-----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, HKvYpPvh6mWodwrsyAc3nu3bgxa8QR0Ivn1TVhpaojNzf1GGHAIQcdmzA/gVHjRU 8okNtkjWKwrJU9Mld9fA8g== 0000893220-99-000012.txt : 19990112 0000893220-99-000012.hdr.sgml : 19990112 ACCESSION NUMBER: 0000893220-99-000012 CONFORMED SUBMISSION TYPE: S-1/A PUBLIC DOCUMENT COUNT: 7 FILED AS OF DATE: 19990111 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: SEC FILE NUMBER: 333-41497 FILM NUMBER: 99504463 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 AMENDMENT NO. 5 TO FORM S-1 MERCER INSURANCE GROUP 1 AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JANUARY 11, 1999 REGISTRATION NO. 333-41497 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ AMENDMENT NO. 5 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 (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER OF 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) ------------------------ WILLIAM C. HART 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 RICHARD A. HEMMINGS, ESQUIRE STEVENS & LEE LORD, BISSELL & BROOK ONE GLENHARDIE CORPORATE CENTER 115 SOUTH LASALLE STREET 1275 DRUMMERS LANE CHICAGO, ILLINOIS 60603 P.O. BOX 236 (312) 443-0700 WAYNE, PENNSYLVANIA 19087 (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 AGGREGATE TITLE OF EACH CLASS OF AMOUNT TO BE OFFERING PRICE OFFERING AMOUNT OF SECURITIES TO BE REGISTERED REGISTERED PER SHARE PRICE(1) REGISTRATION FEES - ------------------------------------------- -------------------- -------------------- -------------------- -------------------- Common Stock, no par value per share....... 3,769,444 shares(2) $10.00 $37,694,440 $11,120 - ------------------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------------------
(1) Estimated solely for the purpose of calculating the registration fee in accordance with Rule 457(d) and based on the maximum of the appraisal valuation range of Mercer Mutual Insurance Company (to be acquired by the registrant in connection with this offering), as determined by an independent appraiser, plus 10% of the shares sold in the offering, reflecting a possible purchase of shares of the Common Stock by the registrant's employee stock ownership plan. (2) Represents maximum number of shares to be issued in the transactions contemplated by this Registration Statement. ------------------------ 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 SECURITIES AND EXCHANGE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a), MAY DETERMINE. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 [TO BE USED IN CONNECTION WITH THE SYNDICATED COMMUNITY OFFERING ONLY] SYNDICATED PROSPECTUS SUPPLEMENT MERCER INSURANCE GROUP, INC. SHARES OF COMMON STOCK Mercer Insurance Group, Inc. (the "Company"), a Pennsylvania corporation, is offering for sale in a syndicated community offering (the "Syndicated Community Offering") shares, at a per share price of $10.00, of its common stock, no par value per share (the "Common Stock"), to be issued upon the conversion (the "Conversion") of Mercer Mutual Insurance Company ("Mercer Mutual") from a Pennsylvania mutual insurance company to a Pennsylvania stock insurance company and the issuance of all of the authorized capital stock of Mercer Mutual to the Company pursuant to a Plan of Conversion from Mutual to Stock Organization (the "Plan"). shares of the Common Stock have been subscribed for in subscription and community offerings (the "Conversion Offerings") by (i) named insureds under policies of insurance issued by Mercer Mutual and in force as of the close of business on October 17, 1997, (ii) the Company's tax-qualified employee stock ownership plan (the "ESOP"), (iii) directors, officers and employees of Mercer Mutual, and then by (iv) certain members of the general public. Contained herein is the Prospectus in the form used in the Conversion Offerings (the "Prospectus"). For a description of the Conversion Offerings, see "The Conversion -- The Conversion Offerings" in the Prospectus. The purchase price for all shares purchased in the Syndicated Community Offering will be $10.00 per share, which is the same purchase price paid by subscribers in the Conversion Offerings (the "Purchase Price"). The Purchase Price must be paid for each share at the time a purchase order is submitted. See the cover page of the Prospectus for information regarding the method of subscribing for shares of the Common Stock. The Syndicated Community Offering will expire no later than , 1999. If the Syndicated Community Offering is not completed by , 1999, the Syndicated Community Offering will be terminated and all funds held will be returned promptly to subscribers without interest. The minimum number of shares which may be purchased is 25 shares. Except for the ESOP, which may purchase up to 10% of the total number of shares of Common Stock issued in the Conversion, no person, together with associates of, and persons acting in concert with, such person, may purchase more than 100,000 shares of Common Stock. See "The Conversion -- Stock Pricing and Number of Shares to Be Issued" and "-- Limitations on Purchases of Common Stock" in the Prospectus. The Company reserves the right, in its absolute discretion, to accept or reject, in whole or in part, any or all subscriptions received in the Syndicated Community Offering. The Company and Mercer Mutual have engaged Sandler O'Neill & Partners, L.P. ("Sandler O'Neill") as financial advisors to assist them with the sale of the Common Stock in the Syndicated Community Offering. It is anticipated that Sandler O'Neill will use the services of other registered broker-dealers ("Selected Dealers") and that fees to Sandler O'Neill and such Selected Dealers will not exceed 7% of the aggregate Purchase Price of the shares sold in the Syndicated Community Offering. Neither Sandler O'Neill nor any Selected Dealer shall have any obligation to take or purchase any shares of Common Stock in the Syndicated Community Offering. See "The Conversion -- Marketing and Underwriting Arrangements" and "-- Syndicated Community Offering" in the Prospectus. The Company has received approval to have its Common Stock listed on the Nasdaq National Market under the symbol "MRCR," subject to completion of the Conversion. Sandler O'Neill has advised the Company that, following completion of the Conversion, it intends to make a market in the Common Stock, but it is under no obligation to do so. Prior to the Conversion, there was no market for the Common Stock, and there can be no assurance that an active and liquid trading market for the Common Stock will develop, or if developed, will be maintained. The absence or discontinuance of a market may have an adverse impact on both the price and liquidity of the stock. THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION, THE PENNSYLVANIA DEPARTMENT OF INSURANCE, OR ANY OTHER FEDERAL OR STATE AGENCY OR ANY STATE SECURITIES COMMISSION, NOR HAS SUCH COMMISSION OR DEPARTMENT, OR ANY SUCH OTHER 3 AGENCY OR SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
ESTIMATED NET ESTIMATED PROCEEDS OF UNDERWRITING ESTIMATED NET SUBSCRIPTION, SYNDICATED COMMISSION PROCEEDS OF COMMUNITY COMMUNITY AND OTHER SYNDICATED AND SYNDICATED OFFERING FEES AND COMMUNITY COMMUNITY PRICE(1) EXPENSES(2) OFFERING OFFERINGS(3)(4) ---------- ------------ ------------- --------------- Per Share............................... $10.00 $ $ $ Total................................... $ $ $ $
- --------------- (1) Based on the sale of shares of Common Stock at the Purchase Price of $10.00 per share. In addition, the Company has received subscriptions for shares of Common Stock in the Conversion Offerings. Alex Sheshunoff & Company has advised the Company that, as of December 28, 1998, the estimated consolidated pro forma market value of Mercer Mutual as a subsidiary of the Company is between $25.1 million and $33.9 million. (2) Consists of the Syndicated Community Offering's pro rata allocation of the estimated expenses of the Company and Mercer Mutual in connection with the Conversion (other than estimated fees to be paid to Sandler O'Neill for services in connection with the Conversion Offerings) and estimated compensation of Sandler O'Neill and Selected Dealers in connection with the sale of shares in the Syndicated Community Offering, which fees are estimated to be $ and may be deemed to be underwriting fees. The information under "Pro Forma Data" in the Prospectus was based on the assumptions stated therein, which may differ from the estimates used for this table. See "The Conversion -- Marketing and Underwriting Agreements" for a more detailed discussion of fee arrangements. (3) The Company intends to contribute $5 million of the net proceeds to Mercer Mutual in exchange for all of the capital stock of Mercer Mutual to be issued in connection with the Conversion. The Company intends to retain the balance of the net proceeds. See "Use of Proceeds." (4) The net proceeds of the Conversion Offerings (based upon the sale of the shares subscribed for at a price of $10.00 per share and after the allocation to the Conversion Offerings of their pro rata portion of the estimated expenses related to the Conversion) are estimated to be $ . SANDLER O'NEILL & PARTNERS, L.P. ------------------------ The date of this Prospectus Supplement is , 1999. 4 PROSPECTUS [LOGO] MERCER INSURANCE GROUP, INC. UP TO 3,392,500 SHARES OF COMMON STOCK Mercer Insurance Group, Inc. (the "Company"), a Pennsylvania corporation and the proposed holding company for Mercer Mutual Insurance Company ("Mercer Mutual"), is offering up to 3,392,500 shares of its common stock, no par value per share (the "Common Stock"), 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 October 17, 1997 ("Eligible Policyholders"), (ii) the Company's tax-qualified employee stock ownership plan (the "ESOP"), and (iii) directors, officers and employees of Mercer Mutual. Subscription rights received in any of the foregoing categories will be subordinated to the subscription rights received by those in a prior category. Subscription rights are not transferable. Except for the ESOP, which may purchase a maximum of between 250,750 and 376,944 shares of Common Stock, no purchaser, together with associates of or persons acting in concert with such person, may purchase, in the aggregate, more than 100,000 shares of Common Stock in the Subscription Offering. The maximum number of shares that may be purchased in the Subscription Offering by all Eligible Policyholders in the aggregate is 3,392,500 shares. The total number of shares of Common Stock offered in the Subscription Offering may be increased to up to 3,769,444 shares if necessary to satisfy the subscription rights of the ESOP. Concurrently with the Subscription Offering, the Company is offering the Common Stock for sale to the general public in a community offering (the "Community Offering"). Preference in the Community Offering will be given to: (i) natural persons and trusts of natural persons (including individual retirement and Keogh retirement accounts) who reside in the states 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) holders of policies of insurance originally issued after October 17, 1997, and (v) providers of goods or services to, and identified by, Mercer Mutual. Sales of Common Stock in the Community Offering will be subject to the prior rights of holders of subscription rights and the right of the Company, in its absolute discretion, to reject orders in the Community Offering in whole or in part. In the sole discretion of the Company, shares not subscribed for in the Subscription Offering and Community Offering (collectively, the "Conversion Offerings"), if any, may be offered to the general public in a syndicated community offering (the "Syndicated Community Offering") to be managed by Sandler O'Neill & Partners, L.P. ("Sandler O'Neill"). The Conversion Offerings and Syndicated Community Offering shall be collectively referred to herein as the "Offerings." The Offerings are being made in connection with the conversion of Mercer Mutual from mutual to stock form and the simultaneous acquisition of the capital stock of Mercer Mutual by the Company pursuant to a Plan of Conversion from Mutual to Stock Organization adopted by the Board of Directors of Mercer Mutual on October 17, 1997, as amended (the "Plan"). The Conversion of Mercer Mutual to stock form, the issuance of the capital stock of Mercer Mutual to the Company and the offer and sale of the Common Stock by the Company are collectively referred to herein as the "Conversion." The completion of the Conversion is contingent upon the sale of a minimum of 2,507,500 shares of Common Stock in the Offerings. No person may purchase fewer than 25 shares of Common Stock in the Offerings. For more information, please call the Stock Information Center (the "Conversion Center") toll-free at 1-888-303-9085. PROSPECTIVE INVESTORS SHOULD REVIEW AND CONSIDER THE DISCUSSION UNDER "RISK FACTORS" BEGINNING ON PAGE 20. SANDLER O'NEILL & PARTNERS, L.P. The date of this Prospectus is , 1999 5 THESE SHARES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION, ANY STATE SECURITIES COMMISSION OR THE PENNSYLVANIA DEPARTMENT OF INSURANCE (THE "PENNSYLVANIA DEPARTMENT"), NOR HAS THE SECURITIES AND EXCHANGE COMMISSION, ANY STATE SECURITIES COMMISSION OR THE PENNSYLVANIA DEPARTMENT PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
PURCHASE FEES AND ESTIMATED NET PRICE(1) EXPENSES(2) PROCEEDS(3) -------------- ------------- -------------- Per Share(4)................................. $ 10.00 $ 0.73 $ 9.27 Total Minimum................................ $25,075,000.00 $2,070,150.00 $23,004,850.00 Total Midpoint............................... $29,500,000.00 $2,149,800.00 $27,350,200.00 Total Maximum................................ $33,925,000.00 $2,229,450.00 $31,695,550.00
- --------------- (1) Determined in accordance with an independent appraisal (the "Appraisal") prepared by Alex Sheshunoff & Company ("Sheshunoff") and updated as of December 28, 1998, which states that the consolidated pro forma market value of Mercer Mutual as a subsidiary of the Company ranged from $25,075,000 (the "Total Minimum") to $33,925,000 (the "Total Maximum") with a midpoint of $29,500,000 (the "Total Midpoint"). Collectively, the range from the Total Minimum to the Total Maximum is referred to herein as the "Estimated Valuation Range." Based on the Estimated Valuation Range, the Board of Directors of the Company and Mercer Mutual have determined to offer up to 3,392,500 shares at a Purchase Price of $10.00 per share (the "Purchase Price"). The Company, however, may issue up to 3,769,444 shares in the event the ESOP purchases shares in excess of the Total Maximum, in order to satisfy the ESOP's 10% subscription. The final appraised value will be determined at the time of the closing of the Offerings and is subject to change. The valuation set forth in the Appraisal must not be construed as a recommendation by the Company, Mercer Mutual, Sandler O'Neill or Sheshunoff as to the advisability of purchasing such shares or that a purchaser subsequently will be able to sell such shares at or above the Purchase Price. If the final valuation is outside the Estimated Valuation Range, then the Company will promptly notify all subscribers by mail of the final valuation. Subscribers will be given the opportunity to confirm or modify their orders. The funds of all subscribers who do not confirm or modify their orders will be returned promptly without interest. See "Use of Proceeds," "Capitalization" and "Pro Forma Data." (2) Consists of the estimated costs to the Company and Mercer Mutual arising in the Conversion, including estimated marketing fees and fixed expenses to be paid to Sandler O'Neill in connection with the Offerings, which fees and expenses are estimated to be $489,150 and $648,450 at the Total Minimum and the Total Maximum, respectively. See "Use of Proceeds" and "Pro Forma Data" for the assumptions used to arrive at these estimates. The actual fees and expenses may vary from these estimates. See "The Conversion -- Marketing and Underwriting Arrangements" and "-- Syndicated Community Offering." (3) Represents net proceeds to the Company before the loan which the Company intends to make to the ESOP, which will be used by the ESOP to purchase 10% of the shares of Common Stock sold in the Subscription Offering. The amount of this loan will be $2.5 million at the Total Minimum, $3.0 million at the Total Midpoint, and $3.4 million at the Total Maximum. See "Use of Proceeds," "Capitalization," and "Pro Forma Data." (4) Based on the Total Midpoint. The estimated net proceeds per share at the Total Minimum and Total Maximum are expected to be $9.17 and $9.34, respectively. All shares of Common Stock will be sold in the Offerings for $10.00 per share (the "Purchase Price"). The Appraisal is intended to be an estimate of the consolidated pro forma market value of Mercer Mutual as a subsidiary of the Company and is based on a review of internal projections and a comparison of the consolidated financial condition and results of operations of Mercer Mutual to property and casualty insurance industry averages and a peer group of representative publicly-owned property and casualty insurance companies. The Appraisal is not intended, and must not be construed, as a recommendation of any kind as to 2 6 the advisability of purchasing Common Stock. In preparing the valuation, Sheshunoff has relied upon and assumed the accuracy and completeness of financial and statistical information provided by the Company and Mercer Mutual. Sheshunoff did not independently verify the financial statements, projections and other information provided by the Company and Mercer Mutual, perform an independent analysis of the assumptions underlying the financial statements or projections or value independently the assets and liabilities of the Company and Mercer Mutual. The valuation considers the Company and Mercer Mutual as a going concern only and should not be considered as an indication of the liquidation value of the Company and Mercer Mutual. Upon completion of the Offerings, Sheshunoff will submit to the Company and to the Pennsylvania Department its updated consolidated pro forma fair market value of Mercer Mutual as a subsidiary of the Company. If the updated estimated valuation is within the Estimated Valuation Range, the Conversion can be completed and the number of shares of Common Stock sold in the Conversion will be determined as follows: (i) If participants in the Subscription Offering subscribe for 3,392,500 shares or more, the Company, as required by the Plan, will sell all 3,392,500 shares offered hereby to participants in the Subscription Offering and will sell up to an additional 376,944 shares to the ESOP to satisfy its subscription in full. Shares will be allocated among participants in the Subscription Offering in accordance with the terms of the Plan and excess funds will be promptly returned to subscribers without interest. For a description of the allocation method and procedure, see "The Conversion -- The Conversion Offerings -- Subscription Offering." (ii) If participants in the Subscription Offering subscribe for at least 2,507,500 shares but less than 3,392,500 shares, then, as required by the Plan, the Company will sell to participants in the Subscription Offering the number of shares of Common Stock sufficient to satisfy their subscriptions in full. The Company, in its sole discretion, may accept subscriptions in the Community Offering and/or sell shares in the Syndicated Community Offering provided the total number of shares of Common Stock sold in the Conversion does not exceed 3,392,500 shares (excluding shares sold to the ESOP). Any excess funds received in the Community Offering and/or the Syndicated Community Offering will be promptly returned to subscribers without interest after the completion of the Offerings. (iii) If participants in the Subscription Offering subscribe for fewer than 2,507,500 shares, then the Company will sell to participants in the Subscription Offering the number of shares of Common Stock sufficient to satisfy their subscriptions in full and will accept subscriptions in the Community Offering and/or sell shares in the Syndicated Community Offering in an amount sufficient to sell at least 2,507,500 shares in the aggregate. The Company, in its sole discretion, may accept additional subscriptions in the Community Offering and sell additional shares in the Syndicated Community Offering provided the total number of shares sold in the Conversion does not exceed 3,392,500 (excluding shares sold to the ESOP). Any excess funds received in the Community Offering and/or the Syndicated Community Offering will be promptly returned to subscribers without interest after the completion of the Offerings. (iv) If the number of shares subscribed for in the Offerings is less than 2,507,500, then the Company will cancel the Offerings and all subscription funds will be returned promptly to subscribers without interest. There is a difference of approximately $8.9 million between the Total Minimum and the Total Maximum of the Estimated Valuation Range. As a result of this broad range, the final updated Appraisal may estimate a consolidated pro forma market value for Mercer Mutual as a subsidiary of the Company that is materially less than the aggregate dollar amount of subscriptions received by the Company. Therefore, subscribers, in the aggregate and on a per share basis, may pay materially more for the Common Stock than such estimated consolidated pro forma market value. See "Risk Factors -- Possible Adverse Impact of Broad Valuation Range and its Use to Determine the Number of Shares of Common Stock Sold." Except for the ESOP, which intends to purchase 10% of the total number of shares of Common Stock issued in the Conversion, no purchaser, together with associates or persons acting in concert with such person, may purchase, in the aggregate, more than 100,000 shares of Common Stock in the Conversion (4.0%, 3.4%, 3.0% and 2.7% of the number of shares issued at the Total Minimum, Total Midpoint, Total Maximum and 3 7 Total Maximum plus ESOP shares, respectively). No person may purchase fewer than 25 shares. There are 42,178 Eligible Policyholders. In the event that subscriptions by Eligible Policyholders for Common Stock exceed the maximum of the Estimated Valuation Range, the Company will be obligated under the Plan to sell to Eligible Policyholders 3,392,500 shares, which is the maximum number of shares offered hereby (excluding shares expected to be purchased by the ESOP), and shares of Common Stock would be allocated among Eligible Policyholders first, so as to permit each subscriber to purchase up to 1,000 shares (unless the magnitude of subscriptions does not permit such an allocation), and then in proportion to the respective amounts of shares for which they subscribed. If all 42,178 Eligible Policyholders were to subscribe for 100,000 shares of Common Stock, then each Eligible Policyholder would receive only 80 shares. The Company is unable to predict the number of Eligible Policyholders that may participate in the Subscription Offering. Directors and executive officers of the Company and Mercer Mutual as a group (10 persons), including their associates, are expected to purchase approximately 186,000 shares of the Common Stock to be issued in the Conversion (7.4%, 6.3%, 5.5% and 4.9% at the Total Minimum, Total Midpoint, Total Maximum and Total Maximum plus ESOP Shares, respectively), not including 10% of such Common Stock expected to be purchased by the ESOP (250,750, 295,000, 339,250 and 376,944 shares at the Total Minimum, Total Midpoint, Total Maximum and Total Maximum plus ESOP shares, respectively) and excluding additional shares that are expected to be issued (or issuable) following the Conversion, subject to shareholder approval, in connection with the implementation of the Company's Stock Compensation Plan. See "Management of the Company -- Certain Benefit Plans and Agreements." The Subscription Offering and the Community Offering will terminate at 1:00 p.m., Eastern Standard Time, on , 1999, unless extended by the Company in its sole discretion for up to an additional 45 days (such date and time, including any extensions, shall be hereinafter referred to as the "Termination Date"). If the Company extends the Offerings, it will give written notice of such extension to all subscribers on or before , 1999, and each subscriber may withdraw or confirm his or her subscription by the extended Termination Date. If a subscriber withdraws a subscription, or does not confirm a subscription by the extended Termination Date, the subscriber's funds will be returned promptly without interest. No action to extend the Offerings will be taken by the Company after , 1999. Subscribers may purchase shares in the Offerings by completing and returning to the Company a stock order form (the "Stock Order Form") and a certification form (the "Certification Form"), together with full payment for all Common Stock subscribed for at the Purchase Price. An executed Stock Order Form, once received by the Company, may not be modified, amended or rescinded without the consent of the Company. Subscriptions will be held in a separate escrow account at State Street Bank and Trust Company, N.A. established specifically for this purpose. If the Conversion is not completed within 45 days after the Termination Date, the Offerings will be terminated and all funds held will be returned promptly without interest. See "The Conversion -- The Conversion Offerings" and "-- Purchases in the Conversion Offerings." The Company and Mercer Mutual have engaged Sandler O'Neill to consult with and advise the Company and Mercer Mutual with respect to the Offerings, and Sandler O'Neill has agreed to use its best efforts to assist the Company with its solicitation of subscriptions and purchase orders for shares of Common Stock in the Offerings. Sandler O'Neill is not obligated to purchase any shares of Common Stock in the Offerings. The Company and Mercer Mutual will pay a fee to Sandler O'Neill which will be based on the aggregate Purchase Price of Common Stock sold in the Offerings. The Company and Mercer Mutual have agreed to indemnify Sandler O'Neill against certain liabilities, including liabilities arising under the Securities Act of 1933, as amended (the "Securities Act"). See "The Conversion -- Marketing and Underwriting Arrangements." The Common Stock has been approved for inclusion in the Nasdaq National Market under the symbol "MRCR," subject to completion of the Conversion. Prior to the Conversion, there was no market for the Common Stock. Sandler O'Neill has advised the Company that, following the completion of the Conversion, it intends to make a market in the Common Stock, 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. There can be no assurance there will be two or more market makers for the Common Stock. Additionally, the development of an active and liquid public market 4 8 depends on the existence of willing buyers and sellers, the presence of which is not within the control of the Company, Mercer Mutual or any market maker. There can be no assurance that an active and liquid trading market for the Common Stock will develop or that, if developed, it will continue. The absence or discontinuance of a market may have an adverse impact on both the price and liquidity of the Common Stock. There is no assurance that persons purchasing shares will be able to sell them at or above the Purchase Price or that quotations will be available on the Nasdaq National Market as contemplated. THE CONVERSION IS CONTINGENT UPON APPROVAL OF THE PLAN BY ELIGIBLE POLICYHOLDERS OF MERCER MUTUAL AT THE SPECIAL MEETING OF ELIGIBLE POLICYHOLDERS CALLED FOR THAT PURPOSE TO BE HELD ON (THE "SPECIAL MEETING") AND THE SALE OF THE MINIMUM NUMBER OF SHARES OFFERED PURSUANT TO THE PLAN. PENNSYLVANIA INSURANCE LAWS AND REGULATIONS PROVIDE THAT NO PERSON MAY ACQUIRE CONTROL OF THE COMPANY, AND THUS INDIRECT CONTROL OF MERCER MUTUAL, UNLESS SUCH PERSON HAS OBTAINED THE PRIOR APPROVAL OF THE PENNSYLVANIA INSURANCE COMMISSIONER. UNDER PENNSYLVANIA LAW, ANY PURCHASER OF 10% OR MORE OF THE VOTING STOCK OF AN INSURANCE HOLDING COMPANY IS PRESUMED TO HAVE ACQUIRED CONTROL OF AFFILIATED OR SUBSIDIARY INSURERS. NEW JERSEY INSURANCE LAWS AND REGULATIONS PROVIDE THAT NO PERSON MAY ACQUIRE CONTROL OF THE COMPANY, AND THUS INDIRECT CONTROL OF MERCER INSURANCE COMPANY OF NEW JERSEY, INC., A WHOLLY-OWNED INDIRECT SUBSIDIARY OF MERCER MUTUAL, UNLESS SUCH PERSON HAS OBTAINED THE PRIOR APPROVAL OF THE NEW JERSEY INSURANCE COMMISSIONER. UNDER NEW JERSEY LAW, ANY PURCHASER OF 10% OR MORE OF THE VOTING STOCK OF AN INSURANCE HOLDING COMPANY IS PRESUMED TO HAVE ACQUIRED CONTROL OF AFFILIATED OR SUBSIDIARY INSURERS. ------------------------ ORGANIZATIONAL STRUCTURE BEFORE THE CONVERSION MERCER MUTUAL INSURANCE COMPANY 100% QUEENSTOWN HOLDING COMPANY, INC. 100% MERCER INSURANCE COMPANY OF NEW JERSEY, INC. ------------------------ ORGANIZATIONAL STRUCTURE AFTER THE CONVERSION [GRAPHIC OF SHAREHOLDERS] SHAREHOLDERS 100% MERCER INSURANCE GROUP, INC. 100% MERCER MUTUAL INSURANCE COMPANY 100% QUEENSTOWN HOLDING COMPANY, INC. 100% MERCER INSURANCE COMPANY OF NEW JERSEY, INC. 5 9 PROSPECTUS SUMMARY The following summary does not purport to be complete and is qualified in its entirety by the more detailed information and the Consolidated Financial Statements and Notes thereto of Mercer Mutual appearing elsewhere in this Prospectus. For an explanation of certain terms used in this Prospectus that are commonly used in the insurance industry, see "Glossary of Selected Insurance Terms." This Prospectus contains certain forward-looking statements within the meaning of the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995. Reference is made in particular to the descriptions of the Company's and its subsidiaries' plans and objectives for future operations, assumptions underlying such plans and objectives and other forward-looking statements included in this Prospectus under "Use of Proceeds," "Business" and "Risk Factors." Such statements are based on management's current expectations and are subject to a number of factors and uncertainties which could cause actual results to differ materially from those described in such forward-looking statements. Factors which could cause such results to differ materially from those described in the forward-looking statements include those set forth under "RISK FACTORS" below. MERCER INSURANCE GROUP, INC... The Company was formed under Pennsylvania law in November 1997 for the purpose of becoming the holding company for Mercer Mutual upon completion of the Conversion. Prior to the Conversion, the Company will not engage in any significant operations. After the Conversion, the Company's primary assets will be the outstanding capital stock of Mercer Mutual and a portion of the net proceeds of the Conversion. The Company's executive offices are located at 10 North Highway 31, Pennington, New Jersey 08534, and the Company's main telephone number is (609) 737-0426. THE INSURANCE COMPANIES....... Mercer Mutual is a Pennsylvania mutual insurance company that began operations in 1844. 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 filed Articles of Domestication with the Pennsylvania Department of State, which changed its state of domicile from New Jersey to Pennsylvania (the "Redomestication"). On the effective date of the Redomestication, the Pennsylvania Department replaced the New Jersey Department of Banking and Insurance (the "New Jersey Department") as Mercer Mutual's primary insurance regulator. Mercer Mutual owns all of the outstanding capital stock of Queenstown Holding Company, Inc. ("QHC"), the holding company for Mercer Insurance Company of New Jersey, Inc. ("MIC," and collectively with Mercer Mutual, the "Insurance Companies"). 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 homeowners and commercial multi-peril policies, as well as other liability, workers' compensation, fire, allied, inland marine and commercial automobile coverages through approximately 140 independent agencies. MIC exclusively offers workers' compensation insurance to businesses located in New Jersey. For the years ended December 31, 1997 and 1996, Mercer Mutual and its subsidiaries had consolidated revenues of $21.0 million and 6 10 $23.7 million respectively, and net income of $2.2 million and $640,000, respectively. For the nine months ended September 30, 1998, Mercer Mutual and its subsidiaries had consolidated revenue of $19.3 million and net income of $2.0 million. At September 30, 1998, Mercer Mutual and its subsidiaries had consolidated assets of $76.7 million, total equity of $25.8 million and over 42,000 property and casualty policies in force. The principal strategies of the Company for the future are to: - Improve the mix of business by increasing commercial and casualty writings in order to enhance profitability and lessen the impact of property losses on overall results; - Geographically diversify its risk through acquisitions of other insurance companies in Pennsylvania and other jurisdictions, in order to reduce its overall exposure to weather-related property losses in its primary coverage area; - Attract and retain high-quality agencies having diverse customer bases in the Company's targeted growth markets within Pennsylvania and New Jersey, through increased marketing activities and the development and tailoring of commercial programs meeting the needs of their customers; and - Reduce its reliance on reinsurance by increasing the maximum exposure retained by the Insurance Companies on individual property and casualty risks, and thereby increase net premium volume. Management views the Conversion as a critical component of its strategic plan. The additional capital generated by the Conversion will permit the Insurance Companies to accelerate implementation of these strategies. The resulting holding company structure will also provide needed flexibility to achieve the Company's goals by permitting the Company to use its Common Stock or preferred stock to effect future acquisitions or raise additional capital. See "The Conversion -- Business Purposes." THE CONVERSION................ Pursuant to the Plan, Mercer Mutual will (i) convert from a Pennsylvania-chartered mutual insurance company to a Pennsylvania-chartered stock insurance company, and (ii) simultaneously issue shares of its capital stock to the Company in exchange for a portion of the net proceeds from the sale of Common Stock in the Conversion. The Conversion will be accounted for as a simultaneous reorganization, recapitalization and share offering which will not change the historical accounting basis of Mercer Mutual's financial statements. BACKGROUND AND REASONS FOR THE CONVERSION.................... Mercer Mutual's exposure to severe weather conditions has been a major factor affecting its underwriting results since 1991. Operating results in 1994 and 1996 were adversely affected by severe winter storms in such years that were largely responsible for Mercer Mutual's $1.4 million net operating loss in 1994 and that reduced net income by $665,000 in 1996. In order to reduce the risk caused by this exposure, Mercer Mutual's strategic plan is 7 11 expressly predicated upon geographically diversifying its business and improving capital strength. Increased capital would facilitate diversification of risk through acquisitions and would provide additional policyholder protection by increasing policyholder surplus. Since 1996, Mercer Mutual has considered various capital formation alternatives and has elected to proceed with the Conversion in accordance with the provisions of the Pennsylvania Insurance Company Mutual to Stock Conversion Act (the "Act"). On October 17, 1997, the Board of Directors of Mercer Mutual unanimously adopted the Plan. An application with respect to the Conversion was filed by Mercer Mutual with the Pennsylvania Department on November 26, 1997 and notice of the filing and the opportunity to comment on and to request and receive a copy of the Plan was simultaneously mailed to all Eligible Policyholders as required by law. On June 5, 1998, the Pennsylvania Department held a public informational hearing regarding the Conversion. By orders dated October 20, 1998 (the "Orders"), the Plan was approved by the Pennsylvania Department and the Company received the approval of the Pennsylvania Department to acquire control of Mercer Mutual. The Plan is subject to the approval of the Eligible Policyholders at the Special Meeting. ATTEMPT TO ACQUIRE MERCER MUTUAL........................ On March 3, 1998, Mercer Mutual received an unsolicited offer from Franklin Mutual Insurance Company ("Franklin") to purchase from Mercer Mutual, upon the consummation of the Conversion, all of the to-be-issued capital stock of Mercer Mutual for a purchase price equal to the audited book value of Mercer Mutual at December 31, 1997. Mercer Mutual's Board of Directors unanimously rejected such offer. On April 3, 1998, Franklin reextended its offer to Mercer Mutual. Mercer Mutual's Board of Directors again unanimously rejected such offer. On both occasions, Mercer Mutual's Board of Directors determined that Franklin's offer was not in the best interests of Mercer Mutual and its policyholders and other constituents. See "Business -- Offer to Acquire Mercer Mutual." LEGAL PROCEEDINGS............. In May 1998, Franklin filed with the Pennsylvania Department a petition to intervene and request for a full adjudicatory hearing with respect to all proceedings of the Pennsylvania Department concerning Mercer Mutual's application for approval of the Plan. The Orders provide that, in approving the Plan, the Pennsylvania Department considered Franklin's petition to intervene and request for adjudicatory hearing as public comments, and not as formal pleadings because formal pleadings are not required or appropriate in the review of a proposed plan of conversion under the Act. On October 27, 1998, Franklin filed with the Pennsylvania Department an appeal of the Orders and a request for a full adjudicatory hearing. On November 6, 1998, the Pennsylvania Department rejected Franklin's appeal because the Pennsylvania Department had no jurisdiction to entertain such appeal. On November 9, 1998, Franklin filed a petition for review in the nature of an appeal with the Pennsylvania Commonwealth Court objecting to and requesting that such court reverse the Orders. Franklin's petition is still 8 12 pending. See "Business -- Legal Proceedings" and "The Conversion -- Background and Reasons for the Conversion." ORGANIZATION BEFORE AND AFTER THE CONVERSION................ Set forth on page 5 of the Prospectus is an illustration of the organizational structure of the Insurance Companies before the Conversion and of the Company and the Insurance Companies after the Conversion. STOCK PRICING AND NUMBER OF SHARES TO BE ISSUED........... Pennsylvania law requires that the aggregate purchase price of the Common Stock to be issued in the Conversion be consistent with an independent appraisal (the "Appraisal") of the estimated consolidated pro forma market value of Mercer Mutual as a subsidiary of the Company following the Conversion. Alex Sheshunoff & Company ("Sheshunoff"), a firm experienced in corporate valuations, has performed the Appraisal and has determined that, as of December 28, 1998, the estimated pro forma market value of Mercer Mutual as a subsidiary of the Company ranged from $25.1 million to $33.9 million, with a midpoint of $29.5 million. The Company, in consultation with its advisors, has determined to offer the shares in the Conversion at the Purchase Price. The Appraisal is intended to be an estimate of the consolidated pro forma market value of Mercer Mutual as a subsidiary of the Company, and is based on a review of internal projections, and a comparison of the consolidated financial condition and results of operations of Mercer Mutual to property and casualty insurance company averages and a peer group of representative publicly owned property and casualty insurance companies. The Appraisal is not intended, and must not be construed, as a recommendation of any kind by the Company, Mercer Mutual, Sandler O'Neill or Sheshunoff as to the advisability of purchasing Common Stock. In preparing the Appraisal, Sheshunoff has relied upon and assumed the accuracy and completeness of financial and statistical information provided by the Company, and Sheshunoff did not independently verify the financial statements, projections and other information provided by the Company and Mercer Mutual, perform an independent analysis of the assumptions underlying the financial statements or projections or value independently the assets and liabilities of the Company and Mercer Mutual. The Appraisal considers the Company and Mercer Mutual as a going concern only and should not be considered as an indication of the liquidation value of the Company and Mercer Mutual. The Appraisal will be updated immediately prior to completion of the Offerings, and such updated Appraisal will be filed with the Securities and Exchange Commission pursuant to a post-effective amendment to the registration statement of which this prospectus is a part. If the value reflected in the updated Appraisal is within the Estimated Valuation Range, the Company will not notify subscribers of the updated Appraisal and the Conversion will be consummated. If participants in the Subscription Offering subscribe for 3,392,500 shares or more, the Company, as required by the Plan, will sell all 9 13 3,392,500 shares offered hereby to participants in the Subscription Offering and will sell up to an additional 376,944 shares to the ESOP to satisfy its subscription in full. Shares will be allocated among participants in the Subscription Offering in accordance with the terms of the Plan and excess funds will be promptly returned to subscribers without interest. If participants in the Subscription Offering subscribe for at least 2,507,500 shares but less than 3,392,500 shares, then, as required by the Plan, the Company will sell to participants in the Subscription Offering the number of shares of Common Stock sufficient to satisfy their subscriptions in full. The Company, in its sole discretion, may accept subscriptions in the Community Offering and sell shares in the Syndicated Community Offering provided the total number of shares of Common Stock sold in the Conversion does not exceed 3,392,500 shares (excluding the shares sold to the ESOP). Any excess funds received in the Community Offering or the Syndicated Community Offering will be promptly returned to subscribers without interest. If participants in the Subscription Offering subscribe for fewer than 2,507,500 shares, then the Company will sell to participants in the Subscription Offering the number of shares of Common Stock sufficient to satisfy their subscriptions in full and will accept subscriptions in the Community Offering and/or sell shares in the Syndicated Community Offering in an amount sufficient to sell at least 2,507,500 shares in the aggregate. The Company, in its sole discretion, may accept additional subscriptions in the Community Offering and sell additional shares in the Syndicated Community Offering provided the total number of shares sold in the Conversion does not exceed 3,392,500 (excluding the shares sold to the ESOP). Any excess funds received in the Community Offering or the Syndicated Community Offering will be promptly returned to subscribers without interest. If the number of shares subscribed for in the Offerings is less than 2,507,500, then the Company will cancel the Offerings and all subscription funds will be returned promptly to subscribers without interest. If the value reflected in the updated Appraisal is not within the Estimated Valuation Range, the Company may terminate the Offerings. If in such event the Company proceeds with the Offerings, then the Company will deliver promptly to the subscribers an updated prospectus containing a description of the updated Appraisal. The Conversion Valuation Report containing the updated Appraisal will not be delivered to subscribers, but will be an exhibit to a post-effective amendment to the registration statement of which this prospectus is a part, and may be obtained through the Securities and Exchange Commission directly or accessed through its Internet website at http://www.sec.gov. See "Available Information." Subscribers will be given the opportunity to confirm or modify their orders. The funds of all subscribers who do not confirm or modify their orders will be returned promptly without interest. Subscription orders may not be withdrawn for any reason if the updated Appraisal is within the Estimated Valuation Range. There is a difference of approximately $8.9 million between the minimum and the maximum of the Estimated Valuation Range. 10 14 Therefore, subscribers, in the aggregate and on a per share basis, may pay more for the Common Stock than the consolidated pro forma market value of Mercer Mutual as a subsidiary of the Company. See "Risk Factors -- Adverse Impact of Broad Valuation Range and Its Use to Determine the Number of Shares of Common Stock Sold." THE SUBSCRIPTION AND COMMUNITY OFFERINGS..................... The shares of Common Stock to be issued in the Conversion are being offered at a purchase price of $10.00 per share (the "Purchase Price") in the Subscription Offering pursuant to nontransferable subscription rights in the following order of priority: (i) Eligible Policyholders, (ii) the ESOP, and (iii) directors, officers and employees of Mercer Mutual. Subscription rights of directors, officers and employees of Mercer Mutual will be subordinated to subscription rights of Eligible Policyholders. Concurrently, and subject to the prior rights of holders of subscription rights, any shares of Common Stock not subscribed for in the Subscription Offering are being offered at the Purchase Price in the Community Offering to members of the general public. 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 (the "Local Community"), (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 October 17, 1997, and (v) providers of goods and services to, and identified by, Mercer Mutual. The Company reserves the absolute right to accept or reject any orders in the Community Offering, in whole or in part. Subscription rights will expire if not exercised by, and the Conversion Offerings will terminate at, 1:00 p.m., Eastern Standard Time on , 1999, unless extended by the Company for up to an additional 45 days (such date and time, including any extensions, shall be hereinafter referred to as the "Termination Date"). If the Company extends the Termination Date, it will given written notice of such extension to all subscribers on or before , 1999, at which time each subscriber may withdraw or confirm his or her subscription by the extended Termination Date. If a Subscriber withdraws a subscription, or does not confirm a subscription by the extended Termination Date, the subscriber's funds will be returned promptly without interest. In no event shall the extended Termination Date be later than , 1999. THE SYNDICATED COMMUNITY OFFERING...................... If participants in the Conversion Offerings (excluding the ESOP) subscribe for fewer than 3,392,500 shares in the aggregate, the Company, in its sole discretion, may sell additional shares in the Syndicated Community Offering. All shares of Common Stock offered in the Syndicated Community Offering will be offered for sale at the Purchase Price to the general public on a best efforts basis through a syndicate of registered broker-dealers to be formed and managed by Sandler O'Neill, acting as agent of the Company 11 15 to assist the Company in the sale of Common Stock. The Syndicated Community Offering would be commenced as soon as practicable following the Termination Date, and must be completed within 45 days thereafter. The Company reserves the absolute right to reject orders, in whole or in part, in its sole discretion, in the Syndicated Community Offering. See "The Conversion -- Marketing and Underwriting Arrangements" and "-- Syndicated Community Offering." PROSPECTUS DELIVERY AND PROCEDURE FOR PURCHASING SHARES........................ To ensure that each purchaser receives a prospectus at least 48 hours prior to the Termination Date in accordance with Rule 15c2-8 of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), no prospectus will be mailed later than five days prior to the Termination Date or hand delivered later than two days prior to such date. Stock Order Forms and Certification Forms will be distributed only with a prospectus. The Company is not obligated to accept for processing orders not submitted on Stock Order Forms and not accompanied by a Certification Form. Any person who desires to subscribe for shares of Common Stock in the Offerings must do so prior to the Termination Date by delivering to the Conversion Center by mail at P.O. Box 15, Pennington, New Jersey 08534-0015, or in person at the Company's principal executive offices located at 10 North Highway 31, Pennington, New Jersey 08534, a properly executed and completed Stock Order Form and Certification Form, together with full payment for all shares for which the subscription is made. A Stock Order Form and Certification Form will be included with each prospectus delivered to a prospective purchaser of Common Stock and no Stock Order Form or Certification Form will be delivered to a prospective purchaser unless accompanied by a prospectus or prior delivery of a prospectus can be verified. Payment for shares of Common Stock may be made by check or money order. All checks or money orders must be made payable to "Mercer Insurance Group, Inc." Subscriptions will be held in a separate escrow account at State Street Bank and Trust Company, N.A. Such funds will not be released until the Conversion is completed or terminated. The Conversion will be completed or terminated no later than , 1999. If the number of shares subscribed for in the Offerings at the Purchase Price through , 1999 is less than 2,507,500 shares, then the Company will cancel the Offerings on such date and all subscription funds will be returned promptly to subscribers without interest. All subscription rights under the Plan will expire on the Termination Date, whether or not the Company has been able to locate each person entitled to such subscription rights. ONCE TENDERED, ORDERS TO PURCHASE COMMON STOCK IN THE OFFERING CANNOT BE REVOKED. In the event of an oversubscription in the Subscription Offering, shares of Common Stock will be allocated among subscribing Eligible Policyholders, as follows. First, shares of Common 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 12 16 shares for which such Eligible Policyholder has subscribed. Second, any shares of Common Stock remaining after such initial allocation will be allocated among the subscribing Eligible Policyholders whose subscriptions remain unsatisfied in the proportion in which the aggregate number of shares as to which each such Eligible Policyholder's subscription remains unsatisfied bears to the aggregate number of shares as to which all such Eligible Policyholders' subscriptions remain unsatisfied, provided, however, that no fractional shares of Common Stock will be issued. If, because of the magnitude of the oversubscription, shares of Common 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 Common 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 Common Stock shall be issued. For more information, please call the Conversion Center toll-free at 1-888-303-9085. See "The Conversion -- The Conversion Offerings," "-- Purchases in the Conversion Offerings" and "-- Marketing and Underwriting Arrangements." PURCHASE LIMITATIONS.......... No person may purchase fewer than 25 shares in the Offerings. The ESOP may purchase up to an aggregate of 10% of the shares of Common Stock to be issued in the Conversion and is expected to do so. With the exception of the ESOP, no person (including Eligible Policyholders who elect to purchase stock in the Conversion), together with his or her associates or persons acting in concert with him or her, may purchase in the aggregate, more than 100,000 shares of Common Stock (4.0% of the shares to be issued in the Conversion at the Total Minimum of the Estimated Valuation Range). There are 42,178 Eligible Policyholders. In the event that subscriptions by Eligible Policyholders for Common Stock exceed the maximum of the Estimated Valuation Range, the Company will be obligated under the Plan to sell to Eligible Policyholders 3,392,500 shares, which is the maximum number of shares offered hereby (excluding shares expected to be purchased by the ESOP), and shares of Common Stock would be allocated among Eligible Policyholders first, so as to permit each subscriber to purchase up to 1,000 shares (unless the magnitude of subscriptions does not permit such an allocation), and then in proportion to the respective amounts of shares for which they subscribed. If all Eligible Policyholders were to subscribe for 100,000 shares of Common Stock offered, then each Eligible Policyholder would receive only approximately 80 shares. The Company is unable to predict the number of Eligible Policyholders that may participate in the Subscription Offering. PURCHASE OF COMMON STOCK BY MANAGEMENT.................... The directors and executive officers of the Company and Mercer Mutual, each of whom is an Eligible Policyholder, together with their associates, propose to purchase, in the aggregate, approxi- 13 17 mately 186,000 shares of Common Stock in the Conversion, which equals 6.3% of the shares of Common Stock to be issued in the Conversion assuming an offering at the Total Midpoint of the Estimated Valuation Range (but excluding shares purchased by the ESOP). All such shares will be purchased by the directors and executive officers and their associates, if any, in the Subscription Offering and in their capacities as Eligible Policyholders. See "The Conversion -- Proposed Management Purchases." BENEFITS TO MANAGEMENT........ Up to 10.9% of the net proceeds of the Offerings is expected to be used to fund the purchase by the ESOP of 10% of the shares of Common Stock sold in the Conversion. These shares will be awarded over a ten-year period to substantially all of Mercer Mutual's employees in exchange for their services rendered to Mercer Mutual. See "Use of Proceeds." Subject to shareholder approval, the Board of Directors of the Company also intends to adopt (i) a Management Recognition Plan (the "MRP") pursuant to which the Company intends to award to employees and directors of the Company, pursuant to awards which vest over a five-year period, up to 4% of the number of shares of Common Stock sold in the Conversion in exchange for their services rendered to Mercer Mutual, and (ii) a Stock Compensation Plan (the "Compensation Plan") pursuant to which the Company intends to grant options to purchase Common Stock (at its fair market value on the date of the option grant) to employees and directors of the Company, in an amount up to 10% of the number of shares of Common Stock sold in the Conversion. The Company intends to award shares under the MRP and to grant stock options under the Compensation Plan as soon as practicable after the approval of the MRP and the Compensation Plan by the Company's shareholders. The MRP and the Stock Compensation Plan must be approved by the Company's shareholders, and may be submitted to the shareholders for approval no sooner than six months after the consummation of the Conversion. 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. See "Management of the Company -- Certain Benefit Plans and Agreements." USE OF PROCEEDS............... The amount of the net proceeds from the Offerings will depend upon the total number of shares sold and the expenses of the Conversion. As a result, the net proceeds from the Offerings cannot be determined until the Conversion is completed. The Company anticipates that net proceeds will be at least $23.0 million. See "Use of Proceeds" for the assumptions used to arrive at this estimate. Between 10.9% and 10.7% of the net proceeds retained by the Company will be used for a loan by the Company to the ESOP to enable it to purchase 10% of the shares of Common Stock issued in the Conversion. The loan will fund the entire purchase price of the shares purchased by the ESOP in the Conversion ($3.8 million at the Total Maximum of the Estimated Valuation Range plus the ESOP shares) and will be repaid principally from Mercer Mutual's contributions to the ESOP and from dividends payable on unallo- 14 18 cated shares of Common Stock held by the ESOP. The Company has received Pennsylvania Department approval to contribute $5.0 million of net proceeds from the Offerings to Mercer Mutual in exchange for all of the capital stock of Mercer Mutual to be issued in the Conversion. Assuming net proceeds from the Offerings of between $23.0 million and $35.4 million and the implementation of the ESOP, the Company would retain between $15.5 million and $26.6 million after acquiring the stock of Mercer Mutual. These funds will be available for a variety of corporate purposes including, but not limited to, additional capital contributions to Mercer Mutual, future acquisitions within the property and casualty insurance industry, dividends to shareholders and future repurchases of Common Stock to the extent permitted by Pennsylvania law and the Pennsylvania Department. With the exception of the ESOP Loan and the capital contribution to Mercer Mutual, the Company currently has no specific plans, intentions, arrangements or understandings regarding any of the foregoing activities. See "Dividend Policy." The portion of the net proceeds contributed to Mercer Mutual will become part of Mercer Mutual's capital, thereby expanding underwriting capacity and permitting diversification of its business. Mercer Mutual may cause a portion of the net proceeds it receives from the Company to be contributed to MIC in connection with MIC's planned expansion of its New Jersey business beyond workers' compensation insurance to include the same types of insurance currently written by Mercer Mutual. See "Business -- Products." NON-TRANSFERABILITY OF SUBSCRIPTION RIGHTS........... The Plan provides that no person shall transfer or enter into any agreement or understanding to transfer the legal or beneficial ownership of subscription rights issued under the Plan or, prior to exercise of the subscription rights, the shares of Common Stock to be issued upon their exercise. Persons violating such prohibition will lose their right to purchase Common Stock in the Conversion. Each person exercising subscription rights will be required to certify that his or her purchase of Common Stock is solely for the purchaser's own account and that there is no agreement or understanding regarding the sale or transfer of such shares. MARKET FOR THE COMMON STOCK... The Company has received approval to have the Common Stock quoted on the Nasdaq National Market under the symbol "MRCR," subject to completion of the Conversion. Sandler O'Neill has advised the Company that following the Conversion, it intends to make a market in the Common Stock, but it is under no obligation to do so. Prior to the Offerings, there was no public market for the Common Stock and there can be no assurance that an active and liquid trading market for the Common Stock will develop or that if developed, it will continue, nor is there any assurance that persons purchasing shares of Common Stock will be able to sell their shares at or above the Purchase Price or that quotations will be available on the Nasdaq National Market as contemplated. See "Market for the Common Stock." 15 19 DIVIDENDS..................... Declaration of dividends by the Board of Directors of the Company will depend on a number of factors, including the requirements of applicable law and the determination by the Board of Directors of the Company that the net income, capital and financial condition of the Company and the Insurance Companies, industry trends, general economic conditions and other factors justify the payment of dividends. In addition, the payment of dividends from Mercer Mutual to the Company and from the Company to its shareholders is subject to a number of regulatory conditions, including conditions imposed by the Pennsylvania Department in the Orders in connection with its approval of the Conversion. The Company has not yet determined whether it will pay dividends to its shareholders in the foreseeable future, and no assurance can be given that dividends will be permitted to be paid under the terms of the Orders or will ultimately be declared by the Board of Directors of the Company. See "Dividend Policy" and "Business -- Regulation." ANTITAKEOVER PROVISIONS....... The Articles of Incorporation and Bylaws of the Company, Pennsylvania statutory provisions and employee benefit arrangements, as well as certain other provisions of state and federal law, may have the effect of discouraging or preventing a non-negotiated change in control of the Company, as well as a proxy contest for control of the Board of Directors of the Company. For a detailed discussion of those provisions, see "Risk Factors -- Articles of Incorporation, Bylaw and Statutory Provisions that Could Discourage Hostile Acquisitions of Control," "Management -- Certain Benefit Plans and Agreements," "Certain Restrictions on Acquisition of the Company" and "Description of Capital Stock." 16 20 MERCER MUTUAL SELECTED CONSOLIDATED FINANCIAL DATA The following table sets forth selected consolidated financial data for Mercer Mutual prior to the Conversion and should be read in conjunction with the Consolidated Financial Statements, and accompanying notes thereto and other financial information included elsewhere herein, as well as "Management's Discussion and Analysis of Financial Condition and Results of Operations." The consolidated statement of income data for the year ended December 31, 1994 and the consolidated balance sheet data at December 31, 1995 are derived from the audited consolidated financial statements of Mercer Mutual and its subsidiaries not included in this Prospectus. The consolidated statement of income data for the year ended December 31, 1993 and for the nine months ended September 30, 1997 and 1998 and the consolidated balance sheet data at December 31, 1993 and 1994 and at September 30, 1997 and 1998 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 the Company considers necessary for a fair presentation of such financial information for such periods. 17 21 MERCER MUTUAL SELECTED CONSOLIDATED FINANCIAL DATA
NINE MONTHS ENDED SEPTEMBER 30, YEAR ENDED DECEMBER 31, --------------------- ---------------------------------------------------------- 1998 1997 1997 1996 1995 1994 1993 ---------- ------- ---------- ------- ------- ----------- ----------- (UNAUDITED) (DOLLARS IN THOUSANDS) (UNAUDITED) Revenue Data: Direct premiums written........... $ 22,977 $21,504 $ 28,453 $24,958 $24,699 $24,355 $23,349 Net premiums written(1)(2)........ 20,734 12,904 17,461 20,124 21,245 19,377 18,964 Statement of Income Data: Net premiums earned............... 17,110 13,288 17,969 20,634 20,817 18,681 18,225 Net investment income............. 1,656 1,793 2,350 2,289 2,132 1,904 2,196 Net realized investment gains..... 368 483 589 596 53 277 509 Other income...................... 124 144 173 155 161 166 159 ---------- ------- ---------- ------- ------- ------- ------- Total revenues............ 19,258 15,708 21,081 23,674 23,163 21,028 21,089 ---------- ------- ---------- ------- ------- ------- ------- Losses and Expenses: Losses and loss adjustment expenses(2)(3)................ 8,739 8,038 10,594 14,801 13,296 14,107 11,631 Other underwriting expenses..... 7,591 5,461 7,269 8,062 8,360 8,976 8,494 ---------- ------- ---------- ------- ------- ------- ------- Total expenses............ 16,330 13,499 17,863 22,863 21,656 23,083 20,125 ---------- ------- ---------- ------- ------- ------- ------- Income (loss) before federal income taxes.................... 2,928 2,209 3,218 811 1,507 (2,055) 964 Federal income tax expense (benefit)....................... 966 694 1,001 171 369 (681) 165 ---------- ------- ---------- ------- ------- ------- ------- Net income (loss)(3).............. $ 1,962 $ 1,515 $ 2,217 $ 640 $ 1,138 $(1,374) $ 799 ========== ======= ========== ======= ======= ======= ======= Selected Balance Sheet Data (at period end): (UNAUDITED) (UNAUDITED) Total investments and cash...... $ 55,976 $47,443 $ 48,506 $45,434 $44,022 $35,470 $40,414 Total assets.................... 76,719 73,258 74,085 74,074 77,523 71,750 71,110 Total liabilities............... 50,883 51,312 50,849 54,792 58,560 57,547 53,469 Total equity.................... $ 25,836 $21,946 $ 23,236 $19,282 $18,963 $14,202 $17,641 GAAP Ratios: Loss and loss adjustment expense ratio(3)(4)................... 51.1% 60.5% 58.9% 71.7% 63.9% 75.5% 63.8% Underwriting expense ratio(5)... 44.4% 41.1% 40.5% 39.1% 40.2% 48.0% 46.6% Combined ratio(6)............... 95.5% 101.6% 99.4% 110.8% 104.1% 123.5% 110.4% Statutory Data: Statutory combined ratio........ 92.2% 102.6% 102.1% 110.5% 103.0% 122.6% 110.7% Industry combined ratio(7)...... 104.2% 101.0% 101.6% 105.9% 106.4% 108.4% 106.9% Statutory surplus............... $ 21,323 $19,034 $ 20,132 $16,087 $14,938 $11,133 $12,979 Ratio of statutory net written premiums to statutory surplus(8).................... 1.30x .90x .87x 1.25x 1.42x 1.74x 1.46x Pro Forma Data(9): Net income...................... $ 1,838 $ 2,051 Net income per share of Common Stock......................... $ 0.80 $ 0.90 Weighted average number of shares of Common Stock outstanding................... 2,291,228 2,269,288
