriptions received. Therefore, subscribers, on a total and per share basis, may pay more for the common stock than the amount of the final valuation, and the percentage interest that a subscriber for a fixed number of shares of common stock will have will be proportionally less as subscriptions increase. The low end of the estimated valuation range is $41,650,000. Therefore this is the minimum amount that the final valuation can be and still permit us to close the offering without resolicitation of subscribers as described above. The following table assumes the final valuation equals the minimum of the estimated valuation range and then sets forth, at assumed subscription levels, the difference between the dollar amount of subscriptions received and the assumed final valuation, the percentage of the Holding Company that a subscriber for 1,000 shares of common stock will own, and the percentage difference between the ownership of a subscriber for a 1,000 shares at higher subscription levels compared to the minimum subscription level. The table does not reflect the possible sale of common stock to Franklin Mutual or the issuance of common stock to the stockholders of Franklin Holding.
PERCENTAGE BY WHICH OWNERSHIP DIFFERENCE INTEREST OF A BETWEEN SUBSCRIBER FOR 1,000 SUBSCRIPTIONS PERCENTAGE SHARES IS LESS THAN RECEIVED AND OWNERSHIP OF OWNERSHIP INTEREST ASSUMED FINAL HOLDING COMPANY AT ASSUMED FINAL VALUATION OF OF A SUBSCRIBER VALUATION OF DOLLAR AMOUNT OF SUBSCRIPTIONS RECEIVED $41,650,000 FOR 1,000 SHARES $41,650,000 - --------------------------------------- ------------------ ---------------- -------------------- Minimum subscription of $41,650,000... $ 0 .024% 0% Midpoint subscription of $49,000,000... $ 7,350,000 .020% 16.7% Maximum subscription of $56,350,000... $14,700,000 .018% 25.0% Maximum subscription plus ESOP purchase of $62,261,110..................... $20,961,110 .016% 33.3%
We cannot assure you that the market price for the common stock immediately following the conversion will equal or exceed $10 per share. Also, you should be aware that, prior to the completion of the offering, you will not have available to you information concerning the final updated valuation. After the offering is completed, the final updated valuation will be filed with the Securities and Exchange Commission as part of a post-effective amendment to the registration statement of which this prospectus forms a part. You will not receive from the Company a copy of this updated valuation. However, you may obtain a copy as indicated under "Where You Can Find Additional Information." 93 IF SUBSCRIPTIONS RECEIVED IN THE SUBSCRIPTION OFFERING MEET OR EXCEED THE MAXIMUM NUMBER OF SHARES OFFERED If, after the subscription and community offerings, the number of shares subscribed for by eligible policyholders, directors, officers and employees in the subscription offering is equal to or greater than 5,635,000 shares, then the conversion will be promptly completed. We will, on the effective date of the conversion, issue shares of common stock to the subscribing participants, including to the ESOP in an amount equal to 10% of the total shares issued to subscribing eligible policyholders, directors, officers and employees and the ESOP in the subscription offering. However, except for the shares purchased by the ESOP, the number of shares of common stock issued will not exceed the number of shares of common stock offered in the subscription offering. In the event of an oversubscription in the subscription offering, shares of common stock will be allocated among the subscribing participants in the priorities set forth in the plan. See page . No fractional shares of common stock will be issued. IF SUBSCRIPTIONS RECEIVED IN THE SUBSCRIPTION OFFERING MEET OR EXCEED THE REQUIRED MINIMUM If the number of shares of common stock subscribed for by eligible policyholders, directors, officers and employees and the ESOP in the subscription offering is equal to or greater than 4,165,000 shares, but less than 5,635,000 shares, then we may promptly complete the conversion. However, prior to doing so, we will have the right in our absolute discretion to accept, in whole or in part, subscriptions received from any or all subscribers in the community offering. We also will have the right to offer shares of common stock to purchasers in a syndicated community offering. In any event, on the effective date we will issue to the subscribing participants shares of common stock in an amount sufficient to satisfy the accepted subscriptions in full, including the ESOP's subscription in an amount equal to 10% of the shares issued to all subscribers in the conversion. No more than 6,261,111 shares of common stock will be issued in the conversion (including the shares issued to the ESOP). No fractional shares of common stock will be issued. IF SUBSCRIPTIONS RECEIVED IN THE SUBSCRIPTION OFFERING DO NOT MEET OR EXCEED REQUIRED MINIMUM If, after the subscription and community offerings, the number of shares of common stock subscribed for by eligible policyholders, directors, officers and employees and the ESOP in the subscription offering is less than 4,165,000 shares, we will accept other subscriptions. We will accept subscriptions received from subscribers in the community offering and we may sell shares of common stock to purchasers in a syndicated community offering so that the aggregate number of shares of common stock sold in this offering is equal to or greater than 4,165,000 shares. At that time, the conversion will be promptly completed. On the effective date of the conversion, we will first issue to subscribing eligible policyholders, directors, officers and employees shares of common stock in an amount sufficient to satisfy their subscriptions in full. Next, we will issue to subscribers in the community offering (and if we conduct a syndicated community offering, to purchasers in the syndicated community offering) sufficient additional shares of common stock so that the total number of shares of common stock to be issued in the conversion, including the shares to be issued to the ESOP, will be equal to at least 4,165,000 shares. No fractional shares of common stock will be issued. In order to raise additional capital, we may in our absolute discretion elect to issue in excess of 4,165,000 shares of common stock to subscribers in the community offering and to purchasers in any syndicated community offering. The number of shares of common stock issued in the conversion cannot exceed 6,261,111 shares of common stock (including shares issued to the ESOP). See the subsections entitled "Community Offering" and "Syndicated Community Offering" in this section. IF SUBSCRIPTIONS RECEIVED IN ALL OF THE OFFERINGS DO NOT MEET THE REQUIRED MINIMUM If the total number of shares of common stock subscribed for in the conversion is less than 4,165,000 shares, then the Holding Company will cancel this offering and all subscription funds will be returned promptly to subscribers without interest. After the return of those funds, we may cause a new valuation of the consolidated pro forma market value of Mercer Mutual, as a subsidiary of the Holding Company, to be performed, and based on this valuation commence a new offering of the common stock. 94 THE VALUATION The Pennsylvania Insurance Company Mutual to Stock Conversion Act requires that the Plan of Conversion set the total price of the common stock to be issued in the conversion at an amount equal to the estimated pro forma market value of the converted stock company, based on an independent valuation by a qualified expert. This pro forma market value may be the value that is estimated to be necessary to attract full subscription for the shares, as indicated by the valuation. It also may be stated as a range of pro forma market values. Our Plan of Conversion requires that the valuation be an independent valuation made by an appraiser who is experienced in corporate valuation. On December 19, 2002, we retained Griffin Financial Group, LLC to prepare the valuation. Griffin, as part of its investment banking business, is engaged regularly in the valuation of assets, securities and companies in connection with various types of asset and security transactions. These transactions include mergers, acquisitions, private placements, and valuations for various other purposes and in the determination of adequate consideration in such transactions. Specifically, Griffin employees have performed a number of valuations of property and casualty insurance companies in connection with mergers, acquisitions and financings. Griffin Financial Group is a wholly owned subsidiary of Stevens & Lee, our legal counsel. Griffin has advised us that its relationship with Stevens & Lee does not impair its ability to provide independent appraisal and advisory services. In preparing the valuation, Griffin: - reviewed the Plan of Conversion; - reviewed financial and operating data concerning Mercer Mutual prepared by its management; - reviewed Mercer Mutual's December 31, 2002 actuarial report; - reviewed Mercer Mutual's unaudited financial statements for the three months ended March 31, 2003, the audited financial statements for the three years ended December 31, 2002, and the unaudited statements for the nine months ended September 30, 2002; - discussed and reviewed, with certain senior members of Mercer Mutual's management, certain aspects of the past, current and future business practices, operations, financial condition and prospects of Mercer Mutual; - reviewed the market valuation of common stocks of property and casualty insurance companies which have made recent initial public offerings; - compared Mercer Mutual to other property and casualty companies that Griffin deemed appropriate; and - compared Mercer Mutual data to certain publicly available industry averages and aggregates provided by industry sources. Griffin also conducted meetings and interviews with the executive officers of Mercer Mutual, as well as certain other non-executive officers. In addition, Griffin visited the Mercer Mutual corporate headquarters in Pennington, New Jersey. In preparing the valuation, Griffin placed emphasis on the following factors: - The history and mutual nature of Mercer Mutual, its lines of business and its position in the industry, including a review of its significant competitors; - The size of Mercer Mutual; - The geographic concentration of Mercer Mutual's business; - The economic outlook for the property and casualty insurance industry; - The financial condition of Mercer Mutual; 95 - The results of operation of Mercer Mutual; - The value of stock of corporations (listed on exchanges, or trading over-the-counter) engaged in similar lines of business as Mercer Mutual; - Acquisitions of companies engaged in similar lines of business as Mercer Mutual; - The degree of liquidity, if any, in shares of stock issued in connection with the conversion; - The financial terms and conditions of the proposed transaction; and - Conditions in the securities markets in general and in the securities market for property and casualty insurance company common stock in particular. In deriving its estimate of the pro forma market value of Mercer Mutual as a subsidiary of the Holding Company, Griffin utilized the market valuation approach. The market valuation approach estimates a value by reviewing the relevant market pricing characteristics of securities of comparable companies that are publicly traded. This produces a market value of a company as if its securities were exchanged in the open market on a minority-interest basis, or a "freely-traded" value. Griffin selected a group of property and casualty insurance companies based on the following factors which Griffin believed investors likely would compare to Mercer Mutual when making a decision to purchase the Holding Company's common stock: - company size; - underwriting profitability; - total profitability; - markets served and geographic concentration; and - companies Mercer Mutual considers competitors or against which Mercer Mutual benchmarks itself. In making these judgements, Griffin did not attribute any particular weight to any one factor listed above compared to any other factor. Griffin also considered relative adjustments to freely-traded value due to size, new issue discount and other factors. In connection with its valuation, Griffin reviewed the following selected merger transactions involving regional property and casualty insurance companies:
ANNOUNCEMENT PRICE/ PRICE/ TARGET BUYER DATE BOOK(%) EARNINGS(X) - ------ ----- ------------ ------- ----------- Farm Family Holdings, American National Insurance Inc. .................... Co. October 2000 130.22 8.64 Old Guard Group, Inc. ..... Ohio Farmers Insurance Company May 2000 58.17 -- Capitol Transamerica, Inc. .................... Alleghany Corporation July 2001 125.00 17.01 Safety Insurance Co. ...... The Jordan Company, LLC July 2001 65.60 7.25
Source: SNL Financial and company SEC filings. This data should not be construed as a comprehensive analysis of merger pricing for regional property and casualty insurance companies. The prices paid in these selected merger transactions indicated that regional property and casualty insurance companies are sometimes sold at a discount to book value or at only a modest premium to book value. Griffin did not utilize a discounted cash flow approach, net asset value approach, or a liquidation approach in deriving its estimate of the pro forma market value. Griffin believes that the use of a discounted cash flow analysis in insurance company valuations and, in particular, valuations performed in connection with other mutual to stock conversions of insurance companies, does not appear to be as customary or as prevalent as it is in other industries with more predictable cash flows. The discounted cash flow method assumes that the value of an enterprise is equal to the net present value of all future net cash flows. This method relies heavily 96 on the accuracy of the projections of future cash flows and works best when future cash flows have a high degree of predictability. Griffin believes that cash flows from the insurance industry are inherently unpredictable because of fluctuating losses. In Griffin's opinion, an infusion of new capital as a result of the conversion and the speed with which Mercer Mutual will be able to utilize this capital to support premiums writing creates uncertainty with respect to future earnings and cash flow. Griffin also believes that Mercer Mutual's plan to diversify geographically and grow by acquisition further creates non-quantifiable changes in earnings and cash flow. The net asset value approach considers the fair market value in use of individual assets and liabilities. Griffin believes that it is best utilized in determining the liquidation value of a company and generally is not used for valuing initial public offerings which contemplate the continuation of the company on a "going concern" basis. For this reason, Griffin did not utilize the net asset value approach, or any liquidation value approach. The following tables set forth the property and casualty insurance companies used by Griffin in its market valuation approach and certain financial data used by Griffin regarding these companies as of or for the 12 months ended March 31, 2003:
LTM(1) LTM(1) TOTAL EQUITY/ POLICY COMBINED LTM(1) LTM(1) COMPANY ASSETS($) ASSETS% REVENUE(1)($) RATIO% ROA% ROE% - ------- --------- ------- ------------- -------- ------ ------ (DOLLARS IN THOUSANDS) Alfa Corporation........ 1,943,438 29.85 500,791 97.68 3.90 13.08 Baldwin & Lyons, Inc. ................. 663,720 43.21 114,429 85.63 1.83 4.07 Commerce Group, Inc. ... 2,572,495 30.65 1,267,263 100.34 0.97 2.85 Donegal Group Inc. ..... 513,554 26.80 188,318 98.94 2.81 10.50 EMC Insurance Group Inc. ................. 773,109 21.13 308,916 100.11 2.65 12.41 Erie Indemnity Company............... 2,485,039 41.48 171,921 NA 7.83 18.17 Harleysville Group Inc. ................. 2,367,238 26.34 780,960 105.96 1.29 4.82 Merchants Group, Inc. ................. 264,043 25.53 76,131 109.52 0.96 3.88 Midland Company......... 1,059,855 29.85 594,476 104.40 1.95 6.92 National Security Group, Inc. ................. 101,238 41.97 35,315 112.86 1.34 3.12 Penn-America Group, Inc. ................. 354,116 33.81 126,437 97.15 3.98 12.49 Philadelphia Consolidated Holding Corp. ................ 1,458,803 33.45 480,304 95.74 3.05 8.30 RLI Corp................ 1,771,459 26.72 383,109 95.00 2.59 10.83 Selective Insurance Group, Inc. .......... 3,152,592 20.84 1,021,020 113.04 1.33 6.28 --------- ----- ---------- ------ ---- ----- Mean.................... 1,391,479 30.83 432,099 101.26 2.61 8.41 Median.................. 1,259,329 29.85 346,013 100.11 2.27 7.61 --------- ----- ---------- ------ ---- ----- Mercer Mutual........... 104,346 35.33 42,066 98.22 1.66 4.75
PRICE/ PRICE/ LTM(1) LTM(1) PRICE/ COMPANY PRICE($)(2) REVENUE(X) EARNINGS(X) BOOK(%) - ------- ----------- ---------- ----------- ------- Alfa Corporation......................... 12.85 1.72 14.28 176.03 Baldwin & Lyons, Inc. ................... 23.20 2.92 29.74 118.49 Commerce Group, Inc. .................... 37.40 0.91 53.43 151.23 Donegal Group Inc. ...................... 11.50 0.58 7.77 77.13 EMC Insurance Group Inc. ................ 18.87 0.64 11.37 131.87 Erie Indemnity Company................... 40.12 2.47 16.38 276.31 Harleysville Group Inc. ................. 24.46 0.85 25.22 118.22
97
PRICE/ PRICE/ LTM(1) LTM(1) PRICE/ COMPANY PRICE($)(2) REVENUE(X) EARNINGS(X) BOOK(%) - ------- ----------- ---------- ----------- ------- Merchants Group, Inc. ................... 21.00 0.51 16.94 65.75 Midland Company.......................... 22.50 0.61 19.23 125.21 National Security Group, Inc. ........... 13.11 0.78 24.28 76.09 Penn-America Group, Inc. ................ 10.80 1.12 11.13 131.71 Philadelphia Consolidated Holding Corp. ................................. 40.95 1.74 23.67 183.39 RLI Corp................................. 29.58 1.76 15.90 156.92 Selective Insurance Group, Inc. ......... 26.15 0.58 17.79 107.08 ----- ---- ----- ------ Mean..................................... 1.23 20.51 135.39 Median................................... 0.88 17.37 128.46 ---- ----- ------ Pro Forma Mercer at Midpoint of Valuation Range(3)............................... 1.07 13.85 62.53
- --------------- (1) The term "LTM," as used in these tables, means the 12 months ended March 31, 2003. (2) As of May 30, 2003. (3) The price of Mercer Insurance Group, Inc. common stock used in this table is the offering price of $10.00 per share. Please see the risk factor entitled "The price of our common stock may decrease after the conversion" on page 23 of this prospectus. After applying the adjustments to freely-traded value due to size, new issue discount and other factors, in series, to the comparable group multiples, and then applying these adjusted multiples to pro forma Mercer Mutual metrics, Griffin produced the following range of values.
MEDIAN DISCOUNTS PRO COMPARABLE ----------------------- FORMA ESTIMATED GROUP NEW MERCER ADJUSTED MERCER RANGE OF VALUATION MEASURE MULTIPLE SIZE ISSUE SPECIFIC MULTIPLE METRIC VALUES - ----------------- ---------- ---- ----- -------- -------- ------- --------- Price/Book...................... 128% 25% 20% 10% 69% $90,024 $62,116 Price/Earnings.................. 17.37x 25% 20% 10% 9.38x $ 2,110 $19,796
Griffin believes that, due to the variability of earnings in the property and casualty insurance industry, investors generally place more weight on the price to book ratio than on the price to earnings ratio of a company in this business. Another factor Griffin considered is that the Holding Company will issue approximately 488,280 shares to acquire the remaining outstanding shares and options of Franklin Holding. This will have an 8 - 11% dilutive effect, based on the range of values shown above, on the shares of the Holding Company issued in the conversion. Due to the appreciably lower valuation derived from the price to earnings multiple and the dilutive effect of the issuance of shares to the Franklin Holding shareholders, the valuation, in Griffin's opinion, is within the range shown above. It was Griffin's opinion that, as of May 30, 2003, the estimated pro forma market value range of Mercer Mutual as a subsidiary of the Holding Company was $41,650,000 to $56,350,000, with a midpoint of $49,000,000. Mercer Mutual's Board of Directors met with representatives of Griffin on February 19, 2003. They reviewed the valuation, including the factors considered by Griffin in reaching its conclusion and the assumptions made and the methodology used by Griffin. Griffin's representatives also answered the questions presented by the Board regarding the valuation. Griffin updated its valuation as of March 31, 2003 and May 30, 2003 to reflect the most recent financial results of Mercer Mutual. Griffin also has agreed to update its valuation at the conclusion of the subscription offering, at the closing of the conversion and otherwise as requested by Mercer Mutual. These updates considered and will consider developments in general stock market conditions, the initial public offering and mutual to stock conversion markets of property and casualty insurers, the results of the subscription offering, and Mercer Mutual's financial condition and results of operations. 98 THE VALUATION IS NOT INTENDED, AND MUST NOT BE CONSTRUED, AS A RECOMMENDATION OF ANY KIND AS TO THE ADVISABILITY OF PURCHASING COMMON STOCK. IN PREPARING THE VALUATION, GRIFFIN HAS RELIED UPON AND ASSUMED THE ACCURACY AND COMPLETENESS OF FINANCIAL AND STATISTICAL INFORMATION PROVIDED BY THE HOLDING COMPANY AND MERCER MUTUAL. GRIFFIN DID NOT INDEPENDENTLY VERIFY THE FINANCIAL STATEMENTS AND OTHER INFORMATION PROVIDED BY THE HOLDING COMPANY AND MERCER MUTUAL, NOR DID GRIFFIN VALUE INDEPENDENTLY THE ASSETS AND LIABILITIES OF THE HOLDING COMPANY AND MERCER MUTUAL. THE VALUATION CONSIDERS THE HOLDING COMPANY AND MERCER MUTUAL ONLY AS A GOING CONCERN AND SHOULD NOT BE CONSIDERED AS AN INDICATION OF THE LIQUIDATION VALUE OF THE HOLDING COMPANY AND MERCER MUTUAL. THE VALUATION IS NECESSARILY BASED UPON ESTIMATES AND PROJECTIONS OF A NUMBER OF MATTERS, ALL OF WHICH ARE SUBJECT TO CHANGE FROM TIME TO TIME. WE CANNOT ASSURE YOU THAT PERSONS PURCHASING COMMON STOCK WILL BE ABLE TO SELL SUCH SHARES AT OR ABOVE THE INITIAL PURCHASE PRICE. COPIES OF THE VALUATION REPORT OF GRIFFIN SETTING FORTH THE METHOD AND ASSUMPTIONS FOR ITS VALUATION ARE ON FILE AND AVAILABLE FOR INSPECTION AT THE PRINCIPAL EXECUTIVE OFFICES OF THE HOLDING COMPANY. ANY SUBSEQUENT UPDATED VALUATION REPORT OF GRIFFIN ALSO WILL BE AVAILABLE FOR INSPECTION. Griffin will receive a fee of $125,000 for its valuation. Griffin also is receiving a separate fee of $300,000 for serving as our financial advisor in the conversion. Griffin will be reimbursed for its reasonable out-of-pocket expenses incurred in providing its services. We have agreed to indemnify Griffin for its liabilities, costs and expenses in connection with certain claims, including certain liabilities under the Securities Act. Griffin has received its valuation services fee and $25,000 of its financing advisory services fee. Griffin is a subsidiary of Stevens and Lee, our legal counsel. Each was engaged by Mercer Mutual separately. Stevens and Lee was engaged to provide independent legal advice in connection with the conversion. Griffin was engaged to perform the valuation and provide financial advisory services, especially in connection with Mercer Mutual's consideration of its strategic alternatives. We do not believe there is any real or apparent conflict of interest because of the affiliation between Griffin and Stevens and Lee, except with respect to the negotiation of the engagement letters between Mercer Mutual and Griffin. Because it would have been a conflict of interest for Stevens and Lee to advise Mercer Mutual with respect to the negotiation of these engagement letters, Mercer Mutual did not request and Stevens and Lee did not provide any legal advice to Mercer Mutual in connection with these engagement letters. Neither Stevens and Lee's legal fees nor Griffin's valuation fee is contingent upon successful completion of the conversion. The Griffin financial advisory fee is contingent, and the completion of the transaction is contingent upon delivery of legal opinions by Stevens and Lee. TAX EFFECTS GENERALLY Mercer Mutual has obtained from the IRS a private letter ruling (PLR) concerning the material tax effects of the conversion and the subscription offering to Mercer Mutual, eligible policyholders, and certain other participants in the subscription offering. The PLR confirms, among other things, that the conversion of Mercer Mutual from mutual to stock form will constitute a reorganization within the meaning of Section 368(a)(1)(E) of the Internal Revenue Code of 1986, as amended (the "Code"). For federal income tax purposes, the following will apply: - No gain or loss will be recognized by Mercer Mutual in its pre-conversion mutual or post-conversion stock form as a result of the reorganization. - Mercer Mutual's basis in its assets, holding period for its assets, net operating loss carryforward, if any, capital loss carryforward, if any, earnings and profits and accounting methods will not be affected by the reorganization. - As discussed below, eligible policyholders will be required to recognize gain upon the receipt of subscription rights if and to the extent that the subscription rights that are allocated to an eligible policyholder are determined to have fair market value. 99 - The basis of the common stock purchased by an eligible policyholder pursuant to the exercise of subscription rights will equal the sum of the purchase price of the stock, plus the gain, if any, recognized by the eligible policyholder on the subscription rights that are exercised. - The holding period of the common stock purchased by an eligible policyholder through the exercise of subscription rights will begin on the date on which the subscription rights are exercised. In all other cases, the holding period of common stock purchased by an eligible policyholder will begin on the date following the date on which the stock is purchased. TAX CONSEQUENCES OF SUBSCRIPTION RIGHTS Generally, the federal income tax consequences of the receipt, exercise and lapse of subscription rights are uncertain. They present novel issues of tax law that are not addressed by any direct authorities. Nevertheless, the IRS has ruled in the PLR that: - any gain realized by an eligible policyholder as a result of the receipt of subscription rights with a fair market value must be recognized, whether or not such rights are exercised; and - the amount of gain recognized by each eligible policyholder should equal the fair market value of subscription rights received by the eligible policyholder. Although not free from doubt, if an eligible policyholder is required to recognize gain on the receipt of subscription rights and does not exercise some or all of such subscription rights, the eligible policyholder should recognize a corresponding loss upon the expiration or lapse of his or her unexercised subscription rights. The amount of that loss should equal the gain previously recognized upon receipt of the unexercised subscription rights, although the loss may not have the same character as the corresponding gain. Although not free from doubt, if the membership interests in Mercer Mutual that are held by an eligible policyholder are capital assets in the hands of that eligible policyholder on the effective date of the conversion, then any gain resulting from the receipt of the subscription rights should constitute a capital gain. If the common stock that an eligible policyholder would have received upon exercise of the lapsed subscription rights would have constituted a capital asset in the hands of that eligible policyholder, the resulting loss upon expiration of the subscription rights should constitute a capital loss. For purposes of determining gain, it is unclear how the subscription rights should be valued or how to determine the number of subscription rights that may be allocated to each eligible policyholder during the subscription offering. In the opinion of Griffin Financial Group, the subscription rights do not have any fair market value, for a number of reasons. These rights are nontransferable, personal rights of short duration. They are provided without charge, and give the holder only the right to purchase shares of common stock in the subscription offering at a price equal to its estimated fair market value. This price is the same price at which such stock will be sold to purchasers in the community offering or the syndicated community offering, if any. Nevertheless, eligible policyholders are encouraged to consult with their tax advisors about the tax consequences of the conversion and the subscription offering. This federal income tax discussion does not purport to consider all aspects of federal income taxation that may be relevant to each eligible policyholder. A policyholder may be subject to special treatment under the code, such as trusts, individual retirement accounts, other employee benefit plans, insurance companies, and eligible policyholders who are employees of an insurance company or who are not citizens or residents of the United States. Due to the individual nature of tax consequences, each eligible policyholder is urged to consult his or her tax or financial advisor. TERMINATION DATES OF THE SUBSCRIPTION AND COMMUNITY OFFERINGS The subscription and community offerings will expire at 3:00 p.m., Eastern Time, on [September 8, 2003], unless on or prior to that date the Board of Directors of the Holding Company extends the offerings to a date no later than [October 27, 2003]. Subscription rights not exercised prior to the termination date of this offering will be void. If we extend this offering, we will give written notice of the extension to all subscribers on 100 or promptly after [September 8, 2003], and each subscriber must confirm his or her subscription by the extended termination date. The method for confirming a subscription will be described in our notice of extension. This notice, which will be in the form of a supplement to this prospectus, will be filed with the SEC pursuant to Rule 424 under the Securities Act of 1933. If a subscriber does not confirm his or her subscription by the extended termination date, the subscriber's funds will be returned promptly without interest. Subscriptions for common stock will not be accepted by the Holding Company until we receive subscriptions for at least 4,165,000 shares of common stock. If we have not received subscriptions for at least 4,165,000 shares of common stock by the termination date of this offering, all funds delivered to the Holding Company for the purchase of stock in this offering will be promptly returned to subscribers without interest. USE OF ORDER FORMS IN THIS OFFERING Any person who wants to subscribe for shares of common stock in this offering must complete and return, prior to the termination date of this offering, a stock order form together with full payment for all shares for which the subscription is made. The stock order form should be delivered by mail to the Mercer Insurance Group, Inc. Stock Processing Center, c/o Sandler O'Neill & Partners, L.P., 919 Third Avenue, 6th Floor, New York, NY 10022, or in person at the Holding Company's principal executive office located at 10 North Highway 31, Pennington, New Jersey. Payment by check or money order must accompany the stock order form. No wire transfers will be accepted. All checks or money orders must be made payable to "WILMINGTON TRUST COMPANY, AS ESCROW AGENT FOR MERCER INSURANCE GROUP, INC." All subscription rights under the Plan of Conversion will expire at 3:00 p.m., Eastern Time, on the termination date of this offering, whether or not the Holding Company has been able to locate each person entitled to subscription rights. ONCE TENDERED, ORDERS TO PURCHASE COMMON STOCK IN THE OFFERING CANNOT BE REVOKED. No prospectus will be mailed any later than five days prior to the termination date of this offering, or hand delivered any later than two days prior to such date. This procedure is intended to ensure that each purchaser receives a prospectus at least 48 hours prior to the termination of the offering in accordance with Rule 15c2-8 under the Securities Exchange Act of 1934. Execution of the Stock Order Form will confirm receipt or delivery in accordance with Rule 15c2-8. Stock order forms will be distributed only with a prospectus. Photocopies and facsimile copies of stock order forms will not be accepted. Only eligible policyholders, directors, officers, or employees of Mercer Mutual may exercise subscription rights, and they may do so only for their own account. THE SUBSCRIPTION RIGHTS GRANTED UNDER MERCER MUTUAL'S PLAN OF CONVERSION ARE NONTRANSFERABLE. Each eligible policyholder, director, officer, or employee subscribing for shares of common stock is required to represent to the Holding Company that he or she is purchasing the shares for his or her own account. Each eligible policyholder, director, officer, or employee also must represent that he or she has no agreement or understanding with any other person for the sale or transfer of the shares. The Holding Company is not aware of any restrictions that would prohibit eligible policyholders who purchase shares of common stock in the conversion, and who are not executive officers or directors of the Holding Company or Mercer Mutual, from freely transferring shares after the conversion. See "Limitations on Resales" on page 104. Under certain circumstances a subscriber will be treated as having failed to return the completed stock order form within the time period specified and the subscription rights of the subscriber will not be honored. These circumstances are: - a stock order form is not delivered and is returned to the sender by the United States Postal Service or the Holding Company is unable to locate the addressee; - a stock order form is not returned or is received after the termination date of this offering; - a stock order form is defectively completed or executed; and - a stock order form that is not accompanied by payment in full for the shares of common stock subscribed for in the form. We may, but are not required to, waive any irregularity relating to any stock order form. We also may require the submission of a corrected stock order form or the remittance of full payment for the shares of 101 common stock subscribed for by any date that we specify. Our interpretations of the terms and conditions of the Plan of Conversion and determinations concerning the acceptability of the stock order forms will be final, conclusive and binding upon all persons. Neither the Holding Company nor Mercer Mutual (or the directors, officers, employees and agents of any of them) will be liable to any person in connection with any interpretation or determination. PAYMENT FOR SHARES When you submit a completed stock order form, you must include payment in full for all subscribed shares of common stock. Payment may be made by check or money order in U.S. dollars payable to "Wilmington Trust Company, as escrow agent for Mercer Insurance Group, Inc. Payments will be placed in an escrow account at Wilmington Trust Company, who will serve as the escrow agent. The escrow account will be administered by the escrow agent. An executed stock order form, once received by us, may not be modified, amended or rescinded without our consent. Funds accompanying stock order forms will not be released until the conversion is completed or terminated. The ESOP will not be required to pay for shares at the time it subscribes, but will be required to pay for its shares at or before the completion of this offering. DELIVERY OF CERTIFICATES Certificates representing shares of the common stock will be delivered to subscribers promptly after completion of the offering. Until certificates are delivered to subscribers, you may not be able to sell the shares even though trading of the common stock will have begun. MARKETING AND UNDERWRITING ARRANGEMENTS We have engaged Sandler O'Neill & Partners, L.P. as a financial advisor in connection with the offering of the common stock in the conversion. Sandler O'Neill & Partners, L.P. has agreed to use its best efforts to assist us with the solicitation of subscriptions and purchase orders for shares of common stock in the conversion. Sandler O'Neill & Partners, L.P. is not obligated to take or purchase any shares of common stock in this offering. Sandler O'Neill & Partners, L.P. is not acting as a financial advisor with respect to, or rendering any assistance to us in connection with, the offering and sale of common stock to the Franklin Holding shareholders and Franklin Mutual. We have agreed to pay Sandler O'Neill & Partners, L.P. a fee equal to 1.4% of the total purchase price of the common stock sold in the subscription and community offerings, except for common stock sold to any director, officer or employee of Mercer Mutual or the Holding Company or their immediate families, or to the ESOP. We will pay an additional fee to Sandler O'Neill & Partners, L.P. if we conduct the syndicated community offering and any shares are sold under a selected dealers' agreement with one or more NASD member firms. We will pay a sales commission to each selected dealer, any sponsoring dealer's fees, and a management fee to Sandler O'Neill & Partners, L.P. of 1.5% of the total purchase price of the shares sold. However, the total fees payable to Sandler O'Neill & Partners, L.P. for common stock sold pursuant to such selected dealer's agreement cannot exceed 1.5% of the total purchase price of the shares sold under such agreement. In addition, the total fees payable to Sandler O'Neill & Partners, L.P. and the selected and sponsoring dealers cannot exceed 7.0% of the total purchase price of the shares sold under any such agreement. Fees to Sandler O'Neill & Partners, L.P. and to any other broker-dealer may be deemed to be underwriting fees. Sandler O'Neill & Partners, L.P. and any other broker-dealers may be deemed to be underwriters. Sandler O'Neill & Partners, L.P. also will be reimbursed for its reasonable out-of-pocket expenses, including legal fees, in an amount not to exceed $100,000. If the conversion is not consummated or Sandler O'Neill & Partners, L.P. ceases under certain circumstances to provide assistance to the Holding Company, Sandler O'Neill & Partners, L.P. will be reimbursed for its reasonable out-of-pocket expenses. We have agreed to indemnify Sandler O'Neill & Partners, L.P. for its liabilities, costs and expenses in connection with certain claims, including certain liabilities under the Securities Act. Sandler O'Neill & Partners, L.P. has 102 received an advance of $25,000 toward its fees and expenses. Total financial advisory fees to Sandler O'Neill & Partners, L.P. are expected to be $478,000 if 4,165,000 shares are sold in the conversion and $742,000 if 6,261,111 shares are sold in the conversion. See "Pro Forma Data" for the assumptions used to arrive at these estimates. Sandler O'Neill & Partners, L.P. also will perform conversion agent services and records management services for Mercer Mutual in the Conversion. Sandler O'Neill & Partners, L.P. will receive a fee for this service of $50,000, plus reimbursement of reasonable out-of-pocket expenses incurred in performing this service. Directors and executive officers of the Holding Company and Mercer Mutual may participate in the solicitation of offers to purchase common stock in this offering. Employees of BICUS Services Corporation may participate in administrative capacities or by providing clerical work in effecting a sales transaction. Other questions from prospective purchasers will be directed to executive officers or registered representatives. The BICUS employees have been instructed not to solicit offers to purchase common stock or provide advice regarding the purchase of common stock. The Holding Company will rely on Rule 3a4-1 under the Exchange Act, and sales of common stock will be conducted within the requirements of Rule 3a4-1, so as to permit officers, directors and employees to participate in the sale of common stock. No officer, director or employee of the Holding Company or Mercer Mutual will be compensated in connection with his or her participation in this offering. PROPOSED MANAGEMENT PURCHASES The following table lists the approximate number of shares of common stock that each of the Holding Company's directors and executive officers and their associates intend to purchase in the conversion. All of the directors and executive officers will be purchasing shares in their capacity as eligible policyholders of Mercer Mutual, except for Samuel J. Malizia, who will be purchasing shares in his capacity as a director of Mercer Mutual, and Gordon A. Coleman, who will be purchasing shares in his capacity as an officer of Mercer Mutual. These numbers include shares that each person and his associates intend to purchase. The table also shows the number of shares to be purchased by all directors and executive officers as a group, including the shares that all of their associates intend to purchase, and other related information. For purposes of the following table, we have assumed that sufficient shares will be available to satisfy subscriptions in all categories.
TOTAL SHARES NAME (1)(2) - ---- ------------ Roland D. Boehm(3)(4)....................................... 25,000 H. Thomas Davis, Jr.(3)(5)(8)............................... 100,000 William V.R. Fogler(3)...................................... 15,000 William C. Hart(3).......................................... 15,000 George T. Hornyak, Jr.(3)................................... 100,000 Samuel J. Malizia(3)........................................ 20,000 Richard U. Niedt(3)......................................... 12,000 Andrew R. Speaker(3)(6)(8).................................. 26,500 Richard G. Van Noy(3)(7).................................... 15,000 Gordon A. Coleman (8)....................................... 300 John Danka(8)............................................... 2,500 Paul Ehrhardt(8)............................................ 5,000 ------- Total..................................................... 336,300 =======
- --------------- (1) Does not include shares that will be allocated to employees under the ESOP. Under the ESOP, employees of the Holding Company and its subsidiaries will be allocated over time, in the aggregate, shares in an amount equal to 10% of the common stock issued in the conversion (which equals 416,500 shares if 4,165,000 shares are sold in the conversion, 490,000 shares if 4,900,000 shares are sold in the 103 conversion, 563,500 shares if 5,635,000 shares are sold in the conversion and 626,111 shares if 6,261,111 shares are sold in the conversion). (2) Does not include shares that would be issuable upon the exercise of options or the vesting of restricted stock awards granted under our proposed stock-based incentive plan. Under the stock-based incentive plan, we expect to grant to directors, executive officers and other employees options to purchase common stock and restricted stock awards in an aggregate amount equal to 14% of the shares issued in the conversion (which equals 583,100 shares if 4,165,000 shares are sold in the conversion, 686,000 shares if 4,900,000 shares are sold in the conversion, 788,900 shares if 5,635,000 shares are sold in the conversion, and 876,556 shares if 6,261,111 shares are sold in the conversion). No options or awards will be granted or awarded unless the stock-based incentive plan is approved by the Holding Company's shareholders at a meeting held not less than six months after completion of the conversion. (3) Director of the Holding Company and Mercer Mutual. (4) Vice Chairman of the Board of Directors of the Holding Company and Mercer Mutual. (5) Shares do not include the 251,715 shares of Holding Company common stock that Mr. Davis is receiving after the conversion in exchange for his shares of Franklin Holding Company stock. See "Additional Shares Being Issued after the Conversion." (6) President and Chief Executive Officer of the Holding Company and Mercer Mutual. (7) Chairman of the Board of Directors of the Holding Company and Mercer Mutual. (8) Executive officer of the Holding Company and Mercer Mutual. LIMITATIONS ON RESALES The common stock issued in the conversion will be freely transferable under the Securities Act of 1933. However, the transfer of shares issued to directors and officers of Mercer Mutual or its affiliates will be restricted for a period of one year from the effective date of the conversion. This restriction is required by the Pennsylvania Mutual-to-Stock Conversion Act. The directors and officers also are subject to additional resale restrictions under Rule 144 of the Securities Act of 1933. Shares of common stock issued to directors and officers will bear a legend giving appropriate notice of these restrictions. We will give instructions to the transfer agent for the common stock regarding these transfer restrictions. Any shares issued to our directors and officers as a stock dividend, stock split or otherwise with respect to restricted stock will be subject to the same restrictions. Shares acquired by our directors and officers after the completion of the conversion will not be subject to the Mutual-to-Stock Conversion Act's restrictions, but will be subject to the requirements of Rule 144. In addition, under guidelines of the NASD, members of the NASD and their associates are subject to certain restrictions on the transfer of securities purchased in accordance with subscription rights. Members of the NASD and their associates also are subject to certain reporting requirements upon purchase of such securities. William V. R. Fogler, a director of the Holding Company and Mercer Mutual, is an associate of an NASD member and is therefore subject to these restrictions. See the subsection entitled "Directors and Officers" under the section entitled "Management." INTERPRETATION AND AMENDMENT OF THE PLAN OF CONVERSION All interpretations of the Plan of Conversion by the Board of Directors of Mercer Mutual and the Board of Directors of the Holding Company will be final, subject to the limitations of applicable law. The Plan of Conversion may be amended at any time before it is approved by the Pennsylvania Insurance Department, provided that the amendment is approved by the affirmative vote of two-thirds of the directors of the Holding Company and Mercer Mutual. The Plan also may be amended at any time after it is approved by the Pennsylvania Insurance Department, provided that the amendment is approved by the affirmative vote of two-thirds of the directors of the Holding Company and Mercer Mutual, and by the Pennsylvania Insurance Department. The Plan may be amended at any time after it is approved by the eligible policyholders of Mercer Mutual and prior to the effective date of the conversion, provided that the amendment is approved by the affirmative vote of two-thirds of the directors of the Holding Company and of Mercer Mutual then in office and by the Pennsylvania Insurance Department. In addition, if the Pennsylvania Insurance Department 104 determines that the amendment is material, the amendment also must be approved by the affirmative vote of at least two-thirds of the votes cast at a meeting of eligible policyholders called for that purpose. If eligible policyholders are required to approve an amendment to the plan, the Holding Company will send a proxy statement to each eligible policyholder as soon as practical after the amendment is approved by the directors of the Holding Company and Mercer Mutual and the Pennsylvania Insurance Department. If prior to the effective date of the conversion, the Pennsylvania Insurance Department adopts regulations containing mandatory or optional provisions applicable to the conversion, the plan may be amended to conform to these regulations. This type of amendment can be made at any time prior to the effective date, provided that it is approved by the affirmative vote of two-thirds of the directors of the Holding Company and Mercer Mutual, and no resolicitation of proxies or further approval by eligible policyholders will be required. TERMINATION The Plan of Conversion may be terminated at any time before it is approved by the eligible policyholders provided that the termination is approved by the affirmative vote of two-thirds of the directors of the Holding Company and Mercer Mutual. The Plan of Conversion may be terminated at any time after it is approved by eligible policyholders and prior to the conversion's effective date by the affirmative vote of two-thirds of the directors of the Holding Company and Mercer Mutual provided that any such termination is also approved by the Pennsylvania Insurance Department. CONDITIONS The Plan has been approved by the Pennsylvania Insurance Department and the Board of Directors of the Holding Company and Mercer Mutual. Completion of the conversion also requires approval of the Plan by the affirmative vote of at least two-thirds of the votes cast by eligible policyholders of Mercer Mutual. If the eligible policyholders do not approve the Plan, the Plan will be terminated, and Mercer Mutual will continue to conduct business as a mutual insurance company. ADDITIONAL SHARES BEING ISSUED AFTER THE CONVERSION Pursuant to an agreement between Mercer Mutual Insurance Company and Franklin Mutual Insurance Company, a New Jersey corporation, in connection with the settlement of litigation between the parties, Mercer Mutual has granted to Franklin Mutual the right to purchase the same number of shares of the Holding Company common stock as an eligible policyholder can purchase under the Plan of Conversion. See the subsection entitled "Subscription Offering" in the section entitled "The Conversion." We do not know whether and, if so, to what extent Franklin Mutual will exercise this right and purchase stock. In 2001, Mercer Mutual acquired a 49% interest in Franklin Holding, a Delaware corporation that owns 100% of the capital stock of Franklin Insurance Company, a Pennsylvania property and casualty insurance company. (Franklin Holding and Franklin Insurance Company are not affiliated in any way with Franklin Mutual.) As part of that transaction, the parties agreed that, in the event of a conversion of Mercer Mutual, the eight holders of the remaining 51% of the capital stock of Franklin Holding would have the right to exchange their Franklin Holding stock for that number of shares of Holding Company common stock equal to the negotiated value of their Franklin Holding stock divided by $10.00 (the purchase price of the Holding Company common stock in this offering). Based on an aggregate Franklin Holding stock value of $4,882,800, the Franklin Holding shareholders have the right to exchange their Franklin Holding shares for 488,280 shares of Holding Company common stock. If any of the eight shareholders do not exercise their exchange rights, Mercer Mutual has the right to require them to exchange their shares on the same terms and we expect that Mercer Mutual would exercise that right. Accordingly, upon completion of the exchange, Mercer Mutual will own 100% of the outstanding capital stock of Franklin Holding. For an additional description of the acquisition of Franklin Holding and Franklin Insurance Company, see the subsection entitled "Our Insurance Companies" under the section entitled "Business." The shares issuable to Franklin Mutual and the shareholders of Franklin Holding are in addition to the 5,635,000 shares being offered in the subscription, community and syndicated community offerings to eligible policyholders, directors, officers and employees of Mercer Mutual and the general public, and to the shares being offered to the ESOP. 105 MANAGEMENT DIRECTORS AND OFFICERS The Board of Directors of the Holding Company consists of Roland D. Boehm, H. Thomas Davis, Jr., William V.R. Fogler, William C. Hart, George T. Hornyak, Jr., Samuel J. Malizia, Richard U. Niedt, Andrew R. Speaker, and Richard G. Van Noy, each of whom presently serves as a director of Mercer Mutual. The Board is divided into three classes with directors serving for three-year terms with approximately one-third of the directors being elected at each annual meeting of shareholders. Messrs. Hornyak, Malizia and Speaker have terms of office expiring at the annual meeting to be held in 2004. Messrs. Boehm, Davis and Fogler have terms of office expiring at the annual meeting to be held in 2005. Messrs. Hart, Niedt and Van Noy have terms of office expiring at the annual meeting to be held in 2006. The executive officers of the Holding Company are elected annually and, subject to the terms of their respective employment agreements, hold office until their respective successors have been elected and qualified or until death, resignation or removal by the Board of Directors of the Holding Company. The following table sets forth certain information regarding the directors and executive officers of the Holding Company.
AGE AT MARCH 31, DIRECTOR 2003 SINCE(1) POSITION WITH THE HOLDING COMPANY --------- -------- --------------------------------- Roland D. Boehm................ 64 1980 Vice Chairman of the Board of Directors H. Thomas Davis, Jr............ 54 2001 Senior Vice President and Director William V. R. Fogler........... 58 2000 Director William C. Hart................ 70 1970 Director George T. Hornyak, Jr. ........ 53 1985 Director Samuel J. Malizia.............. 48 2003 Director Richard U. Niedt............... 71 1979 Director Andrew R. Speaker.............. 40 1997 President, Chief Executive Officer, and Director Richard G. Van Noy............. 61 1979 Chairman of the Board of Directors Gordon A. Coleman.............. 45 N/A Treasurer John G. Danka.................. 54 N/A Vice President Paul D. Ehrhardt............... 45 N/A Senior Vice President and Corporate Secretary
- --------------- (1) Indicates year first elected as a director of Mercer Mutual. All members of the Board of Directors of the Holding Company have served as directors of the Holding Company since its incorporation in 1997 except for Mr. Fogler, who was elected to that Board in 2000; Mr. Davis, who was elected to that Board in 2001, and Mr. Malizia, who was elected to that Board in 2003. Each director of the Holding Company also serves as a director of Mercer Mutual Insurance Company, Franklin Insurance Company and Mercer Insurance Company of New Jersey, Inc. The business experience of each director of the Holding Company for at least the past five years is set forth below. Roland D. Boehm is a self-employed business consultant. He has served as a director of Commerce Bank/Central from 1999 to present, and served as a director of Prestige Financial Corp., a bank holding company, from 1993 to 1999. H. Thomas Davis, Jr. has served as Senior Vice President for Mercer Mutual and Franklin Insurance Company since September 2001. His responsibilities include serving as the liaison between Mercer Mutual and Franklin Insurance Company, as well as coordinating corporate planning. He served as Vice President of such companies from June 2001 to September 2001. He founded Franklin Insurance Company in 1997 and served as its President and Chief Executive Officer until its acquisition by Mercer Mutual in June 2001. He 106 has been the owner of Davis Insurance Agency since 1973. He is a member of the board of directors of Penns Woods Bancorp, Inc., a bank holding company. He also owns all of the outstanding capital stock of Central Pennsylvania Insurance Group, Inc. and Advantage Premium Finance Co., and owns 75% of HTD Real Estate, LLC. However, Mr. Davis is not an active employee of these companies. He devotes substantially all of his working time and efforts to Mercer Mutual and its affiliated companies, and we believe that he will continue to do so after the Conversion. William V. R. Fogler is the owner of Van Rensselaer, Ltd., an investment advisor registered with the Securities and Exchange Commission. Van Rensselaer, Ltd. provides investment management advice to Mercer Mutual. He is also a registered representative of American General Securities, Inc., a broker-dealer. William C. Hart is retired. He served as the President and Chief Executive Officer of Mercer Mutual and Mercer Insurance Company of New Jersey, Inc. from 1987 until March 2000. He currently serves on the Board of Directors of Assurance Partners Bank, Carmel, Indiana. George T. Hornyak, Jr. is a self employed private investor. He served as the President, Chief Executive Officer and Director of Pulse Bancorp, Inc. and Pulse Savings Bank from 1991 to 1998. He currently serves on the Board of Directors of First Sentinel Bancorp, Inc., a savings and loan holding company. Samuel J. Malizia is the Chairman of the Board of Nittany Financial Corp. and its subsidiary, Nittany Bank, located in State College, Pennsylvania. Mr. Malizia also serves as the managing partner of the law firm of Malizia Spidi & Fisch, PC, Washington, DC. Richard U. Niedt is retired. Andrew R. Speaker has served as the President and Chief Executive Officer of Mercer Mutual and Mercer Insurance Company of New Jersey, Inc. since March 2000. He also has served as the President of Franklin Insurance Company since June 2001. He served as the Executive Vice President and Chief Operating Officer of Mercer Mutual and Mercer Insurance Company of New Jersey, Inc. from October 1997 until March 2000. He also served as the Chief Financial Officer of Mercer Mutual and Mercer Insurance Company of New Jersey, Inc from 1990 to 2000 and as their Treasurer from 1990 to 1999. He is a member of the Board of Trustees of MSO, Inc. Richard G. Van Noy is retired. He served as the Administrator of Washington Township, Mercer County, New Jersey from December 2000 until December 2001. Prior to that time, he served as the Administrator of Hopewell Township, Mercer County, New Jersey from February 1995 until November 1999 and as the Administrator of West Windsor Township, Mercer County, New Jersey from November 1999 until December 2000. Gordon A. Coleman has served as the Treasurer of Mercer Mutual and Mercer Insurance Company of New Jersey, Inc. since 1999. From 1997 until 1999, he served as their Controller. John Danka has served as Vice President of Marketing for Mercer Mutual and Mercer Insurance Company of New Jersey, Inc. since June 2001. He has served as their Assistant Secretary since 1998. From 1994 until June 2001, he served as Vice President of Personal Lines of Mercer Mutual. Paul D. Ehrhardt has served as Senior Vice President of Underwriting for Mercer Mutual and Mercer Insurance Company of New Jersey, Inc. since June 2001. He also has served as their Corporate Secretary since 1998. From 1996 to June 2001, he served as the Vice President of Commercial Lines for Mercer Mutual. 107 COMMITTEES OF THE BOARD OF DIRECTORS Compensation Committee. The compensation committee of the Holding Company's board of directors consists of Messrs. Hart (Committee Chairman), Hornyak, Niedt and Van Noy. The compensation committee will: - review the compensation and benefits of BICUS employees, - grant stock options and restricted stock awards to employees, management and directors under our proposed stock-based incentive plan; and - make recommendations to our board of directors regarding these matters. Audit Committee. The audit committee consists of Messrs. Hornyak (Committee Chairman), Hart, Niedt and Van Noy. The audit committee will: - be responsible for the selection, retention and termination of our independent auditors; - approve the non-audit services provided by the independent auditors; - review the results and scope of the audit and other services provided by our independent auditors; - approve the estimated cost of the annual audit; - review the annual financial statements and the results of the audit with management and the independent auditors; - review with management and the independent auditors the adequacy of our system of internal accounting controls; - review with management and the independent auditors the significant recommendations made by the auditors with respect to changes in accounting procedures and internal accounting controls; and - report to the Board on the results of its review and make such recommendations as it may deem appropriate. Nominating/Governance Committee. The Nominating/Governance Committee of the Holding Company's board of directors consists of Messrs. Niedt (Committee Chairman), Hart, Hornyak, and Van Noy. This committee will: - make independent recommendations to the Board of Directors as to best practices for Board governance and evaluation of Board performance; - identify suitable candidates for Board membership and in such capacity will consider any nominees recommended by shareholders; - propose to the Board a slate of directors for election by the shareholders at each annual meeting; and - propose candidates to fill vacancies on the Board based on qualifications it determines to be appropriate. Mercer Mutual Committees. In addition, Mercer Mutual Insurance Company has an Investment Committee and an Executive Committee. The Investment Committee is responsible for the investment of the funds belonging to Mercer Mutual. The members of the Investment Committee are Messrs. Boehm (Committee Chairman), Hart, Hornyak, Niedt and Speaker. The Executive Committee gives consideration to matters of policy and general interest to the board of directors or members and makes recommendations to the board of directors. During the interval between the meetings of the board of directors, the Executive Committee also has and may exercise all the powers of the board of directors in the management of the business and affairs of Mercer Mutual in all cases in which specific directions have not been given by the board of directors. The members of the Executive Committee are Messrs. Van Noy (Committee Chairman), Boehm, Fogler, Hart and Speaker. 108 COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION The members of the compensation committee of our board of directors are currently Messrs. Hart, Hornyak, Niedt and Van Noy. None of our executive officers serves as a member of the board of directors or compensation committee of any entity that has one or more executive officers serving on our board of directors or compensation committee. DIRECTOR COMPENSATION No director of the Holding Company has received any remuneration from the Holding Company since its formation and the Holding Company does not presently intend to pay any fees for service as a director of the Holding Company. Following the conversion, non-employee directors of Mercer Mutual will be paid a monthly retainer of $1,900 and a monthly meeting fee of $700. The Chairman of the Board receives an additional $1,600 per month and the Vice Chairman of the Board receives an additional $1,200 per month. Directors of Franklin Insurance Company and Mercer Insurance Company of New Jersey, Inc. are not paid any fees for their service as directors. Directors may elect to defer payment of such fees until a later date pursuant to the terms of our Executive Nonqualified "Excess" Plan. We pay interest on these deferred amounts at a market rate established annually by the Board of Directors. Directors of Mercer Mutual elected after October 1, 1997 who receive a salary from Mercer Mutual or its affiliates are not entitled to receive an annual retainer or other additional compensation from Mercer Mutual for services rendered as directors or committee members. Mercer Mutual also maintains a Benefit Agreement pursuant to which it provides a pension to all directors upon their retirement from the Board. The pension is in the form of a lifetime monthly payment equal to the director's monthly retainer fee in effect on the director's retirement date. If a participating director dies prior to receiving 120 monthly payments under this plan, his beneficiaries are entitled to receive these payments until the total number of payments received by the director and his beneficiaries equals 120. CERTAIN TRANSACTIONS H. Thomas Davis, Jr., a director and executive officer, is the owner of Davis Insurance Agency. The Davis Insurance Agency is our largest producer, accounting for $7.1 million (13.9%) and $4.2 million (10.0%) of our direct premiums written during the years ended December 31, 2002 and 2001, respectively. For those years, we paid the Davis Insurance Agency $1.2 million and $630,000, respectively, in commissions and profit sharing amounts. Mr. Davis first became a director and officer of Mercer Mutual in 2001. Since 1994, Mercer Mutual had been a party to a consulting agreement (the "Consulting Agreement") with director Roland D. Boehm. The Consulting Agreement provided that Mr. Boehm was required to provide certain advisory services to Mercer Mutual for annual compensation of $31,200. This agreement was terminated by the Board of Directors on January 15, 2003. Van Rensselaer, Ltd., which is owned by William V.R. Fogler, a director, has provided investment management services to Mercer Mutual since the year 2000. Fees to Van Rensselaer, Ltd. amounted to $138,571 in 2002, $135,847 in 2001 and $142,795 in 2000. EXECUTIVE COMPENSATION The executive officers of the Holding Company have not received any compensation from the Holding Company since its formation. The following table sets forth information regarding the compensation of our President and Chief Executive Officer, and each other executive officer whose total salary and bonus for the year ended December 31, 2002, exceeded $100,000. This compensation information is for each of the fiscal years ended December 31, 2002, 2001 and 2000. All compensation paid to these executive officers from January 1, 2000 to September 30, 2001 was paid by Mercer Mutual, and all compensation paid from 109 October 1, 2001 to December 31, 2002 was paid by BICUS. No other executive officer of Mercer Mutual received compensation in excess of $100,000 for the fiscal year ended December 31, 2002.
