-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, TP7aMKLm5H6XspH3t3hwKGxGWBllFUTQIiPQH+u/oGHVx2eycsh8aKkwv24OAzhg K5aChSKoyAiHYt5U6SjCMw== 0000950152-99-002808.txt : 19990402 0000950152-99-002808.hdr.sgml : 19990402 ACCESSION NUMBER: 0000950152-99-002808 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990331 FILER: COMPANY DATA: COMPANY CONFORMED NAME: MERCHANTS GROUP INC CENTRAL INDEX KEY: 0000803027 STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331] IRS NUMBER: 161280763 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 001-09640 FILM NUMBER: 99580199 BUSINESS ADDRESS: STREET 1: 250 MAIN ST CITY: BUFFALO STATE: NY ZIP: 14202 BUSINESS PHONE: 7168493333 MAIL ADDRESS: STREET 1: 250 MAIN ST CITY: BUFFALO STATE: NY ZIP: 14202 10-K405 1 MERCHANTS GROUP, INC. 10-K405 1 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 [ ] 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, 1998 COMMISSION FILE NUMBER 1-9640 MERCHANTS GROUP, INC. (Exact name of registrant as specified in its charter) DELAWARE 16-1280763 (State or other jurisdiction (I.R.S. Employer Identification No.) of 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 1, 1999, 2,834,952 shares of common stock were outstanding. The aggregate market value of the common shares held by non-affiliates of Merchants Group, Inc. on March 1, 1999 was $55,791,000. DOCUMENTS INCORPORATED BY REFERENCE Portions of the definitive Proxy Statement for the 1999 Annual Meeting of stockholders are incorporated by reference into Part III. 2 MERCHANTS GROUP, INC. ANNUAL REPORT ON FORM 10-K DECEMBER 31, 1998 PART I ------- ITEM 1. BUSINESS. ITEM 2. PROPERTIES. ITEM 3. LEGAL PROCEEDINGS. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS PART II -------- ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. ITEM 6. SELECTED FINANCIAL DATA. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. PART III --------- ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT ITEM 11. EXECUTIVE COMPENSATION. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. PART IV -------- ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. 3 PART I Item 1. BUSINESS. General - ------- Merchants Group, Inc. (the "Company") was incorporated in August 1986 as a Delaware holding company which, through its wholly owned subsidiary Merchants Insurance Company of New Hampshire, Inc. ("MNH"), offers property and casualty insurance to preferred risk individuals and small to medium size 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"). Mutual owns 9.0% of the Company's issued and outstanding common stock. The Company and MNH do not have any significant operating assets and have no employees. 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 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 terminate the Management Agreement to Mutual. 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. 4 Marketing - --------- The Company markets its products through approximately 625 independent agents, which also represent Mutual. The Company's primary marketing efforts are directed to those independent agents that are dedicated to providing superior service to their customers. The Company believes the opportunity for growth exists through further penetration of agencies that are strategically aligned with the Company's commitment to growth in its targeted markets. 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 five 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 of the agency, and ensures that the principal of the agency communicates these objectives to the agency's sales staff. Strategic Business Center managers and Agency Business Managers, or "ABM's," develop customized business plans for each agent, which identify the opportunities to increase business and the actions required to achieve the objectives agreed to by the agent and the Company. In each of its Strategic Business Centers, the Company uses ABM's who are trained underwriters. ABM's meet with targeted agents' sales staff on a frequent basis to underwrite the Company's renewal policies, as well as to solicit and underwrite policies new to the agent and/or to the Company. ABM's are equipped with electronic technology to provide prompt and efficient pricing and communication and can provide quotes for all lines of business at the agents' offices. The Company believes personal contact between ABM'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 met. Additionally, the Chairpersons of the Advisory Councils from each Strategic Business Center meet twice each year with senior officers of the Company. 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 a two year loss and allocated loss and loss adjustment expense ("LAE") ratio on business placed by the agent with the Company. Payments under the Agents' Profit Sharing 5 Plan for 1998 totaled $2,499,000, or 2.5% of total direct premiums written, and increased participating agents' commissions received from the Company by approximately 40%. 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. Unlike many of its competitors, the Company pays the same commission rate on policies billed directly to the insured by the Company and on policies billed to the agent and, in turn, re-billed to the insured by the agent. By offering to bill the insured directly for both personal and commercial policies, the Company helps its agents minimize their administrative costs without a reduction in commission income. Approximately 87% of the voluntary premiums written by the Company in 1997 and 1998 were billed directly to policyholders. 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. In 1998, the Company began development of Merchants MerLink(TM) system. MerLink(TM) allows 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 15 agents for private passenger automobile and homeowners' policies. The Company plans to offer MerLink(TM) capability for commercial insurance policies during the first half of 1999. The Company believes that developing automation capabilities to facilitate the sharing of information with its agents will improve its competitive position compared to other property and casualty insurers that do not yet have such capabilities. Insurance Underwriting - ---------------------- The Company is licensed to issue insurance policies in 13 states, primarily in the northeastern United States. In 1998, net premiums written totaled $92,758,000, 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:
Years Ended December 31, ------------------------ 1996 1997 1998 ---- ---- ---- New York 64% 66% 65% New Jersey 15 15 18 New Hampshire 11 10 9 Rhode Island 3 3 3 Pennsylvania 3 2 2 Massachusetts 3 2 2 Other 1 2 1 --- --- --- Total 100% 100% 100% === === ===
6 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 size 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: o Personal automobile - full coverage of family-owned standard performance automobiles, generally requiring drivers with good driving records during the past three years. o (degree) Homeowners' - properties generally with no losses in the last three years and that are less than 30 years old and valued between $75,000 and $300,000. o (degree) Commercial automobile - primarily light and medium use vehicles operating in a limited radius, with complete background information required of all drivers. o 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. o General liability - low hazard service, mercantile and light processing businesses, generally with three years of business experience and with no losses in the last three years. o 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 underwriting 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 makes the Company's rates non-competitive with respect to certain lines of insurance or certain geographic regions. For example, the Company's published rates for personal automobile insurance in the densely populated areas within its region of operations are significantly higher than those of some of its competitors. 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. During the years 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 meet MNH's more stringent underwriting guidelines. The terms of the 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 1999. 7 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 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, 1998 (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, -------------------------------------------------------------------------------------------------- 1996 1997 1998 -------------------------------------------------------------------------------------------------- Premiums Premiums Premiums Written Written Written -------------------------------------------------------------------------------------------------- Loss Loss Loss Amount % Ratio Amount % Ratio Amount % Ratio -------------------------------------------------------------------------------------------------- (dollars in thousands) Personal Auto Liability $23,964 24.8% 80.9% $26,187 27.0% 69.7% $21,394 23.1% 79.3% Auto Physical Damage 12,241 12.7 60.3 13,570 14.0 45.8 13,199 14.2 45.8 Homeowners' Multi-Peril 7,269 7.5 68.1 7,789 8.0 35.7 8,066 8.7 36.5 ------- ----- ------- ----- ------- ----- Total 43,474 45.0 73.1 47,546 49.0 57.5 42,659 46.0 61.8 Commercial Auto Liability 13,050 13.5 43.4 12,377 12.8 100.7 12,986 14.0 41.5 Auto Physical Damage 3,225 3.3 51.7 2,948 3.1 45.8 3,025 3.3 49.8 Commercial Multi-Peril 20,725 21.5 59.9 21,287 22.0 44.6 21,878 23.6 49.5 Workers' Compensation 10,023 10.4 110.7 7,070 7.3 169.0 7,159 7.7 87.8 Other Lines 6,125 6.3 57.4 5,583 5.8 6.0 5,051 5.4 39.1 ------- ----- ------- ----- ------- ----- Total 53,148 55.0 63.5 49,265 51.0 73.6 50,099 54.0 50.6 ------- ----- ------- ----- ------- ----- Total Personal & Commercial $96,622 100.0% 67.7 $96,811 100.0% 65.7 $92,758 100.0% 56.5 ======= ===== ======= ===== ======= =====
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. 8 The following table sets forth the composition of voluntary direct premiums written for 1994 through 1998:
Year Ended December 31, ----------------------- 1994 1995 1996 1997 1998 ---- ---- ---- ---- ---- Commercial 62% 62% 60% 57% 58% Personal 38 38 40 43 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 size, 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 for artisan and trade contractors, and BusinessElite for specified retail, service and office risks. Despite the lack of significant premium rate increases in recent years in most of its commercial lines and the significant level of competition in the lines of business that the Company targets, 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 in certain instances, 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 relative 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 have developed automated underwriting procedures for personal automobile and homeowners 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 personal lines underwriters who review the applications and assess 9 exposure, or rejected if the risk characteristics are such that neither the Company nor Mutual would accept 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 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 $11,325,000, $12,719,000 and $6,036,000 in 1996, 1997 and 1998, respectively, mostly in New York. The Company is unable to predict the level of its annual involuntary business for 1999 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 meritorious 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 has implemented 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 their estimates because during the life of a claim, which may be many years, additional facts affecting an insurer's liability may become known. The reserves of an insurer are frequently adjusted based on monitoring by the insurer and periodic review 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. 10 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 exception of an amount relating to 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 increases in reserves for prior accident year losses in several years. These increases were necessary because of several factors, including inaccurate estimation of the extent of liability associated with a number of claims involving serious injuries and claims handling practices that did not produce accurate and timely reserve levels for a broad range of claims. In 1996 and 1997, the Company increased its reserves for prior years by $6,832,000 and $4,508,000, respectively. These increases were primarily attributable to higher than anticipated severity of claims on workers' compensation policies. In 1998, the Company decreased its reserves for prior years by $2,145,000, primarily due to favorable loss experience related to automobile liability policies. 11 The following table sets forth the changes in the reserve for losses and LAE for 1996, 1997 and 1998.
Year Ended December 31, ----------------------- 1996 1997 1998 ---- ---- ---- (in thousands) Reserve for losses and LAE at beginning of year $119,722 $133,479 $141,205 Less reinsurance recoverables 6,004 7,219 10,372 -------- -------- -------- Net balance at beginning of year 113,718 126,260 130,833 -------- -------- -------- Provision for losses and LAE for claims occurring in: Current year 72,771 67,119 67,379 Prior years 6,832 4,508 (2,145) -------- -------- -------- 79,603 71,627 65,234 -------- -------- -------- Losses and LAE payments for claims occurring in: Current year 28,512 26,100 26,765 Prior years 38,549 40,954 42,433 -------- -------- -------- 67,061 67,054 69,198 -------- -------- -------- Reserve for losses and LAE at end of year, net 126,260 130,833 126,869 Plus reinsurance recoverables 7,219 10,372 9,816 -------- -------- -------- Balance at end of year $133,479 $141,205 $136,685 ======== ======== ========
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 1998. 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. 12
Year Ended December 31, ----------------------- 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- (in thousands) Liability for losses and LAE: $55,412 $66,892 $71,222 $77,274 $ 86,159 $ 89,939 $ 97,614 $113,718 $126,260 $130,781 Liability re-estimated as of: One year later 57,238 75,614 77,548 80,841 88,284 94,921 108,659 120,550 130,768 128,636 Two years later 61,534 76,310 75,987 81,743 91,224 100,607 113,091 128,192 133,029 Three years later 61,928 73,578 78,106 83,693 95,396 106,382 121,051 129,724 Four years later 61,014 75,672 79,563 87,105 99,779 112,983 121,791 Five years later 61,787 76,746 81,308 90,428 104,699 112,963 Six years later 62,201 77,026 84,530 92,370 104,808 Seven years later 62,332 79,690 85,219 93,046 Eight years later 64,388 79,890 84,765 Nine years later 64,194 79,415 Ten years later 64,014 Cumulative Redundancy (Deficiency): $ (8,602) (12,523) (13,543) (15,772) (18,649) (23,024) (24,177) (16,006) (6,769) 2,145 % (15.5) (18.7) (19.0) (20.4) (21.6) (25.6) (24.8) (14.1) (5.4) 1.6 Paid (Cumulative) as of: One year later 21,393 32,538 32,666 30,082 35,724 34,551 36,916 38,549 40,954 42,433 Two years later 37,459 47,816 47,339 50,490 56,003 56,965 60,074 64,323 69,035 Three years later 47,816 58,489 61,585 63,925 69,863 72,963 77,982 84,638 Four years later 52,758 66,466 70,219 72,917 80,156 83,998 91,948 Five years later 56,732 71,322 75,018 79,374 86,808 93,295 Six years later 59,162 73,558 78,398 82,602 91,919 Seven years later 59,994 75,822 79,884 84,707 Eight years later 61,546 76,683 80,706 Nine years later 62,183 76,996 Ten years later 62,357
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 ("STAT") as follows:
As of December 31, ------------------ 1996 1997 1998 ---- ---- ---- (in thousands) Loss and LAE reserves on a STAT basis $125,821 $130,781 $126,820 Adjustments: Loss reserves ceded under a quota share agreement with an unrelated party 379 -- -- Ceded reinsurance balances recoverable 7,219 10,372 9,816 Write-down of reinsurance recoverable 60 52 49 -------- -------- -------- Loss and LAE reserves on a GAAP basis $133,479 $141,205 $136,685 ======== ======== ========
13 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. Effective January 1, 1998, the Company changed its primary reinsurer and coverage. Prior to that time, 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. 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. Property catastrophe coverage placed with many reinsurers worldwide provided for recovery of 95% of $40,000,000, subject to aggregate retained losses of $5,000,000 for each natural disaster. The reinsurance premium rate paid varied for each line of business. Effective January 1, 1998, the new property and casualty excess of loss reinsurance agreements provide 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. Property catastrophe coverage provides for recovery of 95% of $50,000,000, 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. In 1987, the Company and its primary reinsurer agreed to limit the losses which could be recovered by the Company under its excess of loss treaties for the 1980 through 1986 accident years in exchange for a cap on retrospective premiums due to the reinsurer. At December 31, 1998, recoverable losses exceeded the cap and the excess losses have been retained by the Company. 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 14 losses and allocated LAE in exchange for a reinsurance commission of 35%. The agreement also provides for MNH to 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 portion 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 1999. 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 $27,066,000 of tax-exempt bonds in its investment portfolio at December 31, 1998. The Company believes these tax-exempt bonds are of high quality (rated A or better) and offer an after-tax total return greater than comparable taxable securities. At December 31, 1998, the Company had $6,280,000 of short-term investments with maturities less than 30 days, and $6,706,000 of non-investment grade securities. These non-investment grade securities represented 3% of its investment portfolio. The table below gives information regarding the Company's investments as of the dates indicated. 15
As of December 31, --------------------------------------------------------- 1996 1997 1998 --------------------------------------------------------- Amount % Amount % Amount % ------ ---- ------ ---- ------ ---- (dollars in thousands) Fixed Maturities (1): U.S. Government and Agencies $ 49,990 24.8% $ 48,734 23.2% $ 30,392 14.1% Corporate Bonds 86,308 42.8 117,060 55.7 140,326 65.2 Tax-Exempt Bonds 46,818 23.2 28,764 13.7 27,066 12.6 -------- ----- -------- ----- -------- ----- Total Bonds 183,116 90.8 194,558 92.6 197,784 91.9 Preferred stocks (2) 7,928 3.9 10,582 5.0 10,373 4.9 Short-Term Investments (3) 8,248 4.1 4,470 2.1 6,280 2.9 Other (4) 2,305 1.2 634 .3 735 .3 -------- ----- -------- ----- -------- ----- Total Invested Assets $201,597 100.0% $210,244 100.0% $215,172 100.0% ======== ===== ======== ===== ======== =====
(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, ----------------------- 1996 1997 1998 ---- ---- ---- (dollars in thousands) Average investments (1) $194,677 $202,041 $211,272 Net investment income 11,724 12,770 13,277 Net investment income as a percentage of average investments (2) 6.0% 6.3% 6.3% Net realized gains (losses) on investments $ 996 $ 112 $ (2)
(1) At amortized cost. (2) The taxable equivalent yield for the years ended December 31, 1996, 1997 and 1998 was 6.6%, 6.9%, and 6.8%, respectively, assuming an effective tax rate of 34%. 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. 16
As of December 31, ------------------------------------------------------------ 1996 1997 1998 ------------------------------------------------------------ Amount % Amount % Amount % -------- ----- -------- ----- -------- ----- (dollars in thousands) 1 year or less $ 15,518 8.5% $ 47,499 24.4% $ 51,892 26.2% 1 year through 5 years 123,856 67.6 116,508 59.9 126,631 64.0 5 years through 10 years 32,452 17.7 27,877 14.3 17,721 9.0 More than 10 years 11,290 6.2 2,674 1.4 1,540 .8 -------- ----- -------- ----- -------- ----- Total $183,116 100.0% $194,558 100.0% $197,784 100.0% ======== ===== ======== ===== ======== =====
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. 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 when or if market conditions for the industry will 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 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 and the maintenance of specified reserves and capital. 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. 17 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 new 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 1999 without the prior approval of the New Hampshire Insurance Commissioner is $5,058,000. 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, 1998, investments of MNH having a par value of $1,800,000 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. 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 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, 1998. 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 18 state insurance departments. The ratios relate to leverage, profitability, liquidity and loss reserve development. One of the Company's ratios as of December 31, 1998 relating to loss reserve development fell outside of the acceptable range of ratios. The ratio was outside of the acceptable range due to the $4,508,000 increase in the provision for losses and LAE recorded in 1997 for claims occurring in prior years, as discussed in this Item under the heading "Loss and LAE Reserves". The Company's inability to operate within an acceptable range of the aforementioned IRIS ratio is not expected to have a material effect on the Company's business or its operations. 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 New York and certain other states, insurers writing private passenger automobile policies and 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 Department's prior approval in order to implement rate increases or decreases beyond these flex-bands. Insurance Holding Companies - --------------------------- The Company is subject to statutes governing insurance holding company systems. Typically, such 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, 1998, Mutual had 350 full-time equivalent employees. The Company believes that Mutual's relationship with its employees is satisfactory. 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 19 underwriting and/or claims office facilities in Buffalo, Albany and Central Islip, New York; Bedford, New Hampshire; and Moorestown, New Jersey. 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 20 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.
1998: High Low - ----- ---- --- Fourth Quarter $21.75 $18.50 Third Quarter 24.38 19.25 Second Quarter 26.25 23.63 First Quarter 22.75 19.75 1997: High Low - ----- ---- --- Fourth Quarter $21.25 $18.63 Third Quarter 20.38 17.38 Second Quarter 20.50 18.75 First Quarter 19.13 17.50
The number of stockholders of record of the Company's Common Stock as of February 26, 1999 was 122. Securities held by nominees are counted as one stockholder of record. The Company has paid a quarterly cash dividend of $.05 per share 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 1999 without prior approval of the New Hampshire Insurance Commissioner is $5,058,000. 21 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, 1998 have been derived from the audited consolidated financial statements of the Company.
Year Ended December 31, --------------------------------------------------------------------- 1994 1995 1996 1997 1998 ---- ---- ---- ---- ---- (in thousands, except per share amounts) Net premiums written $ 90,187 $ 97,577 $ 96,622 $ 96,811 $ 92,758 ======== ======== ======== ======== ======== Net premiums earned $ 90,845 $ 94,749 $ 95,752 $ 96,054 $ 93,540 Net investment income 9,849 10,368 11,724 12,770 13,277 Net realized investment gains (losses) 20 (832) 996 112 (2) Other revenues 638 259 172 214 153 -------- -------- -------- -------- -------- Total revenues 101,352 104,544 108,644 109,150 106,968 -------- -------- -------- -------- -------- Net losses and loss adjustment expenses 70,800 78,195 79,603 71,627 65,234 Amortization of deferred policy acquisition costs 24,424 25,458 25,374 25,454 24,788 Other underwriting expenses 5,892 7,709 6,700 6,647 8,689 -------- -------- -------- -------- -------- Total expenses 101,116 111,362 111,677 103,728 98,711 -------- -------- -------- -------- -------- Income (loss) before income taxes 236 (6,818) (3,033) 5,422 8,257 Provision (benefit) for income taxes (895) (2,999) (1,885) 1,224 2,334 -------- -------- -------- -------- -------- Net income (loss) $ 1,131 $ (3,819) $ (1,148) $ 4,198 $ 5,923 ======== ======== ======== ======== ======== Earnings (loss) per share: Basic $ .36 $ (1.19) $ (.36) $ 1.41 $ 2.05 ======== ======== ======== ======== ======== Diluted $ .36 $ (1.19) $ (.36) $ 1.41 $ 2.04 ======== ======== ======== ======== ======== Weighted average number of shares outstanding: Basic 3,158 3,214 3,174 2,973 2,895 Diluted 3,177 3,219 3,182 2,980 2,904 Balance Sheet Data: (at year end) - --------------------------------- Total investments $170,747 $192,218 $201,597 $210,244 $215,172 Total assets 227,750 252,808 262,123 273,974 274,523 Reserve for losses and loss adjustment expenses 104,015 119,722 133,479 141,205 136,685 Unearned premiums 45,449 48,773 49,710 50,406 49,382 Stockholders' equity 67,279 69,970 65,029 67,462 71,783 Dividend Data: - -------------- Cash dividend per common share $ .20 $ .20 $ .20 $ .20 $ .20
22 "Safe Harbor" Statement under the Private Securities Litigation Reform Act of 1995: Certain statements made in this Annual Report on Form 10-K constitute forward-looking statements and are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. 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, size and frequency of claims, increasing crime rates, 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; government regulation of the insurance industry; exposure to environmental claims; dependence of the Company on its relationship with Mutual; 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. 23 Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 1998 Compared to 1997. - ---------------------- Total revenues for 1998 were $106,968,000, a decrease of $2,182,000, or 2%, from $109,150,000 in 1997. Direct premiums written for 1998 were $98,956,000, a decrease of $2,108,000, or 2%, from $101,064,000 in 1997. Net written premiums for 1998 were $92,758,000, a decrease of $4,053,000, or 4%, from $96,811,000 in 1997. Voluntary personal lines direct premiums written for 1998 were $39,518,000, substantially unchanged from $39,415,000 in 1997. Private passenger automobile direct premiums written, which comprised 78% and 79% of total voluntary personal lines direct premiums written in 1998 and 1997, respectively, decreased 1% in 1998 compared to 1997 primarily due to intensified price-based market competition. Homeowners direct premiums written increased 5% in 1998 compared to 1997 due to a 5% increase in average premium per policy. Voluntary commercial lines direct premiums written for 1998 were $54,246,000, an increase of 5% from $51,572,000 in 1997. This increase resulted primarily from a $1,260,000, or 9%, increase in commercial auto direct premiums written, a $1,014,000, or 17%, increase in workers' compensation direct premiums written and a $530,000, or 6%, increase in commercial package policies direct premiums written. The increase in commercial auto direct premiums written was primarily due to an 8% increase in average premium per policy at December 31, 1998 compared to December 31, 1997. The increase in workers' compensation direct premiums written was due to a 36% increase in new business units (policies written by the Company for the first time) in 1998 as compared to 1997. The increase in commercial package policy direct premiums written was due to an 11% increase in policies in force at December 31, 1998 compared to 1997, partially offset by a 3% decrease in average premium size. Involuntary direct premiums written, primarily involuntary private passenger automobile insurance, which comprised 5% and 10% of total direct premiums written during 1998 and 1997, respectively, were $5,192,000 for 1998 compared to $10,077,000 in 1997. This 48% decrease resulted primarily from decreased mandatory 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. During 1998 the Plan adjusted its assignments as a result of having over assigned policies to the Company in 1997 and an overall decrease in the NYAIP's pool of business. Assignments from the NYAIP vary depending upon a company's private passenger automobile market share and the size of the NYAIP. Net premiums earned for 1998 were $93,540,000, a decrease of $2,514,000, or 3%, from $96,054,000 in 1997. Net premiums earned decreased primarily due to a $2,503,000 (22%) decrease in involuntary earned premiums. 24 Net investment income was $13,277,000 in 1998, an increase of 4% from $12,770,000 in 1997, due to a 5% increase in average invested assets. Realized investment losses were $2,000 in 1998 compared to $112,000 of realized gains in 1997. Net losses and LAE were $65,234,000 for 1998, a decrease of 9% from $71,627,000 in 1997. The loss and LAE ratio decreased to 69.7% in 1998 from 74.6% in 1997. The decrease in net losses and LAE resulted from the fact that there was a net decrease of $2,145,000 recorded during 1998 for losses occurring in prior accident years. The Company recorded an increase to its reserves for losses related to prior accident years of $4,508,000 in 1997. Involuntary automobile insurance business increased the Company's calendar year loss and LAE ratio by approximately 3.5 and 3.4 percentage points for the years ended December 31, 1998 and 1997, respectively. The combined ratio on involuntary automobile business was greater than the combined ratio on voluntary automobile business. The ratio of policy acquisition costs and other underwriting expenses to net premiums earned increased to 35.8% in 1998 from 33.4% in 1997 primarily due to increased agency incentive commissions related to the Company's improved underwriting results. Commissions, premium taxes and other state assessments that vary directly with the Company's premium volume represented 21.7% and 20.8% of net premiums earned in 1998 and 1997, respectively. The increase was due primarily to the increase in agency incentive commissions. 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 amounts recorded by the Company for income taxes in 1998 and 1997 differed from those calculated using the statutory federal income tax rate primarily due to tax exempt bond income. 1997 Compared to 1996. - ---------------------- Total revenues, net premiums earned, net premiums written and direct premiums written were all substantially unchanged when compared to 1996. Total revenues for 1997 were $109,150,000, compared to $108,644,000 in 1996. Net premiums earned for 1997 were $96,054,000, compared to $95,752,000 in 1996. Net premiums written for 1997 were $96,811,000, compared to $96,622,000 in 1996. Direct premiums written for 1997 were $101,064,000, compared to $101,007,000 in 1996. Voluntary personal lines direct premiums written for 1997 were $39,415,000, an increase of 5% from $37,616,000 in 1996. Private passenger automobile direct premiums written, which comprised 79% of total voluntary personal lines direct premiums written in 1997 and 1996, increased 5% in 1997 compared to 1996. This increase resulted primarily from a 6% increase in average premium per policy at December 31, 1997 compared to December 31, 1996. Homeowners direct premiums written increased 4% in 1997 compared to 1996 due to a 6% increase in average premium per policy. Voluntary commercial lines direct premiums written for 1997 were $51,572,000, a decrease of 7% from $55,467,000 in 1996. This decrease resulted primarily from a $2,416,000, or 28%, decrease in workers' compensation direct premiums written and an $804,000, or 5%, decrease in commercial 25 auto direct premiums written. The decrease in workers' compensation direct premiums written resulted from the Company's decision in late 1996 to exit certain unprofitable classes of that business starting in late 1996 and continuing throughout 1997. The decrease in commercial auto direct premiums written was due to a 4% decrease in policies in force at December 31, 1997 compared to December 31, 1996, which resulted in part from the Company's decision not to write certain related workers' compensation policies. Involuntary direct premiums written, primarily involuntary private passenger automobile insurance, which comprised 10% and 8% of total direct premiums written during 1997 and 1996, respectively, were $10,077,000 for 1997 compared to $7,923,000 in 1996. This 27% increase resulted from increased assignments from the NYAIP. Net investment income was $12,770,000 in 1997, an increase of 9% from $11,724,000 in 1996, primarily due to a 4% increase in average invested assets and a 5% increase in the investment portfolio yield. Realized investment gains were $112,000 in 1997 compared to $996,000 in 1996. Losses and LAE were $71,627,000 for 1997, a decrease of 10% from $79,603,000 in 1996. The loss and LAE ratio decreased to 74.6% in 1997 from 83.1% in 1996. In 1997, the Company recorded increases to its reserve for losses that occurred prior to 1997, primarily for its workers' compensation line of business. The net increase in the reserve for prior year losses and LAE was $4,508,000 and added 4.7 percentage points to the loss and LAE ratio in 1997. Losses and LAE in 1996 included a $6,896,000 increase in reserves for accidents that occurred prior to 1996, which added 7.2 percentage points to the loss and LAE ratio in 1996. Losses and LAE in 1996 included $2,200,000 of higher than normal losses related to unusually severe winter weather that affected the northeastern United States during the first quarter of 1996. These higher than normal weather related losses increased the 1996 loss and LAE ratio by 2.3 percentage points. There were no such higher than normal weather related losses in 1997. Involuntary automobile insurance business increased the Company's calendar year loss and LAE ratio by approximately 3.4 and .7 percentage points for the years ended December 31, 1997 and 1996, respectively. The ratio of policy acquisition costs and other underwriting expenses to net premiums earned decreased to 33.4% in 1997 from 33.5% in 1996. Commissions, premium taxes and other state assessments that vary directly with the Company's premium volume represented 20.8% and 22.0% of net premiums earned in 1997 and 1996, 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 recorded an income tax provision in 1997 and an income tax benefit in 1996. The amounts recorded for income taxes differed from those calculated using the statutory federal income tax rate primarily due to tax exempt bond income. 