MERCHANTS GROUP, INC. 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Form 10-Q
|
|
|
þ |
|
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended June 30, 2005
or
|
|
|
o |
|
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from ________ to ________.
Commission File Number 1-9640
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
(Registrants 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 þ No o
Indicate by checkmark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of
the Act). Yes o No þ
Indicate the number of shares outstanding of each of the issuers classes of common stock, as of
the latest practicable date (August 8, 2005): 2,114,152 shares of Common Stock.
1
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
MERCHANTS GROUP, INC.
CONSOLIDATED BALANCE SHEET
(in thousands)
|
|
|
|
|
|
|
|
|
|
|
June 30, |
|
December 31, |
|
|
2005 |
|
2004 |
|
|
(unaudited) |
|
|
|
|
Assets |
|
|
|
|
|
|
|
|
Investments: |
|
|
|
|
|
|
|
|
Fixed maturities: |
|
|
|
|
|
|
|
|
Available for sale at fair value (amortized cost
$179,439 in 2005 and $184,171 in 2004) |
|
$ |
178,938 |
|
|
$ |
184,092 |
|
Preferred stock at fair value |
|
|
4,487 |
|
|
|
3,509 |
|
Other long-term investments at fair value |
|
|
625 |
|
|
|
2,696 |
|
Short-term investments |
|
|
10,228 |
|
|
|
7,412 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total investments |
|
|
194,278 |
|
|
|
197,709 |
|
|
|
|
|
|
|
|
|
|
Cash |
|
|
1,030 |
|
|
|
145 |
|
Interest due and accrued |
|
|
1,040 |
|
|
|
1,079 |
|
Premiums receivable, net of allowance for doubtful
accounts of $186 in 2005 and $215 in 2004 |
|
|
14,429 |
|
|
|
15,136 |
|
Deferred policy acquisition costs |
|
|
6,586 |
|
|
|
7,570 |
|
Reinsurance recoverable on paid and unpaid losses |
|
|
15,236 |
|
|
|
15,630 |
|
Prepaid reinsurance premiums |
|
|
4,938 |
|
|
|
4,595 |
|
Deferred income taxes |
|
|
4,824 |
|
|
|
5,028 |
|
Receivable from affiliate |
|
|
991 |
|
|
|
|
|
Other assets |
|
|
12,343 |
|
|
|
13,557 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets |
|
$ |
255,695 |
|
|
$ |
260,449 |
|
|
|
|
|
|
|
|
|
|
See Notes to the Consolidated Financial Statements
2
MERCHANTS GROUP, INC.
CONSOLIDATED BALANCE SHEET
(in thousands except share amounts)
|
|
|
|
|
|
|
|
|
|
|
June 30, |
|
December 31, |
|
|
2005 |
|
2004 |
|
|
(unaudited) |
|
|
|
|
Liabilities and Stockholders Equity |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities: |
|
|
|
|
|
|
|
|
Reserve for losses and loss adjustment expenses |
|
$ |
120,431 |
|
|
$ |
128,415 |
|
Unearned premiums |
|
|
30,270 |
|
|
|
33,685 |
|
Payable for securities |
|
|
11,009 |
|
|
|
4,751 |
|
Payable to affiliate |
|
|
|
|
|
|
5,571 |
|
Retrospective commission payable to affiliate |
|
|
3,004 |
|
|
|
1,141 |
|
Income taxes payable |
|
|
1,204 |
|
|
|
|
|
Other liabilities |
|
|
14,056 |
|
|
|
14,912 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities |
|
|
179,974 |
|
|
|
188,475 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders equity: |
|
|
|
|
|
|
|
|
Common stock, 10,000,000 shares authorized, 2,114,152
shares issued and outstanding at June 30, 2005 and
December 31, 2004 |
|
|
33 |
|
|
|
33 |
|
Additional paid in capital |
|
|
35,878 |
|
|
|
35,878 |
|
Treasury stock, 1,139,700 shares at June 30, 2005 and
December 31, 2004 |
|
|
(22,766 |
) |
|
|
(22,766 |
) |
Accumulated other comprehensive loss |
|
|
(731 |
) |
|
|
(536 |
) |
Accumulated earnings |
|
|
63,307 |
|
|
|
59,365 |
|
|
|
|
|
|
|
|
|
|
Total stockholders equity |
|
|
75,721 |
|
|
|
71,974 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commitments and contingent liabilities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and stockholders equity |
|
$ |
255,695 |
|
|
$ |
260,449 |
|
|
|
|
|
|
|
|
|
|
See Notes to the Consolidated Financial Statements
3
MERCHANTS GROUP, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
(in thousands except per share amounts)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months |
|
Six Months |
|
|
Ended June 30, |
|
Ended June 30, |
|
|
2005 |
|
2004 |
|
2005 |
|
2004 |
|
|
(unaudited) |
Revenues: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net premiums earned |
|
$ |
12,767 |
|
|
$ |
14,364 |
|
|
$ |
24,744 |
|
|
$ |
28,433 |
|
Net investment income |
|
|
1,908 |
|
|
|
1,965 |
|
|
|
3,844 |
|
|
|
4,019 |
|
Net investment gains |
|
|
|
|
|
|
93 |
|
|
|
|
|
|
|
470 |
|
Other revenues |
|
|
114 |
|
|
|
97 |
|
|
|
250 |
|
|
|
263 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenues |
|
|
14,789 |
|
|
|
16,519 |
|
|
|
28,838 |
|
|
|
33,185 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net losses and loss adjustment expenses |
|
|
4,617 |
|
|
|
9,152 |
|
|
|
11,911 |
|
|
|
19,241 |
|
Amortization of deferred policy acquisition
costs |
|
|
3,319 |
|
|
|
3,739 |
|
|
|
6,433 |
|
|
|
7,397 |
|
Other underwriting expenses |
|
|
2,321 |
|
|
|
1,670 |
|
|
|
4,363 |
|
|
|
3,459 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total expenses |
|
|
10,257 |
|
|
|
14,561 |
|
|
|
22,707 |
|
|
|
30,097 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes |
|
|
4,532 |
|
|
|
1,958 |
|
|
|
6,131 |
|
|
|
3,088 |
|
Income tax provision |
|
|
1,354 |
|
|
|
408 |
|
|
|
1,765 |
|
|
|
727 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
3,178 |
|
|
$ |
1,550 |
|
|
$ |
4,366 |
|
|
$ |
2,361 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings per share: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic |
|
$ |
1.50 |
|
|
$ |
.73 |
|
|
$ |
2.07 |
|
|
$ |
1.12 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted |
|
$ |
1.50 |
|
|
$ |
.73 |
|
|
$ |
2.06 |
|
|
$ |
1.11 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares outstanding: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic |
|
|
2,114 |
|
|
|
2,114 |
|
|
|
2,114 |
|
|
|
2,113 |
|
Diluted |
|
|
2,119 |
|
|
|
2,119 |
|
|
|
2,119 |
|
|
|
2,118 |
|
See Notes to the Consolidated Financial Statements
4
MERCHANTS GROUP, INC.