ALL OTHER NAME AND PRINCIPAL POSITION YEAR SALARY(1)(2) BONUS COMPENSATION(3) - --------------------------- ---- ------------ ------- --------------- Andrew R. Speaker...................... 2002 221,605 106,790 $25,581 President, Chief Executive Officer, 2001 198,307 129,917 18,432 and Chief Financial Officer 2000 169,053 99,973 16,486 H. Thomas Davis, Jr. .................. 2002 86,442 32,500 5,257 Senior Vice President 2001(4) 38,173 35,000 595 2000(4) -- -- -- Paul D. Ehrhardt....................... 2002 173,906 63,500 19,193 Senior Vice President 2001 145,096 78,000 16,195 and Corporate Secretary 2000 128,942 65,000 15,188 John G. Danka.......................... 2002 103,514 25,000 11,955 Vice President 2001 98,077 40,000 11,672 2000 92,980 42,500 11,273 Gordon A. Coleman...................... 2002 100,577 25,000 10,891 Treasurer 2001 92,632 35,000 10,375 2000 90,384 32,500 8,863
- --------------- (1) Includes amounts deferred by the executive pursuant to Mercer Mutual's Retirement Savings Plan and Mercer Mutual's Executive Nonqualified "Excess" Plan. Under the Retirement Savings Plan, employees who elect to participate may elect to have up to 20% of their earnings contributed to Mercer Mutual's Retirement Savings Plan's related trust under its 401(k) feature. Any Employee who has completed one year of service, is at least 21 years of age and has worked 1,000 hours in a plan year is eligible to participate in the Retirement Savings Plan. Under the Executive Nonqualified "Excess" Plan (available to officers and directors only), a participant can elect to defer any portion of his or her compensation and cause such amount to be contributed to that Plan's related trust. (2) Mercer Mutual and BICUS provided other benefits to the executive officers in connection with their employment. The value of these personal benefits, which is not directly related to job performance, is not included in the table above because the value of the benefits does not exceed the lesser of $50,000 or 10% of the salary and bonus paid to any executive officer. (3) Includes amounts contributed by Mercer Mutual and BICUS under the Retirement Savings Plan for the benefit of the executive officer. Mercer Mutual contributed and BICUS contributes annually 2% of an employee's salary. In addition, BICUS will make a matching contribution equal to 66.7% of the employee's salary reduction up to a maximum of 2% of the employee's salary. Any employee who has completed one year of service and has worked 1,000 hours in a plan year is eligible to participate in the Retirement Savings Plan. Also includes voluntary contributions, if any, by Mercer Mutual or BICUS for the executive in conjunction with the Executive Nonqualified "Excess" Plan. (4) Mr. Davis commenced his employment on June 1, 2001. BENEFIT PLANS AND AGREEMENTS General. Messrs. Speaker, Davis, Ehrhardt and Danka are parties to employment agreements with BICUS Services Corporation and Mercer Mutual. In addition, in connection with Mercer Mutual's conversion to stock form the Holding Company's Board of Directors has approved the ESOP. After completion of the conversion, the Holding Company's Board of Directors intends to adopt the stock-based incentive plan, subject to shareholder approval. In addition, Mercer Mutual has an existing 401(k) plan and profit sharing plan in which the executive officers of the Holding Company will be eligible to participate after the conversion. 110 Stock-Based Incentive Plan. The Holding Company's Board of Directors has adopted a stock-based incentive plan. This plan must be approved by the Holding Company's shareholders at the Holding Company's first annual meeting of shareholders held after the conversion. The purpose of the stock-based incentive plan will be to assist us in attracting, motivating and retaining persons who will be in a position to substantially contribute to our financial success. This incentive plan will assist us in this effort by providing a convenient method for these persons to acquire Holding Company common stock. We anticipate that the stock-based incentive plan will have a term of ten years (unless the plan is earlier terminated by the Board of Directors of the Holding Company). The incentive plan will permit the granting of stock or stock-based awards in the form of incentive stock options (ISOs), nonqualified stock options (NQSOs), stock appreciation rights (SARs), SARs issued in tandem with stock options and shares of restricted common stock to directors and employees. However, neither ISOs nor SARs coupled with ISOs may be granted to non-employee directors. Pursuant to the stock-based incentive plan, the aggregate number of shares of common stock with respect to which all awards under the incentive plan may be granted is limited to 14% of the number of shares issued in the conversion (taking into account the shares issued to the ESOP, but not including the shares issued to Franklin Mutual or the shareholders of Franklin Holding). No more than that number of shares equal to 10% of the shares of common stock issued in the conversion will be issuable under the incentive plan upon exercise of stock options, SARs and SARs issued in tandem with stock options, and no more than that number of shares equal to 4% of the shares of common stock issued in the conversion will be issuable under the incentive plan as restricted common stock. The Holding Company may purchase shares of Holding Company common stock in the open market to hold as treasury shares for use in issuing stock upon the exercise of stock options or making restricted stock awards, or it may issue new shares from its authorized but unissued common stock. For a period of three years following the completion of the conversion, the purchase of shares in the open market would require the prior approval of the Pennsylvania Insurance Department. Assuming that all of the common stock eligible to be issued under the stock-based incentive plan is purchased in the open market, the number of shares purchased in the open market would be between 583,100 shares and 788,900 shares, and assuming that all of the shares purchased in the open market are purchased at $10.00 per share, the cost to the Holding Company would be between $5.8 million and $7.9 million. To the extent that the common stock issued under the stock-based incentive plan is issued upon the exercise of stock options, the Holding Company would receive from option holders the exercise price of the options. All awards granted under the stock-based incentive plan are subject to such vesting, performance criteria or other conditions as are provided in the incentive plan document or in the agreement pursuant to which the award is granted. The failure to satisfy such vesting, performance criteria or other conditions may result in the forfeiture, lapse or other loss of the benefit of the award. Each ISO issued under the stock-based incentive plan would entitle the option holder, upon exercise at or after vesting, to purchase a number of shares of Holding Company common stock, and at a price per share, specified in the agreement issued to him or her. ISOs afford favorable tax treatment to recipients upon compliance with certain restrictions under Section 422 of the Internal Revenue Code of 1986. That is, no taxable income will be recognized by the option holder upon exercise, although he or she may become subject to alternative minimum tax. ISOs do not result in tax deductions to the Holding Company unless participants fail to comply with Section 422. Each NQSO issued under the stock-based incentive plan will entitle the option holder, upon exercise at or after vesting, to purchase a number of shares of Holding Company common stock, and at a price per share, specified in the agreement issued to him or her. Non-qualified stock options are options that do not qualify for the favorable tax treatment of Section 422. The option holder will recognize compensation income upon the exercise of the NQSO in an amount equal to the excess of the then fair market value of the stock acquired over the aggregate exercise price paid for that stock. The Holding Company will be entitled to a federal income tax deduction equal to the amount reportable as income by the option holder. 111 The exercise price for stock options to be granted under the stock-based incentive plan would be determined as of the date the option is granted and would equal the then market price of the Holding Company common stock. Each SAR issued under the stock-based incentive plan would entitle the SAR holder, upon exercise at or after vesting, to receive the excess of the then fair market value of the Holding Company's common stock attributable to the exercised SAR over the fair market value of that stock on the date the SAR was granted. Such excess could be paid in cash or common stock. SARs issued under the incentive plan will not be subject to favorable income tax treatment. The SAR holder will recognize compensation income upon exercise of the SAR in an amount equal to the cash received and the fair market value of any common stock received. The Holding Company will be entitled to a federal income tax deduction equal to the amount reportable as income by the SAR holder. The term of a SAR may not exceed ten years and one month. Restricted stock is Holding Company common stock that is typically granted at no cost to the recipient. It is nontransferable and forfeitable until the holder's interest in the stock vests. Vesting can be tied to performance or the passage of time. Nevertheless, the holder would be entitled to vote the restricted stock but would not be entitled to receive dividends and other distributions made with respect to the restricted stock until the stock vests. The grantee of restricted stock will not be entitled to special federal income tax treatment. Upon vesting and release of the restricted stock, the grantee will recognize compensation income equal to the then fair market value of the stock (plus the amount of any retained dividends that are then paid over to him or her), unless a special election has been timely filed with the Internal Revenue Service to recognize the income on the grant date. The Holding Company will be entitled to a federal income tax deduction equal to the amount reportable as income by the grantee. The initial grant of awards under the incentive plan is expected to take place on the date of the receipt of shareholder approval of the incentive plan. No decisions concerning the number or type of awards to be granted to any director or officer have been made at this time. No grants will be made prior to the receipt of shareholder approval of the incentive plan. Employee Stock Ownership Plan. In connection with the conversion, we have adopted the Employee Stock Ownership Plan, or ESOP, for the exclusive benefit of participating employees, to be implemented upon the completion of the conversion. Participating employees are all employees of the Holding Company or any of its affiliates, including BICUS Services Corporation, who have attained age 21 and completed one year of service. All officers of the Holding Company and its affiliates are participating employees. As of March 31, 2003, there were 68 participating employees. The Holding Company will submit to the IRS an application for a letter of determination as to the tax-qualified status of the ESOP. We expect that the ESOP will receive a favorable letter of determination from the IRS. The ESOP intends to borrow funds from the Holding Company in an amount sufficient to purchase 10% of the common stock issued in the conversion. This loan will bear an interest rate equal to the prime rate of interest set forth in The Wall Street Journal on the closing date of the conversion. Depending on the number of shares issued in the conversion, the ESOP loan will require the ESOP to make annual level principal and interest payments of between $512,000 and $770,000 for a term of 10 years. The loan will be secured by the shares of Holding Company common stock purchased and dividends on such shares. Shares purchased with the ESOP loan proceeds will be held in a suspense account for allocation among participants as the ESOP loan is repaid. Through dividends from Mercer Mutual and cash on hand, the Holding Company expects to contribute sufficient funds to the ESOP to repay the ESOP loan in full. Contributions to the ESOP and shares released from the suspense account will be allocated among participants in accordance with the ESOP plan document and IRS regulations. Generally, allocations are made on the basis of annual wages subject to federal income tax withholding, plus any amounts withheld under a plan qualified under Sections 125 or 401(k) of the Internal Revenue Code and sponsored by the Holding Company or an affiliate of the Holding Company. Participants must be employed at least 500 hours in a calendar year in order to receive an allocation. A participant becomes 100% vested in his or her right to ESOP benefits only after completing 5 years of service. For vesting purposes, a year of service means any year in which an employee completes at least 1,000 hours of service. Vesting will be accelerated to 100% upon a 112 participant's attainment of age 65, death, or disability. Forfeitures will be reallocated to participants on the same basis as other contributions. Benefits are payable upon a participant's retirement, death, disability, or separation from service, and will be paid in a lump sum or whole shares of common stock (with cash paid in lieu of fractional shares). Any dividends paid on allocated shares are expected to be credited to participant accounts within the ESOP or paid to participants, and any dividends on unallocated shares are expected to be used to repay the ESOP loan. The Holding Company will administer the ESOP, and an unaffiliated bank or trust company will be appointed as trustee of the ESOP. The ESOP trustee must vote all allocated shares held in the ESOP in accordance with the instructions of the participants. Unallocated shares and allocated shares for which no timely direction is received will be voted by the ESOP trustee in the same proportion as the participant-directed voting of allocated shares. Executive Employment Agreements. Andrew R. Speaker, H. Thomas Davis, Jr., Paul D. Ehrhardt and John G. Danka are each parties to employment agreements with BICUS Services Corporation and Mercer Mutual. The employment agreements with Messrs. Speaker, Davis, Ehrhardt and Danka each have an initial five-year term. After the expiration of each year of the term, they provide for a one-year extension, upon review by the Board of Directors, so as to maintain a five-year term, unless BICUS or the executive gives prior written notice of nonrenewal. Under their respective employment agreements, as currently in effect, Mr. Speaker is entitled to receive an annual base salary of not less than $255,000; Mr. Davis is entitled to receive an annual base salary of not less than $110,000; Mr. Ehrhardt is entitled to receive a base salary of not less than $185,000; and Mr. Danka is entitled to receive a base salary of not less than $105,000. In addition, under their employment agreements Messrs. Speaker, Davis, Ehrhardt and Danka are each entitled to participate in any other incentive compensation and employee benefit plans that BICUS or its affiliates maintain. Under each of the employment agreements, in the event the executive's employment is terminated for cause, as defined in the employment agreement, the executive will be entitled to receive his accrued but unpaid base salary and an amount for all accumulated but unused vacation time earned through the date of his termination. In the event the executive's employment is terminated without cause, the executive will be entitled to receive an annual amount equal to the greater of (i) his highest base salary received during one of the two years immediately preceding the year in which he is terminated, or (ii) his base salary in effect immediately prior to his termination, for the remainder of the term of his employment agreement. In addition, during the remaining term of his employment agreement, the executive annually will be entitled to (i) an amount equal to the higher of the aggregate bonuses paid to him in one of the two years immediately preceding the year in which he is terminated, and (ii) an amount equal to the sum of the highest annual contribution made on his behalf (other than his own salary reduction contributions) to any tax qualified and non-qualified defined contribution plans (as such term is defined in Section 3(35) of the Employee Retirement Income Security Act of 1974 ("ERISA")) in the year in which he is terminated or in one of the two years immediately preceding such year. The executive also will be entitled to certain retirement, health and welfare benefits. In the event the executive terminates his employment for good reason, as defined in the employment agreement, the executive will be entitled to receive the same amounts and benefits he would receive if terminated without cause. In the event the executive terminates his employment without good reason, the executive will be entitled to receive his accrued but unpaid base salary until the date of termination and an amount for all accumulated but unused vacation time through the date of the termination of his employment. In the event of the executive's death or disability during the term of his employment, the executive and his eligible dependents or his spouse and her eligible dependents, as the case may be, will be entitled to receive certain cash amounts and certain health and welfare benefits. In the event that the executive is required to pay any excise tax imposed under Section 4999 of the Internal Revenue Code (or any similar tax imposed under federal, state or local law) as a result of any compensation and benefits received under the employment agreement in connection with a change in control, 113 the executive will be paid an additional amount such that the net amount retained by him, after the payment of such excise taxes (and any additional income tax resulting from such payment), equals the amount he would have received but for the imposition of such taxes. The employment agreements further provide that in the event the executive's employment is terminated for cause or he voluntarily terminates his employment prior to a change in control, as defined in the employment agreement, the executive may not, for a period of twelve months after the date of termination, without the prior written consent of BICUS' Board of Directors, become an officer, director or a shareholder or equity owner of 4.9% or more of any property and casualty insurance company with its corporate headquarters located within Pennsylvania or New Jersey. In addition, during the executive's employment and for a period of 12 months following the termination of his employment, except following a change in control, the executive may not solicit, endeavor to entice away from Mercer Mutual or its subsidiaries or affiliates, or otherwise interfere with the relationship of Mercer Mutual or its subsidiaries or affiliates with any person who is, or was within the then most recent 12-month period, an employee or associate of Mercer Mutual or any of its subsidiaries or affiliates. RESTRICTIONS ON ACQUISITION OF THE HOLDING COMPANY Our articles of incorporation and by-laws contain numerous provisions that are intended to encourage potential acquirors to negotiate directly with our Board of Directors, but which also may deter a nonnegotiated tender or exchange offer for our stock or a proxy contest for control of the Holding Company. Certain provisions of Pennsylvania law also may discourage nonnegotiated takeover attempts or proxy contests. In addition, the terms of the employment agreements with our executive officers (see the subsection entitled "Certain Benefit Plans and Agreements" under the heading "Management") may be viewed as having the effect of discouraging these efforts. All of these provisions may serve to entrench existing management. These provisions also may deter institutional interest in and ownership of our stock and, accordingly, may depress the market price for, and liquidity of, the common stock. Following is a description of these provisions and the purpose and possible effects of these provisions. We do not presently intend to propose additional anti-takeover provisions for the articles of incorporation or by-laws. Because of the possible adverse effect these provisions may have on shareholders, this discussion should be read carefully. ANTITAKEOVER PROVISIONS OF OUR ARTICLES OF INCORPORATION AND BYLAWS 1. Prohibition of Ownership and Voting of Shares in Excess of 10%. Our articles of incorporation impose limitations upon the ability of certain shareholders and groups of shareholders to acquire or vote shares of our stock. The articles of incorporation prohibit any person (whether an individual, company or a group acting in concert, as defined) from acquiring voting control, as defined. Voting control is generally defined as the beneficial ownership at any time of shares with more than 10% of the total voting power of the outstanding stock of the Holding Company. These provisions would not apply to the purchase of shares by underwriters in connection with a public offering. A group acting in concert includes persons seeking to combine or pool their voting power or other interests in common stock for a common purpose. Such a group does not include actions by the Board of Directors acting solely in their capacity as the Board. Under this provision, shares of common stock, if any, owned in excess of 10% will not be entitled to vote on any matter or take other shareholder action. For purposes of determining the voting rights of other shareholders, these excess shares are essentially treated as no longer outstanding. As a result, where excess shares are present, other shareholders will realize a proportionate increase in their voting power, but this 10% voting restriction will not be applicable to other shareholders if their voting power increases above 10% as a result of application of this rule to another shareholder. The potential effect of this voting rights limitation is significant. Any person or group acting in concert owning more than 10% of the outstanding common stock will generally be unable to exercise voting rights proportionate to their equity interest. When operating in conjunction with other provisions in our articles of 114 incorporation described below, the practical effect of the limitation on voting rights may be to render it virtually impossible for any one shareholder or group acting in concert to determine the outcome of any shareholder vote. The 10% voting rights limitation may make it extremely difficult for any one person or group of affiliated persons to acquire voting control of the Holding Company, with the result that it may be extremely difficult to bring about a change in the Board of Directors or management. This provision may have the effect of discouraging holders of large amounts of shares from purchasing additional shares, or would be holders who may desire to acquire enough shares to exercise control from purchasing any shares. As a result, this provision may have an adverse effect on the liquidity and market price of the shares. 2. Classified Board of Directors. Our articles of incorporation provide for a classified Board of Directors of between seven (7) and twenty-five (25) members, which number is fixed by the Board of Directors, divided into three classes serving for successive terms of three years each. This provision is designed to assure experience, continuity, and stability in the Board's leadership and policies. We believe that this can best be accomplished by electing each director to a three-year term and electing only approximately one-third of the directors each year. The election of directors for staggered terms significantly extends the time required to make any change in control of the Board of Directors and may tend to discourage any surprise or nonnegotiated takeover bid for control of the Holding Company. Under the articles of incorporation, it will take at least two annual meetings for holders of a majority of the Holding Company's voting securities to make a change in control of the Board of Directors because only a minority (approximately one-third) of the directors will be elected at each meeting. In addition, because certain actions require more than majority approval of the Board, as described herein, it may take as many as three annual meetings for a controlling block of shareholders to obtain complete control of the Board and the Holding Company's management. This provision may tend to perpetuate present management because of the additional time required to change control of the Board. Because the provision will increase the amount of time required for a takeover bidder to obtain control without the cooperation of the Board even if the takeover bidder were to acquire a majority of the outstanding stock, it may tend to discourage certain tender offers, perhaps including some tender offers that the shareholders may believe would be in their best interests. The classified Board provision will apply to all elections of directors and, accordingly, it will make it more difficult for shareholders to change the composition of the Board if the shareholders believe such a change would be desirable, even in the absence of any third party's acquisition of voting control. This is especially true in light of the denial of cumulative voting described below. 3. No Cumulative Voting. Cumulative voting entitles a shareholder to multiply the number of votes to which the shareholder is entitled by the number of directors to be elected, with the shareholder being able to cast all votes for a single nominee or distribute them among the nominees as the shareholder sees fit. The Pennsylvania Business Corporation Law provides that shareholders are entitled to cumulate their votes for the election of directors, unless a corporation's articles of incorporation provide otherwise. Cumulative voting is specifically prohibited in the articles of incorporation because we believe that each director should represent and act in the interest of all shareholders and not any special shareholder or group of shareholders. In light of current acquisition techniques and activity, minority representation could be disruptive and could impair the efficient management of the Holding Company for the benefit of shareholders generally. In addition, the absence of cumulative voting also will tend to deter greenmail, in which a substantial minority shareholder uses his holdings as leverage to demand that a corporation purchase his shares at a significant premium over the market value of the stock to prevent the shareholder from obtaining or attempting to obtain a seat on the Board of Directors. In the absence of cumulative voting, a majority of the votes cast in any election of directors can elect all of the directors of the class in any given year. The absence of cumulative voting, coupled with a classified Board of Directors, also may deter a proxy contest designed to win representation on the Board of Directors or remove management because a group or entity owning less than a majority of the voting stock may be unable to elect a single director. Although this 115 may tend to make removal of incumbent management more difficult, we believe deterring proxy contests will avoid the significant cost, in terms of money and management's time, in opposing such actions. 4. Nominations for Directors and Shareholder Proposals. Our by-laws require that nominations for the election of directors made by shareholders (as opposed to those made by the Board of Directors) and any shareholder proposals for the agenda at any annual meeting generally must be made by notice (in writing) delivered or mailed to the Secretary not less than 90 days prior to the meeting of shareholders at which directors are to be elected. We believe that this procedure will assure that the Board of Directors and shareholders will have an adequate opportunity to consider the qualifications of all nominees for directors and all proposals, and will permit the shareholders' meetings to be conducted in an orderly manner. It may have the effect, however, of deterring nominations and proposals other than those made by the Board of Directors. 5. Mergers, Sale of Assets, Liquidation Approval. Our articles of incorporation provide that any merger, consolidation, sale of assets or similar transaction involving the Holding Company requires the affirmative vote of shareholders entitled to cast at least 80% of the votes which all shareholders are entitled to cast, unless the transaction is approved in advance by 66 2/3% of the members of the Board of Directors. If the transaction is approved in advance by 66 2/3% of the members of the Board, approval by the affirmative vote of a majority of the votes cast by holders of outstanding voting stock at a meeting at which a quorum was present would be required. The articles of incorporation also provide that liquidation or dissolution of the Holding Company requires the affirmative vote of shareholders entitled to cast at least 80% of the votes that all shareholders are entitled to cast, unless such transaction is approved by 66 2/3% of the members of the Board of Directors. We believe that in a merger or other business combination, the effects on our employees and our customers and the communities we serve might not be considered by a tender offeror when merging the Holding Company into an entity controlled by an offeror as the second part of a two-step acquisition. By requiring approval of a merger or similar transaction by the affirmative vote of shareholders holding 80% or more of the combined voting power of outstanding stock of the Holding Company, it will be extremely difficult for a group or person owning a substantial block of Holding Company stock, after a successful tender or exchange offer, to accomplish a merger or similar transaction without negotiating an agreement acceptable to the Board of Directors. Accordingly, the Board of Directors will be able to protect the interests of the remaining shareholders as well as our employees and the customers and communities that we serve. If Board approval is not obtained, the proposed transaction must be on terms sufficiently attractive to obtain approval by a vote of shareholders holding 80% or more of the combined voting power of outstanding Holding Company capital stock. The 80% approval requirement could result in the Board and management being able to exercise a stronger influence over any proposed takeover by refusing to approve the proposed business combination and obtaining sufficient votes, including votes controlled directly or indirectly by management, to preclude the 80% approval requirement. Because this provision will tend to discourage nonnegotiated takeover bids and will encourage other takeover bidders to negotiate with the Board, it also will tend to assist the Board and, therefore, management in retaining their present positions. In addition, if the Board does not grant its prior approval, a takeover bidder may still proceed with a tender offer or other purchases of Holding Company stock although any resulting acquisition of the Holding Company may be more difficult and more expensive. Because of the increased expense and the tendency of this provision to discourage competitive bidders, the price offered to shareholders may be lower than if this provision were not present in the articles of incorporation. 6. Qualifications for Directors. Our articles of incorporation provide that, unless waived by the Board of Directors, a person must be a shareholder of the Holding Company for the lesser of three years or the time that has elapsed since the completion of the conversion, before he or she can be elected to the Board of Directors. This provision is designed to discourage non-shareholders who are interested in buying a controlling 116 interest in the Holding Company for the purpose of having themselves elected to the Board, by requiring them to wait for such period before being eligible for election. 7. Mandatory Tender Offer by 25% Shareholder. Our articles of incorporation require any person or entity that acquires stock of the Holding Company with a combined voting power of 25% or more of the total voting power of outstanding capital stock, to offer to purchase, for cash, all outstanding shares of the Holding Company's voting stock at a price equal to the highest price paid within the preceding twelve months by such person or entity for shares of the respective class or series of Holding Company stock. In the event this person or entity did not purchase any shares of a particular class or series of stock within the preceding twelve months, the price per share for such class or series of Holding Company stock would be the fair market value of such class or series of stock as of the date on which such person acquires 25% or more of the combined voting power of outstanding Holding Company stock. The Pennsylvania Business Corporation Law provides that, following any acquisition by a person or group of more than 20% of a publicly-held corporation's voting stock, the remaining shareholders have the right to receive payment, in cash, for their shares from the acquiror of an amount equal to the fair value of their shares, including a proportionate amount for any control premium. Our articles of incorporation provide that if provisions of the respective articles and the Pennsylvania Business Corporation Law both apply in a given instance, the price per share to be paid will be the higher of the price per share determined under the provision in the articles or under the Pennsylvania Business Corporation Law. Our Board of Directors believes that any person or entity who acquires control of the Holding Company in a nonnegotiated manner should be required to offer to purchase all shares of voting stock remaining outstanding after the assumption of control, at a price not less than the amount paid to acquire the control position. A number of companies have been the subject of tender offers for, or other acquisitions of, 20% or more of their outstanding shares of common stock. In many cases, such purchases have been followed by mergers in which the tender offeror or other purchaser has paid a lower price for the remaining outstanding shares than the price it paid in acquiring its original interest in the company and has paid in a potentially less desirable form in the merger (often securities of the purchaser that do not have an established trading market at the time of issuance). The statutory right of the remaining shareholders of a company to dissent in connection with certain mergers and receive the fair value of their shares in cash may involve significant expense and uncertainty to dissenting shareholders and may not be meaningful because the appraisal standard to be applied under Pennsylvania law does not take into account any appreciation in the stock price due to the merger. This provision in the articles of incorporation is intended to prevent these potential inequities. In many situations, the provision would require that a purchaser pay shareholders a higher price for their shares or structure the transaction differently than might be the case without the provision. Accordingly, we believe that, to the extent a merger were involved as part of a plan to acquire control of the Holding Company, adoption of the provision would increase the likelihood that a purchaser would negotiate directly with our Board of Directors. We further believe that our Board is in a better position than our individual shareholders to negotiate effectively on behalf of all shareholders and that the Board is likely to be more knowledgeable than any individual shareholder in assessing the business and prospects of the Holding Company. Accordingly, we are of the view that negotiations between the Board of Directors and a would-be purchaser will increase the likelihood that shareholders, as a whole, will receive a higher average price for their shares. The provision will tend to discourage any purchaser whose objective is to seek control of the Holding Company at a relatively low price by offering a lesser value for shares in a subsequent merger than it paid for shares acquired in a tender or exchange offer. The provision also should discourage the accumulation of large blocks of shares of Holding Company voting stock, which the Board of Directors believes to be disruptive to the stability of our vitally important relationships with our employees and customers and the communities that we serve, and which could precipitate a change of control of the Holding Company on terms unfavorable to the other shareholders. 117 Tender offers or other private acquisitions of stock are usually made at prices above the prevailing market price of a company's stock. In addition, acquisitions of stock by persons attempting to acquire control through market purchases may cause the market price of the stock to reach levels that are higher than otherwise would be the case. This provision may discourage any purchases of less than all of the outstanding shares of voting stock of the Holding Company and may thereby deprive shareholders of an opportunity to sell their stock at a higher market price. Because of having to pay a higher price to other shareholders in a merger, it may become more costly for a purchaser to acquire control of the Holding Company. Open market acquisitions of stock may be discouraged by the requirement that any premium price paid in connection with such acquisitions could increase the price that must be paid in a subsequent merger. The provision may therefore decrease the likelihood that a tender offer will be made for less than all of the outstanding voting stock of the Holding Company and, as a result, may adversely affect those shareholders who would desire to participate in such a tender offer. 8. Prohibition of Shareholders' Action Without a Meeting and of Shareholders' Right to Call a Special Meeting. Our articles of incorporation prohibit shareholder action without a meeting (i.e., the written consent procedure is prohibited) and prohibit shareholders from calling a special meeting. Therefore, in order for shareholders to take any action, it will require prior notice, a shareholders' meeting and a vote of shareholders. Special meetings of shareholders can only be called by the Board of Directors. Therefore, without the cooperation of the Board, any shareholder will have to wait until the annual meeting of shareholders to have a proposal submitted to the shareholders for a vote. These provisions are intended to provide the Board of Directors and nonconsenting shareholders with the opportunity to review any proposed action, express their views at the meeting and take any necessary action to protect the interests of our shareholders and the Holding Company before the action is taken, and to avoid the costs of holding multiple shareholder meetings each year to consider proposals of shareholders. These provisions also will preclude a takeover bidder who acquires a majority of outstanding Holding Company stock from completing a merger or other business combination of the Holding Company without granting the Board of Directors and the remaining shareholders an opportunity to make their views known and vote at an annual shareholders' meeting. The delay caused by the necessity for an annual shareholders' meeting may allow us to take preventive actions, even if you believe such actions are not in the best interests of the shareholders. 9. Amendment of Articles of Incorporation. The Pennsylvania Business Corporation Law provides that the articles of incorporation of a Pennsylvania business corporation (such as the Holding Company) may be amended by the affirmative vote of a majority of the votes cast by all shareholders entitled to vote, except as otherwise provided by the corporation's articles of incorporation. Our articles of incorporation provide that the following provisions of the articles can only be amended by an affirmative vote of shareholders entitled to cast at least 80% of all votes which shareholders are entitled to cast, or by an affirmative vote of 80% of the members of the Board of Directors and of shareholders entitled to cast at least a majority of all votes which shareholders are entitled to cast: (1) the provisions that require 80% shareholder approval of certain actions, (2) those establishing a classified Board of Directors, (3) the prohibition on cumulative voting for directors (4) the prohibition on acquiring or voting more than 10% of the voting stock, (5) the prohibition on shareholder action without a meeting, (6) the prohibition on shareholders calling special meetings, (7) the requirement of a 25% shareholder to purchase all remaining shareholders' stock, and (8) the provisions that no shareholder shall have preemptive rights. On other matters, the articles of incorporation can be amended by an affirmative vote of a majority of the votes cast by all shareholders entitled to vote thereon at a meeting at which a quorum is present. 118 10. Amendment of By-Laws. Generally, our articles of incorporation vest authority to make and amend the By-Laws in the Board of Directors, acting by a vote of a majority of the entire Board. In addition, except as described below, shareholders may amend the by-laws by an affirmative vote of the holders of 66 2/3% of the outstanding voting stock. However, the provision of the by-laws concerning directors' liabilities and indemnification of directors, officers and others may not be amended to increase the exposure of directors to liability or decrease the degree of indemnification except by the two-thirds vote of the entire Board of Directors or 80% of all votes of shareholders entitled to be cast. This provision is intended to provide additional continuity and stability in our policies and governance so as to enable us to carry out our long range plans. The provision also is intended to discourage nonnegotiated efforts to acquire the Holding Company, since a greater percentage of outstanding voting stock will be needed before effective control over its affairs could be exercised. The Board of Directors will have relatively greater control over the by-laws than the shareholders because, except with respect to the director liability and indemnification provisions, the Board could adopt, alter, amend or repeal the by-laws upon a majority vote by the directors. PENNSYLVANIA FIDUCIARY DUTY PROVISIONS The Pennsylvania Business Corporation Law provides that: (a) the board of directors can consider, in determining whether a certain action is in the best interests of the corporation: (1) the effects of any action upon any or all groups affected by such action, including shareholders, employees, suppliers, customers and creditors of the corporation, and upon communities in which offices or other establishments of the corporation are located, (2) the short-term and long-term interests of the corporation, including benefits that may accrue to the corporation from its long-term plans and the possibility that these interests may be best served by the continued independence of the corporation, (3) the resources, intent and conduct (past, stated and potential) of any person seeking to acquire control of the corporation, and (4) all other pertinent factors; (b) the board of directors need not consider the interests of any particular group as dominant or controlling; (c) directors, in order to satisfy the presumption that they have acted in the best interests of the corporation, need not satisfy any greater obligation or higher burden of proof with respect to actions relating to an acquisition or potential acquisition of control; (d) actions relating to acquisitions of control that are approved by a majority of disinterested directors are presumed to satisfy the directors' standard unless it is proven by clear and convincing evidence that the directors did not assent to such action in good faith after reasonable investigation; and (e) the fiduciary duty of directors is solely to the corporation and not its shareholders, and may be enforced by the corporation or by a shareholder in a derivative action, but not by a shareholder directly. The Pennsylvania Business Corporation Law also explicitly provides that the fiduciary duty of directors does not require directors to act as the board of directors, a committee of the board or an individual director solely because of the effect such action might have on an acquisition or potential or proposed acquisition of control of the corporation or the consideration that might be offered or paid to shareholders in such an acquisition. One of the effects of these fiduciary duty provisions may be to make it more difficult for a shareholder to successfully challenge the actions of our Board of Directors in a potential change in control context. Pennsylvania case law appears to provide that the fiduciary duty standard under the Pennsylvania Business 119 Corporation Law grants directors the statutory authority to reject or refuse to consider any potential or proposed acquisition of the corporation. OTHER PROVISIONS OF PENNSYLVANIA LAW The Pennsylvania Business Corporation Law also contains provisions applicable to us that may have the effect of impeding a change in control. These provisions: - prohibit for five years, subject to certain exceptions, a "business combination," which includes a merger or consolidation of the Holding Company or a sale, lease or exchange of assets, with a shareholder or group of shareholders beneficially owning 20% or more of a public corporation's voting power; - prevent a shareholder acquiring different levels of voting power (20%, 33% and 50%) from voting any shares in excess of the applicable threshold unless disinterested shareholders approve such voting rights; and - require any person or group that publicly announces that it may acquire control of the Holding Company, or that acquires or publicly discloses an intent to acquire 20% or more of the voting power of the Holding Company, to disgorge to the Holding Company any profits it receives from sales of the Holding Company's equity securities purchased over the prior 18 months. DESCRIPTION OF THE CAPITAL STOCK GENERAL The Holding Company is authorized to issue 15,000,000 shares of common stock, without par value, and 5,000,000 shares of preferred stock having a par value determined by the Board of Directors of the Holding Company. In the conversion, we expect the Holding Company to issue between 4,165,000 and 6,261,111 shares of common stock and no shares of preferred stock. COMMON STOCK Voting Rights. Each share of the common stock will have the same relative rights and will be identical in all respects with every other share of common stock. The holders of common stock will possess exclusive voting rights in the Holding Company, except if and to the extent shares of preferred stock issued in the future have voting rights. Except for the limitation on the right of a person or group acting in concert to vote shares with voting power in excess of 10% (see the subsection entitled "Antitakeover Provisions of Our Articles of Incorporation and Bylaws" under the heading "Restrictions on Acquisition of the Holding Company"), each holder of shares of common stock will be entitled to one vote for each share held of record on all matters submitted to a vote of holders of shares of common stock. Shareholders are not be entitled to cumulate their votes for election of directors. Dividends. Under the Pennsylvania Business Corporation Law, we may only pay dividends if solvent and if payment of such dividend would not render us insolvent. Funds for dividend distribution initially must come from either proceeds of this offering retained by the Holding Company or dividends paid to the Holding Company by our insurance companies. Therefore, the restrictions on our insurance companies' ability to pay dividends affect our ability to pay dividends. These restrictions are described in the section of this prospectus entitled "Business" under the subsection entitled "Regulation." We presently intend to retain earnings to support our growth. Accordingly, we do not currently anticipate paying cash dividends to shareholders for the foreseeable future. Liquidation. In the event of any liquidation, dissolution or winding up of Mercer Mutual, the Holding Company, as holder of all of the capital stock of Mercer Mutual, would be entitled to receive all assets of Mercer Mutual after payment of all debts and liabilities of Mercer Mutual. In the event of a liquidation, dissolution or winding up of the Holding Company, each holder of shares of common stock would be entitled to receive, after payment of all debts and liabilities of the Holding Company, a pro rata portion of all assets of 120 the Holding Company available for distribution to holders of common stock. If any preferred stock is issued, the holders thereof are likely to have a priority in liquidation or dissolution over the holders of the common stock. Transfer. Shares of common stock are freely transferable except for shares that are held by affiliates. Shares issued to directors and officers of Mercer Mutual or of the Holding Company in the conversion will be restricted as to transfer for a period of one year from the effective date of the conversion. Shares held by affiliates must be transferred in accordance with the requirements of Rule 144 of the Securities Act of 1933. Other Characteristics. Holders of the common stock will not have preemptive rights with respect to any additional shares of common stock that may be issued. The common stock is not subject to call for redemption, and the outstanding shares of common stock, when issued and upon our receipt of their full purchase price, will be fully paid and nonassessable. PREFERRED STOCK None of the 5,000,000 authorized shares of preferred stock of the Holding Company will be issued in the conversion. We are authorized, without shareholder approval, to issue preferred stock or rights to acquire preferred stock, and to fix and state voting powers, designations, preferences or other special rights of such shares or rights, and the qualifications, limitations and restrictions thereof. The preferred stock may rank prior to the common stock as to dividend rights or liquidation preferences, or both, and may have full or limited voting rights. The Board of Directors has no present intention to issue any of the preferred stock. TRANSFER AGENT AND REGISTRAR The transfer agent and registrar for the common stock is Registrar and Transfer Company, Cranford, New Jersey. LEGAL MATTERS The legality of the common stock will be passed upon for the Holding Company by Stevens & Lee, King of Prussia, Pennsylvania. Stevens & Lee has consented to the reference herein to its opinion. Certain legal matters will be passed upon for Sandler O'Neill & Partners, L.P. by Lord, Bissell & Brook, Chicago, Illinois. EXPERTS The consolidated financial statements and schedules of Mercer Mutual as of December 31, 2002 and 2001, and for each of the years in the three-year period ended December 31, 2002, have been included in this prospectus in reliance upon the reports of KPMG LLP, independent certified public accountants, appearing elsewhere in this prospectus, and upon the authority of said firm as experts in accounting and auditing. Griffin Financial Group has consented to the publication in this document of the summary of its valuation of Mercer Mutual setting forth its conclusions as to the consolidated pro forma aggregate range of market values of Mercer Mutual as a subsidiary of the Holding Company, and the value of subscription rights to purchase the common stock, and has also consented to the use of its name and statements with respect to it appearing in this document. Griffin Financial Group is a subsidiary of Stevens & Lee, our legal counsel. REGISTRATION REQUIREMENTS We do not presently file reports with the Securities and Exchange Commission. However, in connection with the conversion, we will register the common stock with the Securities and Exchange Commission under Section 12(g) of the Securities Exchange Act of 1934 and, upon such registration, the Holding Company and its shareholders will become subject to the proxy solicitation rules, the annual and periodic reporting requirements, the restrictions on stock purchases and sales by directors, officers and greater than 10% shareholders, and certain other requirements of the Securities Exchange Act. 121 WHERE YOU CAN FIND ADDITIONAL INFORMATION We have filed with the Securities and Exchange Commission a Registration Statement on Form S-1 under the Securities Act of 1933 with respect to the common stock offered in this document. As permitted by the rules and regulations of the SEC, this prospectus does not contain all the information set forth in the Registration Statement. You should review the Registration Statement and all of its exhibits, including Griffin Financial Group's valuation of the consolidated pro forma aggregate market value of Mercer Mutual as a subsidiary of the Holding Company. Statements in this prospectus about the contents of any contract or other document are not necessarily complete, and those statements are qualified in all respects by reference to the Registration Statement and its Exhibits. The Registration Statement, together with exhibits, can be examined without charge at the Public Reference Room of the SEC located at Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and copies of such material can be obtained from the SEC at prescribed rates. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. In addition, electronic copies of such documents may be obtained on the SEC's Internet web site at http://www.sec.gov. This web site contains registration statements, reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. Mercer Mutual has filed an Application to Convert from Mutual to Stock Form with the Pennsylvania Insurance Department with respect to the conversion and has received the Department's order approving such application. The application and the order may be examined at the principal office of the Pennsylvania Insurance Department located in Harrisburg, Pennsylvania, and the full text of the order is available on the Department's Internet web site at http://www.insurance.state.pa.us. In addition, copies of the Plan of Conversion and the order, as well as other information concerning our insurance companies, can be found on our Internet web site at http://www.mercerins.com. We do not intend for the information contained on this website to be part of this prospectus. A copy of the articles of incorporation and the bylaws of the Holding Company and Mercer Mutual are available without charge from Mercer Mutual by contacting Paul D. Ehrhardt, Corporate Secretary, Mercer Insurance Group, Inc., 10 North Highway 31, Pennington, New Jersey 08534. 122 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS OF MERCER MUTUAL
PAGE ---- Independent Auditors' Report................................ F-2 Consolidated Financial Statements Balance Sheets (As of December 31, 2002 and 2001)......... F-3 Statements of Earnings (For the years ended December 31, 2002, 2001 and 2000)................................... F-4 Statements of Changes in Equity (For the years ended December 31, 2002, 2001 and 2000)...................... F-5 Statements of Cash Flows (For the years ended December 31, 2002, 2001 and 2000)................................... F-6 Notes to Consolidated Financial Statements................ F-7 Interim Condensed Consolidated Financial Statements Balance Sheets (As of March 31, 2003 (Unaudited) and December 31, 2002)..................................... F-22 Statements of Earnings (Unaudited) (For three months ended March 31, 2003 and 2002)............................... F-23 Statements of Changes in Equity (Unaudited) (For three months ended March 31, 2003)........................... F-24 Statements of Cash Flows (Unaudited) (For three months ended March 31, 2003 and 2002)......................... F-25 Notes to Condensed Consolidated Financial Statements...... F-26
F-1 INDEPENDENT AUDITORS' REPORT The Board of Directors Mercer Mutual Insurance Company and Subsidiaries: We have audited the accompanying consolidated balance sheets of Mercer Mutual Insurance Company and subsidiaries (the Group) as of December 31, 2002 and 2001, and the related consolidated statements of earnings, changes in equity, and cash flows for each of the years in the three-year period ended December 31, 2002. These financial statements are the responsibility of the Group's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards 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. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Group as of December 31, 2002 and 2001, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States of America. As discussed in note 1, the Group adopted the provisions of SFAS No. 142, Goodwill and Other Intangible Assets, effective January 1, 2002. /s/ KPMG LLP Philadelphia, PA March 28, 2003 F-2 MERCER MUTUAL INSURANCE COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS DECEMBER 31, 2002 AND 2001
2002 2001 ----------- --------- (DOLLARS IN THOUSANDS) ASSETS Investments, at fair value: Fixed income securities, available-for-sale, at fair value (cost $48,330 and $44,775, respectively)............... $ 49,247 44,078 Equity securities, at fair value (cost $16,697 and $14,486, respectively)................................. 20,332 20,653 -------- ------ Total investments.................................... 69,579 64,731 Cash and cash equivalents................................... 7,201 8,435 Premiums receivable......................................... 7,121 5,231 Reinsurance receivables..................................... 3,489 5,293 Prepaid reinsurance premiums................................ 1,146 789 Deferred policy acquisition costs........................... 5,783 4,962 Accrued investment income................................... 599 618 Property and equipment, net................................. 5,713 3,228 Deferred income taxes....................................... 1,411 359 Goodwill.................................................... 2,876 3,212 Other assets................................................ 930 261 -------- ------ Total assets................................................ $105,848 97,119 ======== ====== LIABILITIES AND EQUITY Liabilities: Losses and loss adjustment expenses....................... $ 31,348 31,059 Unearned premiums......................................... 24,923 20,548 Accounts payable and accrued expenses..................... 8,000 6,622 Other reinsurance balances................................ 210 605 Other liabilities......................................... 1,238 962 -------- ------ Total liabilities.................................... 65,719 59,796 -------- ------ Minority interest in subsidiary............................. 3,112 1,926 Equity: Unassigned equity......................................... 34,029 31,787 Accumulated other comprehensive income: Unrealized gains in investments, net of deferred income taxes................................................. 2,988 3,610 -------- ------ Total equity......................................... 37,017 35,397 -------- ------ Total liabilities and equity................................ $105,848 97,119 ======== ======
See accompanying notes to consolidated financial statements. F-3 MERCER MUTUAL INSURANCE COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF EARNINGS YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
2002 2001 2000 ------- ------ ------ (DOLLARS IN THOUSANDS) Revenue: Net premiums earned....................................... $40,454 30,728 27,635 Investment income, net of expenses........................ 2,061 2,425 2,517 Net realized investment gains (losses).................... (220) 42 (288) Other revenue............................................. 329 250 167 ------- ------ ------ Total revenue.......................................... 42,624 33,445 30,031 ------- ------ ------ Expenses: Losses and loss adjustment expenses....................... 20,067 14,534 13,711 Amortization of deferred policy acquisition costs (related party amounts of $955, $173 and $0, respectively)...... 10,953 8,137 7,478 Other expenses............................................ 7,974 6,103 4,575 Stock conversion expenses................................. 95 -- -- ------- ------ ------ Total expenses......................................... 39,089 28,774 25,764 ------- ------ ------ Income before income taxes and minority interest in income of subsidiary............................................. 3,535 4,671 4,267 Income taxes................................................ 1,155 1,271 1,199 ------- ------ ------ Income before minority interest in income of subsidiary..... 2,380 3,400 3,068 Minority interest in income of subsidiary................... (138) (100) -- ------- ------ ------ Net income.................................................. $ 2,242 3,300 3,068 ======= ====== ======
See accompanying notes to consolidated financial statements. F-4 MERCER MUTUAL INSURANCE COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
2002 2001 2000 ------- ------ ------ (DOLLARS IN THOUSANDS) Balance, beginning of period................................ $35,397 32,912 27,929 Net income.................................................. 2,242 3,300 3,068 Other comprehensive income (loss), net of tax: Unrealized gains (losses) on securities: Unrealized holding gains (losses) arising during period, net of related income tax expense (benefit) of $(395), $(405), and $889.............................. (767) (787) 1,725 Less reclassification adjustment for (gains) losses included in net income, net of related income tax benefit (expense) of $75, $(14), and $98.............. 145 (28) 190 ------- ------ ------ (622) (815) 1,915 ------- ------ ------ Comprehensive income........................................ 1,620 2,485 4,983 ------- ------ ------ Balance, end of period...................................... $37,017 35,397 32,912 ======= ====== ======
See accompanying notes to consolidated financial statements. F-5 MERCER MUTUAL INSURANCE COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
2002 2001 2000 -------- ------- ------ (DOLLARS IN THOUSANDS) Cash flows from operating activities: Net income................................................ $ 2,242 3,300 3,068 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation of property and equipment................. 819 491 216 Net accretion of discount.............................. (208) (70) (28) Amortization of goodwill............................... -- 98 -- Net realized investment (gain) loss.................... 220 (42) 288 Net realized gain on sale of property and equipment......................................... (5) (5) (2) Deferred income tax.................................... (58) (232) (315) Change in assets and liabilities: Premiums receivable.................................. (1,890) (799) (475) Reinsurance receivables.............................. 1,804 414 1,187 Prepaid reinsurance premiums......................... (357) 1,646 (136) Deferred policy acquisition costs.................... (821) (644) (39) Other assets......................................... (650) 242 74 Losses and loss adjustment expenses.................. 289 821 (705) Unearned premiums.................................... 4,375 732 550 Other................................................ 1,401 1,489 755 -------- ------- ------ Net cash provided by operating activities......... 7,161 7,441 4,438 -------- ------- ------ Cash flows from investing activities: Purchase of fixed income securities, available-for-sale... (35,444) (31,781) (5,730) Purchase of equity securities............................. (6,240) (5,354) (1,598) Purchase of FHC, net of cash acquired..................... -- (722) -- Sale and maturity of fixed income securities available-for-sale..................................... 32,371 30,981 6,083 Sale of equity securities................................. 3,528 2,381 1,303 Purchase of property and equipment........................ (3,323) (1,488) (327) Sale of property and equipment............................ 24 5 2 -------- ------- ------ Net cash used in investing activities............. (9,084) (5,978) (267) -------- ------- ------ Cash flows from financing activities: Proceeds from sale of securities in subsidiary to minority interest shareholder................................... 689 -- -- -------- ------- ------ Net cash provided by financing activities......... 689 -- -- -------- ------- ------ Net increase (decrease) in cash and cash equivalents..................................... (1,234) 1,463 4,171 Cash and cash equivalents at beginning of period............ 8,435 6,972 2,801 -------- ------- ------ Cash and cash equivalents at end of period.................. $ 7,201 8,435 6,972 ======== ======= ====== Cash paid during the year for: Interest.................................................. $ 33 35 42 Income taxes.............................................. 1,605 1,720 1,410
See accompanying notes to consolidated financial statements. F-6 MERCER MUTUAL INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS) (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (A) DESCRIPTION OF BUSINESS Mercer Mutual Insurance Company and Subsidiaries (collectively, the Group) includes Mercer Mutual Insurance Company (MMIC), its subsidiaries Queenstown Holding Company, Inc. (QHC) and BICUS Services Corporation (BICUS), QHC's subsidiary Mercer Insurance Company of New Jersey, Inc. (MIC), and Franklin Holding Company, Inc. (FHC). On June 1, 2001, FHC was added to the Group when MMIC purchased a 49% controlling interest in FHC and its wholly owned insurance subsidiary, Franklin Insurance Company (FIC) (note 12). The companies in the Group are operated under common management. The Group provides property and casualty insurance to both individual and commercial customers in New Jersey and Pennsylvania. The Group's business activities can be separated into three operating segments, which include commercial lines of insurance, personal lines of insurance and the investment function. The commercial lines of business consist primarily of multi-peril and general liability coverage. These two commercial lines represented 26% and 13%, respectively, of the Group's net premiums written in 2002. The personal lines of business consist primarily of homeowners and private passenger automobile insurance. These two personal lines represented 27% and 14%, respectively, of net written premiums in 2002. (B) CONSOLIDATION POLICY AND BASIS OF PRESENTATION The consolidated financial statements include the accounts of each member of the Group since the date of acquisition. The insurer affiliates within the Group participate in a reinsurance pooling arrangement (the Pool) whereby each insurer affiliate's underwriting results are combined and distributed proportionately to each participant. Each insurer's share in the Pool is based on their respective statutory surplus as of the beginning of each year. The effects of the Pool as well as all other significant intercompany accounts and transactions have been eliminated in consolidation. The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America, which differ in some respects from those followed in reports to insurance regulatory authorities. (C) USE OF ESTIMATES The preparation of the accompanying financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant items subject to such estimates include liabilities for losses and loss adjustment expenses, deferred income tax assets and other than temporary impairment of investments. Actual results could differ from those estimates. (D) INVESTMENTS Due to periodic shifts in the portfolio arising from income tax and asset-liability matching, as well as securities markets and economic factors, management considers the entire portfolio of fixed income securities as available-for-sale. Fixed income securities available-for-sale and equity securities are stated at fair value with changes in fair value, net of deferred income tax, reflected in equity as accumulated other comprehensive income. Realized gains and losses are determined on the specific identification basis. A decline in the market value of an investment below its cost that is deemed other than temporary is charged to earnings. Interest on fixed maturities is credited to income as it accrues on the principal amounts outstanding, adjusted for amortization of premiums and accretion of discounts computed utilizing the effective interest rate method. Premiums and discounts on mortgage-backed securities are amortized using anticipated prepayments with significant changes in anticipated prepayments accounted for prospectively. F-7 MERCER MUTUAL INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (DOLLARS IN THOUSANDS) (E) CASH AND CASH EQUIVALENTS Cash and cash equivalents are carried at cost which approximates market value. The Group considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. (F) FAIR VALUES OF FINANCIAL INSTRUMENTS The Group has used the following methods and assumptions in estimating its fair values: Investments -- The fair values for fixed income securities available-for-sale are based on quoted market prices, when available. If not available, fair values are based on values obtained from investment brokers. Fair values for marketable equity securities are based on quoted market prices and on statutory equity for the security indicated below. The fair value of an equity security in a reinsurance company is estimated based on statutory book value because the security is not traded and because of restrictions placed on the investors. After receipt of a bona fide offer to purchase this security, the stock must first be offered to the investee or its other shareholders at the lower of statutory book value or the offered price. The investee also has the ability to determine that the potential purchaser is not appropriate and void such an offer. The carrying value of this investment was $1,228 and $1,589 at December 31, 2002 and 2001, respectively. Cash and cash equivalents -- The carrying amounts reported in the balance sheet for these instruments approximate their fair values. Premium and reinsurance receivables -- The carrying amounts reported in the balance sheet for these instruments approximate their fair values. (G) REINSURANCE The Group cedes insurance to, and assumes insurance from, unrelated insurers to limit its maximum loss exposure through risk diversification. Ceded reinsurance receivables and unearned premiums are reported as assets; loss and loss adjustment expenses reserves are reported gross of ceded reinsurance credits. Premiums receivable is recorded gross of ceded premiums payable. (H) DEFERRED POLICY ACQUISITION COSTS Acquisition costs such as commissions, premium taxes, and certain other expenses which vary with and are directly related to the production of business, are deferred and amortized over the effective period of the related insurance policies. The method followed in computing deferred policy acquisition costs limits the amount of such deferred costs to their estimated realizable value, which gives effect to premiums to be earned, anticipated investment income, loss and loss adjustment expenses, and certain other maintenance costs expected to be incurred as the premiums are earned. To the extent that deferred policy acquisition costs are not realizable, the deficiency is charged to income currently. (I) PROPERTY AND EQUIPMENT Property and equipment are carried at cost less accumulated depreciation calculated on the straight-line basis. Property is depreciated over useful lives generally ranging from five to forty years. Equipment is depreciated over three to ten years. F-8 MERCER MUTUAL INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (DOLLARS IN THOUSANDS) (J) PREMIUM REVENUE Premiums include direct writings plus reinsurance assumed less reinsurance ceded to other insurers and are recognized as revenue over the period that coverage is provided using the monthly pro-rata method. Unearned premiums represent that portion of premiums written that are applicable to the unexpired terms of policies in force. (K) LOSSES AND LOSS ADJUSTMENT EXPENSES The liability for losses includes the amount of claims which have been reported to the Group and are unpaid at the statement date as well as provision for claims incurred but not reported, after deducting anticipated salvage and subrogation. The liability for loss adjustment expenses is determined as a percentage of the liability for losses based on the historical ratio of paid adjustment expenses to paid losses by line of business. Management believes that the liabilities for losses and loss adjustment expenses at December 31, 2002 are adequate to cover the ultimate net cost of losses and claims to date, but these liabilities are necessarily based on estimates, and the amount of losses and loss adjustment expenses ultimately paid may be more or less than such estimates. Changes in the estimates for losses and loss adjustment expenses are recognized in the period in which they are determined. (L) INCOME TAXES The Group uses the asset and liability method of accounting for income taxes. Deferred income taxes arise from the recognition of temporary differences between financial statement carrying amounts and the tax bases of the Group's assets and liabilities and operating loss carryforwards. A valuation allowance is provided when it is more likely than not that some portion of the deferred tax asset will not be realized. The effect of a change in tax rates is recognized in the period of the enactment date. (M) GOODWILL In July 2001, the Financial Accounting Standard Board (FASB) issued Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets (SFAS 142). SFAS 142 applies to all acquired intangible assets whether acquired singularly, as part of a group, or in a business combination. SFAS 142 changes the accounting for goodwill and intangible assets with indefinite lives from an amortization method to an impairment-only approach. The Group adopted SFAS 142 on January 1, 2002. The amortization of goodwill from past business combinations ceased upon adoption of this statement. In connection with SFAS No. 142's transitional goodwill impairment evaluation, the Statement required the Group to perform an assessment of whether there was an indication that goodwill was impaired as of the date of adoption. To accomplish this, the Group was required to identify its reporting units and determine the carrying value of each reporting unit by assigning the assets and liabilities, including the existing goodwill to those reporting units as of January 1, 2002. The Group has only one reporting unit with goodwill. Based on the results of this assessment, the fair value of this reporting unit exceeded its carrying value, including existing goodwill, as of January 1, 2002. SFAS 142 also requires that an impairment test be performed annually or more frequently if changes in circumstances or the occurrence of events indicate goodwill may be impaired. The Group performed the annual impairment test as of December 31, 2002 and the results indicated that the fair value of the reporting unit exceeded its carrying amounts. Prior to the adoption of SFAS No. 142, goodwill was amortized on a straight-line basis over the expected periods to be benefited, of 15 years, and assessed for recoverability by determining whether the amortization of F-9 MERCER MUTUAL INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (DOLLARS IN THOUSANDS) the goodwill balance over its remaining life could be recovered through undiscounted future operating cash flows of the acquired operation. (2) INVESTMENTS Net investment income, net realized investment gains, and change in unrealized capital gains (losses) on investment securities are as follows. Net investment income and net realized investment gains:
2002 2001 2000 ------ ----- ----- Investment income: Fixed income securities................................... $2,346 2,545 2,681 Equity securities......................................... 470 319 318 Cash and cash equivalents................................. 170 323 170 Other..................................................... 24 40 50 ------ ----- ----- Gross investment income................................ 3,010 3,227 3,219 Less investment expenses.................................. 949 802 702 ------ ----- ----- Net investment income.................................. 2,061 2,425 2,517 ------ ----- ----- Realized gains (losses): Fixed income securities................................... 281 252 (220) Equity securities......................................... (501) (210) (68) ------ ----- ----- Net realized investment gains (losses)................. (220) 42 (288) ------ ----- ----- Net investment income and net realized investment gains..... $1,841 2,467 2,229 ====== ===== =====
Investment expenses include salaries, counseling fees, and other miscellaneous expenses attributable to the maintenance of investment activities. The changes in unrealized gains (losses) of securities are as follows:
2002 2001 2000 ------- ------ ----- Fixed income securities.................................... $ 1,614 (285) 2,239 Equity securities.......................................... (2,532) (949) 663 ------- ------ ----- $ (918) (1,234) 2,902 ======= ====== =====
F-10 MERCER MUTUAL INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (DOLLARS IN THOUSANDS) The cost and estimated fair value of available-for-sale investment securities at December 31, 2002 and 2001 are shown below.
