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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Form 10-Q
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[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ________ TO ________.
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2001
COMMISSION FILE NUMBER 1-9640
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MERCHANTS GROUP, INC.
(Exact name of registrant as specified in its charter)
DELAWARE
(State or other jurisdiction of incorporation or organization)
16-1280763
(I.R.S. Employer Identification No.)
250 MAIN STREET, BUFFALO, NEW YORK
(Address of principal executive offices)
14202
(Zip Code)
716-849-3333
(Registrant's telephone number, including area code)
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, and (2) has been subject to such filing requirements
for the past 90 days. Yes [ x ] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of July 31, 2001.
2,317,652 SHARES OF COMMON STOCK.
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
MERCHANTS GROUP, INC.
CONSOLIDATED BALANCE SHEET
(in thousands)
December 31, June 30,
Assets 2000 2001
------ ---- ----
(unaudited)
Investments:
Fixed maturities:
Held to maturity at amortized cost (fair value
$13,576 in 2000 and $13,841 in 2001) $ 12,874 $ 12,940
Available for sale at fair value (amortized cost
$183,392 in 2000 and $179,405 in 2001) 183,283 181,510
Preferred stock at fair value 13,911 14,536
Other long-term investments at fair value 1,036 1,516
Short-term investments 4,550 3,755
-------- --------
Total investments 215,654 214,257
Cash 5 4
Interest due and accrued 2,816 2,371
Premiums receivable, net of allowance for doubtful
accounts of $395 in 2000 and $418 in 2001 19,843 21,036
Deferred policy acquisition costs 12,331 12,176
Ceded reinsurance balances receivable 13,089 16,121
Prepaid reinsurance premiums 4,326 4,075
Deferred income taxes 6,263 4,799
Other assets 7,537 7,867
-------- --------
Total assets $281,864 $282,706
======== ========
See Notes to the Consolidated Financial Statements
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MERCHANTS GROUP, INC.
CONSOLIDATED BALANCE SHEET
(in thousands except share amounts)
December 31, June 30,
2000 2001
---- ----
(unaudited)
Liabilities and Stockholders' Equity
------------------------------------
Liabilities:
Reserve for losses and loss adjustment expenses $ 145,075 $ 146,653
Unearned premiums 50,857 50,023
Payable to affiliate 608 1,792
Other liabilities 15,202 13,232
--------- ---------
Total liabilities 211,742 211,700
--------- ---------
Stockholders' equity:
Common stock, 10,000,000 shares authorized, 2,430,752
shares issued and outstanding at December 31, 2000
and 2,318,552 shares issued and outstanding
at June 30, 2001 32 32
Additional paid in capital 35,680 35,680
Treasury stock, 811,100 shares at December 31, 2000
and 923,300 shares at June 30, 2001 (16,063) (18,123)
Accumulated other comprehensive income (loss) (875) 1,113
Accumulated earnings 51,348 52,304
--------- ---------
Total stockholders' equity 70,122 71,006
--------- ---------
Commitments and contingent liabilities -- --
Total liabilities and stockholders' equity $ 281,864 $ 282,706
========= =========
See Notes to the Consolidated Financial Statements
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MERCHANTS GROUP, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
(in thousands except per share amounts)
Three Months Six Months
Ended June 30, Ended June 30,
2000 2001 2000 2001
---- ---- ---- ----
(unaudited)
Revenues:
Net premiums earned $23,606 $23,154 $46,639 $46,507
Net investment income 3,388 3,472 6,844 7,035
Net realized investment gains 5 39 5 82
Other revenues 16 117 82 254
--------- --------- -------- ---------
Total revenues 27,015 26,782 53,570 53,878
--------- --------- -------- ---------
Expenses:
Net losses and loss adjustment
expenses 16,703 17,620 34,196 36,381
Amortization of deferred policy
acquisition costs 6,256 6,136 12,359 12,324
Other underwriting expenses 1,273 1,116 2,960 2,933
--------- --------- -------- ---------
Total expenses 24,232 24,872 49,515 51,638
--------- --------- -------- ---------
Income before income taxes 2,783 1,910 4,055 2,240
Income tax provision 982 693 1,437 812
--------- --------- -------- ---------
Net income $ 1,801 $ 1,217 $ 2,618 $ 1,428
========= ========= ======== =========
Basic and diluted earnings per share $.72 $.52 $1.04 $.60
==== ==== ===== ====
Weighted average shares outstanding:
Basic 2,488 2,357 2,524 2,389
Diluted 2,489 2,359 2,526 2,391
See Notes to the Consolidated Financial Statements
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MERCHANTS GROUP, INC.
