10-K405 1 l92254ae10-k405.txt MERCHANTS GROUP, INC. FORM 10-K405 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM __________ TO ___________. FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001 COMMISSION FILE NUMBER 1-9640 MERCHANTS GROUP, INC. (Exact name of registrant as specified in its charter) DELAWARE 16-1280763 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 250 MAIN STREET, BUFFALO, NEW YORK 14202 (Address of principal executive offices) (Zip Code) 716-849-3333 (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: Title of each class - COMMON STOCK, $.01 PAR VALUE PER SHARE Name of each exchange on which registered - AMERICAN STOCK EXCHANGE, INC. Securities registered pursuant to Section 12 (g) of the Act: NONE Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [x] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [x] As of March 13, 2002, 2,110,152 shares of common stock were outstanding. The aggregate market value of the common shares held by non-affiliates of Merchants Group, Inc. on March 13, 2002 was $13,760,000. Solely for purposes of this calculation, the Company deemed every person who beneficially owned 5% or more of its common stock and all directors and executive officers to be affiliates. DOCUMENTS INCORPORATED BY REFERENCE Portions of the definitive Proxy Statement for the 2002 Annual Meeting of stockholders are incorporated by reference into Part III. 1 MERCHANTS GROUP, INC. ANNUAL REPORT ON FORM 10-K DECEMBER 31, 2001
PART I PAGE # ------ ------ ITEM 1. BUSINESS. 3 ITEM 2. PROPERTIES. 19 ITEM 3. LEGAL PROCEEDINGS. 19 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 19 PART II ------- ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. 20 ITEM 6. SELECTED FINANCIAL DATA. 21 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. 23 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. 31 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. 33 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. 33 PART III -------- ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT 34 ITEM 11. EXECUTIVE COMPENSATION. 34 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS 34 AND MANAGEMENT. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. 34 PART IV ------- ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND 35 REPORTS ON FORM 8-K.
2 PART I Item 1. BUSINESS. GENERAL Merchants Group, Inc. (the Company), which was incorporated in August 1986 as a Delaware holding company, offers through its wholly owned subsidiary, Merchants Insurance Company of New Hampshire, Inc. (MNH), property and casualty insurance to preferred risk individuals and small to medium sized businesses in the northeastern United States. ADMINISTRATION The Company and MNH operate and manage their business in conjunction with Merchants Mutual Insurance Company (Mutual), a New York domiciled mutual property and casualty insurance company, under a management agreement (the Management Agreement). At December 31, 2001, Mutual owned 11.5% of the Company's issued and outstanding common stock. The Company and MNH do not have any operating assets and have only one employee. Under the Management Agreement, Mutual provides the Company and MNH with the facilities, management and personnel required to operate their day-to-day business. All costs incurred by Mutual with respect to underwriting expenses are shared pro rata between Mutual and MNH based upon their annual direct premiums written, and unallocated loss adjustment expenses are allocated on the basis of the number of claims outstanding each month that are attributable to each company. All of Mutual's and MNH's investment expenses are shared pro rata based upon the average book value of the invested assets of each company. MNH also pays Mutual an annual management fee of $50,000. The Management Agreement requires that the Company and MNH pay Mutual 110% of Mutual's costs of providing them with non-insurance related services, and that the Company pay Mutual an annual fee of one half of one percent (.5%) of the average book value of the Company's invested assets exclusive of the Company's shares of MNH. Since the inception of the Management Agreement, Mutual has not provided the Company or MNH with any non-insurance related services. The Management Agreement has certain features that are intended to prevent conflicts of interest or to deal with them on an equitable basis should they occur. Generally, business opportunities which are presented to the common officers or employees of the companies must be presented to each company's Board of Directors and approved and determined to be fair to each company in the transaction by a majority of the directors of each company who are not affiliated with any other company in the transaction. Any amendment to or modification of the Management Agreement must be approved by the New York Insurance Department (the Department). The Management Agreement provides that it may be terminated by any party to the agreement upon five years written notice. On July 23, 1998, the Company gave notice to Mutual of the Company's intention to terminate the Management Agreement, and accordingly, the Management Agreement will terminate on July 23, 2003, unless the parties agree to renew or extend it. Mutual and MNH have jointly developed and paid for all accounting, computer and insurance marketing systems used in their businesses. Upon termination of the Management Agreement, each company will have the right, at no cost, to obtain copies of all these systems, together with the right to use these systems in perpetuity. 3 MARKETING The Company markets its products through approximately 540 independent agents, who also represent Mutual. The Company's primary marketing efforts are directed to those independent agents who through their insurance expertise, access to a broad range of products and focus on service, provide value for the insurance consumer. The Company believes the opportunity for profit exists in its targeted markets through further penetration of agencies who are strategically aligned with the Company's commitment to growth. The Company believes that as a regional insurance company it has certain advantages, including a closer relationship with its agents and a better knowledge of its operating territories, that enable it to compete effectively against larger regional and national carriers. The Company believes it distinguishes itself from its competitors by providing its agents and policyholders with superior service and ease of doing business, products that target certain segments of the commercial and personal insurance markets, and an agents' compensation program which, in addition to standard commission rates, provides agents with a profit sharing plan. The Company services its agents from six Strategic Business Centers and from its home office in Buffalo, New York. The Strategic Business Centers are located in the Company's operating territories and focus primarily on policy sales and underwriting. The manager of a Strategic Business Center appoints new agents, agrees upon annual unit sales and premium objectives with the principal(s) of the agency, and ensures that the principal(s) of the agency communicates these objectives to the agency's sales staff. Strategic Business Center managers and Territory Managers, or "TM's," develop customized business plans for each agent that identify the opportunities to increase profitable business and the actions required to achieve the objectives agreed to by the agent and the Company. TM's meet with targeted agents' sales staff on a frequent basis to review the Company's renewal policies, as well as to solicit policies new to the agent and/or to the Company. TM's are equipped with electronic technology to provide prompt and efficient pricing and communication and can provide quotes for most lines of business at the agents' offices. The Company believes personal contact between TM's, who have underwriting authority, and an agent's sales staff provides the Company with a competitive advantage compared to many other property and casualty insurers, whose field representatives have limited or no underwriting authority. By placing an underwriting decision maker in the agent's office, and thereby simplifying the underwriting process, the Company believes it can maintain and improve the retention rate on its renewal policies, as well as attract new policies. Each Strategic Business Center has an Agents' Advisory Council that meets at least twice a year. The Advisory Councils provide a forum for the Company and its agents to discuss issues of mutual interest, and to assure that the agents' business needs are being considered by the Company. Additionally, the Co-chairpersons of the Advisory Councils from each Strategic Business Center meet twice each year with senior officers of Mutual. In addition to standard commissions paid as a percentage of premiums written, the Company's agents are eligible to participate in the Agents' Profit Sharing Plan. This plan rewards agents based on premiums written and the loss and allocated loss adjustment expense (LAE) ratio on business placed by the agent with the Company and Mutual. Company payments under the Agents' Profit Sharing Plan for 2001 totaled $2,049,000, or 2.0% of total direct premiums written. The Company believes the terms of its Agents' Profit Sharing Plan encourage its agents to increase the volume of profitable business they place with the Company. 4 In order to assist its independent agents to compete more effectively with insurance companies that have direct sales forces, and to strengthen its relationship with those agents, the Company provides advanced automation services. The Company introduced the Merchants MerLink(TM) system in 1999. MerLink(TM) enables independent agents to submit policies to Merchants over the Internet using their existing business computer and software, and to have these submissions automatically update the Company's insurance policy processing system. The benefits to agents are simplified client management, more time available for sales activities, and fewer errors. Currently, the Company is using MerLink(TM) for policy transactions with approximately 100 agents primarily for private passenger automobile and homeowners' policies. In 2000, the Company began offering MerLink(TM) capability for certain commercial lines insurance policies. In 2001, the Company began using its website to distribute underwriting manuals, rate pages and applications to its agents. The Company believes that developing automation capabilities to facilitate the sharing of information with its agents improves its competitive position compared to other property and casualty insurers that do not have such capabilities. INSURANCE UNDERWRITING The Company is licensed to issue insurance policies in 13 states, primarily in the northeastern United States. In 2001, net premiums written totaled $93,973,000, with 54% of the net premiums written derived from commercial lines of insurance and 46% from personal lines of insurance. The following table sets forth the distribution of the Company's direct premiums written by state for the years indicated: As of December 31, --------------------------------------- 1999 2000 2001 --------------------------------------- New York 64% 66% 66% New Jersey 19 16 12 New Hampshire 8 8 10 Rhode Island 4 4 5 Massachusetts 2 3 3 Pennsylvania 2 2 2 Other 1 1 2 ---- ---- ---- Total 100% 100% 100% === === === 5 The Company is licensed to underwrite most major lines of property and casualty insurance. It issues policies primarily to preferred risk individuals and small to medium sized commercial risks. In general, the Company does not insure risks that involve a high potential of loss or have a long-tail reporting period. The types of risks insured in the Company's lines of business include: - Personal automobile - full coverage of standard performance automobiles, generally requiring drivers with good driving records during the past three years. - Homeowners' - properties generally with no losses in the last three years that are less than 30 years old and valued between $125,000 and $500,000. - Commercial automobile - primarily light and medium use vehicles operating in a limited radius, with complete background information required of all drivers. - Commercial multi-peril - properties with medium to high construction quality and low to moderate fire exposure, and occupancies with low to moderate exposure to hazardous materials and processes. - General liability - low hazard service, mercantile and light processing businesses, generally with at least three years of business experience and with no losses in the last three years. - Workers' compensation - risks with low loss frequency and severity, low to moderate exposure to hazardous materials and processes, and favorable experience modification factors. Generally, workers' compensation insurance is written in conjunction with other commercial insurance. The Company's pricing strategy is to offer its insurance at rates which are designed to cover its costs, including the costs of any involuntary business associated with a particular line of insurance or a particular territory. This pricing strategy may make the Company's rates non-competitive with respect to certain lines of insurance or certain geographic regions. The Company believes that its pricing strategy allows the Company to write the types of insurance for which the price charged reflects the cost of providing coverage. Agents of the Company are also agents of Mutual, which generally sells the same lines of insurance as the Company to standard risk individuals and businesses. Applicants that meet the Company's preferred risk criteria are issued policies by the Company. Applicants that do not meet the Company's underwriting criteria, but which meet the less restrictive criteria of Mutual, are issued policies by Mutual, generally at higher premium rates. From 1993 through 1995, under a quota share reinsurance agreement with Mutual, MNH assumed 10% of the standard risks insured by Mutual, which would not generally have met MNH's more stringent underwriting guidelines. The terms of that agreement allow Mutual to reduce its cessions to MNH to 0% of Mutual's direct voluntary premiums written for any calendar year prior to the beginning of that calendar year. Mutual has not ceded any of its voluntary direct written premiums to MNH under this agreement since 1995 and has informed the Company that it will not cede any of its voluntary direct written premiums to MNH in 2002. The Company establishes premium rates for most of its policies based on its loss experience, in some cases after considering prospective loss costs suggested by the Insurance Services Office, Inc., an industry advisory group, for the preferred individual and commercial classes of business that it insures. The Company 6 establishes rates independently for its personal automobile and homeowners insurance policies and its specialty products, such as its Contractors Coverall Plus and businessowners' policies. The following table shows, for each of the years in the three year period ended December 31, 2001 (i) the amount of the Company's net premiums written attributable to various personal lines and commercial lines and (ii) underwriting results attributable to each such line as measured by the calendar year loss ratio for such line. The loss ratio is the ratio of incurred losses to net premiums earned for a given period.