GROSS GROSS ESTIMATED UNREALIZED UNREALIZED FAIR COST(1) GAINS LOSSES VALUE ------- ---------- ---------- --------- 2002: Fixed income securities, available-for-sale: U.S. government and government agencies............................. $38,802 750 53 39,499 Obligations of states and political subdivisions......................... 5,976 176 3 6,149 Industrial and miscellaneous........... 3,216 68 25 3,259 Mortgage-backed securities............. 336 4 -- 340 ------- ----- ----- ------ Total fixed maturities............... 48,330 998 81 49,247 ------- ----- ----- ------ Equity securities: At market value........................ 16,603 3,871 1,370 19,104 At estimated value..................... 94 1,134 -- 1,228 ------- ----- ----- ------ Total equity securities.............. 16,697 5,005 1,370 20,332 ------- ----- ----- ------ Total available-for-sale.................... $65,027 6,003 1,451 69,579 ======= ===== ===== ====== 2001: Fixed income securities, available-for-sale: U.S. government and government agencies............................. $20,337 112 485 19,964 Obligations of states and political subdivisions......................... 19,846 89 358 19,577 Industrial and miscellaneous........... 3,674 56 102 3,628 Mortgage-backed securities............. 918 3 12 909 ------- ----- ----- ------ Total fixed maturities............... 44,775 260 957 44,078 ------- ----- ----- ------ Equity securities: At market value........................ 14,392 5,214 533 19,064 At estimated value..................... 94 1,495 9 1,589 ------- ----- ----- ------ Total equity securities.............. 14,486 6,709 542 20,653 ------- ----- ----- ------ Total available-for-sale.................... $59,261 6,969 1,499 64,731 ======= ===== ===== ======
- --------------- (1) Original cost of equity securities; original cost of fixed income securities adjusted for amortization of premium and accretion of discount. F-11 MERCER MUTUAL INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (DOLLARS IN THOUSANDS) The amortized cost and estimated fair value of fixed income securities at December 31, 2002, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
ESTIMATED AMORTIZED FAIR COST VALUE --------- --------- Due in one year or less..................................... $ 250 250 Due after one year through five years....................... 4,640 4,730 Due after five years through ten years...................... 25,109 25,610 Due after ten years......................................... 17,995 18,317 ------- ------ 47,994 48,907 Mortgage-backed securities.................................. 336 340 ------- ------ $48,330 49,247 ======= ======
The gross realized gains and losses on investment securities are as follows:
2002 2001 2000 ----- ---- ---- Gross realized gains........................................ $ 703 463 436 Gross realized losses....................................... (923) (421) (724) ----- ---- ---- $(220) 42 (288) ===== ==== ====
The gross realized investment losses included write-downs for the other than temporary impairment of securities totaling $647, $185 and $219 for the years ended 2002, 2001 and 2000, respectively. Proceeds from the sale and maturity of available-for-sale securities were $35,899, $33,362, and $7,386 for 2002, 2001, and 2000, respectively. The amortized cost of invested securities on deposit with regulatory authorities at December 31, 2002 and 2001 amounted to $202 and $202, respectively. (3) DEFERRED POLICY ACQUISITION COSTS Changes in deferred policy acquisition costs are as follows:
2002 2001 2000 -------- ------ ------ Balance, January 1....................................... $ 4,962 3,899 3,860 Acquisition costs deferred............................... 11,774 9,200 7,517 Amortization charged to earnings......................... (10,953) (8,137) (7,478) -------- ------ ------ Balance, December 31..................................... $ 5,783 4,962 3,899 ======== ====== ======
F-12 MERCER MUTUAL INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (DOLLARS IN THOUSANDS) (4) PROPERTY AND EQUIPMENT Property and equipment was as follows:
2002 2001 ------- ------ Home office: Land...................................................... $ 423 423 Buildings and improvements................................ 3,699 1,785 Furniture, fixtures, and equipment........................ 5,868 4,510 ------- ------ 9,990 6,718 Accumulated depreciation.................................. (4,277) (3,490) ------- ------ $ 5,713 3,228 ======= ======
(5) LIABILITIES FOR LOSSES AND LOSS ADJUSTMENT EXPENSES Activity in the liabilities for losses and loss adjustment expenses is summarized as follows:
2002 2001 2000 ------- ------ ------ Balance, January 1........................................ $31,059 28,766 29,471 Less reinsurance recoverable on unpaid losses and loss expenses............................................. (5,425) (4,675) (5,828) ------- ------ ------ Net balance at January 1............................. 25,634 24,091 23,643 ------- ------ ------ Incurred related to: Current year............................................ 22,211 17,813 17,665 Prior years............................................. (2,144) (3,279) (3,954) ------- ------ ------ Total incurred....................................... 20,067 14,534 13,711 ------- ------ ------ Paid related to: Current year............................................ 11,128 7,265 7,421 Prior years............................................. 7,375 5,726 5,842 ------- ------ ------ Total paid........................................... 18,503 12,991 13,263 ------- ------ ------ Net balance, December 31............................. 27,198 25,634 24,091 Plus reinsurance recoverable on unpaid losses and loss expenses............................................. 4,150 5,425 4,675 ------- ------ ------ Balance at December 31.................................... $31,348 31,059 28,766 ======= ====== ======
As a result of changes in estimates of insured events in prior years, the liabilities for losses and loss adjustment expense decreased by $2,144, $3,279, and $3,954 in 2002, 2001, and 2000, respectively. These redundancies are primarily concentrated in the commercial multi-peril and other liability lines in 2002 and 2001, and in the homeowners and commercial multi-peril lines in 2000. (6) REINSURANCE The Group has geographic exposure to catastrophe losses in its operating region. Catastrophes can be caused by various events including hurricanes, windstorms, earthquakes, hail, explosion, severe weather, and fire. The incidence and severity of catastrophes are inherently unpredictable. The extent of losses from a catastrophe is a function of both the total amount of insured exposure in the area affected by the event and the severity of the event. Most catastrophes are restricted to small geographic areas. However, hurricanes and F-13 MERCER MUTUAL INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (DOLLARS IN THOUSANDS) earthquakes may produce significant damage in large, heavily populated areas. The Group generally seeks to reduce its exposure to catastrophe through individual risk selection and the purchase of catastrophe reinsurance. In the ordinary course of business, the Group seeks to limit its exposure to loss on individual claims and from the effects of catastrophes by entering into reinsurance contracts with other insurance companies. Reinsurance is ceded on excess of loss and pro-rata bases with the Group's retention not exceeding $300 per occurrence. Insurance ceded by the Group does not relieve its primary liability as the originating insurer. The Group also assumes reinsurance from other companies on a pro-rata basis. The effect of reinsurance with unrelated insurers on premiums written and earned is as follows:
2002 2001 2000 ------- ------ ------ Premiums written: Direct.................................................. $50,858 41,497 31,782 Assumed................................................. 808 1,474 322 Ceded................................................... (7,195) (8,261) (4,055) ------- ------ ------ Net....................................................... $44,471 34,710 28,049 ======= ====== ====== Premiums earned: Direct.................................................. $46,625 37,326 31,211 Assumed................................................. 666 1,440 343 Ceded................................................... (6,837) (8,038) (3,919) ------- ------ ------ Net....................................................... $40,454 30,728 27,635 ======= ====== ======
The effect of reinsurance on unearned premiums as of December 31, 2002 and 2001 is as follows:
2002 2001 ------- ------ Direct...................................................... $24,580 20,347 Assumed..................................................... 343 201 ------- ------ $24,923 20,548 ======= ======
The effect of reinsurance on the liabilities for losses and loss adjustment and losses and loss adjustment expenses incurred is as follows:
2002 2001 ------- ------ Liabilities: Direct.................................................... $29,329 28,905 Assumed................................................... 2,019 2,154 ------- ------ $31,348 31,059 ======= ======
F-14 MERCER MUTUAL INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (DOLLARS IN THOUSANDS)
2002 2001 2000 ------- ------ ------ Losses and loss expenses incurred: Direct.................................................. $20,388 18,258 14,305 Assumed................................................. 415 342 169 Ceded................................................... (736) (4,066) (763) ------- ------ ------ Net....................................................... $20,067 14,534 13,711 ======= ====== ======
The Group performs credit reviews of its reinsurers, focusing on financial stability. To the extent that a reinsurer may be unable to pay losses for which it is liable under the terms of a reinsurance agreement, the Group is exposed to the risk of continued liability for such losses. At December 31, 2002, one independent reinsurer accounted for approximately $2,080 of amounts recoverable for paid and unpaid losses and loss adjustment expenses. (7) RETIREMENT PLANS AND DEFERRED COMPENSATION PLAN Effective January 1, 1997, the Company implemented a defined contribution pension plan to replace a defined benefit pension plan. The plan covers substantially all of its employees. Benefits are based on years of service and the employee's annual compensation. Pension expense from the defined contribution plan amounted to $181, $129, and $106 for 2002, 2001, and 2000, respectively. The Group also maintains a 401(k) retirement savings plan covering substantially all employees. The Group matches a percentage of each employees' pre-tax contribution and also contributes an amount equal to 2% of each employee's annual compensation. The cost of this plan amounted to $119, $90, and $86 for the years ended December 31, 2002, 2001, and 2000, respectively. The Group maintains a nonqualified unfunded retirement plan for its directors. The plan provides for monthly payments for ten years upon retirement. The expense for this plan amounted to $93, $86, and $79 for 2002, 2001, and 2000 respectively. Costs accrued under this plan amounted to $558 and $499 at December 31, 2002 and 2001, respectively. The Group also maintains a deferred compensation plan for its directors and officers. Under the plan, participants may elect to defer receipt of all or a portion of their fees. Amounts deferred, together with accumulated interest, are distributed either as a lump sum or in installments over a period of not greater than ten years. Deferred compensation, including accumulated interest, amounted to $661 and $602 at December 31, 2002 and 2001, respectively. In 2002, the Group elected to purchase Company-owned life insurance. The Group's cost for the Company-owned life insurance was $350 for 2002. The cash surrender value of the Company-owned life insurance totaling $217 is included in other assets at December 31, 2002. F-15 MERCER MUTUAL INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (DOLLARS IN THOUSANDS) (8) FEDERAL INCOME TAXES The tax effect of significant temporary differences that give rise to the Group's net deferred tax asset as of December 31, is as follows:
2002 2001 ------ ----- Net loss reserve discounting................................ $1,365 1,340 Net unearned premiums....................................... 1,633 1,231 Impairment of investments................................... 220 63 Net operating loss carryforwards............................ 459 586 Other....................................................... 1,534 1,337 ------ ----- 5,211 4,557 Less: Valuation allowance................................... -- (685) ------ ----- Deferred tax assets....................................... 5,211 3,872 ------ ----- Deferred policy acquisition costs........................... 1,966 1,564 Unrealized gain on investments.............................. 1,548 1,860 Other....................................................... 286 89 ------ ----- Deferred tax liabilities.................................. 3,800 3,513 ------ ----- Net deferred tax asset...................................... $1,411 359 ====== =====
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management believes it is more likely than not the Company will realize the benefits of the deferred tax assets at December 31, 2002, and as a result, removed the valuation allowance. During the year ended December 31, 2002, the Group reversed its valuation allowance related to deferred tax assets of FHC based on revised estimates of future taxable income of FHC. In accordance with Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (SFAS No. 109), this resulted in a reduction to goodwill, totaling $336 and an increase in minority interest in subsidiary totaling $349 (See Note 12). Actual income tax expense differed from expected tax expense, computed by applying the United States federal corporate tax rate of 34% to income before income taxes, as follows:
2002 2001 2000 ------ ----- ----- Expected tax expense........................................ $1,202 1,588 1,451 Tax-exempt interest......................................... (135) (217) (195) Dividends received deduction................................ (94) (65) (64) Company-owned life insurance................................ 45 -- -- Other....................................................... 137 (35) 7 ------ ----- ----- Income tax expense.......................................... $1,155 1,271 1,199 ====== ===== =====
F-16 MERCER MUTUAL INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (DOLLARS IN THOUSANDS) The components of the provision for income taxes are as follows:
2002 2001 2000 ------ ----- ----- Current..................................................... $1,213 1,503 1,514 Deferred.................................................... (58) (232) (315) ------ ----- ----- Income tax expense.......................................... $1,155 1,271 1,199 ====== ===== =====
At December 31, 2002, the Group's 49% owned subsidiary FHC has net operating loss carryforwards available to offset future federal taxable income as follows:
EXPIRES AMOUNT - ------- ------ 2018........................................................ $ 395 2019........................................................ 256 2020........................................................ 567 2021........................................................ 132 ------ $1,350 ======
(9) SEGMENT INFORMATION The Group markets its products through independent insurance agents, which sell commercial lines of insurance to small to medium-sized businesses and personal lines of insurance to individuals. Financial data by segment is as follows:
2002 2001 2000 ------- ------ ------ Revenues: Net premiums earned: Commercial lines..................................... $20,088 15,119 13,685 Personal lines....................................... 20,366 15,609 13,950 ------- ------ ------ Total net premiums earned.......................... 40,454 30,728 27,635 ------- ------ ------ Expenses: Loss and loss adjustment expenses: Commercial lines..................................... 7,283 6,425 5,166 Personal lines....................................... 12,784 8,109 8,545 ------- ------ ------ Total loss and loss expenses....................... 20,067 14,534 13,711 ------- ------ ------ Other underwriting expenses: Commercial lines..................................... 9,913 7,240 6,179 Personal lines....................................... 9,014 7,000 5,874 ------- ------ ------ Total other underwriting expenses.................. 18,927 14,240 12,053 ------- ------ ------
F-17 MERCER MUTUAL INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (DOLLARS IN THOUSANDS)
2002 2001 2000 ------- ------ ------ Underwriting gain (loss): Commercial lines........................................ 2,892 1,454 2,340 Personal lines.......................................... (1,432) 500 (469) ------- ------ ------ Total underwriting gain (loss)..................... 1,460 1,954 1,871 ------- ------ ------ Investment income, net of expenses........................ 2,061 2,425 2,517 Net realized investment gains (losses).................... (220) 42 (288) Other..................................................... 234 250 167 ------- ------ ------ Income before income taxes and minority interest in income of subsidiary........................................... $ 3,535 4,671 4,267 ======= ====== ======
Assets are not allocated to the commercial and personal lines, and are reviewed in total by management for purposes of decision making. (10) RECONCILIATION OF STATUTORY FILINGS TO AMOUNTS REPORTED HEREIN A reconciliation of the Group's statutory net income and surplus to the Group's net income and surplus, under accounting principles generally accepted in the United States of America (GAAP), is as follows:
2002 2001 2000 ------- ------ ----- Net income: Statutory net income..................................... $ 1,292 2,019 2,717 Deferred policy acquisition costs........................ 821 643 39 Deferred federal income taxes............................ 58 232 315 Minority interest in income of subsidiary................ 138 100 -- Other.................................................... (67) 306 (3) ------- ------ ----- GAAP net income............................................ $ 2,242 3,300 3,068 ======= ====== ===== Surplus: Statutory surplus........................................ $28,877 31,655 Deferred policy acquisition costs........................ 5,783 4,962 Deferred federal income taxes............................ (987) (593) Nonadmitted assets....................................... 2,524 1,351 Unrealized gain (loss) on fixed income securities........ 917 (697) Statutory change in accounting principles................ -- (947) Other.................................................... (97) (334) ------- ------ GAAP equity................................................ $37,017 35,397 ======= ======
The Group's insurance companies are required to file statutory financial statements with various state insurance regulatory authorities. Statutory financial statements are prepared in accordance with accounting principles and practices prescribed or permitted by the various states of domicile. Prescribed statutory accounting practices include state laws, regulations, and general administrative rules, as well as a variety of publications of the National Association of Insurance Commissioners (NAIC). Furthermore, the NAIC adopted the Codification of Statutory Accounting Principles effective of January 1, 2001. The codified principles are intended to provide a comprehensive basis of accounting recognized and adhered to in the F-18 MERCER MUTUAL INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (DOLLARS IN THOUSANDS) absence of conflict with, or silence of, state statutes and regulations. The effects of such do not affect financial statements prepared under accounting principles generally accepted in the United States of America. The Group's insurance companies are required by law to maintain certain minimum surplus on a statutory basis, are subject to risk-based capital requirements and are subject to regulations under which payment of a dividend from statutory surplus is restricted and may require prior approval of regulatory authorities. Applying the current regulatory restrictions as of December 31, 2002, approximately $4,197 would be available for distribution without prior approval. (11) CONVERSION COSTS In December 2002 the Group's boards of directors approved a plan of conversion for changing the corporate form of MMIC from the mutual form to the stock form. Under the plan, policyholders and certain other groups will have the opportunity to acquire stock in a holding company, Mercer Insurance Group, Inc. MMIC must receive the approval of two-thirds of policyholders' votes in order to complete the plan. The Group incurred $95 in 2002 in expenses related to the planned stock conversion. These expenses are shown as a separate line item in the consolidated statement of earnings. (12) PURCHASE OF FHC, GOODWILL, AND MINORITY INTEREST On June 1, 2001, MMIC purchased certain holdings in FHC and its wholly owned insurance subsidiary, FIC (note 1). For an investment of $3,500, MMIC acquired 49% of all outstanding voting common stock; 50% of all common stock options; 50% of convertible, redeemable Series A preferred stock and certain rights to purchase the remaining voting common stock in the future. The transaction resulted in goodwill totaling $3,310. MMIC and a minority interest shareholder exercised options to purchase Series B, non-voting common stock and paid $662 and $689, respectively, during 2002, for such shares. These exercises did not change MMIC's ownership percentage in FHC. Options outstanding as of December 31, 2002 for MMIC and minority interest shareholders were 228,800 and 226,100, respectively. The options are exercisable at $10 per share. The following unaudited pro forma information presents the consolidated results of operations for the year ended December 31, 2001, with pro forma adjustments as if the acquisition of FHC had been consummated as of January 1, 2001. This pro forma information is not necessarily indicative of what would have occurred had the acquisition been made on the date indicated, or of future results of operations of MMIC. For the year ended December 31, 2001: Total revenue $34,665 Net income $ 3,015
The Group consolidates FHC as it has a controlling interest as evidenced by the following: MMIC has control of the Board of Directors of FHC (seven of the eight board members of FHC were previously and continue to be on the board of MMIC), MMIC has common management with FHC and the ability to direct the policies and management that guide the ongoing activities and all substantive decision making of FHC, and MMIC has the option to purchase the remaining stock of FHC. In addition, FHC and MMIC entered into a reinsurance pooling agreement in connection with the acquisition whereby 100% of the direct business of FHC is ceded to MMIC. MMIC then retrocedes a percentage of the combined business to FHC. The effect of this agreement subsequent to the acquisition is eliminated in consolidation. The Group's investment in FHC including common stock, options to purchase common equity, and preferred stock have been eliminated in consolidation. The minority interest in subsidiary of $3,112 and $1,926 F-19 MERCER MUTUAL INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (DOLLARS IN THOUSANDS) shown on the consolidated balance sheets represents the interest held in FHC by parties other than MMIC as of December 31, 2002 and 2001, respectively. The Group evaluates the fair value of the written put options held by the minority shareholders and reports them at such value. Changes to the fair value of the options are reported in the statement of earnings. There is no readily ascertainable market value for these options. The Group's analysis indicates that they had no value as of the date of the acquisition and have no value as of December 31, 2002 or 2001. FHC, has two series of redeemable preferred stock issued and outstanding, Series A and Series B. Following is a description of FHC's redeemable preferred stock held by outside parties. There are 5,000 shares of Series A shares with a par value of $100 per share issued, outstanding and held by outside parties. Series A shares have no voting rights. The holders are entitled to receive dividends from available funds only if declared by the Board at its sole discretion with the limit of a certain amount per year ($5.00 per annum). The right to receive dividends is not cumulative. However, whenever a cash dividend is paid on Series B preferred shares, then a cash dividend must be paid on Series A preferred shares on a pari passu basis. FHC can redeem Series A shares using available funds after April 1, 2004 at a price of par plus 2% compounded annually from June 1, 2001. The shares have a mandatory repurchase provision which allows the holders to require FHC to repurchase the shares from available funds after September 30, 2007 at the same price through 2011. If FHC merges or consolidates with another insurance company subsidiary or if FHC registers a class of securities under the Securities Act of 1933, the holders of the Series A preferred are entitled to convert each share of Series A preferred stock into 10 shares of class B common stock. There are 11,836 shares of Series B shares with a par value of $100 per share issued, outstanding and held by outside parties. Series B shares have no voting rights. Through June 1, 2001, the holders of Series B preferred shares were entitled to receive dividends at a compounded annual rate of 5%. The dividends were cumulative and could be paid in cash or through the issuance of more Series B Preferred. After May 31, 2001, dividends are paid at the sole discretion of the board of directors. However, whenever a cash dividend is paid on Series A preferred shares, then a cash dividend must be paid on Series B preferred shares on a pari passu basis. FHC can redeem the stock using available funds at any time at an aggregate amount of $1,616 as of May 31, 2001, after which, the redemption amount is compounded annually at 7.5%. The shares have a mandatory repurchase provision which allows the shareholders to require FHC to repurchase the shares after September 30, 2007 at the same price. FHC is also required to repurchase a pro-rata amount of the shares of Series B preferred if there is any redemption or repurchase of Series A Preferred stock, a change in control, or a transfer by FHC of any ownership interest in the subsidiary. Upon a stock conversion of MMIC, the preferred shareholders of FHC would have certain rights to exchange their shares for registered voting common stock of the Group based on the redemption price at the date of conversion. In addition, the MMIC has the right to compel such an exchange. The minority interest share of the redeemable preferred stock is included in minority interest in subsidiary on the consolidated balance sheet. The changes in the carrying amount of goodwill for the year ended December 31, 2002 are as follows:
2002 ------ Balance as of December 31, 2001............................. $3,212 Change...................................................... (336) ------ Balance as of December 31, 2002............................. $2,876 ======
In accordance with SFAS 109, the Group reduced the valuation allowance on deferred tax assets which resulted in a $336 reduction in goodwill. F-20 MERCER MUTUAL INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (DOLLARS IN THOUSANDS) The consolidated statements of earnings for the year ended December 31, 2001 include $98 of goodwill amortization. Following the adoption of SFAS No. 142, no goodwill amortization expense was recognized for the year ended December 31, 2002. The following table adjusts the reported net income for the year ended December 31, 2001 on a pro forma basis assuming the provisions of SFAS No. 142 were adopted effective January 1, 2001:
2001 ------ Net income -- as reported................................... $3,300 Net income -- as adjusted................................... 3,398 ------
(13) CONTINGENCIES The Group becomes involved with certain claims and legal actions arising in the ordinary course of business operations. Such legal actions involve disputes by policyholders relating to claims payments as well as other litigation. In addition, the Group's business practices are subject to review by various state insurance regulatory authorities. The Group is regularly subject to such reviews, and several such reviews are currently pending. These reviews may result in changes or clarifications of the Group's business practices, and may result in fines, penalties or other sanctions. In the opinion of management, while the ultimate outcome of these actions and these regulatory proceedings cannot be determined at this time, they are not expected to result in liability for amounts material to the financial condition, results of operations, or liquidity, of the Group. (14) RELATED PARTY TRANSACTIONS The Group produces a large percentage of its business through one insurance agent, Davis Insurance Agency (Davis). The 51% common shareholder of FHC owns Davis. In 2002 and 2001, premiums written through Davis totaled 13.9% and 10.0%, respectively, of the Group's direct written premiums. Commissions paid to Davis were $1,182 and $630 in 2002 and 2001, respectively. Van Rensselaer, Ltd., which is owned by William V.R. Fogler, a director, has provided investment management services to MMIC since the year 2000. Fees to Van Rensselaer, Ltd. amounted to $139 in 2002, $136 in 2001 and $143 in 2000. F-21 MERCER MUTUAL INSURANCE COMPANY AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS AS OF MARCH 31, 2003 AND DECEMBER 31, 2002
AS OF AS OF MARCH 31, 2003 DECEMBER 31, 2002 -------------- ----------------- (DOLLARS IN THOUSANDS) (UNAUDITED) ASSETS Investments, at fair value: Fixed income securities, available-for-sale, at fair value (cost $44,405 and $48,330, respectively).... $ 45,062 49,247 Equity securities, at fair value (cost $15,346 and $16,697, respectively)............................ 18,651 20,332 -------- ------- Total investments................................. 63,713 69,579 Cash and cash equivalents.............................. 10,403 7,201 Premiums receivable.................................... 7,274 7,121 Reinsurance receivables................................ 3,759 3,489 Prepaid reinsurance premiums........................... 1,078 1,146 Deferred policy acquisition costs...................... 5,805 5,783 Accrued investment income.............................. 571 599 Property and equipment, net............................ 6,027 5,713 Deferred income taxes.................................. 1,661 1,411 Goodwill............................................... 2,876 2,876 Other assets........................................... 1,179 930 -------- ------- Total assets......................................... $104,346 105,848 ======== ======= LIABILITIES AND SURPLUS Liabilities: Losses and loss adjustment expenses.................. $ 32,920 31,348 Unearned premiums.................................... 25,057 24,923 Accounts payable and accrued expenses................ 5,055 8,000 Other reinsurance balances........................... 174 210 Other liabilities.................................... 1,122 1,238 -------- ------- Total liabilities................................. 64,328 65,719 -------- ------- Minority interest in subsidiary........................ 3,149 3,112 -------- ------- Equity: Unassigned equity.................................... 34,263 34,029 Accumulated other comprehensive income: Unrealized gains in investments, net of deferred income taxes.................................... 2,606 2,988 -------- ------- Total equity......................................... 36,869 37,017 -------- ------- Total liabilities and equity......................... $104,346 105,848 ======== =======
See accompanying notes to condensed consolidated financial statements. F-22 MERCER MUTUAL INSURANCE COMPANY AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS THREE MONTHS ENDED MARCH 31, 2003 AND 2002
2003 2002 ------- ------ (DOLLARS IN THOUSANDS) (UNAUDITED) Revenue: Net premiums earned....................................... $11,056 9,444 Investment income, net of expenses........................ 427 529 Net realized investment gains............................. 149 118 Other revenue............................................. 80 76 ------- ------ Total revenue.......................................... 11,712 10,167 ------- ------ Expenses: Losses and loss adjustment expenses....................... 6,514 4,634 Amortization of deferred policy acquisition costs......... 2,973 2,643 Other expenses............................................ 1,849 1,697 Stock conversion expenses................................. 12 -- ------- ------ Total expenses......................................... 11,348 8,974 ------- ------ Income before income taxes and minority interest in income of subsidiary............................................. 364 1,193 Income taxes................................................ 88 418 ------- ------ Income before minority interest in income of subsidiary..... 276 775 Minority interest in income of subsidiary................... (43) (4) ------- ------ Net income.................................................. $ 233 771 ======= ======
See accompanying notes to condensed consolidated financial statements. F-23 MERCER MUTUAL INSURANCE COMPANY AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SURPLUS THREE MONTHS ENDED MARCH 31, 2003
(DOLLARS IN THOUSANDS) (UNAUDITED) Balance, beginning of period................................ $37,017 Net income.................................................. 233 Other comprehensive income (loss), net of tax: Unrealized gains (losses) on securities: Unrealized holding losses arising during period (net of related income tax benefit of $(146))................. (283) Less: Reclassification adjustment for gains included in net income (net of related income tax expense of $51)... (98) ------- (381) ------- Comprehensive income (loss)............................... (148) ------- Balance, end of period...................................... $36,869 =======
See accompanying notes to condensed consolidated financial statements. F-24 MERCER MUTUAL INSURANCE COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOW THREE MONTHS ENDED MARCH 31, 2003 AND 2002
2003 2002 ------- ------ (DOLLARS IN THOUSANDS) (UNAUDITED) Cash flows from operating activities: Net income................................................ $ 233 771 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization of fixed assets.......... 325 174 Net accretion of discount.............................. (24) (52) Net realized investment gain........................... (149) (118) Deferred income tax.................................... (50) (17) Change in assets and liabilities: Premiums receivable.................................. (153) (1,075) Reinsurance receivables.............................. (270) 782 Prepaid reinsurance premiums......................... 68 19 Deferred policy acquisition costs.................... (22) 42 Other assets......................................... (221) (982) Losses and loss expenses............................. 1,572 7 Unearned premiums.................................... 134 560 Other liabilities.................................... (3,052) (1,419) ------- ------ Net cash used in operating activities............. (1,609) (1,308) ------- ------ Cash flows from investing activities: Purchase of fixed income securities, available-for-sale... (6,220) (4,632) Purchase of equity securities............................. (879) (1,724) Sale and maturity of fixed income securities available-for-sale..................................... 10,252 4,312 Sale of equity securities................................. 2,297 1,211 Purchase of property and equipment........................ (639) (414) ------- ------ Net cash provided by (used in) investing activities....................................... 4,811 (1,247) ------- ------ Net cash provided by financing activities......... -- 689 ------- ------ Net increase (decrease) in cash and cash equivalents...................................... 3,202 (1,866) Cash and cash equivalents at beginning of period............ 7,201 8,435 ------- ------ Cash and cash equivalents at end of period.................. $10,403 6,569 ======= ====== Cash paid during the period for: Interest.................................................. $ 7 9 Income taxes.............................................. $ -- 30
See accompanying notes to condensed consolidated financial statements. F-25 MERCER MUTUAL INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS) (UNAUDITED) (1) BASIS OF PRESENTATION The financial information for the interim periods included herein is unaudited; however, such information reflects all adjustments which are, in the opinion of management, necessary to a fair presentation of the financial position, results of operations, and cash flows for the interim periods. The results of operations for interim periods are not necessarily indicative of results to be expected for the full year. These financial statements should be read in conjunction with the financial statements and notes for the year ended December 31, 2002 included herein. (2) REINSURANCE Premiums earned are net of amounts ceded of $2,101 and $1,650 for the three months ended March 31, 2003 and 2002, respectively. Losses and loss adjustment expenses are net of amounts ceded of $602 and $27 for the three months ended March 31, 2003 and 2002, respectively. F-26 MERCER MUTUAL INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (DOLLARS IN THOUSANDS) (UNAUDITED) (3) SEGMENT INFORMATION Financial data by segment is as follows for the three months ended March 31, 2003 and 2002:
2003 2002 ------- ----- Revenues: Net premiums earned: Commercial lines....................................... $ 5,736 4,371 Personal lines......................................... 5,320 5,073 ------- ----- Total net premiums earned......................... 11,056 9,444 ------- ----- Expenses: Loss and loss adjustment expenses: Commercial lines....................................... 1,954 1,483 Personal lines......................................... 4,560 3,151 ------- ----- Total loss and loss expenses...................... 6,514 4,634 ------- ----- Other underwriting expenses: Commercial lines....................................... 2,707 2,277 Personal lines......................................... 2,115 2,063 ------- ----- Total other underwriting expenses................. 4,822 4,340 ------- ----- Underwriting gain (loss): Commercial lines....................................... 1,075 611 Personal lines......................................... (1,355) (141) ------- ----- Total underwriting gain(loss)..................... (280) 470 ------- ----- Investment income, net of expenses.......................... 427 529 Net realized investment gains............................... 149 118 Other....................................................... 68 76 ------- ----- Income before income taxes and minority interest in income of subsidiary............................................. $ 364 1,193 ======= =====
F-27 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- MERCER INSURANCE GROUP, INC. (PROPOSED HOLDING COMPANY FOR MERCER MUTUAL INSURANCE COMPANY) UP TO SHARES COMMON STOCK ------------------------- PROSPECTUS ------------------------- SANDLER O'NEILL & PARTNERS, L.P. , 2003 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- [TO BE USED IN CONNECTION WITH THE SYNDICATED COMMUNITY OFFERING ONLY] SYNDICATED PROSPECTUS SUPPLEMENT [LOGO] MERCER INSURANCE GROUP, INC. (PROPOSED HOLDING COMPANY FOR MERCER MUTUAL INSURANCE COMPANY) SHARES OF COMMON STOCK Mercer Mutual Insurance Company is converting from the mutual to the stock form of organization. As part of the conversion, Mercer Insurance Group, Inc. is offering for sale shares of common stock in a syndicated community offering. Mercer Mutual will become a wholly-owned subsidiary of Mercer Insurance Group. We expect that the common stock will be listed on the Nasdaq National Market under the symbol "MIGP." --------------------- TERMS OF THE SYNDICATED COMMUNITY OFFERING PRICE: $10.00 PER SHARE Number of shares offered.................................... Gross proceeds.............................................. $ Underwriting commissions and expenses....................... $ Net proceeds................................................ $ Net proceeds per share...................................... $
Applicable law requires Mercer Insurance Group to sell its common stock in an amount equal to the estimated pro forma market value of Mercer Mutual, as determined by an independent valuation. In addition to the shares being offered in the syndicated community offering, we have received subscriptions, at a purchase price of $10 per share, for shares of the common stock in the subscription and community offerings conducted in connection with the conversion, and for 100,000 shares of common stock from a third party offered pursuant to a contractual obligation. Ten percent of the shares sold in the conversion will be sold to our employee stock ownership plan (ESOP). We must sell a minimum of shares of common stock in the syndicated community offering in order to complete this offering and the conversion. If we do not receive orders in the syndicated community offering for at least shares, the offering and the conversion will be terminated. The syndicated community offering expires on , 2003. We may extend the syndicated community offering to [December 9, 2003] without notice to you. Orders are irrevocable unless the syndicated community offering is terminated. The minimum number of shares that you may purchase is 25, and the maximum is 100,000, subject to availability. Mercer Mutual has engaged Sandler O'Neill & Partners, L. P. to assist with the sale of the common stock in the syndicated community offering. It is anticipated that Sandler O'Neill & Partners, L. P. will use the services of selected registered broker-dealers and that total fees to Sandler O'Neill & Partners, L. P. and such selected dealers will not exceed 7% of the aggregate purchase price of the shares sold in the syndicated community offering. Sandler O'Neill & Partners, L.P. is not required to sell any specific number of shares or dollar amount, but has agreed to use its best efforts to sell the common stock offered. An investment in our common stock involves risks. See the section entitled "Risk Factors" that begins on page . Mercer Mutual is converting to stock form pursuant to a Plan of Conversion adopted by Mercer Mutual's Board of Directors and approved by the Pennsylvania Insurance Commissioner. The Pennsylvania Insurance Commissioner's approval of Mercer Mutual's Plan of Conversion does not constitute or imply endorsement of the conversion, and does not constitute investment advice or a recommendation by the Pennsylvania Insurance Commissioner or the Pennsylvania Insurance Department to purchase our common stock. Neither the Securities and Exchange Commission nor any state insurance department or securities regulator has approved or disapproved these securities or determined if this prospectus is accurate or complete. Any representation to the contrary is a criminal offense. SANDLER O'NEILL & PARTNERS, L.P. The date of this prospectus supplement is , 2003 [TO BE USED ONLY FOR THE OFFERING TO FRANKLIN MUTUAL INSURANCE COMPANY] PROSPECTUS SUPPLEMENT (TO PROSPECTUS DATED , 2003) [LOGO] MERCER INSURANCE GROUP, INC. (PROPOSED HOLDING COMPANY FOR MERCER MUTUAL INSURANCE COMPANY) 100,000 SHARES OF COMMON STOCK Mercer Mutual Insurance Company is converting from the mutual to the stock form of organization. In the conversion, Mercer Insurance Group, Inc. is offering 6,261,111 shares of its common stock to the eligible policyholders, directors, officers and employees of Mercer Mutual, to its employee stock ownership plan (ESOP), and to the general public. It will use a portion of the proceeds from that offering and this offering to purchase all of the authorized capital stock of Mercer Mutual Insurance Company. Under the terms of the Settlement Agreement dated August 13, 2002 between Mercer Mutual and you, Franklin Mutual Insurance Company, Mercer Mutual has granted to you the right to purchase the same number of shares of the common stock of Mercer Insurance Group that an eligible policyholder can purchase in the conversion. Therefore, we are offering to you 100,000 shares of common stock, subject to reduction in the event of an oversubscription by eligible policyholders, at a purchase price of $10.00 per share. The basic terms of this offering and the offering to eligible policyholders and others described above, considered together, are listed in the table below. --------------------- PRICE: $10.00 PER SHARE
MINIMUM MAXIMUM ----------- ----------- Number of shares offered.................................... 4,265,000 6,361,111 Gross proceeds.............................................. $42,650,000 $63,611,110 Less: Proceeds from ESOP shares(1).......................... $ 4,165,000 $ 6,261,111 Underwriting commissions and expenses....................... $ 2,938,200 $ 3,202,310 Net proceeds................................................ $35,546,800 $54,147,689 Net proceeds per share...................................... $ 8.33 $ 8.51
- --------------- (1) The calculation of net proceeds from this offering does not include the shares being purchased by the ESOP because the ESOP is not paying cash for these shares, but is instead purchasing them with the proceeds of a loan from Mercer Insurance Group, Inc. The ESOP will purchase shares in the conversion in an amount equal to 10% of the total shares sold in the conversion. We expect that the common stock will be listed on the Nasdaq National Market under the symbol "MIGP." In the conversion, we are offering a maximum of 5,635,000 shares in the following order of priority: first, to eligible policyholders (persons who, on December 13, 2002, were named insureds under policies issued by Mercer Mutual); second, to directors, officers and employees of Mercer Mutual; and third, to the general public. If eligible policyholders, directors, officers and employees of Mercer Mutual and the general public subscribe for the maximum of 5,635,000 shares in the conversion, the ESOP will purchase an additional 626,111 shares, bringing the total shares sold in the conversion to 6,261,111 shares. If eligible policyholders subscribe for more than 5,635,000 shares in the conversion, the number of shares you may purchase in this offering will be reduced to the amount that may be purchased in the conversion by an eligible policyholder subscribing for the same number of shares for which you subscribe. In an oversubscription, shares of common stock will be allocated among subscribing eligible policyholders and you to allow each of them and you to purchase at least 1,000 shares, to the extent possible. Any remaining shares will be allocated among the eligible policyholders subscribing for more than 1,000 shares and you (provided you subscribe for more than 1,000 shares) based on the size of each subscription. The minimum number of shares that you may purchase is 25. Your funds will be held in a segregated account at Wilmington Trust Company until completion or termination of the offering. If the offering is terminated, we will return your funds promptly, without interest. The offering expires on [September 8, 2003]. We may extend the offering to a date no later than [October 27, 2003] upon written notice to you. Your order is irrevocable unless the offering is terminated or extended beyond [September 8, S-1 2003]. If the offering is extended beyond [September 8, 2003], you will have the right to modify or rescind your order. If we do not receive orders in the conversion for at least 4,165,000 shares by the expiration date of the offering (including the 10% being purchased by the ESOP), we may sell additional shares in a syndicated community offering using a syndicate of registered broker/dealers managed by Sandler O'Neill & Partners, L.P. This syndicated community offering must be completed or terminated by [December 9, 2003]. This prospectus supplement supplements the prospectus of Mercer Insurance Group dated August , 2003, which is being delivered to prospective purchasers in the conversion substantially in the form attached to this supplement. This prospectus supplement does not purport to be a complete description of this offering or of other matters relating to the conversion or Mercer Insurance Group or Mercer Mutual generally. This prospectus supplement should be read together with the attached prospectus. In addition to the shares offered by this prospectus supplement and the shares being offered in the conversion through the attached prospectus, we are concurrently offering a total of 488,280 shares in a separate offering to all of the other shareholders in one of our subsidiaries in exchange for their outstanding shares in that subsidiary. This offering is described under the section of the attached prospectus entitled "Additional Shares Being Issued After the Conversion." An investment in our common stock involves risks. See the section entitled "Risk Factors" that begins on page of the attached prospectus. Mercer Mutual is converting to stock form pursuant to a Plan of Conversion adopted by Mercer Mutual's Board of Directors and approved by the Pennsylvania Insurance Commissioner. The Pennsylvania Insurance Commissioner's approval of the Plan of Conversion does not constitute or imply endorsement of the conversion, and does not constitute investment advice or a recommendation by the Pennsylvania Insurance Commissioner or the Pennsylvania Insurance Department to purchase our common stock. Neither the Securities and Exchange Commission nor any state insurance department or securities regulator has approved or disapproved these securities or determined if this prospectus supplement is accurate or complete. Any representation to the contrary is a criminal offense. The date of this Prospectus Supplement is August , 2003 S-2 [TO BE USED ONLY FOR THE OFFERING TO THE SHAREHOLDERS OF FRANKLIN HOLDING COMPANY, INC.] PROSPECTUS SUPPLEMENT (TO PROSPECTUS DATED , 2003) MERCER INSURANCE GROUP, INC. OFFER TO EXCHANGE ALL OUTSTANDING SHARES OF COMMON AND PREFERRED STOCK OF FRANKLIN HOLDING COMPANY, INC. FOR 488,280 SHARES OF COMMON STOCK OF MERCER INSURANCE GROUP, INC. OFFER WILL EXPIRE AT 5:00 P.M., EASTERN TIME, ON , 2003, UNLESS EXTENDED. Mercer Mutual Insurance Company is converting from a mutual insurance company to a stock insurance company. Therefore, pursuant to the terms of the Shareholders Agreement of Franklin Holding Company, Inc. dated June 1, 2001 among Mercer Mutual, H. Thomas Davis, Jr. and Franklin Holding, and the Certificate of Incorporation of Franklin Holding, you, as a holder of shares of common or preferred stock of Franklin Holding or options to acquire shares of Franklin Holding common stock, have the right to exchange all of your shares and options for the number of shares of common stock of Mercer Insurance Group, Inc. set forth on Schedule 1 attached to this prospectus supplement. In total, Mercer Insurance Group will issue up to 488,280 shares of Mercer Insurance Group common stock in exchange for the outstanding shares of Franklin Holding common and preferred stock and the outstanding options to acquire Franklin Holding common stock. Your exchange rights were granted in connection with Mercer Mutual's acquisition on June 1, 2001 of a 49% interest in Franklin Holding, which owns 100% of the outstanding capital stock of Franklin Insurance Company, a Pennsylvania property and casualty insurance company. As part of that transaction, Mercer Mutual agreed that in the event of a mutual-to-stock conversion of Mercer Mutual, you would have the right to exchange your Franklin Holding shares (and your options to purchase Franklin Holding shares) for shares of the common stock of Mercer Mutual or its holding company that are equal in value to the value of your Franklin Holding shares (and options), as determined by formulas set forth in the transaction documents. If on or before , 2003 you do not exercise your exchange rights in the manner described in this prospectus, we have the right to require you to exchange your shares and options on the same terms, and we intend to exercise that right, if necessary. Accordingly, upon completion of the share exchange, Mercer Mutual will own 100% of the outstanding capital stock of Franklin Holding. This prospectus supplement is being furnished by Mercer Insurance Group to you in connection with the proposed mutual-to-stock conversion of Mercer Mutual. This prospectus supplement supplements the attached prospectus of Mercer Insurance Group dated , 2003, and contains a description of the exchange offer and of Franklin Holding and Franklin Insurance Company in general. This prospectus supplement does not purport to be a complete description of the share exchange or of other matters relating to the conversion or of Mercer Insurance Group or Mercer Mutual generally. This prospectus supplement should be read together with the attached prospectus. In addition to the shares offered by this prospectus supplement and the shares being offered in the conversion through the attached prospectus, we are concurrently offering 100,000 shares at a purchase price of $10.00 per share in a separate offering to a third party pursuant to a contractual obligation. This other offering is described under the section of the attached prospectus entitled "Additional Shares Being Issued After the Conversion." An investment in our common stock involves risks. See the section entitled "Risk Factors" that begins on page [18] of the attached prospectus. S-3 We expect that after the conversion, the common stock will be listed on the Nasdaq National Market under the symbol "MIGP." Mercer Mutual is converting to stock form pursuant to a Plan of Conversion adopted by Mercer Mutual's Board of Directors and approved by the Pennsylvania Insurance Commissioner. The Pennsylvania Insurance Commissioner's approval of the Plan of Conversion does not constitute or imply endorsement of the conversion, and does not constitute investment advice or a recommendation by the Pennsylvania Insurance Commissioner or the Pennsylvania Insurance Department to purchase our common stock. Neither the Securities and Exchange Commission nor any state insurance department or securities regulator has approved or disapproved these securities or determined if this prospectus supplement is accurate or complete. Any representation to the contrary is a criminal offense. The date of this prospectus supplement is August , 2003. S-4 DESCRIPTION OF THE SHARE EXCHANGE You, as a holder of shares of common or preferred stock of Franklin Holding or options to acquire shares of Franklin Holding common stock, have the right to exchange all of your shares and options for the number of shares of common stock of Mercer Insurance Group, Inc. set forth on Schedule 1 attached to this prospectus supplement. To exercise your exchange right, you must notify Mercer Mutual on or before , 2003 of your intent to exchange your shares and options, and the number of shares and options you wish to exchange. Your notice must be in writing and may be delivered personally or by a commercial delivery service, or mailed by registered or certified mail (return receipt requested) or sent by facsimile (with confirmation of receipt) to Mercer Mutual at the following address: Mercer Mutual Insurance Company Route 31 North Pennington, New Jersey Attention: Andrew R. Speaker, President and Chief Executive Officer Facsimile No.: 609-737-8719 Telephone No.: 609-737-0426 If you exercise your exchange right, you will receive the following: Common Stock: If you are exchanging common stock of Franklin Holding, you will receive shares of the common stock of Mercer Insurance Group in an amount equal to: - The number of shares of Franklin Holding common stock that you own multiplied by $11.88, - divided by 10. The $11.88 amount is determined pursuant to the terms of the Shareholders Agreement of Franklin Holding Company, Inc. dated June 1, 2001, as amended on July 7, 2003, among Mercer Mutual, H. Thomas Davis, Jr. and Franklin Holding, by taking the greater of: (1) the product of (x) $10.00 and (y) the sum of 1.00 plus a fraction equal to the sum of each quarterly Franklin Holding ROI factor for the calendar quarters beginning with the quarter that started on July 1, 2001 and ending with the quarter ending on the date of the most recent audited or interim balance sheet of Mercer Mutual included in the registration statement filed with and declared effective by the Securities and Exchange Commission in connection with Mercer Mutual's conversion from mutual to stock form (the quarterly ROI factor being equal to the consolidated net income of Franklin Holding for such calendar quarter divided by the sum of (i) $5,050,920 plus (ii) the qualified amount of cash or the fair value of any property hereafter invested by Mercer Mutual in shares of the capital stock of Franklin Holding or contributed to the capital accounts of Franklin Holding); (2) the product of (x) $10.00 and (y) the sum of 1.00 plus a fraction equal to the sum of each quarterly Mercer Mutual ROE factor for the calendar quarters beginning with the quarter that started on July 1, 2001 and ending with the quarter ending on the date of the most recent audited or interim balance sheet of Mercer Mutual included in the registration statement filed with and declared effective by the Securities and Exchange Commission in connection with Mercer Mutual's conversion from mutual to stock form (the quarterly ROE factor being equal to the consolidated net income of Mercer Mutual for such calendar quarter divided by the surplus of Mercer Mutual at the commencement of such calendar quarter); or (3) $10.00. Options to Purchase Common Stock: If you are exchanging options to purchase common stock, you will receive shares of the common stock of Mercer Insurance Group in an amount equal to: - The number of shares of Franklin Holding common stock issuable to you upon the exercise in full of the stock options that you own multiplied by $1.88, S-5 - divided by 10. The $1.88 amount is determined by taking the $11.88 amount described above and subtracting the $10.00 per share exercise price of the outstanding options. Series A Convertible Redeemable Preferred Stock: If you are exchanging Series A Convertible Redeemable Preferred Stock of Franklin Holding, you will receive shares of the common stock of Mercer Insurance Group in an amount equal to: (1) the number of shares of Series A preferred stock that you own multiplied by $100, plus -- (2) interest on that amount at a rate of 2% compounded annually from June 1, 2001 through the effective date of the exchange, plus (3) the amount of any declared and unpaid dividends on these shares, (4) divided by 10. Series B Cumulative Redeemable Preferred Stock: If you are exchanging Series B Cumulative Redeemable Preferred Stock of Franklin Holding, you will receive shares of the common stock of Mercer Insurance Group in an amount equal to: (1) the number of shares of Series B preferred stock that you own multiplied by $1,615,930, plus (2) interest on that amount at 7.5% per annum compounded annually from June 1, 2001 through the effective date of the exchange, (3) divided by 10. If you fail to notify Mercer Mutual in writing on or before , 2003 of your intent to exchange your shares and options in the manner set forth above, or if prior to that date you advise Mercer Mutual that you do not intend to exercise your right to compel the share exchange for all of your Franklin Holding shares or options, we have the right to compel the share exchange for any or all of your Franklin Holding shares and options by providing written notice to you not later than 60 days prior to the completion of the conversion that we are exercising our right to compel the share exchange. In such event, pursuant to the terms of the Shareholders Agreement and Certificate of Incorporation of Franklin Holding, you are required to cooperate in the share exchange by executing such documents and taking such other actions, in a timely manner, as may be required to complete the share exchange simultaneously with the completion of the Conversion. S-6 DESCRIPTION OF THE BUSINESS OF FRANKLIN HOLDING COMPANY Franklin Insurance Company serves as the holding company for Franklin Insurance Company, a property and casualty stock insurance company that was incorporated in Pennsylvania in 1997. Franklin Insurance Company offers private passenger automobile and homeowners insurance to individuals located in Pennsylvania. Franklin Insurance Company is represented by approximately 50 independent producers. All transactions conducted between Franklin Insurance Company and its producers are performed electronically. Franklin Insurance Company is subject to examination and comprehensive regulation by the Pennsylvania Insurance Department. PRODUCTS The following tables set forth the direct premiums written, net premiums earned, net loss ratios, expense ratios and combined ratios by product line of Franklin Insurance Company for the periods indicated:
THREE MONTHS ENDED MARCH 31, YEAR ENDED DECEMBER 31, --------------- -------------------------- 2003 2002 2002(1) 2001(2) 2000 ------ ------ ------- ------- ------ Direct Premiums Written: Homeowners................................... $ 261 $ 187 $1,112 $ 893 $ 805 Personal Automobile.......................... 2,004 1,701 6,865 5,807 4,940 ------ ------ ------ ------ ------ Total...................................... $2,265 $1,888 $7,977 $6,700 $5,745 ====== ====== ====== ====== ====== Net Premiums Earned: Homeowners................................... $ 277 $ 211 $ 831 $ 906 $ 307 Commercial multi-peril....................... 255 148 674 554 -- Personal Automobile.......................... 145 98 416 768 2,138 Other liability.............................. 130 79 359 313 -- Workers' compensation........................ 69 41 196 8 -- Fire, allied, inland marine.................. 59 46 182 199 -- Commercial automobile........................ 60 38 174 132 -- ------ ------ ------ ------ ------ Total...................................... $ 995 $ 661 $2,832 $2,880 $2,445 ====== ====== ====== ====== ====== Net Loss Ratios: Homeowners................................... 88.2% 71.3% 69.1% 53.9% 91.0% Commercial multi-peril....................... 23.8 36.8 40.5 38.8 -- Personal Automobile.......................... 79.0 67.2 65.8 114.9 82.1 Other liability.............................. 33.5 24.2 28.0 28.9 -- Workers' compensation........................ 44.0 33.5 38.6 65.2 -- Fire, allied, inland marine.................. 58.0 10.7 12.5 62.9 -- Commercial automobile........................ 97.4 42.9 49.6 46.2 -- ------ ------ ------ ------ ------ Total...................................... 59.0% 49.1% 49.6% 64.9% 83.2% ====== ====== ====== ====== ======
S-7
THREE MONTHS ENDED MARCH 31, YEAR ENDED DECEMBER 31, --------------- -------------------------- 2003 2002 2002(1) 2001(2) 2000 ------ ------ ------- ------- ------ Expense Ratio: Homeowners................................... 35.2% 50.7% 49.4% 32.4% 53.9% Commercial multi-peril....................... 44.5 47.6 53.6 17.5 -- Personal Automobile.......................... 52.2 60.6 46.9 128.2 54.3 Other liability.............................. 40.5 48.5 48.1 17.5 -- Workers' compensation........................ 38.0 19.0 33.8 17.5 -- Fire, allied, inland marine.................. 38.2 44.5 49.2 17.5 -- Commercial automobile........................ 34.7 59.1 44.4 17.5 -- ------ ------ ------ ------ ------ Total...................................... 41.1% 49.3% 48.5% 51.7% 54.3% ====== ====== ====== ====== ====== Combined Ratios(3): Homeowners................................... 123.4% 122.0% 118.5% 86.3% 144.9% Commercial multi-peril....................... 68.3 84.4 94.1 56.3 -- Personal Automobile.......................... 131.2 127.8 112.7 243.1 136.4 Other liability.............................. 74.0 72.7 76.1 46.4 -- Workers' compensation........................ 82.0 52.5 72.4 82.7 -- Fire, allied, inland marine.................. 96.2 55.2 61.7 80.4 -- Commercial automobile........................ 132.1 102.0 94.0 63.7 -- ------ ------ ------ ------ ------ Total...................................... 100.1% 98.4% 98.1% 116.6% 137.5% ====== ====== ====== ====== ======
- --------------- (1) Effective January 1, 2002 Franklin Holding began pooling its business with Mercer Mutual and Mercer Insurance Company of New Jersey, Inc. (2) For the period April 1, 2001 to December 31, 2001, Franklin Holding participated in reinsurance arrangements with Mercer Mutual. (3) A combined ratio over 100% means that an insurer's underwriting operations are not profitable. HOMEOWNERS Franklin Insurance Company's homeowners policy is a multi-peril policy providing property and liability coverages and optional inland marine coverage. The homeowners policy is sold to provide coverage for an insured's residence. Franklin Insurance Company markets both a standard and a preferred homeowner product. The preferred product is offered at a discount to its standard rates to customers who have a lower risk of loss. As of March 31, 2003, Franklin Insurance Company had approximately 3,500 homeowners policies in force, with 68% of those being the preferred product. PRIVATE PASSENGER AUTOMOBILE Franklin Insurance Company writes comprehensive personal automobile coverage including liability, property damage and all state required insurance minimums for individuals domiciled in Pennsylvania. This product is multi-tiered with an emphasis placed on individuals with lower than average risk profiles. As of March 31, 2003, Franklin Insurance Company had approximately 8,200 personal automobile policies in force. MARKETING Franklin Insurance Company markets its property and casualty insurance products in Pennsylvania exclusively through independent producers. All of these producers represent multiple carriers and are established businesses in the communities in which they operate. They generally market and write the full S-8 range of our insurance companies' products. Franklin Insurance Company considers its relationships with its producers to be good. Franklin Insurance Company manages its producers through quarterly business reviews (with underwriter participation) and establishment of benchmarks/goals for premium volume and profitability. Franklin Insurance Company in recent years has eliminated a number of low volume or unprofitable producers. For the three months ended March 31, 2003, Franklin Insurance Company's largest producer accounted for approximately 69.6% of its direct premiums written. This producer is the Davis Insurance Agency which is owned by H. Thomas Davis, Jr., a director, officer and the founder of Franklin Holding and Franklin Insurance Company. Mercer Mutual has a first right of refusal to acquire the Davis Agency. No other producer accounted for more than 5% of its direct premiums written. For the three months ended March 31, 2003, Franklin Insurance Company's top five producers accounted for 81.2% of direct premiums written, with the largest producer generating approximately $1.6 million of its premium revenue. Franklin Insurance Company emphasizes personal contact between its producers and the policyholders. Franklin Insurance Company believes that its producers' fast and efficient service and name recognition, as well as its policyholders' loyalty to and satisfaction with producer relationships are the principal sources of new customer referrals, cross-selling of additional insurance products and policyholder retention. Franklin Insurance Company depends upon its producer force to produce new business and to provide customer service. The network of independent producers also serves as an important source of information about the needs of the communities served by our insurance companies. This information is utilized by Franklin Insurance Company to develop new products and new product features. Producers are compensated through a fixed base commission with an opportunity for profit sharing depending on the producer's premiums earned and loss experience. They are monitored and supported by Franklin Insurance Company's marketing representatives. These marketing representatives also have principal responsibility for recruiting producers and training new producers. Franklin Insurance Company periodically holds seminars for producers and conducts training programs that provide both technical training about products and sales training on how to market Franklin Insurance Company's products. Franklin Insurance Company also provides personal computer software to producers that allows them to quote rates on various policies. Franklin Insurance Company's marketing efforts are further supported by our claims philosophy, which is designed to provide prompt and efficient service, resulting in a positive experience for producers and policyholders. Franklin Insurance Company believes that these positive experiences are then conveyed by producers and policyholders to many potential customers. UNDERWRITING Franklin Insurance Company writes its personal lines by evaluating each risk with consistently applied standards. It maintains information on all aspects of its business that is regularly reviewed to determine product line profitability. Franklin Insurance Company also employs numerous underwriters, who generally have many years of experience as underwriters. Specific information is monitored with regard to individual insureds to assist Franklin Insurance Company in making decisions about policy renewals or modifications. Franklin Insurance Company relies on information provided by its independent producers. Subject to certain guidelines, producers also pre-screen policy applicants. The producers have the authority to sell and bind insurance coverages in accordance with pre-established guidelines. Producers' results are continuously monitored. On occasion, producers with historically poor loss ratios have had their binding authority removed until more profitable underwriting results were achieved. CLAIMS Claims on insurance policies are received directly from the insured or through our independent producers. Claims are then assigned to either an in-house adjuster or an independent adjuster, depending upon the size S-9 and complexity of the claim. The adjuster investigates and settles the claim. As of March 31, 2003, Franklin Insurance Company had four in-house adjusters and worked with numerous independent adjusters. Claims settlement authority levels are established for each claims adjuster based upon his or her level of experience. Multi-line teams exist to handle all claims. The claims department is responsible for reviewing all claims, obtaining necessary documentation, estimating the loss reserves and resolving the claims. Franklin Insurance Company attempts to minimize claims costs by encouraging the use of alternative dispute resolution procedures. Less than 4% of all open claims under its policies have resulted in litigation. Litigated claims are assigned to outside counsel. TECHNOLOGY Franklin Insurance Company was formed in 1997 with the idea that, by building an efficient information system, it could reduce expenses for both the producer and the company. Because homeowners' and private passenger automobile insurance are largely commodity businesses, low cost product delivery is crucial, especially for small companies that do not otherwise enjoy economies of scale. Franklin Insurance licensed a flexible insurance software package and internally built a front-end Internet based interface to the system. All business generated by Franklin Insurance's producers is processed and maintained in this system through the Internet, and these producers have access to their books of business through the Internet. This system provides efficiency because information for all users is entered only one time. REINSURANCE In accordance with insurance industry practice, Franklin Insurance Company reinsures a portion of its exposure and pays to the reinsurers a portion of the premiums received on all policies reinsured. However, this reinsurance is obtained on a consolidated basis by Mercer Mutual pursuant to inter-company reinsurance agreements. For more information, see the section of the attached prospectus entitled "Business" under the subsection entitled "Reinsurance." LOSS AND LAE RESERVES Franklin Insurance Company is required by applicable insurance laws and regulations to maintain reserves for payment of losses and loss adjustment expenses (LAE). These reserves are established for both reported claims and for claims incurred but not reported (IBNR), arising from the policies it has issued. The laws and regulations require that provision be made for the ultimate cost of those claims without regard to how long it takes to settle them or the time value of money. The determination of reserves involves actuarial and statistical projections of what Franklin Insurance Company expects to be the cost of the ultimate settlement and administration of such claims. The reserves are set based on facts and circumstances then known, estimates of future trends in claims severity, and other variable factors such as inflation and changing judicial theories of liability. Estimating the ultimate liability for losses and LAE is an inherently uncertain process. Therefore, the reserve for losses and LAE does not represent an exact calculation of that liability. Franklin Insurance Company's reserve policy recognizes this uncertainty by maintaining reserves at a level providing for the possibility of adverse development relative to the estimation process. Franklin Insurance Company does not discount its reserves to recognize the time value of money. When a claim is reported to Franklin Insurance Company, claims personnel establish a "case reserve" for the estimated amount of the ultimate payment. This estimate reflects an informed judgment based upon general insurance reserving practices and on the experience and knowledge of the estimator. The individual estimating the reserve considers the nature and value of the specific claim, the severity of injury or damage, and the policy provisions relating to the type of loss. Case reserves are adjusted by the claims staff as more information becomes available. It is Franklin Insurance Company's policy to settle each claim as expeditiously as possible. S-10 Franklin Insurance Company maintains IBNR reserves to provide for already incurred claims that have not yet been reported and developments on reported claims. The IBNR reserve is determined by estimating Franklin Insurance Company's ultimate net liability for both reported and IBNR claims and then subtracting the case reserves for reported claims. Each quarter, Franklin Insurance Company computes its estimated ultimate liability using principles and procedures applicable to the lines of business written. However, because the establishment of loss reserves is an inherently uncertain process, Franklin Insurance Company cannot assure you that ultimate losses will not exceed the established loss reserves. Adjustments in aggregate reserves, if any, are reflected in the operating results of the period during which such adjustments are made. Franklin Insurance Company is not subject to any material potential asbestos or environmental liability claim. The following table provides a reconciliation of beginning and ending consolidated loss and LAE reserve balances of Franklin Insurance Company for three months ended March 31, 2003 and 2002 and the years ended December 31, 2002, 2001 and 2000, prepared in accordance with GAAP. RECONCILIATION OF RESERVE FOR LOSSES AND LOSS ADJUSTMENT EXPENSES
THREE MONTHS ENDED MARCH 31, YEAR ENDED DECEMBER 31, --------------- ------------------------ 2003 2002 2002 2001 2000 ------ ------ ------ ------ ------ (IN THOUSANDS) Reserves for losses and loss adjustment expenses at the beginning of period...................... $1,904 $1,196 $1,196 $1,019 $ 792 Less: Reinsurance recoverable and receivable...... -- (333) (333) (571) (586) ------ ------ ------ ------ ------ Net reserves for losses and loss adjustment expenses at beginning of period................. 1,904 863 863 448 206 ------ ------ ------ ------ ------ Add: Provision for losses and loss adjustment expenses for claims occurring in: The current year............................. 597 375 1,556 1,749 1,910 Prior years.................................. (10) (50) (150) 119 125 ------ ------ ------ ------ ------ Total incurred losses and loss adjustment expenses................................... 587 325 1,406 1,868 2,035 ------ ------ ------ ------ ------ Less: Loss and loss adjustment expenses payments for claims occurring in: The current year............................. 174 88 780 1,023 1,524 Prior years.................................. (248) (747) (415) 430 269 ------ ------ ------ ------ ------ Total losses and loss adjustment expenses paid.... (74) (659) 365 1,453 1,793 ------ ------ ------ ------ ------ Net reserves for losses and loss adjustment expenses at end of period....................... 2,565 1,847 1,904 863 448 Add: Reinsurance recoverables and receivables..... -- -- -- 333 571 ------ ------ ------ ------ ------ Reserves for losses and loss adjustment expenses at end of period................................ $2,565 $1,847 $1,904 $1,196 $1,019 ====== ====== ====== ====== ======
S-11 The following table shows the development of Franklin Insurance Company's reserves for unpaid losses and LAE on a GAAP basis. Although Franklin Insurance Company was formed in 1997, due to its participation in a reinsurance pooling arrangement with Mercer Mutual and Mercer Insurance Company of New Jersey, Inc., loss activity if reflected for years prior to Franklin Insurance Company's formation. The top line of the table shows the liabilities at the balance sheet date, including losses incurred but not yet reported. The upper portion of the table shows the cumulative amounts subsequently paid as of successive years with respect to the liability. The lower portion of the table shows the reestimated amount of the previously recorded liability based on experience as of the end of each succeeding year. The estimates change as more information becomes known about the frequency and severity of claims for individual years. The redundancy (deficiency) exists when the reestimated liability at each December 31 is less (greater) than the prior liability estimate. The "cumulative redundancy (deficiency)" depicted in the table, for any particular calendar year, represents the aggregate change in the initial estimates over all subsequent calendar years. DEVELOPMENT OF RESERVES FOR UNPAID LOSSES
YEAR ENDED DECEMBER 31, ----------------------------------------- 1992 1993 1994 1995 1996 1997 ---- ---- ---- ---- ----- ----- (IN THOUSANDS) Liability for unpaid losses and LAE net of reinsurance recoverable........................ $ -- $ -- $ -- $ -- $ -- $ -- Cumulative amount of liability paid through: One year later................................. -- -- -- -- -- -- Two years later................................ -- -- -- -- -- -- Three years later.............................. -- -- -- -- -- -- Four years later............................... -- -- -- -- -- -- Five years later............................... -- -- -- -- -- (186) Six years later................................ -- -- -- -- (136) Seven years later.............................. -- -- -- (79) Eight years later.............................. -- -- (53) Nine years later............................... -- (34) Ten years later................................ (22) Liability estimated as of: One year later................................. -- -- -- -- -- -- Two years later................................ -- -- -- -- -- -- Three years later.............................. -- -- -- -- -- -- Four years later............................... -- -- -- -- -- -- Five years later............................... -- -- -- -- -- (20) Six years later................................ -- -- -- -- (20) Seven years later.............................. -- -- -- (1) Eight years later.............................. -- -- 5 Nine years later............................... -- 4 Ten years later................................ 4
S-12
YEAR ENDED DECEMBER 31, ----------------------------------------- 1992 1993 1994 1995 1996 1997 ---- ---- ---- ---- ----- ----- (IN THOUSANDS) Cumulative total redundancy (deficiency)......... (4) (4) (5) 1 20 20 Gross liability -- end of year................... -- -- -- -- -- -- Reinsurance recoverables(1)...................... -- -- -- -- -- -- ---- ---- ---- ---- ----- ----- Net liability -- end of year..................... $ -- $ -- $ -- $ -- $ -- $ -- ==== ==== ==== ==== ===== ===== Gross reestimated liability -- latest............ 4 4 5 (1) (20) (20) Reestimated reinsurance recoverables -- latest(1)...................... -- -- -- -- -- -- ---- ---- ---- ---- ----- ----- Net reestimated liability -- latest.............. 4 4 5 (1) (20) (20) ==== ==== ==== ==== ===== ===== Gross cumulative redundancy (deficiency)......... (4) (4) (5) 1 20 20 ==== ==== ==== ==== ===== =====
YEAR ENDED DECEMBER 31, ----------------------------------------- 1998 1999 2000 2001 2002 ----- ------ ------ ------ ------ (IN THOUSANDS) Liability for unpaid losses and LAE net of reinsurance recoverable.......................... $ 102 $ 206 $ 448 $ 863 $1,904 Cumulative amount of liability paid through: One year later................................... 110 270 430 (414) -- Two years later.................................. 118 314 (227) Three years later................................ 125 (165) Four years later................................. (207) Five years later................................. Six years later.................................. Seven years later................................ Eight years later................................ Nine years later................................. Ten years later.................................. Liability estimated as of : One year later................................... 120 331 570 714 -- Two years later.................................. 125 345 481 Three years later................................ 125 272 Four years later................................. 69 Five years later................................. Six years later.................................. Seven years later................................ Eight years later................................ Nine years later................................. Ten years later.................................. Cumulative total redundancy (deficiency)........... 34 (66) (33) 150 -- Gross liability -- end of year..................... 337 792 1,018 2,255 4,102 Reinsurance recoverables(1)........................ 235 586 570 1,391 2,198 ----- ------ ------ ------ ------ Net liability -- end of year....................... $ 102 $ 206 $ 448 $ 863 $1,904 ===== ====== ====== ====== ======
S-13
YEAR ENDED DECEMBER 31, ----------------------------------------- 1998 1999 2000 2001 2002 ----- ------ ------ ------ ------ (IN THOUSANDS) Gross reestimated liability -- latest.............. 180 1,131 1,745 2,314 Reestimated reinsurance recoverables -- latest(1)........................ 111 859 1,265 1,601 ----- ------ ------ ------ Net reestimated liability -- latest................ 69 272 481 714 ===== ====== ====== ====== Gross cumulative redundancy (deficiency)........... 157 (339) (727) (59) ===== ====== ====== ======
- --------------- (1) Includes reinsurance recoverables under reinsurance arrangements with its affiliates, Mercer Mutual and Mercer Insurance Company of New Jersey, Inc. INVESTMENTS All of Franklin Insurance Company's investment securities are classified as available for sale and are carried at fair market value. An important component of Franklin Insurance Company's operating results has been the return on invested assets. Franklin Insurance Company's investments adhere to Mercer Mutual's investment policy. For a description of this investment policy, see the section of the attached prospectus entitled "Business" under the subsection entitled "Investments." The following table sets forth consolidated information concerning our investments.
AT MARCH 31, 2003 AT DECEMBER 31, 2002 ------------------ -------------------- MARKET MARKET COST(2) VALUE COST(2) VALUE ------- ------ -------- ------- (IN THOUSANDS) Fixed income securities(1): United states government and government agencies................................... $3,766 $3,792 $5,007 $5,052 ------ ------ ------ ------ Total...................................... $3,766 $3,792 $5,007 $5,052 ====== ====== ====== ======
- --------------- (1) In Franklin Holding's consolidated financial statements, investments are carried at fair value as established by quoted market prices on secondary markets. (2) Original cost of equity securities; original cost of fixed income securities adjusted for amortization of premium and accretion of discount. The table below contains consolidated information concerning the investment ratings of Franklin Insurance Company's fixed maturity investments at March 31, 2003.
AMORTIZED MARKET TYPE/RATINGS OF INVESTMENT(1) COST VALUE PERCENTAGES(2) - ----------------------------- --------- ------ -------------- (IN THOUSANDS) U.S. Government and agencies......................... $3,766 $3,792 100.0 % ------ ------ ----- Total.............................................. $3,766 $3,792 100.0 % ====== ====== =====
- --------------- (1) The ratings set forth in this table are based on the ratings assigned by Standard & Poor's Corporation (S&P). If S&P's ratings were unavailable, the equivalent ratings supplied by Moody's Investors Services, Inc., Fitch Investors Service, Inc. or the NAIC were used where available. (2) Represents percent of market value for classification as a percent of total for each portfolio. S-14 The table below sets forth the maturity profile of Franklin Insurance Company's fixed maturity investments as of March 31, 2003:
AMORTIZED MARKET MATURITY COST(1) VALUE PERCENTAGES(2) - -------- --------- ------ -------------- (IN THOUSANDS) More than 1 year through 5 years..................... $ 500 $ 505 13.3 % More than 5 years through 10 years................... 2,264 2,275 60.0 More than 10 years................................... 1,002 1,012 26.7 ------ ------ ----- Total.............................................. $3,766 $3,792 100.0 %
- --------------- (1) Fixed maturities are carried at market value in Franklin Holding's consolidated financial statements. (2) Represents percent of market value of the classification as a percent of the total. The average duration of Franklin Insurance Company's fixed maturity investments was approximately 4.4 years as of March 31, 2003. As a result, the market value of these investments may fluctuate significantly in response to changes in interest rates. In addition, Franklin Insurance Company may experience investment losses to the extent its liquidity needs require the disposition of fixed maturity securities in unfavorable interest rate environments. Our average cash and invested assets, net investment income and return on average cash and invested assets for the three months ended March 31, 2003 and 2002 and the years ended December 31, 2002, 2001 and 2000 were as follows:
THREE MONTHS ENDED MARCH 31, YEAR ENDED DECEMBER 31, --------------- ------------------------ 2003 2002 2002 2001 2000 ------ ------ ------ ------ ------ (IN THOUSANDS) Average cash and invested assets............ $6,643 $3,733 $5,084 $3,207 $3,133 Net investment income....................... 42 13 119 116 175 Return on average cash and invested assets.................................... 2.5% 1.4% 2.3% 3.6% 5.6%
LEGAL PROCEEDINGS Franklin Insurance Company is a party to litigation in the normal course of business. Based upon information presently available, Franklin Insurance Company does not consider any litigation to be material. However, given the uncertainties attendant to litigation, Franklin Insurance Company cannot assure you that its results of operations and financial condition will not be materially adversely affected by any litigation. ADDITIONAL INFORMATION For additional information concerning the business of Franklin Holding and Franklin Insurance Company, including information on A. M. Best ratings, competition, properties, employees and supervision and regulation, see the section of the attached prospectus entitled "Business." S-15 SELECTED FINANCIAL DATA OF FRANKLIN HOLDING COMPANY The following table sets forth selected consolidated financial data for Franklin Holding as of and for the three months ended March 31, 2003 and 2002 and as of and for each of the years in the five year period ended December 31, 2002. You should read this data in conjunction with Franklin Holding's consolidated financial statements and accompanying notes, "Management's Discussion and Analysis of Franklin Holding's Financial Condition and Results of Operations" and other financial information of Franklin Holding included elsewhere in this prospectus supplement. The consolidated statement of income data for each of the years in the three-year period ended December 31, 2002, and the consolidated balance sheet data at December 31, 2002, and December 31, 2001 is derived from the audited consolidated financial statements of Franklin Holding and its subsidiary beginning on page SF-2 of this prospectus supplement. The consolidated statement of income data for the three months ended March 31, 2003 and 2002 and the years ended December 31, 1999 and 1998, and the consolidated balance sheet data at March 31, 2003 and 2002 and at December 31 of each of the years in the three-year period ended December 31, 2000, is derived from unaudited consolidated financial statements of Franklin Holding and its subsidiary that are not included in this prospectus supplement.
THREE MONTHS ENDED MARCH 31, YEAR ENDED DECEMBER 31, --------------- ---------------------------------------------------- 2003 2002 2002 2001 2000 1999 1998 ------ ------ ------ ------ ------ ----------- ----------- (IN THOUSANDS) (UNAUDITED) (UNAUDITED) Revenue Data: Direct premiums written......... $2,265 $1,888 $7,978 $6,700 $5,742 $4,711 $1,985 Net premiums written............ 1,489 214 2,625 3,832 2,567 2,116 939 Statement of Income Data: Net premiums earned............. 995 661 2,832 2,880 2,445 1,682 577 Investment income, net of expenses..................... 42 13 119 116 175 163 176 Net realized investment loss.... (4) -- -- -- -- -- -- Other income.................... 41 32 135 121 73 56 17 ------ ------ ------ ------ ------ ------ ------ Total revenue................ 1,074 706 3,086 3,117 2,693 1,901 770 ------ ------ ------ ------ ------ ------ ------ Expenses: Loss and loss adjustment expenses..................... 587 325 1,406 1,868 2,035 1,274 490 Amortization of deferred policy acquisition costs............ 221 185 767 666 435 313 182 Other expenses.................. 188 141 606 848 892 584 549 ------ ------ ------ ------ ------ ------ ------ Total expenses............... 996 651 2,779 3,382 3,362 2,171 1,221 ------ ------ ------ ------ ------ ------ ------ Income (loss) before income taxes........................... 77 55 307 (265) (669) (270) (451) ------ ------ ------ ------ ------ ------ ------ Income tax (benefit).............. 27 (607) (517) -- -- 174 (174) ------ ------ ------ ------ ------ ------ ------ Net income(loss).................. $ 51 $ 662 $ 824 $ (265) $ (669) $ (444) $ (277) ====== ====== ====== ====== ====== ====== ======
S-16
THREE MONTHS ENDED MARCH 31, YEAR ENDED DECEMBER 31, ------------------ --------------------------------------------------------- 2003 2002 2002 2001 2000 1999 1998 ------- ------- ------ ------ ----------- ----------- ----------- (UNAUDITED) (IN THOUSANDS) (UNAUDITED) (UNAUDITED) (UNAUDITED) Selected Balance Sheet Data (at period end): Total investments and cash.......... $6,645 $3,940 $6,641 $3,526 $2,888 $3,378 $3,717 Total assets........................ 9,735 6,892 9,093 5,558 6,284 6,297 5,749 Reserves for Loss and loss adjustment expenses............... 2,565 1,847 1,904 1,196 1,019 792 337 Unearned premiums................... 2,158 1,424 1,664 1,871 1,743 1,466 724 Total liabilities................... 5,316 2,702 4,712 3,382 3,843 3,187 2,195 Redeemable preferred stock.......... 2,884 2,735 2,845 2,699 2,161 2,104 2,038 Total shareholders equity (deficit)......................... 1,535 1,454 1,536 (523) 280 1,005 1,515 GAAP Ratios: Loss and loss adjustment expense ratio(1).......................... 59.0% 49.2% 49.6% 64.9% 83.2% 75.7% 85.1% Underwriting expense ratio(2)....... 41.1% 49.3% 48.5% 51.7% 54.3% 53.3% 126.7% Combined ratio(3)................... 100.1% 98.5% 98.1% 116.6% 137.5% 129.0% 211.8% Statutory Data (at period end): Statutory combined ratio............ 88.1% 189.9% 103.1% 104.8% 130.3% 120.6% 172.6% Surplus............................. 3,639 3,195 3,226 1,817 1,850 2,411 2,778 Ratio of net premiums written to statutory surplus................. 1.64x(5) .27x(5) .74x 2.45x 1.37x .87x .34x Industry Statutory Data(4) Loss and loss adjustment expense ratio............................. -- -- -- 88.4 81.1 78.4 76.3 Underwriting expense ratio.......... -- -- -- 26.7 27.6 27.9 27.6 Combined ratio...................... -- -- -- 115.1 108.7 106.3 103.9
- --------------- (1) Calculated by dividing losses and loss adjustment expenses by net premiums earned. (2) Calculated by dividing other underwriting expenses by net premiums earned. (3) The sum of the loss and loss adjustment expense ratio and the underwriting expense ratio. A combined ratio of less than 100% means a company is making an underwriting profit. (4) As reported by A.M. Best Company, Inc., an independent insurance rating organization, for 940 property and casualty insurance organizations (excluding state funds) representing 2,412 companies. Data for the year ended December 31, 2002 is not available. (5) Calculated by annualizing net written premiums. S-17 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FRANKLIN HOLDING COMPANY'S FINANCIAL CONDITION AND RESULTS OF OPERATIONS This discussion relates to the consolidated financial condition and results of operations of Franklin Holding and Franklin Insurance Company for the three months ended March 31, 2003 and 2002 and the years ended December 31, 2002, 2001 and 2000. Franklin Insurance Company is a property and casualty stock insurance company offering private passenger automobile and homeowners insurance to individuals located in Pennsylvania. You should read the following analysis of Franklin Holding's consolidated financial condition and results of operations, together with the consolidated financial statements beginning on page SF-1. CRITICAL ACCOUNTING POLICIES AND ESTIMATES Franklin Holding's consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America, which require Franklin Holding to make estimates and assumptions (see Note 1 of the notes to our consolidated financial statements on page F- ). For a discussion of the significant accounting policies that Franklin Holding believes may involve a higher degree of judgment and estimation, see the section of the attached prospectus entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations" under its subsection entitled "Critical Accounting Policies and Estimates." RESULTS OF OPERATIONS For a description of the factors that influence operations in general in the property and casualty insurance industry, including market conditions, see the section of the attached prospectus entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations" under its subsection entitled "Results of Operations." On June 1, 2001, Mercer Mutual acquired 49% of the outstanding shares of common stock of Franklin Holding. H. Thomas Davis, Jr., an executive officer and director of Mercer Mutual and Franklin Holding, owns the remaining 51% of the outstanding common stock. As of March 31, 2003, there also were 26,450 shares of preferred stock outstanding; however, these shares have limited voting rights. Immediately after the completion of the conversion, Mercer Mutual will acquire the remaining outstanding shares of common and preferred stock of Franklin Holding in exchange for 488,280 shares of Mercer Insurance Group common stock. As a result of that purchase of these remaining shares, Franklin Holding will be a wholly owned subsidiary of Mercer Insurance Group. THREE MONTHS ENDED MARCH 31, 2003 COMPARED TO THE THREE MONTHS ENDED MARCH 31, 2002 Total revenues of Franklin Holding for the three months ended March 31, 2003 were $1.1 million compared to $706,000 for the three months ended March 31, 2002. Net premiums earned increased by 50.5% to $1.0 million for the three months ended March 31, 2003. The increase in net premiums earned reflects the impact of a reinsurance pooling arrangement with Mercer Mutual and Mercer Insurance Company of New Jersey, Inc. entered into effective January 1, 2002. Under this arrangement, all premiums, losses and underwriting expenses of the three insurance companies are combined and subsequently shared based on each individual company's statutory surplus from the most recently filed statutory annual statement. The Franklin Holding Company share of the pool, through its subsidiary Franklin Insurance Company, increased to 9% of the combined business of the three insurance companies in 2003 from 7% in 2002. Net investment income increased $29,000, or 323.1%, to $42,000 for the three months ended March 31, 2003, as compared to the same period in 2002, because Franklin Holding was invested in bonds in 2003 compared to investing strictly in cash and cash equivalents for the three months ended March 31, 2002. For the three months ended March 31, 2003, we had a combined ratio of 100.1%, a loss and loss adjustment expense ratio of 59.0% and an underwriting expense ratio of 41.1%, compared to a combined ratio of 98.5%, a loss and loss adjustment expense ratio of 49.2% and an underwriting expense ratio of 49.3% for the S-18 three months ended March 31, 2002. Net losses and loss adjustment expenses incurred increased by $262,000, or 80.6%, to $587,000 for the quarter ended March 31, 2003 from the same period in 2002. The increase in loss and loss adjustment expenses reflects the implementation of the reinsurance pooling arrangement. Underwriting expenses increased by $83,000, or 25.5%, to $409,000 for the quarter ended March 31, 2003 from the same period in 2002. This increase was attributable to the pooling arrangement. Federal income tax expense was $27,000 in the first quarter of 2003, compared to a federal income tax benefit of $607,000 for the first quarter of 2002. During 2002, the valuation allowance which had previously been established for deferred taxes was eliminated. Please see the discussion of such elimination under the heading below. YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001 Total revenues of Franklin Holding Company for 2002 were $3.1 million, which was equivalent with 2001 revenues. Net premiums earned decreased by 1.6% to $2.8 million from 2001. The decrease in net premiums earned reflects the implementation of the reinsurance pooling arrangement with Mercer Mutual and Mercer Insurance Company of New Jersey, Inc. Net investment income increased $3,000, or 2.6%, to $119,000 for the year ended December 31, 2002, as compared to the same period in 2001 as Franklin Holding began investing in bonds as compared to investing strictly in cash and cash equivalents. For the year ended December 31, 2002, we had a combined ratio of 98.1%, a loss and loss adjustment expense ratio of 49.6% and an underwriting expense ratio of 48.5%, compared to a combined ratio of 116.6%, a loss and loss adjustment expense ratio of 64.9% and an underwriting expense ratio of 51.7% for the year ended December 31, 2001. Net losses and loss adjustment expenses incurred decreased by $462,000, or 24.7%, to $1.4 million for the year ended December 31, 2002 from the same period in 2001. The decrease in loss and loss adjustment expenses reflects the implementation of the reinsurance pooling arrangement. Underwriting expenses decreased by $141,000, or 9.1%, to $1.4 million for the year ended December 31, 2002 from the same period in 2001. This decrease was attributable to the pooling arrangement. Federal income tax benefit was $517,000 in 2002, as the valuation allowance which had previously been established for deferred taxes was eliminated. Prior to the implementation of the aforementioned pooling arrangement, Franklin Holdings did not recognize the deferred tax asset associated with previous net operating losses (NOL's). This was because under applicable tax law it was not clear that Franklin Holding would generate future operating profit sufficient to permit it to utilize these NOL's, given its history of operating losses. Therefore, Franklin was required to establish a valuation allowance. Because of Mercer Mutual's history of profitable operations, the pooling arrangement with Mercer Mutual made it more likely than not that Franklin Holding would generate sufficient future operating profit to utilize the NOL's and therefore Franklin Holding no longer needed a valuation allowance. YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000 Total revenues for 2001 were $3.1 million, which were $424,000 or 15.7%, greater than 2000. Net premiums earned increased by 17.8% to $2.9 million from 2000. The increase in net premiums earned reflects an increase in direct written premiums and the establishment of a reinsurance agreement with Mercer Mutual. Net investment income decreased $59,000, or 33.7%, to $116,000 for the year ended December 31, 2001, as compared to the same period in 2000 due to the declining interest rate environment. For the year ended December 31, 2001, we had a combined ratio of 116.6%, a loss and loss adjustment expense ratio of 64.9% and an underwriting expense ratio of 51.7%, compared to a combined ratio of 137.5%, a loss and loss adjustment expense ratio of 83.2% and an underwriting expense ratio of 54.3% for the year ended December 31, 2000. Net losses and loss adjustment expenses incurred decreased by $167,000, or 8.2%, to $1.9 million for the year ended December 31, 2001, from the same period in 2000. These improved underwriting results reflect the aforementioned reinsurance arrangement with Mercer Mutual as well as improved direct results. Underwriting expenses increased by $187,000, or 14.1%, to $1.5 million for the year ended December 31, 2001, from the same period in 2000. This increase was largely attributable to an increase in net commissions and other expenses associated with increased direct writings. S-19 LIQUIDITY AND CAPITAL RESOURCES Franklin Insurance Company generates sufficient funds from its operations and maintains a high degree of liquidity in its investment portfolios. The primary source of funds to meet the demands of claim settlements and operating expenses are premium collections, investment earnings and maturing investments. Franklin Insurance Company maintains investment and reinsurance programs that are intended to provide sufficient funds to meet its obligations without forced sales of investments. It maintains a portion of its investment portfolio in relatively short-term and highly liquid assets to ensure the availability of funds. The principal source of liquidity for Franklin Holding will be dividend payments and other fees received from Franklin Insurance Company. Franklin Insurance Company is restricted by the insurance laws of Pennsylvania as to the amount of dividends or other distributions it may pay to the Franklin Holding. Under Pennsylvania law, there is a maximum amount that may be paid by Franklin Insurance Company during any twelve-month period after notice to, but without prior approval of, the Pennsylvania Insurance Department. This limit is the greater of 10% of Franklin Insurance Company's statutory surplus as reported on its most recent annual statement filed with the Pennsylvania Insurance Department, or the net income of Franklin Insurance Company for the period covered by such annual statement. As of December 31, 2002, the amount available for payment of dividends from Franklin Insurance Company in 2003 without the prior approval of the Pennsylvania Insurance Department is approximately $355,000. QUANTITATIVE AND QUALITATIVE INFORMATION ABOUT MARKET RISK For a description of Franklin Holding's exposure to market risk and inflation, see the section of the attached prospectus entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations" under its subsections entitled "Quantitative and Qualitative Information about Market Risk" and "Impact of Inflation," respectively. DIRECTORS AND EXECUTIVE OFFICERS The following table sets forth certain information regarding the directors and executive officers of the Franklin Holding.