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(in thousands)
Three Months Six Months
Ended June 30, Ended June 30,
2000 2001 2000 2001
---- ---- ---- ----
(unaudited)
Net income $ 1,801 $ 1,217 $ 2,618 $ 1,428
------- ------- ------- -------
Other comprehensive income (loss)
before taxes:
Unrealized gains (losses)
on securities 195 467 (596) 3,302
Reclassification adjustment
for gains and losses included
in net income -- (39) -- (82)
------- ------- ------- -------
Other comprehensive income (loss)
before taxes 195 428 (596) 3,220
Income tax provision (benefit) related to
items of other comprehensive income 74 164 (294) 1,232
------- ------- ------- -------
Other comprehensive income (loss) 121 264 (302) 1,988
------- ------- ------- -------
Comprehensive income $ 1,922 $ 1,481 $ 2,316 $ 3,416
======= ======= ======= =======
See Notes to the Consolidated Financial Statements
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MERCHANTS GROUP, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(in thousands)
Six Months
Ended June 30,
2000 2001
---- ----
(unaudited)
Common stock, beginning and end $ 32 $ 32
---------- ----------
Additional paid in capital beginning and end: 35,680 35,680
------ ------
Treasury stock:
Beginning of period (13,139) (16,063)
Purchase of treasury shares (2,352) (2,060)
-------- --------
End of period (15,491) (18,123)
------- -------
Accumulated other comprehensive income (loss):
Beginning of period (1,188) (875)
Other comprehensive income (loss) (302) 1,988
------- -------
End of period (1,490) 1,113
------- -------
Accumulated earnings:
Beginning of period 48,002 51,348
Net income 2,618 1,428
Cash dividends (503) (472)
---------- ----------
End of period 50,117 52,304
-------- --------
Total stockholders' equity $68,848 $71,006
======= =======
See Notes to the Consolidated Financial Statements
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MERCHANTS GROUP, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(in thousands)
Six Months
Ended June 30,
2000 2001
---- ----
(unaudited)
Cash flows from operations:
Collection of premiums $46,239 $44,657
Payment of losses and loss adjustment expenses (35,547) (37,661)
Payment of other underwriting expenses (17,191) (17,193)
Investment income received 6,678 6,919
Investment expenses paid (216) (157)
Income taxes paid (1,353) (830)
Other 81 252
--------- --------
Net cash used in operations (1,309) (4,013)
------- -------
Cash flows from investing activities:
Proceeds from fixed maturities sold or matured 35,276 53,140
Purchase of fixed maturities (24,516) (47,978)
Net increase in preferred stock (416) (117)
Net (increase) decrease in other long-term investments 62 (480)
Net (increase) decrease in short-term investments (5,581) 795
------- --------
Net cash provided by investing activities 4,825 5,360
------- -------
Cash flows from financing activities:
Settlement of affiliate balances (85) 1,184
Decrease in demand loan, net (575) -
Purchase of treasury stock (2,352) (2,060)
Cash dividends (503) (472)
-------- --------
Net cash used in financing activities (3,515) (1,348)
------- -------
Increase (decrease) in cash 1 (1)
Cash:
Beginning of period 2 5
--------- ---------
End of period $ 3 $ 4
========= =========
See Notes to the Consolidated Financial Statements
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MERCHANTS GROUP, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
RECONCILIATION OF NET INCOME TO NET CASH
PROVIDED BY OPERATIONS
(in thousands)
Six Months
Ended June 30,
2000 2001
---- ----
(unaudited)
Net income $2,618 $1,428
Adjustments:
Accretion of bond discount (231) (718)
Realized investment gains (5) (82)
(Increase) decrease in assets:
Interest due and accrued (151) 445
Premiums receivable (1,314) (1,193)
Deferred policy acquisition costs (308) 155
Ceded reinsurance balances receivable (503) (3,032)
Prepaid reinsurance premiums (5,061) 251
Deferred income taxes 235 233
Other assets (176) (274)
Increase (decrease) in liabilities:
Reserve for losses and loss adjustment expenses (1,127) 1,578
Unearned premiums 6,223 (834)
Other liabilities (1,509) (1,970)
-------- --------
Net cash used in operations $(1,309) $(4,013)
======== =======
See Notes to the Consolidated Financial Statements
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MERCHANTS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION
The consolidated balance sheet as of June 30, 2001 and the related consolidated
statements of operations, of comprehensive income, of changes in stockholders'
equity and of cash flows for the three and six month periods ended June 30, 2000
and 2001, respectively, are unaudited. In the opinion of management, the interim
financial statements reflect all adjustments necessary for a fair presentation
of financial position and results of operations. Such adjustments consist only
of normal recurring items. Interim results are not necessarily indicative of
results for a full year.