Year Ended December 31, ---------------------------------------------------------------------------------- 1999 2000 2001 ---------------------------------------------------------------------------------- Premiums Premiums Premiums Written Written Written ---------------------------------------------------------------------------------- Loss Loss Loss Amount % Ratio Amount % Ratio Amount % Ratio ---------------------------------------------------------------------------------- (dollars in thousands) Personal Auto Liability $18,915 20.0% 77.1% $17,295 18.3% 79.0% $20,059 21.3% 93.3% Auto Physical Damage 12,328 13.1 49.0 12,031 12.8 54.6 13,254 14.1 52.4 Homeowners' Multi-Peril 8,630 9.1 56.2 9,144 9.7 58.4 9,847 10.5 37.3 ------ ---- ------ ---- ------- ---- ---- Total 39,873 42.2 64.1 38,470 40.8 66.7 43,160 45.9 67.7 Commercial Auto Liability 14,816 15.7 50.9 15,548 16.5 87.4 12,685 13.5 72.1 Auto Physical Damage 3,819 4.1 54.7 4,065 4.3 58.2 2,972 3.2 40.8 Commercial Multi-Peril 22,854 24.2 69.5 25,900 27.4 52.1 27,411 29.2 76.1 Workers' Compensation 7,692 8.1 22.0 7,421 7.9 84.6 6,735 7.2 61.3 Other Lines 5,416 5.7 37.6 2,938 3.1 10.3 1,010 1.0 5.1 ------ ---- ------ ---- ------- ---- ---- Total 54,597 57.8 53.7 55,872 59.2 63.4 50,813 54.1 66.5 ------ ---- ------ ---- ------- ---- ---- Total Personal & Commercial $94,470 100.0% 58.2 $94,342 100.0% 64.7 $93,973 100.0% 67.0 ======= ===== ======= ===== ====== =====
Calendar year loss ratios set forth in the table above include an estimate of losses for that accident year, as well as increases or decreases in estimates made in that year for prior accident year losses. Depending on the size of the increase or decrease in prior accident year losses, calendar year loss ratios may not be as indicative of the profitability of policies in force in a particular year as accident year loss ratios, which do not take into account increases or decreases in reserves for prior accident year losses. 7 The following table sets forth the composition of voluntary direct premiums written for 1997 through 2001:
As of December 31, --------------------------------------------------- 1997 1998 1999 2000 2001 ---- ---- ---- ---- ---- Commercial 57% 58% 61% 64% 58% Personal 43 42 39 36 42 --- --- --- --- --- Total 100% 100% 100% 100% 100% === === === === ===
COMMERCIAL LINES The Company's commercial business is primarily retail and mercantile in nature and generally consists of small to medium sized, low hazard commercial risks which as a group have relatively stable loss ratios. The Company's underwriting criteria exclude lines of business and classes of risks that are considered by the Company to be high hazard or volatile, or which involve latent injury potential or other long-tail liability exposures. Although the commercial underwriting objectives of the Company and Mutual are similar, the Company has refined its selection criteria to include specific classes of businesses, occupancies, and operations with lower hazard ratings, which present a relatively lower exposure to loss and are charged a correspondingly lower premium. The Company offers specialized products within the commercial multi-peril line such as the Contractors Coverall Plus policy for artisan and trade contractors. The Company believes it can insure commercial business profitably by selecting those classes of risks that offer better than average profit potential. The Company competes for commercial business based upon the service it provides to agents and policyholders, the compensation it pays to its agents and the price of its products. The Company establishes prices after considering its costs, the exposures inherent in a particular class of risk, estimated investment income, projected future trends in loss frequency and severity, and the degree of competition within a specific territory. Accordingly, the prices of the Company's commercial products may vary considerably in relation to competitors' prices. PERSONAL LINES The Company offers personal automobile and homeowners' insurance to preferred risk individuals, generally requiring experienced drivers with no accidents or moving violations in the last three years for personal automobile insurance, and medium to high value homes with systems that are less than thirty years old in fire protected areas for homeowners' insurance. Personal automobile premium rates attempt to cover costs associated with required participation in involuntary personal automobile programs, in addition to the costs directly associated with the policies written voluntarily. The Company and Mutual utilize automated underwriting procedures for personal automobile, homeowners and certain commercial lines of business, which perform an initial review of policy applications based upon established underwriting guidelines. Applications that do not meet the guidelines for automated acceptance are either referred to underwriters who review the applications and assess exposure, or rejected if the risk characteristics are such that neither the Company nor Mutual would insure the applicant. As a condition to writing voluntary business in most states in which it operates, the Company must participate in state-mandated programs which provide insurance for individuals and businesses unable to 8 obtain insurance voluntarily, primarily for personal automobile insurance. The legislation creating these programs usually allocates a pro rata portion of the risks attributable to such insureds to each company writing voluntary business in the state on the basis of its voluntary premiums written or the number of automobiles which it insures voluntarily. The Company's gross (direct and assumed) premiums written attributable to involuntary policies were $3,726,000, $2,158,000 and $5,850,000 in 1999, 2000 and 2001, respectively, mostly in New York. The Company is unable to predict the level of its annual involuntary business for 2002 or future years. CLAIMS Insurance claims on policies written by the Company are investigated and settled by claims adjusters employed by Mutual pursuant to the Management Agreement. The Company and Mutual maintain several claims offices within their operating territories. In areas where there is insufficient claim volume to justify the cost of internal claims staff, the Company and Mutual use independent appraisers and adjusters to investigate claims. The Company's claims policy emphasizes timely investigation of claims, settlement of valid claims for equitable amounts, maintenance of adequate reserves for claims and control of external claims adjustment expenses. In order to support its claims policy, the Company maintains a program designed to ensure that as soon as practical, claims are assigned an accurate value based on available information. The program includes the centralization of certain branch claims operations and an emphasis on the training of claims adjusters and supervisors by senior claims staff. This claims policy is designed to support the Company's marketing policy and provide agents and policyholders with prompt service and support. Claims settlement authority levels are established for each adjuster, supervisor and manager based on their expertise and experience. When the Company receives notice of a claim, it is assigned to an adjuster based upon its type, severity and line of business. The claims staff then reviews the claim, obtains appropriate information and establishes a loss reserve. Claims that exceed certain dollar amounts or that cannot be readily settled are assigned to more senior claims staff. LOSS AND LAE RESERVES The Company, like other insurance companies, establishes reserves for losses and LAE. These reserves are estimates intended to cover the probable ultimate cost of settling all losses incurred and unpaid, including those losses not yet reported to the Company. An insurer's ultimate liability is likely to differ from its interim estimates because during the life of a claim, which may be many years, additional facts affecting the amount of damages and an insurer's liability may become known. The reserves of an insurer are frequently adjusted based on monitoring by the insurer and are periodically reviewed by state insurance departments. The Company retains an independent actuarial firm to satisfy state insurance departments' requirements with respect to the certification of reserves for losses and LAE. Loss reserves are established for known claims based on the type and circumstance of the loss and the results of similar losses. For claims not yet reported to the Company, loss reserves are based on statistical information from previous experience periods adjusted for inflation, trends in court decisions and economic conditions. LAE reserves are intended to cover the ultimate cost of investigating all losses that have occurred and defending lawsuits, if any, arising from these losses. LAE reserves are evaluated periodically using statistical techniques which compare current costs with historical data. Inflation is implicitly reflected in the reserving process through analysis of cost trends and review of historical reserve results. With the 9 exception of workers' compensation claims, loss reserves are not discounted for financial statement purposes. The Company's reserving process is based on the assumption that past experiences, adjusted for the effect of current developments and trends, are relevant in predicting future events. In the absence of specific developments, the process also assumes that the legal climate regarding the claims process and underlying liabilities remains constant. Other assumptions employed by the Company or its actuarial firm change from time to time as circumstances change. In estimating loss and LAE reserves, the Company employs a number of actuarial methods, depending on their applicability to each line of business, in order to balance the advantages and disadvantages of each method. No single method is used to estimate loss and LAE reserves. Although different actuarial methods may give rise to different reserve estimates, which may be higher or lower than the reserves actually established by the Company, the Company believes that those differences are not material. The Company has recorded changes in reserves for prior accident year losses in most years. In 1999 and 2001, the Company decreased its reserves for prior years by $3,749,000 and $1,474,000, respectively, primarily due to favorable loss experience related to workers compensation policies. In 2000, the Company increased its reserves for prior years by $1,428,000, primarily due to higher than anticipated frequency and severity of losses related to personal automobile, commercial automobile and workers' compensation policies. The following table sets forth the changes in the reserve for losses and LAE for 1999, 2000 and 2001.
Year Ended December 31, ----------------------- 1999 2000 2001 ---- ---- ---- (in thousands) Reserve for losses and LAE at beginning of year $ 136,685 $ 133,526 $ 145,075 Less reinsurance recoverables 9,816 6,026 13,826 --------- --------- --------- Net balance at beginning of year 126,869 127,500 131,249 --------- --------- --------- Provision for losses and LAE for claims occurring in: Current year 69,835 69,946 76,618 Prior years (3,749) 1,428 (1,474) --------- --------- --------- 66,086 71,374 75,144 --------- --------- --------- Losses and LAE payments for claims occurring in: Current year 28,330 26,655 28,719 Prior years 37,125 40,970 45,561 --------- --------- --------- 65,455 67,625 74,280 --------- --------- --------- Reserve for losses and LAE at end of year, net 127,500 131,249 132,113 Plus reinsurance recoverables 6,026 13,826 19,242 --------- --------- --------- Balance at end of year $ 133,526 $ 145,075 $ 151,355 ========= ========= =========
10 The first line of the following table presents, as of the end of the year at the top of each column, the estimated amount of unpaid losses and LAE for claims arising in that year and in all prior years, including claims that had occurred but were not yet reported to the Company. For each column, the rows of the table present, for the same group of claims, the amount of unpaid losses and LAE as re-estimated as of the end of each succeeding year. The estimate is modified as more information becomes known about the number and severity of claims for each year. The "cumulative redundancy (deficiency)" represents the change in the estimated amount of unpaid losses and LAE from the end of the year at the top of each column through the end of 2001. For each column in the table, the change from the liability for losses and LAE shown on the first line to the liability as re-estimated as of the end of the following year was included in operating results for the following year. That change includes the change in the previous year's column from the liability as re-estimated one year later to the liability as re-estimated two years later which, in turn, includes the change in the second preceding column from the liability as re-estimated two years later to the liability as re-estimated three years later, and so forth. The rows of the lower portion of the table present, as of the end of each succeeding year, the amount of paid losses and LAE for claims unpaid at the end of the year at the top of each column. 11
As of December 31, ------------------------------------------------------------------------------------------------------------------------------------ 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 ---- ---- ---- ---- ---- ---- --- ---- ---- ---- (in thousands) Liability for losses and LAE: $77,274 $86,159 $89,939 $97,614 $113,718 $126,260 $130,781 $126,820 $127,458 $131,178 Liability re-estimated as of: One year later 80,841 88,284 94,921 108,659 120,550 130,768 128,636 123,071 128,886 129,704 Two years later 81,743 91,224 100,607 113,091 128,192 133,029 130,498 120,345 123,299 Three years later 83,693 95,396 106,382 121,051 129,724 132,948 127,893 113,661 Four years later 87,105 99,779 112,983 121,791 131,647 129,210 122,508 Five years later 90,428 104,699 112,963 122,886 127,183 124,238 Six years later 92,370 104,808 112,886 120,128 123,521 Seven years later 93,046 105,183 110,843 117,589 Eight years later 93,346 103,196 109,864 Nine years later 91,920 102,837 Ten years later 92,049
Cumulative Redundancy (Deficiency): $(14,475) (16,678) (19,925) (19,975) (9,803) 2,022 8,273 13,159 4,159 1,474 % (18.7) (19.4) (22.2) (20.5) (8.6) 1.6 6.3 10.4 3.3 1.1 Paid (Cumulative) as of: One year later 30,082 35,724 34,551 36,916 38,549 40,954 42,433 37,125 40,970 36,708 Two years later 50,490 56,003 56,965 60,074 64,323 69,035 66,477 63,325 61,132 Three years later 63,925 69,863 72,963 77,982 84,638 86,364 86,313 80,435 Four years later 72,917 80,156 83,998 91,948 96,491 98,300 94,590 Five years later 79,374 86,808 93,295 99,171 104,063 100,392 Six years later 82,602 91,919 96,949 103,829 105,096 Seven years later 84,707 94,022 99,525 99,724 Eight years later 85,920 95,347 100,033 Nine years later 86,555 96,883 Ten years later 88,006
The loss and LAE reserves reported in the Company's consolidated financial statements prepared in accordance with generally accepted accounting principles ("GAAP") differ from those reported in the statements filed by MNH with the New Hampshire Insurance Department in accordance with statutory accounting principles (SAP) as follows:
As of December 31, ------------------ 1999 2000 2001 ---- ---- ---- (in thousands) Loss and LAE reserves on a SAP basis $127,458 $131,178 $132,113 Adjustments: Ceded reinsurance balances recoverable 6,026 13,826 19,242 Write-down of reinsurance recoverable 42 71 -- -------- -------- -------- Loss and LAE reserves on a GAAP basis $133,526 $145,075 $151,355 ======== ======== ========
12 REINSURANCE The Company follows the customary industry practice of reinsuring a portion of the exposure under its policies and as consideration pays to its reinsurers a portion of the premium received on its policies. Insurance is ceded principally to reduce an insurer's liability on individual risks and to protect against catastrophic losses. Although reinsurance does not legally discharge an insurer from its primary liability for the full amount of coverage provided by its policies, it does make the assuming reinsurer liable to the insurer to the extent of the reinsurance ceded. The Company is a party to reinsurance contracts under which certain types of policies are automatically reinsured without the need for approval by the reinsurer with respect to the individual risks that are covered ("treaty" reinsurance). The Company also is a party to reinsurance contracts which are handled on an individual policy or per risk basis and require the specific agreement of the reinsurer as to each risk insured ("facultative" reinsurance). Occasionally, the Company may secure facultative reinsurance to supplement its coverage under treaty reinsurance. Prior to January 1, 1998, the Company's excess of loss arrangements for automobile liability, general liability and workers' compensation insurance provided for recovery of losses over $500,000 up to a maximum of $5,000,000 per occurrence. For claims occurring prior to 1993, the $500,000 threshold was indexed for inflation for casualty lines other than workers' compensation and New York State no-fault, and applied retroactively to all occurrences until they are settled. There was no index provision for casualty claims occurring after 1992. This coverage was supplemented by additional treaty reinsurance covering losses up to $5,000,000 in excess of the first $5,000,000. Between January 1, 1998 and December 31, 2001, the Company's property and casualty excess of loss reinsurance agreement provided for recovery of casualty losses over $500,000 up to $10,000,000 per occurrence and property losses over $500,000 up to $10,000,000 per occurrence. This coverage is supplemented by a contingent casualty layer of reinsurance for workers' compensation claims of $5,000,000 in excess of the first $10,000,000 subject to a calendar year limit of $20,000,000. Effective January 1, 2002, the Company increased its retention on casualty losses to $750,000. Property catastrophe coverage provides for recovery of 50% of $5,000,000 and of 95% of the next $56,750,000, subject to aggregate retained losses of $5,000,000 per occurrence. The property catastrophe reinsurance coverage is shared by the Company and Mutual on a pro rata basis based upon the gross reported losses of the Company and Mutual for a covered event. Prior to January 1, 1998, property reinsurance agreements provided for recovery of property losses over $500,000 up to $2,000,000 per occurrence without any index provision. During 2000, the Company implemented a program to underwrite specialized commercial auto insurance. All policies issued under this program were 100% reinsured through certain subscribing underwriting members of Lloyd's of London and therefore had no impact on net premiums earned or net losses and LAE incurred by the Company. This program was discontinued for 2001. Effective January 1, 1993, Mutual and MNH entered into a quota share reinsurance agreement under which MNH may assume up to 10% of Mutual's direct voluntary written premiums and related losses and allocated LAE in exchange for a reinsurance commission of 35%. The agreement also provides for MNH to 13 pay a contingent commission to Mutual equal to any underwriting profit on the premiums assumed. Mutual pays the ceded premiums, net of commissions and paid losses, to MNH on a monthly basis and MNH invests these funds and earns investment income. To the extent commissions and paid losses exceed premiums, MNH is required to pay the net monthly balance to Mutual. The agreement may be terminated by either party effective as of any January 1 with the prior approval of the New York Superintendent of Insurance and upon six months' notice to the other party. In addition, the agreement may be terminated by MNH at any time if any amount payable to MNH by Mutual becomes more than 90 days overdue or if there is a change in control of Mutual approved by the New York Superintendent of Insurance. Further, the agreement allows Mutual to reduce its cessions to MNH from a maximum of 10% to a minimum of 0% of Mutual's direct voluntary premiums written for any calendar year prior to the beginning of that calendar year. Mutual has not ceded any of its direct voluntary written premiums to MNH since 1995 and has informed the Company that it will not cede any voluntary direct written premiums to MNH in 2002. INVESTMENTS The primary source of funds for investment by the Company is premiums collected. Although premiums, net of commissions and other underwriting costs, are taken into income ratably over the terms of the policies, they provide funds for investment from the date they are received. Similarly, although establishment of and changes in reserves for losses and LAE are included in results of operations immediately, the amounts so set aside are available to be invested until the Company pays those claims. The investments of the Company are regulated by New Hampshire insurance law and are reviewed by the Board of Directors of the Company. Other than certain short-term investments held to maintain liquidity, the Company primarily invests in medium-term bonds, mortgage-backed and other asset-backed securities including collateralized mortgage obligations, and tax-exempt securities. The mortgage-backed securities held by the Company are typically purchased at expected yields which are greater than comparable maturity Treasury securities and are AAA or AA rated. The Company had $8,999,000 of tax-exempt bonds in its investment portfolio at December 31, 2001. The Company believes these tax-exempt bonds are of high quality (rated A or better) and, at the time of purchase, offered an after-tax total return greater than comparable taxable securities. At December 31, 2001, the Company had $6,905,000 of short-term investments with maturities less than 30 days, and $10,163,000 of non-investment grade securities. These non-investment grade securities represented 5% of the investment portfolio as compared to $10,083,000, or 5%, of the investment portfolio at December 31, 2000. 14 The table below gives information regarding the Company's investments as of the dates indicated.