AGE AT MARCH 31, DIRECTOR 2002 SINCE(1) POSITION WITH FRANKLIN HOLDING --------- -------- ------------------------------ Roland D. Boehm............... 64 2001 Vice Chairman of the Board of Directors H. Thomas Davis, Jr. ......... 54 1997 Senior Vice President and Director William V. R. Fogler.......... 58 2001 Director William C. Hart............... 70 2001 Director George T. Hornyak, Jr. ....... 53 2001 Director Samuel J. Malizia............. 48 2003 Director Paul R. McDermott............. 53 2003 Director Richard U. Niedt.............. 71 2001 Director Andrew R. Speaker............. 40 2001 President, Chief Executive Officer, and Director Richard G. Van Noy............ 61 2001 Chairman of the Board of Directors Gordon A. Coleman............. 45 2001 Treasurer John G. Danka................. 54 2001 Vice President Paul D. Ehrhardt.............. 45 2001 Senior Vice President and Corporate Secretary
Mr. McDermott was recently appointed to the Board of Directors of Franklin Holdings to fill the seat entitled to the holder of all of the outstanding shares of Franklin Holding's Series B Cumulative Redeemable Preferred Stock, American Re-Insurance Company. Mr. McDermott is Senior Vice President, Strategic S-20 Investments for American Re. For a description of the business experience of each of the other directors except Mr. McDermott, for at least the past five years, see the section of the attached prospectus entitled "Management." Each director of Franklin Holding also serves as a director of Franklin Insurance Company, Mercer Mutual Insurance Company, and Mercer Insurance Company of New Jersey, Inc. EXECUTIVE COMPENSATION The executive officers of Franklin Holding hold the identical positions with Mercer Mutual. Therefore, for information regarding the compensation of the President and Chief Executive Officer of Franklin Holding, and each other executive officer whose total salary and bonus for the year ended December 31, 2002 exceeded $100,000, see the section of the attached prospectus entitled "Management" under its subsection entitled "Executive Compensation." BENEFIT PLANS AND AGREEMENTS For a description of the employment agreements of Franklin Holding's executive officers and the employee benefit plans under which Franklin Holding's executive officers are compensated, see the section of the attached prospectus entitled "Management" in its subsection entitled "Benefit Plan and Agreements." SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth information as to those persons believed by management to be beneficial owners of more than 5% of any class of Franklin Holding's outstanding voting securities. Other than those persons listed below, we are not aware of any person, as such term is defined in the Securities and Exchange Act of 1934, that owns more than 5% of Franklin Holding's outstanding voting securities.
AMOUNT AND NATURE OF PERCENT TITLE OF CLASS NAME AND ADDRESS OF BENEFICIAL OWNER BENEFICIAL OWNERSHIP OF CLASS - -------------- ------------------------------------ -------------------- -------- Class A Voting Common Stock..... Mercer Mutual Insurance Company 10 102,900 49% North Highway 31 Pennington, New Jersey 08534 Class A Voting Common Stock..... H. Thomas Davis, Jr. 10 North 107,100 51% Highway 31 Pennington, New Jersey 08534
S-21 DESCRIPTION OF THE CAPITAL STOCK OF FRANKLIN HOLDING COMPANY The issued and outstanding capital stock of Franklin Holding consists of: the Class A Voting Common Stock, the Class B Non-Voting Common Stock, the Series A Convertible Redeemable Preferred Stock, and the Series B Cumulative Redeemable Preferred Stock. COMMON STOCK Each share of common stock of Franklin Holding has the same relative rights and is identical in all respects with every other share of common stock, except that the shares of Class A Voting Common Stock entitle their holders to one vote for each share on all matters to be voted on by stockholders, and the shares of the Class B Non-Voting Common Stock do not have voting rights on any matters. Dividends paid on shares of the common stock of Franklin Holding are not permitted to exceed $0.50 per share per annum. PREFERRED STOCK The holders of shares of preferred stock of Franklin Holding do not have any voting rights, except for one vote for each share to vote only on any amendment, alteration or repeal of Franklin Holding's certificate of incorporation that materially or adversely affects the powers, rights or preference of the preferred stock, or to approve any class or series of stock that ranks on a parity with the preferred stock. In the event of a dissolution, liquidation, or winding up of the affairs of Franklin Holding, the holders of the preferred stock are entitled to receive, out of the net assets of Franklin Holding, an amount before any payment is made or any assets of Franklin Holding are distributed or paid to the holders of any other class of stock. The payment to the holders of the Series A Convertible Redeemable Preferred Stock would be equal to $100 per share plus interest on that amount at a rate of 2% compounded annually from June 1, 2001, plus the amount of any declared and unpaid dividends. The payment to the holders of the Series B Cumulative Redeemable Preferred Stock in the aggregate would be equal to $1,615,930, plus interest on that amount at 7.5% per annum compounded annually from June 1, 2001. The amount of these payments are referred to in this prospectus supplement as the "liquidation preference value" of these shares. Holders of Series A and Series B Preferred Stock are entitled to receive dividends, when, as and if declared by the board of directors, out of funds legally available for payment of dividends, at the rate of $5.00 per share annum. The dividends on the Series B Preferred Stock are cumulative and accrue, whether or not declared and whether or not there are funds available for payment, at an annual rate of 5%. The dividends on the Series A Preferred Stock are not cumulative. If a cash dividend is paid on the Series A or the Series B Preferred Stock, then a cash dividend must be declared and paid on each share of Series A and Series B Preferred Stock on a pari passu basis. Otherwise, any dividends on the Series B Preferred Stock may be paid, at the option of the Franklin Holding board of directors, by issuing additional shares of Series B Preferred Stock such that the liquidation preference value of such additional shares of Series B Preferred Stock, plus the amount of any cash dividends paid with such shares, constitute payment of the full amount of the dividend. The Series A and the Series B Preferred Stock may be redeemed by and at the option of Franklin Holding for cash on the first business day following April 1st of any year subsequent to 2005 for an amount equal to the liquidation preference value of the shares. Any holder of Series A Preferred Stock may require that his or her shares be repurchased by Franklin Holding for cash on the first business day following September 3 of any year beginning with the year 2007 but prior to the year 2011 for an amount equal to the liquidation preference value of the shares. Franklin Holding must repurchase all of the issued and outstanding shares of Series B Preferred Stock on September 3, 2007 for an amount equal to the liquidation preference value of the shares. Prior to that date, Franklin Holding also must repurchase all of the issued and outstanding shares of Series B Preferred Stock at their liquidation preference value in the event of: - any redemption or repurchase of the Series A Preferred Stock; - any change in the voting control of Franklin Holding or Franklin Insurance Company; S-22 - any merger or consolidation of, or substantial disposition of assets out of the ordinary course of the insurance business by, Franklin Holding; or - any transfer by Franklin Holding of any ownership interest in Franklin Insurance Company. Each share of Series A Preferred Stock may be converted at the option of the holder into ten shares of Class B Non-Voting Common Stock in the event of: - any merger or consolidation of Franklin Holding or Franklin Insurance Company with or into another corporation; - the sale of all or substantially all of the assets of Franklin Holding or Franklin Insurance Company; - the registration of securities of Franklin Holding or Franklin Insurance Company under the Securities Act of 1933; or - the issuance by Franklin Holding of any notice calling the Series A Preferred Stock for redemption. The Franklin Holding Certificate of Incorporation further provides that in the event of a conversion of Mercer Mutual from mutual to stock form, the holders of the Series A and Series B Preferred Stock have the right to exchange any and all of their shares into a number of shares equal to, for each share of Series A or Series B Preferred Stock held by the holder, such number of shares of Mercer Mutual or its holding company that equals the Liquidation Preference Value of the share as of the date of the mutual to stock conversion divided by the initial per share price to the public of the common stock of Mercer Mutual or its holding company. If any holder of Series A or Series B Preferred Stock fails to provide notice of its intent or indicates in such notice that it does not intend to exercise its rights to the share exchange, Mercer Mutual has the right to compel the share exchange by providing written notice to any and all of these holders not less than 60 days prior to the closing date of the mutual to stock conversion. EXPERTS The consolidated financial statements and schedules of Franklin Holding as of December 31, 2002 and 2001, and for each of the years in the two-year period ended December 31, 2002, have been included in this prospectus supplement in reliance upon the report of KPMG LLP, independent certified public accountants, appearing elsewhere in this prospectus supplement, and upon the authority of said firm as experts in accounting and auditing. The consolidated financial statements of Franklin Holding for the year ended December 31, 2000, have been included in this prospectus supplement in reliance upon the report of Brown Schultz Sheridan & Fritz, independent certified public accountants, appearing elsewhere in this prospectus supplement, and upon the authority of said firm as experts in accounting and auditing. S-23 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS OF FRANKLIN HOLDING COMPANY
PAGE ----- Independent Auditors' Reports............................... SF-2 Consolidated Financial Statements: Balance Sheets (As of December 31, 2002 and 2001)...... SF-4 Statements of Earnings (For the years ended December 31, 2002, 2001 and 2000).............................. SF-5 Statements of Changes in Shareholders' Equity (Deficit) (For the years ended December 31, 2002, 2001 and 2000)................................................. SF-6 Statements of Cash Flows (For the years ended December 31, 2002, 2001 and 2000).............................. SF-7 Notes to Consolidated Financial Statements.................. SF-8 Interim Condensed Consolidated Financial Statements Balance Sheets (As of March 31, 2003 (Unaudited) and December 31, 2002).................................... SF-18 Statements of Earnings (Unaudited) (For three months ended March 31, 2003 and 2002)........................ SF-19 Statements of Changes in Shareholders' Equity (Unaudited) (For three months ended March 31, 2003)... SF-20 Statements of Cash Flows (Unaudited) (For three months ended March 31, 2003 and 2002)........................ SF-21 Notes to Condensed Consolidated Financial Statements... SF-22
SF-1 INDEPENDENT AUDITORS' REPORT The Board of Directors Franklin Holding Company, Inc.: We have audited the accompanying consolidated balance sheets of Franklin Holding Company, Inc. and subsidiary (the Group) as of December 31, 2002 and 2001, and the related consolidated statements of earnings, changes in shareholders' equity (deficit), and cash flows for each of the years in the two-year period ended December 31, 2002. These financial statements are the responsibility of the Group's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards 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. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Group as of December 31, 2002 and 2001, and the results of their operations and their cash flows for each of the years in the two-year period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States of America. /s/ KPMG LLP Philadelphia, PA March 28, 2003 SF-2 INDEPENDENT AUDITORS' REPORT Board of Directors Franklin Holding Company, Inc. We have audited the accompanying consolidated statements of earnings, changes in shareholders' equity and cash flows of Franklin Holding Company, Inc. and subsidiary for the year ended December 31, 2000. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards 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. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the results of operations and cash flows of Franklin Holding Company, Inc. and subsidiary for the year ended December 31, 2000 in conformity with accounting principles generally accepted in the United States of America. BROWN SCHULTZ SHERIDAN & FRITZ Camp Hill, Pennsylvania April 27, 2001 SF-3 FRANKLIN HOLDING COMPANY, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS DECEMBER 31, 2002 AND 2001
2002 2001 ---------- --------- (DOLLARS IN THOUSANDS) ASSETS Investments, at fair value: Fixed income securities, available-for-sale, at fair value (cost $5,007 and $0, respectively)..................... $ 5,052 -- Cash and cash equivalents................................... 1,589 3,526 Premiums receivable......................................... 633 515 Reinsurance receivables..................................... -- 508 Deferred policy acquisition costs........................... 405 363 Accrued investment income................................... 85 9 Fixed assets, net........................................... 443 513 Deferred income taxes....................................... 502 -- Other assets................................................ 384 124 ------- ------ Total assets................................................ $ 9,093 5,558 ======= ====== LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Losses and loss adjustment expenses....................... $ 1,904 1,196 Unearned premiums......................................... 1,664 1,871 Accounts payable and accrued expenses..................... 671 281 Reinsurance balances payable.............................. 473 34 ------- ------ Total liabilities...................................... 4,712 3,382 ------- ------ Redeemable preferred stock.................................. 2,845 2,699 Shareholders' equity (deficit): Series A common stock, $.10 par, 210,000 shares authorized, issued and outstanding..................... 21 21 Series B common stock, $.10 par, 800,000 shares authorized, 135,100 shares issued and outstanding...... 14 -- Additional paid-in capital................................ 2,571 1,380 Unassigned deficit........................................ (1,100) (1,924) Accumulated other comprehensive income: Unrealized gains in investments, net of deferred income taxes................................................. 30 -- ------- ------ Total shareholders' equity (deficit)................. 1,536 (523) ------- ------ Total liabilities and shareholders' equity.................. $ 9,093 5,558 ======= ======
See accompanying notes to consolidated financial statements. SF-4 FRANKLIN HOLDING COMPANY, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF EARNINGS YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
2002 2001 2000 ------ ----- ----- (DOLLARS IN THOUSANDS) Revenue: Net premiums earned....................................... $2,832 2,880 2,445 Investment income, net of expenses........................ 119 116 175 Other revenue............................................. 135 121 73 ------ ----- ----- Total revenue.......................................... 3,086 3,117 2,693 ------ ----- ----- Expenses: Losses and loss adjustment expenses....................... 1,406 1,868 2,035 Amortization of deferred policy acquisition costs......... 767 666 435 Other expenses............................................ 606 848 892 ------ ----- ----- Total expenses......................................... 2,779 3,382 3,362 ------ ----- ----- Income (loss) before income taxes...................... 307 (265) (669) Income tax benefit.......................................... (517) -- -- ------ ----- ----- Net income (loss)........................................... $ 824 (265) (669) ====== ===== =====
See accompanying notes to consolidated financial statements. SF-5 FRANKLIN HOLDING COMPANY, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (DEFICIT) YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
ACCUMULATED SERIES A SERIES B ADDITIONAL OTHER COMMON COMMON PAID-IN UNASSIGNED COMPREHENSIVE STOCK STOCK CAPITAL DEFICIT INCOME TOTAL -------- -------- ---------- ---------- ------------- ----- (DOLLARS IN THOUSANDS) Balance, December 31, 1999........ $21 -- 1,974 (990) -- 1,005 Net loss.......................... -- -- -- (669) -- (669) Preferred stock dividends......... -- -- (56) -- -- (56) --- -- ----- ------ -- ----- Balance, December 31, 2000........ 21 -- 1,918 (1,659) -- 280 Net loss.......................... -- -- -- (265) -- (265) Preferred stock dividends......... -- -- (538) -- -- (538) --- -- ----- ------ -- ----- Balance, December 31, 2001........ 21 -- 1,380 (1,924) -- (523) Net income........................ -- -- -- 824 -- 824 Other comprehensive income, net of tax: Unrealized holding gains arising during period, net of related income tax expense of $15.... -- -- -- -- 30 30 --- -- ----- ------ -- ----- Comprehensive income.............. 854 Preferred stock dividends......... -- -- (146) -- -- (146) Issuance on common stock on exercise of options............. -- 14 1,337 -- -- 1,351 --- -- ----- ------ -- ----- Balance, December 31, 2002........ $21 14 2,571 (1,100) 30 1,536 === == ===== ====== == =====
See accompanying notes to consolidated financial statements. SF-6 FRANKLIN HOLDING COMPANY, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
2002 2001 2000 ------- ----- ----- (DOLLARS IN THOUSANDS) Cash flows from operating activities: Net income (loss)......................................... $ 824 (265) (669) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation of property and equipment................. 275 261 213 Net accretion of discount.............................. 1 -- -- Deferred income tax.................................... (517) -- -- Change in assets and liabilities: Premiums receivable.................................. (118) (52) (97) Reinsurance receivables.............................. 508 616 (160) Prepaid reinsurance premiums......................... -- 824 (154) Deferred policy acquisition costs.................... (42) (160) (27) Other assets......................................... (336) (11) (61) Losses and loss expenses............................. 708 178 226 Unearned premiums.................................... (207) 128 276 Other liabilities.................................... 829 (742) 242 ------- ----- ----- Net cash provided by (used in) operating activities...................................... 1,925 777 (211) ------- ----- ----- Cash flows from investing activities: Purchase of fixed income securities, available-for-sale... (5,258) -- -- Sale and maturity of fixed income securities available-for-sale..................................... 250 -- -- Purchase of property and equipment........................ (205) (139) (190) ------- ----- ----- Net cash used in investing activities............. (5,213) (139) (190) ------- ----- ----- Cash flows from financing activities: Proceeds from exercised options........................... 1,351 -- -- Debt repayment............................................ -- -- (89) ------- ----- ----- Net cash provided by (used in) financing activities...................................... 1,351 -- (89) ------- ----- ----- Net increase (decrease) in cash and cash equivalents..................................... (1,937) 638 (490) Cash and cash equivalents at beginning of period............ 3,526 2,888 3,378 ------- ----- ----- Cash and cash equivalents at end of period.................. $ 1,589 3,526 2,888 ======= ===== ===== Cash paid during the year for: Interest.................................................. $ -- -- 6
See accompanying notes to consolidated financial statements. SF-7 FRANKLIN HOLDING COMPANY, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS) (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (A) DESCRIPTION OF BUSINESS Franklin Holding Company, Inc. (FHC) was formed as the holding company for Franklin Insurance Company (FIC). FHC and FIC are collectively referred to as the "Group". Insurance operations began in 1998. The Group directly writes personal lines of insurance, including personal automobile insurance (86% of total written in 2002) and homeowners (14% of total written in 2002) in Pennsylvania. On June 1, 2001, Mercer Mutual Insurance Company (Mercer) acquired a controlling interest in the Group. Additionally, FIC and Mercer entered into a reinsurance arrangement effective January 1, 2002 (note 6). (B) CONSOLIDATION POLICY AND BASIS OF PRESENTATION The consolidated financial statements include the accounts of each member of the Group. All significant intercompany accounts and transactions have been eliminated in consolidation. The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America, which differ in some respects from those followed in reports to insurance regulatory authorities. (C) USE OF ESTIMATES The preparation of the accompanying financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant items subject to such estimates and assumptions include liabilities for losses and loss adjustment expenses, deferred income tax assets, and other than temporary impairment of investments. Actual results could differ from those estimates. (D) INVESTMENTS Due to periodic shifts in the portfolio arising from income tax and asset-liability matching, as well as securities markets and economic factors, management considers the entire portfolio of fixed income securities as available-for-sale. Fixed income securities available-for-sale are stated at fair value with changes in fair value, net of deferred income tax, reflected in equity as accumulated other comprehensive income. Realized gains and losses are determined on the specific identification basis. A decline in the market value of an investment below its cost that is deemed other than temporary is charged to earnings. Interest on fixed maturities is credited to income as it accrues on the principal amounts outstanding, adjusted for amortization of premiums and accretion of discounts computed utilizing the effective interest rate method. (E) CASH AND CASH EQUIVALENTS Cash and cash equivalents are carried at cost which approximates market value. The Group considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. SF-8 FRANKLIN HOLDING COMPANY, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (DOLLARS IN THOUSANDS) (F) FAIR VALUES OF FINANCIAL INSTRUMENTS The Group has used the following methods and assumptions in estimating its fair values: Investments -- The fair values for fixed income securities available-for-sale are based on quoted market prices, when available. If not available, fair values are based on values obtained from investment brokers. Cash and cash equivalents -- The carrying amounts reported in the balance sheet for these instruments approximate their fair values. Premium and reinsurance receivables -- The carrying amounts reported in the balance sheet for these instruments approximate their fair values. (G) REINSURANCE The Group cedes insurance to, and assumes insurance from, affiliated and unrelated insurers to limit its maximum loss exposure through risk diversification. Ceded reinsurance receivables and unearned premiums are reported as assets; loss and loss adjustment expenses reserves are reported gross of ceded reinsurance credits. (H) DEFERRED POLICY ACQUISITION COSTS Acquisition costs such as commissions, premium taxes, and certain other expenses which vary with and are directly related to the production of business, are deferred and amortized over the effective period of the related insurance policies. The method followed in computing deferred policy acquisition costs limits the amount of such deferred costs to their estimated realizable value, which gives effect to premiums to be earned, anticipated investment income, loss and loss adjustment expenses, and certain other maintenance costs expected to be incurred as the premiums are earned. To the extent that deferred policy acquisition costs are not realizable, the deficiency is charged to income currently. (I) FIXED ASSETS Fixed assets are carried at cost less accumulated depreciation calculated on the straight-line basis. Fixed assets are depreciated over three to ten years. (J) PREMIUM REVENUE Premiums include direct writings plus reinsurance assumed less reinsurance ceded to other insurers and are recognized as revenue over the period that coverage is provided using the monthly pro-rata method. Unearned premiums represent that portion of premiums written that are applicable to the unexpired terms of policies in force. (K) LOSSES AND LOSS ADJUSTMENT EXPENSES The liability for losses includes the amount of claims which have been reported to the Group and are unpaid at the statement date as well as provision for claims incurred but not reported, after deducting anticipated salvage and subrogation. The liability for loss adjustment expenses is determined as a percentage of the liability for losses based on the historical ratio of paid adjustment expenses to paid losses by line of business. Management believes that the liabilities for losses and loss adjustment expenses at December 31, 2002 are adequate to cover the ultimate net cost of losses and claims to date, but these liabilities are necessarily SF-9 FRANKLIN HOLDING COMPANY, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (DOLLARS IN THOUSANDS) based on estimates, and the amount of losses and loss adjustment expenses ultimately paid may be more or less than such estimates. Changes in the estimates for losses and loss adjustment expenses are recognized in the period in which they are determined. (L) INCOME TAXES The Group uses the asset and liability method of accounting for income taxes. Deferred income taxes arise from the recognition of temporary differences between financial statement carrying amounts and the tax bases of the Group's assets and liabilities and operating loss carryforwards. A valuation allowance is provided when it is more likely than not that some portion of the deferred tax asset will not be realized. The effect of a change in tax rates is recognized in the period of the enactment date. (2) INVESTMENTS Net investment income and change in unrealized capital gains on investment securities are as follows. Net investment income:
2002 2001 2000 ---- ---- ---- Investment income: Fixed income securities................................... $ 89 -- -- Cash and cash equivalents................................. 92 135 189 ---- --- --- Gross investment income................................ 181 135 189 Less investment expenses.................................. 62 19 14 ---- --- --- Net investment income.................................. $119 116 175 ==== === ===
Investment expenses include salaries, counseling fees, and other miscellaneous expenses attributable to the maintenance of investment activities. The changes in unrealized gains of securities are as follows:
2002 ---- Fixed income securities..................................... $45 --- $45 ===
The cost and estimated fair value of available-for-sale investment securities at December 31, 2002 are shown below.
GROSS GROSS ESTIMATED AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE --------- ---------- ---------- --------- U.S. Government and government agencies..... $5,007 46 1 5,052 ------ -- -- ----- $5,007 46 1 5,052 ====== == == =====
The amortized cost and estimated fair value of bonds at December 31, 2002, 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. SF-10 FRANKLIN HOLDING COMPANY, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (DOLLARS IN THOUSANDS)
ESTIMATED AMORTIZED FAIR COST VALUE --------- --------- Due after one year through five years....................... $ 750 759 Due after five years through ten years...................... 2,254 2,273 Due after ten years......................................... 2,003 2,020 ------ ----- $5,007 5,052 ====== =====
Proceeds from the sale of available-for-sale securities were $250 for 2002, and resulted in no gain or loss upon disposal. (3) DEFERRED POLICY ACQUISITION COSTS Changes in deferred policy acquisition costs are as follows:
2002 2001 2000 ----- ---- ---- Balance, January 1.......................................... $ 363 202 176 Acquisition costs deferred.................................. 809 827 461 Amortization charged to earnings............................ (767) (666) (435) ----- ---- ---- Balance, December 31........................................ $ 405 363 202 ===== ==== ====
(4) FIXED ASSETS Fixed assets were as follows:
2002 2001 ------- ----- Data processing equipment................................... $ 350 315 Data processing software and development.................... 1,027 863 Furniture, fixtures, and equipment.......................... 39 33 Other....................................................... 96 96 ------- ----- 1,512 1,307 Accumulated depreciation.................................... (1,069) (794) ------- ----- $ 443 513 ======= =====
SF-11 FRANKLIN HOLDING COMPANY, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (DOLLARS IN THOUSANDS) (5) LIABILITIES FOR LOSSES AND LOSS ADJUSTMENT EXPENSES Activity in the liabilities for losses and loss adjustment expenses is summarized as follows:
2002 2001 2000 ------ ----- ----- Balance, January 1.......................................... $1,196 1,019 792 Less reinsurance recoverable on unpaid losses and loss expenses............................................... (333) (571) (586) ------ ----- ----- Net balance at January 1............................... 863 448 206 ------ ----- ----- Incurred related to: Current year.............................................. 1,556 1,749 1,910 Prior years............................................... (150) 119 125 ------ ----- ----- Total incurred......................................... 1,406 1,868 2,035 ------ ----- ----- Paid related to: Current year.............................................. 780 1,023 1,524 Prior years............................................... 516 430 269 Adjustments to beginning reserves resulting from termination of reinsurance agreement and implementation of pooling agreement................................... (931) -- -- ------ ----- ----- Total paid............................................. 365 1,453 1,793 ------ ----- ----- Net balance, December 31............................... 1,904 863 448 Plus reinsurance recoverable on unpaid losses and loss expenses............................................... -- 333 571 ------ ----- ----- Balance at December 31...................................... $1,904 1,196 1,019 ====== ===== =====
As a result of changes in estimates of insured events in prior years, the liabilities for losses and loss adjustment expense increased (decreased) by $(150), $119, and $125 in 2002, 2001, and 2000, respectively. These re-estimations are primarily concentrated in the commercial multi-peril and other liability lines in 2002 and the private passenger auto physical damage line in 2001 and 2000. (6) REINSURANCE The Group has geographic exposure to catastrophe losses in its operating region. Catastrophes can be caused by various events including hurricanes, windstorms, earthquakes, hail, explosion, severe weather, and fire. The incidence and severity of catastrophes are inherently unpredictable. The extent of losses from a catastrophe is a function of both the total amount of insured exposure in the area affected by the event and the severity of the event. Most catastrophes are restricted to small geographic areas. However, hurricanes and earthquakes may produce significant damage in large, heavily populated areas. The Group generally seeks to reduce its exposure to catastrophe through individual risk selection and the purchase of catastrophe reinsurance. In the ordinary course of business, the Group seeks to limit its exposure to loss on individual claims and from the effects of catastrophes by entering into reinsurance contracts with other insurance companies. Reinsurance is ceded on excess of loss and pro-rata bases with the Group's retention not exceeding $300 per occurrence. Insurance ceded by the Group does not relieve its primary liability as the originating insurer. The Group also assumes reinsurance from other companies on a pro-rata basis. SF-12 FRANKLIN HOLDING COMPANY, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (DOLLARS IN THOUSANDS) FIC entered into a pooling reinsurance arrangement with its affiliate Mercer, effective April 1, 2001, whereby 100% of the direct business of FIC was ceded to Mercer. Mercer then retrocedes to FIC 10% of the combined business of both companies. As of January 1, 2002, the prior pooling arrangement between FIC and Mercer was terminated. Also effective January 1, 2002, the Group's insurance subsidiary FIC, and their affiliates Mercer, and Mercer Insurance Company of New Jersey, Inc. ("Mercer Insurance," a 100% owned subsidiary of Mercer) entered into a pooling agreement (the "Pool"). FIC and Mercer Insurance cede 100% of their insurance business to Mercer, and Mercer in turn retrocedes a portion back to the FIC and Mercer Insurance based on each company's surplus in relation to total pooled surplus. For 2002, FIC and Mercer Insurance assumed 7% and 20%, respectively, of the Pool. The effect of reinsurance on premiums written and earned is as follows:
2002 2001 2000 ------- ------ ------ Premiums written: Direct.................................................. $ 7,978 6,700 5,742 Assumed -- affiliates................................... 2,625 4,140 -- Ceded -- nonaffiliates.................................. -- (15) (3,175) Ceded -- affiliates..................................... (7,978) (6,993) -- ------- ------ ------ Net....................................................... $ 2,625 3,832 2,567 ======= ====== ====== Premiums earned: Direct.................................................. $ 7,627 6,444 5,466 Assumed -- affiliates................................... 2,832 2,270 -- Ceded -- nonaffiliates.................................. -- (839) (3,021) Ceded -- affiliates..................................... (7,627) (4,995) -- ------- ------ ------ Net....................................................... $ 2,832 2,880 2,445 ======= ====== ======
The effect of reinsurance on unearned premiums as of December 31 is as follows:
2002 2001 ------- ------ Direct...................................................... $ 2,349 1,998 Assumed -- affiliate........................................ 1,664 1,871 Ceded -- affiliate.......................................... (2,349) (1,998) ------- ------ $ 1,664 1,871 ======= ======
The effect of reinsurance on the liabilities for losses and loss adjustment expenses and losses and loss adjustment expenses incurred is as follows:
2002 2001 ------- ------ Liabilities: Direct.................................................... $ 2,248 1,629 Assumed -- affiliates..................................... 1,904 625 Ceded -- affiliate........................................ (2,248) (1,058) ------- ------ Liabilities per Consolidated Balance Sheets............ 1,904 1,196 ------- ------ Ceded -- nonaffiliate..................................... -- (333) ------- ------ Net after ceded to nonaffiliate............................. $ 1,904 863 ======= ======
SF-13 FRANKLIN HOLDING COMPANY, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (DOLLARS IN THOUSANDS)
2002 2001 2000 ------- ------ ------ Losses and loss adjustment expenses incurred: Direct.................................................. $ 4,677 4,501 4,117 Assumed -- affiliates................................... 1,406 1,090 -- Ceded -- nonaffiliate................................... 333 (676) (2,082) Ceded -- affiliate...................................... (5,010) (3,047) -- ------- ------ ------ Net....................................................... $ 1,406 1,868 2,035 ======= ====== ======
Affiliated reinsurance balances are presented net on the consolidated balance sheets due to the right of offset in accordance with the pooling agreement. The Group performs credit reviews of its reinsurers, focusing on financial stability. To the extent that a reinsurer may be unable to pay losses for which it is liable under the terms of reinsurance agreements, the Group is exposed to the risk of continued liability for such losses. (7) FEDERAL INCOME TAXES The tax effect of significant temporary differences that give rise to the Group's net deferred tax liability as of December 31, is as follows:
2002 2001 ---- ---- Net loss reserve discounting................................ $ 96 38 Net unearned premiums....................................... 114 127 Net operating loss carryforwards............................ 459 586 Other....................................................... 20 62 ---- ---- 689 813 Less: Valuation allowance................................... -- (685) ---- ---- Deferred tax assets....................................... 689 128 ---- ---- Deferred policy acquisition costs........................... 138 123 Unrealized gain on investments.............................. 15 -- Other....................................................... 34 5 ---- ---- Deferred tax liabilities.................................. 187 128 ---- ---- Net deferred income tax (liability) asset................... $502 -- ==== ====
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. During the year ended December 31, 2002, the Group reversed the valuation allowance established as of December 31, 2001 based on revised estimates of future taxable income. Management believes it is more likely than not the Group will realize the benefits of the deferred tax assets at December 31, 2002, and as a result, removed the valuation allowance. SF-14 FRANKLIN HOLDING COMPANY, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (DOLLARS IN THOUSANDS) Actual income tax expense (benefit) differed from expected tax expense (benefit), computed by applying the United States federal corporate tax rate of 34% to income before income taxes, as follows:
2002 2001 2000 ----- ---- ---- Expected tax expense (benefit).............................. $ 104 (82) (227) Increase (decrease) in valuation allowance for deferred tax assets.................................................... (685) 82 227 Other....................................................... 64 -- -- ----- --- ---- Income tax expense (benefit)................................ $(517) -- -- ===== === ====
The components of the provision for income taxes are as follows:
2002 2001 2000 ----- ---- ---- Current..................................................... $ -- -- -- Deferred.................................................... (517) -- -- ----- ---- ---- Income tax expense (benefit)................................ $(517) -- -- ===== ==== ====
At December 31, 2002, the Group has net operating loss carryforwards available to offset future federal taxable income as follows:
EXPIRES AMOUNT - ------- ------ 2018........................................................ $ 395 2019........................................................ 256 2020........................................................ 567 2021........................................................ 132 ------ $1,350 ======
(8) REDEEMABLE PREFERRED STOCK FHC has two series of redeemable preferred stock issued and outstanding, Series A and Series B. There are 10,000 shares of Series A shares with a par value of $100 per share issued and outstanding. Series A shares have no voting rights. The holders are entitled to receive dividends from available funds only if declared by the Board at its sole discretion with the limit of a certain amount per year ($5.00 per annum). The right to receive dividends is not cumulative. However, whenever a cash dividend is paid on Series B preferred shares, then a cash dividend must be paid on Series A preferred shares on a pari passu basis. FHC can redeem Series A shares using available funds after April 1, 2004 at a price of par plus 2% compounded annually from June 1, 2001. The shares have a mandatory repurchase provision which allows the holders to require FHC to repurchase the shares from available funds after September 30, 2007 at the same price through 2011. If FHC merges or consolidates with another insurance company subsidiary or if FHC registers a class of securities under the Securities Act of 1933, the holders of the series A preferred are entitled to convert each share of Series A preferred stock into 10 shares of class B common stock. There are 11,836 shares of Series B shares with a par value of $100 per share issued and outstanding. Series B shares have no voting rights. Through June 1, 2001, the holders of Series B preferred shares were entitled to receive dividends at a compounded annual rate of 5%. The dividends were cumulative and could be paid in cash or through the issuance of more Series B Preferred. After May 31, 2001, dividends are paid at the sole discretion of the board of directors. However, whenever a cash dividend is paid on Series A preferred shares, then a cash dividend must be paid on Series B preferred shares on a pari passu basis. FHC can redeem SF-15 FRANKLIN HOLDING COMPANY, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (DOLLARS IN THOUSANDS) the stock using available funds at any time at an aggregate amount of $1,616 as of May 31, 2001, after which, the redemption amount is compounded annually at 7.5%. The shares have a mandatory repurchase provision which allows the shareholders to require FHC to repurchase the shares after September 30, 2007 at the same price. FHC is also required to repurchase a pro-rata amount of the shares of Series B preferred if there is any redemption or repurchase of Series A Preferred stock, a change in control, or a transfer by the corporation of any ownership interest in the subsidiary. Upon a stock conversion of Mercer, the preferred shareholders would have certain rights to exchange their shares for registered voting common stock of Mercer based on the redemption price at the date of conversion. In addition, Mercer has the right to compel such an exchange. (9) OPTIONS EXERCISED ON COMMON STOCK Mercer and a minority interest shareholder exercised options to purchase Series B, non-voting common stock and paid $662 and $689, respectively, during 2002, for such shares. Options outstanding as of December 31, 2002 for Mercer and minority interest shareholders were 228,800 and 226,100, respectively. The options are exercisable at $10 per share. (10) RECONCILIATION OF STATUTORY FILINGS TO AMOUNTS REPORTED HEREIN A reconciliation of the Group's statutory net income and surplus to the Group's net income and surplus, under accounting principles generally accepted in the United States of America (GAAP), is as follows:
2002 2001 2000 ------- ------- ----- Net income: Statutory net income (loss)............................. $ 251 (295) (567) Deferred policy acquisition costs....................... 42 160 27 Deferred federal income taxes........................... 517 -- -- Other................................................... 14 (130) (129) ------- ------- ----- GAAP net income (loss).................................... $ 824 (265) (669) ======= ======= ===== Surplus: Statutory surplus....................................... $ 3,226 1,817 Redeemable preferred stock.............................. (2,845) (2,699) Deferred policy acquisition costs....................... 405 363 Deferred federal income taxes........................... 305 -- Unrealized gain on fixed income securities.............. 30 -- Other................................................... 415 (4) ------- ------- GAAP equity (deficit)..................................... $ 1,536 (523) ======= =======
The Group's insurance subsidiary is required to file statutory financial statements with various state insurance regulatory authorities. Statutory financial statements are prepared in accordance with accounting principles and practices prescribed or permitted by the various states of domicile. Prescribed statutory accounting practices include state laws, regulations, and general administrative rules, as well as a variety of publications of the National Association of Insurance Commissioners (NAIC). Furthermore, the NAIC adopted the Codification of Statutory Accounting Principles effective of January 1, 2001. The codified principles are intended to provide a comprehensive basis of accounting recognized and adhered to in the SF-16 FRANKLIN HOLDING COMPANY, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (DOLLARS IN THOUSANDS) absence of conflict with, or silence of, state statutes and regulations. The effects of such do not affect financial statements prepared under generally accepted accounting principles. The Group's insurance subsidiary is required by law to maintain certain minimum surplus on a statutory basis, is subject to risk-based capital requirements and is subject to regulations under which payment of a dividend from statutory surplus is restricted and may require prior approval of regulatory authorities. Applying the current regulatory restrictions as of December 31, 2002, approximately $355 would be available for distribution without prior approval. (11) CONTINGENCIES The Group becomes involved with certain claims and legal actions arising in the ordinary course of business operations. Such legal actions involve disputes by policyholders relating to claims payments as well as other litigation. In addition, the Group's business practices are subject to review by various state insurance regulatory authorities. The Group is regularly subject to such reviews, and several such reviews are currently pending. These reviews may result in changes or clarifications of the Group's business practices, and may result in fines, penalties or other sanctions. In the opinion of management, while the ultimate outcome of these actions and these regulatory proceedings cannot be determined at this time, they are not expected to result in liability for amounts material to the financial condition, results of operations, or liquidity, of the Group. (12) CONCENTRATION OF RISK The Group's insurance subsidiary produces a large percentage of its business through one insurance agent, Davis Insurance Agency (Davis). The 51% common shareholder of the Group owns Davis. In 2002 and 2001, premiums written through Davis totaled 74.8% and 80.6%, respectively, of the Group's direct written premiums. Commissions paid to Davis were $889 and $877 in 2002 and 2001, respectively. SF-17 FRANKLIN HOLDING COMPANY, INC. AND SUBSIDIARY CONDENSED CONSOLIDATED BALANCE SHEETS AS OF MARCH 31, 2003 AND DECEMBER 31, 2002
MARCH 31, DECEMBER 31, 2003 2002 --------- ------------ (DOLLARS IN THOUSANDS) (UNAUDITED) ASSETS Investments, at fair value; Fixed income securities, available for sale, at fair value (cost of $3,766 and $5,007, respectively)....... $ 3,792 5,052 Cash and cash equivalents................................... 2,853 1,589 Premiums receivable......................................... 646 633 Reinsurance receivables..................................... 758 -- Deferred policy acquisition costs........................... 454 405 Accrued investment income................................... 50 85 Property and equipment, net................................. 401 443 Deferred income taxes....................................... 481 502 Other assets................................................ 300 384 ------- ------- Total assets................................................ $ 9,735 9,093 ======= ======= LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Losses and loss adjustment expenses.................... $ 2,565 1,904 Unearned premiums...................................... 2,158 1,664 Accounts payable and accrued expenses.................. 593 671 Reinsurance balances payable........................... -- 473 ------- ------- Total liabilities...................................... 5,316 4,712 ------- ------- Redeemable preferred stock.................................. 2,884 2,845 Shareholders' equity: Series A common stock.................................. 21 21 Series B common stock.................................. 14 14 Additional paid-in capital............................. 2,532 2,571 Unassigned deficit..................................... (1,049) (1,100) Accumulated other comprehensive income: Unrealized gains in investments, net of deferred income taxes........................................ 17 30 ------- ------- Total shareholders' equity............................. 1,535 1,536 ------- ------- Total liabilities and shareholders' equity.................. $ 9,735 9,093 ======= =======
See accompanying notes to condensed consolidated financial statements. SF-18 FRANKLIN HOLDING COMPANY, INC. AND SUBSIDIARY CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS THREE MONTHS ENDED MARCH 31, 2003 AND 2002
THREE MONTHS ENDED MARCH 31, ---------------------- 2003 2002 --------- ------- (DOLLARS IN THOUSANDS) (UNAUDITED) Revenue: Net premiums earned....................................... $ 995 661 Investment income, net of expenses........................ 42 13 Net realized capital losses............................... (4) -- Other revenue............................................. 41 32 ------ ---- Total revenue.......................................... 1,074 706 ------ ---- Expenses: Losses and loss adjustment expenses....................... 587 325 Amortization of deferred policy acquisition costs......... 221 185 Other expenses............................................ 188 141 ------ ---- Total expenses......................................... 996 651 ------ ---- Income before tax........................................... 78 55 Income tax expense (benefit)................................ 27 (607) ------ ---- Net income.................................................. $ 51 662 ====== ====
See accompanying notes to condensed consolidated financial statements. SF-19 FRANKLIN HOLDING COMPANY, INC. AND SUBSIDIARY CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY THREE MONTHS ENDED MARCH 31, 2003
ACCUMULATED SERIES A SERIES B ADDITIONAL OTHER COMMON COMMON PAID-IN UNASSIGNED COMPREHENSIVE STOCK STOCK CAPITAL DEFICIT INCOME TOTAL -------- -------- ---------- ---------- ------------- ----- (DOLLARS IN THOUSANDS) (UNAUDITED) Balance, December 31, 2002....... $21 14 2,571 (1,100) 30 1,536 Net income....................... -- -- -- 51 -- 51 Other comprehensive loss, net of tax: Unrealized losses on securities: Unrealized holding losses arising during period (net of related income tax benefit of $(8)).......... -- -- -- -- (16) (16) Less: Reclassification adjustment for losses included in net income (net of related income tax benefit of $(1))... -- -- -- -- 3 3 ------ ----- (13) (13) ------ ----- Comprehensive income............. 38 Preferred stock dividends........ -- -- (39) -- -- (39) --- ----- ----- ------ ------ ----- Balance, March 31, 2003.......... $21 14 2,532 (1,049) 17 1,535 === ===== ===== ====== ====== =====
See accompanying notes to condensed consolidated financial statements. SF-20 FRANKLIN HOLDING COMPANY, INC. AND SUBSIDIARY CONSOLIDATED STATEMENT OF CASH FLOW THREE MONTHS ENDED MARCH 31, 2003 AND 2002
THREE MONTHS ENDED MARCH 31 ------------------ 2003 2002 ------- ------- (DOLLARS IN THOUSANDS) (UNAUDITED) Cash flow from operating activities: Net income................................................ $ 51 662 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation of property and equipment................. 71 66 Net realized investment loss........................... 4 -- Deferred income tax.................................... 28 (607) Change in assets and liabilities: Premiums receivable.................................. (13) (84) Reinsurance receivables.............................. (758) 332 Deferred policy acquisition costs.................... (49) 19 Other assets......................................... 119 (608) Losses and loss expenses............................. 661 651 Unearned premiums.................................... 494 (447) Other liabilities.................................... (551) (884) ------ ------ Net cash provided by (used in) operating activities....................................... 57 (900) ------ ------ Cash flows from investing activities: Purchase of fixed income securities, available-for-sale.................................... (764) -- Sale of fixed income securities, available-for-sale.... 2,000 -- Purchase of equipment.................................. (29) (37) ------ ------ Net cash provided by (used in) investing activities....................................... 1,207 (37) ------ ------ Cash flows from financing activities: Proceeds from exercised options........................ -- 1,351 ------ ------ Net cash provided by financing activities......... 0 1,351 ------ ------ Net increase in cash and cash equivalents......... 1,264 414 Cash and cash equivalents at beginning of period............ 1,589 3,526 ------ ------ Cash and cash equivalents at end of period.................. $2,853 3,940 ====== ====== Cash paid during the period for: Interest.................................................. $ 1 --
See accompanying notes to condensed consolidated financial statements. SF-21 FRANKLIN HOLDING COMPANY, INC. AND SUBSIDIARY NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS) (UNAUDITED) (1) BASIS OF PRESENTATION The financial information for the interim periods included herein is unaudited; however, such information reflects all adjustments which are, in the opinion of management, necessary to a fair presentation of the financial position, results of operations, and cash flows for the interim periods. The results of operations for interim periods are not necessarily indicative of results to be expected for the full year. These financial statements should be read in conjunction with the financial statements and notes for the year ended December 31, 2002 included herein. SF-22 SCHEDULE 1 SHARES OF MERCER INSURANCE GROUP, INC. TO BE ISSUED TO FRANKLIN HOLDING COMPANY, INC. SHAREHOLDERS
NUMBER OF SHARES NAME TO BE ISSUED - ---- ---------------- H. Thomas Davis, Jr. ....................................... 251,715 Anthony R. Scatena.......................................... 25,928 Raymond E. Nestlerode, Sr. ................................. 5,185 Raymond E. Nestlerode, Jr. ................................. 5,185 Victoria C. Nestlerode...................................... 5,185 William J. Edwards.......................................... 5,185 Michael P. Nestarick........................................ 5,185 American Re-Insurance Company............................... 184,712
SF-23 PART II INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 13. OTHER EXPENSE OF ISSUANCE AND DISTRIBUTION We anticipate the following expenses: SEC registration fee........................................ $ 5,541 NASDAQ listing fee.......................................... $ 110,000 Printing, postage, and mailing*............................. $ 700,000 Legal fees and expenses*.................................... $ 700,000 Financial advisory fees and expenses........................ $ 300,000 Accounting fees and expenses*............................... $ 250,000 Valuation fees and expenses................................. $ 185,000 Transfer and conversion agent fees and expenses*............ $ 110,000 Miscellaneous*.............................................. $ 99,461 ---------- Total....................................................... $2,460,002 ==========
- --------------- * Estimated ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS Pennsylvania law provides that a Pennsylvania corporation may indemnify directors, officers, employees, and agents of the corporation against liabilities they may incur in such capacities for any action taken or any failure to act, whether or not the corporation would have the power to indemnify the person under any provision of law, unless such action or failure to act is determined by a court to have constituted recklessness or willful misconduct. Pennsylvania law also permits the adoption of a bylaw amendment, approved by shareholders, providing for the elimination of a director's liability for monetary damages for any action taken or any failure to taken any action unless the director has breached or failed to perform the duties of his/her office, and the breach or failure to perform constitutes self-dealing, willful misconduct or recklessness. Our bylaws provide for the indemnification of the directors, officers, employees, and agents of the Holding Company and its subsidiaries to the fullest extent permitted by Pennsylvania law. They also provide for the elimination of our directors' liability for monetary damages to the fullest extent permitted by Pennsylvania law. We also maintain an insurance policy insuring our directors, officers and certain other persons against liabilities and expenses incurred by any of them in certain stated proceedings and under certain stated conditions. In the agency agreement with Sandler O'Neill & Partners, L.P., Sandler O'Neill & Partners, L.P. agrees to indemnify our officers, directors and controlling persons against certain liabilities, including liabilities under the Securities Act of 1933 under certain conditions and with respect to certain limited information. II-1 ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES None. ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES (a) Exhibits: 1.1 Form of Agency Agreement to be entered into among the Holding Company, Mercer Mutual and Sandler O'Neill & Partners, L.P. 2.1 Plan of Conversion from Mutual to Stock Organization of Mercer Mutual Insurance Company, dated as of December 13, 2002 and amended and restated on March 19, 2003, April 15, 2003 and June 18, 2003 3.1 Articles of Incorporation of Mercer Insurance Group, Inc.* 3.2 Bylaws of Mercer Insurance Group, Inc.* 4.1 Form of certificate evidencing shares of common stock of Mercer Insurance Group, Inc.* 5.1 Opinion of Stevens & Lee re: Legality* 8.1 Private Letter Ruling, dated May 8, 2003, from the Internal Revenue Service to Mercer Mutual Insurance Company.* 10.1 Mercer Insurance Group, Inc. Employee Stock Ownership Plan* 10.2 Employment Agreement, dated as of October 1, 2001, among BICUS Services Corporation, Mercer Mutual Insurance Company and Andrew R. Speaker* 10.3 Employment Agreement, dated as of October 1, 2001, among BICUS Services Corporation, Mercer Mutual Insurance Company and H. Thomas Davis, Jr.* 10.4 Employment Agreement, dated as of October 1, 2001, among BICUS Services Corporation, Mercer Mutual Insurance Company and Paul D. Ehrhardt* 10.5 Employment Agreement, dated as of October 1, 2001, among BICUS Services Corporation, Mercer Mutual Insurance Company and John G. Danka* 10.6 Mercer Mutual Insurance Company Executive Nonqualified "Excess" Plan dated June 1, 2002* 10.7 Mercer Mutual Insurance Company Benefit Agreement dated December 11, 1989, as amended.* 10.8 Stock Purchase Agreement dated April 6, 2001 by and among Mercer Mutual Insurance Company, H. Thomas Davis, Jr. and Franklin Holding.* 10.9 Stock Purchase Agreement dated May 9, 2001 by and among Mercer Mutual Insurance Company and Anthony Robert Scatena, Raymond Edward Nestlerode, Sr., Raymond Edward Nestlerode, Jr., Joseph Russell Nestlerode, Sr., William J. Edwards and Michael Peter Nestarick* 10.10 Shareholders Agreement dated June 1, 2001, as amended, among Mercer Mutual Insurance Company, H. Thomas Davis, Jr. and Franklin Holding Company, Inc. 10.11 Third Amended and Restated Certificate of Incorporation of Franklin Holding Company, Inc.* 10.12 Mercer Insurance Group, Inc. 2003 Stock-Based Incentive Plan 10.13 Form of Escrow Agreement to be entered into among Mercer Insurance Group, Inc., Sandler O'Neill & Partners, L.P. and Wilmington Trust Company, as escrow agent 23.1 Consent of KPMG with respect to Franklin Holding Company, Inc. 23.2 Consent of KPMG with respect to Mercer Mutual Insurance Company (contained in Item 16(b) of this Registration Statement) 23.3 Consent of Brown Schultz Sheridan and Fritz 23.4 Consent of Griffin Financial Group, LLC 23.5 Consent of Stevens & Lee (contained in Exhibit 5) 24.1 Power of Attorney* 99.1.1 Pro Forma Appraisal Report, dated as of January 2, 2003, prepared for Mercer Mutual Insurance Company by Griffin Financial Group, LLC*
II-2 99.1.2 Pro Forma Appraisal Update Report dated as of March 31, 2003, prepared by Griffin Financial Group, LLC* 99.1.3 Letter dated January 2, 2003 to Mercer Mutual insurance Company from Griffin Financial Group, LLC regarding fair market value of subscription rights* 99.1.4 Pro Forma Appraisal Update Report dated as of May 30, 2003, prepared by Griffin Financial Group, LLC* 99.2 Marketing Materials, including letters to prospective purchasers of stock in offering, Stock Order Form and Question and Answer Brochure 99.5 Mercer Mutual Insurance Company Policyholder Information Statement*
- --------------- * Previously filed. (b) Financial Statement Schedules: Independent Auditor's Consent and Report on Schedules Schedule I -- Summary of Investments -- Other than Investments in Related Parties. Schedule II -- Condensed Financial Information of Registrant (Not Applicable). Schedule III -- Supplementary Insurance Information. Schedule IV -- Reinsurance. Schedule VI -- Supplemental Information Concerning Property -- Casualty Insurance Operations. II-3 EXHIBIT 23.2 INDEPENDENT AUDITORS' REPORT AND CONSENT The Board of Directors Mercer Mutual Insurance Company and Subsidiaries: The audits referred to in our report dated March 28, 2003, included the related financial statement schedules as of December 31, 2002, and for each of the years in the three-year period ended December 31, 2002, included in the registration statement. These financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statement schedules based on our audits. In our opinion, such financial statement schedules, when considered in relation to the consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein. We consent to the use of our reports included herein and to the reference to our firm under the heading "Experts" in the prospectus. Our report on the consolidated financial statements refers to the adoption of SFAS No. 142, Goodwill and Other Intangible Assets, effective January 1, 2002. /s/ KPMG LLP Philadelphia, PA July 29, 2003 II-4 SCHEDULES TO REGISTRATION STATEMENT MERCER MUTUAL INSURANCE COMPANY AND SUBSIDIARIES SCHEDULE I -- SUMMARY OF INVESTMENTS -- OTHER THAN INVESTMENTS IN RELATED PARTIES AS OF DECEMBER 31, 2002
COLUMN C COLUMN D COLUMN A COLUMN B ESTIMATED BALANCE TYPE OF INVESTMENT COST VALUE SHEET - ------------------ -------- --------- -------- (DOLLARS IN THOUSANDS) Fixed maturities: Bonds: United States Government and government agencies and authorities............................................ 38,802 39,499 39,499 States, municipalities and political subdivisions......... 5,976 6,149 6,149 All other................................................. 3,552 3,599 3,599 ------ ------ ------ Total fixed maturities................................. 48,330 49,247 49,247 ------ ------ ------ Equity securities: Preferred stock........................................... 4,567 4,663 4,663 Common stocks: Public utilities.......................................... 102 112 112 Banks, trust and insurance companies...................... 1,545 4,481 4,481 Industrial, miscellaneous and all other................... 10,483 11,076 11,076 ------ ------ ------ Total equity securities................................ 16,697 20,332 20,332 ------ ------ ------ Total investments...................................... 65,027 69,579 69,579
II-5 MERCER MUTUAL INSURANCE COMPANY AND SUBSIDIARIES SCHEDULE III -- SUPPLEMENTARY INSURANCE INFORMATION
COLUMN A COLUMN C COLUMN D COLUMN F COLUMN G COLUMN H COLUMN B FUTURE POLICY COLUMN E BENEFITS DEFERRED BENEFITS OTHER POLICY CLAIMS, POLICY LOSSES, CLAIMS CLAIMS AND NET LOSSES, AND ACQUISITION AND LOSS UNEARNED BENEFITS PREMIUMS INVESTMENT SETTLEMENT SEGMENT COSTS EXPENSES PREMIUMS PAYABLE EARNED INCOME EXPENSES - ------- ----------- -------------- -------- ------------ -------- ---------- ----------- (DOLLARS IN THOUSANDS) December 31, 2002 Commercial lines....... 3,263 18,636 14,332 0 20,088 7,283 Personal lines......... 2,520 12,712 10,591 0 20,366 12,784 ----- ------ ------ -- ------ ----- ------ Total............... 5,783 31,348 24,923 0 40,454 2,061 20,067 ===== ====== ====== == ====== ===== ====== December 31, 2001 Commercial lines....... 2,438 19,872 10,447 0 15,119 6,425 Personal lines......... 2,524 11,187 10,101 0 15,609 8,109 ----- ------ ------ -- ------ ----- ------ Total............... 4,962 31,059 20,548 0 30,728 2,425 14,534 ===== ====== ====== == ====== ===== ====== December 31, 2000 Commercial lines....... 13,685 5,166 Personal lines......... 13,950 8,545 ------ Total............... 27,635 2,517 13,711 ====== COLUMN A COLUMN I COLUMN J COLUMN K OTHER AMORTIZATION OPERATING PREMIUMS SEGMENT OF DPAC EXPENSES WRITTEN - ------- ------------ --------- -------- (DOLLARS IN THOUSANDS) December 31, 2002 Commercial lines....... 5,737 4,176 23,591 Personal lines......... 5,216 3,798 20,880 ------ ----- ------ Total............... 10,953 7,974 44,471 ====== ===== ====== December 31, 2001 Commercial lines....... 4,137 3,103 17,072 Personal lines......... 4,000 3,000 17,638 ------ ----- ------ Total............... 8,137 6,103 34,710 ====== ===== ====== December 31, 2000 Commercial lines....... 3,834 2,345 14,401 Personal lines......... 3,644 2,230 13,648 Total............... 7,478 4,575 28,049
II-6 MERCER MUTUAL INSURANCE COMPANY AND SUBSIDIARIES FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000 SCHEDULE IV -- SUPPLEMENTAL INFORMATION
COLUMN A COLUMN B COLUMN D COLUMN E COLUMN F COLUMN C ASSUMED PERCENTAGE CEDE TO FROM OF AMOUNT GROSS OTHER OTHER NET ASSUMED PREMIUM EARNED AMOUNT COMPANIES COMPANIES AMOUNT TO NET - -------------- -------- --------- --------- -------- ---------- (DOLLARS IN THOUSANDS) For the year ended December 31, 2002......................................... 46,425 6,837 666 40,454 1.6% For the year ended December 31, 2001......................................... 37,326 8,038 1,440 30,728 4.7% For the year ended December 31, 2000......................................... 31,211 3,919 343 27,635 1.2%
II-7 MERCER MUTUAL INSURANCE COMPANY AND SUBSIDIARIES FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2002? SCHEDULE VI -- SUPPLEMENTAL INFORMATION
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E COLUMN F COLUMN G COLUMN H LOSSES AND LAE DEFERRED RESERVE FOR DISCOUNT IF INCURRED POLICY LOSSES AND ANY NET NET ---------------- ACQUISITION LOSS ADJ. DEDUCTED IN UNEARNED EARNED INVESTMENT CURRENT PRINT AFFILIATION WITH REGISTRANT COSTS EXPENSES COLUMN C PREMIUMS PREMIUM INCOME YEAR YEAR - --------------------------- ----------- ----------- ----------- -------- -------- ---------- ------- ------ (DOLLARS IN THOUSANDS) For the year ended December 31, 2002............ 5,783 31,348 0 24,923 40,454 2,061 22,211 (2,144) For the year ended December 31, 2001............ 4,962 31,059 0 20,548 30,728 2,425 17,813 (3,279) For the year ended December 31, 2000............ 27,635 2,517 17,665 (3,954) COLUMN A COLUMN I COLUMN K COLUMN J PAID LOSSES AND LOSSES AND NET AMORTIZATION ADJUSTMENT WRITTEN AFFILIATION WITH REGISTRANT OF DPAC EXPENSES PREMIUMS - --------------------------- ------------ ---------- -------- (DOLLARS IN THOUSANDS) For the year ended December 31, 2002............ 10,953 18,503 44,471 For the year ended December 31, 2001............ 8,137 12,991 34,710 For the year ended December 31, 2000............ 7,478 13,263 28,049
II-8 ITEM 17. UNDERTAKINGS (a) Rule 415 Offering: The undersigned registrant hereby undertakes: (1) To file, during any period in which offers or sales are being made, a post-effective amendment to this registration statement: (i) to include any prospectus required by Section 10(a)(3) of the Securities Act of 1933; (ii) to reflect in the prospectus any fact or events arising after the effective date of the registration statement (or the most recent post-effective amendment thereof) which, individually or in the aggregate, represent a fundamental change in the information set forth in the registration statement. Notwithstanding the foregoing, any increase or decrease in volume of securities offered (if the total dollar value of securities offered would not exceed that which was registered) and any deviation from the low or high end of the range of shares offered may be reflected in the form of prospectus filed with the Commission pursuant to Rule 424(b) if, in the aggregate, the changes in volume and price represent no more than a 20 percent change in the maximum offering price set forth in the "Calculation of Registration Fee" table in the effective registration statement; and (iii) to include any material information with respect to the plan of distribution not previously disclosed in the registration statement or any material change to such information in the registration statement. (2) That, for the purpose of determining any liability under the Securities Act of 1933, each such post-effective amendment shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. (3) To remove from registration by means of a post-effective amendment any of the securities being registered which remain unsold at the termination of the offering. (b) Request for acceleration of effective date: Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the registrant pursuant to the bylaws of the registrant, or otherwise, the registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the 1933 Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue. II-9 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, the Registrant has duly caused this amendment to Registration Statement No. 333-104897 to be signed on its behalf by the undersigned, thereunto duly authorized, in the Borough of Pennington, State of New Jersey, on July 29, 2003 MERCER INSURANCE GROUP, INC. By: /s/ ANDREW R. SPEAKER ------------------------------------ Andrew R. Speaker, President and Chief Executive Officer Pursuant to the requirements of the Securities Act of 1933, this amendment to Registration Statement No. 333-104897 has been signed below by the following persons in the capacities and on the dates indicated.