26 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. Net cash provided by operations decreased by $5,234,000, or 55%, from $9,533,000 in 1997 to $4,299,000 in 1998 primarily due to a $1,981,000 decrease in the collection of premiums, a $2,144,000 increase in the payment of losses and LAE and a $1,337,000 increase in income taxes paid. Net cash used in investing activities decreased $1,478,000, or 25%, from $5,905,000 in 1997 to $4,427,000 in 1998. This decrease resulted primarily from a $6,625,000 net decrease in cash used to purchase fixed maturities, and a $2,067,000 decrease in cash used to acquire preferred stock, partly offset by a net increase in cash used to purchase short-term investments ($5,588,000). Net cash provided by financing activities increased $3,763,000 from a $3,629,000 use of cash in 1997 to a $134,000 source of cash in 1998, primarily due to a $2,048,000 increase in receipts from the Company's affiliate to settle monthly transactions under the Management Agreement. The Company's objectives with respect to its investment portfolio include maximizing total return while protecting policyholders' surplus, maintaining flexibility and liquidity, and maintaining a reasonable duration match between assets and liabilities. 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 carefully 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, 1998, the Company had recorded $1,173,000 of unrealized gains, net of tax, associated with its fixed maturity investments as accumulated other comprehensive income. During 1998 the Company recorded $112,000 of unrealized gains, net of tax, related to its investment portfolio as a component of other comprehensive income. At December 31, 1998, the Company's portfolio of fixed maturity investments represented 91.9% 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. At December 31, 1998, $126,250,000, or 63.8%, of the Company's fixed maturity portfolio was invested in mortgage-backed and other asset- backed securities. The Company invests in a 27 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 an active secondary market and their effect on the Company's liquidity does not differ from that of other fixed maturity investments. The Company does not own any other derivative financial instruments. At December 31, 1998, $6,706,000, or 3%, of the Company's investment portfolio was invested in non-investment grade securities, compared to $861,000, or .4%, at December 31, 1997. During 1998 the Company repurchased 58,800 shares of its common stock at an average price of $20.26 and was holding 378,400 shares in treasury as of December 31, 1998. 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 31. The maximum amount of dividends that MNH could pay during any twelve month period ending in 1999 without the prior approval of the New Hampshire Insurance Commissioner is $5,058,000. The Company paid a $.05 per share quarterly cash dividend to its common stockholders totaling $579,000 in 1998. Industry and 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 1998 was 1.8 to 1. Year 2000 - --------- The Year 2000 issue relates to the way in which information systems distinguish date data between the twentieth and twenty-first centuries. Also, many systems and equipment that are not typically thought of as relating to computers contain embedded hardware or software ("non-IT") that may have a time element. Under the Management Agreement, Mutual is responsible for the Company's being Year 2000 compliant. The Company is relying upon the expertise of Mutual's employees for assuring that the necessary precautions for Year 2000 compliance are taken. Mutual has advised the Company that the process of preparing all of its computer systems to be Year 2000 compliant is substantially completed. Mutual began work on becoming Year 2000 compliant in 1996. The scope of the project includes: ensuring the compliance of all computer software applications and operating systems, mainframe, mid-range and personal computers, local and wide-area networks, and telecommunications equipment; addressing issues related to non-IT embedded software and equipment; remediation of affected systems and equipment; and addressing the compliance of key suppliers. The project has three phases: assessment of systems, equipment and business relationships affected by the Year 2000 issue; definition of strategies necessary to address affected systems and relationships; and remediation or replacement and testing of affected systems, equipment and relationships. 28 Mutual's target for completing all phases of the project is the fourth quarter of 1999. Mutual has completed the assessment and strategy phases for all systems. Mutual began converting to a mid-range computer based policy and claims system known as "MOST" (Merchants Optimum Services & Technology) in 1994. The final phase of the conversion to MOST was completed in October 1998. All new business and policy renewals for all products are now processed on the MOST system. Mutual has advised the Company that it believes the MOST system, its mainframe, mid-range and personal computers, and its local area networks are substantially Year 2000 compliant. Mutual and the Company depend upon a number of key business partners and suppliers. As part of its Year 2000 project, Mutual has identified key business partners, vendors, suppliers, and service providers with whom it and the Company conduct business, and has made substantial progress in contacting these organizations to determine their Year 2000 readiness. Based upon the responses to Mutual's inquiries to these organizations, Mutual has taken and will continue to take appropriate actions. In certain instances where it may not be possible to verify with certainty a supplier's Year 2000 compliance (for example, it may not be possible for Mutual to test the operational ability of its telecommunications, electricity or gas service suppliers in a Year 2000 environment) and where alternate sources of supply are not feasible, Mutual and the Company may have to rely on the assurances of the supplier. The Company estimates that its share of the total expenses associated with becoming Year 2000 compliant will total approximately $290,000. Approximately $150,000 of the expenses have been for external costs, which include approximately $112,000 in outside consultant expenses and $38,000 for specific upgrades of software to address Year 2000 compliance, and $140,000 of the expenses have been for internal resources dedicated to achieving Year 2000 compliance. It is estimated that any remaining external or internal costs will not be material. The Company estimates its share of costs incurred in 1998 to be $210,000, which has been expensed. There has not been a material impact on the Company's results of operations or financial condition as a result of information technology projects being deferred due to resource constraints caused by the Year 2000 project. Although based on the successful implementation of the MOST system Mutual has notified the Company that it believes that critical systems are substantially Year 2000 compliant and that to the best of Mutual's knowledge, the likelihood that critical systems will have a failure that materially affects operating results is remote. Mutual also informed the Company that testing will continue as needed to assure that systems are Year 2000 compliant and that any situation that develops which needs to be addressed will be corrected by January 1, 2000. Mutual is continuing to work with third party vendors to assess their ability to operate in the Year 2000, to assess third-party remediation plans, and to take steps to identify and transfer support to third party vendors who are Year 2000 compliant. The Company will continue to monitor and assess the reasonably likely worst case Year 2000 scenario and plans to have contingency plans, as required, in place by mid-1999. If the Company does not complete its Year 2000 program prior to the commencement of the Year 2000, if it fails to identify and remediate all critical Year 2000 problems, or if major suppliers or customers experience material Year 2000 problems, the Company's results of operations or financial condition could be materially affected. MNH continues to evaluate the complex issues related to insurance coverage for losses arising from the various possible situations involving Year 2000 problems and its potential liability to its insureds. The Company believes that the coverages MNH provides do not extend to the types of losses which are most likely to occur as a result of Year 2000 problems. MNH plans to use coverage exclusion endorsements based on its evaluation of the potential exposure to Year 2000 problems for certain classes of commercial risks, and has adopted endorsements to its policies based on forms provided and filed for approval with 29 various regulatory authorities by the Insurance Services Office, Inc. Use of these special endorsements is governed by the law and regulatory policies of states in which MNH is authorized to do business. It is possible, however, that future court interpretations of policy language based on specific facts, or legislation mandating coverage, could result in coverage for losses attributable to Year 2000 problems. Such decisions or legislation could have a material adverse impact MNH's results of operations and financial condition. It is also possible that MNH may incur expenses defending claims for which it is ultimately determined there is no insurance coverage. MNH has made no provision for reserves for losses or LAE on claims based on potential Year 2000 problems. 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 generally 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. Mutual currently owns 9.0% of the Company's common stock. Under the Management Agreement, Mutual provides the Company and MNH with all facilities and personnel to operate their business. 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 the Company'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's Directors who are not affiliated with Mutual 30 (the "Independent Directors") determined that the terms proposed by Mutual were inadequate. The Independent Directors also determined that the Management Agreement prevents the Company's shareholders from realizing the Company's fair value in a sale or merger, and on July 23, 1998 the Company gave notice to Mutual of its intention to terminate the Management Agreement. The provisions of the Management Agreement require five year's prior written notice for its termination. The Company does not expect the notice of termination to have any material, short-term effect on the Company's operations. However, the Independent Directors believe that the Management Agreement, as currently written, creates conflicts of interest between the Company and Mutual in their joint operations and prevents the Company's shareholders from realizing the fair value of their shares. 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 $215,172,000 at December 31, 1998 is subject to changes in interest rates and to a lesser extent on credit quality. Further, certain mortgage-backed and asset-backed securities are exposed to accelerated prepayment risk generally caused by interest rate movements. If interest rates were to decline, mortgage holders would be more likely to refinance existing mortgages at lower rates. Acceleration of future repayments could adversely affect future investment income, if reinvestment of the accelerated receipts was made in lower yielding securities. The table below provides information related to the Company's fixed maturity investments at December 31, 1998. The table presents cash flows of principal amounts and related weighted average interest rates by expected maturity dates. The cash flows are based upon the maturity date or, in the case of mortgage-backed and asset-backed securities, expected payment patterns. Actual cash flows could differ from those shown in the table. 31 Fixed Maturities - ---------------- Expected Cash Flows of Principal Amounts ($ in 000's):
TOTAL ----- Esti- Amor- mated There- tized Market 1999 2000 2001 2002 2003 after Cost Value ---- ---- ---- ---- ---- ----- ---- ----- Held to Maturity - ---------------- U.S. Treasury securities and obligations of U.S. Government corporations and agencies $ 0 $ 1,647 $ 0 $ 0 $ 0 $ 0 $ 1,647 $ 1,635 Average interest rate 0.0% 5.4% 0.0% 0.0% 0.0% 0.0% -- -- Mortgage & asset backed securities 4,799 2,514 2,972 1,071 1,933 2,064 15,353 16,121 Average interest rate 8.0% 7.8% 7.7% 7.7% 7.5% 7.3% -- -- ------- ------- ------- ------- ------- ------- -------- -------- Total $ 4,799 $ 4,161 $ 2,972 $ 1,071 $ 1,933 $ 2,064 $ 17,000 $ 17,756 ======= ======= ======= ======= ======= ======= ======== ======== Available for Sale - ------------------ U.S. Treasury securities and obligations of U.S. Government corporations and agencies $ 5,005 $ 7,400 $ 0 $ 350 $ 0 $ 0 $ 12,755 $ 12,776 Average interest rate 4.7% 5.3% 0.0% 6.3% 0.0% 0.0% -- -- Obligations of states and political subdivisions 701 11,858 10,812 1,708 0 1,455 26,534 27,066 Average interest rate 4.9% 4.8% 4.9% 5.6% 0.0% 5.4% -- -- Corporate securities 6,711 3,601 1,104 10,233 6,912 825 29,386 30,045 Average interest rate 6.0% 5.5% 6.9% 7.1% 8.5% 8.6% -- -- Mortgage & asset backed securities 34,375 19,561 21,136 17,338 2,779 14,777 109,966 110,897 Average interest rate 6.8% 6.9% 6.9% 7.0% 7.1% 7.2% -- -- ------- ------- ------- ------- ------- ------- -------- -------- Total $46,792 $42,420 $33,052 $29,629 $ 9,691 $17,057 $178,641 $180,784 ======= ======= ======= ======= ======= ======= ======== ========
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) 1998 - ---- Net premiums earned $23,740 $23,875 $23,448 $22,477 Net investment income 3,290 3,331 3,317 3,339 Net realized investment gains (losses) -- -- (2) -- Other revenues 42 42 51 18 ------- ------- ------- ------- Total revenues $27,072 $27,248 $26,814 $25,834 ======= ======= ======= ======= Income before income taxes $ 1,846 $ 2,098 $ 2,041 $ 2,272 Net income $ 1,346 $ 1,520 $ 1,483 $ 1,574 Net income per diluted share $ .46 $ .52 $ .51 $ .55 1997 - ---- Net premiums earned $23,000 $24,158 $23,764 $25,132 Net investment income 3,029 3,190 3,223 3,328 Net realized investment gains (losses) 107 (4) 9 -- Other revenues 61 25 77 51 ------- ------- ------- ------- Total revenues $26,197 $27,369 $$7,073 $28,511 ======= ======= ======= ======= Income before income taxes $ 617 $ 1,395 $ 1,689 $ 1,721 Net income $ 481 $ 1,059 $ 1,289 $ 1,369 Net income per diluted share $ .16 $ .35 $ .43 $ .47
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 1999 Annual Meeting of Shareholders to be held on or about May 5, 1999. Item 11. EXECUTIVE COMPENSATION. The information in response to this item is incorporated by reference herein to the information under the caption "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 1999 Annual Meeting of Shareholders to be held on or about May 5, 1999, 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 1999 Annual Meeting of Stockholders to be held on or about May 5, 1999. 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 1999 Annual Meeting of Shareholders to be held on or about May 5, 1999. 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-22: Report of Independent Accountants Consolidated Balance Sheet - December 31, 1997 and 1998. Consolidated Statement of Operations - Years ended December 31, 1996, 1997 and 1998. Consolidated Statement of Changes in Stockholders' Equity - Years ended December 31, 1996, 1997 and 1998. Consolidated Statement of Cash Flows - Years ended December 31, 1996, 1997 and 1998. 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, 1998. (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 Catastrophe Reinsurance Agreement (HCI Agreement No. 439) between Merchants Mutual Insurance Company, Merchants Insurance Company of New Hampshire, Inc. and General Reinsurance Corporation, et. al., dated January 1, 1997, (incorporated by reference to Exhibit No. 10f to the Company's 1996 Annual Report on Form 10-K filed on March 28, 1997). (g) 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, (filed herewith). (h) 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, 1998 (filed herewith). * (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). 36 * (j) Merchants Mutual Capital Accumulation Plan, fourth amendment, effective January 1, 1996 (incorporated by referenced to Exhibit 10(h) to the Company's 1996 Annual Report on Form 10-K (File No. 1-9640) filed on March 28, 1997). * (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 Incentive Compensation Plan, as amended January 24, 1996 (incorporated by reference to Exhibit No. 10(n) to the Company's 1996 Annual Report on Form 10-K (File No. 1-9640) filed on March 28, 1997). * (q) Employment Agreement between Robert M. Zak and Merchants Mutual Insurance Company dated as of June 1, 1994 (incorporated by reference to Exhibit No. 10O to the Company's 1994 Annual Report on Form 10-K (File No. 1-9640) filed on March 31, 1995). (r) Employee Retention Agreement between Edward M. Murphy and Merchant Mutual Insurance Company dated as of March 1, 1999 (filed herewith). (s) Employee Retention Agreement between Kenneth J. Wilson and Merchants Mutual Insurance Company dated as of March 1, 1999 (filed herewith). (11) (a) Statement re computation of per share earnings (incorporated herein by reference to Note 1 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). 37 (23) Consent of Independent Accountants (filed herewith). (27) Financial Data Schedule (filed herewith). * Indicates a management contract or compensation plan or arrangement. 38 MERCHANTS GROUP, INC. SCHEDULE I - SUMMARY OF INVESTMENTS - OTHER THAN INVESTMENTS IN RELATED PARTIES December 31, 1998 (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 $ 14,402 $ 14,411 $ 14,423 Corporate bonds 29,386 30,045 30,045 Mortgage and asset backed securities 125,319 127,018 126,250 Tax exempt bonds 26,534 27,066 27,066 -------- -------- -------- Total fixed maturities 195,641 198,540 197,784 Preferred stocks 10,099 10,373 10,373 Short-term investments 6,280 6,280 6,280 Other 735 735 735 -------- -------- -------- $212,755 $215,928 $215,172 ======== ======== ========
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, 1996, 1997 and 1998 (in thousands)
1996 1997 1998 ---- ---- ---- Receivable from (payable to) Merchants Mutual Insurance Company(1): Balance at beginning of period $ 1,091 $ 327 $ 527 Increase (decrease) (764) 200 (1,848) ------- ------- ------- Balance at end of period $ 327 $ 527 $(1,321) ======= ======= =======
(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, - ------------- ------------ 1997 1998 ---- ---- Assets ------ Investment in subsidiary $67,116 $70,788 Other assets 407 1,043 ------- ------- Total Assets $67,523 $71,831 ======= ======= Liabilities and Stockholders' Equity ------------------------------------ Other liabilities $ 61 $ 48 ------- ------- Total liabilities 61 48 ------- ------- 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, 1997 or 1998 -- -- Common stock, $.01 par value, authorized 10,000,000 shares; issued and outstanding of 2,906,502 shares at December 31, 1997 and 2,851,452 shares at December 31, 1998 32 32 Additional paid in capital 35,455 35,511 Treasury stock, 319,600 shares at December 31, 1997 and 378,400 shares at December 31, 1998 (5,906) (7,097) Accumulated other comprehensive income 1,061 1,173 Accumulated earnings 36,820 42,164 ------- ------- Total stockholders' equity 67,462 71,783 ------- ------- Total liabilities and stockholders' equity $67,523 $71,831 ======= =======
41 MERCHANTS GROUP, INC. SCHEDULE III - CONDENSED FINANCIAL INFORMATION OF REGISTRANT Continued (in thousands) INCOME STATEMENT - ----------------
Year ended December 31, -------------------------------- 1996 1997 1998 ---- ---- ---- Revenues: Equity in net income (loss) of subsidiary $(1,570) $ 4,485 $ 6,161 Investment income 133 21 61 Net realized investment gains 902 2 -- ------- ------- ------- Total revenues (535) 4,508 6,222 Expenses: General and administrative expenses 281 230 337 ------- ------- ------- Operating income before income taxes (816) 4,278 5,885 Income tax expense (benefit) 332 80 (38) ------- ------- ------- Net income (loss) $(1,148) $ 4,198 $ 5,923 ======= ======= =======
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, ----------------------- 1996 1997 1998 ---- ---- ---- (in thousands) Cash flows from operating activities: $ 560 $ (227) $ (251) ------- ------- ------- Cash flows from investing activities: Receipt of subsidiary common stock dividend -- 2,800 2,600 Sale (purchase) of other investments, net 2,992 853 (630) ------- ------- ------- Cash flows from investing activities 2,992 3,653 1,970 ------- ------- ------- Cash flows from financing activities: Purchase of treasury stock (2,983) (2,923) (1,191) Cash dividend on common stock (634) (589) (579) Exercise of common stock options 70 83 56 ------- ------- ------- Cash flows from financing activities (3,547) (3,429) (1,714) ------- ------- ------- Net increase (decrease) in cash and cash equivalents 5 (3) 5 Cash and cash equivalents, beginning of year 3 8 5 ------- ------- ------- Cash and cash equivalents, end of year $ 8 $ 5 $ 10 ======= ======= ======= Reconciliation of net income to net cash provided by operations: Net income (loss) $(1,148) $ 4,198 $ 5,923 Adjustments to reconcile net income to net cash provided by operations: Equity in (income) loss of subsidiary 1,570 (4,485) (6,161) Net realized investment gains (902) (2) -- Decrease in liabilities (219) (20) (13) (Increase) decrease in other (non-investment) assets 514 93 (6) Other, net 745 (11) 6 ------- ------- ------- Net cash provided by (used in) operating activities $ 560 $ (227) $ (251) ======= ======= =======
43 MERCHANTS GROUP, INC. SCHEDULE III - CONDENSED FINANCIAL INFORMATION NOTES TO CONDENSED FINANCIAL STATEMENTS Cash dividends of $2,800,000 and $2,600,000 were paid to the Registrant by its consolidated subsidiary in the years ended December 31, 1997 and 1998, respectively. No cash dividends were paid to the Registrant by its consolidated subsidiary in 1996. 44 MERCHANTS GROUP, INC. SCHEDULE VI - REINSURANCE YEARS ENDED DECEMBER 31, 1996, 1997, 1998 (in thousands) Percentage
Percentage Ceded Assumed of amount Gross to other from other Net assumed amount companies companies amount to net ------ --------- --------- ------ ------ Year ended December 31, 1996 Property and Casualty Premiums $101,007 $7,786 $3,401 $96,622 3.5% Year Ended December 31, 1997 Property and Casualty Premiums $101,064 $6,895 $2,642 $96,811 2.7% Year ended December 31, 1998 Property and Casualty Premiums $ 98,956 $7,042 $ 844 $92,758 .9%
45 MERCHANTS GROUP, INC. SCHEDULE X - SUPPLEMENTAL INSURANCE INFORMATION CONCERNING PROPERTY - CASUALTY SUBSIDIARIES Years ended December 31, 1996, 1997 and 1998 (in thousands)
Reserves Losses & loss Deferred for Discount adjustment expenses Amoritiza- policy losses & if any, Net incurred related to tion of Paid losses acquis- loss ad- deducted Net invest- (1) (2) deferred & loss ad- Direct ition justment from Unearned earned ment Current Prior acquisition justment premium costs expenses reserves premiums premiums income years years costs expenses written ----- -------- -------- -------- -------- ------ ----- ----- ----- -------- ------- Yar ended: December 31, 1996 $12,396 $133,479 $1,113 $49,710 $95,752 $11,724 $72,771 $ 6,832 $25,374 $67,061 $101,007 December 31, 1997 $12,597 $141,205 $6,394 $50,406 $96,054 $12,770 $67,119 $ 4,508 $25,454 $67,054 $101,064 December 31, 1998 $12,390 $136,685 $9,256 $49,382 $93,540 $13,277 $67,379 $(2,145) $24,788 $69,198 $ 98,956
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 29, 1999 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 29, 1999 - ----------------------- of the Board Richard E. Garman /s/Brent D. Baird Director, President March 29, 1999 - ----------------------- Brent D. Baird /s/Robert M. Zak Director, Sr. VP & March 29, 1999 - ----------------------- Chief Operating Robert M. Zak Officer /s/Kenneth J. Wilson Vice President & CFO March 29, 1999 - ----------------------- (principal financial Kenneth J. Wilson and accounting officer) /s/Andrew A. Alberti Director March 29, 1999 - ----------------------- Andrew A. Alberti /s/Frank J. Colantuono Director March 29, 1999 - ----------------------- Frank J. Colantuono /s/Henry P. Semmelhack Director March 29, 1999 - ----------------------- 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) and (2) present fairly, in all material respects, the financial position of Merchants Group, Inc. and its subsidiaries at December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards 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 the opinion expressed above. /s/ PricewaterhouseCoopers Buffalo, New York February 15, 1999 F-1 48 MERCHANTS GROUP, INC. CONSOLIDATED BALANCE SHEET (in thousands)
December 31, ------------ 1997 1998 ---- ---- Assets ------ Investments: Fixed maturities: Held to maturity at amortized cost $ 19,631 $ 17,000 Available for sale at fair value 174,927 180,784 Preferred stock at fair value 10,582 10,373 Other long-term investments at fair value 634 735 Short-term investments 4,470 6,280 -------- -------- Total investments 210,244 215,172 Cash Interest due and accrued 10 16 Premiums receivable, net of allowance for doubtful accounts 1,858 1,923 of $543 in 1997 and $454 in 1998 Deferred policy acquisition costs 21,084 20,629 Ceded reinsurance balances receivable 12,597 12,390 Prepaid reinsurance premiums 11,132 9,741 Receivable from affiliate 2,871 2,629 Deferred federal income taxes 527 -- Other assets 6,319 5,055 7,332 6,968 -------- -------- Total assets $273,974 $274,523 ======== ========
The accompanying notes are an integral part of these consolidated financial statements. F-2 49 MERCHANTS GROUP, INC. CONSOLIDATED BALANCE SHEET (in thousands except share amounts)
December 31, ------------ 1997 1998 ---- ---- Liabilities and Stockholders' Equity ------------------------------------ Liabilities: Reserve for losses and loss adjustment expenses $ 141,205 $ 136,685 Unearned premiums 50,406 49,382 Payable to affiliate -- 1,321 Other liabilities 14,901 15,352 --------- --------- Total liabilities 206,512 202,740 --------- --------- Stockholders' equity: Common stock, issued and outstanding 2,906,502 shares at December 31, 1997 and 2,851,452 shares at December 31, 1998 32 32 Additional paid in capital 35,455 35,511 Treasury stock, 319,600 shares at December 31, 1997 and 378,400 shares at December 31, 1998 (5,906) (7,097) Accumulated other comprehensive income 1,061 1,173 Accumulated earnings 36,820 42,164 --------- --------- Total stockholders' equity 67,462 71,783 --------- --------- Commitments and contingent liabilities (Note 10) -- -- Total liabilities and stockholders' equity $ 273,974 $ 274,523 ========= =========
The accompanying notes are an integral part of these consolidated financial statements. F-3 50 MERCHANTS GROUP, INC. CONSOLIDATED STATEMENT OF OPERATIONS (in thousands except per share amounts)
Year ended December 31, ----------------------- 1996 1997 1998 ---- ---- ---- Revenues: Net premiums earned $ 95,752 $ 96,054 $ 93,540 Net investment income 11,724 12,770 13,277 Net realized investment gains (losses) 996 112 (2) Other revenues 172 214 153 --------- --------- --------- Total revenues 108,644 109,150 106,968 --------- --------- --------- Expenses: Net losses and loss adjustment expenses 79,603 71,627 65,234 Amortization of deferred policy acquisition costs 25,374 25,454 24,788 Other underwriting expenses 6,700 6,647 8,689 --------- --------- --------- Total expenses 111,677 103,728 98,711 --------- --------- --------- Income (loss) before income taxes (3,033) 5,422 8,257 Income tax provision (benefit) (1,885) 1,224 2,334 --------- --------- --------- Net income (loss) $ (1,148) $ 4,198 $ 5,923 ========= ========= ========= Earnings (loss) per share: Basic $ (.36) $ 1.41 $ 2.05 ========= ========= ========= Diluted $ (.36) $ 1.41 $ 2.04 ========= ========= ========= Weighted average number of shares outstanding: Basic 3,174 2,973 2,895 Diluted 3,182 2,980 2,904
The accompanying notes are an integral part of these consolidated financial statements. F-4 51 MERCHANTS GROUP, INC. CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (in thousands)
Year ended December 31, ----------------------- 1996 1997 1998 ---- ---- ---- Net income (loss) $(1,148) $ 4,198 $ 5,923 ------- ------- ------- Other comprehensive income (loss) before tax: Unrealized gains (losses) on securities (1,187) 2,595 185 Reclassification adjustment for gains and losses included in net income 814 (74) (15) ------- ------- ------- Other comprehensive income (loss) before tax (373) 2,521 170 Income tax provision (benefit) related to items of other comprehensive income (127) 857 58 ------- ------- ------- Other comprehensive income (loss) (246) 1,664 112 ------- ------- ------- Comprehensive income (loss) $(1,394) $ 5,862 $ 6,035 ======= ======= =======
The accompanying notes are an integral part of these consolidated financial statements. F-5 52 MERCHANTS GROUP, INC. CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (in thousands)
Year ended December 31, ----------------------- 1996 1997 1998 ---- ---- ---- Common stock: Beginning and end of year $ 32 $ 32 $ 32 -------- -------- -------- Additional paid in capital: Beginning of year 35,302 35,372 35,455 Exercise of common stock options 70 83 56 -------- -------- -------- End of year 35,372 35,455 35,511 -------- -------- -------- Treasury stock: Beginning of year -- (2,983) (5,906) Purchase of treasury shares (2,983) (2,923) (1,191) -------- -------- -------- End of year (2,983) (5,906) (7,097) -------- -------- -------- Accumulated other comprehensive income (loss) Beginning of year (357) (603) 1,061 Other comprehensive income (loss) (246) 1,664 112 -------- -------- -------- End of year (603) 1,061 1,173 -------- -------- -------- Accumulated earnings: Beginning of year 34,993 33,211 36,820 Net income (loss) (1,148) 4,198 5,923 Cash dividends (634) (589) (579) -------- -------- -------- End of year 33,211 36,820 42,164 -------- -------- -------- Total stockholders' equity $ 65,029 $ 67,462 $ 71,783 ======== ======== ========
The accompanying notes are an integral part of these consolidated financial statements. F-6 53 MERCHANTS GROUP, INC. CONSOLIDATED STATEMENT OF CASH FLOWS (in thousands)
Year ended December 31, ----------------------- 1996 1997 1998 ---- ---- ---- Cash flows from operations: Collection of premiums $ 96,684 $ 96,102 $ 94,121 Payment of losses and loss adjustment expenses (67,061) (67,054) (69,198) Payment of underwriting expenses (32,311) (32,019) (32,159) Investment income received 11,917 12,763 13,220 Investment expenses paid (287) (309) (341) Income taxes (paid) recovered 2,734 (164) (1,501) Other cash receipts 188 214 157 -------- -------- -------- Net cash provided by operations 11,864 9,533 4,299 -------- -------- -------- Cash flows from investing activities: Proceeds from fixed maturities sold or matured 55,899 81,035 95,217 Purchase of fixed maturities (55,910) (90,176) (97,733) Net increase in preferred stock (6,928) (2,067) -- Net (increase) decrease in other long-term investments 2,148 1,671 (101) Net (increase) decrease in short-term investments (3,778) 3,778 (1,810) Purchase of equipment, net (540) (146) -- -------- -------- -------- Net cash used in investing activities (9,109) (5,905) (4,427) -------- -------- -------- Cash flows from financing activities: Settlement of affiliate balances 764 (200) 1,848 Purchase of treasury stock (2,983) (2,923) (1,191) Proceeds from exercise of common stock options 70 83 56 Cash dividends (634) (589) (579) -------- -------- -------- Net cash provided by (used in) financing activities (2,783) (3,629) 134 -------- -------- -------- Increase (decrease) in cash (28) (1) 6 Cash, beginning of year 39 11 $ 10 -------- -------- -------- Cash, end of year $ 11 $ 10 $ 16 ======== ======== ========
The accompanying notes are an integral part of these consolidated financial statements. F-7 54 MERCHANTS GROUP, INC. CONSOLIDATED STATEMENT OF CASH FLOWS RECONCILIATION OF NET INCOME TO NET CASH PROVIDED BY OPERATIONS (in thousands)
Year ended December 31, ----------------------- 1996 1997 1998 ---- ---- ---- Net income (loss) $ (1,148) $ 4,198 $ 5,923 Adjustments: Depreciation and amortization 33 (19) (123) Net realized investment (gains) losses (996) (112) 2 (Increase) decrease in assets: Interest due and accrued 93 (65) (65) Premiums receivable (141) (583) 455 Deferred policy acquisition costs (231) (201) 207 Ceded reinsurance balances receivable (821) (3,297) 1,391 Prepaid reinsurance premiums (66) 61 242 Federal income taxes receivable 1,877 1,266 -- Deferred federal income taxes (1,027) (532) 1,206 Other assets 35 8 154 Increase (decrease) in liabilities: Reserve for losses and loss adjustment expenses 13,757 7,726 (4,520) Unearned premiums 937 696 (1,024) Other liabilities (438) 387 451 -------- -------- -------- Net cash provided by operations $ 11,864 $ 9,533 $ 4,299 ======== ======== ========
