10-Q 1 cgi-q3.htm FORM 10-Q FOR SEPTEMBER 30, 2005

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

[X] Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 2005

or

[ ] Transition Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934

Commission File Number 001-13672

THE COMMERCE GROUP, INC.
(Exact name of registrant as specified in our charter)

Massachusetts	04-2599931
(State or other jurisdiction	(IRS Employer
of Incorporation)	Identification No.)

211 Main Street, Webster, Massachusetts	01570
(Address of principal executive offices)	(Zip Code)

Registrant's telephone number, including area code: (508) 943-9000

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 and 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 whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act) . Yes X No

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) . Yes No X

As of September 30, 2005, the number of shares outstanding of the Registrant's common stock (excluding Treasury Shares) was 33,653,202.

<PAGE> 1

The Commerce Group, Inc.

Table of Contents

Part I - Financial Information

Item 1.	Financial Statements	Page No.

Consolidated Balance Sheet at September 30, 2005 (Unaudited) and December 31, 2004		3

Consolidated Statement of Earnings and Comprehensive Income for the Three and Nine
Months ended September 30, 2005 and 2004 (Unaudited)		4
Consolidated Statement of Cash Flows and Reconciliation of Net Earnings to Cash from
Operating Activities for the Nine Months Ended September 30, 2005 and 2004 (Unaudited)		5
Notes to Unaudited Consolidated Financial Statements		6

Item 2.	Management's Discussion and Analysis of Results of Operations and
	Financial Condition

Business Overview		13
Results of Operations		16
Financial Condition		21
Forward-Looking Statements		23

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	24

Item 4.	Controls and Procedures	24

Part II - Other Information

Item 1.	Legal Proceedings	24

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	25

Item 6.	Exhibits	25

Signature		26

<PAGE> 2

Part I - Financial Information

Item 1. Financial Statements

The Commerce Group, Inc. and Subsidiaries
Consolidated Balance Sheet
September 30, 2005 and December 31, 2004
(Thousands of Dollars)

	2005	2004

ASSETS	(Unaudited)

Investments:
Fixed maturities, at market (amortized cost: $1,996,018 and $1,674,849)	$1,991,574	$1,692,523
Preferred stocks, at market (cost: $446,263 and $421,247)	446,036	422,344
Common stocks, at market (cost: $115,374 and $74,865)	116,776	81,433
Preferred stock mutual funds, at equity (cost: $63,324 and $54,653)	71,330	61,429
Mortgage loans on real estate and collateral notes receivable (less allowance
for possible loan losses of $388 and $372)	17,296	14,735
Cash and cash equivalents	27,662	220,988
Other investments, at equity (cost: $46,264 and $48,588)	29,090	34,281

Total investments	2,699,764	2,527,733
Accrued investment income	22,076	18,643
Premiums receivable (less allowance for doubtful receivables of $2,254)	508,192	457,928
Deferred policy acquisition costs	185,195	163,645
Property and equipment, net of accumulated depreciation	59,397	53,757
Residual market receivable	202,865	193,618
Due from reinsurers	145,832	133,328
Deferred income taxes	51,431	43,372
Current income taxes	6,517	--
Other assets	20,068	18,372

Total assets	$3,901,337	$3,610,396


LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Unpaid losses and loss adjustment expenses	$1,000,997	$ 990,260
Unearned premiums	1,002,710	902,566
Bonds payable ($300,000 face less discount)	298,337	298,186
Current income taxes	-	5,115
Deferred income	9,845	9,906
Accrued agents' profit sharing	153,561	109,432
Other liabilities and accrued expenses	170,635	173,649

Total liabilities	2,636,085	2,489,114

Minority interest	5,742	5,126

Stockholders' equity:
Preferred stock, authorized 5,000,000 shares at $1.00 par value	--	--
Common stock, authorized 100,000,000 shares at $.50 par value, 40,915,773 and
40,728,715 shares issued	20,458	20,364
Paid-in capital	148,130	134,943
Net accumulated other comprehensive income (loss), net of income tax (benefit)
expense of $(902) and $8,833	(1,676)	16,403
Retained earnings	1,312,814	1,169,009

Total stockholders' equity before treasury stock	1,479,726	1,340,719
Treasury stock, 7,262,571 and 7,405,966 shares, at cost	(220,216)	(224,563)

Total stockholders' equity	1,259,510	1,116,156

Total liabilities, minority interest and stockholders' equity	$3,901,337	$3,610,396


The accompanying notes are an integral part of these consolidated financial statements.

<PAGE> 3

The Commerce Group, Inc. and Subsidiaries
Consolidated Statement of Earnings and Comprehensive Income
Three and Nine Months Ended September 30, 2005 and 2004
(Thousands of Dollars, Except Per Share Data)
(Unaudited)

	Three Months		Nine Months

	2005	2004	2005	2004


Revenues:
Direct premiums written	$479,076	$466,612	$1,470,088	$1,433,185
Assumed premiums	18,435	24,799	107,679	102,369
Ceded premiums	(76,084)	(75,239)	(211,347)	(195,949)

Net premiums written	421,427	416,172	1,366,420	1,339,605
Decrease (increase) in unearned premiums	6,870	(2,421)	(87,129)	(125,775)

Earned premiums	428,297	413,751	1,279,291	1,213,830
Net investment income	30,040	30,021	90,360	85,730
Premium finance and service fees	7,210	7,312	21,455	21,377
Net realized investment gains (losses)	196	(2,247)	20,800	9,610
Other income (loss)	(11)	2	4	115

Total revenues	465,732	448,839	1,411,910	1,330,662


Expenses:
Losses and loss adjustment expenses	240,279	237,918	790,174	796,606
Policy acquisition costs	134,715	128,457	346,766	318,881
Interest expense and amortization of bond fees	4,584	4,608	13,711	13,703

Total expenses	379,578	370,983	1,150,651	1,129,190


Earnings before income taxes and minority interest	86,154	77,856	261,259	201,472
Income taxes	26,084	23,329	80,146	58,233

Earnings before minority interest	60,070	54,527	181,113	143,239
Minority interest in net earnings of subsidiary	(240)	(213)	(683)	(495)

Net earnings	$ 59,830	$ 54,314	$ 180,430	$ 142,744


Comprehensive income	$ 45,029	$ 87,923	$ 162,351	$ 125,449

Net earnings per common share:
Basic	$ 1.78	$ 1.65	$ 5.38	$ 4.37

Diluted	$ 1.77	$ 1.64	$ 5.33	$ 4.35


Cash dividends paid per common share	$ 0.38	$ 0.33	$ 1.09	$ 0.98


Weighted average number of common shares
outstanding:
Basic	33,631,090	32,984,958	33,563,163	32,652,594

Diluted	33,875,796	33,196,077	33,843,042	32,808,858


The accompanying notes are an integral part of these consolidated financial statements.

<PAGE> 4

The Commerce Group, Inc. and Subsidiaries
Consolidated Statement of Cash Flows and Reconciliation
of Net Earnings to Cash from Operating Activities
Nine Months Ended September 30, 2005 and 2004
(Thousands of Dollars)
(Unaudited)

	2005	2004


Operating activities:
Premiums collected	$ 1,291,764	$ 1,239,265
Net investment income received	87,809	81,498
Premium finance and service fees received	21,455	21,376
Losses and loss adjustment expenses paid	(770,488)	(736,973)
Policy acquisition costs paid	(312,555)	(302,675)
Federal income tax payments	(89,309)	(66,739)
Interest paid	(8,925)	(8,925)
Other income	4	115

Cash from operating activities	219,755	226,942


Investing activities:
Investment sales, repayments and maturities	1,449,859	1,624,655
Mortgage loans and collateral notes receipts	3,472	3,304
Investment purchases	(1,820,554)	(1,947,659)
Mortgage loans and collateral notes originated	(6,049)	(1,288)
Property and equipment purchases	(11,306)	(5,408)
Other investing activities	2,924	5,060

Cash for investing activities	(381,654)	(321,336)


Financing activities:
Dividends paid to stockholders	(36,625)	(32,056)
Capital stock issued	2,437	19,269
Outstanding checks payable	2,761	(679)
Bond issue costs	-	(457)

Cash for financing activities	(31,427)	(13,923)


Decrease in cash and cash equivalents	(193,326)	(108,317)
Cash and cash equivalents at beginning of period	220,988	215,541

Cash and cash equivalents at end of period	$ 27,662	$ 107,224


Reconciliation of net earnings to cash from operating activities:
Net earnings	$ 180,430	$ 142,744
Adjustments to reconcile net earnings to cash from operating activities:
Premiums receivable	(69,200)	(96,766)
Deferred policy acquisition costs	(21,550)	(21,950)
Residual market receivable	(9,248)	(21,326)
Due from reinsurers	(12,504)	(17,901)
Unpaid losses and loss adjustment expenses	10,737	55,518
Unearned premiums	100,144	148,517
Current income taxes	(11,632)	(18,246)
Deferred income taxes	2,469	2,355
Deferred income	(61)	2,591
Accrued agents' profit sharing	44,129	39,377
Net realized investment gains	(20,800)	(9,610)
Stock option exercises	15,191	20,539
Other - net	11,650	1,100

Cash from operating activities	$ 219,755	$ 226,942


The accompanying notes are an integral part of these consolidated financial statements.