The consolidated financial statements include the accounts of Merchants Group,
Inc. (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. The accompanying
consolidated financial statements should be read in conjunction with the
following notes and the Notes to Consolidated Financial Statements included in
the Company's Annual Report on Form 10-K for the year ended December 31, 2000.
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. All
significant intercompany balances and transactions have been eliminated.
2. RELATED PARTY TRANSACTIONS
The Company and MNH have no paid employees. Under a management agreement dated
September 29, 1986 (the Management Agreement), Merchants Mutual Insurance
Company (Mutual), which owned 11.0% of the Company's common stock at June 30,
2001, provides the Company and MNH with the facilities, management and personnel
required to manage their day-to-day business. All underwriting, administrative,
claims and investment expenses incurred on behalf of Mutual and MNH are shared
on an allocated cost basis, determined as follows: for underwriting and
administrative expenses, the respective share of total direct premiums written
for Mutual and MNH serves as the basis of allocation; for claims expenses, the
average number of outstanding claims is used; investment expenses are shared
based on each company's share of total invested assets.
3. EARNINGS PER SHARE
Basic and diluted earnings per share were computed by dividing net income by the
weighted average number of shares of common stock outstanding during each
period, increased by the assumed exercise of 8,000 shares of common stock
options for the three and six month periods in 2001 and 2000, respectively,
which would have resulted in 2,015 and 900 additional shares outstanding for the
three month periods, respectively, and 1,949 and 1,407 additional shares
outstanding for the six month
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periods, respectively, assuming the proceeds to the Company from exercise were
used to purchase shares of the Company's common stock at its average market
value per share during the respective period.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
RESULTS OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2001 AS COMPARED TO THE
SIX MONTHS ENDED JUNE 30, 2000
Total revenues for the six months ended June 30, 2001 were $53,878,000, an
increase of $308,000 or 1%, from $53,570,000 for the six months ended June 30,
2000.
Direct premiums written for the six months ended June 30, 2001 were $49,735,000,
a decrease of $8,559,000 or 15%, from $58,294,000 for the six months ended June
30, 2000. Voluntary direct premiums written for the six months ended June 30,
2001 were $48,212,000, a decrease of $9,527,000 or 17%, from $57,739,000 for the
six months ended June 30, 2000.
Voluntary personal lines direct premiums written for the six months ended June
30, 2001 were $18,605,000, an increase of $587,000 or 3%, from $18,018,000 for
the six months ended June 30, 2000. Private passenger automobile (PPA) direct
premiums written, which represented 76% of total voluntary personal lines direct
premiums written for the six months ended June 30, 2001 and 2000, increased 2%
from the year earlier period. Homeowners direct premiums written for the six
months ended June 30, 2001 increased 7% compared to the six months ended June
30, 2000 primarily due to a 7% increase in policies in force at June 30, 2001 as
compared to June 30, 2000.
The Company implemented a program to underwrite specialized commercial auto
insurance (the Auto Program) during the quarter ended June 30, 2000. All
policies issued under the Auto Program were 100% reinsured through certain
Lloyds syndicates and therefore had no impact on net premiums written, net
premiums earned or net losses and loss adjustment expenses (LAE) incurred by the
Company. The Company recorded all direct underwriting expenses incurred,
including commissions with respect to the acquisition of these policies, which
were offset by reinsurance commission income. The resulting net impact of the
Auto Program reduced other underwriting expenses by $82,000 in the six month
period ended June 30, 2000. The Auto Program was discontinued in 2001 and had no
impact on current year net income.