SIGNATURE CAPACITY DATE --------- -------- ---- /s/ ROLAND D. BOEHM* Vice Chairman of the Board of July 29, 2003 ------------------------------------------------ Directors Roland D. Boehm /s/ H. THOMAS DAVIS, JR.* Senior Vice President and a Director July 29, 2003 ------------------------------------------------ H. Thomas Davis, Jr. /s/ WILLIAM V.R. FOGLER* Director July 29, 2003 ------------------------------------------------ William V. R. Fogler /s/ WILLIAM C. HART* Director July 29, 2003 ------------------------------------------------ William C. Hart /s/ GEORGE T. HORNYAK, JR.* Director July 29, 2003 ------------------------------------------------ George T. Hornyak, Jr. /s/ SAMUEL J. MALIZIA* Director July 29, 2003 ------------------------------------------------ Samuel J. Malizia /s/ RICHARD U. NIEDT* Director July 29, 2003 ------------------------------------------------ Richard U. Niedt /s/ ANDREW R. SPEAKER President and Chief Executive July 29, 2003 ------------------------------------------------ Officer and a Director (Principal Andrew R. Speaker Executive and Financial Officer)
SIGNATURE CAPACITY DATE --------- -------- ---- /s/ RICHARD G. VAN NOY* Chairman of the Board of Directors July 29, 2003 ------------------------------------------------ Richard G. Van Noy /s/ GORDON A. COLEMAN Treasurer (Principal Accounting July 29, 2003 ------------------------------------------------ Officer) Gordon A. Coleman *By /s/ ANDREW R. SPEAKER ------------------------------------------ Attorney-in-fact
EXHIBIT INDEX
NUMBER TITLE - ------- ----- 1.1 Form of Agency Agreement to be entered into among the Holding Company, Mercer Mutual and Sandler O'Neill & Partners, L.P. 2.1 Plan of Conversion from Mutual to Stock Organization of Mercer Mutual Insurance Company, dated as of December 13, 2002 and amended and restated on March 19, 2003, April 15, 2003 and June 18, 2003 3.1 Articles of Incorporation of Mercer Insurance Group, Inc., as amended* 3.2 Bylaws of Mercer Insurance Group, Inc.* 4.1 Form of certificate evidencing shares the common stock of Mercer Insurance Group, Inc.* 5.1 Opinion of Stevens & Lee re: Legality* 8.1 Private Letter Ruling, dated May 8, 2003, from the Internal Revenue Service to Mercer Mutual Insurance Company.* 10.1 Mercer Insurance Group, Inc. -- Employee Stock Ownership Plan* 10.2 Employment Agreement, dated as of October 1, 2001 among BICUS Services Corporation, Mercer Mutual Insurance Company and Andrew R. Speaker* 10.3 Employment Agreement, dated as of October 1, 2001 among BICUS Services Corporation, Mercer Mutual Insurance Company and H. Thomas Davis, Jr.* 10.4 Employment Agreement, dated as of October 1, 2001, among BICUS Services Corporation, Mercer Mutual Insurance Company and Paul D. Ehrhardt.* 10.5 Employment Agreement, dated as of October 1, 2001, among BICUS Services Corporation, Mercer Mutual Insurance Company and John G. Danka* 10.6 Mercer Mutual Insurance Company Executive Nonqualified "Excess" Plan dated June 1, 2002.* 10.7 Mercer Mutual Insurance Company Benefit Agreement dated December 11, 1989, as amended* 10.8 Stock Purchase Agreement dated April 6, 2001 by and among Mercer Mutual Insurance Company, H. Thomas Davis, Jr. and Franklin Holding Company, Inc.* 10.9 Stock Purchase Agreement dated May 9, 2001 by and among Mercer Mutual Insurance Company and Anthony Robert Scatena, Raymond Edward Nestlerode, Sr., Raymond Edward Nestlerode, Jr., Joseph Russell Nestlerode, Sr., William J. Edwards and Michael Peter Nestarick* 10.10 Shareholders Agreement dated June 1, 2001, as amended, among Mercer Mutual Insurance Company, H. Thomas Davis, Jr. and Franklin Holding Company, Inc. 10.11 Third Amended and Restated Certificate of Incorporation of Franklin Holding Company, Inc.* 10.12 Mercer Insurance Group, Inc. 2003 Stock-Based Incentive Plan 10.13 Form of Escrow Agreement to be entered into among Mercer Insurance Group, Inc., Sandler O'Neill & Partners, L.P. and Wilmington Trust Company, as escrow agent 23.1 Consent of KPMG with respect to Franklin Holding Company, Inc. 23.2 Consent of KPMG with respect to Mercer Mutual Insurance Company (contained in Item 16(b) of this Registration Statement) 23.3 Consent of Brown Schultz Sheridan and Fritz 23.4 Consent of Griffin Financial Group, LLC 23.5 Consent of Stevens & Lee (contained in Exhibit 5) 24.1 Power of Attorney* 99.1.1 Pro Forma Appraisal Report, dated as of January 2, 2003, prepared for Mercer Mutual Insurance Company by Griffin Financial Group, LLC* 99.1.2 Pro Forma Appraisal Update Report dated as of March 31, 2003, prepared by Griffin Financial Group, LLC* 99.1.3 Letter dated January 2, 2003 to Mercer Mutual insurance Company from Griffin Financial Group, LLC regarding fair market value of subscription rights.*
NUMBER TITLE - ------- ----- 99.1.4 Pro Forma Appraisal Update Report dated as of May 30, 2003, prepared by Griffin Financial Group, LLC* 99.2 Marketing Materials, including letters to prospective purchasers of stock in offering, Stock Order Form and Question and Answer Brochure 99.5 Mercer Mutual Insurance Company Policyholder Information Statement*
- --------------- * Previously filed. EX-1.1 4 e85343a2exv1w1.txt FORM OF AGENCY AGREEMENT Up to 6,261,111 Shares MERCER INSURANCE GROUP, INC (a Pennsylvania corporation) Common Stock (no par value per share) FORM OF AGENCY AGREEMENT August ____, 2003 SANDLER O'NEILL & PARTNERS, L.P. 919 3rd Avenue, 6th Floor New York, New York 10022 Ladies and Gentlemen: Mercer Insurance Group, Inc., a Pennsylvania corporation (the "Company"), and Mercer Mutual Insurance Company, a Pennsylvania mutual insurance company ("Mercer Mutual"), hereby confirm their agreement with Sandler O'Neill & Partners, L.P. ("Sandler O'Neill" or the "Agent") with respect to the offer and sale by the Company of up to 6,261,111 shares of the Company's Common Stock, no par value (the "Common Stock"). The shares of Common Stock to be sold by the Company are hereinafter called the "Securities." The Company is the proposed holding company for Mercer Mutual and its subsidiaries, Queenstown Holding Company ("QHC"), the holding company for Mercer Insurance Company of New Jersey, Inc. ("MIC"), and BICUS Services Corporation ("BICUS"), a provider of management services to Mercer Mutual. Mercer Mutual also owns a controlling interest in Franklin Holding Company, Inc. ("Franklin Holding"), the holding company for Franklin Insurance Company ("FIC"). Mercer Mutual, QHC, MIC, BICUS, Franklin Holding and FIC are referred to collectively herein as the "Mercer Companies". The Securities are being offered in connection with the conversion of Mercer Mutual from mutual to stock form (the "Conversion") and the simultaneous acquisition of the capital stock of Mercer Mutual by the Company pursuant to a plan of conversion which has been adopted by the Board of Directors of Mercer Mutual (the "Plan"). The Securities to be issued in the Conversion will be offered by the Company at $10.00 per share (the "Purchase Price") in a subscription offering (the "Subscription Offering") pursuant to nontransferable subscription rights in the following order of priority: (i) named insureds under policies of insurance issued by Mercer Mutual and in force as of the close of business on December 13, 2002 ("Eligible Policyholders"), and (ii) directors, officers and employees of the Mercer Mutual. Subscription rights in any category will be subordinated to subscription rights in a prior category. Subject to the prior rights of holders of subscription rights, any Securities not subscribed for in the Subscription Offering may be offered to members of the general public at the Purchase Price in a direct community offering (the "Community Offering," and together with the Subscription Offering, as each may be extended, the "Subscription and Community Offering") to be commenced concurrently with the Subscription Offering. Preference will be given in the Community Offering to (i) natural persons and trusts of natural persons who are permanent residents of New Jersey and Pennsylvania, (ii) principals of Eligible Policyholders in the case of an Eligible Policyholder that is not a natural person, (iii) licensed insurance agencies that have been appointed by Mercer Mutual to market and distribute policies of insurance, and their owners, (iv) named insureds under policies of insurance issued by Mercer Mutual after December 13, 2002, and (v) providers of goods and services to Mercer Mutual. In addition, a tax-qualified employee stock ownership plan of the Company (the "ESOP") will have the right to purchase shares in an amount up to 10% of the shares sold in the conversion (the "ESOP Offering"). It is currently anticipated by the Company and Mercer Mutual that any Securities not subscribed for in the Subscription and Community Offering will be offered in a syndicated community offering (the "Syndicated Community Offering"). The Subscription and Community Offering, the ESOP Offering and the Syndicated Community Offering are hereinafter referred to collectively as the "Offerings." The Company has filed with the Securities and Exchange Commission (the "Commission") a registration statement on Form S-1 (No. 333-104897), including a related prospectus, for the registration of the Securities under the Securities Act of 1933, as amended (the "Securities Act"), has filed such amendments thereto and such amended prospectuses as may have been required to the date hereof by the Commission in order to declare such registration statement effective, and will file such additional amendments thereto and such amended prospectuses and prospectus supplements as may hereafter be required. Such registration statement (as amended to date, if applicable, and as from time to time amended or supplemented hereafter) and the prospectuses constituting a part thereof (including in each case all documents incorporated or deemed to be incorporated by reference therein and the information, if any, deemed to be a part thereof pursuant to the rules and regulations of the Commission under the Securities Act, as from time to time amended or supplemented pursuant to the Securities Act or otherwise (the "Securities Act Regulations")), are hereinafter referred to as the "Registration Statement" and the "Prospectus," respectively, except that if any revised prospectus shall be used by the Company in connection with the Subscription and Community Offering or the Syndicated Community Offering which differs from the Prospectus on file at the Commission at the time the Registration Statement becomes effective (whether or not such revised prospectus is required to be filed by the Company pursuant to Rule 424(b) of the Securities Act Regulations), the term "Prospectus" shall refer to such revised prospectus from and after the time it is first provided to the Agent for such use. In addition to and separate from the Offerings, the Company is also offering shares of its Common Stock to Franklin Mutual Insurance Company and the shareholders of Franklin Holding pursuant to rights of such persons to acquire Common Stock as described in the Prospectus (the "Franklin Offerings"). The Agent is not involved in or responsible for any matter involving the Franklin Offerings and is not receiving any compensation in connection with the Franklin Offerings. Concurrently with the execution of this Agreement, the Company is delivering to the Agent copies of the Prospectus of the Company to be used in the Subscription and Community Offering. Such prospectus contains information with respect to Mercer Mutual, the Company, the Subscription and Community Offering, and the Common Stock. SECTION 1. REPRESENTATIONS AND WARRANTIES. (a) The Company and Mercer Mutual jointly and severally represent and warrant to the Agent as of the date hereof as follows: (i) The Registration Statement has been declared effective by the Commission, no stop order has been issued with respect thereto and no proceedings therefor have been initiated or, to the knowledge of the Company or Mercer Mutual, threatened by the Commission. At the time the Registration Statement became effective and at the Closing Time referred to in Section 2 hereof, the Registration Statement complied and will comply in all material respects with the requirements of the Securities Act and the Securities Act Regulations and did not and will not contain an untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein not misleading. At the date hereof the Prospectus does not and at the Closing Time referred to in Section 2 hereof, will not include an untrue statement of a material fact or omit to state a material fact necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading; provided, however, that the representations and warranties in this subsection shall not apply to statements in or omissions from the Registration Statement or Prospectus made in reliance upon and in conformity with information with respect to the Agent and the services to be provided by the Agent furnished to the Company in writing by the Agent expressly for use in the Registration Statement or Prospectus (the "Agent Information," which the Company and Mercer Mutual acknowledge appears only in the sections of the Prospectus captioned _________________). (ii) Pursuant to the Pennsylvania Insurance Company Mutual-to-Stock Conversion Act (the "Conversion Act"), Mercer Mutual has filed with the Pennsylvania Insurance Department (the "Department") an application requesting approval of the Plan, and has filed such amendments thereto and supplementary materials as may have been required to the date hereof (such application, as amended to date, if applicable, and as from time to time amended or supplemented hereafter, is hereinafter referred to as the "Conversion Application"), including copies of Mercer Mutual's Notice and Proxy Statement relating to the Conversion (the "Proxy Statement"). The Department has, by written order dated July 8, 2003, approved the Plan, such approval remains in full force and effect and no order has been issued by the Department suspending or revoking such approval and no proceedings therefor have been initiated or, to the knowledge of the Company or Mercer Mutual, threatened by the Department. At the date of such approval and at the Closing Time referred to in Section 2, the Plan complied and will comply in all material respects with the applicable provisions of the Conversion Act. (iii) At the time of their use, the Proxy Statement and any other proxy solicitation materials will comply in all material respects with the applicable provisions of the Conversion Act and will not contain an untrue statement of a material fact or omit to state a material fact necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading. The Company and Mercer Mutual will promptly file the Prospectus and any supplemental sales literature with the Commission and the Department. The Prospectus and all supplemental sales literature, as of the date the Registration Statement became effective and at the Closing Time referred to in Section 2, will have received all required authorizations for use in final form. (iv) Neither the Commission nor the Department has, by order or otherwise, prevented or suspended the use of the Proxy Statement, Prospectus or any supplemental sales literature authorized by the Company or Mercer Mutual for use in connection with the Offerings, and no action by or before any such governmental entity to prevent or suspend the use of any such documents is pending, or to the best knowledge of the Company, threatened. (v) At the Closing Time referred to in Section 2, the Company and Mercer Mutual will have completed the conditions precedent to the Conversion in accordance with the Plan, the Conversion Act and all other applicable laws, regulations, decisions and orders, including all material terms, conditions, requirements and provisions precedent to the Conversion imposed upon the Company or Mercer Mutual by any regulatory authority, other than those which the regulatory authority permits to be completed after the Conversion. (vi) Griffin Financial Group, LLC ("Griffin"), which prepared the valuation of Mercer Mutual as part of the Conversion, has advised the Company and Mercer Mutual in writing that it believes it is independent of Mercer Mutual. Mercer Mutual believes that Griffin is a "qualified expert" within the meaning of the Conversion Act. (vii) The accountants who certified the consolidated financial statements and supporting schedules of Mercer Mutual included in the Registration Statement have advised the Company and Mercer Mutual in writing that they are independent public accountants with respect to the Company within the meaning of the Code of Ethics of the American Institute of Certified Public Accountants and the Securities Act Regulations and such accountants are in compliance with the auditor independence requirements of the Sarbanes-Oxley Act. (viii) The only direct and indirect subsidiaries of Mercer Mutual are QHC, MIC, BICUS, Franklin Holding and FIC. Upon consummation of the Conversion, the Mercer Companies will be the only subsidiaries of the Company. (ix) The consolidated financial statements and the related notes thereto included in the Registration Statement and the Prospectus present fairly the financial position of Mercer Mutual and its consolidated subsidiaries at the dates indicated and the related statements of operations, changes in surplus, and cash flows for the periods specified, and comply as to form in all material respects with the applicable accounting requirements of the Securities Act Regulations; except as otherwise stated in the Registration Statement, said financial statements have been prepared in conformity with generally accepted accounting principles applied on a consistent basis; and the supporting schedules and tables included in the Registration Statement present fairly the information required to be stated therein. The pro forma consolidated financial data of the Company included in the Registration Statement have been prepared and compiled in all material respects on the pro forma basis described therein, and the pro forma adjustments have in all material respects been properly and fairly applied to the historical combined financial statements of the Mercer Companies for the periods to which they relate. The financial information set forth in the Prospectus under "Selected Consolidated Financial Data" presents fairly, on the basis stated in the Prospectus, the information set forth therein. Except as disclosed in the Prospectus, neither the Company nor any of the Mercer Companies has any material liability of any kind, whether actual, contingent or otherwise. (x) Since the respective dates as of which information is given in the Registration Statement and the Prospectus, except as otherwise stated therein (A) there has been no material adverse change in the financial condition, results of operations or business affairs of the Company and the Mercer Companies considered as one enterprise, whether or not arising in the ordinary course of business, and (B) except for transactions specifically referred to or contemplated in the Prospectus, there have been no transactions entered into by the Company or any of the Mercer Companies which are material with respect to the Company and the Mercer Companies, considered as one enterprise. (xi) The Company and each of the Mercer Companies has been duly incorporated and is validly existing as a corporation in good standing under the laws of its respective jurisdiction of incorporation with full corporate power and authority to own, lease and operate its properties and to conduct its business as described in the Prospectus; and the Company and each of the Mercer Companies is duly qualified as a foreign corporation to transact business and is in good standing in each jurisdiction in which such qualification is required, whether by reason of the ownership or leasing of property or the conduct of business, except where the failure to so qualify would not have a material adverse effect on the financial condition, results of operations or business affairs of the Company and the Mercer Companies, considered as one enterprise. Mercer Mutual has all requisite power and authority to carry on an insurance business pursuant to and to the extent of the certificates of authority issued under the laws of the Commonwealth of Pennsylvania and State of New Jersey. MIC and FIC have all requisite power and authority to carry on an insurance business pursuant to and to the extent of the certificate of authority issued under the laws of the State of New Jersey and the Commonwealth of Pennsylvania, respectively. Except as disclosed in the Prospectus, the authority of each of Mercer Mutual, MIC and FIC to write the classes and lines of insurance authorized by such licenses, certificates, permits and other authorizations and described in the Prospectus is unrestricted and neither the Company nor any of the Mercer Companies is a party to any agreement, formal or informal, with any regulatory official or other person limiting the ability of any of the Mercer Companies from making full use of the licenses, certificates, permits and other authorizations issued to it or requiring the Company or any of the Mercer Companies to comply with regulatory standards or procedures or requirements different from those applicable to companies with comparable or similar licenses, certificates, permits and other authorizations, except where such restriction, limitation or requirement would not have a material adverse effect on the financial condition, results of operations or business affairs of the Company and the Mercer Companies, considered as one enterprise. (xii) The Company and each of the Mercer Companies conducts its business in compliance in all material respects with applicable federal, state, local and foreign laws and regulations, except where the failure to be in compliance would not have a material adverse effect on the financial condition, results of operations or business affairs of the Company and the Mercer Companies, considered as one enterprise. The Company and each of the Mercer Companies has obtained all licenses, permits and other governmental authorizations currently required for the conduct of their respective businesses or required for the conduct of their respective businesses as contemplated by the Conversion Application, except where the failure to obtain such licenses, permits or other governmental authorizations would not have a material adverse effect on the financial condition, results of operations or business affairs of the Company and the Mercer Companies considered as one enterprise; all such licenses, permits and other governmental authorizations are in full force and effect and the Company and each of the Mercer Companies is in all material respects in compliance therewith; neither the Company nor any of the Mercer Companies has received notice of any proceeding or action relating to the revocation or modification of any such license, permit or other governmental authorization which, singly or in the aggregate, if the subject of an unfavorable decision, ruling or finding, might have a material adverse effect on the financial condition, results of operations or business affairs of the Company and the Mercer Companies, considered as one enterprise. (xiii) Upon consummation of the Conversion and the Franklin Offerings, the authorized, issued and outstanding capital stock of the Company will be within the ranges set forth in the Prospectus under "Capitalization" (except for subsequent issuances, if any, pursuant to reservations, agreements or employee benefit plans referred to in the Prospectus); no shares of Common Stock have been or will be issued and outstanding prior to the Closing Time referred to in Section 2; at the time of Conversion, the Securities will have been duly authorized for issuance and, when issued and delivered by the Company pursuant to the Plan against payment of the consideration calculated as set forth in the Plan and stated on the cover page of the Prospectus, will be duly and validly issued and fully paid and non-assessable; the terms and provisions of the Common Stock and the capital stock of the Company conform to all statements relating thereto contained in the Prospectus; the certificates representing the shares of Common Stock conform to the requirements of applicable law and regulations; and the issuance of the Securities is not subject to preemptive or other similar rights. There are no options, agreements, contracts or other rights in existence to acquire from the Company any shares of Common Stock, except as set forth in the Prospectus. (xiv) Upon consummation of the Conversion, the authorized capital stock of Mercer Mutual will be 2,100,000 shares of common stock, par value $1.00 per share (the "Mercer Common Stock"), and no shares of Mercer Common Stock have been or will be issued prior to the Closing time referred to in Section 2. The shares of Mercer Common Stock to be issued to the Company will have been duly authorized for issuance and, when issued and delivered by Mercer Mutual pursuant to the Plan against payment of the consideration calculated as set forth in the Plan and as described in the Prospectus, will be duly and validly issued and fully paid and nonassessable, and all such Mercer Common Stock will be owned beneficially and of record by the Company free and clear of any security interest, mortgage, pledge, lien, encumbrance or legal or equitable claim; the certificates representing the shares of Mercer Common Stock will conform with the requirements of applicable laws and regulations; and the issuance of Mercer Common Stock is not subject to preemptive or similar rights, and there are no other warrants, options or rights of any kind to acquire additional shares of Mercer Common Stock. (xv) All of the issued and outstanding capital stock of QHC, MIC and BICUS, and 49% of the issued and outstanding capital stock of Franklin Holding, has been duly authorized and validly issued, is fully paid and nonassessable and is owned by Mercer Mutual, directly or indirectly, free and clear of any security interest, mortgage, pledge, lien, encumbrance or legal or equitable claim. As described in the Prospectus, Mercer Mutual has the right to acquire the remaining 51% of the issued and outstanding capital stock of Franking Holding that it does not own. All of the issued and outstanding capital stock of FIC has been duly authorized and validly issued, is fully paid and nonassessable and is owned by Franklin Holding free and clear of any security interest, mortgage, pledge, lien, encumbrance or legal or equitable claim. (xvi) The Company and Mercer Mutual have the corporate power to enter into and to perform this Agreement and have taken all corporate action necessary for them to execute, deliver and perform this Agreement, and this Agreement has been duly executed and delivered by, and is the valid and binding agreement of, the Company and Mercer Mutual, enforceable in accordance with its terms, except as may be limited by bankruptcy, insolvency or other laws affecting the enforceability of the rights of creditors generally and judicial limitations on the right of specific performance and except as the enforceability of indemnification and contribution provisions may be limited by applicable securities laws. (xvii) Subsequent to the respective dates as of which information is given in the Registration Statement and the Prospectus and prior to the Closing Time, except as otherwise may be indicated or contemplated therein, none of the Company or any of the Mercer Companies will have (A) issued any securities or incurred any liability or obligation, direct or contingent, or borrowed money, except liabilities, obligations and borrowings in the ordinary course of business consistent with past practices or as indicated in the Prospectus, or (B) entered into any transaction or series of transactions which is material in light of the business of the Company and the Mercer Companies considered as one enterprise. (xviii) No approval of any regulatory or supervisory or other public authority is required in connection with the execution and delivery of this Agreement or the issuance of the Securities that has not been obtained and a copy of which has been delivered to the Agent, except as may be required under the securities laws of various jurisdictions. (xix) Neither the Company nor any of the Mercer Companies is in violation of its certificate of incorporation, organization certificate, articles of incorporation or charter, as the case may be, or bylaws (and Mercer Mutual will not be in violation of its charter or bylaws upon consummation of the Conversion); and neither the Company nor any of the Mercer Companies is in default (nor has any event occurred which, with notice or lapse of time or both, would constitute a default) in the performance or observance of any obligation, agreement, covenant or condition contained in any contract, indenture, mortgage, loan agreement, note, lease or other instrument to which the Company or any of the Mercer Companies is a party or by which it or any of them may be bound, or to which any of the property or assets of the Company or any of the Mercer Companies is subject, except for such defaults that would not, individually or in the aggregate, have a material adverse effect on the financial condition, results of operations or business of the Company and the Mercer Companies considered as one enterprise. (xx) The consummation of the Conversion, execution, delivery and performance of this Agreement and the consummation of the transactions contemplated herein do not and will not conflict with or constitute a breach of, or default under, or result in the creation or imposition of any lien, charge or encumbrance upon any property or assets of the Company or any of the Mercer Companies pursuant to any contract, indenture, mortgage, loan agreement, note, lease or other instrument to which the Company or any of the Mercer Companies is a party or by which it or any of them may be bound, or to which any of the property or assets of the Company or any of its subsidiaries is subject, except for such defaults that would not, individually or in the aggregate, have a material adverse effect on the financial condition, results of operations or business affairs of the Company and the Mercer Companies considered as one enterprise; nor will such action result in any violation of the provisions of certificate of incorporation, organization certificate, articles of incorporation or charter or by-laws of the Company or any of the Mercer Companies, or any applicable law, administrative regulation or administrative or court decree. (xxi) No labor dispute with the employees of the Company or any of the Mercer Companies exists or, to the knowledge of the Company or Mercer Mutual, is imminent or threatened; and the Company and Mercer Mutual are not aware of any existing or threatened labor disturbance by the employees of any of its principal suppliers or contractors which might be expected to result in any material adverse change in the financial condition, results of operations or business affairs of the Company and the Mercer Companies considered as one enterprise. (xxii) Each of the Company and the Mercer Companies has good and marketable title to all properties and assets for which ownership is material to the business of the Company or any of the Mercer Companies and to those properties and assets described in the Prospectus as owned by them, free and clear of all liens, charges, encumbrances or restrictions, except such as are described in the Prospectus or are not material in relation to the business of the Company or any of the Mercer Companies considered as one enterprise; and all of the leases and subleases material to the business of the Company or any of the Mercer Companies under which the Company or any of the Mercer Companies hold properties, including those described in the Prospectus, are valid and binding agreements of the Company and the Mercer Companies, enforceable in accordance with their terms. (xxiii) Neither the Company nor any of the Mercer Companies is in violation of any directive from the Department or any other regulatory authority to make any material change in the method of conducting their respective businesses; except as described in the Prospectus under the section "Risk Factors--New Jersey `retaliatory tax' laws could possibly have an adverse impact on our results of operations," the Mercer Companies have conducted and are conducting their business so as to comply in all material respects with all applicable statutes, regulations and administrative and court decrees (including, without limitation, all regulations, decisions, directives and orders of the Department). (xxiv) Except as disclosed in the Prospectus, there is no action, suit or proceeding before or by any court or governmental agency or body, domestic or foreign, now pending, or, to the knowledge of the Company or Mercer Mutual, threatened, against or affecting the Company or any of the Mercer Companies which is required to be disclosed in the Registration Statement (other than as disclosed therein), or which might result in any material adverse change in the financial condition, results of operations or business affairs of the Company and the Mercer Companies considered as one enterprise, or which might materially and adversely affect the properties or assets thereof or which might materially and adversely affect the consummation of the Conversion; and all pending legal or governmental proceedings to which the Company or any of the Mercer Companies is a party or of which any of their respective property or assets is the subject which are not described in the Registration Statement, including ordinary routine litigation incidental to the business, are considered in the aggregate not material. (xxv) Mercer Mutual has obtained an opinion of its counsel, Stevens & Lee, with respect to the legality of the Securities to be issued in the Conversion, a copy of which is filed as an exhibit to the Registration Statement. Mercer Mutual has obtained from the Internal Revenue Service a private letter ruling (the "PLR"), concerning the material tax effects of the Conversion and the Subscription Offering to Mercer Mutual, Eligible Policyholders, and certain other participants in the Subscription Offering. All material aspects of the aforesaid opinion and PLR are accurately summarized in the Prospectus; the facts and representations upon which such opinion and PLR are based are truthful, accurate and complete in all material respects; and neither Mercer Mutual nor the Company has taken or will take any action inconsistent therewith. (xxvi) The Company is not and, upon completion of the Conversion and the offerings and sale of Common Stock and the application of the net proceeds therefrom, will not be required to be registered under the Investment Company Act of 1940, as amended. (xxvii) To the knowledge of the Company and Mercer Mutual, with the exception of the intended loan to Mercer Mutual's ESOP by the Company to enable the ESOP to purchase shares of Common Stock in an amount of up to 10% of the Common Stock issued in the Conversion, none of the Company, Mercer Mutual or employees of any of the Mercer Companies has made any payment of funds of the Company or any of the Mercer Companies as a loan for the purchase of the Common Stock or made any other payment of funds prohibited by law, and no funds have been set aside to be used for any payment prohibited by law. (xxviii) Except as disclosed in the Prospectus, there are no affiliations between any directors or officers of the Company or any of the Mercer Companies and any NASD member. (xxix) Neither the Company nor any of the Mercer Companies nor any properties owned or operated by the Company or any of the Mercer Companies is in violation of or liable under any Environmental Law (as defined below), except for such violations or liabilities that, individually or in the aggregate, would not have a material adverse effect on the financial condition, results of operations or business affairs of the Company and the Mercer Companies considered as one enterprise. There are no actions, suits or proceedings, or demands, claims, notices or investigations (including, without limitation, notices, demand letters or requests for information from any environmental agency) instituted or pending, or to the knowledge of the Company or any of the Mercer Companies threatened, relating to the liability of any property owned or operated by the Company or any of the Mercer Companies, under any Environmental Law. For purposes of this subsection, the term "Environmental Law" means any federal, state, local or foreign law, statute, ordinance, rule, regulation, code, license, permit, authorization, approval, consent, order, judgment, decree, injunction or agreement with any regulatory authority relating to (i) the protection, preservation or restoration of the environment (including, without limitation, air, water, vapor, surface water, groundwater, drinking water supply, surface soil, subsurface soil, plant and animal life or any other natural resource), and/or (ii) the use, storage, recycling, treatment, generation, transportation, processing, handling, labeling, production, release or disposal of any substance presently listed, defined, designated or classified as hazardous, toxic, radioactive or dangerous, or otherwise regulated, whether by type or by quantity, including any material containing any such substance as a component. (xxx) Each of the Company and the Mercer Companies has fulfilled, in all material respects, its obligations, if any, under the minimum funding standards of Section 302 of the United States Employee Retirement Income Security Act of 1974, as amended ("ERISA"), and the regulations promulgated thereunder with respect to each "plan" (as defined in Section 3(3) of ERISA and the regulations thereunder), which is maintained by the Company or any of the Mercer Companies for their employees, and each such plan is in compliance in all material respects with the presently applicable provisions of ERISA and the regulations thereunder. Neither the Company nor any of the Mercer Companies has incurred any unpaid liability under Title IV of ERISA to the Pension Benefit Guaranty Corporation (other than for the payment of premiums in the ordinary course) or to any such plan (xxxi) Except as described in the Prospectus under the section "Risk Factors--New Jersey 'retaliatory tax' laws could possibly have an adverse impact on our results of operations," the Company and the Mercer Companies have filed all federal income and state and local income and franchise tax returns required to be filed and have made timely payments of all taxes shown as due and payable in respect of such returns, and no deficiency has been asserted with respect thereto by any taxing authority. (xxxii) The Company has received approval, subject to completion of the Conversion, to have the Securities quoted on the National Market of the Nasdaq Stock Market ("Nasdaq Stock Market") effective as of the Closing Time referred to in Section 2 hereof. (xxxiii) Except as disclosed in the Prospectus, all material reinsurance treaties or agreements to which Mercer Mutual, MIC or FIC is a party or is a named reinsured are in full force and effect. Neither Mercer Mutual, MIC or FIC, nor to the knowledge of the Company any other party thereto, is in default under any such agreement, and no party may terminate any such agreement by reason of the transactions contemplated by the Conversion. (xxxiv) The Company has filed a registration statement on Form 8-A to register the Common Stock under Section 12(g) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and pursuant to Form 8-A such registration statement shall be effective concurrent with the effectiveness of the Registration Statement. (xxxv) There is no contract or other document of a character required to be described in the Registration Statement or the Prospectus or to be filed as an exhibit to the Registration Statement or the Conversion Application which is not described or filed as required. (xxxvi) The Company and each of the Mercer Companies maintains a system of internal accounting controls sufficient to provide reasonable assurances that (i) transactions are executed in accordance with management's general or specific authorizations, (ii) transactions are recorded as necessary to permit preparation of financial statements in conformity with generally accepted accounting principles and to maintain accountability for assets, (iii) access to cash and other liquid assets is permitted only in accordance with management's general or specific authorization, and (iv) the recorded ledger assets are compared with existing assets at reasonable intervals and appropriate action is taken with respect to any differences. (xxxvii) The Company has established and maintains disclosure controls and procedures (as such term is defined in Rule 13a-14 and 15d-14 under the Exchange Act); such disclosure controls and procedures (A) are designed to ensure that material information relating to the Company including its consolidated subsidiaries, is made known to the Company's Chief Executive Officer and its principal financial officer by others within those entities, particularly during the periods in which the periodic reports required under the Exchange Act are being prepared, (B) have been (or will be) evaluated for effectiveness as of a date within 90 days prior to the filing of the Company's most recent annual or quarterly report filed with the Commission and (C) are effective to perform the functions for which they were established; the Company's auditors and the Audit Committee of the Board of Directors have been advised of: (i) any significant deficiencies in the design or operation of internal controls which could adversely affect the Company's ability to record, process, summarize, and report financial data and (ii) any fraud, whether or not material, that involves management or other employees who have a role in the Company's internal controls; and such deficiencies or fraud have either been disclosed in the Prospectus or are not material to the Company and the Mercer Companies; and since the date of the most recent evaluation of such disclosure controls and procedures, there have been no significant changes in internal controls or in other factors that could significantly affect internal controls, including any corrective actions with regard to significant deficiencies, material weaknesses or fraud. (xxxviii)Except as described in the Prospectus, there are no contractual encumbrances or contractual restrictions or regulatory restrictions on the ability (i) of the Company to pay dividends or make any other distributions on the Company's capital stock or (ii) of the Company or any of the Mercer Companies (A) to pay any indebtedness owed to the Company or any of the Mercer Companies, or (B) to make any loans or advances to, or investments in, the Company or any of the Mercer Companies, or (C) to transfer any of its property or assets to the Company or any of the Mercer Companies. (xxxix) The Company has not relied upon the Agent or Agent's counsel for any legal, tax or accounting advice in connection with the Conversion. (xl) The policyholder records of Mercer Mutual are accurate and complete in all material respects. (b) Any certificate signed by any officer of the Company or Mercer Mutual and delivered to either of the Agent or to counsel for the Agent shall be deemed a representation and warranty by the Company or Mercer Mutual to the Agent as to the matters covered thereby. SECTION 2. APPOINTMENT OF SANDLER O'NEILL; SALE AND DELIVERY OF THE SECURITIES; CLOSING. On the basis of the representations and warranties herein contained and subject to the terms and conditions herein set forth, the Company hereby appoints Sandler O'Neill as its Agent to consult with and advise the Company, and to assist the Company with the solicitation of subscriptions and purchase orders for Securities, in connection with the Company's sale of Common Stock in the Subscription and Community Offering and the Syndicated Community Offering. On the basis of the representations and warranties herein contained, and subject to the terms and conditions herein set forth, Sandler O'Neill accepts such appointment and agrees to use its best efforts to assist the Company with the solicitation of subscriptions and purchase orders for Securities in accordance with this Agreement; provided, however, that the Agent shall not be obligated to take any action which is inconsistent with any applicable laws or regulations, or decisions or orders of any governmental department, private or public arbitral tribunal, court, governmental commission, governmental agency or other governmental entity or authority. The services to be rendered by Sandler O'Neill pursuant to this appointment include the following: (i) consulting as to the securities marketing implications of any aspect of the Plan or related corporate documents; (ii) reviewing with the Board of Directors the financial and securities marketing implications of the independent appraiser's appraisal of the Common Stock; (iii) reviewing all offering documents, including the Prospectus, stock order form and related offering materials (it being understood that such documents are the sole responsibility of the Company and Mercer Mutual); (iv) assisting in the design and implementation of a marketing strategy for the Offerings; (v) assisting the Company and Mercer Mutual in obtaining all requisite regulatory approvals; (vi) assisting management in preparing for meetings with potential investors and broker-dealers; and (vii) providing such other general advice and assistance as may be requested to promote the successful completion of the Offerings. The appointment of the Agent hereunder shall terminate upon the earlier to occur of (a) forty-five (45) days after the last day of the Subscription and Community Offering, unless the Company and the Agent agree in writing to extend such period, or (b) the receipt and acceptance of subscriptions and purchase orders for all of the Securities, or (c) the completion of the Syndicated Community Offering. If any of the Securities remain available after the expiration of the Subscription and Community Offering, at the request of the Company and Mercer Mutual, Sandler O'Neill will seek to form a syndicate of registered brokers or dealers ("Selected Dealers") to assist in the solicitation of purchase orders of such Securities on a best efforts basis, subject to the terms and conditions set forth in a selected dealers' agreement (the "Selected Dealers' Agreement"), substantially in the form set forth in Exhibit A to this Agreement. Sandler O'Neill will endeavor to limit the aggregate fees to be paid by the Company and Mercer Mutual under any such Selected Dealers' Agreement to an amount competitive with gross underwriting discounts charged at such time for underwritings of comparable amounts of stock sold at a comparable price per share in a similar market environment; provided, however, that the aggregate fees payable to Sandler O'Neill and Selected Dealers shall not exceed 7% of the aggregate Purchase Price of the Securities sold by such Selected Dealers. Sandler O'Neill will endeavor to distribute the Securities among the Selected Dealers in a fashion which best meets the distribution objective of the Company and the requirements of the Plan, which may result in limiting the allocation of stock to certain Selected Dealers. It is understood that in no event shall Sandler O'Neill be obligated to act as a Selected Dealer or to take or purchase any Securities. In the event the Company is unable to sell at least the total minimum of the Securities, as set forth on the cover page of the Prospectus, within the period herein provided, this Agreement shall terminate and the Company shall refund to any persons who have subscribed for any of the Securities the full amount which it may have received from them, without interest, and no party to this Agreement shall have any obligation to the others hereunder, except for the obligations of the Company and Mercer Mutual as set forth in Sections 4, 6(a) and 7 hereof and the obligations of the Agent as provided in Sections 6(b) and 7 hereof. Arrangements for placing the funds received from subscriptions for Securities or other offers to purchase Securities in a separate escrow account with Wilmington Trust Company until all Securities are sold and paid for were made prior to the commencement of the Subscription Offering, with provision for refund to the purchasers as set forth above, or for delivery to the Company if all Securities are sold. If at least the total minimum of Securities, as set forth on the cover page of the Prospectus, are sold, the Company agrees to issue or have issued the Securities sold and to release for delivery certificates for such Securities at the Closing Time against payment therefor by release of funds from the escrow account referred to above. The closing shall be held at the King of Prussia, Pennsylvania offices of Stevens & Lee, at 10:00 a.m., eastern time, or at such other place and time as shall be agreed upon by the parties hereto, on a business day to be agreed upon by the parties hereto. The Company shall notify the Agent by telephone, confirmed in writing, when funds shall have been received for all the Securities. Certificates for Securities shall be delivered directly to the purchasers thereof in accordance with their directions. Notwithstanding the foregoing, certificates for Securities purchased through Selected Dealers shall be made available to the Agent for inspection at least 48 hours prior to the Closing Time at such office as the Agent shall designate. The hour and date upon which the Company shall release for delivery all of the Securities, in accordance with the terms hereof, is herein called the "Closing Time." The Company will pay any stock issue and transfer taxes which may be payable with respect to the sale of the Securities. In addition to reimbursement of the expenses specified in Section 4 hereof, the Agent will receive the following compensation for its services hereunder: (c) one and four tenths percent (1.4%) of the aggregate Purchase Price of the Securities sold in the Subscription and Community Offering, excluding in each case shares purchased by (i) any employee benefit plan of the Company or Mercer Mutual established for the benefit of their respective directors, officers and employees, (ii) any director, officer or employee of the Company or Mercer Mutual or members of their immediate families (which term shall mean parents, grandparents, spouse, siblings, children and grandchildren), and (iii) purchasers in the Franklin Offerings; and (d) with respect to any Securities sold by an NASD member firm (other than Sandler O'Neill) under the Selected Dealers' Agreement in the Syndicated Community Offering, (i) the compensation payable to Selected Dealers under any Selected Dealers' Agreement, (ii) any sponsoring dealer's fees; and (iii) a management fee to Sandler O'Neill of one and one-half percent (1.5%) of the aggregate Purchase Price for the Securities. Any fees payable to Sandler O'Neill for Securities sold by Sandler O'Neill under any such agreement shall be limited to an aggregate of one and one-half percent (1.5%) of the aggregate Purchase Price of such Securities, and the aggregate fees payable to Sandler O'Neill and the selected and sponsoring dealers will not exceed seven percent (7%) of the aggregate Purchase Price for such Securities. If this Agreement is terminated by the Agent in accordance with the provisions of Section 9(a) hereof or the Conversion is terminated by the Company, no fee shall be payable by the Company to Sandler O'Neill; however, the Company shall reimburse the Agent for all of its reasonable out-of-pocket expenses incurred prior to termination, including the reasonable fees and disbursements of counsel for the Agent in accordance with the provisions of Section 4 hereof. All fees payable to the Agent hereunder shall be payable in immediately available funds at Closing Time, or upon the termination of this Agreement, as the case may be. In recognition of the long lead times involved in the conversion process, Mercer Mutual has made advance payments to the Agent in the aggregate amount of $25,000, which shall be credited against any fees or reimbursement of expenses payable hereunder. SECTION 3. COVENANTS OF THE COMPANY. The Company and Mercer Mutual covenant with the Agent as follows: (e) The Company and Mercer Mutual will prepare and file such amendments or supplements to the Registration Statement, the Prospectus, the Conversion Application and the Proxy Statement as may hereafter be required by the Securities Act Regulations or the Conversion Act or as may hereafter be requested by the Agent. Following completion of the Offerings, the Company and Mercer Mutual will promptly prepare and file with the Commission a post-effective amendment to the Registration Statement relating to the results of the updated valuation of Mercer Mutual prepared by Griffin. The Company and Mercer Mutual will notify the Agent immediately, and confirm the notice in writing, (i) of the effectiveness of any post-effective amendment of the Registration Statement, the filing of any supplement to the Prospectus and the filing of any amendment to the Conversion Application, (ii) of the receipt of any comments from the Department or the Commission with respect to the transactions contemplated by this Agreement or the Plan, (iii) of any request by the Commission or the Department for any amendment to the Registration Statement or the Conversion Application or any amendment or supplement to the Prospectus or for additional information, (iv) of the issuance by the Department of any order suspending the Offerings or the use of the Prospectus or the initiation of any proceedings for that purpose, (v) of the issuance by the Commission of any stop order suspending the effectiveness of the Registration Statement or the initiation of any proceedings for that purpose, and (vi) of the receipt of any notice with respect to the suspension of any qualification of the Securities for offering or sale in any jurisdiction. The Company and Mercer Mutual will make every reasonable effort to prevent the issuance of any stop order and, if any stop order is issued, to obtain the lifting thereof at the earliest possible moment. (f) The Company and Mercer Mutual will give the Agent notice of its intention to file or prepare any amendment to the Conversion Application or Registration Statement (including any post-effective amendment) or any amendment or supplement to the Prospectus (including any revised prospectus which the Company proposes for use in connection with the Syndicated Community Offering of the Securities which differs from the prospectus on file at the Commission at the time the Registration Statement becomes effective, whether or not such revised prospectus is required to be filed pursuant to Rule 424(b) of the Securities Act Regulations), will furnish the Agent with copies of any such amendment or supplement a reasonable amount of time prior to such proposed filing or use, as the case may be, and will not file any such amendment or supplement or use any such prospectus to which the Agent or counsel for the Agent may object. (g) The Company and Mercer Mutual will deliver to the Agent as many signed copies and as many conformed copies of the Conversion Application and the Registration Statement as originally filed and of each amendment thereto (including exhibits filed therewith or incorporated by reference therein) as the Agent may reasonably request, and from time to time such number of copies of the Prospectus as the Agent may reasonably request. (h) During the period when the Prospectus is required to be delivered, the Company and Mercer Mutual will comply, at their own expense, with all requirements imposed upon them by the Department, by the Conversion Act, as from time to time in force, and by the Nasdaq, the Securities Act, the Securities Act Regulations, the Exchange Act, and the rules and regulations of the Commission promulgated thereunder, including, without limitation, Regulation M under the Exchange Act, so far as necessary to permit the continuance of sales or dealing in shares of Common Stock during such period in accordance with the provisions hereof and the Prospectus. (i) If any event or circumstance shall occur as a result of which it is necessary to amend or supplement the Prospectus in order to make the Prospectus not misleading in the light of the circumstances existing at the time it is delivered to a purchaser, the Company and Mercer Mutual will forthwith amend or supplement the Prospectus (in form and substance satisfactory to counsel for the Agent) so that, as so amended or supplemented, the Prospectus will not include an untrue statement of a material fact or omit to state a material fact necessary in order to make the statements therein, in the light of the circumstances existing at the time it is delivered to a purchaser, not misleading, and the Company and Mercer Mutual will furnish to the Agent a reasonable number of copies of such amendment or supplement. For the purpose of this subsection, the Company and Mercer Mutual will each furnish such information with respect to itself as the Agent may from time to time reasonably request. (j) The Company and Mercer Mutual will take all necessary action, in cooperation with the Agent, to qualify the Securities for offering and sale under the applicable securities laws of such states of the United States and other jurisdictions as may be required and as the Agent and the Company have agreed; provided, however, that the Company and Mercer Mutual shall not be obligated to file any general consent to service of process or to qualify as a foreign corporation in any jurisdiction in which it is not so qualified. In each jurisdiction in which the Securities have been so qualified, the Company and Mercer Mutual will file such statements and reports as may be required by the laws of such jurisdiction to continue such qualification in effect for a period of not less than one year from the effective date of the Registration Statement. (k) The Company authorizes Sandler O'Neill and any Selected Dealers to act as agent of the Company in distributing the Prospectus to persons entitled to receive subscription rights and other persons to be offered Securities having record addresses in the states or jurisdictions set forth in a survey of the securities or "blue sky" laws of the various jurisdictions in which the Offerings will be made (the "Blue Sky Survey"). (l) The Company will make generally available to its security holders as soon as practicable, but not later than 60 days after the close of the period covered thereby, an earnings statement (in form complying with the provisions of Rule 158 of the Securities Act Regulations) covering a twelve month period beginning not later than the first day of the Company's fiscal quarter next following the "effective date" (as defined in said Rule 158) of the Registration Statement. (m) During the period ending on the third anniversary of the expiration of the fiscal year during which the closing of the transactions contemplated hereby occurs, the Company will furnish to its shareholders as soon as practicable after the end of each such fiscal year an annual report (including consolidated statements of financial condition and consolidated statements of income, shareholders' equity and cash flows, certified by independent public accountants) and, as soon as practicable after the end of each of the first three quarters of each fiscal year (beginning with the first such fiscal quarter ending after the effective date of the Registration Statement), consolidated summary financial information of the Company and the Mercer Companies for such quarter in reasonable detail. In addition, annual and quarterly consolidated summary financial information shall be made public through the issuance of appropriate press releases at the same time or prior to the time of the furnishing thereof to shareholders of the Company. (n) During the period ending on the third anniversary of the expiration of the fiscal year during which the closing of the transactions contemplated hereby occurs, the Company will furnish to the Agent (i) as soon as publicly available, a copy of each report or other document of the Company furnished generally to shareholders of the Company or furnished to or filed with the Commission under the Exchange Act or any national securities exchange or system on which any class of securities of the Company is listed, and (ii) from time to time, such other publicly available information concerning the Company as the Agent may reasonably request. (o) The Company and Mercer Mutual will conduct the Conversion in all material respects in accordance with the Plan, the Conversion Act and all other applicable regulations, decisions and orders, including all applicable terms, requirements and conditions precedent to the Conversion imposed upon the Company or Mercer Mutual by the Department. (p) The Company and Mercer Mutual will use the net proceeds received from the sale of the Securities in the manner specified in the Prospectus under "Use of Proceeds." (q) The Company will file with the Commission such report as may be required pursuant to Rule 463 of the Securities Act Regulations, if such report or substantially similar report is required by the SEC. (r) The Company will maintain the effectiveness of its Exchange Act Registration Statement for not less than three years. The Company will use best efforts to effect and maintain its listing on the Nasdaq Stock Market/NMS and will comply with all applicable listing standards relating thereto. (s) The Company and Mercer Mutual will take such actions and furnish such information as are reasonably requested by the Agent in order for the Agent to ensure compliance with the National Association of Securities Dealers, Inc.'s "Interpretation Relating to Free-Riding and Withholding." (t) Other than in connection with any employee benefit plan or arrangement described in the Prospectus, the Company will not, without the prior written consent of the Agent, sell or issue, contract to sell or otherwise dispose of, any shares of Common Stock other than the Securities for a period of 180 days following the Closing Time. (u) During the period beginning on the date hereof and ending on the fifth anniversary of the Closing Time, or the date on which the Agent receives full payment in satisfaction of any claim for indemnification or contribution to which it may be entitled pursuant to Sections 6 or 7 which is pending upon such fifth anniversary, neither the Company nor Mercer Mutual shall, without the prior written consent of the Agent, which consent shall not be unreasonably withheld, take or permit to be taken any action that could result in Mercer Common Stock becoming subject to any security interest, mortgage, pledge, lien or encumbrance. (v) The Company and Mercer Mutual will comply with any conditions imposed by or agreed to with the Department in connection with their approval of the Plan. (w) The Company shall not deliver the Securities until the Company and Mercer Mutual have satisfied each condition set forth in Section 5 hereof, unless such condition is waived in writing by the Agent. (x) The Company or Mercer Mutual will furnish to Sandler O'Neill as early as practicable prior to the delivery of the letters to be furnished by KPMG LLP pursuant to subsections (e) and (f) of Section 5 hereof, but no later than two (2) full business days prior thereto, a copy of the latest available unaudited interim consolidated financial statements of Mercer Mutual and the Subsidiaries which have been read by KPMG LLP, as stated in their letters to be furnished pursuant to subsections (e) and (f) of Section 5 hereof. (y) The Company and the Mercer Companies will, prior to the Closing Time, conduct their respective businesses in compliance in all material respects with all applicable federal and state laws, rules, regulations, decisions, directives and orders, including all decisions, directives and orders of the Commission, the Nasdaq Stock Market, the Department and the New Jersey Department. (z) The Company will not amend the Plan in any manner during the pendency of the Offerings without the consent of the Agent. (aa) The Company will not, prior to the Closing Time, incur any liability or obligation, direct or contingent, or enter into any material transaction, other than in the ordinary course of business consistent with past practice, except as contemplated by the Prospectus. (bb) The Company will use all reasonable efforts to comply with, or cause to be complied with, the conditions precedent to the several obligations of the Agent specified in Section 5 hereof. (cc) The Company will provide the Agent with any information necessary to carry out the allocation of the Securities in the event of an oversubscription, and such information will be accurate and reliable in all material respects. (dd) The Company will notify the Agent when funds have been received for the minimum number of Securities set forth in the Prospectus. SECTION 4. PAYMENT OF EXPENSES. The Company and Mercer Mutual jointly and severally agree to pay all expenses incident to the performance of their obligations under this Agreement, including but not limited to (i) the cost of obtaining all securities and insurance regulatory approvals, (ii) the preparation, printing and filing of the Registration Statement and the Conversion Application as originally filed and of each amendment thereto, (iii) the preparation, issuance and delivery of the certificates for the Securities to the purchasers in the Offerings, (iv) the fees and disbursements of the Company's and Mercer Mutual's counsel, accountants, appraiser and other advisors, (v) the qualification of the Securities under securities laws in accordance with the provisions of Section 3(f) hereof, including filing fees and the fees and disbursements of counsel in connection therewith and in connection with the preparation of the Blue Sky Survey, (vi) the printing and delivery to the Agent (in such quantities as the Agent shall reasonably request) of copies of the Registration Statement as originally filed and of each amendment thereto and the printing and delivery of the Prospectus and any amendments or supplements thereto to the purchasers in the Offerings and the Agent (in such quantities as the Agent shall reasonably request), (vii) the printing and delivery to the Agent of copies of a Blue Sky Survey, and (viii) the fees and expenses incurred in connection with the listing of the Securities on the Nasdaq Stock Market. In the event the Agent incurs any such fees and expenses on behalf of Mercer Mutual or the Company, Mercer Mutual will reimburse the Agent for such fees and expenses whether or not the Conversion is consummated; provided, however, that the Agent shall not incur any substantial expenses on behalf of Mercer Mutual or the Company pursuant to this Section without the prior approval of Mercer Mutual. The Company and Mercer Mutual jointly and severally agree to pay certain expenses incident to the performance of the Agent's obligations under this Agreement, regardless of whether the Conversion is consummated, including (i) the filing fees paid or incurred by the Agent in connection with all filings with the National Association of Securities Dealers, Inc., and (ii) all reasonable out of pocket expenses incurred by the Agent relating to the Offerings, including, without limitation, advertising, promotional, syndication and travel expenses and fees and expenses of the Agent's counsel, up to a maximum amount of $100,000. All fees and expenses to which the Agent is entitled to reimbursement under this paragraph of this Section 4 shall be due and payable upon receipt by the Company or Mercer Mutual of a written accounting therefor setting forth in reasonable detail the expenses incurred by the Agent. SECTION 5. CONDITIONS OF AGENT'S OBLIGATIONS. The Company, Mercer Mutual and the Agent agree that the issuance and the sale of Securities and all obligations of the Agent hereunder are subject to the accuracy of the representations and warranties of the Company and Mercer Mutual herein contained as of the date hereof and the Closing Time, to the accuracy in all material respects of the statements of officers and directors of the Company and Mercer Mutual made pursuant to the provisions hereof, to the performance by the Company and Mercer Mutual of their obligations hereunder, and to the following further conditions: (ee) No stop order suspending the effectiveness of the Registration Statement shall have been issued under the Securities Act or proceedings therefor initiated or threatened by the Commission, no order suspending the Conversion shall have been issued or proceedings therefor initiated or threatened by the Department, and no order suspending the sale of the Securities in any jurisdiction shall have been issued. (ff) At Closing Time, the Agent shall have received: (1) The favorable opinion, dated as of Closing Time, of Stevens & Lee, counsel for the Company and Mercer Mutual, in form and substance satisfactory to counsel for the Agent, to the effect that: (i) The Company has been incorporated and is validly existing as a corporation in good standing under the laws of the Commonwealth of Pennsylvania with full corporate power and authority to own, lease and operate its properties and to conduct its business as described in the Registration Statement and Prospectus and to enter into and perform its obligations under this Agreement; and to the best of such counsel's knowledge the Company is not transacting business in any other jurisdiction in which qualification as a foreign corporation is required to transact business, whether by reason of the ownership or leasing of property or the conduct of business, except where the failure to so qualify would not have a material adverse effect upon the financial condition, results of operations or business affairs of the Company and the Mercer Companies, considered as one enterprise. (ii) An opinion to the same general effect as subsection 5(b)(1)(i) in respect of each of the Mercer Companies. (iii) Mercer Mutual has all requisite power and authority to enter into and perform its obligations under the Agreement and to carry on an insurance business pursuant to and to the extent of the certificates of authority issued under the laws of the Commonwealth of Pennsylvania and the State of New Jersey; MIC and FIC have all requisite power and authority to carry on an insurance business pursuant to and to the extent of the certificate of authority issued under the laws of the State of New Jersey and the Commonwealth of Pennsylvania, respectively; the Company and each of the Mercer Companies has obtained all licenses, permits and other governmental authorizations currently required for the conduct of their respective businesses, except where the failure to obtain any such license, permit or authorization would not have a material adverse effect upon the financial condition, results of operations or business affairs of the Company and the Mercer Companies, considered as one enterprise. (iv) The Securities have been duly and validly authorized for issuance and sale and, when issued and delivered by the Company pursuant to the Plan against payment of the consideration calculated as set forth in the Plan, will be duly and validly issued and fully paid and non-assessable; and all corporate actions required to be taken for the authorization, issuance and sale of the Securities have been validly and sufficiently taken. (v) The issuance of the Securities is not subject to preemptive or other similar rights arising by operation of law or under the articles of incorporation or bylaws of the Company or Mercer Mutual. (vi) Upon consummation of the Conversion, the authorized, issued and outstanding capital stock of the Company will be within the range set forth in the Prospectus under "Capitalization" and no shares of Common Stock have been or will be issued and outstanding prior to the Closing Time. (vii) All of the issued and outstanding capital stock of each of QHC and MIC has been duly authorized and validly issued and, to such counsel's best knowledge, is fully paid and non-assessable and is owned by Mercer Mutual, directly or through subsidiaries, to such counsel's knowledge free and clear of any security interest, mortgage, pledge, lien, encumbrance, claim or equity, except such as would not result in a material adverse effect on the financial condition or results of operations of Mercer Mutual and its subsidiaries, taken as a whole. (viii) Upon consummation of the Conversion, all of the issued and outstanding capital stock of Mercer Mutual when issued and delivered pursuant to the Plan against payment of consideration as set forth in the Plan and set forth in the Prospectus, will be duly authorized and validly issued and fully paid and nonassessable, and all such capital stock will be owned beneficially and of record by the Company, to the best of such counsel's knowledge free and clear of any security interest, mortgage, pledge, lien, encumbrance, claim or equity. (ix) The execution and delivery of this Agreement and the consummation of the transactions contemplated hereby, including without limitation the Conversion, have been duly and validly authorized by all necessary corporate action on the part of each of the Company and Mercer Mutual, and this Agreement constitutes the legal, valid and binding agreement of each of the Company and Mercer Mutual, enforceable in accordance with its terms, except as rights to indemnity and contribution hereunder may be limited under applicable law (it being understood that such counsel may avail itself of customary exceptions concerning the effect of bankruptcy, insolvency or similar laws and the availability of equitable remedies); the execution and delivery of this Agreement, the incurrence of the obligations herein set forth and the consummation of the transactions contemplated herein, including without limitation the Conversion, will not result in any violation of the provisions of the charter or by-laws of the Company or any of the Mercer Companies; and, to the best of such counsel's knowledge, the execution and delivery of this Agreement, the incurrence of the obligations herein set forth and the consummation of the transactions contemplated herein, including without limitation the Conversion, will not constitute a breach of, or default under, and no event has occurred which, with notice or lapse of time or both, would constitute a default under, or result in the creation or imposition of any lien, charge or encumbrance, that, individually or in the aggregate, would have a material adverse effect on the financial condition, results of operations or business affairs of the Company and the Mercer Companies considered as one enterprise, upon any property or assets of the Company or any of the Mercer Companies pursuant to any contract, indenture, mortgage, loan agreement, note, lease or other instrument described in or filed as an exhibit to the Registration Statement. (x) The Registration Statement is effective under the Securities Act and no stop order suspending the effectiveness of the Registration Statement has been issued under the Securities Act or, to the best of such counsel's knowledge, proceedings therefor initiated or threatened by the Commission. The Department confirmed in writing on _________, 2003 that it has no further comments on the Prospectus, and the Department has not amended or rescinded that confirmation since that date. (xi) Subject to the satisfaction of any conditions set forth in any approvals or orders received from the Department or the New Jersey Department of Banking and Insurance required to be performed after the date of the opinion, no further approval, authorization, consent or other order of any public board or body is required in connection with the execution and delivery of this Agreement, the issuance of the Securities and the consummation of the Conversion, except as may be required under the securities or Blue Sky laws of various jurisdictions as to which no opinion need be rendered. (xii) At the time the Registration Statement became effective, the Registration Statement (other than the financial statements, notes to financial statements, financial tables and other financial and statistical data included therein and the appraisal valuation as to which no opinion need be rendered) complied as to form in all material respects with the requirements of the Securities Act and the Securities Act Regulations and the Conversion Act. (xiii) The Common Stock conforms to the description thereof contained in the Prospectus, and the form of certificate used to evidence the Common Stock is in due and proper form and complies with all applicable statutory requirements. (xiv) To the best of such counsel's knowledge and without performing any docket search or similar search of judicial or administrative records (i) except as described in the Prospectus under the section "Risk Factors--New Jersey 'retaliatory tax' laws could possibly have an adverse impact on our results of operations," there are no legal or governmental proceedings pending or threatened against or affecting the Company or any of the Mercer Companies which are required, individually or in the aggregate, to be disclosed in the Registration Statement and Prospectus, other than those disclosed therein, and (ii) all pending legal or governmental proceedings to which the Company or any of the Mercer Companies is a party or to which any of their property is subject which are not described in the Registration Statement, including ordinary routine litigation incidental to the business, are considered, in the aggregate, not material. (xv) The information in the Prospectus under "Business--Regulation," "The Conversion--Effect of Conversion on Policyholders," "Risk Factors," "The Conversion--Tax Effects Generally," "The Conversion -- Tax Consequences of Subscription Rights," "Certain Restrictions on Acquisition of the Holding Company" and "Description of the Capital Stock," to the extent that it constitutes matters of law, summaries of legal matters, documents or proceedings, or legal conclusions, has been reviewed by them and is complete and accurate in all material respects. (xvi) To the best of such counsel's knowledge, there are no contracts, indentures, mortgages, loan agreements, notes, leases or other instruments required to be described or referred to in the Registration Statement or to be filed as exhibits thereto other than those described or referred to therein or filed as exhibits thereto, and the descriptions thereof or references thereto are correct in all material respects. (xvii) The Conversion Application complies in all material respects with the applicable requirements of the Conversion Act, includes all documents required to be filed as exhibits thereto, and is, to the best of such counsel's knowledge and information, truthful, accurate and complete in all material respects. The Plan has been duly authorized by all necessary corporate actions, and all necessary regulatory consents thereto and regulatory approvals thereof have been obtained and the Conversion has been consummated; Mercer Mutual's charter has been amended to authorize the issuance of capital stock; to the best of such counsel's knowledge, the Company and Mercer Mutual have conducted the Conversion in all material respects in accordance with applicable requirements of the Conversion Act, the Plan and all other applicable regulations, decisions and orders of the Department, including all material applicable terms, conditions, requirements and conditions precedent to the Conversion imposed upon the Company or Mercer Mutual by the Department, except for those required to be completed after the date of the opinion, and, to the best of such counsel's knowledge, no order has been issued by the Department to suspend the Conversion and no action for such purpose has been instituted or threatened by the Department; and, to the best of such counsel's knowledge, no person has sought to obtain review of the final action of the Department in approving the Plan. (xviii) Neither the Company nor any of the Mercer Companies is in violation of its articles of incorporation or, to the best of such counsel's knowledge, in default (nor has any event occurred which, with notice or lapse of time or both, would constitute a default) in the performance or observance of any obligation, agreement, covenant or condition contained in any contract, indenture, mortgage, loan agreement, note, lease or other instrument described in or filed as an exhibit to the Registration Statement. (xix) The Company is not and upon completion of the Conversion and Offering will not be required to be registered as an investment company under the Investment Company Act of 1940. (2) The favorable opinion, dated as of Closing Time, of Lord, Bissell & Brook, counsel for the Agent, with respect to certain of the matters set forth in Sections 5(b)(1)(i), (iv), (v), (vi) and (xii) as the Agent may reasonably require. (3) In giving their opinions required by subsections (b)(l) and (b)(2), respectively, of this Section, Stevens & Lee and Lord, Bissell & Brook shall each additionally state to the effect that during the preparation of the Registration Statement and the Prospectus, such counsel participated in conferences with certain officers and other representatives of the independent public accountants for the Company and the Mercer Companies and representatives of the Agent at which the contents of the Registration Statement and the Prospectus and related matters were discussed and, although such counsel is not passing upon the accuracy of the statements contained in the Registration Statement and Prospectus (except as otherwise provided in subsections (b)(1) and (b)(2)), on the basis of the foregoing and without independent verification (relying as to factual matters on certificates and other factual representations provided by officers of the Company and the