- --------------- (1) The increase from September 30, 1997 to September 30, 1998 reflects the restructuring of Mercer Mutual's reinsurance programs during both years. (2) The decrease from December 31, 1996 to December 31, 1997 reflects the termination, as of December 31, 1996, of Mercer Mutual's participation in a pooling arrangement with two other insurance companies. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." (3) Losses and loss adjustment expenses, net income and loss and loss expense ratios for the years ended December 31, 1994 and 1996 were adversely affected by the frequency and severity of weather-related 18 22 MERCER MUTUAL SELECTED CONSOLIDATED FINANCIAL DATA -- (CONTINUED) property losses. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." (4) Calculated by dividing losses and loss adjustment expenses by net premiums earned. (5) Calculated by dividing other underwriting expenses by net premiums earned. (6) The sum of the Loss and Loss Adjustment Expense Ratio and the Underwriting Expense Ratio. (7) As reported by A.M. Best Company, Inc., an independent insurance rating organization. (8) Annualized for the periods ended September 30, 1997 and 1998. (9) Information excerpted from unaudited Pro Forma Condensed Consolidated Statements of Income for the year ended December 31, 1997 and the nine months ended September 30, 1998. See "Pro Forma Data." 19 23 RISK FACTORS Before investing in the Common Stock offered hereby, prospective investors should carefully consider all of the information set forth in this prospectus and, in particular, the matters presented below. POSSIBLE ADVERSE IMPACT OF CATASTROPHE AND NATURAL PERIL LOSSES ON FINANCIAL CONDITION AND RESULTS OF OPERATIONS In common with other property and casualty insurers, Mercer Mutual is subject to claims arising from catastrophes that may have a significant impact on its results of operations and financial condition. Mercer Mutual has experienced, and can be expected to experience in the future, catastrophe losses that may materially affect its financial condition and results of operations. Catastrophe losses can be caused by various events, including coastal storms, snow storms, ice storms, freezing, hurricanes, earthquakes, tornadoes, wind, hail and fires, and their incidence and severity are inherently unpredictable. The extent of net losses from catastrophes is a function of three factors: the total amount of insured exposure in the area affected by the event, the severity of the event and the amount of reinsurance coverage. Mercer Mutual's financial condition and results of operations also are affected periodically by losses caused by natural perils, regardless of whether such losses, because of their magnitude, qualify as "catastrophes" as classified by the Property Claims Service Division of American Insurance Services Group, Inc., an insurance industry body. Because of the geographic concentration of its business, Mercer Mutual may be more exposed to losses of this type than other property and casualty insurers. The blizzard of January 1996 that adversely affected Mercer Mutual's results of operations for 1996 is an example of a "catastrophe." A multiplicity of such events, all or some of which do not qualify as catastrophes, in the aggregate, may materially affect the Company's financial condition and results of operations, partly because losses from individual events may not permit recovery under Mercer Mutual's catastrophe reinsurance coverage. The frequency and severity of winter storms during 1994 that adversely affected Mercer Mutual's results of operations for such year is an example of this phenomenon. See "-- Geographic Concentration of Business," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business -- Reinsurance." POSSIBLE ADVERSE IMPACT DUE TO GEOGRAPHIC CONCENTRATION OF BUSINESS All direct premiums written by Mercer Mutual are generated in New Jersey and Pennsylvania. For the years ended December 31, 1995, 1996 and 1997 and the nine months ended September 30, 1998, 99.3%, 99.1%, 98.7% and 98.5%, respectively, of Mercer Mutual's direct premiums written were derived from policies written in New Jersey. As such, Mercer Mutual has a significant exposure to weather-related property losses, as evidenced by severe winter storms in New Jersey that were largely responsible for Mercer Mutual's $1.4 million net loss for the year ended December 31, 1994 and that reduced net income by $665,000 in the year ended December 31, 1996. The revenues and profitability of Mercer Mutual could be significantly affected by legal and judicial trends and prevailing economic, regulatory, demographic and other conditions in New Jersey as well as the impact of catastrophe and natural peril losses in that state. See "-- Catastrophe and Natural Peril Losses." POSSIBLE ADVERSE IMPACT OF LITIGATION On February 11, 1997, the affiliated companies of Old Guard Mutual Insurance Company, Old Guard Mutual Fire Insurance Company and Goschenhoppen-Home Mutual Insurance Company (the "Old Guard Companies") completed the first mutual to stock conversions under the Pennsylvania Insurance Company Mutual to Stock Conversion Act (the "Act"). Since such time, no other mutual to stock conversions similar to the Conversion have been completed under the Act. On January 7, 1997, a policyholder of one of the Old Guard Companies filed an action in the Commonwealth Court of Pennsylvania against the Pennsylvania Department, the Old Guard Companies and their holding company seeking, among other things, to have the court (1) declare the Act unconstitutional, and (2) direct the Pennsylvania Department to rescind its approval of the conversions (the "Old Guard Policyholder Action"). On July 21, 1997, the Old Guard Policyholder 20 24 Action was settled and the litigation terminated without any admissions of liability or lack of merit of the claims. Under the terms of this settlement, (i) the Pennsylvania Department implemented certain additional procedures designed to ensure the dissemination of greater information and disclosure to policyholders and others; (ii) the Pennsylvania Department agreed to use certain defined criteria to evaluate whether a hearing should be held on a conversion plan; (iii) the parties mutually released each other from all claims relating to the Old Guard Policyholder Action; and (iv) no money or other consideration was paid by any party to the litigation to any other party to the litigation. On February 10, 1997, the Old Guard Companies and their holding company and each of their respective directors were served with an eleven count combination class action and derivative lawsuit, filed in the United States District Court for the Eastern District of Pennsylvania (the "Old Guard Class Action") challenging the constitutionality of the Act, and alleging violations of the Act and the breach by the directors of the Old Guard Companies of their fiduciary duties of care and loyalty. The suit seeks compensatory damages as may be allowed by law, a declaration that the plan of conversion violates the Act and the United States and Pennsylvania Constitutions and the rights of the plaintiffs thereunder, and other relief. The holding company for the Old Guard Companies has stated in its filings under the Exchange Act that the Old Guard Companies and their directors believe they have meritorious defenses to the action and intend to defend this action vigorously. The Old Guard Class Action is still pending. The Pennsylvania Department has stated that it believes the Act is constitutional. The Company and Mercer Mutual, based on the advice of their counsel, believe that it is unlikely that any litigation challenging the constitutionality of the Act would be successful principally because of (i) the existence of court decisions that have consistently upheld the constitutionality of a very similar federal statutory provision providing for the conversion to stock form of mutual savings and loan associations, pursuant to which over 1,000 mutual to stock conversions have been completed to date, and (ii) a court decision upholding the constitutionality of a similar Pennsylvania statutory provision providing for the conversion to stock form of a Pennsylvania mutual savings bank. However, because of the recent passage of the Act in December 1995 and the settlement of the Old Guard Policyholder Action, no legal precedent exists directly governing the determination of the claims made in the Old Guard Class Action. In May 1998, Franklin Mutual Insurance Company ("Franklin") filed with the Pennsylvania Department a petition to intervene and request for a full adjudicatory hearing with respect to all proceedings of the Pennsylvania Department concerning Mercer Mutual's application for approval of the Plan. The Orders provide that, in approving the Plan, the Pennsylvania Department considered Franklin's petition to intervene and request for adjudicatory hearing as public comments, and not as formal pleadings because formal pleadings are not required or appropriate in the review of a proposed plan of conversion under the Act. On October 27, 1998, Franklin filed with the Pennsylvania Department an appeal of the Orders and a request for a full adjudicatory hearing. On November 6, 1998, the Pennsylvania Department rejected Franklin's appeal because the Pennsylvania Department had no jurisdiction to entertain such appeal. On November 9, 1998, Franklin filed a petition for review in the nature of an appeal with the Pennsylvania Commonwealth Court objecting to and requesting that such court reverse the Orders (the "Franklin Action"). Such petition is still pending. See "-- Requirement for Policyholder Approval," "Business -- Offer to Acquire Mercer Mutual" and "-- Legal Proceedings" and "The Conversion -- Background and Reasons for the Conversion." No assurance can be given that the Company or Mercer Mutual will ultimately prevail in the Franklin Action or in any other litigation that may be commenced relating to the Conversion. In addition, no assurance can be given that the Franklin Action, the commencement of any other litigation or the risks associated therewith would not result in less than the minimum number of shares of Common Stock being sold, in which case the Conversion would not be consummated, or that only the minimum number of shares of Common Stock will be sold, resulting in a sale of Common Stock at the lower end of the Estimated Valuation Range and reduced net proceeds therefrom. Mercer Mutual's directors and officers liability insurance policy may not cover losses, damages, liabilities, and attorneys' fees and other expenses resulting from any claims made against its directors and officers arising as a result of the Conversion (collectively, "Director and Officer Liabilities"). Mercer Mutual intends to 21 25 indemnify and hold harmless its directors and officers from and against all Director and Officer Liabilities to the fullest extent permitted by law. Even if Mercer Mutual is successful on the merits defending its directors and officers against any such claims, the attorneys' fees and expenses incurred in such a defense could be material. If (i) the Act, or any portion of the Act, is declared unconstitutional, (ii) the Orders are reversed by the Commonwealth Court or (iii) the Conversion is otherwise declared by a court to be invalid, and the Conversion has yet to be completed, then the Company would cancel the Offerings and all subscription funds would be returned to subscribers promptly without interest. If, however, the Conversion is completed before one of such events occurs, the remedy a court would grant is uncertain, and is subject to the court's broad discretion. Relief could be applied on a prospective basis only or on a retroactive basis. No prediction can be made concerning the remedy a court would fashion in such an event. However, in the event of any litigation challenging the validity of the Conversion, two possibilities include: - A requirement that the Company pay all purchasers of Common Stock, (i) the aggregate Purchase Price paid, plus interest, or (ii) the market value of the Common Stock sold in the Conversion, less any proceeds received by such purchaser from a subsequent sale of such Common Stock; or - The Company could be required to distribute to policyholders of Mercer Mutual all or a portion of the surplus of Mercer Mutual as of the date of the Conversion (statutory surplus as of September 30, 1998 was $21.3 million). Such distribution could be required to be made in cash, Common Stock or other debt or equity securities. Any required distribution of Common Stock or other equity securities would materially dilute the interests of existing holders of the Common Stock. No assurance can be given that the Company would have sufficient funds, or the capacity to borrow sufficient funds, to honor any of its obligations under any remedy imposed by a court in any litigation. In such event, the Company could be forced to seek the protection of the bankruptcy laws and Mercer Mutual could be deemed insolvent and seized by the Pennsylvania Department. In addition, any litigation could have a material adverse impact on the market price of the Common Stock during the pendency of the litigation and an adverse determination of such litigation would have such a material adverse effect. POSSIBLE ADVERSE IMPACT OF BROAD VALUATION RANGE AND ITS USE TO DETERMINE THE NUMBER OF SHARES OF COMMON STOCK SOLD If the value set forth in the final updated Appraisal is within the Estimated Valuation Range, the Conversion can be completed and the Company can sell between 2,507,500 and 3,392,500 shares of Common Stock. There is a difference of approximately $8.9 million between the minimum and the maximum of the Estimated Valuation Range. As a result, the percentage interest in the Company that a subscriber for a fixed number of shares of Common Stock will have is approximately 26% smaller if 3,392,500 shares are sold than if 2,507,500 shares are sold. Furthermore, as a result of this broad range, the final updated Appraisal may estimate a consolidated pro forma market value for Mercer Mutual as a subsidiary of the Company that is materially more or less than the aggregate dollar amount of subscriptions received by the Company. Subscribers will not receive a refund or have any right to withdraw subscriptions if the updated Appraisal estimates a consolidated pro forma market value that is within the Estimated Valuation Range, but is less than the aggregate dollar amount of subscriptions received by the Company. Therefore, subscribers, in the aggregate and on a per share basis, may pay materially more for the Common Stock than the estimated consolidated pro forma market value of Mercer Mutual as a subsidiary of the Company. Accordingly, no assurance can be given that the market price for the Common Stock immediately following the Conversion will equal or exceed the Purchase Price. POSSIBLE ADVERSE IMPACT OF NEW JERSEY TAX LAWS Prior to the Redomestication, Mercer Mutual, as a New Jersey-domiciled insurance company, 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 22 26 to policyholders located in Pennsylvania. For the year ended December 31, 1997, Mercer Mutual has calculated expenses of approximately $72,000 and $7,000 for amounts due to New Jersey and Pennsylvania, respectively, pursuant to such taxes. New Jersey has a statutory retaliatory tax provision that, because Mercer Mutual is now a Pennsylvania-domiciled insurance company, could be interpreted to require Mercer Mutual to pay, for all or a portion of 1997 and for all future years, a tax to New Jersey equal to 2.0% of the total net direct premiums collected by Mercer Mutual on all policies of insurance issued to policyholders located in New Jersey. If such interpretation is correct, Mercer Mutual would be required to pay substantially more in taxes to New Jersey than it has in the past, which would have a material adverse effect on the results of operations of Mercer Mutual. Under this interpretation, if the Redomestication had occurred on January 1, 1997, Mercer Mutual would have been required to pay approximately $542,000 in taxes to New Jersey for the year ended December 31, 1997, $469,000 more than the amount which has been calculated as due for such year. No assurance can be given that the New Jersey taxing authorities will not interpret such retaliatory tax provision in a manner adverse to Mercer Mutual, and that if so, they would not seek to enforce such retaliatory tax provision against Mercer Mutual. If enforcement is sought, Mercer Mutual would likely challenge such enforcement before the appropriate administrative and judicial authorities, but no assurance can be given that Mercer Mutual would be successful in such a challenge. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Effect of Conversion and Redomestication on the Company's Future Financial Condition and Results of Operations -- State Taxes." POSSIBLE SIGNIFICANT FLUCTUATIONS IN OPERATING RESULTS The operating results of property and casualty insurers are subject to significant fluctuation due to a number of factors, including extreme weather conditions and natural disasters, regulation, competition, judicial trends, changes in the investment and interest rate environment and general economic conditions. The Company's operating results may also be affected by changes in the supply of, and the pricing for, property and casualty insurance and reinsurance, which historically have been highly cyclical. The unpredictability of claims experience and the competitive nature of the property and casualty insurance industry has contributed historically to significant quarter-to-quarter and year-to-year fluctuations in the underwriting results and net earnings of Mercer Mutual. Because of these and other factors, historic results of operations may not be indicative of future operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." POSSIBLE ADVERSE IMPACT OF INADEQUATE LOSS RESERVES ON FINANCIAL CONDITION AND RESULTS OF OPERATION Mercer Mutual is required to maintain reserves to cover its estimated ultimate liability for losses and loss adjustment expenses ("LAE") with respect to reported and unreported claims incurred. Reserves are estimates involving actuarial and statistical projections at a given time of what Mercer Mutual expects to be the cost of the ultimate settlement and administration of claims based on facts and circumstances then known, predictions of future events, estimates of future trends in claims severity and judicial theories of liability, legislative activity and other variable factors, such as inflation. Mercer Mutual's overall reserve practice provides for ongoing claims evaluation and adjustment (if necessary) based on the development of related data and other relevant information pertaining to such claims. Loss and LAE reserves, including reserves for claims that have been incurred but not yet reported, are adjusted no less frequently than quarterly. The uncertainties of estimating insurance reserves are greater for certain types of property and casualty insurance lines written by the Insurance Companies, particularly workers' compensation and other liability coverages, because a longer period of time may elapse before a definitive determination of ultimate liability may be made and because of the changing judicial and political climates relating to these types of claims. Management believes that Mercer Mutual's reserves for losses and loss adjustment expenses are adequate and are in accordance with generally accepted actuarial principles and practices. However, the establishment of appropriate loss and loss adjustment expense reserves is an inherently uncertain process and there can be no assurance that ultimate losses will not exceed Mercer Mutual's loss reserves. To the extent that reserves prove to be inadequate in the future, Mercer Mutual would have to increase reserves which would adversely affect 23 27 earnings in the period such reserves are increased and could have a material adverse effect on the Company's results of operations and financial condition. See "Business -- Loss and LAE Reserves." POSSIBLE ADVERSE OR INADEQUATE IMPACT OF GEOGRAPHIC DIVERSIFICATION STRATEGY The Company intends to pursue a strategy of growth through the attraction of new agencies in Pennsylvania and the acquisition of other insurance companies in Pennsylvania and other jurisdictions. The success of the Company's growth strategy will depend largely upon its ability to attract new agencies and successfully market to them, and to identify suitable acquisition candidates and effect acquisitions at a reasonable cost. No assurance can be given that the Company will be successful in implementing its growth strategy. Moreover, this growth strategy may present special risks, such as the risk that Mercer Mutual will not efficiently integrate an acquisition with present operations, the risk of dilution of book value and earnings per share of the Common Stock as a result of an acquisition, the risk that the Company and Mercer Mutual will not be able to attract and retain qualified personnel needed for expanded operations, and the risk that internal monitoring and control systems may prove inadequate. Purchasers of Common Stock should also be aware that the Company, in many instances, may be able to make an acquisition without shareholder approval. HIGHLY COMPETITIVE NATURE OF INSURANCE INDUSTRY The property and casualty insurance market is highly competitive. Competition is based on many factors, including perceived financial strength of the insurer, premiums charged, policy terms and conditions, service, reputation and experience. Mercer Mutual competes 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 Mercer Mutual. Many of the lines of insurance written by Mercer Mutual are subject to significant price competition. Some companies may offer insurance at lower premium rates through the use of salaried personnel or other methods, rather than the use of agents paid on a commission basis as Mercer Mutual does. See "Business -- Competition." POSSIBLE ADVERSE IMPACT OF CHANGE IN A.M. BEST RATING Ratings assigned by A.M. Best Company, Inc. ("A.M. Best") are an important factor influencing the competitive position of insurance companies. A.M. Best ratings are based upon factors of concern to policyholders and are not directed toward the protection of investors. As such, the Insurance Companies' A.M. Best rating should not be relied upon as a basis for an investment decision to purchase the Common Stock. A.M. Best affirmed an "A-" (Excellent) rating (its fourth highest out of 15 rating categories) for the Insurance Companies as a group in 1998 based on year-end 1997 financial data. A.M. Best stated in its report that due to the Insurance Companies' significant catastrophe exposure, their results continue to be heavily influenced by weather related events. This catastrophe exposure results from the geographic concentration of the Insurance Companies' business. As a geographically concentrated insurer, the Insurance Companies are susceptible to a weather-related event such as a windstorm, a hurricane, hail, a tornado, freezing temperatures or other extraordinary event. In fact, Mercer Mutual's exposure to severe weather conditions has been a major factor affecting its underwriting results since 1991. See "-- Possible Adverse Impact Due to Geographic Concentration of Business." A.M. Best stated further that as the Insurance Companies continue to penetrate the commercial market, they will be subject to such market's increasingly competitive environment. See "-- Highly Competitive Nature of Insurance Industry" and "Business -- Strategy." Therefore, there can be no assurance that the Insurance Companies will be able to maintain their current A.M. Best rating. Management believes that the Insurance Companies' business is sensitive to ratings and that a rating downgrade may affect their ability to underwrite new business. As a result, if the Insurance Companies were to experience a rating downgrade, the independent agents that sell the Insurance Companies' products could be inclined to place their customers with higher-rated insurance carriers, which could have a material adverse effect on the Company's business and results of operations. 24 28 Management met with A.M. Best personnel in February 1997 and September 1998 to discuss the measures the Insurance Companies are implementing to reduce the risk caused by their exposure to severe weather conditions and preserve their A.M. Best Rating. These measures include an increase in the rates charged for homeowners insurance, the termination of their relationships with unprofitable agencies, decreasing their catastrophe exposure by improving the Insurance Companies' mix of business through an increase in commercial and casualty writings, the planned geographic diversification of business through the acquisition of other insurance companies, and the planned improvement of capital strength through the Conversion and the Offerings. Each of these measures is in various stages of implementation. See "Business -- A.M. Best Rating." RELIANCE ON KEY AGENCIES AND PRODUCT LINES For the nine months ended September 30, 1998 and the year ended December 31, 1997, the Insurance Companies' largest agency accounted for approximately 7.6% and 7.3%, respectively, of the Insurance Companies' direct premiums written, and generated approximately $1.7 million and $2.1 million, respectively, in premium revenue for the Insurance Companies. For the nine months ended September 30, 1998 and the year ended December 31, 1997, the Insurance Companies' 10 largest agencies accounted for 31.0% and 26.8%, respectively, of direct premiums written. A significant decrease in business from, or the loss of, its largest agency or several of its other large agencies would have a material adverse effect on the Company. Furthermore, the Insurance Companies' largest agency has written a significant portion of its business with religious institutions using a specialized multi-peril policy specially designed by Mercer Mutual for this market segment. See "Business -- Products -- Commercial Multi-Peril Products -- Religious Institutions." Decisions by such institutions to discontinue certain coverages or to emphasize certain coverages over others, and any inability of Mercer Mutual to offer such coverages at a price satisfactory to such institutions may have a material adverse effect on the Company. POSSIBLE ADVERSE IMPACT OF REGULATORY CHANGES The Insurance Companies are subject to substantial regulation by government agencies in the states in which they do business. Such regulation usually includes (i) regulating premium rates, policy forms, and lines of business, (ii) setting minimum capital and surplus requirements, (iii) imposing guaranty fund assessments and requiring residual market participation, (iv) licensing companies and agents, (v) approving accounting methods and methods of setting loss and expense reserves, (vi) setting requirements for and limiting the types and amounts of investments, (vii) establishing requirements for the filing of annual statements and other financial reports, (viii) conducting periodic statutory examinations of the affairs of insurance companies, (ix) approving proposed changes in control, (x) limiting the amount of dividends that may be paid without prior notice or approval, (xi) regulating transactions with affiliates, and (xii) regulating trade practices and market conduct. Such regulation and supervision are primarily for the benefit and protection of policyholders and not for the benefit of investors. The insurance regulatory structure has been subject to increased scrutiny in recent years by federal and state legislative bodies and state regulatory authorities. 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. 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 September 30, 1998, Pennsylvania and New Jersey, the states in which Mercer Mutual and MIC, respectively, are domiciled, were accredited. The NAIC has adopted risk-based capital ("RBC") requirements that require insurance companies to calculate and report information under a risk-based formula that attempts to measure statutory capital and surplus needs based on the risks in a company's mix of products and investment portfolio. The formula is designed to allow state insurance regulators to identify weakly capitalized companies. The RBC requirements provide for four different levels of regulatory attention in the event of noncompliance with required capital levels, which range from a requirement to file a corrective plan of action to mandatory seizure. Neither of the 25 29 Insurance Companies has ever failed to meet the required levels of capital. There can be no assurance, however, that the capital requirements applicable to the respective businesses of the Insurance Companies will not increase in the future, or that the Insurance Companies will continue to meet these requirements. The NAIC has also developed a set of eleven financial ratios, referred to as the Insurance Regulatory Information System ("IRIS"), for use by state insurance regulators in monitoring the financial condition of insurance companies. The NAIC has established an acceptable range of values for each of the eleven IRIS financial ratios. Generally, an insurance company will become the subject of increased scrutiny when four or more of its IRIS ratios fall outside the range deemed acceptable by the NAIC. The nature of increased regulatory scrutiny resulting from IRIS ratios that are outside the acceptable range is subject to the judgment of the applicable state insurance department, but generally will result in accelerated review of annual and quarterly filings. Depending on the nature and severity of the underlying cause of the IRIS ratios being outside the acceptable range, increased regulatory scrutiny could range from increased but informal regulatory oversight to placing a company under regulatory control. During the years ended December 31, 1995 and 1996, each of the Insurance Companies reported two ratios outside the acceptable range for certain IRIS tests. However, neither of the Insurance Companies had four or more IRIS ratios outside the acceptable range and, to their knowledge, neither of the Insurance Companies is subject to increased regulatory scrutiny. During the year ended December 31, 1997, neither Insurance Company reported any ratio outside the acceptable IRIS range. See "Business -- Regulation." No assurance can be given that future legislation or regulatory changes will not adversely affect the business and results of operations of the Insurance Companies. See "Business -- Regulation." Adverse legislative and regulatory activity constraining the Insurance Companies' ability to price adequately workers' compensation and other insurance coverages may occur in the future. In recent years, insurers have been under pressure from regulators, legislatures and special interest groups to reduce, freeze or set workers' compensation insurance rates at levels that may not correspond with current underlying costs. Any such required rate levels could have a material adverse effect on the Company's business and results of operations. DEPENDENCE UPON DIVIDENDS FROM INSURANCE COMPANIES Because the operations of the Company following the Conversion will be conducted through the Insurance Companies, after the Company deploys the net proceeds of the Offerings, it will be dependent upon dividends and other payments from Mercer Mutual for funds to meet its obligations. The Pennsylvania Department's approval of the Conversion 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 any dividend to the Company without the Pennsylvania Department's prior approval. In addition, state law regulates the distribution of dividends and other payments by Mercer Mutual to the Company and by MIC to Mercer Mutual. Such restrictions or any subsequently imposed restrictions may in the future affect the Company's ability to pay debt, expenses and cash dividends. See "Dividend Policy" and "Business -- Regulation." AVAILABILITY AND ADEQUACY OF REINSURANCE The Insurance Companies' insurance operations rely on the use of reinsurance arrangements to limit and manage the amount of risk retained, to stabilize underwriting results and increase underwriting capacity. The availability and cost of reinsurance are subject to prevailing market conditions and may vary significantly over time. No assurance can be given that reinsurance will continue to be available to the Insurance Companies in the future at commercially reasonable rates. While the Insurance Companies seek to obtain reinsurance with coverage limits that they believe are appropriate for the risk exposures assumed, there can be no assurance that losses experienced by the Insurance Companies will be within the coverage limits of their reinsurance treaties and facultative arrangements. During 1997 and 1998, the Company has reduced its reliance on reinsurance by increasing the maximum exposure retained by the Insurance Companies on individual property and casualty risks. The Company may further increase such maximum exposure in the future. The Company will rely, in part, on the additional capital raised in the Conversion to protect itself in the event of individual 26 30 property losses up to the increased maximum exposure amounts under its reinsurance agreements. The Company's maximum exposure will be adjusted by the Company from time to time based on the amount of capital raised in the Conversion, the Company's evaluation of its ability to incur multiple losses without a corresponding material adverse effect on its future financial condition and results of operations, and negotiations with its reinsurers. The decrease in reinsurance will increase the Company's risk of loss. The Insurance Companies also are subject to credit risk with respect to their reinsurers because the ceding of risk to reinsurers does not relieve the Insurance Companies of their liability to insureds. The insolvency or inability of any reinsurer to meet its obligations may have a material adverse effect on the business and results of operations of the Company. See "Business -- Strategy" and "-- Reinsurance." RELIANCE ON EXISTING MANAGEMENT The operations of the Company and the Insurance Companies are largely dependent on existing management. The loss to the Company or the Insurance Companies of one or more of their existing executive officers could have a material adverse effect on the Company's business and results of operations. The Company and Mercer Mutual have entered into employment agreements with four of their five executive officers, including their chief executive officer and chief operating and chief financial officer. See "Management of the Company -- Executive Officers" and "-- Certain Benefit Plans and Agreements." POTENTIAL BENEFITS OF CONVERSION TO MANAGEMENT AND IMPACT OF PURCHASES BY MANAGEMENT AND STOCK BENEFIT PLANS It is currently expected that directors and executive officers of the Insurance Companies and their associates will subscribe for approximately 186,500 shares of the Common Stock to be issued in the Conversion, or 7.4% thereof at the Total Minimum of the Estimated Valuation Range, and that the ESOP will purchase 10% of the shares to be issued in the Conversion. In addition, following the Conversion, and subject to shareholder approval, the Company intends to implement the MRP and the Compensation Plan. At the Total Minimum, Total Midpoint and Total Maximum, assuming that all options that may be granted under the Compensation Plan are granted and exercised, such persons would receive under the MRP and the Stock Compensation Plan, in the aggregate, 351,050, 413,000 and 474,950 shares, respectively, or in each case, 12.7% of the Common Stock issued in the Conversion and outstanding after such issuance and exercise. In addition to the possible financial benefits under the ESOP, MRP and Compensation Plan, management could benefit from certain statutory and regulatory provisions, as well as certain provisions in the Company's Articles of Incorporation and Bylaws, that may tend to promote the continuity of existing management and discourage certain acquisition proposals. As a result of the foregoing, management could acquire a substantial interest in the Company and, if each member of management were to act consistently with each other, could have significant influence over the outcome of the election of directors and any other shareholder vote, especially a vote on matters requiring the approval of 80% of the outstanding Common Stock, such as certain business combinations. Management might thus have the power to authorize actions that may be viewed as contrary to the best interests of non- affiliated holders of Common Stock and might have substantial power to block actions that such holders may deem to be in their best interests. See "Pro Forma Data," "Management -- Certain Benefit Plans and Agreements," "The Conversion -- Proposed Management Purchases," and "Certain Restrictions on Acquisition of the Company." REQUIREMENT FOR POLICYHOLDER APPROVAL The Conversion is contingent upon the approval of the Plan by the Eligible Policyholders. Approval of the Plan will require the affirmative vote, either in person or by proxy, of at least two-thirds of the votes cast by the Eligible Policyholders. Each Eligible Policyholder is entitled to one vote. The Special Meeting has been scheduled for , 1999 for the purpose of considering and voting on the Plan. Mercer Mutual's Board of Directors is unanimously recommending to the Eligible Policyholders that they vote in favor of the Plan. 27 31 On March 3, 1998, Mercer Mutual received an unsolicited offer from Franklin, an Eligible Policyholder, to purchase from Mercer Mutual, upon the consummation of the Conversion, all of the to-be-issued capital stock of Mercer Mutual for a purchase price equal to the audited book value of Mercer Mutual at December 31, 1997 under generally accepted accounting principles. Mercer Mutual's Board of Directors unanimously rejected such offer. See "Business -- Offer to Acquire Mercer Mutual." Franklin has requested and received access to Mercer Mutual's list of all Eligible Policyholders for the purpose of communicating with Eligible Policyholders concerning the Plan. Mercer Mutual had opposed such request on the basis that Franklin's intended purposes for requesting a list of Eligible Policyholders were (i) to solicit opposition to the Plan so that the Conversion would not be approved by the Eligible Policyholders and Mercer Mutual, a competitor of Franklin, would not be able to complete the Conversion and become a stronger competitor, and (ii) to use the list to make an offer for the stock of Mercer Mutual that violates applicable insurance holding company laws. Franklin also could use the list to communicate and market Franklin and its insurance products directly to Mercer Mutual's policyholders. However, a Pennsylvania court ordered Mercer Mutual to deliver the policyholder list to a third party mailer designated by Franklin. The mailer will mail Franklin's communications to Mercer Mutual policyholders but is prohibited from disclosing the list to Franklin or any other person. Franklin has already mailed several communications to Mercer Mutual policyholders and has indicated to Mercer Mutual that it intends to solicit proxies in opposition to the Plan. Mercer Mutual will actively solicit proxies in favor of the Plan. If, however, as a result of Franklin's efforts in opposition to the Plan or otherwise, the Eligible Policyholders fail to approve the Plan at the Special Meeting, the Company will cancel the Offerings and all subscription funds will be returned promptly to subscribers without interest. In such event, Mercer Mutual would maintain and continue its existence as an independent property and casualty insurance company. RISK OF DELAYED OFFERING The Company and Mercer Mutual expect to complete the Conversion within the time periods indicated in this Prospectus. Nevertheless, it is possible, although not anticipated, that adverse market, economic or regulatory conditions, delays in obtaining the required policyholder approval of the Plan caused by Franklin or otherwise, or other factors could significantly delay the completion of the Conversion and result in increased Conversion costs or in changes in the Estimated Valuation Range. The Subscription and Community Offerings could be extended to , 1999. If the Conversion is not completed within 45 days after , 1999, the Offerings will be terminated and all funds held will be promptly returned without interest. See "The Conversion -- The Conversion Offerings" and "-- Purchases in the Conversion Offerings." DILUTIVE EFFECT OF STOCK OPTIONS AND MRP The Compensation Plan and the MRP will be subject to shareholder approval at the Company's first annual meeting of shareholders to be held after the Conversion. The Company anticipates that, if approved, these plans would be implemented as soon as practicable after such meeting. Because the shares of Common Stock issued pursuant to the exercise of options granted under the Compensation Plan would consist of newly issued shares, upon the exercise of options granted under the Compensation Plan, the interests of existing shareholders would be diluted. The total number of shares that could be issued pursuant to the exercise of options granted under the Compensation Plan would be an amount equal to 10% of the Common Stock issued in the Conversion. In addition, in lieu of purchasing shares of Common Stock for the MRP in the open market, the Company may issue authorized but unissued shares of Common Stock to the MRP. The total number of shares that could be issued to the MRP would be an amount equal to 4% of the Common Stock issued in the Conversion. Such newly issued shares would dilute the interests of existing shareholders. See "-- Potential Benefits of Conversion to Management and Impact of Purchases by Management and Stock Benefit Plans," "Pro Forma Data" and "Management -- Certain Benefit Plans and Agreements -- Stock Compensation Plan" and "-- Management Recognition Plan." 28 32 ARTICLES OF INCORPORATION, BYLAW AND STATUTORY PROVISIONS THAT COULD DISCOURAGE HOSTILE ACQUISITIONS OF THE COMPANY The Company's Articles of Incorporation and Bylaws contain certain provisions that may have the effect of discouraging a non-negotiated tender or exchange offer for the Common Stock, a proxy contest for control of the Company, the assumption of control of the Company by a holder of a large block of Common Stock or the removal of the Company's management, all of which certain shareholders might deem to be in their best interests. These provisions include, among other things (i) the classification of the terms of the members of the Board of Directors, (ii) supermajority provisions for the approval of certain business combinations and the amendment of the Articles of Incorporation or Bylaws of the Company, (iii) elimination of cumulative voting in the election of directors, and (iv) restrictions on the voting of the Company's equity securities by any individual, entity or group owning more than 10% of the Common Stock. The provisions in the Company's Articles of Incorporation requiring a supermajority vote for the approval of certain business combinations and containing restrictions on voting of the Company's equity securities provide that the supermajority voting requirements and voting restrictions do not apply to business combinations and acquisitions of Common Stock meeting specified Board of Directors' approval requirements. The Articles of Incorporation also authorize the issuance of 5,000,000 shares of preferred stock as well as additional shares of Common Stock. Under certain circumstances, these shares or rights to acquire these shares could be issued at any time without shareholder approval on terms or in circumstances that could deter a future takeover attempt. In addition, the Pennsylvania Business Corporation Law (the "Pennsylvania BCL") provides for certain restrictions on the acquisition of the Company, and Pennsylvania law contains various restrictions on acquisitions of control of insurance holding companies. The Articles of Incorporation, Bylaw and statutory provisions, as well as certain other provisions of state and federal law, may have the effect of discouraging or preventing a future takeover attempt not supported by the Company's Board of Directors in which shareholders of the Company otherwise might receive a substantial premium for their shares over then-current market prices. For a detailed discussion of those provisions, see "Management -- Certain Benefit Plans and Agreements," "Certain Restrictions on Acquisition of the Company," "Certain Anti-Takeover Provisions in the Articles of Incorporation and Bylaws" and "Description of Capital Stock." POSSIBLE ADVERSE INCOME TAX CONSEQUENCES OF THE DISTRIBUTION OF SUBSCRIPTION RIGHTS If the subscription rights granted to Eligible Policyholders are deemed to have an ascertainable value, receipt of such rights could result in taxable gain to those Eligible Policyholders who receive or exercise the subscription rights, in an amount equal to such value. Additionally, Mercer Mutual could recognize a gain for tax purposes on such distribution. Whether subscription rights are considered to have ascertainable value is an inherently factual determination. Mercer Mutual has been advised by Sheshunoff that the subscription rights granted to Eligible Policyholders have no value. However, Sheshunoff's conclusion is not binding on the Internal Revenue Service ("IRS"). See "The Conversion -- Effects of Conversion on Policyholders" and "-- Tax Effects." ABSENCE OF PRIOR MARKET FOR THE COMMON STOCK The Company has never issued capital stock, and consequently there is no established market for the Common Stock. The Company has received approval to have the Common Stock quoted on the Nasdaq National Market under the symbol "MRCR," subject to completion of the Conversion. However, there can be no assurance that an active and liquid trading market for the Common Stock will develop or that, if one develops, it will continue, nor is there any assurance that persons purchasing Common Stock will be able to sell the Common Stock at or above the Purchase Price. See "Market for the Common Stock." 29 33 USE OF PROCEEDS The Company has received Pennsylvania Department approval to contribute $5.0 million of net proceeds from the Offerings to Mercer Mutual in exchange for all of its capital stock. The Company will retain the balance of the net proceeds, from which it will fund a loan to the ESOP in the amount necessary to purchase 10% of the shares of Common Stock sold in the Offerings (the "ESOP Loan"). The amount of the ESOP Loan may range from $2.5 million to $3.8 million based on a sale of 250,750 shares to the ESOP (at the Total Minimum) and 376,944 shares to the ESOP (at the Total Maximum plus the shares sold to the ESOP), respectively, at the Purchase Price. It is anticipated that the ESOP Loan will have a ten year term with interest payable at the prime rate as published in The Wall Street Journal on the closing date of the Conversion. The ESOP Loan will be repaid principally from Mercer Mutual's contributions to the ESOP and from any dividends paid on the unallocated shares of Common Stock held by the ESOP. See "Management of the Company -- Certain Benefit Plans and Agreements -- Employee Stock Ownership Plan." On a short-term basis, the remaining net proceeds retained by the Company will be invested primarily in U.S. government securities and other federal agency securities. The net proceeds retained by the Company will be available for a variety of corporate purposes, including additional capital contributions, future acquisitions and diversification of business, and dividends to shareholders. The Company also may use a portion of the net proceeds of the Offerings to fund the purchase by the MRP, if implemented, in the open market of all or a portion of the shares of Common Stock to be acquired by the MRP. Implementation of the MRP requires shareholder approval, which is expected to be sought at the first annual meeting of shareholders to be held no earlier than six months following the Conversion. See "Management of the Company -- Certain Benefit Plans and Agreements -- Management Recognition Plan." The net proceeds used to acquire the stock of Mercer Mutual will become part of Mercer Mutual's capital, thereby expanding underwriting capacity and permitting diversification of its business. Mercer Mutual may contribute a portion of the net proceeds it receives from the Company to MIC in connection with MIC's planned expansion of its New Jersey business to include the same types of insurance currently written by Mercer Mutual. Any payment of dividends by Mercer Mutual to the Company and by MIC to Mercer Mutual will be limited by state regulatory restrictions on capital distributions. Further, the Orders require the approval of the Pennsylvania Department prior to the payment of any dividends by Mercer Mutual to the Company or by the Company to its shareholders, during the three year period following the Conversion. See "Business -- Regulation." With the exception of the ESOP Loan, the capital contributions to Mercer Mutual and possibly to MIC, and the possible funding of the MRP, the Company and Mercer Mutual currently have no specific plans, arrangements or understandings regarding the use of the net proceeds from the Offerings. See "Dividend Policy" and "Management of the Company -- Certain Benefit Plans and Agreements -- Employee Stock Ownership Plan" and "-- Management Recognition Plan." The amount of proceeds from the sale of Common Stock in the Offerings will depend upon the total number of shares actually sold, the relative percentages of Common Stock sold in 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. Set forth below are the estimated net proceeds to the Company, assuming the sale of Common Stock at the Total Minimum, Total Midpoint and Total Maximum, and at the Total Maximum plus the shares to be issued to the ESOP, based upon the following assumptions: (i) shares of Common Stock will be sold as follows: (a)(1) 10% of the shares will be sold to the ESOP and (2) 186,000 shares will be sold to the directors, officers and employees of the Company and Mercer Mutual, with respect to which no commission will be paid to Sandler O'Neill and (b) the remaining shares will be sold to Eligible Policyholders and the community with respect to which the Company will pay a 2.0% commission to Sandler O'Neill; (ii) the purchase of the shares sold to the ESOP will be financed with the proceeds of the ESOP Loan from the Company; and (iii) other Conversion expenses, not including sales commissions, will be approximately $1.6 million. The foregoing assumption that all shares will be purchased in the Subscription Offerings is illustrative only and is based upon one (and the only) recent comparable transaction. Actual expenses may vary from those estimated. 30 34
TOTAL TOTAL TOTAL TOTAL MAXIMUM OF MINIMUM OF MIDPOINT OF MAXIMUM OF 3,392,500 2,507,500 2,950,000 3,392,500 SHARES AT SHARES AT SHARES AT SHARES AT $10.00 PER $10.00 $10.00 $10.00 SHARE PLUS PER SHARE PER SHARE PER SHARE ESOP SHARES ---------- ----------- ---------- ----------- (IN THOUSANDS) Gross proceeds of Offerings............... $25,075 $29,500 $33,925 $37,694 Less estimated expenses, including underwriting fees.................... (2,070) (2,150) (2,229) (2,297) ------- ------- ------- ------- Estimated net proceeds.................... 23,005 27,350 31,696 35,397 Less: Common Stock to be acquired by ESOP..... (2,508) (2,950) (3,393) (3,769) ------- ------- ------- ------- Estimated net proceeds, as adjusted(1).... $20,497 $24,400 $28,303 $31,628 ======= ======= ======= =======
- --------------- (1) Does not include any adjustment for the portion of the estimated net proceeds of the Offerings which may be used to fund the purchase by the MRP, if implemented, of shares of Common Stock in the open market because (i) the implementation of the MRP is subject to shareholder approval, (ii) any such implementation would not occur until at least six months after the consummation of the Conversion and, therefore, the Company is unable to predict with any certainty the market price of the Common Stock at that time, (iii) the Company may fund a portion of the costs of such purchase from its cash flow, and (iv) the Company may issue new shares directly to the MRP in lieu of purchasing shares in the open market. DIVIDEND POLICY Payment of dividends on the Common Stock is subject to determination and declaration by the Company's Board of Directors. Any dividend policy of the Company will depend upon the financial condition, results of operations and future prospects of the Company. In addition, the Orders prohibit the Company from declaring or paying any dividends during the three years following the Conversion, unless such dividends are approved by the Pennsylvania Department. At present, the Company has not made any determination as to whether it intends to pay dividends to its shareholders in the foreseeable future. There can be no assurance that dividends will be paid or, if approved by the Department and paid initially, that they will continue to be paid in the future. In addition, because the Company initially will have no significant source of income other than dividends from Mercer Mutual and earnings from the repayment of the ESOP Loan and the investment of the net proceeds of the Conversion retained by the Company, the payment of dividends by the Company will depend significantly upon receipt of dividends from Mercer Mutual. The Orders prohibit Mercer Mutual from declaring or paying any dividends during the three years following the Conversion, unless such dividends are approved by the Pennsylvania Department. No assurance can be given that the Pennsylvania Department will approve the declaration or payment by Mercer Mutual of any dividends to the Company. See "Business -- Regulation." Except as described above, the Company is not subject to regulatory restrictions on the payment of dividends to shareholders. The Company is subject to the requirements of the Pennsylvania BCL, which generally permits dividends or distributions to be paid as long as, after making the dividend or distribution, the Company will be able to pay its debts in the ordinary course of business and the 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 Company were to be dissolved at the time the dividend or distribution is paid. 31 35 MARKET FOR THE COMMON STOCK The Common Stock has been approved for quotation on the Nasdaq National Market under the symbol "MRCR," subject to the completion of the Conversion. The 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, however, depends upon the presence in the marketplace of a sufficient number of willing buyers and sellers at any given time, over which neither the Company nor any market maker has any control. Accordingly, there can be no assurance that an established and liquid market for the Common Stock will develop, or if one develops, that it will continue. Sandler O'Neill has advised the Company 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. There can be no assurance that there will be two or more market makers for the Common Stock. Furthermore, there can be no assurance that purchasers will be able to resell their shares of Common Stock at or above the Purchase Price, or that quotations will be available on the Nasdaq National Market, as contemplated. 32 36 CAPITALIZATION The following table sets forth information regarding the consolidated historical capitalization of Mercer Mutual and its subsidiaries at September 30, 1998 and the pro forma consolidated capitalization of the Company giving effect to the sale of Common Stock at the Total Minimum, Total Midpoint and Total Maximum of the Estimated Valuation Range, and at the Total Maximum of the Estimated Valuation Range plus the shares to be issued to the ESOP in an amount equalling 10% of the shares issued in the Conversion, based upon the assumptions set forth under "Use of Proceeds." For additional financial information regarding Mercer Mutual, see the Consolidated Financial Statements and related Notes appearing elsewhere herein. Depending on market and financial conditions, the total number of shares to be issued in the Conversion will range from 2,507,500 shares to 3,769,444 shares. See "Use of Proceeds" and "The Conversion -- Stock Pricing and Number of Shares to be Issued."
PRO FORMA CONSOLIDATED CAPITALIZATION OF THE COMPANY BASED ON THE SALE OF ------------------------------------------------- HISTORICAL 3,392,500 CONSOLIDATED SHARES AT CAPITALIZATION $10.00 OF MERCER 2,507,500 2,950,000 3,392,500 PER MUTUAL AT SHARES AT SHARES AT SHARES AT SHARE PLUS SEPTEMBER 30, $10.00 $10.00 $10.00 ESOP 1998 PER SHARE PER SHARE PER SHARE SHARES -------------- --------- --------- --------- ---------- (IN THOUSANDS) Long term debt........................ -- -- -- -- -- Shareholders' equity(1): 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(2)....... -- 23,005 27,350 31,696 35,397 Retained earnings................... 22,655 22,655 22,655 22,655 22,655 Unrealized gains.................... 3,181 3,181 3,181 3,181 3,181 Less: Common stock to be acquired by ESOP(3).......................... -- (2,508) (2,950) (3,393) (3,769) ------ ------ ------ ------ ------ Total(4).................... 25,836 46,333 50,236 54,139 57,464 ====== ====== ====== ====== ======
- --------------- (1) Pro forma shareholders' equity is not intended to represent the fair market value of the Common Stock, the net fair market value of the Company's assets and liabilities or the amounts, if any, that would be available for distribution to shareholders in the event of liquidation. Such 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. (2) Does not reflect additional shares of Common Stock that could be purchased pursuant to the Compensation Plan, if implemented, under which directors, executive officers and other employees of the Company would be granted options to purchase an aggregate amount of Common Stock equal to 10% of the shares issued in the Conversion (250,750, 295,000, 339,250 and 376,944 shares at the Total Minimum, Total Midpoint, Total Maximum and Total Maximum plus ESOP shares, respectively). Implementation of the Compensation Plan requires shareholder approval, which is expected to be sought at the first annual meeting of shareholders to be held no earlier than six months following the Conversion. See "Risk Factors -- Dilutive Effect of Stock Options" and "Management of the Company -- Certain Benefit Plans and Agreements -- Stock Compensation Plan." (3) Assumes that 10% of the shares of Common Stock to be sold in the Conversion are purchased by the ESOP, and that the funds used to purchase such shares are borrowed from the Company. Under GAAP, the aggregate Purchase Price of shares of Common Stock to be purchased by the ESOP in the Offerings 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 33 37 reduction in the charge against capital will occur. See "Pro Forma Data" and "Management of the Company -- Certain Benefit Plans and Agreements -- Employee Stock Ownership Plan." (4) Does not reflect any adjustments to shareholders' equity that would result from the implementation of the MRP because (i) of the total shares of Common Stock to be acquired by the MRP, an undetermined portion may be newly issued shares and an undetermined portion may be purchased in the open market, each of which methods and amounts would have different and varying effects on the Company's shareholders' equity, (ii) the implementation of the MRP is subject to shareholder approval, (iii) any such implementation would not occur until at least six months after the consummation of the Conversion and, therefore, the Company is unable to predict with any certainty the market price of the Common Stock at that time, and (iv) the Company may fund a portion of the costs of any open-market purchase of shares from its then current cash flow. See "Management of the Company -- Certain Benefit Plans and Agreements -- Management Recognition Plan." PRO FORMA DATA The following pro forma condensed consolidated balance sheet as of September 30, 1998 gives effect to the Conversion and implementation of the ESOP as if they had occurred as of September 30, 1998 and assumes that 2,507,500 shares of Common Stock (the minimum number of such shares required to be sold) are sold in the Subscription Offering. The following pro forma condensed consolidated statements of income for the year ended December 31, 1997 and the nine months ended September 30, 1998 present consolidated operating results for Mercer Mutual and its subsidiaries as if the Conversion and implementation of the ESOP had occurred as of January 1, 1997. Pursuant to the Plan, Mercer Mutual will convert from a Pennsylvania-chartered mutual insurance company to a Pennsylvania-chartered stock insurance company and simultaneously issue shares of its capital stock to the Company in exchange for a portion of the net proceeds from the sale of Common Stock in the Offerings. The Conversion will be accounted for as a simultaneous reorganization, recapitalization and share offering which 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 2,507,500 shares of Common Stock. If less than 2,507,500 shares of Common Stock are subscribed for in the Conversion Offerings, the remaining shares, up to a maximum of 3,392,500 shares (not including shares sold to the ESOP), will be offered in the Syndicated Community Offering. The unaudited pro forma information does not purport to represent what Mercer Mutual's consolidated financial position or results of operations actually would have been had the Conversion and implementation of the ESOP occurred on the dates indicated, or to project Mercer Mutual's 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 Mercer Mutual believes are factually supportable and reasonable under the circumstances. The unaudited pro forma consolidated financial information should be read in conjunction with the accompanying notes thereto, 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. Mercer Mutual's consolidated financial statements will reflect the effects of the Conversion and implementation of the ESOP only from the dates such events occur. 34 38 UNAUDITED PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET AS OF SEPTEMBER 30, 1998
HISTORICAL PRO FORMA CONSOLIDATED ADJUSTMENTS CONSOLIDATED(4) ------------ ----------- --------------- (IN THOUSANDS) ASSETS Investments: Fixed income securities............................ $36,074 $20,497(1) $56,571 Equity securities.................................. 12,867 12,867 ------- ------- ------- Total investments.................................. 48,941 20,497 69,438 Cash and cash equivalents............................ 7,035 7,035 Receivables.......................................... 12,985 12,985 Prepaid reinsurance premiums......................... 479 479 Deferred policy acquisition costs, and other assets............................................. 7,279 7,279 ------- ------- ------- Total assets......................................... $76,719 $20,497 $97,216 ======= ======= ======= LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Losses and loss adjustment expenses................ $$30,331 $30,331 Unearned premiums.................................. 15,780 15,780 Other liabilities.................................. 4,772 4,772 ------- ------- ------- Total liabilities.................................. 50,883 0 50,883 Shareholders' equity: Common stock....................................... -- 23,005 23,005 Unearned Employee Stock Ownership Plan compensation.................................... -- (2,508)(2) (2,508) Retained earnings.................................. 22,655 22,655 Accumulated other comprehensive income............. Unrealized gains in investments net of deferred income taxes.................................... 3,181 3,181 ------- ------- ------- Total shareholders' equity........................... 25,836 20,497(3) 46,333 ------- ------- ------- Total liabilities and stockholders' equity........... $76,719 $20,497 $97,216 ======= ======= =======
See accompanying Notes to Unaudited Pro Forma Condensed Consolidated Balance Sheet 35 39 NOTES TO UNAUDITED PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET (IN THOUSANDS, EXCEPT PER SHARE DATA) (1) The pro forma adjustment to reflect the Conversion is as follows (in thousands): Issuance of 2,507,500 shares at $10/share................... $25,075 Estimated conversion expenses............................... (2,070) ------- Net proceeds from Conversion................................ $23,005 ======= Less: Common Stock to be purchased by ESOP.................. (2,508) ------- Net investable proceeds..................................... $20,497 =======
(2) Upon completion of the Conversion, the Company will implement an ESOP for the benefit of participating employees. The ESOP will borrow funds from the Company in an amount sufficient to purchase 10% of the Common Stock issued in the Conversion or $2,508. The ESOP Loan will bear interest at a per annum rate equal to the prime rate as published in The Wall Street Journal on the closing date of the Conversion, which rate is currently 7.75%. The ESOP Loan will require monthly principal payments of approximately $21 for a term of ten years. The amount of this borrowing has been reflected as a reduction from gross proceeds to determine estimated net investable proceeds. Mercer Mutual 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. Mercer Mutual's payment of amounts due under the ESOP Loan is based upon equal installments of principal over a 10-year period, assuming a combined federal and state income tax rate of 34.0%. Interest income earned by the Company on the ESOP Loan offsets the interest paid by Mercer Mutual on the ESOP Loan. The ESOP expense reflects adoption of Statement of Position 93-6, which will require 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, which, for purposes of this calculation, was assumed to be equal to the Purchase Price. See "Management of the Company -- Certain Benefit Plans and Agreements -- Employee Stock Ownership Plan." (3) Does not reflect the proposed implementation of the MRP, which is subject to shareholder approval and, therefore, is not "factually supportable," within the meaning of the Securities and Exchange Commission's rules and regulations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Effect of Conversion on the Company's Future Financial Condition and Results of Operations," and "Management of the Company -- Certain Benefit Plans and Agreements -- Management Recognition Plan." (4) The unaudited pro forma condensed consolidated balance sheet, as prepared, gives effect to the sale of Common Stock at the Total Minimum of the Estimated Valuation Range based upon the assumptions set forth under "Use of Proceeds." The following table provides a comparison between the sale of Common Stock at the Total Minimum and Total Maximum of the Estimated Valuation Range and at the Total Maximum of the Estimated Valuation Range plus shares issued to the ESOP in the amount equal to 10% of the shares issued in the Conversion.
TOTAL MAXIMUM TOTAL TOTAL PLUS MINIMUM MAXIMUM ESOP ------- ------- ------- Net proceeds from Conversion................................ $23,005 $31,696 $35,397 Common Stock to be acquired by ESOP......................... $2,508 $3,393 $ 3,769
36 40 UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF INCOME YEAR ENDED DECEMBER 31, 1997 (IN THOUSANDS, EXCEPT SHARE DATA)
HISTORICAL PRO FORMA PRO FORMA CONSOLIDATED ADJUSTMENTS(1) CONSOLIDATED(5) ------------ -------------- --------------- Revenue: Net premiums earned.............................. $17,969 $ 17,969 Investment income, net of expenses............... 2,350 2,350 Net realized investment gains.................... 589 589 Other revenue.................................... 173 173 ------- ----- ---------- Total revenue............................ 21,081 0 21,081 ------- ----- ---------- Expenses: Losses and loss adjustment expenses.............. 10,594 10,594 Amortization of deferred policy acquisition costs......................................... 4,706 4,706 Operating expenses............................... 2,563 251(2) 2,814 ------- ----- ---------- Total expenses........................... 17,863 251(3) 18,114 ------- ----- ---------- Income before taxes................................ 3,218 (251) 2,967 Income taxes....................................... 1,001 (85)(4) 916 ------- ----- ---------- Net income......................................... $ 2,217 $(166) $ 2,051 ======= ===== ========== Earnings per share data: Net income per share of Common Stock..... $ 0.90 Weighted average number of shares of Common Stock outstanding............... 2,269,288(6)
See accompanying Notes to Unaudited Pro Forma Condensed Consolidated Statement of Income. 37 41 UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF INCOME NINE MONTHS ENDED SEPTEMBER 30, 1998 (IN THOUSANDS, EXCEPT SHARE DATA)
HISTORICAL PRO FORMA PRO FORMA CONSOLIDATED ADJUSTMENTS(1) CONSOLIDATED(5) ------------ -------------- --------------- Revenue: Net premiums earned........................... $17,110 $ 17,110 Investment income, net of expenses............ 1,656 1,656 Net realized investment gains................. 368 368 Other revenue................................. 124 124 ------- ----- ---------- Total revenue......................... 19,258 0 19,258 ------- ----- ---------- Expenses: Losses and loss adjustment expenses........... 8,739 8,739 Amortization of deferred policy acquisition costs...................................... 4,836 4,836 Operating expenses............................ 2,755 188(2)(3) 2,943 ------- ----- ---------- Total expenses........................ 16,330 188 16,518 ------- ----- ---------- Income before taxes............................. 2,928 (188) 2,740 Income taxes.................................... 966 (64)(4) 902 ------- ----- ---------- Net income...................................... $ 1,962 $(124) $ 1,838 ======= ===== ========== Earnings per share data: Net income per share of Common Stock.......... $ 0.80 Weighted average number of shares of Common Stock outstanding................... 2,291,228(6)
See accompanying Notes to Unaudited Pro Forma Condensed Consolidated Statement of Income. 38 42 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 investable proceeds assumed to be received as of January 1, 1997, as such 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, such 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, 1996, March 31, 1997, June 30, 1997 and September 30, 1997 was 5.14% per annum. If such proceeds were invested at 5.14% for the year ended December 31, 1997 and the nine months ended September 30, 1998, pro forma net income (after tax), as reported herein, would have increased by $695 and $521 for the year ended December 31, 1997 and the nine months ended September 30, 1998, respectively, and pro forma net income per share, as reported herein, would have increased by $0.31 and $0.23, respectively. (2) Pro forma adjustment to recognize compensation expense under ESOP for shares of Common Stock committed to be released to participants as the principal balance of the ESOP Loan is repaid. Interest income earned by the Company on the ESOP Loan offsets the interest expense paid by Mercer Mutual under the ESOP Loan at the assumed rate of 7.75% for 10 years. Therefore, no pro forma adjustment is required with respect to the interest paid on the ESOP Loan. (3) Does not reflect compensation expense associated with the grant of shares which may be awarded under the MRP, as implementation of the MRP is subject to shareholder approval and, therefore, is not "factually supportable," within the meaning of the Securities and Exchange Commission's rules and regulations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Effect of Conversion on the Company's Financial Condition and Results of Operations," and "Management of the Company -- Certain Benefit Plans and Agreements -- Management Recognition Plan." (4) Adjustment to reflect the federal income tax effects of (2) above. (5) The unaudited pro forma condensed consolidated statements of income, as prepared, give effect to the sale of Common Stock at the Total Minimum of the Estimated Valuation Range based upon the assumptions set forth under "Use of Proceeds." The following table provides a comparison between the sale of Common Stock at the Total Minimum and Total Maximum of the Estimated Valuation Range.