Voluntary commercial lines direct premiums written for the six months ended June
30, 2001 were $29,607,000, a decrease of $10,114,000 or 25%, from $39,721,000
for the six months ended June 30, 2000. This decrease was primarily attributable
to the aforementioned discontinuation of the Auto Program, which produced
$6,579,000 of direct written premiums in the six months ended June 30, 2000.
The Company has and continues to experience higher loss frequency for certain of
its commercial lines of business not adequately covered by premiums collected
from those lines of business. As a response to these higher losses, the Company
has filed for and received approval of rate increases in certain lines of
business, revised its underwriting guidelines, and removed discretionary pricing
credits where warranted. As a consequence of these actions, voluntary commercial
lines direct premiums written,
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excluding Auto Program premiums written, for the six months ended June 30, 2001
decreased $3,519,000 or 11%, to $29,623,000 from $33,142,000 for the six months
ended June 30, 2000. Direct premiums written for all of the Company's commercial
lines of business, except commercial package policies, decreased in the six
months ended June 30, 2001 compared to the six months ended June 30, 2000.
Commercial lines policies in force at June 30, 2001 decreased 15% compared to
commercial lines policies in force at June 30, 2000. The Company expects that
its tightening of underwriting guidelines and increases in rates will cause the
decreases in voluntary direct premiums written to accelerate through the end of
the year.
Involuntary direct premiums written, primarily PPA insurance, which comprised 3%
and 1% of all direct premiums written during the six months ended June 30, 2001
and 2000, respectively, increased by $967,000, or 174%, to $1,523,000 in the six
months ended June 30, 2001 from $556,000 for the six months ended June 30, 2000.
The Company believes it is likely that, due to a decrease in the willingness of
several major competitors to insure non-standard business voluntarily, the
number of policies written by the New York Automobile Insurance Plan (NYAIP)
will continue to increase and therefore the amount of the Company's involuntary
direct written premiums will also continue to increase. However, the Company is
unable to predict the volume of future assignments from the NYAIP.
Net premiums written decreased $1,878,000, or 4%, to $45,924,000 for the six
months ended June 30, 2001 from $47,802,000 for the six months ended June 30,
2000, due to the 4% decrease in non-Auto Program direct premiums written.
Net premiums earned for the six months ended June 30, 2001 were $46,507,000, a
decrease of less than 1% from $46,639,000 for the six months ended June 30,
2000. This decrease is attributable to the fact that the unearned premiums at
December 31, 2000 contributed more to earned premiums in the six months ended
June 30, 2000 than the unearned premiums at December 31, 1999, contributed to
earned premiums in the six months ended June 30, 2000, thereby substantially
offsetting the effect on net premiums earned of the aforementioned 4% decrease
in net premiums written.
Net investment income was $7,035,000 for the six months ended June 30, 2001, an
increase of 3% from $6,844,000 for the six months ended June 30, 2000. The
average pre-tax yield associated with the investment portfolio increased 9 basis
points to 6.75% for the six months ended June 30, 2001. Average invested assets
for the six months ended June 30, 2001 increased 1% compared to the year earlier
period.
Other revenues were $254,000 for the six months ended June 30, 2001, an increase
of $172,000, or 210%, from $82,000 for the six months ended June 30, 2000. This
increase primarily resulted from an increase in installment fee income and a
decrease in charge-offs related to uncollectible premiums receivable.
Losses and LAE were $36,381,000 for the six months ended June 30, 2001, an
increase of $2,185,000 or 6%, from $34,196,000 for the six months ended June 30,
2000. The loss and LAE ratio increased to 78.2% for the six months ended June
30, 2001 from 73.3% for the six months ended June 30, 2000. The increase in the
loss and LAE ratio resulted from increased claims frequency and severity
experienced in 2001, primarily for private passenger automobile, commercial
automobile and workers' compensation policies.