The accompanying notes are an integral part of these consolidated financial statements. F-8 55 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 $46,006,000 and $50,576,000 at December 31, 1997 and 1998, respectively. MNH's net income (loss) as reported in its Annual Statement was ($2,788,000) in 1996, $3,481,000 in 1997 and $7,367,000 in 1998. All significant intercompany balances and transactions have been eliminated. 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. 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. The net aggregate unrealized gain or loss, net of applicable income taxes, related to fixed maturities available for sale is included as a component of accumulated other comprehensive income in stockholders' equity. Fixed maturities include mortgage backed and asset backed securities which are valued using the interest method. The Company estimates prepayments utilizing published data when F-9 56 applying the interest method. Periodic adjustments to prepayment assumptions are credited or charged to investment income. Preferred stocks are carried at fair value. 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. 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 F-10 57 Statistical Plan Table III A at a rate of 3.5%. The amount of discount at December 31, 1997 and 1998 is $6,394,000 and $9,256,000, 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 $5,942,000 and $5,764,000 at December 31, 1997 and 1998, respectively, are recorded in the Company's consolidated balance sheet. Income taxes The Company and its wholly owned subsidiary 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. Earnings per share During 1997, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share". This statement prescribes new standards for computing and presenting earnings per share ("EPS") and makes those standards consistent with international standards. The Company has calculated EPS in conformity with the requirements of SFAS No. 128 for all periods presented in these financial statements. Other comprehensive income In 1997, the Financial Accounting Standards Board issued SFAS No. 130, "Reporting Comprehensive Income". SFAS No. 130 establishes standards for the reporting of comprehensive income in a full set of general-purpose financial statements. Comprehensive income as described in SFAS No. 130 includes net income as well as items under existing accounting standards that are reported as adjustments to stockholders' equity. Such adjustments to stockholders' equity include unrealized gains and losses on certain investments in debt and equity securities. The Company adopted SFAS No. 130 in the first quarter of 1998. F-11 58 Insurance-Related assessments In December 1997, the American Institute of Certified Public Accountants ("AICPA") Accounting Standards Executive Committee issued Statement of Position ("SOP") 97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related Assessments". The accounting guidance of this SOP focuses on the timing of recognition and measurement of liabilities for insurance-related assessments. The SOP is effective for fiscal years beginning after December 15, 1998. The Company estimates that implementation of this SOP will not have a material impact on the Company's financial condition or results of operations. 2. Related Party Transactions The Company and MNH have no paid employees. Under a management agreement Merchants Mutual Insurance Company ("Mutual"), which owns 8.9% of the Company's outstanding common stock at December 31, 1998, 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 five years after the date of notice. 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 59 3. Investments Investments in fixed maturities and preferred stocks The amortized cost and estimated fair values 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:
Amortized Gross Gross Cost/ Unrealized Unrealized Estimated Cost Gains Losses Fair Value --------- ---------- ---------- ---------- (in thousands) December 31, 1997 ----------------- Fixed maturities: Held to maturity ---------------- U.S. Treasury securities and obligations of U.S. government corporations and agencies $ 2,147 $ 1 $ 30 $ 2,118 Mortgage and asset backed securities 17,484 725 -- 18,209 -------- -------- -------- -------- Total $ 19,631 $ 726 $ 30 $ 20,327 ======== ======== ======== ======== Available for sale ------------------ U.S. Treasury securities and obligations of U.S. government corporations and agencies $ 21,755 $ 7 $ 113 $ 21,649 Obligations of states and political subdivisions 28,217 547 -- 28,764 Corporate securities 20,035 513 -- 20,548 Mortgage and asset backed securities 102,989 1,016 39 103,966 -------- -------- -------- -------- Total $172,996 $ 2,083 $ 152 $174,927 ======== ======== ======== ======== Preferred stocks $ 10,038 $ 544 $ -- $ 10,582 ======== ======== ======== ========
F-13 60
Amortized Gross Gross Cost/ Unrealized Unrealized Estimated Cost Gains Losses Fair Value --------- ---------- ---------- ---------- (in thousands) December 31, 1998 ----------------- Fixed maturities: Held to maturity ---------------- U.S. Treasury securities and obligations of U.S. government corporations and agencies $ 1,647 $ -- $ 12 $ 1,635 Mortgage and asset backed securities 15,353 768 -- 16,121 -------- -------- -------- -------- Total $ 17,000 $ 768 $ 12 $ 17,756 ======== ======== ======== ======== Available for sale ------------------ U.S. Treasury securities and obligations of U.S. government corporations and agencies $ 12,755 $ 21 $ -- $ 12,776 Obligations of states and -- political subdivisions 26,534 532 34 27,066 Corporate securities 29,386 693 30,045 Mortgage and asset backed securities 109,966 976 45 110,897 -------- -------- -------- -------- Total $178,641 $ 2,222 $ 79 $180,784 ======== ======== ======== ======== Preferred stocks $ 10,099 $ 408 $ 134 $ 10,373 ======== ======== ======== ========
The amortized cost and fair value of fixed maturities by expected maturity at December 31, 1998 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 61
Estimated Fair Amortized Cost Value -------------- -------------- (in thousands) Held to maturity ---------------- Due in one year or less $ 4,799 $ 5,039 Due after one year through five years 10,138 10,550 Due after five years through ten years 1,876 1,970 Due after ten years 187 197 -------- -------- Total $ 17,000 $ 17,756 ======== ======== Available for sale ------------------ Due in one year or less $ 46,792 $ 47,093 Due after one year through five years 114,792 116,493 Due after five years through ten years 15,715 15,845 Due after ten years 1,342 1,353 -------- -------- Total $178,641 $180,784 ======== ========
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 $1,800,000 were on deposit at December 31, 1998 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, -------------------------------- 1996 1997 1998 ---- ---- ---- (in thousands) Proceeds from sales $38,499 $26,652 $ 9,955 Gross realized gains 1,012 138 1 Gross realized losses 16 26 3
F-15 62 Net investment income Net investment income consists of:
Year ended December 31, ----------------------- 1996 1997 1998 ---- ---- ---- (in thousands) Fixed maturities $10,956 $11,472 $12,236 Short-term investments 443 686 513 Other 612 921 869 ------- ------- ------- Total investment income 12,011 13,079 13,618 Investment expenses 287 309 341 ------- ------- ------- Net investment income $11,724 $12,770 $13,277 ======= ======= =======
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, 1997 and 1998 is as follows:
1997 1998 ------------------------- ------------------------- Premiums Premiums Premiums Premiums Written Earned Written Earned ------- ------ ------- ------ (in thousands) Direct $ 101,064 $ 100,146 $ 98,956 $ 99,556 Assumed 2,642 2,864 844 1,267 Ceded (6,895) (6,956) (7,042) (7,283) --------- --------- --------- --------- Net premiums $ 96,811 $ 96,054 $ 92,758 $ 93,540 ========= ========= ========= =========
Reinsurance ceded transactions decreased losses and LAE by $5,528,000 and $483,000 for the years ended December 31, 1997 and 1998, respectively. As a result of the reinsurance agreements maintained by MNH, MNH is exposed to certain credit risk if its primary reinsurers were to become financially unstable. As of December 31, 1998, MNH has recognized amounts to be recovered from its primary reinsurers related to ceded losses and ceded unearned premiums totaling $11,259,000. MNH generally does not require collateral for reinsurance recoverable. F-16 63 5. Reserve for Losses and Loss Adjustment Expenses Activity in the reserve for losses and LAE is summarized as follows:
1997 1998 ---- ---- (in thousands) Reserve for losses and LAE at beginning of year $ 133,479 $ 141,205 Less reinsurance recoverables 7,219 10,372 --------- --------- Net balance at beginning of year 126,260 130,833 --------- --------- Provision for losses and LAE for claims occurring in: Current year 67,119 67,379 Prior years 4,508 (2,145) --------- --------- 71,627 65,234 --------- --------- Loss and LAE payments for claims occurring in: Current year 26,100 26,765 Prior years 40,954 42,433 --------- --------- 67,054 69,198 --------- --------- Reserve for losses and LAE at end of year, net 130,833 126,869 Plus reinsurance recoverables 10,372 9,816 --------- --------- Balance at end of year $ 141,205 $ 136,685 ========= =========
In 1997, the Company increased its reserves for prior years by $4,508,000. The increase in reserves for prior years recorded in 1997 was primarily attributable to higher than anticipated severity of claims on workers' compensation policies. In 1998, the Company decreased its reserves for prior years by $2,145,000, primarily due to favorable loss experience related to automobile liability policies. 6. Income Taxes The provision (benefit) for federal income taxes consists of:
Year ended December 31, --------------------------------- 1996 1997 1998 ---- ---- ---- (in thousands) Current $(1,208) $ 1,756 $ 1,127 Deferred (677) (532) 1,207 ------- ------- ------- Total federal income tax provision (benefit) $(1,885) $ 1,224 $ 2,334 ======= ======= =======
F-17 64 A reconciliation of the difference between the Company's total federal income tax provision and that calculated using the federal statutory income tax rate is as follows:
Year ended December 31, ---------------------------------- 1996 1997 1998 ---- ---- ---- (in thousands) Computed provision (benefit) at statutory rate $(1,031) $ 1,843 $ 2,807 Adjustments: Tax-exempt investment income (726) (491) (393) Dividend exclusion (47) (147) (128) Other items (81) 19 48 ------- ------- ------- Total federal income tax provision (benefit) $(1,885) $ 1,224 $ 2,334 ======= ======= =======
Deferred federal tax liabilities (assets) are comprised of the following:
December 31, ----------------------- 1997 1998 ---- ---- (in thousands) Deferred policy acquisition costs $ 4,283 $ 4,213 Unrealized investment gains 547 604 Accretion of bond discount 100 349 Other 187 204 -------- -------- Total deferred federal tax liabilities 5,117 5,370 -------- -------- Discounting of reserve for losses and loss adjustment expenses (7,450) (6,826) Unearned premiums (3,232) (3,179) Other (311) (279) Minimum tax credit carryforward (443) (141) -------- -------- Total deferred federal tax assets (11,436) (10,425) -------- -------- Net deferred federal income taxes $ (6,319) $ (5,055) ======== ========
Although realization is not assured, based upon the available evidence the Company believes that it is more likely than not that the net deferred federal 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. F-18 65 7. Stockholders' Equity Preferred and common stock Stockholders' equity is comprised of the following: Preferred stock, no par value, $424.30 stated value, 10,000 shares authorized; no shares issued or outstanding at December 31, 1997 or December 31, 1998. The Company also has 3,000,000 shares of $.01 par value preferred stock which is authorized and unissued. Common stock, $.01 par value, authorized 10,000,000 shares; issued and outstanding 2,906,502 shares at December 31, 1997 and 2,851,452 shares at December 31, 1998. 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 1999, without the prior approval of the New Hampshire Insurance Commissioner, is $5,058,000. The Company paid a quarterly cash dividend to its common stockholders in 1996, 1997 and 1998. Stock option plans 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 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 may be exercised in cumulative annual increments of 25% commencing one year from the date of grant. During 1996, 53,000 options were granted under the Plan at an exercise price of $21.00 per share. The weighted average fair value of options granted in 1996 was $6.48 per option. In March 1994, the Company's Board of Directors approved a stock option program providing for the issuance of options to purchase a total of 25,000 shares of the Company's common stock to certain of MNH's independent insurance agents. In June 1994, the Company issued options to purchase 22,500 shares of common stock under the program at $16.38 per share. These options became exercisable on June 1, 1996. In 1996, the Company adopted the disclosure provisions of SFAS No. 123 "Accounting for Stock Based Compensation", but opted to remain under the expense recognition provisions of F-19 66 Accounting Principles Board Opinion No. 25 "Accounting for Stock Issued to Employees" in accounting for its stock option plans. No compensation expense was recognized in 1996, 1997 or 1998 for options granted under these plans. Had compensation expense for stock options granted under the Company's stock option plans 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 years ended December 31, 1997 and 1998 would have been as follows:
1997 1998 ---- ---- Net income: As reported $4,198,000 $5,923,000 Pro forma $4,123,000 $5,884,000 Diluted earnings per share: As reported $1.41 $2.04 Pro forma $1.38 $2.03
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. A summary of the status of the Company's outstanding options as of December 31, 1996, 1997 and 1998, and changes during the years ending on those dates is presented below:
1996 1997 1998 -------------------------- --------------------------- --------------------- Weighted Weighted Average Average Options Exercise Options Exercise Options Exercise Outstanding Price Outstanding Price Outstanding Price ----------- -------- ----------- -------- ----------- -------- Beginning of year 49,083 $ 14.51 90,750 $ 18.28 79,250 $18.39 Granted 53,000 21.00 -- -- -- -- Exercised (6,458) 12.01 (5,750) 14.64 (3,750) 15.04 Forfeited (4,875) 18.50 (5,750) 20.40 (4,000) 21.00 ------ ------ ------ End of year 90,750 18.28 79,250 18.39 71,500 18.38 ====== ====== ====== Options exer- cisable at year-end 40,750 14.93 45,500 16.45 51,000 17.37 ====== ====== ======
F-20 67 The following table summarizes information about the Company's outstanding stock options at December 31, 1998:
Number Remaining Average Number Outstanding Contractual Exercise Exercisable at 12/31/98 Life in Years Price at 12/31/98 ----------- ------------- ----- ----------- 4,000 .2 $ 9.38 4,000 8,000 3.1 14.38 8,000 18,500 .4 16.38 18,500 41,000 7.1 21.00 20,500 ------ ------ 71,500 51,000 ====== ======
Common stock repurchases During 1996, 1997 and 1998, the Company repurchased 160,700, 158,900 and 58,800 shares of its common stock, respectively. The Company was holding 378,400 of these shares in treasury as of December 31, 1998. 8. Earnings Per Share The computations for basic and diluted earnings per share are as follows:
Year Ended December 31, ------------------------------------- 1996 1997 1998 ------- ------- ------- Basic: Net income (loss) $(1,148) $ 4,198 $ 5,923 Weighted average shares outstanding 3,174 2,973 2,895 Basic earnings (loss) per share $ (.36) $ 1.41 $ 2.05 Diluted: Net income (loss) $(1,148) $ 4,198 $ 5,923 Weighted average shares outstanding 3,174 2,973 2,895 Plus incremental shares from assumed conversion of stock options 8 7 9 ------- ------- ------- Weighted average shares outstanding-adjusted 3,182 2,980 2,904 ======= ======= ======= Diluted earnings (loss) per share $ (.36) $ 1.41 $ 2.04
F-21 68 9. 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 one year 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 $238,000, $457,000 and $554,000 for the years ended December 31, 1996, 1997 and 1998, respectively. 10. 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. 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-22 EX-10.G 2 EXHIBIT 10(G) 1 Exhibit 10(g) PROPERTY AND CASUALTY EXCESS OF LOSS REINSURANCE AGREEMENT between MERCHANTS MUTUAL INSURANCE COMPANY MERCHANTS INSURANCE COMPANY OF NEW HAMPSHIRE, INC. and AMERICAN RE-INSURANCE COMPANY 2 TABLE OF CONTENTS
ARTICLE PAGE ------- ---- I PARTIES TO THIS AGREEMENT 1 II EXHIBITS COVERED 1 III MANAGEMENT OF CLAIMS AND LOSSES 2 IV SALVAGE AND SUBROGATION 2 V SPECIAL ACCEPTANCES 3 VI EXTRA CONTRACTUAL OBLIGATIONS AND/OR EXCESS JUDGMENTS 4 VII DECLARATORY JUDGMENT EXPENSES 5 VIII ERRORS AND OMISSIONS 5 IX OFFSET AND SECURITY CLAUSE 6 X ACCESS TO RECORDS 6 XI RESERVES AND TAXES 7 XII INSOLVENCY CLAUSE 7
3 PROPERTY AND CASUALTY EXCESS OF LOSS ------------------------------------ REINSURANCE AGREEMENT --------------------- THIS AGREEMENT made and entered into by and between MERCHANTS MUTUAL INSURANCE COMPANY, Buffalo, New York and MERCHANTS INSURANCE COMPANY OF NEW HAMPSHIRE, INC., Concord, New Hampshire (hereinafter collectively referred to as "Company") and AMERICAN RE-INSURANCE COMPANY, a Delaware Corporation with Administrative Offices in Princeton, New Jersey (hereinafter referred to as "Reinsurer"). WITNESSETH: The Reinsurer hereby reinsures the Company to the extent and on the terms and conditions and subject to the exceptions, exclusions and limitations hereinafter set forth and nothing hereinafter shall in any manner create any obligations or establish any rights against the Reinsurer in favor of any third parties or any persons not parties to this Agreement. ARTICLE I --------- PARTIES TO THIS AGREEMENT - ------------------------- A. This Agreement is solely between the Company and the Reinsurer. When more than one Company is named as a party to this Agreement, the first reinsured company named shall be the agent of the other reinsured companies as to all matters pertaining to this Agreement. Any payments by the Reinsurer to any of the parties comprising the Company shall constitute payment due from the Reinsurer to the Company under this Agreement. B. The retention of the Company and the liability of the Reinsurer and all other benefits accruing to the Company as provided in this Agreement or any amendments hereto, shall apply to the reinsured companies comprising the Company as a group and not separately to each of the reinsured companies named in this Agreement. C. Performance of the obligations of each party to this Agreement shall be rendered solely to the other party; however, if the Company becomes insolvent, the liability of the Reinsurer shall be modified to the extent set forth in the Article entitled INSOLVENCY CLAUSE. ARTICLE II ---------- EXHIBITS COVERED - ---------------- The Company will reinsure with the Reinsurer and the Reinsurer will accept reinsurance -3- 4 from the Company as set forth in Exhibits A, B and C, which are attached hereto and made a part of this Agreement, such Exhibits being entitled for purposes of identification as follows: EXHIBIT A - CASUALTY EXCESS OF LOSS REINSURANCE COVER EXHIBIT B - PROPERTY PER RISK EXCESS OF LOSS REINSURANCE COVER EXHIBIT C - EACH CLAIMANT WORKERS' COMPENSATION EXCESS OF LOSS REINSURANCE COVER ARTICLE III ----------- MANAGEMENT OF CLAIMS AND LOSSES - ------------------------------- The Company shall investigate and settle or defend all claims and losses. When requested by the Reinsurer, the Company shall permit the Reinsurer, at the expense of the Reinsurer, to be associated with the Company in the defense or control of any claim, loss, or legal proceeding which involves or is likely to involve the Reinsurer. All payments of claims or losses by the Company within the limits of its policies which are within the limits set forth in the applicable Exhibit shall be binding on the Reinsurer, subject to the terms of this Agreement. ARTICLE IV ---------- SALVAGE AND SUBROGATION - ----------------------- A. The Reinsurer shall be subrogated, as respects any loss for which the Reinsurer shall actually pay or become liable, but only to the extent of the amount of payment by or the amount of liability to the Reinsurer, to all the rights of the Company against any person or other entity who may be legally responsible in damages for said loss. The Company hereby agrees to enforce such rights, but in case the Company shall refuse or neglect to do so the Reinsurer is hereby authorized and empowered to bring any appropriate action in the name of the Company or its policyholders, or otherwise to enforce such rights. B. Any recoveries, salvages or reimbursements applying to risks covered under this Agreement shall always be used to reimburse the excess carriers (from the last to the first, beginning with the carrier of the last excess), according to their participation, before being used in any way to reimburse the Company for its primary loss. C. If loss expense is pro rated in the attached Exhibits, then in the event there are any -4- 5 recoveries, salvages or reimbursements recovered subsequent to a loss settlement, it is agreed that if the expenses incurred in obtaining salvage or other recoveries are less than the amount recovered, such expenses shall be borne by each party in the proportion that each party benefits from the recoveries. Otherwise, the amount recovered shall first be applied to the reimbursement of the expense of recovery and the remaining expense shall be borne by the Company and the Reinsurer in proportion to the liability of each party for the loss before such recovery had been obtained. D. If loss expense is included in the ultimate net loss in the attached Exhibits, all salvages recoveries or reimbursements, after deduction of expenses applicable thereto, recovered or received subsequent to a loss settlement under this Agreement shall be applied as if recovered or received prior to the aforesaid settlement and all necessary adjustments shall be made by the parties hereto, provided always, that nothing in this clause shall be construed to mean that losses under this Agreement are not recoverable until the Company's ultimate net loss has been ascertained. E. Expenses hereunder shall exclude all office expenses of the Company and all salaries and expenses of its officials and employees. However, should litigation be necessary in order to effect recovery and the Company use its in-house counsel to conduct or monitor the litigation, the Company may include the salary of said in-house counsel while so engaged and any direct costs incurred by or on behalf of said in-house counsel associated with the litigation. ARTICLE V --------- SPECIAL ACCEPTANCES - ------------------- A. Business not within the terms of this Agreement may be submitted to the Reinsurer for special acceptance and, if accepted by the Reinsurer, shall be subject to all of the terms of this Agreement except as modified by the special acceptance. B. Notwithstanding the above, it is agreed that the following business shall be covered under this Agreement, subject to all of the terms of this Agreement except as otherwise indicated below, until the expiration, cancellation or next anniversary date of the Company's policies covering said business. 1. Business specially accepted under the Company's Agreement of Reinsurance No. 8009 (hereinafter the "prior reinsurance agreement") with General Reinsurance Corporation. Such specially accepted business shall be subject to all of the terms of this Agreement except as modified by the special acceptance made by General Reinsurance Corporation under the prior reinsurance agreement. -5- 6 2. Business covered under the prior reinsurance agreement. ARTICLE VI ---------- EXTRA CONTRACTUAL OBLIGATIONS AND/OR EXCESS JUDGMENTS - ----------------------------------------------------- A. This Agreement shall indemnify the Company, within the limits of this Agreement, for Extra Contractual Obligations and/or Excess Judgments awarded by a court of competent jurisdiction against the Company that arise from policies that are reinsured hereunder. Such Extra Contractual Obligation and/or Excess Judgment shall be added to the amount of the loss within the Company's policy limit and the sum thereof shall be considered one loss subject to the exclusions and limitations set forth in this Agreement and its Exhibits. B. "Extra Contractual Obligations" are defined as damages paid by the Company that are not covered under any other provision of this Agreement, including legal costs and expenses in connection therewith, that arise as a result of the Company's handling of any claim on the policy reinsured hereunder, such liabilities arising because of, but not limited to, the following: failure by the Company to settle within the policy limit, or by reason of alleged or actual negligence or bad faith or alleged fraud in rejecting an offer of settlement or in the preparation of the defense or in the trial of any action against its insured or in the preparation or prosecution of an appeal consequent upon such action. C. "Excess Judgments" are defined as those damages paid by the Company which amounts are in excess of its policy limits, but otherwise within the coverage terms of the policy reinsured hereunder, including legal costs and expenses in connection therewith, as a result of an action against it by its insured or its insured's assignee to recover damages awarded by a court of competent jurisdiction to a third party claimant, arising out of, but not limited to, the Company's alleged or actual negligence or bad faith or alleged fraud in rejecting a settlement, in discharging its duty to defend, in preparing the defense in an action against its insured or discharging its duty to prepare or prosecute an appeal consequent upon such action. D. The date on which an Extra Contractual Obligation and/or an Excess Judgment award is incurred by the Company shall be deemed, in all circumstances, to have arisen on the same date as the original loss occurrence that gave rise to the Extra Contractual Obligation and/or an Excess Judgment. E. However, this Article shall not apply where the loss has been incurred due to the fraud of a member of the Board of Directors or a corporate officer of the Company or any other employee of the Company with claims settlement authority acting individually or collectively or in collusion with any individual or corporation or any other organization or party involved in the presentation, defense or settlement of any claim covered hereunder. F. Recoveries, collectibles or retentions from any form of insurance and/or reinsurance, including but not limited to, deductibles or self-insured retentions, that protect the Company against claims the subject matter of this clause, will inure to the benefit of the Reinsurer and shall be deducted from the total amount -6- 7 of Extra Contractual Obligation and/or Excess Judgment award for purposes of determining the amount recoverable hereunder, whether collectible or not. G. If any provision of this Article shall be rendered illegal or unenforceable by the laws, regulations or public policy of any state, such provision shall be considered void in such state, but this shall not affect the validity or enforceability of any other provision of this Agreement or the enforceability of such provision in any other jurisdiction. ARTICLE VII ----------- DECLARATORY JUDGMENT EXPENSES - ----------------------------- A. This Agreement shall indemnify the Company, within the limits of this Agreement, for Declaratory Judgment Expenses paid by the Company, as provided in this Agreement, under policies reinsured hereunder. B. "Declaratory Judgment Expenses" as used herein shall mean legal expenses paid by the Company for the investigation, analysis, evaluation, and/or resolution of litigation of coverage by the Company and any other party to determine if there is coverage to indemnify and/or pay to its insured(s) under the policies issued by the Company and reinsured hereunder for a specific loss which loss is not specifically excluded under this Agreement. C. Recoveries from any form of insurance and/or reinsurance that protect the Company against claims the subject matter of this clause will inure to the benefit of the Reinsurer and shall be deducted from the total amount of Declaratory Judgment Expenses for purposes of determining the amount recoverable hereunder. ARTICLE VIII ------------ ERRORS AND OMISSIONS - -------------------- Errors or omissions on the part of the Company shall not invalidate the reinsurance under this Agreement, provided such errors or omissions are corrected promptly after discovery thereof, but the liability of the Reinsurer under this Agreement or any exhibits or endorsements attached thereto shall in no event exceed the limits specified therein, nor be extended to cover any risks, perils or classes of insurance generally or specifically excluded therein. ARTICLE IX ---------- OFFSET AND SECURITY CLAUSE - -------------------------- A. Each party hereto has the right, which may be exercised at any time, to offset any amounts, whether on account of premiums or losses or otherwise, due from such party to another party under this Agreement or any other reinsurance agreement heretofore or hereafter entered into between them, against any amounts, whether on account of premiums or losses or otherwise due from the latter party to the former party. The party asserting the right of offset may exercise this right, whether as assuming or ceding insurer or in both roles in the relevant agreement -7- 8 or agreements. B. Each party hereby assigns and pledges to the other party (or to each other party, if more than one) all of its rights under this Agreement to receive premium or loss payments at any time from such other party ("Collateral"), to secure its premium or loss obligations to such other party at any time under this Agreement and any other reinsurance agreement heretofore or hereafter entered into by and between them ("Secured Obligations"). If at any time a party is in default under any Secured Obligation or shall be subject to any liquidation, rehabilitation, reorganization or conservation proceeding, each other party shall be entitled in its discretion, to apply, or to withhold for the purpose of applying in due course, any Collateral assigned and pledged to it by the former party and otherwise to realize upon such Collateral as security for such Secured Obligations. C. The security interest described herein, and the term "Collateral," shall apply to all payments and other proceeds in respect of the rights assigned and pledged. A party's security interest in Collateral shall be deemed evidenced only by the counterpart of this Agreement delivered to such party. D. Each right under this Article is a separate and independent right, exercisable, without notice or demand, alone or together with other rights, in the sole election of the party entitled thereto, and no waiver, delay, or failure to exercise, in respect of any right, shall constitute a waiver of any other right. The provisions of this Article shall survive any cancellation or other termination of this Agreement. E. In the event of the insolvency of a party hereto, offsets shall only be allowed in accordance with the laws of the insolvent party's state of domicile. ARTICLE X --------- ACCESS TO RECORDS - ----------------- The Company shall place at the disposal of the Reinsurer and the Reinsurer shall have the right to inspect, through its authorized representatives, at all reasonable times during the currency of this Agreement and thereafter, the books, records and papers of the Company pertaining to the reinsurance provided hereunder and all claims made in connection therewith. ARTICLE XI ---------- RESERVES AND TAXES - ------------------ A. The Reinsurer shall maintain legal reserves with respect to claims hereunder. B. The Company will be liable for all taxes on premiums reported to the Reinsurer hereunder and will reimburse the Reinsurer for such taxes where the Reinsurer is required to pay the same. -8- 9 ARTICLE XII ----------- INSOLVENCY CLAUSE - ----------------- (If more than one reinsured company is included in the designation of "Company" this Article shall apply only to the insolvent company or companies) In the event of the insolvency of the Company and the appointment of a conservator, liquidator or statutory successor, the reinsurance provided by this Agreement shall be payable by the Reinsurer directly to the Company or to its liquidator, receiver or statutory successor on the basis of the liability of the Company under the contract or contracts reinsured. Subject to the right of offset and the verification of coverage, the Reinsurer shall pay its share of the loss without diminution because of the insolvency of the Company. The liquidator, receiver or statutory successor of the Company shall give written notice of the pendency of each claim against the Company on a policy or bond reinsured within a reasonable time after such claim is filed in the insolvency proceeding. During the pendency of such claim, the Reinsurer may, at its own expense, investigate such claim and interpose in the proceeding where such claim is to be adjudicated any defense or defenses which it may deem available to the Company, its liquidator or receiver or statutory successor. Subject to court approval, any expense thus incurred by the Reinsurer shall be chargeable against the Company as part of the expense of liquidation to the extent of such proportionate share of the benefit as shall accrue to the Company solely as a result of the defense undertaken by the Reinsurer. The reinsurance shall be payable as set forth above except where (i) the Agreement specifies another payee of such reinsurance in the event of the insolvency of the Company and (ii) the Reinsurer with the consent of the direct insureds has assumed such policy obligations of the Company as its direct obligations to the payees under such policies, in substitution for the obligations of the Company to such payees; or where the Reinsurer has guaranteed performance of a contract insuring against physical damage to property for the benefit of mortgagees or other loss payees named in this Agreement in accordance with Section 1114(c) of the New York Insurance Law. -9- 10 IN WITNESS WHEREOF the parties hereto have caused this Agreement to be executed in duplicate this day of , 19 . ACCEPTED: MERCHANTS MUTUAL INSURANCE COMPANY MERCHANTS INSURANCE COMPANY OF NEW HAMPSHIRE, INC. - ----------------------- - ----------------------- Attested by: AMERICAN RE-INSURANCE COMPANY --------------------------------- --------------------------------- Attested by: -10- 11 EXHIBIT A --------- CASUALTY EXCESS OF LOSS REINSURANCE COVER ----------------- Section 1 --------- COVER - ----- The Reinsurer agrees to reimburse the Company, on an excess of loss basis, for the amounts of ultimate net loss which the Company may pay as a result of losses occurring on and after 12:01 A.M., January 1, 1998, as respects the Company's policies in force as of said date and new and renewal policies becoming effective on and after said date, covering the Company's Casualty Business, subject to the limitations and exclusions hereinafter set forth. Section 2 --------- LIMITS OF COVER - --------------- A. With respect to the business covered under this Exhibit, the Reinsurer shall pay to the Company the amount of ultimate net loss each occurrence in excess of the Company Retention but not exceeding the Reinsurer's Limits of Liability as set forth in the Schedule of Reinsurance below.