<PAGE> 5

1. Organization and Interim Financial Statements

Unless otherwise stated, "we," "our" or "us" means The Commerce Group, Inc. and its subsidiaries. Our consolidated financial statements include the accounts of The Commerce Group, Inc. and its subsidiaries. The Commerce Group, Inc. is a holding company and our operations are conducted through subsidiaries, the principal ones being The Commerce Insurance Company (Commerce), Citation Insurance Company (Citation), American Commerce Insurance Company (American Commerce), and Commerce West Insurance Company (Commerce West). We have eliminated significant intercompany accounts and transactions in consolidating these financial statements. Also, we have reclassified certain amounts for 2004 to conform with 2005 presentations.

We have prepared these financial statements in accordance with accounting principles generally accepted in the United State of America (GAAP). In preparing these financial statements in conformity with GAAP, we are required to make estimates and assumptions that affect the reported amounts of assets and liabilities at reporting dates and the reported amounts of revenues and expenses during the reporting periods. Actual results will differ from these estimates and assumptions. We employ significant estimates and assumptions in the determination of unpaid losses and loss adjustment expenses (LAE), the potential impairment of investments for other-than-temporary declines in market value and accrued agents' profit sharing. Our significant accounting policies are presented in the notes to our consolidated financial statements in our annual report on Form 10-K for the year ended December 31, 2004.

Our interim financial statements do not include all of the disclosures required by GAAP for annual financial statements. In our opinion, we have included all adjustments, consisting of normal, recurring adjustments, considered necessary for a fair statement of the results for the interim period. Operating results for the three and nine month periods ended September 30, 2005 are not necessarily indicative of the results that may be expected for the year ending December 31, 2005. We usually experience greater claim losses in the first quarter of the year than during the other quarters of the year due to the winter weather. These unaudited consolidated financial statements should be read in conjunction with our consolidated financial statements in our annual report on Form 10-K for the year ended December 31, 2004.

2. Stock-Based Compensation

Pro forma net earnings as if we had applied the fair value method of accounting for our stock-based compensation plans accounted for under the intrinsic value method for the nine months ended September 30, 2004 is $142,292. Pro forma diluted and basic earnings per share under this assumption are $4.34 and $4.36, respectively, for the nine months ended September 30, 2004. There is no related pro forma effect for the three and nine month periods ended September 30, 2005. All awards accounted for under the intrinsic value method were earned as of the end of the first quarter of 2004; therefore, no additional expense was required after the first quarter of 2004.

3. Comprehensive Income

Our comprehensive income for the three and nine months ended September 30, 2005 and 2004 follows:

		Three Months		Nine Months

		2005	2004	2005	2004


Net earnings
Other comprehensive income, net of taxes:		$ 59,830	$54,314	$180,430	$142,744

Change in unrealized gains (losses)^(a)		(14,263)	39,129	(10,741)	2,465
Reclassification adjustment^(b)		(538)	(5,520)	(7,338)	(19,760)

Other comprehensive income (loss)		(14,801)	33,609	(18,079)	(17,295)

Comprehensive income		$ 45,029	$87,923	$162,351	$125,449


___________________
a.	Unrealized gains (losses) are net of income tax expenses (benefits) of $(7,680) and $21,024 for the three months ended 2005 and 2004, respectively, and $(5,784) and $1,325 for the nine months ended 2005 and 2004, respectively.
b.	Reclassification adjustments are net of income tax benefits of $(289) and $(2,972) for the three months ended 2005 and 2004, respectively, and $(3,951) and $(10,640) for the nine months ended 2005 and 2004, respectively

<PAGE> 6

4. Earnings Per Share (EPS)

Basic EPS is based on the weighted average number of common shares outstanding. Diluted EPS is based on the weighted average number of common shares outstanding adjusted by the number of additional common shares that would have been outstanding had the potentially dilutive common shares been issued and reduced by the number of common shares we could have purchased from the proceeds of the potentially dilutive shares. Our only dilutive instruments are stock options outstanding. We had 2,415,463 and 3,302,578 stock options outstanding at September 30, 2005 and 2004, respectively. Our outstanding stock options at September 30, 2005 consisted of 11,288 stock options which were granted to our employees under our Incentive Compensation Plan; the remainder of the total outstanding stock options at September 30, 2005 consisted of American Commerce agents' options. Basic and diluted EPS for the three and nine months ended September 30, 2005 and 2004 follow:

	Three Months		Nine Months

	2005	2004	2005	2004


Net earnings for basic and diluted EPS	$59,830	$54,314	$180,430	$142,744

Common share information:
Average shares outstanding for basic EPS	33,631,090	32,984,958	33,563,163	32,652,594
Dilutive effect of stock options	244,706	211,119	279,879	156,264

Average shares outstanding for dilutive EPS	33,875,796	33,196,077	33,843,042	32,808,858


Basic EPS	$ 1.78	$ 1.65	$ 5.38	$ 4.37

Diluted EPS	$ 1.77	$ 1.64	$ 5.33	$ 4.35

Diluted EPS excludes stock options with exercise prices greater than the average market price of our common stock during the periods, because their inclusion would be anti-dilutive. For the three and nine months ended September 30, 2005, there were 400,000 anti-dilutive options. There were 1,100,000 anti-dilutive options for the three and nine months ended September 30, 2004.

5. Realized and Unrealized Investment Gains and Losses

Realized Investment Gains and Losses

Net realized investment gains (losses) for the three and nine months ended September 30, 2005 and 2004 follow:

	Three Months		Nine Months

	2005	2004	2005	2004


Other-than-temporary impairment losses:
Fixed maturity securities	$ (146)	$(12,399)	$ (305)	$(13,964)
Equity securities	(743)	--	(4,547)	(203)

Total other-than-temporary impairment losses	(889)	(12,399)	(4,852)	(14,167)

Transaction net gains (losses):
Fixed maturity securities	1,882	(635)	19,899	2,636
Equity securities	1,123	4,383	3,093	16,565
Venture capital funds	3,445	-	4,567	696
Other investments	(726)	(7)	(396)	(204)

Transaction net gains	5,724	3,741	27,163	19,693

Equity in earnings (losses) of closed-end
preferred stock mutual fund	(1,411)	3,153	1,230	7
Equity in venture capital funds	(3,228)	3,258	(2,741)	4,077

Net realized investment gains (losses)	$ 196	$ (2,247)	$20,800	$ 9,610

<PAGE> 7

Unrealized Investment Gains and Losses

The change in net unrealized gain (loss) on our fixed maturity and equity securities, excluding the impact of minority interest, from December 31, 2004 to September 30, 2005 follows:

	September 30,	December 31,
	2005	2004	Change


Net unrealized gain (loss):
Fixed maturity securities	$(3,751)	$17,674	$(21,425)
Equity securities	1,174	7,665	(6,491)

Net unrealized gain (loss)	$(2,577)	$25,339	$(27,916)

Gross unrealized losses on our equity and fixed maturity securities at September 30, 2005 by duration of unrealized loss follow:

		0-6	7-12	13-24	Over 24
	Total	Months	Months	Months	Months


Total equity and fixed maturity securities:
Number of positions	400	236	122	38	4

Total fair value	$1,735,811	$1,117,247	$481,658	$130,391	$6,515
Total amortized cost	1,762,819	1,131,004	491,627	133,570	6,618

Unrealized loss	$ (27,008)	$ (13,757)	$ (9,969)	$ (3,179)	$ (103)

Unrealized loss percentage to fair value	1.6%	1.2%	2.1%	2.4%	1.6%


Equity securities:
Number of positions	56	37	16	2	1

Total fair value	$ 261,971	$ 214,664	$ 46,437	$ 4	$ 866
Total cost	267,609	219,256	47,473	5	875

Unrealized loss	$ (5,638)	$ (4,592)	$ (1,036)	$ (1)	$ (9)

Unrealized loss percentage to fair value	2.2%	2.1%	2.2%	2.5%	1.0%


Total fixed maturity securities:
Number of positions	344	199	106	36	3

Total fair value	$1,473,840	$ 902,583	$435,221	$130,387	$5,649
Total amortized cost	1,495,210	911,748	444,154	133,565	5,743

Unrealized loss	$ (21,370)	$ (9,165)	$ (8,933)	$ (3,178)	$ (94)

Unrealized loss percentage to fair value	1.4%	1.0%	2.1%	2.4%	1.7%

We determined that the impairments of the securities represented in the above gross unrealized loss table are temporary, based on a review of the credit quality, duration and severity of the unrealized losses for our impaired securities. Gross unrealized losses for equity and fixed maturity securities have increased from $14,340 at December 31, 2004 primarily due to general market conditions in a rising interest rate environment. We currently intend to hold to recovery or maturity all of our temporarily impaired equity and fixed maturity securities, respectively.