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The ratio of amortized deferred policy acquisition costs and other underwriting
expenses to net premiums earned was 32.8% for both of the six month periods
ended June 30, 2001 and June 30, 2000. Commissions, premium taxes and other
state assessments that vary directly with the Company's premium volume
represented 20.2% of net premiums earned in the six months ended June 30, 2001
compared to 20.1% for the six months ended June 30, 2000.
The Company's effective income tax rate for the six months ended June 30, 2001
was 36.3%. This rate was calculated based upon the Company's estimate of its
effective income tax rate for all of 2001. Non-taxable investment income,
primarily tax-exempt income, reduced the Company's effective tax rate by
approximately four percentage points as compared to statutory rates.
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30, 2001 AS COMPARED TO
THE THREE MONTHS ENDED JUNE 30, 2000
Total revenues for the three months ended June 30, 2001 were $26,782,000, a
decrease of $233,000, or 1%, from $27,015,000 for the three months ended June
30, 2000.
Voluntary personal lines direct premiums written for the three months ended June
30, 2001 were $10,092,000, an increase of $538,000, or 6%, from $9,554,000 for
the three months ended June 30, 2000. PPA direct premiums written increased 5%
from the year earlier period, primarily due to a 6% increase in average premium
per policy. Homeowners direct premiums written for the three months ended June
30, 2001 increased 8% compared to the three months ended June 30, 2000 primarily
due to a 7% increase in policies in force.
Voluntary commercial lines direct premiums written excluding Auto Program
premiums written for the three months ended June 30, 2001 were $16,441,000, a
decrease of $1,952,000, or 11%, from $18,393,000 for the three months ended June
30, 2000. This decrease in commercial lines direct written premiums is
attributable to the same factors affecting voluntary commercial lines direct
premiums written for the six months ended June 30, 2001, and is expected to
accelerate, as discussed earlier in this item.
Involuntary direct premiums written for the three months ended June 30, 2001
were $1,005,000, an increase of $705,000, or 235%, from $300,000 for the three
months ended June 30, 2000. Involuntary written premiums are affected by the
size of the involuntary markets in which the Company operates, primarily the New
York Automobile Insurance Plan.
Net investment income was $3,472,000 for the three months ended June 30, 2001,
an $84,000, or 2%, increase from $3,388,000 for the three months ended June 30,
2000, primarily due to a 1% increase in average invested assets.
Losses and LAE were $17,620,000 for the three months ended June 30, 2001, an
increase of $917,000, or 5%, from $16,703,000 for the three months ended June
30, 2000. The loss and LAE ratio increased to 76.1% for the three months ended
June 30, 2001 from 70.8% for the three months ended June 30, 2000. The increase
in the loss and LAE ratio is attributable to the same factors affecting losses
and LAE for the six months ended June 30, 2001 discussed earlier in this item.
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The ratio of amortized deferred policy acquisition costs and other underwriting
expenses to net premiums earned decreased to 31.3% for the three months ended
June 30, 2001 from 31.9% for the three months ended June 30, 2000. Commissions,
premium taxes and other state assessments that vary with the Company's premium
volume represented 19.4% of net premiums earned in the three months ended June
30, 2001 compared to 20.4% for the three months ended June 30, 2000.
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 flow
from investments, has provided the Company with short-term funds in excess of
normal operating demands for cash.
The Company's objectives with respect to its investment portfolio include
maximizing total returns within investment guidelines while protecting
stockholders' equity and maintaining flexibility. Like other property and
casualty insurers, the Company relies on premiums as a major source of cash, and
therefore liquidity. Cash flows from the Company's investment portfolio, either
in the form of interest or principal payments, are an additional source of
liquidity. Because the duration of the Company's investment portfolio relative
to the duration of its liabilities are closely managed, increases or decreases
in market interest rates are not expected to have a material effect on the
Company's liquidity or its results of operations.
The Company generally designates newly acquired fixed maturity investments as
available for sale and carries these investments at fair value. Unrealized gains
and losses related to these investments are recorded as a component of
accumulated other comprehensive income within stockholders' equity. At June 30,
2001, the Company had recorded $1,113,000 of unrealized gains, net of taxes,
associated with its investments classified as "available for sale" as
accumulated other comprehensive income. During the six months ended June 30,
2001 the Company recorded $1,988,000 of unrealized gains, net of tax, associated
with its available for sale investments as other comprehensive income.
