Back to GetFilings.com
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended JUNE 30, 2002.
-----------------
OR
[ ] 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 0-14697
-----------
HARLEYSVILLE GROUP INC.
--------------------------------------------------------------
(Exact name of registrant as specified in its charter)
DELAWARE 51-0241172
------------------ ---------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
355 MAPLE AVENUE, HARLEYSVILLE, PENNSYLVANIA 19438-2297
--------------------------------------------------------------
(Address of principal executive offices, including zip code)
(215) 256-5000
--------------------------------------------------------
(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 (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days.
Yes X. No.
---
At August 1, 2002, 29,844,809 shares of common stock of Harleysville Group
Inc. were outstanding.
Page 1
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
INDEX
Page Number
------------
Part I - Financial Information
Consolidated Balance Sheets - June 30, 2002
and December 31, 2001 3
Consolidated Statements of Income - For the three
months ended June 30, 2002 and 2001 4
Consolidated Statements of Income - For the six
months ended June 30, 2002 and 2001 5
Consolidated Statement of Shareholders' Equity -
For the six months ended June 30, 2002 6
Consolidated Statements of Cash Flows - For the
six months ended June 30, 2002 and 2001 7
Notes to Consolidated Financial Statements 8
Management's Discussion and Analysis of Results
of Operations and Financial Condition 13
Quantitative and Qualitative Disclosure About
Market Risk 18
Part II - Other Information 19
Page 2
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
JUNE 30, DECEMBER 31,
2002 2001
---------- -------------
(unaudited)
ASSETS
------
Investments:
Fixed maturities:
Held to maturity, at amortized cost
(fair value $435,826 and $459,588) $ 410,865 $ 439,499
Available for sale, at fair value
(amortized cost $859,447 and
$956,047) 897,542 984,264
Equity securities, at fair value
(cost $96,002 and $110,803) 119,858 150,686
Short-term investments, at cost,
which approximates fair value 41,787 36,695
Fixed maturity securities on loan
Held to maturity, at amortized
cost (fair value $6,019) 5,522
Available for sale, at fair value
(amortized cost $149,620) 157,551
---------- ----------
Total investments 1,633,125 1,611,144
Cash 2,403 1,839
Receivables:
Premiums 142,132 122,508
Reinsurance 79,008 81,640
Accrued investment income 21,371 21,862
---------- ----------
Total receivables 242,511 226,010
Deferred policy acquisition costs 92,677 86,076
Prepaid reinsurance premiums 20,623 20,096
Property and equipment, net 28,702 28,873
Deferred income taxes 36,868 29,435
Securities lending collateral 169,320
Other assets 39,142 41,817
---------- ----------
Total assets $2,265,371 $2,045,290
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Liabilities:
Unpaid losses and loss settlement expenses $ 893,251 $ 879,056
Unearned premiums 406,134 373,737
Accounts payable and accrued expenses 94,297 96,440
Securities lending obligation 169,320
Debt 95,620 96,055
Due to affiliate 4,301 9,704
---------- ----------
Total liabilities 1,662,923 1,454,992
---------- ----------
Shareholders' equity:
Preferred stock, $1 par value, authorized
1,000,000 shares; none issued
Common stock, $1 par value, authorized
80,000,000 shares; issued 30,760,552
and 30,444,678 shares; outstanding
29,760,552 and 29,444,678 shares 30,761 30,445
Additional paid-in capital 145,999 140,065
Accumulated other comprehensive income 45,423 44,265
Retained earnings 395,830 391,088
Treasury stock, at cost, 1,000,000 shares (15,565) (15,565)
---------- ----------
Total shareholders' equity 602,448 590,298
---------- ----------
Total liabilities and shareholders' equity $2,265,371 $2,045,290
========== ==========
See accompanying notes to consolidated financial statements.
