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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 SEPTEMBER 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
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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 November 1, 2002, 29,901,945 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 - September 30, 2002
and December 31, 2001 3
Consolidated Statements of Income - For the three
months ended September 30, 2002 and 2001 4
Consolidated Statements of Income - For the nine
months ended September 30, 2002 and 2001 5
Consolidated Statement of Shareholders' Equity -
For the nine months ended September 30, 2002 6
Consolidated Statements of Cash Flows - For the
nine months ended September 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
Evaluation of Disclosure Controls and Procedures 19
Part II - Other Information 20
Page 2
ITEM 1. FINANCIAL STATEMENTS
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
SEPTEMBER 30, DECEMBER 31,
2002 2001
------------- -------------
(Unaudited)
ASSETS
------
Investments:
Fixed maturities:
Held to maturity, at amortized cost
(fair value $432,247 and $459,588) $ 398,902 $ 439,499
Available for sale, at fair value
(amortized cost $889,332
and $956,047) 958,555 984,264
Equity securities, at fair value
(cost $90,591 and $110,803) 92,094 150,686
Short-term investments, at cost,
which approximates fair value 72,052 36,695
Fixed maturity securities on loan
Held to maturity, at amortized
cost (fair value $9,090) 8,357
Available for sale, at fair value
(amortized cost $117,484) 127,824
---------- ----------
Total investments 1,657,784 1,611,144
Cash 2,665 1,839
Receivables:
Premiums 141,408 122,508
Reinsurance 78,675 81,640
Accrued investment income 20,603 21,862
---------- ----------
Total receivables 240,686 226,010
Deferred policy acquisition costs 94,747 86,076
Prepaid reinsurance premiums 21,405 20,096
Property and equipment, net 27,767 28,873
Deferred income taxes 26,553 29,435
Securities lending collateral 147,900
Due from affiliate 13,452
Other assets 67,249 41,817
---------- ----------
Total assets $2,300,208 $2,045,290
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Liabilities:
Unpaid losses and loss settlement expenses $ 916,170 $ 879,056
Unearned premiums 415,038 373,737
Accounts payable and accrued expenses 102,932 96,440
Securities lending obligation 147,900
Debt 95,620 96,055
Due to affiliate 9,704
---------- ----------
Total liabilities 1,677,660 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 30,882,000
and 30,444,678 shares; outstanding
29,882,000 and 29,444,678 shares 30,882 30,445
Additional paid-in capital 148,423 140,065
Accumulated other comprehensive income 52,693 44,265
Retained earnings 406,115 391,088
Treasury stock, at cost, 1,000,000 shares (15,565) (15,565)
---------- ----------
Total shareholders' equity 622,548 590,298
---------- ----------
Total liabilities and
shareholders' equity $2,300,208 $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 SEPTEMBER 30, 2002 AND 2001
(dollars in thousands, except per share data)
2002 2001
--------- ---------
Revenues:
Premiums earned $196,524 $184,804
Investment income, net of
investment expenses 21,739 21,388
Realized investment gains (losses) 57 (4,154)
Other income 3,967 3,783
-------- --------
Total revenues 222,287 205,821
-------- --------
Losses and expenses:
Losses and loss settlement expenses 134,708 134,275
Amortization of deferred policy
acquisition costs 47,375 44,839
Other underwriting expenses 17,878 15,561
Interest expense 1,423 1,515
Other expenses 1,178 1,206
-------- --------
Total expenses 202,562 197,396
-------- --------
Income before income taxes 19,725 8,425
Income taxes 4,509 570
-------- --------
Net income $ 15,216 $ 7,855
======== ========
Per common share:
Basic earnings $ .51 $ .27
======== ========
Diluted earnings $ .50 $ .26
======== ========
Cash dividend $ .165 $ .15
======== ========
See accompanying notes to consolidated financial statements.
Page 4
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001
(dollars in thousands, except per share data)
2002 2001
-------- ---------
Revenues:
Premiums earned $566,737 $541,450
Investment income, net of
investment expenses 64,747 63,856
Realized investment losses (20,448) (7,532)
Other income 11,610 11,809
-------- --------
Total revenues 622,646 609,583
-------- --------
Losses and expenses:
Losses and loss settlement expenses 389,789 387,936
Amortization of deferred policy
acquisition costs 137,570 134,496
Other underwriting expenses 54,295 45,913
Interest expense 4,278 4,701
Other expenses 3,270 4,182
-------- --------
Total expenses 589,202 577,228
-------- --------
Income before income taxes 33,444 32,355
Income taxes 4,592 3,804
-------- --------
Net income $ 28,852 $ 28,551
======== ========
Per common share:
Basic earnings $ .97 $ .98
======== ========
Diluted earnings $ .95 $ .96
======== ========
Cash dividend $ .465 $ .43
======== ========
See accompanying notes to consolidated financial statements.