<PAGE> 8

6. Unpaid Losses and LAE

Liabilities for unpaid losses and loss adjustment expenses at September 30, 2005 and December 31, 2004 follow:

		September 30,	December 31,
		2005	2004


Net voluntary unpaid losses and LAE		$ 795,569	$783,159
Voluntary salvage and subrogation recoverable		(95,381)	(97,218)
Assumed unpaid losses and LAE reserves from CAR^(a)		161,319	167,502
Assumed salvage and subrogation recoverable from CAR		(23,317)	(23,317)

Total voluntary and assumed unpaid losses and LAE reserves		838,190	830,126
Adjustment for ceded unpaid losses and LAE reserves		171,807	169,134
Adjustment for ceded salvage and subrogation recoverable		(9,000)	(9,000)

Total unpaid losses and LAE		$1,000,997	$990,260

___________________
(a)	Commonwealth Automobile Reinsurers

7. Bonds Payable

On December 9, 2003, we issued $300,000 face value of senior unsecured and unsubordinated debt (the Senior Notes) which matures December 9, 2013. The Senior Notes were issued at 99.3% to yield 6.04%, and bear a coupon interest rate of 5.95%, payable semi-annually on June 9 and December 9 beginning 2004. The fair market value of the Senior Notes at September 30, 2005 was estimated to be $304,317.

8. Ceded Reinsurance Recoverable

Ceded reinsurance recoverable amounts, which include amounts ceded to CAR and other unaffiliated reinsurers, are included in unpaid losses and loss adjustment expenses and unearned premiums. At September 30, 2005 and December 31, 2004, $162,807 and $160,134 were included in unpaid losses and loss adjustment expense amounts, respectively. At September 30, 2005 and December 31, 2004, $144,655 and $131,639 were included in the unearned premium liability amounts, respectively.

9. Reinsurance

Quota Share Reinsurance

On June 30, 2005, our 70% one-year quota share reinsurance program expired. This program was extended another year, effective July 1, 2005, with the primary change in terms being an increase in the quota share rate to 75%.

FAIR Plan

Our insurance subsidiaries are required to participate in various Property Insurance Underwriting Associations, the most significant of which is the Fair Access to Insurance Requirements Plan (FAIR Plan) in Massachusetts. The federal government reinsures those insurers participating in FAIR Plans against losses sustained from riots and civil disorders. The Massachusetts FAIR Plan has coastal exposures which could be significant and could result in losses which could be material to the FAIR Plan and participating insurance companies. The Massachusetts FAIR Plan does not purchase catastrophe reinsurance; consequently, we have exposure from our proportionate share of catastrophic events.

Effective July 1, 2005, we have a one-year Catastrophe Treaty for our exposure to FAIR Plan losses in excess of $100,000 up to a total FAIR Plan loss of $1,000,000 (gross). We have purchased 6% of this treaty, which will afford us recovery of $54,000 excess of a $6,000 retention, if the FAIR Plan should suffer a $1,000,000 or greater loss. The estimated 250-year probable maximum loss for the FAIR Plan is approximately $1,000,000.

10. Contingencies Related to Our Business in Massachusetts

Member companies of CAR have joint and several liabilities for the obligations of CAR, the Massachusetts-mandated personal automobile reinsurance mechanism that enables us and other Servicing Carriers to reinsure in CAR any risk. If one member of CAR fails to pay its assessments, the remaining members of CAR will be required to pay the pro-rata share of the member who fails to pay its obligations. As of September 30, 2005, we were not aware of any CAR member company which has failed to meet its obligations.

<PAGE> 9

CAR Regulatory Reform

As disclosed in our Form 10-Q filed for the period ended June 30, 2005, we had previously filed an action in Suffolk Superior Court asking the Court to determine whether the Final Reform Proposal approved by the Massachusetts Commissioner of Insurance on December 31, 2004 was consistent with Massachusetts law. On June 20, 2005, the Court ruled that the Commissioner did not have the statutory authority to issue the Final Reform Proposal. The Court's ruling annuls the Commissioner's order, vacates the Final Reform Proposal, and establishes that an assigned risk plan cannot be created without the approval of the Massachusetts Legislature. The Commissioner filed a Notice of Appeal with the Court on August 19, 2005. On October 26, 2005, this case was accepted for Direct Appellate Review by the Supreme Judicial Court. Neither a briefing schedule nor a hearing date has been established for the appeal. We cannot predict the result of the Commissioner's appeal.

Also as previously disclosed, the Commissioner had not established 2005 values for CAR Rules 11 and 12 as of the filing of our Form 10-Q for June 30, 2005. The values adjust a company's market share to determine its ultimate participation in the results of the 2005 CAR deficit. We used our market share of 29.6% as the estimate of our participation in the 2005 CAR deficit for the six months ended June 30, 2005. On October 5, 2005, CAR sent out a correspondence relating to CAR Rules of Operations 11 and 12. The correspondence stated that the proposed amendment to Rule 11 would provide that the existing private passenger K-factor value of 4.0 for all ceded business be extended to policy year 2005. The correspondence also provided the Rule 12 Credit Matrix indications. These proposed values for Rules 11 and 12 must be acted upon by the Commissioner within 30 days. If the Commissioner does not act, the proposed values will become final. With this information, we were able to estimate our 2005 participation ratio for CAR to be 25.4%. The utilization of the 25.4% participation ratio in place of our previously utilized market share percentage of 29.6% resulted in an approximately $3,201 pre-tax positive impact related to our financial results reported for the six months ended June 30, 2005. This impact is included in our results for the three and nine months ended September 30, 2005.

Governor's Reform Proposal

The Massachusetts Governor has introduced legislation intended to reform the Massachusetts automobile insurance system. Among other things, this proposed legislation would give the Commissioner the authority to create an assigned risk plan and allow for the gradual phase-in of competitively set personal automobile rates. We cannot determine at this time whether the Governor's reform proposal will be acted on by the Legislature or, if passed, how it may affect our financial condition and results of operations.

11. Legal Proceedings

As is common with property and casualty insurance companies, we are a defendant in various legal actions arising from the normal course of our business, including claims based on the Massachusetts Unfair Claims Settlement Practices Act, or Chapter 176D and the Massachusetts Consumer Protection Act, or Chapter 93A. Similar provisions exist in other states where we do business. These proceedings are considered ordinary to operations or without foundation in fact. We believe that these actions will not have a material adverse effect on our consolidated financial position.

AAA Arizona

As disclosed in our Form 10-Q for the period ended June 30, 2005, in AAA Arizona, Inc. v. American Commerce Insurance Company (United States District Court for the District of Arizona), originally filed on May 16, 2005, AAA Arizona alleges, among other claims, that American Commerce has violated its contract with AAA Arizona by failing to pay approximately $1.7 million in profit sharing that AAA Arizona claims to have earned during 2004. AAA Arizona also alleges that American Commerce is interfering with AAA Arizona's relationship with its members. AAA Arizona seeks an order from the court and an award of actual and consequential damages. We cannot estimate the amount of consequential damages as of September 30, 2005. American Commerce intends to vigorously defend this action, unless a reasonable settlement appears appropriate.

In the third quarter of 2005, American Commerce filed a counterclaim against AAA Arizona, Inc. and a complaint against the President and Chief Executive Officer of AAA Arizona, Inc., who formerly served as a Director of American Commerce, alleging breach of fiduciary duties, civil conspiracy, breach of duty of good faith and fair dealing, and other claims relating to the business relationship between AAA Arizona, Inc. and a competitor of American Commerce.

<PAGE> 10

12. Segments

Selected segment information for the three and nine months ended September 30, 2005 and 2004 follows. Earnings are before income taxes and include minority interest.