Mercer Companies), nothing has come to their attention that would lead them to believe that the Registration Statement (except for financial statements and schedules and other financial or statistical data included therein, as to which counsel need make no statement), at the time it became effective, contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading or that the Prospectus (except for financial statements and schedules and other financial or statistical data included therein, as to which counsel need make no statement), at the time the Registration Statement became effective or at Closing Time, included an untrue statement of a material fact or omitted to state a material fact necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading. In giving their opinions, Stevens & Lee and Lord, Bissell & Brook may rely as to matters of fact, to the extent such counsel deems proper, on certificates of officers and directors of the Company and Mercer Mutual and certificates of public officials, provided that copies of any such certificates are delivered to the Agent together with the opinion to be rendered by such counsel, and Lord, Bissell & Brook may also rely on the opinion of Stevens & Lee regarding matters of Pennsylvania law. Further, the opinion of Stevens & Lee may be limited to matters governed by the laws of the Commonwealth of Pennsylvania and federal law. (gg) At Closing Time referred to in Section 2, the Plan shall have been approved by the policyholders of Mercer Mutual and Mercer Mutual shall have completed in all material respects the conditions precedent to the Conversion in accordance with the Plan, the Conversion Act and all other applicable laws, regulations, decisions and orders, including all terms, conditions, requirements and provisions precedent to the Conversion imposed upon the Company or Mercer Mutual by the Department, or any other regulatory authority, other than those which the Department permits to be competed after the Conversion. (hh) At Closing Time, there shall not have been, since the respective dates as of which information is given in the Registration Statement and the Prospectus, any material adverse change in the financial condition, results of operations or business affairs of the Company and the Mercer Companies considered as one enterprise, whether or not arising in the ordinary course of business, and the Agent shall have received a certificate of the President and Chief Executive Officer of the Company and of Mercer Mutual, and the chief financial or chief accounting officer of the Company and of Mercer Mutual, dated as of Closing Time, to the effect that (i) there has been no such material adverse change, (ii) there shall have been no material transaction entered into by the Company or Mercer Mutual from the latest date as of which the financial condition of the Company or Mercer Mutual is set forth in the Registration Statement and the Prospectus, other than transactions referred to or contemplated therein and transactions in the ordinary cause of business, (iii) neither the Company nor Mercer Mutual shall have received from the Department any direction (oral or written) to make any material change in the method of conducting its business (which direction, if any, shall have been disclosed to the Agent) which materially and adversely would affect the business, financial condition or results of operations of the Company or Mercer Mutual, (iv) the representations and warranties in Section 1 hereof are true and correct in all material respects with the same force and effect as though expressly made at and as of the Closing Time, (v) the Company and Mercer Mutual have complied in all material respects with all agreements and satisfied in all material respects all conditions on their part to be performed or satisfied at or prior to Closing Time, (vi) no stop order suspending the effectiveness of the Registration Statement has been issued and no proceedings for that purpose have been initiated or threatened by the Commission and (vii) no order suspending any of the Offerings or the authorization for final use of the Prospectus has been issued and no proceedings for that purpose have been initiated or threatened by the Department and no person has sought to obtain regulatory or judicial review of the action of the Department in approving the Plan in accordance with the Conversion Act. (ii) At the time of the execution of this Agreement, the Agent shall have received from KPMG LLP a letter dated such date, in form and substance satisfactory to the Agent, to the effect that (i) they are independent public accountants with respect to the Company and the Mercer Companies within the meaning of the Code of Ethics of the American Institute of Certified Public Accountants, the Securities Act and the Securities Act Regulations and the Conversion Act; (ii) it is their opinion that the consolidated financial statements and supporting schedules included in the Registration Statement and covered by their opinions therein comply as to form in all material respects with the applicable accounting requirements of the Securities Act and the Securities Act Regulations; (iii) based upon limited procedures as agreed upon by the Agent and KPMG LLP set forth in detail in such letter, nothing has come to their attention which causes them to believe that (A) the unaudited financial statements of the Mercer Companies included in the Registration Statement do not comply as to form in all material respects with the applicable accounting requirements of the Securities Act, the Securities Act Regulations Act or are not presented in conformity with generally accepted accounting principles, (B) the unaudited pro forma consolidated financial data of the Company included in the Registration Statement do not comply as to form in all material respects with the applicable accounting requirements of rule 11-02 of Regulation S-X and that the pro forma adjustments were not properly applied to the applicable historical amounts in the compilation of such data, (C) at a specified date not more than five days prior to the date of this Agreement, there has been any change in capital stock, increase in the consolidated debt or any decrease in consolidated assets or surplus of the Mercer Companies, in each case as compared with the amounts shown in the [March 31, 2003] balance sheet included in the Registration Statement or, (D) during the period from the date of such balance sheet to a specified date not more than five days prior to the date of this Agreement, there were any decreases, as compared with the corresponding period in the preceding year, in consolidated net income of the Mercer Companies, except in all instances for increases or decreases which the Registration Statement and the Prospectus disclose have occurred or may occur; and (iv) in addition to the examination referred to in their opinions and the limited procedures referred to in clause (iii) above, they have carried out certain specified procedures, not constituting an audit, with respect to certain amounts, percentages and financial information which are included in the Registration Statement and Prospectus and which are specified by the Agent, and have found such amounts, percentages and financial information to be in agreement with the relevant accounting, financial and other records of the Company and the Mercer Companies identified in such letter. (jj) At Closing Time, the Agent shall have received from KPMG LLP a letter, dated as of Closing Time, to the effect that they reaffirm the statements made in the letter furnished pursuant to subsection (d) of this Section, except that the specified date referred to shall be a date not more than five days prior to Closing Time. (kk) At Closing Time, the Securities shall have been approved for listing on the Nasdaq Stock Market upon notice of issuance. (ll) At Closing Time, the Agent shall have received a letter from Griffin, dated as of the Closing Time, confirming its appraisal. (mm) At Closing Time, counsel for the Agent shall have been furnished with such documents and opinions as they may require for the purpose of enabling them to pass upon the issuance and sale of the Securities as herein contemplated and related proceedings, or in order to evidence the accuracy of any of the representations or warranties, or the fulfillment of any of the conditions, herein contained; and all proceedings taken by the Company in connection with the issuance and sale of the Securities as herein contemplated shall be reasonably satisfactory in form and substance to the Agent and counsel for the Agent. (nn) At any time prior to Closing Time, (i) there shall not have occurred any material adverse change in the financial markets in the United States or elsewhere or any outbreak of hostilities or escalation thereof or other calamity or crisis, or any change or development involving a prospective change in political, financial or economic conditions, in each case the effect of which, in the reasonable judgment of the Agent, is so material and adverse as to make it impracticable to market the Securities or to enforce contracts, including subscriptions or orders, for the sale of the Securities, and (ii) trading generally on either the Nasdaq Stock Market or the New York Stock Exchange shall not have been suspended, and minimum or maximum prices for trading shall not have been fixed, or maximum ranges for prices for securities have been required, by either of said trading markets or by order of the Commission or any other governmental authority, and a banking moratorium shall not have been declared by either Federal or New York authorities. SECTION 6. INDEMNIFICATION. (oo) The Company and Mercer Mutual, jointly and severally, agree to indemnify and hold harmless the Agent, each person, if any, who controls (within the meaning of Section 15 of the Securities Act or Section 20 of the Exchange Act), the Agent and its respective partners, directors, officers, employees and agents as follows: (i) from and against any and all loss, liability, claim, damage and expense whatsoever, as incurred, based upon or arising out, in whole or in part, of the Conversion or any action taken by the Agent where acting as agent of the Company or Mercer Mutual or otherwise as described in Section 2 hereof; provided, however, that this indemnity agreement shall not apply to any loss, liability, claim, damage or expense found in a final judgment by a court of competent jurisdiction to have resulted primarily from the bad faith, willful misconduct or gross negligence of the Agent seeking indemnification hereunder. (ii) from and against any and all loss, liability, claim, damage and expense whatsoever, as incurred, based upon or arising out of, in whole or in part, any untrue statement or alleged untrue statement of a material fact contained in the Registration Statement (or any amendment thereto), or the omission or alleged omission therefrom of a material fact required to be stated therein or necessary to make the statements therein not misleading, or arising out of any untrue statement or alleged untrue statement of a material fact contained in the Prospectus (or any amendment or supplement thereto) or the omission or alleged omission therefrom of a material fact necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading; (iii) from and against any and all loss, liability, claim, damage and expense whatsoever, as incurred, to the extent of the aggregate amount paid in settlement of any litigation, or any investigation or proceeding by any governmental agency or body, commenced or threatened, or of any claim whatsoever described in clauses (i) or (ii) above, if such settlement is effected with the written consent of the Company or Mercer Mutual, which consent shall not be unreasonably withheld or delayed; and (iv) from and against any and all expense whatsoever, as incurred (including, subject to Section 6(c) hereof, the fees and disbursements of counsel chosen by the Agent), reasonably incurred in investigating, preparing for or defending against any litigation, or any investigation, proceeding or inquiry by any governmental agency or body, commenced or threatened, or any claim whatsoever described in clauses (i) or (ii) above, to the extent that any such expense is not paid under (i), (ii) or (iii) above; provided, however, that this indemnity agreement shall not apply to any loss, liability, claim, damage or expense to the extent arising out of any untrue statement or alleged untrue statement of a material fact contained in the Prospectus (or any amendment or supplement thereto) or the omission or alleged omission therefrom of a material fact necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading which was made in reliance upon and in conformity with the Agent Information furnished to the Company or Mercer Mutual expressly for use in the Prospectus (or any amendment or supplement thereto). (pp) The Agent agrees to indemnify and hold harmless the Company, Mercer Mutual, their directors, each of their officers, agents and employees, and each person, if any, who controls the Company within the meaning of Section 15 of the Securities Act or Section 20 of the Exchange Act against any and all loss, liability, claim, damage and expense described in the indemnity contained in subsection (a) of this Section, as incurred, but only with respect to untrue statements or omissions, or alleged untrue statements or omissions, of a material fact made in the Prospectus (or any amendment or supplement thereto) in reliance upon and in conformity with the Agent Information. (qq) Each indemnified party shall give notice as promptly as reasonably practicable to each indemnifying party of any action commenced against it in respect of which indemnity may be sought hereunder, but failure to so notify an indemnifying party shall not relieve such indemnifying party from any liability which it may have otherwise than on account of this indemnity agreement. An indemnifying party may participate at its own expense in the defense of any such action. In no event shall the indemnifying parties be liable for fees and expenses of more than one counsel (in addition to no more than one local counsel in each separate jurisdiction in which any action or proceeding is commenced) separate from their own counsel for all indemnified parties in connection with any one action or separate but similar or related actions in the same jurisdiction arising out of the same general allegations or circumstances. No indemnifying party shall without the prior written consent of the indemnified parties (which shall not be unreasonably withheld or delayed), settle or compromise or consent to the entry of any judgment with respect to any litigation, or any investigation or proceeding by any governmental agency or body, commenced or threatened, or any claim whatsoever in respect of which indemnification or contribution could be sought under this Section 6 or Section 7 hereof (whether or not the indemnified parties are actual or potential parties thereto), unless such settlement, compromise or consent (i) includes an unconditional release of each indemnified party from all liability arising out of such litigation, investigation, proceeding or claim and (ii) does not include a statement as to or an admission of fault, culpability or a failure to act by or on behalf of any indemnified party. (rr) The Company and Mercer Mutual also agree that the Agent shall not have any liability (whether direct or indirect, in contract or tort or otherwise) to Mercer Mutual, the Company, its security holders or Mercer Mutual's or the Company's creditors relating to or arising out of the engagement of the Agent pursuant to, or the performance by the Agent in good faith of the services contemplated by, this Agreement, except to the extent that any loss, claim, damage or liability is found in a final judgment by a court of competent jurisdiction to have resulted primarily from the Agent's bad faith, willful misconduct or gross negligence. (ss) In addition to, and without limiting, the provisions of Section (6)(a)(iv) hereof, in the event that any Agent, any person, if any, who controls the Agent within the meaning of Section 15 of the Securities Act or Section 20 of the Exchange Act or any of its partners, directors, officers, employees or agents is requested or required to appear as a witness or otherwise gives testimony in any action, proceeding, investigation or inquiry brought by or on behalf of or against the Company, Mercer Mutual, the Agent or any of its respective affiliates or any participant in the transactions contemplated hereby in which the Agent or such person or agent is not named as a defendant, the Company and Mercer Mutual jointly and severally agree to reimburse the Agent for all reasonable and necessary out-of-pocket expenses incurred by it in connection with preparing or appearing as a witness or otherwise giving testimony and to compensate the Agent in an amount to be mutually agreed upon. (tt) SECTION 7. CONTRIBUTION. In order to provide for just and equitable contribution in circumstances in which the indemnity agreement provided for in Section 6 hereof is for any reason held to be unenforceable by the indemnified parties although applicable in accordance with its terms, the Company, Mercer Mutual and the Agent shall contribute to the aggregate losses, liabilities, claims, damages and expenses of the nature contemplated by said indemnity agreement incurred by the Company or Mercer Mutual and the Agent, as incurred, in such proportions (i) that the Agent is responsible for that portion represented by the percentage that the maximum aggregate marketing fees appearing on the cover page of the Prospectus bears to the maximum aggregate gross proceeds appearing thereon and the Company and Mercer Mutual are jointly and severally responsible for the balance or (ii) if, but only if, the allocation provided for in clause (i) is for any reason held unenforceable, in such proportion as is appropriate to reflect not only the relative benefits to the Company and Mercer Mutual on the one hand and the Agent on the other, as reflected in clause (i), but also the relative fault of the Company and Mercer Mutual on the one hand and the Agent on the other, as well as any other relevant equitable considerations; provided, however, that no person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Securities Act) shall be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation. For purposes of this Section, each partner, director, officer, employee and agent of the Agent, and each person, if any, who controls the Agent within the meaning of Section 15 of the Securities Act or Section 20 of the Exchange Act shall have the same rights to contribution as the Agent, and each director, officer, agent and employee of the Company, and Mercer Mutual, and each person, if any, who controls the Company or Mercer Mutual within the meaning of Section 15 of the Securities Act or Section 20 of the Exchange Act shall have the same rights to contribution as the Company and Mercer Mutual. Notwithstanding anything to the contrary set forth herein, to the extent permitted by applicable law, in no event shall the Agent be required to contribute an aggregate amount in excess of the aggregate marketing fees to which the Agent is entitled and actually paid pursuant to this Agreement. The relative fault of the Company and Mercer Mutual, on the one hand, and the Agent, on the other hand, shall be determined by reference to, among other things, whether any such untrue or alleged untrue statements of a material fact or omission or alleged omission to state a material fact relates to information supplied by the Company and Mercer Mutual or by the Agent and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission. The Company and Mercer Mutual and the Agent agree that it would not be just and equitable if contribution pursuant to this Section 7 were determined by pro rata allocation or by any other method of allocation which does not take account of the equitable considerations referred to above in this Section 7. The aggregate amount of losses, liabilities, claims, damages and expenses incurred by an indemnified party and referred to above in this Section 7 shall be deemed to include any legal or other expenses reasonably incurred by such indemnified party in investigating, preparing or defending against any litigation, or any investigation or proceeding by any governmental agency or body, commenced or threatened, or any claim whatsoever based upon any such untrue or alleged untrue statement or omission or alleged omission. SECTION 8. REPRESENTATIONS, WARRANTIES AND AGREEMENTS TO SURVIVE DELIVERY. All representations, warranties and agreements contained in this Agreement, or contained in certificates of officers of the Company or Mercer Mutual submitted pursuant hereto, shall remain operative and in full force and effect, regardless of any investigation made by or on behalf of any Agent or controlling person, or by or on behalf of the Company, and shall survive delivery of the Securities. SECTION 9. TERMINATION OF AGREEMENT. (uu) The Agent may terminate this Agreement, by notice to the Company, at any time at or prior to Closing Time (i) if there has been, since the respective dates as of which information is given in the Registration Statement, any material adverse change in the financial condition, results of operations or business affairs of the Company or Mercer Mutual, or the Company and the Mercer Companies considered as one enterprise, whether or not arising in the ordinary course of business, or (ii) if there has occurred any material adverse change in the financial markets in the United States or elsewhere or any outbreak of hostilities or escalation thereof or other calamity or crisis, or any change or development involving a prospective change in political, financial or economic conditions, in each case the effect of which, in the reasonable judgment of the Agent, is so material and adverse as to make it impracticable to market the Securities or to enforce contracts, including subscriptions or orders, for the sale of the Securities, (iii) or if trading generally on the Nasdaq Stock Market or New York Stock Exchange has been suspended, or minimum or maximum prices for trading have been fixed, or maximum ranges for prices for securities have been required, by either of said trading markets or by order of the Commission or any other governmental authority, or if a banking moratorium has been declared by either Federal or New York authorities, (iv) if any condition specified in Section 5 shall not have been fulfilled when and as required to be fulfilled; (v) if there shall have been such material adverse change in the condition or prospects of the Company or Mercer Mutual or the prospective market for the Company's securities which in the Agent's good faith opinion would make it inadvisable to proceed with the offering, sale or delivery of the Securities; (vi) if in the Agent's good faith opinion, the price for the Securities established by Griffin is not reasonable or equitable under then prevailing market conditions, or (vii) if the Conversion is not consummated within 45 days following the Termination Date (as defined in the Prospectus). (vv) If this Agreement is terminated pursuant to this Section 9, such termination shall be without liability of any party to any other party except as provided in Section 4 hereof relating to the reimbursement of expenses and except that the provisions of Sections 6 and 7 hereof shall survive any termination of this Agreement. SECTION 10. NOTICES. All notices and other communications hereunder shall be in writing and shall be deemed to have been duly given if mailed or transmitted by any standard form of telecommunication. Notices to the Agent shall be directed to the Agent at 919 3rd Avenue, 6th Floor, New York, New York 10022, attention of Catherine A. Lawton, Principal (with a copy to John S. Chapman, Esq. and J. Brett Pritchard, Esq., Lord, Bissell & Brook, 115 S. LaSalle Street, Chicago, Illinois 60603); notices to the Company and Mercer Mutual shall be directed to either of them at 10 North Highway 31, Pennington, New Jersey 08534, attention of Andrew R. Speaker, President (with a copy to Jeffrey P. Waldron, Esq. and Edward C. Hogan, Esq., Stevens & Lee, 620 Freedom Business Center, Suite 200, King of Prussia, Pennsylvania 19406). SECTION 11. PARTIES. This Agreement shall inure to the benefit of and be binding upon the Agent, the Company and Mercer Mutual and their respective successors. Nothing expressed or mentioned in this Agreement is intended or shall be construed to give any person, firm or corporation, other than the Agent, the Company and Mercer Mutual and their respective successors and the controlling persons and officers and directors referred to in Sections 6 and 7 and their heirs and legal representatives, any legal or equitable right, remedy or claim under or in respect of this Agreement or any provision herein or therein contained. This Agreement and all conditions and provisions hereof and thereof are intended to be for the sole and exclusive benefit of the Agent, the Company and Mercer Mutual and their respective successors, and said controlling persons and officers and directors and their heirs and legal representatives, and for the benefit of no other person, firm or corporation. SECTION 12. ENTIRE AGREEMENT; AMENDMENT. This Agreement represents the entire understanding of the parties hereto with reference to the transactions contemplated hereby and supersedes any and all other oral or written agreements heretofore made, except for the engagement letter dated November 8, 2002, by and between the Agent and the Company and Mercer Mutual, relating to the Agent's providing conversion agent services to the Company and Mercer Mutual in connection with the Conversion. No waiver, amendment or other modification of this Agreement shall be effective unless in writing and signed by the parties hereto. SECTION 13. GOVERNING LAW AND TIME. This Agreement shall be governed by and construed in accordance with the laws of the State of New York applicable to agreements made and to be performed in said State without regard to the conflicts of laws provisions thereof. Unless otherwise noted, specified times of day refer to Eastern time. SECTION 14. SEVERABILITY. Any term or provision of this Agreement which is invalid or unenforceable in any jurisdiction shall, as to that jurisdiction, be ineffective to the extent of such invalidity or unenforceability without rendering invalid or unenforceable the remaining terms and provisions of this Agreement or affecting the validity or enforceability of any of the terms or provisions of this Agreement in any other jurisdiction. If any provision of this Agreement is so broad as to be unenforceable, the provision shall be interpreted to be only so broad as is enforceable. SECTION 15. HEADINGS. Sections headings are not to be considered part of this Agreement, are for convenience and reference only, and are not to be deemed to be full or accurate descriptions of the contents of any paragraph or subparagraph. [Signature page follows] If the foregoing is in accordance with your understanding of our agreement, please sign and return to the Company a counterpart hereof, whereupon this instrument, along with all counterparts, will become a binding agreement between the Agent, the Company and Mercer Mutual in accordance with its terms. Very truly yours, MERCER INSURANCE GROUP, INC. By:______________________________________ Title:____________________________________ MERCER MUTUAL INSURANCE COMPANY By:______________________________________ Title:____________________________________ CONFIRMED AND ACCEPTED, as of the date first above written: SANDLER O'NEILL & PARTNERS, L.P. By: Sandler O'Neill & Partners Corp., the sole general partner By:________________________________ Title_______________________________ EX-2.1 5 e85343a2exv2w1.txt PLAN OF CONVERSION EXHIBIT 2.1 PLAN OF CONVERSION FROM MUTUAL TO STOCK ORGANIZATION MERCER MUTUAL INSURANCE COMPANY ADOPTED DECEMBER 13, 2002 AMENDED AND RESTATED MARCH 19, 2003, APRIL 15, 2003 AND JUNE 18, 2003 I. BACKGROUND AND BUSINESS PURPOSE As of and effective on December 13, 2002, the Board of Directors of Mercer Mutual Insurance Company ("Mercer Mutual"), after careful study and consideration, adopted by unanimous vote this Plan of Conversion from Mutual to Stock Organization (the "Plan"). Under this Plan, Mercer Mutual will convert from a Pennsylvania mutual insurance company to a Pennsylvania stock insurance company pursuant to the Insurance Company Mutual-to-Stock Conversion Act, 40 P.S. Sections 911-A, et seq. (the "Act") and will become a wholly-owned subsidiary of Mercer Insurance Group, Inc., a holding company (the "Holding Company) incorporated under Pennsylvania law at the direction of Mercer Mutual. Mercer Mutual, as converted, is sometimes hereinafter referred to as the "Converted Company" and the foregoing transaction is sometimes hereinafter referred to as the "Conversion." The Conversion is subject to provisions of the Act and the policies of the Pennsylvania Insurance Department (the "Department"). This Plan is subject to the prior written approval of the Department. This Plan also must be approved by: (i) the affirmative vote of a majority of the members of the Board of Directors of the Holding Company, and (ii) the affirmative vote of at least two-thirds of the votes cast at a meeting of Eligible Policyholders (as hereinafter defined) of Mercer Mutual called for the purpose of considering and voting upon this Plan. Pursuant to this Plan, shares of stock of the Holding Company will be offered at a predetermined and uniform price in a subscription offering pursuant to the exercise of non-transferable subscription rights granted to the following persons (collectively, the "Participants"): first to the Eligible Policyholders of Mercer Mutual; second, to a tax-qualified employee stock benefit plan to be established by the Holding Company, and third, to the Directors, Officers and Employees (as hereinafter defined). Shares not subscribed for in the subscription offering may be offered to the general public in a community offering conducted concurrently with the subscription offering. Shares remaining unsold, if any, then may be offered to the general public in a best efforts or firm commitment underwritten public offering. The aggregate purchase price of the Holding Company stock to be sold in the Conversion will be based upon an independent valuation of Mercer Mutual and will reflect the estimated consolidated pro forma market value of the Converted Company as a subsidiary of the Holding Company. The pro forma market value may be that value that is estimated to be necessary to attract full subscription of the shares. The valuation range may be changed or revised only if such change or revision is approved by the Department. It is the desire of the Board of Directors of Mercer Mutual to attract new capital to the Converted Company in order to: (i) increase statutory surplus (and thereby strengthen policyholder protection), (ii) support current operations, (iii) achieve diversification of risk through product growth, (iv) fund geographic expansion both through acquisition and increased agency representation, (v) provide increased opportunities for existing Employees, and (vi) create new jobs. It is the further desire of the Board of Directors of Mercer Mutual to reorganize the Converted Company as a wholly-owned subsidiary of the Holding Company. The Board of Directors believes a holding company structure will enhance and improve operational flexibility and facilitate product expansion and acquisitions, in order to diversify risk and enable the Converted Company to compete more effectively with other insurance companies. In addition, the Board of Directors of the Holding Company intends to adopt a stock compensation plan to better attract, motivate and retain highly qualified Directors, Officers and Employees. 1 No change will be made in the Board of Directors or management of Mercer Mutual as a result of the Conversion. II. DEFINITIONS Act means the Insurance Company Mutual-to-Stock Conversion Act (40 P.S. Sections 911-A, et seq.). Acting in Concert means (i) knowing participation in a joint activity or interdependent conscious parallel action toward a common goal whether or not pursuant to an express agreement; or (ii) a combination or pooling of voting or other interests in the securities of an issuer for a common purpose pursuant to any contract, understanding, relationship, agreement or other arrangement, whether written or otherwise. A Person who acts in concert with another Person ("other party") also shall be deemed to be acting in concert with any Person who also is acting in concert with that other party, except that any Tax-Qualified Employee Stock Benefit Plan will not be deemed to be acting in concert with its trustee or a Person who serves in a similar capacity solely for the purpose of determining whether stock held by the trustee and stock held by the Tax- Qualified Employee Stock Benefit Plan will be aggregated. Affiliate means, with respect to a Person, any Person that, directly or indirectly through one or more intermediaries, controls, is controlled by, or is under common control with such Person. Application means the application for approval of the Conversion to be filed by Mercer Mutual with the Department as described in Section III of this Plan. Appraiser means a Person that is not an Affiliate of the Holding Company or Mercer Mutual, experienced and expert in the area of corporate appraisals, to be chosen by Mercer Mutual and retained by it to prepare an independent valuation of the consolidated pro forma market value of the Converted Company as a subsidiary of the Holding Company. Associate, when used to indicate a relationship with any Person, means: (i) any corporation or organization (other than Mercer Mutual, the Holding Company, FHI, a majority-owned subsidiary of Mercer Mutual or the Holding Company or any other entity that is a member of the same consolidated group as Mercer Mutual or the Holding Company under generally accepted accounting principles) of which such Person is an officer or partner or is, directly or indirectly the beneficial owner of 10% or more of any class of equity securities; (ii) any trust or other estate in which such Person has a substantial beneficial interest or as to which such Person serves as trustee or in a similar fiduciary capacity, except that such term shall not include a Tax-Qualified Employee Stock Benefit Plan in which a Person has a substantial beneficial interest or serves as a trustee or in a similar fiduciary capacity; and (iii) any relative or spouse of such Person, or any relative of such spouse, who has the same home as such Person. Code means the Internal Revenue Code of 1986, as amended. Commissioner means the Insurance Commissioner of the Commonwealth of Pennsylvania. Community Offering or Syndicated Community Offering means the offering of shares of Conversion Stock to the general public by the Holding Company concurrently with or subsequent to the Subscription Offering, giving preference to: (i) natural Persons and trusts of natural Persons (including individual retirement and Keogh retirement accounts and personal trusts in which such natural Persons have substantial interests) who are Residents of the Local Community, (ii) principals of Eligible Policyholders in the case of an Eligible Policyholder that is a corporation, partnership, limited liability company or other entity, (iii) licensed insurance agencies that have been appointed by Mercer Mutual to market and distribute policies of insurance, and their affiliates, (iv) named insureds under policies of insurance issued by Mercer Mutual after December 13, 2002, and (v) providers of goods or services to Mercer Mutual. The Holding Company may retain the assistance of a broker-dealer or a syndicate of broker-dealers to assist it in connection with the sale of Conversion Stock in the Community Offering. If a syndicate of broker-dealers is formed, the Community Offering may sometimes be called a Syndicated Community Offering, but in all events the term Community Offering shall be deemed to include a Syndicated Community Offering. 2 Conversion means: (i) the amendment of the articles of incorporation of Mercer Mutual to authorize the issuance of shares of Converted Company Capital Stock and to conform to the requirements of a Pennsylvania stock insurance company under the laws of the Commonwealth of Pennsylvania, (ii) the offer and sale of Conversion Stock by the Holding Company in the Subscription Offering, the Community Offering and any Underwritten Public Offering, and (iii) the purchase by the Holding Company of all the Converted Company Capital Stock; all in accordance with the terms of this Plan. Conversion Stock means the shares of no par value common stock of the Holding Company to be offered and sold by the Holding Company pursuant to this Plan but shall not include shares of no par value common stock of the Holding Company issued pursuant to the FHC Certificate of Incorporation, the FHC Shareholder Agreement or the Franklin Settlement Agreement. Converted Company means Mercer Mutual in its form as a Pennsylvania stock insurance company resulting from its conversion to the stock form of organization in accordance with the terms of this Plan. Converted Company Capital Stock means any and all authorized shares of capital stock of the Converted Company. Director means a director of the Holding Company, Mercer Mutual or the Converted Company, as the context may require. Effective Date means the date articles of conversion with respect to Mercer Mutual are filed in the office of the Department of State of the Commonwealth of Pennsylvania or such later date as may be specified in such articles. Eligibility Record Date means the close of business on December 13, 2002, the effective date of the adoption of this Plan by the Board of Directors of Mercer Mutual. Eligible Policyholder means a Person who, on the Eligibility Record Date, is a named insured under a Qualifying Policy issued by Mercer Mutual. Employee means any employee of the Holding Company, Mercer Mutual, the Converted Company or their Affiliates. FHC means Franklin Holding Company, Inc., a Delaware insurance holding company, that owns Franklin Insurance Company, a Pennsylvania insurance company, and with respect to which 49% of the voting stock is owned by Mercer Mutual. FHC Certificate of Incorporation means the Third Amended and Restated Certificate of Incorporation of FHC. FHC Shareholders Agreement means the Shareholders Agreement of Franklin Holding Company, Inc. dated June 1, 2002, by and among FHC, Mercer Mutual and H. Thomas Davis. Franklin Settlement Agreement means the Settlement Agreement dated August 18, 2002, between Mercer Mutual and Franklin Mutual Insurance Company pursuant to which Mercer Mutual and Franklin Mutual Insurance Company agreed to terminate certain litigation. Holding Company means Mercer Insurance Group, Inc., a Pennsylvania business corporation incorporated at the direction of Mercer Mutual for the purpose of becoming a holding company for the Converted Company. Holding Company Stock means any and all authorized shares of capital stock of the Holding Company. Local Community means the State of New Jersey and the Commonwealth of Pennsylvania, in their entirety, which States comprise the primary geographic market area of Mercer Mutual. Market Maker means a dealer (i.e., any Person who engages, either for all or part of such Person's time, directly or indirectly, as agent, broker or principal in the business of offering, buying, selling or otherwise dealing or trading in securities issued by another Person) who, with respect to a particular security: (i) regularly publishes bona fide, competitive bid and offer quotations in a recognized interdealer quotation 3 system or furnishes bona fide competitive bid and offer quotations on request, and (ii) is ready, willing and able to effect transactions in reasonable quantities at such dealer's quoted prices with other brokers or dealers. Maximum of the Valuation Range means the valuation that is fifteen percent (15%) above the midpoint of the Valuation Range as provided in Section VII(A)(1) of this Plan. Mercer Mutual means Mercer Mutual Insurance Company. Minimum of the Valuation Range means the valuation that is fifteen percent (15%) below the midpoint of the Valuation Range as provided in Section VII(A)(1) of this Plan. Offering means the offering of Conversion Stock by the Holding Company in the Subscription Offering, the Community Offering and in the Underwritten Public Offering pursuant to this Plan. Officer means an executive officer of the Holding Company, Mercer Mutual or the Converted Company, as the case may be, including the President, the Executive Vice President, any Senior Vice President, and Vice Presidents in charge of principal business functions. Order Form means the original order form or forms to be used by Eligible Policyholders and other Persons eligible to purchase Conversion Stock pursuant to this Plan. Participant means a Person entitled to purchase shares of Conversion Stock in the Subscription Offering, which includes an Eligible Policyholder, a Tax-Qualified Employee Stock Benefit Plan, or a Director, Officer or Employee. Person means any individual, corporation, partnership, association, limited liability company, trust or other entity. Plan means this Plan of Conversion, as it from time to time may be amended, under which Mercer Mutual will convert from a Pennsylvania-chartered mutual insurance company to a Pennsylvania-chartered stock insurance company and become a wholly-owned subsidiary of the Holding Company. Purchase Price means the uniform price per share at which the Conversion Stock will be offered and sold in the Offering, which price shall be determined by the Holding Company in accordance with Section VII(A)(2) of this Plan. Qualifying Policy means a policy of insurance issued by Mercer Mutual and in force as of the close of business on the Eligibility Record Date. Registration Statement means the Registration Statement on Form S-1 and any amendments thereto filed by the Holding Company with the SEC pursuant to the Securities Act of 1933, as amended, to register the offer and sale of shares of Conversion Stock. Resident, as used in this Plan in relation to the preference afforded natural Persons and trusts of natural Persons in the Local Community, means any natural Person who occupies a dwelling within the Local Community, has an intention to remain within the Local Community for a period of time (manifested by establishing a physical, ongoing, non-transitory presence within the Local Community) and continues to reside therein at the time of the Subscription and Community Offerings. Mercer Mutual may utilize policyholder records and such other evidence as it may determine to be relevant to make a determination as to whether a Person resides in the Local Community. In the case of a corporation or other business entity, such entity shall be deemed to be a Resident only if its principal place of business or headquarters is located within the Local Community. All determinations as to the status of a Person as a Resident shall be made by Mercer Mutual in its sole and absolute discretion and shall be final and binding. SEC means the Securities and Exchange Commission or any successor agency. Special Meeting means the Special Meeting of Eligible Policyholders to be called by Mercer Mutual for the purpose of submitting this Plan to Eligible Policyholders for approval. Subscription Offering means the offering by the Holding Company of shares of Conversion Stock to Eligible Policyholders, a Tax-Qualified Employee Stock Benefit Plan and Directors, Officers and Employees. 4 The Holding Company may retain the assistance of a broker-dealer to assist it in connection with the sale of Conversion Stock in the Subscription Offering. Subscription and Community Offering Prospectus means the final prospectus to be used in connection with the Subscription and Community Offerings. Subscription Rights means the non-transferable, non-negotiable, personal rights of Eligible Policyholders, the Tax-Qualified Employee Stock Benefit Plan and Directors, Officers and Employees to subscribe to purchase Conversion Stock at the Purchase Price. Tax-Qualified Employee Stock Benefit Plan means any defined benefit plan or defined contribution plan of Mercer Mutual or of the Holding Company, such as an employee stock ownership plan, stock bonus plan, profit sharing plan or other plan that, with its related trust, meets the requirements to be "qualified" under Section 401 of the Internal Revenue Code of 1986, as amended. The term "Non-Tax-Qualified Employee Stock Benefit Plan" means any defined benefit plan or defined contribution plan which is not so qualified. Underwritten Public Offering means the offer and sale by the Holding Company of Conversion Stock in a best efforts or firm commitment underwritten public offering as contemplated under Section VII of this Plan. The Holding Company may retain the assistance of a broker-dealer or a syndicate of broker-dealers to assist it in connection with the sale of Conversion Stock in the Underwritten Public Offering. Valuation Range means the estimated range of the consolidated pro forma market value of Mercer Mutual as a subsidiary of the Holding Company, to be prepared by the Appraiser as provided in Section VII(A)(1) of this Plan. III. APPLICATION Within 90 days after adoption of this Plan by the Board of Directors of Mercer Mutual and prior to submission of this Plan to the Eligible Policyholders for approval at the Special Meeting, Mercer Mutual shall file the Application. The Application shall contain the following: (A) This Plan; (B) The independent valuation of pro forma market value required by Section VII(A) of this Plan; (C) The form of notice required by this Section III; (D) The form of proxy to be solicited from Eligible Policyholders pursuant to Section IV of this Plan; (E) The form of notice required by Section 809-A of the Act to Persons whose policies are issued after adoption of this Plan but before the Effective Date; (F) The proposed amended Articles of Incorporation and Bylaws of the Converted Company; and (G) The acquisition of control statement, as required by Section 1402 of the Insurance Company Act of 1921, as amended. Upon the filing of the Application, Mercer Mutual shall send a notice by first class mail to each Eligible Policyholder, which notice shall: (i) advise such Eligible Policyholder of the adoption of this Plan, (ii) advise such Eligible Policyholder of the filing of this Plan with the Department, (iii) notify such Eligible Policyholder of his or her right to provide comments on this Plan to the Department and to Mercer Mutual, (iv) advise such Eligible Policyholder of the procedure to be followed in providing comments on this Plan; (v) notify such Eligible Policyholder of his or her right to request and receive a copy of this Plan; and (vi) disclose to such Eligible Policyholder that the initial Plan is not the final approved Plan and that the Commissioner's approval, if any, of the final Plan does not constitute or imply endorsement of this Plan or the Conversion by the Commissioner or the Department. Such notice may be given by mailing one notice to the address of each Qualifying Policy, as such address appears on the records of Mercer Mutual. In the case of a Qualifying Policy with more than one named insured, separate notices to each Person who is an Eligible Policyholder in respect of such Qualifying Policy shall not be required. 5 IV. THE SPECIAL MEETING Following the filing of the Application with, and its approval by, the Department, a Special Meeting to vote on this Plan shall be held by Mercer Mutual in accordance with the bylaws of Mercer Mutual and applicable law. Notice of the Special Meeting will be given by Mercer Mutual to Eligible Policyholders by mailing: (i) a notice of special meeting, (ii) a proxy statement, (iii) a form of proxy authorized for use by the Department, and (iv) a copy of this Plan as approved by the Department, to the address of each Eligible Policyholder as such address appears on the records of Mercer Mutual on the Eligibility Record Date. Distribution of the proxy solicitation materials described in (i)-(iv) above shall commence at least 30 days prior to the date of the Special Meeting. Pursuant to the Act, this Plan must be approved by the affirmative vote of at least two-thirds of the votes cast at the Special Meeting. Voting may be in person or by proxy. The Department shall be promptly notified of the vote of the Eligible Policyholders taken at the Special Meeting. V. DISTRIBUTION OF OFFERING DOCUMENTS The Holding Company may commence the Subscription Offering and, provided that the Subscription Offering has commenced, may commence the Community Offering concurrently with, or any time after, commencement of the solicitation of proxies from Eligible Policyholders. Upon commencement of the Subscription Offering, Mercer Mutual shall mail a Subscription and Community Offering Prospectus to each Eligible Policyholder and, in its discretion, may include the Subscription and Community Offering Prospectus with the mailing of the proxy solicitation materials. The Holding Company may close the Subscription Offering and the Community Offering before the Special Meeting, provided that the sale of the Conversion Stock is conditioned upon approval of this Plan by the Eligible Policyholders. Prior to the commencement of the Subscription and Community Offerings, the Holding Company shall file the Registration Statement with the SEC pursuant to the Securities Act of 1933, as amended. The Holding Company shall not distribute the Subscription and Community Offering Prospectus until the SEC has declared the Registration Statement effective. The Subscription and Community Offering Prospectus may be combined with the proxy statement prepared in connection with the Special Meeting. VI. CONSUMMATION OF CONVERSION The Effective Date will be the date upon which Articles of Conversion are filed by Mercer Mutual in the office of the Department of State of the Commonwealth of Pennsylvania. On the Effective Date, the Conversion Stock will be issued and sold by the Holding Company, the Converted Company Capital Stock will be issued and sold by Mercer Mutual to the Holding Company and the Converted Company will become a wholly-owned subsidiary of the Holding Company. The Converted Company will issue to the Holding Company 100,000 shares of common stock, representing all of the shares of Converted Company Capital Stock to be issued in the Conversion, and the Holding Company will pay to the Converted Company that portion of the aggregate net proceeds realized by the Holding Company from the sale of the Conversion Stock under this Plan as may be determined by the Holding Company, subject to any requirement of the Department. Notwithstanding anything contained herein to the contrary, the Effective Date shall not occur unless the requirement of VII(A)(4) of this Plan that the updated estimated valuation (as described therein) fall within the Valuation Range (as defined therein) is satisfied. 6 VII. THE OFFERING A. DETERMINATION OF THE NUMBER OF SHARES OF CONVERSION STOCK REQUIRED TO BE OFFERED AND SOLD The number of shares of Conversion Stock required to be offered and sold in the Conversion will be determined as follows: 1. Appraiser. An expert who is experienced in the field of corporate appraisals and who is not an Affiliate of the Holding Company or Mercer Mutual (the "Appraiser") will be retained by the Holding Company and Mercer Mutual to prepare an independent valuation of the consolidated pro-forma market value of the Converted Company as a subsidiary of the Holding Company. The Appraiser will establish a valuation range (the "Valuation Range") consisting of a midpoint valuation, a valuation fifteen percent (15%) above the midpoint valuation (the "Maximum of the Valuation Range") and a valuation fifteen percent (15%) below the midpoint valuation (the "Minimum of the Valuation Range"). The valuation of the Appraiser will be based upon the financial condition of Mercer Mutual, a comparison of Mercer Mutual with comparable publicly-held insurance companies, and such other factors as the Appraiser may deem to be relevant and as are not inconsistent with the provisions of the Act, including (as required by the Act) that value which the Appraiser estimates to be necessary to attract a full subscription for the Conversion Stock. The independent valuation of the Appraiser will be submitted to the Department as part of the Application to be filed by Mercer Mutual for approval of the Conversion. 2. Purchase Price. The Purchase Price will be uniform as to all purchasers in the Offering, will be determined by the Holding Company, and will be an amount that when multiplied by the number of shares of Conversion Stock offered (without regard to the shares offered or issued pursuant to clauses VII(A)(3)(ii) and (iii)) is within the Valuation Range. 3. Number of Shares of Conversion Stock to be Offered. The number of shares of Conversion Stock to be offered in the Offering shall be equal to the sum of: (i) the Maximum of the Valuation Range divided by the Purchase Price, plus (ii) the number of shares required to enable the Tax-Qualified Employee Stock Benefit Plan to purchase in the aggregate ten percent (10%) of the total shares of Conversion Stock issued in the Offering. 4. Number of Shares of Conversion Stock to be Sold. Immediately following the completion of the Subscription Offering and the Community Offering, the Appraiser will submit to the Holding Company and to the Department its updated estimate of the pro-forma fair market value of the Converted Company as a subsidiary of the Holding Company, as of the later of the last day of the Subscription Offering or the last day of the Community Offering. If such updated estimated valuation does not fall within the Valuation Range, then the Holding Company, after consultation with the Department, may cancel the Offering and terminate this Plan, establish a new Valuation Range, extend, reopen or hold a new Offering or take such other action as may be authorized by the Department. If such updated estimated valuation falls within the Valuation Range, the following steps will be taken: (a) Subscription Offering Meets or Exceeds Maximum. If, upon conclusion of the Subscription Offering and the Community Offering, the number of shares subscribed for by Participants in the Subscription Offering multiplied by the Purchase Price is equal to or greater than the Maximum of the Valuation Range, then in such event the Conversion shall be promptly consummated and the Holding Company on the Effective Date shall issue shares of Conversion Stock to the subscribing Participants; provided, however, that the number of shares of Conversion Stock issued shall not exceed the number of shares of Conversion Stock offered in the Offering. In the event of an oversubscription in the Subscription Offering, shares of Conversion Stock shall be allocated among the subscribing Participants as provided in Section VII(C) below; provided, however, that no fractional shares of Conversion Stock shall be issued. (b) Subscription Offering Meets or Exceeds Minimum. If, upon conclusion of the Subscription Offering and the Community Offering, the number of shares of Conversion Stock subscribed for 7 by Participants in the Subscription Offering multiplied by the Purchase Price is equal to or greater than the Minimum of the Valuation Range, but less than the Maximum of the Valuation Range, then in such event the Conversion shall be promptly consummated and the Holding Company on the Effective Date shall issue to the subscribing Participants shares of Conversion Stock in an amount sufficient to satisfy the subscriptions of such Participants in full. To the extent that shares of Conversion Stock remain unsold after the subscriptions of all Participants in the Subscription Offering have been satisfied in full, the Holding Company shall have the right in its absolute discretion to accept, in whole or in part, subscriptions received from any or all subscribers in the Community Offering and/or to sell shares of Conversion Stock to purchasers in an Underwritten Public Offering; provided, however, that the number of shares of Conversion Stock issued shall not exceed the number of shares of Conversion Stock offered in the Offering; and, provided further, that no fractional shares of Conversion Stock shall be issued. (c) Subscription Offering Does Not Meet Minimum. If, upon conclusion of the Subscription Offering and the Community Offering, the number of shares of Conversion Stock subscribed for by Participants in the Subscription Offering multiplied by the Purchase Price is less than the Minimum of the Valuation Range, then in such event the Holding Company shall accept subscriptions received from subscribers in the Community Offering and/or sell shares of Conversion Stock to purchasers in an Underwritten Public Offering. If the aggregate number of shares of Conversion Stock subscribed for in the Subscription Offering, the Community Offering and in any Underwritten Public Offering multiplied by the Purchase Price is equal to or greater than the Minimum of the Valuation Range, then in such event the Conversion shall be consummated promptly and the Holding Company on the Effective Date shall: (i) issue to subscribing Participants shares of Conversion Stock in an amount sufficient to satisfy the subscriptions of such Participants in full, and (ii) issue to subscribers in the Community Offering and/or to purchasers in any Underwritten Public Offering such additional number of shares of Conversion Stock such that the aggregate number of shares of Conversion Stock to be issued to subscribing Participants, to subscribers in the Community Offering and/or to purchasers in any Underwritten Public Offering multiplied by the Purchase Price shall be equal to the Minimum of the Valuation Range; provided, however, that no fractional shares of Conversion Stock shall be issued. The Holding Company may in its absolute discretion elect to issue shares of Conversion Stock to subscribers in the Community Offering and/or to purchasers in any Underwritten Public Offering in excess of the number determined by reference to clause (ii) of the preceding sentence; provided, however, that the number of shares of Conversion Stock issued shall not exceed the number of shares of Conversion Stock offered in the Offering. (d) Offering Does Not Meet Minimum. If the aggregate number of shares of Conversion Stock subscribed for in the Subscription Offering, the Community Offering and in any Underwritten Public Offering multiplied by the Purchase Price is less than the Minimum of the Valuation Range, then in such event the Holding Company, in consultation with the Department, may cancel the Offering and terminate this Plan, establish a new Valuation Range, extend, reopen or hold a new Offering or take such other action as may be approved by the Department. If, following a reduction in the Valuation Range approved by the Department, the aggregate number of shares of Conversion Stock subscribed for in the Offering multiplied by the Purchase Price is equal to or greater than the Minimum of the Valuation Range (as such Valuation Range has been reduced), then in such event the Conversion shall be promptly consummated. The Holding Company on the Effective Date shall: (i) issue shares of Conversion Stock to Participants in the Subscription Offering in an amount sufficient to satisfy the subscriptions of such subscribers in full, and (ii) issue to subscribers in the Community Offering and/or to purchasers in any Underwritten Public Offering such additional number of shares of Conversion Stock such that the aggregate number of shares of Conversion Stock to be issued multiplied by the Purchase Price shall be at least equal to the Minimum of the Valuation Range (as such Valuation Range has been reduced). (e) Discretion of the Holding Company; Dilution. Notwithstanding anything to the contrary set forth in this Plan, the Holding Company shall have the right in its absolute discretion and without 8 liability to any subscriber, purchaser, underwriter or any other Person: (i) to determine which subscriptions, if any, to accept in the Community Offering and to accept or reject any such subscription in whole or in part for any reason or for no reason, and (ii) to determine whether and to what extent shares of Conversion Stock are to be sold in an Underwritten Public Offering. Any subscriptions accepted in the Community Offering and any shares of Conversion Stock sold in an Underwritten Public Offering will be dilutive to the ownership interests of Eligible Policyholders. B. SUBSCRIPTION RIGHTS Subscription Rights are nontransferable, nonnegotiable personal rights to subscribe for and purchase shares of Conversion Stock at the Purchase Price. Subscription Rights will be granted by the Holding Company, without payment, to each Participant. The receipt of Subscription Rights by a Participant will permit (but will not require) the Participant to subscribe to purchase shares of Conversion Stock at the Purchase Price in the Subscription Offering. The exercise of Subscription Rights is irrevocable and an executed Order Form may not be modified, amended or rescinded. Conversely, the failure of a Participant to timely deliver a duly executed Order Form, together with full payment for the shares of Conversion Stock subscribed for, will be deemed to constitute an irrevocable waiver and release by the Participant of all rights to subscribe for and purchase Conversion Stock in the Subscription Offering. C. THE SUBSCRIPTION OFFERING Subscription Rights to purchase shares of Conversion Stock at the Purchase Price will be distributed by the Holding Company to the Participants in the following priorities: 1. Eligible Policyholders. Each Eligible Policyholder will receive, without payment, Subscription Rights to purchase up to the lesser of 3.5% or one hundred thousand (100,000) shares of Conversion Stock; provided, however, that the maximum number of shares that may be purchased by Eligible Policyholders in the aggregate shall be equal to the Maximum of the Valuation Range divided by the Purchase Price. In the event of an oversubscription, shares of Conversion Stock will be allocated among subscribing Eligible Policyholders, as follows. First, shares of Conversion Stock will be allocated among subscribing Eligible Policyholders so as to permit each such Eligible Policyholder, to the extent possible, to purchase the lesser of: (i) 1,000 shares, or (ii) the number of shares for which such Eligible Policyholder subscribed. Second, any shares of Conversion Stock remaining after such initial allocation will be allocated among the subscribing Eligible Policyholders whose subscriptions remain unsatisfied in the proportion in which: (i) the aggregate number of shares as to which each such Eligible Policyholder's subscription remains unsatisfied bears to (ii) the aggregate number of shares as to which all such Eligible Policyholders' subscriptions remain unsatisfied; provided, however, that no fractional shares of Conversion Stock shall be issued. If, because of the magnitude of the oversubscription, shares of Conversion Stock cannot be allocated among subscribing Eligible Policyholders so as to permit each such Eligible Policyholder to purchase the lesser of 1,000 shares or the number of shares subscribed for, then shares of Conversion Stock will be allocated among the subscribing Eligible Policyholders in the proportion in which: (i) the aggregate number of shares subscribed for by each such Eligible Policyholder bears to (ii) the aggregate number of shares subscribed for by all Eligible Policyholders; provided, however, that no fractional shares of Conversion Stock shall be issued. 2. Tax-Qualified Employee Stock Benefit Plans. The Tax-Qualified Employee Stock Benefit Plan will receive, without payment, Subscription Rights to purchase in the aggregate up to ten percent (10%) of the shares of Conversion Stock to be issued in the Conversion. An oversubscription by Eligible Policyholders shall not reduce the number of Subscription Rights that a Tax-Qualified Employee Stock Benefit Plan will receive pursuant to this paragraph. 3. Directors, Officers and Employees. Each Director, Officer and Employee will receive, without payment, Subscription Rights to purchase up to the lesser of 3.5% or one hundred thousand (100,000) shares of Conversion Stock; provided, however, that such Subscription Rights shall be subordinated to the Subscription Rights received by Eligible Policyholders and may be exercised only to the extent that 9 there are shares of Conversion Stock that could have been purchased by Eligible Policyholders, but which remain unsold after satisfying the subscriptions of all Eligible Policyholders. In the event of an oversubscription among the Directors, Officers and Employees, shares of Conversion Stock shall be allocated among them on the basis of a point system under which one point will be assigned for each year of service to Mercer Mutual, one point for each then current annual salary increment of $5,000, and one point for each office held in Mercer Mutual. Each subscribing Director, Officer or Employee will then receive that number of shares of Conversion Stock equal to the remaining unallocated shares of Conversion Stock multiplied by a fraction the numerator of which is the number of points held by such Director, Officer or Employee and the denominator of which is the total number of points held by all subscribing Directors, Officers and Employees. A Director, Officer or Employee who subscribes to purchase shares of Conversion Stock and who also is eligible to purchase shares of Conversion Stock as an Eligible Policyholder will be deemed to purchase Conversion Stock first in his or her capacity as an Eligible Policyholder. D. COMMUNITY OFFERING To the extent that fewer than the maximum number of shares of Conversion Stock permitted to be sold to Eligible Policyholders, any Tax-Qualified Employee Stock Benefit Plan and to the Directors, Officers and Employees are purchased in the Subscription Offering, shares of Conversion Stock may be sold to subscribers in the Community Offering or Syndicated Community Offering as provided in Section VII(A) above. Shares of Conversion Stock will be offered in the Community Offering (which may commence concurrently with the Subscription Offering) to the general public, giving preference to: (i) natural Persons and the trusts of natural Persons (including individual retirement and Keogh retirement accounts and personal trusts in which such natural Persons have substantial interests) who are Residents of the Local Community, (ii) principals of Eligible Policyholders in the case of an Eligible Policyholder that is a corporation, partnership, limited liability company or other entity, (iii) licensed insurance agencies that have been appointed by Mercer Mutual to market and distribute policies of insurance, and their affiliates, (iv) named insureds under policies of insurance issued by Mercer Mutual after December 13, 2002, and (v) providers of goods or services to Mercer Mutual. In the event that the Holding Company elects to sell shares of Conversion Stock to subscribers in the Community Offering, shares of Conversion Stock will be allocated among such subscribers by the Holding Company in its sole discretion and the Holding Company will have the right in its sole discretion to accept or reject subscriptions from subscribers in the Community Offering, including the preferred subscribers described in clauses (i)-(v) of this paragraph, in whole or in part for any reason or for no reason. Subject to the preferences described in the preceding paragraph, the Conversion Stock to be offered in the Community Offering shall be offered and sold in a manner designed to achieve a wide distribution of the Conversion Stock. E. UNDERWRITTEN PUBLIC OFFERING. To the extent that fewer than the maximum number of shares of Conversion Stock permitted to be sold to Eligible Policyholders, any Tax-Qualified Employee Stock Benefit Plan and to the Directors, Officers and Employees are purchased in the Subscription Offering, shares of Conversion Stock may be sold in an Underwritten Public Offering as provided in Section VII(A) above. In the event that an Underwritten Public Offering is impractical, the Holding Company will consult with the Department to determine the most practical alternative available to effect the completion of the Conversion, including a reduction in the Valuation Range. F. LIMITATIONS UPON PURCHASES OF SHARES OF CONVERSION STOCK. The following additional limitations and exceptions shall apply to all purchases of Conversion Stock: 1. To the extent that shares are available, no Person may purchase fewer than the lesser of 25 shares of Conversion Stock or shares of Conversion Stock having an aggregate purchase price of $500.00 in the Conversion. 10 2. Purchases of shares of Conversion Stock in the Offering by any Person, when aggregated with purchases by such Person's Affiliates and Associates, or by a group of Persons Acting in Concert, shall not exceed the lesser of 3.5% or one hundred thousand (100,000) shares of Conversion Stock, except that Tax-Qualified Employee Stock Benefit Plans may purchase up to ten percent (10%) of the total shares of Conversion Stock issued in the Offering. 3. Officers and Directors, together with their Associates, may not purchase in the aggregate more than thirty-three percent (33.0%) of the shares of Conversion Stock issued in the Offering. 4. For purposes of determining compliance with paragraphs 2 and 3 above, (i) Holding Company Stock issued pursuant to the FHC Shareholder Agreement shall not be aggregated with shares of Conversion Stock purchased by any Participant in the Subscription Offering, and (ii) shares of Conversion Stock to be held by the Tax-Qualified Employee Stock Benefit Plans and attributable to a Participant thereunder shall not be aggregated with shares of Conversion Stock purchased by such Participant or any other purchaser of Conversion Stock in the Conversion. 5. Directors shall not be deemed to be Associates of one another or a group Acting in Concert with other Directors solely as a result of membership on the Board of Directors of the Holding Company or the Board of Directors of Mercer Mutual or any subsidiary of Mercer Mutual. Subject to any required regulatory approval and the requirements of applicable law, the Holding Company may increase or decrease any of the purchase limitations set forth herein at any time; provided that in no event shall the maximum purchase limitation percentage applicable to Eligible Policyholders be less than the maximum purchase limitation percentage applicable to any other class of subscribers or purchasers in the Offerings. In the event that the individual purchase limitation is increased after commencement of the Subscription Offering and the Community Offering, the Holding Company shall permit any Person who subscribed for the maximum number of shares of Conversion Stock to purchase an additional number of shares, such that such Person shall be permitted to subscribe for the then maximum number of shares permitted to be subscribed for by such Person, subject to the rights and preferences of any Person who has priority Subscription Rights. In the event that either the individual purchase limitation or the number of shares of Conversion Stock to be sold in the Conversion is decreased after commencement of the Subscription Offering and the Community Offering, the order of any Person who subscribed for the maximum number of shares of Conversion Stock shall be decreased by the minimum amount necessary so that such Person shall be in compliance with the then maximum number of shares permitted to be subscribed for by such Person. Each Person purchasing Conversion Stock in the Conversion shall be deemed to confirm that such purchase does not conflict with the purchase limitations under this Plan or otherwise imposed by law. In the event that such purchase limitations are violated by any Person (including any Associate or Affiliate of such Person or Person otherwise Acting in Concert with such Person), the Holding Company shall have the right to purchase from such Person at the Purchase Price all shares acquired by such Person in excess of any such purchase limitation or, if such excess shares have been sold by such Person, to receive the difference between the aggregate Purchase Price paid for such excess shares and the proceeds received by such Person from the sale of such excess shares. This right of the Holding Company to purchase such excess shares shall be assignable by the Holding Company. G. RESTRICTIONS ON AND OTHER CHARACTERISTICS OF CONVERSION STOCK. 1. Transferability. Conversion Stock purchased by Persons other than Directors and Officers may be transferred without restriction under this Plan. Conversion Stock purchased by such Directors and Officers may not be sold for a period of one (1) year from the Effective Date, provided that a sale by a personal representative of a deceased Director or Officer shall not be considered a sale by such Director or Officer. 11 The certificates representing shares of Conversion Stock issued by the Holding Company to such Directors and Officers shall bear the following legend: The shares of stock evidenced by this Certificate are restricted as to transfer pursuant to the provisions of the Pennsylvania Insurance Company Mutual-to-Stock Conversion Act (the "Conversion Act") and the Securities Act of 1933, as amended (the "Securities Act"), and may not be sold without an opinion of counsel for Mercer Insurance Group, Inc. that such sale is permissible under the provisions of the Conversion Act and the Securities Act. In addition, the Holding Company shall give appropriate instructions to its transfer agent with respect to the foregoing restrictions. Any shares of Holding Company Stock subsequently issued pursuant to a stock dividend, stock split or otherwise, with respect to such restricted shares of Conversion Stock shall be subject to the same restrictions as are then applicable to such restricted shares of Conversion Stock. 2. Voting Rights. After the consummation of the Conversion, exclusive voting rights with respect to the Holding Company shall be vested in the holders of Holding Company Stock and the Holding Company will have exclusive voting rights with respect to the Converted Company Capital Stock. 3. Purchases by Officers, Directors and Associates Following Conversion. Without the prior approval of the Commissioner, Officers and Directors of the Converted Company and Officers and Directors of the Holding Company, and their Associates, shall be prohibited for a period of three (3) years following the Effective Date from purchasing outstanding shares of Holding Company Stock, except through a broker-dealer. Notwithstanding this restriction: (i) block purchases involving more than one percent (1%) of the then outstanding shares of Holding Company Stock may be made without the use of a broker-dealer if approved in writing by the Department, and (ii) purchases may be made by or for the account of an Officer or Director (a) pursuant to a Tax-Qualified Employee Stock Benefit Plan or (b) pursuant to a Non-Tax-Qualified Employee Stock Benefit Plan approved by the shareholders of the Holding Company pursuant to Section 921-A(b) of the Act. H. MAILING OF OFFERING MATERIALS AND COLLECTION OF SUBSCRIPTIONS. After approval of this Plan by the Department and the declaration of the effectiveness of the Registration Statement by the SEC, the Holding Company shall distribute the Subscription and Community Offering Prospectus and Order Forms for the purchase of shares of Conversion Stock in accordance with the terms of this Plan. The recipient of an Order Form must properly complete, execute and return the original Order Form to the Holding Company on or before the last day of the Subscription Offering or the Community Offering, as the case may be. Photocopies of Order Forms will not be accepted. A self-addressed, postage paid return envelope shall accompany the Order Form when delivered by the Holding Company to a potential subscriber. The Holding Company will collate the returned Order Forms upon completion of the Subscription Offering and the Community Offering. The failure by a Person to return a properly completed and executed original Order Form within the prescribed time limit shall be deemed a waiver and a release by such Person of any right to purchase shares of Conversion Stock hereunder. The sale of all shares of Conversion Stock shall be completed within 45 days after the last day of the Subscription Offering unless extended by the Holding Company with the approval of the Department. I. METHOD OF PAYMENT. Payment for all shares of Conversion Stock subscribed for in the Subscription Offering and the Community Offering must be received in full by the Holding Company, together with properly completed and executed Order Forms indicating the number of shares being subscribed for and such other information as may be required thereon, on or prior to the expiration date specified on the Order Form, unless such date is extended by the Holding Company. Payment for all shares of Conversion Stock may be made by check or money order. 12 Tax-Qualified Employee Stock Benefit Plans may subscribe for shares of Conversion Stock by submitting an Order Form, together with (in the case of an employee stock ownership plan) evidence of a loan commitment from the Holding Company or an unrelated financial institution for the purchase of the shares of Conversion Stock, during the Subscription Offering and by making payment for the shares subscribed for on or before the Effective Date. J. UNDELIVERED, DEFECTIVE OR LATE ORDER FORMS, INSUFFICIENT PAYMENT. In the event that an Order Form: (i) is not delivered to the addressee and is returned to the Holding Company by the United States Postal Service (or the Holding Company or Mercer Mutual are unable to locate the addressee); (ii) is not received by the Holding Company or is received by the Holding Company after the date specified thereon; (iii) is a photocopy or is defectively completed or executed, (iv) is not accompanied by payment in full for the shares of Conversion Stock subscribed for, or (v) is violative of the Act or this Plan in any way, then the Subscription Rights of the Person to whom such rights have been granted will not be honored and such Person will be treated as having failed to return the completed Order Form within the time period specified. Alternatively, the Holding Company may (but will not be required to) waive any irregularity relating to any Order Form or require the submission of a corrected Order Form or the remittance of full payment for the shares of Conversion Stock subscribed for by such date as the Holding Company may specify. Subscription orders, once tendered, may not be revoked. The Holding Company's determinations with respect to the acceptability of the Order Forms will be final, conclusive and binding upon all Persons and neither the Holding Company nor Mercer Mutual (or the Directors, Officers, Employees and agents of any of them) shall be liable to any Person in connection with any such determination. K. PERSONS WHO RESIDE IN NON-QUALIFIED STATES OR IN FOREIGN COUNTRIES. The Holding Company will make reasonable efforts to comply with the securities laws of all states in the United States in which Persons entitled to subscribe for Conversion Stock pursuant to this Plan reside. However, the Holding Company shall not be required to offer or sell Conversion Stock to any Person who resides in a foreign country or who resides in a state of the United States with respect to which any of the following apply: (i) a small number of Persons otherwise eligible to subscribe for shares of Conversion Stock under this Plan reside in such state or foreign country, (ii) the granting of Subscription Rights or the offer or sale of shares of Conversion Stock to such Person would require the Holding Company or Mercer Mutual or their Employees to register under the securities laws of such state as a broker, dealer, salesman or agent or to register or otherwise qualify its securities for sale in such state or foreign country, or (iii) such registration qualification would be impracticable for reasons of cost or otherwise. No payment will be made to any Person in lieu of the granting of Subscription Rights to any such Person. L. SALES COMMISSIONS. Sales commissions may be paid as determined by the Holding Company or its designee to securities dealers assisting subscribers in making purchases of Conversion Stock in the Subscription Offering or in the Community Offering. In addition, a sales commission may be paid to a securities dealer for advising and consulting with respect to, or for managing the sale of Conversion Stock in, the Subscription Offering, the Community Offering or any other offering. M. FRACTIONAL SHARES. No fractional shares of Conversion Stock shall be issued in the Conversion. All allocations required to be made hereunder in the event of an oversubscription in the Subscription Offering shall be rounded down to the nearest whole share. 