DECEMBER 31, 1997 SEPTEMBER 30, 1998 ------------------------ ------------------------ MINIMUM MAXIMUM MINIMUM MAXIMUM ---------- ---------- ---------- ---------- Compensation expense........................ $ 251 $ 339 $ 188 $ 254 Net income.................................. $ 2,051 $ 1,993 $ 1,838 $ 1,734 Net income per share of Common Stock........ $ 0.90 $ 0.65 $ 0.80 $ 0.56 Weighted average number of shares of Common Stock outstanding......................... 2,269,288 3,070,213 2,291,228 3,099,897
(6) Calculation of weighted average number of shares outstanding:
TOTAL SHARES LESS: UNALLOCATED SHARES WEIGHTED ISSUED ESOP SHARES OUTSTANDING AVERAGE ------------ ----------------- ----------- --------- January 1, 1997........................ 2,507,500 (250,750) 2,256,750 -- Shares allocated....................... -- 25,075 25,075 -- --------- -------- --------- --------- December 31, 1997...................... 2,507,500 (225,675) 2,281,825 2,269,288 Shares allocated....................... -- 18,806 18,806 -- --------- -------- --------- --------- September 30, 1998..................... 2,507,500 (206,869) 2,300,631 2,291,228 ========= ======== ========= =========
ESOP shares are allocated evenly to plan participants throughout each of the periods and therefore the weighted average number of shares outstanding is determined by adding beginning of period and end of period shares outstanding and dividing by two. 39 43 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL The Company has only recently been formed and, accordingly, has no results of operations. As a result, this discussion relates to the financial condition and results of operations of Mercer Mutual and its subsidiaries on a consolidated basis. The Insurance Companies underwrite property and casualty insurance, including homeowners, commercial multi-peril, general liability and other lines of business, in New Jersey and Pennsylvania. The Insurance Companies market their products through independent agencies. Historically, due to the concentration of the Insurance Companies' business in New Jersey, the Insurance Companies' results have been influenced by weather-related property losses in that state. These results have also been influenced by other factors affecting the property and casualty insurance industry in general, such as competition, catastrophic events, regulation, general economic conditions and changes in the investment environment. This analysis of Mercer Mutual's consolidated financial condition and results of operations, as well as the selected financial data set forth in the table below, should be read in conjunction with Mercer Mutual's Consolidated Financial Statements and the other financial data regarding Mercer Mutual found elsewhere in this Prospectus. The discussion covers Mercer Mutual's consolidated financial condition and results of operations for the nine months ended September 30, 1997 and 1998 and the three years ended December 31, 1997. Mercer Mutual's fiscal year ends on December 31, and reference herein to a particular year means, unless otherwise stated, the fiscal year ended on December 31 of that year. For an explanation of certain terms used in this discussion and analysis that are commonly used in the insurance industry, see the "Glossary to Selected Insurance Terms." 40 44 MERCER INSURANCE GROUP, INC. MD & A SELECTED FINANCIAL DATA
NINE MONTHS ENDED SEPTEMBER 30, (UNAUDITED) YEAR ENDED DECEMBER 31, ----------------------------- ---------------------------------------------------- % % % 1998 CHANGE 1997 1997 CHANGE 1996 CHANGE 1995 ------- ------ ------- ------- ------ ------- ------- ------- (IN THOUSANDS) Revenue Data: Direct premiums written... $22,977 6.8% $21,504 $28,453 14.0% $24,958 1.0% $24,699 Assumed premiums written................ 500 17.4% 426 547 (89.1)% 5,013 (51.3)% 10,287 Ceded premiums written.... 2,743 (69.6)% 9,026 11,539 17.2% 9,847 (28.3)% 13,741 ------- ------- ------- ------- ------- Net premiums written...... 20,734 60.7% 12,904 17,461 (13.2)% 20,124 (5.3)% 21,245 Change in unearned premiums............... (3,624) 384 508 510 (428) ------- ------- ------- ------- ------- Net premiums earned....... 17,110 28.8% 13,288 17,969 (12.9)% 20,634 (0.9)% 20,817 Net investment income..... 1,656 (7.6)% 1,793 2,350 2.7% 2,289 7.4% 2,132 Net realized investment gains.................. 368 (23.8)% 483 589 (1.2)% 596 1,024.5% 53 Other income.............. 124 (13.9)% 144 173 11.6% 155 (3.7)% 161 ------- ------- ------- ------- ------- Total revenue..... 19,258 22.6% 15,708 21,081 (11.0)% 23,674 2.2% 23,163 ------- ------- ------- ------- ------- Losses and expenses: Loss and loss adjustment expenses............... 8,739 8.7% 8,038 10,594 (28.4)% 14,801 11.3% 13,296 Other underwriting expenses............... 7,591 39.0% 5,461 7,269 (9.8)% 8,062 (3.6)% 8,360 ------- ------- ------- ------- ------- Total expenses.... 16,330 21.0% 13,499 17,863 (21.9)% 22,863 5.6% 21,656 ------- ------- ------- ------- ------- Income before federal income taxes..................... 2,928 32.5% 2,209 3,218 296.8% 811 (46.2)% 1,507 Federal income tax expenses.................. 966 39.2% 694 1,001 485.4% 171 (53.7)% 369 ------- ------- ------- ------- ------- Net income.................. $ 1,962 29.5% $ 1,515 $ 2,217 246.4% $ 640 (43.8)% $ 1,138 ======= ======= ======= ======= ======= Loss and loss adjustment expense ratio............. 51.1% 60.5% 58.9% 71.7% 63.9% Expense ratio............... 44.4% 41.1% 40.5% 39.1% 40.2% Combined ratio.............. 95.5% 101.6% 99.4% 110.8% 104.1%
RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO THE NINE MONTHS ENDED SEPTEMBER 30, 1997 Premiums -- Direct premiums written for the nine months ended September 30, 1998 increased by $1.5 million or 6.8%, as compared to the same period in 1997, reflecting Mercer Mutual's strategic decision to increase its commercial business. Commercial lines premiums increased by $1.5 million, or 17.0%, for the nine months ended September 30, 1998 over the comparable prior period. The increase in commercial lines writings reflects the continued success of recently introduced commercial programs such as the religious institution program and the commercial automobile program. Commercial lines now represent nearly 50% of the total direct writings of Mercer Mutual. The effect on direct premiums written caused by the increase in direct commercial writings was slightly offset by a decrease in personal lines writings of $67,000. Assumed premiums written increased by $74,000 or 17.4%, reflecting Mercer Mutual's share of increasing residual market facilities. Certain residual markets in which Mercer Mutual must participate, as directed by statute, have grown in recent years thereby increasing Mercer Mutual's dollar participation. 41 45 Ceded premiums written decreased $6.3 million, or 69.6%, for the nine months ended September 30, 1998 compared to the nine months ended September 30, 1997, reflecting changes in Mercer Mutual's reinsurance programs during both periods. Effective January 1, 1998, Mercer Mutual converted its reinsurance program to one that is predominantly an excess of loss program, and also increased its retention levels. As a result, there have been significant reductions in premiums ceded to outside reinsurers. Ceded premiums for the nine months ended September 30, 1997 included approximately $1.3 million of additional ceded premiums attributable to the introduction of a new quota share reinsurance program for the homeowners business (the "Homeowners Quota Share Program") at January 1, 1997. See "Business -- Reinsurance" for a description of Mercer Mutual's reinsurance programs. Also see "Risk Factors -- Availability and Adequacy of Reinsurance." Net premiums written increased $7.8 million or 60.7%, to $20.7 million for the nine months ended September 30, 1998 from the nine months ended September 30, 1997. For the same comparative period, net premiums earned increased by $3.8 million, or 28.8%, to $17.1 million. The increases in net premiums written and net premiums earned for the nine months ended September 30, 1998 are attributable to the increase in direct commercial writings and the restructuring of the reinsurance program discussed above. Net Investment Income -- Net investment income decreased $137,000, or 7.6%, to $1.7 million for the nine months ended September 30, 1998, as compared to the same period in 1997. This decrease was partly due to a slight decrease in the yield on fixed income securities, which was 6.34% for the nine months ended September 30, 1998 compared to 6.69% for the same period in 1997. In addition, investment income from equity securities decreased by $22,000 for the nine months ended September 30, 1998 compared to the same period in 1997. Net Realized Investment Gains -- Net realized investment gains decreased by $115,000 for the nine months ended September 30, 1998 compared to the nine months ended September 30, 1997. Underwriting Results -- For the nine months ended September 30, 1998, Mercer Mutual had an underwriting gain of $780,000 and a combined ratio of 95.5%, compared to an underwriting loss of $211,000 and a combined ratio of 101.6% for the nine months ended September 30, 1997. The improvement in underwriting results reflects the low claim volume for 1998, due in part to the lack of severe weather conditions during 1998, and the restructuring of its reinsurance program. Losses and Loss Adjustment Expenses -- Net losses and loss adjustment expenses incurred increased by $701,000, or 8.7%, to $8.7 million for the nine months ended September 30, 1998 from the same period in 1997. Despite such increase, loss and loss adjustment expenses were 51.1% of net premiums earned for the nine months ended September 30, 1998 compared to 60.5% for the nine months ended September 30, 1997. The favorable ratio for 1998 is largely attributable to the lack of severe weather conditions during 1998. Winter conditions were extremely mild, and the number of losses reported to Mercer Mutual during the nine months ended September 30, 1998 was the lowest number reported during such period in the past five years. Underwriting Expenses -- Underwriting expenses increased by $2.1 million, or 39.0%, to $7.6 million for the nine months ended September 30, 1998 from the same period in 1997. This increase was primarily attributable to an increase in net commissions, which resulted from changes in Mercer Mutual's reinsurance program. The termination of most of the proportional reinsurance arrangements significantly reduces the amount of ceded commissions received. The reduction in ceded commissions results in the increase in net commissions. In addition, $365,000 in non-recurring legal fees were incurred during the nine months ended September 30, 1998. Federal Income Tax Expense -- Federal income tax expense was $966,000 for the nine months ended September 30, 1998 compared to $694,000 for the same period in 1997, which is attributable to the increase in net income before taxes. Net Income -- Mercer Mutual had net income of $2.0 million for the nine months ended September 30, 1998, compared to $1.5 million for the same period in 1997, primarily as a result of the factors discussed above. 42 46 RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1997 COMPARED TO THE YEAR ENDED DECEMBER 31, 1996 Premiums -- Mercer Mutual experienced an increase in direct premiums written for the year ended December 31, 1997 of $3.5 million or 14.0%, as compared to the same period in 1996, which reflects Mercer Mutual's strategy to increase its commercial business. Commercial lines premiums increased by $2.6 million, or 28.2%, for the year ended December 31, 1997 over the comparable prior period. The increase in commercial lines business reflects the introduction of a religious institution program and a commercial automobile program in early 1997, combined with enhancements to existing commercial products. In addition to the commercial lines increase, homeowners premiums increased in the year ended December 31, 1997, as compared to the prior period, as a result of an increase in certain rates. Territorial rating by county was introduced for Mercer Mutual's New Jersey homeowners product to better reflect Mercer Mutual's exposures. This rate change resulted in an increase of 7.9% in direct homeowners premiums written despite a decrease of 4.3% in the number of homeowners policies written. Assumed premiums written decreased by $4.5 million, or 89.1%, for the year ended December 31, 1997 as compared to the same period in 1996. Approximately $4.3 million of this decrease is directly attributable to the termination of Mercer Mutual's participation in the New Jersey Homeowners Pool (the "Homeowners Pool") as of December 31, 1996 because premiums are no longer assumed under the terms of that agreement. Ceded premiums written increased $1.7 million, or 17.2%, for the year ended December 31, 1997 compared to the year ended December 31, 1996, principally because of the above-described increase in direct premiums written of 14.0%. As premiums subject to reinsurance coverage increase, ceded written premiums increase at similar levels. The increase in ceded premiums also reflects the introduction of reinsurance for Mercer Mutual's new commercial automobile program and small increases in certain premium rates. Net premiums written decreased $2.7 million or 13.2%, to $17.4 million for the year ended December 31, 1997 from the year ended December 31, 1996. For the same comparative period, net premiums earned decreased by $2.7 million, or 12.9%, to $18.0 million. The decrease in net premiums written and net premiums earned for the year ended December 31, 1997 is principally attributable to the termination of the Homeowners Pool. Net Investment Income -- Net investment income increased $61,000, or 2.7%, to $2.4 million for the year ended December 31, 1997 as compared to the same period in 1996. Mercer Mutual continues to principally invest its available funds in taxable fixed income securities which generally produce higher yields than nontaxable securities. For the year ended December 31, 1997, the yield on fixed income securities remained at the 6.7% level attained in 1996. Net Realized Investment Gains -- Net realized investment gains decreased by $7,000 for the year ended December 31, 1997 compared to the year ended December 31, 1996. Despite this small decrease, realized investment gains in 1997 reflect continued favorable equity market conditions. Underwriting Results -- For the year ended December 31, 1997, Mercer Mutual had an underwriting gain of $106,000 and a combined ratio of 99.4% compared to an underwriting loss of $2.2 million and a combined ratio of 110.8% for the year ended December 31, 1996. The change in underwriting results is largely attributable to the improved winter weather conditions in 1997. In addition, the improvement in underwriting results reflects Mercer Mutual's strategy to increase its casualty business, which is less sensitive to weather conditions. Losses and Loss Adjustment Expenses -- Net losses and loss adjustment expenses incurred decreased by $4.2 million, or 28.4%, to $10.6 million for the year ended December 31, 1997 from the same period in 1996. Loss and loss adjustment expenses were 58.9% of net premiums earned for the year ended December 31, 1997 compared to 71.7% for the year ended December 31, 1996. The favorable improvement in this ratio is largely attributable to the lack of severe weather conditions in the 1997 period. The 1997 winter conditions were among the mildest in recent history, as compared to the severe winter conditions of 1996 which resulted in increased property loss claims. In January 1996, a damaging blizzard struck Mercer Mutual's operating region. The net cost of the blizzard was approximately $1 million in additional claims. In addition, as of January 1, 43 47 1997, the Homeowners Pool was replaced with the Homeowners Quota Share Program. The termination of the Homeowners Pool and the placement of the Homeowners Quota Share Program served to reduce net loss and loss adjustment expenses in 1997 by $2.3 million over 1996. In 1996, participation in the Homeowners Pool increased losses and loss adjustment expenses by $1.4 million. In 1997, however, because participation in the Homeowners Quota Share Program does not require the assumption of premiums or losses (unlike the Homeowners Pool) but does require the ceding of premiums and losses, such participation decreased loss and loss adjustment expenses by $865,000. See "Business -- Reinsurance" for a description of the Homeowners Pool, the Homeowners Quota Share Program and Mercer Mutual's other reinsurance programs. Underwriting Expenses -- Underwriting expenses decreased by $793,000, or 9.8%, to $7.3 million for the year ended December 31, 1997 from the same period in 1996. This decrease was partially attributable to a reduction in net commissions, which resulted from changes in Mercer Mutual's reinsurance program. The new Homeowners Quota Share Program pays a higher ceding commission to Mercer Mutual than was available as a participant in the Homeowners Pool. In addition, the termination of the Homeowners Pool resulted in a substantial reduction in assumed commissions. Also, favorable weather conditions during the year ended December 31, 1997 resulted in additional ceded commissions recognized under profit commission arrangements. Federal Income Tax Expense -- Federal income tax expense was $1.0 million for the year ended December 31, 1997 compared to $171,000 for the same period in 1996, which is attributable to the increase in net income before taxes. Net Income -- Mercer Mutual had net income of $2.2 million for the year ended December 31, 1997, compared to $640,000 for the same period in 1996, primarily as a result of the factors discussed above. RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995 Premiums -- Mercer Mutual experienced a 1.0% increase in direct premiums written in the year ended December 31, 1996 to $25.0 million, as compared to $24.7 million for the year ended December 31, 1995. Premiums written under commercial line classifications increased during 1996 as Mercer Mutual substantially increased its underwriting in this direction. The increase in commercial lines business was somewhat offset by a reduction in business caused by the termination of unprofitable agencies. Assumed premiums written decreased by $5.3 million in 1996, reflecting the termination of Mercer Mutual's participation in the Homeowners Pool. See "Business -- Reinsurance." As a result of this termination, unearned premium reserves assumed from the other pool participants were returned on December 31, 1996, which resulted in the reduction of assumed written premiums for the year. Ceded premiums written decreased $3.9 million for the year ended December 31, 1996 compared to the year ended December 31, 1995. As a result of the termination of the Homeowners Pool, unearned premium reserves ceded to the other pool participants were returned to Mercer Mutual. The return of ceded unearned premium reserves was offset by an increase in catastrophe reinsurance premiums, as Mercer Mutual restructured its catastrophe reinsurance coverage. Net premiums written decreased $1.1 million, or 5.3%, to $20.1 million for the year ended December 31, 1996 from the year ended December 31, in 1995. For the same comparative periods, net premiums earned decreased by $183,000, or 0.9%, to $20.6 million. The decrease in net premiums earned was the result of the previously discussed increase in direct premiums written, decrease in premiums assumed from reinsurers, decrease in premiums ceded to reinsurers and a decrease in unearned premiums of $510,000. Net Investment Income -- Net investment income increased $158,000, or 7.4%, to $2.3 million for the year ended December 31, 1996 from the year ended December 31, 1995. Reflecting Mercer Mutual's continued strategy to principally invest in high grade fixed income securities, fixed income securities increased $1.3 million, or 4.0%, to $35.0 million for the year ended December 31, 1996 from the year ended December 31, 1995. For the year ended December 31, 1996, the yield on fixed income securities remained at the 6.8% level attained for the year ended December 31, 1995. As a result, income from fixed income securities increased by $258,000. 44 48 Due to increased claim activity from the 1996 winter conditions, cash and cash equivalents decreased $892,000 to $2.7 million for the year ended December 31, 1996 from the year ended December 31, 1995. This resulted in a decrease in 1996 of investment income from cash and cash equivalents of $50,000. Income from other investments was down slightly in 1996, from $54,000 in 1995 to $46,000 in 1996, as funds have principally been reinvested in fixed income securities. Net Realized Investment Gains -- Net realized investment gains were $596,000 for the year ended December 31, 1996 compared to $53,000 for the year ended December 31, 1995. Investment gains in 1996 reflect more favorable equity market conditions, and compare with smaller gains recognized in 1995. Investments gains in 1995 from equity securities were offset by investment losses recognized on the disposal of certain collateralized mortgage obligations ("CMOs"). This reflected Mercer Mutual's restructuring of its fixed income portfolio in 1995 to less interest rate sensitive products. Underwriting Results -- For the year ended December 31, 1996, Mercer Mutual had an underwriting loss of $2.2 million and a combined ratio of 110.8% compared to an underwriting loss of $839,000 and a combined ratio of 104.1% for the year ended December 31, 1995. The increased underwriting loss for the year ended December 31, 1996 was primarily attributable to severe winter weather conditions in New Jersey. Losses and Loss Adjustment Expenses -- Net losses and loss adjustment expenses incurred increased by $1.5 million, or 11.3%, to $14.8 million for the year ended December 31, 1996 from the year ended December 31, 1995. Loss and loss adjustment expenses were 71.7% of net premiums earned for the year ended December 31, 1996 compared to 63.9% for the year ended December 31, 1995. Affecting losses and loss adjustment expenses in 1996 were severe winter weather conditions which resulted in increased property loss claims. In January 1996, a damaging blizzard struck Mercer Mutual's operating region. The net cost of the blizzard was approximately $1 million in additional claims. Mercer Mutual was further impacted by additional smaller localized severe conditions. The difference in non-storm activity between 1996 and 1995 was further influenced by favorable weather conditions in 1995. Underwriting Expenses -- Underwriting expenses decreased by $298,000, or 3.6%, for the year ended December 31, 1996 to $8.1 million for the year ended December 31, 1995. This decrease was largely attributable to a reduction in net commissions resulting from the restructuring of Mercer Mutual's reinsurance programs. For the year ended December 31, 1996, Mercer Mutual had an underwriting expense ratio of 39.1% compared to 40.2% for the year ended December 31, 1995. Federal Income Tax Expense -- Federal income tax expense was $171,000 for the year ended December 31, 1996 compared to $369,000 for the year ended December 31, 1995. This decrease is attributable to the decrease in net income before taxes for the compared periods. Net Income -- Mercer Mutual had net income of $640,000 for the year ended December 31, 1996 compared to $1.1 million for the year ended December 31, 1995, primarily as a result of the factors discussed above. EFFECT OF CONVERSION AND REDOMESTICATION ON THE COMPANY'S FUTURE FINANCIAL CONDITION AND RESULTS OF OPERATIONS The future financial condition and results of operations of the Company will be affected by the Conversion and related transactions. Upon completion of the Conversion, the Company's capital will increase by between $20.5 million and $31.6 million, an increase of approximately 79.3% to 122.4% over the consolidated capital of Mercer Mutual at September 30, 1998. See "Use of Proceeds," "Capitalization" and "Pro Forma Data." This increased capitalization should permit the Company to (i) increase direct premium volume to the extent competitive conditions permit, (ii) increase net premium volume by decreasing its reliance on reinsurance (see "Business -- Strategy -- Reduced Reliance on Reinsurance"), and (iii) enhance investment income by increasing its 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 from the ESOP Loan, and Mercer Mutual will 45 49 make annual contributions to the ESOP sufficient to repay the ESOP Loan, which the Company estimates will total, on a pre-tax basis, between $250,750 (at the Total Minimum) and $376,944 (at the Total Maximum) annually, plus interest at the prime rate in effect as of the consummation of the Conversion. See "Management of the Company -- Certain Benefit Plans and Agreements -- Employee Stock Ownership Plan." MRP. The Company may contribute to the MRP the amount necessary to purchase up to an aggregate number of shares equal to 4% of the shares of Common Stock that were issued in the Conversion (up to 135,700 shares at the Total Maximum of the Estimated Valuation Range). The cost of any Common Stock purchased by the MRP will represent unearned compensation. As the 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 MRP is subject to shareholder approval. See "Management of the Company -- Certain Benefit Plans and Agreements -- Management Recognition Plan." State Taxes. Prior to the Redomestication, which occurred on October 16, 1997, Mercer Mutual was subject to tax in New Jersey as a New Jersey-domiciled insurance company. New Jersey has a statutory retaliatory tax provision that, because Mercer Mutual is now a Pennsylvania-domiciled insurance company, could be interpreted to require Mercer Mutual to pay, for all or a portion of 1997 and for all future years, substantially more in taxes to New Jersey than it has in the past, which would have a material adverse affect on the results of operations of Mercer Mutual. Under this interpretation, if the Redomestication had occurred on January 1, 1997, Mercer Mutual would have been required to pay $542,000 in taxes to New Jersey for the year ended December 31, 1997, $469,000 more than the amount which Mercer Mutual has calculated as due for such year. Management does not believe that this interpretation is correct. If it is, however, the New Jersey retaliatory tax provision would materially affect the Company's future results of operations and cash flows, but would not be expected to materially affect the Company's liquidity because the investment and reinsurance strategies in place provide liquidity to Mercer Mutual. See "Risk Factors -- Possible Adverse Impact of New Jersey Tax Laws." Mercer Mutual, however, may have the ability to mitigate a portion of any adverse tax consequences by renewing policies in MIC, a New Jersey domestic insurance company. LIQUIDITY AND CAPITAL RESOURCES Liquidity is a measure of the ability to generate sufficient cash to meet cash obligations as they come due. Historically, the principal sources of Mercer Mutual's cash flow have been premiums, investment income, and maturing investments. In addition to the need for cash flow to meet operating expenses, the liquidity requirements of Mercer Mutual relate primarily to the payment of losses and loss adjustment expenses. The short- and long-term liquidity requirements of Mercer Mutual vary because of the uncertainties regarding the settlement dates for liabilities for unpaid claims and because of the potential for large losses, either individually or in the aggregate. Mercer Mutual maintains investment and reinsurance programs which are intended to provide sufficient funds to meet Mercer Mutual s obligations without forced sales of investments. Mercer Mutual maintains a portion of its investment portfolio in relatively short-term and highly liquid assets to ensure the availability of funds. Mercer Mutual had no material commitments for capital expenditures at September 30, 1998. The NAIC's risk based capital standards require insurance companies to calculate and report statutory capital and surplus needs based on a formula measuring underwriting, investment and other business risks inherent in an individual company's operations. At December 31, 1997, the capital and surplus of each of the Insurance Companies were substantially above these requirements. See "Risk Factors -- Possible Adverse Impact of Regulatory Changes." The principal source of liquidity for the Company will be dividend payments and other fees received from Mercer Mutual. The Pennsylvania Department's approval of the Conversion 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 any dividend to the Company without the approval of the Pennsylvania Department. After such three-year period, Mercer Mutual will be restricted by the insurance laws of Pennsylvania as to the amount of dividends 46 50 or other distributions it may pay to the Company without the prior approval of the Pennsylvania Department. Under Pennsylvania law, the maximum amount that may be paid by Mercer Mutual during any twelve-month period after notice to, but without prior approval of, the Pennsylvania Department cannot exceed the greater of 10% of Mercer Mutual's statutory surplus as reported on its most recent annual statement filed with the Pennsylvania Department, or the net income of Mercer Mutual for the period covered by such annual statement. If the dividend restrictions contained in the Orders were not in effect, then as of December 31, 1997 the amounts available for payment of dividends from Mercer Mutual in 1998 without the prior approval of the Pennsylvania Department would have been approximately $2.0 million. MIC is required to provide notice to the New Jersey Department prior to its payment of any dividends. The New Jersey Department has the power to limit or prohibit dividend payments if certain conditions exist. Such restrictions or any subsequently imposed restrictions may in the future affect the Company's liquidity. CHANGES IN REINSURANCE Mercer Mutual terminated its participation in the Garden State Reinsurance Association ("GSRA") as of December 31, 1997. The termination of this arrangement is not expected to have a material impact on the Company's results of operations and cash flows because the cost to reinsure this business should approximate the net cost incurred in participating in the GSRA. Effective January 1, 1998, the Insurance Companies restructured their reinsurance program by increasing the exposure retained by the Insurance Companies on certain coverages. The level of such restructuring with respect to each coverage was based largely on historical loss experience, with overall consideration given to a recent reduction in the amount of the Insurance Companies' Probable Maximum Loss. By increasing retention levels, the amount of premiums ceded to reinsurers will decrease, thus increasing net premiums. Losses and loss adjustment expenses will increase because fewer losses and loss adjustment expenses will be recovered from reinsurers. Net reserve estimates should increase as recoveries from reinsurers decrease. Management believes that by restructuring the Insurance Companies' retention levels, there should be a positive impact on its results of operations and financial condition, as increased premium earnings should exceed any increase in losses and loss adjustment expenses caused by this restructuring. No assurance can be made, however, that any future losses resulting from this restructuring would not exceed the aggregate increase in net premiums resulting from the restructuring, or would not otherwise have a material adverse effect on the Insurance Companies' financial condition and results of operations. See "Business -- Reinsurance." CHANGES IN INTEREST RATES Much of the Company's fixed income investment portfolio matures after five years. It is the Company's strategy to hold these securities until maturity. Even so, fluctuations in near-term interest rates could have an impact on the Company's results of operations and cash flows. Certain of these 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, because of its strategy of holding these securities to maturity, the Company's ability to invest in higher yielding securities would be limited. EFFECTS OF INFLATION The effects of inflation on Mercer Mutual are implicitly considered in estimating reserves for unpaid losses and loss adjustment expenses, and in the premium rate-making process. The actual effects of inflation on Mercer Mutual's results of operations cannot be accurately known until the ultimate settlement of claims. However, based upon the actual results reported to date, it is management's opinion that Mercer Mutual's loss reserves, including reserves for losses that have been incurred but not yet reported, make adequate provision for the effects of inflation. 47 51 NEW ACCOUNTING STANDARDS Stock-Based Compensation (Financial Accounting Standards Board ("FASB") Statement No. 123) -- The Company does not presently have any stock-based compensation plans. It plans to account for any shares issued under the proposed stock-based compensation plans under APB Opinion 25 and will disclose the difference, if any, on net earnings and earnings per share if compensation cost were determined under FASB Statement No. 123. Earnings Per Share (FASB Statement No. 128) -- This statement defines the computation, presentation and disclosure requirements for earnings per share calculations. The Company plans to adopt the provisions of this statement with respect to the Company's reports to shareholders. Comprehensive Income (FASB Statement No. 130) -- The Company adopted FASB Statement No. 130 in 1997 and comprehensive income is displayed in its statements of changes in surplus for all periods presented. Material provisions of this statement include reclassification adjustments of other comprehensive income components, the prominent display of other comprehensive income components and the disclosure on the amount of income tax expense or benefit allocated to each component. All such provisions have been applied for all periods presented. Segment Disclosures (FASB Statement No. 131) -- This statement establishes standards for the way that public companies report operating segments and standards for related disclosure about products and services, geographic areas and major customers. The Company plans to adopt the provisions of this statement commencing with the year ended December 31, 1998. IMPACT OF YEAR 2000 ISSUE The Insurance Companies have taken measures to address the impact of the "Year 2000" issue on their information systems. The Year 2000 issue, which is common to most businesses, concerns the inability of certain information systems, primarily certain computer software programs, to properly recognize and process date sensitive information beyond the year 1999. This inability could result in system failures or miscalculations causing possible inaccuracies in data and disruption of operations, including among other things, a temporary inability to process transactions, prepare invoices, or engage in similar normal business activities. The Company completed its initial assessment of the impact of this issue on the Company, and has determined that its vulnerability is mainly (i) with the third party provider who processes all of the Insurance Companies' premium, loss and billing transactions, (ii) with certain other third parties with whom the Insurance Companies deal in the ordinary course of their business, such as agents, governmental agencies and providers of investment and banking services, and (iii) under policies of insurance providing business interruption and other coverages to insureds who are adversely impacted by the Year 2000. Under the Insurance Companies' agreement with the third party provider, the provider is obligated to pay all software related costs incurred in order to make its system Year 2000 compliant. In its compliance project, the provider made certain modifications to its system in an effort to make it Year 2000 compliant, and prepared a detailed schedule of functions to be performed in order to test the system's compliance. Testing of such modifications has not resulted in any problems with the system. However, such testing is ongoing and will be completed no later than March 1999. The Insurance Companies are obligated to incur only the hardware cost associated with implementing the changes required by the service provider. These hardware costs to date are less than $10,000 and are not expected to exceed $50,000 at the completion of the compliance project. Other computer programs utilized by the Insurance Companies, such as accounting packages and investment packages, either are believed to be Year 2000 compliant or are expected to be Year 2000 compliant in the near future at no significant cost to the Insurance Companies. The Insurance Companies do not have any significant noninformational technology requiring Year 2000 remediation. The Insurance Companies have risk that certain third parties with whom they deal in the ordinary course of their business will suffer Year 2000 problems. Systems used by the Insurance Companies' independent insurance agencies may not yet be Year 2000 compliant. Some information used in underwriting policies and adjusting claims, such as motor vehicle reports and crime data bases, is generally obtained electronically. Certain investment portfolio pricing information and banking information is also obtained electronically. The 48 52 Insurance Companies are communicating with and monitoring the Year 2000 compliance progress of such third parties and will decide on contingency plans, if any, by mid-1999. With respect to insurance policies providing coverages to insureds who may incur losses as a result of Year 2000 problems, the Insurance Companies are in the process of reviewing these coverages to evaluate the Insurance Companies' possible exposure under such coverages. Endorsements excluding losses relating to or resulting from Year 2000 issues are being attached to all commercial policies issued or renewed on or after January 1, 1999. To the extent that the Insurance Companies' systems and those of their policyholders are not fully Year 2000 compliant, the Insurance Companies do not have any contingency plan. Therefore, in a worst case scenario, systems interruptions, the cost necessary to update software, and resulting losses and loss adjustment expenses under policies issued by the Insurance Companies would have a materially adverse effect on the Insurance Companies' business, financial condition and results of operations. 49 53 BUSINESS THE COMPANY The Company was incorporated under Pennsylvania law in November 1997 for the purpose of serving as a holding company for Mercer Mutual upon the acquisition of all of its capital stock in the Conversion. The Company has received the approval of the Pennsylvania Department to acquire control of Mercer Mutual. Prior to the Conversion, the Company has not engaged and will not engage in any significant operations. Upon completion of the Conversion, the Company's primary assets will be the outstanding capital stock of Mercer Mutual and a portion of the net proceeds of the Conversion. Management believes that the holding company structure will permit the Company to expand the products and services it offers to beyond those currently offered through the Insurance Companies, although presently there are no definitive plans or arrangements for such expansion. As a holding company, the Company will have greater flexibility to diversify its business activities through existing or newly formed subsidiaries or through the issuance of capital stock to facilitate acquisitions or mergers 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 Company will contribute to Mercer Mutual will substantially increase Mercer Mutual's surplus, which will, in turn, enhance policyholder protection and increase the amount of funds available to support both current operations and future growth. After the Conversion, the Company will be subject to regulation by the Pennsylvania Department and the New Jersey Department as the holding company for Mercer Mutual and MIC, respectively. THE 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 completing the Redomestication and thereby changing its state of domicile from New Jersey to Pennsylvania. Mercer Mutual owns all of the issued and outstanding capital stock of QHC, which owns all of the issued and outstanding capital stock of MIC. 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 homeowners and commercial multi-peril policies, as well as other liability, workers' compensation, fire, allied, inland marine and commercial automobile coverages through approximately 140 independent agencies. Mercer Mutual is subject to examination and comprehensive regulation by the Pennsylvania Department. See "Business -- Regulation." MIC is a property and casualty stock insurance company that was incorporated in 1981. Currently, MIC offers only workers' compensation insurance to businesses located in New Jersey. However, MIC is in the process of applying to the New Jersey Department for permission to expand its business to include those types of insurance offered by Mercer Mutual, and expects to receive such approval in the first half of 1999. MIC is subject to examination and comprehensive regulation by the New Jersey Department. See "Business -- Regulation." Direct premiums written in New Jersey accounted for in excess of 98.5% of the direct premiums written by the Insurance Companies for the nine months ended September 30, 1998 and each of the years in the three-year period ended December 31, 1997. As of September 30, 1998, the Insurance Companies had approximately 42,000 property and casualty policies in force. Mercer Mutual is licensed to underwrite property and casualty insurance in New Jersey and Pennsylvania. MIC is licensed only in New Jersey. At September 30, 1998, the consolidated assets of Mercer Mutual and its subsidiaries were $76.7 million. 50 54 STRATEGY The Company's principal strategies for the future are to: - Improve the mix of business by increasing commercial and casualty writings in order to enhance profitability and lessen the impact of property losses on overall results; - Geographically diversify its risk through its acquisition of other insurance companies in Pennsylvania and other jurisdictions, in order to reduce its overall exposure to weather-related property losses in its primary coverage area; - Attract and retain high-quality agencies having diverse customer bases located in the Company's targeted growth markets within Pennsylvania and western New Jersey, through increased marketing activities and the development and tailoring of commercial programs meeting the needs of their customers; and - Reduce its reliance on reinsurance by increasing the maximum exposure retained by the Insurance Companies on individual property and casualty risks, and thereby increase net premium volume. Management views the Conversion as a critical component of its strategic plan. The additional capital generated by the Conversion will permit the Insurance Companies to accelerate implementation of these strategies and the resulting holding company structure will provide needed flexibility to achieve the Company's goals. Diversification of Lines of Business. Mercer Mutual has taken, and will continue to take, steps to increase commercial and casualty premium volume, both to provide greater product diversification from personal into commercial lines that may provide greater flexibility in establishing rates, higher premiums and a countercyclical balance to personal lines and to potentially reduce property loss exposure. One such initiative is a religious institution program available for churches and synagogues which includes many preferred coverages and special pricing. Management believes that this market is underserved and Mercer Mutual's program has been able to attract agencies which have substantial books of business with religious institutions. Mercer Mutual has developed new policy forms tailored for these institutions, which typically have long-standing relationships with Mercer Mutual's agencies. Mercer Mutual has also refined and expanded its "main street" business owner program, which targets commercial coverages for those businesses that are a normal daily part of "main street" business, such as bakeries, funeral homes, delicatessens, pizzerias, florists and restaurants. Under this program, insurance packages are written using existing policy forms and are chosen based on the experience of the underwriting staff and market opportunities available to existing agents. Mercer Mutual also introduced a program in 1997 offering 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, Mercer Mutual offered a preferred rate for risks meeting specified underwriting standards, with the goal to complement the coverages maintained by its existing accounts as well as to attract new accounts. To further its goal of increasing its commercial business, in June 1997 Mercer Mutual received approval from the Pennsylvania Department to transact commercial automobile liability and workers' compensation insurance in Pennsylvania. Management believes that it has the opportunity to increase the volume of casualty business by (i) marketing such business to existing agents, many of whom have traditionally associated Mercer Mutual with homeowners' property insurance and may not identify and choose Mercer Mutual for their customers as providers of casualty line products, and (ii) forming and developing relationships with new agencies that focus on commercial and casualty business. Management believes an increasing share of this market is desirable and attainable given the existing relationships among Mercer Mutual, its agents and its insureds, as well as the extensive experience and agency relationships of its commercial business management personnel. Capital raised in the Conversion is expected to supply additional surplus necessary to support any substantial increase in commercial and casualty premium volume. 51 55 Geographic Diversification. The Company's goal is to geographically diversify its risk by increasing the level of its business outside of New Jersey in areas with reduced or different weather-related property loss exposure and in which management believes insurers generally have been permitted to manage risk selection and pricing without undue regulatory interference. Concentration of property insurance in New Jersey has caused Mercer Mutual to be susceptible to localized severe weather conditions. The Company expects to accomplish geographic diversification principally through acquisitions. Upon completion of the Conversion, the Company plans to seek acquisitions outside of New Jersey. The Company is currently targeting for acquisition companies located in Pennsylvania and other jurisdictions within the mid-Atlantic and Mid-western United States. Completion of the Conversion will provide funds for cash acquisitions and the holding company structure will facilitate the use of capital stock for acquisitions. High-Quality Agencies. Management believes the Insurance Companies have a strong reputation for personal attention and prompt efficient service to agencies and insureds. This reputation has allowed the Insurance Companies to grow and foster their relationships with many high volume agencies, several of which focus primarily on commercial business and are located in areas which the Insurance Companies have targeted as growth areas within Pennsylvania and New Jersey. The Company intends to focus its marketing efforts on maintaining and improving its relationship with these agencies, as well as on attracting new high-quality agencies in areas with a substantial potential for growth, particularly in Pennsylvania. The Company also intends to continue to develop and tailor its commercial programs to enable its products to meet the needs of the customers served by its agencies. The religious institutions, "main street" business and commercial automobile programs are successful examples of this effort. Reduced Reliance on Reinsurance. The Company intends to reduce its reliance on reinsurance by increasing the maximum exposure retained by the Insurance Companies on individual property and casualty risks. The Company will rely on the additional capital raised in the Conversion to protect itself in the event of individual property losses up to the increased maximum exposure amounts under its reinsurance agreements. The precise increase in its maximum exposure will be determined by the Company based on the amount of capital raised in the Conversion, the Company's evaluation of its ability to incur multiple losses without a corresponding material adverse effect on its future financial condition and results of operations, and negotiations with its reinsurers. A decrease in reinsurance could result in a decrease in ceded premiums and a corresponding increase in net premium income, but would increase the Company's risk of loss. PRODUCTS Mercer Mutual offers a variety of property and casualty insurance products primarily designed to meet the insurance needs of the businesses and property owners located in New Jersey and Pennsylvania. MIC currently offers only workers' compensation insurance to businesses located in New Jersey, but is in the process of applying to the New Jersey Department for permission to expand its business to include those types of insurance offered by Mercer Mutual. Mercer Mutual's products are developed in part by MSO, Inc. which provides custom product development, rating and statistical services for the property and casualty lines of its member companies, both mutual and stock. MSO, Inc.'s programs are currently available in a regional area which includes New Jersey, Pennsylvania, Maryland and Delaware. It is also licensed in Massachusetts and Virginia, and its programs may be licensed to companies in other states. The following tables set forth the direct premiums written, net premiums earned, net loss ratios, expense ratios and combined ratios by product line of the Insurance Companies on a consolidated basis for the periods indicated: 52 56
NINE MONTHS ENDED SEPTEMBER 30, YEAR ENDED DECEMBER 31, --------------------------------- --------------------------------------------------- % OF % OF % OF % OF % OF 1998 TOTAL 1997 TOTAL 1997 TOTAL 1996 TOTAL 1995 TOTAL ------- ----- ------- ----- ------- ----- ------- ----- ------- ----- (IN THOUSANDS) DIRECT PREMIUMS WRITTEN: Homeowners................. $ 9,750 42.4% $ 9,662 44.9% $13,057 45.9% $12,101 48.5% $11,602 47.0% Commercial multi-peril..... 5,507 24.0 4,797 22.3 6,374 22.4 5,065 20.3 4,437 17.8 Other liability............ 3,181 13.8 3,164 14.7 3,965 13.9 3,486 14.0 3,563 14.3 Fire, allied, inland marine................... 2,524 11.0 2,566 11.9 3,413 12.0 3,437 13.8 4,112 16.5 Workers' compensation...... 1,182 5.2 1,041 4.9 1,239 4.4 869 3.5 985 3.9 Commercial automobile...... 833 3.6 274 1.3 405 1.4 -- -- -- -- ------- ----- ------- ----- ------- ----- ------- ----- ------- ----- Total.................... $22,977 100.0% $21,504 100.0% $28,453 100.0% $24,958 100.0% $24,699 100.0% ======= ===== ======= ===== ======= ===== ======= ===== ======= ===== NET PREMIUMS EARNED: Homeowners................. $ 7,554 44.2% $ 6,053 45.6% $ 8,215 45.7% $10,347 50.1% $10,182 48.9% Commercial multi-peril..... 3,185 18.6 2,195 16.5 2,969 16.5 2,903 14.1 2,471 11.9 Other liability............ 2,587 15.1 2,033 15.3 2,825 15.7 2,925 14.2 2,829 13.6 Fire, allied, inland marine................... 2,256 13.2 2,063 15.5 2,746 15.3 3,250 15.8 3,991 19.2 Workers' compensation...... 1,153 6.7 927 7.0 1,235 6.9 1,209 5.8 1,344 6.5 Commercial automobile(1)... 375 2.2 17 0.1 (21) (0.1) -- -- -- -- ------- ----- ------- ----- ------- ----- ------- ----- ------- ----- Total.................... $17,110 100.0% $13,288 100.0% $17,969 100.0% $20,634 100.0% $20,817 100.0% ======= ===== ======= ===== ======= ===== ======= ===== ======= ===== NET LOSS RATIOS: Homeowners(2).............. 47.0% 73.3% 67.2% 85.4% 78.8% Commercial multi-peril..... 64.4 49.2 33.5 59.3 34.3 Other liability............ 62.0 52.8 70.7 102.7 72.1 Fire, allied, inland marine................... 32.5 41.7 49.4 36.3 38.4 Workers' compensation...... 55.2 60.2 54.4 5.2 63.8 Commercial automobile(1)... 43.3 170.6 (239.4) -- -- Total.................... 51.1% 60.5% 58.9% 71.7% 63.9% EXPENSE RATIOS: Homeowners................. 44.4% 41.1% 43.1% 38.4% 41.4% Commercial multi-peril..... 45.0 39.9 31.2 42.1 38.9 Other liability............ 43.2 45.9 42.5 39.1 41.8 Fire, allied, inland marine................... 41.7 36.9 38.6 37.0 37.0 Workers' compensation...... 47.8 40.3 40.7 43.2 39.0 Commercial automobile(1)... 52.6 164.5 (173.4) -- -- Total.................... 44.4% 41.1% 40.5% 39.1% 40.2% COMBINED RATIOS(3): Homeowners................. 91.4% 114.4% 110.3% 123.8% 120.2% Commercial multi-peril..... 109.4 89.1 64.7 101.4 73.3 Other liability............ 105.2 98.7 113.2 141.8 113.9 Fire, allied, inland marine................... 74.2 78.6 88.0 73.3 75.3 Workers' compensation...... 103.0 100.5 95.1 48.4 102.8 Commercial automobile(1)... 95.9 335.1 (412.8) -- -- Total.................... 95.5% 101.6% 99.4% 110.8% 104.1% Industry Combined Ratio.... 104.2% 104.0% 101.6% 105.9% 106.4%
- --------------- (1) The Insurance Companies commenced writing commercial automobile coverages in 1997. The negative balances for commercial automobile result from the minimum reinsurance charges incurred in connection with the commencement of this line of business. (2) The reduction in the net loss ratio related to homeowners insurance for the nine months ended September 30, 1998 as compared to the nine months ended September 30, 1997, and for the year ended December 31, 1997 as compared to the year ended December 31, 1996, is principally due to improved 53 57 weather conditions and lower claim volume combined with changes in the Insurance Companies' reinsurance programs introduced in 1997. See "Management's Discussion and Analyses of Financial Condition and Results of Operations -- Results of Operations for the Year Ended December 31, 1997 compared to the Year Ended December 31, 1996. (3) A combined ratio over 100% means that an insurer's underwriting operations are not profitable. Homeowners Mercer Mutual's current homeowners policy, introduced in 1987, 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. Mercer Mutual markets both a standard and a preferred homeowner product targeted for both the newly constructed homes and the older more mature market. As of September 30, 1998, Mercer Mutual had approximately 29,250 homeowners policies in force, with 34.2% of those the preferred product. Commercial Multi-peril Products. Commercial Multi-Peril. Mercer Mutual writes a number of multi-peril policies in New Jersey and Pennsylvania providing property and liability coverage to accounts that include all of Mercer Mutual's 3-4 family dwelling policies, as well as a number of larger apartment risks. Various other non-business owners risk classes are also written on this policy, such as larger contractors. As of September 30, 1998, approximately 1,600 multi-peril policies were in force. Mercer Mutual is working to increase market penetration for this product because it includes commercial liability risks that have more flexible and profitable rate structures and also help to diversify exposures and lessen the impact of property losses on overall results. Businessowners. Mercer Mutual introduced a businessowners policy in the mid-1980s that provides property and liability coverages to small businesses throughout New Jersey. This product is marketed to several distinct groups: (i) apartment building owners with 60 or fewer units; (ii) condominium associations; (iii) business owners who lease their buildings to tenants; (iv) mercantile businessowners, such as florists, delicatessens, and beauty parlors; and (v) offices with owner and/or tenant occupancies. As of September 30, 1998, approximately 2,500 businessowners policies were in force. Religious Institutions. Mercer Mutual enhanced its product offerings for religious institutions in 1997 through the creation of a specialized multi-peril policy specifically designed for this market segment. The enhanced product included the introduction of directors and officers coverage, religious counseling coverage and systems breakdown coverage (through a reinsurance arrangement). Coverage for child care centers and schools is also available. Other Liability. Commercial General Liability. Mercer Mutual also writes 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 items. Coverage for both premises/operations and products/completed operations exposures are routinely provided. Coverage is provided for other exposures such as vacant land and habitational risks. There were approximately 1,400 commercial general liability policies in force as of September 30, 1998. Commercial Umbrella Liability. Commercial umbrella coverage is available for insureds who insure their primary general liability exposures with Mercer Mutual through a businessowners, commercial multi-peril, religious institution or commercial general liability policy. Limits of $1,000,000 to $5,000,000 are readily available with higher limits provided if needed. To improve processing efficiencies and maintain underwriting standards, Mercer Mutual prefers to offer this coverage as an endorsement to the underlying liability policy rather than as a separate stand-alone policy. Personal Excess Liability. Mercer Mutual writes personal line excess liability, or "umbrella," policies covering personal liabilities in excess of amounts covered under Mercer Mutual's homeowners policies. Such 54 58 policies are available generally with limits of $1 million to $5 million. Mercer Mutual does not generally market excess liability policies to individuals unless they also write an underlying primary liability policy. Fire, Allied Lines and Inland Marine. 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. Mercer Mutual offers 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 businessowners policy. Combination Dwelling Policy. The current combination dwelling product, developed in 1987, 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 four families. The dwelling policy combines property and liability insurance but may also 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. Commercial Automobile This product was introduced in New Jersey in 1997 and 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 directors vehicles can also be covered. The policy is marketed as a companion offering to Mercer Mutual's businessowners, commercial multi-peril, religious institution, commercial property or general liability policies. Workers' Compensation. The Insurance Companies generally write workers' compensation policies in conjunction with an otherwise eligible businessowners, commercial multi-peril, religious institution, commercial property or general liability policy. Stand-alone workers' compensation policies are available only as a management accommodation and, as of September 30, 1998, most of the Insurance Companies' workers' compensation insureds have other Mercer Mutual policies. There were approximately 1,200 workers' compensation policies in effect as of September 30, 1998. MARKETING The Insurance Companies market their property and casualty insurance products in New Jersey and Pennsylvania exclusively through approximately 140 independent agencies, most of which are located in New Jersey. The Insurance Companies manage their agencies through quarterly business reviews (with underwriter participation) and establishment of benchmarks/goals for premium volume and profitability. The Insurance Companies have in recent years eliminated a number of low volume or unprofitable agencies. All of the Insurance Companies' independent agencies represent multiple carriers and are established businesses in the communities in which they operate. The Insurance Companies' independent agencies generally market and write the full range of the Insurance Companies' products. The Insurance Companies consider their relationships with agencies to be good. For the nine months ended September 30, 1998 and the year ended December 31, 1997, the Insurance Companies' largest agency accounted for approximately 7.6% and 7.3%, respectively, of the Insurance Companies' direct premiums written, and no other agency accounted for more than 5% of the Insurance Companies' direct premiums written. For the nine months ended September 30, 1998 and the year ended December 31, 1997, the Insurance Companies' top 10 agencies accounted for 31.0% and 26.8%, respectively, of direct premiums written, with the largest agency generating approximately $1.7 million and $2.1 million, respectively, in premium revenue for the Insurance Companies. The Insurance Companies emphasize personal contact between their agents and the policyholders. The Insurance Companies believe that their fast and efficient service, name recognition, policyholder loyalty and 55 59 policyholder satisfaction with agency and claims relationships are the principal sources of new customer referrals, cross-selling of additional insurance products and policyholder retention. The Insurance Companies depend upon their agency force to produce new business and to provide customer service. The network of independent agencies also serves as an important source of information about the needs of the communities served by the Insurance Companies. This information is utilized by the Insurance Companies to develop new products and new product features. Agencies are compensated through a fixed base commission with an opportunity for profit sharing depending on the agency's premiums earned and loss experience. The Insurance Companies' independent agencies are monitored and supported by marketing representatives, who are employees of the Insurance Companies and who also have principal responsibility for recruiting agencies and training new agents. To support their marketing efforts, the Insurance Companies hold seminars for agents and conduct training programs that provide both technical training about products and sales training on how to market such products. The Insurance Companies also provide personal computer software to agencies that allows them to quote rates on homeowners and commercial multi-peril policies. The Insurance Companies marketing efforts are further supported by their claims philosophy, which is designed to provide prompt and efficient service, thereby making the claims process a positive experience for agents and policyholders. UNDERWRITING The Insurance Companies write their personal and commercial lines by evaluating each risk with consistently applied standards. The Insurance Companies maintain information on all aspects of their business that is regularly reviewed to determine product line profitability. The Insurance Companies' employ 15 underwriters, who generally specialize in either personal or commercial lines. Specific information is monitored with regard to individual insureds that is used to assist the Insurance Companies in making decisions about policy renewals or modifications. The Insurance Companies' underwriters have an average of over 12 years of experience as underwriters. The Insurance Companies rely on information provided by their independent agencies who, subject to certain guidelines, also act as field underwriters and pre-screen policy applicants. Their independent agencies have the authority to sell and bind insurance coverages in accordance with pre-established guidelines. Agencies' underwriting results are monitored and, on occasion, agencies with historically poor loss ratios have had their binding authority removed until more profitable underwriting results were achieved. CLAIMS Claims on insurance policies written by the Insurance Companies are received directly from the insured or through the Insurance Companies' independent agencies. Claims are then assigned to either an in-house adjuster or an independent adjuster, depending upon the size and complexity of the claim, who investigates and settles the claim. As of September 30, 1998, the Insurance Companies had six in-house adjusters and worked with 15 independent adjusters. Until December 31, 1997 workers' compensation claims were assigned to the GSRA, an insurance pool which provides for the sharing of workers' compensation losses under an excess of loss reinsurance treaty. Since January 1, 1998, workers' compensation claims have been handled in the same manner as all other claims. 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. The Insurance Companies attempt to minimize claims costs by encouraging the use of alternative dispute resolution procedures. Less than 22% of all open claims under the Insurance Companies' policies have resulted in litigation. Litigated claims are assigned to outside counsel. 56 60 REINSURANCE Reinsurance Ceded In accordance with insurance industry practice, the Insurance Companies reinsure a portion of their exposure and pay to the reinsurers a portion of the premiums received on all policies reinsured. Insurance is ceded principally to reduce net liability on individual risks, to mitigate the effect of individual loss occurrences (including catastrophic losses), to stabilize underwriting results and to increase the Insurance Companies' underwriting capacity. Reinsurance can be facultative reinsurance or treaty reinsurance. Under facultative reinsurance, each risk or portion of a risk is reinsured individually. Under treaty reinsurance, an agreed-upon portion of business written is automatically reinsured. Reinsurance can also 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, and in turn will recover 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. The Insurance Companies place all of their reinsurance either through the use of brokers or directly with the reinsurance company. The Insurance Companies determine the amount and scope of reinsurance coverage to purchase each year based upon their evaluation of the risks accepted, consultations with reinsurance representatives and a review of market conditions, including the availability and pricing of reinsurance. The Insurance Companies' reinsurance arrangements are placed with non-affiliated reinsurers, and are generally renegotiated annually. For the year ended December 31, 1996, the Insurance Companies ceded to reinsurers $14.4 million of earned premiums. For the year ended December 31, 1997, the Insurance Companies ceded to reinsurers earned premiums of $9.5 million. The significant decrease in ceded premiums for the year ended December 31, 1997 reflects the effect of a restructuring of the reinsurance program as of January 1, 1997, which restructuring is described below. For the nine months ended September 30, 1998, the Insurance Companies ceded to reinsurers earned premiums of $5.3 million, compared to $7.0 million in earned premiums ceded to reinsurers for the nine months ended September 30, 1997. For the year ended December 31, 1997, the largest exposure retained by the Insurance Companies on any one individual property risk was $75,000. Excess reinsurance was provided on a treaty basis in layers as follows: Individual property risks in excess of $75,000 were covered on an excess of loss basis up to $250,000 per risk pursuant to various reinsurance treaties. Except for commercial automobile physical damage, per risk property losses in excess of $250,000 was reinsured on a proportional basis through treaty coverage or facultative coverage. Commercial automobile physical damage was reinsured separately on a quota share and excess of loss basis. The maximum commercial automobile physical damage exposure was $50,000. Effective January 1, 1998, the largest exposure retained by the Insurance Companies on any one individual property risk is $250,000. Individual property risks in excess of $250,000 are covered on an excess of loss basis pursuant to various reinsurance treaties. As of January 1, 1998, all property lines of business, including commercial automobile physical damage, are reinsured under the same treaties. For the year ended December 31, 1997, except for workers' compensation, umbrella liability, and commercial automobile liability, individual casualty risks that were in excess of $100,000 were covered on an excess of loss basis, up to $1.2 million per occurrence, pursuant to various reinsurance treaties. Casualty losses arising from workers' compensation claims were reinsured on a per occurrence and per person treaty basis by various reinsurers up to $10.0 million through GSRA. Umbrella liability losses were reinsured on a 95% 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 with a ceding commission of 35.0%. Commercial automobile liability was reinsured separately on a quota share and excess of loss basis. The maximum commercial automobile liability exposure was $50,000. The Insurance 57 61 Companies also purchased casualty contingency loss excess reinsurance providing $3.0 million of coverage in excess of $1.2 million. Effective January 1, 1998, except for umbrella liability, individual casualty risks that are in excess of $250,000 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, with a ceding commission of 32.5%. The Insurance Companies 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 arising from a single event such as windstorm, hail, tornado, hurricane, earthquake, riot, blizzard, freezing temperatures or other extraordinary events. Mercer Mutual purchased layers of excess treaty reinsurance for catastrophic property losses for 1997, under which Mercer Mutual reinsured 100% of losses per occurrence in excess of $1.0 million and up to $2.0 million, and 95% of losses per occurrence in excess of $2.0 million, up to a maximum of $45.0 million per occurrence. Effective January 1, 1998, Mercer Mutual purchased layers of excess treaty reinsurance for catastrophic property losses, under which Mercer Mutual reinsures 100% of losses per occurrence in excess of $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. Mercer Mutual reduced its catastrophe excess reinsurance amounts in 1998 because its estimated exposure to catastrophes, as calculated in 1997 by computer modeling techniques, demonstrated a significant reduction in such exposures. Mercer Mutual also has an aggregate excess of loss treaty reinsurance agreement designed to protect against multiple events each of which is below the $1.0 million retention under the primary catastrophe reinsurance treaty. During 1997, under this agreement, losses were reinsured for 90% of losses exceeding 70% of annual earned premiums, up to $2.2 million. Such agreement has been amended so that, effective January 1, 1998, losses are reinsured for 90% of losses exceeding 70% of annual earned premiums up to $2.7 million. Effective January 1, 1997, the Insurance Companies terminated their participation in the Homeowners Pool. Prior to 1997, the Insurance Companies pooled their New Jersey homeowners business with two other companies providing homeowners coverage to New Jersey residents. Premiums were ceded to the other Homeowners Pool participants based on the respective writings reinsured in the Homeowners Pool. The Insurance Companies in turn assumed reinsurance from the other participants. Losses were reinsured among the Homeowners Pool participants on a pro-rata basis in the same proportion premiums were ceded. At January 1, 1997, the Insurance Companies replaced the Homeowners Pool reinsurance with a combination of the Homeowners Quota Share Program and its existing pro-rata agreements. The Homeowners Pool was terminated in order to reduce the Insurance Companies' New Jersey exposure and to eliminate fluctuations in operating results arising from business assumed from outside the Insurance Companies under the Homeowners Pool. The restructuring of the reinsurance program caused a material reduction in both the consolidated net earned premiums and net expense of Mercer Mutual. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." The insolvency or inability of any reinsurer to meet its obligations to the Insurance Companies could have a material adverse effect on the results of operations or financial condition of the Insurance Companies. As of 58 62 September 30, 1998 the Company's five largest reinsurers based on percentage of ceded premiums are set forth in the following table:
PERCENTAGE OF A.M. BEST NAME CEDED PREMIUMS BEST RATING - ---- -------------- ----------- American Re-Insurance Co.......................... 23.46% A+ Motors Insurance Corporation...................... 16.79% A+ Hartford Fire Insurance Co........................ 15.55% A+ Vesta Fire Insurance Corporation.................. 3.95% A Gerling Global Reinsurance Corp. ................. 2.78% A-
The following table sets forth the five largest amounts of loss and loss expenses recoverable from reinsurers on unpaid claims as of September 30, 1998.