SCHEDULE OF REINSURANCE - ----------------------------------------------------------------------- Company Retention Reinsurer's Limits of Liability Each Occurrence Each Occurrence - ----------------------------------------------------------------------- First Excess Second Excess Third Excess Cover Cover Cover $500,000 $1,500,000 $3,000,000 $5,000,000
B. If an occurrence takes place which involves the classes of business reinsured under this Exhibit and one risk reinsured under Exhibit B to this Agreement in combination, the Reinsurer shall pay to the Company the amount of ultimate net loss in excess of a Company Retention of $500,000 with respect to such occurrence, but not exceeding a Limit of Liability to the Reinsurer of $500,000. The Reinsurer's Limit of Liability specified in this Section shall be in addition to the Limits of Liability of the Reinsurer set forth in the sections entitled LIABILITY OF THE REINSURER of this Exhibit and said Exhibit B. -11- 12 Section 3 --------- COMPANY POLICY LIMITS - --------------------- For the purpose of determining the Company Retention and the Reinsurer's Limit of Liability with respect to each layer specified in this Exhibit, the limits of liability of the Company with respect to any one policy shall be deemed not to exceed:
(a) Automobile Bodily Injury Liability $1,000,000 each person $1,000,000 each occurrence (b) Automobile Property Damage Liability $1,000,000 each occurrence (c) Automobile Liability Combined Single Limit $1,000,000 each occurrence (d) Uninsured/Underinsured Motorists Coverage $1,000,000 each person $1,000,000 each occurrence (e) Personal Injury Protection Coverage $1,000,000 each occurrence (f) Other Bodily Injury Liability $2,000,000 each occurrence (g) Other Property Damage Liability $2,000,000 each occurrence (h) Other Liability Combined Single Limit $2,000,000 each occurrence (i) Section II Liability under Commercial Multiple Peril $2,000,000 each occurrence (j) Section II Liability under Businessowners $1,000,000 each occurrence (k) Section II Liability under Homeowners Multiple Peril $1,000,000 each occurrence (l) Section II Liability under Farmowners Multiple Peril $1,000,000 each occurrence (m) Employers' Liability (1) In all states with Statutory Limits Statutory Limits (2) In All Other States (i) Bodily Injury by Accident $1,000,000 each accident (ii) Bodily Injury by Disease $1,000,000 policy limit (iii) Bodily Injury by Disease $1,000,000 each employee
Section 4 --------- ULTIMATE NET LOSS - ----------------- A. The term "ultimate net loss" as used herein shall be understood to mean the sum actually paid by the Company in settlement of losses for which it is held liable, including 90% of any Extra Contractual Obligations and/or Excess Judgments and/or Declaratory Judgment Expenses, in accordance with their respective articles, after making proper deductions for all recoveries, salvages, and claims upon other reinsurance which inures to the benefit of the Reinsurer under this Agreement whether collectible or not; provided, however, that in the event of the insolvency of the Company, "ultimate net loss" shall mean the amount of loss which the Company has incurred or for which it is liable, and payment by the Reinsurer shall be made to the liquidator, receiver or statutory successor of the Company in accordance with the provisions of the Article entitled INSOLVENCY CLAUSE. -12- 13 B. All expenses incurred by the Company which are included as part of the policy limit under the Company's original policies reinsured hereunder shall be included in "ultimate net loss" as defined above. C. All office expenses of the Company and all salaries and expenses of its officials and employees shall be excluded under this Agreement, except that the Company may include the costs and expenses of its in-house counsel as provided in D. below. D. All expenses other than as provided in B. and C. above, including taxed court costs, prejudgment and postjudgment interest, and loss expenses incurred in investigation, adjustment and litigation, defense and settlement of claims made against the Company under its original policies reinsured hereunder, including the costs and expenses of the Company's in-house counsel while engaged in the litigation of claims covered hereunder, shall be apportioned in proportion to the respective interests of the parties hereto in the ultimate net loss. E. In the event a verdict or judgment is reduced by an appeal or a settlement, subsequent to the entry of a judgment, resulting in an ultimate saving on such verdict or judgment, or a judgment is reversed outright, the expense incurred in securing such final reduction or reversal shall (1) be prorated between the Reinsurer and the Company in proportion that each benefits from such reduction or reversal and the expense incurred up to the time of the original verdict or judgment shall be prorated in proportion to each party's interest in such verdict or judgment; or (2) when the terms and conditions of the Company's original policies reinsured hereunder include expenses as part of the policy limit, be added to the Company's ultimate net loss. Section 5 --------- DEFINITIONS - ----------- A. Casualty Business ----------------- This term shall mean insurance which is classified in the NAIC form of annual statement as Farmowners Multiple Peril (Section II), Homeowners Multiple Peril (Section II), Commercial Multiple Peril (Sections II and III, including Section II of Business Owners), Workers' Compensation, Other Liability, Automobile Liability, and Automobile Personal Injury Protection, and described in the manuals of the Insurance Services Office, or the standard workers' compensation form of policy, subject to the Section of this Exhibit entitled EXCLUSIONS, as respects losses occurring in the United States of America, its territories and possessions, and Canada. -13- 14 B. Company Retention ----------------- This term shall mean the amount the Company shall retain for its own account; however, this requirement shall be satisfied if this amount is retained by the Company or its affiliated companies under common management or common ownership. C. Occurrence ---------- This term shall mean each accident or occurrence or series of accidents or occurrences arising out of one event regardless of the number of policies involved, and as respects workers' compensation and employers' liability policies, regardless of the number of employees or employers involved, except as modified below: (1) As respects exposures reinsured hereunder other than occupational and other disease or cumulative injury under workers' compensation policies, all bodily injury or property damage arising out of continuous or repeated exposure to substantially the same general conditions shall be considered as arising out of one occurrence. The date of occurrence shall be deemed to be the following: (i) As respects a loss involving one or more policies written on an occurrence basis, the date on which bodily injury or property damage occurs. (ii) As respects a loss involving one or more policies written on a claimsmade basis, the date when notice of claim is received and recorded by the Company or the insured, whichever comes first, and any related claims reported subsequent to such date shall be included in such loss. However, if notice of claim is received and recorded by the Company or the insured during an Extended Reporting Period, the date of occurrence shall be deemed to be the last day of the policy period. (iii) As respects a loss involving one or more policies written on an occurrence basis and one or more policies written on a claimsmade basis, the date on which bodily injury or property damage occurs, and any related claims reported subsequent to such date shall be included in such loss whether they are covered under occurrence or claims-made policies. -14- 15 (2) As respects an occupational or other disease or cumulative injury under workers' compensation or employers' liability policies for which the employer is liable: (i) Which arises from a specific sudden and accidental event limited in time and place, such occupational or other disease suffered by one or more employees of one or more employers shall be deemed to be an occurrence within the meaning of this Exhibit and the date of occurrence shall be deemed to be the date of the sudden and accidental event. (ii) Which does not arise from a specific sudden and accidental event limited in time and place, such occupational or other disease or cumulative injury shall be deemed to be an occurrence within the meaning of this Exhibit, and the date of occurrence shall be deemed to be the date of the beginning of the disability for which compensation is payable if the case is compensable under the Workers' Compensation law; or the date that disability due to said disease actually began if the case is not compensable under the Workers' Compensation law. Each case of an employee contracting such occupational or other disease or cumulative injury for which the employer insured by the Company is held liable shall be considered a separate occurrence regardless of the date of loss. Section 6 --------- EXCLUSIONS - ---------- This Exhibit shall not apply to: A. Business accepted by the Company as reinsurance from other insurers other than its affiliates; B. Nuclear incident per the Nuclear Incident Exclusion Clause Liability Reinsurance attached hereto; C. Policies covering liability of any insurer or reinsurer for its acts or omissions in the negotiation, settlement, or defense of claims or any act or omission in dealings with its policyholders; D. Any loss or liability accruing to the Company directly or indirectly from any insurance written by or through any pool or association including pools or associations in which membership by the Company is required under any statutes or regulations and including automobile assigned risk -15- 16 pools and voluntary or involuntary market assistance programs; however, this exclusion shall not apply to individual risks under this Agreement which are assigned to the Company as a result of the business reinsured hereunder; E. Any liability of the Company arising from its participation or membership in any insolvency fund; F. Any loss or damage which is occasioned by war, invasion, hostilities, acts of foreign enemies, civil war, rebellion, insurrection, military or usurped power, or martial law or confiscation by order of any government or public authority; however, this exclusion shall not apply to workers' compensation and employers liability nor to any policy which contains a standard war exclusion; G. Business written on a coindemnity basis not controlled by the Company; H. Business written to apply in excess of a deductible or self insured amount of more than $25,000 or business written to apply specifically in excess over underlying insurance; I. Automobile liability insurance relating to the ownership, maintenance (but this shall not apply to Garage Liability or Garagekeepers Liability), or use of: (1) Emergency vehicles including police and fire department vehicles; however, this exclusion shall not apply to renewal business; (2) Automobiles used in organized speed contests; (3) Vehicles leased or rented to others, except customer rental exposures for garage risks; (4) Commercial automobiles, as defined in the manuals of the Insurance Services Office, which customarily operate beyond a 500 mile radius; (5) Public automobiles, other than school or church buses or funeral home vehicles, as defined in the manuals of the Insurance Services Office; (6) Motor vehicles used for transporting explosives, munitions, corrosives, flammable and nonflammable gas, flammable liquid, poison, radioactive materials and hazardous waste; -16- 17 J. Liability insurance written by the aviation underwriting unit of the Company, howsoever styled; K. Liability insurance issued to any state or governmental agency or any political subdivision whatsoever; however, this exclusion shall not apply to school districts and school boards nor to renewal business. This exclusion shall also not apply to Owners and Contractors Protective policies issued to any such entities; L. Liability insurance relating to premises or operations involving: (1) Aircraft or airports, as respects coverage for all liability arising out of the ownership, maintenance, or use of any aircraft or flight operations; (2) Amusement parks or devices, carnivals or circuses, sports or other entertainment events, arenas, grandstands, or stadiums; however, this exclusion shall not apply to coverage for locations or events with daily admissions of 1,000 or less or seating capacity of 1,000 or less; (3) Manufacturing, packing, handling, shipping, or storage of explosives, ammunitions, fuses, arms, magnesium, fireworks, nitroglycerine, celluloid, pyroxylin or explosive substances intended for use as an explosive; however, this exclusion shall not apply to incidental handling and storage in connection with the sale of such substances; (4) Gas or public utility companies, gas or public utility works, or gas lease operations; (5) Production, refining, handling, shipping, or storage of natural or artificial fuel gasses, synthetic or coal or shale based fuel, butane, propane, gasoline, or liquefied petroleum gas; however this exclusion shall not apply to gasoline service stations, convenience stores and fuel oil dealers; (6) Oil or gas pipelines, wells, or drilling operations; (7) Railroad operations; however, this exclusion shall not apply to Railroad Protective policies; (8) Ship building, boat manufacturing, ship repair yards, dry docks, stevedoring, or watercraft; however, this exclusion shall not apply to watercraft commonly insured under homeowners polices, nor to -17- 18 non-owned watercraft up to 51 feet in length for commercial policies; (9) Underground work, including underground mining and quarrying, tunneling, and subway construction; however, this exclusion shall not apply to underground work up to a depth of 12 feet; (10) Offshore and subaqueous work; (11) Wrecking or demolition of structures over 3 stories in height, or marine wrecking; (12) Chemical manufacturing; however, this exclusion shall not apply to operations with annual gross receipts from chemical manufacturing of $500,000 or less; M. Liability insurance relating to products or completed operations involving the manufacture or importation of: (1) Cosmetics, hair, and skin products, but this exclusion shall not apply if the total annual receipts from this exposure are $250,000 or less; (2) Drugs, pharmaceuticals, and agricultural chemicals; (3) Aircraft, aircraft parts, or aircraft engines, all motorized vehicles, or mobile equipment (critical parts only). "Critical parts" shall mean 1. Safety equipment, including but not limited to airbags, and seat belts; but "critical parts" shall not include mirrors or other such items; 2. Operating parts, including but not limited to brakes, tires, suspension, engines, head lights, and steering columns; but "critical parts" shall not include steering wheel, gearshift knobs, seat upholstery or similar items; (4) Heavy machinery and equipment, home power tools, or oil drilling equipment: N. Insurance covering damages claimed for the withdrawal, inspection, repair, replacement, or loss of use of the insured's products or of any property of which such products form a part, or if such products or property are withdrawn from the market or from use because of any -18- 19 known or suspected defect or deficiency therein; O. Malpractice insurance, directors and officers liability insurance, or any other form of errors and omissions or professional liability insurance; however, this exclusion shall not apply to druggists operating outside the State of Florida, funeral directors, veterinarians', beauty and barber shops', hearing aid service specialists', cemetery operators' liability, opticians' or printers' liability business, nor to employee benefits liability business; P. Insurance written for governmental bodies to afford protection against liability arising out of riot, civil commotion, or mob action or out of any act or omission in connection with the prevention or suppression of any riot, civil commotion, or mob action; Q. Liability insurance relating to or involving satellites, spacecraft, and launch vehicles, including cargo and freight carried therein, in all phases of operation (including but not limited to manufacturing, transit, pre-launch, launch and inorbit); R. Pollution liability insurance or environmental impairment liability, howsoever styled; however, this exclusion shall not apply to herbicide or pesticide use by landscapers and/or gardeners in commercial landscaping or gardening operations; S. Pollution under any commercial multiple peril policy, farmowners multiple peril policy, farm liability policy or any other commercial other liability policy written by the Company which does not contain the pollution exclusion set forth in ISO Commercial General Liability Form CG 00 01 (Ed. 11/88) or as subsequently amended or under any garage liability policy written by the Company which does not contain the pollution exclusion set forth in ISO Garage Coverage Form CA 00 05 (Ed. 1/87) or as subsequently amended. However, this exclusion does not apply to: (1) pollution coverage under the Motor Carriers Act of 1980 as contained within the MCS-90 endorsement attached to the Company's commercial automobile liability policies, or (2) any risk located in a jurisdiction which has not approved the Insurance Services Office exclusion or where other regulatory constraints prohibit the Company from attaching such endorsement. If the Company elects to file an endorsement independent of ISO, such endorsement will be deemed a suitable substitute provided the Company has submitted the wording to the Reinsurer and received the Reinsurer's prior approval. -19- 20 T. Workers' compensation and employers' liability insurance with respect to operations principally involving: (1) Aircraft flight and ground operations or operations in which the flying hazard is a major part; (2) Amusement parks or devices, exhibitions (including fireworks), carnivals or circuses, sports events and/or participants; however, this exclusion shall not apply to coverage for locations or events with daily admissions of 1,000 or less or seating capacity of 1,000 or less; (3) Manufacturing, packing, handling, shipping, or storage of explosives, substances intended for use as an explosive, ammunitions, fuses, arms, magnesium, propellant charges, detonating devices, fireworks, nitroglycerine, celluloid, or pyroxylin; however, this exclusion shall not apply to the incidental packing, handling or storage of same in connection with the sale of such substances; (4) Gas companies, dealers, or distributors, except those in the gasoline service station, convenience store or fuel oil dealer business; oil or gas operators, lease operators or contractors; oil or gas well works; oil or gas pipeline construction or operations; oil rig and derrick work; onshore or offshore gas or oil drilling operations; (5) Manufacturing, packing, handling, shipping or storage of natural gas or artificial fuel gasses, butane, propane, gasoline, or liquified petroleum gas; however, this exclusion shall not apply to the incidental packing, handling or storage of same in connection with the sale of such substances: (6) Railroad operation or construction, except this exclusion shall not apply if the excluded exposure is not normally associated with the insured's operation and does not present a larger exposure than the overall unexcluded portion of the risk; (7) Maritime or federal employments; steamship lines, agencies, or stevedoring, navigation or operation of vessels; operation of drydocks; and including all United States Longshoremen's and Harbor Workers' exposures, except this exclusion shall not apply if the excluded exposure (a) is endorsed on an "if any" basis or (b) is not normally associated with the insured's operation and does not -20- 21 present a larger exposure than the overall unexcluded portion of the risk; (8) Subway construction, shaft sinking, or tunneling; (9) Wrecking or demolition of vessels or buildings or structures of more than three stories in height; (10) Underground mining, strip mining, or quarrying; (11) Subaqueous work; (12) Caisson or coffer dam work; dam, dike, lock, or revetment construction: (13) Chemical manufacturing; however, this exclusion shall not apply to operations with annual gross receipts from chemical manufacturing of $500,000 or less; (14) Nuclear Regulatory Commission projects or operations conducted under license from the Nuclear Regulatory Commission; (15) Asbestos removal contractors; (16) Firefighters and police officers. If the Company provides insurance for an insured with respect to the ownership, maintenance, or use of items listed in exclusions I.(l) through I.(6) and if such ownership maintenance, or use constitutes only a minor and incidental part of the total ownership, maintenance, or use of such items of the insured, such exclusion(s) shall not apply. If the Company provides insurance for an insured with respect to any premises, operations, products, or completed operations listed in exclusions L. and M., except exclusions L.(3) and L.(4), and if such premises, operations, products, or completed operations constitute only a minor incidental part of the total premises, operations, products, or completed operations of the insured, such exclusion(s) shall not apply. If the Company is bound, without the knowledge of and contrary to the instructions of the Company's supervisory underwriting personnel, on any business falling within the scope of one or more of the exclusions set forth in this Section, these exclusions, except A. through G., L.(3), L.(4), N. through R., T.(3) and T.(4) shall be suspended with respect to such business until the greater of 30 days or the minimum period of time required by statute after an underwriting supervisor of the Company acquires knowledge of such business. -21- 22 Section 8 --------- REINSURANCE PREMIUM - ------------------- A. First Excess Cover: (1) With respect to business in force at the effective time and date of this Exhibit, the Company shall pay the Reinsurer a reinsurance premium equal to the product of the applicable First Excess reinsurance rate set forth in Appendix A attached hereto and the Company's unearned premium for the classes of business reinsured hereunder, calculated on the monthly pro rata basis as of the effective time and date of this Exhibit. (2) With respect to business becoming effective at and after the effective time and date of this Exhibit, the Company shall pay the Reinsurer a reinsurance premium equal to the product of the applicable First Excess reinsurance rate set forth in Appendix A attached hereto and the Company's written premium for the classes of business reinsured hereunder. B. Second Excess Cover: (1) With respect to business in force at the effective time and date of this Exhibit, the Company shall pay the Reinsurer a reinsurance premium equal to 0.19% of the Company's unearned premium for the classes of business reinsured hereunder, calculated on the monthly pro rata basis as of the effective time and date of this Exhibit. (2) With respect to business becoming effective at and after the effective time and date of this Exhibit, the Company shall pay the Reinsurer a reinsurance premium equal to 0.19% of the Company's written premium for the classes of business reinsured hereunder, subject to an annual minimum and deposit reinsurance premium of $200,000. C. Third Excess Cover: Unless otherwise mutually agreed, the Company shall pay the Reinsurer an annual reinsurance premium of $40,000 for each calendar year during which the Third Excess remains in force. D. For the purpose of the calculation of the reinsurance premium for business owners policies reinsured hereunder, the reinsurances rates in A. and B. above shall be applied against 40% of the business owners policy premium -22- 23 unearned or written, as applicable. Section 9 --------- CONTINGENT COMMISSION - --------------------- A. The Reinsurer shall pay the Company a contingent commission equal to 50% of the net profit, if any, accruing to the Reinsurer during each accounting period defined herein. The first accounting period shall be from the effective date of this Agreement through December 31, 2000 and each subsequent 36-month period shall be a separate accounting period. However, if this Agreement is terminated, the final accounting period shall be from the beginning of the then current accounting period through the date of termination if this Agreement is terminated on a "cutoff" basis, or the end of the runoff period if this Agreement is terminated on a "runoff" basis. B. The Reinsurer's net profit for each accounting period shall be calculated in accordance with the following formula, it being understood that a positive balance equals net profit and a negative balance equals net loss: (1) Premiums earned for the accounting period; less (2) Ceding commission allowed the Company on premiums earned for the accounting period; less (3) Expenses incurred by the Reinsurer at 12.5% of premiums earned for the accounting period; less (4) Losses incurred for the accounting period; less (5) The Reinsurer's net loss, if any, from the immediately preceding accounting period. C. The Company shall calculate and report the Reinsurer's net profit within 60 days after the end of each 12-month period within each accounting period, within 60 days after the end of each accounting period, and within 60 days after the end of each December 31 thereafter until all losses subject hereto have been finally settled. Each such calculation shall be based on cumulative transactions hereunder from the beginning of the accounting period through the date of calculation, including the Reinsurer's net loss, if any, from the immediately preceding accounting period. As respects the initial calculation referred to above, any contingent commission shown to be due the Company shall be paid by the Reinsurer as promptly as possible after receipt and verification of the Company's report. As respects each subsequent calculation, any additional contingent commission shown to be due the Company shall be paid by the Reinsurer as promptly as possible after receipt and verification -23- 24 of the Company's report. Any return contingent commission shown to be due the Reinsurer shall be paid by the Company with its report. D. "Premiums earned" as used herein shall mean ceded unearned premiums at the beginning of the accounting period, plus ceded net written premiums during the period, less ceded unearned premiums at the end of the period. E. "Losses incurred" as used herein shall mean ceded losses and loss adjustment expense paid as of the effective date of calculation, plus the ceded reserves for losses and loss adjustment expense outstanding as of the same date, all as respects losses occurring during the accounting period under consideration. Section 10 ---------- REPORTS AND REMITTANCES - ----------------------- A. Reinsurance Premium ------------------- (1) In Force Premium (Applicable to the First and Second Excess Covers only): Within 45 days after the commencement of this Exhibit, the Company shall render to the Reinsurer a report of the reinsurance premium with respect to the business of the Company in force at the effective time and date of this Exhibit, summarizing the reinsurance premium by line of insurance, by term, and by month and year of expiration; and the amount due the Reinsurer shall be remitted within the earlier of: (a) 180 days after the commencement of this Exhibit, or (b) 5 days after receipt of General Reinsurance Corporation's return premium under the prior casualty reinsurance program. (2) New and Renewal Premium: a. First Excess Cover: Within 25 days after the close of each month, the Company shall render to the Reinsurer a report of the reinsurance premium for the month with respect to business of the Company written during the month, summarizing the reinsurance premium by line of insurance; and the amount due either party shall be remitted within 60 days after the close of the month. Within 25 days after the close of each calendar quarter, the Company shall render to the Reinsurer a report of the -24- 25 reinsurance premium unearned by line of insurance and the contribution for the quarter to the reinsurance premium in force by line of insurance, by term and by month and year of expiration. b. Second Excess Cover Within 25 days after the beginning of each calendar quarter, the Company shall pay to the Reinsurer one quarter of the annual minimum and deposit reinsurance premium stipulated in subparagraph B.2 of the section entitled REINSURANCE PREMIUM. Within 60 days after the close of each calendar year, the Company shall render to the Reinsurer a report of the premium written by the Company on the classes of business reinsured hereunder during such calendar year. The Company shall calculate the reinsurance premium thereon and remit to the Reinsurer the amount of reinsurance premium, if any, in excess of the annual minimum and deposit reinsurance premium previously paid. c. Third Excess Cover Within 25 days after the beginning of each calendar quarter, the Company shall pay to the Reinsurer one quarter of the annual reinsurance premium stipulated in subparagraph C. of the section entitled REINSURANCE PREMIUM. B. Claims and Losses ----------------- The Company shall report promptly to the Reinsurer each claim or loss for which the Company's estimated amount of net loss is 50% or more of the amount of the Company Retention and shall also report all cases of serious injury which, regardless of considerations of liability or coverage, might involve this reinsurance, including but not limited to the following: (1) Cord injury paraplegia, quadriplegia; (2) Amputations requiring a prosthesis; (3) Brain damage affecting mentality or central nervous system such as permanent disorientation, behavior disorder, personality change, seizures, motor deficit, inability to speak (aphasia), hemiplegia or -25- 26 unconsciousness (comatose); (4) Blindness; (5) Burns involving over 10% of body with third degree or 30% of body with second degree; (6) Multiple fractures involving more than one member or non-union; (7) Fracture of both heel bones (fractured bilateral or calcis); (8) Nerve damage causing paralysis and loss of sensation in arm and hand (brachial plexus nerve damage); (9) Massive internal injuries affecting body organs; (10) Injury to nerves at base of spinal canal (Cauda Equina) or any other back injury resulting in incontinence of bowel and/or bladder; (11) Fatalities; (12) Any other serious injury which, in the judgment of the Company, might involve the Reinsurer. The Company shall advise the Reinsurer of the estimated amount of ultimate net loss and loss expense in connection with each such claim or loss and of any subsequent changes in such estimates. Upon receipt of a definitive statement of ultimate net loss and loss expense from the Company, the Reinsurer shall pay promptly to the Company the Reinsurer's portion of ultimate net loss and Reinsurer's portion of loss expense, if any. Any subsequent changes shall be reported by the Company to the Reinsurer and the amount due either party shall be remitted promptly. C. General ------- In addition to the reports required in A. and B. above, the Company shall furnish such other information as may be required by the Reinsurer for the completion of the Reinsurer's quarterly and annual statements and internal records. All reports shall be rendered in forms acceptable to the Company and the Reinsurer. -26- 27 Section 11 ---------- REINSTATEMENT - ------------- A. First Excess Cover In the event of any portion of the liability under the First Excess Cover being exhausted by loss, the amount so exhausted is automatically reinstated from the time of the occurrence of the loss without payment of additional premium. Nevertheless, the Reinsurer's liability shall not exceed $1,500,000 in respect of all losses from any one occurrence. B. Second Excess Cover In the event of any portion of the liability under the Second Excess Cover being exhausted by loss, the amount so exhausted is automatically reinstated from the time of the occurrence of the loss without payment of additional premium. Nevertheless, the Reinsurer's liability shall not exceed $3,000,000 in respect of all losses from any one occurrence. C. Third Excess Cover The limit of liability of the Reinsurer under the Third Excess Cover with respect to each occurrence shall be reduced by an amount equal to the amount of liability paid by the Reinsurer, but that part of the liability of the Reinsurer that is so reduced shall be automatically reinstated, subject to the maximum payment of $20,000,000 with respect to all occurrences taking place during each calendar year that the Third Excess Cover is in effect. In consideration of this automatic reinstatement, the Company shall pay to the Reinsurer: (a) For the first $5,000,000 so reinstated an additional reinsurance premium which shall be the product of the annual reinsurance premium set forth in the section entitled REINSURANCE PREMIUM and the amount so reinstated divided by $5,000,000, (b) For the next two full reinstatements of $5,000,000 each, an additional reinsurance premium which shall be the product of 50% of the annual reinsurance premium set forth in the section entitled REINSURANCE PREMIUM and the amount so reinstated divided by $5,000,000. The reinsurance premium so developed for each amount reinstated shall be in addition to the reinsurance premium set forth in the section entitled REINSURANCE PREMIUM, and shall be paid by the Company -27- 28 immediately following loss payment by the Reinsurer. If at the time of loss payment, the adjusted annual reinsurance premium is unknown, calculation of such additional reinsurance premium shall be based upon the annual minimum and deposit reinsurance premium subject to adjustment when the adjusted annual reinsurance premium is established. Section 12 ---------- COMMENCEMENT AND TERMINATION - ---------------------------- A. As respects policies written on a claimsmade basis, this Exhibit shall apply to claims received and recorded by the Company or the insured at and after 12:01 A.M., January 1, 1998, provided that each such policy includes a specific retroactive date and the occurrence which results in each such claim takes place on or after such retroactive date, and provided further that such retroactive date is on or after the inception date of the first of one or more consecutive claimsmade policies issued by the Company or another insurer(s) to the named insured. However, this Exhibit shall not apply to claims received and recorded by the Company or the insured during any Extended Reporting Period in force at such time and date. As respects policies written on an occurrence basis, this Exhibit shall apply to claims and losses resulting from occurrences taking place at and after 12:01 A.M., January 1, 1998. B. This Exhibit may be terminated by either party sending to the other, by registered mail to its principal office, notice stating the time and date when, not less than 90 days after the date of mailing of such notice, termination shall be effective. C. Upon termination of this Exhibit, the Reinsurer's liability hereunder will terminate on a cut-off basis. However, the Company may elect to have the Reinsurer's liability terminate on a run-off basis. The phrases "cut-off basis" and "run-off basis" shall have the meanings set forth below: (1) Cut-Off Basis: As respects policies written on a claims-made basis, the Reinsurer shall not be liable for claims received and recorded by the Company or the insured at and after the effective time and date of termination, unless such claim is received and recorded by the Company or the insured during an Extended Reporting Period in force or provided under policy conditions in effect at the time and date of termination. As respects policies written on an occurrence basis, the Reinsurer shall not be liable for claims and losses resulting from occurrences taking place at and after the effective time and date of termination. -28- 29 (2) Run-Off Basis: The Reinsurer shall continue to be liable, with respect to policies in force at the time and date of termination, for occurrences taking place until the expiration, cancellation, or next anniversary date, not to exceed one year, of each such policy of the Company, whichever occurs first, provided that with respect to policies written on a claims-made basis, the claim is received and recorded by the Company or the insured before such expiration, cancellation, or next anniversary date. However, if the Company provides an Extended Reporting Period within one year after the termination date of this Exhibit on any claims-made policy which is in force at such termination date or if an Extended Reporting Period is in force at the time and date of termination, the Reinsurer shall continue to be liable for claims received and recorded by the Company or the insured during such Extended Reporting Period, provided always that the occurrence which results in any such claim takes place prior to the expiration or cancellation date of the policy. For the First and Second Excess Covers, the reinsurance premium for policies in force at the time and date of termination shall be calculated by applying the provisions of the Section entitled REINSURANCE PREMIUM to the quarterly earned premiums that derive from the unearned premium applicable to policies in force at the time and date of termination, provided such reinsurance premium is at least 50% of the reinsurance premium for the prior calendar year. Further, the reinsurance premium for any unlimited Extended Reporting Period provided within one year after the termination date of this Exhibit on any claims-made policy which is in force at such termination date shall be calculated in accordance with the provisions of the Section entitled REINSURANCE PREMIUM. For the Third Excess Cover, the run-off reinsurance premium shall be mutually agreed by the parties. D. When all reinsurance is expired or terminated, the Reinsurer shall return to the Company the reinsurance premium unearned, if any, calculated on the monthly pro rata basis, less the commission previously allowed thereon. -29- 30 APPENDIX A ---------- MERCHANTS MUTUAL INSURANCE COMPANY MERCHANTS INSURANCE COMPANY OF NEW HAMPSHIRE, INC. CASUALTY EXCESS OF LOSS REINSURANCE EXHIBIT ------------------------------------------- FIRST EXCESS COVER REINSURANCE RATES