13 N. REPURCHASE OF CONVERSION STOCK. Without the prior approval of the Department, for a period of three (3) years from the Effective Date, neither the Holding Company nor the Converted Company shall repurchase any Holding Company Stock from any Person, except that this restriction shall not apply to either: (1) A repurchase on a pro rata basis pursuant to an offer made to all shareholders of the Holding Company; or (2) A purchase in the open market by a Tax-Qualified or Non-Tax-Qualified Employee Stock Benefit Plan in an amount reasonable and appropriate to fund such Tax-Qualified or Non-Tax-Qualified Employee Stock Benefit Plan. VIII. ARTICLES OF INCORPORATION As part of the Conversion, Articles of Incorporation will be adopted by Mercer Mutual to authorize the Converted Company to operate as a Pennsylvania stock insurance company. By approving this Plan, the Eligible Policyholders of Mercer Mutual also will approve amending Mercer Mutual's existing Articles of Incorporation. Prior to completion of the Conversion, the form of amended Articles of Incorporation may be revised in accordance with the provisions and limitations for amending this Plan under Section XI below. The amendment of the existing Articles of Incorporation of Mercer Mutual shall occur on the Effective Date. IX. REGISTRATION AND MARKET MAKERS In connection and concurrently with the Conversion, the Holding Company shall register the Holding Company Stock with the SEC pursuant to the Securities Exchange Act of 1934, as amended. The Holding Company shall use its best efforts to encourage and assist various Market Makers to establish and maintain a market for the Holding Company Stock. The Holding Company also shall use its best efforts to have the Holding Company Stock quoted on the National Association of Securities Dealers Automated Quotation System or listed on a national or regional securities exchange. X. STATUS OF POLICIES IN FORCE ON THE EFFECTIVE DATE Each policy of insurance issued by Mercer Mutual and in force on the Effective Date shall remain in force as a policy issued by the Converted Company in accordance with the terms of such policy, except that, as of the Effective Date: (i) all voting rights (if any) of the holder of such policy shall be extinguished, (ii) all rights (if any) of the holder of such policy to share in the surplus of Mercer Mutual or the Converted Company shall be extinguished, and (iii) in the case of a participating policy, the Converted Company shall have the right on the renewal date of such policy to issue a nonparticipating policy as a substitute for the participating policy. XI. INTERPRETATION, AMENDMENT AND TERMINATION OF THE PLAN A. INTERPRETATION OF THIS PLAN The Board of Directors of Mercer Mutual and the Board of Directors of the Holding Company shall have the exclusive authority to interpret and apply the provisions of this Plan to particular facts and circumstances and to make all determinations necessary or desirable to implement this Plan. Any such interpretation, application or determination made in good faith and on the basis of such information and assistance as was then reasonably available for such purpose, shall be final, conclusive and binding upon all Persons, and neither the Holding Company nor Mercer Mutual (or the Directors, Officers, Employees or agents of either of them) shall be liable to any Person in connection with any such interpretation, application or determination. 14 B. AMENDMENT This Plan may be amended, as follows: 1. Before Approval by the Department. This Plan may be amended at any time before it is approved by the Department by the affirmative vote of two-thirds of the Directors of the Holding Company and two-thirds of the Directors of Mercer Mutual then in office. 2. After Approval by the Department. This Plan may be amended at any time after its approval by the Department by the affirmative vote of two-thirds of the Directors of the Holding Company and two-thirds of the Directors of Mercer Mutual then in office; provided, however, that any such amendment shall be subject to approval by the Department. 3. After Approval by the Eligible Policyholders. This Plan may be amended at any time after its approval by the Eligible Policyholders and prior to the Effective Date by the affirmative vote of two-thirds of the Directors of the Holding Company and two-thirds of the Directors of Mercer Mutual then in office; provided, however, that any such amendment shall be subject to approval by the Department; and provided further that, if such amendment is determined by the Department to be material, such amendment shall be subject to approval by the affirmative vote of at least two-thirds of the votes cast at a meeting of the Eligible Policyholders called for that purpose. 4. Certain Conforming Amendments. In the event that the Department adopts mandatory regulations applicable to the Conversion prior to the Effective Date, this Plan may be amended to conform to such regulations at any time prior to the Effective Date by the affirmative vote of two-thirds of the Directors of the Holding Company and two-thirds of the Directors of Mercer Mutual then in office and no resolicitation of proxies or further approval by the Eligible Policyholders shall be required. In the event that the Department adopts regulations applicable to the Conversion prior to the Effective Date and if such regulations contain optional provisions, this Plan may be amended to conform to any such optional provision at any time before the Effective Date by the affirmative vote of two-thirds of the Directors of the Holding Company and two-thirds of the Directors of Mercer Mutual then in office, and no resolicitation of proxies or further approval by the Eligible Policyholders shall be required. C. TERMINATION This Plan may be terminated as follows: 1. Before Approval by the Department. This Plan may be terminated at any time before it is approved by the Department by the affirmative vote of two-thirds of the Directors of the Holding Company and two-thirds of the Directors of Mercer Mutual then in office. 2. After Approval by the Department. This Plan may be terminated at any time after it is approved by the Department by the affirmative vote of two-thirds of the Directors of the Holding Company and two-thirds of the Directors of Mercer Mutual then in office. 3. After Approval by the Eligible Policyholders. This Plan may be terminated at any time after it is approved by the Eligible Policyholders and prior to the Effective Date by the affirmative vote of two-thirds of the Directors of the Holding Company and two-thirds of the Directors of Mercer Mutual then in office. D. BINDING UPON ELIGIBLE POLICYHOLDERS By approving this Plan, the Eligible Policyholders of Mercer Mutual authorize the amendment and termination of this Plan in accordance with the provisions of this Section XI. XII. STOCK COMPENSATION PLAN It is the intention of the Holding Company to adopt a stock compensation plan (the "Stock Compensation Plan"). In accordance with the requirements of the Act, the Stock Compensation Plan will be 15 subject to approval by the shareholders of the Holding Company at a meeting to be held after the expiration of six (6) months from the Effective Date. The Stock Compensation Plan will authorize the Board of Directors of the Holding Company to grant to Directors, Officers and Employees (i) options to purchase in the aggregate that number of shares of Holding Company Stock equal to ten percent (10%) of the number of shares sold in the Offering, and (ii) in the aggregate, that number of restricted shares of Holding Company Stock equal to four percent (4%) of the number of shares sold in the Offering, which shares of restricted stock will vest at a rate no greater than ratably over a period of five (5) years (i.e., if vesting is ratable, then twenty percent (20%) of the shares would vest each year on the anniversary of the date of grant), except that accelerated vesting will be permitted under the Stock Compensation Plan upon the occurrence of certain events specified therein. XIII. OTHER ISSUANCE OF HOLDING COMPANY STOCK OUTSIDE OF THE PLAN On May 31, 2001, Mercer Mutual acquired 49% of the voting common stock and 50% of the nonvoting series A preferred stock of FHC. Pursuant to the FHC Shareholder Agreement and the FHC Certificate of Incorporation, in the event of the Conversion of Mercer Mutual, the holders of all capital stock of FHC have the right to exchange their FHC capital stock for that number of shares of Holding Company Stock equal to the value of each class of FHC capital stock, as determined pursuant to the FHC Shareholders Agreement and the FHC Certificate of Incorporation, divided by the Purchase Price. Holding Company Stock issued to the holders of capital stock of FHC will be dilutive to the ownership interests of Eligible Policyholders. Pursuant to the Franklin Settlement Agreement, the parties agreed that, in the event of a Conversion, (i) Mercer Mutual will grant to Franklin Mutual Insurance Company the right to purchase the same number of shares of Holding Company Stock as an Eligible Policyholder can purchase under Section VII(C)(1) of this Plan, and (ii) Franklin Mutual Insurance Company will not interfere with the Conversion or support or finance any other Person in doing so. If Franklin Mutual Insurance Company exercises its option to acquire Holding Company Stock, any shares of Holding Company Stock so issued, if any, will be dilutive to the ownership interests of Eligible Policyholders. 16 EX-10.10 6 e85343a2exv10w10.txt SHAREHOLDERS AGREEMENT DATED JUNE 1, 2001 EXHIBIT 10.10 SHAREHOLDERS AGREEMENT OF FRANKLIN HOLDING COMPANY, INC. This Shareholders Agreement (this "Agreement"), dated as of the 1st day of June, 2001, is entered into by and among MERCER MUTUAL INSURANCE COMPANY, a Pennsylvania corporation ("Mercer"), H. THOMAS DAVIS ("Davis"), and FRANKLIN HOLDING COMPANY, INC., a Delaware corporation (the "Company"). Background Mercer has entered into a stock purchase agreement (the "Stock Purchase Agreement") with Davis and the Company, dated April 6, 2001 for the purchase of 102,900 shares of Class A voting common stock, $0.10 par value per share, of the Company ("Class A Stock") and options to acquire 295,000 shares of Class B non-voting stock, $0.10 par value per share, of the Company ("Class B Stock"). A condition to the obligations of the parties under the Stock Purchase Agreement, pursuant to Section 7.1 (d) thereof, is the mutual execution of this Agreement by Mercer, the Company and Davis, the controlling stockholder of the Company. Desiring Mercer's purchase of the Class A Stock and the options to acquire Class B Stock pursuant to the terms of the Stock Purchase Agreement, Davis is willing to enter into this Agreement. NOW THEREFORE, in consideration of the foregoing recitals and the mutual covenants hereinafter contained, and intending to be legally bound thereby, the parties hereto agree as follows: Certain Definitions "Affiliate" with respect to any Person (other than Davis) means a Person that directly or indirectly through one or more intermediaries controls, is controlled by or is under common control with the person specified, as well as, with respect to Davis only, any transferee who received Davis Stock in an Exempt Transaction. "Class A Stock" has the meaning set forth in the background hereof. "Class B Stock" has the meaning set forth in the background hereof. 1 "Company Quarterly Net Income" means the consolidated net income of the Company for such calendar quarter determined in accordance with GAAP. "Company Quarterly ROI Factor" means, for any particular calendar quarter, a fraction (expressed as a decimal) the numerator of which is the Company Quarterly Net Income for such quarter and the denominator of which is the sum of (i) $5,050,920, and (ii) the qualified amount of cash or the fair value of any property hereafter invested in shares of the capital stock of the Company or contributed to the capital accounts of the Company. For purposes of this definition, the qualified amount of any investment or contribution shall be any amount invested or contributed to the Company by Mercer or an Affiliate of Mercer with the knowledge and consent of Davis, including his consent to the determination of the fair market value of any property contributed or invested. "Company Aggregate ROI Factor" means, as of the date of determination, the sum of each Company Quarterly ROI Factor for the period beginning with the calendar quarter that starts on July 1, 2001, and ending with the last full calendar quarter immediately preceding the date of determination. "Davis Options" means all options for Class B Stock held by Davis. "Davis Shares" means all shares of Class A Stock and Class B Stock and all Davis Options at any time issued to Davis. "Disability" means a mental or physical disability, incapacity or incompetence of an individual that either (a) renders such individual permanently disabled so that such individual is prevented from properly performing the duties previously performed by such individual as certified by a physician selected by the Company within thirty (30) days of such disability, incapacity or incompetence, such certification to be determined within ten (10) days of selection; or (b) has prevented such individual from properly performing a major portion of the duties performed by such individual prior to such disability, incapacity or incompetence for a period of six (6) consecutive months or for shorter periods aggregating nine (9) months or more in any 12 month period; or (c) causes the appointment of a guardian for such individual which would restrict such individual's ability to act on his own. "Exempt Transaction" means: (i) a transfer by Davis of any Davis Shares to a family member or to a trust for the benefit of Davis and/or a family member, or transfers among 2 such family members or trusts, (ii) a transfer of Davis Shares under Davis' or a family member's last will and testament or, in the absence of a last will and testament, as a consequence of the laws of descent, (iii) a transfer of Davis Shares to an entity owned solely by Davis and/or any of the transferees described in clause (i) or (ii) above, but only for so long as such entity is so owned, (iv) a transfer of Davis Shares resulting from a divorce decree, divorce settlement, or the laws of equitable distribution in divorce, or (v) a transfer effected by Davis' grant of an encumbrance to any lender providing purchase money financing to Davis for the purchase of Davis Shares or to the successors or assigns of such lender. "GAAP" means generally accepted accounting principles, as set forth in the opinions and pronouncements of the Accounting Principles Board of the American Institute of Certified Public Accountants and statements and pronouncements of the Financial Accounting Standards Board or in such other statements by such other entities as may be approved by a significant segment of the accounting profession of the United States of America. "Mercer Quarterly Net Income" means the consolidated net income of Mercer for such calendar quarter before policyholder dividends, determined in accordance with GAAP. "Mercer Quarterly ROE Factor means, for any particular calendar quarter, a fraction (expressed as a decimal) the numerator of which is the Mercer Quarterly Net Income for such quarter and the denominator of which is the surplus of Mercer at the commencement of such calendar quarter determined in accordance with GAAP. "Mercer Aggregate ROE Factor" means, as of the date of determination, the sum of each Mercer Quarterly ROE Factor for the period beginning with the calendar quarter that starts on July 1, 2001, and ending with the last full calendar quarter immediately preceding the date of determination. "Person" means any natural person or individual, trustee, corporation, general or limited partnership, limited liability company or partnership, joint venture, joint stock company, bank, firm, governmental entity, trust, association, organization or unincorporated entity of any kind. "Stock Purchase Agreement" has the meaning set forth in the background hereof. "Transfer" means, collectively, any sale, assignment, encumbrance, hypothecation, pledge, conveyance in trust, gift, transfer by bequest, devise or descent, or other 3 transfer or disposition of any kind, including, but not limited to, transfers to receivers, levying creditors, trustees or receivers in bankruptcy proceedings for general assignees for the benefit of creditors, whether voluntary or by operation of law, indirectly or indirectly. Terms of Agreement 1. Restricted Period. During the period beginning on the date hereof and ending on the second anniversary hereof (the "Restricted Period"), neither Davis, nor any of his Affiliates, shall Transfer any Davis Shares to any Person other than Mercer, other than pursuant to an Exempt Transaction or except in accordance with the terms of this Agreement. Any purported Transfer of Davis Shares in violation of the terms of this Agreement shall be void. In the event of a Transfer pursuant to an Exempt Transaction, Davis shall provide written notice thereof to Mercer and the Company not later than the effective date of such Exempt Transaction. 2. Right of First Refusal. (a) Offer to Purchase. If, at any time after the Restricted Period, Davis desires to Transfer any Davis Shares to any Person (the "Proposed Transferee") other than pursuant to an Exempt Transaction, and has received a bona fide written offer (the "Bona Fide Offer") from such Proposed Transferee to purchase such Davis Shares, Davis shall submit a written offer (the "Offer") to sell such Davis Shares (the "Offered Shares") to Mercer on terms and conditions, including price, not less favorable to Mercer than those on which Davis proposes to Transfer such Offered Shares to the Proposed Transferee. (i) The Offer shall disclose the identity of the Proposed Transferee, the number of Offered Shares proposed to be Transferred, and the terms and conditions, including price, of the proposed Transfer, and shall be accompanied by a copy of the Bona Fide Offer. The Offer shall further state that Mercer may acquire, in accordance with the provisions of this Agreement, all, but not less than all, of the Offered Shares for the price and upon the other terms and conditions, including deferred payment (if applicable), of the proposed Transfer to the Proposed Transferee set forth therein. (ii) If the purchase price to be paid by the Proposed Transferee is to be payable in property other than in cash, Mercer shall have the right to pay the purchase price in the form of cash in an amount equal to the fair market value (as determined in good faith by 4 [____________]) of such non-cash property. In the event of any dispute between Davis and Mercer regarding the determination of the fair market value of non-cash property, at the request of either of them, the Company shall engage a consulting or investment banking firm selected by the Board of Directors of the Company and approved by Davis and Mercer to prepare an independent appraisal of the fair market value of such property, which appraisal shall be binding. The expense of any appraisal by such a consulting or investment banking firm shall be borne by the Company. (b) Exercise of Purchase Right by Company. If Mercer desires to purchase all of the Offered Shares, Mercer shall deliver a written notice of its election to purchase such Offered Shares to Davis, which shall be delivered in person or mailed to Davis within 30 days of the date of receipt by Mercer of the Offer. Such notice, when taken in conjunction with the Offer, shall be deemed to constitute a valid, legally binding and enforceable agreement for the sale and purchase of such Offered Shares to Mercer on the terms of the Offer as set forth in Section 2 (a) hereof. The closing of the sale of Offered Shares to Mercer pursuant to this Section 2 (b) shall be made at the offices of the Company on such date as may be agreed by Mercer and Davis but no later than the 60th day following the date the Offer is received by Davis (or if such 60th day is not a business day, then on the next succeeding business day). Such sale shall be effected by Davis' delivery to Mercer of a certificate or certificates evidencing the Offered Shares, duly endorsed for Transfer to Mercer, against payment to Davis of the purchase price by Mercer. The exercise or non-exercise by Mercer of its rights pursuant to this Section 2 shall be without prejudice to its rights under this Section 2 with respect to any future sales of Offered Shares. (c) Transfer of Offered Shares to Proposed Transferee. If Mercer does not purchase all of the Offered Shares, the Offered Shares may be Transferred by Davis at any time within 150 days after the date the Offer was made to Davis. Any such Transfer shall be to the Proposed Transferee, at not less than the price and upon other terms and conditions, if any, not more favorable to the Proposed Transferee than those specified in the Offer subject to the provisions of this Section 2 (c). Davis shall provide written notice of such sale (the "Notice") to the Company and Mercer not later than the date of sale. Any Offered Shares not Transferred within the 150 day period shall again be subject to the requirements of a prior offer pursuant to this Section 2. If Offered Shares are Transferred pursuant to this Section 2 to any purchaser who 5 is not a party to this Agreement, the Offered Shares so Transferred shall no longer be subject to any of the restrictions imposed by this Agreement. 3. Exchange Rights. In the event of a conversion of Mercer from the mutual form of organization to the stock form of organization, including the simultaneous acquisition of Mercer by a publicly traded company (the Publicly Traded Acquirer), or any similar transaction (collectively, a "Conversion"), Davis shall have the right to exchange any and all of the Davis Shares for such number of shares ( the "Exchange Shares") of registered voting common stock of Mercer or the Publicly Traded Acquirer (the "Share Exchange") as determined in accordance with this Section 3(a), by notifying Mercer of his intent on or before the later of the 30th day after the receipt by Davis of : (i) a final prospectus forming a part of a registration statement declared effective under the Securities Act of 1933, as amended, or (ii) any supplement to such prospectus. In exchange for the Davis Shares, Davis shall receive, and Mercer shall, or Mercer shall cause the Publicly Traded Acquirer to, issue to Davis such number of Exchange Shares that equals the product of (i) the number of Davis Shares and (ii) the Share Value per share (as defined in Section 6 hereof) divided by the initial price to the public of the common stock of Mercer or Publicly Traded Acquirer as the case may be. If Davis fails to provide timely notice of his intent or indicates in such notice that Davis does not intend to exercise his right to the Share Exchange, Mercer shall have the right to compel the Share Exchange, by providing written notice thereof to Davis not later than 60 days prior to the closing of the Conversion. In such event, Davis shall cooperate in the Share Exchange by executing such documents and taking such other actions, in a timely manner, as may be required to complete the Share Exchange simultaneously with the closing of the Conversion. 4. Davis' Put Right. Davis or his personal representative, as applicable, shall have the right to require Mercer to purchase, and Mercer shall be obligated to purchase, the Davis Shares ("Put") at the Share Value per share, (a) at any time on or after September 3, 2007, or (b) prior to such date, in the event of (i) his death or Disability, (ii) the expiration of the employment agreement between Mercer and Davis (unless immediately renewed and continued) or the termination (except as a result of his resignation without good reason or termination for cause) of his employment with Mercer or (iii) the acquisition, merger, consolidation, or reorganization of Mercer in a transaction not described in Section 3 with any public or private company or with a mutual company if, after such event, the individuals who, immediately before 6 such acquisition, merger, consolidation, or reorganization, were members of the Mercer Board of Directors, do not continue to constitute at least a majority of the board of directors of the surviving entity. To exercise such Put right, Davis or his personal representative, as applicable, shall give written notice thereof to Mercer. In the case of an event described in clause (b) of this Section, such notice shall describe such event with specificity and be given not more than 90 days after the event giving rise to the Put right. The closing of such transaction shall occur at a place and at a time mutually agreeable to the Parties but in no event shall the time of closing be later that 60 days after the date of notice. If the Parties cannot agree on the place for closing, such place shall be the principal place of business of the Company at such time. 5. Mercer's Call Right. Mercer shall have the right to purchase, and Davis or his personal representative, as applicable, shall be obligated to sell, any Davis Shares ("Call") at the Share Value per share, (a) at any time on or after September 3, 2007, or (b) in the event Davis resigns his employment with Mercer during the three (3) year period beginning as of the date hereof without good reason. To exercise such Call right, Mercer shall give written notice thereof to Davis or his personal representative. In the case of an event described in clause (b) of this Section, such notice shall describe such event with specificity and be given not more than 30 days after the event giving rise to the Call right. The closing of such transaction shall occur at a place and at a time mutually agreeable to the Parties but in no event shall the time of closing be later that 60 days after the date of notice. If the Parties cannot agree on the place for closing, such place shall be the principal place of business of the Company at such time. 6. Determination of Value. In determining either (a) the consideration payable to Davis in the event of a Put or a Call, or (b) the number of Exchange Shares to be exchanged in connection with the Conversion, or (c) the amount of cash, securities or combination thereof to be received by Davis in connection with the Merger, as applicable, the total amount of consideration to be received by Davis shall be equal, in the aggregate, to the value of the Davis Shares (the "Share Value") sold or exchanged, as applicable. The Share Value per share of the Davis Shares, as of any date, shall equal the greatest of: (a) the product of (x) $10.00 and (y) the sum of (i) 1.00 and (ii) the Company Aggregate ROI Factor, 7 (b) the product of (x) $10.00 times (y) the sum of (i) 1.00 and (ii) the Mercer Aggregate ROE Factor, or (c) $10.00. The Share Value shall be determined (A) in the case of the Merger, as of the effective date thereof, (B) in the case of the Share Exchange, as of the effective date of the Conversion, and (C) in the case of a Put or Call, as of the date of the event giving rise to such Put or Call, as applicable. By way of example only, Exhibit 1, attached hereto and made a part hereof, sets forth the method for calculating the Share Value per share of Davis Shares. 7. Special Provisions Concerning Davis Options. In the event that any unexercised Davis Options are subject to a Share Exchange, Share Conversion, Put or Call, Davis may exercise such Davis Options to purchase shares of Class B Stock not later than immediately prior to, or concurrently with, the closing of such event; provided that any Davis Options not so exercised shall nevertheless be deemed to have been exercised on a net basis as of the time immediately prior to the closing of such event. By way of example only, if Davis holds options for 295,000 shares of stock with an option exercise price of $10.00 per share, and the Share Value of the stock is $15.00 per share, then Davis shall be entitled, on a net basis, to the issuance of 147,500 shares of stock without payment by Davis (i.e. [295,000 X ($15.00-$10.00)/$10.00] = 147,500 shares). Such "net" shares shall then be subject to the Share Exchange, Share Conversion, Put or Call, as applicable. Subject to customary antidilution provisions that will be set forth in an amended option agreement, in no event shall Davis be entitled to the issuance of shares on a "net basis" that is in excess of the number of shares that may be acquired pursuant to outstanding Davis Options. 8. Injunction; Specific Performance. Because of the unique character of the securities of the Company and the important business purposes underlying this Agreement, each Party acknowledges that he or it will be irreparably damaged in the event this Agreement is not specifically enforced. If any dispute arises concerning the Transfer of any securities of the Company, an injunction may be issued restraining that sale or disposition until the controversy has been resolved. If any controversy arises concerning a right or obligation to purchase or sell any securities of the Company, that right or obligation may be enforced in a court of equity by a 8 decree of specific performance. However, that remedy shall be cumulative and not exclusive, enforceable singly, alternatively, successively or concurrently. 9. Election of Mercer and Davis Directors. Concurrently with the execution of this Agreement and the closing of the transactions contemplated by the Stock Purchase Agreement, the existing directors of the Company and its Subsidiary will tender their resignations and Davis and Mercer hereby agree to elect a Board of Directors of the Company and its Subsidiary that shall consist of the existing directors of Mercer, Davis and one additional director designated by Davis. In addition, concurrently with the closing of the transactions contemplated by the Stock Purchase Agreement, Mercer hereby agrees to elect Davis a director of Mercer and each of its subsidiaries. For so long as Davis and Mercer each continue to own any Class A Shares, they hereby agree to elect: (i) Davis and his designee to the Board of Directors of the Company and its Subsidiary, (ii) Davis to the Board of Directors of Mercer and each of its subsidiaries, and (iii) the nominees designated by Mercer for election to the Board of Directors of the Company and its Subsidiary. After closing under the Stock Purchase Agreement and for so long as Davis and Mercer each continue to own any Class A Shares, Davis hereby agrees not to take any action to expand the size of the Board of Directors of the Company without the concurrence of Mercer. 10. Termination of Agreement. All of the provisions of this Agreement, shall terminate on the date the Company is required to file reports with respect to any class of its common stock with the Securities and Exchange Commission pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, except with respect to any notices issued prior to that date under the provisions of this Agreement. 11. Shares to Bear Legend. All certificates evidencing Davis Shares (whether now outstanding or hereafter issued) shall bear the following conspicuous legend: "This stock certificate and the shares represented hereby are held subject to the terms, covenants and conditions of an agreement dated June 1, 2001, by and among the Company and certain of its stockholders, as it may be amended or restated from time to time, and may not be transferred or disposed of except in accordance with the terms and conditions thereof. A copy of such agreement is on file and may be inspected at the offices of the Company. These securities have not been registered under the Securities 9 Act of 1933, as amended, or any state securities law, including the Pennsylvania Securities Act of 1972. These securities may not be transferred in the absence of an effective registration statement or an opinion from counsel to the Company that registration is not required." 12. Binding Effect. This Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective legal representatives, heirs, legatees, successors and assigns. 13. Amendments. The provision of this Agreement, including the provisions of this sentence, may be amended, modified or supplemented only by a written instrument executed by (i) holders of at least a majority of Davis Shares, and (ii) Mercer. 14. Governing Law. This Agreement shall be governed by and construed in accordance with the laws of the Commonwealth of Pennsylvania. 15. Interpretation. The headings of the sections contained in this Agreement are solely for the purpose of reference, are not part of the agreement of the parties and shall not affect the meaning or interpretation of this Agreement. 16. Notices. All notices and other communications hereunder shall be in writing and shall be deemed given if delivered personally or by commercial delivery services, or mailed by registered or certified mail (return receipt requested) or sent via facsimile (with confirmation of receipt) to the parties at the following address (or at such other address for a party as shall be specified by like notice): if to Mercer, to: Mercer Mutual Insurance Company Route 31 North Pennington, New Jersey Attention: Andrew R. Speaker, President and Chief Executive Officer Facsimile No.: 609-737-8719 Telephone No.: 609-737-0426 10 with a copy to: Stevens & Lee 1275 Drummers Lane P.O. Box 236 Wayne, Pennsylvania 19087-0236 Attention: Jeffrey P. Waldron Facsimile No.: 610-687-1384 Telephone No.: 610-293-4961 to the Company, to: Franklin Holding Company, Inc. 214 East Church Street Lock Haven, Pennsylvania 17745 Facsimile No.: 717-570-6655 Telephone No.: 717-570-3234 with a copy to: Rosenn, Jenkins & Greenwald, LLP 15 South Franklin Street Wilkes-Barre, Pennsylvania 18711 Attention: Bruce C. Rosenthal, Esquire Facsimile No.: 570-826-5640 Telephone No.: 570-826-5643 if to Davis, to: H. Thomas Davis Franklin Insurance Company 214 East Church Street Suite 100 Lock Haven, Pennsylvania 17743 with a copy to: Rosenn, Jenkins & Greenwald, LLP 15 South Franklin Street Wilkes-Barre, Pennsylvania 18711 Attention: Bruce C. Rosenthal, Esquire Facsimile No.: 570-826-5640 Telephone No.: 570-826-5643 17. Counterparts. This Agreement may be executed in one or more counterparts, all of which shall be considered one and the same agreement and shall become 11 effective when one or more counterparts have been signed by each of the parties and delivered to the other Parties, it being understood that all Parties need not sign the same counterpart. 18. Waiver and Consent. No action taken pursuant to this Agreement, including, without limitation, any investment by or on behalf of any party, shall be deemed to constitute a waiver by the party taking such action of compliance with any representations, warranties, covenants or agreements contained herein. The waiver by any party hereto of a breach of any provision of this Agreement shall not operate or be construed as a waiver of any preceding or succeeding breach and no failure by any party to exercise any right or privilege hereunder shall be deemed a waiver of such party's rights or privileges hereunder or shall be deemed a waiver of such party's rights to exercise the same at any subsequent time or times hereunder. Each party hereto, in addition to being entitled to exercise all rights provided herein, in the charter or granted by law, including recovery of damages, will be entitled to specific performance of its rights under this Agreement. Each party hereto agrees that monetary damages would not be adequate compensation for any loss incurred by reason of a breach by it of the provisions of this Agreement and hereby agrees to waive that defense in any action for specific performance that a remedy at law would be adequate. 12 19. Inspection. Copies of this Agreement will be available for inspection or copying by any party at the offices of the Company through the Secretary of the Company. IN WITNESS WHEREOF, the parties have executed the Agreement as of the date first above written. MERCER MUTUAL INSURANCE COMPANY By:/s/ Andrew R. Speaker _________________________________________ Andrew R. Speaker, President and Chief Executive Officer WITNESS: /s/ H. Thomas Davis ___________________________ ____________________________________________ H. THOMAS DAVIS, individually FRANKLIN HOLDING COMPANY, INC. By:/s/ H. Thomas Davis _________________________________________ H. Thomas Davis, President and Chief Executive Officer 13 EXHIBIT 1 Calculation of Share Value Assume the following Company Quarterly Net Income, a valuation of the Company of $5,050,920 (210,000 shares x $24.052) and no further investment by Mercer in the Company.
- ----------------------------------------------------------------------------------- Company Quarter Ending Company Quarterly Net Company Quarterly ROI Aggregate ROI Income Factor Factor - ----------------------------------------------------------------------------------- 9/30/01 $ (505,092) (0.10) (0.10) - ----------------------------------------------------------------------------------- 12/31/01 $ 252,546 0.05 (0.05) - ----------------------------------------------------------------------------------- 03/31/02 $ (50,509) (0.01) (0.06) - ----------------------------------------------------------------------------------- 6/30/02 $ 1,010,184 0.20 (0.14) - ----------------------------------------------------------------------------------- 9/30/02 $ 505,092 0.10 (0.24) - -----------------------------------------------------------------------------------
Mercer Aggregate ROE Factor is assumed in the examples below but not illustrated as above Example 1 Date of Event - December 29, 2001 Company Aggregate ROI Factor = (.10) $10.00 x (1-.10) $ 9.00 Mercer Aggregate ROE Factor = 0.15 $10.00 x (1+.15) $11.50 Minimum Share Value $10.00 Share Value (greatest of) $11.50
Example 2 Date of Event - October 15, 2002 Company Aggregate ROI Factor = 0.24 $10.00 x (1+.24) $12.40 Mercer Aggregate ROE Factor = 0.15 $10.00 x (1+.15) $11.50 Minimum Share Value $10.00 Share Value (greatest of) $12.40
14 [LETTERHEAD OF MERCER INSURANCE GROUP] July 7, 2003 Mr. H. Thomas Davis, Jr. 143 Davis Lane Lock Haven, PA 17745 Dear Tom: Reference is made to Section 6 of the Shareholders Agreement of Franklin Holding Company, Inc. ("Franklin") dated June 1, 2001, by and among you, Franklin and Mercer Mutual Insurance Company. The first sentence of the last paragraph of Section 6 is hereby amended to read as follows: The Share Value shall be determined (A) in the case of the Merger, as of the effective date thereof, (B) in the case of the Share Exchange, as of the date of the most recent audited or interim balance sheet of Mercer included in the registration statement filed with and declared effective by the Securities and Exchange Commission in connection with the Conversion, and (C) in the case of a Put or Call, as of the date of the event giving rise to such Put or Call, as applicable. If the foregoing is acceptable to you, please execute the enclosed copy of this letter in the space provided below. MERCER MUTUAL INSURANCE COMPANY By: /s/ Andrew R. Speaker --------------------------------------- Andrew R. Speaker, President and Chief Executive Officer ACCEPTED AND AGREED /s/ H. Thomas Davis, Jr. - --------------------------- H. Thomas Davis, Jr. EX-10.12 7 e85343a2exv10w12.txt MERCER MUTUAL STOCK-BASED INCENTIVE PLAN MERCER INSURANCE GROUP, INC. 2003 STOCK-BASED INCENTIVE PLAN MERCER INSURANCE GROUP, INC. 2003 STOCK-BASED INCENTIVE PLAN TABLE OF CONTENTS
ARTICLE PAGE - ------- ---- Article 1. PURPOSE OF THE PLAN; TYPES OF AWARDS 1 Article 2. DEFINITIONS 1 Article 3. ADMINISTRATION 5 Article 4. COMMON STOCK SUBJECT TO THE PLAN 6 Article 5. ELIGIBILITY 7 Article 6. STOCK OPTIONS IN GENERAL 7 Article 7. TERM, VESTING AND EXERCISE OF OPTIONS 9 Article 8. EXERCISE OF OPTIONS FOLLOWING TERMINATION OF EMPLOYMENT 10 Article 9. RESTRICTED STOCK 12 Article 10. STOCK APPRECIATION RIGHTS 13 Article 11. ADJUSTMENT PROVISIONS 13 Article 12. SPECIAL PROVISIONS RELATING TO DIRECTOR AWARDS 15 Article 13. GENERAL PROVISIONS 15
ARTICLE 1. PURPOSE OF THE PLAN; TYPES OF AWARDS 1.1 Purpose. The Mercer Insurance Group, Inc. 2003 Stock-Based Incentive Plan is intended to provide selected Employees and Directors of Mercer Insurance Group, Inc. and its Subsidiaries with an opportunity to acquire Common Stock of the Corporation. The Plan is designed to help the Corporation and its Subsidiaries attract, retain and motivate selected persons to make substantial contributions to the success of the Corporation's business and the businesses of its Subsidiaries. Awards will be granted under the Plan based, among other things, on the Participant's level of responsibility and performance within the Corporation and its Subsidiaries. 1.2 Authorized Plan Awards. Incentive Stock Options, Nonqualified Stock Options, Restricted Stock and SARs (including Tandem SARs) may be awarded within the limitations of the Plan herein described; provided, however, that Incentive Stock Options (including Tandem SARs coupled with Incentive Stock Options) may not be granted to Directors. ARTICLE 2. DEFINITIONS 2.1 "Agreement". A written instrument evidencing the grant of an Award. A Participant may be issued one or more Agreements from time to time, reflecting one or more Awards. 2.2 "Award". The grant of an Option, Restricted Stock or an SAR (including a Tandem SAR). 2.3 "Board". The Board of Directors of the Corporation. 2.4 "Change in Control". Except as otherwise provided in an Agreement, the first to occur of any of the following events: (a) any "Person" (as such term is used in Sections 13(d) and 14(d) of the Exchange Act), except for any of the Corporation's or a Subsidiary's employee benefit plans, or any entity holding the Corporation's voting securities for, or pursuant to, the terms of any such plan (or any trust forming a part thereof) (the "Benefit Plan(s)"), is or becomes the beneficial owner, directly or indirectly, of the Corporation's securities representing 19.9% or more of the combined voting power of the Corporation's then outstanding securities other than pursuant to a transaction excepted in Clause (c) or (d); (b) there occurs a contested proxy solicitation of the Corporation's shareholders that results in the contesting party obtaining the ability to vote securities representing 19.9% or more of the combined voting power of the Corporation's then outstanding securities; (c) a binding written agreement is executed (and, if legally required, approved by the Corporation's shareholders) providing for a sale, exchange, transfer or other disposition of all or substantially all of the assets of the Corporation to another entity, 1 except to an entity controlled directly or indirectly by the Corporation; (d) the shareholders of the Corporation approve a merger, consolidation, or other reorganization of the Corporation, unless: (i) under the terms of the agreement approved by the Corporation's shareholders providing for such merger, consolidation or reorganization, the shareholders of the Corporation immediately before such merger, consolidation or reorganization, will own, directly or indirectly immediately following such merger, consolidation or reorganization, at least 51% of the combined voting power of the outstanding voting securities of the Corporation resulting from such merger, consolidation or reorganization (the "Surviving Corporation") in substantially the same proportion as their ownership of the voting securities immediately before such merger, consolidation or reorganization; (ii) under the terms of the agreement approved by the Corporation's shareholders providing for such merger, consolidation or reorganization, the individuals who were members of the Board immediately prior to the execution of such agreement will constitute at least 51% of the members of the board of directors of the Surviving Corporation after such merger, consolidation or reorganization; and (iii) based on the terms of the agreement approved by the Corporation's shareholders providing for such merger, consolidation or reorganization, no Person (other than (A) the Corporation or any Subsidiary of the Corporation, (B) any Benefit Plan, (C) the Surviving Corporation or any Subsidiary of the Surviving Corporation, or (D) any Person who, immediately prior to such merger, consolidation or reorganization had beneficial ownership of 19.9% or more of the then outstanding voting securities) will have beneficial ownership of 19.9% or more of the combined voting power of the Surviving Corporation's then outstanding voting securities; (e) a plan of liquidation or dissolution of the Corporation, other than pursuant to bankruptcy or insolvency laws, is adopted; or (f) during any period of two consecutive years, individuals, who at the beginning of such period, constituted the Board cease for any reason to constitute at least a majority of the Board unless the election, or the nomination for election by the Corporation's shareholders, of each new director was approved by a vote of at least two-thirds of the directors then still in office who were directors at the beginning of the period. Notwithstanding Clause (a), a Change in Control shall not be deemed to have occurred if a Person becomes the beneficial owner, directly or indirectly, of the Corporation's securities representing 19.9% or more of the combined voting power of the Corporation's then outstanding securities solely as a result of an acquisition by the Corporation of its voting securities which, by 2 reducing the number of shares outstanding, increases the proportionate number of shares beneficially owned by such Person to 19.9% or more of the combined voting power of the Corporation's then outstanding securities; provided, however, that if a Person becomes a beneficial owner of 19.9% or more of the combined voting power of the Corporation's then outstanding securities by reason of share purchases by the Corporation and shall, after such share purchases by the Corporation, become the beneficial owner, directly or indirectly, of any additional voting securities of the Corporation (other than as a result of a stock split, stock dividend or similar transaction), then a Change in Control of the Corporation shall be deemed to have occurred with respect to such Person under Clause (a). In no event shall a Change in Control of the Corporation be deemed to occur under Clause (a) with respect to Benefit Plans. 2.5 "Code". The Internal Revenue Code of 1986, as amended. 2.6 "Committee". The Compensation Committee of the Board, or any successor to such committee. 2.7 "Common Stock". The common stock of the Corporation (no par value) as described in the Corporation's Articles of Incorporation, or such other stock as shall be substituted therefor. 2.8 "Corporation". Mercer Insurance Group, Inc., a Pennsylvania corporation. 2.9 "Director". A non-employee director of the Corporation or a Subsidiary. 2.10 "Disability". Permanent and total disability, within the meaning of such term in Code Section 22(e)(3). 2.11 "Effective Date". The effective date of the Plan as provided in Section 13.1. 2.12 "Employee". Any common law employee of the Corporation or a Subsidiary. 2.13 "Exchange Act". The Securities Exchange Act of 1934, as amended. 2.14 "Fair Market Value". The amount determined as such with respect to a share of Common Stock pursuant to the provisions of Section 6.3. 2.15 "Incentive Stock Option". A Stock Option intended to satisfy the requirements of Code Section 422(b). 2.16 "Initial Public Offering". The initial public offering of Common Stock that occurs on [INSERT THE DATE OF CONVERSION], 2003. 2.17 "Nonqualified Stock Option". A Stock Option other than an Incentive Stock Option. 2.18 "Optionee". A Participant who is awarded a Stock Option pursuant to the 3 provisions of the Plan. 2.19 "Participant". An Employee or Director to whom an Award has been granted and remains outstanding. 2.20 "Performance Criteria". Any objective test based on one or more of the following areas of performance of the Corporation, a Subsidiary, or any division, department or group of either: (a) earnings, (b) cash flow, (c) revenue, (d) financial ratios, (e) market performance, (f) shareholder return, (g) operating profits (including earnings before interest, taxes, depreciation and amortization), (h) earnings per share, (i) return on assets, (j) return on equity, (k) return on investment, (l) stock price and (m) expense reduction. Performance Criteria shall be derived from the financial statements of the Corporation and its Subsidiaries prepared in accordance with generally accepted accounting principles consistently applied, or, for Performance Criteria that cannot be so derived, under a methodology established by the Committee prior to the issuance of a Performance Grant that is consistently applied. 2.21. "Performance Goal". A goal established by the Committee, with respect to an Award intended to constitute a Performance Grant, that relates to one or more Performance Criteria. A Performance Goal shall relate to such period of time, not less than one year (unless coupled with a vesting schedule of at least one year) or more than three years, as may be specified by the Committee at the time of the awarding of a Performance Grant. 2.22. "Performance Grant". An Award, the vesting or receipt without restriction of which, is conditioned on the satisfaction of one or more Performance Goals. 2.23 "Plan". The Mercer Insurance Group, Inc. 2003 Stock-Based Incentive Plan. 2.24 "Reference Value". The dollar amount fixed as such at the date of the grant of an SAR, which amount shall not be less than the Fair Market Value of the Common Stock on such date. 2.25 "Restricted Stock". A grant of Common Stock pursuant to the provisions of the Plan, which grant is subject to such restrictions and other conditions as may be specified by the Committee at the time of such grant. 2.26 "Retirement". The termination of a Participant's employment following attainment of age 65. 2.27 "SAR". A stock appreciation right, which represents the potential right to receive the increase (if any) in the Fair Market Value of a share of Common Stock on the date of the exercise of such right over the Reference Value of such share on the date the right is granted. 2.28 "Securities Act". The Securities Act of 1933, as amended. 2.29 "Stock Option" or "Option". A grant of a right to purchase Common Stock pursuant to the provisions of the Plan. 4 2.30 "Subsidiary". A subsidiary corporation, as defined in Code Section 424(f), that is a subsidiary of a relevant corporation. 2.31 "Tandem SAR". An SAR granted in connection with the concurrent grant of an Option, which SAR shall expire to the extent the related Option is exercised and vice versa. ARTICLE 3. ADMINISTRATION 3.1 The Committee. The Plan shall be administered by the Compensation Committee of the Board or any successor committee. The Committee shall be composed of three or more members of the Board, all of whom are (a) "non-employee directors" as such term is defined under the rules and regulations adopted from time to time by the Securities and Exchange Commission pursuant to Section 16(b) of the Exchange Act, (b) "outside directors" within the meaning of Code Section 162(m), and (iii) "independent" within the meaning of any applicable Nasdaq Stock Market listing requirement or the requirement of any other market or exchange on which the Common Stock is listed. The Board may from time to time remove members from, or add members to, the Committee. Vacancies on the Committee, howsoever caused, shall be filled by the Board. 3.2 Powers of the Committee. (a) The Committee shall be vested with full authority to make such rules and regulations as it deems necessary or desirable to administer the Plan and to interpret the provisions of the Plan, unless otherwise determined by a majority of the disinterested members of the Board. Any determination, decision or action of the Committee in connection with the construction, interpretation, administration or application of the Plan shall be final, conclusive and binding upon all Participants and any person claiming under or through a Participant, unless otherwise determined by a majority of the disinterested members of the Board. (b) Subject to the terms, provisions and conditions of the Plan and subject to review and approval by a majority of the disinterested members of the Board, the Committee shall have exclusive jurisdiction to: (i) determine and select the Employees to be granted Awards (it being understood that more than one Award may be granted to the same person); (ii) determine the number of shares subject to each Award; (iii) determine the date or dates when the Awards will be granted; (iv) determine the exercise price of shares subject to Options in accordance with Article 6; 5 (v) determine the date or dates when an Option may be exercised within the term of the Option specified pursuant to Article 7; (vi) determine whether an Option constitutes an Incentive Stock Option or a Nonqualified Stock Option; (vii) determine the Reference Value applicable to SARs (including Tandem SARs) granted under the Plan; (viii) prescribe the form, which shall be consistent with the Plan document, of the Agreement evidencing any Awards granted under the Plan; and (ix) prescribe such administrative forms as are deemed necessary for the proper operation of the Plan, including, if deemed appropriate, a beneficiary designation form. 3.3 Liability. No member of the Board or the Committee shall be liable for any action or determination made in good faith by the Board or the Committee with respect to this Plan or any Awards granted under this Plan. 3.4 Establishment and Certification of Performance Goals. The Committee shall establish, prior to grant, Performance Goals with respect to each Award intended to constitute a Performance Grant. Notwithstanding anything herein to the contrary, no Option or SAR (including a Tandem SAR) that is intended to constitute a Performance Grant may be exercised until the Performance Goal or Goals applicable thereto is or are certified as having been satisfied by the Committee, nor shall any share of Restricted Stock that is intended to constitute a Performance Grant be released to a Participant until such certification is made. 3.5 Performance Grants Not Mandatory. Nothing herein shall be construed as requiring that any Award be made a Performance Grant. ARTICLE 4. COMMON STOCK SUBJECT TO THE PLAN 4.1 Common Stock Authorized. The aggregate number of shares of Common Stock with respect to which Awards may be granted under this Plan shall not exceed 14% of the shares of Common Stock offered and sold in the Initial Public Offering; provided, however, that Restricted Stock Awards made under this Plan shall not exceed 4% of the shares of Common Stock so offered and sold. The limitation established by the preceding sentence shall be subject to adjustment as provided in Article 11. 4.2 Shares Available. The Common Stock to be issued under the Plan shall be the Corporation's Common Stock which shall be made available at the discretion of the Board, either from authorized but unissued Common Stock or from Common Stock acquired by the Corporation, including shares purchased in the open market. 6 4.3 Use and Replenishment of Authorized Shares. All Awards shall be charged, on a share-for-share basis, against the shares authorized under Section 4.1; provided, however, that shares subject to a Tandem SAR shall be charged against the authorized shares only once for the overall number of shares subject thereto and not for both the number of shares subject to the SAR portion of the Award and the number of shares subject to the Option portion of the Award. The provisions of the preceding sentence shall apply whether an exercised SAR is settled in cash or stock, or partly in both. In the event that any outstanding Award under the Plan for any reason expires, terminates or is forfeited, the shares of Common Stock allocable to such expiration, termination or forfeiture may thereafter again be made subject to an Award under the Plan; provided, however, shares subject to a Tandem SAR shall be replenished only once for the overall number of shares subject thereto and not for both the number of shares subject to the SAR portion of the Award and the number of shares subject to the Option portion of the Award. ARTICLE 5. ELIGIBILITY 5.1 Participation. Except as otherwise provided herein, Awards shall be granted by the Committee only to persons who are Employees and shall be ratified by a majority of the disinterested members of the Board. 5.2 Incentive Stock Option Eligibility. Notwithstanding any other provision of the Plan to the contrary, an individual who owns more than ten percent of the total combined voting power of all classes of outstanding stock of the Corporation shall not be eligible for the grant of an Incentive Stock Option, unless the special requirements set forth in Sections 6.1 and 7.1 are satisfied. For purposes of this section, in determining stock ownership, an individual shall be considered as owning the stock owned, directly or indirectly, by or for his brothers and sisters (whether by the whole or half blood), spouse, ancestors and lineal descendants. Stock owned, directly or indirectly, by or for a corporation, partnership, estate or trust shall be considered as being owned proportionately by or for its shareholders, partners or beneficiaries. "Outstanding stock" shall include all stock actually issued and outstanding immediately before the grant of the Option. "Outstanding stock" shall not include shares authorized for issue under outstanding options held by an Optionee or by any other person. ARTICLE 6. STOCK OPTIONS IN GENERAL 6.1 Exercise Price. The exercise price of an Option to purchase a share of Common Stock shall be, in the case of an Incentive Stock Option, not less than 100% of the Fair Market Value of a share of Common Stock on the date the Option is granted, except that the exercise price shall be not less than 110% of such Fair Market Value in the case of an Incentive Stock Option granted to any individual described in Section 5.2. The exercise price of an Option to purchase a share of Common Stock shall be, in the case of a Nonqualified Stock Option, not less than 100% percent of the Fair Market Value of a share of Common Stock on the date the Option is granted. The exercise price shall be subject to adjustment as provided in Article 11. 6.2 Limitation on Incentive Stock Options. The aggregate Fair Market Value 7 (determined as of the date an Option is granted) of the Common Stock with respect to which Incentive Stock Options are exercisable for the first time by any individual in any calendar year (under the Plan and all other plans maintained by the Corporation and Subsidiaries) shall not exceed $100,000. 6.3 Determination of Fair Market Value. (a) During such time as the Common Stock is not listed on an established stock exchange or exchanges but is quoted on the NASDAQ National Market System, the Fair Market Value per share of the Common Stock shall be the closing sale price for such a share on the relevant day. If no sale of Common Stock has occurred on that day, the Fair Market Value shall be determined by reference to such price for the next preceding day on which a sale occurred. (b) During such time as the Common Stock is not listed on an established stock exchange or quoted on the NASDAQ National Market System, the Fair Market Value per share of the Common Stock shall be the mean between the closing "bid" and "asked" prices for such a share on the relevant day. If no closing "bid" and "asked" prices are quoted for that day, the Fair Market Value shall be determined by reference to such prices for the next preceding day on which such closing prices were quoted. (c) If the Common Stock is listed on an established stock exchange or exchanges, the Fair Market Value per share of the Common Stock shall be the composite closing sale price for such a share on the relevant day. If no sale of Common Stock has occurred on that day, the Fair Market Value shall be determined by reference to such price for the next preceding day on which a sale occurred. (d) In the event that the Common Stock is not traded on an established stock exchange or quoted on the NASDAQ National Market System, and no closing "bid" and "asked" prices are available on a relevant day, then the Fair Market Value per share of Common Stock will be the price established by the Committee in good faith. In connection with determining the Fair Market Value of a share of Common Stock on any relevant day, the Committee may use any source deemed reliable; and its determination shall be final and binding on all affected persons, absent clear error. 6.4 Limitation on Option Awards. Commencing on the Effective Date, grants under this Plan (and any plan of the Corporation or a Subsidiary providing for stock option awards) to an Employee described in Code Section 162(m)(3) shall not exceed, in the aggregate, Options to acquire 125,000 shares of Common Stock during any period of 12 consecutive months. Such limitation shall be subject to adjustment in the manner described in Article 11. The limitation in this section shall not include Options that are granted as part of Tandem SARs. 6.5 Transferability of Options. (a) Except as provided in Subsection (b), an Option granted hereunder shall 8 not be transferable other than by will or the laws of descent and distribution, and such Option shall be exercisable, during the Optionee's lifetime, only by him or her. (b) An Optionee may, with the prior approval of the Committee, transfer a Nonqualified Stock Option (but not a Nonqualified Stock Option that is part of a Tandem SAR) for no consideration to or for the benefit of one or more members of the Optionee's "immediate family" (including a trust, partnership or limited liability company for the benefit of one or more of such members), subject to such limits as the Committee may impose, and the transferee shall remain subject to all terms and conditions applicable to the Option prior to its transfer. The term "immediate family" shall mean an Optionee's spouse, parents, children, stepchildren, adoptive relationships, sisters, brothers and grandchildren (and, for this purpose, shall also include the Optionee). ARTICLE 7. TERM, VESTING AND EXERCISE OF OPTIONS 7.1 Term and Vesting. Each Option granted under the Plan shall terminate on the date determined by the Committee and approved by a majority of the disinterested members of the Board, and specified in the Agreement; provided, however, that (i) each intended Incentive Stock Option granted to an individual described in Section 5.2 shall terminate not later than five years after the date of grant, (ii) each other intended Incentive Stock Option shall terminate not later than ten years after the date of grant, and (iii) each Option granted under the Plan which is intended to be a Nonqualified Stock Option shall terminate not later than ten years and one month after the date of grant. Each Option granted under the Plan shall be exercisable (i.e., become vested) only after the earlier of the date on which (i) the Optionee has completed one year of continuous employment with the Corporation or a Subsidiary immediately following the date of the grant of the Option (or such later date as may be specified in an Agreement, including a date that may be tied to the satisfaction of one or more Performance Goals) or (ii) unless otherwise provided in an Agreement, a Change in Control occurs. Notwithstanding the preceding sentence, any Option Agreement may provide that vesting will be accelerated in the event of death or Disability. An Option may be exercised only during the continuance of the Optionee's employment, except as provided in Article 8. 7.2 Exercise. (a) A person electing to exercise an Option shall give written notice to the Corporation of such election and of the number of shares he or she has elected to purchase, in such form as the Committee shall have prescribed or approved, and shall at the time of exercise tender the full exercise price of the shares he or she has elected to purchase. The exercise price shall be paid in full, in cash, upon the exercise of the Option; provided, however, that in lieu of cash, with the approval of the Committee at or prior to exercise, an Optionee may exercise an Option by tendering to the Corporation shares of Common Stock owned by him or her and having a Fair Market Value equal to the cash exercise price applicable to the Option (with the Fair Market Value of such stock to be determined in the manner provided in Section 6.3) or by delivering such combination of cash and such shares as the Committee in its sole discretion may approve. 9 Notwithstanding the foregoing, Common Stock may not be tendered as payment unless it has been held, beneficially and of record, for at least six months (or such longer time as may be required by applicable securities law or accounting principles to avoid adverse consequences to the Corporation or a Participant). (b) A person holding more than one Option at any relevant time may, in accordance with the provisions of the Plan, elect to exercise such Options in any order. (c) At the request of the Participant and to the extent permitted by applicable law, the Committee may, in its sole discretion, selectively approve arrangements whereby the Participant irrevocably authorizes a third party to sell shares of Common Stock (or a sufficient portion of the shares) acquired upon the exercise of an Option and to remit to the Corporation a sufficient portion of the sales proceeds to pay the entire exercise price and any tax withholding required as a result of such exercise. (d) In the case of the death of a Participant, any vested Award shall be exercisable by his or her estate (or the person to whom the Option is lawfully distributed by the estate) in accordance with the conditions and limitations of the Plan, unless a valid beneficiary designation form providing otherwise is on file with the Corporation. ARTICLE 8. EXERCISE OF OPTIONS FOLLOWING TERMINATION OF EMPLOYMENT 8.1 Retirement. In the event of an Optionee's termination of employment due to Retirement, the vested portion of his or her Option shall lapse at the earlier of the expiration of the term of the Option or: (a) in the case of an Incentive Stock Option, three months from the date of Retirement; and (b) in the case of a Nonqualified Stock Option, up to 24 months from the date of Retirement (as specified in the relevant Agreement). 8.2 Death or Disability. In the event of termination of an Optionee's employment due to his or her death or Disability, the vested portion of his or her Option shall lapse at the earlier of (a) the expiration of the term of the Option, or (b) one year after termination due to such a cause. 8.3 Termination For Cause. In the event of an Optionee's termination of employment "for cause," the vested portion of his or her Option shall lapse on the date of such termination. Termination "for cause" shall mean the Optionee was terminated after: (a) any government regulatory agency recommends or orders in writing that the Corporation or a Subsidiary terminate the employment of the Optionee or relieve him or her of his or her duties; 10 (b) the Optionee is convicted of or enters a plea of guilty or nolo contendere to a felony, a crime of falsehood, or a crime involving fraud or moral turpitude, or the actual incarceration of the Optionee for a period of 45 consecutive days; or (c) the Optionee willfully fails to follow the lawful instructions of the Board (or the board of directors of a Subsidiary) after receipt of written notice of such instructions, other than a failure resulting from the Optionee's incapacity because of physical or mental illness. 8.4 Special Termination Provisions. (a) Notwithstanding anything herein to the contrary, in the case of a corporate downsizing, the Retirement of an Optionee or other circumstances where it is deemed equitable to do so, the Committee may, in its discretion and subject to the approval of a majority of the disinterested members of the Board, waive the one-year (or other) continuous service requirement for vesting specified in an Agreement pursuant to Section 7.1 and permit the exercise of an Option held by an Optionee prior to the satisfaction of such requirement. Any such waiver may be made with retroactive effect, provided it is made within 60 days following the Optionee's termination of employment. (b) In the event the Committee waives the continuous service requirement with respect to an Option and the circumstance of an Optionee's termination of employment is described in Section 8.1 or 8.2, the affected Option will lapse as otherwise provided in the relevant section. (c) Notwithstanding anything herein to the contrary, in the case of a corporate downsizing or other circumstances where it is deemed equitable to do so, the Committee may, in its discretion and subject to the approval of a majority of the disinterested members of the Board, waive the otherwise applicable lapse provision of the Option of a Participant and permit its exercise until a date which is the earlier of the expiration of the term of the Option or: (i) in the case of an Incentive Stock Option, three months from the date of termination of employment; and (ii) in the case of a Nonqualified Stock Option, up to 24 months from the date of termination of employment (as specified in the relevant resolution). (d) No exercise of discretion under this section with respect to an event or person shall create an obligation to exercise such discretion in any similar or same circumstance. 8.5 Other Termination By the Corporation or Optionee. Except as otherwise provided elsewhere in this article, (a) in the event of an Optionee's termination of employment at the election of the Corporation or a Subsidiary, his or her Option shall lapse at the earlier of (i) 11 the expiration of the term of the Option, or (ii) three months after such termination; and (b) in the event of termination of employment at the election of an Optionee, his or her Option shall lapse on the date of such termination. ARTICLE 9. RESTRICTED STOCK 9.1 In General. Restricted Stock Awards shall be subject to such terms and conditions as may be specified in the Agreement issued to a Participant to evidence the grant of such Award. Among other things, a Restricted Stock Award shall be subject to a vesting schedule or Performance Goals, or both. 9.2 Minimum Vesting Period for Certain Awards. In the case of a Restricted Stock Award that is not intended to constitute a Performance Grant, such Award shall not fully vest over a period of less than three years; provided, however, that this minimum vesting period shall not be construed as precluding terms in an Agreement that may accelerate vesting of an Award by reason of death, Disability or the occurrence of a Change in Control. 9.3 Limitation on Restricted Stock Awards. Commencing on the Effective Date, grants under this Plan (and any other plan of the Corporation or a Subsidiary providing for restricted stock awards) to any Employee described in Code Section 162(m)(3) shall not exceed, in the aggregate, Restricted Stock Awards for 60,000 shares of Common Stock during any period of 12 consecutive months. Such limitation shall be subject to adjustment in the manner described in Article 11. 9.4 Issuance and Retention of Share Certificates By Corporation. One or more share certificates shall be issued upon the grant of a Restricted Stock Award; but until such time as the Restricted Stock shall vest or otherwise become distributable by reason of satisfaction of one or more Performance Goals, the Corporation shall retain such share certificates. 9.5 Stock Powers. At the time of the grant of a Restricted Stock Award, the Participant to whom the grant is made shall deliver such stock powers, endorsed in blank, as may be requested by the Corporation. 9.6 Release of Shares. Within 30 days following the date on which a Participant becomes entitled under an Agreement to receive shares of previously Restricted Stock, the Corporation shall deliver to him or her a certificate evidencing the ownership of such shares, together with an amount of cash (without interest) equal to the dividends that have been paid on such shares with respect to record dates occurring on and after the date of the related Award. 9.7 Forfeiture of Restricted Stock Awards. In the event of the forfeiture of a Restricted Stock Award, by reason of the termination of employment prior to vesting, the failure to achieve a Performance Goal or otherwise, the Corporation shall take such steps as may be necessary to cancel the affected shares and return the same to its treasury. 9.8 Assignment, Transfer, Etc. of Restricted Stock Rights. The potential rights of a 12 Participant to shares of Restricted Stock may not be assigned, transferred, sold, pledged, hypothecated or otherwise encumbered or disposed of until such time as unrestricted certificates for such shares are received by him or her; provided, however, that the Committee may permit a transfer of a type described in Section 6.5(b). ARTICLE 10. STOCK APPRECIATION RIGHTS 10.1 In General. SARs and Tandem SARs shall be subject to such terms and conditions as may be specified in the Agreement issued to the Participant to evidence the grant of such an Award. Among other things, SARs and Tandem SARs shall be subject to a vesting schedule or Performance Goals, or both. 10.2 Term, Vesting and Exercise Following Termination. SARs shall be subject to the Plan's term and vesting rules, and the rules for exercise following termination of service, applicable to Nonqualified Stock Options; provided, however, that in the case of a Tandem SAR, such SAR shall be subject to the same term and vesting rules, and the rules for exercise following termination of service, applicable to its related Option. 10.3 Exercise Procedures and Payment. SARs and Tandem SARs shall be subject to such exercise procedures as may be established by the Committee in the relevant Agreement. Payment required upon the exercise of a SAR or Tandem SAR shall be made within 30 days of exercise and may be made in cash, stock or partly in both, as specified by the Committee in the relevant Agreement or otherwise. 10.4 Limitation on SAR Awards. Commencing on the Effective Date, grants under this Plan (and any other plan of the Corporation or a Subsidiary providing for SAR awards) to any Employee described in Code Section 162(m)(3) shall not exceed, in the aggregate, SAR Awards for 125,000 shares of Common Stock during any period of 12 consecutive months. Such limitation shall be subject to adjustment in the manner described in Article 11. The limitation in this section shall also include SARs granted in the form of Tandem SARs. 10.5 Certain Additional Provisions and Conditions. The Agreement evidencing the grant of any Tandem SAR under the Plan shall contain such additional provisions and conditions as may be necessary to comply with any applicable securities law and exchange-related requirements and, in the case of a Tandem SAR that includes an intended Incentive Stock Option, such provisions and conditions as may be necessary to qualify the Option as such. 10.6 Assignment, Transfer, Etc. of SARs. The rights of a Participant under a SAR (including a Tandem SAR) shall not be transferable other than by will or the laws of descent and distribution and such SAR (or Tandem SAR) shall be exercisable, during the Participant's lifetime, only by him or her. 13 ARTICLE 11. ADJUSTMENT PROVISIONS 11.1 Share Adjustments. (a) In the event that the shares of Common Stock of the Corporation, as presently constituted, shall be changed into or exchanged for a different number or kind of shares of stock or other securities of the Corporation, or if the number of such shares of Common Stock shall be changed through the payment of a stock dividend, stock split or reverse stock split, then (i) the shares of Common Stock authorized hereunder to be made the subject of Awards, (ii) the shares of Common Stock then subject to outstanding Awards and the exercise price or Reference Value thereof (where relevant), (iii) the maximum number of Awards that may be granted within a 12-month period and (iv) the nature and terms of the shares of stock or securities subject to Awards hereunder shall be increased, decreased or otherwise changed to such extent and in such manner as may be necessary or appropriate to reflect any of the foregoing events. (b) If there shall be any other change in the number or kind of the outstanding shares of the Common Stock of the Corporation, or of any stock or other securities into which such Common Stock shall have been changed, or for which it shall have been exchanged, and if a majority of the disinterested members of the Board shall, in its sole discretion, determine that such change equitably requires an adjustment in any Award which was theretofore granted or which may thereafter be granted under the Plan, then such adjustment shall be made in accordance with such determination. (c) The grant of an Award pursuant to the Plan shall not affect in any way the right or power of the Corporation to make adjustments, reclassifications, reorganizations or changes of its capital or business structure, to merge, to consolidate, to dissolve, to liquidate or to sell or transfer all or any part of its business or assets. 11.2 Corporate Changes. A liquidation or dissolution of the Corporation, a merger or consolidation in which the Corporation is not the surviving Corporation or a sale of all or substantially all of the Corporation's assets, shall cause each outstanding Award to terminate, except to the extent that another corporation may and does, in the transaction, assume and continue the Award or substitute its own awards and/or otherwise provides for the payment of value therefor. In the case of an event described in the preceding sentence, vested and nonvested Awards may be treated differently. 11.3 Fractional Shares. Fractional shares resulting from any adjustment in Awards pursuant to this article may be settled as a majority of the disinterested members of the Board shall determine. 11.4 Binding Determination. To the extent that the foregoing adjustments relate to stock or securities of the Corporation, such adjustments shall be made by a majority of the disinterested members of the Board, whose determination in that respect shall be final, binding and conclusive. Notice of any adjustment shall be given by the Corporation to each holder of an Award which shall have been so adjusted. 14 ARTICLE 12. SPECIAL PROVISIONS RELATING TO DIRECTOR AWARDS 12.1 In General. Subject to Section 12.2, Awards granted to Directors shall be subject to the same terms and conditions as are applicable to Awards granted to Employees, except for any term or condition that is clearly not applicable or otherwise should be construed differently under the circumstances. 12.2 Special Provisions. The following provisions shall, with respect to Director Awards, supersede any contrary provision in this Plan document. (a) Termination of Service In General. References herein to an individual's employment or termination of employment shall be deemed references to a Director's service or termination of service as a member of the Board or the board of directors of a Subsidiary. (b) Special Termination Provision. The provisions of Section 8.5(a) shall apply in the case of a termination described in Section 8.5(b). (c) Grant of Awards. The Board, acting as a whole, shall grant all Awards to Directors and specify the conditions and limitations applicable to such Awards. (d) Limitation on Awards. Commencing on the Effective Date, grants under this Plan to any Director shall not exceed 50% of the relevant limitation applicable to Employees. (e) Retirement of Director. Notwithstanding Section 2.26, in the case of a Director, the term "Retirement" shall mean his or her termination of service as such following the attainment of age 70. ARTICLE 13. GENERAL PROVISIONS 13.1 Effective Date; Issuance of Awards. The Plan shall be deemed adopted and its Effective Date shall be the date of the Initial Public Offering; provided, however, that the Plan shall be subject to approval by the shareholders of the Corporation no earlier than 6 nor later than 12 months after the Initial Public Offering. Until such time as the shareholders approve the Plan, no Awards shall be granted hereunder. 13.2 Termination of the Plan. Unless previously terminated by the Board, the Plan shall terminate on, and no Award shall be granted after, the day immediately preceding the tenth anniversary of the Effective Date. 13.3 Limitation on Termination, Amendment or Modification. (a) The Board may at any time terminate, amend, modify or suspend the Plan, provided that, without the approval of the shareholders of the Corporation, no amendment 15 or modification shall be made solely by the Board which: (i) increases the maximum number of shares of Common Stock as to which Awards may be granted under the Plan; (ii) changes the class of eligible Participants; or (iii) otherwise requires the approval of shareholders under applicable state law or under applicable federal law to avoid potential liability or adverse consequences to the Corporation or a Participant. (b) No amendment, modification, suspension or termination of the Plan shall in any manner affect any Award theretofore granted under the Plan without the consent of the Participant or any person validly claiming under or through the Participant. 13.4 No Right to Grant of Award or Continued Employment. Nothing contained in this Plan or otherwise shall be construed to (a) require the grant of an Award to an individual who qualifies as an Employee, or (b) confer upon a Participant any right to continue in the employ of the Corporation or any Subsidiary or limit in any respect the right of the Corporation or of any Subsidiary to terminate the Participant's employment at any time and for any reason. 13.5 Certain Rules of Interpretation. Without limiting the power of the Committee to interpret the provisions of the Plan, the following rules shall apply in connection with the administration of the Plan: (a) Except as otherwise provided herein, nonvested Awards shall be forfeited immediately upon a Participant's termination of employment. (b) The transfer of a Participant's employment between and among the Corporation and a Subsidiary shall not constitute termination of employment. (c) A Participant, who is employed by a Subsidiary, shall be deemed to have terminated employment in the event and on the day such entity ceases to qualify as a Subsidiary. 