LOSS AND LOSS EXPENSES RECOVERABLE A.M. BEST NAME ON UNPAID CLAIMS RATING - ---- ---------------- --------- (IN THOUSANDS) Franklin Mutual Insurance Co....................... $1,115 A Cumberland Mutual Fire Ins. Co..................... 1,102 A+ Hartford Fire Insurance Co......................... 982 A+ Motors Insurance Corporation....................... 831 A+ Odyssey Reinsurance Co............................. 688 A-
The A+ and A ratings are the second and third highest of A.M. Best's fifteen ratings. All of the Insurance Companies' other reinsurers are rated "A-" or better by A.M. Best. According to A.M. Best, companies with a rating of "A-" or better have a strong ability to meet their ongoing obligations to policyholders. The Insurance Companies monitor the solvency of reinsurers through regular review of their financial statements and A.M. Best ratings. The Insurance Companies have experienced no significant difficulties collecting amounts due from reinsurers. Reinsurance Assumed The Insurance Companies assume reinsurance on a voluntary and non-voluntary basis. Reinsurance is assumed on an excess of loss basis and pro-rata basis. For the year ended December 31, 1996 the Insurance Companies assumed $10.3 million in earned premiums. For the year ended December 31, 1997, the Insurance Companies assumed $598,000 in earned premiums. The significant decrease in assumed earned premiums for the year ended December 31, 1997 reflects the above-described termination by the Insurance Companies of their participation in the Homeowners Pool effective December 31, 1996, which resulted in the Insurance Companies no longer assuming business from the other Homeowners Pool participants. For the nine months ended September 30, 1998, the Insurance Companies assumed $466,000 in earned premiums compared with $479,000 in earned premiums assumed for the nine months ended September 30, 1997. Under its agreement with GSRA, which was terminated effective December 31, 1997, the Insurance Companies assumed reinsurance on a voluntary basis from four mutual insurance companies providing workers' compensation coverage to New Jersey businesses. The Insurance Companies assumed 7% of losses incurred by those carriers in excess of $50,000 up to $250,000 or a maximum of $14,000 per occurrence. In return, the Insurance Companies assume 7% of the premiums of such carrier on the same excess of loss basis. The Insurance Companies are also required by statute to participate in two residual market pools. The Insurance Companies assume business for workers' compensation and for property exposures which are not insured in the voluntary marketplace. The Insurance Companies participate in these residual markets on a market share basis for the jurisdiction in which it writes business. 59 63 LOSS AND LAE RESERVES Property and Casualty Reserves. The Insurance Companies are required by applicable insurance laws and regulations to maintain reserves for payment of losses and loss adjustment expenses ("LAE") for both reported claims and for claims incurred but not reported ("IBNR"), arising from the policies they have issued. These 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 the Insurance Companies expect to be the cost of the ultimate settlement and administration of such claims 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. The estimation of ultimate liability for losses and LAE is an inherently uncertain process and does not represent an exact calculation of that liability. The Insurance Companies' reserve policy recognizes this uncertainty by maintaining reserves at a level providing for the possibility of adverse development relative to the estimation process. The Insurance Companies do not discount their reserves to recognize the time value of money. When a claim is reported to the Insurance Companies, 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 regarding 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 Insurance Companies' claims staff as more information becomes available. It is the Insurance Companies' policy to settle each claim as expeditiously as possible. The Insurance Companies maintain IBNR reserves to provide for future reporting of already incurred claims and developments on reported claims. The IBNR reserve is determined by estimating the Insurance Companies' ultimate net liability for both reported and IBNR claims and then subtracting the case reserves for reported claims. Each quarter, the Insurance Companies compute their estimated ultimate liability using principles and procedures applicable to the lines of business written. Such reserves are also considered annually by the Insurance Companies' independent auditors in connection with their audit of the Insurance Companies' consolidated financial statements. However, because the establishment of loss reserves is an inherently uncertain process, there can be no assurance that ultimate losses will not exceed the Insurance Companies' loss reserves. Adjustments in aggregate reserves, if any, are reflected in the operating results of the period during which such adjustments are made. As required by insurance regulatory authorities, the Insurance Companies submit to the jurisdictions in which they are licensed a statement of opinion by its appointed actuary concerning the adequacy of statutory reserves. The results of these actuarial studies have consistently indicated that reserves are adequate. Management of the Insurance Companies does not believe the 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 for the nine months ended September 30, 1998 and 1997 and the years ended December 31, 1997, 1996 and 1995 as prepared in accordance with GAAP. 60 64 RECONCILIATION OF RESERVE FOR LOSSES AND LOSS ADJUSTMENT EXPENSES
NINE MONTHS ENDED SEPTEMBER 30, YEAR ENDED DECEMBER 31, -------------------- -------------------------------- 1998 1997 1997 1996 1995 -------- -------- -------- -------- -------- (IN THOUSANDS) Reserves for losses and loss adjustment expenses at the beginning of period............... $ 31,872 $ 35,221 $ 35,221 $ 36,176 $ 35,531 Less: Reinsurance recoverables and receivables....................... (12,021) (15,147) (15,147) (16,819) (17,233) -------- -------- -------- -------- -------- Net reserves for losses and loss adjustment expenses at beginning of period......................... 19,851 20,074 20,074 19,357 18,298 -------- -------- -------- -------- -------- Add: Provision for losses and loss adjustment expenses for claims occurring in: The current year............... 9,527 8,865 11,649 16,445 14,251 Prior years.................... (788) (827) (1,055) (1,644) (955) -------- -------- -------- -------- -------- Total incurred losses and loss adjustment expenses.......... 8,739 8,038 10,594 14,801 13,296 -------- -------- -------- -------- -------- Less: Loss and loss adjustment expenses payments for claims occurring in: The current year............... 3,064 3,209 4,775 7,715 5,302 Prior years.................... 3,662 5,389 6,042 6,369 6,935 -------- -------- -------- -------- -------- Total losses and loss adjustment expenses.......... 6,726 8,598 10,817 14,084 12,237 -------- -------- -------- -------- -------- Net reserves for losses and loss adjustment expenses at end of period............................ 21,864 19,514 19,851 20,074 19,357 Add: Reinsurance recoverables and receivables....................... 8,467 13,298 12,021 15,147 16,819 -------- -------- -------- -------- -------- Reserves for losses and loss adjustment expenses at end of period............................ $ 30,331 $ 32,812 $ 31,872 $ 35,221 $ 36,176 ======== ======== ======== ======== ========
The following table shows the development of the consolidated reserves for unpaid losses and LAE from 1987 through 1997 for the Insurance Companies 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. 61 65
YEAR ENDED DECEMBER 31, ----------------------------------------------------------------------------- 1987 1988 1989 1990 1991 1992 1993 1994 ------- ------- ------- ------- ------- ------- ------- ------- (IN THOUSANDS) Liability for unpaid losses and LAE net of reinsurance recoverable............ $ 7,646 $ 9,266 $13,247 $16,698 $18,509 $20,067 $18,995 $18,298 Cumulative amount of liability paid through: One year later........................ 2,760 3,268 4,702 5,195 5,621 6,329 6,023 6,935 Two years later....................... 4,101 5,129 7,282 8,091 8,587 9,940 9,786 10,272 Three years later..................... 5,181 6,684 9,342 10,307 11,315 12,723 12,144 12,336 Four years later...................... 5,825 7,899 10,888 12,112 13,162 14,160 13,590 Five years later...................... 6,363 8,643 11,694 12,904 14,033 14,852 Six years later....................... 6,627 9,063 11,997 13,262 14,389 Seven years later..................... 6,800 9,169 12,096 13,470 Eight years later..................... 6,857 9,236 12,177 Nine years later...................... 6,851 9,275 Ten years later....................... 6,864 Liability estimated as of: One year later........................ 7,895 10,446 14,766 16,168 17,400 18,246 17,746 17,344 Two years later....................... 7,657 10,914 13,989 15,632 16,293 17,603 17,088 16,860 Three years later..................... 7,581 10,330 13,540 14,787 15,973 16,985 16,779 16,495 Four years later...................... 7,256 10,076 12,724 14,209 15,411 16,490 16,244 Five years later...................... 7,272 9,603 12,643 13,945 15,298 16,225 Six years later....................... 7,100 9,595 12,556 13,996 15,153 Seven years later..................... 7,055 9,586 12,518 13,963 Eight years later..................... 7,035 9,522 12,517 Nine years later...................... 7,033 9,529 Ten years later....................... 7,040 Cumulative total redundancy (deficiency).......................... 606 (263) 730 2,735 3,356 3,842 2,751 1,803 Gross liability -- end of year.......... 38,472 33,308 35,531 Reinsurance recoverables................ 18,405 14,313 17,233 ------- ------- ------- Net liability -- end of year............ $20,067 $18,995 $18,298 ======= ======= ======= Gross reestimated liability-latest...... 33,323 28,775 31,011 Reestimated reinsurance recoverables-latest................... 17,097 12,531 14,515 ------- ------- ------- Net reestimated liability-latest........ 16,225 16,244 16,495 ======= ======= ======= Gross cumulative redundancy............. 5,149 4,533 4,520 ======= ======= ======= YEAR ENDED DECEMBER 31, --------------------------- 1995 1996 1997 ------- ------- ------- (IN THOUSANDS) Liability for unpaid losses and LAE net of reinsurance recoverable............ $19,357 $20,074 $19,851 Cumulative amount of liability paid through: One year later........................ 6,368 6,042 -- Two years later....................... 9,554 Three years later..................... Four years later...................... 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........................ 17,712 19,018 -- Two years later....................... 17,247 Three years later..................... Four years later...................... Five years later...................... Six years later....................... Seven years later..................... Eight years later..................... Nine years later...................... Ten years later....................... Cumulative total redundancy (deficiency).......................... 2,110 1,056 -- Gross liability -- end of year.......... 36,176 35,221 31,872 Reinsurance recoverables................ 16,819 15,147 12,021 ------- ------- ------- Net liability -- end of year............ $19,357 $20,074 $19,851 ======= ======= ======= Gross reestimated liability-latest...... 30,974 31,539 Reestimated reinsurance recoverables-latest................... 13,726 12,521 ------- ------- Net reestimated liability-latest........ 17,247 19,018 ======= ======= Gross cumulative redundancy............. 5,202 3,682 ======= =======
62 66 INVESTMENTS On a consolidated basis, all of Mercer Mutual's investment securities are classified as available for sale and are carried at fair market value. An important component of the consolidated operating results of Mercer Mutual has been the return on invested assets. The Company's investment objectives are (i) to maximize current yield, (ii) to maintain safety of capital through a balance of high quality, diversified investments which minimize risk, (iii) to maintain adequate liquidity for its insurance operations, (iv) to meet regulatory requirements, and (v) to increase surplus through appreciation. The Board of Directors sets the investment policy of the Company, which requires that investments be made in a portfolio consisting of bonds, common stock and short-term money market instruments. The Company's equity investments are required to be concentrated in larger capitalization, quality companies. The policy does not permit investment in unincorporated businesses, private placements or direct mortgages, foreign denominated securities, financial guarantees or commodities. The following table sets forth certain consolidated information concerning Mercer Mutual's investments.
AT SEPTEMBER 30, 1998 AT DECEMBER 31, 1997 AT DECEMBER 31, 1996 ---------------------- -------------------- -------------------- MARKET MARKET MARKET COST(2) VALUE COST(2) VALUE COST(2) VALUE --------- --------- -------- -------- -------- -------- (IN THOUSANDS) Fixed income securities(1): United States government and government agencies....... $22,585 $23,008 $25,195 $25,407 $23,702 $23,691 Obligations of states and political subdivisions.... 6,890 7,082 3,396 3,517 4,313 4,343 Industrial and miscellaneous............. 753 769 300 300 -- -- Mortgage-backed securities... 5,354 5,215 6,106 5,723 7,631 6,930 ------- ------- ------- ------- ------- ------- Total fixed income securities......... 35,582 36,074 34,997 34,947 35,646 34,964 Equity securities.............. 8,539 12,867 6,948 10,852 5,892 7,795 ------- ------- ------- ------- ------- ------- Total................ $44,121 $48,941 $41,945 $45,799 $41,538 $42,759 ======= ======= ======= ======= ======= =======
- --------------- (1) In the consolidated financial statements of Mercer Mutual, 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. 63 67 The table below contains consolidated information concerning the investment ratings of Mercer Mutual's fixed maturity investments at September 30, 1998.
AMORTIZED MARKET TYPE/RATINGS OF INVESTMENT(1) COST VALUE PERCENTAGES(2) ----------------------------- --------- ------- -------------- (IN THOUSANDS) U.S. Government and agencies.............. $22,585 $23,008 63.8% AAA....................................... 11,164 11,177 31.0 AA........................................ 770 803 2.2 A......................................... 963 982 2.7 BBB....................................... 100 104 0.3 ------- ------- ----- Total........................... $35,582 $36,074 100.0% ======= ======= =====
- --------------- (1) The ratings set forth in this table are based on the ratings, if any, 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. The table below sets forth the maturity profile of Mercer Mutual's consolidated fixed maturity investments as of September 30, 1998:
AMORTIZED MARKET MATURITY COST(1) VALUE PERCENTAGES(2) - -------- --------- ------- -------------- (IN THOUSANDS) 1 year or less.................................... $ 100 $ 101 0.3% More than 1 year through 5 years.................. 3,180 3,304 9.2 More than 5 years through 10 years................ 20,870 21,237 58.9 More than 10 years................................ 6,078 6,217 17.2 Mortgage-backed securities(3)..................... 5,354 5,215 14.4 ------- ------- ----- Total................................... $35,582 $36,074 100.0% ======= ======= =====
- --------------- (1) Fixed maturities are carried at market value in the consolidated financial statements of Mercer Mutual. (2) Represents percent of market 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 follow a structured principal repayment schedule and are of high credit quality rated "AAA" or better by Standard & Poor's. These securities are presented separately in the maturity schedule due to the inherent risk associated with prepayment or early authorization. The average duration of this portfolio is 3.6 years. The average duration of Mercer Mutual's fixed maturity investments, excluding mortgage backed securities which are subject to paydown, as of September 30, 1998 was approximately 5.7 years. As a result, the market value of the Company's investments may fluctuate significantly in response to changes in interest rates. In addition, the Company may experience investment losses to the extent its liquidity needs require the disposition of fixed maturity securities in unfavorable interest rate environments. 64 68 Mercer Mutual's consolidated net investment income, average cash and invested assets and return on average cash and invested assets for the nine months ended September 30, 1998 and 1997 and the years ended December 31, 1997, 1996 and 1995 and were as follows:
NINE MONTHS ENDED SEPTEMBER 30, YEAR ENDED DECEMBER 31, -------------------- ----------------------------- 1998 1997 1997 1996 1995 -------- -------- ------- ------- ------- (IN THOUSANDS) Average invested assets.......... $52,241 $46,439 $46,970 $44,728 $39,746 Net investment income............ 1,656 1,793 2,350 2,289 2,132 Return on average invested assets......................... 4.2% 5.2% 5.0% 5.1% 5.4%
A.M. BEST RATING A.M. Best, which rates insurance companies based on factors of concern to policyholders, currently assigns an "A-" (Excellent) rating (its fourth highest rating category out of 15 categories) to the Insurance Companies as a group. A.M. Best assigns "A" or "A-" ratings to companies which, in its opinion, have demonstrated excellent overall performance when compared to the standards established by A.M. Best. Companies rated "A" and "A-" have a strong ability to meet their obligations to policyholders over a long period of time. In evaluating a company's financial and operating performance, A.M. Best reviews the company's profitability, leverage and liquidity, as well as the company's book of business, the adequacy and soundness of its reinsurance, the quality and estimated market value of its assets, the adequacy of its loss reserves, the adequacy of its surplus, its capital structure, the experience and competency of its management and its market presence. No assurance can be given that A.M. Best will not reduce the Insurance Companies' current rating in the future. In its 1998 ratings report on the Insurance Companies, in which A.M. Best assigned the Insurance Companies its current "A-" rating, A.M. Best also stated that due to Mercer Mutual's significant catastrophe exposure resulting from the geographic concentration of its business, the Insurance Companies' results continue to be heavily influenced by weather related events such as hurricanes and winter storm activity. In addition, A.M. Best noted that as the Insurance Companies continue to penetrate the commercial market, they will be subject to such market's increasingly competitive environment. See "-- Competition." However, A.M. Best also recognized the Insurance Companies' continuing efforts to mitigate their catastrophe exposure, as well as to diversify their book of business. Accordingly, A.M. Best viewed the Insurance Companies' ratings outlook as stable. In 1997 and again in 1998, management met with A.M. Best personnel to discuss the measures the Insurance Companies are implementing to mitigate Mercer Mutual's catastrophe exposure. These measures include an increase in the rates charged for homeowners insurance, the termination of relationships with unprofitable agencies, improving their mix of business through an increase in commercial and casualty writings, the planned geographic diversification of its business through acquisitions, and the planned improvement of capital strength through the Offerings. A.M. Best uses independent computer modeling systems to measure an insurance company's catastrophe exposure. One of the measurements generated by such computer modeling systems and utilized by A.M. Best in the rating process is Probable Maximum Loss. From August 31, 1996 to August 31, 1997, the Probable Maximum Loss (before catastrophe reinsurance) of the Insurance Companies has been reduced by 69.5% from $64.9 million to $19.8 million. See "Risk Factors -- A.M. Best Rating." COMPETITION The property and casualty insurance market is highly competitive. The 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 the Insurance Companies. The Insurance Companies' ability to compete successfully in their principal markets is dependent upon a number of factors, many of which (including market and competitive conditions) are 65 69 outside the Insurance Companies' control. Many of the lines of insurance written by the Insurance Companies are subject to significant price competition. Some companies may offer insurance at lower premium rates through the use of salaried personnel or other methods, rather than through independent agents paid on a commission basis, as the Insurance Companies do. In addition to price, competition in the lines of business written by the Insurance Companies is based on quality of the products, quality and speed of service (including claims service), financial strength, ratings, distribution systems and technical expertise. REGULATION General. Insurance companies are subject to supervision and regulation in the states in which they transact business. Such supervision and regulation relates to numerous aspects of an insurance company's business and financial condition. The primary purpose of such supervision and regulation is the protection of policyholders. The extent of such regulation varies, but generally derives from state statutes which delegate regulatory, supervisory and administrative authority to state insurance departments. Accordingly, the authority of the state insurance departments includes the establishment of standards of solvency which must be met and maintained by insurers, the licensing to do business of insurers and agents, the nature of and limitations on investments, premium rates for property and casualty insurance, the provisions which insurers must make for current losses and future liabilities, the deposit of securities for the benefit of policyholders, the approval of policy forms, notice requirements for the cancellation of policies and the approval of certain changes in control. State insurance departments also conduct periodic examinations of the affairs of insurance companies and require the filing of annual and other reports relating to the financial condition of insurance companies. Examinations. Examinations are regularly conducted by the Pennsylvania Department and the New Jersey Department every three to five years. Because the volume of Mercer Mutual's business in Pennsylvania to date has been minimal and Mercer Mutual did not change its domicile from New Jersey to Pennsylvania until October 1997, Mercer Mutual has never been examined by the Pennsylvania Department. The New Jersey Department's last examination of Mercer Mutual and MIC was as of December 31, 1995. These examinations did not result in any adjustments to the financial position of either of the 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 the Insurance Companies. NAIC Requirements. In addition to state-imposed insurance laws and regulations, the NAIC has adopted risk-based capital ("RBC") requirements that require insurance companies to calculate and report information under a risk-based formula that attempts 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 ("ACL") by taking 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 RBC instructions may provide. The formula is designed to allow state insurance regulators to identify potential 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 ACL but greater than or equal to 1.5 times its ACL. At the Company Action Level, the company must submit a comprehensive plan to the regulatory authority which discusses proposed corrective actions to improve the capital position. The "Regulatory Action Level" is triggered if a company's Total Adjust Capital is less than 1.5 times but greater than or equal to 1.0 times its ACL. 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 than 1.0 times but greater than or equal to 0.7 times its ACL, and 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 ACL, and the regulatory authority is mandated to place the company under its control. The Insurance Companies have never failed to exceed these required 66 70 levels of capital. There can be no assurance, however, that the capital requirements applicable to the business of the Insurance Companies will not increase in the future. The NAIC has also developed a set of eleven financial ratios, referred to as the Insurance Regulatory Information System (IRIS), for use by state insurance regulators in monitoring the financial condition of insurance companies. The NAIC has established an acceptable range of values for each of the IRIS financial ratios. Generally, an insurance company will become the subject of increased scrutiny where four or more of its IRIS ratio results fall outside the range deemed acceptable by the NAIC. The nature of increased regulatory scrutiny resulting from IRIS ratio results that are outside the acceptable range is subject to the judgment of the applicable state insurance department, but generally will result in accelerated review of annual and quarterly filings. Depending on the nature and severity of the underlying cause of the IRIS ratio results being outside the acceptable range, increased regulatory scrutiny could range from increased but informal regulatory oversight to placing a company under regulatory control. During the years ended December 31, 1995 and 1996, either or both of the Insurance Companies reported results outside the acceptable range for the following IRIS tests: the two-year overall operating ratio and the change in net writings. The two-year overall operating ratio is a measure of company profitability which combines three ratios: the loss ratio, plus the expense ratio, minus the investment income ratio. A ratio result below 100% indicates a profit, and a ratio result above 100% indicates a loss. The change in net writings ratio is a measurement of the stability of a company's operations. For the year ended December 31, 1997, neither of the Insurance Companies reported results outside the acceptable range for any IRIS test. The table below sets forth IRIS ratios outside the acceptable range for the Insurance Companies during 1995, 1996 and 1997:
INSURANCE VALUES EQUAL TO OR MERCER MUTUAL MIC ------------- -------------------- -------------------- RATIO NAME/DESCRIPTION OVER UNDER 1997 1996 1995 1997 1996 1995 - ---------------------- ---- ----- ---- ---- ---- ---- ---- ---- Change in net writings................... 33 (33) 263 (84) Two-year overall operating ratio......... 100 100 109
For Mercer Mutual, the 1995 two-year overall operating ratio was outside the acceptable range. Operating results were adversely impacted by winter storms and wind storms which resulted in significant losses in 1994, thereby increasing the 1995 two-year operating ratio. For MIC, the 1995 two-year overall operating ratio was outside the acceptable range. This ratio was negatively impacted by MIC's share of losses from winter storms and wind storms it assumed from Mercer Mutual under terms of their reinsurance treaties at the time. (These storms occurred in 1994 and increased MIC's 1995 two-year operating ratio.) The treaties with Mercer Mutual were terminated as of January 1, 1995. The termination of the intercompany reinsurance agreements resulted in the return of unearned premium reserves from MIC to Mercer Mutual. As a result, net writings dropped dramatically in 1995. The drop in net premium writings in 1995 caused the unusual results for the 1996 and 1995 net writings ratio. Guaranty Fund Laws. The states in which the Insurance Companies do business (New Jersey and Pennsylvania) have guaranty fund laws under which insurers doing business in such states can be assessed on the basis of premiums written by the insurer in that state in order to fund policyholder liabilities of insolvent insurance companies. Under these laws in general, an insurer is subject to assessment, depending upon its market share of a given line of business, to assist in the payment of policyholder claims against insolvent insurers. The Insurance Companies make accruals for their portion of assessments related to such insolvencies when notified of assessments by the guaranty associations. 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. It is not possible to predict whether, in what form or in what jurisdictions any of these proposals might be adopted or the effect, if any, on the Insurance Companies. However, most of 67 71 these proposals relate to automobile insurance. The Insurance Companies do not write, nor do they have any present intention to write in the future, personal automobile insurance (except through businesses which may be acquired through acquisition), and the Insurance Companies' commercial automobile insurance business is not material to the business of the Insurance Companies. Dividends. The Insurance Companies are restricted by the insurance laws of their respective states of domicile as to the amount of dividends or other distributions they may pay without notice to or the prior approval of the state regulatory authority. With respect to Mercer Mutual, the Pennsylvania Department's approval of the Conversion 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 Company without the approval of the Pennsylvania Department. After such three-year period has expired, Mercer Mutual's ability to declare and pay dividends to the Company will be subject to Pennsylvania law, which provides that the maximum amount that may be paid by Mercer Mutual during any twelve-month period after notice to, but without prior approval of, the Pennsylvania Department cannot exceed the greater of 10% of Mercer Mutual's statutory surplus as reported on the most recent annual statement filed with the Pennsylvania Department, or the net income of Mercer Mutual for the period covered by such annual statement. If the dividend restrictions contained in the Orders were not in effect, then as of December 31, 1997, amounts available for payment of dividends by Mercer Mutual to the Company in 1998 without the prior approval of the Pennsylvania Department would have been approximately $2.0 million. 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 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 the Insurance Companies and the Company at any time, require disclosure of material transactions by the Insurance Companies and the Company and require prior notice of approval of certain transactions, such as "extraordinary dividends" from the Insurance Companies to the Company. All transactions within the holding company system affecting the Insurance Companies and the Company must be fair and equitable. Notice of certain material transactions between an insurer and any person in its holding company system is required to be given to the applicable insurance commissioner and, in some states, certain of such transactions cannot be consummated without the prior approval of the applicable insurance commissioner. Approval of the applicable insurance commissioner is required prior to consummation of transactions affecting the control of an insurer. 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 consummation of such an acquisition, such person would be in control of such insurer, or (ii) effecting or attempting to effect an acquisition of control of or merger with a Pennsylvania insurer, unless such offer, request, invitation, acquisition, effectuation or attempt has received the prior approval of the Pennsylvania Department. New Antitakeover Legislation. On December 21, 1998, the Governor of Pennsylvania signed into law legislation that prohibits, from the time a mutual insurance company files with the Pennsylvania 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 such converting company (the "Antitakeover Law"). Any such offer, announcement or acquisition would constitute a violation of the Act as well as the Pennsylvania holding company law described above. The Antitakeover Law only applies to conversion applications filed on or after December 21, 1998. 68 72 OFFER TO ACQUIRE MERCER MUTUAL On March 3, 1998, Mercer Mutual received an unsolicited offer from Franklin Mutual Insurance Company ("Franklin") to purchase from Mercer Mutual, upon the consummation of the Conversion, all of the to-be-issued capital stock of Mercer Mutual for a purchase price equal to the audited book value of Mercer Mutual at December 31, 1997 under generally accepted accounting principles. Under Franklin's proposal, Mercer Mutual was asked to amend the Plan to provide that policyholders would receive a distribution equal to such purchase price in accordance with a fair and equitable formula approved by the Pennsylvania Department. Franklin also committed to contribute an additional $5 million of capital to Mercer Mutual. Franklin made such offer without receiving the prior approval of the Pennsylvania Department. Mercer Mutual's Board of Directors unanimously rejected such offer because it was not in the best interests of Mercer Mutual and its policyholders and other constituents. On April 3, 1998, Mercer Mutual received a letter from Franklin reextending its offer. Such reextention was also made without the prior approval of the Pennsylvania Department. Mercer Mutual's Board of Directors again unanimously rejected such offer. Mercer Mutual believes, based on the advice of its counsel, that if the Antitakeover Law were applicable to the conversion application approved by the Orders (i.e., if Mercer Mutual had filed such application on or after December 21, 1998), Franklin's offers would be expressly prohibited by the Antitakeover Law. LEGAL PROCEEDINGS Franklin Litigation. In May 1998, Franklin filed with the Pennsylvania Department a petition to intervene and request for a full adjudicatory hearing with respect to all proceedings of the Pennsylvania Department concerning Mercer Mutual's application for approval of the Plan. On October 20, 1998, the Pennsylvania Department issued the Orders approving the Plan and concluding that, among other things, in its review of the Plan, the Pennsylvania Department considered Franklin's petition to intervene and request for adjudicatory hearing as public comments, and not as formal pleadings because formal pleadings are not required or appropriate in the review of a proposed plan of conversion under the Act. Therefore, no further action was required to be taken by the Pennsylvania Department in response to Franklin's petition and request. On October 27, 1998, Franklin filed with the Pennsylvania Department an appeal of the Orders and a request for a full adjudicatory hearing. On November 6, 1998, the Pennsylvania Department rejected Franklin's appeal because the Pennsylvania Department had no jurisdiction to entertain such appeal. On November 9, 1998, Franklin filed a petition for review in the nature of an appeal with the Pennsylvania Commonwealth Court objecting to and requesting that the Court reverse the Orders (the "Franklin Action"). Mercer Mutual has filed with the Commonwealth Court a notice to intervene in the Franklin Action. The Franklin Action is still pending. Mercer Mutual believes that Franklin's claims in the Franklin Action are without merit, and Mercer Mutual intends to vigorously contest such claims. However, no assurance can be given that the Pennsylvania Department or Mercer Mutual will ultimately prevail in the Franklin Action or in any other litigation relating to the Conversion. For a description of the potentially adverse consequences that may result from the Franklin Action and other litigation that may affect the Conversion, see "Risk Factors -- Possible Adverse Impact of Litigation." Defamation Action. In July 1998, Mercer filed an action in the Pennsylvania Court of Common Pleas for Chester County against Franklin and its president, George H. Guptill, Jr., for intentional and negligent defamation relating to statements made by Franklin and Mr. Guptill in a June 5, 1998 press release that Mercer Mutual believes are false and misleading. In August 1998, Mercer Mutual dismissed such action and simultaneously filed the same action in the Superior Court of New Jersey for Mercer County. Franklin and Mr. Guptill have filed counterclaims against Mercer Mutual and its president, William C. Hart, alleging that certain statements made by Mercer Mutual and Mr. Hart in a July 2, 1998 press release were defamatory. Franklin and Mr. Guptill are seeking compensatory and punitive damages, interest, costs and attorneys' fees. Mercer Mutual and Mr. Hart believe that Franklin's and Mr. Guptill's allegations in their counterclaim are without merit and intend to vigorously defend this action. The bylaws of Mercer Mutual require Mercer Mutual to indemnify Mr. Hart against expenses (including attorneys' fees), amounts paid in settlement, judgments, and fines incurred by Mr. Hart in connection with this action, except that no indemnification is 69 73 permitted if the act giving rise to the claim is determined by a court to constitute willful misconduct or recklessness. Other Litigation. In addition to the foregoing, the Insurance Companies are parties to litigation in the normal course of business. Based upon information presently available to them, the Insurance Companies' do not consider any such litigation to be material. However, given the uncertainties attendant to litigation, there can be no assurance that the Insurance Companies' results of operations and financial condition will not be materially adversely affected by any such litigation. INTERCOMPANY AGREEMENTS Mercer Mutual and MIC are parties to a Management Agreement pursuant to which, in exchange for functions and services performed by employees of Mercer Mutual, all expenses for the workers' compensation business conducted by the Insurance Companies are borne by MIC. Mercer Mutual and MIC are also parties, together with QHC, to a Consolidated Tax Allocation Agreement whereby each company is allocated a pro rata share of the consolidated income tax expense based upon its contribution of taxable income to the consolidated group. PROPERTIES The Company's and Insurance Companies' main offices are located at 10 North Highway 31, Pennington, New Jersey in a 14,357 square foot facility owned by Mercer Mutual. The Company also owns a tract of land adjacent to its main office property. Mercer Mutual also leases 1,000 square feet of office space in Yardley, Pennsylvania. EMPLOYEES As of September 30, 1998, the total number of full-time equivalent employees of Mercer Mutual was 48. None of these employees are covered by a collective bargaining agreement and Mercer Mutual believes that employee relations are good. MIC does not have any employees. 70 74 MANAGEMENT OF THE COMPANY DIRECTORS The Board of Directors of the Company consists of Roland D. Boehm, James J. Freda, William C. Hart, George T. Hornyak, 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, beginning with the first annual meeting of shareholders following the Conversion. Messrs. Boehm and Freda have terms of office expiring at the first annual meeting, Messrs. Hart, Niedt and Van Noy have terms of office expiring at the annual meeting to be held one year thereafter, and Messrs. Hornyak and Speaker have terms of office expiring at the annual meeting to be held two years thereafter. The following table sets forth certain information regarding the directors of the Company.
AGE AT BUSINESS EXPERIENCE SEPTEMBER 30, DIRECTOR FOR THE LAST FIVE YEARS; 1998 SINCE(1) OTHER DIRECTORSHIPS ------------- -------- ------------------------ Roland D. Boehm....... 60 1980 Vice Chairman of the Board of Directors of the Company, Mercer Mutual and MIC; Owner of Boehm Appraisal; Director of Prestige Financial Corp. James J. Freda........ 77 1985 Director of the Company, Mercer Mutual and MIC; Owner of James J. Freda, Inc. William C. Hart....... 65 1970 President, Chief Executive Officer and Director of the Company, Mercer Mutual and MIC George T. Hornyak, 48 1985 Director of the Company, Mercer Mutual and Jr.................. MIC; President, Chief Executive Officer and Director of Pulse Bancorp, Inc. and Pulse Savings Bank Richard U. Niedt...... 67 1979 Director of the Company, Mercer Mutual and MIC; Retired Andrew R. Speaker..... 35 1997 Executive Vice President, Chief Operating Officer, Chief Financial Officer, Treasurer and Director of the Company, Mercer Mutual and MIC Richard G. Van Noy.... 57 1979 Chairman of the Board of Directors of the Company and Mercer Mutual and MIC; Hopewell Township Administrator
- --------------- (1) Indicates year first elected as a director of Mercer Mutual. All members of the Board of Directors of the Company have served as directors of the Company since its incorporation. Following the Conversion, directors of Mercer Mutual will be paid a monthly retainer of $950 and a monthly meeting fee of $700 and directors of MIC will be paid a monthly retainer of $350. Directors may elect to defer payment of such fees until a later date pursuant to the terms of Mercer Mutual's Corporate Director Deferred Compensation Plan. Mercer Mutual pays interest on such deferred amounts at a floating market rate. No director of the Company has received any remuneration from the Company since its formation and the Company does not presently intend to pay any fees for service as a director of the Company. 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. Since 1990, Mercer Mutual has maintained 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 monthly payment equal to the director's monthly retainer fee in effect on such director's retirement date. If a participating director 71 75 dies prior to receiving 120 monthly payments under this plan, his beneficiaries are entitled to receive such payments until the total number of payments received by the director and his beneficiaries equals 120. Certain Transactions Since 1994, Mercer Mutual has been a party to a consulting agreement (the "Consulting Agreement") with director Roland D. Boehm. The Consulting Agreement provides that Mr. Boehm is required to provide certain advisory services to Mercer Mutual for annual compensation of $31,200. The Consulting Agreement has a term of one year and is renewable at the option of the Board of Directors. The current term expires on April 1, 1999 and management expects that the Board of Directors will renew the one-year term at that time. EXECUTIVE OFFICERS The executive officers of the Company are elected annually and hold office until their respective successors have been elected and qualified or until death, resignation or removal by the Board of Directors of the Company. The following table sets forth certain information regarding the executive officers of the Company.