Class of Business Rate - ----------------------------------------------------- Private Passenger Automobile 0.05% Liability (including PIP) Commercial Automobile Liability 1.76% (including PIP) Workers' Compensation and 2.80% Employers' Liability Commercial Multiple Peril 3.07% (Section II) and Business Owners (Section II) Homeowners Multiple Peril No Charge (Section II) and Farmowners Multiple Peril (Section II)
-30- 31 EXHIBIT B --------- PROPERTY PER RISK EXCESS OF LOSS REINSURANCE COVER ----------------- Section 1 --------- COVER - ----- The Reinsurer agrees to reimburse the Company, on an excess of loss basis, for the amounts of ultimate net loss which the Company may pay as a result of losses occurring on and after 12:01 A.M., January 1, 1998, as respects: (1) First Excess Cover: the Company's policies in force as of said date, and new and renewal policies becoming effective on and after said date; (2) Second Excess Cover: new and renewal policies of the Company becoming effective on and after said date, covering the Company's Property Business, subject to the limitations and exclusions set forth. Section 2 --------- LIMITS OF COVER - --------------- A. With respect to the business covered under this Exhibit, the Reinsurer shall pay to the Company the amount of ultimate net loss each risk, each occurrence sustained by the Company in excess of the Company Retention but not exceeding the Reinsurer's Limit of Liability as set forth in the Schedule of Reinsurance below. The Reinsurer's Limit of Liability for the First Excess Cover of this Exhibit shall not exceed a total payment of $3,000,000 on all risks involved in one occurrence. -31- 32
SCHEDULE OF REINSURANCE - -------------------------------------------------------------------- COMPANY RETENTION REINSURER'S LIMIT OF LIABILITY EACH RISK, EACH EACH RISK, EACH OCCURRENCE OCCURRENCE - -------------------------------------------------------------------- FIRST SECOND EXCESS COVER EXCESS COVER $ 500,000 $1,500,000 $8,000,000 - --------------------------------------------------------------------
B. All insurance written under one or more policies of the Company against the same peril on the same risk shall be combined, and Company Retention and Reinsurer's Limit of Liability shall be determined on the basis of the sum of all insurance against the same peril and on the same risk which is in force at the time of a claim or loss. C. If an occurrence takes place which involves one risk reinsured under this Exhibit and the classes of business reinsured under Exhibit A to this Agreement in combination, the provisions of paragraph C. of the section entitled LIMITS OF COVER of said Exhibit A shall apply. Section 3 --------- ULTIMATE NET LOSS - ----------------- A. The term "ultimate net loss" as used herein shall be understood to mean the sum actually paid by the Company in settlement of losses for which it is held liable, including 90% of any Extra Contractual Obligations and/or Excess Judgments and/or Declaratory Judgment Expenses, in accordance with their respective articles, after making proper deductions for all recoveries, salvages, and claims upon other reinsurance which inures to the benefit of the Reinsurer under this Agreement whether collectible or not; provided, however, that in the event of the insolvency of the Company, "ultimate net loss" shall mean the amount of loss which the Company has incurred or for which it is liable, and payment by the Reinsurer shall be made to the liquidator, receiver or statutory successor of the Company in accordance with the provisions of the Article entitled INSOLVENCY CLAUSE. B. All expenses incurred by the Company which are included as part of the policy limit under the Company's original policies reinsured hereunder shall be included in "ultimate net loss" as defined above. -32- 33 C. All office expenses of the Company and all salaries and expenses of its officials and employees shall be excluded under this Agreement, except that the Company may include the costs and expenses of its in-house counsel as provided in D. below. D. All expenses other than as provided in B. and C. above, including taxed court costs, prejudgment and postjudgment interest, and loss expenses incurred in investigation, adjustment and litigation, defense and settlement of claims made against the Company under its original policies reinsured hereunder, including the costs and expenses of the Company's in-house counsel while engaged in the litigation of claims covered hereunder, shall be apportioned in proportion to the respective interests of the parties hereto in the ultimate net loss. E. In the event a verdict or judgment is reduced by an appeal or a settlement, subsequent to the entry of a judgment, resulting in an ultimate saving on such verdict or judgment, or a judgment is reversed outright, the expense incurred in securing such final reduction or reversal shall (1) be prorated between the Reinsurer and the Company in proportion that each benefits from such reduction or reversal and the expense incurred up to the time of the original verdict or judgment shall be prorated in proportion to each party's interest in such verdict or judgment; or (2) when the terms and conditions of the Company's original policies reinsured hereunder include expenses as part of the policy limit, be added to the Company's ultimate net loss. F. Recoveries from catastrophe reinsurance shall be deemed not to reduce the amount required with respect to the Company Retention. Section 4 --------- DEFINITIONS - ----------- A. Property Business ----------------- This term shall mean insurance which is classified in the NAIC form of annual statement as Fire, Allied Lines, Farmowners Multiple Peril (Section I), Homeowners Multiple Peril (Section I), Commercial Multiple Peril (Section I including Section I of Business Owners), Inland Marine, and Automobile Physical Damage (including collision, water damage, fleet dealers' and garagekeepers' legal liability) except those lines specifically excluded in the section entitled EXCLUSIONS, on risks wherever located in the United States of America, its territories and possessions, and Canada. B. Company Retention ----------------- This term shall mean the amount the Company shall retain for its own -33- 34 account; however, this requirement shall be satisfied if this amount is retained by the Company or its affiliated companies under common management or common ownership. C. Property Risk ------------- The Company shall establish what constitutes one risk, provided: (1) a building and its contents, including time element coverages, shall never be considered more than one risk: (2) when two or more buildings and their contents are situated at the same general location, the Company shall identify on its records at the time of acceptance by the Company those individual buildings and their contents that are considered to constitute each risk; if such identification is not made, each building and its contents shall be considered to be a separate risk. D. Building -------- This term shall mean each structure that is considered by the local fire insurance rating organization to be a separate building for rate making purposes. With reference to structures not rated specifically by the local fire insurance rating organization, the term building shall mean each separately roofed structure enclosed within exterior walls. E. Automobile Physical Damage Risk ------------------------------- The Company shall establish what constitutes one automobile physical damage risk, provided: (1) a tractor and trailer(s) or a tractor and semi-trailer(s) shall never be considered more than one risk; (2) with respect to fleet dealers' business and garage keepers legal liability business, all vehicles housed in one building shall never be considered more than one risk; (3) with respect to fleet dealers' business and garage keepers legal liability business, any location where all vehicles are situated out-of-doors shall never be considered more than one risk. F. Occurrence ---------- This term shall mean each occurrence or series of occurrences arising out -34- 35 of one event. Section 5 --------- EXCLUSIONS - ---------- This Exhibit shall not apply to: A. Reinsurance accepted by the Company other than: (1) Facultative reinsurance on a share basis of risks accepted individually and not forming part of any agreement, or (2) Local agency reinsurance on a share basis accepted in the normal course of business, or (3) From its affiliates; B. Nuclear incident per the Nuclear Incident Exclusion - Physical Damage Reinsurance attached hereto; C. Any loss or liability accruing to the Company directly or indirectly from any insurance written by or through any pool or association including pools or associations in which membership by the Company is required under any statutes or regulations; however, this exclusion shall not apply to individual risks under this Agreement which are assigned to the Company as a result of the business reinsured hereunder; D. Any liability of the Company arising from its participation or membership in any insolvency fund; E. Any loss or damage which is occasioned by war, invasion, hostilities, acts of foreign enemies, civil war, rebellion, insurrection, military or usurped power, or martial law or confiscation by order of any government or public authority; however, this exclusion shall not apply to workers' compensation and employers liability nor to any policy which contains a standard war exclusion; F. Policies written to apply in excess of underlying insurance or policies written with a deductible or franchise of more than $25,000; however, this exclusion shall not apply to policies which provide a percentage of deductibles or franchise in connection with windstorm; G. Insurance against earthquake, except when written in conjunction with fire and otherwise eligible perils; -35- 36 H. Insurance on growing crops; I. Insurance against flood, surface water, waves, tidal water or tidal wave, overflow of streams or other bodies of water or spray from any of the foregoing, all whether driven by wind or not, except when written in conjunction with fire and otherwise eligible perils; J. Business classified as fidelity; K. Liability under coverage afforded for loss or damage resulting from failure to account or pay for any goods or merchandise sold on credit, delivered under deferred payment agreements, consigned for sale, or delivered under any trust or floor plan agreements, except under standard accounts receivable policies; L. Any loss or damage caused by or resulting from explosion, rupture, or bursting of steam boilers, steam pipes, steam turbines, steam engines, or rotating parts of machinery caused by centrifugal force; if owned by, leased by, or actually operated under the control of the insured. This exclusion shall not apply to ensuing loss by fire not otherwise excluded; M. Mortgage impairment insurance and similar kinds of insurance, howsoever styled, providing coverage to an insured with respect to its mortgagee interest in property or its owner interest in foreclosed property; N. Difference in conditions insurance and similar kinds of insurance, howsoever styled, except when written in conjunction with fire and otherwise eligible perils; O. Risks which have a total insurable value of more than $250,000,000; P. Any collection of fine arts with an insurable value of $5,000,000 or more; Q. Mobile homes; however, this exclusion shall not apply to dealers' physical damage renewal business; R. Inland marine business with respect to the following: (1) All bridges and tunnels; (2) Cargo insurance when written as such with respect to ocean, lake, or inland waterways vessels, except transit insurance with a limit of $100,000 each or less; (3) Commercial negative film insurance and cast insurance; -36- 37 (4) Oil drilling rigs; (5) Furriers' customers policies; (6) Garment contractors policies; (7) Insurance on livestock under so-called "mortality policies"; (8) Jewelers block policies and furriers' block policies; (9) Mining equipment while underground; (10) Motor truck cargo insurance written for common carriers operating beyond a radius of 300 miles; (11) Radio and television broadcasting towers in excess of 100 feet in height; (12) Registered mail insurance when the limit of any one addressee on any one day is more than $50,000; (13) Watercraft, other than watercraft insured under a standard homeowners policy and non-owned watercraft up to 51 feet in length for commercial policies; S. Loss of, damage to, or failure of, or consequential loss resulting therewith (including but not limited to earnings and extra expense) of satellites, spacecraft, and launch vehicles, including cargo and freight carried therein, in all phases of operation (including but not limited to manufacturing, transit, pre-launch, launch, and in orbit); T. Coverage afforded by ISO Pollutant Clean Up and Removal Additional Aggregate Limit of Insurance Endorsement CP 04 07 (Ed. 4/86) or as subsequently amended or by any similar endorsement affording such coverage; U. Pollutant clean up or removal under any commercial property policy or any inland marine policy written by the Company which does not contain ISO ChangesPollutants Endorsement CP 01 86 (Ed. 4/86) or as subsequently amended; however, this exclusion does not apply to any risk located in a jurisdiction which has not approved the Insurance Services Office exclusion or where other regulatory constraints prohibit the Company from attaching such endorsement. If the Company elects to file -37- 38 an endorsement independent of ISO, such endorsement will be deemed a suitable substitute provided the Company has submitted the wording to the Reinsurer and received the Reinsurer's prior approval. If the Company is bound, without the knowledge of and contrary to the instructions of the Company's supervisory underwriting personnel, on any business falling within the scope of one or more of the exclusions set forth in this Section, these exclusions, except A. through F., J., K., P., S., T and U. shall be suspended with respect to such business until 30 days after an underwriting supervisor of the Company acquires knowledge of such business. Section 7 --------- REINSURANCE PREMIUM - ------------------- The Company shall Pay to the Reinsurer: A. First Excess Cover: (1) With respect to business becoming in force at the effective time and date of this Exhibit: a. 0.36% of the Company's unearned premium on homeowners multiple peril (Section I) after deducting that portion, if any, paid for share reinsurance, calculated on the monthly pro rata basis as of the effective time and date of this Exhibit; and b. 4.86% of the Company's unearned premium on all other classes of business reinsured hereunder (except automobile physical damage), after deducting that portion, if any, paid for share reinsurance, calculated on the monthly pro rata basis as of the effective time and date of this Exhibit. (2) With respect to business becoming effective at and after the effective time and date of this Exhibit: a. 0.36% of the Company's written premium on homeowners multiple peril (Section I) after deducting that portion, if any, paid for share reinsurance; and b. 4.86% of the Company's written premium on all other classes of business reinsured hereunder (except automobile physical damage), after deducting that portion, if any, paid for share reinsurance. B. Second Excess Cover: -38- 39 For each risk ceded hereunder, the Company shall pay to the Reinsurer a reinsurance premium equal to the product of the applicable reinsurance rate set forth in Appendix B attached hereto and the Company's written premium for the risk being reinsured. The applicable reinsurance rate shall be determined based on the total insured value and construction of the reinsured risk. C. For the purpose of the calculation of the reinsurance premium for business owners policies reinsured hereunder, the reinsurance rate above shall be applied against business owners policy written premium. Section 8 --------- CONTINGENT COMMISSION - --------------------- The Reinsurer's underwriting experience under the First Excess Cover of this Exhibit and under the First Excess Cover and the Combination Cover of Exhibit A to this Agreement shall be combined for the purposes of calculating the contingent commission on accordance with the provisions of the section entitled CONTINGENT COMMISSION of said Exhibit A. Section 9 --------- REPORTS AND REMITTANCES - ----------------------- A. Reinsurance Premium ------------------- (1) In Force Premium (Applicable to the First Excess Cover only): Within 45 days after the commencement of this Exhibit, the Company shall render to the Reinsurer a report of the reinsurance premium with respect to the business of the Company in force at the effective time and date of this Exhibit, summarizing the reinsurance premium by line of insurance, by term, and by month and year of expiration; and the amount due the Reinsurer shall be remitted within the earlier of (a) 180 days after the commencement of this Exhibit, or (b) 5 days after receipt of General Reinsurance Corporation's return premium under the prior property reinsurance program. (2) New and Renewal Premium: Within 25 days after the close of each month, the Company shall render to the Reinsurer a report of the reinsurance premium for the month with respect to business of the Company written during the month, summarizing the reinsurance premium by line of insurance; and the amount due either party shall be remitted within 60 days after the close of -39- 40 the month. Within 25 days after the close of each calendar quarter, the Company shall render to the Reinsurer a report of the reinsurance premium unearned by line of insurance and the contribution for the quarter to the reinsurance premium in force by line of insurance, by term, and by month and year of expiration. B. Claims and Losses ----------------- The Company shall report promptly to the Reinsurer each claim or loss which, in the Company's opinion, may involve the reinsurance afforded by this Exhibit. The Company shall advise the Reinsurer of the estimated amount of ultimate net loss in connection with each such claim or loss and of any subsequent changes in such estimates. Upon receipt of a definitive statement of ultimate net loss from the Company, the Reinsurer shall promptly pay to the Company the Reinsurer's portion of ultimate net loss and the Reinsurer's portion of loss expense, if any. Any subsequent changes in the amount of ultimate net loss shall be reported by the Company to the Reinsurer and the amount due either party shall be remitted promptly. C. General ------- In addition to the reports required in A., B. and C. above, the Company shall furnish such other information as may be required by the Reinsurer for the completion of the Reinsurer's quarterly and annual statements and internal records. All reports shall be rendered in forms acceptable to the Company and the Reinsurer. Section 10 ---------- COMMENCEMENT AND TERMINATION - ---------------------------- A. This Exhibit shall apply to new and renewal policies of the Company becoming effective at and after 12:01 A.M., January 1, 1998, and to policies of the Company in force at 12:01 A.M., January 1, 1998, with respect to claims or losses resulting from occurrences taking place at and after the aforesaid time and date. B. This Exhibit may be terminated by either party sending to the other, by registered mail to its principal office, notice stating the time and date when, not less than 90 days after the date of mailing of such notice, termination shall be effective. -40- 41 C. Upon termination of this Exhibit, the Reinsurer's liability hereunder will terminate on a cut-off basis. However, the Company may elect to have the Reinsurer's liability terminate on a run-off basis. The phrases "cut-off basis" and "run-off basis" shall have the meanings set forth below: (1) Cut-Off Basis: The Reinsurer shall not be liable for claims and losses resulting from occurrences taking place at and after the effective time and date of termination. (2) Run-Off Basis: The Reinsurer shall continue to be liable, with respect to policies in force at the time and date of termination, for occurrences taking place until the expiration, cancellation, or next anniversary date, not to exceed one year, of each such policy of the Company, whichever occurs first. The reinsurance premium for policies in force at the time and date of termination shall be calculated by applying the provisions of the Section entitled REINSURANCE PREMIUM to the quarterly earned premiums that derive from the unearned premium applicable to policies in force at the time and date of termination, provided such reinsurance premium is at least 50% of the reinsurance premium for the prior calendar year. D. When all reinsurance is expired or terminated, the Reinsurer shall return to the Company the reinsurance premium unearned, if any, calculated on the monthly pro rata basis. -41- 42 APPENDIX B ---------- MERCHANTS MUTUAL INSURANCE COMPANY MERCHANTS INSURANCE COMPANY OF NEW HAMPSHIRE, INC. PROPERTY EXCESS OF LOSS REINSURANCE EXHIBIT Second Excess Reinsurance Rates -------------------------------
Total Insured Value Protection Class 1-8 Protection Class 9-10 - ------------------- -------------------- --------------------- Greater than $2.0 - $2.5 million 1% 3% Greater than $2.5 - $3.0 million 2% 7% Greater than $3.0 - $3.5 million 4% 10% Greater than $3.5 - $4.0 million 5% 12% Greater than $4.0 - $4.5 million 6% 14% Greater than $4.5 - $5.0 million 7% 16% Greater than $5.0 - $5.5 million 9% 18% Greater than $5.5 - $6.0 million 10% 19% Greater than $6.0 - $6.5 million 11% 21% Greater than $6.5 - $7.0 million 12% 22% Greater than $7.0 - $7.5 million 13% 23% Greater than $7.5 - $8.0 million 14% 24% Greater than $8.0 - $8.5 million 15% 25% Greater than $8.5 - $9.0 million 16% 26% Greater than $9.0 - $9.5 million 17% 27% Greater than $9.5 - $10.0 million 18% 28%
-42- 43 EXHIBIT C --------- EACH CLAIMANT WORKERS' COMPENSATION EXCESS OF LOSS REINSURANCE COVER ----------------- Section 1 --------- COVER - ----- The Reinsurer agrees to reimburse the Company, on an excess of loss basis, for the amounts of ultimate net loss which the Company may pay as a result of losses occurring on and after 12:01 A.M., January 1, 1998, as respects the Company's policies in force as of said date and new and renewal policies becoming effective on and after said date, covering the Company's Workers' Compensation Business, subject to the limitations and exclusions hereinafter set forth. Section 2 --------- LIMITS OF COVER - --------------- A. With respect to the business covered under this Exhibit, the Reinsurer shall pay to the Company the amount of ultimate net loss for each claimant, each occurrence in excess of the Company Retention but not exceeding the Reinsurer's Limits of Liability as set forth in the Schedule of Reinsurance below.
SCHEDULE OF REINSURANCE - ------------------------------------------------------------------------------------- COMPANY RETENTION REINSURER'S LIMITS OF LIABILITY ALL OCCURRENCES EACH CLAIMANT, EACH CLAIMANT, DURING EACH EACH OCCURRENCE EACH OCCURRENCE CALENDAR YEAR - ------------------------------------------------------------------------------------- $10,000,000 $5,000,000 $20,000,000 - -------------------------------------------------------------------------------------
Section 3 --------- ULTIMATE NET LOSS - ----------------- A. The term "ultimate net loss" as used herein shall be understood to mean the sum actually paid by the Company in settlement of losses for which it is held liable, including: (1) 90% of any Extra Contractual Obligations and/or Excess Judgments and/or Declaratory Judgment Expenses, in accordance with their respective articles; and (2) All expenses, other than as provided in B. below, including taxed court -43- 44 costs, prejudgment and postjudgment interest, and loss expenses incurred in investigation, adjustment and litigation, defense and settlement of claims made against the Company under its original policies reinsured hereunder, including the costs and expenses of the Company's in-house counsel while engaged in the litigation of claims covered hereunder; after making proper deductions for all recoveries, salvages, and claims upon other reinsurance which inures to the benefit of the Reinsurer under this Agreement whether collectible or not; provided, however, that in the event of the insolvency of the Company, "ultimate net loss" shall mean the amount of loss which the Company has incurred or for which it is liable, and payment by the Reinsurer shall be made to the liquidator, receiver or statutory successor of the Company in accordance with the provisions of the Article entitled INSOLVENCY CLAUSE. B. All office expenses of the Company and all salaries and expenses of its officials and employees shall be excluded under this Agreement, except that the Company may include costs and expenses of the Company's in-house counsel while engaged in the litigation of claims covered hereunder. Section 5 --------- DEFINITIONS - ----------- A. Workers' Compensation Business ------------------------------ This term shall mean insurance afforded by Parts One and Three of the Company's Workers' Compensation and Employers' Liability Policy and any endorsements included therein or attached thereto. B. Company Retention ----------------- This term shall mean the amount the Company shall retain for its own account; however, this requirement shall be satisfied if this amount is retained by the Company or its affiliated companies under common management or common ownership. C. Occurrence ---------- This term shall mean each accident or occurrence or series of accidents or occurrences arising out of one event regardless of the number of policies involved, and as respects workers' compensation and employers' liability policies, regardless of the number of employees or employers involved, except as modified below: (1) As respects exposures reinsured hereunder other than occupational -44- 45 and other disease or cumulative injury under workers' compensation policies, all bodily injury or property damage arising out of continuous or repeated exposure to substantially the same general conditions shall be considered as arising out of one occurrence. The date of occurrence shall be deemed to be the following: (i) As respects a loss involving one or more policies written on an occurrence basis, the date on which bodily injury or property damage occurs. (ii) As respects a loss involving one or more policies written on a claimsmade basis, the date when notice of claim is received and recorded by the Company or the insured, whichever comes first, and any related claims reported subsequent to such date shall be included in such loss. However, if notice of claim is received and recorded by the Company or the insured during an Extended Reporting Period, the date of occurrence shall be deemed to be the last day of the policy period. (iii) As respects a loss involving one or more policies written on an occurrence basis and one or more policies written on a claimsmade basis, the date on which bodily injury or property damage occurs, and any related claims reported subsequent to such date shall be included in such loss whether they are covered under occurrence or claims-made policies. (2) As respects an occupational or other disease or cumulative injury under workers' compensation or employers' liability policies for which the employer is liable: (i) Which arises from a specific sudden and accidental event limited in time and place, such occupational or other disease suffered by one or more employees of one or more employers shall be deemed to be an occurrence within the meaning of this Exhibit and the date of occurrence shall be deemed to be the date of the sudden and accidental event. (ii) Which does not arise from a specific sudden and accidental event limited in time and place, such occupational or other disease or cumulative injury shall be deemed to be an occurrence within the meaning of this Exhibit, and the date of occurrence shall be deemed to be the date of the -45- 46 beginning of the disability for which compensation is payable if the case is compensable under the Workers' Compensation law; or the date that disability due to said disease actually began if the case is not compensable under the Workers' Compensation law. Each case of an employee contracting such occupational or other disease or cumulative injury for which the employer insured by the Company is held liable shall be considered a separate occurrence regardless of the date of loss. Section 6 --------- EXCLUSIONS - ---------- This Exhibit shall not apply to: A. Business accepted by the Company as reinsurance from other insurers other than its affiliates; B. Nuclear incident per the Nuclear Incident Exclusion Clause - Liability - Reinsurance attached hereto; C. Any loss or liability accruing to the Company directly or indirectly from any insurance written by or through any pool or association including pools or associations in which membership by the Company is required under any statutes or regulations and including automobile assigned risk pools and voluntary or involuntary market assistance programs; however, this exclusion shall not apply to individual risks under this Agreement which are assigned to the Company as a result of the business reinsured hereunder; D. Any liability of the Company arising from its participation or membership in any insolvency fund; E. War, Civil War; F. Business written with a deductible of more than $25,000 (unless the deductible is $100,000 or more and ceded to Exhibit A of this Agreement in accordance with its terms) or written to apply in excess of a self-insured amount of more than $25,000 (unless the self-insured amount is $100,000 or more and ceded to Exhibit A of this Agreement in accordance with its terms) or business written to apply specifically in excess over underlying insurance; G. Workers' compensation and employers' liability insurance with respect to operations principally involving: -46- 47 (1) Aircraft flight and ground operations or operations in which the flying hazard is a major part; (2) Amusement parks or devices, exhibitions (including fireworks), carnivals or circuses, sports events and/or participants; however, this exclusion shall not apply to coverage for locations or events with daily admissions of 1,000 or less or seating capacity of 1,000 or less; (3) Manufacturing, packing, handling, shipping, or storage of explosives, substances intended for use as an explosive, ammunitions, fuses, arms, magnesium, propellant charges, detonating devices, fireworks, nitroglycerine, celluloid, or pyroxylin; however, this exclusion shall not apply to the incidental packing, handling or storage of same in connection with the sale of such substances; (4) Gas companies, dealers, or distributors, except those in the gasoline service station, convenience store or fuel oil dealer business; oil or gas operators, lease operators or contractors; oil or gas well works; oil or gas pipeline construction or operations; oil rig and derrick work; onshore or offshore gas or oil drilling operations; (5) Manufacturing, packing, handling, shipping or storage of natural gas or artificial fuel gasses, butane, propane, gasoline, or liquified petroleum gas; however, this exclusion shall not apply to the incidental packing, handling or storage of same in connection with the sale of such substances; (6) Railroad operation or construction, except this exclusion shall not apply if the excluded exposure is not normally associated with the insured's operation and odes not present a larger exposure than the overall unexcluded portion of the risk; (7) Maritime or federal employments; steamship lines, agencies, or stevedoring, navigation or operation of vessels; operation of drydocks; and including all United States Longshoremen's and Harbor Workers' exposures, except this exclusion shall not apply if the excluded exposure (a) is endorsed on an "if any" basis or (b) is not normally associated with the insured's operation and does not present a larger exposure than the overall unexcluded portion of the risk; -47- 48 (8) Subway construction, shaft sinking, or tunneling; (9) Wrecking or demolition of vessels or buildings or structures of more than three stories in height; (10) Underground mining, strip mining, or quarrying; (11) Subaqueous work; (12) Caisson or coffer dam work; dam, dike, lock, or revetment construction; (13) Chemical manufacturing; however, this exclusion shall not apply to operations with annual gross receipts from chemical manufacturing of $500,000 or less; (14) Nuclear Regulatory Commission projects or operations conducted under license from the Nuclear Regulatory Commission; (15) Asbestos removal contractors; (16) Firefighters and police officers. If the Company is bound, without the knowledge of and contrary to the instructions of the Company's supervisory underwriting personnel, on any business falling within the scope of one or more of the exclusions set forth in this Section, these exclusions, except A. through E., G.(3) and G.(4) shall be suspended with respect to such business until the greater of 30 days or the minimum period of time required by statute after an underwriting supervisor of the Company acquires knowledge of such business. Section 7 --------- REINSURANCE PREMIUM - ------------------- Unless otherwise mutually agreed, the Company shall pay the Reinsurer an annual reinsurance premium of $30,000 for each calendar year during which this Exhibit remains in force. Section 8 --------- REPORTS AND REMITTANCES - ----------------------- A. Reinsurance Premium ------------------- Within 25 days after the beginning of each calendar quarter, the Company shall pay to the Reinsurer one quarter of the annual reinsurance premium stipulated in the section entitled REINSURANCE PREMIUM. -48- 49 B. Claims and Losses ----------------- The Company shall report promptly to the Reinsurer each claim or loss for which the Company's estimated amount of net loss is 50% or more of the amount of the Company Retention and shall also report all cases of serious injury which, regardless of considerations of liability or coverage, might involve this reinsurance, including but not limited to the following: (1) Cord injury paraplegia, quadriplegia; (2) Amputations requiring a prosthesis; (3) Brain damage affecting mentality or central nervous system such as permanent disorientation, behavior disorder, personality change, seizures, motor deficit, inability to speak (aphasia), hemiplegia or unconsciousness (comatose); (4) Blindness; (5) Burns involving over 10% of body with third degree or 30% of body with second degree; (6) Multiple fractures involving more than one member or non-union; (7) Fracture of both heel bones (fractured bilateral or calcis); (8) Nerve damage causing paralysis and loss of sensation in arm and hand (brachial plexus nerve damage); (9) Massive internal injuries affecting body organs; (10) Injury to nerves at base of spinal canal (Cauda Equina) or any other back injury resulting in incontinence of bowel and/or bladder; (11) Fatalities; (12) Any other serious injury which, in the judgment of the Company, might involve the Reinsurer. The Company shall advise the Reinsurer of the estimated amount of ultimate net loss and loss expense in connection with each such claim or loss and of any subsequent changes in such estimates. Upon receipt of a definitive statement of ultimate net loss and loss -49- 50 expense from the Company, the Reinsurer shall pay promptly to the Company the Reinsurer's portion of ultimate net loss and Reinsurer's portion of loss expense, if any. Any subsequent changes shall be reported by the Company to the Reinsurer and the amount due either party shall be remitted promptly. C. General ------- In addition to the reports required in A. and B. above, the Company shall furnish such other information as may be required by the Reinsurer for the completion of the Reinsurer's quarterly and annual statements and internal records. All reports shall be rendered in forms acceptable to the Company and the Reinsurer. Section 9 --------- REINSTATEMENT - ------------- A. The limit of liability of the Reinsurer under this Exhibit with respect to each occurrence shall be reduced by an amount equal to the amount of liability paid by the Reinsurer, but that part of the liability of the Reinsurer that is so reduced shall be automatically reinstated, subject to the maximum payment of $20,000,000 with respect to all occurrences taking place during each calendar year this Exhibit is in effect. In consideration of this automatic reinstatement, the Company shall pay to the Reinsurer: (a) For the first $5,000,000 so reinstated an additional reinsurance premium which shall be the product of the annual reinsurance premium set forth in the section entitled REINSURANCE PREMIUM and the amount so reinstated divided by $5,000,000, (b) For the next two full reinstatements of $5,000,000 each, an additional reinsurance premium which shall be the product of 50% of the annual reinsurance premium set forth in the section entitled REINSURANCE PREMIUM and the amount so reinstated divided by $5,000,000. The reinsurance premium so developed for each amount reinstated shall be in addition to the reinsurance premium set forth in the section entitled REINSURANCE PREMIUM, and shall be paid by the Company immediately following loss payment by the Reinsurer. -50- 51 Section 10 ---------- COMMENCEMENT AND TERMINATION - ---------------------------- A. This Exhibit shall apply to claims and losses resulting from occurrences taking place at and after 12:01 A.M., January 1, 1998. B. This Exhibit may be terminated by either party sending to the other, by registered mail to its principal office, notice stating the time and date when, not less than 90 days after the date of mailing of such notice, termination shall be effective. C. Upon termination of this Exhibit, the Reinsurer's liability hereunder will terminate on a cut-off basis. However, the Company may elect to have the Reinsurer's liability terminate on a run-off basis. The phrases "cut-off basis" and "run-off basis" shall have the meanings set forth below: (1) Cut-Off Basis: The Reinsurer shall not be liable for claims and losses resulting from occurrences taking place at and after the effective time and date of termination. (2) Run-Off Basis: The Reinsurer shall continue to be liable, with respect to policies in force at the time and date of termination, for occurrences taking place until the expiration, cancellation, or next anniversary date, not to exceed one year, of each such policy of the Company, whichever occurs first. The reinsurance premium for policies in force at the time and date of termination shall be mutually agreed by the parties. -51- 52 ENDORSEMENT Page 1 of 6 ENDORSEMENT Attached to and forming part of the PROPERTY AND CASUALTY EXCESS OF LOSS REINSURANCE AGREEMENT NO. 2530-0004 (hereinafter referred to as the "Agreement") between MERCHANTS MUTUAL INSURANCE COMPANY, Buffalo, New York and MERCHANTS INSURANCE COMPANY OF NEW HAMPSHIRE, INC., Concord, New Hampshire (hereinafter collectively referred to as the "Company") and AMERICAN REINSURANCE COMPANY, a Delaware Corporation with Administrative Offices in Princeton, New Jersey (hereinafter referred to as the "Reinsurer"). It is hereby mutually understood and agreed that the following changes are made in the Agreement effective 12:01 A.M., January 1, 1998. I. EXHIBIT A IS AMENDED AS FOLLOWS: (A) SECTION 8, REINSURANCE PREMIUM, IS DELETED IN ITS ENTIRETY AND REPLACED BY THE FOLLOWING: Section 8 REINSURANCE PREMIUM AND COMMISSION A. First Excess Cover: (1) With respect to business in force at the effective time and date of this Exhibit, the Company shall pay the Reinsurer a reinsurance premium equal to the product of the applicable First Excess reinsurance rate set forth in Appendix A attached hereto and the Company's unearned premium for the classes of business reinsured hereunder, calculated on the monthly pro rata basis as of the effective time and date of this Exhibit. (2) With respect to business becoming effective at and after the effective time and date of this Exhibit, the Company shall pay the Reinsurer a reinsurance premium equal to the product of the applicable First Excess reinsurance rate set forth in Appendix A attached hereto and the Company's written premium for the classes of business reinsured hereunder. B. Second Excess Cover: (1) With respect to business in force at the effective time and date of this Exhibit, the Company shall pay the Reinsurer a reinsurance premium equal to 0.38% of the Company's unearned premium for the classes of business reinsured hereunder, calculated on the monthly pro rata basis as of the effective time and date of this Exhibit. (2) With respect to business becoming effective at and after the effective time and date of this Exhibit, the Company shall pay the Reinsurer a reinsurance premium equal to 0.38% of the Company's written premium for the classes of business reinsured hereunder, subject to an annual minimum and deposit reinsurance premium of $400,000. 