At June 30, 2001, the Company's portfolio of fixed maturities represented 90.8%
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 June 30, 2001, $83,125,000, or 42.7%, of the Company's fixed maturity
portfolio was invested in mortgage-backed and other asset backed securities. The
Company invests in a variety of collateralized mortgage obligation (CMO)
products but has not invested in the derivative type of CMO products such as
interest only, principal only or inverse floating rate securities. All of the
Company's CMO investments have an active secondary market and their effect on
the Company's liquidity does not differ
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from that of other fixed maturity investments. The Company does not own any
other derivative financial instruments.
At June 30, 2001, $10,522,000, or 4.9% of the Company's investment portfolio was
invested in non-investment grade securities compared to $9,806,000, or 4.7% at
June 30, 2000. All of the Company's non-investment grade securities are
currently performing to the Company's purchase expectations.
During the six months ended June 30, 2001, the Company repurchased 112,200
shares of its common stock at an average price per share of $18.36. The Company
was holding 923,300 shares of its common stock in treasury at June 30, 2001.
The Company has arranged for a $2,000,000 unsecured credit facility from a bank
in the form of a master grid note. Any borrowings under this facility are
payable on demand and carry an interest rate which can be fixed or variable and
is negotiated at the time of each advance. This facility is available for
general working capital purposes and for repurchases of the Company's common
stock. At June 30, 2001, no amount was outstanding on this loan.
As a holding company, the Company is dependent on cash dividends from MNH to
meet its obligations, pay any cash dividends and repurchase its shares. 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 statutory policyholders' surplus as of the preceding December
31st. The maximum amount of dividends that MNH could pay during any twelve month
period ending in 2001 without the prior approval of the New Hampshire Insurance
Commissioner is $5,061,000. MNH paid $5,200,000 of dividends to the Company in
2000. Dividends were paid in February 2000, May 2000 and September 2000, of
$2,200,000, $1,500,000 and $1,500,000, respectively. MNH paid dividends to the
Company of $2,200,000 and $1,350,000 on February 15, 2001 and May 24, 2001,
respectively, and as such is restricted from paying another dividend to the
Company until September 2001. On July 26, 2001, the Board of Directors of MNH
declared a $1,510,000 cash dividend payable to MGI on September 6, 2001. The
Company paid cash dividends to its common stockholders of $.20 per share in the
first half of 2001 amounting to $472,000.
Under the Management Agreement, Mutual provides employees, services and
facilities for MNH to conduct its insurance business on a cost reimbursed basis.
The balance in the payable to or receivable from affiliate account represents
the amount owing to or owed by Mutual to the Company for the difference between
premiums collected and payments made for losses, employees, services and
facilities by Mutual on behalf of MNH.
Industry and regulatory guidelines suggest that the ratio of a property-casualty
insurer's annual net premiums written to its statutory surplus should not exceed
3 to 1. MNH has consistently followed a business strategy that would allow it to
meet this 3 to 1 regulatory guideline. For the first six months of 2001, MNH's
ratio of net premiums written to statutory surplus, annualized for a full year,
was 1.7 to 1.
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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 11.0% 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 determined that the
terms proposed by Mutual were inadequate. The Company 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
Company believes 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 3. 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 $214,257,000 at June 30, 2001 is subject to
changes in interest rates and to a lesser extent on credit quality. Further,
certain mortgage-backed and asset-backed securities are exposed to accelerated
prepayment risk generally caused by interest rate movements. If interest rates
were to decline, mortgage holders would be more likely to refinance existing
mortgages at lower rates. Acceleration of future repayments could adversely
affect future investment income, if reinvestment of the accelerated receipts was
made in lower yielding securities.
The following table provides information related to the Company's fixed maturity
investments at June 30, 2001. The table presents cash flows of principal amounts
and related weighted average interest rates by expected maturity dates. The cash
flows are based upon the maturity date or, in the case of mortgage-backed and
asset-backed securities, expected payment patterns. Actual cash flows could
differ from those shown in the table.