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (LOSS)
(in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months |
|
Six Months |
|
|
Ended June 30, |
|
Ended June 30, |
|
|
2005 |
|
2004 |
|
2005 |
|
2004 |
|
|
|
|
|
|
(unaudited) |
|
|
|
|
Net income |
|
$ |
3,178 |
|
|
$ |
1,550 |
|
|
$ |
4,366 |
|
|
$ |
2,361 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other comprehensive income (loss) before taxes: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized gains (losses) on securities |
|
|
1,815 |
|
|
|
(5,853 |
) |
|
|
(295 |
) |
|
|
(4,069 |
) |
Reclassification adjustment
for gains included in net income |
|
|
|
|
|
|
(93 |
) |
|
|
|
|
|
|
(470 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other comprehensive income (loss) before taxes |
|
|
1,815 |
|
|
|
(5,946 |
) |
|
|
(295 |
) |
|
|
(4,539 |
) |
Income taxes (benefit) related to items
of other comprehensive income (loss) |
|
|
617 |
|
|
|
(2,021 |
) |
|
|
(100 |
) |
|
|
(1,543 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other comprehensive income (loss) |
|
|
1,198 |
|
|
|
(3,925 |
) |
|
|
(195 |
) |
|
|
(2,996 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive income (loss) |
|
$ |
4,376 |
|
|
$ |
(2,375 |
) |
|
$ |
4,171 |
|
|
$ |
(635 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See Notes to the Consolidated Financial Statements
5
MERCHANTS GROUP, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS EQUITY
(in thousands)
|
|
|
|
|
|
|
|
|
|
|
Six Months |
|
|
Ended June 30, |
|
|
2005 |
|
2004 |
|
|
(unaudited) |
Common stock: |
|
|
|
|
|
|
|
|
Beginning of period |
|
$ |
33 |
|
|
$ |
32 |
|
Exercise of common stock options |
|
|
|
|
|
|
1 |
|
|
|
|
|
|
|
|
|
|
End of period |
|
|
33 |
|
|
|
33 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Additional paid in capital: |
|
|
|
|
|
|
|
|
Beginning of period |
|
|
35,878 |
|
|
|
35,795 |
|
Exercise of common stock options |
|
|
|
|
|
|
83 |
|
|
|
|
|
|
|
|
|
|
End of period |
|
|
35,878 |
|
|
|
35,878 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Treasury stock beginning and end: |
|
|
(22,766 |
) |
|
|
(22,766 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated other comprehensive income (loss): |
|
|
|
|
|
|
|
|
Beginning of period |
|
|
(536 |
) |
|
|
750 |
|
Other comprehensive loss |
|
|
(195 |
) |
|
|
(2,996 |
) |
|
|
|
|
|
|
|
|
|
End of period |
|
|
(731 |
) |
|
|
(2,246 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated earnings: |
|
|
|
|
|
|
|
|
Beginning of period |
|
|
59,365 |
|
|
|
56,448 |
|
Net income |
|
|
4,366 |
|
|
|
2,361 |
|
Cash dividends |
|
|
(424 |
) |
|
|
(420 |
) |
|
|
|
|
|
|
|
|
|
End of period |
|
|
63,307 |
|
|
|
58,389 |
|
|
|
|
|
|
|
|
|
|
Total stockholders equity |
|
$ |
75,721 |
|
|
$ |
69,288 |
|
|
|
|
|
|
|
|
|
|
See Notes to the Consolidated Financial Statements
6
MERCHANTS GROUP, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(in thousands)
|
|
|
|
|
|
|
|
|
|
|
Six Months |
|
|
Ended June 30, |
|
|
2005 |
|
2004 |
|
|
(unaudited) |
Cash flows from operations: |
|
|
|
|
|
|
|
|
Collection of premiums |
|
$ |
21,917 |
|
|
$ |
25,244 |
|
Payment of losses and loss adjustment expenses |
|
|
(18,393 |
) |
|
|
(25,446 |
) |
Payment of other underwriting expenses |
|
|
(8,921 |
) |
|
|
(11,271 |
) |
Investment income received |
|
|
4,024 |
|
|
|
4,283 |
|
Investment expenses paid |
|
|
(207 |
) |
|
|
(143 |
) |
Income taxes paid |
|
|
(259 |
) |
|
|
(376 |
) |
Other |
|
|
250 |
|
|
|
263 |
|
|
|
|
|
|
|
|
|
|
Net cash used in operations |
|
|
(1,589 |
) |
|
|
(7,446 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from investing activities: |
|
|
|
|
|
|
|
|
Proceeds from fixed maturities sold or matured |
|
|
29,678 |
|
|
|
23,289 |
|
Purchase of fixed maturities |
|
|
(24,882 |
) |
|
|
(21,259 |
) |
Purchase of preferred stock |
|
|
(850 |
) |
|
|
|
|
Net (increase) decrease in other long-term investments |
|
|
2,072 |
|
|
|
(14 |
) |
Net increase in short-term investments |
|
|
(2,816 |
) |
|
|
(1,896 |
) |
Increase in payable for securities |
|
|
6,258 |
|
|
|
8,382 |
|
Decrease in receivable for securities |
|
|
|
|
|
|
893 |
|
|
|
|
|
|
|
|
|
|
Net cash provided by investing activities |
|
|
9,460 |
|
|
|
9,395 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from financing activities: |
|
|
|
|
|
|
|
|
Settlement of affiliate balances, net |
|
|
(6,562 |
) |
|
|
(1,632 |
) |
Exercise of common stock options |
|
|
|
|
|
|
84 |
|
Cash dividends |
|
|
(424 |
) |
|
|
(420 |
) |
|
|
|
|
|
|
|
|
|
Net cash used in financing activities |
|
|
(6,986 |
) |
|
|
(1,968 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Increase (decrease) in cash |
|
|
885 |
|
|
|
(19 |
) |
|
|
|
|
|
|
|
|
|
Cash: |
|
|
|
|
|
|
|
|
Beginning of period |
|
|
145 |
|
|
|
23 |
|
|
|
|
|
|
|
|
|
|
End of period |
|
$ |
1,030 |
|
|
$ |
4 |
|
|
|
|
|
|
|
|
|
|
See Notes to the Consolidated Financial Statements
7
MERCHANTS GROUP, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
RECONCILIATION OF NET INCOME TO NET CASH
USED IN OPERATIONS
(in thousands)
|
|
|
|
|
|
|
|
|
|
|
Six Months |
|
|
Ended June 30, |
|
|
2005 |
|
2004 |
|
|
(unaudited) |
Net income |
|
$ |
4,366 |
|
|
$ |
2,361 |
|
|
|
|
|
|
|
|
|
|
Adjustments: |
|
|
|
|
|
|
|
|
Accretion |
|
|
(66 |
) |
|
|
(9 |
) |
Realized investment gains |
|
|
|
|
|
|
(470 |
) |
|
|
|
|
|
|
|
|
|
(Increase) decrease in assets: |
|
|
|
|
|
|
|
|
Interest due and accrued |
|
|
39 |
|
|
|
130 |
|
Premiums receivable |
|
|
707 |
|
|
|
389 |
|
Deferred policy acquisition costs |
|
|
984 |
|
|
|
973 |
|
Reinsurance recoverable on paid and unpaid losses |
|
|
394 |
|
|
|
3,630 |
|
Prepaid reinsurance premiums |
|
|
(343 |
) |
|
|
(1,636 |
) |
Income taxes receivable |
|
|
|
|
|
|
330 |
|
Deferred income taxes |
|
|
304 |
|
|
|
249 |
|
Other assets |
|
|
1,214 |
|
|
|
816 |
|
|
|
|
|
|
|
|
|
|
Increase (decrease) in liabilities: |
|
|
|
|
|
|
|
|
Reserve for losses and loss adjustment expenses |
|
|
(7,984 |
) |
|
|
(10,297 |
) |
Unearned premiums |
|
|
(3,415 |
) |
|
|
(2,070 |
) |
Income taxes payable |
|
|
1,204 |
|
|
|
|
|
Retrospective commission payable to affiliate |
|
|
1,863 |
|
|
|
749 |
|
Other liabilities |
|
|
(856 |
) |
|
|
(2,591 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash used in operations |
|
$ |
(1,589 |
) |
|
$ |
(7,446 |
) |
|
|
|
|
|
|
|
|
|
See Notes to the Consolidated Financial Statements
8
MERCHANTS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Principles of Consolidation and Basis of Presentation
The consolidated balance sheet as of June 30, 2005 and the related consolidated statements of
operations and comprehensive income for the three and six month periods ended June 30, 2005 and
2004, and changes in stockholders equity and cash flows for the six months ended June 30, 2005 and
2004, 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 Companys Annual Report on
Form 10-K for the year ended December 31, 2004.