		Three Months		Nine Months

	Assets	Revenue	Earnings	Revenue	Earnings


2005:
Property and casualty insurance:
Massachusetts	$3,481,472	$410,399	$82,231	$1,238,895	$265,999
Other than Massachusetts	360,999	56,819	15,050	175,019	27,126
Real estate and commercial lending	17,726	674	674	965	965
Corporate and other	41,140	(2,160)	(12,041)	(2,969)	(33,514)

Consolidated	$3,901,337	$465,732	$85,914	$1,411,910	$260,576

2004:
Property and casualty insurance:
Massachusetts	$3,132,728	$388,620	$73,980	$1,149,414	$208,789
Other than Massachusetts	335,746	60,307	11,189	180,906	25,530
Real estate and commercial lending	29,461	202	202	602	602
Corporate and other	52,431	(290)	(7,728)	(260)	(33,944)

Consolidated	$3,550,366	$448,839	$77,643	$1,330,662	$200,977

Premium Results

Direct premiums written and earned for the three months ended September 30, 2005 and 2004 follow:

	2005	2004	$ Change	% Change

Massachusetts Direct Premiums Written:
Personal automobile	$345,100	$332,805	$12,295	3.7%
Commercial automobile	21,305	21,276	29	0.1%
Homeowners	40,551	36,349	4,202	11.6%
Other lines	10,382	10,266	116	1.1%

Massachusetts direct premiums written	417,338	400,696	16,642	4.2%

Other than Massachusetts Direct Premiums Written:
Personal automobile	46,946	51,390	(4,444)	(8.6)%
Commercial automobile	2,631	2,232	399	17.9%
Homeowners	11,841	11,991	(150)	(1.3)%
Other lines	320	303	17	5.6%

Other than Massachusetts direct premiums written	61,738	65,916	(4,178)	(6.3)%

Total direct premiums written	$479,076	$466,612	$12,464	2.7%

Massachusetts Direct Earned Premiums:
Personal automobile	$339,838	$321,693	$18,145	5.6%
Commercial automobile	23,978	23,905	73	0.3%
Homeowners	32,784	28,547	4,237	14.8%
Other lines	9,667	9,584	83	0.9%

Massachusetts direct earned premiums	406,267	383,729	22,538	5.9%

Other than Massachusetts Direct Earned Premiums:
Personal automobile	48,027	50,576	(2,549)	(5.0)%
Commercial automobile	2,473	2,240	233	10.4%
Homeowners	11,015	10,251	764	7.5%
Other lines	321	275	46	16.7%

Other than Massachusetts direct earned premiums	61,836	63,342	(1,506)	(2.4)%

Total direct earned premiums	$468,103	$447,071	$21,032	4.7%

<PAGE> 11

Direct premiums written and earned for the nine months ended 2005 and 2004 follow:

	2005	2004	$ Change	% Change

Massachusetts Direct Premiums Written:
Personal automobile	$1,079,907	$1,047,026	$32,881	3.1%
Commercial automobile	72,100	73,513	(1,413)	(1.9)%
Homeowners	100,829	89,267	11,562	13.0%
Other lines	30,082	30,323	(241)	(0.8)%

Massachusetts direct premiums written	1,282,918	1,240,129	42,789	3.5%

Other than Massachusetts Direct Premiums Written:
Personal automobile	144,945	152,483	(7,538)	(4.9)%
Commercial automobile	7,737	6,938	799	11.5%
Homeowners	33,524	32,783	741	2.3%
Other lines	964	852	112	13.1%

Other than Massachusetts direct premiums written	187,170	193,056	(5,886)	(3.0)%

Total direct premiums written	$1,470,088	$1,433,185	$36,903	2.6%

Massachusetts Direct Earned Premiums:
Personal automobile	$1,001,434	$ 929,896	$71,538	7.7%
Commercial automobile	71,030	69,573	1,457	2.1%
Homeowners	94,602	81,388	13,214	16.2%
Other lines	29,145	27,927	1,218	4.4%

Massachusetts direct earned premiums	1,196,211	1,108,784	87,427	7.9%

Other than Massachusetts Direct Earned Premiums:
Personal automobile	145,530	150,620	(5,090)	(3.4)%
Commercial automobile	7,086	6,295	791	12.6%
Homeowners	32,297	29,028	3,269	11.3%
Other lines	933	787	146	18.6%

Other than Massachusetts direct earned premiums	185,846	186,730	(884)	(0.5)%

Total direct earned premiums	$1,382,057	$1,295,514	$86,543	6.7%

13. Significant Changes since December 31, 2004

Investments

Total investments increased $172,031, or 6.8%, since December 31, 2004. This was due to our investing proceeds from operating and investing activities, partially offset by unrealized losses.

Premiums Receivable

Premiums receivable increased $50,264, or 11.0%, since December 31, 2004. The increase is primarily due to our premium growth and the timing of the payments received by December 31, 2004 for business with effective dates of 2005.

Unearned Premiums

Unearned premiums increased $100,144, or 11.1%, since December 31, 2004. This was primarily due to an increase in personal automobile written premiums coupled with the seasonality of the policy effective dates. The total amount of a policy's premium is recorded as written premium on the first day the policy is effective; however, the policy premium is earned ratably over the ensuing year.

Accrued Agents' Profit Sharing

Accrued agents' profit sharing increased $44,129, or 40.3%, since December 31, 2004. The increase is a result of substantially better underwriting results in 2005.

14. Accounting Pronouncement

In September 2005, the AICPA issued a new accounting pronouncement, Statement of Position (SOP) 05-1, Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection With Modifications or Exchanges of Insurance Contracts. This SOP provides guidance on accounting for deferred acquisition costs on internal replacements of

<PAGE> 12

insurance and investment contracts other than those specifically described in Statement of Financial Accounting Standards No. 97. Internal replacements are modifications in product benefits, features, rights, or coverages that occur by the exchange of a contract for a new contract, or by amendment, endorsement, or rider to a contract, or by the election of a feature or coverage within a contract. The provisions of this SOP are effective for internal replacements occurring in fiscal years beginning after December 15, 2006. Financial statement application of this SOP is prospective and initial application would generally occur as of the beginning of the fiscal year. The impact that adoption of this SOP is expected to have on our future financial statements is not yet known or reasonably estimable. We are reviewing the provisions of this SOP to determine the expected impact.

Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition

Unless otherwise stated, "we," "our" or "us" means The Commerce Group, Inc. and its subsidiaries. "Commerce" refers to The Commerce Insurance Company, "Commerce West" refers to Commerce West Insurance Company, "American Commerce" refers to American Commerce Insurance Company, "Citation" refers to Citation Insurance Company, and "AHC" refers to ACIC Holding Co., Inc. In addition, unless otherwise stated, all references to "quarters ended" are for our fiscal quarter, beginning July 1 and ending September 30, and dollar amounts are in thousands, except per share data.

The purpose of the following discussion and analysis is to provide you with information that will assist you in understanding our financial condition and results of operations as reported in our consolidated financial statements. Therefore, the following should be read in conjunction with our consolidated financial statements in this Form 10-Q and with our Management's Discussion and Analysis of Results of Operations and Financial Condition in our Form 10-K for the year ended December 31, 2004.

Business Overview

We provide personal and commercial property and casualty insurance primarily in Massachusetts and in other states. Our core product lines are personal automobile, homeowners, and commercial automobile. We market our products exclusively through our network of independent agents in all states, except California where we use agents and brokers, and except Arizona as discussed in this report under "Other than Massachusetts Segment." Our primary business strategy is to focus on the personal automobile insurance market in Massachusetts and to grow and diversify by increasing the proportion of our business written in other states in which we currently have a significant presence, primarily from Commerce West and American Commerce.

We manage our business in four reportable segments: property and casualty insurance - Massachusetts, property and casualty insurance - other than Massachusetts, real estate and commercial lending, and corporate and other.

Our ability to capitalize on our business strengths and implement our strategies is subject to particular risks. For example, because we are primarily a personal automobile insurance carrier, adverse developments in this industry could negatively affect us more than insurers that are more diversified across multiple business lines. Additionally, the concentration of our business in Massachusetts makes us more susceptible to any adverse development in the prevailing legislative, regulatory, economic, demographic, competitive and other conditions, including weather-related events, and adverse judicial decisions in Massachusetts, and could make it more costly or difficult for us to conduct our business. Our affinity group marketing programs provide members of participating groups and associations with a convenient means of purchasing discounted private passenger automobile insurance. We would lose a significant avenue for offering our existing affinity group discounts and our sales of personal automobile and homeowner insurance products in Massachusetts would likely decline if our affinity relationship with the AAA Clubs of Massachusetts is substantially changed or terminated and we are unable to devise and implement effective mitigation measures. These AAA arrangements have rolling three-year terms, and a Massachusetts AAA Club may terminate the agreement upon a minimum of two years' written notice. American Commerce has relationships with various AAA Clubs outside of Massachusetts, which are not subject to any minimum advance notice to terminate. As further explained in this Form 10-Q, we have been notified by AAA Arizona that it has terminated its relationship with American Commerce. If American Commerce's relationship with one or more other large AAA clubs terminates, then American Commerce could lose a substantial portion of its business, which could have a material adverse effect on our business and results of operations.

Massachusetts personal automobile insurance rates are set annually by the Commissioner. All companies writing personal automobile policies are required to use such mandated rates, unless they have received prior approval from the Commissioner to offer a lower rate. In establishing the classifications of risks and personal automobile rates for 2006, the Commissioner must consider numerous factors that are based upon data primarily for the 2004 calendar year supplemented by trending data from previous years. In addition, the Commissioner considers rates proposed by the Automobile Insurance

<PAGE> 13

Bureau of Massachusetts (AIB), the State Rating Bureau of Massachusetts (SRB), and the Massachusetts Attorney General (AG). Each of these organizations has submitted its proposal for the 2006 rate. The Commissioner has not established the rate for 2006 personal automobile policies; however, we expect the Commissioner will reduce the rate from its current level, based on the industry's profitable underwriting results for calendar year 2004. The rate for 2006 will be effective for policies written from January 1, 2006 through March 31, 2007. The personal automobile policy rate changes proposed for policy years 2003 - 2006 contrasted with the state mandated average rate change for each year follows:

	2006	2005	2004	2003

Proposed rate changes by:
AIB	(0.1)%	9.2%	12.4%	7.0%
SRB	(7.6)%	1.0%	3 to 4%	2.0%
AG	(18.0)%	(6.2)%	0%	(5.7)%

Actual state mandated average rate change	Unknown	(1.7)%	2.5%	2.7%

The Commissioner is required by statute to announce the 2006 rate by December 15, 2005.