Page 3
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
FOR THE THREE MONTHS ENDED JUNE 30, 2002 AND 2001
(dollars in thousands, except per share data)
2002 2001
-------- --------
Revenues:
Premiums earned $187,708 $179,372
Investment income, net of
investment expenses 21,526 21,143
Realized investment losses, net (20,983) (1,025)
Other income 3,898 3,952
-------- --------
Total revenues 192,149 203,442
-------- --------
Losses and expenses:
Losses and loss settlement expenses 127,809 127,152
Amortization of deferred policy
acquisition costs 45,573 44,482
Other underwriting expenses 19,495 15,629
Interest expense 1,434 1,565
Other expenses 1,042 1,481
------- --------
Total expenses 195,353 190,309
-------- --------
Income (loss) before income taxes (3,204) 13,133
Income taxes (benefit) (3,500) 2,155
-------- --------
Net income $ 296 $ 10,978
======== ========
Per common share:
Basic earnings $ .01 $ .38
======== ========
Diluted earnings $ .01 $ .37
======== ========
Cash dividend $ .15 $ .14
======== ========
See accompanying notes to consolidated financial statements.
Page 4
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
FOR THE SIX MONTHS ENDED JUNE 30, 2002 AND 2001
(dollars in thousands, except per share data)
2002 2001
-------- --------
Revenues:
Premiums earned $370,213 $356,646
Investment income, net of
investment expenses 43,008 42,468
Realized investment losses, net (20,505) (3,378)
Other income 7,643 8,026
-------- --------
Total revenues 400,359 403,762
-------- --------
Losses and expenses:
Losses and loss settlement expenses 255,081 253,661
Amortization of deferred policy
acquisition costs 90,195 89,657
Other underwriting expenses 36,417 30,352
Interest expense 2,855 3,186
Other expenses 2,092 2,976
-------- --------
Total expenses 386,640 379,832
-------- --------
Income before income taxes 13,719 23,930
Income taxes 83 3,234
-------- --------
Net income $ 13,636 $ 20,696
======== ========
Per common share:
Basic earnings $ .46 $ .71
======== ========
Diluted earnings $ .45 $ .70
======== ========
Cash dividend $ .30 $ .28
======== ========
See accompanying notes to consolidated financial statements.
Page 5
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(UNAUDITED)
FOR THE SIX MONTHS ENDED JUNE 30, 2002
(dollars in thousands)
ACCUMULATED
COMMON STOCK ADDITIONAL OTHER
------------ PAID-IN COMPREHENSIVE RETAINED TREASURY
SHARES AMOUNT CAPITAL INCOME EARNINGS STOCK TOTAL
---------- ----- ---------- ------------- -------- -------- --------
Balance,
December 31,
2001 30,444,678 $30,445 $140,065 $44,265 $391,088 $(15,565) $590,298
--------
Net income 13,636 13,636
Other compre-
hensive income,
net of tax:
Unrealized
investment
gains, net of
reclassification
adjustment 1,158 1,158
--------
Comprehensive
income 14,794
--------
Issuance of
common stock 315,874 316 5,934 6,250
Cash dividend
paid (8,894) (8,894)
---------- ------- -------- -------- -------- -------- --------
Balance at
June 30,
2002 30,760,552 $30,761 $145,999 $45,423 $395,830 $(15,565) $602,448
========== ======= ======== ======= ======== ======== ========
See accompanying notes to consolidated financial statements.
Page 6
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
FOR THE SIX MONTHS ENDED JUNE 30, 2002 AND 2001
(in thousands)
2002 2001
--------- ----------
Cash flows from operating activities:
Net income $ 13,636 $ 20,696
Adjustments to reconcile net income
to net cash provided by operating
activities:
Change in receivables, unearned
premiums, prepaid reinsurance
and due to affiliate 9,966 (9,755)
Increase (decrease) in unpaid losses
and loss settlement expenses 14,195 (5,821)
Deferred income taxes (8,057) (3,241)
Increase in deferred policy
acquisition costs (6,601) (3,034)
Amortization and depreciation 1,372 1,201
Realized investment losses 20,505 3,378
Other, net 1,833 (4,959)
--------- ---------
Net cash provided (used) by
operating activities 46,849 (1,535)
--------- ---------
Cash flows from investing activities:
Fixed maturity investments:
Purchases (106,013) (177,225)
Sales or maturities 76,347 184,441
Equity securities:
Purchases (12,745) (5,967)
Sales 7,212 7,429
Net purchases of short-term investments (5,092) (1,678)
Purchase of property and equipment (1,728) (1,331)
--------- ---------
Net cash provided (used) by
investing activities (42,019) 5,669
--------- ---------
Cash flows from financing activities:
Issuance of common stock 5,063 4,171
Repayment of debt obligations (435) (395)
Dividend paid (8,894) (8,177)
--------- ---------
Net cash used by
financing activities (4,266) (4,401)
--------- ---------
Increase (decrease) in cash 564 (267)
Cash at beginning of period 1,839 2,002
--------- ---------
Cash at end of period $ 2,403 $ 1,735
========= =========
See accompanying notes to consolidated financial statements.