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Fixed Maturities
----------------
Expected Cash Flows of Principal Amounts ($ in 000's):
TOTAL
-----
Amor- Estimated
There- tized Market
Held to Maturity 2001 2002 2003 2004 2005 After Cost Value
---------------- ---- ---- ---- ---- ---- ----- ---- -----
Mortgage & asset backed
securities $ 0 $ 642 $ 1,644 $ 1,556 $ 1,355 $ 7,743 $ 12,940 $ 13,841
Average interest rate 0.0% 7.2% 7.1% 7.1% 7.1% 7.3% -- --
-------- -------- -------- -------- -------- -------- -------- --------
Total $ 0 $ 642 $ 1,644 $ 1,556 $ 1,355 $ 7,743 $ 12,940 $ 13,841
======== ======== ======== ======== ======== ======== ======== ========
AVAILABLE FOR SALE
U.S. Treasury securities and
obligations of U.S.
Government corporations
and agencies $4, 987 $ 3,832 $ 1,000 $ 0 $ 0 $ 21,806 $ 31,625 $ 32,559
Average interest rate 5.3% 6.9% 5.1% 0.0% 0.0% 7.3% -- --
Obligations of states and
political subdivisions 2,245 1,483 5,357 0 0 110 9,195 9,368
Average interest rate 5.1% 5.6% 5.3% 0.0% 0.0% 5.3% -- --
Corporate securities 10,734 25,454 28,873 1,071 0 2,445 68,577 69,397
Average interest rate 6.8% 6.6% 5.9% 19.2% 0.0% 8.0% -- --
Mortgage & asset
backed securities 19,195 17,766 14,868 6,339 1,743 10,097 70,008 70,186
Average interest rate 6.8% 6.7% 6.8% 6.9% 7.0% 7.1% -- --
-------- -------- -------- -------- -------- -------- -------- --------
Total $ 37,161 $ 48,535 $ 50,098 $ 7,410 $ 1,743 $ 34,458 $179,405 $181,510
======== ======== ======== ======== ======== ======== ======== ========
The discussion and the estimated amounts referred to above include
forward-looking statements of market risk which involve certain assumptions as
to market interest rates and the credit quality of the fixed maturity
investments. Actual future market conditions may differ materially from such
assumptions. Accordingly, the forward-looking statements should not be
considered projections of future events by the Company.
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PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders
On May 2, 2001 the Company held its annual meeting of stockholders. During the
meeting, Brent D. Baird and Richard E. Garman were re-elected Directors of the
Company for three year terms to expire at the annual meeting in 2004. Andrew A.
Alberti, Frank J. Colantuono, Thomas E. Kahn, Henry P. Semmelhack and Robert M.
Zak are Directors of the Company whose terms of office as Director continue
beyond the date of the meeting. Mr. Alberti's and Mr. Colantuono's terms expire
in 2002 and Mr. Kahn's, Mr. Semmelhack's and Mr. Zak's terms expire in 2003.
Also during the meeting, stockholders ratified the appointment of
PricewaterhouseCoopers LLP to serve as the Company's independent accountants for
the year ending December 31, 2001.
A summary of stockholder voting with respect to the election of Directors is as
follows:
Election of Election of
B. Baird R. Garman
-------- ---------
For 2,211,202 2,213,052
Withheld 8,150 6,300
A summary of stockholder voting with respect to the ratification of
PricewaterhouseCoopers to serve as the Company's independent accountants for the
year ending December 31, 2001 is as follows:
For 2,215,177
Against 800
Abstained 3,375
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(b) Reports on Form 8-K.
No reports on Form 8-K were filed during the period for
which this report is filed.
* * * * * * * * *
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"Safe Harbor" Statement under the Private Securities Litigation Reform Act of
1995:
With the exception of historical information, the matters and statements
discussed, made or incorporated by reference in this Quarterly Report on Form
10-Q constitute forward-looking statements and are discussed, made or
incorporated by reference, as the case may be, pursuant to the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995. 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 the statements. These assumptions, risks and uncertainties
include, but are not limited to, those associated with factors affecting the
property-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
date of this report.
SIGNATURES
Pursuant to the requirements 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.
(Registrant)
Date: August 13, 2001 By:/s/ Kenneth J. Wilson
---------------------
Kenneth J. Wilson
Chief Financial Officer and
Treasurer (duly authorized
officer of the registrant and
chief accounting officer)
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