In our Form 10-Q for the quarter ended June 30, 2005, we disclosed our anticipated liquidity needs for technology-based initiatives. One of our major initiatives will significantly improve the way in which we serve our agents and insureds at American Commerce, Commerce and Citation. American Commerce licensed and is implementing the Agency Port web portal for use by its club and agent partners. The implementation will provide automated underwriting and an easy-to-use web-enabled interface for quoting and servicing American Commerce products. We anticipate implementation in the first half of 2006.

Commonwealth Automobile Reinsurers

A significant aspect of our automobile insurance business relates to our interaction with Commonwealth Automobile Reinsurers (CAR). CAR is a reinsurance mechanism mandated in Massachusetts, which enables us and the other participating servicing carriers to reinsure any automobile risk that the carriers perceive to be under-priced. Since its inception, CAR has annually generated significant underwriting losses, primarily in the personal automobile pool. All companies writing automobile insurance in Massachusetts share in the underwriting results of CAR business for their respective product line or lines.

Member companies of CAR have joint and several liabilities for the obligations of CAR. If one member of CAR fails to pay its assessments, the remaining members of CAR will be required to pay the pro-rata share of the member who fails to pay its obligations. As of September 30, 2005, we were not aware of any current CAR member company which failed to meet its obligations.

CAR Regulatory Reform

As disclosed in our Form 10-Q filed for the period ended June 30, 2005, we had previously filed an action in Suffolk Superior Court asking the Court to determine whether the Final Reform Proposal approved by the Massachusetts Commissioner of Insurance on December 31, 2004, was consistent with Massachusetts law. On June 20, 2005, the Court ruled that the Commissioner did not have the statutory authority to issue the Final Reform Proposal. The Court's ruling annuls the Commissioner's order, vacates the Final Reform Proposal, and establishes that an assigned risk plan cannot be created without the approval of the Massachusetts Legislature. The Commissioner filed a Notice of Appeal with the Court on August 19, 2005. On October 26, 2005, this case was accepted for Direct Appellate Review by the Supreme Judicial Court. We cannot predict the result of the Commissioner's appeal.

<PAGE> 14

$3,201 pre-tax positive impact related to our financial results reported for the six months ended June 30, 2005. This impact is included in our results for the three and nine months ended September 30, 2005.

On September 30, 2005, the Commissioner directed CAR to complete, within 60 days, a physical redistribution of Exclusive Representative Producers (ERPs) for the purpose of establishing parity in the quantity and quality of ERP exposures for all servicing carriers in Massachusetts. In addition, the Commissioner's order calls for CAR to expand its random selection methodology, as used to select the ERPs that will be redistributed when a Servicing Carrier secures ERP subscription relief, to assure that the redistribution process addresses both the quality and the quantity of the ERP exposures. ERPs are automobile insurance agencies in Massachusetts which are assigned by CAR to companies writing automobile insurance in Massachusetts, because they have not been able to receive a voluntary contract. We expect the redistribution of ERPs to result in a prospective increase in our overall direct loss ratio from ERPs. CAR is presently preparing to perform the loss ratio calculations that will be the basis for the redistribution of ERPs, which are to be announced by November 29, 2005. The redistribution is expected to become effective on January 1, 2006 for new business and March 1, 2006 for renewal business. We cannot reasonably estimate the degree to which our ERP loss ratio may change, as noted above, although the change could be material to our future financial results. We are closely monitoring the redistribution plan as it develops.

Our Revenues and Expenses

Our revenue principally reflects:

	*	earned premiums, consisting of:

		-	premiums that we receive from sales by independent agents of our property and casualty insurance policies, primarily personal automobile, homeowners and commercial automobile, which we refer to as direct premiums written, plus

		-	premiums we receive from insurance policies that we assume, primarily CAR, which we refer to as assumed premiums, less

		-	the portion of our premiums that is ceded to CAR and other reinsurers, which we refer to as ceded premiums, less

		-	the change in the portion of premiums that will not be recognized as income for accounting purposes until a future period, which we refer to as unearned premiums;

	*	investment income that we earn on our invested assets;

	*	premium finance charges and service fee income that we earn in connection with the billing and deferral of premium payments; and

	*	realized investment gains and losses.

	Our expenses principally reflect:

	*	incurred losses and loss adjustment expenses (which we sometimes refer to as LAE) plus losses and LAE assumed from CAR, including estimates for losses incurred during the period but not yet reported to us and changes in estimates from prior periods related to direct and assumed business, less the portion of those incurred losses and loss adjustment expenses that are ceded to CAR and other insurers; and

	*	policy acquisition costs, including agent compensation and general and administrative costs, such as salaries and benefits, and advertising that are not deferred for accounting purposes to a future period, along with expenses assumed from CAR less expense allowances received from CAR.

Our Performance Measures

We evaluate our operations by monitoring key measures of growth and profitability. We measure our growth by examining our direct premiums written as well as increases in exposures and policies. We generally measure our operating results in accordance with accounting principles generally accepted in the United States of America (GAAP) by examining

<PAGE> 15

our net earnings, return on equity (ROE), and our loss and LAE, underwriting expense and combined ratios on a consolidated basis. Our key measures include:

	*	Return on Equity. Return on equity is net earnings divided by stockholders' equity at the beginning of the period.

	*	Direct Premiums Written. Direct premiums written is the sum of the total policy premiums, net of cancellations, associated with policies underwritten and issued by our insurance subsidiaries. We use direct premiums written, which includes premiums that we cede to CAR and other reinsurers, as a measure of the underlying growth of our insurance business from period to period.

	*	Direct Earned Premiums. Direct earned premiums are the portion of direct premiums written over the preceding twelve-month period equal to the expired portion of policies and recognized as income during an accounting period.

	*	Investment Income. Investment income represents earnings on our investment portfolio. We rely on after-tax investment income as a significant source of net earnings since we generally seek to achieve a combined ratio (see below) of slightly less than 100%.

	*	Loss and LAE Ratio. The loss and LAE ratio is the percentage of losses and loss adjustment expenses (including corporate expenses) incurred to earned premiums. We calculate this ratio net of our reinsurance recoveries. We use this ratio as a measure of the overall underwriting profitability of the insurance business we write and to assess the adequacy of our pricing.

	*	Underwriting Expense Ratio. The underwriting expense ratio is the percentage of underwriting expenses (including corporate expenses) incurred to net premiums written. Underwriting expenses are the aggregate of policy acquisition costs, including commissions, and the portion of administrative, general and other expenses attributable to underwriting operations. In addition, underwriting expenses are grossed-up for any change in deferred acquisition costs.

	*	Combined Ratio. The combined ratio is the sum of the loss and LAE ratio and the underwriting expense ratio and measures a company's overall underwriting profit. If the combined ratio is 100% or more, an insurance company cannot be profitable without investment income, and may not be profitable if investment income is insufficient. We use the combined ratio in evaluating our overall underwriting profitability and for comparing our profitability to our competitors' profitability.

Results of Operations for the Periods Ended September 30, 2005 and 2004

Consolidated Results

Our key operating measures for the three and nine months ended September 30, 2005 and 2004 follow:

	Three Months		Nine Months

	2005	2004	2005	2004


Diluted earnings per share	$1.77	$1.64	$5.33	$4.35
Return on equity	4.9%	5.7%	16.2%	15.6%
Direct premiums written	$479.1	$466.6	$1,470.1	$1,433.2
Direct earned premiums	$468.1	$447.1	$1,382.1	$1,295.5
Net investment income	$30.0	$30.0	$90.4	$85.7

Loss and LAE ratio	56.1%	57.5%	61.8%	65.6%
Underwriting expense ratio	32.0%	31.1%	27.0%	25.4%

Combined ratio	88.1%	88.6%	88.8%	91.0%

The increase in diluted earnings per share is primarily due to a decrease in our loss ratio partially offset by an increase in our underwriting expense ratio. Diluted EPS also benefited in 2005 from increases in net realized investment gains of $2,443 for the quarter and $11,190 year-to-date over the comparable 2004 periods. The primary reasons for the increase in our underwriting expense ratio are a significant increase in our agents' profit sharing expense, a slight increase

<PAGE> 16

in 2005 policy year mandated personal automobile commission rates in Massachusetts, partially offset by an increase in reinsurance commissions on ceded business. The increase in agents' profit sharing expense is a result of substantially better underwriting results for the first nine months of 2005 versus the first nine months of 2004. The quarterly and year-to-date decrease in our loss and LAE ratio is due to:

	1.	improved current year results and continued favorable prior years' loss development from CAR;

	2.	an increase in average earned premium revenue per automobile;

	3.	a decrease in the current year personal and commercial automobile bodily injury claim frequency, offset by less favorable voluntary loss reserve development.