Page 7
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
(UNAUDITED)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1 - Basis of Presentation
The financial information for the interim periods included herein is
unaudited; however, such information reflects all adjustments (consisting of
only normal recurring adjustments) which are, in the opinion of management,
necessary to a fair presentation of the financial position, results of
operations, and cash flows for the interim periods. The results of operations
for interim periods are not necessarily indicative of results to be expected for
the full year.
These financial statements should be read in conjunction with the financial
statements and notes for the year ended December 31, 2001 included in the
Company's 2001 Annual Report filed with the Securities and Exchange Commission
on Form 10-K.
2 - Earnings Per Share
The computation of basic and diluted earnings per share is as follows:
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
2002 2001 2002 2001
------- ------- ------- -------
(in thousands,
except per share data)
Numerator for basic
and diluted earnings
earnings per share:
Net income $ 296 $10,978 $13,636 $20,696
======= ======= ======= =======
Denominator for basic
earnings per share --
weighted average
shares outstanding 29,638 29,206 29,574 29,172
Effect of stock
incentive plans 656 593 617 594
------- ------- ------- -------
Denominator for
diluted earnings
per share 30,294 29,799 30,191 29,766
======== ======= ======= =======
Basic earnings
per share $ .01 $ .38 $ .46 $ .71
======== ======= ======= =======
Diluted earnings
per share $ .01 $ .37 $ .45 $ .70
======== ======= ======= =======
Page 8
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
(UNAUDITED)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
The following options to purchase shares of common stock were not included
in the computation of diluted earnings per share because the exercise price of
the options was greater than the average market price:
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
2002 2001 2002 2001
------- ------ ------ ------
(in thousands)
Number of options - 453 473 -
===== ===== ===== =====
3 - Reinsurance
Premiums earned are net of amounts ceded of $17,014,000 and $33,462,000 for
the three and six months ended June 30, 2002, respectively, and $16,032,000 and
$31,003,000 for the three and six months ended June 30, 2001, respectively.
Losses and loss settlement expenses are net of amounts ceded of $10,265,000 and
$16,046,000 for the three and six months ended June 30, 2002, respectively, and
$19,623,000 and $35,964,000 for the three and six months ended June 30, 2001,
respectively. Such amounts do not include the reinsurance transactions with
Mutual under the pooling arrangement, but do include the reinsurance described
in the following paragraph.
Harleysville Group has a reinsurance agreement with Harleysville Mutual
Insurance Company (Mutual) whereby Mutual reinsures accumulated catastrophe
losses in a quarter up to $14,400,000 in excess of $3,600,000 in return for a
reinsurance premium. The agreement excludes catastrophe losses resulting from
earthquakes or hurricanes, and supplements the existing external catastrophe
reinsurance program. Effective July 1, 2002 the agreement was amended to
exclude terrorism losses in order to reflect current reinsurance market
conditions. The premium rate and other terms were not changed. Harleysville
Group ceded to Mutual premiums earned of $2,072,000 and $1,864,000 and losses
incurred of $38,000 and $4,833,000, for the three months ended June 30, 2002 and
2001, respectively. Harleysville Group ceded to Mutual premiums earned of
$3,863,000 and $3,481,000 and loss incurred of $66,000 and $4,992,000 for the
six months ended June 30, 2002 and 2001, respectively.
Harleysville Group cedes business to and assumes business from Mutual under
a reinsurance pooling agreement. Because this agreement does not relieve
Harleysville Group of primary liability as the originating insurer, there is a
concentration of credit risk arising from business ceded to Mutual. However,
the reinsurance pooling agreement provides for the right of offset and
Page 9
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
(UNAUDITED)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
the net balance with Mutual is a liability at June 30, 2002 and December 31,
2001. Mutual has an A. M. Best rating of "A" (Excellent) and, in accordance
with certain state regulatory requirements, maintained $367.7 million (fair
value) of investments in a trust account to secure liabilities under the
reinsurance pooling agreement at June 30, 2002.