As of December 31, ---------------------------------------------------------------------------- 1999 2000 2001 ---------------------------------------------------------------------------- AMOUNT % AMOUNT % AMOUNT % ------ --- ------ --- ------ --- (dollars in thousands) Fixed Maturities (1): U.S. Government and Agencies $ 27,663 13.0% $ 44,055 20.4% $ 41,965 19.7% Corporate Bonds 152,984 71.9 135,895 63.0 144,248 67.7 Tax-Exempt Bonds 15,982 7.5 16,207 7.5 8,999 4.2 -------- ----- -------- ----- -------- ----- Total Bonds 196,629 92.4 196,157 90.9 195,212 91.6 Preferred Stocks (2) 12,941 6.1 13,911 6.5 9,422 4.4 Short-Term Investments (3) 2,544 1.2 4,550 2.1 6,905 3.2 Other (4) 797 .3 1,036 .5 1,593 .8 -------- ----- -------- ----- -------- ----- Total Invested Assets $212,911 100.0% $215,654 100.0% $213,132 100.0% ======== ===== ======== ===== ======== =====
(1) Fixed Maturities are shown at their carrying amounts in the respective balance sheet. Held to Maturity fixed maturities are included at amortized cost. Available for Sale fixed maturities are included at fair value. (2) Shown at fair value. (3) Shown at cost, which approximates fair value. (4) Shown at estimated fair value or unpaid principal balance, which approximates estimated fair value. The table below sets forth the Company's net investment income and net realized gains and losses, excluding the effect of income taxes, for the periods shown:
Year Ended December 31, ----------------------- 1999 2000 2001 ---- ---- ---- (dollars in thousands) Average investments (1) $ 211,956 $ 212,832 $ 213,449 Net investment income 13,147 13,903 13,295 Net investment income as a percentage of average investments (2) 6.2% 6.5% 6.2% Net realized gains (losses) on investments $ 60 $ 109 (580)
(1) At amortized cost. (2) The taxable equivalent yield for the years ended December 31, 1999, 2000 and 2001 was 7.0%, 7.2% and 6.5%, respectively, assuming an effective tax rate of 34%. 15 The table below sets forth the carrying value of bonds and percentage distribution of various maturities at the dates indicated. Fixed Maturities are shown at their carrying amounts in the respective balance sheet. Held to Maturity fixed maturities are included at amortized cost. Available for Sale fixed maturities are included at fair value. The estimated repayment date is used instead of the ultimate repayment date for mortgage-backed and other asset-backed securities.
As of December 31, --------------------------------------------------------------------- 2000 2001 1999 --------------------------------------------------------------------- AMOUNT % AMOUNT % AMOUNT % ------ --- ------ --- ------ --- (dollars in thousands) 1 year or less $ 49,742 25.3% $ 78,181 39.9% $ 40,356 20.7% 1 year through 5 years 132,421 67.4 81,827 41.7 111,445 57.1 5 years through 10 years 12,619 6.4 34,562 17.6 39,029 20.0 More than 10 years 1,847 .9 1,587 .8 4,382 2.2 -------- ----- -------- ----- -------- ----- Total $196,629 100.0% $196,157 100.0% $195,212 100.0% ======== ===== ======== ===== ======== =====
COMPETITION The property and casualty insurance business is highly competitive. The Company is in direct competition with many national and regional multiple-line insurers, many of which are substantially larger than the Company and have considerably greater financial resources. Competition is further intensified by the independent agency system because each of the independent agents who sells the Company's policies also represents one or more other insurers. Also, the Company's agents compete with direct writing insurers and this indirectly affects the Company. Historically, the property and casualty industry has tended to be cyclical in nature. During the "up" cycle, or "hard market," the industry is characterized by price increases, strengthening of loss and LAE reserves, surplus growth and improved underwriting results. Near the end of the "up" cycle, an increase in capacity causes insurance companies to begin to compete for market share on the basis of price. This price competition causes the emergence of the "down" cycle, or "soft market," characterized by a reduction in the premium growth rate and a general decline in profitability. Generally, the down cycle is eventually accompanied by a decline in the adequacy of loss and LAE reserves and a decrease in premium writing capacity. The property and casualty insurance industry has experienced a cyclical downturn for the past several years due primarily to intense premium rate competition and an excess capacity to write premiums. Recently, there has been evidence of price firming primarily within the commercial lines segment of the property casualty industry. However, many of the circumstances which led to the current cyclical downturn in the property and casualty insurance industry continue to exist, and the Company cannot predict for how long market conditions for the industry will continue to improve. REGULATION GENERAL MNH is subject to regulation under applicable insurance statutes, including insurance holding company statutes, of the various states in which it writes insurance. Insurance regulation is intended to provide safeguards for policyholders rather than to protect stockholders of insurance companies or their holding 16 companies. Insurance laws of the various states establish regulatory agencies with broad administrative powers including, but not limited to, the power to grant or revoke licenses to transact insurance business and to regulate trade practices, investments, premium rates, the deposit of securities, the form and content of financial statements and insurance policies, accounting practices, the maintenance of specified reserves and capital, and insurers' consumer privacy policies. The regulatory agencies of each state have statutory authority to enforce their laws and regulations through various administrative orders, civil and criminal enforcement proceedings, and the suspension or revocation of certificates of authority. In extreme cases, including insolvency, impending insolvency and other matters, a regulatory authority may take over the management and operation of an insurer's business and assets. Under insolvency or guaranty laws in the states in which MNH operates, insurers doing business in those states can be assessed up to prescribed limits for policyholder losses caused by other insurance companies that become insolvent. The extent of any requirement for MNH to make any further payment under these laws is not determinable. Most laws do provide, however, that an assessment may be excused or deferred if it would threaten a solvent insurer's financial strength. In addition, MNH is required to participate in various mandatory pools or underwriting associations in certain states in which it operates. The property and casualty insurance industry has been the subject of regulations and legislative activity in various states attempting to address the affordability and availability of different lines of insurance. The regulations and legislation generally restrict the discretion an insurance company has in operating its business. It is not possible to predict the effect, if any, that new regulations and legislation would have on the Company and MNH. The Company depends on cash dividends from MNH to pay cash dividends to its stockholders and to meet its expenses. MNH is subject to New Hampshire state insurance laws which restrict its ability to pay dividends without the prior approval of state regulatory authorities. These restrictions limit dividends to those that, when added to all other dividends paid within the preceding twelve months, would not exceed 10% of the insurer's policyholders' surplus as of the preceding December 31st. The maximum amount of dividends that MNH could pay during any twelve month period ending in 2002 without the prior approval of the New Hampshire Insurance Commissioner is $5,263,000. MNH paid the maximum allowable dividends to the Company in 2001. Dividends were paid in February 2001, May 2001 and September 2001, of $2,200,000, $1,350,000 and $1,510,000, respectively. MNH paid a dividend of $2,300,000 to the Company on February 19, 2002 and as such is restricted from paying another dividend to the Company until May 2002 without the prior approval of the New Hampshire Insurance Commissioner. In certain states in which it operates, MNH is required to maintain deposits with the appropriate regulatory authority to secure its obligations under certain insurance policies written in the jurisdiction. At December 31, 2001, investments of MNH having a par value of $1,900,000 were on deposit with regulatory authorities. MNH and Mutual are required to file detailed annual reports with the appropriate regulatory agency in each of the states in which they do business. Their business and accounts are subject to examination by such agencies at any time, and the laws of many states require periodic examination. The State of New Hampshire Insurance Department most recently examined the accounts of MNH as of December 31, 1999. MNH's annual statement as of that date was accepted as submitted, without adjustment. In 1993 the National Association of Insurance Commissioners (NAIC) adopted a risk-based capital measurement formula to be applied to all property and casualty insurance companies. The formula 17 calculates a minimum required statutory net worth, based on the underwriting, investment, credit, loss reserve and other business risks inherent in an individual company's operations. Any insurance company that does not meet threshold risk-based capital measurement standards could be forced to reduce the scope of its operations and ultimately could become subject to statutory receivership proceedings. MNH's capital substantially exceeds the statutory minimum as determined by the risk-based capital measurement formula as of December 31, 2001. The NAIC has established eleven financial ratios (the Insurance Regulatory Information System, or "IRIS") to assist state insurance departments in their oversight of the financial condition of insurance companies operating in their respective states. The NAIC calculates these ratios based on information submitted by insurers on an annual basis and shares the information with the applicable state insurance departments. The ratios relate to leverage, profitability, liquidity and loss reserve development. Each of the Company's ratios for 2001 falls within the usual or acceptable range as published by the NAIC. RATES Premium rate regulations vary greatly among states and lines of insurance, and frequently require approval of the regulatory authority or limited review by the authority prior to changes in rates. However, in certain states, insurers writing in designated commercial risk, professional liability and public entity insurance markets may periodically revise rates within the limits of applicable flexibility bands (flex-bands) on a file and use basis, but must obtain the state insurance department's prior approval in order to implement rate increases or decreases outside these flex-bands. INSURANCE HOLDING COMPANIES The Company is subject to statutes governing insurance holding company systems. Typically, these statutes require the Company to file information periodically concerning its capital structure, ownership, financial condition and general business operations and material inter-company transactions not in the ordinary course of business. Under the terms of applicable New Hampshire statutes, any person or entity desiring to purchase shares which would result in such person beneficially owning 10% or more of the Company's outstanding voting securities would be required to obtain regulatory approval prior to the purchase. INVOLUNTARY INSURANCE As a condition to writing voluntary insurance in most of the states in which it operates, the Company must participate in programs that provide insurance for persons or businesses unable to obtain insurance voluntarily. Uncertainties as to the size of the involuntary market population make it difficult to predict the amount of involuntary business in a given year. EMPLOYEES The Company has no employees. At December 31, 2001, Mutual had 347 full-time equivalent employees. The Company believes that Mutual's relationship with its employees is satisfactory. 18 Item 2. PROPERTIES. Although the Company has no facilities, it benefits from the facilities of Mutual pursuant to the Management Agreement, under which the Company is charged a proportionate share of the costs of such facilities. The Company's corporate headquarters are located in Buffalo, New York in a building owned by Mutual that contains approximately 113,000 square feet of office space. Mutual also has regional underwriting and/or claims office facilities in Buffalo, Albany and Hauppauge, New York; Manchester, New Hampshire; Moorestown, New Jersey and Columbus, Ohio. All of the offices except the Buffalo office are leased. Item 3. LEGAL PROCEEDINGS. MNH, like many other property and casualty insurance companies, is subject to environmental damage claims asserted by or against its insureds. Management of the Company is of the opinion that based on various court decisions throughout the country such claims should not be recoverable under the terms of MNH's insurance policies because of either specific or general coverage exclusions contained in the policies. However, there is no assurance that the courts will agree with MNH's position in every case, nor can there be assurance that material claims will not be asserted under policies which a court will find do not explicitly or implicitly exclude claims for environmental damages. Management, however, is not aware of any pending claim or group of claims which would result in a liability that would have a material adverse effect on the financial condition of the Company or MNH. In addition to the foregoing matters, MNH is a defendant in a number of other legal proceedings in the ordinary course of its business. Management of the Company is of the opinion that the ultimate aggregate liability, if any, resulting from such proceedings will not materially affect the financial condition of the Company or MNH. Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. None. 19 PART II Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. The Company's common stock is traded on the American Stock Exchange (AMEX symbol: MGP). The following table sets forth the high and low closing prices of the common stock for the periods indicated as reported on the American Stock Exchange. 2001: High Low Dividend ---- --- -------- Fourth Quarter $23.10 $20.30 $.10 Third Quarter 22.60 20.20 .10 Second Quarter 21.25 18.10 .10 First Quarter 19.39 17.50 .10 2000: High Low Dividend ---- --- -------- Fourth Quarter $18.25 $17.00 $.10 Third Quarter 18.50 17.00 .10 Second Quarter 16.88 15.06 .10 First Quarter 20.00 14.88 .10 The number of stockholders of record of the Company's Common Stock as of February 28, 2002 was 89. Securities held by nominees are counted as one stockholder of record. The Company has paid a quarterly cash dividend to its common stockholders since the third quarter of 1993. Continued payment of this dividend and its amount will depend upon the Company's operating results, financial condition, capital requirements and other relevant factors, including legal restrictions applicable to the payment of dividends by its insurance subsidiary, MNH. As a holding company, the Company depends on dividends from its subsidiary, MNH, to pay cash dividends to its stockholders. MNH is subject to New Hampshire state insurance laws which restrict its ability to pay dividends without the prior approval of state regulatory authorities. These restrictions limit dividends to those that, when added to all other dividends paid within the preceding twelve months, would not exceed 10% of the insurer's policyholders' surplus as of the preceding December 31. The maximum amount of dividends that MNH could pay during any twelve month period ending in 2002 without prior approval of the New Hampshire Insurance Commissioner is $5,263,000. 20 Item 6. SELECTED FINANCIAL DATA. The selected financial data set forth in the following table for each of the five years in the period ended December 31, 2001 have been derived from the audited consolidated financial statements of the Company.