53 ENDORSEMENT Page 2 of 6 C. Third Excess Cover: Unless otherwise mutually agreed, the Company shall pay the Reinsurer an annual reinsurance premium of $40,000 for each calendar year during which the Third Excess remains in force. D. The Reinsurer shall allow the Company (and the Company shall allow the Reinsurer, in the event of return premiums) a flat ceding commission of 50% on all premiums ceded under the First and Second Excess Covers. There shall be no commission on the premiums ceded under the Third Excess Cover. The commission will include premium taxes of all kinds, local board assessments, and all other expenses and charges whatsoever based on the premium for business ceded under this Agreement. E. For the purpose of the calculation of the reinsurance premium for business owners policies reinsured hereunder, the reinsurances rates in A. and B. above shall be applied against 60% of the business owners policy premium unearned or written, as applicable. (B) PARAGRAPH A OF SECTION 10, REPORTS AND REMITTANCES, IS DELETED AND REPLACED BY THE FOLLOWING: Section 10 REPORTS AND REMITTANCES A. Reinsurance Premium (1) In Force Premium (Applicable to the First and Second Excess Covers only): Within 45 days after the commencement of this Exhibit, the Company shall render to the Reinsurer a report of the reinsurance premium with respect to the business of the Company in force at the effective time and date of this Exhibit, summarizing the reinsurance premium by line of insurance, by term, and by month and year of expiration; and the amount due the Reinsurer, less ceding commission, shall be remitted within the earlier of: (a) 180 days after the commencement of this Exhibit, or (b) 5 days after receipt of General Reinsurance Corporation's return premium under the prior casualty reinsurance program. (2) New and Renewal Premium: a. First Excess Cover: Within 25 days after the close of each month, the Company shall render to the Reinsurer a report of the reinsurance premium for the month with respect to business of the Company written during the month, summarizing the reinsurance premium by line of insurance; and the amount due either party, less ceding commission, shall be remitted within 60 days after the close of the month. Within 25 days after the close of each calendar quarter, the Company shall render to the Reinsurer a report of the reinsurance premium unearned by line of insurance and the contribution for the quarter to the reinsurance premium in force by line of insurance, by term and by month and year of expiration. 54 ENDORSEMENT Page 3 of 6 b. Second Excess Cover Within 25 days after the beginning of each calendar quarter, the Company shall pay to the Reinsurer one quarter of the annual minimum and deposit reinsurance premium stipulated in subparagraph B.2 of the section entitled REINSURANCE PREMIUM, less ceding commission thereon. Within 60 days after the close of each calendar year, the Company shall render to the Reinsurer a report of the premium written by the Company on the classes of business reinsured hereunder during such calendar year. The Company shall calculate the reinsurance premium thereon and remit to the Reinsurer the amount of reinsurance premium, if any, in excess of the annual minimum and deposit reinsurance premium previously paid, less ceding commission thereon. c. Third Excess Cover Within 25 days after the beginning of each calendar quarter, the Company shall pay to the Reinsurer one quarter of the annual reinsurance premium stipulated in subparagraph C. of the section entitled REINSURANCE PREMIUM. (C) PARAGRAPH D OF SECTION 12, COMMENCEMENT AND TERMINATION, IS DELETED AND REPLACED BY THE FOLLOWING: D. When all reinsurance is expired or terminated, the Reinsurer shall return to the Company the reinsurance premium unearned, if any, calculated on the monthly pro rata basis, less any commission previously allowed thereon. (D) APPENDIX A IS DELETED IN ITS ENTIRETY AND REPLACED BY THE FOLLOWING: APPENDIX A MERCHANTS MUTUAL INSURANCE COMPANY MERCHANTS INSURANCE COMPANY OF NEW HAMPSHIRE, INC. CASUALTY EXCESS OF LOSS REINSURANCE EXHIBIT FIRST EXCESS COVER REINSURANCE RATES Class of Business Rate Private Passenger Automobile 0.10% Liability (including PIP) Commercial Automobile Liability 3.52% 55 ENDORSEMENT Page 4 of 6 (including PIP) Workers' Compensation and 5.60% Employers' Liability Commercial Multiple Peril 6.14% (Section II) and Business Owners (Section II) Homeowners Multiple Peril No Charge (Section II) and Farmowners Multiple Peril (Section II) II. EXHIBIT B IS AMENDED AS FOLLOWS: (A) SECTION 7, REINSURANCE PREMIUM, IS DELETED IN ITS ENTIRETY AND REPLACED BY THE FOLLOWING: Section 7 REINSURANCE PREMIUM AND COMMISSION The Company shall pay to the Reinsurer: A. First Excess Cover: (1) With respect to business becoming in force at the effective time and date of this Exhibit: a. 0.72% of the Company's unearned premium on homeowners multiple peril (Section I) after deducting that portion, if any, paid for share reinsurance, calculated on the monthly pro rata basis as of the effective time and date of this Exhibit; and b. 9.72% of the Company's unearned premium on all other classes of business reinsured hereunder (except automobile physical damage), after deducting that portion, if any, paid for share reinsurance, calculated on the monthly pro rata basis as of the effective time and date of this Exhibit. (2) With respect to business becoming effective at and after the effective time and date of this Exhibit: a. 0.72% of the Company's written premium on homeowners multiple peril (Section I) after deducting that portion, if any, paid for share reinsurance; and b. 9.72% of the Company's written premium on all other classes of business reinsured hereunder 56 ENDORSEMENT Page 5 of 6 (except automobile physical damage), after deducting that portion, if any, paid for share reinsurance. B. Second Excess Cover: For each risk ceded hereunder, the Company shall pay to the Reinsurer a reinsurance premium equal to the product of the applicable reinsurance rate set forth in Appendix B attached hereto and the Company's written premium for the risk being reinsured. The applicable reinsurance rate shall be determined based on the total insured value and construction of the reinsured risk. C. The Reinsurer shall allow the Company (and the Company shall allow the Reinsurer, in the event of return premiums) a flat ceding commission of 50% on all premiums ceded under the First Excess Cover. There shall be no commission on premiums ceded under the Second Excess Cover. The commission will include premium taxes of all kinds, local board assessments, and all other expenses and charges whatsoever based on the premium for business ceded under this Agreement. D. For the purpose of the calculation of the reinsurance premium for business owners policies reinsured hereunder, the reinsurance rate above shall be applied against 40% of business owners policy written premium. (B) PARAGRAPH A OF SECTION 9, REPORTS AND REMITTANCES, IS DELETED AND REPLACED BY THE FOLLOWING: Section 9 REPORTS AND REMITTANCES A. Reinsurance Premium (1) In Force Premium (Applicable to the First Excess Cover only): Within 45 days after the commencement of this Exhibit, the Company shall render to the Reinsurer a report of the reinsurance premium with respect to the business of the Company in force at the effective time and date of this Exhibit, summarizing the reinsurance premium by line of insurance, by term, and by month and year of expiration; and the amount due the Reinsurer, less ceding commission, shall be remitted within the earlier of (a) 180 days after the commencement of this Exhibit, or (b) 5 days after receipt of General Reinsurance Corporation's return premium under the prior property reinsurance program. (2) New and Renewal Premium: Within 25 days after the close of each month, the Company shall render to the Reinsurer a report of the reinsurance premium for the month with respect to business of the Company written during the month, summarizing the reinsurance premium by line of insurance; and the amount due either party, less ceding commission, shall be remitted within 60 days after the close of the month. Within 25 days after the close of each calendar quarter, the Company shall render to the Reinsurer a report of the reinsurance premium unearned by line of insurance and the contribution for the quarter to the reinsurance premium in force by line of insurance, by term, and by month and year of expiration. 57 ENDORSEMENT Page 6 of 6 (C) PARAGRAPH D OF SECTION 10, COMMENCEMENT AND TERMINATION, IS DELETED AND REPLACED BY THE FOLLOWING: D. When all reinsurance is expired or terminated, the Reinsurer shall return to the Company the reinsurance premium unearned, if any, calculated on the monthly pro rata basis, less any ceding commission previously allowed thereon. Nothing herein contained shall alter, vary or extend any provision or condition of the Agreement other than as above stated. IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed in duplicate by their duly authorized officers. In Buffalo, New York, this 6th day of October, 1998. ACCEPTED: MERCHANTS MUTUAL INSURANCE COMPANY MERCHANTS INSURANCE COMPANY OF NEW HAMPSHIRE, INC. By: /s/ Kenneth J. Wilson By: /s/ Thomas B. Harris Attested by: And in Princeton, New Jersey this 6th day of October, 1998. AMERICAN RE-INSURANCE COMPANY By: /s/ David M. Domino By: /s/ Thomas D. Bell Attested by: EX-10.H 3 EXHIBIT 10(H) 1 Exhibit 10(h) PROPERTY CATASTROPHE EXCESS OF LOSS REINSURANCE AGREEMENT (HEREINAFTER CALLED THE "AGREEMENT") BETWEEN MERCHANTS INSURANCE GROUP BUFFALO, NEW YORK COMPRISED OF: MERCHANTS MUTUAL INSURANCE COMPANY, MERCHANTS INSURANCE COMPANY OF NEW HAMPSHIRE, INC., (HEREINAFTER REFERRED TO AS THE "COMPANY") AND THE SUBSCRIBING REINSURERS EXECUTING THE INTERESTS AND LIABILITIES CONTRACTS ATTACHED TO THIS AGREEMENT (HEREINAFTER COLLECTIVELY REFERRED TO AS THE "REINSURER") EFFECTIVE JANUARY 1, 1998 2 TABLE OF CONTENTS
ARTICLE PAGE ARTICLE 1 -COVER..................................................................................................1 ARTICLE 2 - TERM..................................................................................................1 ARTICLE 3 - TERRITORY.............................................................................................1 ARTICLE 4 - EXCLUSIONS............................................................................................1 ARTICLE 5 - NET RETAINED LINES....................................................................................4 ARTICLE 6 - ULTIMATE NET LOSS.....................................................................................5 ARTICLE 7 - LOSS OCCURRENCE.......................................................................................5 ARTICLE 8 - RETENTION AND LIMIT...................................................................................6 ARTICLE 9 - REINSTATEMENT.........................................................................................7 ARTICLE 10 - REINSURANCE PREMIUM..................................................................................7 ARTICLE 11 - REPORTS AND REMITTANCES..............................................................................7 ARTICLE 12 - CURRENCY.............................................................................................8 ARTICLE 13 - TAXES................................................................................................8 ARTICLE 14 - FEDERAL EXCISE TAX...................................................................................8 ARTICLE 15 - ERRORS AND OMISSIONS.................................................................................8 ARTICLE 16 - LOSS NOTICE..........................................................................................8 ARTICLE 17 - LOSS SETTLEMENTS.....................................................................................9 ARTICLE 18 - OFFSET...............................................................................................9 ARTICLE 19 - ACCESS TO RECORDS....................................................................................9 ARTICLE 20 - UNAUTHORIZED REINSURANCE.............................................................................9 ARTICLE 21 - SERVICE OF SUIT.....................................................................................11 ARTICLE 22 - INSOLVENCY..........................................................................................11 ARTICLE 23 - ARBITRATION.........................................................................................12 ARTICLE 24 - INTERMEDIARY........................................................................................13 SCHEDULE A.......................................................................................................14
3 PROPERTY CATASTROPHE EXCESS OF LOSS REINSURANCE AGREEMENT ARTICLE 1 -COVER - ---------------- A. The Reinsurer agrees to reimburse the Company, on an excess of loss basis, for the amounts of ultimate net loss which the Company may pay as a result of losses occurring during the term of this Agreement, under policies of the Company that are in force, new or renewed during the term of this Agreement, covering business classified by the Company as Property, including but not limited to: Fire, Allied Lines (including Extended Coverage), the Property Sections of Homeowners Multiple Peril, Farmowners Multiple Peril and Commercial Multiple Peril policies, Earthquake, Inland Marine (including Section I of boatowners), and Automobile Physical Damage (excluding collision but including water damage, fleet dealers' and garagekeepers' legal liability). B. The term "policies" as used herein means each of the Company's binders, policies, contracts, and other evidences of insurance, whether written or oral, providing insurance on the business covered hereunder. ARTICLE 2 - TERM - ---------------- This Agreement shall become effective as respects losses occurring during the period January 1, 1998 through December 31, 1998, both dates inclusive, at the place of the loss occurrence. B. Upon expiration, the Reinsurer shall remain liable for losses occurring prior to the expiration date, but all liability shall terminate hereunder as to losses occurring on or after the date and time of expiration, except as provided in paragraph C below. C. If this Agreement should terminate while an occurrence giving rise to a claim hereunder is in progress, subject to the other conditions of this Agreement, the Reinsurer shall be liable for its proportion of the entire loss or damage caused by such occurrence. ARTICLE 3 - TERRITORY - --------------------- This Agreement shall cover losses occurring in the United States of America, its territories and possessions, and Canada. ARTICLE 4 - EXCLUSIONS - ---------------------- This Agreement shall not apply to: 1. Reinsurance accepted by the Company other than: Page 3 4 (a) Facultative reinsurance on a share basis of risks accepted individually and not forming part of any agreement, or (b) Local agency reinsurance on a share basis accepted in the normal course of business, or (c) From its affiliates; 2. Nuclear incident per the following clauses which are deemed to form a part of this Agreement: (a) "Nuclear Incident Exclusion Clause - Physical Damage - Reinsurance" - U.S.A. (BRMA 35B) (b) "Nuclear Incident Exclusion Clause - Physical Damage - Reinsurance" - Canada (BRMA 35G) Clause; 3. Any extra or non-contractual damages (including loss in excess of policy limits) or legal fees and expense attendant to the defense thereof, including but not limited to compensatory, exemplary and punitive damages or fines or statutory penalties which are awarded against the Company as a result of an act, omission, or course of conduct committed by or on behalf of the Company; 4. Any loss or liability accruing to the Company directly or indirectly from any insurance written by or through any pool or association including pools or associations in which membership by the Company is required under any statutes or regulations; however this exclusion shall not apply to: (a) The Alabama Insurance Underwriting Association; (b) The Florida Windstorm Underwriting Association; (c) The Louisiana Insurance Underwriting Association; (d) The Mississippi Windstorm Underwriting Association; (e) The New York Coastal Market Assistance Program (CMAP); (f) The North Carolina Insurance Underwriting Association; (g) The South Carolina Windstorm and Hail Underwriting Association; (h) The Texas Catastrophe Property Insurance Association; (i) All "Fair Plan" and "Rural Risk Plan" business; (j) The Devco Mutual Association, However, this Agreement shall not cover any increase in such liability resulting from the inability of any other participant in any such pool or plan to meet its liability; 5. Any liability of the Company arising from its participation or membership in any insolvency fund; Page 4 5 6. Any loss or damage which is occasioned by war, invasion, hostilities, acts of foreign enemies, civil war, rebellion, insurrection, military or usurped power, or martial law or confiscation by order of any government or public authority; however this exclusion shall not apply to any policy which contains a standard war exclusion; Page 5 6 7. Risks written on a layered basis, whether primary or excess of loss, or policies written with a deductible or franchise of more than $5,000; however, this exclusion shall not apply to policies which provide a percentage deductible or franchise in connection with windstorm; 7. Insurance against earthquake, except when written in conjunction with fire and otherwise eligible perils; 8. Insurance on growing crops; 9. Insurance against flood, surface water, waves, tidal water or tidal wave, overflow of streams or other bodies of water or spray from any of the foregoing, all whether driven by wind or not except when written in conjunction with fire and otherwise eligible perils; 10. Any loss in respect of overhead transmission and distribution lines and their supporting structures other than those on or within 1000 feet of the insured premises; however, this exclusion shall not apply to public utilities extension and/or suppliers extension and/or contingent business interruption coverage, provided that these are not part of a transmitters' or distributors' policy; 11. Business classified as fidelity; 12. Liability under coverage afforded for loss or damage resulting from failure to account or pay for any goods or merchandise sold on credit, delivered under deferred payment agreements, consigned for sale, or delivered under any trust or floor plan agreements, except under standard accounts receivable policies; 13. Any loss or damage caused by or resulting from explosion, rupture, or bursting of steam boilers, steam pipes, steam turbines, steam engines, or rotating parts of machinery caused by centrifugal force; if owned by, leased by, or actually operated under the control of the insured. This exclusion shall not apply to ensuing loss by fire not otherwise excluded; 14. Mortgage impairment insurance and similar kinds of insurance, howsoever styled, providing coverage to an insured with respect to its mortgagee interest in property or its owner interest in foreclosed property; 15. Difference in conditions insurance and similar kinds of insurance, howsoever styled; 16. Risks which have a total insurable value of more than $250,000,000; however this exclusion shall not apply if the Company writes 100% of the risk; Page 6 7 17. Any collection of fine arts with an insurable value of $5,000,000 or more; 18. Mobile homes; Page 7 8 19. Inland marine business with respect to the following: (a) All bridges and tunnels; (b) Cargo insurance when written as such with respect to ocean, lake, or inland waterways vessels; (c) Commercial negative film insurance and cast insurance; (d) Drilling rigs; (e) Furriers' customers policies; (f) Garment contractors policies; (g) Insurance on livestock under so-called "mortality policies"; (h) Jewelers' block policies and furriers' block policies; (i) Mining equipment while underground; (j) Motor truck cargo insurance written for common carriers operating beyond a radius of 300 miles; (k) Radio and television broadcasting towers; (l) Registered mail insurance when the limit of any one addressee on any one day is more than $50,000; 20. Watercraft, other than watercraft insured under a standard homeowners policy; 21. Loss of, damage to, or failure of, or consequential loss resulting therewith (including but not limited to earnings and extra expense) of satellites, spacecraft, and launch vehicles, including cargo and freight carried therein, in all phases of operation (including but not limited to manufacturing, transit, pre-launch, launch, and in-orbit); 22. Coverage afforded by ISO Pollutant Clean Up and Removal Additional Aggregate Limit of Insurance Endorsement CP 04 07 (Ed., 4/86) or as subsequently amended or by any similar endorsement affording such coverage; Pollutant clean up or removal, including time element coverage associated therewith, under any commercial property policy or any inland marine policy written by the Company which does not contain ISO Changes- Pollutants Endorsement CP 01 86 (Ed. 4/86) or as subsequently amended; however this exclusion does not apply to any risk located in a jurisdiction which has not approved the Insurance Services Office exclusion or where other regulatory constraints prohibit the Company from attaching such endorsement. If the Company elects to file an endorsement independent of ISO, such endorsement will be deemed a suitable substitute provided the Company has submitted the wording to the Reinsurers and received the Reinsurers' prior approval. ARTICLE 5 - NET RETAINED LINES - ------------------------------ This Agreement applies only to that portion of any policy which the Company retains net for its Page 8 9 own account, and in calculating the amount of any loss hereunder and also in computing the amount or amounts in excess of which this Agreement attaches, only loss or losses in respect of that portion of any policy which the Company retains net for its own account shall be included. Page 9 10 The amount of the Reinsurer's liability hereunder in respect of any loss or losses shall not be increased by reason of the inability of the Company to collect from any other reinsurer(s), whether specific or general, any amounts which may have become due from such reinsurer(s), whether such inability arises from the insolvency of such other reinsurer(s) or otherwise. ARTICLE 6 - ULTIMATE NET LOSS - ----------------------------- The term "ultimate net loss" as used herein shall be understood to mean the sum actually paid by the Company in settlement of losses for which it is liable, after making proper deductions for all other reinsurance or insurance which inures to the benefit of the Reinsurer under this Agreement, whether collectible or not, and all salvages and all recoveries, and shall include all expenses incurred by the Company in the settlement or defense of claims including the salaries and expenses of salaried adjusters but excluding the office expenses of the Company and the salaries and expenses of its other employees; provided, however, that in the event of the insolvency of the Company, "ultimate net loss" shall mean the amount of loss and expense which the Company has incurred or for which it is liable, and payment by the Reinsurer shall be made to the liquidator, receiver or statutory successor of the Company in accordance with the provisions of the Insolvency Article of this Agreement. ARTICLE 7 - LOSS OCCURRENCE - --------------------------- NMA 2244 Amended (BRMA 27a) A. The term "Loss Occurrence" shall mean the sum of all individual losses directly occasioned by any one disaster, accident or loss or series of disasters, accidents or losses arising out of one event which occurs within the area of one state of the United States or province of Canada and states or provinces contiguous thereto and to one another. However, the duration and extent of any one "Loss Occurrence" shall be limited to all individual losses sustained by the Company occurring during any period of 168 consecutive hours arising out of and directly occasioned by the same event except that the term "Loss Occurrence" shall be further defined as follows: (i) As regards windstorm, hail, tornado, hurricane, cyclone, including ensuing collapse and water damage, all individual losses sustained by the Company occurring during any period of 72 consecutive hours arising out of and directly occasioned by the same event. However, the event need not be limited to one state or province or states or provinces contiguous thereto. (ii) As regards riot, riot attending a strike, civil commotion, vandalism and malicious mischief, all individual losses sustained by the Company occurring during any period of 72 consecutive hours within the area of one municipality or county and the municipalities or counties contiguous thereto arising out of and directly occasioned by the same event. The maximum duration of 72 consecutive hours may be extended in respect of individual losses which occur beyond such 72 consecutive hours during the continued occupation of an assured's premises by strikers, provided such occupation commenced during the aforesaid period. Page 10 11 (iii) As regards earthquake (the epicenter of which need not necessarily be within the territorial confines referred to in the opening paragraph of this Article) and fire following directly occasioned by the earthquake, only those individual fire losses which commence during the period of 168 consecutive hours may be included in the Company's "Loss Occurrence." (iv) As regards "Freeze," only individual losses directly occasioned by collapse, breakage of glass and water damage (caused by bursting of frozen pipes and tanks) may be included in the Company's "Loss Occurrence." B. For all "Loss Occurrences," other than (ii) above, the Company may choose the date and time when any such period of consecutive hours commences, provided that it is not earlier than the date and time of the occurrence of the first recorded individual loss sustained by the Company arising out of that disaster, accident or loss and provided that only one such period of 168 consecutive hours shall apply with respect to one event, except for any "Loss Occurrence" referred to in sub-paragraph (i) above where only one such period of 72 consecutive hours shall apply with respect to one event. C. As respects those "Loss Occurrences" referred to in (ii) above, the Company may choose the date and time when any such period of consecutive hours commences. If the disaster, accident or loss occasioned by the event is of greater duration than 72 consecutive hours, then the Company may divide that disaster, accident or loss into two or more "Loss Occurrences" provided no periods overlap and no individual loss is included in more than one such period and provided that no period commences earlier than the date and time of the occurrence of the first recorded individual loss sustained by the Company arising out of that disaster, accident or loss. D. No individual losses occasioned by an event that would be covered by 72 hours clauses may be included in any "Loss Occurrence" claimed under the 168 hours provision. ARTICLE 8 - RETENTION AND LIMIT - ------------------------------- A. As respects each Excess Layer of reinsurance coverage provided by this Agreement, the Company shall retain the amount of ultimate net loss, shown as the Company's Retention for each Excess Layer in SCHEDULE A attached hereto, arising out of each and every loss occurrence. The Reinsurer shall then be liable, as respects its participation in the Excess Layer, for the amount by which such ultimate net loss exceeds the Company's Retention, each and every loss occurrence, but the limit of liability of the Reinsurer shall not exceed the amount shown in SCHEDULE A as Reinsurer's Limit of Liability, each and every loss occurrence during the term of this Agreement. B. In addition to the Company's Retention, the Company will retain net for its own account, with respect to each loss occurrence, the remaining 5% in each Excess Layer. Page 11 12 ARTICLE 9 - REINSTATEMENT A. In the event of a claim attaching to this Agreement, it is understood and agreed that the amount of liability hereunder shall be reduced from the commencement of the loss occurrence giving rise to such claim by the sum payable on such claim, but any amount so exhausted shall be reinstated from the time of the loss occurrence. Reinstatements of the limits hereunder for each Excess Layer; i.e., the liability of the Reinsurer under each Excess Layer of reinsurance coverage hereunder, shall not exceed the Reinsurer's Limit of Liability as shown in SCHEDULE A with respect to each and every loss occurrence under such Excess Layer, and shall be further limited to a Reinsurer's Maximum Annual Limit as shown in SCHEDULE A for all loss occurrences under such Excess Layer during the term of this Agreement. B. For each amount so reinstated, the Company shall pay to the Reinsurer an additional premium calculated as shown in SCHEDULE A. Any such additional premium shall be immediately payable at the time the loss giving rise to such reinstatement is settled; however, such additional premium shall be based on the Deposit premium with adjustment as required at the end of the term of this Agreement, when the actual reinsurance premium hereunder shall be finally determined. ARTICLE 10 - REINSURANCE PREMIUM - -------------------------------- A. The premium to be paid by the Company to the Reinsurer hereunder shall be calculated by applying the Premium Rate, for each Excess Layer shown in SCHEDULE A, to the Company's subject gross net earned premium income during the term of this Agreement. B. The Deposit Premium, for each Excess Layer as shown in SCHEDULE A, shall be payable by the Company quarterly, in advance, in equal installments each on January 1, April 1, July 1, and October 1, 1998. As promptly as possible after the termination of this Agreement, the Company shall render a statement to the Reinsurer showing the actual reinsurance premium due hereunder, calculated as set forth in paragraph A. above. Subject to a Minimum Premium for each Excess Layer as shown in SCHEDULE A, the difference between the actual reinsurance premium and the Deposit Premium shall be paid by the debtor party to the creditor party. ARTICLE 11 - REPORTS AND REMITTANCES - ------------------------------------ Within 60 days following expiration of this Agreement, the Company will furnish the Reinsurers with a report of reinsurance premium due them for that period. Such report will show and properly segregate the Company's subject premium to which the reinsurance rate applies as well as contain such other information as may be required by the Reinsurers for completion of their NAIC interim and/or annual statements. The actual reinsurance premium will be calculated in accordance with ARTICLE 10 - REINSURANCE PREMIUM, and any balance shown to be due the Reinsurers will be remitted with said report. Any balance shown to be due the Company will be payable within 30 days following receipt of the report by the Reinsurers. Page 12 13 ARTICLE 12 - CURRENCY (BRMA 14C) A. Whenever the word "Dollars" or the "$" sign appears in this Agreement, they shall be construed to mean United States Dollars and all transactions under this Agreement shall be in United States Dollars. B. Amounts paid or received by the Company in any other currency shall be converted to United States Dollars at the rate of exchange at the date such transaction is entered on the books of the Company. ARTICLE 13 - TAXES - ------------------ (BRMA 50B) In consideration of the terms under which this Agreement is issued, the Company will not claim a deduction in respect of the premium hereon when making tax returns, other than income or profits tax returns, to any state or territory of the United States of America or the District of Columbia. ARTICLE 14 - FEDERAL EXCISE TAX - ------------------------------- (BRMA 17A) (Applicable to those reinsurers, excepting Underwriters at Lloyd's London and other reinsurers exempt from Federal Excise Tax, who are domiciled outside the United States of America.) A. The Reinsurer has agreed to allow for the purpose of paying the Federal Excise Tax the applicable percentage of the premium payable hereon (as imposed under Section 4371 of the Internal Revenue Code) to the extent such premium is subject to the Federal Excise Tax. B. In the event of any return of premium becoming due hereunder the Reinsurer will deduct the applicable percentage from the return premium payable hereon and the Company or its agent should take steps to recover the tax from the United States Government. ARTICLE 15 - ERRORS AND OMISSIONS - --------------------------------- (BRMA 12A) Any inadvertent delay, omission or error shall not be held to relieve either party hereto from any liability which would attach to it hereunder if such delay, omission or error had not been made, provided such omission or error is rectified upon discovery. ARTICLE 16 - LOSS NOTICE - ------------------------ (BRMA 26B) The Company shall advise the Reinsurer promptly of all losses which, in the opinion of the Company, may result in a claim hereunder and of all subsequent developments thereto which, in the opinion of the Company, may materially affect the position of the Reinsurer. Page 13 14 ARTICLE 17 - LOSS SETTLEMENTS (BRMA 29E) All loss settlements made by the Company, under policies subject hereto, whether under policy terms and conditions or by way of compromise, shall be binding upon the Reinsurer, and, upon receipt of satisfactory proof of loss, the Reinsurer agrees to pay or allow, as the case may be, its share of each such settlement in accordance with this Agreement. ARTICLE 18 - OFFSET - ------------------- (BRMA 36B) The Company and the Reinsurer may offset any balance or amount due from one party to the other under this Agreement or any other contract heretofore or hereafter entered into between the Company and the Reinsurer, whether acting as assuming reinsurer or ceding company. However, in the event of the insolvency of any party hereto, offset shall only be allowed in accordance with applicable law. ARTICLE 19 - ACCESS TO RECORDS - ------------------------------ (BRMA 1D) The Reinsurer or its designated representatives shall have access at any reasonable time to all records of the Company which pertain in any way to this reinsurance. ARTICLE 20 - UNAUTHORIZED REINSURANCE - ------------------------------------- (BRMA 55D) (Applies only to a Reinsurer who does not qualify for full credit with any insurance regulatory authority having jurisdiction over the Company's reserves.)A. As regards policies or bonds issued by the Company coming within the scope of this Agreement, the Company agrees that when it shall file with the insurance regulatory