4 - Contingency
GE Reinsurance Corporation (GE Re) has sought recession of a reinsurance
agreement between Mutual and GE Re relating to certain automobile insurance
policies written in California through a managing general agent beginning in
1999. Harleysville Group's share of underwriting losses, assumed under the
pooling agreement, that have been ceded to GE Re was $34.2 million from
inception through June 30, 2002. Harleysville Group's pooling share of the
written premium ceded by Mutual under the agreement was $2.7 million and $7.6
million for the six months ended June 30, 2002 and 2001, respectively, and is
likely to continue to decline in the remainder of 2002.
Both Mutual and the Company believe GE Re's claims to be wholly without
merit and are litigating the matter vigorously. While the Company does not
expect this matter to materially affect its financial condition or results of
operations, there can be no assurance of any particular outcome.
In July 2002, the U. S. District Court for the Eastern District of
Pennsylvania granted the Company's motion for summary judgement for breach of
contract and declared that the contract with GE Re is valid and binding. GE Re
has appealed this ruling.
5 - Cash Flows
There were cash tax payments of $7,250,000 and $7,183,000 and cash interest
payments of $2,804,000 and $3,156,000 in the first six months of 2002 and 2001,
respectively.
6 - Restructuring Charges
In 1999 and 2000, Harleysville Group recorded restructuring charges in
connection with the consolidation of its claims offices and field operations.
The remaining accrual for these restructurings, which relates to occupancy
obligations, is $104,000 at June 30, 2002. The liability declined from $194,000
at December 31, 2001 primarily due to payments on the occupancy obligations.
Page 10
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
(UNAUDITED)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
7 - Segment Information
The performance of the personal lines and commercial lines is evaluated
based upon underwriting results as determined under statutory accounting
practices (SAP).
Financial data by segment is as follows:
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
2002 2001 2002 2001
-------- -------- -------- ---------
(in thousands)
Revenues:
Premiums earned:
Commercial lines $134,384 $119,923 $262,689 $236,381
Personal lines 53,324 59,449 107,524 120,265
-------- -------- -------- --------
Total premiums earned 187,708 179,372 370,213 356,646
Net investment income 21,526 21,143 43,008 42,468
Realized investment
losses (20,983) (1,025) (20,505) (3,378)
Other 3,898 3,952 7,643 8,026
-------- -------- -------- --------
Total revenues $192,149 $203,442 $400,359 $403,762
======== ======== ======== ========
Income before income
taxes:
Underwriting gain (loss):
Commercial lines $ (2,989) $ 717 $(13,153) $ (2,478)
Personal lines (5,797) (12,266) (4,373) (18,353)
-------- -------- -------- --------
SAP underwriting loss (8,786) (11,549) (17,526) (20,831)
GAAP adjustments 3,617 3,658 6,046 3,807
-------- -------- -------- --------
GAAP underwriting loss (5,169) (7,891) (11,480) (17,024)
Net investment income 21,526 21,143 43,008 42,468
Realized investment
losses (20,983) (1,025) (20,505) (3,378)
Other 1,422 906 2,696 1,864
-------- -------- -------- --------
Income (loss) before
income taxes $ (3,204) $ 13,133 $ 13,719 $ 23,930
======== ======== ======== ========
Page 11
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
(UNAUDITED)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
8 - Comprehensive Income
Comprehensive income consisted of the following (all amounts are net of
taxes):
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
2002 2001 2002 2001
-------- --------- -------- --------
(in thousands)
Net income $ 296 $10,978 $ 13,636 $20,696
Other comprehensive
income:
Unrealized investment
holding losses
arising
during period (1,654) (36) (12,336) (6,412)
Less:
Reclassification
adjustment for
losses included
in net income 13,652 668 13,494 2,216
------- ------- -------- -------
Net unrealized
investment gains
(losses) 11,998 632 1,158 (4,196)
------- ------- -------- -------
Comprehensive income $12,294 $11,610 $ 14,794 $16,500
======= ======= ======== =======
Page 12
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
Critical Accounting Policies and Estimates
The consolidated financial statements are prepared in conformity with
accounting principles generally accepted in the United States of America, which
require Harleysville Group to make estimates and assumptions (see Note 1 of the
Notes to Consolidated Financial Statements for the year ended December 31, 2001
included in the Company's 2001 Annual Report filed with the Securities and
Exchange Commission on Form 10-K). Harleysville Group believes that of its
significant accounting policies, the following may involve a higher degree of
judgement and estimation.