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 operate and manage their business in conjunction with Merchants Mutual
Insurance Company (Mutual) under a services agreement (the Services Agreement) which became
effective on January 1, 2003. At June 30, 2005 Mutual owned 12.1% of the Companys issued and
outstanding common stock. The Company and MNH do not have any operating assets or employees.
Under the Services Agreement, Mutual provides the Company and MNH with the facilities, management
and personnel required to operate their day-to-day business. The Services Agreement covers
substantially the same services previously provided under a management agreement amongst the
Company, MNH and Mutual from 1986 to 2002. The Services Agreement provides for negotiated fees
(subject to periodic adjustment) for administrative, underwriting, claims and investment management
services.
As of January 1, 2003 MNH and Mutual entered into a reinsurance pooling agreement (the Reinsurance
Pooling Agreement) that provides for the pooling, or sharing, of the insurance business
traditionally written by Mutual and MNH. The Reinsurance Pooling Agreement applies to premiums
earned and losses incurred on or after its effective date.
9
The terms of these agreements are more fully described under the heading Administration in Part
I, Item 1, Business, in the Companys Annual Report on Form 10-K for the year ended December 31,
2004. In accordance with the terms of the Services Agreement in June 2005 the Company and MNH
issued notice to Mutual to terminate the Investment and Cash Management Services Annex of the
Services Agreement as of June 30, 2006. The Company and MNH intend to solicit bids, including
possibly from Mutual, for the management of their investment portfolios after the effective date of
termination.
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. For diluted earnings per share,
the weighted average number of shares outstanding was increased by the assumed exercise of options
for each period. The effect on the number of shares outstanding assumes the proceeds to the
Company from exercise were used to purchase shares of the Companys common stock at its average
market value per share during the period. The number of options assumed to be exercised and the
incremental effect on average shares outstanding for purposes of calculating diluted earnings per
share are shown below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months |
|
Six Months |
|
|
Ended June 30, |
|
Ended June 30, |
|
|
2005 |
|
2004 |
|
2005 |
|
2004 |
Options assumed exercised |
|
|
31,500 |
|
|
|
31,500 |
|
|
|
31,500 |
|
|
|
31,500 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Incremental shares outstanding |
|
|
5,022 |
|
|
|
5,260 |
|
|
|
4,988 |
|
|
|
5,043 |
|
10
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
Results of Operations for the Six Months Ended June 30, 2005 As Compared to the Six Months
Ended June 30, 2004
The following discussion should be considered in light of the statements under the heading Safe
Harbor Statement under the Securities Litigation Reform Act of 1995, at the end of this Item. All
capitalized terms used in this Item that are not defined in this Item have the meanings given to
them in Notes to Consolidated Financial Statements contained in Item 1 of this Form 10-Q, which is
incorporated herein by reference.
Results of operations for the six months ended June 30, 2005 and 2004 reflect the effects of the
Services Agreement and the Reinsurance Pooling Agreement among the Company and its wholly-owned
insurance subsidiary, Merchants Insurance Company of New Hampshire, Inc. (MNH), and Merchants
Mutual Insurance Company (Mutual), effective January 1, 2003. The Services Agreement calls for
Mutual to provide underwriting, administrative, claims and investment services to the Company and
MNH. The Reinsurance Pooling Agreement provides for the pooling, or sharing, of insurance business
traditionally written by Mutual and MNH on or after the effective date. MNHs share of pooled
(combined Mutual and MNH) premiums earned and losses and loss adjustment expenses (LAE) for 2005 in
accordance with the Reinsurance Pooling Agreement is 30%. MNHs share of pooled premiums earned
and losses and LAE was 35% in 2004. The Reinsurance Pooling Agreement pertains to premiums earned
and incurred losses and LAE. Pursuant to the terms of the Reinsurance Pooling Agreement, MNHs
share of pooled premiums earned will be 25% in 2006 and 2007, though not to exceed $42,500,000 and
$37,500,000 in net premiums written, respectively.