authority or set up on its books reserves for losses covered hereunder which it shall be required by law to set up, it will forward to the Reinsurer a statement showing the proportion of such reserves which is applicable to the Reinsurer. The Reinsurer hereby agrees to fund such reserves in respect of known outstanding losses that have been reported to the Reinsurer and allocated loss adjustment expense relating thereto, and losses and allocated loss adjustment expense paid by the Company but not recovered from the Reinsurer, as shown in the statement prepared by the Company (hereinafter referred to as "Reinsurer's Obligations") by funds withheld, cash advances or a Letter of Credit. The Reinsurer shall have the option of determining the method of funding provided it is acceptable to the insurance regulatory authorities having jurisdiction over the Company's reserves. B. When funding by a Letter of Credit, the Reinsurer agrees to apply for and secure timely delivery to the Company of a clean, irrevocable and unconditional Letter of Credit issued by a bank and containing provisions acceptable to the insurance regulatory authorities having jurisdiction over the Company's reserves in an amount equal to the Reinsurer's proportion of said reserves. Such Letter of Credit shall be issued for a period of not less than one year, and shall be automatically extended for one year from its date of expiration or any future expiration date unless thirty (30) days (sixty (60) days where required by insurance regulatory authorities) Page 14 15 prior to any expiration date the issuing bank shall notify the Company by certified or registered mail that the issuing bank elects not to consider the Letter of Credit extended for any additional period. C. The Reinsurer and Company agree that the Letters of Credit provided by the Reinsurer pursuant to the provisions of this Agreement may be drawn upon at any time, notwithstanding any other provision of this Agreement, and be utilized by the Company or any successor, by operation of law, of the Company including, without limitation, any liquidator, rehabilitator, receiver or conservator of the Company for the following purposes, unless otherwise provided for in a separate Trust Agreement: (a) to reimburse the Company for the Reinsurer's Obligations, the payment of which is due under the terms of this Agreement and which has not been otherwise paid; (b) to make refund of any sum which is in excess of the actual amount required to pay the Reinsurer's Obligations under this Agreement; (c) to fund an account with the Company for the Reinsurer's Obligations. Such cash deposit shall be held in an interest bearing account separate from the Company's other assets, and interest thereon not in excess of the prime rate shall accrue to the benefit of the Reinsurer; (d) to pay the Reinsurer's share of any other amounts the Company claims are due under this Agreement. B. In the event the amount drawn by the Company on any Letter of Credit is in excess of the actual amount required for (a) or (c), or in the case of (d), the actual amount determined to be due, the Company shall promptly return to the Reinsurer the excess amount so drawn. All of the foregoing shall be applied without diminution because of insolvency on the part of the Company or the Reinsurer. C. The issuing bank shall have no responsibility whatsoever in connection with the propriety of withdrawals made by the Company or the disposition of funds withdrawn, except to ensure that withdrawals are made only upon the order of properly authorized representatives of the Company. D. At annual intervals, or more frequently as agreed but never more frequently than quarterly, the Company shall prepare a specific statement of the Reinsurer's Obligations, for the sole purpose of amending the Letter of Credit, in the following manner: (a) If the statement shows that the Reinsurer's Obligations exceed the balance of credit as of the statement date, the Reinsurer shall, within thirty (30) days after receipt of notice of such excess, secure delivery to the Company of an amendment to the Letter of Credit increasing the amount of credit by the amount of such difference. Page 15 16 (b) If, however, the statement shows that the Reinsurer's Obligations are less than the balance of credit as of the statement date, the Company shall, within thirty (30) days after receipt of written request from the Reinsurer, release such excess credit by agreeing to secure an amendment to the Letter of Credit reducing the amount of credit available by the amount of such excess credit. ARTICLE 21 - SERVICE OF SUIT - ---------------------------- (BRMA 49A) (This Article only applies to reinsurers domiciled outside of the United States and/or unauthorized in any state, territory, or district of the United States having jurisdiction over the Company). A. It is agreed that in the event of the failure of the Reinsurer hereon to pay any amount claimed to be due hereunder, the Reinsurer hereon, at the request of the Company, will submit to the jurisdiction of a court of competent jurisdiction within the United States. Nothing in this Article constitutes or should be understood to constitute a waiver of the Reinsurer's rights to commence an action in any court of competent jurisdiction in the United States, to remove an action to a United States District Court, or to seek a transfer of a case to another court as permitted by the laws of the United States or of any state in the United States. It is further agreed that service of process in such suit may be made upon Messrs. Mendes & Mount, 750 Seventh Avenue, New York, New York l00l9, U.S.A., and that in any suit instituted, the Reinsurer will abide by the final decision of such court or of any appellate court in the event of an appeal. B. The above-named are authorized and directed to accept service of process on behalf of the Reinsurer in any such suit and/or upon the request of the Company to give a written undertaking to the Company that they will enter a general appearance upon the Reinsurer's behalf in the event such a suit shall be instituted. C. Further, pursuant to any statute of any state, territory or district of the United States which makes provision therefore, the Reinsurer hereon hereby designates the Superintendent, Commissioner or Director of Insurance or other officer specified for that purpose in the statute, or his successor or successors in office, as its true and lawful attorney upon whom may be served any lawful process in any action, suit or proceeding instituted by or on behalf of the Company or any beneficiary hereunder arising out of this Agreement of reinsurance, and hereby designates the above-named as the person to whom the said officer is authorized to mail such process or a true copy thereof. ARTICLE 22 - INSOLVENCY - ----------------------- The reinsurance provided by this Agreement shall be payable by the Reinsurer directly to the Company or to its liquidator, receiver or statutory successor on the basis of the liability of the Company under the contract or contracts reinsured. Subject to the right of offset and the verification of coverage, the Reinsurer shall pay its share of the loss without diminution because of the insolvency of the Company. In the event of the insolvency of the Company, the liquidator, receiver or statutory successor of the Company shall give written notice of the Page 16 17 pendency of each claim against the Company on a policy or bond reinsured within a reasonable time after such claim is filed in the insolvency proceeding. During the pendency of such claim, the Reinsurer may, at its own expense, investigate such claim and interpose in the proceeding where such claim is to be adjudicated any defense or defenses which it may deem available to the Company, its liquidator or receiver or statutory successor. Subject to court approval, any expense thus incurred by the Reinsurer shall be chargeable against the Company as part of the expense of liquidation to the extent of such proportionate share of the benefit as shall accrue to the Company solely as a result of the defense undertaken by the Reinsurer. The reinsurance shall be payable as set forth above except where this Agreement specifically provides for the payment of reinsurance proceeds to another party in the event of the insolvency of the Company. ARTICLE 23 - ARBITRATION - ------------------------ (BRMA 6B) A. As a condition precedent to any right of action hereunder, any irreconcilable dispute between the parties to this Agreement will be submitted for decision to a board of arbitration composed of two arbitrators and an umpire meeting in Buffalo, New York. B. Arbitration shall be initiated by the delivery of a written notice of demand for arbitration by one party to the other within a reasonable time after the dispute has arisen. C. The members of the board of arbitration shall be active or retired disinterested officials of insurance or reinsurance companies, or Underwriters at Lloyd's, London, not under the control or management of either party to this Agreement. Each party shall appoint its arbitrator, and the two arbitrators shall choose an umpire before instituting the hearing. If the respondent fails to appoint its arbitrator within four (4) weeks after being requested to do so by the claimant, the latter shall also appoint the second arbitrator. If the two arbitrators fail to agree upon the appointment of an umpire within four (4) weeks after their nominations, each of them shall name three of whom the other shall decline two, and the decision shall be made by drawing lots. The claimant shall submit its initial brief within forty-five (45) days from appointment of the umpire. The respondent shall submit its brief within forty-five (45) days thereafter, and the claimant may submit a reply brief within thirty (30) days after filing of the respondent's brief. D. The board shall make its decision with regard to the custom and usage of the insurance and reinsurance business. The board shall issue its decision in writing based upon a hearing in which evidence may be introduced without following strict rules of evidence but in which cross-examination and rebuttal shall be allowed. The board shall make its decision within sixty (60) days following the termination of the hearings unless the parties consent to an extension. The majority decision of the board shall be final and binding upon all parties to the proceeding. Judgment may be entered upon the award of the board in any court having jurisdiction. E. If more than one reinsurer is involved in the same dispute, all such reinsurers shall constitute and act as one party for purposes of this clause, and communications shall be made by the Company to each of the reinsurers constituting the one party provided, however, that nothing therein shall impair the rights of such reinsurers to assert several rather than joint defenses or claims, nor be construed as changing the liability of the reinsurers under the terms of this Agreement from several to joint. Page 17 18 F. Each party shall bear the expense of its own arbitrator and shall jointly and equally bear with the other party the expense of the umpire. The remaining costs of the arbitration proceedings shall be allocated by the board. ARTICLE 24 - INTERMEDIARY AM-RE Brokers, Inc. is hereby recognized as the Intermediary negotiating this Agreement for all business hereunder. All communications (including but not limited to notices, statements, premium, return premium, commissions, taxes, losses, loss adjustment expense, salvages and loss settlements) relating thereto shall be transmitted to the Company or the Reinsurer through AM-RE Brokers, Inc., 685 College Road East, Princeton, New Jersey 08543-5212. Payments by the Company to the Intermediary shall be deemed to constitute payment to the Reinsurer. Payments by the Reinsurer to the Intermediary shall be deemed to constitute payment to the Company only to the extent that such payments are actually received by the Company. Page 19 19
SCHEDULE A ---------- - -------------------------------------------------------------------------------- EXCESS LAYER: FIRST SECOND THIRD FIRST EXCESS EXCESS EXCESS SECOND $ 5,000,000 THIRD $10,000,000 FOURTH $20,000,000 FIFTH $35,000,000 - -------------------------------------------------------------------------------- COMPANY'S $5,000,000 $10,000,000 $20,000,000 RETENTION: - -------------------------------------------------------------------------------- REINSURER'S $5,000,000 $10,000,000 $30,000,000 OF LIMIT *See Below LIABILITY (95% *See Below OF): *See Below *See Below - -------------------------------------------------------------------------------- REINSURER'S MAXIMUM $10,000,000 $20,000,000 $60,000,000 ANNUAL LIMIT (95% OF): $15,000,000 $30,000,000 $40,000,000 $70,000,000 - -------------------------------------------------------------------------------- PREMIUM RATE: 1.2276% 1.4800% 2.2110% - -------------------------------------------------------------------------------- DEPOSIT PREMIUM: $425,800 $513,350 $766,900 - -------------------------------------------------------------------------------- MINIMUM PREMIUM: $378,500 $456,300 $681,680 - -------------------------------------------------------------------------------- REINSTATEMENT Pro-rata as to Pro-rata as to Pro-rata as to PREMIUM amount; amount; amount; CALCULATIONS: 100% for time 100% for time 100% for time - --------------------------------------------------------------------------------
Page 20 20 INTEREST AND LIABILITIES CONTRACT --------------------------------- This Contract is made and entered into by and between the MERCHANTS INSURANCE GROUP of Buffalo, New York, Comprised of MERCHANTS MUTUAL INSURANCE COMPANY and MERCHANTS INSURANCE COMPANY OF NEW HAMPSHIRE, INC., (hereinafter call the "Company"), and the following party (hereinafter called the "Subscribing Reinsurer"): It is mutually agreed between the parties hereto that the Subscribing Reinsurer shall have the following share(s) of the interests and liabilities of the "Reinsurer" as set forth in the attached PROPERTY CATASTROPHE EXCESS OF LOSS REINSURANCE AGREEMENT: First Layer: Second Layer: Third Layer: The share(s) of the Subscribing Reinsurer in the interests and liabilities of the Reinsurer in respect of said Agreement shall be separate and apart from the participation of the other Reinsurers, and shall not be joined with that of the other Reinsurers and the Subscribing Reinsurer shall in no event participate in the interests and liabilities of the other Reinsurers. This Contract shall be effective at 12:01 A.M. Local Standard Time, January 1, 1998 with respect to losses occurring on and after that date, and it shall continue in force until its expiration in accordance with the terms of the attached Agreement at 12:01 A.M., Local Standard Time, January 1, 1999. IN WITNESS WHEREOF the parties hereto have caused this Contract to be executed in triplicate by their duly authorized representatives. MERCHANTS INSURANCE GROUP COMPRISED OF MERCHANTS MUTUAL INSURANCE COMPANY, AND MERCHANTS INSURANCE COMPANY OF NEW HAMPSHIRE, INC. By: Date: ----------------------------------------- ----------------- Title: -------------------------------------- By: Date: ----------------------------------------- ----------------- Title: -------------------------------------- EX-10.R 4 EXHIBIT 10(R) 1 EXHIBIT 10-R EMPLOYEE RETENTION AGREEMENT BETWEEN EDWARD M. MURPHY and MERCHANTS MUTUAL INSURANCE COMPANY Dated: March 1, 1999 2 EMPLOYEE RETENTION AGREEMENT ---------------------------- This AGREEMENT ("Agreement"), dated as of March 1, 1999, is by and between EDWARD M. MURPHY, residing at 256 Louvaine Drive, Buffalo, New York 14223 (the "Executive") and MERCHANTS MUTUAL INSURANCE COMPANY, a New York mutual insurance company with its principal office at 250 Main Street, Buffalo, New York 14202 (the "Company"). RECITALS: WHEREAS, the Company is responsible for managing the business of Merchants Group, Inc. ("MGI") and MGI's wholly-owned subsidiary, Merchants Insurance Company of New Hampshire, Inc. ("MNH"), under a Management Agreement dated September 29, 1986 by and among the Company, MGI and MNH (the "Management Agreement"); and WHEREAS, MGI has given notice to the Company that it will terminate the Management Agreement no later than at the end of the required five-year notice period; and WHEREAS, the Executive is a key employee of the Company; and WHEREAS, the Company believes that the Executive's continued employment with the Company will enhance the Company's ability to continue to manage the business of the Company, MGI and MNH throughout the period prior to the effective date of the termination of the Management Agreement; and WHEREAS, the Company believes that the Executive's continued employment with the Company will be in the collective best interests of the Company, MGI and MNH; and WHEREAS, the Company believes that by extending certain financial incentives to the Executive it will assist the Company in retaining the services of the Executive throughout the period prior to the effective date of the termination of the Management Agreement; and WHEREAS, the Executive and the Company desire to enter into this Agreement in order to provide for such financial incentives. NOW, THEREFORE, in consideration of the promises and the mutual agreements herein contained, the adequacy and sufficiency of which are hereby acknowledged, the Company and the Executive agree as follows: 3 1. SALARY CONTINUATION AND BENEFITS. --------------------------------- (a) The purpose of this paragraph 1 is to provide the Executive with a continuation of salary and certain benefits in the event it is necessary or advisable for the Company, through no fault of the Executive, to either terminate the Executive's employment or eliminate his position. In order to give effect to this purpose, the Executive shall receive certain payments and benefits from the Company if there is a "Termination of Employment" during the "Protection Period," as those terms are defined below, subject to the following terms and conditions. (b) The "Protection Period" shall be that period of time from the date of this Agreement through and including December 31, 2003. (c) "Termination of Employment" is defined to mean the termination of the Executive's full-time employment with the Company for any reason other than (i) the Executive's death, (ii) the Executive's "total disability" (as defined in paragraph 2(e) below), (iii) the Executive's voluntary termination of employment with the Company, (iv) the termination of the Executive's employment by the Company for "good cause" (as defined in paragraph 2(b) below), or (v) the termination of the Executive's employment by the Company as a result of the Company's determination in its sole judgment that the Executive has either (A) repeatedly failed to perform the duties and assignments given to him or (B) consistently failed to perform the duties and assignments given to him in a manner that is acceptable to the Company, based on the level and quality of performance expected from an experienced executive at the Executive's level in the Company. (d) If there is a Termination of Employment during the Protection Period, the Executive or his duly designated beneficiary will continue to receive his gross bi-weekly salary in effect on the date of Termination of Employment, subject to all required withholding taxes, in the form of salary continuation ("Salary Continuation"), during the time period set forth in Schedule I attached hereto (the "Salary Continuation Period"). (e) In addition to the Salary Continuation provided under paragraph 1(d) above, during the Salary Continuation Period the Company shall maintain in full force for the Executive's and his family's benefit, all life insurance, health and accident insurance, and disability and medical reimbursement plans in which the Executive and his family were entitled to participate immediately prior to the date of Termination of Employment, under the same terms as are made available during the Salary Continuation Period to other executive employees of the Company from time to time, if the continued participation of the Executive and his family in such - 2 - 4 plans is possible under the general terms and provisions of such plans, programs and arrangements. The costs of the Executive's and his family's continued participation in such insurance and reimbursement plans shall be allocated between the Company and the Executive in the same proportion as such costs were allocated prior to the date of Termination of Employment. If the Executive's or his family's continued participation is not possible, the Company shall reimburse the Executive for his cost in obtaining comparable coverage, subject to a maximum reimbursement during the Salary Continuation Period equal to 10% of the Executive's base annual salary for the calendar year preceding the date of Termination of Employment. For purposes of the Consolidated Omnibus Budget Reconciliation Act ("COBRA"), the qualifying event that begins the Executive's period of coverage shall be considered to occur on the last day for which health coverage is provided during the Salary Continuation Period and for which the Company contributes to the costs of such coverage pursuant to this paragraph 1(e). (f) This paragraph 1 shall not be applicable to any Termination of Employment following a "change in control" as defined in paragraph 2(c) of this Agreement. (g) The salary payments and benefits continuation provided for in paragraphs 1(d) and 1(e) shall be in lieu of any other severance payments the Executive might otherwise be entitled to from the Company whether in this Agreement, under any employment agreement, or under a severance plan or policy maintained by the Company for employees of Executive's rank and seniority. (h) The Executive shall not be considered to be an employee of the Company during the Salary Continuation Period for purposes of accruing any benefits under the Company's 401(k) retirement plan, or any other retirement, pension, profit sharing, savings or incentive or bonus plan maintained, sponsored or administered by the Company ("Retirement or Bonus Plans") or under the Company's vacation policy. During the Salary Continuation Period the Executive shall not be entitled to any contribution by the Company on his behalf or to his account under any Retirement or Bonus Plans nor shall he be entitled to accrue any benefits under the Company's vacation policy. 2. CHANGE IN CONTROL PAYMENTS. -------------------------- (a) If during the Protection Period there is a "change in control" and within two (2) years thereafter (i) the employment of the Executive is terminated by the Company for other than "good cause" or the death or "total disability" of the Executive or (ii) the Executive shall declare his employment terminated for "good reason," then the Executive shall be entitled to the following: - 3 - 5 A. All unpaid salary through the date of termination of employment plus credit for any vacation earned but not taken through the date of termination of employment (as permitted by the Company's policy on vacations) together with reimbursement for expenses not previously reimbursed through the date of termination, all of which will be paid immediately subject to all required withholding taxes. B. As a severance benefit, the Executive shall be entitled to an amount equal to his current base annual salary ("X") plus the annual average of all incentive compensation paid to the Executive by the Company during the three (3) calendar years preceding the date of termination or such portion of that period during which Executive was an employee ("Y"), multiplied by the number set forth in Schedule II attached hereto ("Severance Benefit"). The Severance Benefit will equal (X + Y) multiplied by the number set forth in Schedule II. C. This Severance Benefit, less all proper payroll deductions, shall be paid immediately to the Executive in a lump sum. D. In addition to the Severance Benefit, the Executive shall be entitled to continued participation for the number of months set forth in Schedule III attached hereto following the date of the termination of his employment, in all life insurance, health and accident insurance, disability and medical reimbursement plans, programs and arrangements in which the Executive and his family were entitled to participate immediately prior to the date of a "change in control," if the continued participation of the Executive and his family in such plans, programs and arrangements is possible under the general terms and provisions of such plans, programs and arrangements. The costs of the Executive's and his family's continued participation in such plans, programs and arrangements shall be allocated between the Company and the Executive in the same proportion as such costs were allocated prior to the date of the termination of his employment. If the Executive's or his family's continued participation is not possible, the Company shall reimburse the Executive at the end of each month during the period specified in Schedule III for his cost in obtaining comparable coverage, subject to a maximum reimbursement - 4 - 6 during each month equal to 2% of the Executive's base annual salary for the calendar year preceding the date of the termination of his employment. For purposes of COBRA, the qualifying event that begins the Executive's period of coverage shall be considered to occur on the last day for which health coverage is provided and for which the Company contributes to the costs of such coverage pursuant to this paragraph 2(a)D. The Company's obligations under this paragraph 2(a)D. with respect to life, health, accident and disability coverage shall be suspended with respect to any such coverage at any time that the Executive is eligible for comparable coverage from another employer. The parties agree that the payments provided for in this paragraph 2(a) shall be liquidated damages which are in lieu of any other severance payments that the Executive would otherwise be entitled to under this Agreement or under any severance plan or policy that would apply to him but for this Agreement, and the Company agrees that the Executive shall not be required to mitigate his damages by seeking other employment or otherwise. (b) "Good cause" shall mean (i) the Executive's dishonesty, fraud or breach of trust, or substantial misconduct in the performance of or substantial nonperformance of his duties as an employee of the Company, (ii) any act or omission by the Executive that results in a felony conviction or in a regulatory body with jurisdiction over the Company removing the Executive from office or requesting or recommending the suspension or removal of the Executive or taking punitive action against the Executive, or (iii) a material breach by the Executive of paragraphs 3 or 4 of this Agreement. (c) For purposes of this Agreement, a "change in control" shall have occurred if, after the date of this Agreement: A. Any person (as such term is used in Section 13(d) or Section 14(d)(2) of the Securities Exchange Act of 1934, as amended, and the rules and regulations thereunder and including any affiliate or associate of such person, as defined in Rule 12b-2 under said Act, and any person acting in concert with such person), directly or indirectly acquires or becomes the beneficial owner of (within the meaning of Rule 13d-3 under said Act), or otherwise becomes entitled to vote, stock of the Company or MGI or MNH (hereinafter referred to individually as a "Merchants Company" and collectively as the - 5 - 7 "Merchants Companies") with 25% or more of the voting power entitled to be cast at elections for directors (excluding any acquisition of stock in one Merchants Company by another Merchants Company or the voting of stock in one Merchants Company by another Merchants Company); or B. There occurs any merger or consolidation of a Merchants Company (excluding any merger or consolidation of one Merchants Company with another) or any sale, lease or exchange of all or any substantial part of the assets of any of the Merchants Companies and their subsidiaries to any other person, excluding any of the Merchants Companies, and (i) in the case of a merger or consolidation, the holders of the outstanding stock of any of the Merchants Companies entitled to vote in elections of directors ("voting stock") immediately before such merger or consolidation hold less than 50% of the voting stock of the survivor of such merger or consolidation or its parent; or (ii) in the case of any such sale, lease or exchange, neither the Company nor either of the other Merchants Companies or the Merchants Companies as a group owns at least 50% of the voting stock of the other person; or C. During any period of two (2) consecutive years, individuals who at the beginning of such period constitute the entire Board of Directors of any of the Merchants Companies shall cease for any reason to constitute a majority thereof, unless the election or the nomination for the election by that company's shareholders or policyholders of each new Director was approved by a vote of at least two-thirds of the Directors then still in office who were Directors at the beginning of the period. (d) "Good reason" shall mean any of the following subsequent to a "change in control" (i) the requirement that the Executive relocate his principal place of business to a location that is more than 25 miles from the Executive's principal place of business immediately prior to the date of a "change in control," (ii) any assignment to the Executive without his express written consent of any material duties, functions, authority or responsibilities with respect to any of the Merchants Companies other than those duties, functions, authority and responsibilities assigned to the Executive by the Company prior to the "change in control," or any material limitation or expansion without the Executive's express written consent of the material duties, functions, authority and responsibilities assigned to the Executive by the Company prior to the "change in - 6 - 8 control," any such assignment, limitation or expansion being deemed a continuing breach of this Agreement, (iii) a reduction in the Executive's then annual salary paid by any of the Merchants Companies or (iv) failure by the Company to obtain the assumption of, and the agreement to perform, this Agreement by any successor or assign as contemplated in paragraph 8 hereof, and such relocation described in the foregoing clause (i), such assignment, limitation or expansion described in the foregoing clause (ii), reduction described in the foregoing clause (iii) or failure described in the foregoing clause (iv) is not cured within thirty (30) days after receipt by the Company of written notice from the Executive describing such event, or (v) any removal of the Executive from, or any failure to re-designate or re-elect the Executive to the position he held immediately prior to the "change in control"; provided that in any event set forth above in this subparagraph 2(d), the Executive shall have elected to terminate his employment under this Agreement upon not less than sixty (60) days' advance written notice to the Company, given, except in the case of a continuing breach, within three calendar months after (A) failure to be so elected or re-elected, or such removal, or (B) expiration of the thirty-day cure period with respect to such event. An election by the Executive to terminate his employment given under the provisions of this paragraph 2(d) shall not be deemed a voluntary termination of employment by the Executive for the purpose of this Agreement or any plan or practice of the Company. (e) "Total disability," as used herein, shall mean total disability as defined in any long-term disability plan sponsored by the Company in which the Executive participates, or, if there is no such plan or it does not define such term, then it shall mean the physical or mental incapacity of the Executive which prevents him from substantially performing his duties as an employee of the Company for a period of at least 180 days and the incapacity is expected to be permanent and continues for the remainder of the Executive's life. (f) The payments provided for in this paragraph 2 are in lieu of any payments provided for in any severance agreement, employment agreement or similar agreement between the Executive and the Company which is dated prior to the date of this Agreement ("Severance Agreement"). This Employee Retention Agreement hereby voids, terminates and supersedes any such Severance Agreement and the Executive hereby acknowledges that any such Severance Agreement is hereby terminated and he no longer has any rights or benefits thereunder. 3. NON-DISCLOSURE OF CONFIDENTIAL INFORMATION. ------------------------------------------- The Executive will not at any time use or disclose to any third party any confidential information or trade secrets relating to the business of any of the Merchants Companies, including business methods and techniques, research data, - 7 - 9 marketing and sales information, agent lists, underwriting and claims procedures, investment strategies, reinsurance arrangements, agent compensation plans, pricing data, and any other information concerning the business of any of the Merchants Companies, their manner of operation, their plans, or other information not disclosed to the general public or known in the insurance industry, except for disclosure in the course of the Executive's duties hereunder, or disclosure required by any law, rule, regulation or court order, or disclosure which the Executive reasonably believes would subject him or any of the Merchants Companies to liability if not made. This covenant will survive the termination of this Agreement. 4. COVENANT NOT TO COMPETE. ----------------------- (a) The Executive shall not "compete," as that term is defined in paragraph 4(c) below, with any of the Merchants Companies while employed by the Company. (b) If the Executive is receiving Salary Continuation payments under paragraph 1(d) of this Agreement, he shall not compete with any of the Merchants Companies during the first ninety (90) days of the Salary Continuation Period, nor shall he "solicit," as that term is defined in paragraph 4(d) below, any employee of the Company for a period of six (6) months after his last day of employment with the Company, unless he shall have received prior written approval from the Company. (c) As used in this paragraph 4, the term "compete" means the direct or indirect ownership, management, operation or control of, or participation in the ownership, management, operation, or control of, or the holding of the position of an officer, employee, partner, director, consultant or similar positions, or the holding of any financial interest in, or the giving of any aid or assistance to anyone else in the conduct of, any business that is engaged in a property-casualty insurance business that offers substantially any of the same lines of insurance and coverages offered, or proposed to be offered, by any of the Merchants Companies at the time of the Executive's withdrawal from or termination of employment with the Company, in any of the geographic markets in which any of the Merchants Companies is then conducting business. Ownership of stock of MGI or of one percent (1%) or less of the voting stock of any other publicly held corporation shall not constitute a violation of this paragraph 4. (d) As used in paragraph 4(b) above, the term "solicit" shall mean the solicitation of any employee of the Company for the purpose of hiring or engaging such employee to work for or otherwise assist any person who does or intends to compete with any of the Merchants Companies. - 8 - 10 (e) In addition to any other remedies that the Company may have in law or in equity for a breach of the Executive's covenants set forth in this paragraph 4, the Company may also cancel its obligations to pay to the Executive any monies and other benefits otherwise due to the Executive under this Agreement. 5. ENTIRE AGREEMENT. ---------------- The terms and provisions of this Agreement constitute the entire agreement between the parties and supersede any previous oral or written communications, representations, or agreements with respect to the subject matter hereof. 6. NOTICE. ------- Any notices given hereunder shall be in writing and shall be given by personal delivery or by certified or registered mail, return receipt requested, addressed to the addressee at the address set forth at the head of this Agreement or such other address that such addressee has duly notified the other party to forward notices to hereunder. 7. SEVERABILITY. ------------- The invalidity or unenforceability of any particular provision of this Agreement shall not affect the other provisions hereof, and this Agreement shall be construed in all respects as if the invalid or unenforceable provision had been omitted. 8. COMPANY ASSIGNMENT. ------------------- The Company may not assign this Agreement, except that the Company's obligations hereunder shall be binding legal obligations of any successor to all or substantially all of the Company's business by purchase, merger, consolidation, or otherwise. The Company shall require any successor or assign (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of the Company, by agreement in form and substance satisfactory to the Executive, expressly, absolutely and unconditionally to assume and agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform it if no such succession or assignment had taken place. Any failure of the Company to obtain such agreement prior to the effectiveness of any such succession or assignment shall be a material breach of this Agreement. As used in this Agreement, the term "Company" shall mean the Company as hereinbefore defined and any successor or assign to its business and/or assets as aforesaid which executes and delivers the agreement provided for in this paragraph 8 or which otherwise - 9 - 11 becomes bound by all the terms and provisions of this Agreement by operation of law. 9. NO ASSIGNMENT BY EXECUTIVE. --------------------------- No interest of the Executive or the Executive's spouse or any other beneficiary under this Agreement, or any right to receive any payments or distributions hereunder, shall be subject in any manner to sale, transfer, assignment, pledge, attachment, garnishment, or other alienation or encumbrance of any kind, nor may such interest or right to receive a payment or distribution be taken, voluntarily or involuntarily, for the satisfaction of the obligations or debts of, or other claims against, the Executive or the Executive's spouse or other beneficiary, including claims for alimony, support, separate maintenance, and claims in bankruptcy proceedings. 