Liabilities for Losses and Loss Settlement Expenses. The liability for
losses and loss settlement expenses represents estimates of the ultimate unpaid
cost of all losses incurred, including losses for claims which have not yet been
reported to Harleysville Group. The amount of loss reserves for reported claims
is based primarily upon a case-by-case evaluation of the type of risk involved,
knowledge of the circumstances surrounding each claim and the insurance policy
provisions relating to the type of loss. The amounts of loss reserves for
unreported claims and loss settlement expense reserves are determined utilizing
historical information by line of insurance as adjusted to current conditions.
Inflation is implicitly provided for in the reserving function through analysis
of costs, trends and reviews of historical reserving results. Reserves are
closely monitored and are recomputed periodically using the most recent
information on reported claims and a variety of statistical techniques. It is
expected that such estimates will be more or less than the amounts ultimately
paid when the claims are settled. Changes in these estimates are reflected in
current operations.
Investments. Unrealized investment gains or losses on investments carried
at fair value, net of applicable income taxes, are reflected directly in
shareholders' equity as a component of comprehensive income and, accordingly,
have no effect on net income. A decline in fair value of an investment below
its cost that is deemed other than temporary is charged to earnings.
Harleysville Group monitors its investment portfolio and quarterly reviews
investments that have experienced a decline in fair value below cost to evaluate
whether the decline is other than temporary. Such evaluations involve judgement
and consider the magnitude and reasons for a decline and the prospects for the
fair value to recover in the near term. Future adverse investment market
conditions, or poor operating results of underlying investments, could result in
an impairment charge in the future.
Page 13
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
(Continued)
Policy Acquisition Costs. Policy acquisition costs, such as commissions,
premium taxes and certain other underwriting and agency expenses that vary with
and are directly related to the production of business, are deferred and
amortized over the effective period of the related insurance policies. The
method followed in computing deferred policy acquisition costs limits the amount
of such deferred costs to their estimated realizable value, which gives effect
to the premium to be earned, related investment income, losses and loss
settlement expenses, and certain other costs expected to be incurred as the
premium is earned. Future changes in estimates, the most significant of which
is expected losses and loss settlement expenses, may require adjustments to
deferred policy acquisition costs.
Contingencies. Besides claims related to its insurance products,
Harleysville Group is subject to proceedings, lawsuits and claims in the normal
course of business. Harleysville Group assesses the likelihood of any adverse
outcomes to these matters as well as potential ranges of probable losses. There
can be no assurance that actual outcomes will not differ from those assessments.
Results of Operations
Premiums earned increased $8.3 million and $13.6 million during the three
and six months ended June 30, 2002, respectively. The increases are primarily
due to increases in premiums earned for commercial lines of $14.4 million and
$26.3 million partially offset by decreases of $6.1 million and $12.7 million in
personal lines premiums earned for the three and six months ended June 30, 2002,
respectively. The increase in premiums earned for commercial lines was 12.1%
and 11.1% for the three and six months ended June 30, 2002, respectively,
primarily due to higher rates partially offset by fewer policy counts. Premiums
earned for commercial lines are expected to continue to increase throughout
2002. The decline in premiums earned for personal lines was 10.3% and 10.6% for
the three and six months ended June 30, 2002, respectively, primarily due to
fewer policy counts partially offset by higher rates. Premiums earned for
personal lines are expected to continue to decline throughout 2002 as
Harleysville Group is planning to continue reducing its personal lines volume in
certain less profitable states.
Investment income increased $0.4 million and $0.5 million for the three and
six months ended June 30, 2002 resulting from an increase in invested assets,
partially offset by a lower yield on the fixed maturity investment portfolio.