Total combined Mutual and MNH or group-wide direct premiums written (DWP) for the six months
ended June 30, 2005 were $100,538,000, an increase of $3,172,000 from $97,366,000 in 2004. The
Companys pro-forma share of combined direct premiums written in 2005, in accordance with the
Reinsurance Pooling Agreement, was $30,161,000 compared to $34,077,000 in 2004. The table below
shows a comparison of direct premiums written by major category in 2005 and 2004:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Group-wide DWP |
|
|
|
|
|
MNH Pro-forma Share |
|
|
|
|
Six months ended |
|
|
|
|
|
Six months ended |
|
|
|
|
June 30, |
|
|
|
|
|
June 30, |
|
|
|
|
2005 |
|
2004 |
|
Change |
|
2005 |
|
2004 |
|
Change |
Major Category |
|
(000s omitted) |
|
|
|
|
|
|
|
|
|
(000s omitted) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(30 |
%)* |
|
|
(35 |
%)* |
|
|
|
|
Voluntary Personal Lines |
|
$ |
19,505 |
|
|
$ |
25,927 |
|
|
|
(25 |
%) |
|
$ |
5,852 |
|
|
$ |
9,074 |
|
|
|
(36 |
%) |
Voluntary Commercial Lines |
|
|
67,414 |
|
|
|
59,469 |
|
|
|
13 |
% |
|
|
20,224 |
|
|
|
20,814 |
|
|
|
(3 |
%) |
Umbrella Program |
|
|
12,011 |
|
|
|
10,138 |
|
|
|
18 |
% |
|
|
3,603 |
|
|
|
3,548 |
|
|
|
2 |
% |
Involuntary |
|
|
1,608 |
|
|
|
1,832 |
|
|
|
(12 |
%) |
|
|
482 |
|
|
|
641 |
|
|
|
(25 |
%) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Direct Written Premiums |
|
$ |
100,538 |
|
|
$ |
97,366 |
|
|
|
3 |
% |
|
$ |
30,161 |
|
|
$ |
34,077 |
|
|
|
(11 |
%) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
11
The 25% (or $6,422,000) decrease in group-wide voluntary personal lines direct premiums
written resulted from a 36% (or $6,453,000) decrease in private passenger automobile (PPA) direct
premiums written. The decrease in PPA direct premiums written is the result of the companies
decision, implemented in 2002, not to write new policies in certain jurisdictions. In addition,
the approval by the New Jersey Department of Banking and Insurance of the companies request to
withdraw from the New Jersey PPA market was effective in June 2003 and provided for the non-renewal
of New Jersey PPA policies beginning in June 2004 and completed in May 2005. As a result,
voluntary PPA policies in force at June 30, 2005 were 16,444, a decrease of 33%, from 24,640 at
June 30, 2004.
The monoline commercial umbrella program (the Umbrella Program) resulted in $12,011,000 of direct
premiums written in the first six months of 2005 compared to $10,138,000 in the first six months of
2004. The Umbrella Program is marketed exclusively through one independent agent and approximately
95% of the premiums and losses related to Umbrella Program Policies are reinsured with an A rated
national reinsurer through a quota share reinsurance treaty.
Group-wide voluntary commercial lines direct premiums written increased $7,945,000, or 13%, to
$67,414,000 for the six months ended June 30, 2005, from $59,469,000 for the six months ended June
30, 2004. This increase resulted from period to period increases in every group wide commercial
line of business. The average premium per group-wide, non-Umbrella Program commercial lines policy
increased 5% from the year earlier period. Total non-Umbrella commercial lines policies in force
at June 30, 2005 were 35,197, an increase of 10% from 31,907 at June 30, 2004.
Group-wide involuntary direct premiums written decreased $224,000 or 12%. Direct premiums written
related to the New York Automobile Insurance Plan (NYAIP) comprised approximately 68% of group-wide
involuntary direct premiums written in the six months ended June 30, 2005. The NYAIP provides
coverage for individuals who are unable to obtain auto insurance in the voluntary market.
Assignments from the NYAIP vary depending upon a companys PPA market share and the size of the
NYAIP. Direct premiums written related to policies assigned from the NYAIP increased 10% to
$1,089,000 for the six months ended June 30, 2005 from $994,000 for the six months ended June 30,
2004. This increase in involuntary direct premiums written related to the NYAIP was more than
offset by decreases in other, non-NYAIPdirect premiums written primarily related to New Jersey PPA.
The Company is unable to predict the volume of future assignments from the NYAIP.
Group-wide pooled net premiums written for 2005 were $83,809,000, an increase of $1,338,000, or 2%
from $82,471,000 for the six months ended June 30, 2004. This increase in group-wide net premiums
written is due to the increase in group wide direct premiums written. The Companys share of 2005
pooled net premiums written was $20,987,000, a decrease of $3,739,000, or 15%, from $24,726,000 in
2004. The decrease in the Companys share of net premiums written resulted primarily from the
Companys decreased percentage participation in the Reinsurance Pooling Agreement for 2005 as
compared to 2004.
Total revenues for the six months ended June 30, 2005 were $28,838,000, a decrease of $4,347,000 or
13% from $33,185,000 for the six months ended June 30, 2004.
12
The Companys share of pooled net premiums earned in accordance with the Reinsurance Pooling
Agreement for the six months ended June 30, 2005 was $24,744,000, compared to $28,433,000 for the
six months ended June 30, 2004. This $3,689,000, or 13%, decrease in net premiums earned resulted
primarily from the five percentage point decrease in the Companys participation in the Reinsurance
Pooling Agreement.
Net investment income was $3,844,000 for the six months ended June 30, 2005, a decrease of 4% from
$4,019,000 for the six months ended June 30, 2004, primarily due to a 6% decrease in average
invested assets resulting from declining net premiums written.
Net losses and LAE were $11,911,000 for the six months ended June 30, 2005, a decrease of
$7,330,000, or 38%, from $19,241,000 for the six months ended June 30, 2004. The decrease in net
losses and LAE was due to the 13% decrease in net premiums earned and a 19.6 percentage point
decrease in the loss and LAE ratio to 48.1% for the six months ended June 30, 2005 from 67.7% for
the six months ended
June 30, 2004. The decrease in the loss and LAE ratio is due to an improvement in the loss and LAE
ratio for the 2005 accident year (losses occurring in the first six months of 2005) compared to the
2004 accident year (losses occurring in the first six months of 2004) and favorable development of
losses related to prior accident years. The Company recorded a decrease to its estimate of losses
and LAE related to prior accident years of $2,567,000 in the first six months of 2005. This
decrease in losses and LAE for prior accident years reduced the loss and LAE ratio by 10.4
percentage points. There was no similar decrease in prior accident year reserves recorded in 2004.
The changes in the estimate of losses and LAE related to prior accident years recorded in 2005 for
the Companys major lines of business is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial |
|
Workers |
|
|
|
|
|
|
|
|
Accident |
|
Home- |
|
PPA |
|
Auto |
|
Compen- |
|
Commercial |
|
General |
|
All |
|
|
Year |
|
owners |
|
Liability |
|
Liability |
|
sation |
|
Package |
|
Liability |
|
Other |
|
Total |
Prior to |
|
|
|
|
|
|
|
|
|
Increases (decreases) (in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
2001 |
|
$ |
134 |
|
|
$ |
71 |
|
|
$ |
(560 |
) |
|
$ |
(1,499 |
) |
|
$ |
725 |
|
|
$ |
610 |
|
|
$ |
304 |
|
|
$ |
(215 |
) |
2002 |
|
|
109 |
|
|
|
(13 |
) |
|
|
(116 |
) |
|
|
(155 |
) |
|
|
727 |
|
|
|
(93 |
) |
|
|
7 |
|
|
|
466 |
|
2003 |
|
|
123 |
|
|
|
(344 |
) |
|
|
(99 |
) |
|
|
50 |
|
|
|
(183 |
) |
|
|
38 |
|
|
|
(98 |
) |
|
|
(513 |
) |
2004 |
|
|
(303 |
) |
|
|
(1,052 |
) |
|
|
(645 |
) |
|
|
95 |
|
|
|
(195 |
) |
|
|
247 |
|
|
|
(452 |
) |
|
|
(2,305 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
63 |
|
|
$ |
(1,338 |
) |
|
$ |
(1,420 |
) |
|
$ |
(1,509 |
) |
|
$ |
1,074 |
|
|
$ |
802 |
|
|
$ |
(239 |
) |
|
$ |
(2,567 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The Companys reduction in its estimate of losses and LAE related to prior accident years
represented 2% of the recorded reserve for losses and LAE at December 31, 2004. During 2005, both
paid and incurred losses and LAE emerged at amounts that were less than anticipated when reserves
for loss and LAE were estimated and recorded at December 31, 2004 for the workers compensation and
auto liability lines of business. This favorable emergence was offset by greater than anticipated
loss and LAE emergence in the Companys commercial liability lines of business.