AGE AT EXECUTIVE SEPTEMBER 30, OFFICER BUSINESS EXPERIENCE NAME 1998 SINCE(1) TITLE FOR THE LAST FIVE YEARS ---- ------------- --------- ----- ----------------------- William C. Hart........ 65 1986 President and Chief President, Chief Executive Executive Officer Officer, and Director of Mercer Mutual and MIC Andrew R. Speaker...... 35 1990 Executive Vice Senior Vice President of President, Chief Mercer Mutual and MIC from Operating Officer, Chief April 1994 to October 1, Financial Officer and 1997; Chief Financial Treasurer Officer and Treasurer of Mercer Mutual and MIC since 1990 Marion J. Crum......... 55 1984 Vice President and Vice President and Secretary Secretary of Mercer Mutual and MIC John G. Danka.......... 50 1995 Vice President and Vice President of Mercer Marketing Director Mutual and MIC since 1995; Marketing Director of Mercer Mutual and MIC since 1994; Senior Manager, American Reliance Companies from 1988 to 1994 Paul D. Ehrhardt....... 40 1996 Vice President Vice President of Mercer Mutual and MIC since 1996; Regional Vice President, VIK Brothers Insurance Group from 1995 to 1996; Branch Manager, American Reliance Companies from 1991 to 1995
- --------------- (1) Indicates year first appointed as an executive officer of Mercer Mutual. Each executive officer of the Company was first appointed on November 12, 1997. EXECUTIVE COMPENSATION The executive officers of the Company have received no compensation from the Company since its formation. The following table sets forth information regarding the compensation of the President and Chief Executive Officer, the Executive Vice President, Chief Operating Officer, Chief Financial Officer and Treasurer, and a Vice President of the Company, for each of the fiscal years ended December 31, 1996, 1997 and 1998. All compensation paid in 1996, 1997 and 1998 to such executive officers was paid by Mercer Mutual. No other executive officer of the Company received compensation in excess of $100,000 for the fiscal year ended December 31, 1998. 72 76
SALARY ALL OTHER NAME AND PRINCIPAL POSITION YEAR (1)(2) BONUS COMPENSATION(4) - --------------------------- ---- -------- ------- --------------- William C. Hart................................. 1998 $163,076 $ --(3) $6,392 President and Chief Executive Officer 1997 144,905 30,000 5,925 1996 135,776 9,102 5,919 Andrew R. Speaker............................... 1998 127,404 --(3) 4,568 Executive Vice President, 1997 108,421 25,000 4,110 Chief Operating Officer, 1996 97,964 7,079 3,768 Chief Financial Officer and Treasurer Paul D. Ehrhardt................................ 1998 95,384 --(3) 3,731 Vice President 1997 84,616 19,000 2,003 1996(5) 50,769 4,045 0
- --------------- (1) Includes amounts which were deferred pursuant to Mercer Mutual's 401(k) plan. Under the 401(k) plan, employees who elect to participate may elect to have earnings reduced and to cause the amount of such reduction to be contributed to the 401(k) plan's related trust in an amount up to 15% of earnings. 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 401(k) plan. (2) Mercer Mutual provided other benefits to the executive officers in connection with their employment. The value of such personal benefits, which is not directly related to job performance, is not included in the table above because the value of such benefits does not exceed the lesser of $50,000 or 10% of the salary and bonus paid to any executive officer. (3) Bonuses for the year ended December 31, 1998 will not be determined until February 1999. These determinations will be first calculated for the officer group as a whole, based on the net income, combined ratio and underwriting profitability of the Insurance Companies. The Compensation Committee of the Board of Directors will then allocate to each individual officer his or her share of the total bonus amount, based on job performance. (4) Includes amounts contributed under the 401(k) plan for the benefit of the executive officer. Mercer Mutual contributes 2% of an employee's salary. In addition, Mercer Mutual 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. (5) Mr. Ehrhardt commenced his employment with Mercer Mutual in 1996. CERTAIN BENEFIT PLANS AND AGREEMENTS In connection with the Conversion, the Company's Board of Directors has approved the ESOP and certain employment agreements with the executive officers of the Company. After completion of the Conversion, the Company's Board of Directors intends to adopt the Compensation Plan and the MRP, 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 Company will be eligible to participate after the Conversion. Stock Compensation Plan. After completion of the Conversion, the Company's Board of Directors intends to adopt the Compensation Plan, subject to receipt of shareholder approval at the Company's first annual meeting of shareholders after the Conversion. The purpose of the Compensation Plan will be to provide additional incentive to directors and employees of the Company and Mercer Mutual by facilitating their purchase of stock in the Company. It is anticipated that the Compensation Plan will have a term of ten years from the date of its approval by the Company's shareholders (unless the plan is earlier terminated by the Board of Directors of the Company), after which ten year period no awards may be made. Pursuant to the Compensation Plan, a number of shares equal to 10% of the shares of Common Stock that are issued in the Conversion will be reserved for future issuance by the Company, in the form of newly-issued or treasury shares, upon exercise of stock options ("Options") or stock 73 77 appreciation rights ("SARs"), or the grant of restricted stock ("Restricted Stock"). Options, SARs, and Restricted Stock are collectively referred to herein as "Awards." It is intended that Options granted under the Compensation Plan will constitute either incentive stock options (options that afford favorable tax treatment to recipients upon compliance with certain restrictions pursuant to Section 422 of the Internal Revenue Code of 1986, as amended (the "Code"), and that do not result in tax deductions to the Company unless participants fail to comply with Section 422 of the Code) ("ISOs")) or options that do not so qualify ("Non-ISOs"). Management expects that the exercise price for Options will be determined as of the date the Option is granted based on the then market price of the Common Stock and other factors. A SAR may be granted in tandem with all or any part of any Option or without any relationship to any Option. Whether or not a SAR is granted in tandem with an Option, exercise of the SAR will entitle the optionee to receive all or a percentage of the excess of the then fair market value of the shares of Common Stock subject to the SAR at the time of its exercise, over the aggregate exercise price of the shares subject to the SAR. Restricted Stock is Common Stock which is nontransferable and forfeitable until a grantee's interest therein vests. Nevertheless, the grantee typically is entitled to vote the Restricted Stock and to receive dividends and other distributions made with respect to the Restricted Stock. The terms and conditions of the Compensation Plan are currently under consideration by the Company's Board of Directors. The initial grant of Options under the Compensation Plan is expected to take place on the date of the receipt of shareholder approval of the Compensation Plan. No decisions concerning the number of options to be granted to any director or officer have been made at this time. No Awards will be made prior to the receipt of shareholder approval of the Compensation Plan. Employee Stock Ownership Plan. In connection with the Conversion, the Company's Board of Directors has adopted the Company's Employee Stock Ownership Plan (the "ESOP") for the exclusive benefit of participating employees, to be implemented upon the completion of the Conversion. Participating employees are all employees of the Company and its subsidiaries who have attained age 21 and completed one year of service with the Company or its subsidiaries. The Company will submit to the IRS an application for a letter of determination as to the tax-qualified status of the ESOP. Although no assurances can be given, the Company expects that the ESOP will receive a favorable letter of determination from the IRS. The ESOP intends to borrow funds from the Company pursuant to the ESOP Loan in an amount sufficient to purchase 10% of the Common Stock issued in the Conversion. The ESOP 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. At the Total Midpoint, the ESOP Loan will require the ESOP to make monthly principal payments of $24,583, plus interest, for a term of 10 years. The loan will be secured by the shares of Common Stock purchased and earnings thereon. Shares purchased with the ESOP Loan proceeds will be held in a suspense account for allocation among participants as the ESOP Loan is repaid. Mercer Mutual expects to contribute sufficient funds to the ESOP to repay the ESOP Loan. Contributions to the ESOP and shares released from the suspense account will be allocated among participants on the basis of their annual wages subject to federal income tax withholding, plus any amounts withheld under a plan qualified under Sections 125 or 401(k) of the Code and sponsored by the Company or an affiliate of the 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 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 74 78 shares). Dividends paid on allocated shares are expected to be credited to participant accounts within the ESOP or paid to participants, and dividends on unallocated shares are expected to be used to repay the ESOP loan. The Company will administer the ESOP, and an unaffiliated bank or trust company will be appointed as trustee of the ESOP (the "ESOP Trustee"). 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. Management Recognition Plan. After completion of the Conversion, the Company's Board of Directors intends to adopt the MRP subject to receipt of shareholder approval at the Company's first annual meeting of shareholders after the Conversion. The objective of the MRP will be to enable the Company to reward and retain key personnel. Those eligible to receive benefits under the MRP will be directors and executive officers of the Company and the Insurance Companies. It is intended that the MRP may grant up to an aggregate number of shares equal to 4% of the shares of the Common Stock that were issued in the Conversion (the "MRP Shares"). The Company intends to contribute sufficient funds to the MRP Trust to enable it to purchase the MRP shares in the open market. However, if the MRP Trustees are unable to purchase all of the MRP Shares in the open market at a price which is satisfactory to the MRP Trustees in their discretion, then all or a portion of the MRP Shares will consist of newly issued shares of authorized Common Stock issued directly by the Company to the MRP Trust. Subject to the foregoing, at the Total Minimum, Total Midpoint, Total Maximum, the Company anticipates that the number of MRP Shares purchased in the open market would be 100,300 shares, 118,000 shares, and 135,700 shares, respectively, and assuming that all of the MRP Shares purchased in the open market are purchased at the Purchase Price, the cost to the Company would be $1,003,000, $1,180,000 and $1,357,000, respectively. It is anticipated that all of the MRP Shares will be awarded to eligible directors and executive officers in exchange for service and at no cost to them pursuant to the terms of the MRP. It is further anticipated that vesting will occur at the rate of 20% per year of service following the award date. The terms and conditions of the MRP are currently under consideration by the Company's Board of Directors. The Company's Board of Directors intends to seek shareholder approval of the MRP at the first annual meeting of shareholders following completion of the Conversion. No decisions have been made concerning the number of MRP awards to be granted to any director or officer. No awards will be made prior to shareholder approval of the MRP. Executive Employment Agreements. As of October 1, 1997, William C. Hart and Andrew R. Speaker, and as of October 1, 1998, Paul D. Ehrhardt, each entered into Employment Agreements with the Company and Mercer Mutual (collectively, the "Employment Agreements"). Each Employment Agreement has an initial three-year term and after the expiration of each year of the term, provides for a one-year extension, upon review by the Board of Directors, so as to maintain a three-year term, unless the Company or the executive gives prior written notice of nonrenewal. Under their respective Employment Agreements, as currently in effect, Mr. Hart is entitled to receive an annual base salary of not less than $170,000; Mr. Speaker is entitled to receive an annual base salary of not less than $135,000; and Mr. Ehrhardt is entitled to receive a base salary of not less than $110,000. In addition, Messrs. Hart, Speaker and Ehrhardt are each entitled to participate in any other incentive compensation and employee benefit plans that the Company maintains. In the event the Company terminates the executive's employment for "Cause" as defined in the Employment Agreements, 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. 75 79 In the event the Company terminates the executive's employment 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 will annually 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 each of the Company's 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, as amended ("ERISA")) in the year in which he is terminated or in one of the two years immediately preceding such year. The executive will also be entitled to certain retirement, health and welfare benefits. In the event the executive terminates his employment with the Company for "Good Reason," as defined in the Employment Agreements, 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 with the Company 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 determination 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 Code (or any similar tax imposed under federal, state or local law) as a result of any compensation and benefits received under his Employment Agreement in connection with a change in control, the Company will pay to the executive 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 by the Company), 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 Agreements, the executive may not, for a period of twelve months after the date of termination, without the prior written consent of the Company's 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 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 the Company, its subsidiaries or affiliates, or otherwise interfere with the relationship of the Company 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 the Company or any of its subsidiaries or affiliates. THE CONVERSION THE PLAN HAS BEEN APPROVED BY THE PENNSYLVANIA DEPARTMENT, SUBJECT TO THE PLAN'S APPROVAL BY THE POLICYHOLDERS OF MERCER MUTUAL ENTITLED TO VOTE AND THE SATISFACTION OF CERTAIN OTHER CONDITIONS IMPOSED BY THE PENNSYLVANIA DEPARTMENT IN ITS APPROVAL. APPROVAL BY THE PENNSYLVANIA DEPARTMENT DOES NOT CONSTITUTE A RECOMMENDATION OR ENDORSEMENT OF THE PLAN. BACKGROUND AND REASONS FOR THE CONVERSION Mercer Mutual's exposure to severe winter weather conditions has been a major factor affecting its underwriting results since 1991. Operating results in 1994 and 1996 were adversely affected by losses from severe winter storms in such years that were largely responsible for Mercer Mutual's $1.4 million net operating 76 80 loss in 1994 and that reduced net income by $665,000 in 1996. In order to reduce the risk caused by this exposure, Mercer Mutual's strategic plan is expressly predicated upon geographically diversifying its business and improving capital strength. Mercer Mutual's Board of Directors believes that the geographic diversification that could be achieved under Mercer Mutual's current organizational structure as a mutual insurance company, by engaging in relationships with independent agencies in other geographic areas, through acquisitions or otherwise, would be a lengthy process, and would be limited to the extent of Mercer Mutual's capital and personnel resources, as well as by its inability to issue stock to finance acquisitions. The Board of Directors of Mercer Mutual has determined that the fastest and most effective method to achieve its goals is through a conversion to a stock company and a simultaneous and substantial infusion of capital. The ability to issue stock and the additional capital would immediately allow Mercer Mutual to seek and finance the acquisition of companies with significant business in other geographic areas, and would provide additional policyholder protection. Since 1996, Mercer Mutual has considered various capital formation alternatives and has elected to proceed with the Conversion in accordance with the provisions of the Pennsylvania Insurance Company Mutual to Stock Conversion Act (the "Act"). The Act was passed by the Pennsylvania General Assembly in December 1995. On August 12, 1997, management was directed by the Board of Directors of Mercer Mutual to explore the process and feasibility of Conversion under the Act. On September 11, 1997, the Board of Directors authorized further study and requested a presentation with respect to the process at its meeting on September 26, 1997. At such meeting, management was directed to prepare the Plan for consideration at the next regularly scheduled meeting of the Board of Directors. On October 17, 1997, the Board of Directors of Mercer Mutual unanimously adopted the Plan, subject to approval by the Pennsylvania Department and the policyholders of Mercer Mutual. The Board of Directors unanimously adopted amendments to the Plan on November 12, 1997 and on April 15 and May 13, 1998. An application with respect to the Conversion was filed by Mercer Mutual with the Pennsylvania Department on November 26, 1997 and notice of the filing and the opportunity to comment on and to request and receive a copy of the Plan was mailed on December 2, 1997 to all Eligible Policyholders, as required by law. In May 1998, Franklin Mutual Insurance Company ("Franklin") filed with the Pennsylvania Department a petition to intervene and request for a full adjudicatory hearing with respect to all proceedings of the Pennsylvania Department concerning Mercer Mutual's application for approval of the Plan. The Pennsylvania Department held an informational public hearing regarding the Conversion on June 5, 1998. By orders dated October 20, 1998 (the "Orders"), the Plan was approved by the Pennsylvania Department and the Company received the approval of the Pennsylvania Department to acquire control of Mercer Mutual. The Orders also conclude that, among other things, in its review of the Plan, the Pennsylvania Department considered Franklin's petition to intervene and request for adjudicatory hearing as public comments, and not as formal pleadings because formal pleadings are not required or appropriate in the review of a proposed plan of conversion under the Act. Therefore, no further action was required to be taken by the Pennsylvania Department in response to Franklin's petition and request. On October 27, 1998, Franklin filed with the Pennsylvania Department an appeal of the Orders and a request for a full adjudicatory hearing. On November 6, 1998, the Pennsylvania Department rejected Franklin's appeal because the Pennsylvania Department had no jurisdiction to entertain such appeal. On November 9, 1998, Franklin filed a petition for review in the nature of an appeal with the Pennsylvania Commonwealth Court objecting to and requesting that the Court reverse the Orders (the "Franklin Action"). Mercer Mutual has filed with the Commonwealth Court a notice to intervene in the Franklin Action. The Franklin Action is still pending. See "Risk Factors -- Possible Adverse Impact of Litigation" and "-- Requirement for Policyholder Approval," and "Business -- Offer to Acquire Mercer Mutual" and "-- Legal Proceedings." The Plan is subject to the approval of the Eligible Policyholders at the Special Meeting. GENERAL The Conversion will be accomplished through the filing with the Department of State of the Commonwealth of Pennsylvania of amended and restated Articles of Incorporation of Mercer Mutual to authorize the issuance of shares of the capital stock of Mercer Mutual and to conform to the requirements of a Pennsylvania stock insurance company. The Company has received the approval of the Pennsylvania Department to contribute $5.0 million of the net proceeds of the Offering to Mercer Mutual in exchange for all of the capital 77 81 stock of Mercer Mutual to be issued in the Conversion. See "Use of Proceeds." Upon issuance of the shares of capital stock of Mercer Mutual to the Company, Mercer Mutual will become a wholly-owned subsidiary of the Company. The Conversion will be effected only upon completion of the sale of at least the minimum number of shares of Common Stock required to be sold by the Company pursuant to the Plan. The Conversion will be accounted for as a simultaneous reorganization, recapitalization and share offering which will not change the historical accounting basis of Mercer Mutual's financial statements. The aggregate purchase price of the Common Stock to be issued in the Conversion will be within the Estimated Valuation Range of between $25,075,000 and $33,925,000, based upon an independent Appraisal of the estimated consolidated pro forma market value of the Common Stock prepared by Sheshunoff. 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. The independent Appraisal will be affirmed or, if necessary, updated upon the completion of the Conversion Offerings if all shares are subscribed for or at the completion of any Syndicated Community Offering. Sheshunoff is a consulting firm experienced in corporate valuations. For additional information, see "Stock Pricing and Number of Shares to be Issued" herein. The following is a summary of certain aspects of the Conversion. The summary is qualified in its entirety by reference to the provisions of the Plan, a copy of which is available for inspection at the Company's principal executive offices located at 10 North Highway 31, Pennington, New Jersey. A copy of the Plan was also sent by Mercer Mutual to each Eligible Policyholder together with the notice of the Special Meeting. The Plan is also filed as an exhibit to the Registration Statement of which this Prospectus is a part, copies of which may be obtained from the SEC. See "Available Information." OFFERING OF COMMON STOCK Under the Plan, the Company is offering shares of Common Stock in the Subscription Offering first to the Eligible Policyholders, second to the ESOP, and third to the directors, officers and employees of Mercer Mutual. Subscription rights received in the third category will be subordinated to the subscription rights of the Eligible Policyholders. The Company is also concurrently offering Common Stock to the general public in the Community Offering. See "The Conversion Offerings." It is anticipated that all shares not subscribed for in the Conversion Offerings will be offered for sale by the Company to the general public in the Syndicated Community Offering. See "Syndicated Community Offering." The completion of the Offerings is subject to market conditions and other factors beyond the Company's control. In the event that 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. In addition, Mercer Mutual would be required to charge all Conversion expenses against current income. As of September 30, 1998, such charge would equal $916,000, and would have a material adverse effect on Mercer Mutual's financial condition and results of operations. BUSINESS PURPOSES The Company was formed to serve as the holding company for all of the issued and outstanding capital stock of Mercer Mutual upon completion of the Conversion. The portion of the net proceeds from the sale of Common Stock in the Conversion that the Company will contribute to Mercer Mutual will substantially increase Mercer Mutual's surplus which will, in turn, enhance policyholder protection and increase the amount of funds available to support both current operations and future growth and thereby provide increased opportunities for existing employees while creating new jobs. The holding company structure also will provide greater flexibility for diversification of business activities and geographic operations. Management believes that this increased capital and operating flexibility will enable the Company and Mercer Mutual to compete more effectively with other insurance companies. In addition, the Conversion will enhance the future access of the Company and Mercer Mutual to the capital markets. After completion of the Conversion, the unissued Common Stock and preferred stock authorized by the Company's Articles of Incorporation will permit the Company to raise additional equity capital through further sales of securities and to issue securities in connection with possible acquisitions. At the present time, 78 82 the Company has no plans with respect to additional offerings of securities following the Conversion, other than the possible issuance of additional shares under the MRP and Compensation Plan, if implemented. Following completion of Conversion, the Company also will be able to use stock-related incentive programs to attract, motivate and retain highly qualified employees for itself and its subsidiaries. See "Management of the Company -- Certain Benefit Plans and Agreements." EFFECT OF CONVERSION ON POLICYHOLDERS General. Each policyholder in a mutual insurance company, including each policyholder of Mercer Mutual, has certain interests in its policy issuing insurance company in addition to the contractual right to insurance coverage afforded by the policyholder's policy of insurance. These interests are (i) the right to vote with respect to the election of directors of the company and certain other fundamental corporate transactions, such as an amendment to the articles of incorporation of the company or a merger of the company, and (ii) the right to receive dividends if, as and when declared by the board of directors of the company (Mercer Mutual has never declared a policyholder dividend and currently does not anticipate doing so in the future). In addition, Pennsylvania law is unclear as to the consequences in the unlikely event of a solvent dissolution of the company. One provision of Pennsylvania law with respect to nonstock corporations (such as Mercer Mutual) states that in the absence of any controlling provisions of the articles, bylaws or other documents evidencing membership in a nonstock corporation, upon a solvent dissolution, members have the right to receive a pro rata distribution of any surplus remaining after the satisfaction of all claims and other liabilities of the company. A more recently enacted provision of Pennsylvania law that is specifically applicable to mutual insurance companies states that any surplus of a mutual insurance company remaining after satisfaction of all claims and liabilities escheats to the Commonwealth of Pennsylvania. In the view of the Pennsylvania Department, the more recent statute specifically applicable to mutual insurance companies which provides for escheat is controlling. In any event, all interests in a mutual insurance company are incident to, and contingent upon the existence of, the underlying insurance policy. These interests have no tangible market value separate from such insurance policy, and a policyholder who terminates his policy automatically forfeits the interests in the company described above. Upon the completion of the Conversion, policyholder interests in Mercer Mutual, other than contract rights under policies of insurance, will be terminated as a result of the Conversion. If the Plan is not approved by the Eligible Policyholders or if the Conversion fails to be completed for any other reason, Mercer Mutual will continue its existence as a mutual insurance company and Eligible Policyholders will retain the rights described above. Continuity of Insurance Coverage and Business Operations. The Conversion will not affect the contractual rights of policyholders to insurance protection under their individual insurance policies with Mercer Mutual. During and after the Conversion, the normal business of Mercer Mutual of issuing insurance policies in exchange for premium payments and processing and paying claims will continue without change or interruption. After the Conversion, Mercer Mutual will continue to provide services for policyholders under current policies and by its present management and staff. 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 Company will consist of the following persons, each of whom is an existing director of Mercer Mutual: Roland D. Boehm, James J. Freda, William C. Hart, George T. Hornyak, Richard U. Niedt, Andrew R. Speaker and Richard G. Van Noy. See "Management of the Company -- Directors." All officers of Mercer Mutual at the time of the Conversion will retain their positions with Mercer Mutual after the Conversion. 79 83 Voting Rights. Upon completion of the Conversion, the voting rights of all policyholders in Mercer Mutual will terminate and 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 vested exclusively in the Company, which will own all the capital stock of Mercer Mutual. Voting rights in the Company will be vested exclusively in the shareholders of the Company, including Eligible Policyholders who purchase shares of Common Stock in the Subscription Offering. Each holder of Common Stock shall be entitled to vote on any matter to be considered by the shareholders of the Company, subject to the terms of the Company's Articles of Incorporation, Bylaws and to the provisions of Pennsylvania and federal law. See "Description of Capital Stock -- Common Stock." Policyholder Dividends. The Conversion will not affect the right of a policyholder to receive dividends from Mercer Mutual in accordance with the terms of the policyholder's existing policy of insurance, which provides that dividends will be paid only if, as and when declared by the Board of Directors of Mercer Mutual. However, Mercer Mutual has never declared a policyholder dividend and presently does not anticipate doing so in the future, whether or not Mercer Mutual converts to stock form. With respect to the Company, its shareholders, including Eligible Policyholders who purchase shares of Common Stock in the Subscription Offering, will have the exclusive right to receive dividends paid by the Company, if any. See "Description of Capital Stock -- Common Stock." Rights Upon Dissolution. While it may be unclear what right policyholders would have if there were a solvent dissolution of Mercer Mutual, it is clear that after the Conversion, policyholders will no longer have the right to receive a pro rata distribution of any remaining surplus of Mercer Mutual. Instead, this right will vest in the Company as the sole shareholder of Mercer Mutual. In the event of a liquidation, dissolution or winding up of the Company, shareholders of the Company, including Eligible Policyholders who purchase shares of Common Stock in the Subscription Offering, would be entitled to receive, after payment of all debts and liabilities of the Company, a pro rata portion of all assets of the Company. See "Description of Capital Stock -- Common Stock." THE CONVERSION OFFERINGS Subscription Offering. Nontransferable subscription rights to purchase shares of Common Stock are being issued to all persons entitled to purchase stock in the Subscription Offering at no cost to such persons. The amount of Common Stock that these parties may purchase will be determined, in part, by the total number of shares of Common Stock to be issued and the availability of Common Stock for purchase under the categories set forth in the Plan. 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 (those persons who are named insureds at the close of business on October 17, 1997 (the "Eligibility Record Date") under an existing insurance policy issued by Mercer Mutual). Each Eligible Policyholder will receive, without payment, subscription rights to purchase up to 100,000 shares of Common Stock at the Purchase Price; provided, however, that the maximum number of shares that may be purchased by Eligible Policyholders in the aggregate is 3,392,500 shares. In the event of an oversubscription, shares of Common Stock will be allocated among subscribing Eligible Policyholders, as follows. First, shares of Common 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 has subscribed. Second, any shares of Common Stock remaining after such initial allocation will be allocated 80 84 among the subscribing Eligible Policyholders whose subscriptions remain unsatisfied in the proportion in which the aggregate number of shares as to which each such Eligible Policyholder's subscription remains unsatisfied bears to the aggregate number of shares as to which all Eligible Policyholders' subscriptions remain unsatisfied; provided, however, that no fractional shares of Common Stock shall be issued. If, because of the magnitude of the oversubscription, shares of Common 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 Common 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. The following table sets forth the maximum number of shares that an Eligible Policyholder could purchase if a certain number of Eligible Policyholders each subscribed for the maximum number of shares:
NUMBER OF PERCENTAGE OF MAXIMUM NUMBER ELIGIBLE POLICYHOLDERS ELIGIBLE POLICYHOLDERS OF SHARES SUBSCRIBING FOR SUBSCRIBING FOR EACH SUBSCRIBER 100,000 SHARES(1) 100,000 SHARES COULD PURCHASE(1) - ---------------------- ---------------------- ----------------- 42,178 100% 80 31,634 75% 107 21,089 50% 160 10,545 25% 321
- --------------- (1) Assumes that all subscribing Eligible Policyholders subscribe for 100,000 shares. If any other Eligible Policyholders subscribes for less than 100,000 shares, the maximum number of shares that a subscriber for 100,000 shares could purchase could be less than the amount reflected in the table. Subscription Category No. 2 is reserved for the ESOP, which shall receive, without payment, nontransferable subscription rights to purchase at the Purchase Price, in the aggregate, up to 10% of the total shares of Common Stock to be issued in the Offerings. The ESOP is expected to purchase 10% of the total shares of Common Stock issued in the Offerings. See "Management of the Company -- Certain Benefit Plans and Agreements -- Employee Stock Ownership Plan." Subscription Category No. 3 is reserved for directors, officers and employees of Mercer Mutual. Each director, officer and employee of Mercer Mutual will receive, without payment, subscription rights to purchase up to 100,000 shares of Common Stock at the Purchase Price; provided, however, that such subscription rights will be subordinated to the subscription rights received by the Eligible Policyholders and may be exercised only to the extent that there are shares of Common 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 Common Stock shall be allocated among them on the basis of a point system under which each director, officer and employee will be assigned one point 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 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. A director, officer or employee of Mercer Mutual who subscribes to purchase shares of Common Stock and who is also eligible to purchase shares of Common Stock as an Eligible Policyholder will be deemed to purchase Common Stock first in his or her capacity as an Eligible Policyholder. The total number of shares that each director, officer or employee will be able to purchase both in his or her capacities as an Eligible Policyholder and a director, officer or employee, will equal 100,000 shares in the aggregate. Each of the Company's directors and executive officers is also an Eligible Policyholder and will purchase all of his or her shares in his or her capacity as an Eligible Policyholder and not under Subscription Category No. 3. 81 85 The 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 Common Stock pursuant to the Plan reside. However, no person will be offered or allowed to purchase any Common Stock under the Plan if he or she resides in a foreign country or in a state of the United States with respect to which any or all of the following apply: (i) a small number of persons otherwise eligible to subscribe for shares under the Plan reside in such state or foreign country; (ii) the granting of subscription rights or the offer or sale of shares of Common Stock to such persons would require the 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 or qualification would be impracticable for reasons of cost or otherwise. No payments will be made in lieu of the granting of subscription rights to any such person. Community Offering. Concurrently with the Subscription Offering, the Company is offering shares of the Common Stock to the general public in a Community Offering. Preference in the Community Offering will be 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 permanent residents in the Local Community of the State of New Jersey or the Commonwealth of Pennsylvania, (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 who have been appointed by Mercer Mutual to market and distribute insurance products, and their owners, (iv) named insureds under policies of insurance issued by Mercer Mutual after October 17, 1997, and (v) providers of goods or services to, and identified by, Mercer Mutual. The term "resident," as used in relation to the preference afforded 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 one of the states in the Local Community) and continues to reside in the Local Community at the time of the Community Offering. The Company may utilize policyholder records or such other evidence provided to it to make the determination whether a person is a resident of the Local Community. In the case of a corporation or other business entity, such entity shall be deemed to be a resident of the Local Community 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 of the Local Community shall be made by Mercer Mutual in its sole and absolute discretion. Subscriptions for Common Stock received from members of the general public in the Community Offering will be subject to the availability of shares of Common Stock after satisfaction of all subscriptions in the Subscription Offering, as well as the maximum and minimum purchase limitations set forth in the Plan. If 2,507,500 or more shares of the Common Stock are subscribed for in the Subscription Offering, the Company, in its sole discretion, will determine whether to accept subscriptions for shares in the Community Offering. If 3,392,500 or more shares of the Common Stock are subscribed for in the Subscription Offering, no shares will be sold in the Community Offering. FURTHERMORE, THE RIGHT OF ANY PERSON TO PURCHASE SHARES IN THE COMMUNITY OFFERING, INCLUDING THE PREFERRED SUBSCRIBERS DESCRIBED IN CLAUSES (I)-(V) ABOVE, IS SUBJECT TO THE ABSOLUTE RIGHT OF THE COMPANY TO ACCEPT OR REJECT SUCH PURCHASES IN WHOLE OR IN PART. STOCK PRICING AND NUMBER OF SHARES TO BE ISSUED The Plan requires that the purchase price of the Common Stock be based on the appraised pro forma market value of Mercer Mutual following the Conversion, on a consolidated basis, as a subsidiary of the Company, as determined on the basis of an independent valuation by an appraiser who is experienced in corporate valuation. The Company has retained Sheshunoff to prepare the appraisal, and Sheshunoff, 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, including mergers, acquisitions, private placements, and valuations for various other purposes and in the determination of adequate consideration in such transactions. Sheshunoff will receive a fee of approximately $75,000 for its appraisal. 82 86 Sheshunoff has determined that, as of December 28, 1998, the estimated consolidated pro forma market value of Mercer Mutual as a subsidiary of the Company was between $25.1 million and $33.9 million. Under the Plan, the aggregate purchase price of the common Stock to be offered in the Conversion must equal the pro forma market value of Mercer Mutual following the Conversion, on a consolidated basis, as a subsidiary of the Company. Under the Act, the Company is permitted to require a minimum subscription of 25 shares of Common Stock provided that any required minimum subscription amount established cannot exceed $500. Based on these minimum subscription parameters, the maximum price at which the Company could offer shares of Common Stock in the Conversion is $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 1,696,250 shares compared to a maximum of 3,392,500 shares at $10 per share. Therefore, the Company determined to offer the Common Stock in the Conversion at the price of $10.00 per share to increase the number of shares available for purchase by policyholders. There were no other factors considered by the Board of Directors of the Company in determining to offer shares of Common Stock at $10.00 per share in the Conversion. The Purchase Price will be $10.00 per share regardless of any change in the estimated consolidated pro forma market value of Mercer Mutual following the Conversion as a subsidiary of the Company, as determined by Sheshunoff. The Company plans to issue between 2,507,500 and 3,392,500 shares (exclusive of purchases by the ESOP) of the Common Stock in the Conversion. This range was determined by dividing the price per share into the Estimated Valuation Range. The Plan requires that an appraiser establish a valuation range (the "Estimated Valuation Range") consisting of a midpoint valuation (the "Total Midpoint"), a valuation 15 percent (15%) above the midpoint valuation (the "Total Maximum") and a valuation 15 percent (15%) below the midpoint valuation (the "Total Minimum"). Accordingly, Sheshunoff has established an Estimated Valuation Range of $25,075,000 to $33,925,000. Upon completion of the Conversion Offerings, after taking into account factors similar to those involved in its initial Appraisal, Sheshunoff will submit to the Company and to the Pennsylvania Department its updated estimate of the consolidated pro forma market value of Mercer Mutual following the Conversion as a subsidiary of the Company immediately prior to the completion of the Offerings. If such updated estimated valuation does not fall within the Estimated Valuation Range, the Company may cancel the Offerings and terminate the Plan. If the Company proceeds with the Offerings using the updated estimated valuation, subscribers will be promptly notified by mail of the updated estimated valuation and subscribers will be given an opportunity to confirm or modify their orders. The funds of any subscribers who do not withdraw or confirm their orders will be returned promptly without interest. Subscription orders may not be withdrawn for any reason if the updated appraisal is within the Estimated Valuation Range. There is a difference of approximately $8.9 million between the Total Minimum and the Total Maximum of the Estimated Valuation Range. As a result, the percentage interest in the Company that a subscriber for a fixed number of shares of Common Stock will have is approximately 26% smaller if 3,392,500 shares are sold than if 2,507,500 shares are sold. Furthermore, as a result of this broad range, the updated appraisal may estimate a consolidated pro forma market value for Mercer Mutual as subsidiary of the Company that is materially more or less than the aggregate dollar amount of subscriptions received by the Company. Subscribers will not receive a refund or have any right to withdraw subscriptions if the updated appraisal estimates a consolidated pro forma market value that is less than the aggregate dollar amount of subscriptions received by the Company. Therefore, subscribers, in the aggregate and on a per share basis, may pay more for the Common Stock than the estimated consolidated pro forma market value of Mercer Mutual as subsidiary of the Company. Accordingly, no assurance can be given that the market price for the Common Stock immediately following the Conversion will equal or exceed the Purchase Price. Also, subscribers should be aware that, prior to the consummation of the Offerings, they will not have available to them information concerning the final updated Appraisal. After completion of the Offerings, the final updated Appraisal will be filed with the Securities and Exchange Commission pursuant to a post-effective amendment to the registration statement of which this prospectus forms a part. See "Available Information." THE APPRAISAL 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, SHESHUNOFF HAS RELIED UPON AND ASSUMED THE ACCURACY AND COMPLETENESS OF FINANCIAL AND STATISTICAL INFORMATION PROVIDED BY THE COMPANY 83 87 AND MERCER MUTUAL. SHESHUNOFF DID NOT INDEPENDENTLY VERIFY THE FINANCIAL STATEMENTS AND OTHER INFORMATION PROVIDED BY THE COMPANY AND MERCER MUTUAL AND SHESHUNOFF DID NOT VALUE INDEPENDENTLY THE ASSETS AND LIABILITIES OF THE COMPANY AND MERCER MUTUAL. THE VALUATION CONSIDERS THE COMPANY AND MERCER MUTUAL ONLY AS A GOING CONCERN AND SHOULD NOT BE CONSIDERED AS AN INDICATION OF THE LIQUIDATION VALUE OF THE COMPANY AND MERCER MUTUAL. MOREOVER, BECAUSE SUCH VALUATION IS NECESSARILY BASED UPON ESTIMATES AND PROJECTIONS OF A NUMBER OF MATTERS, ALL OF WHICH ARE SUBJECT TO CHANGE FROM TIME TO TIME, NO ASSURANCE CAN BE GIVEN THAT PERSONS PURCHASING COMMON STOCK WILL THEREAFTER BE ABLE TO SELL SUCH SHARES AT OR ABOVE THE INITIAL PURCHASE PRICE. COPIES OF THE APPRAISAL REPORT OF SHESHUNOFF SETTING FORTH THE METHOD AND ASSUMPTIONS FOR SUCH APPRAISAL ARE ON FILE AND AVAILABLE FOR INSPECTION AT THE PRINCIPAL EXECUTIVE OFFICES OF THE COMPANY. ANY SUBSEQUENT UPDATED APPRAISAL REPORT OF SHESHUNOFF ALSO WILL BE AVAILABLE FOR INSPECTION. If the updated estimated valuation Sheshunoff submits to the Company and the Pennsylvania Department upon completion of the Offerings falls within the Estimated Valuation Range, the following steps will be taken: Subscription Offering Meets or Exceeds Total Maximum. If, upon conclusion of the Conversion Offerings, the number of shares subscribed for by participants in the Subscription Offering is equal to or greater than 3,392,500 shares, then in such event the Conversion shall be promptly consummated and the Company shall, on the effective date of the Conversion (the "Effective Date"), issue shares of Common Stock to the subscribing participants; provided, however, that the number of shares of Common Stock issued shall 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 shall be allocated among the subscribing participants in the priorities set forth in the Plan; provided, however, that no fractional shares of Common Stock shall be issued. See "-- Subscription Offering" herein. Subscription Offering Meets or Exceeds Total Minimum. If, upon conclusion of the Conversion Offerings, the number of shares of Common Stock subscribed for by participants in the Subscription Offering is equal to or greater than 2,507,500 shares, but less than 3,392,500 shares, then in such event the Company may promptly consummate the Conversion, in which case the Company shall on the Effective Date issue to the subscribing participants shares of Common Stock in an amount sufficient to satisfy the subscriptions of such participants in full. Prior to consummating the Conversion, however, the 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 offer shares of Common Stock to purchasers in the Syndicated Community Offering; provided, however, that no more than 3,392,500 shares of Common Stock shall be issued in the Offerings (not including shares issued to the ESOP); and, provided further, that no fractional shares of Common Stock shall be issued. Subscription Offering Does Not Meet Total Minimum. If, upon conclusion of the Conversion Offerings, the number of shares of Common Stock subscribed for by participants in the Subscription Offering is less than 2,507,500 shares, the Company will accept subscriptions received from subscribers in the Community Offering and/or sell shares of Common Stock to purchasers in a Syndicated Community Offering so that the aggregate number of shares of Common Stock sold in the Offerings is equal to or greater than 2,507,500 shares. The Conversion will be consummated promptly and the Company shall on the Effective Date: (i) issue to subscribing participants in the Subscription Offering shares of Common 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 Syndicated Community Offering such additional number of shares of Common Stock such that the aggregate number of shares of Common Stock to be issued in the Offerings will be equal to 2,507,500 shares; provided, however, that no fractional shares of Common Stock will be issued. In order to raise additional capital, the Company may in its absolute discretion elect to issue in excess of 2,507,500 shares of Common Stock to subscribers in the Community Offering and/or to purchasers in any Syndicated Community Offering; provided, however, that the number of shares of Common Stock issued shall not exceed 3,392,500 shares of 84 88 Common Stock (not including shares issued to the ESOP). See "The Conversion -- The Conversion Offerings -- Community Offering" and "-- Syndicated Community Offering." Offerings Do Not Meet Minimum. If the aggregate number of shares of Common Stock subscribed for in the Offerings is less than 2,507,500 shares, then in such event the Company will cancel the Offerings and all subscription funds will be returned promptly to subscribers without interest. TAX EFFECTS. General. Mercer Mutual has obtained from the IRS 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. The PLR confirms, among other things, that the Conversion of Mercer Mutual from a mutual to stock form of corporation will constitute a reorganization within the meaning of Section 368(a)(1)(E) of the Internal Revenue Code of 1986, as amended (the "Code"), and that, for federal income tax purposes: (i) 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; (ii) 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; (iii) 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; (iv) 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 such stock, plus the gain, if any, recognized by the Eligible Policyholder on the subscription rights that are exercised by the Eligible Policyholder; and (v) the holding period of the Common Stock purchased by an Eligible Policyholder pursuant to 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. 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 which 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. The amount of gain recognized by each Eligible Policyholder should equal the fair market value of subscription rights received by the Eligible Policyholder. 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, such Eligible Policyholder should recognize a corresponding loss upon the expiration or lapse of such Eligible Policyholder's unexercised subscription rights. The amount of such loss should equal the gain previously recognized upon receipt of such unexercised subscription rights, although such loss may not have the same character as the corresponding gain. Although not free from doubt, provided the subscription rights are capital assets in the hands of an Eligible Policyholder, any gain resulting from the receipt of the subscription rights should constitute a capital gain, and provided the Common Stock that an Eligible Policyholder would have received upon exercise of the lapsed subscription rights would have constituted a capital asset, the resulting loss upon expiration of such 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 Sheshunoff, the subscription rights do not have any fair market value, inasmuch as such rights are nontransferable, personal rights of short duration, that are provided to Eligible Policyholders and 85 89 other participants in the Subscription Offering without charge, and afford 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, which 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. THE FEDERAL INCOME TAX DISCUSSION SET FORTH ABOVE DOES NOT PURPORT TO CONSIDER ALL ASPECTS OF FEDERAL INCOME TAXATION WHICH MAY BE RELEVANT TO EACH ELIGIBLE POLICYHOLDER THAT 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 AND FINANCIAL ADVISOR AS TO THE EFFECT OF SUCH FEDERAL INCOME TAX CONSEQUENCES ON HIS OR HER OWN PARTICULAR FACTS AND CIRCUMSTANCES, INCLUDING THE RECEIPT AND EXERCISE OF SUBSCRIPTION RIGHTS, AND ALSO AS TO ANY STATE, LOCAL, FOREIGN OR OTHER TAX CONSEQUENCES ARISING OUT OF THE CONVERSION. PURCHASES IN THE CONVERSION OFFERINGS. Termination Dates. The Conversion Offerings will expire at 1:00 p.m., Eastern Standard Time, on , 1999, unless extended by the Board of Directors of the Company for up to an additional 45 days (such date and time, including any extension, are referred to herein as the "Termination Date"). Subscription rights not exercised prior to the Termination Date will be void. If the Company extends the Subscription Offering or the Community Offering, it will give written notice of such extension to all subscribers on or before , 1999, at which time each subscriber may withdraw or confirm his or her subscription by the extended Termination Date. If a subscriber does not confirm a subscription by the extended Termination Date, the subscriber's funds will be returned promptly without interest. No action to extend the Subscription Offering or Community Offering will be taken by the Company after , 1999. Orders will not be executed by the Company until at least 2,507,500 shares of Common Stock have been subscribed for or sold. If at least the 2,507,500 shares of Common Stock have not been subscribed for or sold by the Termination Date, all funds delivered to the Company pursuant to the Offerings will be promptly returned to subscribers without interest. Use of Order Forms. Rights to subscribe may be exercised only by completion of a Stock Order Form. Any person who desires to subscribe for shares of Common Stock must do so prior to the Termination Date by delivering by mail to the Conversion Center at P.O. Box 15, Pennington, New Jersey 08534-0015, or in person at the Company's principal executive offices located at 10 North Highway 31, Pennington, New Jersey, a properly executed and completed Stock Order Form, together with full payment for all shares for which the subscription is made. All checks or money orders must be made payable to "MERCER INSURANCE GROUP, INC." All subscription rights under the Plan will expire at 1:00 p.m., local time, on the Termination Date whether or not the Company has been able to locate each person entitled to such subscription rights. ONCE TENDERED, ORDERS TO PURCHASE COMMON STOCK IN THE OFFERING CANNOT BE REVOKED. To ensure that each purchaser receives a prospectus at least 48 hours prior to the Termination Date in accordance with Rule 15c2-8 under the Exchange Act, 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. 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. Payment by cash, check or money order must accompany the Stock Order Form. No wire transfers will be accepted. 86 90 Each subscription right may be exercised only by the Eligible Policyholder to whom it is issued and only for his or her own account. THE SUBSCRIPTION RIGHTS GRANTED UNDER THE PLAN ARE NONTRANSFERABLE. Each Eligible Policyholder subscribing for shares of Common Stock is required to represent to the Company that such Eligible Policyholder is purchasing such shares for such Eligible Policyholder's own account and that such Eligible Policyholder has no agreement or understanding with any other person for the sale or transfer of such shares. The Company is not aware of any restrictions which would prohibit Eligible Policyholders who purchase shares of Common Stock in the Conversion, and who are not executive officers or directors of the Company or Mercer Mutual, from freely transferring such shares after the Conversion. See "-- Limitations on Resales." In the event a subscriber submits a Stock Order Form that (i) is not delivered and is returned to the sender by the United States Postal Service or the Company is unable to locate the addressee, (ii) is not returned or is received after the Termination Date (iii) is defectively completed or executed, or (iv) is not accompanied by payment in full for the shares of Common Stock subscribed for, any subscription rights of such subscriber will not be honored, and such subscriber will be treated as having failed to return the completed Stock Order Form within the time period specified therein. Alternatively, the Company may (but will not be required to) waive any irregularity relating to any Stock Order Form or require the submission of a corrected Stock Order Form or the remittance of full payment for the shares of Common Stock subscribed for by such date as the Company may specify. Subscription orders, once tendered, may not be revoked. The Company's interpretations of the terms and conditions of the Plan and determinations with respect to the acceptability of the Stock Order Forms will be final, conclusive and binding upon all persons and neither the 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 interpretation or determination. Payment for Shares. Payment in full for all subscribed shares of Common Stock is required to accompany all completed Stock Order Forms for subscriptions to be considered complete. Payment for subscribed shares of Common Stock may be made by check or money order in U.S. Dollars. Payments will be placed in an Escrow Account at State Street Bank and Trust Company, N.A. (the "Escrow Agent"). The Escrow Account will be administered by the Escrow Agent. An executed Stock Order Form, once received by the Company, may not be modified, amended or rescinded without the consent of the Company. 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 the shares at the time it subscribes, but is required to pay for such shares at or before the completion of the Offerings. Delivery of Certificates. Certificates representing shares of the Common Stock will be delivered to subscribers promptly after completion of the Offerings. Until certificates for the Common Stock are available and delivered to subscribers, subscribers may not be able to sell the shares of Common Stock for which they subscribed even though trading of the Common Stock will have commenced. MARKETING AND UNDERWRITING ARRANGEMENTS Mercer Mutual and the Company have engaged Sandler O'Neill as a financial advisor in connection with the offering of the Common Stock, and Sandler O'Neill has agreed to use its best efforts to assist the Company with its solicitation of subscriptions and purchase orders for shares of Common Stock in the Offerings. Sandler O'Neill is not obligated to take or purchase any shares of Common Stock in the Offerings. Mercer Mutual and the Company have agreed to pay Sandler O'Neill a fee equal to 2.0% of the aggregate Purchase Price of Common Stock sold in the Conversion Offerings, excluding subscriptions by any director, officer or employee of Mercer Mutual or the Company or members of their immediate families or the ESOP, for which Sandler O'Neill will not receive a fee. In the event that the Company enters into selected dealers' agreements with one or more NASD member firms in connection with a Syndicated Community Offering, the 87 91 Company will pay a fee to such selected dealer, any sponsoring dealer's fees, and a management fee to Sandler O'Neill of 1.5% for shares sold by the NASD member firm pursuant to such selected dealer's agreement; provided, however, that the aggregate fees payable to Sandler O'Neill for Common Stock sold pursuant to such selected dealer's agreement shall not exceed 2.0% of the aggregate Purchase Price and that the aggregate fees payable to Sandler O'Neill and the selected and sponsoring dealers will not exceed 7% of the aggregate Purchase Price of the shares sold under any such agreement. Fees to Sandler O'Neill and to any other broker-dealer may be deemed to be underwriting fees and Sandler O'Neill and such broker-dealers may be deemed to be underwriters. Sandler O'Neill will also be reimbursed for its reasonable out-of-pocket expenses, including legal fees, in an amount not to exceed $75,000. In the event the Conversion is not consummated or Sandler O'Neill ceases, under certain circumstances after the subscription solicitation activities are commenced, to provide assistance to the Company, Sandler O'Neill will be entitled to be reimbursed for its reasonable out-of-pocket expenses incurred prior to termination as described above. The Company and Mercer Mutual have agreed to indemnify Sandler O'Neill for reasonable costs and expenses in connection with certain claims or liabilities, including certain liabilities under the Securities Act. Sandler O'Neill has received advances towards its fees and expenses totaling $25,000. Total marketing fees to Sandler O'Neill are expected to be $489,050 and $648,350 at the Total Minimum and the Total Maximum, respectively. See "Pro Forma Data" for the assumptions used to arrive at these estimates. Sandler O'Neill will also perform conversion agent services and records management services for Mercer Mutual in the Conversion and will receive a fee for this service of $30,000, plus reimbursement of reasonable out-of-pocket expenses. Directors and executive officers of the Company and Mercer Mutual may participate in the solicitation of offers to purchase Common Stock. Other employees of Mercer Mutual may participate in the Offerings in ministerial 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. Such other employees have been instructed not to solicit offers to purchase Common Stock or provide advice regarding the purchase of Common Stock. The 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 Company or Mercer Mutual will be compensated in connection with his participation by the payment of commissions or other remuneration based either directly or indirectly on the transactions in the Common Stock. SYNDICATED COMMUNITY OFFERING As a final step in the Conversion, the Plan provides that, in the sole discretion of the Company, all shares of Common Stock not purchased in the Conversion Offerings, if any, may be offered for sale to the general public in a Syndicated Community Offering through a syndicate of registered broker-dealers to be formed and managed by Sandler O'Neill acting as agent of the Company, to assist the Company and Mercer Mutual in the sale of the Common Stock. THE COMPANY AND MERCER MUTUAL RESERVE THE RIGHT TO REJECT ORDERS IN WHOLE OR PART IN THEIR SOLE DISCRETION IN THE SYNDICATED COMMUNITY OFFERING. Neither Sandler O'Neill nor any registered broker-dealer shall have any obligation to take or purchase any shares of the Common Stock in the Syndicated Community Offering; however, Sandler O'Neill has agreed to use its best efforts in the sale of shares in the Syndicated Community Offering. The price at which Common Stock is sold in the Syndicated Community Offering will be the Purchase Price. Shares of Common Stock purchased in the Syndicated Community Offering by any persons, together with associates of or persons acting in concert with such persons, will be aggregated with purchases in the Conversion Offerings for purposes of the maximum purchase limitation of 100,000 shares. In addition to the foregoing, if a syndicate of broker-dealers ("selected dealers") is formed to assist in the Syndicated Community Offering, a purchaser may pay for his shares with funds held by or deposited with a selected dealer. If a Stock Order Form is executed and forwarded to the selected dealer or if the selected dealer is authorized to execute the Stock Order Form on behalf of a purchaser, the selected dealer is required to forward the Stock Order Form and funds to Mercer Mutual for deposit in a segregated account on or before 88 92 noon of the business day following receipt of the Stock Order Form or execution of the Stock Order Form by the selected dealer. Alternatively, selected dealers may solicit indications of interest from their customers to place orders for shares. Such selected dealers shall subsequently contact their customers who indicated an interest and seek their confirmation as to their intent to purchase. Those indicating an intent to purchase shall execute Stock Order Forms and forward them to their selected dealer or authorize the selected dealer to execute such forms. The selected dealer will acknowledge receipt of the order to its customer in writing on the following business day and will debit such customer's account on the third business day after the customer has confirmed his intent to purchase (the "debit date") and on or before noon of the next business day following the debit date will send Stock Order Forms and funds to Mercer Mutual for deposit in a segregated account. Although purchasers' funds are not required to be in their accounts with selected dealers until the debit date in the event that such alternative procedure is employed, once a confirmation of an intent to purchase has been received by the selected dealer, the purchaser has no right to rescind his order. Certificates representing shares of Common Stock purchased, together with any refund due, will be mailed to purchasers at the address specified in the Stock Order Form as soon as practicable following consummation of the sale of the Common Stock. Any certificates returned as undeliverable will be disposed of in accordance with applicable law. The Syndicated Community Offering will terminate no more than 45 days following the Termination Date. LIMITATIONS ON PURCHASES OF COMMON STOCK The Plan provides for certain limitations upon the purchase of shares in the Conversion. No person may purchase fewer than 25 shares of Common Stock in the Conversion. Except for the ESOP, which intends to purchase 10% of the total number of shares of Common Stock issued in the Conversion, no purchaser (including Eligible Policyholders who elect to purchase stock in the Conversion) together with such person's affiliates and associates (as defined in the Plan) or a group acting in concert (as defined in the Plan) may purchase more than 100,000 shares of Common Stock in the Conversion (4.0%, 3.4% and 3.0% of the number of shares to be issued in the Conversion at the Total Minimum, Total Midpoint and Total Maximum, respectively, of the Estimated Valuation Range). The Plan states that subscribers in the Subscription Offering can purchase up to 100,000 shares. There are 42,178 Eligible Policyholders. In the event that subscriptions by Eligible Policyholders for Common Stock exceed the maximum of the Estimated Valuation Range, the Company will be obligated under the Plan to sell to Eligible Policyholders 3,392,500 shares, which is the maximum number of shares offered hereby, and shares of Common Stock would be allocated among Eligible Policyholders in proportion to their respective amounts subscribed for. If each Eligible Policyholder subscribed for 100,000 shares of Common Stock offered, then each Eligible Policyholder would receive only approximately 80 shares. Except as set forth below under "-- Proposed Management Purchases," the Company is unable to predict the number of Eligible Policyholders that may participate in the Subscription Offering or the extent of any such participation. Shares of Common Stock to be held by the ESOP and attributable to a participant thereunder shall not be aggregated with shares of Common Stock purchased by such participant or any other purchase of Common Stock in the Conversion. Officers and directors of Mercer Mutual and the Company, together with their associates, may not purchase, in the aggregate, more than thirty-four percent (34.0%) of the shares of Common Stock. Directors of the Company and of Mercer Mutual 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 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 Company may increase or decrease any of the purchase limitations at any time. In the event that the individual purchase limitation is increased after commencement of the Conversion Offerings, the Company shall permit any person who subscribed for the maximum number of shares of Common Stock to purchase an additional number of shares, such that such person shall be permitted to subscribe for the then maximum number of 89 93 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 Common Stock to be sold in the Conversion is decreased after commencement of the Conversion Offerings, the order of any person who subscribed for the maximum number of shares of Common 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 Common Stock in the Conversion shall be deemed to confirm that such purchase does not conflict with the purchase limitations under the 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 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 Company to purchase such excess shares shall be assignable by the Company. The Company shall have the right in its absolute discretion and without 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 Common Stock are to be offered or sold in a Syndicated Community Offering. PROPOSED MANAGEMENT PURCHASES The following table sets forth information regarding the approximate number of shares of Common Stock intended to be purchased by each of the directors and executive officers of the Company and Mercer Mutual, including each such person's associates, and by all directors, trustees and executive officers as a group, including all of their associates, and other related information. For purposes of the following table, it has been assumed that sufficient shares will be available to satisfy subscriptions in all categories.
TOTAL NAME SHARES(1)(2)(3) - ---- --------------- Roland D. Boehm(4)(5)....................................... 20,000 James J. Freda(4)........................................... 15,000 William C. Hart(4)(6)....................................... 15,000 George T. Hornyak, Jr.(4)................................... 100,000 Richard U. Niedt(4)......................................... 6,000 Andrew R. Speaker(4)(7)..................................... 10,000 Richard G. Van Noy(4)(8).................................... 15,000 Marion J. Crum(9)........................................... 1,000 John Danka(9)............................................... 1,500 Paul Ehrhardt(9)............................................ 2,500 ------- Total.................................................. 186,000 =======