As of December 31, --------------------------------------------------------------- 1997 1998 1999 2000 2001 ---- ---- ---- ---- ---- (in thousands, except per share amounts) Net premiums written $ 96,811 $ 92,758 $ 94,470 $ 94,342 $ 93,973 ========= ========= ========= ========= ========= Net premiums earned $ 96,054 $ 93,540 $ 94,775 $ 94,259 $ 93,885 Net investment income 12,770 13,277 13,147 13,903 13,295 Net realized investment gains (losses) 112 (2) 60 109 (580) Other revenues 214 153 434 355 696 --------- --------- --------- --------- --------- Total revenues 109,150 106,968 108,416 108,626 107,296 --------- --------- --------- --------- --------- Net losses and loss adjustment expenses 71,627 65,234 66,086 71,374 75,144 Amortization of deferred policy acquisition costs 25,454 24,788 25,115 24,979 24,880 Other underwriting expenses 7,063 8,173 6,801 5,266 6,017 --------- --------- --------- --------- --------- Total expenses 104,144 98,195 98,002 101,619 106,041 --------- --------- --------- --------- --------- Income before income taxes 5,006 8,773 10,414 7,007 1,255 Provision for income taxes 808 2,850 3,621 2,668 434 --------- --------- --------- --------- --------- Net income $ 4,198 $ 5,923 $ 6,793 $ 4,339 $ 821 ========= ========= ========= ========= ========= Earnings per share: Basic $ 1.41 $ 2.05 $ 2.48 $ 1.75 $ .35 ========= ========= ========= ========= ========= Diluted $ 1.41 $ 2.04 $ 2.48 $ 1.74 $ .35 ========= ========= ========= ========= ========= Weighted average number of shares outstanding: Basic 2,973 2,895 2,738 2,485 2,343 Diluted 2,980 2,904 2,743 2,487 2,343 BALANCE SHEET DATA: (AT YEAR END) Total investments $ 210,244 $ 215,172 $ 212,911 $ 215,654 $ 213,132 Total assets 273,974 274,523 269,523 281,621 286,563 Reserve for losses and loss adjustment expenses 141,205 136,685 133,526 145,075 151,355 Unearned premiums 50,406 49,382 49,616 50,857 50,179 Stockholders' equity 67,462 71,783 69,387 70,122 68,551 DIVIDEND DATA: Cash dividend per common share $ .20 $ .20 $ .35 $ .40 $ .40
21 "Safe Harbor" Statement under the Private Securities Litigation Reform Act of 1995: With the exception of historical information, the matters and statements discussed, made or incorporated by reference in this Annual Report on Form 10-K constitute forward-looking statements and are discussed, made or incorporated by reference, as the case may be, pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements may include, without limitation, statements relating to the Company's plans, strategies, objectives, expectations and intentions. Words such as "believes," "forecasts," "intends," "possible," "expects," "anticipates," "estimates," or "plans" and similar expressions are intended to identify forward-looking statements. Such forward-looking statements involve certain assumptions, risks and uncertainties that could cause actual results to differ materially from those included in or contemplated by those statements. These assumptions, risks and uncertainties include, but are not limited to, those associated with factors affecting the property and casualty insurance industry generally, including price competition, the Company's dependence on state insurance departments for approval of rate increases, size and frequency of claims, escalating damage awards, natural disasters, fluctuations in interest rates and general business conditions; the Company's dependence on investment income; the geographic concentration of the Company's business in the northeastern United States and in particular in New York, New Hampshire, New Jersey, Rhode Island, Pennsylvania and Massachusetts; the adequacy of the Company's loss reserves; the Company's dependence on the general reinsurance market; government regulation of the insurance industry; exposure to environmental claims; dependence of the Company on its relationship with Mutual and the uncertainty concerning what will happen if the Management Agreement with Mutual is either not renewed or extended by its termination date of July 23, 2003; the Company's intention to reduce written premium in business segments that it believes no longer provide a satisfactory return; and the other risks and uncertainties discussed or indicated in all documents filed by the Company with the Commission. The Company expressly disclaims any obligation to update any forward-looking statements as a result of developments occurring after the filing of this report. 22 Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 2001 COMPARED TO 2000. Total revenues for 2001 were $107,296,000, a decrease of $1,330,000, or 1%, from $108,626,000 in 2000. Direct premiums written for 2001 were $100,953,000, a decrease of $6,281,000 or 6%, from $107,234,000 for 2000. Voluntary direct premiums written for 2001 were $96,515,000, a decrease of $9,201,000 or 9%, from $105,716,000 for 2000. Voluntary personal lines direct premiums written for 2001 were $40,192,000, an increase of $1,701,000 or 4% from $38,491,000 in 2000. Private passenger automobile direct premiums written, which comprised 74% of total voluntary personal lines direct premiums written in 2001 and in 2000, increased 4% in 2001 compared to 2000 primarily due to a 3% increase in policies in force at December 31, 2001 as compared to December 31, 2000. Homeowners direct premiums written increased 7% in 2001 compared to 2000 due to a 7% increase in policies in force, resulting primarily from a 7% increase in new business units in 2001 as compared to 2000. Voluntary commercial lines direct premiums written for 2001 were $56,323,000, a decrease of 16% from $67,225,000 in 2000. This decrease was attributable in part to the discontinuation in 2001 of a program to underwrite specialized commercial auto insurance (the Auto Program) which produced $5,470,000 of direct premiums written in 2000. All policies issued under the Auto Program were 100% reinsured through certain Lloyd's syndicates and therefore had no impact on net premiums written, net premiums earned or net losses and LAE incurred by the Company. The Company recorded all direct underwriting expenses incurred, including commissions with respect to the acquisition of these policies, which were offset by reinsurance commission income. The Company continues to experience higher loss frequency for certain of its commercial lines of business not adequately covered by premiums collected from those lines of business. In response to these higher losses, the Company has filed for and received approval of rate increases in certain lines of business, revised its underwriting guidelines, and removed discretionary pricing credits where warranted. As a consequence of these actions, voluntary commercial lines direct premiums written, excluding Auto Program premiums written, for 2001 decreased $5,416,000 or 9%, to $56,339,000 from $61,755,000 for 2000. Direct premiums written for all of the Company's commercial lines of business, except commercial package policies, decreased in 2001 compared to 2000. Commercial lines policies in force at December 31, 2001 decreased 18% compared to commercial lines policies in force at December 31, 2000. Commercial lines new business units decreased 45% in 2001, compared to 2000. The Company intends to continue to reduce direct written premiums in business segments that it believes no longer provide the opportunity to earn a satisfactory return for its shareholders. The Company estimates that its voluntary direct written premiums will decline in 2002 with further reductions possible thereafter. Involuntary direct premiums written, primarily involuntary private passenger automobile insurance, which comprised 4% and 1% of total direct premiums written during 2001 and 2000, respectively, were $4,438,000 for 2001 compared to $1,518,000 in 2000, an increase of $2,920,000 or 192%. This increase 23 resulted primarily from increased assignments from the New York Automobile Insurance Plan (NYAIP), which provides coverage for individuals who are unable to obtain auto insurance in the voluntary market. Assignments from the NYAIP vary depending upon a company's private passenger automobile market share and the size of the NYAIP. The Company believes it is likely that, due to a decrease in the willingness of several major competitors to insure non-standard business voluntarily, the number of policies written by the NYAIP will continue to increase and therefore the amount of the Company's involuntary direct written premiums will also continue to increase. However, the Company is unable to predict the volume of future assignments from the NYAIP. Net premiums written decreased $369,000 or less than 1% to $93,973,000 for 2001 from $94,342,000 for 2000. Net premiums earned for 2001 were $93,885,000, a decrease of $374,000, or less than 1%, from $94,259,000 in 2000. This decrease in net premiums earned resulted primarily from a decrease in assumed premiums earned and is consistent with the decrease in net written premiums. Net investment income was $13,295,000 in 2001, a decrease of 4% from $13,903,000 in 2000, primarily due to a decrease in average portfolio yield. Lower reinvestment rates in the Company's targeted maturity sector (2 years) led to the decrease in average portfolio yield. Net realized investment losses were $580,000 for 2001 compared to net realized investment gains of $109,000 for 2000. Net realized investment losses for 2001 included $781,000 of unrealized losses related to the Company's fixed maturity investment in a commercial finance company. The Company believes that the decline in fair value of this investment is other than temporary and has therefore recorded a realized loss. Other revenues were $696,000 for 2001, an increase of $341,000, or 96%, from $355,000 for 2000. This increase resulted from an increase in premium installment fee income and a decrease in charge-offs related to uncollectible premiums receivable. The reduction in charge-offs resulted from a decline in the average age of the Company's premium receivable. Net losses and LAE were $75,144,000 for 2001, an increase of $3,770,000 or 5% from $71,374,000 for 2000. The loss and LAE ratio increased to 80.0% for 2001 from 75.7% for 2000. Losses and LAE include $1,305,000 of losses and LAE related to the September 11, 2001 terrorist attack on the World Trade Center (WTC) in New York City. The WTC event added 1.4 percentage points to the Company's loss and LAE ratio for 2001. Excluding the effect of the WTC event, the increase in the loss and LAE ratio resulted primarily from the increase in involuntary automobile insurance business which increased the Company's net loss and LAE ratio by 6.3 percentage points in 2001, compared to 2.7 percentage points in 2000. The ratio of amortized deferred policy acquisition costs and other underwriting expenses to net premiums earned increased to 32.9% in 2001 from 32.1% in 2000, primarily due to higher agency incentive commissions and lower commissions earned on ceded reinsurance. Expenses that vary directly with the Company's premium volume, primarily commissions, premium taxes and state assessments, represented 20.7% and 20.0% of net premiums earned in 2001 and 2000, respectively. Certain other underwriting expenses, such as salaries, employee benefits and other operating expenses vary indirectly with volume and comprise the remainder of the Company's underwriting expenses. The Company's effective income tax rate was 34.6% for 2001 compared to 38.1% for 2000. 24 2000 COMPARED TO 1999. Total revenues for 2000 were $108,626,000, an increase of $210,000, or less than 1%, from $108,416,000 in 1999. Direct premiums written for 2000 were $107,234,000, an increase of $7,007,000, or 7%, from $100,227,000 in 1999. Net written premiums for 2000 were $94,342,000, a decrease of $128,000 from $94,470,000 in 1999. Voluntary personal lines direct premiums written for 2000 were $38,491,000, substantially unchanged from $38,493,000 in 1999. Private passenger automobile direct premiums written, which comprised 74% and 76% of total voluntary personal lines direct premiums written in 2000 and 1999, respectively, decreased 2% in 2000 compared to 1999 primarily due to fewer new policies and renewal policies retained resulting from price-based market competition. Homeowners direct premiums written increased 6% in 2000 compared to 1999 due to an 8% increase in policies in force resulting primarily from a 7% increase in new business units in 2000 as compared to 1999. Voluntary commercial lines direct premiums written for 2000 were $67,225,000, an increase of 13% from $59,621,000 in 1999. This increase resulted primarily from a $6,553,000, or 35%, increase in commercial auto direct premiums written and a $1,013,000, or 13%, increase in contractors coverall direct premiums written. The increase in commercial auto direct premiums written was primarily attributable to $5,470,000 of direct premiums written for the Auto Program. There were no Auto Program direct premiums written in 1999. Voluntary commercial auto direct premiums written excluding the Auto Program were $19,654,000, an increase of $1,083,000, or 6%, from $18,571,000 in 1999, primarily due to an increase in average premium per policy. The increase in contractors coverall direct premiums written was primarily due to a 24% increase in policies in force in 2000 compared to 1999 somewhat offset by a decrease in average premium per policy. Involuntary direct premiums written, primarily involuntary private passenger automobile insurance, which comprised 1% and 2% of total direct premiums written during 2000 and 1999, respectively, were $1,518,000 for 2000 compared to $2,113,000 in 1999, a decrease of $595,000 or 28%. This decrease resulted primarily from decreased assignments from the NYAIP. Net premiums earned for 2000 were $94,259,000, a decrease of $516,000, or less than 1%, from $94,775,000 in 1999. This decrease in net premiums earned resulted primarily from a decrease in assumed premiums earned and is consistent with the decrease in net written premiums. Net investment income was $13,903,000 in 2000, an increase of 6% from $13,147,000 in 1999, primarily due to an increase in average portfolio yield. Higher reinvestment rates in the Company's targeted maturity sector (2 years) led to the increase in average portfolio yield. Net losses and LAE were $71,374,000 for 2000, an increase of 8% from $66,086,000 for 1999. The loss and LAE ratio increased to 75.7% in 2000 from 69.7% in 1999. In 2000, the Company recorded an increase to its reserves related to all prior accident years of $1,428,000. This increase, which was primarily attributable to higher than estimated loss experience on personal and commercial automobile and workers' compensation policies, added 1.5 percentage points to the Company's 2000 calendar year loss and LAE ratio. 25 In 1999, the Company recorded a decrease to its reserves for prior years' accidents of $3,749,000, which in turn reduced the Company's 1999 calendar year loss and LAE ratio by 3.9 percentage points. The ratio of amortized deferred policy acquisition costs and other underwriting expenses to net premiums earned decreased to 32.1% in 2000 from 33.7% in 1999, primarily due to lower agency incentive commissions resulting from the increase in net losses and LAE and revisions to the profit sharing program for agents, and to lower incentive compensation expenses. Expenses that vary directly with the Company's premium volume, primarily commissions, premium taxes and state assessments, represented 19.3% and 20.6% of net premiums earned in 2000 and 1999, respectively. Certain other underwriting expenses, such as salaries, employee benefits and other operating expenses vary indirectly with volume and comprise the remainder of the Company's underwriting expenses. The Company's effective income tax rate for 2000 was 38.1%. Non-taxable investment income reduced the Company's effective tax rate by approximately five percentage points. CRITICAL ACCOUNTING POLICIES RESERVE FOR LOSSES AND LAE The Company establishes reserves for losses and LAE. These reserves are estimates of future payments to be made to settle all insurance claims for reported losses and estimates of incurred but not reported losses based upon past experience modified for current trends. With the exception of workers' compensation losses, loss reserves are not discounted. Estimated amounts of salvage and subrogation on paid and unpaid losses are deducted from the liability for unpaid claims. The estimated liabilities may be more or less than the amount ultimately paid when the claims are settled. Management and the Company's independent consulting actuary regularly review the estimates of reserves needed and any changes are reflected in current operating results. Loss reserves are established for known claims based on the type and circumstance of the loss and the results of similar losses. For claims not yet reported to the Company, loss reserves are based on statistical information from previous experience periods adjusted for inflation, trends in court decisions and economic conditions. LAE reserves are intended to cover the ultimate cost of investigating all losses that have occurred and defending lawsuits, if any, arising from these losses. LAE reserves are evaluated periodically using statistical techniques which compare current costs with historical data. Inflation is implicitly reflected in the reserving process through analysis of cost trends and review of historical reserve results. The Company's reserving process is based on the assumption that past experiences, adjusted for the effect of current developments and trends, are relevant in predicting future events. In the absence of specific developments, the process also assumes that the legal climate regarding the claims process and underlying liabilities remains constant. Other assumptions employed by the Company or its actuarial firm change from time to time as circumstances change. In estimating loss and LAE reserves, the Company employs a number of actuarial methods, depending on their applicability to each line of business, in order to balance the advantages and disadvantages of each method. No single method is used to estimate loss and LAE reserves. Although different actuarial methods may give rise to different reserve estimates, which may be higher or lower than the reserves actually established by the Company, the Company believes that those differences are not material. 