Page 14
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
(Continued)
Realized investment losses increased $20.0 and $17.1 million for the three
and six months ended June 30, 2002, respectively, primarily resulting from
lesser gains on the sale of fixed maturity securities and from increases of
$16.8 million and $15.6 million, respectively, in loss recognized on investments
that were trading below cost on an other-than-temporary basis, partially offset
by greater gains on the sale of equity securities for the six month period ended
June 30, 2002. The realized losses of $21.0 million for the three months ended
June 30, 2002 primarily relate to the write-down of ten equity securities and
one fixed maturity security that were trading significantly below cost.
Income (loss) before income taxes decreased $16.3 million and $10.2 million
for the three and six months ended June 30, 2002, respectively. The decreases
primarily were due to greater realized losses, partially offset by the greater
investment income and lower underwriting losses. Harleysville Group's statutory
combined ratio decreased to 100.6% and 101.9% for the three and six months ended
June 30, 2002, respectively, from 103.5% and 103.8% for the three and six months
ended June 30, 2001, respectively. The improved combined ratio is primarily due
to better results in personal lines, particularly homeowners. Commercial lines
were less profitable for the three and six months ended June 30, 2002 than the
same prior year periods primarily due to worse results in workers compensation
insurance where losses have been trending higher in recent quarters. Losses
ceded under the aggregate catastrophe reinsurance agreement with Mutual
decreased $4.8 million and $4.9 million for the three and six months ended June
30, 2002 due to fewer and less severe catastrophes in the 2002 periods.
The income tax expense for the three and six months ended June 30, 2002
includes the tax benefit of $2.4 million and $4.7 million associated with
tax-exempt interest compared to $2.5 million and $5.2 million in the same prior
year periods.
Effective for one year from July 1, 2002, the Company's subsidiaries and
Mutual and its wholly-owned subsidiaries renewed its catastrophe reinsurance
which provides coverage ranging from 84.8% to 94.3% of up to $140 million in
excess of a retention of $30 million for any given catastrophe excluding
terrorism for commercial lines. Harleysville Group's 2002 pooling share of this
coverage would range from 84.8% to 94.3% of up to $100.8 million in excess of a
retention of $21.6 million for any given catastrophe. Pursuant to the terms of
the treaty, the maximum recovery would be $127 million for any catastrophe
involving an insured loss equal to or greater than $170 million. Harleysville
Group's 2002 pooling share of this maximum recovery would be $91 million for any
catastrophe involving an insured loss of $122 million or greater. The treaty
includes reinstatement provisions providing for coverage for a second
catastrophe and requiring
Page 15
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
(Continued)
payment of an additional premium in the event of a first catastrophe occurring.
Harleysville Group and Mutual have purchased property per risk excess of loss
reinsurance which covers certain terrorism losses and provides for recovery of
up to $8.5 million in excess $1.5 million of terrorism losses for any one risk
under certain circumstances. The maximum recovery by Harleysville Group on a
terrorism loss occurrence is $27 million. The aggregate catastrophe reinsurance
agreement between Harleysville Group and Mutual has been amended effective July
1, 2002, to exclude terrorism losses in order to reflect current reinsurance
market conditions. The premium rate and other terms were not changed.
New Accounting Standard
In June 2001, the Financial Accounting Standards Board issued Statement No.
142, Goodwill and Other Intangible Assets. Statement No. 142 requires that
goodwill and intangible assets with indefinite useful lives no longer be
amortized, but instead be tested for impairment at least annually in accordance
with the provisions of Statement No. 142. Harleysville Group adopted the
provisions of Statement No. 142 effective January 1, 2002, at which time
Harleysville Group ceased to record amortization expense related to its
goodwill. The adoption of Statement No. 142 resulted in a $0.4 million
reduction in amortization expense in the six months ended June 30, 2002 as
compared to the six months ended June 30, 2001. Harleysville Group's goodwill
balance was $23.4 million at June 30, 2002. Harleysville Group completed its
analysis of any potential impairment of the goodwill during the second quarter
of 2002 and no adjustment was necessary.
Liquidity and Capital Resources
Net cash provided by operating activities was $46.8 million for the six
months ended June 30, 2002 and net cash of $1.5 million was used by operating
activities for the six months ended June 30, 2001. The change primarily is from
improved underwriting cash flow and a change in the amount of realized losses.