- --------------- (1) Does not include shares that could be allocated to participants in the ESOP, under which officers and other employees would be allocated, in the aggregate, 10% of the Common Stock issued in the Conversion. See "Management of the Company -- Certain Benefit Plans and Agreements -- Employee Stock Ownership Plan." (2) Does not include shares that would be awarded to participants in the MRP, if implemented, under which directors, officers and other employees would be awarded, at no cost to them, an aggregate number of shares equal to 4% of the Common Stock issued in the Conversion (100,300, 118,000, 135,700 and 150,778 shares at the Total Minimum, Total Midpoint, Total Maximum and Total Maximum plus ESOP 90 94 shares, respectively). Implementation of the MRP requires shareholder approval. See "Management of the Company -- Certain Benefit Plans and Agreements -- Management Recognition Plan." (3) Does not include shares that would be purchased by participants in the Compensation Plan, if implemented, under which directors, executive officers and other employees would be granted options to purchase an aggregate amount of Common Stock equal to 10% of the shares issued in the Conversion (250,750, 295,000, 339,250 and 376,944 shares at the Total Minimum, Total Midpoint, Total Maximum and Total Maximum plus ESOP shares). Implementation of the Compensation Plan requires shareholder approval. See "Management of the Company -- Certain Benefit Plans and Agreements -- Stock Compensation Plan." (4) Director of the Company and Mercer Mutual. (5) Vice Chairman of the Board of Directors of the Company and Mercer Mutual. (6) President and Chief Executive Officer of the Company and Mercer Mutual. (7) Executive Vice President, Chief Operating Officer, Chief Financial Officer and Treasurer of the Company and Mercer Mutual. (8) Chairman of the Board of Directors of the Company and Mercer Mutual. (9) Executive officer of the Company and Mercer Mutual. See "Management of the Company -- Executive Officers." LIMITATIONS ON RESALES The Common Stock issued in the Conversion will be freely transferable under the Securities Act; provided, however that shares issued to directors and officers of Mercer Mutual or of the Company would be restricted as to transfer for a period of one year from the Effective Date pursuant to the provisions of the Act and would be subject to additional resale restrictions under Rule 144 of the Securities Act. Shares of Common Stock issued to directors and officers will bear a legend giving appropriate notice of these restrictions and the Company will give instructions to the transfer agent for the Common Stock with respect to these transfer restrictions. Any shares issued to directors and officers as a stock dividend, stock split or otherwise with respect to restricted stock shall be subject to the same restrictions. Shares acquired by directors and officers other than in the Conversion will not be subject to these restrictions. 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 and to certain reporting requirements upon purchase of such securities. INTERPRETATION AND AMENDMENT OF THE PLAN OF CONVERSION To the extent permitted by law, all interpretations of the Plan by the Board of Directors of Mercer Mutual and the Board of Directors of the Company will be final. The Plan may be amended at any time before it is approved by the Pennsylvania Department by the affirmative vote of two-thirds of the directors of the Company and Mercer Mutual. The Plan similarly may be amended at any time after it is approved by the Pennsylvania Department, subject to the Pennsylvania Department's approval of such amendment. 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 by the affirmative vote of two-thirds of the directors of the Company and of Mercer Mutual then in office; provided, however, that any such amendment shall be subject to approval by the Pennsylvania Department; and provided further, that, if such amendment is determined by the Pennsylvania 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 Eligible Policyholders called for that purpose. In the event Eligible Policyholders are required to approve an amendment to the Plan, the Company will send a Proxy Statement to each Eligible Policyholder as soon as practical after the amendment is approved by the directors of the Company and Mercer Mutual and, if required, the Pennsylvania Department. In the event that the Pennsylvania Department adopts regulations containing mandatory or optional provisions applicable to the Conversion prior to the Effective Date, the Plan may be amended to conform to 91 95 such regulations at any time prior to such Effective Date by the affirmative vote of two-thirds of the directors of the Company and Mercer Mutual, and no resolicitation of proxies or further approval by Eligible Policyholders shall be required. TERMINATION The Plan may be terminated at any time before it is approved by the Pennsylvania Department by the affirmative vote of two-thirds of the directors of the Company and Mercer Mutual. The Plan may be terminated at any time after it is approved by the Pennsylvania Department by the affirmative vote of two- thirds of the directors of the Company and Mercer Mutual. The Plan may be terminated at any time after it is approved by Eligible Policyholders and prior to the Effective Date by the affirmative vote of two-thirds of the directors of the Company and Mercer Mutual provided, however, that any such termination shall be subject to approval by the Pennsylvania Department. CONDITIONS As required by the Plan, the Plan has been approved by the Pennsylvania Department and the Board of Directors of the 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. See "Risk Factors -- Requirement for Policyholder Approval." CERTAIN RESTRICTIONS ON ACQUISITION OF THE COMPANY PENNSYLVANIA LAW The Pennsylvania BCL contains certain provisions applicable to the Company that may have the effect of impeding a change in control of the Company. These provisions, among other things, (a) require that, following any acquisition by any person or group of 20% of a public corporation's voting power, the remaining shareholders have the right to receive payment for their shares, in cash, from such person or group in an amount equal to the "fair value" of their shares, including an increment representing a proportion of any value payable for acquisition of control of the corporation; and (b) prohibit, for five years after an interested shareholder's acquisition date, a "business combination" (which includes a merger or consolidation of the corporation or a sale, lease or exchange of assets having a minimum specified aggregate value or representing a minimum specified percentage earning power or net income of the corporation) with a shareholder or group of shareholders beneficially owning 20% or more of a public corporation's voting power. In 1990, the Pennsylvania legislature further amended the Pennsylvania BCL to expand the antitakeover protections afforded by Pennsylvania law by redefining the fiduciary duty of directors and adopting disgorgement and control-share acquisition statutes. To the extent applicable to the Company at the present time, this legislation generally (a) expands the factors and groups (including shareholders) that the Board of Directors can consider in determining whether a certain action is in the best interests of the corporation; (b) provides that the Board of Directors need not consider the interests of any particular group as dominant or controlling; (c) provides that 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) provides that 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) provides that the fiduciary duty of directors is solely to the corporation and may be enforced by the corporation or by a shareholder in a derivative action, but not by a shareholder directly. 92 96 The 1990 amendments to the BCL explicitly provide that the fiduciary duty of directors shall not be deemed to require directors (a) to redeem any rights under, or to modify or render inapplicable, any shareholder rights plan; (b) to render inapplicable, or make determinations under, provisions of the BCL relating to control transactions, business combinations, control-share acquisitions or disgorgement by certain controlling shareholders following attempts to acquire control; or (c) 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 the Company's Board of Directors in a potential change in control context. Pennsylvania case law appears to provide that the fiduciary duty standard under the 1990 amendment to the BCL grants directors the statutory authority to reject or refuse to consider any potential or proposed acquisition of the corporation. Under the Pennsylvania control-share acquisition statute, a person or group is entitled to voting rights with respect to "control shares" only after shareholders (both disinterested shareholders and all shareholders) have approved the granting of such voting rights at a meeting of shareholders. "Control shares" are shares acquired since January 1, 1988, that upon acquisition of voting power by an "acquiring person," would result in a "control-share acquisition." ("Control shares" also include voting shares where beneficial ownership was acquired by the "acquiring person" within 180 days of the control-share acquisition or with the intention of making a control-share acquisition.) An "acquiring person" is a person or group who makes or proposes to make a "control-share acquisition." A "control-share acquisition" is an acquisition, directly or indirectly, of voting power over voting shares that would, when added to all voting power of the person over other voting shares, entitle the person to cast or direct the casting of such percentage of votes for the first time with respect to any of the following ranges that all shareholders would be entitled to cast in an election of directors: (a) at least 20% but less than 33 1/3%; (b) at least 33 1/3 but less than 50%; or (c) 50% or more. The effect of these provisions is to require a new shareholder vote when each threshold is exceeded. In the event shareholders do not approve the granting of voting rights, voting rights are lost only with respect to "control shares." A special meeting of shareholders is required to be called to establish voting rights of control shares if an acquiring person (a) files with the corporation an information statement containing specified information, (b) makes a written request for a special meeting at the time of delivery of the information statement, (c) makes a control-share acquisition or a bona fide written offer to make a control-share acquisition, and (d) provides a written undertaking at the time of delivery of the information statement to pay or reimburse the corporation for meeting expenses. If the information statement is filed and a control-share acquisition is made or proposed to be made, but no request for a special meeting is made or no written undertaking to pay expenses is provided, the issue of voting rights will be submitted to shareholders at the next annual or special meeting of shareholders of the corporation. A corporation may redeem all "control shares" at the average of the high and low sales price, as reported on a national securities exchange or national quotation system or similar quotation system, on the date the corporation provides notice of redemption (a) at any time within 24 months after the date on which the control-share acquisition occurs if the acquiring person does not, within 30 days after the completion of the control-share acquisition, properly request that shareholders consider the issue of voting rights to be accorded to control shares and (b) at any time within 24 months after the issue of voting rights is submitted to shareholders and such voting rights either are not accorded or are accorded and subsequently lapse. Voting rights accorded to control shares by a vote of shareholders lapse and are lost if any proposed control-share acquisition is not consummated within 90 days after shareholder approval is obtained. A person will not be considered an "acquiring person" if the person holds voting power within any of the ranges specified in the definition of "control-share acquisition" as a result of a solicitation of revocable proxies if such proxies (a) are given without consideration in response to a proxy or consent solicitation made in accordance with the Exchange Act and (b) do not empower the holder to vote the shares except on the specific matters described in the proxy and in accordance with the instructions of the giver of the proxy. 93 97 The statute does not apply to certain control-share acquisitions effected pursuant to a gift or laws of inheritance, in connection with certain family trusts or pursuant to a merger, consolidation or plan of share exchange if the corporation is a party to the agreement. The effect of this statutory provision is to deter the accumulation of a substantial block of Common Stock, including accumulation with a view to effecting a non-negotiated tender or exchange offer for Common Stock. Under the disgorgement provisions of the Pennsylvania BCL, any profit realized by any person or group who is or was a "controlling person or group" from the disposition of any equity security of a corporation shall belong to and be recoverable by the corporation where the profit is realized (i) within 18 months after the person becomes a "controlling person or group" and (ii) the equity security had been acquired by the "controlling person or group" within 24 months prior to or 18 months after obtaining the status of a "controlling person or group." A "controlling person or group" is a person or group who (a) has acquired, offered to acquire or, directly or indirectly, publicly disclosed the intention of acquiring 20% voting power of the corporation or (b) publicly disclosed that it may seek to acquire control of the corporation. A person will not be deemed a "controlling person or group" if the person holds voting power as a result of a solicitation of revocable proxies if, among other things, such proxies (a) are given without consideration in response to a proxy or consent solicitation made in accordance with the Exchange Act and (b) do not empower the holder to vote the shares except on the specific matters described in the proxy and in accordance with the instructions of the giver of the proxy. This exception does not apply to proxy contests in connection with or as a means toward acquiring control of the Company. The effect of this statutory provision is to deter the accumulation of a substantial block of Common Stock with a view to putting the Company "in play" and then selling shares at a profit (whether to the Company, in the market or in connection with an acquisition of the Company). CERTAIN ANTI-TAKEOVER PROVISIONS IN THE ARTICLES OF INCORPORATION AND BYLAWS The Board believes that it is appropriate to include certain provisions as part of the Company's Articles of Incorporation to protect the interests of the Company and its shareholders from hostile takeovers that the Board might conclude are not in the best interests of the Company or the Company's shareholders. These provisions may have the effect of discouraging a future takeover attempt that is not approved by the Board but which individual shareholders may deem to be in their best interests or in which shareholders may receive a substantial premium for their shares over the then current market price. As a result, shareholders who might desire to participate in such a transaction may not have an opportunity to do so. Such provisions will also render the removal of the Company's current Board of Directors or management more difficult. While the Board of Directors of the Company is not aware of any specific effort that might be made to obtain control of the Company after the Conversion, Franklin is currently making a hostile attempt to acquire control of Mercer Mutual, and may continue such attempt after the completion of the Conversion. See "Business -- Offer to Acquire Mercer Mutual" and "-- Legal Proceedings." The following discussion is a general summary of certain provisions of the Articles of Incorporation and Bylaws of the Company that may be deemed to have such an "anti-takeover" effect. The description of these provisions is necessarily general and reference should be made in each case to the Articles of Incorporation and Bylaws of the Company. For information regarding how to obtain a copy of these documents without charge, see "Additional Information." Classified Board of Directors and Related Provisions The Company's Articles of Incorporation provide that the Board of Directors is to be divided into three classes which shall be as nearly equal in number as possible. The directors in each class will hold office following their initial appointment to office for terms of one year, two years and three years, respectively, and, upon reelection, will serve for terms of three years thereafter. Each director will serve until his or her successor 94 98 is elected and qualified. The Articles of Incorporation provide that a director may be removed by shareholders only upon the affirmative vote of at least a majority of the votes which all shareholders would be entitled to cast. The Articles of Incorporation further provide that any vacancy occurring in the Board of Directors, including a vacancy created by an increase in the number of directors, shall be filled for the remainder of the unexpired term by a majority vote of the directors then in office. A classified board of directors could make it more difficult for shareholders, including those holding a majority of the outstanding shares, to force an immediate change in the composition of a majority of the Board of Directors. Because the terms of only one-third of the incumbent directors expire each year, it requires at least two annual elections for the shareholders to change a majority, whereas a majority of a non-classified board may be changed in one year. In the absence of the provisions of the Articles of Incorporation classifying the Board, all of the directors would be elected each year. Management of the Company believes that the staggered election of directors tends to promote continuity of management because only one-third of the Board of Directors is subject to election each year. Staggered terms guarantee that in the ordinary course approximately two-thirds of the Directors, or more, at any one time have had at least one year's experience as directors of the Company, and moderate the pace of change in the composition of the Board of Directors by extending the minimum time required to elect a majority of Directors from one to two years. Other Antitakeover Provisions The Company's Articles of Incorporation and Bylaws contain certain other provisions that may also have the effect of deterring or discouraging, among other things, a non-negotiated tender or exchange offer for the Common Stock, a proxy contest for control of the Company, the assumption of control of the Company by a holder of a large block of the Common Stock and the removal of the Company's management. These provisions: (1) empower the Board of Directors, without shareholder approval, to issue preferred stock, the terms of which, including voting power, are set by the Board; (2) restrict the ability of shareholders to remove directors; (3) require that shares with at least 80% of total voting power approve mergers and other similar transactions, if the transaction is not approved, in advance, by the Board of Directors; (4) prohibit shareholders' actions without a meeting; (5) eliminate the right of shareholders to call a special meeting; (6) require that shares with at least 80%, or in certain instances a majority, of total voting power approve the repeal or amendment of the Articles of Incorporation; (7) require any person who acquires stock of the Company with voting power of 25% or more to offer to purchase for cash all remaining shares of the Company's voting stock at the highest price paid by such person for shares of the Company's voting stock during the preceding year; (8) limit the right of a person or entity to vote more than 10% of the Company's voting stock; (9) eliminate cumulative voting in elections of directors; and (10) require that shares with at least 66 2/3% of total voting power approve, repeal or amend the Bylaws. Should Franklin continue its hostile attempt to acquire Mercer Mutual after the approval of the Plan by the Eligible Policyholders at the Special Meeting (see "Business -- Offer to Acquire Mercer Mutual"), the Company's Board of Directors may consider adopting a shareholder rights plan in the form adopted by many companies that have publicly-traded common stock. Such plans typically provide for the issuance of rights to all shareholders that, in the event of a hostile takeover attempt of the issuer, become exercisable and permit all shareholders (except for the hostile acquiror) to acquire shares of the common stock of the issuer or the acquiror at a price that is substantially less than the market price. The Company's Board of Directors has not made any determination as to whether it would adopt such a rights plan. The adoption of such a rights plan would not require shareholder approval. DESCRIPTION OF CAPITAL STOCK GENERAL The Company is authorized to issue 15,000,000 shares of Common Stock, without par value, and 5,000,000 shares of preferred stock, having such par value as the Board of Directors of the Company shall fix 95 99 and determine. The Company currently expects to issue between 2,507,500 and 3,392,500 shares (or, as permitted by the Plan, in the event the ESOP purchases shares in excess of the maximum of the Estimated Valuation Range in order to satisfy its 10% subscription, up to 3,769,444 shares), subject to adjustment, of the Common Stock and no shares of preferred stock in the Conversion. 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 the Common Stock. The holders of the Common Stock will possess exclusive voting rights in the Company, except to the extent that shares of preferred stock issued in the future may have voting rights, if any. Each holder of shares of the 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 the Common Stock. Holders of Common Stock will not be entitled to cumulate their votes for election of directors. Dividends The Company may, from time to time, declare dividends to the holders of Common Stock, who will be entitled to share equally in any such dividends. For additional information as to cash dividends, see "Dividend Policy." Liquidation In the event of any liquidation, dissolution or winding up of Mercer Mutual, the 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 Company, each holder of shares of Common Stock would be entitled to receive, after payment of all debts and liabilities of the Company, a pro rata portion of all assets of the Company available for distribution to holders of Common Stock. If any preferred stock is issued, the holders thereof may have a priority in liquidation or dissolution over the holders of the Common Stock. 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 receipt by the Company of the full purchase price therefor, will be fully paid and nonassessable. PREFERRED STOCK None of the 5,000,000 authorized shares of preferred stock of the Company will be issued in the Conversion. The Board of Directors of the Company is 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. The Board of Directors of the Company may consider issuing rights to acquire the Company's preferred stock to all shareholders pursuant to the adoption of a shareholder rights plan, should Franklin continue its hostile attempt to acquire control of Mercer Mutual. Such rights also typically permit, in the event of a hostile takeover attempt of the issuer, all shareholders, except the hostile acquiror, to acquire shares of the common stock of the issuer or the acquiror at a price that is substantially less than the market price. See "Business -- Offer to Acquire Mercer Mutual" and "-- Legal Proceedings." Should the Board of Directors of the Company subsequently issue preferred stock or rights to acquire preferred stock, no holder of any such stock shall have any preemptive right to subscribe for or purchase any stock or any other securities of the Company other than such, if any, as the Board of Directors, in its sole 96 100 discretion, may determine and at such price or prices and upon such other terms as the Board of Directors, in its sole discretion, may fix. TRANSFER AGENT AND REGISTRAR The transfer agent and registrar for the Common Stock is Registrar and Transfer Company, Cranford, New Jersey. LEGAL OPINIONS The legality of the Common Stock will be passed upon for the Company by Stevens & Lee, Wayne, Pennsylvania. Stevens & Lee has consented to the reference herein to its opinion. Certain legal matters will be passed upon for Sandler O'Neill by Lord, Bissell & Brook, Chicago, Illinois. EXPERTS The consolidated financial statements and schedules of Mercer Mutual as of December 31, 1997 and 1996, and for each of the years in the three-year period ended December 31, 1997 have been included herein and in the Registration Statement in reliance upon the reports of KPMG LLP, independent certified public accountants, appearing elsewhere herein, and upon the authority of said firm as experts in accounting and auditing. Sheshunoff has consented to the publication herein of the summary of its opinion as to the estimated consolidated pro forma aggregate market value of the Common Stock to be issued in the Conversion and the value of subscription rights to purchase the Common Stock, and to the use of its name and statements with respect to it appearing herein. AVAILABLE INFORMATION The Company has filed with the Securities and Exchange Commission ("SEC") a Registration Statement on Form S-1 under the Securities Act with respect to the Common Stock offered hereby (the "Registration Statement"). As permitted by the rules and regulations of the SEC, this prospectus does not contain all the information set forth in the Registration Statement. Such information and all exhibits to the Registration Statement, including the Appraisal which is an exhibit to the Registration Statement, can be examined without charge at the public reference facilities of the SEC located at Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and at the SEC's Regional Offices located at Citicorp Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661, and at Seven World Trade Center, Suite 1300, New York, New York 10048, and copies of such material can be obtained from the SEC at prescribed rates. In addition, copies of such documents may be obtained on the Internet at http://www.sec.gov. Mercer Mutual has filed an Application to Convert from Mutual to Stock Form with the Pennsylvania Department with respect to the Conversion and has received the Orders approving such application. The application and the Orders may be examined at the principal office of the Pennsylvania Department located in Harrisburg, Pennsylvania. In connection with the Conversion, the Company will register its Common Stock with the SEC under Section 12(g) of the Exchange Act and, upon such registration, the Company and the holders of its stock 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% stockholders, and certain other requirements of the Exchange Act. Under the Plan, the Company has undertaken that it will not terminate such registration for a period of at least three years following the Conversion. A copy of the Articles of Incorporation and the Bylaws of the Company and Mercer Mutual are available without charge from Mercer Mutual. 97 101 GLOSSARY OF SELECTED INSURANCE TERMS Acquisition costs............. Agents' or brokers' commissions, premium taxes, marketing, and certain underwriting expenses associated with the production of business. Assumed reinsurance........... Insurance or reinsurance transferred from another insurance or reinsurance entity. Cede.......................... To transfer to an insurer or a reinsurer all or a part of the insurance or reinsurance written by an insurance or reinsurance entity. Combined ratio................ The sum of the expense ratio and the loss ratio, determined either in accordance with statutory accounting practices or GAAP. A combined ratio under 100% generally indicates an underwriting profit and a combined ratio over 100% generally indicates an underwriting loss. The extent by which the combined ratio deviates from 100% indicates relative underwriting profit or loss. Commercial Multi-peril........ Commercial multi-peril coverage insures against losses to businesses and business personal property, such as those caused by fire, wind, hail, water damage, theft and vandalism, as well as comprehensive general liability for injuries to others. Optional coverages written include inland marine, crime and boiler and machinery. Direct written premiums....... Total premiums written by an insurer other than premiums for reinsurance assumed by an insurer. Earned premiums............... The portion of net written premiums applicable to the expired period of policies. Expense ratio................. Under statutory accounting practices, the ratio of underwriting expenses to net written premiums. Fire & Allied Lines........... Fire and allied lines insurance generally covers fire, lightning, and removal and extended coverage. Gross premiums................ Total premiums for insurance written and reinsurance assumed during a given period. Homeowners.................... Homeowners coverage insures individuals for losses to their residences and personal property, such as those caused by fire, wind, hail, water damage, theft and vandalism, and against third party liability claims. Incurred losses............... The sum of losses paid plus the change in the estimated liability for claims which have been reported but which have not been settled and claims which have occurred but have not yet been reported to the insurer. Inland marine................. Inland marine coverage insures merchandise or cargo in transit and business and personal property. It is also written as an endorsement to a homeowner's policy to provide coverage for scheduled property, such as antiques, fine art, sports equipment, boats, firearms, jewelry and camera equipment. Loss adjustment expenses...... The expenses of settling claims, including legal and other fees and the general expenses of administering the claims adjustment process. 98 102 Loss and LAE ratio............ Under statutory accounting practices, the ratio of incurred losses and loss adjustment expenses to earned premiums. Net earned premiums........... The portion of written premiums that is recognized for accounting purposes as revenue during a period. Net premiums.................. Gross premiums written less premiums ceded to reinsurers. Net written premiums.......... Gross premiums written and insured by an insurer less premiums ceded to reinsurers. Probable Maximum Loss......... The largest loss that a catastrophe will probably cause under most circumstances. It is not ordinarily the "maximum possible loss," which is the worst possible scenario and which would, in many cases, be 100% of the property value. It is a concept used by underwriters, reinsurers and A.M. Best in evaluating catastrophe loss potential. Reinsurance................... A procedure whereby an insurer remits or cedes a portion of the premiums to another insurer or reinsurer as payment to that insurer or reinsurer for assuming a portion of the related risk. Statutory accounting practices..................... Recording transactions and preparing financial statements in accordance with the rules and procedures prescribed or permitted by statute or regulatory authorities, generally reflecting a liquidating, rather than a going concern, concept of accounting. The principal differences between statutory accounting practices ("SAP") and GAAP for property and casualty insurance companies, are: (a) under SAP, certain assets that are not admitted assets are eliminated from the balance sheet; (b) under SAP, policy acquisition costs are expenses as incurred, while under GAAP, they are deferred and amortized over the term of the policies; (c) under SAP, no provision is made for deferred income taxes; (d) under SAP, certain reserves are recognized that are not recognized under GAAP; and (e) under SAP, fixed income securities (bonds, redeemable preferred stocks and mortgage-backed securities) are carried at cost, while under GAAP, they are carried at market value. Statutory surplus............. The sum remaining after all liabilities are subtracted from all assets, applying statutory accounting practices. This sum is regarded as financial protection to policyholders in the event an insurance company suffers unexpected or catastrophic losses. Umbrella policy............... An insurance policy covering liabilities in excess of amounts covered under a standard policy. Underwriting.................. The process whereby an insurer reviews applications submitted for insurance coverage and determines whether it will accept all or part of the coverage being requested and what the applicable premiums should be. Underwriting also includes an ongoing review of existing policies and their pricing. Underwriting expenses......... The aggregate of policy acquisition costs and the portion of administrative, general and other expenses attributable to underwriting operations. 99 103 Underwriting profit (loss).... The excess (deficiency), determined under statutory accounting practices, resulting from the difference between earned premiums and the sum of incurred losses, loss adjustment expenses and underwriting expenses. Voluntary market.............. The market consisting of those persons who insurance companies voluntarily choose to insure because such companies believe that they can do so profitably at competitive rates. Workers' Compensation......... Workers' compensation coverage insures employers against employee medical and indemnity claims resulting from injuries related to work as well as third party employer's liability. 100 104 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS OF MERCER MUTUAL
PAGE ---- INDEPENDENT AUDITORS' REPORT................................ F-2 CONSOLIDATED FINANCIAL STATEMENTS BALANCE SHEETS (As of December 31, 1997 and 1996)..... F-3 STATEMENTS OF EARNINGS (For the years ended December 31, 1997, 1996 and 1995)............................. F-4 STATEMENTS OF CHANGES IN SURPLUS (For the years ended December 31, 1997, 1996 and 1995).................... F-5 STATEMENTS OF CASH FLOWS (For the years ended December 31, 1997, 1996 and 1995)............................. F-6 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS............ F-7 INTERIM CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) BALANCE SHEETS (Unaudited) (As of September 30, 1998 and December 31, 1997)............................... F-18 STATEMENTS OF EARNINGS (Unaudited) (For the nine months ended September 30, 1998 and 1997)............ F-19 STATEMENTS OF CHANGES IN SURPLUS (Unaudited) (For the nine months ended September 30, 1998 and 1997)....... F-20 STATEMENTS OF CASH FLOWS (Unaudited) (For the nine months ended September 30, 1998 and 1997)............ F-21
F-1 105 INDEPENDENT AUDITORS REPORT The Board of Directors Mercer Mutual Insurance Company: We have audited the accompanying consolidated balance sheets of Mercer Mutual Insurance Company and subsidiaries (the Group) as of December 31, 1997 and 1996, and the related statements of earnings, changes in surplus, and cash flows for each of the years in the three-year period ended December 31, 1997. These financial statements are the responsibility of the Group's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. 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 financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Group as of December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1997, in conformity with generally accepted accounting principles. KPMG LLP Philadelphia, Pennsylvania February 18, 1998 F-2 106 MERCER MUTUAL INSURANCE COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1997 AND 1996
1997 1996 --------- --------- (DOLLARS IN THOUSANDS) ASSETS Investments, at fair value: Fixed income securities, available-for-sale............... $34,947 $34,964 Equity securities......................................... 10,852 7,795 Total investments...................................... 45,799 42,759 Cash and cash equivalents................................... 2,707 2,675 Premiums receivable......................................... 3,334 2,308 Reinsurance receivables..................................... 13,206 18,908 Prepaid reinsurance premiums................................ 3,046 994 Deferred policy acquisition costs........................... 3,019 2,989 Accrued investment income................................... 625 602 Property and equipment, net................................. 1,413 1,441 Deferred income taxes....................................... -- 802 Other assets................................................ 936 596 ------- ------- Total assets........................................... $74,085 $74,074 ======= ======= LIABILITIES AND SURPLUS Liabilities: Losses and loss adjustment expenses....................... $31,872 $35,221 Unearned premiums......................................... 14,723 13,179 Accounts payable and accrued expenses..................... 2,417 1,700 Deferred income taxes..................................... 177 -- Other reinsurance balances................................ 835 4,028 Other liabilities......................................... 825 664 ------- ------- Total liabilities...................................... 50,849 54,792 ------- ------- Surplus: Unassigned surplus........................................ 20,693 18,476 Accumulated other comprehensive income: Unrealized gains in investments, net of deferred income taxes................................................. 2,543 806 ------- ------- Total surplus.......................................... 23,236 19,282 ------- ------- Total liabilities and surplus.......................... $74,085 $74,074 ======= =======
See accompanying notes to consolidated financial statements. F-3 107 MERCER MUTUAL INSURANCE COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF EARNINGS YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
1997 1996 1995 ------- ------- ------- (DOLLARS IN THOUSANDS) Revenue: Net premiums earned....................................... $17,969 $20,634 $20,817 Investment income, net of expenses........................ 2,350 2,289 2,132 Net realized investment gains............................. 589 596 53 Other revenue............................................. 173 155 161 ------- ------- ------- Total revenue.......................................... 21,081 23,674 23,163 ------- ------- ------- Expenses: Losses and loss adjustment expenses....................... 10,594 14,801 13,296 Amortization of deferred policy acquisition costs......... 4,706 5,491 5,944 Other expenses............................................ 2,563 2,571 2,416 ------- ------- ------- Total expenses......................................... 17,863 22,863 21,656 ------- ------- ------- Income before income tax.................................... 3,218 811 1,507 Income tax.................................................. 1,001 171 369 ------- ------- ------- Net income.................................................. $ 2,217 $ 640 $ 1,138 ======= ======= =======
See accompanying notes to consolidated financial statements. F-4 108 MERCER MUTUAL INSURANCE COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SURPLUS YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
1997 1996 1995 ------- ------- ------- (DOLLARS IN THOUSANDS) Balance, beginning of period................................ $19,282 $18,963 $14,203 Net income.................................................. 2,217 640 1,138 Other comprehensive income, net of tax: Unrealized gains on securities: Unrealized holding gains arising during period (net of related income tax expense of $1,095, $37 and $1,884).............................................. 2,126 72 3,657 Less: Reclassification adjustment for gains included in net income (net of related income tax expense of $200, $203 and $18)........................................ (389) (393) (35) ------- ------- ------- Total.................................................. 1,737 (321) 3,622 ------- ------- ------- Comprehensive income...................................... 3,954 319 4,760 ------- ------- ------- Balance, end of period...................................... $23,236 $19,282 $18,963 ======= ======= =======
See accompanying notes to consolidated financial statements. F-5 109 MERCER MUTUAL INSURANCE COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOW YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
1997 1996 1995 ------- ------- -------- (DOLLARS IN THOUSANDS) Cash flows from operating activities: Net income................................................ $ 2,217 $ 640 $ 1,138 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation of property and equipment................. 117 137 134 Net accretion of discount.............................. (51) (58) (54) Net realized investment gain........................... (589) (596) (53) Net realized gain on sale of property and equipment.... -- 3 -- Deferred income tax.................................... 83 (120) (55) Change in assets and liabilities: Premiums receivable.................................. (1,026) 2,345 (286) Reinsurance receivables.............................. 5,702 (2,019) 368 Prepaid reinsurance premiums......................... (2,052) 4,564 (55) Deferred policy acquisition costs.................... (30) 167 174 Other assets......................................... (363) 98 724 Losses and loss expenses............................. (3,349) (955) 645 Unearned premiums.................................... 1,544 (5,074) 483 Other liabilities.................................... (2,355) 2,300 (214) ------- ------- -------- Net cash provided by (used in) operating activities...................................... (152) 1,432 2,949 ------- ------- -------- Cash flows from investing activities: Purchase of fixed income securities, available-for-sale... (7,747) (6,477) (15,118) Purchase of equity securities............................. (7,477) (6,938) (5,891) Sale and maturity of fixed income securities available-for-sale..................................... 8,368 4,294 10,146 Sale of equity securities, available for sale............. 7,089 6,983 9,412 Change in receivable/payable of securities................ 40 (39) 99 Purchase of property and equipment........................ (89) (176) (92) Sale of property and equipment............................ -- 29 -- ------- ------- -------- Net cash used in investing activities.................. 184 (2,324) (1,444) ------- ------- -------- Net increase (decrease) in cash and cash equivalents... 32 (892) 1,505 Cash and cash equivalents at beginning of year.............. 2,675 3,567 2,062 ------- ------- -------- Cash and cash equivalents at end of period.................. $ 2,707 $ 2,675 $ 3,567 ======= ======= ======== Cash paid during the year for: Interest.................................................. $ 0 $ 0 $ 0 Income taxes.............................................. $ 730 $ 125 $ 281
See accompanying notes to consolidated financial statements. F-6 110 MERCER MUTUAL INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS) (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Description of Business Mercer Mutual Insurance Company (MMIC), its subsidiary Queenstown Holding Company, Inc. (QHC) and QHC's subsidiary Mercer Insurance Company (MIC) collectively referred herein as the "Group", provide property and casualty insurance to both individual and commercial customers in New Jersey and Pennsylvania. The principal lines of business are homeowners, commercial multi-peril, general liability and fire and allied which represent approximately 46%, 22%, 13% and 10%, respectively, of net premiums written in 1997. MMIC has filed an application with the Insurance Department of the Commonwealth of Pennsylvania to form of an insurance holding company, incorporated in Pennsylvania, to purchase all of the authorized stock of MMIC, which plans to convert from the mutual to the stock form of organization. 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 generally accepted accounting principles, which differ in some respects from those followed in reports to insurance regulatory authorities. 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. Actual results could differ from those estimates. Investments Due to periodic shifts in the portfolio arising out of 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 surplus. Realized gains and losses are calculated on the specific identification basis. 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. 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. 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 F-7 111 MERCER MUTUAL INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 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. 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. 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 are reported gross of ceded reinsurance credits. 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, 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. 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 ranging from five to forty-five years. Equipment is depreciated three to ten years. 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. Losses and Loss Adjustment Expenses The liability for losses includes the amount of claims which have been reported to the Company 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, 1997 are adequate to cover the ultimate net cost of losses and claims to date, but these liabilities are necessarily F-8 112 MERCER MUTUAL INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) based on estimates, and the amount of losses and loss adjustment expenses ultimately paid may be more or less than such estimates. 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. 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, net realized investment gains and change in unrealized capital gains (losses) on investment securities are as follows:
1997 1996 1995 ------ ------ ------ (DOLLARS IN THOUSANDS) Investment income: Fixed income securities.............................. $2,379 $2,326 $2,068 Equity securities.................................... 192 153 168 Cash and cash equivalents............................ 118 143 194 Other................................................ 41 46 54 ------ ------ ------ Gross investment income........................... 2,730 2,668 2,484 Less investment expenses(1)............................ 380 379 352 ------ ------ ------ Net investment income............................. 2,350 2,289 2,132 Realized gains (losses): Fixed income securities.............................. (78) (21) (173) Equity securities.................................... 667 617 226 ------ ------ ------ Net realized investment gains..................... 589 596 53 ------ ------ ------ Net investment income and net realized investment gains........................................... $2,939 $2,885 $2,185 ====== ====== ======
Change in unrealized gains (losses) of securities, net of tax, are as follows:
1997 1996 1995 ------ ----- ------ Fixed income securities................................. $ 417 $(576) $1,987 Equity securities....................................... 1,320 255 1,635 ------ ----- ------ $1,737 $(321) $3,622 ====== ===== ======
- --------------- (1) Investment expenses include salaries, counseling fees and other miscellaneous expenses attributable to the maintenance of investment activities. F-9 113 MERCER MUTUAL INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The cost and estimated fair value of available-for-sale investment securities at December 31, 1997 and 1996 are shown below.
GROSS GROSS ESTIMATED UNREALIZED UNREALIZED FAIR 1997 COST(1) GAINS LOSSES VALUE - ---- ------- ---------- ---------- --------- (DOLLARS IN THOUSANDS) Fixed income securities, available-for-sale U.S. Government and government agencies......... $25,195 $ 266 $ 54 $25,407 Obligations of states and political subdivisions................................. $ 3,396 $ 121 $ -- $ 3,517 Industrial and miscellaneous.................... $ 300 $ 1 $ 1 $ 300 Mortgage-backed securities...................... $ 6,106 $ 10 $393 $ 5,723 ------- ------ ---- ------- Total fixed maturities............................ $34,997 $ 398 $448 $34,947 ------- ------ ---- ------- Equity securities: At market value................................. $ 6,854 $2,664 $104 $ 9,414 At estimated value.............................. $ 94 $1,344 $ -- $ 1,438 ------- ------ ---- ------- Total equity securities........................... $ 6,948 $4,008 $104 $10,852 ------- ------ ---- ------- Total available-for-sale.......................... $41,945 $4,406 $552 $45,799 ======= ====== ==== =======
GROSS GROSS ESTIMATED UNREALIZED UNREALIZED FAIR 1996 COST(1) GAINS LOSSES VALUE ---- ------- ---------- ---------- --------- Fixed income securities, available-for-sale U.S. Government and government agencies........... $23,702 $ 223 $ 234 $23,691 Obligations of states and political subdivisions................................. 4,313 48 18 4,343 Mortgage-backed securities...................... 7,631 12 713 6,930 ------- ------ ------ ------- Total fixed maturities............................ 35,646 283 965 34,964 ------- ------ ------ ------- Equity securities: At market value................................. 5,892 1,119 329 6,682 At estimated value.............................. -- 1,113 -- 1,113 ------- ------ ------ ------- Total equity securities........................... 5,892 2,232 329 7,795 ------- ------ ------ ------- Total available-for-sale.......................... $41,538 $2,515 $1,294 $42,759 ======= ====== ====== =======
- --------------- (1) Original cost of equity securities; original cost of fixed income securities adjusted for amortization of premium and accretion of discount. F-10 114 MERCER MUTUAL INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The amortized cost and estimated fair value of fixed income securities at December 31, 1997, 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.
AMORTIZED ESTIMATED COST FAIR VALUE --------- ---------- (DOLLARS IN THOUSANDS) Due after one year through five years................... $ 1,361 $ 1,496 Due after five years through ten years.................. 25,251 25,470 Due after ten years..................................... 2,279 2,258 ------- ------- 28,891 29,224 Mortgage backed securities.............................. 6,106 5,723 ------- ------- $34,997 $34,947 ======= =======
The gross realized gains and losses on investment securities are as follows:
1997 1996 1995 ------ ----- ----- (DOLLARS IN THOUSANDS) Gross realized gains...................................... $1,027 $ 921 $ 778 Gross realized losses..................................... (438) (325) (725) ------ ----- ----- $ 589 $ 596 $ 53 ====== ===== =====
Proceeds from the sale of available-for-sale securities were $15,457, $11,276 and $19,032 for 1997, 1996 and 1995, respectively. (3) DEFERRED POLICY ACQUISITION COSTS Changes in deferred policy acquisition costs are as follows:
1997 1996 1995 ------- ------- ------- (DOLLARS IN THOUSANDS) Balance, January 1.................................... $ 2,989 $ 3,155 $ 3,330 Acquisition costs deferred............................ 4,736 5,325 5,769 Amortization charged to earnings...................... (4,706) (5,491) (5,944) ------- ------- ------- Balance, December 31.................................. $ 3,019 $ 2,989 $ 3,155 ======= ======= =======
(4) PROPERTY AND EQUIPMENT Property and equipment was as follows:
1997 1996 --------- --------- (DOLLARS IN THOUSANDS) Home Office: Land...................................................... $ 456 $ 456 Buildings and improvements................................ 1,479 1,468 Furniture, fixtures and equipment......................... 1,368 1,290 ------- ------- 3,303 3,214 Accumulated depreciation.................................. (1,890) (1,773) ------- ------- $ 1,413 $ 1,441 ======= =======
F-11 115 MERCER MUTUAL INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (5) LIABILITIES FOR LOSSES AND LOSS ADJUSTMENT EXPENSES Activity in the liabilities for losses and loss adjustment expenses is summarized as follows:
1997 1996 1995 -------- -------- -------- (DOLLARS IN THOUSANDS) Balance, January 1................................. $ 35,221 $ 36,176 $ 35,531 Less reinsurance recoverable on unpaid losses and loss expenses................................. (15,147) (16,819) (17,233) -------- -------- -------- Net balance at January 1........................... 20,074 19,357 18,298 Incurred related to: Current year..................................... 11,649 16,445 14,251 Prior years...................................... (1,055) (1,644) (955) -------- -------- -------- Total incurred..................................... 10,594 14,801 13,296 -------- -------- -------- Paid related to: Current year..................................... 4,775 7,715 5,302 Prior years...................................... 6,042 6,369 6,935 Total paid......................................... 10,817 14,084 12,237 -------- -------- -------- Net balance, December 31........................... 19,851 20,074 19,357 Plus reinsurance recoverable on unpaid losses and loss expenses................................. 12,021 15,147 16,819 -------- -------- -------- Balance at December 31............................. $ 31,872 $ 35,221 $ 36,176 ======== ======== ========
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 functions 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. (6) REINSURANCE In the ordinary course of business, the Company 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 Company's retention not exceeding $100,000 per occurrence. Insurance ceded by the Company does not relieve its primary liability as the originating insurer. The Company 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:
1997 1996 1995 -------- ------- -------- (DOLLARS IN THOUSANDS) PREMIUMS WRITTEN Direct............................................ $ 28,453 $24,958 $ 24,699 Assumed........................................... 547 5,013 10,287 Ceded............................................. (11,539) (9,847) (13,741) -------- ------- -------- Net............................................... $ 17,461 $20,124 $ 21,245 ======== ======= ========
F-12 116 MERCER MUTUAL INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1997 1996 1995 ------- -------- -------- PREMIUMS EARNED Direct............................................ $26,858 $ 24,760 $ 24,700 Assumed........................................... 598 10,286 9,803 Ceded............................................. (9,487) (14,412) (13,686) ------- -------- -------- Net............................................... $17,969 $ 20,634 $ 20,817 ======= ======== ========
The effect of reinsurance on unearned premiums as of December 31, 1997, 1996 and 1995 is as follows:
1997 1996 1995 ------- ------- ------- (DOLLARS IN THOUSANDS) Direct.............................................. $14,552 $12,957 $12,759 Assumed............................................. 171 222 5,494 ------- ------- ------- Net................................................. $14,723 $13,179 $18,253 ======= ======= =======
The effect of reinsurance on the liabilities for losses and loss adjustment and losses and loss adjustment expenses incurred is as follows:
1997 1996 1995 ------- ------- ------- (DOLLARS IN THOUSANDS) Liabilities Direct.............................................. $27,068 $27,429 $27,906 Assumed............................................. 4,804 7,792 8,270 ------- ------- ------- $31,872 $35,221 $36,176 ======= ======= =======
1997 1996 1995 ------- ------- ------- (DOLLARS IN THOUSANDS) Expenses Incurred Direct.............................................. $11,743 $14,597 $13,120 Assumed............................................. 301 7,234 6,694 Ceded............................................... (1,450) (7,030) (6,518) ------- ------- ------- Net................................................. $10,594 $14,801 $13,296 ======= ======= =======
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, 1997, three independent reinsurers accounted for approximately $4,867 of amounts recoverable for paid losses and loss adjustment expenses. Effective December 31, 1996, the Group terminated its participation in certain ceded and assumed reinsurance agreements. As a result of the termination of these agreements, premiums unearned as of December 31, 1996 were returned to the ceding companies, less commission. The Group, as a ceding reinsured, received back from reinsurers $4,895 in unearned premium less $1,224 in commission. The Group, as an assuming reinsurer, returned to reinsureds $5,508 in unearned premium less $1,377 in commission. Ceded loss and loss adjustment reserves attributable to these agreements were $5,669 at December 31, 1996, and assumed loss and loss adjustment reserves attributable to these agreements were $6,016 at December 31, 1996. F-13 117 MERCER MUTUAL INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (7) RETIREMENT PLANS AND DEFERRED DIRECTORS' FEES 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 in 1997 amounted to $95. Benefits under the defined benefit pension plan ceased accruing to participants as of December 31, 1996. Benefits were based on years of service and the employee's career-average annual compensation. The Group's funding policy was to contribute annually at least the minimum required contribution in accordance with minimum funding standards established by ERISA. Contributions were intended to provide not only for benefits attributed to service to date, but also for those expected to be earned in the future. As a result of the termination of the defined benefit pension plan, the Group incurred a loss of $173. In December 1997, the Group completed distribution of all benefits. Plan assets were sufficient to discharge all obligations without further expense attributable to the defined benefit pension plan. Plan assets were generally invested in fixed income and equity securities. The following table sets forth the year-end funded status of the terminated defined benefit pension plan:
1996 ------- Actuarial present value of benefit obligations: Accumulated and projected benefit obligation, including vested benefits of $1,009............................. $(1,021) Plan assets at fair value.................................. 862 Excess of the projected benefit obligation over plan....... (159)
The net periodic pension cost for the terminated defined benefit pension plan included the following components:
1996 1995 ----- ----- Service costs -- benefits earned during the period.......... $ 119 $ 98 Interest cost on projected benefit obligation............... 95 81 Return on plan assets....................................... (120) (56) Net amortization and deferral............................... 62 7 ----- ----- Net periodic pension cost................................... $ 156 $ 130 ===== =====
In determining the actuarial present value of the projected benefit obligation, the weighted-average discount rate was 7.5% and 7.25% for 1996 and 1995, respectively. The rate of increase in future compensation levels was 4.5%. The expected long-term rate of return on retirement plan assets was 8.0%. 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 $57, $58 and $56 for the years ended December 31, 1997, 1996 and 1995, respectively. The Group maintains a non-qualified unfunded retirement plan for its directors. The plan provides for monthly payments for 10 years upon retirement. The expense for this plan amounted to $57, $55 and $52 for 1997, 1996 and 1995, respectively. Costs accrued under this plan amounted to $306 and $249 at December 31, 1997 and 1996, respectively. The Group maintains a deferred directors' compensation plan. Under the plan, a director may elect to defer receipt of all or a portion of their fees. Amounts deferred, together with accumulated interest, are F-14 118 MERCER MUTUAL INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) distributed either as a lump sum or in installments over a period of not greater than ten years. Deferred directors' fees and accumulated interest amounted to $549 and $476 at December 31, 1997 and 1996, respectively. (8) FEDERAL INCOME TAXES The tax effect of significant temporary differences that give rise to the Group's net deferred tax asset (liability) as of December 31, is as follows:
1997 1996 --------- --------- (DOLLARS IN THOUSANDS) Net loss reserve discounting............................. $ 1,173 $ 1,181 Net unearned premiums.................................... 794 828 Unrealized loss on investments........................... 188 440 Other.................................................... 272 298 ------- ------- Deferred tax assets.................................... 2,427 2,747 ------- ------- Deferred policy acquisition costs........................ 1,027 1,016 Unrealized gain on investment............................ 1,498 855 Other.................................................... 79 74 ------- ------- Deferred tax liabilities............................... 2,604 1,945 ------- ------- Net deferred tax asset (liability)..................... $ (177) $ 802 ======= =======
The deferred tax asset has not been reduced by a valuation allowance because management believes that, while it is not assured, it is more likely than not that it will generate sufficient future taxable income to utilize these net excess tax deductions. The amount of the deferred tax asset considered realizable, however, could be materially reduced in the near term if estimates of future taxable income in the years in which the differences are expected to reverse are not realized. 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, for each of the three years ended December 31 as follows:
1997 1996 1995 ------ ---- ------ (DOLLARS IN THOUSANDS) Expected tax expense....................................... $1,094 $276 $ 513 Tax-exempt interest........................................ (56) (73) (107) Dividends received deduction............................... (28) (25) (35) Other...................................................... (9) (7) (2) ------ ---- ------ Income tax expense....................................... $1,001 $171 $ 369 ====== ==== ======
The components of the provision for income taxes are as follows:
1997 1996 1995 ------ ---- ------ (DOLLARS IN THOUSANDS) Current.................................................... $ 918 $291 $ 424 Deferred................................................... 83 (120) (55) ------ ---- ------ Income tax expense....................................... $1,001 $171 $ 369 ====== ==== ======
F-15 119 MERCER MUTUAL INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (9) 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 generally accepted accounting principles (GAAP), is as follows:
NET INCOME: 1997 1996 1995 ----------- ------ ---- ------ (DOLLARS IN THOUSANDS) Statutory net income....................................... $2,129 $809 $1,219 Deferred policy acquisition................................ 30 (167) (174) Deferred federal income taxes.............................. (83) 120 55 Pension.................................................... 116 (129) 24 Other...................................................... 25 7 14 ------ ---- ------ GAAP net income............................................ $2,217 $640 $1,138 ====== ==== ======
SURPLUS: 1997 1996 1995 -------- ------- ------- ------- (DOLLARS IN THOUSANDS) Statutory surplus..................................... $20,132 $16,087 $14,938 Deferred policy acquisition........................... 3,019 2,989 3,155 Deferred federal income taxes......................... (177) 802 516 Non-admitted assets................................... 177 185 192 Unrealized gain (loss) on fixed income securities..... (50) (682) 192 Other................................................. 135 (99) (30) ------- ------- ------- GAAP surplus.......................................... $23,236 $19,282 $18,963 ======= ======= =======
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). Permitted statutory accounting practices encompass all accounting practices that are not prescribed; such practices differ from state to state, may differ from company to company within a state, and may change in the future. Furthermore, the NAIC has a project to codify statutory accounting practices, the result of which is expected to constitute the only source of "prescribed" statutory accounting practices. Accordingly, that project will likely change the definitions of what comprise prescribed versus permitted statutory accounting practices, and may result in changes to the accounting policies that insurance enterprises use to prepare their statutory financial statements. The effects of any such changes are not presently determinable and will not likely affect financial statements prepared under generally accepted accounting principles. (10) DEMUTUALIZATION In October 1997 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 (demutualization). Under the plan, policyholders and certain other groups will have the opportunity to acquire stock in a newly formed holding company, Mercer Insurance Group, Inc. (MRCR). MRCR will in turn acquire all of the newly issued stock of MMIC upon conversion. Prior to the conversion, MRCR will not engage in any significant operations and will have no assets or liabilities. The demutualization plan is subject to approval from the Pennsylvania Insurance Department and ultimately receipt of sufficient stock subscriptions to effect the transaction. The Group has requested a ruling from the Internal Revenue Service regarding the tax treatment of the demutualization as a tax-free reorganization. In F-16 120 MERCER MUTUAL INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) the event that the plan is executed, the converted companies will be subject to certain insurance laws and regulations specific to stock insurance companies as well as regulations of the Securities and Exchange Commission. Limitations on the payment of dividends and Insurance Holding Company regulations are among the types of regulatory requirements with which the Group will have to comply. Assuming the conversion were complete as of December 31, 1997, dividends and other distributions in 1997 to MRCR from MMIC would be limited to approximately $2,000 without prior approval of the Insurance Department. (11) FAIR AUTOMOBILE INSURANCE REFORM ACT OF 1990 The Fair Automobile Insurance Reform Act of 1990 (FAIRA) substantially reformed various aspects of the State of New Jersey s motor vehicle system. As a result of this legislation, the Group has paid $410, $420 and $467 in 1997, 1996 and 1995, respectively, as its share of the funding of the New Jersey Full Insurance Underwriting Association (the JUA). The amounts represent the sixth, seventh and eighth installments of eight to be paid toward funding the JUA. Such amounts are based on the premiums written in New Jersey. F-17 121 MERCER MUTUAL INSURANCE COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS AS OF SEPTEMBER 30, 1998 AND DECEMBER 31, 1997 (DOLLARS IN THOUSANDS)
SEPTEMBER 30, DECEMBER 31, 1998 1997 ------------- ------------ (UNAUDITED) ASSETS Investments, at fair value: Fixed income securities, available-for-sale............... $36,074 $34,947 Equity securities......................................... 12,867 10,852 ------- ------- Total investments...................................... 48,941 45,799 Cash and cash equivalents................................... 7,035 2,707 Premiums receivable......................................... 3,688 3,334 Reinsurance receivables..................................... 9,297 13,206 Prepaid reinsurance Premiums................................ 479 3,046 Deferred policy acquisition costs........................... 3,906 3,019 Accrued investment income................................... 443 625 Property and equipment, net................................. 1,512 1,413 Other assets................................................ 1,418 936 ------- ------- Total assets........................................... $76,719 $74,085 ------- ------- LIABILITIES AND SURPLUS Liabilities: Losses and loss adjustment expenses....................... $30,331 $31,872 Unearned premiums......................................... 15,780 14,723 Accounts payable and accrued expenses..................... 2,820 2,417 Deferred income taxes..................................... 310 177 Other reinsurance balances................................ 886 835 Other liabilities......................................... 756 825 ------- ------- Total liabilities...................................... 50,883 50,849 ------- ------- Surplus: Unassigned surplus........................................ 22,655 20,693 Accumulated other comprehensive income: Unrealized gains in investments, net of deferred income taxes................................................. 3,181 2,543 ------- ------- Total surplus.......................................... 25,836 23,236 ------- ------- Total liabilities and surplus.......................... $76,719 $74,085 ======= =======
F-18 122 MERCER MUTUAL INSURANCE COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENT OF EARNINGS NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997 (DOLLARS IN THOUSANDS)
1998 1997 ------- ------- (UNAUDITED) Revenue: Net premiums earned....................................... $17,110 $13,288 Investment income, net of expenses........................ 1,656 1,793 Net realized investment gains............................. 368 483 Other revenue............................................. 124 144 ------- ------- Total revenue..................................... 19,258 15,708 ------- ------- Expenses: Losses and loss adjustment expenses....................... 8,739 8,038 Amortization of deferred policy acquisition costs......... 4,836 3,533 Other expenses............................................ 2,755 1,928 ------- ------- Total expenses.................................... 16,330 13,499 ------- ------- Income before income tax.................................... 2,928 2,209 Income tax.................................................. 966 694 ------- ------- Net income.................................................. $ 1,962 $ 1,515 ------- -------
F-19 123 MERCER MUTUAL INSURANCE COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CHANGES IN SURPLUS NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997 (DOLLARS IN THOUSANDS)
1998 1997 ------- ------- (UNAUDITED) Balance, beginning of period................................ $23,236 $19,282 Net income.................................................. 1,962 1,515 Other comprehensive income, net of tax: Unrealized gains on securities: Unrealized holding gains arising during period (net of related income tax expense of $453, and $750)......... 880 1,468 Less: Reclassification adjustment for gains included in net income (net of related income tax expense of $125 and $164)........................................... (242) (319) ------- ------- 638 1,149 ------- ------- Comprehensive income...................................... 2,600 2,664 ------- ------- Balance, end of period...................................... $25,836 $21,946 ------- -------
F-20 124 MERCER MUTUAL INSURANCE COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOW NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997 (DOLLARS IN THOUSANDS)
1998 1997 -------- ------- (UNAUDITED) Cash flows from operating activities: Net income................................................ $ 1,962 $ 1,515 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation of property and equipment................. 104 84 Net accretion of discount.............................. (29) (39) Net realized investment gain........................... (367) (483) Deferred income tax.................................... (195) (22) Change in assets and liabilities: Premiums receivable.................................. (354) (1,139) Reinsurance receivables.............................. 3,909 5,020 Prepaid reinsurance premiums......................... 2,567 (2,002) Deferred policy acquisition costs.................... (886) 81 Other assets......................................... (301) 290 Losses and loss expenses............................. (1,541) (2,409) Unearned premiums.................................... 1,058 1,617 Other liabilities.................................... 484 (2,628) -------- ------- Net cash provided by (used in) operating activities....................................... 6,411 (115) -------- ------- Cash flows from investing activities: Purchase of fixed income securities, available-for-sale... (11,529) (6,695) Purchase of equity securities............................. (6,042) (5,477) Sale and maturity of fixed income securities available-for-sale..................................... 11,069 6,784 Sale of equity securities................................. 4,722 5,235 Change in receivable/payable for securities............... (100) (60) Purchase of property and equipment........................ (203) (81) -------- ------- Net cash provided by (used in) investing activities.......................................... (2,083) (294) -------- ------- Net increase in cash and cash equivalents............ 4,328 (409) Cash and cash equivalents at beginning of period............ 2,707 2,675 -------- ------- Cash and cash equivalents at end of period.................. $ 7,035 $ 2,266 -------- ------- Cash paid during the year for: Interest.................................................. $ 0 $ 0 Income taxes.............................................. $ 1,462 $ 730
F-21 125 No dealer, salesman or any other person has been authorized to give any information or to make any representation other than as contained in this Prospectus in connection with the offering made hereby, and, if given or made, such information shall not be relied upon as having been authorized by the Company, Mercer Mutual, or Sandler O'Neill. This Prospectus does not constitute an offer to sell or a solicitation of an offer to buy any of the securities offered hereby to any person in any jurisdiction in which such offer or solicitation is not authorized or in which the person making such offer or solicitation is not qualified to do so, or to any person to whom it is unlawful. Neither the delivery of this Prospectus nor any sale hereunder shall under any circumstances create any implication that there has been no change in the affairs of the Company or Mercer Mutual, since the date as of which information is furnished herein or since the date hereof. TABLE OF CONTENTS
PAGE ---- Prospectus Summary.......................................... 6 Mercer Mutual Selected Consolidated Financial Data.......... 17 Risk Factors................................................ 20 Use of Proceeds............................................. 30 Dividend Policy............................................. 31 Market for the Common Stock................................. 32 Capitalization.............................................. 33 Pro Forma Data.............................................. 34 Management's Discussion and Analysis of Financial Condition 40 and Results of Operations................................. Business.................................................... 50 Management of the Company................................... 71 The Conversion.............................................. 76 Certain Restrictions on Acquisition of the Company.......... 92 Description of Capital Stock................................ 95 Transfer Agent and Registrar................................ 97 Legal Opinions.............................................. 97 Experts..................................................... 97 Available Information....................................... 97 Glossary of Selected Insurance Terms........................ 98 Index to Consolidated Financial Statements.................. F-1
Until , 1999, or days after commencement of the Syndicated Community Offering, if any, whichever is later, all dealers effecting transactions in the registered securities, whether or not participating in this distribution, may be required to deliver a prospectus. This is in addition to the obligation of dealers to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions. 126 MERCER INSURANCE GROUP, INC. (PROPOSED HOLDING COMPANY FOR MERCER MUTUAL INSURANCE COMPANY) UP TO 3,392,500 SHARES COMMON STOCK ------------------------ PROSPECTUS ------------------------ SANDLER O'NEILL & PARTNERS, L.P. JANUARY , 1999 127 PART II INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 13. OTHER EXPENSE OF ISSUANCE AND DISTRIBUTION. The Company anticipates the following expenses: SEC registration fee........................................ $ 11,120 Printing, postage, and mailing*............................. $ 350,000 Legal fees and expenses*.................................... $ 500,000 Accounting fees and expenses*............................... $ 220,000 Appraisal fees and expenses................................. $ 250,000 Blue sky fees and expenses (including counsel fees)*........ $ 25,000 Transfer and conversion agent fees and expenses*............ $ 100,000 Miscellaneous*.............................................. $ 124,880 ---------- Total..................................................... $1,581,000 ==========
- --------------- * 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 (1) the director has breached or failed to perform the duties of his/ her office; and (2) the breach or failure to perform constitutes self-dealing, willful misconduct or recklessness. The Bylaws of the Company provide for (1) indemnification of directors, officers, employees, and agents of the Company and its subsidiaries; and (2) the elimination of a director's liability for monetary damages, each to the fullest extent permitted by Pennsylvania law. Directors and officers are also insured against certain liabilities for their actions as such by an insurance policy obtained by the Company. ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES. Not applicable. ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES. (a) Exhibits: 1.1 Form of Agency Agreement among the Company, Mercer Mutual and Sandler O'Neill 2.1 Plan of Conversion, dated as of October 17, 1997, as amended and restated on May 13, 1998, of Mercer Mutual Insurance Company** 3.1.1 Articles of Incorporation of Mercer Insurance Group, Inc.** 3.1.2 Articles of Amendment to Articles of Incorporation of Mercer Insurance Group, Inc.** 3.2 Bylaws of Mercer Insurance Group, Inc.** 4.1 Form of certificate evidencing shares of Mercer Insurance Group, Inc.**
II-1 128 5. Opinion of Stevens & Lee re: Legality** 10.1 Mercer Insurance Group, Inc. Employee Stock Ownership Plan** 10.2 Employment Agreement, dated as of October 1, 1997, among Mercer Insurance Group, Inc., Mercer Mutual Insurance Company and William C. Hart** 10.3 Employment Agreement, dated as of October 1, 1997, among Mercer Insurance Group, Inc., Mercer Mutual Insurance Company and Andrew R. Speaker** 10.4 Consultant's Agreement, dated April 1, 1994, among Mercer Mutual Insurance Company, Mercer Insurance Company and Roland D. Boehm** 10.5 Mercer Mutual Insurance Company Benefit Agreement dated December 11, 1989, as amended. 10.6 Mercer Mutual Insurance Company Corporate Director Deferred Compensation Plan dated April 1, 1986, as amended** 10.7 Employment Agreement, dated as of October 1, 1998, among Mercer Insurance Group, Inc., Mercer Mutual Insurance Company and Paul D. Ehrhardt. 23.1 Consent of KPMG LLP and Report on Schedules (contained in Schedules) 23.2 Consent of Alex Sheshunoff & Company 23.3 Consent of Stevens & Lee (contained in Exhibit 5) 24.1 Power of Attorney** 27.1 Financial Data Schedule 99.1.1 Conversion Valuation Report, as amended through June 4, 1998, prepared for Mercer Mutual Insurance Company by Alex Sheshunoff & Company** 99.1.2 Conversion Valuation Update Report dated August 19, 1998, prepared for Mercer Mutual Insurance Company by Alex Sheshunoff & Company** 99.1.3 Conversion Valuation Update Report dated December 28, 1998, prepared for Mercer Mutual Insurance Company by Alex Sheshunoff & Company 99.2 Stock Order Form** 99.3 Question and Answer Brochures** 99.4 Letters to prospective purchasers** 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 IV -- Reinsurance. Schedule VI -- Supplemental Information Concerning Property -- Casualty Insurance Operations. II-2 129 INDEPENDENT AUDITOR'S CONSENT AND REPORT ON SCHEDULES The Board of Directors Mercer Mutual Insurance Company: The audits referred to in our report dated February 18, 1998 included the related financial statement schedules as of December 31, 1997, and for each of the years in the three-year period ended December 31, 1997, 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 basic 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 report included herein and to the reference to our firm under the heading "Experts" in the prospectus. /s/ KPMG LLP Philadelphia, Pennsylvania January 8, 1999 II-3 130 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, 1997
COLUMN C COLUMN D COLUMN A COLUMN B MARKET BALANCE TYPE OF INVESTMENT COST VALUE SHEET - ------------------ -------- -------- -------- (DOLLARS IN THOUSANDS) Fixed maturities: Bonds: United States Government and government agencies and authorities............................................ $31,203 $31,031 $31,031 States, municipalities and political subdivisions......... 3,396 3,517 3,517 All other................................................. 548 555 555 ------- ------- ------- Total fixed maturities................................. 35,147 35,103 35,103 ======= ======= ======= Equity securities: Common stocks Public utilities....................................... 102 111 111 Banks, trust and insurance companies................... 842 3,472 3,472 Industrial, miscellaneous and all other................ 5,854 7,113 7,113 ------- ------- ------- Total equity securities.............................. 6,798 10,696 10,696 ======= ======= ======= Total investments.................................... $41,945 xxxxxx $45,799 ======= =======
II-4 131 MERCER MUTUAL INSURANCE COMPANY AND SUBSIDIARIES FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 SCHEDULE IV -- REINSURANCE
COLUMN D COLUMN F COLUMN C ASSUMED PERCENTAGE COLUMN B CEDED TO FROM COLUMN E OF AMOUNT COLUMN A GROSS OTHER OTHER NET ASSUMED PREMIUMS AMOUNT COMPANIES COMPANIES AMOUNT TO NET - -------- -------- --------- --------- -------- ---------- (DOLLARS IN THOUSANDS) For the year ended December 31, 1997............................... 26,858 9,487 598 17,969 3.3% For the year ended December 31, 1996............................... 24,760 14,412 10,286 20,634 49.8% For the year ended December 31, 1995............................... 24,700 13,686 9,803 20,817 47.1%
II-5 132 MERCER MUTUAL INSURANCE COMPANY AND SUBSIDIARIES FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 SCHEDULE VI -- SUPPLEMENTAL INFORMATION
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E COLUMN F COLUMN G DEFERRED RESERVE FOR DISCOUNT POLICY LOSSES AND IF ANY NET NET AFFILIATION WITH ACQUISITION LOSS ADJ. DEDUCTED IN UNEARNED EARNED INVESTMENT REGISTRANT COSTS EXPENSES COLUMN C PREMIUMS PREMIUMS INCOME ---------------- ----------- ----------- ----------- -------- -------- ---------- (DOLLARS IN THOUSANDS) Consolidated Property and Casualty Entities For the year ended December 31, 1997...... 3,019 31,872 0 14,723 17,969 2,350 For the year ended December 31, 1996...... 2,989 35,221 0 13,179 20,634 2,289 For the year ended December 31, 1995...... 3,155 36,176 0 18,253 20,817 2,132
COLUMN I COLUMN K COLUMN H COLUMN J LOSSES AND LAE PAID INCURRED LOSSES AND ------------------ LOSS NET CURRENT PRIOR AMORTIZATION ADJUSTMENT WRITTEN YEAR YEAR OF DPAC EXPENSES PREMIUMS -------- ------ ------------ ---------- -------- (DOLLARS IN THOUSANDS) Consolidated Property and Casualty Entities For the year ended December 31, 1997... 11,649 (1,055) 4,706 10,817 17,461 For the year ended December 31, 1996... 16,445 (1,644) 5,491 14,084 20,124 For the year ended December 31, 1995... 14,251 (955) 5,944 12,237 21,245
II-6 133 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; 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-7 134 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, the Registrant has duly caused this Pre-Effective Amendment No. 5 to Registration Statement No. 333-41497 to be signed on its behalf by the undersigned, thereunto duly authorized, in the Borough of Pennington, State of New Jersey, on January 11, 1999. MERCER INSURANCE GROUP, INC. By: /s/ ANDREW R. SPEAKER ------------------------------------ Andrew R. Speaker, Executive Vice President and Chief Operating Officer Pursuant to the requirements of the Securities Act of 1933, this Pre-Effective Amendment No. 5 to Registration Statement No. 333-41497 has been signed below by the following persons in the capacities and on the dates indicated.