The Company made no changes to the key assumptions used in evaluating the adequacy of its reserves
for losses and LAE during the first six months of 2005. A reasonable possibility exists in any
year that relatively minor fluctuations in the estimate of reserves for losses and LAE may have a
significant impact on the Companys net income. This is due primarily to the size of the Companys
reserves for losses and LAE ($120,431,000 at June 30, 2005) relative to its net income.
13
The ratio of amortization of deferred policy acquisition costs and other underwriting expenses to
net premiums earned increased to 43.6% for the six months ended June 30, 2005 from 38.2% for the
six months ended June 30, 2004. Amortization of deferred acquisition costs decreased $964,000 or
13% compared to the year earlier period. Other underwriting expenses as a percentage of net
premiums earned increased by 5.4 percentage points due to an increase in retrospective commissions
related to the Reinsurance Pooling Agreement, which provides for retrospective commission income or
expense based on actual cumulative experience of the pooled business compared to a target loss and
LAE ratio of 74%. The commission is owed to Mutual based on a decrease during the first six months
of 2005 in the estimated cumulative loss and LAE ratio on the pooled business since the inception
of the Reinsurance Pooling Agreement which includes favorable experience for the first six months
of the 2005 accident year. Retrospective commission expense totaled $1,863,000 (7.5 percentage
points of the expense ratio) for the six months ended June 30, 2005 compared to $749,000 (2.6
percentage points of the expense ratio) for the six months ended June 30, 2004. The Company is
reducing its reliance on the traditional business by reducing its percentage participation in the
Reinsurance Pooling Agreement and by seeking alternative opportunities in which to invest its
capital. To the extent that the Company does not invest in such alternative opportunities, fixed
expenses will become a greater percentage of net premiums earned in future periods. Commissions
(other than retrospective commissions under the Reinsurance Pooling Agreement), premium taxes and
other state assessments that vary directly with the Companys premium volume represented 19.7% of
net premiums earned in the six month period ended June 30, 2005 compared to 19.2% of net premiums
earned in the six months ended June 30, 2004.
The Companys effective income tax rate for the six months ended June 30, 2005 and 2004 was 28.8%
and 24.2%, respectively. These rates were calculated based upon the Companys estimate of its
effective income tax rate for all of 2005 and 2004 as applicable. In 2005, the effective income
tax rate differed from the federal statutory rate of 34% due to non-taxable income, primarily
tax-exempt income from fixed maturity investments. In 2004, the effective income tax rate differed
from the federal statutory rate of 34% due to non-taxable income, primarily tax-exempt income and
to an adjustment to prior years taxes and the reversal of certain excess tax reserves related to
uncertain tax positions.
14
Results of Operations for the Three Months Ended June 30, 2005 As Compared to the Three Months
Ended June 30, 2004
Total combined Mutual and MNH direct premiums written (DWP) for the three months ended June 30,
2005 were $55,251,000, an increase of $2,986,000 from $52,265,000 in 2004. The Companys pro-forma
share of combined direct premiums written in 2005, in accordance with the Reinsurance Pooling
Agreement, was $16,575,000 compared to $18,293,000 in 2004. The table below shows a comparison of
direct premiums written by major category in 2005 and 2004:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Group-wide DWP |
|
|
|
|
|
MNH Pro-forma Share |
|
|
|
|
Three months ended |
|
|
|
|
|
Three months ended |
|
|
|
|
March 31, |
|
|
|
|
|
March 31, |
|
|
|
|
2005 |
|
2004 |
|
Change |
|
2005 |
|
2004 |
|
Change |
Major Category |
|
(000s omitted) |
|
|
|
|
|
(000s omitted) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(30 |
%)* |
|
|
(35 |
%)* |
|
|
|
|
Voluntary Personal Lines |
|
$ |
10,294 |
|
|
$ |
13,371 |
|
|
|
(23 |
%) |
|
$ |
3,088 |
|
|
$ |
4,680 |
|
|
|
(34 |
%) |
Voluntary Commercial Lines |
|
|
37,247 |
|
|
|
32,608 |
|
|
|
14 |
% |
|
|
11,174 |
|
|
|
11,413 |
|
|
|
(2 |
%) |
Umbrella Program |
|
|
6,795 |
|
|
|
5,339 |
|
|
|
27 |
% |
|
|
2,039 |
|
|
|
1,869 |
|
|
|
9 |
% |
Involuntary |
|
|
915 |
|
|
|
947 |
|
|
|
(3 |
%) |
|
|
274 |
|
|
|
331 |
|
|
|
(17 |
%) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Direct Written Premiums |
|
$ |
55,251 |
|
|
$ |
52,265 |
|
|
|
6 |
% |
|
$ |
16,575 |
|
|
$ |
18,293 |
|
|
|
(9 |
%) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The 23% (or $3,077,000) decrease in group-wide voluntary personal lines direct premiums
written resulted from a 34% (or $3,097,000) decrease in private passenger automobile (PPA) direct
premiums written. The decrease in PPA direct premiums written is the result of the companies
decision, implemented in 2002, not to write new policies in certain jurisdictions. In addition,
the approval by the New Jersey Department of Banking and Insurance of the companies request to
withdraw from the New Jersey PPA market was effective in June 2003 and provided for non-renewal of
New Jersey PPA policies beginning in June 2004 and completed in May 2005.
Group-wide voluntary commercial lines direct premiums written increased $4,639,000, or 14%, to
$37,247,000 for the three months ended June 30, 2005, from $32,608,000 for the three months ended
June 30, 2004. This increase resulted from period to period increases in every group-wide
commercial line of business.
Group-wide pooled net premiums written for the three months added June 30, 2005 were $46,940,000,
an increase of $2,379,000, or 5% from $44,561,000 for the three months ended June 30, 2004. This
increase in group-wide net premiums written is due to the increase in group wide direct premiums
written. The Companys share of 2005 pooled net premiums written was $14,082,000, a decrease of
$1,514,000, or 10%, from $15,596,000 in 2004. The decrease in the Companys share of net premiums
written resulted primarily from the Companys decreased percentage participation in the Reinsurance
Pooling Agreement for 2005 as compared to 2004.
Total revenues for the three months ended June 30, 2005 were $14,789,000, a decrease of $1,730,000
or 10% from $16,519,000 for the three months ended June 30, 2004.