26 The Company has recorded changes in reserves for prior accident year losses in most years. In 1999 and 2001, the Company decreased its reserves for prior years by $3,749,000 and $1,474,000, respectively, primarily due to favorable loss experience related to workers compensation policies. In 2000, the Company increased its reserves for prior years by $1,428,000, primarily due to higher than anticipated frequency and severity of losses related to personal automobile, commercial automobile and workers' compensation policies. The total reserves for losses and LAE were $151,355,000 and $145,075,000 at December 31, 2001 and 2000, respectively. LIQUIDITY AND CAPITAL RESOURCES In developing its investment strategy, the Company determines a level of cash and short-term investments which, when combined with expected cash flow, is estimated to be adequate to meet expected cash obligations. Historically, the excess of premiums collected over payments on claims, combined with cash income from investments, has provided the Company with short-term funds in excess of normal operating demands for cash. In 2001, however, the Company's operating activities used $1,549,000 of cash. In 2000, operating activities provided $6,564,000 of cash. This decrease in cash provided by operations was primarily the result of a $2,690,000 (3%) decrease in premiums collected and a $6,655,000 (10%) increase in loss and LAE payments. The Company's intention to continue to reduce direct premiums written in business segments where returns are unsatisfactory will likely result in future negative cash flows from operations. The Company believes that careful management of the relationship between assets and liabilities will minimize the likelihood that investment portfolio sales will be necessary to fund insurance operations and that the effect of any such sale on the Company's stockholders' equity will not be material. Further, the Company believes that the WTC event will not require any unplanned liquidation of its investment portfolio. The Company's objectives with respect to its investment portfolio include maximizing total return within investment guidelines while protecting policyholders' surplus and maintaining flexibility. Like other property and casualty insurers, the Company relies on premiums as a major source of cash, and therefore liquidity. Cash flows from the Company's investment portfolio, either in the form of interest or principal payments, are an additional source of liquidity. Because the duration of the Company's investment portfolio relative to the duration of its liabilities is closely managed, increases or decreases in market interest rates are not expected to have a material effect on the Company's liquidity, or its results of operations. The Company generally designates newly acquired fixed maturity investments as available for sale and carries these investments at fair value. Unrealized gains and losses related to these investments are recorded as accumulated other comprehensive income within stockholders' equity. At December 31, 2001, the Company recorded as accumulated other comprehensive income in its Consolidated Balance Sheet $1,812,000 of unrealized gains, net of taxes, associated with its investments classified as available for sale. During 2001 the Company recorded $2,687,000 of unrealized gains, net of tax, associated with its available for sale investments as other comprehensive income. At December 31, 2001, the Company's portfolio of fixed maturity investments represented 91.6% of invested assets. Management believes that this level of bond holdings is consistent with the Company's liquidity needs because it anticipates that cash receipts from net premiums written and investment income will enable the Company to satisfy its cash obligations. Furthermore, a portion of the Company's bond portfolio is invested in mortgage-backed and other asset-backed securities which, in addition to interest income, provide monthly paydowns of bond principal. 27 At December 31, 2001, $71,798,000, or 33.7%, of the Company's fixed maturity portfolio was invested in mortgage-backed and other asset-backed securities. The Company invests in a variety of collateralized mortgage obligation ("CMO") products but has not invested in the derivative type of CMO products such as interest only, principal only or inverse floating rate securities. All of the Company's CMO investments have a secondary market and their effect on the Company's liquidity does not differ from that of other fixed maturity investments. At December 31, 2001, $41,965,000 or 19.7% of the Company's investment portfolio was invested in fixed maturity obligations of the U.S. Government or its government sponsored agencies. Of this amount, $33,802,000 was invested in United States Treasury Inflation Index Notes (TIPS). TIPS differ from traditional treasury securities in that in addition to regular coupon payments, the principal value changes daily based upon the Consumer Price Index (CPI) as published by the United States Department of Labor. Accretion based upon the CPI becomes part of the total return of the security and is subject to change as the CPI rises or falls. Accretion can therefore be positive or negative and is recorded as a component of net investment income. TIPS perform best in a declining interest rate environment when the referenced CPI is rising. At December 31, 2001, $10,163,000, or 5%, of the Company's investment portfolio was invested in non-investment grade securities compared to $10,083,000, or 5%, at December 31, 2000. All of the Company's non-investment grade securities are currently performing to the Company's expectations at the time of purchase. During 2001 the Company repurchased 214,300 shares of its common stock at an average price of $19.92 and was holding 1,025,400 shares in treasury as of December 31, 2001. The Company maintains a $2,000,000 unsecured credit facility from a bank in the form of a master grid note. Any borrowings under this facility are payable on demand and carry an interest rate which can be fixed or variable and is negotiated at the time of each advance. This facility is available for general working capital purposes and for repurchases of the Company's common stock. At December 31, 2001, $200,000 was outstanding on this loan. As a holding company, the Company is dependent upon cash dividends from MNH to meet its obligations and to pay any cash dividends. MNH is subject to New Hampshire insurance laws which place certain restrictions on its ability to pay dividends without the prior approval of state regulatory authorities. These restrictions limit dividends to those that, when added to all other dividends paid within the preceding twelve months, would not exceed 10% of the insurer's policyholders' surplus as of the preceding December 31st. The maximum amount of dividends that MNH could pay during any twelve month period ending in 2001 without the prior approval of the New Hampshire Insurance Commissioner is $5,263,000. MNH paid the maximum allowable dividend to the Company in 2001. Dividends were paid in February 2001, May 2001 and September 2001, of $2,200,000, $1,350,000 and $1,510,000, respectively. MNH paid a dividend of $2,300,000 to the Company on February 19, 2002 and as such is restricted from paying another dividend to the Company until May, 2002. The Company paid a quarterly cash dividend to its common stockholders of $.10 per share in 2001, which amounted to $925,000. Regulatory guidelines suggest that the ratio of a property and casualty insurer's annual net premiums written to its statutory surplus should not exceed 3 to 1. The Company has consistently followed a business strategy that would allow MNH to meet this 3 to 1 regulatory guideline. MNH's ratio of net premiums written to statutory surplus for 2001 was 1.8 to 1. 28 RECENTLY ISSUED ACCOUNTING STANDARDS In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 141 and 142. SFAS No. 141 "Business Combinations" revised accounting standards and disclosure requirements for business combinations. The provisions for SFAS No. 141 were effective for any business combination completed after June 30, 2001. SFAS No. 142 "Goodwill and Other Intangible Assets," revises accounting standards for all purchased intangible assets. SFAS No. 142 is effective for fiscal years beginning after December 15, 2001. Neither SFAS No. 141 nor No. 142 had any impact on the Company's 2001 consolidated financial statements. In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations." SFAS No. 143 requires entities to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred. In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment of Disposal of Long-Lived Assets." This SFAS supercedes SFAS No. 121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of". SFAS No. 144 requires that Long-Lived Assets to be disposed of be measured at the lower of carrying amount or fair value less cost to sell. The provisions of SFAS Nos. 143 and 144 are not expected to have any impact on the Company's consolidated financial statements. ENVIRONMENTAL CLAIMS MNH, like many other property and casualty insurance companies, is subject to environmental damage claims asserted by or against its insureds. Management of the Company is of the opinion that based on various court decisions throughout the country, such claims should not be recoverable under the terms of MNH's insurance policies because of either specific or general coverage exclusions contained in the policies. However, there is no assurance that the courts will agree with MNH's position in every case, nor can there be assurance that material claims will not be asserted under policies which a court will find do not explicitly or implicitly exclude claims for environmental damages. Management, however, is not aware of any pending claim or group of claims which would result in a liability that would have a material adverse effect on the financial condition of the Company or MNH. INFLATION Inflation affects the Company, like other companies in the property and casualty insurance industry, by contributing to higher losses, LAE and operating costs, as well as greater investment income resulting from the higher interest rates which can prevail in an inflationary period. Premium rates, however, may not keep pace with inflation since competitive forces may limit the Company's ability to increase premium rates. The Company considers inflationary trends in estimating its reserves for claims reported and for incurred but not reported claims. RELATIONSHIP WITH MUTUAL The Company's and MNH's business and day-to-day operations are closely aligned with those of Mutual. This is the result of a combination of factors. Mutual has had a historical ownership interest in the Company and MNH. Prior to November 1986 MNH was a wholly-owned subsidiary of Mutual. Following the Company's initial public offering in November 1986 and until a secondary stock offering in July 1993 the Company was a majority-owned subsidiary of Mutual. At December 31, 2001 Mutual owned 11.5% of the Company's common stock. Under the Management Agreement, Mutual provides the Company and 29 MNH with all facilities and with personnel to operate their business. With the exception of the Chief Operating Officer of MNH, the only officers of the Company or MNH who are paid full time employees are employees of Mutual whose services are purchased under the Management Agreement. Also, the operation of MNH's insurance business, which offers substantially the same lines of insurance as Mutual through the same independent insurance agents, creates a very close relationship among the companies. During 1998, Mutual initiated discussions with the Company concerning proposals for the acquisition of the Company by Mutual. The Company determined that the terms proposed by Mutual were inadequate. The Company also determined that the Management Agreement, as currently written, creates a conflict of interest between the Company and Mutual in their joint operation and prevents the Company's shareholders from realizing the Company's fair value in a sale or merger. Accordingly, on July 23, 1998 the Company gave notice to Mutual of its intention to terminate the Management Agreement and, therefore, the Management Agreement will terminate on July 23, 2003, unless the parties agree to renew or extend it. On March 4, 2002, the Company requested that Mutual extend the Management Agreement under its existing terms to December 31, 2003 in order to provide for a more orderly transition to a new management agreement with Mutual or a different manager. The Company is in discussion with various potential candidates, including Mutual, to provide management services to the Company after the current Management Agreement expires. The Company intends to base the new agreement on fee for services, rather than an allocation of expenses, as currently calculated. The Company anticipates that the future manager will be compensated for positive results through profit-sharing and that the Company will be permitted to terminate the new agreement on substantially less than the five (5) year notice that was required under the present Management Agreement. 30 Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK MARKET RISK Market risk represents the potential for loss due to changes in the fair value of financial instruments. The market risk related to the Company's financial instruments primarily relates to its investment portfolio. The value of the Company's investment portfolio of $213,132,000 at December 31, 2001 is subject to changes in interest rates and to a lesser extent on credit quality. Further, certain mortgage-backed and asset-backed securities are exposed to accelerated prepayment risk generally caused by interest rate movements. If interest rates were to decline, mortgage holders would be more likely to refinance existing mortgages at lower rates. Acceleration of future repayments could adversely affect future investment income, if reinvestment of the accelerated receipts was made in lower yielding securities. The table below provides information related to the Company's fixed maturity investments at December 31, 2001. The table presents cash flows of principal amounts and related weighted average interest rates by expected maturity dates. The cash flows are based upon the maturity date or, in the case of mortgage-backed and asset-backed securities, expected payment patterns. Actual cash flows could differ from those shown in the table. 31 Expected Cash Flows of Principal Amounts ($ in 000's):
TOTAL ----- Esti- Amor- mated There- tized Market 2002 2003 2004 2005 2006 after Cost Value ---- ---- ---- ---- ---- ------ ------ ------ HELD TO MATURITY Mortgage & asset backed securities $ 4,786 $ 1,566 $ 2,835 $ 2,601 $ 991 $ 263 $ 13,042 $ 14,035 Average interest rate 7.1% 7.1% 7.1% 7.1% 7.1% 7.2% -- -- -------- -------- -------- -------- -------- -------- -------- -------- Total $ 4,786 $ 1,566 $ 2,835 $ 2,601 $ 991 $ 263 $ 13,042 $ 14,035 ======== ======== ======== ======== ======== ======== ======== ======== AVAILABLE FOR SALE U.S. Treasury securities and obligations of U.S. Government corporations and agencies $ 3,841 $ 4,200 $ 0 $ 0 $ 0 $ 33,381 $ 41,422 $ 41,965 Average interest rate 6.9% 4.1% 0.0% 0.0% 0.0% 7.3% -- -- Obligations of states and political subdivisions 1,484 6,281 1,000 0 0 40 8,805 8,999 Average interest rate 7.9% 7.2% 4.3% 0.0% 0.0% 7.3% -- -- Corporate securities 23,537 36,817 6,260 999 0 3,422 71,035 72,450 Average interest rate 7.2% 5.3% 6.8% 4.2% 0.0% 10.3% -- -- Mortgage & asset backed securities 10,737 24,331 16,342 905 472 4,766 57,553 58,756 Average interest rate 5.9% 5.4% 5.5% 6.5% 7.2% 7.0% -- -- -------- -------- -------- -------- -------- -------- -------- -------- Total $ 39,599 $ 71,629 $ 23,602 $ 1,904 $ 472 $ 41,609 $178,815 $182,170 ======== ======== ======== ======== ======== ======== ======== ========
The discussion and the estimated amounts referred to above include forward-looking statements of market risk which involve certain assumptions as to market interest rates and the credit quality of the fixed maturity investments. Actual future market conditions may differ materially from such assumptions. Accordingly, the forward-looking statements should not be considered projections of future events by the Company. 32 Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. The consolidated financial statements required in response to this Item are submitted as part of Item 14 (a) of this report, and are incorporated in this item by reference. Quarterly data for the two most recent fiscal years is set forth below:
Three Months Ended ----------------------------------------- 3/31 6/30 9/30 12/31 ---- ---- ---- ----- (in thousands, except per share amounts) 2001 ---- Net premiums earned $ 23,353 $ 23,154 $ 23,230 $ 24,148 Net investment income 3,563 3,472 3,244 3,016 Net realized investment gains (losses 43 39 30 (692) Other revenues 137 117 161 281 -------- -------- -------- -------- Total revenues $ 27,096 $ 26,782 $ 26,665 $ 26,753 ======== ======== ======== ======== Income (loss) before income taxes $ 331 $ 1,910 $ (1,230) $ 244 Net income (loss) $ 212 $ 1,217 $ (809) $ 201 Net income (loss) per diluted share $ .09 $ .52 $ (.35) $ .09 2000 ---- Net premiums earned $ 23,033 $ 23,606 $ 23,822 $ 23,798 Net investment income 3,456 3,388 3,481 3,578 Net realized investment gains -- 5 104 -- Other revenues 66 16 81 192 -------- -------- -------- -------- Total revenues $ 26,555 $ 27,015 $ 27,488 $ 27,568 ======== ======== ======== ======== Income before income taxes $ 1,272 $ 2,783 $ 2,617 $ 335 Net income $ 817 $ 1,801 $ 1,670 $ 51 Net income per diluted share $ .32 $ .72 $ .68 $ .02
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. 33 PART III Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. The information in response to this item is incorporated by reference herein to the information under the caption "Election of Directors" presented in the Company's definitive proxy statement filed or to be filed pursuant to Regulation 14A and used in connection with the Company's 2002 Annual Meeting of Shareholders to be held on or about May 1, 2002, provided, however, that information appearing under the heading "Report of the Audit Committee" is not incorporated herein and should not be deemed included in this document for any purpose. Item 11. EXECUTIVE COMPENSATION. The information in response to this item is incorporated by reference herein to the information under the captions "Executive Compensation" and "Compensation of Directors" presented in the Company's definitive proxy statement filed or to be filed pursuant to Regulation 14A and used in connection with the Company's 2002 Annual Meeting of Shareholders to be held on or about May 1, 2002, PROVIDED, HOWEVER that information appearing under the captions "Compensation Committee Report on Executive Compensation" and "Performance Comparison" is not incorporated herein and should not be deemed to be included in this document for any purpose. Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The information in response to this item is incorporated by reference herein to the information under the caption "Security Ownership of Certain Beneficial Owners" and "Security Ownership of Management" presented in the Company's definitive proxy statement filed or to be filed pursuant to Regulation 14A and used in connection with the Company's 2002 Annual Meeting of Stockholders to be held on or about May 1, 2002. Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The information in response to this item is incorporated herein by reference to the information under the caption "Management Agreement" and "Certain Transactions" presented in the Company's definitive proxy statement filed or to be filed pursuant to Regulation 14A and used in connection with the Company's 2002 Annual Meeting of Shareholders to be held on or about May 1, 2002. 34 PART IV Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. (a)1) The following financial statements of Merchants Group, Inc. are included on pages F-1 to F-23: Report of Independent Accountants Consolidated Balance Sheet - December 31, 2000 and 2001. Consolidated Statement of Operations - Years ended December 31, 1999, 2000 and 2001. Consolidated Statement of Changes in Stockholders' Equity - Years ended December 31, 1999, 2000 and 2001. Consolidated Statement of Cash Flows - Years ended December 31, 1999, 2000 and 2001. Notes to Consolidated Financial Statements. (2) The following financial statement schedules of Merchants Group, Inc. are filed herewith pursuant to Item 8: Schedule I - Summary of Investments - Other Than Investments in Related Parties. Schedule II - Amounts Receivable From/Payable to Related Parties, and Underwriters, Promoters and Employees Other Than Related Parties. Schedule III - Condensed Financial Information of Registrant. Schedule V - Supplemental Insurance Information (see Schedule X). Schedule VI - Reinsurance Schedule X - Supplemental Insurance Information Concerning Property - Casualty Subsidiaries (b) Reports on Form 8-K. There were no reports on Form 8-K filed for the quarter ended December 31, 2001. (c) Exhibits required by Item 601 of Regulation S-K: (3)(a) Restated Certificate of Incorporation (incorporated by reference to Exhibit No. 3C to Amendment No. 1 to the Company's Registration Statement (No. 33-9188) on Form S-1 filed on November 7, 1986). (b) Restated By-laws (incorporated by reference to Exhibit No. 3D to Amendment No. 1 to the Company's Registration Statement (No. 33-9188) on Form S-1 filed on November 7, 1986). 35 (10)(a) Management Agreement dated as of September 29, 1986 by and among Merchants Mutual Insurance Company, Registrant and Merchants Insurance Company of New Hampshire, Inc. (incorporated by reference to Exhibit No. 10A to the Company's Registration Statement (No. 33-9188) on Form S-1 filed on September 30, 1986). (b) Agreement of Reinsurance No. 6922 between Merchants Mutual Insurance Company, Merchants Insurance Company of New Hampshire, Inc. and General Reinsurance Corporation (incorporated by reference to Exhibit No. 10E to the Company's Registration Statement (No. 33-9188) on Form S-1 filed on September 30, 1986). (c) Agreement of Reinsurance No. 7299 between Merchants Mutual Insurance Company, Merchants Insurance Company of New Hampshire, Inc. and General Reinsurance Corporation, (incorporated by reference to Exhibit No. 10o to the Company's 1987 Annual Report on Form 10-K (File No. 1-9640) filed on March 19, 1988). (d) Agreement of Reinsurance dated January 27, 1993, between Merchants Mutual Insurance Company and Merchants Insurance Company of New Hampshire, Inc. (incorporated by reference to Exhibit (3) in the Company's Current Report on Form 8-K (File No. 1-9640) filed on January 29, 1993). (e) Agreement of Reinsurance No. 8009 between Merchants Mutual Insurance Company, Merchants Insurance Company of New Hampshire, Inc. and General Reinsurance Corporation, (incorporated by reference to Exhibit 10e to the Company's 1995 Annual Report on Form 10-K filed on March 28, 1996). (f) Property and Casualty Excess of Loss Reinsurance Agreement between Merchants Mutual Insurance Company, Merchants Insurance Company of New Hampshire, Inc. and American Reinsurance Company, including endorsement, (incorporated by reference to Exhibit 10g to the Company's 1998 Annual Report on Form 10-K filed on March 29, 1999). (g) Property Catastrophe Excess of Loss Reinsurance Agreement between Merchants Mutual Insurance Company, Merchants Insurance Company of New Hampshire, Inc. and the Subscribing Reinsurers Executing the Interest and Liabilities Contracts attached to this agreement, effective January 1, 2000 (incorporated by reference to Exhibit 10g to the Company's 2000 Annual Report on Form 10-K filed on March 28, 2001). (h) Quota Share Reinsurance Treaty Agreement between Merchants Insurance Company of New Hampshire, Inc. and The Subscribing Underwriting Members of Lloyd's, London specifically identified on the schedules attached to this agreement dated January 1, 2000 (incorporated by reference to Exhibit 10h to the Company's 2000 Annual Report on Form 10-K filed on March 28, 2001). 36 * (i) Merchants Mutual Capital Accumulation Plan (incorporated by reference to Exhibit No. 10G to the Company's Registration Statement (No. 33-9188) on Form S-1 filed on September 30, 1986). * (j) Merchants Mutual Capital Accumulation Plan, fifth amendment, effective January 1, 1999 (incorporated by reference to Exhibit 10j to the Company's 2000 Annual Report on Form 10-K filed on March 28, 2001). * (k) Merchants Mutual Capital Accumulation Plan Trust Agreement (restated as of January 1, 1996 (incorporated by reference to Exhibit 10(i) to the Company's 1996 Annual Report on Form 10-K (File No. 1-9640) filed on March 28, 1997). * (l) Merchants Mutual Supplemental Executive Retirement Plan dated as of December 29, 1989 and Agreement of Trust dated as of December 29, 1989 (incorporated by reference to Exhibit No. 10K to the Company's 1989 Annual Report on Form 10-K (File No. 1-9640) filed on March 21, 1990). * (m) Amendment dated June 10, 1992 to Agreement of Trust under Merchants Mutual Supplemental Executive Retirement Plan dated as of December 29, 1989 (incorporated by reference to Exhibit No. 10R to the Company's 1992 Annual Report on Form 10-K (File No. 1-9640) filed on March 31, 1993). * (n) Merchants Group, Inc. 1986 Stock Option Plan As Amended Through February 16, 1993 (incorporated by reference to Exhibit No. 10E to the Company's 1992 Annual Report on Form 10-K (File No. 1-9640) filed on March 31, 1993). * (o) Form of Amended Indemnification Agreement entered into by Registrant with each director and executive office of Registrant (incorporated by reference to Exhibit No. 10N to Amendment No. 1 to the Company's Registration Statement on (No. 33-9188) Form S-1 filed on November 7, 1986). * (p) Merchants Mutual Insurance Company Adjusted Return on Equity Incentive Compensation Plan January 1, 2000 (incorporated by reference to Exhibit 10p to the Company's 2000 Annual Report on Form 10-K filed on March 28, 2001). * (q) Merchants Mutual Insurance Company Adjusted Return on Equity Long Term Incentive Compensation Plan January 1, 2000 (incorporated by reference to Exhibit 10q to the Company's 2000 Annual Report on Form 10-K filed on March 28, 2001). * (r) Employee Retention Agreement between Robert M. Zak and Merchants Mutual Insurance Company dated as of March 1, 1999 (incorporated by reference to Exhibit No. 10-A to the Company's June 30, 1999 Quarterly Report on Form 10-Q filed on August 12, 1999). * (s) Employee Retention Agreement between Edward M. Murphy and Merchants Mutual Insurance Company dated as of March 1, 1999 (incorporated by reference to Exhibit 10r to the Company's 1998 Annual Report on Form 10-K filed on March 29, 1999). 37 * (t) Employee Retention Agreement between Kenneth J. Wilson and Merchants Mutual Insurance Company dated as of March 1, 1999 (incorporated by reference to Exhibit 10s to the Company's 1998 Annual Report on Form 10-K filed on March 29, 1999). * (u) Consulting Agreement between Stephen C. June and Merchants Insurance Company of New Hampshire, Inc. ("MNH") dated as of May 7, 2001 (filed herewith). * (v) Employment Agreement between Stephen C. June and MNH dated as of April 1, 2002 (filed herewith). (11)(a) Statement re computation of per share earnings (incorporated herein by reference to Note 9 to the Consolidated Financial Statements included in Item 8). (21) List of Subsidiaries of Registrant (incorporated by reference to Exhibit No. 22 to the Company's Registration Statement ( No. 33-9188) on Form S-1 filed on September 30, 1986). (23) Consent of Independent Accountants (filed herewith). * Indicates a management contract or compensation plan or arrangement. The Company will forward upon request any exhibit not contained herein upon payment of a fee equal to the Company's reasonable expenses in furnishing the exhibits. Requests should be directed to: INVESTOR RELATIONS MERCHANTS GROUP, INC. 250 MAIN STREET BUFFALO, NEW YORK 14202 38 MERCHANTS GROUP, INC. SCHEDULE I - SUMMARY OF INVESTMENTS - OTHER THAN INVESTMENTS IN RELATED PARTIES December 31, 2001 (in thousands)
Amount at which shown Amortized Cost/ Market in the balance Type of Investment Cost Value Sheet ------------------ ---- ----- ----- Fixed maturities: United States Government and government agencies and authorities $ 41,422 $ 41,965 $ 41,965 Corporate bonds 71,035 72,450 72,450 Mortgage and asset backed securities 70,595 72,791 71,798 Tax exempt bonds 8,805 8,999 8,999 -------- -------- -------- Total fixed maturities 191,857 196,205 195,212 Preferred stocks 9,389 9,422 9,422 Short-term investments 6,905 6,905 6,905 Other 1,593 1,593 1,593 -------- -------- -------- $209,744 $214,125 $213,132 ======== ======== ========
39 MERCHANTS GROUP, INC. SCHEDULE II - AMOUNTS RECEIVABLE FROM/PAYABLE TO RELATED PARTIES, AND UNDERWRITERS, PROMOTERS AND EMPLOYEES OTHER THAN RELATED PARTIES Years ended December 31, 1999, 2000 and 2001 (in thousands)
1999 2000 2001 ---- ---- ---- Receivable from (payable to) Merchants Mutual Insurance Company(1): Balance at beginning of period $(1,321) $ (618) $ (608) Change during the period 703 10 (244) ------- ------- ------- Balance at end of period $ (618) $ (608) $ (852) ======= ======= =======
(1) Under a Management Agreement, Merchants Mutual Insurance Company (Mutual) provides employees, services and facilities for Merchants Insurance Company of New Hampshire, Inc. (MNH) to carry on its insurance business on a cost reimbursed basis. The balance in the intercompany receivable (payable) account indicates the amount due from (to) Mutual for the excess (deficiency) of premiums collected over (from) payments for losses, employees, services and facilities provided to MNH. 40 MERCHANTS GROUP, INC. SCHEDULE III - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (in thousands except per share and share amounts)
BALANCE SHEET ------------- December 31, ------------ 2000 2001 ---- ---- ASSETS Investment in subsidiary $ 69,937 $ 68,454 Other assets 243 354 -------- -------- Total assets $ 70,180 $ 68,808 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Other liabilities $ 58 $ 57 Demand loan -- 200 -------- -------- Total liabilities 58 257 -------- -------- Stockholders' equity: Preferred stock, $.01 par value, authorized and unissued 3,000,000 shares -- -- Preferred stock, no par value, $424.30 stated value, no shares issued or outstanding at December 31, 2000 or 2001 -- -- Common stock, $.01 par value, authorized 10,000,000 shares; issued and outstanding of 2,430,752 shares at December 31, 2000 and 2,224,452 shares at December 31, 2001 32 32 Additional paid in capital 35,680 35,795 Treasury stock, 811,100 shares at December 31, 2000 and 1,025,400 shares at December 31, 2001 (16,063) (20,332) Accumulated other comprehensive income (loss) (875) 1,812 Accumulated earnings 51,348 51,244 -------- -------- Total stockholders' equity 70,122 68,551 -------- -------- Total liabilities and stockholders' equity $ 70,180 $ 68,808 ======== ========
41 MERCHANTS GROUP, INC. SCHEDULE III - CONDENSED FINANCIAL INFORMATION OF REGISTRANT Continued (in thousands) INCOME STATEMENT ------------------ Year Ended December 31, ---------------------------- 1999 2000 2001 ----- ---- ---- Revenues: Equity in net income of subsidiary $ 6,937 $ 4,462 $ 887 Investment income (loss) 39 (23) 44 ------- ------- ------- Total revenues 6,976 4,439 931 Expenses: General and administrative expenses 237 174 174 ------- ------- ------- Operating income before income taxes 6,739 4,265 757 Income tax benefit (54) (74) (64) ------- ------- ------- Net income $ 6,793 $ 4,339 $ 821 ======= ======= ======= 42 MERCHANTS GROUP, INC. SCHEDULE III - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (in thousands)
STATEMENT OF CASH FLOWS ----------------------- Increase (Decrease) in Cash and Cash Equivalents: Year Ended December 31, ----------------------- 1999 2000 2001 ---- ---- ---- (in thousands) Cash flows from operating activities: $ (142) $ (169) $ (5) ------- ------- ------- Cash flows from investing activities: Receipt of subsidiary common stock dividend 5,000 5,200 5,060 Sale (purchase) of other investments, net 936 (86) (175) ------- ------- ------- Cash flows from investing activities 5,936 5,114 4,885 ------- ------- ------- Cash flows from financing activities: Purchase of treasury stock (6,042) (2,924) (4,269) Proceeds from (repayment of) demand loan, net 1,025 (1,025) 200 Cash dividends (955) (993) (925) Exercise of common stock options 169 -- 115 ------- ------- ------- Cash flows from financing activities (5,803) (4,942) (4,879) ------- ------- ------- Net increase (decrease) in cash and cash equivalents (9) 3 1 Cash and cash equivalents, beginning of year 10 1 4 ------- ------- ------- Cash and cash equivalents, end of year $ 1 $ 4 $ 5 ======= ======= ======= Reconciliation of net income to net cash provided by operations: Net income $ 6,793 $ 4,339 $ 821 Adjustments to reconcile net income to net cash provided by operations: Equity in income of subsidiary (6,937) (4,462) (887) Increase (decrease) in other liabilities -- 10 (1) (Increase) decrease in other (non-investment) assets -- (56) 64 Other, net 2 -- (2) ------- ------- ------- Net cash used in operating activities $ (142) $ (169) $ (5) ======= ======= =======
43 MERCHANTS GROUP, INC. SCHEDULE III - CONDENSED FINANCIAL INFORMATION NOTES TO CONDENSED FINANCIAL STATEMENTS --------------------------------------- Cash dividends of $5,000,000, $5,200,000 and $5,060,000 were paid to the Registrant by its consolidated subsidiary in the years ended December 31, 1999, 2000 and 2001, respectively. 44 MERCHANTS GROUP, INC. SCHEDULE VI - REINSURANCE YEARS ENDED DECEMBER 31, 1999, 2000, 2001 (in thousands except percentages)
Percentage Ceded Assumed of amount Gross to other from other Net assumed amount companies companies amount to net ------ --------- ---------- ------ --------- Year ended December 31, 1999 Property and Casualty Premiums $100,227 $7,369 $1,612 $94,470 1.7% Year Ended December 31, 2000 Property and Casualty Premiums $107,234 $13,532 $640 $94,342 .7% Year ended December 31, 2001 Property and Casualty Premiums $100,953 $8,392 $1,412 $93,973 1.5%
45 MERCHANTS GROUP, INC. SCHEDULE X - SUPPLEMENTAL INSURANCE INFORMATION CONCERNING PROPERTY - CASUALTY SUBSIDIARIES Years ended December 31, 1999, 2000, and 2001 (in thousands)
Losses & loss Deferred Reserves Discount adjustment expenses Amortiza- policy for losses if any, incurred related to tion of acquis- and loss deducted Net Net (1) (2) deferred ition adjustment from Unearned earned investment Current Prior acquisition costs expenses reserves premiums premiums income years years costs -------- ---------- -------- -------- -------- ---------- ----- ----- ----------- Year ended: December 31, 1999 $12,309 $133,526 $8,492 $49,616 $94,775 $13,147 $69,835 $(3,749) $25,115 December 31, 2000 $12,331 $145,075 $7,170 $50,857 $94,259 $13,903 $69,946 $ 1,428 $24,979 December 31, 2001 $12,354 $151,355 $6,714 $50,179 $93,885 $13,295 $76,618 $(1,474) $24,880