Net cash used by investing activities was $42.0 million for the six months
ended June 30, 2002 and net cash of $5.7 million was provided by investing
activities for the six months ended June 30, 2001. The change primarily is from
an increase in net purchases of fixed maturity and equity securities due to the
increase in cash provided by operations.
Page 16
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
(Continued)
Net cash used by financing activities decreased $0.1 million for the six
months ended June 30, 2002 compared to the six months ended June 30, 2001
primarily due to an increase in dividends paid, partially offset by an increase
in the issuance of common stock.
Harleysville Group participates in a securities lending program whereby
certain fixed maturity securities from the investment portfolio are loaned to
other institutions for a short period of time in return for a fee. At June 30,
2002, Harleysville Group held cash collateral of $169.3 million related to
securities on loan with a market value of $163.6 million. Harleysville Group's
policy is to require collateral of 102% of the then-current market value of
loaned securities as of the close of trading on the preceding business day.
Acceptable collateral includes government securities, letters of credit or cash.
The securities on loan to others have been segregated from the other invested
assets on the balance sheet. In addition, the assets and liabilities have been
grossed up to reflect the collateral held under the securities lending program
and the obligation to return this collateral upon the return of the loaned
securities.
Harleysville Group Inc. maintained $13.7 million of cash and marketable
securities at June 30, 2002 which is available for general corporate purposes
including dividends, debt service, capital contributions to subsidiaries,
acquisitions and the repurchase of stock. The Company has no material
commitments for capital expenditures as of June 30, 2002.
Certain of the statements contained herein (other than statements of
historical facts) are forward looking statements. Such forward looking
statements are made pursuant to the safe harbor provisions of the Private
Securities Litigation Reform Act of 1995 and include estimates and assumptions
related to economic, competitive and legislative developments. These forward
looking statements are subject to change and uncertainty which are, in many
instances, beyond the Company's control and have been made based upon
management's expectations and beliefs concerning future developments and their
potential effect on Harleysville Group. There can be no assurance that future
developments will be in accordance with management's expectations so that the
effect of future developments on Harleysville Group will be those anticipated by
management. Actual financial results including premium growth and underwriting
results could differ materially from those anticipated by Harleysville Group
depending on the outcome of certain factors, which may include changes in
property and casualty loss trends and reserves; natural catastrophe losses;
competition in insurance product pricing; government regulation and changes
therein which may impede the ability to charge adequate rates; performance of
the financial markets; fluctuations in interest rates; availability and price of
reinsurance; and the status of labor markets in which the Company operates.
Page 17
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
(Continued
Sarbanes-Oxley Act of 2002
In connection with the filing of this Quarterly Report of Harleysville
Group Inc. on Form 10-Q for the period ended June 30, 2002 with the Securities
and Exchange Commission ("SEC"), the Company provided the SEC with the
certifications required pursuant to 18 U.S.C. section 1350, as adopted pursuant
to section 906 of the Sarbanes-Oxley Act of 2002.
QUANTITATIVE AND QUALITATIVE DISCLOSURE
ABOUT MARKET RISK
Harleysville Group's market risk generally represents the risk of gain or
loss that may result from the potential change in the fair value of Harleysville
Group's investment portfolio as a result of fluctuations in prices and interest
rates. Harleysville Group attempts to manage its interest rate risk by
maintaining an appropriate relationship between the average duration of the
investment portfolio and the approximate duration of its liabilities.
Harleysville Group has maintained approximately the same duration of its
investment portfolio to its liabilities from December 31, 2001 to June 30, 2002.
In addition, the Company has maintained approximately the same investment mix
during this period.
Page 18
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings - None
ITEM 2. Changes in Securities - None
ITEM 3. Defaults Upon Senior Securities - None
ITEM 4. Submission of Matters to a Vote of Security
Holders - None
ITEM 5. Other Information - None
ITEM 6. a. Exhibits - None
b. Reports on Form 8-K - None
SIGNATURE
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.
HARLEYSVILLE GROUP INC.
Date: August 13, 2002 /s/BRUCE J. MAGEE
----------------- ----------------------------------
Bruce J. Magee
Senior Vice President and
Chief Financial Officer
(principal financial officer and
principal accounting officer)
Page 19