13.6 Withholding Taxes. (a) Subject to the provisions of Subsection (b), the Corporation will require, where sufficient funds are not otherwise available, that a Participant pay or reimburse to it any withholding taxes at such time as withholding is required by law. (b) With the permission of the Committee, a Participant may satisfy the withholding obligation described in Subsection (a), in whole or in part, by electing to have the Corporation withhold shares of Common Stock (otherwise issuable to him or her) having a Fair Market Value equal to the amount required to be withheld. An election by a Participant to have shares withheld for this purpose shall be subject to such 16 conditions as may then be imposed thereon by any applicable tax or securities law. 13.7 Listing and Registration of Shares. (a) No Option or SAR granted pursuant to the Plan shall be exercisable in whole or in part, and no share certificate shall be delivered with respect to an Award, if at any relevant time a majority of the disinterested members of the Board shall determine in its discretion that the listing, registration or qualification of the shares of Common Stock subject to an Award on any securities exchange or under any applicable law, or the consent or approval of any governmental regulatory body, is necessary or desirable as a condition of, or in connection with, such Award, until such listing, registration, qualification, consent or approval shall have been effected or obtained free of any conditions not acceptable to a majority of the disinterested members of the Board. (b) If a registration statement under the Securities Act with respect to the shares issuable under the Plan is not in effect at any relevant time, as a condition of the issuance of the shares, a Participant (or any person claiming through a Participant) shall give the Committee a written statement, satisfactory in form and substance to the Committee, that he or she is acquiring the shares for his or her own account for investment and not with a view to their distribution. The Corporation may place upon any stock certificate for shares issued under the Plan the following legend or such other legend as the Committee may prescribe to prevent disposition of the shares in violation of the Securities Act or other applicable law: 'THE SHARES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933 ("ACT") AND MAY NOT BE SOLD, PLEDGED, HYPOTHECATED OR OTHERWISE TRANSFERRED OR OFFERED FOR SALE IN THE ABSENCE OF AN EFFECTIVE REGISTRATION STATEMENT WITH RESPECT TO THEM UNDER THE ACT OR A WRITTEN OPINION OF COUNSEL FOR THE CORPORATION THAT REGISTRATION IS NOT REQUIRED.' 13.8 Disinterested Director. For purposes of this Plan, a director shall be deemed "disinterested" if such person could qualify as a member of the Committee under Section 3.1. 13.9 Gender; Number. Words of one gender, wherever used herein, shall be construed to include each other gender, as the context requires. Words used herein in the singular form shall include the plural form, as the context requires, and vice versa. 13.10 Applicable Law. Except to the extent preempted by federal law, this Plan document, and the Agreements issued pursuant hereto, shall be construed, administered and enforced in accordance with the domestic internal law of the Commonwealth of Pennsylvania. 13.11 Headings. The headings of the several articles and sections of this Plan document have been inserted for convenience of reference only and shall not be used in the construction of the same. 17 EX-10.13 8 e85343a2exv10w13.txt FORM OF ESCROW AGREEMENT EXHIBIT 10.13 ESCROW AGREEMENT THIS ESCROW AGREEMENT (this "Agreement") is made and entered into as of July __, 2003, by and among Mercer Insurance Group, Inc., a Pennsylvania corporation (the "Company"), Mercer Mutual Insurance Company, a Pennsylvania corporation ("MMIC"), Sandler O'Neill & Partners, L.P. ("Sandler") and Wilmington Trust Company ("Wilmington Trust" or the "Escrow Agent"). RECITALS A. WHEREAS, the Company, which is the proposed holding company for MMIC, proposes to sell up to 6,361,111 shares of its common stock (the "Shares"). Of the Shares, 6,261,111 are being offered, with the assistance of Sandler, pursuant to a subscription offering, a community offering and possibly a syndicated community offering (collectively, the "Offerings"), and 100,000 are being offered to a third party pursuant to a contractual obligation of MMIC (the "Third Party Offering"). The Offerings are being conducted in connection with the conversion of MMIC from mutual to stock form and the simultaneous acquisition of the capital stock of MMIC by the Company pursuant to a Plan of Conversion (the "Plan") adopted by the Board of Directors of each of MMIC and the Company on December 13, 2002, as amended and restated on March 19, 2003, April 15, 2003 and June 18, 2003 (the "Conversion"). The Third Party Offering is not being conducted in connection with, but will be completed immediately after, the Conversion. The parties acknowledge that Sandler is not acting as a financial advisor with respect to, or rendering any assistance to the Company in connection with, the Third Party Offering. B. WHEREAS, the Company intends to offer the Shares pursuant to a Registration Statement on Form S-1 filed with the Securities and Exchange Commission on May 1, 2003 (the "Registration Statement"). C. WHEREAS, the Company desires to establish an escrow account in which funds received from persons subscribing for or purchasing Shares in the Offerings and the Third Party Offering including, without limitation, members of MMIC, the Company's Employee Stock Ownership Plan, and directors, officers and employees of MMIC or its affiliates, will be deposited pending completion of the Offerings and the Third Party Offering. Wilmington Trust agrees to serve as the Escrow Agent to hold funds from, or on behalf of, subscribers or purchasers in accordance with the terms and conditions of this Agreement. The Company and Sandler agree to assist the Escrow Agent in administering the Escrow Account (defined below) and distributing funds held in the Escrow Account. D. WHEREAS, the Offerings will be completed if, among other things, the Company receives subscriptions or purchase orders in the Offerings for at least 4,165,000 Shares, and the Third Party Offering will be completed immediately after the completion of the Offerings. E. WHEREAS, all monies held in the Escrow Account are referred to as the "Escrow Amount." NOW, THEREFORE, in consideration of the foregoing, and for other good and valuable, consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto, intending legally to be bound, agree as follows: 1 I. DESIGNATION AS ESCROW AGENT. Subject to the terms and conditions hereof, the Company hereby appoints Wilmington Trust as Escrow Agent and Wilmington Trust hereby accepts such appointment. II. ESTABLISHMENT OF ESCROW ACCOUNT. On or prior to the date of the commencement of the Offerings, the parties shall establish a non-interest bearing escrow account with the Escrow Agent, which escrow account shall be entitled "Mercer Insurance Group, Inc. Stock Purchase Account" (the "Escrow Account"). The Company will instruct subscribers or purchasers to make checks or money orders for subscriptions or purchases payable to "Wilmington Trust Company, as escrow agent for Mercer Insurance Group, Inc." Escrow Agent agrees to hold all funds received by it in escrow for the subscriber or purchaser desiring to purchase Shares in the Offerings or the Third Party Offering. It is understood that all checks or money orders received by the Escrow Agent are subject to clearance time, and the funds represented thereby cannot be drawn upon or invested until such time as the same constitute good and collected funds. It is also understood that should any checks be returned to the Escrow Agent as uncollectible, the Escrow Agent is authorized and instructed to charge expenses incurred by the Escrow Agent on such uncollected checks to the Company, and the Company and MMIC hereby jointly and severally agree to pay to the Escrow Agent all such expenses. The Escrow Agent shall redeposit such checks(s) for collection only upon the verbal or written instruction of the Company; however, in no instance shall the checks(s) be presented for collection more than two (2) times. Should the check(s) be uncollectible after the second presentation, the Escrow Agent shall promptly notify the Company and hold said check(s) until the subscriber or purchaser has replaced the same with a cashier's check or money order or such other form of draft that the Company and the Escrow Agent approve, at which time the Escrow Agent shall as soon as reasonably practicable return said uncollectible check(s) to the subscriber or purchaser. In the event the subscriber or purchaser does not promptly replace said check(s) with a cashier's check or money order or such other form of draft acceptable to the Escrow Agent and the Company, the Escrow Agent, at the instruction of the Company, shall return the check(s) to such subscriber or purchaser. Except pursuant to the Company's instructions, any checks or money orders received that are made payable to a party other than "Wilmington Trust Company, as escrow agent for Mercer Insurance Group, Inc." shall be returned by the Escrow Agent to the subscriber or purchaser submitting such checks or money orders. In such cases, the Escrow Agent shall promptly notify the Company of such return. III. ADMINISTRATION OF FUNDS HELD IN ESCROW. Sandler shall receive all stock order forms and checks or money orders from subscribers or purchasers in the Offerings and shall keep such appropriate books and records as are required to perform its functions described herein. Sandler will deliver promptly such checks or money orders to the Escrow Agent via Federal Express each business day (a "business day" being any day on which commercial banks are open for general business in Wilmington, Delaware) during the Offerings for deposit into the Escrow Account together with a copy of the subscriber's or purchaser's stock order form which sets forth, among other things, the subscriber's or purchaser's name, address, social security number, telephone number, number of Shares purchased and the amount paid therefor. The Company shall receive all stock order forms and checks or money orders from the subscriber or purchaser in the Third Party Offering and shall keep such appropriate books and records as are required to perform its functions described herein. The Company will deliver promptly to the Escrow Agent via Federal Express such checks or money orders that it receives on any business day (as defined above) during the Third Party Offering for deposit into the Escrow Account together with a copy of the subscriber's or purchaser's stock order form which sets forth, among other things, the subscriber's or purchaser's name, address, social security number, telephone number, number of Shares purchased and the amount paid therefor. The Escrow Agent is hereby authorized and instructed to forward each check or money order it receives from Sandler (with respect to the Offerings) or the Company (with respect to the Third Party Offering) for collection, deposit the check or money order in the Escrow Account and after allowing 2 for collection of the proceeds of each check or money order in accordance with Federal Reserve Board regulations, invest the Escrow Amount in accordance with the terms hereof. Sandler will maintain all subscriber records for the Offerings until the completion or termination of the Offerings. The Company will maintain all subscriber records for the Third Party Offering until the completion or termination of the Third Party Offering. The Escrow Agent shall receive all payments for Shares and shall hold all such payments, together with all investments thereof and all interest accumulated thereon and proceeds therefrom, in escrow in the Escrow Account, in all cases upon the terms and conditions set forth in this Agreement and shall not disburse funds from the Escrow Account except as provided by the terms of this Agreement. The Escrow Agent is hereby instructed to and shall invest the Escrow Amount pursuant to and in accordance with written instructions from the Company that are reasonably acceptable to the Escrow Agent, and in the absence of such instructions, the Escrow Agent is hereby instructed to and shall, and hereby agrees to, invest the Escrow Amount only in a Wilmington Trust Premium Money Market Advantage Account. In its instructions to the Escrow Agent, the Company may only specify investments permissible under Rule 15c2-4 of the Securities and Exchange Act of 1934, as amended, and the interpretations thereof set forth in the NASD Notice to Members 84-7, as reissued or amended. In making its investments, the Escrow Agent may conclusively rely on any investment instructions received from the Company, shall have no duty to independently determine, confirm or verify whether the investments specified in the Company's instructions comply with the condition set forth in the preceding sentence, and shall have no liability for making such investments provided it does so in accordance with the Company's instructions. Subject to the terms of this Agreement, any income, earnings, proceeds or other gain received on any amounts invested hereunder shall be deposited into the Escrow Account, will be added to and increase the Escrow Amount and may be subsequently reinvested in accordance with the terms hereof, and any losses on any amounts invested hereunder shall decrease the Escrow Amount. IV. REJECTION OF PURCHASE ORDERS. The Registration Statement provides that the purchase of Shares in the community and any syndicated community offering is subject to the Company's approval. The Company agrees to notify the Escrow Agent of which purchase orders are being rejected by delivering to the Escrow Agent written instructions pertaining thereto. If a purchase order is rejected, any funds held in the Escrow Account in connection with such purchase order shall, upon receipt of the written confirmation from the Company and/or Sandler set forth in, and otherwise in accordance with, Section VII, be promptly returned to the purchaser, without any interest thereon, and without deduction, penalties or expense to the purchaser. Unless a certificate rejecting a purchase order is delivered to the Escrow Agent pursuant to this Section IV, all purchase orders received in the community or syndicated community offerings shall be deemed to have been accepted by the Company. V. RELEASE OF ESCROW AMOUNT. If on the date of closing of the Offerings (as more fully described in the Registration Statement) the Escrow Agent has received from the Company or Sandler a certificate stating that the Company has received subscriptions or purchase orders in the Offerings for at least 4,165,000 Shares and that the Offerings have closed, then the Escrow Agent is hereby authorized and instructed to: 3 (a) first, upon receipt of the written confirmation from Sandler or the Company set forth in, and otherwise in accordance with, Section VII, distribute to purchasers in the community and syndicated community offerings, out of the Escrow Amount deposited, amounts with respect to purchase orders which the Company has rejected in accordance with Section IV, without interest thereon; (b) second, after making the distributions required in paragraph (a) above, distribute to itself amounts from the Escrow Amount equal to the amounts owing to it pursuant to Section XI (if any); (c) third, after making the distributions required in paragraphs (a) and (b) above, pay to Sandler or any selected dealer out of the Escrow Amount an amount equal to Sandler's or such selected dealer's fees described in the Registration Statement (upon receipt of instructions from the Company as to such persons and amounts to be paid); and (d) fourth, after making the distributions required in paragraphs (a), (b) and (c) above, pay to the Company the Escrow Amount held by the Escrow Agent in the Escrow Account. VI. CANCELLATION OF OFFERINGS. If the Company and Sandler give the Escrow Agent written notice that the Offerings have been canceled, the Escrow Agent shall, upon receipt of the written confirmation from Sandler and/or the Company set forth in, and otherwise in accordance with, Section VII, promptly refund to each subscriber or purchaser in the Offerings and the Third Party Offering, the amount received from the subscriber or purchaser, without any interest thereon and without deduction, penalty or expense to the subscriber or purchaser, and Escrow Agent shall notify the Company and Sandler, in writing, of its distribution of such funds. Any amounts then remaining in the Escrow Account shall, upon instruction from the Company to do so, be distributed to or as instructed by the Company. The amounts returned to each subscriber or purchaser shall be free and clear of any and all claims of the Escrow Agent, the Company or Sandler, or any creditors of any of them. In such event, notwithstanding any other provision of this Agreement to the contrary, the Company and MMIC shall jointly and severally be responsible for and pay any amounts owing to the Escrow Agent pursuant to Section XI. VII. DELIVERY OF PAYMENTS OR REFUNDS. Upon receiving written confirmation from the Company and/or Sandler of the amount due to any subscriber or purchaser, the Escrow Agent shall prepare the necessary checks or money orders. All payments or refunds to be made by the Escrow Agent to a subscriber or purchaser pursuant to Sections IV, V or VI shall be forwarded, by first-class mail, to the last known address of the subscriber or purchaser, as communicated in writing to the Escrow Agent by the Company, Sandler, or the subscriber or purchaser. All payments to be made by the Escrow Agent to the Company pursuant to Section V or Section VI shall be forwarded to the Company at 10 North Highway 31, P.O. Box 278, Pennington, New Jersey 08534, Attention: Andrew R. Speaker, or issued to such account as the Company shall direct, in writing. 4 VIII. THE COMPANY NOT ENTITLED TO ESCROW AMOUNT IN ESCROW UNTIL RELEASED. Until a portion of the Escrow Amount is distributed to it pursuant to Section V or Section VI, the Company acknowledges that (i) it is not entitled to any portion of the Escrow Amount and (ii) no amounts deposited in the Escrow Account shall become the property of the Company or be subject to the liabilities of the Company. IX. INTEREST. Interest, as used in Sections IV, V, VI, VII, and IX of this Agreement, shall mean investment income, if any, earned on the Escrow Amount, as invested in accordance with the terms hereof. Interest accrued on the Escrow Amount shall be reinvested in accordance with the terms hereof and held as part of the Escrow Amount until distributed pursuant to Section V or Section VI hereof. X. ESCROW AMOUNT MAY NOT SECURE LOAN. Until released in accordance herewith, the Escrow Amount shall at no time be used directly or indirectly as security for a loan or any other obligation of the Company and, except as otherwise expressly provided in Section XI hereof, shall be subject to no right, charge, security interest, lien, setoff or claim of any kind in favor of the Escrow Agent or any person claiming through the Escrow Agent. XI. AUTHORITY OF ESCROW AGENT AND LIMITATION OF LIABILITY. (a) In acting hereunder, Escrow Agent shall have only such duties as are specified herein and no implied duties shall be read into this Agreement, and Escrow Agent shall not be liable for any act done, or omitted to be done, by it in the absence of its gross negligence or willful misconduct. (b) Escrow Agent may act in reliance upon any writing, instrument, notice or instruction or signature which it, in good faith, believes to be genuine, and may assume the validity and accuracy of any statement or assertion contained in such a writing, instrument, notice or instruction and may assume that any person purporting to give any writing, instrument, notice, advice or instruction in connection with the provisions hereof has been duly authorized so to do. (c) Escrow Agent shall not be required to use its own funds in the performance of any of its obligations or duties or the exercise of any of its rights or powers, and shall not be required to take any action which, in Escrow Agent's sole and absolute judgment, could involve it in expense or liability unless furnished with security and indemnity which it deems, in its sole and absolute discretion, to be satisfactory. (d) The Company and MMIC jointly and severally agree to pay to Escrow Agent compensation for its services hereunder in accordance with the schedule of fees set forth on Exhibit A attached hereto. In the event Escrow Agent renders any extraordinary services in connection with the Escrow Account, Escrow Agent shall be entitled to additional compensation therefore provided both the Company and Sandler have requested the services and Escrow Agent has informed the Company, in writing, of 5 the additional charge. Each of the Escrow Agent and the other Indemnitees, as provided in (e) below, shall have a first lien against the Company's rights in and to the funds in the Escrow Account to secure the respective obligations of the Company to it hereunder. The terms of this paragraph shall survive termination of this Agreement. (e) The Company and MMIC hereby agree to jointly and severally indemnify Escrow Agent and its officers, agents, employees and directors (collectively, the "Indemnitees") and hold the Indemnitees harmless from any and against all liabilities, losses, actions, suits or proceedings at law or in equity, and any other expenses, fees or charges of any character or nature, including, without limitation, attorney's fees and expenses, which the Indemnitees may incur or with which any Indemnitee may be threatened by reason of Escrow Agent acting as escrow agent under this Agreement or arising out of the existence of the Escrow Account, except to the extent the same shall be caused by any Indemnitee's gross negligence or willful misconduct. The Indemnitees shall have a first lien against the Company's rights in and to the funds in the Escrow Account to secure the obligations of the Company hereunder. The terms of this paragraph shall survive termination of this Agreement. (f) Whenever Escrow Agent is unable to decide between alternative courses of action permitted or required by the terms of this Agreement, is unsure as to the application, intent, interpretation or meaning of any provision of this Agreement, or otherwise determines instruction to be necessary or desirable, Escrow Agent shall promptly give notice (in such form as shall be reasonable under the circumstances) to the Company requesting instruction as to the course of action to be adopted, and, to the extent Escrow Agent acts in good faith in accordance with any such instruction received, Escrow Agent shall not be liable on account of such action to any person. In the event Escrow Agent receives conflicting instructions under this Agreement, Escrow Agent shall be fully protected in refraining from acting until such conflict is resolved to the reasonable satisfaction of Escrow Agent. (g) Escrow Agent shall be entitled to consult with legal counsel in the event that a question or dispute arises with regard to the construction of any of the provisions hereof, and shall incur no liability and shall be fully protected in acting in accordance with the advice or opinion of such counsel, unless such advice or opinion constitutes gross negligence or willful misconduct on the part of such counsel. In addition, Escrow Agent may perform its duties hereunder either directly or by or through agents, accountants or attorneys and shall not be responsible for any misconduct or negligence on the part of any agent, accountant or attorney appointed with due care by it except for willful misconduct and gross negligence; nor shall Escrow Agent be liable for any error of judgment made in good faith by any of its officers or employees unless such error constitutes gross negligence or willful misconduct. (h) The Escrow Agent represents and warrants to the Company that the Escrow Agent is a "bank," as such term is defined in Section 3(a)(6) of the Securities and Exchange Act of 1934, as amended. (i) Escrow Agent may resign as Escrow Agent by giving notice in writing of such resignation to the Company, which notice shall specify a date upon which 6 such resignation shall take effect. The Company shall, within sixty (60) business days after receiving the foregoing notice from Escrow Agent, designate a substitute escrow agent (the "Substitute Escrow Agent"), which Substitute Escrow Agent shall, upon its designation and notice of such designation to Escrow Agent, succeed to all of the rights, duties and obligations of Escrow Agent hereunder. The Escrow Agent's resignation shall not be effective until the Substitute Escrow Agent has been designated. In the event the Company shall not have delivered to Escrow Agent a written designation of Substitute Escrow Agent within the aforementioned sixty (60) day period, together with the consent to such designation by the Substitute Escrow Agent, the Escrow Agent may apply to a court of competent jurisdiction to appoint a Substitute Escrow Agent, and the costs of obtaining such appointment shall be reimbursable from the Company and from the Escrow Amount. Upon the Escrow Agent's effective resignation, the Escrow Agent shall be discharged from any and all further duties and obligations under this Agreement. XII. NOTICES. Except as otherwise provided herein, any notice, instruction, instrument or other document to be delivered hereunder shall be in writing and shall be effective upon receipt at the addresses set forth on the signature page hereof or at such other address specified in writing by the addressee, or upon actual receipt via facsimile or telecopier transmission at the number set forth on the signature page hereof or at such other number specified in writing by the addressee. XIII. AMENDMENT. This Agreement may not be amended, modified, supplemented or otherwise altered except by an instrument in writing signed by the parties hereto. XIV. TERMINATION. This Agreement will terminate upon the disbursement of all funds in the Escrow Account, as provided above, by the Escrow Agent. XV. GOVERNING LAW. This Agreement shall be governed by and construed in accordance with Delaware law in all respects (without regard to principles of conflict of laws). Each of the Company, MMIC and the Escrow Agent hereby consent to (i) the non-exclusive jurisdiction of the courts of the State of Delaware and (ii) service of process by mail in accordance with Section XII. XVI. COUNTERPARTS. This Agreement may be executed in any number of counterparts, each of which when so executed shall be deemed to be an original, and such counterparts together shall constitute and be one and the same instrument. 7 IN WITNESS WHEREOF, the parties hereto have caused their names to be hereto subscribed by their respective officer or representative as of the day and year first above written. MERCER INSURANCE GROUP,INC. MERCER MUTUAL INSURANCE COMPANY By: By --------------------------------- ---------------------------------- Andrew R. Speaker Andrew R. Speaker President and Chief Executive Officer President and Chief Executive Officer Address: Address - ------- ------- 10 North Highway 31 10 North Highway 31 P.O. Box 278 P.O. Box 278 Pennington, NJ 08534 Pennington, NJ 08534 Fax No.: (609) 737-8719 Fax No.: (609) 737-8719 Tel. No.: (609) 737-0426 Tel. No.: (609) 737-0426 SANDLER O'NEILL & PARTNERS, L.P. WILMINGTON TRUST COMPANY, as Escrow Agent By: Sandler O'Neill & Partners, Corp., the sole general partner By: By: --------------------------------- --------------------------------- Title: Address: Address: - ------- ------- 919 Third Avenue 1100 North Market Street 6th Floor Wilmington, Delaware 19890-1625 New York, NY 10022 Fax No.: (302) 636-4149 Fax No.: (212) 466-7711 Tel. No.: (302) 636-6450 Tel. No.: (212) 466-7700 E-mail: mpulgini@wilmingtontrust.com Attention: Margaret Pulgini - Attention: Corporate Trust/Custody -------------------------
8 EXHIBIT A ESCROW AGENT FEES The compensation due and owing to Wilmington Trust Company for services rendered as Escrow Agent shall be as follows: i. Annual Fee: $ 8,500.00 ii. Transaction Fees: (ONLY IF INCURRED) Purchase, sale, withdrawal, maturities, calls $ 15.00 and puts of domestic securities: Physical delivery of domestic securities: $ 50.00 Purchase of Eurodollar certificate of deposit: $ 65.00 Principal amortizing securities (per pool/per $ 10.00 month) Wire charge (per transfer): Outgoing** $ 25.00 Incoming** $ 10.00
Escrow Agent requires the first year's Annual Fee to be paid on the date hereof by wire transfer per the following wire transfer instructions: Wilmington Trust Company Wilmington, Delaware ABA No. 031100092 For credit to the account of Corporate Trust Administration - Income Account Account No. 9974-0 (Income) Attn: Corporate Trust Administration Reference: Mercer Insurance Group, Inc. Thereafter, if applicable, each Annual Fee is due and payable in advance on each anniversary of the date hereof. Outside counsel's fees and expenses up to a total of $4,000 for representing Escrow Agent in connection with the negotiation and execution of the Escrow Agreement are not included in the above and are due and payable within thirty (30) days of receipt of an invoice from outside counsel. Outside counsel fees and expenses in excess of $4,000 for representing Escrow Agent in connection with the negotiation and execution of the Escrow Agreement shall not be the responsibility of the Company or MMIC. Fees incurred are due and payable within thirty (30) days of the receipt of the invoice reflecting same. Any amounts not paid when due shall bear interest at a rate of 18% per annum. All fees are nonrefundable and will not be pro rated in the event of an early termination of the above arrangements. - --------------- ** Transfers made by associate banks may result in additional wire charges. 10 Invoices should be sent to Mercer Insurance Group, Inc. as set forth in the Escrow Agreement. 11 EX-23.1 9 e85343a2exv23w1.txt CONSENT OF KPMG EXHIBIT 23.1 INDEPENDENT AUDITORS' CONSENT The Board of Directors Franklin Holding Company, Inc and Subsidiary: We consent to the use of our report included herein and to the reference to our firm under the heading "Experts" in the prospectus supplement. /s/ KPMG LLP Philadelphia, PA July 29, 2003 EX-23.3 10 e85343a2exv23w3.txt CONSENT OF BROWN SCHULTZ SHERIDAN & FRITZ EXHIBIT 23.3 CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS FRANKLIN HOLDING COMPANY, INC. We hereby consent to the use in this Registration Statement on Form S-1 of our report dated April 27, 2001, relating to the consolidated statements of earnings, changes in stockholders' equity and cash flows of Franklin Holding Company, Inc. and subsidiary, and to the reference to our Firm under the caption "Experts" in the prospectus. BROWN SCHULTZ SHERIDAN & FRITZ Camp Hill, Pennsylvania July 28, 2003 EX-23.4 11 e85343a2exv23w4.txt CONSENT OF GRIFFIN FINANCIAL GROUP LLC EXHIBIT 23.4 GRIFFIN FINANCIAL GROUP, LLC. July 30, 2003 Board of Directors Mercer Insurance Group, Inc. 10 North Highway 31 Pennington, New Jersey 08534 Gentlemen: We hereby consent to the inclusion of (i) our appraisal of the estimated pro forma market value of Mercer Mutual Insurance Company on a consolidated basis as a subsidiary of Mercer Insurance Group, Inc., as updated through May 30, 2003, and (ii) our letter dated January 2, 2003, regarding the value of the subscription rights being granted in the conversion, as exhibits to the Mercer Insurance Group, Inc. Form S-1 Registration Statement, and the publication of the summary of its appraisal and the subscription rights valuation in the prospectus that forms a part of the Registration Statement. We further consent to the use of our name and the statements with respect to us appearing in the sections of the prospectus captioned "Prospectus Summary -- Determination of Offering Price and Total Number of Shares Offered in the Conversion", "Risk Factors -- Risk Factors Relating to the Ownership of Mercer Insurance Group Common Stock" and "-- Risk Factors Relating to the Conversion", "Capitalization", "Pro Forma Data", "The Conversion -- Background and Reasons for the Conversion", "-- Conversion Process", "-- Limitations on Purchases of Common Stock", "-- Stock Pricing and Number of Shares to Be Issued", "-- The Valuation", and "-- Tax Consequences of Subscription Rights", "Experts" and "Where You Can Find Additional Information." Sincerely, /s/ Griffin Financial Group, LLC. GRIFFIN FINANCIAL GROUP, LLC. EX-99.2 12 e85343a2exv99w2.txt MARKETING MATERIALS MERCER MUTUAL INSURANCE COMPANY PROPOSED MAILING AND INFORMATIONAL MATERIALS INDEX 1. Dear Policyholder Letter* 2. Dear Policyholder Letter for Non Eligible States 3. Dear Potential Investor Letter* 4. Dear Customer Letter -- Used as a Cover Letter for States Requiring "Agent" Mailing* 5. Proxy and Stock Q&A (5a-5f)* 6. Proxy Request Letter (immediate follow-up) 7. Proxy Request 8. Stock Order Form (page 1 of 2)* 9. Stock Order Form (page 2 of 2)* 10. Stock Order Form Guidelines* 11. Invitation Letter -- Informational Meetings 12. Dear Subscriber/Acknowledgment Letter -- Initial Response to Stock Order Received 13. Dear Charter Shareholder -- Confirmation Letter 14. Dear Interested Investor -- No Shares Available Letter 15. Welcome Shareholder Letter -- For Initial Certificate Mailing 16. Dear Interested Subscriber Letter -- Subscription Rejection 17. Letter for Sandler O'Neill Mailing to Clients* * Accompanied by a Prospectus Note: Items 1 through 10 are produced by the Financial Printer and Items 11 through 17 are produced by the conversion center. (THE MERCER INSURANCE GROUP LOGO) Dear Policyholder: The Board of Directors of Mercer Mutual Insurance Company has voted unanimously in favor of a plan to convert Mercer Mutual from a Pennsylvania mutual insurance company to a Pennsylvania stock insurance company. As part of this plan, we have formed Mercer Insurance Group, Inc., which will become the parent holding company of Mercer Mutual. We are converting to stock form in order to provide a corporate structure that we believe is necessary for Mercer Mutual Insurance Company to remain a viable, competitive and financially sound insurance company. TO ACCOMPLISH THE CONVERSION, YOUR PARTICIPATION IS EXTREMELY IMPORTANT. A special meeting of eligible policyholders is being held on xxxxxx, xxxxxx xx, 2003. On behalf of the Board, I ask that you help us meet our goal by reading the enclosed material and then casting your vote in favor of the plan of conversion and mailing your signed proxy card immediately in the enclosed [COLOR] postage-paid envelope marked "PROXY RETURN." Should you choose to attend the special meeting of eligible policyholders and vote in person, you may do so by giving written notice of revocation to the secretary of Mercer Mutual. If you have multiple policies at Mercer Mutual, you may receive more than one mailing. If you do receive more than one proxy card, please vote, sign and return each one. If the plan of conversion is approved, let me assure you that: - Existing insurance coverage under your policy will not undergo any change as a result of the conversion. - Voting for approval of the plan will not obligate you to buy any shares of common stock. - Failing to vote on or voting against the plan will not preclude you from buying stock in the offering. As an eligible policyholder, you may also take advantage of your nontransferable rights to subscribe for shares of Mercer Insurance Group, Inc. common stock on a first priority basis. The enclosed proxy statement and prospectus describe the stock offering and the operations of Mercer Mutual. If you wish to purchase shares of common stock, please complete the stock order form and mail it, along with full payment for the shares to Mercer Mutual's conversion center in the enclosed YELLOW postage-paid envelope marked "STOCK ORDER RETURN." Your order must be physically received by Mercer Mutual's conversion center no later than x:00 p.m., xxxxxxx Time, on xxxxxx, xxxxxxxx xx, 2003. PLEASE READ THE PROSPECTUS CAREFULLY BEFORE MAKING AN INVESTMENT DECISION. If you have any questions after reading the enclosed material, please call our conversion center at (xxx) xxx-xxxx, Monday through Friday, between the hours of 10:00 a.m. and 4:00 p.m. Sincerely, /s/ Andrew R. Speaker Andrew R. Speaker President and Chief Executive Officer This is not an offer to sell or a solicitation of an offer to buy common stock. The offer is made only by the prospectus. (MERCER MUTUAL INSURANCE CO. LOGO) Dear Policyholder: The Board of Directors of Mercer Mutual Insurance Company has voted unanimously in favor of a plan to convert Mercer Mutual from a Pennsylvania mutual insurance company to a Pennsylvania stock insurance company. As part of this plan, we have formed Mercer Insurance Group, Inc., which will become the parent holding company of Mercer Mutual. We are converting to stock form in order to provide a corporate structure that we believe is necessary for Mercer Mutual Insurance Company to remain a viable, competitive and financially sound insurance company. TO ACCOMPLISH THE CONVERSION, YOUR PARTICIPATION IS EXTREMELY IMPORTANT. A special meeting of eligible policyholders is being held on xxxxxx, xxxxxx xx, 2003. On behalf of the Board, I ask that you help us meet our goal by reading the enclosed material and then casting your vote in favor of the plan of conversion and mailing your signed proxy card immediately in the enclosed postage-paid envelope marked "PROXY RETURN." Should you choose to attend the special meeting of eligible policyholders to vote in person, you may do so by giving written notice of revocation to the secretary of Mercer Mutual. If you have multiple policies at Mercer Mutual, you may receive more than one mailing. If you do receive more than one proxy card, please vote, sign and return each one. If the plan of conversion is approved let me assure you that existing insurance coverage under your policy will not undergo any change as a result of the conversion. We regret that we are unable to offer you common stock in the subscription offering. The laws of your state or jurisdiction require us to register an agent of Mercer Mutual to solicit the sale of the to-be-issued common stock of Mercer Insurance Group, Inc., and the number of eligible subscribers in your state or jurisdiction does not justify the expense of such registration. If you have any questions after reading the enclosed material, please call our conversion center at (xxx) xxx-xxxx, Monday through Friday, between the hours of 10:00 a.m. and 4:00 p.m. Sincerely, /s/ Andrew R. Speaker Andrew R. Speaker President and Chief Executive Officer This is not an offer to sell or a solicitation of an offer to buy common stock. The offer is made only by the prospectus. (THE MERCER INSURANCE GROUP LOGO) Dear Potential Investor: We are pleased to provide you with the enclosed material regarding the conversion of Mercer Mutual Insurance Company from a mutual insurance company to a stock insurance company. As part of this conversion, Mercer Insurance Group, Inc. will become the parent company of Mercer Mutual. This information packet includes the following: PROSPECTUS: This document provides detailed information regarding Mercer Mutual's operations and the stock offering by Mercer Insurance Group, Inc. Please read it carefully prior to making an investment decision. QUESTIONS & ANSWERS BROCHURE: This brochure answers commonly asked questions about the conversion and offering. STOCK ORDER FORM: Use this form to subscribe for common stock and mail it, along with full payment for the shares, to Mercer Mutual's conversion center in the enclosed postage-paid envelope marked "STOCK ORDER RETURN." Your order must be physically received by Mercer Mutual's conversion center no later than x:00 p.m., xxxxxxxxxx Time, on xxxxxx, xxxxxxxxx xx, 2003. We are pleased to offer you this opportunity to become one of our charter shareholders. If you have any questions regarding the conversion or the prospectus, please call our conversion center at (xxx) xxx-xxxx, Monday through Friday, between the hours of 10:00 a.m. and 4:00 p.m. Sincerely, /s/ Andrew R. Speaker Andrew R. Speaker President and Chief Executive Officer This is not an offer to sell or a solicitation of an offer to buy common stock. The offer is made only by the prospectus. [SANDLER O'NEILL & PARTNERS, L.P. LOGO] Dear Customer of Mercer Mutual Insurance Company: At the request of Mercer Mutual Insurance Company, we have enclosed material regarding the offering of common stock in connection with the conversion of Mercer Mutual from a mutual insurance company to a stock insurance company. As part of this conversion, Mercer Mutual will form Mercer Insurance Group, Inc., which will become the parent holding company of Mercer Mutual. The enclosed materials include a prospectus and a stock order form, which offer you the opportunity to subscribe for shares of common stock of Mercer Insurance Group, Inc. We are also enclosing a questions and answers brochure containing answers to commonly asked questions about the conversion and the offering. PLEASE READ THE PROSPECTUS CAREFULLY BEFORE MAKING AN INVESTMENT DECISION. If you decide to subscribe for shares of common stock, you must return the properly completed and signed stock order form, along with full payment for the shares, to Mercer Mutual's conversion center in the accompanying postage-paid envelope marked "STOCK ORDER RETURN." Your order must be physically received by Mercer Mutual's conversion center no later than x:00 p.m., xxxxxxxxxx Time, on xxxxxx, xxxxxxxx xx, 2003. If you have any questions after reading the enclosed material, please call the conversion center at (xxx) xxx-xxxx, Monday through Friday, between the hours of 10:00 a.m. and 4:00 p.m., and ask for a Sandler O'Neill representative. We have been asked to forward these documents to you in view of certain requirements of the securities laws of your jurisdiction. We should not be understood as recommending or soliciting in any way any action by you with regard to the enclosed material. Sincerely, Sandler O'Neill & Partners, L.P. This is not an offer to sell or a solicitation of an offer to buy common stock. The offer is made only by the prospectus. Enclosure QUESTIONS AND ANSWERS ABOUT THE CONVERSION The Board of Directors of Mercer Mutual Insurance Company has adopted a plan of conversion whereby Mercer Mutual will convert from a mutual insurance company to a stock insurance company and at the same time become a wholly-owned subsidiary of Mercer Insurance Group, Inc., a Pennsylvania corporation formed by Mercer Mutual to own all of its outstanding stock. The common stock of Mercer Insurance Group, Inc. will be offered to Mercer Mutual's eligible policyholders, a tax- qualified employee stock ownership plan, and Mercer Mutual's directors, officers and employees in a subscription offering and then to members of the general public in a community offering. Stock that is not sold in the subscription and community offerings will be offered to the general public in a syndicated community offering. Mercer Mutual Insurance Company has received approval from the Pennsylvania Insurance Department to convert from a mutual insurance company to a stock insurance company, subject to the approval of Mercer Mutual's eligible policyholders. In order to complete the conversion, it is necessary for Mercer Mutual to receive the approval of at least two-thirds of the votes cast at the special meeting, so YOUR VOTE IS VERY IMPORTANT. Please return your proxy in the enclosed [COLOR] postage-paid envelope. YOUR BOARD OF DIRECTORS URGES YOU TO VOTE "FOR" THE PLAN OF CONVERSION & RETURN YOUR PROXY TODAY. MUTUAL TO STOCK CONVERSION Q. WHY IS MERCER MUTUAL CONVERTING TO STOCK FORM? A. We are converting to a stock company because we view it as a critical component of our strategic plan. We believe the conversion will help us realize our goals by providing us with: - capital to be used to support our current operations, expand and strengthen our producer network and reduce our reliance on reinsurance; - the ability to issue stock to make acquisitions and to access capital markets to satisfy future capital needs; and - the opportunity for our policyholders, directors, officers and employees to acquire stock in the Holding Company, which will provide additional incentive for their performance and enable them to participate in our success. Q. WILL THE CONVERSION AFFECT MY INSURANCE COVERAGE WITH MERCER MUTUAL? A. No. The insurance coverage under your policy will not undergo any change as a result of the conversion. ABOUT VOTING Q. WHO IS ELIGIBLE TO VOTE ON THE CONVERSION? A. Policyholders as of the close of business on December 13, 2002 (the "Voting Record Date"). Q. AM I REQUIRED TO VOTE? A. No. Policyholders are not required to vote. However, because the conversion will produce a fundamental change in Mercer Mutual's corporate structure, the Board of Directors encourages all policyholders to vote. Q. HOW DO I VOTE? A. You may vote by mailing your signed proxy card(s) in the [COLOR] postage-paid envelope marked "PROXY RETURN". Should you choose to attend the special meeting of policyholders or you decide to change your vote, you may do so by revoking any previously signed proxy. Q. WHY DID I RECEIVE SEVERAL PROXY CARDS? A. If you have more than one policy, you may have received more than one proxy card depending upon the ownership structure of your policy. PLEASE VOTE, SIGN AND RETURN ALL PROXY CARDS THAT YOU RECEIVED. Q. DOES MY VOTE FOR THE PLAN OF CONVERSION REQUIRE ME TO BUY COMMON STOCK OF MERCER INSURANCE GROUP, INC.? A. No. Voting for the plan of conversion does not obligate you to buy shares of common stock of Mercer Insurance Group, Inc. Q. IF I FAIL TO VOTE ON OR VOTE AGAINST THE PLAN OF CONVERSION, AM I PRECLUDED FROM BUYING THE COMMON STOCK OF MERCER INSURANCE GROUP, INC. IN THE OFFERING? A. No. Failing to vote on or voting against the plan of conversion has no effect on your ability to buy stock in the offering, as long as the plan of conversion is approved by at least two-thirds of the votes cast at the special meeting. ABOUT THE STOCK OFFERING Investment in our common stock involves certain risks. For a discussion of these risks and other factors, investors are urged to read the accompanying Prospectus. Q. WHAT ARE THE PRIORITIES FOR PURCHASING THE COMMON STOCK? A. The common stock of Mercer Insurance Group, Inc. will be offered in a subscription offering in the following order of priority: - First: Mercer Mutual's eligible policyholders (policyholders as of December 13, 2002) - Second: Mercer Mutual's tax qualified employee stock ownership plan - Third: Mercer Mutual's directors, officers and employees Common stock that is not sold in the subscription offering will be offered first to members of the general public in a community offering and then, to the extent any shares remain, to the general public in a syndicated community offering using a syndicate of registered broker/dealers managed by Sandler O'Neill & Partners, L.P. Q. WILL ANY POLICY THAT I HOLD WITH MERCER MUTUAL BE CONVERTED INTO STOCK? A. No. All policies remain as they were prior to the conversion. As an eligible policyholder, you will receive priority over the general public in exercising your non-transferable right to subscribe for shares of common stock. Q. WILL I RECEIVE A DISCOUNT ON THE PRICE OF THE COMMON STOCK? A. No. Policyholders of Mercer Mutual, directors, officers and employees of Mercer Mutual and the general public will pay the same price per share. Q. HOW MANY SHARES OF COMMON STOCK ARE BEING OFFERED, AND AT WHAT PRICE? A. In the conversion, Mercer Insurance Group, Inc. is offering for sale up to 6,261,111 shares of common stock at a subscription price of $10.00 per share. We are also offering 588,280 additional shares to unrelated third parties, at a purchase price of $10.00 per share, in offerings that are not part of the conversion. Q. HOW MANY SHARES OF COMMON STOCK CAN I PURCHASE? A. The minimum purchase is 25 shares; the maximum purchase by any person in the subscription or community offering is $1,000,000 (100,000 shares); no person by himself or herself, with an associate or group of persons acting in concert, may purchase more than $1,000,000 of common stock offered in the offering. Please review the limitations set forth in the section of the prospectus entitled "The Conversion - Limitations on Purchases of Common Stock." Q. HOW DO I ORDER COMMON STOCK? A. You may subscribe for shares of common stock by completing and returning the stock order form, together with your payment, by mail to Mercer Mutual's conversion center in the YELLOW postage-paid envelope marked "STOCK ORDER RETURN". Q. HOW CAN I PAY FOR MY SHARES OF COMMON STOCK? A. You can pay for the common stock by check or money order made payable to "Wilmington Trust Company, as escrow agent for Mercer Insurance Group, Inc." Q. WHEN IS THE DEADLINE TO SUBSCRIBE FOR COMMON STOCK? A. An executed stock order form with the required full payment must be physically received by Mercer Mutual's conversion center no later than x:00 p.m. xxxxxxx time on xxxxxx, xxxxxxxxx xx, 2003. Q. CAN I SUBSCRIBE FOR SHARES AND ADD SOMEONE ELSE WHO IS NOT ON MY POLICY TO MY STOCK REGISTRATION? A. No. Adding or substituting the names of other persons who are not owners of your eligible policy will result in the loss of your subscription rights. Q. WILL PAYMENTS FOR COMMON STOCK EARN INTEREST UNTIL THE CONVERSION CLOSES? A. No. Payments made to subscribe for shares will not earn interest. Q. WILL CASH DIVIDENDS BE PAID ON THE COMMON STOCK? A. No. Dividends are not expected to be paid initially. Following the conversion, the Board of Directors of Mercer Insurance Group, Inc. may consider a policy of paying cash dividends on the stock. However, during the first three years after the conversion, the Pennsylvania Insurance Department must approve the payment of any cash dividend. Q. WILL MY COMMON STOCK BE COVERED BY INSURANCE? A. No. The common stock cannot be insured or guaranteed by any government agency nor is it insured or guaranteed by Mercer Mutual Insurance Company or Mercer Insurance Group, Inc. Q. WHERE WILL THE STOCK BE TRADED? A. Upon completion of the conversion, Mercer Insurance Group, Inc. expects the stock to be traded on the Nasdaq National Market under the symbol "MIGP". Q. CAN I CHANGE MY MIND AFTER I PLACE AN ORDER TO SUBSCRIBE FOR SHARES OF COMMON STOCK? A. No. After receipt by Mercer Mutual, your order may not be modified or withdrawn, except in one limited instance. If the final updated valuation of the pro forma fair market value of Mercer Mutual as a subsidiary of the Holding Company is less than $41,650,000 or greater than $56,350,000, and we decide to proceed with the offering, we would notify you accordingly. You would then have the opportunity to modify or withdraw your order. ADDITIONAL INFORMATION Q. WHAT IF I HAVE ADDITIONAL QUESTIONS OR REQUIRE MORE INFORMATION? A. Mercer Mutual's proxy statement and the prospectus describe the conversion and offering in detail. Please read the proxy statement and prospectus carefully before voting or subscribing for common stock. If you need a copy of the proxy statement or the prospectus, have any questions after reading the enclosed material, you may call our conversion center at (xxx) xxx-xxxx, Monday through Friday, between the hours of 10:00 A.m. and 4:00 p.m. Additional material may only be obtained from the conversion center. TO ENSURE THAT EACH PURCHASER RECEIVES A PROSPECTUS AT LEAST 48 HOURS PRIOR TO THE EXPIRATION DATE OF XXXXXXX, XXXXXXX XX, 2003 AT X:00 P.M., XXXXXX TIME, IN ACCORDANCE WITH RULE 15C2-8 OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED, NO PROSPECTUS WILL BE MAILED ANY LATER THAN FIVE DAYS PRIOR TO SUCH DATE OR HAND DELIVERED ANY LATER THAN TWO DAYS PRIOR TO SUCH DATE. This is not an offer to sell or a solicitation of an offer to buy common stock. The offer is made only by the prospectus. (MERCER MUTUAL INSURANCE CO. LOGO) QUESTIONS & ANSWERS ABOUT THE CONVERSION --------------------- (MERCER MUTUAL INSURANCE CO. LOGO) PROPOSED HOLDING COMPANY FOR MERCER MUTUAL INSURANCE COMPANY A REQUEST THAT YOU VOTE Dear Policyholder: As a follow-up to our recent mailing, this is to remind you that your vote is very important. The Board of Directors of Mercer Mutual Insurance Company has voted unanimously in favor of a plan to convert from a Pennsylvania mutual insurance company to a Pennsylvania stock insurance company. As part of this plan, we have formed Mercer Insurance Group, Inc., which will become the parent holding company of Mercer Mutual. We are converting so that we may obtain capital to support and grow our operations, have the ability to issue stock to make acquisitions and access the capital markets, and greater opportunity for policyholders, directors, officers and employees to acquire our stock and share in our success. TO ACCOMPLISH THE CONVERSION, YOUR PARTICIPATION IS EXTREMELY IMPORTANT. On behalf of the Board, I ask that you help us meet our goal by casting your vote in favor of the plan of conversion and mailing your signed proxy card immediately in the enclosed [COLOR] postage-paid envelope marked "PROXY RETURN." Should you choose to attend the special meeting of eligible policyholders and vote in person, you may do so by giving written notice of revocation to the secretary of Mercer Mutual. If you have multiple policies at Mercer Mutual, you may receive more than one mailing. If you do receive more than one proxy card, please vote, sign and return each one. If the plan of conversion is approved, let me assure you that: - Existing insurance coverage under your policy will not undergo any change as a result of the conversion. - Voting for approval of the plan will not obligate you to buy any shares of common stock. - Failing to vote on or voting against the plan will not preclude you from buying stock in the offering. If you have any questions after reading the enclosed material, please call our conversion center at (xxx) xxx-xxxx, Monday through Friday, between the hours of 10:00 a.m. and 4:00 p.m. Sincerely, /s/ Andrew R. Speaker Andrew R. Speaker President and Chief Executive Officer PROXY REQUEST [THE MERCER INSURANCE GROUP LOGO] WE NEED YOUR VOTE Dear Policyholder: YOUR VOTE ON OUR PLAN OF CONVERSION HAS NOT YET BEEN RECEIVED. Your vote is very important to us. Please vote, sign and mail the enclosed proxy card today. REMEMBER: Voting does not obligate you to buy shares of common stock and voting against the plan of conversion does not preclude you from buying shares. Your Board of Directors has approved the plan of conversion and urges you to vote in favor of the plan of conversion. Your existing insurance coverage under your policy will not undergo any change as a result of the conversion. A postage-paid envelope is enclosed with the proxy card. If you have any questions, please call our conversion center at (xxx) xxx-xxxx. Sincerely, -s- Andrew R. Speaker Andrew R. Speaker President and Chief Executive Officer PLEASE VOTE TODAY BY RETURNING ALL PROXY CARDS RECEIVED. ------------------------------------------------------------------------------- [THE MERCER INSURANCE GROUP LOGO] MERCER MUTUAL INSURANCE COMPANY I/We hereby appoint Roland D. Boehm and George T. Hornyak, Jr., or any one of them acting in the absence of the other, as proxyholders, each with the power to appoint his or her substitute, and hereby authorize them to represent me/us and to vote for me/us as designated on the reverse side, at the Special Meeting of Policyholders to be held on , 2003, or any adjournment thereof. This proxy when properly executed will be voted in the manner directed on the reverse side. IF NO DIRECTION IS MADE, THIS PROXY WILL BE VOTED FOR THE APPROVAL OF THE PLAN OF CONVERSION AND THE RELATED AMENDMENT AND RESTATEMENT OF MERCER MUTUAL'S ARTICLES OF INCORPORATION. THIS PROXY WILL BE VOTED, IN THE DISCRETION OF THE PROXYHOLDERS, UPON SUCH OTHER BUSINESS AS MAY PROPERLY COME BEFORE THE SPECIAL MEETING OF POLICYHOLDERS OR ANY ADJOURNMENT THEREOF. THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS. PLEASE VOTE AND SIGN ON THE OTHER SIDE. Detach Here Detach Here ------------------------------------------------------------------- ITEM (6) PURCHASER INFORMATION (SUBSCRIPTION OFFERING) -- CONTINUED: ------------------------------------------------------------------- Policy Title Policy Number(s) Office (Names on Policy) Use ------------------------------------------------------------------- ------------------------------------------------------------------- ------------------------------------------------------------------- ------------------------------------------------------------------- ------------------------------------------------------------------- ------------------------------------------------------------------- ITEM (10) NASD CONTINUED: a member of the immediate family of any such person to whose support such person contributes, directly or indirectly, or the holder of an account in which an NASD member or person associated with an NASD member has a beneficial interest. To comply with conditions under which an exemption from the NASD's Interpretation With Respect to Free-Riding and Withholding is available, you agree, if you have checked the NASD Affiliation box, (i) not to sell, transfer or hypothecate the stock for a period of three months following issuance, and (ii) to report this subscription in writing to the applicable NASD member within one day of payment therefor. ------------------------------------------------------------------- - ------------------------------------------------------------------------------- ITEM (11) AFFILIATES & ASSOCIATES CONTINUED: List below all other orders submitted by you or Affiliates and Associates (as defined) or by persons acting in concert with you. - -------------------------------------------------------------------------------- Name(s) listed on other stock order forms Number of Shares Ordered - -------------------------------------------------------------------- - -------------------------------------------------------------------- - -------------------------------------------------------------------- - -------------------------------------------------------------------- Name(s) listed on other stock order forms Number of continued Shares Ordered - -------------------------------------------------------------------- - -------------------------------------------------------------------- - -------------------------------------------------------------------- - -------------------------------------------------------------------- "Affiliate" is defined as: With respect to a person, a person that, directly or indirectly through one or more intermediaries, controls, is controlled by, or is under common control with such person. "Associate" is defined as: (i) any corporation or organization (other than Mercer Mutual, the Holding Company, FHI, a majority-owned subsidiary of Mercer Mutual or the Holding Company or any other entity that is a member of the same consolidated group as Mercer Mutual or the Holding Company under generally accepted accounting principles) of which such person is an officer or partner or is, directly or indirectly the beneficial owner of 10% or more of any class of equity securities; (ii) any trust or other estate in which such person has a substantial beneficial interest or as to which such person serves as a trustee or in a similar fiduciary capacity, except that such term shall not include a Tax-Qualified Employee Stock Benefit Plan in which a person has a substantial beneficial interest or serves as a trustee or in a similar fiduciary capacity; and (iii) any relative or spouse of such person, or any relative of such spouse, who has the same home as such person. BY SIGNING THIS STOCK ORDER FORM, YOU HEREBY CONFIRM THAT YOUR PURCHASE OF HOLDING COMPANY COMMON STOCK DOES NOT CONFLICT WITH THE PURCHASE LIMITATIONS UNDER THE PLAN OF CONVERSION DESCRIBED IN THE ACCOMPANYING PROSPECTUS, OR OTHERWISE IMPOSED BY LAW. YOU HEREBY AGREE THAT, IN THE EVENT THAT SUCH PURCHASE LIMITATIONS ARE VIOLATED BY YOU (INCLUDING ANY OF YOUR ASSOCIATES OR AFFILIATES OR ANY PERSON OTHERWISE ACTING IN CONCERT WITH YOU), THE HOLDING COMPANY SHALL HAVE THE RIGHT TO PURCHASE FROM YOU AT THE PURCHASE PRICE OF $10 PER SHARE, ALL SHARES ACQUIRED BY YOU IN EXCESS OF ANY SUCH PURCHASE LIMITATION OR, IF YOU HAVE SOLD SUCH EXCESS SHARES, YOU AGREE TO PAY TO THE HOLDING COMPANY THE DIFFERENCE BETWEEN THE AGGREGATE PURCHASE PRICE THAT YOU PAID FOR SUCH EXCESS SHARES IN THIS OFFERING AND THE PROCEEDS THAT YOU RECEIVED FROM THE SALE OF SUCH EXCESS SHARES. THIS RIGHT OF THE HOLDING COMPANY TO PURCHASE SUCH EXCESS SHARES SHALL BE ASSIGNABLE BY THE HOLDING COMPANY WITHOUT RESTRICTION. - -------------------------------------------------------------------------------- ------------------------------------------------------------------------------- [THE MERCER INSURANCE GROUP LOGO] [X] Please mark your vote as in this The undersigned hereby acknowledges receipt of the Proxy example. Statement dated , 2003 and hereby revokes any proxy or proxies heretofore given to vote at said meeting or any THE BOARD OF DIRECTORS RECOMMENDS A adjournment thereof. VOTE "FOR" THE FOLLOWING: SIGNATURE ------------------------------------ APPROVAL FOR PLAN OF CONVERSION AND DATE ---------------------------, 2003 THE RELATED AMENDMENT AND RESTATEMENT SIGNATURES IF HELD JOINTLY. PLEASE SIGN EXACTLY AS NAME OF MERCER MUTUAL'S ARTICLES OF APPEARS HEREON. INCORPORATION FOR [ ] AGAINST [ ]
(PLEASE DATE, SIGN AND RETURN THIS PROXY IN THE ENCLOSED ADDRESSED ENVELOPE) Detach Here Detach Here [MERCER MUTUAL LOGO] Subscription & Community Office Use Stock Order Form ------------------------------------------------------------------ MERCER MUTUAL INSURANCE COMPANY EXPIRATION DATE Conversion Center for Stock Order Forms: C/O Sandler O'Neill & Partners, L.P. Xxxxxx, July 31, 2003 919 Third Avenue 6th Fl x:00 p.m., xxxxxx Time New York, NY 10022 -- (xxx) xxx-xxxx ------------------------------------------------------------------ IMPORTANT-PLEASE NOTE: A properly completed original stock order form must be used to subscribe for common stock. Photocopies and facsimile copies of stock order forms will are not required to be accepted. Please read the Stock Ownership Guide and Stock Order Form Instructions as you complete this form. - ----------------------------------------------------------------------------------------------------------------------------------
(1) NUMBER OF SHARES (2) TOTAL PAYMENT DUE Subscription Price X 10.00 = The minimum number of shares that may be subscribed for is 25 and the maximum number of shares that may be subscribed for in the subscription offering is 100,000 shares. See Instructions. - -------------------------------------------------------------------------------------------------------------------------- [ ] (3) EMPLOYEE/OFFICER/DIRECTOR INFORMATION Policy Title (Names on Policy) Policy Number(s) Check here if you are an employee, officer or director ------------------------------------------------------------ of Mercer Mutual Insurance Company or member of such ------------------------------------------------------------ immediate family living in the same household. ------------------------------------------------------------ - ------------------------------------------------------------ PLEASE NOTE: FAILURE TO LIST YOUR ELIGIBLE POLICY MAY (4) METHOD OF PAYMENT/CHECK Total Check RESULT IN THE LOSS OF PART OR ALL OF YOUR SUBSCRIPTION RIGHTS. Amount LOSS OF PART OR ALL OF YOUR SUBSCRIPTION RIGHTS. IF Enclosed is a check, bank draft or ADDITIONAL SPACE IS NEEDED, PLEASE UTILIZE THE BACK OF THIS money order payable to "Wilmington Trust STOCK ORDER FORM. Company, as escrow agent for Mercer ------------------------------------------------------------ Insurance Group, Inc." in the amount indicated in this box. (7) PURCHASER INFORMATION (COMMUNITY OFFERING) - ------------------------------------------------------------ (5) FORM OF STOCK OWNERSHIP AND SS# OR TAX ID# a. [ ] Natural persons and trusts of natural persons who [ ] Individual [ ] Uniform Transfers are permanent residents of the states of Pennsylvania or to Minors Act New Jersey. (SS# of minor) [ ] Joint Tenants [ ] Company/Corp/Partnership b. [ ] Principals of corporations, partnerships, limited liability companies or other similar entities that are [ ] Tenants in Common [ ] IRA or other eligible policyholders. qualified plan [ ] Fiduciary (i.e. trust, state) c. [ ] Licensed insurance producers that have been SS# or Tax ID#: appointed by Mercer Mutual to market and distribute SS# or Tax ID#: policies of insurance and their affiliates. - ------------------------------------------------------------ (6) PURCHASER INFORMATION (SUBSCRIPTION OFFERING) d. [ ] Named insureds under policies of insurance issued by Mercer Mutual after December 13, 2002. a. [ ] Check here if you are an Eligible Policyholder as of the Eligibility Record Date of December 13, e. [ ] Providers of goods or services to Mercer Mutual. 2002. List policy information below. b. [ ] Check here if you are a director, officer and f. [ ] Other community members. employee of Mercer Mutual Insurance Company.
- -------------------------------------------------------------------------------- (8) STOCK REGISTRATION: (NAMES IN WHICH STOCK IS TO BE REGISTERED) Adding the names of other persons who are not owners of your eligible policy will result in the loss of your subscription rights. - -------------------------------------------------------------------------------- Name - -------------------------------------------------------------------------------- Street - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- City State Zip Code County of Residence - -------------------------------------------------------------------------------- (9) TELEPHONE Daytime/Evening ( ) ( ) - -------------------------------------------------------------------------------- (10) NASD AFFILIATION (11) AFFILIATES & ASSOCIATES/ACTING IN CONCERT [ ] Check here if you are a member of the National [ ] Check here and complete the reverse side of this form, Association of Securities Dealers, Inc. ("NASD"), a if you or any affiliates and associates or persons acting in person affiliated, or associated, with and NASD member, concert with you have (continued on reverse side) - --------------------------------------------------------------------------------------------------------------------------
(12) ACKNOWLEDGEMENT To be effective, this stock order form must be properly completed and physically received by Mercer Mutual Insurance Company no later than x:00 p.m., xxxxxx Time, on Xxxxxx, xxxxx xx, 2003, unless extended; otherwise this stock order form and all subscription rights will be void. The undersigned agrees that after receipt by Mercer Mutual, this stock order form may not be modified, withdrawn or canceled without the Mercer Mutual's consent. Under penalty of perjury, I hereby certify that the Social Security or Tax ID Number and the information provided on this stock order form is true, correct and complete, that I am not subject to back-up withholding, and that I am purchasing shares solely for my own account and that there is no agreement or understanding regarding the sale or transfer of such shares, or my right to subscribe for shares. It is understood that this stock order form will be accepted in accordance with, and subject to, the terms and conditions of the plan of conversion described in the accompanying prospectus. The undersigned hereby acknowledges receipt of the prospectus at least 48 hours prior to delivery of this stock order form to Mercer Mutual Insurance Company. You also agree to be bound by the agreements on the back of this stock order form. PENNSYLVANIA LAW PROHIBITS ANY PERSON FROM TRANSFERRING, OR ENTERING INTO ANY AGREEMENT, DIRECTLY OR INDIRECTLY, TO TRANSFER THE LEGAL OR BENEFICIAL OWNERSHIP OF SUBSCRIPTION RIGHTS OR THE UNDERLYING SECURITIES TO THE ACCOUNT OF ANOTHER. MERCER MUTUAL INSURANCE COMPANY AND MERCER INSURANCE GROUP, INC. WILL PURSUE ANY AND ALL LEGAL AND EQUITABLE REMEDIES IN THE EVENT THEY BECOME AWARE OF THE TRANSFER OF SUBSCRIPTION RIGHTS AND WILL NOT HONOR ORDERS KNOWN BY THEM TO INVOLVE SUCH TRANSFER. - -------------------------------------------------------------------------------- Signature Date Signature Date [MERCER LOGO] STOCK OWNERSHIP GUIDE INDIVIDUAL Include the first name, middle initial and last name of the shareholder. Avoid the use of two initials. Please omit words that do not affect ownership rights, such as "Mrs.", "Mr.", "Dr.", "special account", "single person", etc. - -------------------------------------------------------------------------------- JOINT TENANTS Joint tenants with right of survivorship may be specified to identify two or more owners. When stock is held by joint tenants with right of survivorship, ownership is intended to pass automatically to the surviving joint tenant(s) upon the death of any joint tenant. All parties must agree to the transfer or sale of shares held by joint tenants. - -------------------------------------------------------------------------------- TENANTS IN COMMON Tenants in common may also be specified to identify two or more owners. When stock is held by tenants in common, upon the death of one co-tenant, ownership of the stock will be held by the surviving co-tenant(s) and by the heirs of the deceased co-tenant. All parties must agree to the transfer or sale of shares held by tenants in common. - -------------------------------------------------------------------------------- UNIFORM TRANSFERS TO MINORS ACT ("UTMA") Stock may be held in the name of a custodian for a minor under the Uniform Transfers to Minors Act of each state. There may be only one custodian and one minor designated on a stock certificate. The standard abbreviation for Custodian is "CUST", while the Uniform Transfers to Minors Act is "UTMA". Standard U.S. Postal Service state abbreviations should be used to describe the appropriate state. For example, stock held by John Doe as custodian for Susan Doe under the New Jersey Uniform Transfers to Minors Act will be abbreviated John Doe, CUST Susan Doe UTMA NJ (use minor's social security number). - -------------------------------------------------------------------------------- FIDUCIARIES Information provided with respect to stock to be held in a fiduciary capacity must contain the following: -- The name(s) of the fiduciary. If an individual, list the first name, middle initial and last name. If a corporation, list the full corporate title (name). If an individual and a corporation, list the corporation's title before the individual. -- The fiduciary capacity, such as administrator, executor, personal representative, conservator, trustee, committee, etc. -- A description of the document governing the fiduciary relationship, such as a trust agreement or court order. Documentation establishing a fiduciary relationship may be required to register your stock in a fiduciary capacity. -- The date of the document governing the relationship, except that the date of a trust created by a will need not be included in the description. -- The name of the maker, donor or testator and the name of the beneficiary. An example of fiduciary ownership of stock in the case of a trust is: John Doe, Trustee Under Agreement Dated 10-1-87 for Susan Doe. STOCK ORDER FORM INSTRUCTIONS ITEMS 1 AND 2- NUMBER OF SHARES AND TOTAL PAYMENT DUE Fill in the number of shares that you wish to purchase and the total payment due. The amount due is determined by multiplying the number of shares by the subscription price of $10.00 per share. The minimum purchase in the subscription offering is 25 shares. As more fully described in the plan of conversion outlined in the prospectus, the maximum purchase in the subscription offering is $1,000,000 (100,000 shares), and the maximum purchase in the community offering (if held) by any person, is $1,000,000 (100,000 shares). However, no person, together with associates and persons acting in concert with such person, may purchase in the aggregate more than $1,000,000 (100,000 shares) of common stock. - -------------------------------------------------------------------------------- ITEM 3- EMPLOYEE/OFFICER/DIRECTOR INFORMATION Check this box to indicate whether you are an employee, officer or director of Mercer Mutual Insurance Company or a member of such person's immediate family living in the same household. - -------------------------------------------------------------------------------- ITEM 4- METHOD OF PAYMENT BY CHECK Indicate the total check(s) amount in this box. Payment may be made by check or money order payable to "Wilmington Trust Company, as escrow agent for Mercer Insurance Group, Inc.". - -------------------------------------------------------------------------------- ITEM 5- FORM OF STOCK OWNERSHIP, SS# OR TAX ID# Check the box that applies to your requested form of ownership which relates to the information supplied in item 8 and supply applicable social security or tax ID number(s). - -------------------------------------------------------------------------------- ITEM 6- PURCHASER INFORMATION (SUBSCRIPTION OFFERING) a. Check this box if you are an Eligible Policyholder as of the Eligibility Record Date of December 13, 2002. b. Check this box if you are a director, officer or employee of Mercer Mutual Insurance Company. Please list all names and all policy numbers on policies you had at these dates in order to insure proper identification of your purchase rights. NOTE: FAILURE TO LIST YOUR ELIGIBLE POLICY MAY RESULT IN THE LOSS OF YOUR SUBSCRIPTION RIGHTS. - -------------------------------------------------------------------------------- ITEM 7- PURCHASER INFORMATION (COMMUNITY OFFERING) Check a-f, whichever is applicable. - -------------------------------------------------------------------------------- ITEMS 8 AND 9- REGISTRATION, MAILING ADDRESS AND TELEPHONE NUMBERS Complete the requested certificate registration and mailing address in item 8. The stock transfer industry has developed a uniform system of shareholder registrations that will be used in the issuance of your common stock. If you have any questions regarding the registration of your stock, please consult your legal advisor. Stock ownership must be registered in one of the ways described above under "Stock Ownership Guide". ADDING THE NAMES OF OTHER PERSONS WHO ARE NOT OWNERS OF YOUR ELIGIBLE POLICY WILL RESULT IN THE LOSS OF YOUR SUBSCRIPTION RIGHTS. Indicate your daytime and evening telephone number(s) in item 9. We may need to call you if we cannot execute your order as given. - -------------------------------------------------------------------------------- ITEM 10- NASD AFFILIATION Check this box if you are a member of the NASD or if this item otherwise applies to you. - -------------------------------------------------------------------------------- ITEM 11- AFFILIATES & ASSOCIATES ACTING IN CONCERT Check this box if you or any associate (as defined on the reverse side of the stock order form) or person acting in concert with you has submitted another order for shares and complete the reverse side of the stock order form. - -------------------------------------------------------------------------------- ITEM 12- ACKNOWLEDGEMENT Sign and date the stock order form where indicated. Before you sign, review the stock order form, including the acknowledgement. - -------------------------------------------------------------------------------- You may mail your completed stock order form in the envelope that has been provided. Your stock order form, properly completed, and payment in full at the subscription price must be physically received by Mercer Mutual no later than x:00 p.m., xxxxxx Time, on xxxxxxx, xxxxxxx xx, 2003 or it will become void. If you have any remaining questions, or if you would like assistance in completing your stock order form, you may call our conversion center at (xxx) xxx-xxxx, Monday through Friday, between the hours of 10:00 a.m. and 4:00 p.m. The conversion center will be closed for national holidays. (THE MERCER INSURANCE GROUP LOGO) , 2003 Dear : We are pleased to announce that the Board of Directors of Mercer Mutual Insurance Company has adopted a plan to convert from a Pennsylvania mutual insurance company to a Pennsylvania stock insurance company. As part of this plan, we have formed Mercer Insurance Group, Inc., which will become the parent holding company of Mercer Mutual. We are converting to stock form in order to provide a corporate structure that we believe is necessary for Mercer Mutual Insurance Company to remain a viable, competitive and financially sound insurance company. To learn more about the conversion and stock offering, you are cordially invited to join members of our senior management team at a community meeting to be held on at x:00 p.m. A member of our staff will be calling to confirm your interest in attending the meeting. If you would like additional information regarding the meeting or our conversion and offering, please call our conversion center at (xxx) xxx-xxxx, Monday through Friday between the hours of 10:00 a.m. to 4:00 p.m. Sincerely, /s/ Andrew R. Speaker Andrew R. Speaker President and Chief Executive Officer This is not an offer to sell or a solicitation of an offer to buy common stock. The offer is made only by the prospectus. (THE MERCER INSURANCE GROUP LOGO) , 2003 Dear Subscriber: We hereby acknowledge receipt of your order for shares of common stock in Mercer Insurance Group, Inc. At this time, we cannot confirm the number of shares of Mercer Insurance Group, Inc. common stock that will be issued to you. Such allocation will be made in accordance with the plan of conversion following completion of the stock offering. If you have any questions, please call our conversion center at (xxx) xxx-xxxx. Sincerely, MERCER INSURANCE GROUP, INC. Conversion Center This is not an offer to sell or a solicitation of an offer to buy common stock. The offer is made only by the prospectus. (THE MERCER INSURANCE GROUP LOGO) , 2003 Dear Charter Shareholder: We appreciate your interest in the stock offering of Mercer Insurance Group, Inc. Due to the excellent response from our eligible policyholders, we are unable to complete all orders in full. Consequently, in accordance with the provisions of the plan of conversion, you were allocated shares at a price of $10.00 per share. A refund of any balance due you will be mailed promptly. The purchase date and closing of the transaction occurred on XX, 2003. Trading will commence on the Nasdaq National Market under the symbol "MIGP" on XX, 2003. Your stock certificate will be mailed to you shortly. We thank you for your interest in Mercer Insurance Group, Inc. and welcome you as a charter shareholder. Sincerely, MERCER INSURANCE GROUP, INC. Conversion Center This is not an offer to sell or a solicitation of an offer to buy common stock. The offer is made only by the prospectus. (THE MERCER INSURANCE GROUP LOGO) , 2003 Dear Interested Investor: We recently completed our subscription and community offerings. Unfortunately, due to the excellent response from our eligible policyholders, stock was not available for any other category. A refund of any balance due you will be mailed promptly. We appreciate your interest in Mercer Insurance Group, Inc. and hope you become an owner of our stock in the future. The stock will trade on the Nasdaq National Market under the symbol "MIGP." Sincerely, MERCER INSURANCE GROUP, INC. Conversion Center This is not an offer to sell or a solicitation of an offer to buy common stock. The offer is made only by the prospectus. (THE MERCER INSURANCE GROUP LOGO) xxxxx, 2003 Welcome Shareholder: We are pleased to enclose the stock certificate that represents your share of ownership in Mercer Insurance Group, Inc., the parent holding company of Mercer Insurance Company. Please examine your stock certificate to be certain that it is properly registered. If you have any questions about your certificate, you should contact our transfer agent immediately at the following address: Registrar and Transfer Company Investor Relations Department 10 Commerce Drive Cranford, NJ 07016-3572 1 (800) 368-5948 email: info@rtco.com Also, please remember that your certificate is a negotiable security that should be stored in a secure place, such as a safe deposit box or on deposit with your stockbroker. On behalf of the Board of Directors of Mercer Insurance Group, Inc., Mercer Insurance Company and our employees, I would like to thank you for supporting our offering. Sincerely, /s/ Andrew R. Speaker Andrew R. Speaker President and Chief Executive Officer This is not an offer to sell or a solicitation of an offer to buy common stock. The offer is made only by the prospectus. (THE MERCER INSURANCE GROUP LOGO) , 2003 Dear Interested Subscriber: We regret to inform you that your order in our community offering for shares of Mercer Insurance Group, Inc. common stock has not been accepted by Mercer Mutual Insurance Company and Mercer Insurance Group, Inc., the holding company for Mercer Mutual. In accordance with our plan of conversion, Mercer Mutual and Mercer Insurance Group, Inc. have the absolute right to reject the subscription of any subscription in the community offering, in whole or in part. Enclosed is a check representing your subscription payment. Sincerely, MERCER INSURANCE GROUP, INC. Conversion Center [SANDLER O'NEILL & PARTNERS, L.P. LOGO] , 2003 To Our Friends: We are enclosing the offering material for Mercer Insurance Group, Inc., established by Mercer Mutual Insurance Company, which is now in the process of converting from a mutual insurance company to a stock insurance company. Sandler O'Neill & Partners, L.P. is managing the subscription offering, which will conclude at x:00 p.m., xxxxxx time, on xxxxx xx, 2003. Sandler O'Neill is also providing conversion agent services for Mercer Mutual. In the event that all the common stock is not sold in the subscription and community offering, Sandler O'Neill may form and manage a syndicate of broker/dealers to sell the remaining common stock and/or offer the stock in a public offering. Members of the general public, other than residents of xxxxxxx, are eligible to participate. If you have any questions about this transaction, please do not hesitate to call. Sincerely, Sandler O'Neill & Partners, L.P. This is not an offer to sell or a solicitation of an offer to buy common stock. The offer is made only by the prospectus. -----END PRIVACY-ENHANCED MESSAGE-----