Page 5
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 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 28,852 28,852
Other compre-
hensive income,
net of tax:
Unrealized
investment
gains, net of
reclassification
adjustment 8,428 8,428
--------
Comprehensive
income 37,280
--------
Issuance
of common
stock 437,322 437 7,023 7,460
Tax benefit
from stock
options
exercised 1,335 1,335
Cash
dividend
paid (13,825) (13,825)
---------- ------- -------- ------- -------- -------- --------
Balance,
September 30,
2002 30,882,000 $30,882 $148,423 $52,693 $406,115 $(15,565) $622,548
========== ======= ======== ======= ======== ======== ========
See accompanying notes to consolidated financial statements.
Page 6
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001
(in thousands)
2002 2001
---------- ----------
Cash flows from operating activities:
Net income $ 28,852 $ 28,551
Adjustments to reconcile net income
to net cash provided by operating
activities:
Change in receivables, unearned
premiums, prepaid reinsurance
and due to affiliate 2,160 (14,907)
Increase in unpaid losses and
loss settlement expenses 37,114 2,904
Deferred income taxes (1,656) (5,590)
Increase in deferred policy
acquisition costs (8,671) (4,302)
Amortization and depreciation 2,238 2,121
Loss on sale of investments 20,448 7,532
Other, net (6,148) 1,475
--------- ---------
Net cash provided by operating
activities 74,337 17,784
--------- ---------
Cash flows from investing activities:
Fixed maturity investments:
Purchases (143,125) (198,924)
Sales or maturities 113,945 210,260
Equity securities:
Purchases (28,470) (7,477)
Sales 28,074 6,970
Net purchases of short-term
investments (35,357) (20,393)
Purchase of property and equipment (1,778) (2,474)
--------- ---------
Net cash used by
investing activities (66,711) (12,038)
--------- ---------
Cash flows from financing activities:
Issuance of common stock 7,460 7,083
Repayment of debt obligations (435) (395)
Dividend paid (13,825) (12,587)
--------- ---------
Net cash used by
financing activities (6,800) (5,899)
--------- ---------
Increase (decrease) in cash 826 (153)
Cash at beginning of period 1,839 2,002
--------- ---------
Cash at end of period $ 2,665 $ 1,849
========= =========
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
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 NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
2002 2001 2002 2001
------- ------- ------- -------
(in thousands, except per share data)
Numerator for basic
and diluted earnings
per share:
Net income $15,216 $ 7,855 $28,852 $28,551
======= ======= ======= =======
Denominator for basic
earnings per share --
weighted average
shares outstanding 29,790 29,359 29,647 29,235
Effect of stock
incentive plans 595 610 611 596
------- ------- ------- -------
Denominator for
diluted earnings
per share 30,385 29,969 30,258 29,831
======= ======= ======= =======
Basic earnings
per share $ .51 $ .27 $ .97 $ .98
======= ======= ======= =======
Diluted earnings
per share $ .50 $ .26 $ .95 $ .96
======= ======= ======= =======
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 NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
2002 2001 2002 2001
------ ------ ------ ------
(in thousands)
Number of options 898 - 898 444
=== === === ===
3 - Reinsurance
Premiums earned are net of amounts ceded of $17,139,000 and $50,601,000 for
the three and nine months ended September 30, 2002, respectively, and
$15,095,000 and $46,098,000 for the three and nine months ended September 30,
2001, respectively. Losses and loss settlement expenses are net of amounts
ceded of $10,008,000 and $26,054,000 for the three and nine months ended
September 30, 2002, respectively, and $17,070,000 and $53,034,000 for the three
and nine months ended September 30, 2001, respectively. Such amounts do not
include the reinsurance transactions with Harleysville Mutual Insurance Company
(Mutual) under the pooling arrangement, but do include the reinsurance described
in the following paragraph.
Harleysville Group has a reinsurance agreement with 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, terrorism or hurricanes,
and supplements the existing external catastrophe reinsurance program.
Harleysville Group ceded to Mutual premiums earned of $1,996,000 and $1,898,000
and losses incurred of $213,000 and $3,447,000 for the three months ended
September 30, 2002 and 2001, respectively. Harleysville Group ceded to Mutual
premiums earned of $5,859,000 and $5,379,000 and losses incurred of $279,000 and
$8,439,000 for the nine months ended September 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
Page 9
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
(UNAUDITED)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
reinsurance pooling agreement provides for the right of offset. Mutual has an A.
M. Best rating of "A" (Excellent) and, in accordance with certain state
regulatory requirements, maintained $320.8 million (fair value) of investments
in a trust account to secure liabilities under the reinsurance pooling agreement
at September 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 $34.4 million from
inception through September 30, 2002. Harleysville Group's pooling share of the
written premium ceded by Mutual under the agreement was $3.7 million and $9.8
million for the nine months ended September 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
Net cash tax payments of $8,750,000 and $7,183,000 were made in the first
nine months of 2002 and 2001, respectively. Cash interest payments of $2,927,000
and $3,361,000 were made in the first nine months of 2002 and 2001,
respectively.