The year-to-date decrease in our loss and LAE ratio was partially offset by an increase in the personal and commercial automobile physical damage claim frequency. The quarterly decrease in our loss and LAE ratio includes a decrease in the personal and commercial automobile physical damage claim frequency.

The improved results from CAR since the third quarter of 2004 have primarily resulted from favorable loss development on the business assumed from CAR, coupled with better current year results. Favorable loss development occurs when actual loss payments are less than the estimated payments that are built into the loss reserves. Actuarial data provided by CAR indicates that this favorable development should continue through year end.

Premium Results

We evaluate our performance and allocate resources based primarily on our property and casualty insurance segments, which represent nearly all of our total revenues. Direct premiums written and earned for the quarters ended September 30, 2005 and 2004 follow:

	2005	2004	$ Change	% Change

Massachusetts Direct Premiums Written:
Personal automobile	$345,100	$332,805	$12,295	3.7%
Commercial automobile	21,305	21,276	29	0.1%
Homeowners	40,551	36,349	4,202	11.6%
Other lines	10,382	10,266	116	1.1%

Massachusetts direct premiums written	417,338	400,696	16,642	4.2%

Other than Massachusetts Direct Premiums Written:
Personal automobile	46,946	51,390	(4,444)	(8.6)%
Commercial automobile	2,631	2,232	399	17.9%
Homeowners	11,841	11,991	(150)	(1.3)%
Other lines	320	303	17	5.6%

Other than Massachusetts direct premiums written	61,738	65,916	(4,178)	(6.3)%

Total direct premiums written	$479,076	$466,612	$12,464	2.7%


Massachusetts Direct Earned Premiums:
Personal automobile	$339,838	$321,693	$18,145	5.6%
Commercial automobile	23,978	23,905	73	0.3%
Homeowners	32,784	28,547	4,237	14.8%
Other lines	9,667	9,584	83	0.9%

Massachusetts direct earned premiums	406,267	383,729	22,538	5.9%

Other than Massachusetts Direct Earned Premiums:
Personal automobile	48,027	50,576	(2,549)	(5.0)%
Commercial automobile	2,473	2,240	233	10.4%
Homeowners	11,015	10,251	764	7.5%
Other lines	321	275	46	16.7%

Other than Massachusetts direct earned premiums	61,836	63,342	(1,506)	(2.4)%

Total direct earned premiums	$468,103	$447,071	$21,032	4.7%


Direct premiums written and earned for the nine months ended September 30, 2005 and 2004 follow:

<PAGE> 17

	2005	2004	$ Change	% Change

Massachusetts Direct Premiums Written:
Personal automobile	$1,079,907	$1,047,026	$32,881	3.1%
Commercial automobile	72,100	73,513	(1,413)	(1.9)%
Homeowners	100,829	89,267	11,562	13.0%
Other lines	30,082	30,323	(241)	(0.8)%

Massachusetts direct premiums written	1,282,918	1,240,129	42,789	3.5%

Other than Massachusetts Direct Premiums Written:
Personal automobile	144,945	152,483	(7,538)	(4.9)%
Commercial automobile	7,737	6,938	799	11.5%
Homeowners	33,524	32,783	741	2.3%
Other lines	964	852	112	13.1%

Other than Massachusetts direct premiums written	187,170	193,056	(5,886)	(3.0)%

Total direct premiums written	$1,470,088	$1,433,185	$36,903	2.6%

Massachusetts Direct Earned Premiums:
Personal automobile	$1,001,434	$ 929,896	$71,538	7.7%
Commercial automobile	71,030	69,573	1,457	2.1%
Homeowners	94,602	81,388	13,214	16.2%
Other lines	29,145	27,927	1,218	4.4%
Massachusetts direct earned premiums	1,196,211	1,108,784	87,427	7.9%
Other than Massachusetts Direct Earned Premiums:
Personal automobile	145,530	150,620	(5,090)	(3.4)%
Commercial automobile	7,086	6,295	791	12.6%
Homeowners	32,297	29,028	3,269	11.3%
Other lines	933	787	146	18.6%

Other than Massachusetts direct earned premiums	185,846	186,730	(884)	(0.5)%

Total direct earned premiums	$1,382,057	$1,295,514	$86,543	6.7%

Massachusetts Segment

Growth in personal automobile direct premiums written was the primary factor in the 2005 quarterly and year-to-date increases in our Massachusetts segment. For the quarter ended 2005, it accounted for approximately 74%, and year-to-date it accounted for approximately 77% of the total increase in Massachusetts direct premiums written. Personal automobile business growth for the quarter ended 2005 was the result of a 0.2% increase in average written premium per written exposure coupled with a 3.4% increase in the number of exposures written. Personal automobile growth year-to-date was the result of a 0.6% increase in average written premium per written exposure coupled with a 2.5% increase in the number of exposures written in 2005. The agents assigned to us by CAR accounted for 54.6% of the year-to-date increase and 44.8% of the quarterly increase in the number of exposures written in 2005. We believe that voluntary agents are currently very cautious regarding moving books of business between carriers due to the uncertainties created by CAR reforms proposed in 2004 and 2005.

The 2005 decrease in commercial auto year-to-date direct premiums written was due to a 1.6% decrease in average premium per policy coupled with a slight decrease in the number of policies. Average premium per policy has declined due to more competitive pricing in a softening market. Our homeowners growth for the quarter ended 2005 was from a 9.8% increase in average premium per policy, partially offset by a 1.0% decrease in the number of policies. Year-to-date homeowners growth in 2005 resulted from an 11.0% increase in average premium per policy, partially offset by a 1.5% decrease in the number of policies.

Other than Massachusetts Segment

The overall decrease in personal automobile direct written premiums for the quarter and year-to-date periods in 2005 is primarily due to a decline in the number of policies, partially offset by a slight increase in average premium per policy. The decline in the number of policies is largely attributable to the loss of American Commerce's former largest agent, AAA Arizona, Inc., as discussed in the following paragraph. In general, we are lowering rates in the states in which we write business in response to competitive pressures. Quarterly and year-to-date growth in homeowners in 2005 was due to additional rate per policy, partially offset by a slight decrease in the number of policies.

<PAGE> 18

AAA Arizona, Inc. stopped writing new business for the segment in the first quarter of 2005. Our wholly-owned subsidiaries, American Commerce and Commerce West, continue to write business in Arizona; however, American Commerce no longer markets its products through AAA Arizona, Inc. American Commerce continued to provide renewal policies for personal automobile through AAA Arizona, Inc. through mid-August of 2005 and through mid-September for homeowners. For renewals effective after this, American Commerce offered renewal quotes directly to insureds as required by Arizona law. Additionally, we began writing business through independent agents in Arizona in the third quarter. The loss of new and renewal business from AAA Arizona, Inc. significantly reduced our segment's direct premiums written and policies in-force for the quarter and nine months ended September 30, 2005. Our total direct premiums written in the state of Arizona decreased $8,359 during the nine months ended September 30, 2005 from the comparable period in 2004. We expect direct written premiums in the state of Arizona to decrease from approximately $49,000 for the year ended 2004 to approximately $32,000 for the year ending 2005.

Net Investment Income

Key measures of net investment income for the quarters ended September 30, 2005 and 2004 follow:

	2005	2004	Change


Average month-end investments (at cost)	$2,666,468	$2,343,915	$322,553
Net investment income, before tax	30,040	30,021	19
Net investment income, after tax	23,795	23,325	470
Net investment income as an annualized percentage of average
net investments (at cost), before tax	4.5%	5.1%	(11.8)%
Net investment income as an annualized percentage of average
net investments (at cost), after tax	3.6%	4.0%	(10.0)%

Key measures of net investment income for the nine months ended September 30, 2005 and 2004 follow:

	2005	2004	Change


Average month-end investments (at cost)	$2,627,629	$2,274,511	$353,118
Net investment income, before tax	90,360	85,730	4,630
Net investment income, after tax	70,415	67,327	3,088
Net investment income as an annualized percentage of average
net investments (at cost), before tax	4.6%	5.0%	(8.0)%
Net investment income as an annualized percentage of average
net investments (at cost), after tax	3.6%	4.0%	(10.0)%

The increases in our net investment income were primarily due to increased invested assets partially offset by lower yields on our municipal and corporate bonds and preferred stock. The decline in yields corresponds with the duration reduction of our portfolio of fixed maturity securities in 2005 in which we sold higher yielding securities and replaced them with lower yielding securities coupled with our decision to begin amortizing to worst call the premiums paid on perpetual preferred securities. Our duration at September 30, 2005 was 4.5 years compared to 5.6 years at year-end 2004. The increase in invested assets is primarily attributable to cash generated from operating activities.