15
The Companys share of pooled net premiums earned in accordance with the Reinsurance Pooling
Agreement for the three months ended June 30, 2005 was $12,767,000, compared to $14,364,000 for the
three months ended June 30, 2004. This $1,597,000, or 11%, decrease in net premiums earned
resulted primarily from the five percentage point decrease in the Companys participation in the
Reinsurance Pooling Agreement.
Net investment income was $1,908,000 for the three months ended June 30, 2005, a decrease of 3%
from $1,965,000 for the three months ended June 30, 2004, primarily due to a 6% decrease in average
invested assets resulting from declining net premiums written.
Net losses and LAE were $4,617,000 for the three months ended June 30, 2005, a decrease of
$4,535,000, or 50%, from $9,152,000 for the three months ended June 30, 2004. The decrease in net
losses and LAE was due to the 11% decrease in net premiums earned and a 27.5 percentage point
decrease in the loss and LAE ratio to 36.2% for the three months ended June 30, 2005 from 63.7% for
the three months ended
June 30, 2004. The decrease in the loss and LAE ratio related to an improvement in the loss and
LAE ratio for the 2005 accident year compared to the 2004 accident year and to favorable
development of losses related to prior accident years. The favorable development for prior
accident years resulted in a decrease in the loss and LAE ratio of 18.4 percentage points in the
quarter. Because of the relative size of reserves for losses and LAE compared to net earned
premiums, a relatively small change in reserves may have a significant impact on the loss and LAE
ratio.
The ratio of amortization of deferred policy acquisition costs and other underwriting expenses to
net premiums earned increased to 44.2% for the three months ended June 30, 2005 from 37.7% for the
three months ended June 30, 2004. Amortization of deferred acquisition costs decreased $420,000 or
11% compared to the year earlier period. Other underwriting expenses as a percentage of net
premiums earned increased by 6.6 percentage points due to an increase in retrospective commissions
related to the Reinsurance Pooling Agreement. The commission is owed to Mutual based on a decrease
during the second quarter of 2005 in the estimated cumulative loss and LAE ratio on the pooled
business since the inception of the Reinsurance Pooling Agreement. Retrospective commission
expense totaled $1,007,000 (7.9 percentage points of the expense ratio) for the three months ended
June 30, 2005 compared to $405,000 (2.8 percentage points of the expense ratio) for the three
months ended June 30, 2004. Commissions (other than retrospective commissions under the
Reinsurance Pooling Agreement), premium taxes and other state assessments that vary directly with
the Companys premium volume represented 19.1% of net premiums earned in the three month period
ended June 30, 2005 compared to 19.6% of net premiums earned in the three months ended June 30,
2004.
The Companys effective income tax rate for the three months ended June 30, 2005 and 2004 was 29.9%
and 20.8%, respectively. These rates were calculated based upon the Companys estimate of its
effective income tax rate for all of 2005. In 2005, the effective income tax rate differed from
the federal statutory rate of 34% due to non-taxable income, primarily tax-exempt income from fixed
maturity investments. In 2004, the effective income tax rate differed from the federal statutory
rate of 34% due to non-taxable income, primarily tax-exempt income and to an adjustment to prior
years taxes and the reversal of certain excess tax reserves related to uncertain tax positions.
16
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. Due to declining written premiums however, the Companys operating
activities have resulted in a use of cash each year since 2001. The Companys decreasing
participation percentage in the pooled business over the remaining years of the Reinsurance Pooling
Agreement will likely result in continued negative cash flows from operations. Net cash used in
operations during the six months ended June 30, 2005 was $1,589,000. The Company believes that
careful management of the relationship between assets and liabilities will minimize the likelihood
that investment portfolio sales will be necessary to fund insurance operations, and that the effect
of any such sales, if any, on the Companys stockholders equity will not be material.
The Companys objectives with respect to its investment portfolio include maximizing total return
within investment guidelines while protecting policyholders surplus and maintaining flexibility.
The Company relies on premiums as a major source of cash, and therefore liquidity. Cash flows from
the Companys investment portfolio, in the form of interest or principal payments as well as from
the maturity of fixed income investments, are an additional source of liquidity.
The Company designates newly acquired fixed maturity investments as available for sale and carries
these investments at fair value. Unrealized gains and losses related to these investments are
recorded as accumulated other comprehensive income (loss) within stockholders equity. At June 30,
2005, the
Company recorded $731,000 of unrealized losses, net of taxes, associated with its investments as
accumulated other comprehensive loss in its Consolidated Balance Sheet.
At June 30, 2005, the Companys portfolio of fixed maturity investments represented 92.1% of
invested assets. Management believes that this level of fixed maturity investments is consistent
with the Companys liquidity needs because it anticipates that cash receipts from net premiums
written, investment income and maturing securities will enable the Company to satisfy its cash
obligations. Furthermore, a portion of the Companys fixed maturity investments are invested in
mortgage-backed and other asset-backed securities which, in addition to interest income, provide
monthly paydowns of bond principal.
At June 30, 2005, $106,818,000, or 59.7%, of the Companys 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
Companys CMO investments have a secondary market and their effect on the Companys liquidity does
not differ from that of other fixed maturity investments.
At June 30, 2005 $4,144,000, or 2%, of the Companys investment portfolio was invested in
non-investment grade securities compared to $2,150,000, or 1%, at December 31, 2004.
17
The Company has arranged for a $2,000,000 unsecured credit facility from a bank. Any borrowings
under this facility are payable on demand and carry an interest rate which can be fixed or variable
and is negotiated at the time of each advance. This facility is available for general working
capital purposes and for repurchases of the Companys common stock. At June 30, 2005 no amount was
outstanding on this loan.
As a holding company, the Company is dependent on cash dividends from MNH to meet its obligations
and to pay any cash dividends. MNH is subject to New Hampshire insurance laws which place certain
restrictions on its ability to pay dividends without the prior approval of state regulatory
authorities. These restrictions limit dividends to those that, when added to all other dividends
paid within the preceding twelve months, would not exceed 10% of the insurers 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 2005 without the prior approval of the New
Hampshire Insurance Commissioner is $6,171,000. MNH paid $1,200,000 and $800,000 of dividends to
the Company in August 2004 and February 2005, respectively. On July 28, 2005 MNH declared a
dividend payable to the Company for $1,200,000 on August 19, 2005. The Company paid cash dividends
to its common stockholders of $.10 per share in the first six months of 2005 amounting to $424,000.
On July 28, 2005 the Company declared a quarterly cash dividend of $.10 per share payable on
September 2, 2005 to shareholders of record as of the close of business on August 18, 2005.
Under the Services Agreement, Mutual has provided services and facilities for MNH to conduct its
insurance business. The balance in the payable to or receivable from affiliate account represents
the amount owing to or owed by Mutual by or to the Company for the difference between premiums
collected and payments made for losses, commissions (including retrospective commissions),
employees, services and facilities by Mutual on behalf of MNH.
Regulatory guidelines suggest that the ratio of a property-casualty insurers 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 2005, MNHs ratio of net premiums written to statutory surplus, annualized for a full
year, was .6 to 1.