Paid losses & loss ad- Direct justment premium expenses written ---------- ------- Year ended: December 31, 1999 $65,455 $100,227 December 31, 2000 $67,625 $107,234 December 31, 2001 $74,280 $100,953
46 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Merchants Group, Inc. Date: March 21, 2002 BY: /s/ Robert M. Zak, Senior Vice President ----------------------------------------- Robert M. Zak, Senior Vice President and Chief Operating Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE --------- ----- ---- /s/RICHARD E. GARMAN Director, Chairman March 21, 2002 -------------------- of the Board Richard E. Garman /s/BRENT D. BAIRD Director, President March 21, 2001 ----------------- Brent D. Baird /s/ROBERT M. ZAK Director, Sr. VP & March 21, 2002 ---------------- Chief Operating Robert M. Zak Officer /s/KENNETH J. WILSON Vice President & CFO March 21, 2002 -------------------- (principal financial Kenneth J. Wilson and accounting officer) /s/ANDREW A. ALBERTI Director March 21, 2002 -------------------- Andrew A. Alberti /s/FRANK J. COLANTUONO Director March 21, 2002 ---------------------- Frank J. Colantuono /s/THOMAS E. KAHN Director March 21, 2002 ----------------- Thomas E. Kahn /s/HENRY P. SEMMELHACK Director March 21, 2002 ---------------------- Henry P. Semmelhack
47 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Stockholders of Merchants Group, Inc. In our opinion, the consolidated financial statements listed in the index appearing under Item 14(a)(1) on page 35 present fairly, in all material respects, the financial position of Merchants Group, Inc. and its subsidiaries at December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statements schedules appearing under Item 14(a)(2) on page 35 present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedules are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. PricewaterhouseCoopers LLP Buffalo, New York February 13, 2002 F-1 MERCHANTS GROUP, INC. CONSOLIDATED BALANCE SHEET (in thousands)
December 31, ------------ Assets 2000 2001 ----- ---- ---- Investments: Fixed maturities: Held to maturity at amortized cost $ 12,874 $ 13,042 Available for sale at fair value 183,283 182,170 Preferred stock at fair value 13,911 9,422 Other long-term investments at fair value 1,036 1,593 Short-term investments 4,550 6,905 -------- -------- Total investments 215,654 213,132 Cash 5 1,197 Interest due and accrued 2,816 2,309 Premiums receivable, net of allowance for doubtful accounts of $395 in 2000 and $431 in 2001 19,843 21,685 Deferred policy acquisition costs 12,331 12,354 Ceded reinsurance balances receivable 13,089 18,810 Prepaid reinsurance premiums 4,326 3,559 Deferred income taxes 6,263 4,790 Other assets 7,537 8,727 -------- -------- Total assets $281,864 $286,563 ======== ========
The accompanying notes are an integral part of these consolidated financial statements. F-2 MERCHANTS GROUP, INC. CONSOLIDATED BALANCE SHEET (in thousands except share and per share amounts)
December 31, ------------ Liabilities and Stockholders' Equity 2000 2001 ------------------------------------ ---- ---- Liabilities: Reserve for losses and loss adjustment expenses $ 145,075 $ 151,355 Unearned premiums 50,857 50,179 Demand loan -- 200 Payable to affiliate 608 852 Other liabilities 15,202 15,426 --------- --------- Total liabilities 211,742 218,012 --------- --------- Stockholders' equity: Common stock, $.01 par value, authorized 10,000,000 shares, issued and outstanding 2,430,752 shares at December 31, 2000 and 2,224,452 shares at December 31, 2001 32 32 Additional paid in capital 35,680 35,795 Treasury stock, 811,100 shares at December 31, 2000 and 1,025,400 shares at December 31, 2001 (16,063) (20,332) Accumulated other comprehensive income (loss) (875) 1,812 Accumulated earnings 51,348 51,244 --------- --------- Total stockholders' equity 70,122 68,551 --------- --------- Commitments and contingencies -- -- Total liabilities and stockholders' equity $ 281,864 $ 286,563 ========= =========
The accompanying notes are an integral part of these consolidated financial statements. F-3 MERCHANTS GROUP, INC. CONSOLIDATED STATEMENT OF OPERATIONS (in thousands except per share amounts)
Year Ended December 31, ----------------------- 1999 2000 2001 ---- ---- ---- Revenues: Net premiums earned $ 94,775 $ 94,259 $ 93,885 Net investment income 13,147 13,903 13,295 Net realized investment gains (losses) 60 109 (580) Other revenues 434 355 696 --------- --------- --------- Total revenues 108,416 108,626 107,296 --------- --------- --------- Expenses: Net losses and loss adjustment expenses 66,086 71,374 75,144 Amortization of deferred policy acquisition costs 25,115 24,979 24,880 Other underwriting expenses 6,801 5,266 6,017 --------- --------- --------- Total expenses 98,002 101,619 106,041 --------- --------- --------- Income before income taxes 10,414 7,007 1,255 Income tax provision 3,621 2,668 434 --------- --------- --------- Net income $ 6,793 $ 4,339 $ 821 ========= ========= ========= Earnings per share: Basic $2.48 $1.75 $.35 ===== ===== ==== Diluted $2.48 $1.74 $.35 ===== ===== ==== Weighted average number of shares outstanding Basic 2,738 2,485 2,343 Diluted 2,743 2,487 2,343
The accompanying notes are an integral part of these consolidated financial statements. F-4 MERCHANTS GROUP, INC. CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (in thousands) Year Ended December 31, ----------------------- 1999 2000 2001 ---- ---- ---- Net income $ 6,793 $ 4,339 $ 821 ------- ------- ------- Other comprehensive income (loss) before tax: Unrealized gains (losses) on securities (3,540) 482 4,454 Reclassification adjustment for gains included in net income (37) (100) (124) ------- ------- ------- Other comprehensive income (loss) before tax (3,577) 382 4,330 Income tax provision (benefit) related to items of other comprehensive income (1,216) 69 1,643 ------- ------- ------- Other comprehensive income (loss) (2,361) 313 2,687 ------- ------- ------- Comprehensive income $ 4,432 $ 4,652 $ 3,508 ======= ======= ======= The accompanying notes are an integral part of these consolidated financial statements. F-5 MERCHANTS GROUP, INC. CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (in thousands except per share amounts)
Year Ended December 31, ----------------------- 1999 2000 2001 ---- ---- ---- Common stock: Beginning and end of year $ 32 $ 32 $ 32 -------- -------- -------- Additional paid in capital: Beginning of year 35,511 35,680 35,680 Exercise of common stock options 169 -- 115 -------- -------- -------- End of year 35,680 35,680 35,795 -------- -------- -------- Treasury stock: Beginning of year (7,097) (13,139) (16,063) Purchase of treasury shares (6,042) (2,924) (4,269) -------- -------- -------- End of year (13,139) (16,063) (20,332) -------- -------- -------- Accumulated other comprehensive income (loss) Beginning of year 1,173 (1,188) (875) Other comprehensive income (loss) (2,361) 313 2,687 -------- -------- -------- End of year (1,188) (875) 1,812 -------- -------- -------- Accumulated earnings: Beginning of year 42,164 48,002 51,348 Net income 6,793 4,339 821 Cash dividends ($.35/share in 1999, $.40/share in 2000 and in 2001) (955) (993) (925) -------- -------- -------- End of year 48,002 51,348 51,244 -------- -------- -------- Total stockholders' equity $ 69,387 $ 70,122 $ 68,551 ======== ======== ========
The accompanying notes are an integral part of these consolidated financial statements. F-6 MERCHANTS GROUP, INC. CONSOLIDATED STATEMENT OF CASH FLOWS (in thousands)
Year Ended December 31, ----------------------- 1999 2000 2001 ---- ---- ---- Cash flows from operations: Collection of premiums $ 95,612 $ 94,497 $ 91,807 Payment of losses and loss adjustment expenses (65,455) (67,625) (74,280) Payment of underwriting expenses (33,381) (30,643) (31,414) Investment income received 13,141 12,949 12,999 Investment expenses paid (381) (387) (304) Income taxes paid (3,064) (2,436) (1,133) Other cash receipts 388 209 776 --------- --------- --------- Net cash provided by (used in) operations 6,860 6,564 (1,549) --------- --------- --------- Cash flows from investing activities: Proceeds from fixed maturities sold or matured 98,624 70,453 104,712 Purchase of fixed maturities (100,385) (68,326) (99,685) Net (increase) decrease in preferred stock (2,977) (1,491) 5,261 Net increase in other long-term investments (62) (239) (557) Net (increase) decrease in short-term investments 3,736 (2,006) (2,355) Disposition of equipment 696 -- -- --------- --------- --------- Net cash provided by (used in) investing activities (368) (1,609) 7,376 --------- --------- --------- Cash flows from financing activities: Settlement of affiliate balances, net (703) (10) 244 Proceeds (repayment) of demand loan, net 1,025 (1,025) 200 Purchase of treasury stock (6,042) (2,924) (4,269) Proceeds from exercise of common stock options 169 -- 115 Cash dividends (955) (993) (925) --------- --------- --------- Net cash used in financing activities (6,506) (4,952) (4,635) --------- --------- --------- Increase (decrease) in cash (14) 3 1,192 Cash, beginning of year 16 2 5 --------- --------- --------- Cash, end of year $2 $5 $ 1,197 ========= ========= =========
The accompanying notes are an integral part of these consolidated financial statements. F-7 MERCHANTS GROUP, INC. CONSOLIDATED STATEMENT OF CASH FLOWS RECONCILIATION OF NET INCOME TO NET CASH PROVIDED BY OPERATONS (in thousands)
Year Ended December 31, ----------------------- 1999 2000 2001 ---- ---- ---- Net income $ 6,793 $ 4,339 $ 821 Adjustments: Depreciation and amortization (143) (642) (1,104) Net realized investment (gains) losses (60) (109) 580 (Increase) decrease in assets: Interest due and accrued (194) (699) 507 Premiums receivable 665 121 (1,842) Deferred policy acquisition costs 81 (22) (23) Ceded reinsurance balances receivable 4,345 (7,693) (5,721) Prepaid reinsurance premiums (539) (1,158) 767 Deferred income taxes 270 (331) (170) Other assets (1,432) 117 (1,190) Increase (decrease) in liabilities: Reserve for losses and loss adjustment expenses (3,159) 11,549 6,280 Unearned premiums 234 1,241 (678) Other liabilities (1) (149) 224 -------- -------- -------- Net cash provided by (used in) operations $ 6,860 $ 6,564 $ (1,549) ======== ======== ========
The accompanying notes are an integral part of these consolidated financial statements. F-8 MERCHANTS GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION The consolidated financial statements of Merchants Group, Inc. (the "Company") include the accounts of the Company, its wholly-owned subsidiary, Merchants Insurance Company of New Hampshire, Inc. ("MNH"), and M.F.C. of New York, Inc., an inactive premium finance company which is a wholly-owned subsidiary of MNH. MNH is a stock property and casualty insurance company domiciled in the state of New Hampshire. MNH offers property and casualty insurance to preferred risk individuals and small to medium sized businesses in the northeast United States, primarily in New York, New Hampshire and New Jersey where a majority of its policies are written. As a holding company, the Company has had no operations. The consolidated financial statements have been prepared in conformity with generally accepted accounting principles ("GAAP") which differ in some respects from those followed in reports to insurance regulatory authorities. In its Annual Statement filed with regulatory authorities, MNH reported policyholders' surplus of $50,607,000 and $52,626,000 at December 31, 2000 and 2001, respectively. MNH's net income as reported in its Annual Statement was $7,141,000 in 1999, $3,981,000 in 2000 and $443,000 in 2001. All significant intercompany balances and transactions have been eliminated. The National Association of Insurance Commissioners has published the "Accounting Practices and Procedures Manual effective January 1, 2001" (the "Codification"). This publication codifies statutory accounting principles effective as of that date. The Codification has been adopted by the New Hampshire Insurance Department. MNH followed the statutory accounting guidance contained in the Codification when preparing its 2001 statutory financial statements. The statutory accounting principles prescribed by the Codification vary in certain instances from those previously used by MNH to prepare its Annual Statement at December 31, 2000 as filed with regulatory authorities. The effect of adopting Codification as of January 1, 2001 was an increase to MNH's surplus of $4,826,000. The preparation of consolidated financial statements in conformity with GAAP 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 may differ from those estimates. F-9 INVESTMENTS The Company has classified its investments in fixed maturities as either held to maturity or available for sale. Fixed maturities classified as held to maturity are presented at amortized cost and consist of debt securities that management intends and has the ability to hold until maturity. Fixed maturities classified as available for sale are presented at fair value and consist of debt securities that management may not hold until maturity. All preferred stocks are classified as available for sale and are presented at fair value. The net aggregate unrealized gain or loss, net of applicable income taxes, related to fixed maturities and preferred stock classified as available for sale is included as a component of accumulated other comprehensive income (loss) in stockholders' equity. Fixed maturities include mortgage backed and asset backed securities that are valued using the interest method. The Company estimates prepayments utilizing published data when applying the interest method. Periodic adjustments to prepayment assumptions are credited or charged to investment income. Other long-term investments include collateralized mortgage obligation residuals, carried at unpaid principal balances which do not vary significantly from fair value. Short-term investments, consisting primarily of money market mutual funds, have original maturities of three months or less and are carried at cost, which approximates fair value. Realized gains and losses on the sale of investments are based on the cost of the specific investment sold. NET PREMIUMS EARNED Premiums are recorded as revenue ratably over the terms of the policies written (principally one year). Unearned premiums are calculated using a monthly pro rata method. DEFERRED POLICY ACQUISITION COSTS Policy acquisition costs, such as commissions (net of reinsurance commissions), premium taxes and certain other underwriting expenses which vary directly with premium volume are deferred and amortized over the terms of the related insurance policies. Deferred policy acquisition costs do not exceed estimated recoverable amounts after allowing for anticipated investment income. REINSURANCE Reinsurance assumed from business written through state reinsurance facilities has been reflected in unearned premiums, loss reserves, premiums earned and losses incurred based on reports received from such facilities. Ceded reinsurance premiums, losses and ceding commissions are netted against earned premiums, losses and commission expense, respectively. F-10 RESERVE FOR LOSSES AND LOSS ADJUSTMENT EXPENSES Liabilities for unpaid losses and loss adjustment expenses ("LAE") are estimates of future payments to be made to settle all insurance claims for reported losses and estimates of incurred but not reported losses based upon past experience modified for current trends. With the exception of workers' compensation losses, loss reserves are not discounted. Estimated amounts of salvage and subrogation on paid and unpaid losses are deducted from the liability for unpaid claims. The estimated liabilities may be more or less than the amount ultimately paid when the claims are settled. Management and the Company's independent consulting actuary regularly review the estimates of reserves needed and any changes are reflected in current operating results. The Company discounts its liability for workers' compensation case reserves on a tabular basis, using the National Council on Compensation Insurance Workers' Compensation Statistical Plan Table III A at a rate of 3.5%. The amount of discount at December 31, 2000 and 2001 is $7,170,000 and $6,714,000, respectively. Reserves for losses incurred but not reported and for LAE are not discounted. Structured settlements have been negotiated for claims on certain insurance policies. Structured settlements are agreements to provide periodic payments to claimants, and are funded by annuities purchased from various life insurance companies. The Company remains primarily liable for payment of these claims. Accordingly, a liability and a corresponding deposit in the amount of $6,699,000 and $7,475,000 at December 31, 2000 and 2001, respectively, are recorded in the Company's consolidated balance sheet. INCOME TAXES The Company and its wholly-owned subsidiaries file a consolidated federal income tax return. The Company follows the asset and liability approach to account for income taxes, which requires the recognition of deferred tax liabilities and assets for the expected future tax consequences of temporary differences between the financial statement carrying amounts and the tax basis of assets and liabilities. OTHER FINANCIAL INSTRUMENTS The fair values of the Company's other financial instruments, principally premiums receivable and certain non-insurance related liabilities, do not vary significantly from the amounts assigned in these financial statements. F-11 2. RELATED PARTY TRANSACTIONS The Company and MNH have one paid employee. Under a management agreement Merchants Mutual Insurance Company ("Mutual"), which owns 11.5% of the Company's outstanding common stock at December 31, 2001, provides the Company and MNH with the facilities, management and personnel required to manage their day-to-day business. All underwriting, administrative, claims and investment expenses incurred on behalf of Mutual and MNH are shared on an allocated cost basis, determined as follows: for underwriting and administrative expenses, the respective share of total direct premiums written for Mutual and MNH serves as the basis of allocation; for claims expenses, the average number of outstanding claims is used; investment expenses are shared based on each company's share of total invested assets. MNH also pays an annual management fee of $50,000 to Mutual. On July 23, 1998, the Company gave notice to Mutual of its intent to terminate the management agreement under its terms, which termination is effective July 23, 2003. MNH's agents are also licensed to sell Mutual's products. The agents are informed of the underwriting criteria of each company as well as the classes of business that are acceptable to each company. Underwriters review each application submitted by an agent to determine which company's underwriting criteria the risk meets and then issue a policy in the appropriate company. The payable to or receivable from Mutual is non-interest bearing and represents the net of premiums collected and loss and operating expense payments made by Mutual on behalf of MNH. This balance is settled in cash on a monthly basis. F-12 3. INVESTMENTS INVESTMENTS IN FIXED MATURITIES AND PREFERRED STOCKS The amortized cost and estimated fair value of investments in fixed maturities held to maturity and available for sale and the cost and estimated fair value of preferred stocks are as follows:
Gross Gross Amortized Unrealized Unrealized Estimated Cost/cost Gains Losses Fair Value --------- ------ ------ ---------- (in thousands) DECEMBER 31, 2000 FIXED MATURITIES: HELD TO MATURITY Mortgage and asset backed securities $ 12,874 $ 702 $ -- $ 13,576 ======== ======== ======== ======== AVAILABLE FOR SALE U.S. Treasury securities and obligations of U.S. government corporations and agencies $ 43,883 $ 215 $ 43 $ 44,055 Obligations of states and political subdivisions 16,074 133 -- 16,207 Corporate securities 56,219 369 1,127 55,461 Mortgage and asset backed securities 67,216 441 97 67,560 -------- -------- -------- -------- Total $183,392 $ 1,158 $ 1,267 $183,283 ======== ======== ======== ======== Preferred stocks $ 14,611 $ 57 $ 757 $ 13,911 ======== ======== ======== ========
F-13
DECEMBER 31, 2001 Gross Gross Amortized Unrealized Unrealized Estimated Cost/cost Gains Losses Fair Value --------- ----- ------ ---------- (in thousands) FIXED MATURITIES: HELD TO MATURITY Mortgage and asset backed securities $ 13,042 $ 993 $ -- $ 14,035 ======== ======== ======== ======== AVAILABLE FOR SALE U.S. Treasury securities and obligations of U.S. government corporations and agencies $ 41,422 $ 666 $ 123 $ 41,965 Obligations of states and political subdivisions 8,805 202 8 8,999 Corporate securities 71,035 1,535 120 72,450 Mortgage and asset backed securities 57,553 1,231 28 58,756 -------- -------- -------- -------- Total $178,815 $ 3,634 $ 279 $182,170 ======== ======== ======== ======== Preferred stocks $ 9,389 $ 105 $ 72 $ 9,422 ======== ======== ======== ========
The amortized cost and fair value of fixed maturities by expected maturity at December 31, 2001 are shown below. Mortgage and asset backed securities are distributed in the table based upon management's estimate of repayment periods. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. F-14
Estimated Fair Amortized Cost Value -------------- ---------- (in thousands) Held to maturity Due in one year or less $ -- $ -- Due after one year through five years 11,787 12,684 Due after five years through ten years 1,255 1,351 Due after ten years -- -- -------- -------- Total $ 13,042 $ 14,035 ======== ======== Available for sale Due in one year or less $ 39,599 $ 40,356 Due after one year through five years 97,607 99,659 Due after five years through ten years 37,352 37,773 Due after ten years 4,257 4,382 -------- -------- Total $178,815 $182,170 ======== ========
Discount and premium pertaining to collateralized mortgage obligations are amortized over the securities' estimated redemption periods using the effective interest method. Yields used to calculate premium or discount are adjusted for prepayments quarterly. Fixed maturities with a par value of $1,900,000 were on deposit at December 31, 2001 with various state insurance departments in compliance with applicable insurance laws. Proceeds from sales of available for sale fixed maturity securities and preferred stocks and gross realized gains and losses related to such sales are as follows: Year Ended December 31, ---------------------- 1999 2000 2001 ---- ---- ---- (in thousands) Proceeds from sales $16,968 $ 5,555 $10,938 Gross realized gains 76 109 218 Gross realized losses 16 -- 17 F-15 NET INVESTMENT INCOME Net investment income consists of:
Year Ended December 31, ----------------------------- 1999 2000 2001 ---- ---- ---- (in thousands) Fixed maturities $ 12,118 $ 12,718 $ 12,366 Short-term investments 464 404 277 Other 946 1,168 954 --------- --------- --------- Total investment income 13,528 14,290 13,597 Investment expenses 381 387 302 --------- --------- --------- Net investment income $ 13,147 $ 13,903 $ 13,295 ========= ========= =========
4. REINSURANCE MNH follows the customary practice of reinsuring a portion of the exposure under its policies. Insurance is ceded principally to reduce net liability on individual risks and to protect against catastrophic losses. Although reinsurance does not legally discharge an insurer from its primary liability for the full amount of coverage provided by its policies, it does make the assuming reinsurer liable to the insurer to the extent of the reinsurance ceded. The effect of reinsurance on premiums written and earned for the years ended December 31, 1999, 2000 and 2001 is as follows:
1999 2000 2001 ---- ---- ------ Premiums Premiums Premiums Premiums Premiums Premiums Written Earned Written Earned Written Earned --------- --------- --------- --------- --------- --------- (in thousands) Direct $ 100,227 $ 99,943 $ 107,234 $ 105,919 $ 100,953 $ 101,871 Assumed 1,612 1,663 640 714 1,412 1,173 Ceded (7,369) (6,831) (13,532) (12,374) (8,392) (9,159) --------- --------- --------- --------- --------- --------- Net Premiums $ 94,470 $ 94,775 $ 94,342 $ 94,259 $ 93,973 $ 93,885 ========= ========= ========= ========= ========= =========
Reinsurance ceded transactions decreased net losses and LAE by $9,506,000 and $9,987,000 for the years ended December 31, 2000 and 2001 respectively. As a result of the reinsurance agreements maintained by MNH, MNH is exposed to certain credit risk if one or more of its primary reinsurers were to become financially unstable. As of December 31, 2001, MNH has recognized amounts to be recovered from its primary F-16 reinsurers related to ceded losses and ceded unearned premiums totaling $21,589,000. MNH generally does not require collateral for reinsurance recoverable. 5. RESERVE FOR LOSSES AND LOSS ADJUSTMENT EXPENSES Activity in the reserve for losses and LAE is summarized as follows:
2000 2001 ---- ---- (in thousands) Reserve for losses and LAE at beginning of year $ 133,526 $ 145,075 Less reinsurance recoverables 6,026 13,826 --------- --------- Net balance at beginning of year 127,500 131,249 --------- --------- Provision for losses and LAE for claims occurring in: Current year 69,946 76,618 Prior years 1,428 (1,474) --------- --------- 71,374 75,144 --------- --------- Loss and LAE payments for claims occurring in: Current year 26,655 28,719 Prior years 40,970 45,561 --------- --------- 67,625 74,280 --------- --------- Reserve for losses and LAE at end of year, net 131,249 132,113 Plus reinsurance recoverables 13,826 19,242 --------- --------- Balance at end of year $ 145,075 $ 151,355 ========= =========
In 2000, the Company increased its reserves for prior years by $1,428,000 primarily due to unfavorable loss experience related to its automobile and workers' compensation policies. In 2001, the Company decreased its reserves for prior years by $1,474,000 primarily due to favorable loss experience related to its workers' compensation policies. 6. DEMAND LOAN The Company has arranged for a $2,000,000 unsecured credit facility from a bank. Any borrowings under this facility are payable on demand and carry an interest rate which can be fixed or variable and is negotiated at the time of each advance. This facility is available for general working capital purposes and for repurchases of the Company's common stock. F-17 7. INCOME TAXES The provision (benefit) for income taxes consists of:
Year Ended December 31, --------------------------------------------- 1999 2000 2001 ---- ---- ---- (in thousands) Current $ 3,351 $ 2,999 $ 605 Deferred 270 (331) (171) --------- --------- --------- Total income tax provision $ 3,621 $ 2,668 $ 434 ========= ========= =========
A reconciliation of the difference between the Company's total income tax provision and that calculated using statutory income tax rates is as follows:
Year Ended December 31, ------------------------------------------- 1999 2000 2001 ---- ---- ---- (in thousands) Computed provision at statutory rate $ 3,541 $ 2,382 $ 427 Adjustments: State income taxes, net of federal effect 495 640 274 Tax-exempt investment income (298) (214) (115) Dividend exclusion (150) (208) (165) Other items 33 68 13 --------- --------- --------- Total income tax provision $ 3,621 $ 2,668 $ 434 ========= ========= =========
F-18 Deferred tax (liabilities) assets are comprised of the following:
December 31, ----------------------------------- 2000 2001 ---- ---- (in thousands) Deferred policy acquisition costs $ (4,458) $ (4,706) Unrealized investment gains -- (811) Bond discounts -- (607) Other (520) (234) -------- -------- Total deferred tax liabilities (4,978) (6,358) -------- -------- Discounting of reserve for losses and loss adjustment expenses 7,149 7,456 Unearned premiums 3,164 3,200 Unrealized investment losses 542 -- Other 386 492 -------- -------- Total deferred tax assets 11,241 11,148 -------- -------- Net deferred income taxes $ 6,263 $ 4,790 ======== ========
Although realization is not assured, based upon the evidence available the Company believes that it is more likely than not that the net deferred income tax asset will be realized. The amount of the deferred tax asset considered realizable, however, could be reduced in the near term if estimates of future taxable income are not achieved. 8. STOCKHOLDERS' EQUITY DIVIDENDS The Company depends on dividends from its subsidiary, MNH, to pay cash dividends to its stockholders and to meet its expenses. MNH is subject to New Hampshire state insurance laws which restrict its ability to pay dividends without the prior approval of state regulatory authorities. These restrictions limit dividends to those that, when added to all other dividends paid within the preceding twelve months, would not exceed 10% of an insurer's policyholders' surplus as of the preceding December 31. The maximum amount of dividends that MNH could pay during any twelve-month period ending in 2002, without the prior approval of the New Hampshire Insurance Commissioner, is $5,263,000. STOCK OPTION PLAN The Company's stock option plan (the "Plan"), which reserved 200,000 shares of common stock for issuance to the Company's and MNH's officers and key employees of the Company's F-19 affiliate, Mutual, expired in 1996. Under the Plan, qualified and non-qualified stock options were granted at amounts not less than the fair market value of the Company's stock on the date of grant. Options granted under the Plan have a 10 year life and vested in cumulative annual increments of 25% commencing one year from the date of grant. In accounting for the Plan, the Company remains under the expense recognition provisions of Accounting Principles Board Opinion No. 25 "Accounting for Stock Issued to Employees" but follows the disclosure provisions of Statement of Financial Accounting Standards ("SFAS") No. 123 "Accounting for Stock Based Compensation". No options were granted in 1999, 2000 or 2001 and, therefore, no compensation expense was recognized in those years. Had compensation expense for stock options granted under the Company's Plan been determined based on the fair value at the grant date consistent with the method required by SFAS No. 123, the Company's net income and earnings per share for the year ended December 31, 1999 would have been as shown below. There would have been no effect on the Company's net income or earnings per share for the years ended December 31, 2000 or 2001. 1999 ---- Net income: As reported $ 6,793,000 Pro forma $ 6,777,000 Diluted earnings per share: As reported $ 2.48 Pro forma $ 2.47 The fair value of each option granted in 1996 was estimated using a binomial option pricing model which is a modification of the Black-Scholes option pricing model, with the following assumptions for 1996: risk free interest rate of 6.25%, volatility of 18.0%, expected dividend yield of 1.1% and expected life of 10 years. F-20 A summary of the status of the Company's outstanding options as of December 31, 1999, 2000 and 2001, and changes during the years ending on those dates is presented below:
1999 2000 2001 ---------------------------- ---------------------------- ------------------------- Weighted Weighted Weighted Average Average Average Options Exercise Options Exercise Options Exercise Outstanding Price Outstanding Price Outstanding Price ------------ ----- ----------- ----- ----------- --------- Beginning of year 71,500 $18.38 47,000 $19.87 45,500 $19.84 Granted -- -- -- -- -- -- Exercised (12,000) 14.05 -- -- (8,000) 14.38 Forfeited (12,500) 17.12 (1,500) 21.00 (2,000) 21.00 -------- --------- -------- End of year 47,000 19.87 45,500 19.84 35,500 21.00 ======== ========= ======== Options exercisable at year-end 37,250 19.58 45,500 19.84 35,500 21.00 ======== ========= ========
The following table summarizes information about the Company's outstanding stock options at December 31, 2001:
Number Remaining Average Number Outstanding Contractual Exercise Exercisable at 12/31/01 Life in Years Price at 12/31/01 ----------- ------------- ----- ----------- 35,500 4.1 $21.00 35,500 ====== ======
COMMON STOCK REPURCHASES During 1999, 2000 and 2001, the Company repurchased 267,600, 165,100 and 214,300 shares of its common stock, respectively. The Company was holding 811,100 and 1,025,400 of these shares in treasury as of December 31, 2000 and 2001, respectively. PREFERRED STOCK The Company's Preferred stock, no par value, $424.30 stated value, consists of 10,000 shares authorized; no shares were issued or outstanding at December 31, 2000 or December 31, 2001. The Company also has 3,000,000 shares of $.01 par value preferred stock which is authorized and unissued. F-21 9. EARNINGS PER SHARE The computations for basic and diluted earnings per share are as follows:
Year Ended December 31, ------------------------------- 1999 2000 2001 ---- ---- ---- (in thousands except per share amounts) Basic: Net income $ 6,793 $ 4,339 $ 821 Weighted average shares outstanding 2,738 2,485 2,343 Basic earnings per share $ 2.48 $ 1.75 $ .35 Diluted: Net income $ 6,793 $ 4,339 $ 821 Weighted average shares outstanding 2,738 2,485 2,343 Plus incremental shares from assumed conversion of stock options 5 2 -- --------- --------- --------- Weighted average shares outstanding-adjusted 2,743 2,487 2,343 ========= ========= ========= Diluted earnings per share $ 2.48 $ 1.74 $ .35 ========= ========= =========
10. BENEFIT PROGRAMS Mutual maintains a capital accumulation plan which is a profit sharing plan under Section 401(a) of the Internal Revenue Code that covers all employees who have completed six months of service. Mutual matches at least 15% and up to 100% of employee contributions, based on the combined net operating profits of Mutual and MNH. Additional contributions may be made at the discretion of the Board of Directors of Mutual. Under the terms of the management agreement, the Company's portion of the total contribution was $580,000, $606,000 and $486,000 for the years ended December 31, 1999, 2000 and 2001, respectively. 11. COMMITMENTS AND CONTINGENCIES MNH, like many other property and casualty insurance companies, is subject to environmental damage claims asserted by or against its insureds. Management is of the opinion that based on various court decisions throughout the country, such claims should not be recoverable under the terms of MNH's insurance policies because of either specific or general coverage exclusions contained in the policies. However, there is no assurance that the courts will agree with MNH's position in every case, nor can there be assurance that material claims will not be asserted under policies which a court will find do not explicitly or implicitly exclude claims for environmental damages. Management, however, is not aware of any pending claim or group of claims which would result in a liability that would have a material adverse effect on the financial condition of MNH. F-22 In addition to the foregoing, MNH is a defendant in a number of other legal proceedings in the ordinary course of its business. Management of the Company is of the opinion that the ultimate aggregate liability, if any, resulting from such proceedings will not materially affect the financial condition of MNH or the Company. F-23