10. BENEFITS UNFUNDED. ------------------ All rights of the Executive and the Executive's spouse or other beneficiary under this Agreement shall at all times be entirely unfunded, and no provision shall at any time be made with respect to segregating any assets of the Company for payment of any amounts due hereunder. Neither the Executive nor the Executive's spouse or other beneficiary shall have any interest in or rights against any specific assets of the Company, and the Executive and the Executive's spouse or other beneficiary shall have only the rights of a general unsecured creditor of the Company. 11. WAIVER. ------- No waiver by any party at any time of any breach by another party of, or compliance with, any condition or provision of this Agreement to be performed by the other party shall be deemed a waiver of any other provisions or conditions at the same time or at any prior or subsequent time. 12. PAYMENTS IN EVENT OF DEATH. --------------------------- Upon the death of the Executive all amounts due and payable to the Executive pursuant to paragraphs 1(d) and (e) and 2(a) of this Agreement shall be paid to the person or persons designated by him as his beneficiary or beneficiaries on the Form of Designation of Beneficiary attached hereto as Exhibit A, or if no such person is designated then to his devisee, legatee or other designee, or in their absence to his estate. 13. REDUCTION OF PARACHUTE PAYMENTS ------------------------------- AND EXCESSIVE EMPLOYEE REMUNERATION. ------------------------------------ (a) In the event that a determination is made by legal counsel for the Company that (i) the Executive would, - 10 - 12 except for this paragraph 13, be subject to the excise tax provisions of Section 4999 of the Internal Revenue Code of 1986 (the "Code"), or any successor sections thereof, as a result of a "parachute payment" (as defined in Section 280G(b)(2)(A) of the Code) made by the Company to the Executive pursuant to this Agreement or any other agreement, plan or arrangement, or (2) a federal income tax deduction would not be allowed to the Company for all or a part of such payments by reason of Section 280G(a) of the Code (or any successor provision), the payments to which the Executive would otherwise be entitled hereunder shall be reduced, eliminated, or postponed in such amounts as are required to reduce the aggregate "present value" (as defined in Section 280G(d)(4) of the Code) of such payments to one dollar less than an amount equal to three times the Executive's "base amount" (as defined in Sections 280G(b)(3)(A) and 280G(d)(1) and (2) of the Code), to the end that the Executive is not subject to tax pursuant to such Section 4999 and no deduction is disallowed by reason of such Section 280G(a). To achieve such reduction in aggregate present value, the Executive shall determine which item or items payable hereunder shall be reduced, eliminated, or postponed, the amount of each such reduction, elimination, or postponement, and the period of each postponement. The Company shall direct its legal counsel to review the payments made to the Executive and shall provide to the Executive such information as is reasonably necessary for the Executive to make the determinations contemplated in this paragraph. (b) In the event that a determination is made by legal counsel for the Company that the Company would not be allowed to deduct remuneration payable to the Executive as a result of the limits imposed by Section 162(m) of the Code, or any successor sections thereof, the payments to which the Executive would otherwise be entitled hereunder shall be reduced, eliminated, or postponed in such amounts as are required to avoid the limits imposed by Section 162(m). The procedures set forth in paragraph 13(a) to accomplish such reduction, elimination or postponement shall apply to this paragraph 13(b). 14. APPLICABLE LAW. --------------- This Agreement shall be construed and interpreted in accordance with the internal substantive laws of the State of New York without taking into account its laws on the conflict of law. 15. ARBITRATION. ------------ The Company and the Executive shall attempt to resolve between them any dispute which arises hereunder. If they cannot agree within ten (10) days after either party submits a demand for arbitration to the other party, then the issue shall be submitted to arbitration with each party having the right to appoint one (1) arbitrator and those two (2) arbitrators mutually - 11 - 13 selecting a third arbitrator. The rules of the American Arbitration Association for the arbitration of commercial disputes shall apply and the decision of 2 of the 3 arbitrators shall be final. The arbitrators must reach a decision within ninety (90) days after the selection of the third arbitrator. The arbitration shall take place in Buffalo, New York. The arbitrators shall apply New York law. 16. AMENDMENT. ---------- This Agreement shall be amended only by a written document signed by each party hereto. 17. GENDER. ------- The use of the masculine gender when used to refer to the Executive in this Agreement or in any Exhibit or Schedule hereto shall be deemed to be the female gender if the Executive is a female. 18. EMPLOYEE-AT-WILL. ----------------- Notwithstanding any provision in this Agreement, the Executive will remain an at-will employee of the Company, whose employment may be terminated by the Company at any time subject to the Executive's rights to receive the benefits specifically provided in paragraphs 1 and 2 in this Agreement, as applicable. IN WITNESS WHEREOF, the parties have executed this Agreement effective as of the day and year first above written. THE EXECUTIVE: /s/Edward M. Murphy ---------------------------------- EDWARD M. MURPHY MERCHANTS MUTUAL INSURANCE COMPANY By /s/ Franklin S. Barry, Jr. -------------------------------- FRANKLYN S. BARRY, JR., CHAIRMAN OF THE COMPENSATION COMMITTEE - 12 - 14 EXHIBIT A FORM OF DESIGNATION OF BENEFICIARY In the event of the death of the undersigned, the undersigned hereby designates the following person or persons as his beneficiary or beneficiaries for the receipt of any payments due to the undersigned under the Employee Retention Agreement between the undersigned and Merchants Mutual Insurance Company: Primary Beneficiary or Beneficiaries: ----------------- ----------------------------------- ----------------------------------- Contingent Beneficiary or Beneficiaries: ----------------- ----------------------------------- ----------------------------------- Dated: _________________ ______________________________ EDWARD M. MURPHY 15 SCHEDULE I Salary Continuation 24 months -- commencing on the day Period: after the date of Termination of - ------------------- Employment. SCHEDULE II The number (multiplier) referred to in paragraph 2(a)B. shall be 2. SCHEDULE III The number of months referred to in paragraph 2(a)D. shall be 24. EX-10.S 5 EXHIBIT 10(S) 1 EXHIBIT 10-S EMPLOYEE RETENTION AGREEMENT BETWEEN KENNETH J. WILSON AND MERCHANTS MUTUAL INSURANCE COMPANY DATED: MARCH 1, 1999 2 EMPLOYEE RETENTION AGREEMENT ---------------------------- This AGREEMENT ("Agreement"), dated as of March 1, 1999, is by and between KENNETH J. WILSON, residing at 15 Snyderwoods Court, Snyder, New York 14226 (the "Executive") and MERCHANTS MUTUAL INSURANCE COMPANY, a New York mutual insurance company with its principal office at 250 Main Street, Buffalo, New York 14202 (the "Company"). RECITALS: WHEREAS, the Company is responsible for managing the business of Merchants Group, Inc. ("MGI") and MGI's wholly-owned subsidiary, Merchants Insurance Company of New Hampshire, Inc. ("MNH"), under a Management Agreement dated September 29, 1986 by and among the Company, MGI and MNH (the "Management Agreement"); and WHEREAS, MGI has given notice to the Company that it will terminate the Management Agreement no later than at the end of the required five-year notice period; and WHEREAS, the Executive is a key employee of the Company; and WHEREAS, the Company believes that the Executive's continued employment with the Company will enhance the Company's ability to continue to manage the business of the Company, MGI and MNH throughout the period prior to the effective date of the termination of the Management Agreement; and WHEREAS, the Company believes that the Executive's continued employment with the Company will be in the collective best interests of the Company, MGI and MNH; and WHEREAS, the Company believes that by extending certain financial incentives to the Executive it will assist the Company in retaining the services of the Executive throughout the period prior to the effective date of the termination of the Management Agreement; and WHEREAS, the Executive and the Company desire to enter into this Agreement in order to provide for such financial incentives. NOW, THEREFORE, in consideration of the promises and the mutual agreements herein contained, the adequacy and sufficiency of which are hereby acknowledged, the Company and the Executive agree as follows: 3 1. SALARY CONTINUATION AND BENEFITS. (a) The purpose of this paragraph 1 is to provide the Executive with a continuation of salary and certain benefits in the event it is necessary or advisable for the Company, through no fault of the Executive, to either terminate the Executive's employment or eliminate his position. In order to give effect to this purpose, the Executive shall receive certain payments and benefits from the Company if there is a "Termination of Employment" during the "Protection Period," as those terms are defined below, subject to the following terms and conditions. (b) The "Protection Period" shall be that period of time from the date of this Agreement through and including December 31, 2003. (c) "Termination of Employment" is defined to mean the termination of the Executive's full-time employment with the Company for any reason other than (i) the Executive's death, (ii) the Executive's "total disability" (as defined in paragraph 2(e) below), (iii) the Executive's voluntary termination of employment with the Company, (iv) the termination of the Executive's employment by the Company for "good cause" (as defined in paragraph 2(b) below), or (v) the termination of the Executive's employment by the Company as a result of the Company's determination in its sole judgment that the Executive has either (A) repeatedly failed to perform the duties and assignments given to him or (B) consistently failed to perform the duties and assignments given to him in a manner that is acceptable to the Company, based on the level and quality of performance expected from an experienced executive at the Executive's level in the Company. (d) If there is a Termination of Employment during the Protection Period, the Executive or his duly designated beneficiary will continue to receive his gross bi-weekly salary in effect on the date of Termination of Employment, subject to all required withholding taxes, in the form of salary continuation ("Salary Continuation"), during the time period set forth in Schedule I attached hereto (the "Salary Continuation Period"). (e) In addition to the Salary Continuation provided under paragraph 1(d) above, during the Salary Continuation Period the Company shall maintain in full force for the Executive's and his family's benefit, all life insurance, health and accident insurance, and disability and medical reimbursement plans in which the Executive and his family were entitled to participate immediately prior to the date of Termination of Employment, under the same terms as are made available during the Salary Continuation Period to other executive employees of the Company from time to time, if the continued participation of the Executive and his family in such - 2 - 4 plans is possible under the general terms and provisions of such plans, programs and arrangements. The costs of the Executive's and his family's continued participation in such insurance and reimbursement plans shall be allocated between the Company and the Executive in the same proportion as such costs were allocated prior to the date of Termination of Employment. If the Executive's or his family's continued participation is not possible, the Company shall reimburse the Executive for his cost in obtaining comparable coverage, subject to a maximum reimbursement during the Salary Continuation Period equal to 10% of the Executive's base annual salary for the calendar year preceding the date of Termination of Employment. For purposes of the Consolidated Omnibus Budget Reconciliation Act ("COBRA"), the qualifying event that begins the Executive's period of coverage shall be considered to occur on the last day for which health coverage is provided during the Salary Continuation Period and for which the Company contributes to the costs of such coverage pursuant to this paragraph 1(e). (f) This paragraph 1 shall not be applicable to any Termination of Employment following a "change in control" as defined in paragraph 2(c) of this Agreement. (g) The salary payments and benefits continuation provided for in paragraphs 1(d) and 1(e) shall be in lieu of any other severance payments the Executive might otherwise be entitled to from the Company whether in this Agreement, under any employment agreement, or under a severance plan or policy maintained by the Company for employees of Executive's rank and seniority. (h) The Executive shall not be considered to be an employee of the Company during the Salary Continuation Period for purposes of accruing any benefits under the Company's 401(k) retirement plan, or any other retirement, pension, profit sharing, savings or incentive or bonus plan maintained, sponsored or administered by the Company ("Retirement or Bonus Plans") or under the Company's vacation policy. During the Salary Continuation Period the Executive shall not be entitled to any contribution by the Company on his behalf or to his account under any Retirement or Bonus Plans nor shall he be entitled to accrue any benefits under the Company's vacation policy. 2. CHANGE IN CONTROL PAYMENTS. (a) If during the Protection Period there is a "change in control" and within two (2) years thereafter (i) the employment of the Executive is terminated by the Company for other than "good cause" or the death or "total disability" of the Executive or (ii) the Executive shall declare his employment terminated for "good reason," then the Executive shall be entitled to the following: - 3 - 5 A. All unpaid salary through the date of termination of employment plus credit for any vacation earned but not taken through the date of termination of employment (as permitted by the Company's policy on vacations) together with reimbursement for expenses not previously reimbursed through the date of termination, all of which will be paid immediately subject to all required withholding taxes. B. As a severance benefit, the Executive shall be entitled to an amount equal to his current base annual salary ("X") plus the annual average of all incentive compensation paid to the Executive by the Company during the three (3) calendar years preceding the date of termination or such portion of that period during which Executive was an employee ("Y"), multiplied by the number set forth in Schedule II attached hereto ("Severance Benefit"). The Severance Benefit will equal (X + Y) multiplied by the number set forth in Schedule II. C. This Severance Benefit, less all proper payroll deductions, shall be paid immediately to the Executive in a lump sum. D. In addition to the Severance Benefit, the Executive shall be entitled to continued participation for the number of months set forth in Schedule III attached hereto following the date of the termination of his employment, in all life insurance, health and accident insurance, disability and medical reimbursement plans, programs and arrangements in which the Executive and his family were entitled to participate immediately prior to the date of a "change in control," if the continued participation of the Executive and his family in such plans, programs and arrangements is possible under the general terms and provisions of such plans, programs and arrangements. The costs of the Executive's and his family's continued participation in such plans, programs and arrangements shall be allocated between the Company and the Executive in the same proportion as such costs were allocated prior to the date of the termination of his employment. If the Executive's or his family's continued participation is not possible, the Company shall reimburse the Executive at the end of each month during the period specified in Schedule III for his cost in obtaining comparable coverage, subject to a maximum reimbursement - 4 - 6 during each month equal to 2% of the Executive's base annual salary for the calendar year preceding the date of the termination of his employment. For purposes of COBRA, the qualifying event that begins the Executive's period of coverage shall be considered to occur on the last day for which health coverage is provided and for which the Company contributes to the costs of such coverage pursuant to this paragraph 2(a)D. The Company's obligations under this paragraph 2(a)D. with respect to life, health, accident and disability coverage shall be suspended with respect to any such coverage at any time that the Executive is eligible for comparable coverage from another employer. The parties agree that the payments provided for in this paragraph 2(a) shall be liquidated damages which are in lieu of any other severance payments that the Executive would otherwise be entitled to under this Agreement or under any severance plan or policy that would apply to him but for this Agreement, and the Company agrees that the Executive shall not be required to mitigate his damages by seeking other employment or otherwise. (b) "Good cause" shall mean (i) the Executive's dishonesty, fraud or breach of trust, or substantial misconduct in the performance of or substantial nonperformance of his duties as an employee of the Company, (ii) any act or omission by the Executive that results in a felony conviction or in a regulatory body with jurisdiction over the Company removing the Executive from office or requesting or recommending the suspension or removal of the Executive or taking punitive action against the Executive, or (iii) a material breach by the Executive of paragraphs 3 or 4 of this Agreement. (c) For purposes of this Agreement, a "change in control" shall have occurred if, after the date of this Agreement: A. Any person (as such term is used in Section 13(d) or Section 14(d)(2) of the Securities Exchange Act of 1934, as amended, and the rules and regulations thereunder and including any affiliate or associate of such person, as defined in Rule 12b-2 under said Act, and any person acting in concert with such person), directly or indirectly acquires or becomes the beneficial owner of (within the meaning of Rule 13d-3 under said Act), or otherwise becomes entitled to vote, stock of the Company or MGI or MNH (hereinafter referred to individually as a "Merchants Company" and collectively as the - 5 - 7 "Merchants Companies") with 25% or more of the voting power entitled to be cast at elections for directors (excluding any acquisition of stock in one Merchants Company by another Merchants Company or the voting of stock in one Merchants Company by another Merchants Company); or B. There occurs any merger or consolidation of a Merchants Company (excluding any merger or consolidation of one Merchants Company with another) or any sale, lease or exchange of all or any substantial part of the assets of any of the Merchants Companies and their subsidiaries to any other person, excluding any of the Merchants Companies, and (i) in the case of a merger or consolidation, the holders of the outstanding stock of any of the Merchants Companies entitled to vote in elections of directors ("voting stock") immediately before such merger or consolidation hold less than 50% of the voting stock of the survivor of such merger or consolidation or its parent; or (ii) in the case of any such sale, lease or exchange, neither the Company nor either of the other Merchants Companies or the Merchants Companies as a group owns at least 50% of the voting stock of the other person; or C. During any period of two (2) consecutive years, individuals who at the beginning of such period constitute the entire Board of Directors of any of the Merchants Companies shall cease for any reason to constitute a majority thereof, unless the election or the nomination for the election by that company's shareholders or policyholders of each new Director was approved by a vote of at least two-thirds of the Directors then still in office who were Directors at the beginning of the period. (d) "Good reason" shall mean any of the following subsequent to a "change in control" (i) the requirement that the Executive relocate his principal place of business to a location that is more than 25 miles from the Executive's principal place of business immediately prior to the date of a "change in control," (ii) any assignment to the Executive without his express written consent of any material duties, functions, authority or responsibilities with respect to any of the Merchants Companies other than those duties, functions, authority and responsibilities assigned to the Executive by the Company prior to the "change in control," or any material limitation or expansion without the Executive's express written consent of the material duties, functions, authority and responsibilities assigned to the Executive by the Company prior to the "change in - 6 - 8 control," any such assignment, limitation or expansion being deemed a continuing breach of this Agreement, (iii) a reduction in the Executive's then annual salary paid by any of the Merchants Companies or (iv) failure by the Company to obtain the assumption of, and the agreement to perform, this Agreement by any successor or assign as contemplated in paragraph 8 hereof, and such relocation described in the foregoing clause (i), such assignment, limitation or expansion described in the foregoing clause (ii), reduction described in the foregoing clause (iii) or failure described in the foregoing clause (iv) is not cured within thirty (30) days after receipt by the Company of written notice from the Executive describing such event, or (v) any removal of the Executive from, or any failure to re-designate or re-elect the Executive to the position he held immediately prior to the "change in control"; provided that in any event set forth above in this subparagraph 2(d), the Executive shall have elected to terminate his employment under this Agreement upon not less than sixty (60) days' advance written notice to the Company, given, except in the case of a continuing breach, within three calendar months after (A) failure to be so elected or re-elected, or such removal, or (B) expiration of the thirty-day cure period with respect to such event. An election by the Executive to terminate his employment given under the provisions of this paragraph 2(d) shall not be deemed a voluntary termination of employment by the Executive for the purpose of this Agreement or any plan or practice of the Company. (e) "Total disability," as used herein, shall mean total disability as defined in any long-term disability plan sponsored by the Company in which the Executive participates, or, if there is no such plan or it does not define such term, then it shall mean the physical or mental incapacity of the Executive which prevents him from substantially performing his duties as an employee of the Company for a period of at least 180 days and the incapacity is expected to be permanent and continues for the remainder of the Executive's life. (f) The payments provided for in this paragraph 2 are in lieu of any payments provided for in any severance agreement, employment agreement or similar agreement between the Executive and the Company which is dated prior to the date of this Agreement ("Severance Agreement"). This Employee Retention Agreement hereby voids, terminates and supersedes any such Severance Agreement and the Executive hereby acknowledges that any such Severance Agreement is hereby terminated and he no longer has any rights or benefits thereunder. 3. NON-DISCLOSURE OF CONFIDENTIAL INFORMATION. The Executive will not at any time use or disclose to any third party any confidential information or trade secrets relating to the business of any of the Merchants Companies, including business methods and techniques, research data, - 7 - 9 marketing and sales information, agent lists, underwriting and claims procedures, investment strategies, reinsurance arrangements, agent compensation plans, pricing data, and any other information concerning the business of any of the Merchants Companies, their manner of operation, their plans, or other information not disclosed to the general public or known in the insurance industry, except for disclosure in the course of the Executive's duties hereunder, or disclosure required by any law, rule, regulation or court order, or disclosure which the Executive reasonably believes would subject him or any of the Merchants Companies to liability if not made. This covenant will survive the termination of this Agreement. 4. COVENANT NOT TO COMPETE. (a) The Executive shall not "compete," as that term is defined in paragraph 4(c) below, with any of the Merchants Companies while employed by the Company. (b) If the Executive is receiving Salary Continuation payments under paragraph 1(d) of this Agreement, he shall not compete with any of the Merchants Companies during the first ninety (90) days of the Salary Continuation Period, nor shall he "solicit," as that term is defined in paragraph 4(d) below, any employee of the Company for a period of six (6) months after his last day of employment with the Company, unless he shall have received prior written approval from the Company. (c) As used in this paragraph 4, the term "compete" means the direct or indirect ownership, management, operation or control of, or participation in the ownership, management, operation, or control of, or the holding of the position of an officer, employee, partner, director, consultant or similar positions, or the holding of any financial interest in, or the giving of any aid or assistance to anyone else in the conduct of, any business that is engaged in a property-casualty insurance business that offers substantially any of the same lines of insurance and coverages offered, or proposed to be offered, by any of the Merchants Companies at the time of the Executive's withdrawal from or termination of employment with the Company, in any of the geographic markets in which any of the Merchants Companies is then conducting business. Ownership of stock of MGI or of one percent (1%) or less of the voting stock of any other publicly held corporation shall not constitute a violation of this paragraph 4. (d) As used in paragraph 4(b) above, the term "solicit" shall mean the solicitation of any employee of the Company for the purpose of hiring or engaging such employee to work for or otherwise assist any person who does or intends to compete with any of the Merchants Companies. - 8 - 10 (e) In addition to any other remedies that the Company may have in law or in equity for a breach of the Executive's covenants set forth in this paragraph 4, the Company may also cancel its obligations to pay to the Executive any monies and other benefits otherwise due to the Executive under this Agreement. 5. ENTIRE AGREEMENT. The terms and provisions of this Agreement constitute the entire agreement between the parties and supersede any previous oral or written communications, representations, or agreements with respect to the subject matter hereof. 6. NOTICE. Any notices given hereunder shall be in writing and shall be given by personal delivery or by certified or registered mail, return receipt requested, addressed to the addressee at the address set forth at the head of this Agreement or such other address that such addressee has duly notified the other party to forward notices to hereunder. 7. SEVERABILITY. The invalidity or unenforceability of any particular provision of this Agreement shall not affect the other provisions hereof, and this Agreement shall be construed in all respects as if the invalid or unenforceable provision had been omitted. 8. COMPANY ASSIGNMENT. The Company may not assign this Agreement, except that the Company's obligations hereunder shall be binding legal obligations of any successor to all or substantially all of the Company's business by purchase, merger, consolidation, or otherwise. The Company shall require any successor or assign (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of the Company, by agreement in form and substance satisfactory to the Executive, expressly, absolutely and unconditionally to assume and agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform it if no such succession or assignment had taken place. Any failure of the Company to obtain such agreement prior to the effectiveness of any such succession or assignment shall be a material breach of this Agreement. As used in this Agreement, the term "Company" shall mean the Company as hereinbefore defined and any successor or assign to its business and/or assets as aforesaid which executes and delivers the agreement provided for in this paragraph 8 or which otherwise - 9 - 11 becomes bound by all the terms and provisions of this Agreement by operation of law. 9. NO ASSIGNMENT BY EXECUTIVE. No interest of the Executive or the Executive's spouse or any other beneficiary under this Agreement, or any right to receive any payments or distributions hereunder, shall be subject in any manner to sale, transfer, assignment, pledge, attachment, garnishment, or other alienation or encumbrance of any kind, nor may such interest or right to receive a payment or distribution be taken, voluntarily or involuntarily, for the satisfaction of the obligations or debts of, or other claims against, the Executive or the Executive's spouse or other beneficiary, including claims for alimony, support, separate maintenance, and claims in bankruptcy proceedings. 10. BENEFITS UNFUNDED. All rights of the Executive and the Executive's spouse or other beneficiary under this Agreement shall at all times be entirely unfunded, and no provision shall at any time be made with respect to segregating any assets of the Company for payment of any amounts due hereunder. Neither the Executive nor the Executive's spouse or other beneficiary shall have any interest in or rights against any specific assets of the Company, and the Executive and the Executive's spouse or other beneficiary shall have only the rights of a general unsecured creditor of the Company. 11. WAIVER. No waiver by any party at any time of any breach by another party of, or compliance with, any condition or provision of this Agreement to be performed by the other party shall be deemed a waiver of any other provisions or conditions at the same time or at any prior or subsequent time. 12. PAYMENTS IN EVENT OF DEATH. Upon the death of the Executive all amounts due and payable to the Executive pursuant to paragraphs 1(d) and (e) and 2(a) of this Agreement shall be paid to the person or persons designated by him as his beneficiary or beneficiaries on the Form of Designation of Beneficiary attached hereto as Exhibit A, or if no such person is designated then to his devisee, legatee or other designee, or in their absence to his estate. 13. REDUCTION OF PARACHUTE PAYMENTS AND EXCESSIVE EMPLOYEE REMUNERATION. (a) In the event that a determination is made by legal counsel for the Company that (i) the Executive would, - 10 - 12 except for this paragraph 13, be subject to the excise tax provisions of Section 4999 of the Internal Revenue Code of 1986 (the "Code"), or any successor sections thereof, as a result of a "parachute payment" (as defined in Section 280G(b)(2)(A) of the Code) made by the Company to the Executive pursuant to this Agreement or any other agreement, plan or arrangement, or (2) a federal income tax deduction would not be allowed to the Company for all or a part of such payments by reason of Section 280G(a) of the Code (or any successor provision), the payments to which the Executive would otherwise be entitled hereunder shall be reduced, eliminated, or postponed in such amounts as are required to reduce the aggregate "present value" (as defined in Section 280G(d)(4) of the Code) of such payments to one dollar less than an amount equal to three times the Executive's "base amount" (as defined in Sections 280G(b)(3)(A) and 280G(d)(1) and (2) of the Code), to the end that the Executive is not subject to tax pursuant to such Section 4999 and no deduction is disallowed by reason of such Section 280G(a). To achieve such reduction in aggregate present value, the Executive shall determine which item or items payable hereunder shall be reduced, eliminated, or postponed, the amount of each such reduction, elimination, or postponement, and the period of each postponement. The Company shall direct its legal counsel to review the payments made to the Executive and shall provide to the Executive such information as is reasonably necessary for the Executive to make the determinations contemplated in this paragraph. (b) In the event that a determination is made by legal counsel for the Company that the Company would not be allowed to deduct remuneration payable to the Executive as a result of the limits imposed by Section 162(m) of the Code, or any successor sections thereof, the payments to which the Executive would otherwise be entitled hereunder shall be reduced, eliminated, or postponed in such amounts as are required to avoid the limits imposed by Section 162(m). The procedures set forth in paragraph 13(a) to accomplish such reduction, elimination or postponement shall apply to this paragraph 13(b). 14. APPLICABLE LAW. This Agreement shall be construed and interpreted in accordance with the internal substantive laws of the State of New York without taking into account its laws on the conflict of law. 15. ARBITRATION. The Company and the Executive shall attempt to resolve between them any dispute which arises hereunder. If they cannot agree within ten (10) days after either party submits a demand for arbitration to the other party, then the issue shall be submitted to arbitration with each party having the right to appoint one (1) arbitrator and those two (2) arbitrators mutually - 11 - 13 selecting a third arbitrator. The rules of the American Arbitration Association for the arbitration of commercial disputes shall apply and the decision of 2 of the 3 arbitrators shall be final. The arbitrators must reach a decision within ninety (90) days after the selection of the third arbitrator. The arbitration shall take place in Buffalo, New York. The arbitrators shall apply New York law. 16. AMENDMENT. This Agreement shall be amended only by a written document signed by each party hereto. 17. GENDER. The use of the masculine gender when used to refer to the Executive in this Agreement or in any Exhibit or Schedule hereto shall be deemed to be the female gender if the Executive is a female. 18. EMPLOYEE-AT-WILL. Notwithstanding any provision in this Agreement, the Executive will remain an at-will employee of the Company, whose employment may be terminated by the Company at any time subject to the Executive's rights to receive the benefits specifically provided in paragraphs 1 and 2 in this Agreement, as applicable. IN WITNESS WHEREOF, the parties have executed this Agreement effective as of the day and year first above written. THE EXECUTIVE: /s/ Kenneth J. Wilson -------------------------------------- KENNETH J. WILSON MERCHANTS MUTUAL INSURANCE COMPANY By /s/ Franklin S. Barry, Jr. ------------------------------------ FRANKLYN S. BARRY, JR., CHAIRMAN OF THE COMPENSATION COMMITTEE - 12 - 14 EXHIBIT A FORM OF DESIGNATION OF BENEFICIARY In the event of the death of the undersigned, the undersigned hereby designates the following person or persons as his beneficiary or beneficiaries for the receipt of any payments due to the undersigned under the Employee Retention Agreement between the undersigned and Merchants Mutual Insurance Company: Primary Beneficiary or Beneficiaries: ----------------- ----------------------------------- ----------------------------------- Contingent Beneficiary or Beneficiaries: ----------------- ----------------------------------- ----------------------------------- Dated: --------------------------------------- ----------------------------- KENNETH J. WILSON 15 SCHEDULE I SALARY CONTINUATION 24 months -- commencing on the day PERIOD: after the date of Termination of Employment. SCHEDULE II The number (multiplier) referred to in paragraph 2(a)B. shall be 2. SCHEDULE III The number of months referred to in paragraph 2(a)D. shall be 24. EX-23 6 EXHIBIT 23 1 Exhibit 23 Consent of Independent Accountants We hereby consent to the incorporation by reference in the Registration Statement on Form S-8 (No. 33-47014) and in the Prospectus constituting part of the Registration Statement on Form S-3 (No. 333-08951) of Merchants Group, Inc. of our report dated February 15, 1999 appearing on page F-1 of this Form 10-K. PricewaterhouseCoopers Buffalo, New York March 29, 1999 EX-27 7 EXHIBIT 27
7 YEAR DEC-31-1998 JAN-01-1998 DEC-31-1998 180,784,000 17,000,000 17,756,000 0 0 0 215,172,000 16,000 9,741,000 12,390,000 274,523,000 136,685,000 49,382,000 0 0 0 0 0 32,000 71,751,000 274,523,000 93,540,000 13,277,000 (2,000) 153,000 65,234,000 24,788,000 8,689,000 8,257,000 2,334,000 5,923,000 0 0 0 5,923,000 2.05 2.04 130,833,000 67,379,000 (2,145,000) 26,765,000 42,433,000 126,869,000 0
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