Realized Investment Gains and Losses

Net realized investment gains (losses) for the quarters ended 2005 and 2004 follow:

	2005	2004	Change

Other-than-temporary impairment losses:
Fixed maturity securities	$ (146)	$(12,399)	$12,253
Equity securities	(743)	-	(743)

Total other-than-temporary impairment losses	(889)	(12,399)	11,510

Transaction net gains (losses):
Fixed maturity securities	1,882	(635)	2,517
Equity securities	1,123	4,383	(3,260)
Venture capital funds	3,445	-	3,445
Other investments	(726)	(7)	(719)

Transaction net gains	5,724	3,741	1,983

Equity in earnings (losses) of closed-end preferred stock mutual funds	(1,411)	3,153	(4,564)
Equity in venture capital funds	(3,228)	3,258	(6,486)

Net realized investment gains (losses)	$ 196	$ (2,247)	$ 2,443

<PAGE> 19

Net realized investment gains (losses) for the nine months ended September 30, 2005 and 2004 follow:

	2005	2004	Change

Other-than-temporary impairment losses:
Fixed maturity securities	$ (305)	$(13,964)	$ 13,659
Equity securities	(4,547)	(203)	(4,344)

Total other-than-temporary impairment losses	(4,852)	(14,167)	9,315

Transaction net gains:
Fixed maturity securities	19,899	2,636	17,263
Equity securities	3,093	16,565	(13,472)
Venture capital funds	4,567	696	3,871
Other investments	(396)	(204)	(192)

Transaction net gains	27,163	19,693	7,470

Equity in earnings (losses) of closed-end preferred stock mutual funds	1,230	7	1,223
Equity in venture capital funds	(2,741)	4,077	(6,818)

Net realized investment gains	$20,800	$ 9,610	$ 11,190

Our bond market realized gains came from a number of different sectors and were a result of both favorable interest rates during certain parts of the period as well as strong performance in certain industry specific and security specific investments.

Unrealized Investment Losses

Gross unrealized losses on our equity and fixed maturity securities at September 30, 2005 by duration of unrealized loss follow:

		0-6	7-12	13-24	Over 24
	Total	Months	Months	Months	Months

Total equity and fixed maturity securities:
Number of positions	400	236	122	38	4

Total fair value	$1,735,811	$1,117,247	$481,658	$130,391	$6,515
Total amortized cost	1,762,819	1,131,004	491,627	133,570	6,618

Unrealized loss	$ (27,008)	$ (13,757)	$ (9,969)	$ (3,179)	$ (103)

Unrealized loss percentage to fair value	1.6%	1.2%	2.1%	2.4%	1.6%


Equity securities:
Number of positions	56	37	16	2	1

Total fair value	$ 261,971	$ 214,664	$ 46,437	$ 4	$ 866
Total cost	267,609	219,256	47,473	5	875

Unrealized loss	$ (5,638)	$(4,592)	$(1,036)	$ (1)	$ (9)

Unrealized loss percentage to fair value	2.2%	2.1%	2.2%	2.5%	1.0%


Total fixed maturity securities:
Number of positions	344	199	106	36	3

Total fair value	$1,473,840	$ 902,583	$435,221	$130,387	$5,649
Total amortized cost	1,495,210	911,748	444,154	133,565	5,743

Unrealized loss	$ (21,370)	$ (9,165)	$ (8,933)	$ (3,178)	$ (94)

Unrealized loss percentage to fair value	1.4%	1.0%	2.1%	2.4%	1.7%

<PAGE> 20

due to general market conditions. We currently intend to hold to recovery or maturity all of our temporarily impaired equity and fixed maturity securities, respectively.

Policy Acquisition Costs

Year-to-date policy acquisition costs increased $27,885, or 8.7%, over the same period a year ago. The increase is primarily due to increases in agents' profit sharing and commissions, offset by an increase in ceded reinsurance commissions. Year-to-date 2005 commissions increased $11,721, or 6.4%, over the same period last year. This increase was due to an increase in direct written premium coupled with a slight increase in the Massachusetts 2005 policy year mandated personal automobile commission rates. Year-to-date 2005 agents' profit sharing increased $29,882, or 50.0%, over the same period last year. This increase resulted from substantially better underwriting results for the first nine months of 2005 versus the first nine months of 2004. The increase in commissions was partially offset by an increase in reinsurance commissions on ceded business of $13,863, or 25.5%, for the first nine months of 2005 as compared to the same period in 2004. This change resulted primarily from a $13,257, or 36.6%, increase in ceded commissions related to the quota share agreement. The primary reasons for the increase were an increase in homeowners direct written premium, coupled with an increase in the participation percentage of the quota share agreement at July 1, 2005 from 70% to 75%, and significantly better other-than-automobile loss results, which had a favorable impact on the sliding scale commission percentage due the company as compared to the same period last year. Policy acquisition costs for the quarter ended September 30, 2005 increased 5.0% over the comparable 2004 period.

Financial Condition

Our stockholders' equity per share increased 11.7% from $33.50 at December 31, 2004 to $37.43 at September 30, 2005, after dividends paid of $1.09 per share. The market and equity value of our total investments increased 6.8% primarily due to cash generated from operating activities, partially offset by unrealized losses. Since December 31, 2004, our premiums receivable increased $50,264, or 11.0%, due to premium growth and the timing of the payments received by December 31, 2004 for business with 2005 effective dates. Since December 31, 2004, the ratio of our total liabilities to stockholders' equity improved 13.7 percentage points primarily due to net earnings for the nine months ended September 30, 2005, partially offset by increases in unearned premiums and accrued agents' profit sharing.

The increase in unearned premiums was primarily due to an increase in personal automobile written premiums coupled with the seasonality of the policy effective dates. The total amount of a policy's premium is recorded as written premium on the first day on which the policy is effective; however, the policy premium is earned ratably over the ensuing year.

Liabilities for unpaid losses and loss adjustment expenses at September 30, 2005 and December 31, 2004 follow:

	September 30,	December 31,
	2005	2004


Net voluntary unpaid losses and LAE	$ 795,569	$783,159
Voluntary salvage and subrogation recoverable	(95,381)	(97,218)
Assumed unpaid losses and LAE reserves from CAR	161,319	167,502
Assumed salvage and subrogation recoverable from CAR	(23,317)	(23,317)

Total voluntary and assumed unpaid losses and LAE reserves	838,190	830,126
Adjustment for ceded unpaid losses and LAE reserves	171,807	169,134
Adjustment for ceded salvage and subrogation recoverable	(9,000)	(9,000)

Total unpaid losses and LAE	$1,000,997	$990,260

Industry and regulatory guidelines suggest that the ratio of a property and casualty insurer's annual net premiums written to statutory policyholders' surplus should not exceed 3.00 to 1.00. Our twelve-month rolling net premiums written to statutory surplus ratio was 1.22 to 1.00 for the period ended September 30, 2005 and 1.38 to 1.00 for the period ended September 30, 2004.

Effective July 1, 2004, we entered into a 70% quota-share agreement for one year with modified terms. This program covers all non-automobile property and liability business, except umbrella policies. This program was extended another year, effective July 1, 2005, with the primary change in terms being an increase in the quota share rate to 75%. Under the terms of the 75% agreement effective July 1, 2005, in the event of a catastrophe, recovery is limited to 75% of the

<PAGE> 21

loss with a maximum recovery estimated at $337,500, equating to a total loss to us of $450,000. There are several limitations in the contract regarding losses related to nuclear, chemical, and biological terrorist events. Our maximum loss recovery in case of these types of events is estimated at $28,000. Our estimated total probable maximum loss, before reinsurance, on our other than automobile business for 100 and 250-year hurricanes is approximately $280,000 and $519,000, respectively. We derived our estimates through the services of Holborn Reinsurance Company on our October 31, 2004 other-than-automobile exposures, which utilized the RMS (Risk Management Solutions) risk assessment system. We believe that most property and casualty insurance companies establish their catastrophe reinsurance programs between the 100-year and 250-year storm estimates.

Liquidity and Capital Resources

The primary sources of our liquidity are funds generated from insurance premiums, net investment income, premium finance and service fees and the maturing and sale of investments. The primary uses of our liquidity are payment of policy claims, operating costs, interest on our senior notes, and payment of dividends to our stockholders.

In April 2005, Commerce's application to become a member of the Federal Home Loan Bank of Boston was accepted. The FHLB of Boston, which is one of 12 regional FHLBs, serves as a reserve or central bank for its members within its assigned region. The FHLB of Boston makes loans, which are referred to as advances, to members in accordance with policies and procedures established by its board of directors. These policies and procedures are subject to the regulation and oversight of the Federal Housing Finance Board. All advances from the FHLB of Boston to Commerce require Board of Director approval and would be required to be fully secured by sufficient collateral as determined by the FHLB of Boston. Our borrowing capacity is based on the composition of our investment portfolio and its related market values. Consequently, our borrowing capacity changes as our portfolio changes both in composition and value. We have not borrowed from the FHLB of Boston and have no current plans to do so.