SIGNATURE CAPACITY DATE --------- -------- ---- /s/ WILLIAM C. HART* President, Chief Executive January 11, 1999 - ----------------------------------------------------- Officer, and Director William C. Hart (Principal Executive Officer) /s/ ROLAND D. BOEHM* Vice Chairman of the Board of January 11, 1999 - ----------------------------------------------------- Directors Roland D. Boehm /s/ JAMES J. FREDA* Director January 11, 1999 - ----------------------------------------------------- James J. Freda /s/ GEORGE T. HORNYAK, JR.* Director January 11, 1999 - ----------------------------------------------------- George T. Hornyak, Jr. /s/ RICHARD U. NIEDT* Director January 11, 1999 - ----------------------------------------------------- Richard U. Niedt /s/ RICHARD G. VAN NOY* Chairman of the Board of January 11, 1999 - ----------------------------------------------------- Directors Richard G. Van Noy
II-8 135
SIGNATURE CAPACITY DATE --------- -------- ---- /s/ ANDREW R. SPEAKER Executive Vice President, January 11, 1999 - ----------------------------------------------------- Chief Operating Officer, Andrew R. Speaker Chief Financial Officer, Treasurer and Director (Principal Financial and Accounting Officer) *By /s/ ANDREW R. SPEAKER ------------------------------------------------- Andrew R. Speaker Attorney-in-fact
II-9 136 EXHIBIT INDEX
NUMBER TITLE - ------ ----- 1.1 Form of Agency Agreement among the Company, Mercer Mutual and Sandler O'Neill 2.1 Plan of Conversion, dated as of October 17, 1997, as amended and restated on May 13, 1998, of Mercer Mutual Insurance Company** 3.1.1 Articles of Incorporation of Mercer Insurance Group, Inc.** 3.1.2 Articles of Amendment to Articles of Incorporation of Mercer Insurance Group, Inc.** 3.2 Bylaws of Mercer Insurance Group, Inc.** 4.1 Form of certificate evidencing shares of Mercer Insurance Group, Inc.** 5. Opinion of Stevens & Lee re: Legality** 10.1 Mercer Insurance Group, Inc. -- Employee Stock Ownership Plan** 10.2 Employment Agreement, dated as of October 1, 1997, among Mercer Insurance Group, Inc., Mercer Mutual Insurance Company and William C. Hart** 10.3 Employment Agreement, dated as of October 1, 1997, among Mercer Insurance Group, Inc., Mercer Mutual Insurance Company and Andrew R. Speaker** 10.4 Consultant's Agreement, dated April 1, 1994, among Mercer Mutual Insurance Company, Mercer Insurance Company and Roland D. Boehm** 10.5 Mercer Mutual Insurance Company Benefit Agreement dated December 11, 1989, as amended. 10.6 Mercer Mutual Insurance Company Corporate Director Deferred Compensation Plan dated April 1, 1986, as amended.** 10.7 Employment Agreement, dated as of October 1, 1998, among Mercer Insurance Group, Inc., Mercer Mutual Insurance Company and Paul D. Ehrhardt. 23.1 Consent of KPMG LLP and Report on Schedules (contained in Schedules) 23.2 Consent of Alex Sheshunoff & Company 23.3 Consent of Stevens & Lee (contained in Exhibit 5) 24.1 Power of Attorney** 27.1 Financial Data Schedule 99.1.1 Conversion Valuation Report, as amended through June 4, 1998, prepared for Mercer Mutual Insurance Company by Alex Sheshunoff & Company** 99.1.2 Conversion Valuation Update Report dated August 19, 1998, prepared for Mercer Mutual Insurance Company by Alex Sheshunoff & Company** 99.1.3 Conversion Valuation Update Report dated December 28, 1998, prepared for Mercer Mutual Insurance Company by Alex Sheshunoff & Company 99.2 Stock Order Form** 99.3 Question and Answer Brochures** 99.4 Letters to prospective purchasers** 99.5 Mercer Mutual Insurance Company Policyholder Information Statement**
- --------------- ** Previously Filed II-10 EX-1.1 2 FORM OF AGENCY AGREEMENT 1 EXHIBIT 1.1 Up to 3,769,444 Shares MERCER INSURANCE GROUP, INC (a Pennsylvania corporation) Common Stock (no par value per share) AGENCY AGREEMENT ____________, 1999 SANDLER O'NEILL & PARTNERS, L.P. Two World Trade Center, 104th Floor New York, New York 10048 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 3,769,444 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 subsidiary, Queenstown Holding Company ("QHC"), the holding company for Mercer Insurance Company of New Jersey, Inc. ("MIC," and collectively with QHC and Mercer Mutual, 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 2 insureds under policies of insurance issued by Mercer Mutual and in force as of the close of business on October 17, 1997 ("Eligible Policyholders"), (ii) a tax-qualified employee stock ownership plan of the Company (the "ESOP"), and (iii) directors, officers and employees of the Mercer Mutual. Subscription rights in any category will be subordinated to subscription rights in a prior category. Concurrently, and 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 October 17, 1997, and (v) providers of goods and services to, and identified by, Mercer Mutual. 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 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. 333-41497), 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. Concurrently with the execution of this Agreement, the Company is delivering to 3 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 "Market for Common Stock," the first two paragraphs of the section "The Conversion--Marketing and Underwriting Arrangements" and the first and third paragraphs of the section "Syndicated Community Offering," and as such information is summarized elsewhere therein). (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 October 20, 1998, 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. 4 (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 Prospectus or any supplemental sales literature authorized by the Company or Mercer Mutual for use in connection with the Offerings. (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) Alex Sheshunoff & Co., 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 Sheshunoff 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. (viii) The only subsidiaries of Mercer Mutual are QHC and MIC. 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 5 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. (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 States of Pennsylvania and New Jersey. MIC has 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. Except as disclosed in the Prospectus, the authority of each of Mercer Mutual and MIC 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 6 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, 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 100,000 shares of common stock, par value $40.00 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; 7 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. (xv) All of the issued and outstanding capital stock of QHC and MIC 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. (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 8 enterprise; and there are no contracts or documents of the Company, Mercer Mutual or any of the Mercer Companies which are required to be filed as exhibits to the Registration Statement or the Conversion Application which have not been so filed. (xx) The 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; 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 9 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 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) 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 10 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. (xxix) The Company and the Mercer Companies have filed all federal income and state and local 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. (xxx) The Company has received approval, subject to completion of the Conversion, to have the Securities quoted on the National Market Tier of the Nasdaq Stock Market ("Nasdaq Stock Market") effective as of the Closing Time referred to in Section 2 hereof. (xxxi) 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 has requested that such registration statement be effective concurrent with the effectiveness of the Registration Statement. (xxxii) 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. (xxxiii) 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. (xxxiv) Except as described in the Prospectus, there are no contractual encumbrances or contractual 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 11 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. (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 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 12 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 State Street Bank and 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 Wayne, Pennsylvania offices of Stevens & Lee, at 10:00 a.m., local 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: (a) two percent (2%) 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, and (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 13 (b) 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 two percent (2%) 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: (a) 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 Alex Sheshunoff & Co. 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 14 moment. (b) 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. (c) 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. (d) 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 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. (e) 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. (f) 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 15 qualification in effect for a period of not less than one year from the effective date of the Registration Statement. (g) 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"). (h) 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. (i) 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. (j) 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. (k) 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. (l) 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." (m) The Company will file with the Commission such reports on Form SR as may be required pursuant to Rule 463 of the Securities Act Regulations, if such report or 16 substantially similar report is required by the SEC. (n) The Company will file with the Nasdaq Stock Market all documents and notices required by the rules of the (i) Nasdaq Stock Market for companies (i) that have issued securities that are traded in the over-the-counter market and (ii) quotations for which are reported by the Nasdaq Stock Market. (o) 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." (p) 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. (q) During the period beginning on the date hereof and ending on the third 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 third 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. (r) 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. (s) 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 by the Agent. (t) 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 Peat Marwick 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 Peat Marwick LLP, as stated in their letters to be furnished pursuant to subsections (e) and (f) of Section 5 hereof. 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 printing and filing of the Registration Statement 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 17 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 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, (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 $75,000. 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: (a) 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. (b) 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: 18 (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 carry on an insurance business pursuant to and to the extent of the certificates of authority issued under the laws of the States of Pennsylvania and New Jersey; MIC has 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; 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, 19 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, 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. (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 a 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. 20 (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) 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," "The Conversion--Tax Effects," "Certain Restrictions on Acquisition of the Company" and "Description of 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, the descriptions thereof or references thereto are correct in all material respects. 21 (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, except as disclosed in writing by Mercer Mutual to the Agent and its counsel. (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 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 22 (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. (c) 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. (d) 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 23 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, other than the appeal of the Department's Order Nos. ID-RC-98-24 and ID-RC-98-25 (the "Orders") filed by Franklin Mutual Insurance Company ("Franklin") with the Department on October 27, 1998 and the Petition for Review filed on November 9, 1998 by Franklin with the Pennsylvania Commonwealth Court with respect to the Orders, 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. (e) At the time of the execution of this Agreement, the Agent shall have received from KPMG Peat Marwick 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 Peat Marwick 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 September 30, 1998 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 24 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. (f) At Closing Time, the Agent shall have received from KPMG Peat Marwick 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. (g) At Closing Time, the Securities shall have been approved for listing on the Nasdaq Stock Market upon notice of issuance. (h) At Closing Time, the Agent shall have received a letter from Alex Sheshunoff & Company, dated as of the Closing Time, confirming its appraisal. (i) 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. (j) 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 the effect of which it, in the reasonable judgment of the Agent, are 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. (a) The Company and Mercer Mutual, jointly and severally, agree to indemnify and hold harmless the Agent, 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, 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, related to or arising out of the Conversion or any action taken by the Agent where acting as agent of the Company or Mercer Mutual or otherwise 25 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 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; 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). (b) 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. (c) Each indemnified party shall give notice as promptly as reasonably 26 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 be liable for any loss, liability, claim, damage and expense incurred in connection with the settlement of any action, proceeding or suit which is effected without the consent of the indemnifying party. (d) 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. (e) 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. 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 27 (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. 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. (a) 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 the effect of which, in the reasonable judgment of the Agent, are 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 Alex Sheshunoff & Co. 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). 28 (b) 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 Two World Trade Center, 104th Floor, New York, New York 10048, attention of Catherine A. Lawton, Principal (with a copy to John S. Chapman, 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 William C. Hart, President (with a copy to Jeffrey P. Waldron, Esq., Stevens & Lee, 1275 Drummers Lane, Wayne, Pennsylvania 19087). 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 October 23, 1997, 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. 29 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. 30 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-10.5 3 MERCER MUTUAL INS. CO. BENEFIT AGREEMENT 12-11-89 1 MERCER MUTUAL INSURANCE COMPANY BENEFIT AGREEMENT THIS AGREEMENT, made and entered into effect this 11th day of December, 1989, to be effective January 1, 1990, by and between the Mercer Mutual Insurance Company, a Corporation organized and existing under the laws of the State of New Jersey, hereinafter called the Corporation, and the Board of Directors of the Corporation: WITNESSETH: WHEREAS, it is the consensus of the Board of Directors that the Affected Members' Service to the Corporation in the past has been of exceptional merit and has constituted an invaluable contribution to the general welfare of the Corporation and in bringing it to its present status of operating efficiency, and its present position in its field of activity; and, WHEREAS, the experience and knowledge of the Affected Members of the affairs of the Corporation, is so valuable that assurance of their continued services being essential for the future growth and profits of the Corporation, and it is in the best interests of the Corporation to arrange terms of continued service for the Affected Members so as to reasonably assure their remaining with the Corporation during their lifetime or until the age of retirement; and, WHEREAS, it is the desire of the Corporation that their services be retained as herein provided; and, WHEREAS, the Affected Members are willing to continue their service to the Corporation provided the Corporation agrees to pay to them or their beneficiaries certain benefits in accordance with the terms and conditions hereinafter set forth; NOW, THEREFORE, in consideration of services performed in the past and to be performed in the future, as well as of the mutual promises and covenants herein contained, it as agreed as follows: - 1 - 2 ARTICLE ONE 1.1 EMPLOYMENT. The Corporation agrees to engage the Affected Members as appointees of the Board of Directors as the Corporation will determine by Election or appointment. The Affected Members will continue service to the Corporation in such capacity and with such duties and responsibilities and with such compensation as may be determined from time to time by the Board of Directors of the Corporation. The benefits provided by this Agreement are granted by the Corporation as a fringe benefit to the Affected Members and are not part of any salary reduction plan or an arrangement deferring a bonus or a salary increase. The Affected Members have no option to take any current payment or bonus in lieu of these benefits. ARTICLE TWO DEFINITIONS 2.1 "Affected Members" means those individuals who are designated as being a Member of the Board of Directors of the Corporation and a participant under this Agreement as evidenced by the Schedule A attached, and as the Schedule may be amended from time to time. 2.2 "Compensation" means the monthly Director's Retainer fee as designated by the Board of Directors. 2.3 "Early Retirement Date" means the first day of the month coinciding with or next following the attainment of age 65 and the completion of at least 10 Years of Service. Members of the Board of Directors who were elected or appointed prior to January 1, 1990, may retire at anytime. 2.4 "Normal Form of Benefit" means an annuity expressed as a ten year certain annuity (no life thereafter). In addition, the Affected Members shall also be permitted to elect a lump sum option on the value of the annuity at his Retirement Date. 2.5 "Normal Retirement Date" means the first day of the month coinciding with or next following the attainment of age 75 and the completion of at least 10 Years of Service. Members of the Board of Directors who were elected or appointed prior to January 1, 1990, may retire at any time. - 2 - 3 ARTICLE THREE 3.1 RETIREMENT BENEFIT. If the Affected Members shall continue in the service of the Corporation until attaining the age of seventy-five (75) and 10 Years of Service, they may retire from service as of the first day of the month next following attainment of age 75 and 10 Years of Service or upon such later date as may be mutually agreed upon by the Affected Members and the Corporation. The Corporation agrees that upon such retirement it will pay to the Affected Member a pension equal to the monthly Director's Retainer Fee which is in effect at the time of such Affected Member's Retirement Date, and such benefit shall not be indexed beyond that date. Notwithstanding the foregoing, said Director's Retainer Fee may be indexed after the effective date of this Agreement and prior to the Affected Member's Retirement Date. Each Affected Member who is appointed or elected to the Board of Directors prior to January 1, 1990, shall be eligible to receive the benefit set forth in the paragraph above regardless of age or service requirements. 3.2 DEATH BENEFIT. The Corporation agrees that if the Affected Member shall retire and then die before he has received 120 monthly payments, it will pay a death benefit to his designated beneficiary or surviving spouse. The death benefit will be equal to the amount calculated pursuant to Section 3.1, to be paid to the surviving spouse or designated beneficiary, with no more than 120 payments being made to the Affected Member and his designated beneficiary or surviving spouse. In addition, the surviving spouse or designated Beneficiary shall also have the option to elect a lump sum distribution on the value of the annuity based on the total of the monthly payments left after the Affected Member dies. If the Affected Member dies before he retires, his surviving spouse or designated beneficiary shall receive a death benefit equal to the accumulated funds contributed under this Agreement to provide such Affected Member with a retirement benefit pursuant to Section 3.1. ARTICLE FOUR 4.1 ALIENABILITY. Neither the Affected Members, their widows, nor any other beneficiary under this Agreement shall have the power or right to transfer, assign, anticipate, hypothecate, mortgage, commute, modify, or otherwise encumber in advance any of the benefits payable hereunder, nor shall any of said benefits be subject to seizure for the payment of debts, judgments, alimony or separate maintenance, owed by the Affected Members or their beneficiaries or any of them, or be transferable by operation of law in the event of bankruptcy, insolvency, or otherwise. In the event the Affected Members or any beneficiaries attempt assignment, - 3 - 4 commutation, hypothecation, transfer, or disposal of the benefit hereunder the Corporation's liabilities shall forthwith cease and terminate. ARTICLE FIVE 5.1 PARTICIPATION IN OTHER PLANS. Nothing contained in this Agreement shall be construed to alter, abridge, or in any manner affect the rights and privileges of Affected Members to participate in and be covered by any Pension, Profit Sharing, Group Insurance, Deferred Compensation, Bonus or similar employee plans which the Corporation may now or hereafter sponsor for their benefit. ARTICLE SIX 6.1 FUNDING. The Corporation reserves the right at its sole and exclusive discretion either to fund the obligations of the Corporation undertaken by this Agreement or to refrain from funding the same, and to determine the extent, nature, and method of such funding. At no time shall the Affected Members be deemed to have any right, title or interest in or to any specified asset or assets of the Corporation. 6.2 This Article shall not be construed as giving the Affected Members or their beneficiaries any greater rights than those of any other unsecured creditor of the Corporation. ARTICLE SEVEN 7.1 REORGANIZATION. If the Corporation shall merge or consolidate into or with another corporation, or reorganize, or sell substantially all of its assets to another corporation, firm, or person, such succeeding or continuing corporation, firm, or person may agree to assume and discharge the obligations of the Corporation under this Agreement. Upon the occurrence of such event, the term "Corporation" as used in this Agreement shall be deemed to refer to such successor or survivor Corporation. However, if such successor or survivor Corporation does not agree to assume the obligations of the Corporation under this Agreement, all benefits under this Agreement shall become immediately vested and the funded amount will be payable to the Affected Members in a lump sum on the effective date of the reorganization. ARTICLE EIGHT 8.1 NOT A CONTRACT OF EMPLOYMENT. This Agreement shall not be deemed to constitute a contract of service between parties hereto, nor shall any provision hereof restrict the right of the Corporation to discharge the Affected Members, or restrict the right of the Affected Members to terminate their service. - 4 - 5 ARTICLE NINE 9.1 CLAIMS PROCEDURE. In the event that benefits under this Plan Agreement are not paid to the Affected Members (or their beneficiaries in the case of the Affected Members' death), and such person feels entitled to receive them, a claim shall be made in writing to the Plan Administrator. Such claims shall be reviewed by the Plan Administrator and the Corporation. If the claim is denied, in full or in part, the Plan Administrator shall provide a written notice within ninety (90) days setting forth the specific reasons for denial, specific reference to the provisions of this Agreement upon which the denial is based, and any additional material or information necessary to perfect the claim, if any. Also, such written notice shall indicate the steps to be taken if a review of the denial is desired. If a claim is denied and a review is desired, the Affected Members (or their beneficiaries in the case of the Affected Members' death), shall notify the Plan Administrator in writing within sixty (60) days and a claim shall be deemed denied if the Plan Administrator does not take any action within the aforesaid ninety (90)-day period. In requesting a review, the Affected Members (or their beneficiaries) may review this Plan Agreement or any documents relating to it and submit any written issues and comments he or she may feel appropriate. In its sole discretion, the Plan Administrator shall then review the claim and provide a written decision within sixty (60) days. This decision likewise shall state the specific reasons for the decision and shall include reference to specific provisions of this Plan Agreement on which the decision is based. For purposes of implementing this claims procedure (but not for any other purpose), the Board of Directors of Mercer Mutual Insurance Company are hereby designated as the Named Fiduciary and Plan Administrator of this Agreement. ARTICLE TEN 10.1 ARBITRATION. In the event of any dispute, controversy or misunderstanding arising between the parties hereto, which may, directly or indirectly concern or involve any of the terms, covenants or conditions hereof, the parties agree that such controversy shall be settled by arbitration in the Borough of Pennington, New Jersey in accordance with the Rules of American Arbitration Association. One arbitrator shall be named by each party involved in the dispute and then an additional arbitrator shall be named by the arbitrators so chosen. Judgment upon the award rendered by the arbitrators may be entered in any court having jurisdiction thereof. The costs of the arbitration shall be borne by the party or parties designated by the arbitrators. - 5 - 6 IN WITNESS WHEREOF, the Corporation has caused this Agreement to be duly executed by its designated representative, and its Corporate seal affixed, duly attested by its Secretary, Marion J. Crum this 14th day December, 1998. FOR MERCER MUTUAL INSURANCE COMPANY /s/ WILLIAM C. HART ----------------------------- Name President ----------------------------- Title ATTEST: /s/ MARION J. CRUM - ------------------------------ Secretary DEBRA A. HARTINGALE - ------------------------------ Witness - 6 - 7 SCHEDULE A Attachment to Mercer Mutual Insurance Company Benefit Agreement Affected Members - -------------------------------------------------------------------------------- YEAR FIRST ELECTED OR NAME DATE OF BIRTH APPOINTED - -------------------------------------------------------------------------------- Roland D. Boehm 12/09/37 1980 - -------------------------------------------------------------------------------- James J. Freda 04/08/21 1985 - -------------------------------------------------------------------------------- William C. Hart 03/15/33 1970 - -------------------------------------------------------------------------------- George T. Hornyak, Jr. 01/26/50 1985 - -------------------------------------------------------------------------------- Richard U. Niedt 08/24/31 1979 - -------------------------------------------------------------------------------- Eric W. Turner, Jr. 09/24/21 1968 - -------------------------------------------------------------------------------- Richard G. Van Noy 05/23/41 1979 - -------------------------------------------------------------------------------- EX-10.7 4 EMPLOYMENT AGREEMENT, DATED AS OF OCTOBER 1, 1998 1 Exhibit 10.7 EMPLOYMENT AGREEMENT AGREEMENT made as of the 1st day of October, 1998, by and between MERCER MUTUAL INSURANCE COMPANY, a Pennsylvania corporation, MERCER INSURANCE GROUP, INC., a Pennsylvania corporation, and PAUL D. EHRHARDT. Mercer Mutual Insurance Company and Mercer Insurance Group, Inc. both desire to employ Mr. Ehrhardt, and Mr. Ehrhardt is willing to serve Mercer Mutual Insurance Company and Mercer Group, Inc. on the terms and conditions herein provided. In order to effect the foregoing, the parties hereto desire to enter into an employment agreement on the terms and conditions set forth below. Accordingly, in consideration of the premises and the respective covenants and agreements of the parties contained herein, and intending to be legally bound hereby, the parties hereto agree as follows: 1. DEFINITIONS AND SPECIAL PROVISIONS. Each capitalized word and term used herein shall have the meaning ascribed to it in the glossary appended hereto, unless the context in which such word or term is used otherwise clearly requires. Such glossary is incorporated herein by reference and made a part hereof. In addition, until such time as Mercer converts from mutual to stock form and the Company acquires all of the common stock, the provisions set forth at Appendix 1 shall apply, notwithstanding anything in this Agreement to the contrary. 2. EMPLOYMENT. Mercer hereby agrees to employ the Executive, and the Executive hereby agrees to serve Mercer, on the terms and conditions set forth herein. 3. TERM OF AGREEMENT. The Executive's employment under this Agreement shall commence on the date hereof and, except as otherwise provided herein, shall continue until October 1, 2001; provided, however, that commencing on October 1, 1999 and each October 1 thereafter, the term of this Agreement shall automatically be extended for one additional year beyond the term otherwise established unless, prior to such October 1st date, Mercer shall not have given a Notice of Extension. 4. POSITION AND DUTIES. The Executive shall serve as Vice President of Mercer and the Company, and he shall have such responsibilities, duties and authority as may, from time to time, be generally associated with such positions. In addition, the Executive shall serve in such capacity, with respect to each Subsidiary or affiliated company, as the Board of Directors of each such Subsidiary or affiliated company shall designate from time to time. During the term of this Agreement, he shall devote substantially all of his working time and efforts to the business 2 and affairs of Mercer, the Subsidiaries and affiliated companies; provided, however, that nothing herein shall be construed as precluding him from devoting a reasonable amount of time to civic, charitable, trade association, and similar activities, at least to the extent he is presently devoting time. 5. COMPENSATION AND RELATED MATTERS. (a) BASE COMPENSATION. During the period of the Executive's employment hereunder, Mercer shall pay to him annual base compensation of $110,000. The Board(s) of Directors of Mercer shall periodically review the Executive's employment performance, in accordance with policies generally in effect from time to time, for possible merit or cost-of-living increases in such base compensation. Except for a reduction which is proportionate to a company-wide reduction in executive pay, the annual base compensation paid to the Executive in any period shall not be less than the annual base compensation paid to him in any prior period. The frequency and manner of payment of such base compensation shall be in accordance with Mercer's executive payroll practices from time to time in effect. Nothing herein shall be construed as precluding the Executive from entering into any salary reduction or deferral plan or arrangement during the term of this Agreement; provided, however, that his base compensation shall be determined without regard to any such salary reduction or deferral for purposes of calculating the amount of any compensation and benefits to which he or his surviving spouse may be entitled under Paragraph 6, 7, 10, or 11 following his termination of employment. The amounts set forth in the first sentence of this subparagraph shall be pro rated to the extent such period is less than a year. (b) INCENTIVE COMPENSATION. During the period of the Executive's employment hereunder, he shall be entitled to participate in all incentive plans, stock option plans, stock appreciation rights plans, and similar arrangements maintained by Mercer for executive officers on a basis and at award levels consistent and commensurate with his position and duties hereunder. (c) EMPLOYEE BENEFIT PLANS AND OTHER PLANS OR ARRANGEMENTS. The Executive shall be entitled to participate in all Employee Benefit Plans of Mercer on the same basis as other executive officers of Mercer. In addition, he shall be entitled to participate in and enjoy any other plans and arrangements which provide for sick leave, vacation, sabbatical, or personal days, company-provided automobile, club memberships and dues, education payment or reimbursement, business-related seminars, and similar fringe benefits provided to or for the executive officers of Mercer from time to time, but at least 2 3 to the extent he is presently entitled to participate in and enjoy such plans and arrangements. (d) EXPENSES. During the period of the Executive's employment hereunder, he shall be entitled to receive prompt reimbursement for all reasonable and customary expenses, including transportation expenses, incurred by him in performing services hereunder in accordance with the general policies and procedures established by Mercer. 6. TERMINATION BY REASON OF DISABILITY. (a) IN GENERAL. In the event the Executive becomes unable to perform his duties on a full-time basis by reason of the occurrence of his Disability and, within 30 days after a Notice of Termination is given, he shall not have returned to the full-time performance of such duties, his employment may be terminated by Mercer. (b) COMPENSATION AND BENEFITS. In the event of the termination of the Executive's employment under Subparagraph (a), Mercer shall pay or provide the compensation and benefits set forth below: (1) The Executive shall be paid an amount per annum equal to the greater of (i) his highest base compensation received during one of the two calendar years immediately preceding the calendar year in which the Date of Termination occurs, or (ii) his base compensation in effect immediately prior to the Date of Termination (or prior to any reduction which entitled him to terminate his employment for Good Reason) for one year beginning with such Date of Termination. The frequency and manner of payment of such amounts shall be in accordance with Mercer's executive payroll practices from time to time in effect. (2) The Executive shall be paid an amount equal to the higher of the aggregate bonus(es) paid to him with respect to one of the two years immediately preceding the year in which the Date of Termination occurs. Such amount shall be paid to him in cash on each of the first and second anniversary dates of the Date of Termination. (3) The Executive shall be paid an amount equal to the highest annual contribution made on his behalf (other than his own salary reduction contributions) to each tax-qualified and non-qualified Defined Contribution Plan of Mercer with respect to the year in which the Date of Termination occurs or one of the two years immediately preceding such year. The amount separately determined for each such plan shall be 3 4 aggregated and shall be paid to him in cash on the first anniversary date of the Date of Termination. (4) The Executive shall accrue benefits equal to the excess of (i) the aggregate retirement benefits he would have received under the terms of each tax-qualified and non-qualified Defined Benefit Plan of Mercer as in effect immediately prior to the Date of Termination had he (A) continued to be employed for one more year, and (B) received (on a pro rated basis, as appropriate) the greater of (I) the highest compensation taken into account under each such plan with respect to one of the two years immediately preceding the year in which the Date of Termination occurs, or (II) his annualized base compensation in effect immediately prior to the Date of Termination (or prior to any reduction which entitled him to terminate his employment for Good Reason), over (ii) the retirement benefits he actually receives under such plans. The frequency, manner and extent of payment of such benefits shall be consistent with the terms of the plans to which they relate and any elections made thereunder. (5) The Executive and his eligible dependents shall be entitled to continue to participate at the same aggregate benefit levels, for one year and at no out-of-pocket or tax cost to him, in the Welfare Benefit Plans in which he was a participant immediately prior to the Date of Termination, to the extent permitted under the terms of such plans and applicable law. To the extent Mercer is unable to provide for continued participation in a Welfare Benefit Plan, it shall provide an equivalent benefit directly at no out-of-pocket or tax cost to him. For purposes of the preceding two sentences, Mercer shall be deemed to have provided a benefit at no tax cost to him if it pays an additional amount to him or on his behalf, with respect to those benefits which would otherwise be nontaxable to him, calculated in a manner consistent with the provisions of Paragraph 12. (c) ADJUSTMENT TO CERTAIN SUBPARAGRAPH (B) COMPENSATION AND BENEFITS. Notwithstanding the provisions of Subparagraph (b)(5), Mercer's obligation to pay or fund any disability insurance premiums on behalf of the Executive shall be suspended while his Disability continues, provided the cessation of payment or funding does not result in the termination of disability benefits. Any amounts otherwise due under Subparagraph (b) shall be reduced (but not below zero) by the dollar amount of disability benefits received by him pursuant to plans or policies funded, directly at its cost, by Mercer. 4 5 (d) EARLIER CESSATION OF CERTAIN WELFARE BENEFITS. Notwithstanding the provisions of Subparagraph (b)(5), Mercer shall not be required to provide, at its cost, the welfare benefits covered therein after the later of (i) the attainment by the Executive and his spouse (if any) of age 65, or (ii) the date specified in the relevant plan document for benefit termination (assuming that he was employed until age 65 or the normal retirement date, if any, specified in such document). (e) DEATH DURING REMAINING TERM OF AGREEMENT. (1) In the event the Executive dies during the remaining term of this Agreement following his termination for Disability and he is survived by a spouse, the compensation and benefits remaining to be paid and provided under Subparagraph (b) shall be unaffected by his death and shall be paid and provided to her or on her behalf; provided, however, that the extent of her rights to the accrued benefits described in Subparagraph (b)(4) shall be determined by reference to the relevant plan provisions and any elections made under such plans; and provided further, that Mercer shall not be required to provide continued benefits with respect to her deceased husband; and provided further, that in no event shall Mercer be required to provide, at its cost, the other welfare benefits described in Subparagraph (b)(5) to such spouse and her eligible dependents after the earlier of (i) her death, or (ii) the later of (A) her attainment of age 65, or (B) the date specified in the relevant plan document for benefit termination (assuming that the Executive was employed until age 65 or the normal retirement date, if any, specified in such document). (2) In the event the Executive dies during the remaining term of this Agreement following his termination for Disability and he is not survived by a spouse, (i) Mercer shall thereafter make the remaining payments described in Subparagraphs (b)(1) through (b)(3) directly to his estate, (ii) the extent of the rights of any person to the accrued benefits described in Subparagraph (b)(4) shall be determined by reference to the relevant plan provisions and any elections made under such plans, and (iii) Mercer's obligation to provide continued benefits under Subparagraph (b)(5) shall terminate. (f) COMPENSATION AND BENEFITS UPON EXPIRATION OF REMAINING TERM OF AGREEMENT. Upon the expiration of the remaining term of this Agreement following the Executive's termination for Disability, and provided his Disability then continues, he shall be entitled to receive the compensation and benefits provided under the terms of Mercer's long-term 5 6 disability plan in effect on the Date of Termination or, if greater, at the expiration of such remaining term. Such compensation and benefits shall continue until the earlier of (i) his death, or (ii) the later of (A) his attainment of age 65, or (B) the date specified in the plan document for benefit termination. To the extent Mercer is unable to provide such compensation and benefits under its long-term disability plan, it shall provide equivalent compensation and benefits directly at no out-of-pocket or tax cost to him. For purposes of the preceding sentence, Mercer shall be deemed to have provided compensation and benefits at no tax cost to him if it pays an additional amount to him or on his behalf, with respect to the compensation and benefits which would otherwise be nontaxable to him, calculated in a manner consistent with the provisions of Paragraph 12. 7. TERMINATION BY REASON OF DEATH. (a) COMPENSATION AND BENEFITS TO SURVIVING SPOUSE. In the event the Executive dies while he is employed under this Agreement and is survived by a spouse, Mercer shall pay or provide the compensation and benefits set forth below: (1) The surviving spouse shall be paid an amount equal to the greater of (i) the Executive's highest base compensation received during one of the two calendar years immediately preceding the calendar year in which the Date of Termination occurs, or (ii) his base compensation in effect immediately prior to the Date of Termination (or prior to any reduction which entitled him to terminate his employment for Good Reason) for a period of one year, beginning with such Date of Termination. The frequency and manner of payment of such amounts shall be in accordance with Mercer's executive payroll practices from time to time in effect. (2) The surviving spouse shall be paid an amount equal to the highest payment made to Executive under each incentive bonus plan of Mercer with respect to one of the two years immediately preceding the year in which the Date of Termination occurs. Such amount shall be paid in cash to her within 30 days after the Date of Termination. (3) The surviving spouse shall be paid an amount equal to the sum of the highest annual contribution made on the Executive's behalf (other than his own salary reduction contributions) to each tax-qualified and non-qualified Defined Contribution Plan of Mercer with respect to the year in which the Date of Termination occurs or one of the two years immediately preceding such year. Such amount shall be paid in cash to her within 30 days after the Date of Termination or 6 7 within 30 days after such amount can first be determined, whichever is later. (4) Subject to the following sentence, the surviving spouse shall be paid benefits determined by reference to the excess of (i) the aggregate retirement benefits the Executive would have accrued under the terms of each tax-qualified and non-qualified Defined Benefit Plan as in effect immediately prior to the Date of Termination, had he (A) continued to be employed for a period of one year following the Date of Termination, and (B) received (on a pro rated basis, as appropriate) the greater of (I) the highest compensation taken into account under each such plan with respect to one of the two years immediately preceding the year in which the Date of Termination occurs, or (II) his annualized base compensation in effect immediately prior to the Date of Termination (or prior to any reduction which entitled him to terminate his employment for Good Reason), over (ii) the retirement benefits actually determined under such plans. The frequency, manner, and extent of payment of such benefits shall be consistent with the terms of the plans to which they relate and any elections made thereunder. (5) The surviving spouse and her eligible dependents shall be entitled to continue to participate at the same aggregate benefit levels, for a period of one year following the Date of Termination and at no out-of-pocket or tax cost to her, in the Welfare Benefit Plans in which the Executive was a participant immediately prior to the Date of Termination, to the extent permitted under the terms of such plans and applicable law; provided, however, that Mercer shall not be required to provide continued benefits with respect to her deceased husband; and provided further, that Mercer shall not thereafter be required to provide, at its cost, the other welfare benefits covered by such plans to such spouse and her eligible dependents after the earlier of (i) her death, or (ii) the later of (A) her attainment of age 65, or (B) the date specified in the relevant plan document for benefit termination (assuming the Executive was employed until age 65 or the normal retirement date, if any, specified in such document). To the extent Mercer is unable to provide for continued participation in a Welfare Benefit Plan as required, it shall provide an equivalent benefit directly at no out-of-pocket or tax cost to her. For purposes of the preceding two sentences, Mercer shall be deemed to have provided a benefit at no tax cost to her if it pays an additional amount to her or on her behalf, with respect to those benefits which would otherwise be nontaxable to her, 7 8 calculated in a manner consistent with the provisions of Paragraph 12. (b) COMPENSATION AND BENEFITS TO ESTATE, ETC. In the event the Executive dies while he is employed under this Agreement and is not survived by a spouse, (i) Mercer shall make the payments described in Subparagraphs (a)(1) through (a)(3) directly to his estate, (ii) the extent of the rights of any person to the accrued benefits described in Subparagraph (a)(4) shall be determined by reference to the relevant plan provisions and any elections made under such plans, and (iii) Mercer's obligation to provide benefits under Subparagraph (a)(5) shall terminate. 8. TERMINATION BY MERCER FOR CAUSE. (a) IN GENERAL. In the event Mercer intends to terminate the Executive's employment for Cause, it shall deliver a Notice of Termination to him which specifies a Date of Termination not less than 30 days following the date of such notice, unless a shorter period of notice is required by the principal regulator of the Company or any affiliate of the Company. (b) COMPENSATION. Within 30 days after the Executive's termination under Subparagraph (a), Mercer shall pay him, in one lump sum, his accrued but unpaid base compensation and vacation compensation earned through the Date of Termination. 9. TERMINATION BY THE EXECUTIVE WITHOUT GOOD REASON. (a) IN GENERAL. In the event the Executive intends to terminate his employment without Good Reason, he shall deliver a Notice of Termination to Mercer which specifies a Date of Termination not less than (i) 90 days following the date of such notice, if a Change in Control shall not have occurred, or (ii) 30 days following the date of such notice, if a Change in Control shall have occurred. (b) COMPENSATION. Within 30 days after the Executive's termination under Subparagraph (a), Mercer shall pay him, in one lump sum, his accrued but unpaid base compensation and vacation compensation earned through the Date of Termination. 10. TERMINATION BY MERCER WITHOUT DISABILITY OR CAUSE. (a) IN GENERAL. In the event Mercer intends to terminate the Executive's employment for any reason other than Disability or Cause, it shall deliver a Notice of Termination to him which specifies a Date of Termination not less than 90 days following the date of such notice. 8 9 (b) COMPENSATION AND BENEFITS DURING REMAINING TERM OF AGREEMENT. In the event of the termination of the Executive's employment under Subparagraph (a), Mercer shall pay or provide the compensation and benefits described in Paragraph 6(b), except that all such compensation and benefits shall be for the remaining term of this Agreement and, with respect to Subparagraphs 6(b)(2) and (3), an additional pro rated amount shall be paid to him in cash on the last day of the remaining term of this Agreement. Such pro rated amount shall be determined by reference to a fraction, the numerator of which is the number of whole months elapsed during the year in which termination occurs, and the denominator of which is 12. (c) ADJUSTMENT TO CERTAIN SUBPARAGRAPH (B) COMPENSATION AND BENEFITS. In the event the Executive suffers a Disability during the remaining term of this Agreement following the Date of Termination, Mercer's obligation to pay or fund any disability insurance premiums on his behalf shall be suspended while his Disability continues, provided the cessation of payment or funding does not result in the termination of disability benefits. Any amounts described in Paragraph 6(b) and otherwise payable under Subparagraph (b) shall be reduced (but not below zero) by the dollar amount of disability benefits received by him pursuant to plans or policies funded, directly at its cost, by Mercer. (d) EARLIER CESSATION OF CERTAIN WELFARE BENEFITS. Notwithstanding the provisions of Subparagraph (b), Mercer shall not be required to provide, at its cost, the welfare benefits covered by Paragraph 6(b)(5) after the later of (i) the attainment by the Executive and his spouse (if any) of age 65, or (ii) the date specified in the relevant plan document for benefit termination (assuming that he was employed until age 65 or the normal retirement date, if any, specified in such document). (e) DEATH DURING REMAINING TERM OF AGREEMENT. (1) In the event the Executive dies during the remaining term of this Agreement following his termination without Disability or Cause by Mercer and he is survived by a spouse, the compensation and benefits required to be paid and provided under Subparagraph (b) shall be unaffected by his death and shall be paid and provided to her or on her behalf; provided, however, that the extent of her rights to the accrued benefits described in Paragraph 6(b)(4) shall be determined by reference to the relevant plan provisions and any elections made under such plans; and provided further, that Mercer shall not be required to provide continued benefits with respect to her deceased husband; and provided further, that in no event shall 9 10 Mercer be required to provide, at its cost, the other welfare benefits described in Paragraph 6(b)(5) to such spouse and her eligible dependents after the earlier of (i) her death, or (ii) the later of (A) her attainment of age 65, or (B) the date specified in the relevant plan document for benefit termination (assuming that the Executive was employed until age 65 or the normal retirement date, if any, specified in such document). (2) In the event the Executive dies during the remaining term of this Agreement following his termination without Disability or Cause and he is not survived by a spouse, (i) Mercer shall thereafter make the remaining payments described in Paragraphs 6(b)(1) through 6(b)(3) directly to his estate, (ii) the extent of the rights of any person to the accrued benefits described in Paragraph 6(b)(4) shall be determined by reference to the relevant plan provisions and any elections made under such plans, and (iii) Mercer's obligation to provide the continued benefits described in Paragraph 6(b)(5) shall terminate. 11. TERMINATION BY THE EXECUTIVE FOR GOOD REASON. (a) IN GENERAL. In the event the Executive intends to terminate his employment for Good Reason, he shall deliver a Notice of Termination to Mercer which specifies a Date of Termination not less than 30 days following the date of such notice. (b) COMPENSATION AND BENEFITS DURING REMAINING TERM OF AGREEMENT. In the event of the termination of the Executive's employment under Subparagraph (a), Mercer shall pay or provide the compensation and benefits described in Paragraph 6(b), except that all such compensation and benefits shall be for the remaining term of this Agreement and, with respect to Subparagraphs 6(b)(2) and (3), an additional pro rated amount shall be paid to him in cash on the last day of the remaining term of this Agreement. Such pro rated amount shall be determined by reference to a fraction, the numerator of which is the number of whole months elapsed during the year in which termination occurs, and the denominator of which is 12. (c) ADJUSTMENT TO CERTAIN SUBPARAGRAPH (B) COMPENSATION AND BENEFITS. In the event the Executive suffers a Disability during the remaining term of this Agreement following the Date of Termination, Mercer's obligation to pay or fund any disability insurance premiums on his behalf shall be suspended while his Disability continues, provided the cessation of payment or funding does not result in the termination of disability benefits. Any amounts described in Paragraph 6(b) and otherwise payable under Subparagraph (b) shall be reduced (but not below zero) 10 11 by the dollar amount of disability benefits received by him pursuant to plans or policies funded, directly at its cost, to Mercer. (d) EARLIER CESSATION OF CERTAIN WELFARE BENEFITS. Notwithstanding the provisions of Subparagraph (b), Mercer shall not be required to provide, at its cost, the welfare benefits covered by Paragraph 6(b)(5) after the later of (i) the attainment by the Executive and his spouse (if any) of age 65, or (ii) the date specified in the relevant plan document for benefit termination (assuming that he was employed until age 65 or the normal retirement date, if any, specified in such document). (e) DEATH DURING REMAINING TERM OF AGREEMENT. (1) In the event the Executive dies during the remaining term of this Agreement following his termination for Good Reason and he is survived by a spouse, the compensation and benefits required to be paid and provided under Subparagraph (b) shall be unaffected by his death and shall be paid and provided to her or on her behalf; provided, however, that the extent of her rights to the accrued benefits described in Paragraph 6(b)(4) shall be determined by reference to the relevant plan provisions and any elections made under such plans; and provided further, that Mercer shall not be required to provide continued benefits with respect to her deceased husband; and provided further, that in no event shall Mercer be required to provide, at its cost, the other welfare benefits described in Paragraph 6(b)(5) to such spouse and her eligible dependents after the earlier of (i) her death, or (ii) the later of (A) her attainment of age 65, or (B) the date specified in the relevant plan document for benefit termination (assuming that the Executive was employed until age 65 or the normal retirement date, if any, specified in such document). (2) In the event the Executive dies during the remaining term of this Agreement following his termination for Good Reason and he is not survived by a spouse, (i) Mercer shall thereafter make the remaining payments described in Paragraphs 6(b)(1) through 6(b)(3) directly to his estate, (ii) the extent of the rights of any person to the accrued benefits described in Paragraph 6(b)(4) shall be determined by reference to the relevant plan provisions and any elections made under such plans, and (iii) Mercer's obligation to provide the continued benefits described in Paragraph 6(b)(5) shall terminate. 11 12 12. PROVISIONS RELATING TO EXCISE TAXES. (a) IN GENERAL. In the event the Executive becomes liable, for any taxable year, for the payment of an Excise Tax (because of a change in control) with respect to the compensation and benefits payable by Mercer under this Agreement or otherwise, Mercer shall make one or more Gross-Up Payments to the Executive or on his behalf. The amount of any Gross-Up Payment shall be calculated by a certified public accountant or other tax professional designated jointly by the Executive and Mercer. The provisions of this paragraph shall apply with respect to the Executive's surviving spouse or estate, where relevant. (b) METHODOLOGY FOR CALCULATION OF GROSS-UP PAYMENT. For purposes of determining the amount of any Gross-Up Payment, the Executive shall be deemed to pay income taxes at the highest federal, state, and local marginal rates of tax for the calendar year in which the Gross-Up Payment is to be made, net of the maximum reduction in federal income tax which could be obtained from the deduction of state and local income taxes. In the event that the Excise Tax is subsequently determined to be less than the amount taken into account at the time the Gross-Up Payment was made, the Executive shall repay to Mercer, at the time that the amount of such reduction in Excise Tax is finally determined, the portion of the Gross-Up Payment attributable to the reduction (plus a portion of the Gross-Up Payment attributable to the Excise Tax and the federal, state, and local income taxes imposed on the portion of the Gross-Up Payment being repaid by the Executive to the extent such repayment results in a reduction in Excise Tax or federal, state, or local income tax), plus interest on the amount of such repayment. Such interest shall be calculated by using the rate in effect under Section 1274(d)(1) of the IRC, on the date the Gross-Up Payment was made, for debt instruments with a term equal to the period of time which has elapsed from the date the Gross-Up Payment was made to the date of repayment. In the event that the Excise Tax is subsequently determined to exceed the amount taken into account at the time the Gross-Up Payment was made (including by reason of any payment the existence or amount of which could not be determined at the time of the Gross-Up Payment), Mercer shall make an additional Gross-Up Payment with respect to the excess at the time the amount thereof is finally determined, plus interest calculated in a manner similar to that described in the preceding sentence. (c) TIME OF PAYMENT. Any Gross-Up Payment provided for herein shall be paid not later than the 30th day following the payment of any compensation or the provision of any benefit which causes such payment to be made; provided, however, that if the amount of such payment cannot be finally determined on or before such day, Mercer shall 12 13 pay on such day an estimate of the minimum amount of such payment and shall pay the remainder of such payment (together with interest calculated in a manner similar to that described in Subparagraph (b)) as soon as the amount thereof can be determined. In the event that the amount of an estimated payment exceeds the amount subsequently determined to have been due, such excess shall constitute a loan by Mercer to the Executive, payable on the 30th day after demand by Mercer (together with interest calculated in a manner similar to that described in Subparagraph (b)). (d) Notwithstanding the provisions of this paragraph to the contrary, the actual amounts payable hereunder as Gross-Up Payments shall be coordinated with any similar amounts paid to the Executive under any other contract, plan, or arrangement. 13. FEES AND EXPENSES OF THE EXECUTIVE. After a Change in Control and except as provided in the following sentence, Mercer shall pay, within 30 days following demand by the Executive, all legal, accounting, actuarial, and related fees and expenses incurred by him in connection with the enforcement of this Agreement. An arbitration panel or a court of competent jurisdiction shall be empowered to deny payment to the Executive of such fees and expenses only if it determines that he instituted a proceeding hereunder, or otherwise acted, in bad faith. 14. REDUCTION FOR COMPENSATION AND BENEFITS RECEIVED UNDER MERCER SEVERANCE POLICY, ETC. Notwithstanding anything herein to the contrary, in the event the Executive, his surviving spouse, or any other person becomes entitled to continued compensation and benefits hereunder by reason of the Executive's termination of employment and, in addition, compensation or similar benefits are payable under a severance policy, program or arrangement maintained by Mercer (other than retirement plans), then the compensation or benefits otherwise payable hereunder shall be reduced by the compensation or benefits provided under such severance policy, program or arrangement. 15. MITIGATION. The Executive shall not be required to mitigate the amount of any compensation or benefits which may become payable hereunder by reason of his termination by seeking other employment or otherwise, nor, except as otherwise provided in the following sentence or elsewhere herein, shall the amount of any such compensation or benefits be reduced by any compensation or benefits received by the Executive as the result of his employment by another employer. Notwithstanding anything in this Agreement to the contrary, Mercer's obligation to provide any medical and dental benefits hereunder may be suspended, with the written concurrence of the Executive or, if applicable, his surviving spouse during any period of time that such benefits are being provided by reason of his or her employment. 13 14 16. FUNDING OF COMPENSATION AND BENEFITS; ACCELERATION OF CERTAIN PAYMENTS. (a) GRANTOR TRUST. In the event the Executive's employment is terminated without Cause or he terminates his employment for Good Reason and a Change in Control has occurred as of the Date of Termination or occurs thereafter, the Executive shall have the right to require Mercer to establish a grantor trust (taxable to Mercer) and fund such trust, on an actuarially sound basis, to provide the compensation and benefits to which he is entitled hereunder, other than those which may be paid pursuant to the provisions of Subparagraph (c). The specific terms of such trust shall be as agreed to by the parties in good faith; provided, however, that the trustee shall be a financial institution independent of Mercer; and provided further, that in no event shall Mercer be entitled to withdraw funds from the trust for its benefit, or otherwise voluntarily assign or alienate such funds, until such time as all compensation and benefits required hereunder are paid and provided. The determination of the extent of required funding, including any supplemental funding in the event of adverse investment performance of trust assets, shall be made by an actuary or a certified public accountant retained by each party. To the extent such professionals cannot agree on the proper level of funding, they shall select a third such professional whose determination shall be binding upon the parties. Notwithstanding the foregoing, Mercer shall remain liable for all compensation and benefits required to be paid or provided hereunder. (b) ALTERNATE SECURITY. In lieu of the right given to the Executive under Subparagraph (a), he shall have the right under such circumstances to require that Mercer provide (i) an irrevocable standby letter of credit issued by a financial institution other than the Company or any Subsidiary of the Company with a senior debt credit rating of "A" or better by Moody's Investors Service or Standard & Poor's Corporation, or (ii) other security reasonably acceptable to him, to secure the payment of such compensation and benefits. (c) ACCELERATED PAYMENT OF PRESENT VALUE OF CERTAIN COMPENSATION. In the event the Executive's employment is terminated without Cause or he terminates his employment for Good Reason and a Change in Control has occurred as of the Date of Termination or occurs thereafter, the Executive shall have the continuing right to demand that the present value of the remaining payments described in Paragraphs 6(b)(1) through (3), and payable by reason of the provisions of Paragraph 10 or 11 (as the case may be), be paid to him in one lump sum within 30 days after the date written demand is given. For purposes of calculating the present value of such payments, a discount factor shall be 14 15 applied to each such payment which is equal to the relevant applicable federal rate in effect on the date written demand is given by him, determined by reference to the period of time between the date of such notice and the scheduled time such payment would otherwise be made. In the event any payment described in Paragraphs 6(b)(1) through (3) is not yet determinable on the date written demand is made, the other payments shall nonetheless be made as provided above; and the undetermined payment shall be made within 30 days after it becomes determinable, calculated as provided in the preceding sentence but by treating the date on which the payment becomes determinable as the date of written notice. Nothing in this subparagraph shall be construed as affecting the Executive's right to one or more Gross-Up Payments in accordance with the provisions of Paragraph 12; and a Gross-Up Payment (if applicable) will be calculated and made with any payment made under this subparagraph, as well as any other Gross-Up Payments that may be required hereunder at a subsequent date. 17. WITHHOLDING TAXES. All compensation and benefits provided for herein shall, to the extent required by law, be subject to federal, state, and local tax withholding. 18. CONFIDENTIAL INFORMATION. The Executive agrees that subsequent to his employment with Mercer, he will not, at any time, communicate or disclose to any unauthorized person, without the written consent of the Mercer, any proprietary or other confidential information concerning the Company or any Subsidiary of the Company; provided, however, that the obligations under this paragraph shall not apply to the extent that such matters (i) are disclosed in circumstances where the Executive is legally obligated to do so, or (ii) become generally known to and available for use by the public otherwise than by his wrongful act or omission; and provided further, that he may disclose any knowledge of insurance, financial, legal and economic principles, concepts and ideas which are not solely and exclusively derived from the business plans and activities of Mercer. 