18
Relationship with Mutual
The Companys and MNHs 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 Companys 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 12.1% of the Companys common stock. Under the Services Agreement, Mutual provides
the Company and MNH with all facilities and personnel to operate their business. All of the
officers of the Company or MNH are employees of Mutual whose services are provided to, and paid for
by, the Company and MNH through the Services Agreement. Also, the operation of MNHs 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. By reducing
its percentage under the Reinsurance Pooling Agreement, the Company is making capital available for
other opportunities in an effort to increase return on shareholders equity and maximize
shareholder value. The Company announced on February 2, 2005 that it retained Philo Smith Capital
Corporation to explore strategic alternatives for its long-term development, and that initiative
continues. In accordance with the Services Agreement, in June of 2005 the Company and MNH notified
Mutual that they will terminate the Cash Management Services Annex to the Services Agreement as of
June 30, 2006. The Company and MNH intend to solicit bids, including possibly from Mutual, for the
management of their investment portfolios after the effective date of the termination.
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.
Forward-looking statements include, without limitation, statements relating to the Companys plans,
strategies, objectives, expectations and intentions. Words such as believes, forecasts,
intends, possible, expects, anticipates, estimates, or plans and similar expressions
are intended to identify forward looking statements. Such forward-looking statements involve
certain assumptions, risks and uncertainties that include, but are not limited to, those associated
with factors affecting the property-casualty insurance industry generally, including price
competition, the Companys dependence on state insurance departments for approval of rate
increases; size and frequency of claims, escalating damage awards, natural disasters, fluctuations
in interest rates and general business conditions; the Companys dependence on investment income;
the geographic concentration of the Companys 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 Companys loss reserves; the Companys dependence on the general reinsurance
market; government regulation of the insurance industry; exposure to environmental claims;
dependence of the Company on its relationship with Mutual; and the other risks and uncertainties
discussed or indicated in all documents filed by the Company with the Securities and Exchange
Commission.
19
There may be other risks and uncertainties that we have not identified that may affect whether
our forward-looking statements will prove accurate. New factors may emerge from time to time that
cause our business not to develop as we predict, and it is not possible for us to predict all of
them. You should not place undue reliance on forward-looking statements. Further, any
forward-looking statement speaks only as of the date on which it is made and, except as required by
law, the Company undertakes no obligation to update any forward-looking statement to reflect events
or other circumstances after the date on which it is made or to reflect the occurrence of
anticipated or unanticipated events or circumstances.
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 Companys financial instruments primarily relates to
its investment portfolio. The value of the Companys investment portfolio of $194,278,000 at June
30, 2005 is subject to changes in interest rates and to a lesser extent on credit quality.
Further, certain mortgage-backed and asset-backed securities are exposed to accelerated prepayment
risk generally caused by interest rate movements. If interest rates were to decline, mortgage
holders would be more likely to refinance existing mortgages at lower rates. Acceleration of
future repayments could adversely affect future investment income, if reinvestment of the
accelerated receipts was made in lower yielding securities.
The following table provides information related to the Companys fixed maturity investments at
June 30, 2005. The table presents cash flows of principal amounts and related weighted average
interest rates by expected maturity dates. The cash flows are based upon the maturity date or, in
the case of mortgage-backed and asset-backed securities, expected payment patterns. Actual cash
flows could differ from those shown in the table.
20
Fixed Maturities
Expected Cash Flows of Principal Amounts ($in 000s):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
TOTAL |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Esti- |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amor- |
|
mated |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
There- |
|
tized |
|
Market |
|
|
2005 |
|
2006 |
|
2007 |
|
2008 |
|
2009 |
|
after |
|
Cost |
|
Value |
Available for Sale |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasury securities and
obligations of U.S.
Government corporations
and agencies |
|
$ |
2,010 |
|
|
$ |
0 |
|
|
$ |
0 |
|
|
$ |
3,005 |
|
|
$ |
0 |
|
|
$ |
0 |
|
|
$ |
5,015 |
|
|
$ |
4,976 |
|
Average interest rate |
|
|
4.4 |
% |
|
|
0.0 |
% |
|
|
0.0 |
% |
|
|
3.2 |
% |
|
|
0.0 |
% |
|
|
0.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Obligations of states and
political subdivisions |
|
|
3,784 |
|
|
|
9,466 |
|
|
|
3,867 |
|
|
|
15,467 |
|
|
|
8,231 |
|
|
|
4,150 |
|
|
|
44,965 |
|
|
|
44,645 |
|
Average interest rate |
|
|
3.4 |
% |
|
|
3.4 |
% |
|
|
4.3 |
% |
|
|
3.9 |
% |
|
|
4.5 |
% |
|
|
4.9 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate securities |
|
|
7,024 |
|
|
|
998 |
|
|
|
0 |
|
|
|
3,241 |
|
|
|
7,078 |
|
|
|
4,330 |
|
|
|
22,671 |
|
|
|
22,499 |
|
Average interest rate |
|
|
4.0 |
% |
|
|
3.2 |
% |
|
|
0.0 |
% |
|
|
3.7 |
% |
|
|
4.9 |
% |
|
|
7.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mortgage & asset
backed securities |
|
|
13,409 |
|
|
|
24,834 |
|
|
|
19,889 |
|
|
|
13,499 |
|
|
|
6,338 |
|
|
|
28,819 |
|
|
|
106,788 |
|
|
|
106,818 |
|
Average interest rate |
|
|
4.8 |
% |
|
|
4.8 |
% |
|
|
4.8 |
% |
|
|
4.9 |
% |
|
|
5.0 |
% |
|
|
5.1 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
26,227 |
|
|
$ |
35,298 |
|
|
$ |
23,756 |
|
|
$ |
35,212 |
|
|
$ |
21,647 |
|
|
$ |
37,299 |
|
|
$ |
179,439 |
|
|
$ |
178,938 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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.
Item 4. Controls and Procedures
The Companys chief executive officer and chief financial officer, after evaluating the
effectiveness of the Companys disclosure controls and procedures (as defined in Rules 13a-15(e)
and 15d-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by
this report, concluded that the Companys disclosure controls and procedures were designed to
ensure that information required to be disclosed by the Company in reports that it files or
submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported
within the time periods specified in the SECs rules and forms.
There was no change in the Companys internal control over financial reporting identified in
connection with the evaluation required by paragraph (d) of Rules 13a-15 or 15d-15 under the
Securities Exchange Act of 1934 that occurred during the Companys last fiscal quarter that has
materially affected, or is reasonably likely to materially affect, the Companys internal control
over financial reporting.
21
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
None.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
None.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Submission of Matters to a Vote of Security Holders
On May 4, 2005 the Company held its annual meeting of stockholders. During the meeting
Andrew A. Alberti and Frank J. Colantuono were re-elected Directors of the Company for three
year terms to expire at the annual meeting in 2008. Brent D. Baird, 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. Semmelhacks and Mr. Zaks terms expire in 2006
and Mr. Bairds and Mr. Kahns terms expire in 2007.