We paid significantly more for agent profit sharing in 2005 than we paid in 2004. We paid approximately $18,000 for agent profit sharing in 2004. Due to our excellent underwriting results during 2004, we paid approximately $40,000 in the second quarter of 2005, which we had accrued at December 31, 2004. We estimate paying about $82,000 for agent profit sharing in 2006, subject to our agents' underwriting results in 2005.

Investment Strategy and Interest Rate Risk

Our investment strategy emphasizes after-tax investment yield while maintaining overall investment quality. The primary focus of our investment objectives continues to be maximizing after-tax investment income through investing primarily in high-quality diversified fixed income investments structured to maximize after-tax investment income while minimizing risk. We generally invest in securities with maturities intended to provide adequate funds to pay claims and meet other operating needs without the forced sale of investments. When the appropriate opportunity arises, we will recognize investment gains to increase after-tax total return. We held no derivatives, emerging market securities or hedge funds at September 30, 2005 and December 31, 2004.

Interest Rate Sensitivity

Our investments include positions in fixed maturity, equity, short-term and cash equivalents markets. Therefore, we are exposed to the impacts of interest rate changes in the market value of investments. We estimated our exposure to interest rate changes and equity price risk at September 30, 2005 using sensitivity analysis. The interest rate impact is the effect of a hypothetical interest rate change of plus-or-minus 100 and 200 basis points on the market value of fixed maturities and preferred stocks.

<PAGE> 22

Changes in interest rates would result in unrealized gains or losses in the market value of the fixed maturity and preferred stock portfolio due to differences between current market rates and the stated rates for these investments. The following table summarized our interest rate risk, based on the results of the sensitivity analysis at September 30, 2005.

		Estimated Market
		Value of Fixed	Estimated
		Income and	Increase	Hypothetical Percentage
		Preferred Stock	(Decrease) in	Increase (Decrease) in
Hypothetical Change in Interest Rates		Investments	Market Value	Stockholders' Equity⁽¹⁾


200 basis point increase		$2,218,029	$(219,581)	(11.3)%
100 basis point increase		2,326,699	(110,911)	(5.7)%
No change		2,437,610	-	-
100 basis point decrease		2,538,905	101,295	5.2%
200 basis point decrease		2,650,752	213,142	11.0%
___________________
(1)	Net of income taxes at an assumed rate of 35%.

Our fixed income portfolio's weighted average duration (which includes all fixed maturities and preferred stocks) as of December 31, 2004 was 5.6 years. The "duration" of a security is the time-weighted present value of the security's expected cash flows and is used to measure a security's price sensitivity to changes in interest rates. The duration reflects industry prepayment assumptions. The analytic systems we used to calculate the above duration data utilize optional call dates, sinking fund requirements and assume a non-static prepayment pattern in deriving these averages. As of September 30, 2005, our weighted average duration has declined to 4.5 years from 5.3 years at September 30, 2004 primarily as a result of sales of securities during the year with proceeds invested in shorter duration securities.

Forward-Looking Statements

This quarterly report may contain statements that are not historical fact and constitute "forward-looking statements" within the meaning of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act. Statements about our expectations, beliefs, plans, objectives, assumptions or future events or performance are not historical facts and may be forward-looking. These statements are often, but not always, made through the use of words or phrases such as "anticipates," "estimates," "plans," "projects," "continuing," "ongoing," "expects," "may," "should," "management believes," "we believe," "we intend," and similar words or phrases. These statements may address, among other things, our strategy for growth, business development, regulatory approvals, market position, expenditures, financial results and reserves. Accordingly, these statements involve estimates, assumptions and uncertainties that could cause actual results to differ materially from those expressed in them. All forward-looking statements are qualified in their entirety by reference to the factors discussed throughout this quarterly report and in our recently filed quarterly and annual reports on Forms 10-Q and 10-K, and other documents filed with the SEC. Among the key factors that could cause actual results to differ materially from forward-looking statements are:

	*	the possibility of severe weather and adverse catastrophic experiences;

	*	adverse trends in claim severity or frequency;

	*	adverse state and federal regulations and legislation;

	*	adverse judicial decisions;

	*	adverse changes to the laws, regulations and rules governing the residual market system in Massachusetts;

	*	interest rate risk;

	*	rate making decisions for private passenger automobile policies in Massachusetts;

	*	potential rate filings;

	*	heightened competition;

<PAGE> 23

	*	concentration of business within Massachusetts;

	*	termination of Commerce's affinity relationship with AAA Clubs of Massachusetts;

	*	market disruption in Massachusetts, if competitors exited the market or become insolvent;

	*	termination of American Commerce's relationship with one or more large AAA clubs;

	*	dependence on our executive officers; and,

	*	the economic, market or regulatory conditions and risks associated with entry into new markets and diversification.

You should not place undue reliance on any forward-looking statement. The risk factors referred to above and those included in Part I, Item I of our Form 10-K for 2004, as well as those elsewhere in this quarterly report, could cause actual results or outcomes to differ materially from those expressed in any forward-looking statement made by us or on our behalf. Further, any forward-looking statement speaks only as of the date on which it is made, and we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events. New factors emerge from time to time, and it is not possible for us to predict which factors will arise. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Refer to "Investment Strategy and Interest Rate Risk" in Item 2, Management's Discussion and Analysis of Financial Condition and Results of Operations, for the interim period information required by this item. Such disclosure is incorporated by reference into this Item 3.

Item 4. Controls and Procedures

Evaluation of disclosure controls and procedures

Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission's rules and forms.

Changes in internal control

There has been no change in our internal control over financial reporting that has occurred during our last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Part II - Other Information

Item 1. Legal Procedings

AAA Arizona

As disclosed in our Form 10-Q for the period ended June 30, 2005, in AAA Arizona, Inc. v. American Commerce Insurance Company (United States District Court for the District of Arizona), originally filed on May 16, 2005, AAA Arizona alleges, among other claims, that American Commerce has violated its contract with AAA Arizona by failing to pay approximately $1.7 million in profit sharing that AAA Arizona claims to have earned during 2004. AAA Arizona also alleges that American Commerce is interfering with AAA Arizona's relationship with its members. AAA Arizona seeks an order from the court and an award of actual and consequential damages. We cannot estimate the amount of consequential damages as of September 30, 2005. American Commerce intends to vigorously defend this action, unless a reasonable settlement appears appropriate.

<PAGE> 24

In the third quarter of 2005, American Commerce filed a counterclaim against AAA Arizona, Inc. and a complaint against the President and Chief Executive Officer of AAA Arizona, Inc., who formerly served as a Director of American Commerce, alleging breach of fiduciary duties, civil conspiracy, breach of duty of good faith and fair dealing, and other claims relating to the business relationship between AAA Arizona, Inc. and a competitor of American Commerce.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

In November 2001, our Board of Directors authorized a stock buy-back program to purchase up to 2,000,000 shares of our common stock. During the three months ended September 30, 2005, we did not acquire any of our common stock. There are 858,300 shares that may yet be purchased under our repurchase plan.

On July 31, 2005, we granted 400,000 stock options to eligible agents of American Commerce pursuant to a Letter Agreement dated January 29, 1999.

No cash consideration was received by us in exchange for the options. The purpose of the options is to provide an incentive for the agents to maintain their existing business volume with American Commerce. Additional options are granted based on the year-over-year increase in the volume of agency business written with American Commerce.

The options have been offered and sold pursuant to Securities Act Rule 506. Neither we nor any person acting on our behalf has offered or sold the options by any form of general solicitation or general advertising, and we have exercised reasonable care to assure that none of the recipients is an underwriter within the meaning of Section 2(11) of the Securities Act. Based upon representations from the recipients, we have reason to believe that not more than one of the recipients was not an accredited investor, as defined in Securities Act Rule 501.

The right of the recipient to exercise these options is contingent upon the average volume of other-than-Massachusetts private passenger automobile and homeowners direct written premiums placed and maintained with American Commerce for a five-year period specified in each option agreement. If qualified, the recipient may purchase our common stock at $76.90 for a period of five years beginning July 31, 2010. Unexercised options will terminate not later than July 31, 2015. The options may be exercised only by withholding option shares to pay the exercise price.

Item 6. Exhibits

Exhibits:

31.1	CEO Certification Statements under Section 302 of The Sarbanes-Oxley Act of 2002

31.2	CFO Certification Statements under Section 302 of The Sarbanes-Oxley Act of 2002

32	CEO and CFO Certification Statements under Section 906 of the Sarbanes-Oxley Act of 2002

10.37	Addendum No. 1 to the Combined Property and Liability Quota Share Reinsurance Agreement filed as Exhibit 10.33 to our Form 10-Q filed August 5, 2004 with the SEC

10.38	Property Catastrophe (1^st through 3^rd) Excess of Loss Reinsurance Contract

<PAGE> 25

Signature

Pursuant to the requirements of the Securities Exchange Act of 1934 as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	THE COMMERCE GROUP, INC.

	/s/ Randall V. Becker

	Randall V. Becker
	Treasurer and Chief Accounting Officer

Dated: November 2, 2005

<PAGE> 26