Page 10
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
(UNAUDITED)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
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 $63,000 at September 30, 2002. The liability declined from
$194,000 at December 31, 2001 primarily due to payments on the occupancy
obligations.
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 NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
2002 2001 2002 2001
-------- --------- --------- ---------
(in thousands)
Revenues:
Premiums earned:
Commercial lines $143,725 $126,031 $406,414 $362,412
Personal lines 52,799 58,773 160,323 179,038
-------- -------- --------- --------
Total premiums earned 196,524 184,804 566,737 541,450
Net investment income 21,739 21,388 64,747 63,856
Realized investment gains
(losses) 57 (4,154) (20,448) (7,532)
Other 3,967 3,783 11,610 11,809
-------- -------- --------- --------
Total revenues $222,287 $205,821 $622,646 $609,583
======== ======== ======== ========
Income before income taxes:
Underwriting loss:
Commercial lines $ (2,459) $ (4,984) $(15,612) $ (7,462)
Personal lines (3,628) (5,925) (8,001) (24,278)
-------- -------- -------- --------
SAP underwriting loss (6,087) (10,909) (23,613) (31,740)
GAAP adjustments 2,650 1,038 8,696 4,845
-------- -------- -------- --------
GAAP underwriting loss (3,437) (9,871) (14,917) (26,895)
Net investment income 21,739 21,388 64,747 63,856
Realized investment gains
(losses) 57 (4,154) (20,448) (7,532)
Other 1,366 1,062 4,062 2,926
-------- -------- --------- -------
Income before income taxes $ 19,725 $ 8,425 $ 33,444 $ 32,355
======== ======== ======== ========
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 NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
2002 2001 2002 2001
-------- ------- -------- --------
(in thousands)
Net income $15,216 $ 7,855 $28,852 $28,551
Other comprehensive
income:
Unrealized investment
holding gains
(losses) arising
during period 7,298 (3,169) (5,038) (9,581)
Less:
Reclassification
adjustment for
(gains) losses
included in net
income (28) 2,769 13,466 4,985
------- ------- ------- -------
Net unrealized
investment gains
(losses) 7,270 (400) 8,428 (4,596)
------- ------- ------- -------
Comprehensive income $22,486 $ 7,455 $37,280 $23,955
======= ======= ======= =======
Page 12
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
ITEM 2. 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 $11.7 million and $25.3 million during the three
and nine months ended September 30, 2002, respectively. The increases are
primarily due to increases in premiums earned for commercial lines of $17.7
million and $44.0 million partially offset by decreases of $6.0 million and
$18.7 million in personal lines premiums earned for the three and nine months
ended September 30, 2002, respectively. The increases in premiums earned for
commercial lines primarily is due to higher rates partially offset by fewer
policy counts. The decreases in premiums earned for personal lines primarily is
due to fewer policy counts partially offset by higher rates.
Investment income increased $0.4 million and $0.9 million for the three and
nine months ended September 30, 2002, respectively, 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 gains (losses) improved $4.2 million for the three
months ended September 30, 2002 primarily due to lesser losses from equity
securities. During the three months ended September 30, 2002, $4.5 million of
losses were recognized on investments that were trading below cost on an
other-than-temporary basis. Such losses were offset by sales of equity
securities, including securities written down earlier in 2002 that were sold for
tax planning purposes. Realized investment losses increased $12.9 million for
the nine months ended September 30, 2002 primarily due to lesser gains on the
sale of fixed maturity securities and greater losses from equity securities.
Income before income taxes increased $11.3 million and $1.1 million for the
three and nine months ended September 30, 2002, respectively. The increase for
the three months ended September 30, 2002 was primarily due to the greater
investment income, improved realized investment gains and lower underwriting
loss. The increase for the nine months ended September 30, 2002 was primarily
due to the greater investment income and lower underwriting loss, partially
offset by the greater realized losses. Harleysville Group's statutory combined
ratio decreased to 101.7% and 101.9% for the three and nine months ended
September 30, 2002, respectively, from 104.6% and 104.1% for the three and nine
months ended September 30, 2001, respectively. The improved combined ratio is
primarily due to better results in personal lines, particularly homeowners. The
commercial lines statutory combined ratio decreased to 100.0% for the three
months ended September 30, 2002 from 103.0% during the same prior year period
and increased to 99.9% for the nine months ended September 30, 2002 from 99.5%
during the same prior year period. The three and nine months ended September
30, 2001 include $3.6 million of commercial lines net losses incurred from the
September 11 terrorist acts. Such losses added 2.9 points and 1.0 point to the
commercial lines combined ratio for the three and nine months ended September
30, 2001, respectively. Excluding these losses, commercial lines profitability
did not change significantly as better results in the commercial multi-peril and
automobile lines were partially offset by 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 $3.2 million and $8.2 million for the three and nine months ended
September 30, 2002, respectively, due to fewer losses and less severe
catastrophes in the 2002 periods.