A summary of stockholder voting with respect to the election of Directors is as follows:
|
|
|
|
|
|
|
|
|
|
|
Election of |
|
Election of |
|
|
Andrew A. Alberti |
|
Frank J. Colantuono |
For
|
|
|
1,882,841 |
|
|
|
1,883,478 |
|
Withheld
|
|
|
21,039 |
|
|
|
20,402 |
|
Item 5. Other Information.
None.
Item 6. Exhibits
|
(a) |
|
Exhibits. |
|
|
|
|
Exhibits required by Item 601 of Regulation S-K. |
|
|
3(a) |
|
Restated Certificate of Incorporation (incorporated by reference to Exhibit No.
3C to Amendment No. 1 to the Companys Registration Statement No. 33-9188 on Form S-1
Filed on November 7, 1986. |
|
|
(b) |
|
Restated By-laws (incorporated by reference to Exhibit 3D to Amendment No. 1 to
the Companys Registration Statement No. 33-9188 on Form S-1 filed on November 7, 1986. |
|
|
4 |
|
Instruments defining the rights of security holders,
including indentures N/A. |
|
|
5 |
|
Opinion re legality N/A. |
22
|
10(a) |
|
Management Agreement dated as of September 29, 1986 by and among Merchants
Mutual Insurance Company, Registrant and Merchants Insurance Company of New Hampshire,
Inc. (incorporated by reference to Exhibit No. 10(a) to the Companys Registration
Statement
(No. 33-9188) on Form S-1 filed on September 30, 1986). |
|
|
(b) |
|
Services Agreement Among Merchants Mutual Insurance Company, Merchants Insurance
Company of New Hampshire, Inc. and Merchants Group, Inc. dated January 1, 2003
(incorporated by reference to Exhibit No. 10(b) to the Companys 2003 Quarterly Report
on Form 10-Q filed on May 14, 2003). |
|
|
(c) |
|
Reinsurance Pooling Agreement between Merchants Insurance Company of New
Hampshire, Inc. and Merchants Mutual Insurance Company effective January 1, 2003
(incorporated by reference to Exhibit No. 10(c) to the Companys 2003 Quarterly Report
on Form 10-Q filed on May 14, 2003). |
|
|
(d) |
|
Endorsement to the Casualty Excess of Loss Reinsurance Agreement between
Merchants Mutual Insurance Company, Merchants Insurance Company of New Hampshire, Inc.
and American Reinsurance Company dated February 23, 2004 (incorporated by reference to
Exhibit 10(d) to the Companys 2004 Annual Report on Form 10-K filed on March 31, 2005). |
|
|
(e) |
|
Property Per Risk Excess of Loss Reinsurance Agreement between Merchants
Mutual Insurance Company, Merchants Insurance Company of New Hampshire, Inc. and
American Reinsurance Company dated April 16, 2004 (incorporated by reference to Exhibit
10(f) to the Companys 2004 Quarterly Report on Form 10-Q filed on November 10, 2004). |
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(f) |
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Property Catastrophe Excess of Loss Reinsurance Agreement between Merchants
Mutual Insurance Company, Merchants Insurance Company of New Hampshire, Inc. and the
various reinsurers as identified by the Interest and Liabilities Agreements attaching
to and forming part of this Agreement (incorporated by reference to Exhibit 10(g) to
the Companys quarterly report on Form 10-Q filed on November 10, 2004). |
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(g) |
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Quota Share Reinsurance Treaty Agreement between Merchants Insurance Company of
New Hampshire, Inc. and The Subscribing Underwriting Members of Lloyds, London
specifically identified on the schedules attached to this agreement dated January 1,
2000 (incorporated by reference to Exhibit 10(h) to the Companys 2000 Annual Report on
Form 10-K filed on March 28, 2001). |
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(h) |
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Merchants Mutual Capital Accumulation Plan (incorporated by reference to
Exhibit No. 10(g) to the Companys Registration Statement (No. 33-9188) on Form S-1
filed on September 30, 1986). |
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(i) |
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Merchants Mutual Capital Accumulation Plan, fifth amendment, effective January
1, 1999 (incorporated by reference to Exhibit 10(j) to the Companys 2000 Annual Report
on Form
10-K filed on March 28, 2001). |
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*(j) |
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Form of Amended Indemnification Agreement entered into by Registrant with each
director and executive officer of Registrant (incorporated by reference to Exhibit No.
10(n) to Amendment No. 1 to the Companys Registration Statement on (No. 33-9188) Form
S-1 filed on November 7, 1986). |
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*(k) |
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Merchants Mutual Insurance Company Adjusted Return on Equity Incentive
Compensation Plan January 1, 2000 (incorporated by reference to Exhibit 10(p) to the
Companys 2000 Annual Report on Form 10-K filed on March 28, 2001). |
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*(l) |
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Merchants Mutual Insurance Company Adjusted Return on Equity Long Term Incentive
Compensation Plan January 1, 2000 (incorporated by reference to Exhibit 10(q) to the
Companys 2000 Annual Report on Form 10-K filed on March 28, 2001). |
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*(m) |
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Amendment No. 1 to Employee Retention Agreement between Robert M. Zak and
Merchants Mutual Insurance Company originally dated as of May 1, 1999, dated February 6,
2002 (incorporated by reference to Exhibit 10(s) to the Companys 2002 Annual Report on
Form 10-K filed on March 31, 2003). |
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*(n) |
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Amendment No. 1 to Employee Retention Agreement between Edward M. Murphy and
Merchants Mutual Insurance Company originally dated as of March 1, 1999, dated February
6, 2002 (incorporated by reference to Exhibit 10(t) to the Companys 2002 Annual Report
on Form 10-K filed on March 31, 2003). |
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*(o) |
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Amendment No. 1 to Employee Retention Agreement between Kenneth J. Wilson and
Merchants Mutual Insurance Company originally dated as of March 1, 1999, dated February
6, 2002 incorporated by reference to Exhibit 10(u) to the Companys 2002 Annual Report
on Form 10-K filed on March 31, 2003. |
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11 |
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Statement re computation of per share earnings N/A. |
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12 |
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Statement re computation of ratios N/A. |
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15 |
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Letter re unaudited interim financial information N/A. |
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18 |
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Letter re change in accounting principles N/A. |
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19 |
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Report furnished to security holder N/A. |
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22 |
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Published report regarding matters submitted to vote of security holders N/A. |
24
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23 |
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Consents of experts and counsel N/A. |
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24 |
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Power of attorney N/A. |
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31 |
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Rule 13a-14(a)/15d-14(a) Certifications (filed herewith)32(a) Certification
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Subsections (a) and (b) of
Section 1350, Chapter 63 of Title 18, United States Code) (filed herewith). |
* Indicates a management contract or compensation plan or arrangement.
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.
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MERCHANTS GROUP, INC. |
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(Registrant) |
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Date: August 12, 2005
|
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By: /s/ Kenneth J. Wilson |
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Kenneth J. Wilson |
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Chief Financial Officer and
Treasurer (duly authorized
officer of the registrant and
chief accounting officer) |
25