19. COVENANTS NOT TO COMPETE OR TO SOLICIT. (a) Noncompetition. If the Executive's employment terminates under Paragraph 8 or 9 prior to a Change in Control, he agrees that for a period of 12 months after the Date of Termination he will not, without the written consent in writing of the Board of Directors of the Company, become an officer, employee, agent, partner, director, or a four and nine-tenths percent or greater shareholder or equity owner of any licensed direct property and casualty insurance company with its corporate headquarters located within New Jersey. If at the time of the enforcement of this paragraph a court holds that the duration, scope, or area restrictions stated herein are unreasonable under the circumstances then existing and, thus, unenforceable, Mercer and the Executive 15 16 agree that the maximum duration, scope, or area reasonable under such circumstances shall be substituted for the stated duration, scope, or area. (b) Nonsolicitation. During his employment and for a period of 12 months following the Date of Termination, the Executive shall not, whether on his own behalf or on behalf of any other individual or business entity, solicit, endeavor to entice away from the Company, a Subsidiary or any affiliated company, or otherwise interfere with the relationship of the Company, a Subsidiary or any affiliated company with any person who is, or was within the then most recent 12 month period, an employee or associate thereof; provided, however, that this subparagraph shall not apply following the occurrence of a Change in Control. 20. ARBITRATION. To the extent permitted by applicable law, any controversy or dispute arising out of or relating to this Agreement, or any alleged breach hereof, shall be settled by arbitration in Pennington, New Jersey, in accordance with the commercial rules of the American Arbitration Association then in existence (to the extent such rules are not inconsistent with the provisions of this Agreement), it being understood and agreed that the arbitration panel shall consist of three individuals acceptable to the parties hereto. In the event that the parties cannot agree on three arbitrators within 20 days following receipt by one party of a demand for arbitration from another party, then the Executive and Mercer shall each designate one arbitrator and the two arbitrators selected shall select the third arbitrator. The arbitration panel so selected shall convene a hearing no later than 90 days following the selection of the panel. The arbitration award shall be final and binding upon the parties, and judgment may be entered thereon in the Pennsylvania Court of Common Pleas or in any other court of competent jurisdiction. 21. ADDITIONAL EQUITABLE REMEDY. The Executive acknowledges and agrees that Mercer's remedy at law for a breach or a threatened breach of the provisions of Paragraphs 18 and 19 would be inadequate; and, in recognition of this fact and notwithstanding the provisions of Paragraph 20, in the event of such a breach or threatened breach by him, it is agreed that Mercer shall be entitled to request equitable relief in the form of specific performance, temporary restraining order, temporary or permanent injunction, or any other equitable remedy which may then be available. Nothing in this paragraph shall be construed as prohibiting Mercer from pursuing any other remedy available under this Agreement for such a breach or threatened breach. 22. RELATED AGREEMENTS. Except as may otherwise be provided herein, to the extent that any provision of any other agreement between Mercer and the Executive shall limit, qualify, duplicate, or be inconsistent with any provision of this Agreement, the provision in this Agreement shall control and such 16 17 provision of such other agreement shall be deemed to have been superseded, and to be of no force or effect, as if such other agreement had been formally amended to the extent necessary to accomplish such purpose. 23. NO EFFECT ON OTHER RIGHTS. Except as otherwise specifically provided herein, nothing contained in this Agreement shall be construed as adversely affecting any rights the Executive may have under any agreement, plan, policy or arrangement to the extent any such right is not inconsistent with the provisions hereof. 24. EXCLUSIVE RIGHTS AND REMEDY. Except for any explicit rights and remedies the Executive may have under any other contract, plan or arrangement with Mercer, the compensation and benefits payable hereunder and the remedy for enforcement thereof shall constitute his exclusive rights and remedy in the event of his termination of employment. 25. DIRECTOR AND OFFICER LIABILITY INSURANCE; INDEMNIFICATION. Mercer shall provide the Executive (including his heirs, executors, and administrators) with coverage under a standard directors' and officers' liability insurance policy, at Mercer's expense, in amounts consistent with amounts provided by peer corporations to their directors and officers, and shall indemnify him as both a director and as an officer (and his heirs, executors, and administrators) to the fullest extent permitted under Pennsylvania law against all expenses and liabilities reasonably incurred by him in connection with or arising out of any action, suit, or proceeding in which he may be involved by reason of his having been an officer or director of Mercer or any Subsidiary or affiliated company (whether or not he continues to be such an officer or director at the time of incurring such expenses or liabilities). Such expenses and liabilities shall include, but not be limited to, judgments, court costs, and attorneys' fees, and the costs of reasonable settlements. 26. NOTICES. Any notice required or permitted under this Agreement shall be sufficient if it is in writing and shall be deemed given (i) at the time of personal delivery to the addressee, or (ii) at the time sent certified mail, with return receipt requested, addressed as follows: If to the Executive-- Mr. Paul D. Ehrhardt 6617 School Lane New Hope, PA 18938 17 18 If to Mercer, or the Company-- 10 North Highway 31 P.O. Box 278 Pennington, NJ 08534 Attention: Chairman of the Board of Directors The name or address of any addressee may be changed at any time and from time to time by notice similarly given. 27. NO WAIVER. The failure by any party to this Agreement at any time or times hereafter to require strict performance by any other party of any of the provisions, terms, or conditions contained in this Agreement shall not waive, affect, or diminish any right of the first party at any time or times thereafter to demand strict performance therewith and with any other provision, term, or condition contained in this Agreement. Any actual waiver of a provision, term, or condition contained in this Agreement shall not constitute a waiver of any other provision, term, or condition herein, whether prior or subsequent to such actual waiver and whether of the same or a different type. The failure of Mercer to promptly terminate the Executive's employment for Cause or the Executive to promptly terminate his employment for Good Reason shall not be construed as a waiver of the right of termination, and such right may be exercised at any time following the occurrence of the event giving rise to such right. 28. JOINT AND SEVERAL OBLIGATIONS OF MERCER AND THE COMPANY. Mercer and the Company shall be jointly and severally liable for all compensation and benefits that may become payable hereunder to or on behalf of the Executive or, if applicable, his surviving spouse, estate or beneficiaries. 29. SURVIVAL. Notwithstanding the nominal termination of this Agreement and the Executive's employment hereunder, the provisions hereof which specify continuing obligations, compensation and benefits, and rights (including the otherwise applicable term hereof) shall remain in effect until such time as all such obligations are discharged, all such compensation and benefits are received, and no party or beneficiary has any remaining actual or contingent rights hereunder. 30. SEVERABILITY. In the event any provision in this Agreement shall be held illegal or invalid for any reason, such illegal or invalid provision shall not affect the remaining provisions hereof, and this Agreement shall be construed, administered and enforced as though such illegal or invalid provision were not contained herein. 31. BINDING EFFECT AND BENEFIT. The provisions of this Agreement shall be binding upon and shall inure to the benefit of the successors and assigns of Mercer and the executors, personal 18 19 representatives, surviving spouse, heirs, devisees, and legatees of the Executive. 32. ENTIRE AGREEMENT. This Agreement embodies the entire agreement among the parties with respect to the subject matter hereof, and it supersedes all prior discussions and oral understandings of the parties with respect thereto. 33. NO ASSIGNMENT. This Agreement, and the benefits and obligations hereunder, shall not be assignable by any party hereto except by operation of law. 34. NO ATTACHMENT. Except as otherwise provided by law, no right to receive compensation or benefits under this Agreement shall be subject to anticipation, commutation, alienation, sale, assignment, encumbrance, charge, pledge, or hypothecation, or to set off, execution, attachment, levy, or similar process, and any attempt, voluntary or involuntary, to effect any such action shall be null and void. 35. CAPTIONS. The captions of the several paragraphs and subparagraphs of this Agreement have been inserted for convenience of reference only. They constitute no part of this Agreement and are not to be considered in the construction hereof. 36. COUNTERPARTS. This Agreement may be executed in any number of counterparts, each of which shall be deemed one and the same instrument which may be sufficiently evidenced by any one counterpart. 37. NUMBER. Wherever any words are used herein in the singular form, they shall be construed as though they were used in the plural form, as the context requires, and vice versa. 38. APPLICABLE LAW. Except to the extent preempted by federal law, the provisions of this Agreement shall be construed, administered, and enforced in accordance with the domestic internal law of the State of New Jersey. 19 20 39. GUARANTEE. The business entities executing this Agreement as Guarantor shall be liable as payment guarantors of the obligations of Mercer and the Company hereunder. IN WITNESS WHEREOF, the parties have executed this Agreement, or caused it to be executed, as of the date first above written. /s/ PAUL D. EHRHARDT (SEAL) ------------------------------- PAUL D. EHRHARDT MERCER MUTUAL INSURANCE COMPANY By: /s/ WILLIAM C. HART ------------------------------- Attest: /s/ MARION J. CRUM --------------------------- MERCER INSURANCE GROUP, INC. By: /s/ WILLIAM C. HART ------------------------------- Attest: /s/ MARION J. CRUM --------------------------- 20 21 APPENDIX 1 The parties hereto acknowledge that the corporate reorganization of Mercer (pursuant to which Mercer will demutualize under Pennsylvania law) and certain other related transactions involving Mercer have not occurred as of the date of this Agreement, so that literal application of the terms of this Agreement prior thereto may be inappropriate or otherwise not feasible. Accordingly, pending the occurrence of such demutualizations and related transactions, the parties agree that this Agreement shall be construed, administered and enforced, to the maximum extent practical, in a manner consistent with the spirit and reasonably inferable intent hereof. 21 22 GLOSSARY "BOARD OF DIRECTORS" means the board of directors of the relevant corporation. "CAUSE" means (i) a documented repeated and willful failure by the Executive to perform his duties, but only after written demand and only if termination is effected by action taken by a vote of (A) prior to a Change in Control, at least a majority of the directors of the Company then in office, or (B) after a Change in Control, at least 80% of the nonofficer directors of the Company then in office, (ii) his final conviction of a felony, (iii) conduct by him which constitutes moral turpitude which is directly and materially injurious to the Company or any Subsidiary or affiliated company, (iv) willful material violation of corporate policy, or (v) the issuance by the regulator of the Company or any Subsidiary or affiliated company of an unappealable order to the effect that he be permanently discharged. For purposes of this definition, no act or failure to act on the part of the Executive shall be considered "willful" unless done or omitted not in good faith and without reasonable belief that the action or omission was in the best interest of the Company or any of its Subsidiaries or affiliated companies. "CHANGE IN CONTROL" means the occurrence of any of the following events: (a) any Person (except (i) the Company or any Subsidiary or prior affiliate of the Company, or (ii) any Employee Benefit Plan (or any trust forming a part thereof) maintained by the Company or any Subsidiary or prior affiliate of the Company) is or becomes the beneficial owner, directly or indirectly, of the Company's securities representing 19.9% or more of the combined voting power of the Company's then outstanding securities, or 50.1% or more of the combined voting power of a Material Subsidiary's then outstanding securities, other than pursuant to a transaction described in Clause (c); (b) there occurs a sale, exchange, transfer or other disposition of substantially all of the assets of the Company or a Material Subsidiary to another entity, except to an entity controlled directly or indirectly by the Company; (c) there occurs a merger, consolidation, share exchange, division or other reorganization of or relating to the Company, unless-- (i) the shareholders of the Company immediately before such merger, consolidation, share exchange, G-1 23 division or reorganization own, directly or indirectly, immediately thereafter at least two-thirds of the combined voting power of the outstanding voting securities of the Surviving Company in substantially the same proportion as their ownership of the voting securities immediately before such merger, consolidation, share exchange, division or reorganization; and (ii) the individuals who, immediately before such merger, consolidation, share exchange, division or reorganization, are members of the Incumbent Board continue to constitute at least two-thirds of the board of directors of the Surviving Company; provided, however, that if the election, or nomination for election by the Company's shareholders, of any new director was approved by a vote of at least two-thirds of the Incumbent Board, such director shall, for the purposes hereof, be considered a member of the Incumbent Board; and provided further, however, that no individual shall be considered a member of the Incumbent Board if such individual initially assumed office as a result of either an actual or threatened Election Contest or Proxy Contest, including by reason of any agreement intended to avoid or settle any Election Contest or Proxy Contest; and (iii) no Person (except (A) the Company or any Subsidiary or prior affiliate of the Company, (B) any Employee Benefit Plan (or any trust forming a part thereof) maintained by the Company or any Subsidiary or prior affiliate of the Company, or (C) the Surviving Company or any Subsidiary or prior affiliate of the Surviving Company) has beneficial ownership of 19.9% or more of the combined voting power of the Surviving Company's outstanding voting securities immediately following such merger, consolidation, share exchange, division or reorganization; (d) a plan of liquidation or dissolution of the Company, other than pursuant to bankruptcy or insolvency laws, is adopted; or (e) during any period of two consecutive years, individuals who, at the beginning of such period, constituted the Board of Directors of the Company cease for any reason to constitute at least a majority of such Board of Directors, unless the election, or the nomination for election by the Company'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; provided, however, that no individual shall be considered a member of the Board of Directors of the Company at the beginning of such period if G-2 24 such individual initially assumed office as a result of either an actual or threatened Election Contest or Proxy Contest, including by reason of any agreement intended to avoid or settle any Election Contest or Proxy Contest. Notwithstanding the foregoing, a Change in Control shall not be deemed to have occurred if a Person becomes the beneficial owner, directly or indirectly, of securities representing 19.9% or more of the combined voting power of the Company's then outstanding securities solely as a result of an acquisition by the Company of its voting securities which, by reducing the number of shares outstanding, increases the proportionate number of shares beneficially owned by such Person; provided, however, that if a Person becomes a beneficial owner of 19.9% or more of the combined voting power of the Company's then outstanding securities by reason of share repurchases by the Company and thereafter becomes the beneficial owner, directly or indirectly, of any additional voting securities of the Company, then a Change in Control shall be deemed to have occurred with respect to such Person under Clause (a). Notwithstanding anything contained herein to the contrary, if the Executive's employment is terminated and he reasonably demonstrates that such termination (i) was at the request of a third party who has indicated an intention of taking steps reasonably calculated to effect a Change in Control and who effects a Change in Control, or (ii) otherwise occurred in connection with, or in anticipation of, a Change in Control which actually occurs, then for all purposes hereof, a Change in Control shall be deemed to have occurred on the day immediately prior to the date of such termination of his employment. "COMPANY" means Mercer Insurance Group, Inc., a Pennsylvania (stock) corporation, and any successor thereto. "DATE OF TERMINATION" means: (a) if the Executive's employment is terminated for Disability, 30 days after the Notice of Termination is given (provided that he shall not have returned to the performance of his duties on a full-time basis during such 30-day period); (b) if the Executive's employment terminates by reason of his death, the date of his death; (c) if the Executive's employment is terminated by Mercer for Cause, the date specified in the Notice of Termination; (d) if the Executive's employment is terminated by him without Good Reason, the date specified in the Notice of Termination; G-3 25 (e) if the Executive's employment is terminated by Mercer for any reason other than for Disability or Cause, the date specified in the Notice of Termination; or (f) if the Executive's employment is terminated by him for Good Reason, the date specified in the Notice of Termination; provided, however that the Date of Termination shall mean the actual date of termination in the event the parties mutually agree to a date other than that described above. "DEFINED BENEFIT PLAN" has the meaning ascribed to such term in Section 3(35) of ERISA. "DEFINED CONTRIBUTION PLAN" has the meaning ascribed to such term in Section 3(34) of ERISA. "DISABILITY" has the meaning ascribed to the term "permanent and total disability" in Section 22(e)(3) of the IRC. "ELECTION CONTEST" means a solicitation with respect to the election or removal of directors that is subject to the provisions of Rule 14a-11 of the 1934 Act. "EMPLOYEE BENEFIT PLAN" has the meaning ascribed to such term in Section 3(3) of ERISA. "ERISA" means the Employee Retirement Income Security Act of 1974, as amended and as the same may be amended from time to time. "EXCISE TAX" means the tax imposed by Section 4999 of the IRC (or any similar tax that may hereafter be imposed by federal, state or local law). "EXECUTIVE" means William C. Hart, an individual residing in Pennington, New Jersey. "GOOD REASON" means: (a) prior to a Change in Control-- (i) a change in the Executive's status or position, or any material diminution in his duties or responsibilities; (ii) a reduction in the Executive's base compensation, other than a reduction which is proportionate to a company-wide reduction in executive pay; (iii) a failure to increase the Executive's base compensation, consistent with his performance rating, G-4 26 within 24 months since the last increase, other than similar treatment on a company-wide basis for executives or a voluntary deferral by him of an increase; (iv) delivery to the Executive of a Notice of Nonextension; or (v) any purported termination of the Executive's employment which is not in accordance with the terms of this Agreement; and (b) after a Change in Control-- (i) a change in the Executive's status or position, or any material diminution in his duties or responsibilities; (ii) any increase in the Executive's duties inconsistent with his position; (iii) any reduction in the Executive's base compensation; (iv) a failure to increase the Executive's base compensation, consistent with his performance review, within 12 months of the last increase; or a failure to consider Executive for an increase within 12 months of his last performance review; (v) a failure to continue in effect any Employee Benefit Plan in which the Executive participates, including (whether or not they constitute Employee Benefit Plans) incentive bonus, stock option, or other qualified or nonqualified plans of deferred compensation (A) other than as a result of the normal expiration of such a plan, or (B) unless such plan is merged or consolidated into, or replaced with, a plan with benefits which are of equal or greater value; (vi) requiring the Executive to be based anywhere other than the county where his principal office was located immediately prior to the Change in Control; (vii) refusal to allow the Executive to attend to matters or engage in activities in which he was permitted to engage prior to the Change in Control; (viii) delivery to the Executive of a Notice of Nonextension; (ix) failure to secure the affirmation by a Successor, within three business days prior to a Change in Control, of this Agreement and its or Mercer's G-5 27 continuing obligations hereunder (or where there is not at least three business days advance notice that a Person may become a Successor, within one business day after having notice that such Person may become or has become a Successor); or (x) any purported termination of the Executive's employment which is not in accordance with the terms of this Agreement. Notwithstanding anything herein to the contrary, at the election of the Executive, beginning with the 181st day following a Change in Control and continuing through the first anniversary of such Change in Control, he may terminate his employment for any reason or no reason and such termination will be treated as having occurred for Good Reason. "GROSS-UP PAYMENT" means an additional payment to be made to or on behalf of the Executive in an amount such that the net amount retained by him, after deduction of any Excise Tax on the Total Payments and any federal, state, and local income tax and Excise Tax on such additional payment, equals the Total Payments. "INCUMBENT BOARD" means the Board of Directors of the Company as constituted at any relevant time. "IRC" means the Internal Revenue Code of 1986, as amended and as the same may be amended from time to time. "MATERIAL SUBSIDIARY" means a Subsidiary whose net worth, determined under generally accepted accounting principles, at the fiscal year end immediately prior to any relevant time is at least 25% of the aggregate net worth of the controlled group of corporations of which the Company is the common parent. "1934 ACT" means the Securities Exchange Act of 1934, as amended and as the same may be amended from time to time. "MERCER" means, prior to conversion from mutual to stock form, Mercer Mutual Insurance Company, and after conversion from mutual to stock form, Mercer Insurance Company. "NOTICE OF EXTENSION" means a written notice delivered to or by the Executive which advises that the Agreement will be extended as provided in Paragraph 3. "NOTICE OF TERMINATION" means a written notice that (i) indicates the specific termination provision in this Agreement relied upon, (ii) sets forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of the Executive's employment under the provision so indicated, and (iii) gives the required advance notice of termination. G-6 28 "PERSON" has the same meaning as such term has for purposes of Sections 13(d) and 14(d) of the 1934 Act. "PROXY CONTEST" means the solicitation of proxies or consents by or on behalf of a Person other than the Board of Directors of the Company. "SUBSIDIARY" means any business entity of which a majority of its voting power or its equity securities or equity interests is owned, directly or indirectly by the Company. "SUCCESSOR" means any Person that succeeds to, or has the practical ability to control (either immediately or with the passage of time), Mercer's business directly, by merger or consolidation, or indirectly, by purchase of Mercer's voting securities or all or substantially all of its assets. "SURVIVING COMPANY" means the business entity that is a resulting company following a merger, consolidation, share exchange, division or other reorganization of or relating to the Company. "TOTAL PAYMENTS" means the compensation and benefits that become payable under the Agreement or otherwise (and which may be subject to an Excise Tax) by reason of the Executive's termination of employment, determined without regard to any Gross-Up Payments that may also be made. "WELFARE BENEFIT PLAN" has the meaning ascribed to the term "employee welfare benefit plan" in Section 3(1) of ERISA. For purposes of determining the Executive's or his dependents' right to continued welfare benefits hereunder following his termination of employment, the meaning of such term shall include any retiree health plan maintained by Mercer at any time after the relevant Date of Termination, notwithstanding the fact that the Executive is not a participant therein prior to such date. G-7 EX-23.2 5 CONSENT OF ALEX SHESHUNOFF & COMPANY 1 ALEX SHESHUNOFF & CO. INVESTMENT BANKING Exhibit 23.2 January 8, 1998 Board of Directors Mercer Insurance Group, Inc. 10 North Highway 31 Pennington, New Jersey 08534 Directors: We hereby consent to the inclusion of our firm's name in (a) the Application for Approval to Convert from Mutual to Stock Form of Mercer Mutual Insurance Company dated November 26, 1997, as filed with the Pennsylvania Department of Insurance, and any amendments thereto, and (b) the Registration Statement on Form S-1 of Mercer Insurance Group, Inc. filed with the Securities and Exchange Commission and any amendments thereto. We also hereby consent to the inclusion of, summary of and reference to (i) our Conversion Valuation Report dated November 16, 1997, as updated through December 28, 1998, and (ii) our statement concerning the value of the subscription rights in such filings and in the Prospectus of Mercer Insurance Group, Inc. Sincerely, /s/ James E. Magee Alex Sheshunoff & Co. Investment Banking 98 SAN JACINTO BOULEVARD * SUITE 1925 * AUSTIN, TEXAS 78701 PHONE 512-479-8200 * FAX 512-472-8953 EX-27.1 6 FINANCIAL DATA SCHEDULE
7 1,000 9-MOS YEAR DEC-31-1998 DEC-31-1997 JAN-01-1998 JAN-01-1997 SEP-30-1998 DEC-31-1997 36,074 34,947 0 0 0 0 12,867 10,852 0 0 0 0 48,941 45,799 7,035 2,707 615 1,074 3,906 3,019 76,719 74,085 30,331 31,872 15,780 14,723 0 0 0 0 0 0 0 0 0 0 0 0 25,836 23,236 76,719 74,085 17,110 17,969 1,656 2,350 368 589 124 173 8,739 10,594 4,836 4,706 2,755 2,563 2,928 3,218 966 1,001 1,962 2,217 0 0 0 0 0 0 1,962 2,217 0 0 0 0 31,872 35,221 9,527 11,649 (788) (1,055) 3,064 4,775 3,662 6,042 30,331 31,872 (6,202) (5,414)
EX-99.1.3 7 CONVERSION VALUATION UPDATE REPORT DATED 12-28-98 1 December 28, 1998 Board of Directors Mercer Mutual Insurance Company 10 North Highway 31 Pennington, New Jersey 08534 Directors: You have requested that we update our independent appraisal (the "Appraisal") of the estimated pro forma market value of Mercer Mutual Insurance Group (the "Company" or "Mercer") as a subsidiary of Mercer Insurance Group, Inc. (the "Corporation"), Pennington, New Jersey, a newly organized Pennsylvania corporation. The Corporation will offer common stock ("Common Stock") consistent with our estimate of the pro forma market value of the Company. Such shares of Common Stock are to be issued in connection with the Company's conversion from a Pennsylvania mutual insurance company to a stock insurance company in accordance with the Company's "Amended and Restated Plan of Conversion from Mutual to Stock Organization" as adopted on October 17, 1997, as amended and restated November 12, 1997 (the "Plan") and as filed on November 26, 1997 with the Insurance Department of the State of Pennsylvania (the "Reorganization"). Our Appraisal as of November 26, 1997 and updates as of March 3, 1998, June 4, 1998 and August 18, 1998, are incorporated herein by reference. This Updated Appraisal was prepared and provided to the Company in conjunction with the filing of the amended Application for Conversion as filed with the Insurance Department and Pre-effective Amendment No. 5 to the Registration Statement on Form S-1 with the Securities and Exchange Commission. Sheshunoff believes it is independent of the Company. Except for the fee which it will receive for providing this appraisal, neither Sheshunoff nor the Company have an economic interest in each other and neither has derived and does not anticipate deriving gross revenues of a material amount from business relationships with each other. Alex Sheshunoff & Co. Investment Banking ("Sheshunoff"), is an independent financial institution consulting firm recognized for its expertise in the financial services industry. Sheshunoff is engaged exclusively in the financial services industry in investment banking, business valuations, management consulting and executive management educational forums. Sheshunoff's investment banking services include advice on business and financial strategy, 2 Mercer Mutual Insurance Company December 28, 1998 Page 2 mergers & acquisitions, fairness opinions, evaluation of capital adequacy and efficiency, finance, capital structure, initial public offerings, primary shares offerings, and mutual to stock conversion valuations. Sheshunoff has relied upon, without independent verification, the accuracy and completeness of the information provided to, and reviewed by, it for the purposes of this Appraisal. Sheshunoff has not made an independent evaluation or valuation of the assets or liabilities of the Company. With respect to financial estimates and projections, Sheshunoff assumed that they have been reasonably prepared and reflect the best currently available estimates and judgments of management of the Company and Sheshunoff assumed such projections will be realized in the amounts and at the times contemplated thereby. We are not actuaries nor have we made an assessment of the underwriting risk of the policies in force at the Company. We have assumed that the reserves established by the Company are adequate to meet future losses. The Appraisal also utilized information obtained from other publicly available sources which Sheshunoff believes to be accurate, however, we cannot attest to the accuracy of such information. Concurrent with the preparation of this Updated Appraisal, Sheshunoff: (i.) reviewed the Corporation's Registration Statement on Form S-1 and a draft of pre-effective Amendment No. 5 thereto, as filed with the Securities and Exchange Commission ("SEC"); (ii.) reviewed financial statements and other financial and operating data concerning the Company prepared by its management for the period ended September 30, 1998; (iii.) reviewed certain financial information and projections of the Company as prepared by its management; (iv.) discussed certain aspects of the past, current and future business practices, operations, financial condition and prospects of the Company with certain senior members of the Company's management; (vi) reviewed the market valuation of common stocks of property/casualty insurance companies, companies which recently converted from mutual to stock organization and companies having made recent initial public offerings; (vi.) compared the Company to other property/casualty companies we deemed appropriate; (vii.) compared the Company to certain publicly available industry averages and aggregates as provided by authoritative industry sources; and (viii) performed such studies, business and financial investigations we deemed appropriate. This Updated Appraisal is not intended and must not be construed as a recommendation to the Policyholders or any other persons as to the purchase of common stock of the Corporation in the Offering or otherwise. This Updated Appraisal is based upon a number of assumptions and estimates which may change from time to time and we provide no guarantee, assurance, representations or warranties that any person who purchases shares 3 Mercer Mutual Insurance Company December 28, 1998 Page 3 of the Corporation's common stock in this conversion will subsequently be able to sell such shares of common stock at a price equivalent to the price indicated in this Updated Appraisal. Sheshunoff is not a seller of securities within the meaning of federal and state securities laws and any opinion or report by Sheshunoff is not meant and shall not be utilized or construed as an offer or solicitation with respect to the purchase or sale of any securities in the Offering. This appraisal will be updated at the conclusion of the subscription offering, or as requested by the Company. Sheshunoff assumes no responsibility to update the appraisal at any other time. Any changes made in the estimated market value of Mercer as a subsidiary of the corporation will be detailed in our later updated appraisal reports. It is our opinion, pursuant to the instructions contained in the Plan that as of December 28, 1998, the estimated pro forma market value of the Mercer as a subsidiary of the Corporation was $29,500,000 at the mid-point. Based upon a range 15% above and below the midpoint, the estimated pro forma range was $25,075,000 million at the minimum and $33,925,000 million at the maximum. Very truly yours, /s/ Alex Sheshunoff & Co. Investment Banking Alex Sheshunoff & Co. Investment Banking 4 CONVERSION VALUATION UPDATE REPORT Prepared for MERCER MUTUAL INSURANCE COMPANY and MERCER INSURANCE GROUP, INC. Pennington, New Jersey Dated December 28, 1998 Alex Sheshunoff & Company Investment Banking Nineteenth Floor 98 San Jacinto Boulevard Austin, Texas 78701 (800) 279-2241 5 Mercer Mutual Insurance Company Mercer Insurance Group, Inc. Conversion Valuation Update Report December 28, 1998 RECENT FINANCIAL PERFORMANCE OF THE COMPANY Overall, the trends discussed in our Appraisal and updated appraisals continued during the third quarter of 1998. Mercer reported net income of $625,000 for the three months ended September 30, 1998, resulting in net income of $1.96 million for the first nine months of 1998. The Company continued to experience catastrophe losses below historic norms during the quarter. Loss and loss adjustment expenses were 51.1% of net premiums earned during the nine months ended September 30, 1998 compared to 60.5% during the comparable 1997 period. For the nine months ended September 30, 1998, the Company's expense ratio (based on GAAP accounting, total underwriting expenses to premiums earned) was 44.4%, and the Loss & LAE Ratio (total incurred losses and loss adjustment expenses to earned premiums) was 51.1%. The GAAP combined ratio during the 1998 nine month period was 95.5% compared to 101.6% during the comparable period in 1997. The positive underwriting trend was also the result of Mercer's strategy of increasing its commercial and casualty business to diversify its risk from weather-related business. Effective January 1, 1998, Mercer converted its reinsurance program to one that is predominately an excess of loss program and increased its retention levels. As a result, there have been significant reductions in premiums ceded to outside reinsurers. Net premiums written for the nine months ended September 30, 1998 increased by 61% to $20.7 million compared to $12.9 million through the first three quarters of 1997. Commercial lines premiums increased the largest as a result of the introduction of the religious institution program and a commercial automobile program in 1997. Net investment income decreased 7.6% to $1.66 million. The Company's principal investment is taxable fixed income securities. The variability of earnings in the Property and Casualty business and the inability to predict near-term earnings remains an important risk factor in the way the market values these Companies. We continue to believe Mercer should be valued both on its recent historic earnings and other trends as well as some measure of adjusted earnings to reflect the fact that 1997 and the early part of 1998 both experienced very low levels of catastrophe losses. 6 Mercer Mutual Insurance Company Mercer Insurance Group, Inc. Conversion Valuation Update Report December 28, 1998 Page 2 In summary, extremely low catastrophe losses and the strong market continued to result in much improved earnings for Mercer. Like many P & C companies, it is difficult to imagine the conditions resulting in 1997 profitability could be better in 1998. We applaud management in its efforts to diversify risk and position the Company for future expansion. However, Mercer will continue to face the same pressures of costly competition and, particularly after conversion, excess capital. COMPARATIVE GROUP PERFORMANCE Table 1 presents the comparative group performance as of December 28, 1998. There was a significant market sell-off during July and early August, leaving many stocks at prior year-end prices by September. The sell-off hit almost all market segments, including insurance company stocks. However, the market quickly staged an impressive comeback with the Dow Jones Industrial Average reaching a new all-time high on November 23, 1998. More recently, the market appears to have stabilized, fluctuating daily, but remaining roughly within 5% of the recent all-time high to date. Among the comparative group, the average and median price changes since our last update on August 18, 1998 were declines of 5.47% and 4.39%, respectively. 7 Mercer Mutual Insurance Company Mercer Insurance Group, Inc. Conversion Valuation Update Report December 28, 1998 Page 3 Mercer Mutual Insurance Company Mercer Insurance Group, Inc. Conversion Valuation Update Report Between August 19, 1998 and December 28, 1998 Page 3
Price Price Percent Company August 18, 1998 December 28, 1998 Change - ------- --------------- ----------------- ------ Farm Family $36.38 $33.25 -8.60% Motor Club of America $13.38 $14.25 6.50% Alfa Corporation $20.25 $23.31 15.11% State Auto $14.63 $12.50 -14.56% Selective Insurance $19.50 $20.19 3.54% Harleysville Group $24.75 $23.38 -5.54% Donegal Group $16.75 $13.50 -19.40% Old Guard Group $16.88 $14.25 -15.58% Merchants Group $20.63 $20.63 0.00% Meridian Ins. Group $18.50 $17.50 -5.41% Average -5.47% Median -4.39%
While stock prices overall are roughly 5% off the all-time high level on November 23, 1998, a level significantly higher than the 20% correction levels experienced just months earlier, we have not adjusted our estimate of the pro forma market value of Mercer pursuant to the Reorganization. While there may have been some softening in investor interest in these offerings in light of the market volatility, the expectation remains that the offering will be fully subscribed within the valuation range. However, if the market continues to exhibit great volatility, some adjustment may be necessary. 8 Mercer Mutual Insurance Company Mercer Insurance Group, Inc. Conversion Valuation Update Report December 28, 1998 Page 4 CONCLUSION Based upon the following, we believe the estimated pro forma market value of Mercer pursuant to the Reorganization was $29,500,000. The resulting range was $25,075,000 at the minimum and $33,925,000 at the maximum. 9 EXHIBIT I 10 [MERCERMUTUAL INSURANCE COMPANY LOGO] MERCER INSURANCE GROUP GAAP CONSOLIDATED FINANCIAL STATEMENTS AS OF SEPTEMBER 30, 1998 11 MERCER MUTUAL INSURANCE COMPANY AND SUBSIDIARIES Consolidated Balance Sheets As of September 30, 1998 and December 31, 1997 (dollars in thousands)
- ----------------------------------------------------------------------------- SEPTEMBER 30, DECEMBER 31, 1998 1997 ASSETS - ----------------------------------------------------------------------------- Investments, at fair value: Fixed income securities, available-for-sale $36,074 34,947 Equity securities 12,867 10,852 - ----------------------------------------------------------------------------- Total investments 48,941 45,799 Cash and cash equivalents 7,035 2,707 Premiums receivable 3,688 3,334 Reinsurance receivables 9,297 13,206 Prepaid reinsurance premiums 479 3,046 Deferred policy acquisition costs 3,906 3,019 Accrued investment income 443 625 Property and equipment, net 1,512 1,413 Other assets 1,418 936 - ----------------------------------------------------------------------------- Total assets $76,719 74,085 - ----------------------------------------------------------------------------- LIABILITIES AND SURPLUS - ----------------------------------------------------------------------------- Liabilities: Losses and loss adjustment expenses $30,331 31,872 Unearned premiums 15,780 14,723 Accounts payable and accrued expenses 2,820 2,417 Deferred income taxes 310 177 Other reinsurance balances 886 835 Other liabilities 756 825 - ----------------------------------------------------------------------------- Total liabilities 50,883 50,849 - ----------------------------------------------------------------------------- Surplus: Unassigned surplus 22,655 20,693 Accumulated other comprehensive income: Unrealized gains in investments, net of deferred income taxes 3,181 2,543 - ----------------------------------------------------------------------------- Total surplus 25,836 23,236 - ----------------------------------------------------------------------------- Total liabilities and surplus $76,719 74,085 - -----------------------------------------------------------------------------
2 12 MERCER MUTUAL INSURANCE COMPANY AND SUBSIDIARIES Consolidated Statements of Earnings Nine months ended September 30, 1998 and 1997 (dollars in thousands)
- ------------------------------------------------------------------------------- 1998 1997 - ------------------------------------------------------------------------------- Revenue: Net premiums earned............................ $17,110 13,288 Investment income, net of expenses............. 1,656 1,793 Net realized investment gains.................. 368 483 Other revenue.................................. 124 144 - ------------------------------------------------------------------------------- Total revenue............................... 19,258 15,708 - ------------------------------------------------------------------------------- Expenses: Losses and loss adjustment expenses............ 8,739 8,038 Amortization of deferred policy acquisition costs.............................. 4,836 3,533 Other expenses................................. 2,755 1,928 - ------------------------------------------------------------------------------- Total expenses.............................. 16,330 13,499 - ------------------------------------------------------------------------------- Income before income tax........................ 2,928 2,209 Income tax...................................... 966 694 - ------------------------------------------------------------------------------- Net income...................................... $ 1,962 1,515 - -------------------------------------------------------------------------------
3 13 MERCER MUTUAL INSURANCE COMPANY AND SUBSIDIARIES Consolidated Statements of Changes in Surplus Nine months ended September 30, 1998 and 1997 (dollars in thousands)
- ------------------------------------------------------------------------------- 1998 1997 - ------------------------------------------------------------------------------- Balance, beginning of period..................... $23,236 19,282 Net income....................................... 1,962 1,515 Other comprehensive income (loss), net of tax: Unrealized gains on securities: Unrealized holding gains arising during period (net of related income tax expense of $453 and $756).................. 880 1,468 Less: Reclassification adjustment for gains included in net income (net of related income tax expense of $125, and $164)..................................... (242) (319) - ------------------------------------------------------------------------------- 638 1,149 - ------------------------------------------------------------------------------- Comprehensive income (loss).................... 2,600 2,664 - ------------------------------------------------------------------------------- Balance, end of period........................... $25,836 21,946 - -------------------------------------------------------------------------------
4 14 MERCER MUTUAL INSURANCE COMPANY AND SUBSIDIARIES Consolidated Statements of Cash Flow Nine months ended September 30, 1998 and 1997 (dollars in thousands)
- ---------------------------------------------------------------------------------- 1998 1997 - ---------------------------------------------------------------------------------- Cash flows from operating activities: Net income $ 1,962 1,515 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation of property and equipment 104 84 Net accretion of discount (29) (39) Net realized investment gain (367) (483) Deferred income tax (195) (22) Change in assets and liabilities: Premiums receivable (354) (1,139) Reinsurance receivables 3,909 5,020 Prepaid reinsurance premiums 2,567 (2,002) Deferred policy acquisition costs (886) 81 Other assets (301) 290 Losses and loss expenses (1,541) (2,409) Unearned premiums 1,058 1,617 Other liabilities 484 (2,628) - ---------------------------------------------------------------------------------- Net cash provided by (used in) operating activities 6,411 (115) - ---------------------------------------------------------------------------------- Cash flows from investing activities: Purchase of fixed income securities, available-for-sale (11,529) (6,695) Purchase of equity securities (6,042) (5,477) Sale and maturity of fixed income securities available-for-sale 11,069 6,784 Sale of equity securities 4,722 5,235 Change in receivable/payable for securities (100) (60) Purchase of property and equipment (203) (81) - ---------------------------------------------------------------------------------- Net cash use in investing activities (2,083) (294) - ---------------------------------------------------------------------------------- Net increase (decrease) in cash and cash equivalents 4,328 (409) Cash and cash equivalents at beginning of period 2,707 2,675 - ---------------------------------------------------------------------------------- Cash and cash equivalents at end of period $ 7,035 2,266 - ---------------------------------------------------------------------------------- Cash paid during the year for: Interest $ 0 0 Income taxes $ 1,462 730
5 15 EXHIBIT II 16 MERCER INSURANCE GROUP RATIOS 9/30/98
THREE MONTHS ENDED NINE MONTHS ENDED GAAP BASIS 9/30/98 9/30/97 9/30/98 9/30/97 ------------------ ----------------- Loss Ratio (Losses/Premiums Earned)...................... 38.6% 43.7% 42.4% 49.2% LAE Ratio (LAE/Premiums Earned).......................... 8.8% 13.4% 8.7% 11.3% ------------------ ----------------- 47.4% 57.1% 51.1% 60.5% Expense Ratio (Expenses/Premiums Earned)................. 46.2% 40.1% 44.4% 41.1% ------------------ ----------------- GAAP Combined Ratio...................................... 93.6% 97.2% 95.5% 101.6% ================== ================= Premiums Earned.......................................... 6,179 4,597 17,110 13,288 Losses................................................... 2,385 2,010 7,254 6,539 Loss Adjustment Expenses (LAE)........................... 543 616 1,485 1,499 ------------------ ----------------- Per Financial Statement............................. 2,928 2,626 8,739 8,038 ------------------ ----------------- Amortization of Deferred Policy Acq. Costs............... 1,436 1,265 4,836 3,533 Other Expenses........................................... 1,418 579 2,755 1,928 ------------------ ----------------- Expenses............................................ 2,854 1,844 7,591 5,461 ------------------ ----------------- STATUTORY BASIS Loss Ratio (Losses/Premiums Earned)...................... 38.6% 43.7% 42.4% 49.2% LAE Ratio (LAE/Premiums Earned).......................... 8.9% 13.5% 8.8% 11.4% ------------------ ----------------- 47.5% 57.2% 51.2% 60.6% Expense Ratio (Expenses/Premiums Written)................ 45.3% 41.5% 41.1% 42.0% ------------------ ----------------- Statutory Combined Ratio................................. 92.8% 98.7% 92.3% 102.6% ================== ================= Net Premiums Written..................................... 7,058 4,887 20,734 12,904 Net Premiums Earned...................................... 6,179 4,597 17,110 13,288 Losses................................................... 2,385 2,010 7,254 6,539 Loss Adjustment Expenses (LAE)........................... 548 621 1,499 1,514 ------------------ ----------------- 2,933 2,631 8,753 8,053 ------------------ ----------------- Other Underwriting Expenses.............................. 3,196 2,027 8,516 5,416
17 EXHIBIT III 18 TABLE 1 SHESHUNOFF PEER GROUP HISTORICAL ANALYSIS FOR THE YEARS ENDING DECEMBER 31, 1993-1997 & LAST TWELVE MONTHS ENDING SEPTEMBER 30, 1998 MERCER MUTUAL INSURANCE COMPANY (Dollars In Thousands, Except Per Share Data)
- ----------------------------------------------------------------------------------------------------------------------------- MERCER INSURANCE DONEGAL FARM GROUP, ALFA GROUP, FAMILY INC. CORPORATION INC. HOLDINGS - ----------------------------------------------------------------------------------------------------------------------------- (in thousands, except for per share amounts) COMMON STOCK SYMBOL ALFA DGIC FFH COMMON STOCK PRICE $ 28-DEC-98 23 5/16 13 1/2 33 1/4 Twelve Month - High 23.19 22.78 42.50 Twelve Month - Low 16.25 12.88 28.00 Last to High 101% 59% 78% COMMON SHARES OUTSTANDING 40,857,111 8,157,569 5,253,813 $ $ $ $ MARKET CAPITALIZATION 935 108 171 BOOK VALUE PER SHARE @ 9/30/98 $ 10.02 $ 11.96 $ 26.86 BOOK VALUE PER SHARE @ 12/31/97 $ 9.39 $ 11.39 $ 24.73 PRICE TO MOST RECENT BOOK VALUE 248% 113% 124% PRICE TO LTM EARNINGS 16.9 13.5 9.2 PRICE TO 1998 ESTIMATED EARNINGS 16.3 11.8 11.9 FULLY DILUTED EARNINGS PER SHARE: $ $ $ $ 1998 Estimated 1.40 1.12 2.73 LTM 30-Sep-98 1.35 0.98 3.52 31-Dec-97 1.29 1.33 3.51 31-Dec-96 0.79 1.45 1.74 31-Dec-95 0.55 1.73 3.20 31-Dec-94 0.81 0.90 1.18 31-Dec-93 1.04 1.44 2.53 CGR 1993 - LTM 1997 5.5% -2.0% 8.5% DIVIDENDS PER COMMON SHARE: Indicated Dividend Yield 45.0% 34.0% 0.0% $ $ $ $ Current Indicated 0.11 0.09 0.00 31-Dec-97 0.40 0.29 0.00 31-Dec-96 0.39 0.33 0.00 31-Dec-95 0.38 0.30 0.00 31-Dec-94 0.34 0.33 0.00 31-Dec-93 0.28 0.18 0.00 CGR 1993-1997 9.2% 12.9% 0.0%
- -------------------------------------------------------------------------------------------------------------------------- MERIDIAN MOTOR HARLEYSVILLE MERCHANTS INSURANCE CLUB GROUP, GROUP, GROUP, OF INC. INC. INC. AMERICA - -------------------------------------------------------------------------------------------------------------------------- (in thousands, except for per share amounts) COMMON STOCK SYMBOL HGIC MGP MIGI MOTR COMMON STOCK PRICE 28-DEC-98 23 3/8 20 5/8 17 1/2 14 1/4 Twelve Month - High 28.22 26.25 19.09 17.63 Twelve Month - Low 18.88 18.50 14.55 11.19 Last to High 83% 79% 92% 81% COMMON SHARES OUTSTANDING 29,115,456 2,881,752 7,307,871 2,116,429 $ $ $ $ MARKET CAPITALIZATION 663 59 124 30 BOOK VALUE PER SHARE @ 9/30/98 $ 17.24 $ 24.92 $ 18.65 $ 12.95 BOOK VALUE PER SHARE @ 12/31/97 $ 15.49 $ 23.21 $ 18.09 $ 10.98 PRICE TO MOST RECENT BOOK VALUE 136% 83% 94% 110% PRICE TO LTM EARNINGS 11.4 10.5 12.7 7.5 PRICE TO 1998 ESTIMATED EARNINGS 12.6 10.9 14.4 6.4 FULLY DILUTED EARNINGS PER SHARE: $ $ $ $ 1998 Estimated 1.80 1.90 1.18 2.22 LTM 30-Sep-98 2.00 1.96 1.34 1.90 31-Dec-97 1.86 1.41 0.94 1.66 31-Dec-96 1.02 (0.36) 0.85 2.56 31-Dec-95 1.51 (1.19) 1.71 1.17 31-Dec-94 0.69 0.36 1.35 2.46 31-Dec-93 1.22 2.12 1.53 1.60 CGR 1993 - LTM 1997 11.1% -9.7% -11.5% 0.9% DIVIDENDS PER COMMON SHARE: Indicated Dividend Yield 50.0% 20.0% 29.1% 0.0% $ $ $ $ Current Indicated 0.13 0.05 0.07 0.00 31-Dec-97 0.44 0.20 0.29 0.00 31-Dec-96 0.40 0.20 0.32 0.00 31-Dec-95 0.36 0.20 0.28 0.00 31-Dec-94 0.33 0.20 0.24 0.00 31-Dec-93 0.30 0.10 0.24 0.00 CGR 1993-1997 10.0% 18.9% 4.9% NA
- ---------------------------------------------------------------------------------------------------------- OLD STATE GUARD SELECTIVE AUTO GROUP, INSURANCE FINANCIAL INC. GROUP CORPORATION - ---------------------------------------------------------------------------------------------------------- (in thousands, except for per share amounts) COMMON STOCK SYMBOL OGGI SIGI STFC COMMON STOCK PRICE 28-DEC-98 14 1/4 20 3/16 12 1/2 Twelve Month - High 21.25 28.63 19.88 Twelve Month - Low 13.38 17.38 11.63 Last to High 67% 71% 63% COMMON SHARES OUTSTANDING 4,032,585 28,457,147 41,921,346 $ $ $ MARKET CAPITALIZATION 57 561 498 BOOK VALUE PER SHARE @ 9/30/98 $ 19.17 $ 20.41 $ 7.78 BOOK VALUE PER SHARE @ 12/31/97 $ 20.01 $ 19.32 $ 6.15 PRICE TO MOST RECENT BOOK VALUE 71% 99% 161% PRICE TO LTM EARNINGS 38.5 10.2 13.7 PRICE TO 1998 ESTIMATED EARNINGS 75.0 10.8 14.3 FULLY DILUTED EARNINGS PER SHARE: $ $ $ 1998 Estimated 0.19 1.84 0.83 LTM 30-Sep-98 0.37 1.94 0.87 31-Dec-97 0.91 2.27 0.91 31-Dec-96 (0.46) 1.83 1.23 31-Dec-95 (0.16) 1.81 1.41 31-Dec-94 0.03 1.29 0.82 31-Dec-93 0.81 0.81 0.77 CGR 1993 - LTM 1997 NM 29.4% 4.3% DIVIDENDS PER COMMON SHARE: Indicated Dividend Yield 20.0% 56.0% 10.0% $ $ $ Current Indicated 0.05 0.14 0.03 31-Dec-97 0.05 0.56 0.09 31-Dec-96 0.00 0.56 0.15 31-Dec-95 0.00 0.56 0.14 31-Dec-94 0.00 0.56 0.13 31-Dec-93 0.00 0.56 0.11 CGR 1993-1997 NM 0.0% -7.0%
19 TABLE 1 SHESHUNOFF PEER GROUP HISTORICAL ANALYSIS FOR THE YEARS ENDING DECEMBER 31, 1993-1997 & LAST TWELVE MONTHS ENDING SEPTEMBER 30, 1998 MERCER MUTUAL INSURANCE COMPANY (Dollars In Thousands, Except Per Share Data)
- ---------------------------------------------------------------------------------------------------------------------------- MERCER INSURANCE DONEGAL FARM GROUP, ALFA GROUP, FAMILY INC. CORPORATION INC. HOLDINGS - ---------------------------------------------------------------------------------------------------------------------------- (in thousands, except for per share amounts) NET INCOME: $ $ $ $ LTM 30-Sep-98 2,664 55,459 8,020 18,695 31-Dec-97 2,217 52,793 10,641 18,504 31-Dec-96 640 32,189 8,558 6,924 31-Dec-95 1,138 22,318 9,858 9,606 31-Dec-94 (1,374) 32,867 5,040 3,526 31-Dec-93 799 44,960 6,382 7,584 CGR 1993-1997 29.1% 4.1% 13.6% 25.0% NET INVESTMENT INCOME (excluding net realized gains/losses) LTM 30-Sep-98 2,213 62,166 11,282 18,881 31-Dec-97 2,350 57,529 11,507 18,077 31-Dec-96 2,289 54,194 10,799 15,952 31-Dec-95 2,132 50,923 9,270 14,326 31-Dec-94 1,804 45,554 7,778 13,190 31-Dec-93 2,196 44,902 6,478 13,861 CGR 1993-1997 1.7% 6.4% 15.4% 6.9% NET REALIZED GAINS (LOSSES): $ $ $ $ LTM 30-Sep-98 474 1,137 615 291 31-Dec-97 589 3,356 314 5,406 31-Dec-96 596 2,808 173 (640) 31-Dec-95 53 1,106 399 912 31-Dec-94 277 572 34 1,340 31-Dec-93 509 4,890 845 (174) CGR 1993-1997 3.7% -9.0% -21.9% NM EARNINGS BEFORE TAXES $ $ $ $ LTM 30-Sep-98 3,937 80,534 10,379 28,155 31-Dec-97 3,218 76,799 14,173 28,251 31-Dec-96 811 45,854 10,737 12,143 31-Dec-95 1,508 30,993 12,647 14,590 31-Dec-94 (2,055) 47,832 7,103 4,973 31-Dec-93 963 63,314 8,519 10,666 CGR 1993-1997 35.2% 4.9% 13.6% 27.6% ASSETS $ $ $ $ 30-Sep-98 79,719 1,218,865 322,782 411,041 31-Dec-97 74,085 1,170,065 304,105 368,278 31-Dec-96 74,074 1,019,330 287,991 319,412 31-Dec-95 77,523 965,433 235,704 278,288 31-Dec-94 71,750 847,870 207,721 243,107 31-Dec-93 71,110 766,077 169,461 244,141 CGR 1993-1997 1.0% 11.2% 15.7% 10.8%
- --------------------------------------------------------------------------------------------------------------------------- MERIDIAN MOTOR HARLEYSVILLE MERCHANTS INSURANCE CLUB GROUP, GROUP, GROUP, OF INC. INC. INC. AMERICA - --------------------------------------------------------------------------------------------------------------------------- (in thousands, except for per share amounts) NET INCOME: $ $ $ $ LTM 30-Sep-98 58,853 5,718 9,741 4,022 31-Dec-97 54,072 4,198 6,921 3,482 31-Dec-96 28,680 (1,148) 5,800 5,330 31-Dec-95 41,331 (3,819) 11,617 2,417 31-Dec-94 18,454 1,131 9,121 5,035 31-Dec-93 31,940 5,909 9,410 3,260 CGR 1993-1997 14.1% -8.2% -7.4% 1.7% NET INVESTMENT INCOME (excluding net realized gains/losses) $ $ $ LTM 30-Sep-98 84,823 13,266 17,036 4,103.00 31-Dec-97 81,783 12,770 16,372 3,595 31-Dec-96 78,008 11,724 14,908 3,087 31-Dec-95 68,445 10,368 14,564 2,764 31-Dec-94 64,366 9,849 13,996 2,730 31-Dec-93 59,198 9,155 13,569 2,784 CGR 1993-1997 8.4% 8.7% 4.8% 6.6% NET REALIZED GAINS (LOSSES): $ $ $ $ LTM 30-Sep-98 10,679 (2) 7,217 28 31-Dec-97 6,541 112 4,477 - 31-Dec-96 3,182 996 3,794 6 31-Dec-95 2,245 (832) 1,538 57 31-Dec-94 3,367 20 286 (43) 31-Dec-93 2,721 1,467 890 288 CGR 1993-1997 24.5% -47.4% 49.8% NM EARNINGS BEFORE TAXES $ $ $ $ LTM 30-Sep-98 73,829 7,706 12,375 5,495 31-Dec-97 67,281 5,422 7,128 4,630 31-Dec-96 31,375 (3,033) 5,950 3,297 31-Dec-95 52,642 (6,818) 15,722 2,455 31-Dec-94 16,832 236 11,536 5,039 31-Dec-93 38,572 7,330 11,649 3,827 CGR 1993-1997 14.9% -7.3% -11.6% 4.9% ASSETS $ $ $ $ 30-Sep-98 1,934,940 278,101 410,082 119,470 31-Dec-97 1,801,195 273,974 413,586 101,347 31-Dec-96 1,622,612 262,123 397,798 95,533 31-Dec-95 1,378,341 252,808 322,588 81,959 31-Dec-94 1,241,072 222,407 291,406 79,172 31-Dec-93 1,180,389 221,556 285,937 86,670 CGR 1993-1997 11.1% 5.5% 9.7% 4.0%
- ----------------------------------------------------------------------------------------------------------- OLD STATE GUARD SELECTIVE AUTO GROUP, INSURANCE FINANCIAL INC. GROUP CORPORATION - ----------------------------------------------------------------------------------------------------------- (in thousands, except for per share amounts) NET INCOME: $ $ $ LTM 30-Sep-98 1,466 59,907 33,718 31-Dec-97 3,485 69,608 33,959 31-Dec-96 (1,920) 55,551 22,602 31-Dec-95 (684) 53,042 25,542 31-Dec-94 144 38,276 14,662 31-Dec-93 3,388 22,678 13,729 CGR 1993-1997 0.7% 32.4% 25.4% NET INVESTMENT INCOME (excluding net realized gains/losses) $ $ $ LTM 30-Sep-98 5,739 99,717 27,862 31-Dec-97 5,877 100,530 25,078 31-Dec-96 4,495 96,952 23,879 31-Dec-95 4,458 91,640 22,617 31-Dec-94 3,932 80,657 17,756 31-Dec-93 3,928 77,326 17,222 CGR 1993-1997 10.6% 6.8% 9.9% NET REALIZED GAINS (LOSSES): $ $ $ LTM 30-Sep-98 1,672 3,454 1,778 31-Dec-97 2,326 6,021 543 31-Dec-96 1,385 2,786 1,401 31-Dec-95 1,011 900 1,201 31-Dec-94 476 4,230 1,506 31-Dec-93 1,758 4,528 718 CGR 1993-1997 7.3% 7.4% -6.7% EARNINGS BEFORE TAXES $ $ $ LTM 30-Sep-98 2,167 74,915 44,877 31-Dec-97 5,488 91,020 47,084 31-Dec-96 (3,347) 69,089 30,148 31-Dec-95 (1,368) 64,898 35,339 31-Dec-94 (388) 43,408 19,105 31-Dec-93 3,771 21,352 16,849 CGR 1993-1997 9.8% 43.7% 29.3% ASSETS $ $ $ 30-Sep-98 180,854 2,410,080 701,381 31-Dec-97 175,399 2,306,191 493,151 31-Dec-96 137,462 2,189,737 453,120 31-Dec-95 134,853 2,113,077 434,496 31-Dec-94 127,831 1,866,680 334,796 31-Dec-93 140,213 1,721,850 320,203 CGR 1993-1997 5.8% 7.6% 11.4%
20 TABLE 1 SHESHUNOFF PEER GROUP HISTORICAL ANALYSIS FOR THE YEARS ENDING DECEMBER 31, 1993-1997 & LAST TWELVE MONTHS ENDING SEPTEMBER 30, 1998 MERCER MUTUAL INSURANCE COMPANY (Dollars In Thousands, Except Per Share Data)
- ---------------------------------------------------------------------------------------------------------------------------- MERCER INSURANCE DONEGAL FARM GROUP, ALFA GROUP, FAMILY INC. CORPORATION INC. HOLDINGS - ---------------------------------------------------------------------------------------------------------------------------- (in thousands, except for per share amounts) LOSS & LAE RESERVES $ $ $ $ 30-Sep-98 30,331 137,926 128,343 176,966 31-Dec-97 31,872 132,086 118,112 156,622 31-Dec-96 35,221 117,672 114,622 141,220 31-Dec-95 36,176 108,303 97,734 137,978 31-Dec-94 35,531 88,208 87,744 127,954 31-Dec-93 33,308 77,169 69,442 123,477 CGR 1993-1997 -1.1% 14.4% 14.2% 6.1% STOCKHOLDERS' EQUITY $ $ $ $ 30-Sep-98 25,836 403,600 95,743 133,102 31-Dec-97 23,236 382,931 91,597 129,927 31-Dec-96 19,282 323,312 81,599 110,741 31-Dec-95 18,963 308,610 72,283 74,164 31-Dec-94 14,203 254,985 60,565 52,977 31-Dec-93 17,641 260,986 57,346 60,512 CGR 1993-1997 7.1% 10.1% 12.4% 21.0% COMBINED RATIO % % % % LTM 30-Sep-98 NA NA NA NA 31-Dec-97 99.4 91.5 97.6 97.2 31-Dec-96 110.8 100.7 100.4 101.8 31-Dec-95 104.1 103.9 97.3 100.9 31-Dec-94 123.6 95.0 101.7 109.9 31-Dec-93 110.4 90.7 99.1 103.4 LOSS & LAE RATIO % % % % LTM 30-Sep-98 NA NA NA NA 31-Dec-97 58.9 65.0 63.0 69.2 31-Dec-96 71.7 67.0 66.6 72.6 31-Dec-95 63.9 63.6 64.2 71.1 31-Dec-94 75.5 64.9 68.9 81.5 31-Dec-93 63.8 64.0 68.9 75.7
- -------------------------------------------------------------------------------------------------------------------------- MERIDIAN MOTOR HARLEYSVILLE MERCHANTS INSURANCE CLUB GROUP, GROUP, GROUP, OF INC. INC. INC. AMERICA - -------------------------------------------------------------------------------------------------------------------------- (in thousands, except for per share amounts) LOSS & LAE RESERVES $ $ $ $ 30-Sep-98 905,288 140,165 165,908 54,875 31-Dec-97 868,393 141,205 169,801 50,247 31-Dec-96 796,820 133,479 161,309 47,667 31-Dec-95 645,941 119,722 123,577 39,824 31-Dec-94 603,088 104,015 123,755 41,665 31-Dec-93 560,811 93,896 119,764 45,818 CGR 1993-1997 11.6% 10.7% 9.1% 2.3% STOCKHOLDERS' EQUITY $ $ $ $ 30-Sep-98 468,215 68,930 137,774 24,066 31-Dec-97 446,515 67,462 131,894 23,001 31-Dec-96 370,245 65,029 122,174 18,786 31-Dec-95 345,009 69,970 118,242 14,081 31-Dec-94 276,924 67,279 94,253 10,546 31-Dec-93 267,749 75,083 94,447 7,168 CGR 1993-1997 13.6% -2.6% 8.7% 33.8% COMBINED RATIO % % % % LTM 30-Sep-98 NA NA NA NA 31-Dec-97 103.6 108.0 107.6 98.4 31-Dec-96 108.4 116.6 108.0 102.4 31-Dec-95 104.0 117.5 100.2 102.6 31-Dec-94 111.5 111.3 101.8 94.1 31-Dec-93 106.7 104.6 101.8 99.8 LOSS & LAE RATIO % % % % LTM 30-Sep-98 NA NA NA NA 31-Dec-97 NA 74.6 76.7 65.1 31-Dec-96 76.2 83.1 77.8 64.5 31-Dec-95 70.3 82.5 69.2 58.7 31-Dec-94 77.9 77.9 69.8 54.8 31-Dec-93 77.9 70.8 69.4 54.1
- ---------------------------------------------------------------------------------------------------------- OLD STATE GUARD SELECTIVE AUTO GROUP, INSURANCE FINANCIAL INC. GROUP CORPORATION - ---------------------------------------------------------------------------------------------------------- (in thousands, except for per share amounts) LOSS & LAE RESERVES $ $ $ 30-Sep-98 47,868 1,184,947 224,515 31-Dec-97 48,719 1,161,169 162,446 31-Dec-96 55,371 1,189,793 165,875 31-Dec-95 52,091 1,120,052 170,575 31-Dec-94 51,309 999,404 133,750 31-Dec-93 59,057 917,691 130,556 CGR 1993-1997 -4.7% 6.1% 5.6% STOCKHOLDERS' EQUITY $ $ $ 30-Sep-98 81,805 594,728 234,483 31-Dec-97 78,654 565,316 225,479 31-Dec-96 39,011 474,299 186,461 31-Dec-95 40,897 436,749 168,252 31-Dec-94 36,531 329,164 130,186 31-Dec-93 39,854 322,807 124,332 CGR 1993-1997 18.5% 15.0% 16.0% COMBINED RATIO % % % LTM 30-Sep-98 NA NA NA 31-Dec-97 100.8 100.3 94.2 31-Dec-96 117.1 102.9 100.3 31-Dec-95 110.7 102.3 97.4 31-Dec-94 108.0 105.1 101.0 31-Dec-93 103.5 109.1 102.1 LOSS & LAE RATIO % % % LTM 30-Sep-98 NA NA NA 31-Dec-97 61.7 NA 65.1 31-Dec-96 82.8 71.3 72.2 31-Dec-95 75.8 71.2 68.2 31-Dec-94 73.2 71.7 75.1 31-Dec-93 69.1 71.8 73.0
21 TABLE 1 SHESHUNOFF PEER GROUP HISTORICAL ANALYSIS FOR THE YEARS ENDING DECEMBER 31, 1993-1997 & LAST TWELVE MONTHS ENDING SEPTEMBER 30, 1998 MERCER MUTUAL INSURANCE COMPANY (Dollars In Thousands, Except Per Share Data)
- ----------------------------------------------------------------------------------------------------------------------------- MERCER INSURANCE DONEGAL FARM GROUP, ALFA GROUP, FAMILY INC. CORPORATION INC. HOLDINGS - ----------------------------------------------------------------------------------------------------------------------------- (in thousands, except for per share amounts) EXPENSE RATIO % % % % LTM 30-Sep-98 NA NA NA NA 31-Dec-97 40.5 26.5 34.6 28.0 31-Dec-96 39.1 33.7 31.2 29.2 31-Dec-95 40.2 40.3 31.8 29.8 31-Dec-94 48.1 30.1 30.7 28.4 31-Dec-93 46.6 26.7 30.2 27.7 RETURN ON EQUITY % % % % LTM 30-Sep-98 10.31 13.98 8.47 14.05 31-Dec-97 9.54 14.95 12.29 15.38 31-Dec-96 3.32 10.19 11.12 7.49 31-Dec-95 6.00 7.92 14.84 15.11 31-Dec-94 -9.67 12.74 8.55 NA 31-Dec-93 4.53 18.52 13.61 NA NET REALIZED GAIN ( LOSS) / EBT % % % % LTM 30-Sep-98 12.04 NA 5.93 1.03 31-Dec-97 18.30 4.37 2.22 19.14 31-Dec-96 73.49 6.12 1.61 -5.27 31-Dec-95 3.51 3.57 3.15 6.25 31-Dec-94 -13.48 1.20 0.48 NA 31-Dec-93 52.86 7.72 9.92 NA
- -------------------------------------------------------------------------------------------------------------------------- MERIDIAN MOTOR HARLEYSVILLE MERCHANTS INSURANCE CLUB GROUP, GROUP, GROUP, OF INC. INC. INC. AMERICA - -------------------------------------------------------------------------------------------------------------------------- (in thousands, except for per share amounts) EXPENSE RATIO % % % % LTM 30-Sep-98 NA NA NA NA 31-Dec-97 NA 33.4 30.9 33.3 31-Dec-96 32.3 33.5 30.2 37.9 31-Dec-95 33.7 35.0 31.0 43.9 31-Dec-94 33.6 33.4 32.0 39.3 31-Dec-93 28.5 33.8 32.4 45.7 RETURN ON EQUITY % % % % LTM 30-Sep-98 12.61 8.29 7.21 16.57 31-Dec-97 13.24 6.34 5.45 16.67 31-Dec-96 8.02 -1.70 4.93 32.43 31-Dec-95 13.29 -5.57 10.93 19.63 31-Dec-94 6.78 1.59 9.67 56.85 31-Dec-93 12.65 9.21 11.69 45.52 NET REALIZED GAIN ( LOSS) / EBT % % % % LTM 30-Sep-98 14.46 -0.03 58.32 0.51 31-Dec-97 9.72 2.07 62.81 0.00 31-Dec-96 10.14 -32.84 63.76 0.18 31-Dec-95 4.26 12.20 9.78 2.32 31-Dec-94 20.00 8.47 2.48 -0.85 31-Dec-93 7.05 20.01 7.64 7.53
- --------------------------------------------------------------------------------------------------------- OLD STATE GUARD SELECTIVE AUTO GROUP, INSURANCE FINANCIAL INC. GROUP CORPORATION - --------------------------------------------------------------------------------------------------------- (in thousands, except for per share amounts) EXPENSE RATIO % % % LTM 30-Sep-98 NA NA NA 31-Dec-97 39.1 NA 29.1 31-Dec-96 34.3 31.6 28.1 31-Dec-95 34.9 31.1 29.2 31-Dec-94 34.8 33.4 25.9 31-Dec-93 34.4 37.3 29.1 RETURN ON EQUITY % % % LTM 30-Sep-98 1.83 10.33 13.95 31-Dec-97 5.92 13.39 16.49 31-Dec-96 -4.81 12.19 12.74 31-Dec-95 -1.81 13.85 17.12 31-Dec-94 NA 11.74 11.52 31-Dec-93 NA 7.15 11.95 NET REALIZED GAIN ( LOSS) / EBT % % % LTM 30-Sep-98 77.16 4.61 3.96 31-Dec-97 42.38 6.62 1.15 31-Dec-96 -41.38 4.03 4.65 31-Dec-95 -73.90 1.39 3.40 31-Dec-94 NA 9.74 7.88 31-Dec-93 NA 21.21 4.26
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