Page 15
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
(Continued)
The income tax provision for the three and nine months ended September 30,
2002 includes the tax benefit of $2.4 million and $7.1 million associated with
tax-exempt investment income, compared to $2.4 million and $7.6 million in the
same prior year periods.
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 $0.6 million
reduction in amortization expense in the nine months ended September 30, 2002 as
compared to the nine months ended September 30, 2001. Harleysville Group's
goodwill balance was $23.4 million at September 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 increased $56.6 million for the
nine months ended September 30, 2002. The increase primarily is from improved
underwriting cash flow.
Net cash used by investing activities increased $54.7 million for the nine
months ended September 30, 2002. The change primarily is from the investment of
cash provided by operating activities into short-term investments and fixed
maturity securities.
Net cash used by financing activities increased $0.9 million for the nine
months ended September 30, 2002 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
Page 16
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
(Continued)
period of time in return for a fee. At September 30, 2002, Harleysville Group
held cash collateral of $147.9 million related to securities on loan with a
market value of $144.8 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.
Other assets includes $7.9 million of loaned securities in transit which have
been sold but not yet delivered and for which collateral is maintained.
Harleysville Group Inc. maintained $12.1 million of cash and short-term
investments at September 30, 2002 which is available for general corporate
business purposes including dividends, debt service, capital contributions to
subsidiaries, acquisitions and the repurchase of stock. The Company had no
material commitments for capital expenditures as of September 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
ITEM 3. 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 September 30,
2002. In addition, the Company has not significantly changed its investment mix
or market risk during this period.
Page 18
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
ITEM 4. EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures. Our chief executive
officer and our co-chief executive officers, after evaluating the effectiveness
of our "disclosure of controls and procedures" (as defined in the Securities
Exchange Act of 1934 Rules 13a-14(c) and 15d-14(c)) as of a date (the
"Evaluation Date") within 90 days before the filing date of this quarterly
report, have concluded that as of the Evaluation Date, our disclosure controls
and procedures were adequate and designed to ensure that material information
relating to us and our consolidated subsidiaries would be made known to them by
others within those entities.
(b) Changes in internal controls. There were no significant changes in our
internal controls or to our knowledge, in other factors that could significantly
affect our internal controls and procedures subsequent to the Evaluation Date.
Page 19
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: November 13, 2002 /s/BRUCE J. MAGEE
------------------- -----------------------------------
Bruce J. Magee
Senior Vice President and
Chief Financial Officer
(principal financial officer and
principal accounting officer)
Page 20
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Harleysville Group Inc. (the
"Company") on Form 10-Q for the period ended September 30, 2002 as filed with
the Securities and Exchange Commission on the date hereof (the "Report"), I,
Bruce J. Magee, Chief Financial Officer of the Company, certify, pursuant to 18
U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley
Act of 2002, that:
(1) The Report fully complies with the requirements of section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of the Company.
Date: November 13, 2002 /s/BRUCE J. MAGEE
------------------- ----------------------------
Bruce J. Magee
Senior Vice President and
Chief Financial Officer
Page 21
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Harleysville Group Inc. (the
"Company") on Form 10-Q for the period ended September 30, 2002 as filed with
the Securities and Exchange Commission on the date hereof (the "Report"), I,
Walter R. Bateman, Chairman of the Board, President and Chief Executive Officer
of the Company, certify, pursuant to 18 U.S.C. section 1350, as adopted pursuant
to section 906 of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of the Company.
Date: November 13, 2002 /s/WALTER R. BATEMAN
------------------- ------------------------------
Walter R. Bateman
Chairman of the Board, and
Chief Executive Officer
Page 22
CERTIFICATION PURSUANT TO SECTION 302
OF THE SARBANES-OXLEY ACT OF 2002
I, Bruce J. Magee certify that:
1. I have reviewed this quarterly report on Form 10Q of Harleysville
Group Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial conditions, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 13, 2002 /s/BRUCE J. MAGEE
------------------- ----------------------------
Bruce J. Magee
Senior Vice President and
Chief Financial Officer
Page 23
CERTIFICATION PURSUANT TO THE SECTION 302
OF THE SARBANES-OXLEY ACT OF 2002
I, Walter R. Bateman certify that:
1. I have reviewed this quarterly report on Form 10Q of Harleysville
Group Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial conditions, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 13, 2002 /s/WALTER R. BATEMAN
------------------- -----------------------------
Walter R. Bateman
Chairman of the Board and
Chief Executive Officer
Page 24