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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 JUNE 30, 2004.
----------------
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 .
----- -----
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes X . No .
----- -----
At July 31, 2004, 30,074,171 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, 2004 and
December 31, 2003 3
Consolidated Statements of Income - For the three
months ended June 30, 2004 and 2003 4
Consolidated Statements of Income - For the six
months ended June 30, 2004 and 2003 5
Consolidated Statement of Shareholders' Equity -
For the six months ended June 30, 2004 6
Consolidated Statements of Cash Flows -
For the six months ended June 30, 2004
and 2003 7
Notes to Consolidated Financial Statements 8
Management's Discussion and Analysis of Results
of Operations and Financial Condition 15
Quantitative and Qualitative Disclosure About
Market Risk 28
Controls and Procedures 29
Part II - Other Information 30
Page 2
Item 1. Financial Statements
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
JUNE 30 DECEMBER 31,
2004 2003
----------- -----------
(unaudited)
ASSETS
------
Investments:
Fixed maturities:
Held to maturity, at amortized cost
(fair value $509,071 and $463,953) $ 495,221 $ 436,521
Available for sale, at fair value
(amortized cost $997,743 and $980,936) 1,024,795 1,033,855
Equity securities, at fair value
(cost $109,196 and $97,189) 146,418 137,590
Short-term investments, at cost,
which approximates fair value 47,980 31,411
Fixed maturity securities on loan:
Held to maturity, at amortized
cost (fair value $1,711 and $3,532) 1,623 3,092
Available for sale, at fair value
(amortized cost $136,409 and $202,222) 140,424 212,164
---------- ----------
Total investments 1,856,461 1,854,633
Cash 1,050 13,430
Receivables:
Premiums 151,012 140,674
Reinsurance (affiliate $1,489 and $699) 174,880 164,841
Accrued investment income 23,042 23,086
---------- ----------
Total receivables 348,934 328,601
Deferred policy acquisition costs 103,924 99,033
Prepaid reinsurance premiums 29,007 30,899
Property and equipment, net 22,497 23,824
Deferred income taxes 55,292 43,020
Security lending collateral 145,505 221,454
Other assets 64,435 65,495
---------- ----------
Total assets $2,627,105 $2,680,389
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Liabilities:
Unpaid losses and loss settlement expenses
(affiliate $194,377 and $189,891) $1,253,283 $1,219,977
Unearned premiums (affiliate $49,483 and $52,839) 450,511 437,883
Accounts payable and accrued expenses 83,275 91,999
Security lending obligation 145,505 221,454
Debt (affiliate $18,500 and $18,500) 119,625 120,145
Due to affiliate 5,353 16,184
---------- ----------
Total liabilities 2,057,552 2,107,642
---------- ----------
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 31,381,457
and 31,298,532 shares; outstanding
29,983,548 and 29,900,623 shares 31,381 31,299
Additional paid-in capital 158,271 156,997
Accumulated other comprehensive income 37,718 60,450
Retained earnings 366,870 350,844
Deferred compensation (200) (2,356)
Treasury stock, at cost, 1,397,909 shares (24,487) (24,487)
---------- ----------
Total shareholders' equity 569,553 572,747
---------- ----------
Total liabilities and shareholders' equity $2,627,105 $2,680,389
========== ==========
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, 2004 AND 2003
(dollars in thousands, except per share data)
2004 2003
-------- --------
Revenues:
Premiums earned from affiliate (ceded
to affiliate, $193.619 and $176,376) $207,652 $203,755
Investment income, net of
investment expenses 21,437 21,649
Realized investment gains, net 59 67
Other income (affiliate $1,680
and $1,821) 3,671 4,073
-------- --------
Total revenues 232,819 229,544
-------- --------
Losses and expenses:
Losses and loss settlement expenses
from affiliate(ceded to affiliate,
$122,097 and $125,308) 148,711 147,426
Amortization of deferred policy
acquisition costs 50,698 49,898
Other underwriting expenses 19,726 18,121
Interest expense (affiliate $84
and $92) 1,566 1,393
Other expenses 1,266 1,176
-------- --------
Total expenses 221,967 218,014
-------- --------
Income before income taxes 10,852 11,530
Income taxes 1,124 1,462
-------- --------
Net income $ 9,728 $ 10,068
======== ========
Per common share:
Basic earnings $ .32 $ .33
======== ========
Diluted earnings $ .32 $ .33
======== ========
Cash dividend $ .17 $ .165
======== ========
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, 2004 AND 2003
(dollars in thousands, except per share data)
2004 2003
--------- ---------
Revenues:
Premiums earned from affiliate (ceded
to affiliate, $364,795 and $348,681) $414,600 $402,584
Investment income, net of
investment expenses 43,079 43,096
Realized investment gains (losses), net 12,547 (366)
Other income (affiliate $3,455 and $3,831) 8,235 8,593
-------- --------
Total revenues 478,461 453,907
-------- --------
Losses and expenses:
Losses and loss settlement expenses
from affiliate (ceded to affiliate,
$261,782 and $268,190) 299,821 311,185
Amortization of deferred policy
acquisition costs 101,386 98,215
Other underwriting expenses 39,364 36,678
Interest expense (affiliate $168 and $186) 3,143 2,787
Other expenses 2,685 2,387
-------- --------
Total expenses 446,399 451,252
-------- --------
Income before income taxes 32,062 2,655
Income taxes (benefit) 5,841 (4,173)
-------- --------
Net income $ 26,221 $ 6,828
======== ========
Per common share:
Basic earnings $ .88 $ .23
======== ========
Diluted earnings $ .87 $ .23
======== ========
Cash dividend $ .34 $ .33
======== ========
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, 2004
(dollars in thousands)
ACCUMULATED
COMMON STOCK ADDITIONAL OTHER
------------------- PAID-IN COMPREHENSIVE RETAINED DEFERRED TREASURY
SHARES AMOUNT CAPITAL INCOME EARNINGS COMPENSATION STOCK TOTAL
---------- ------- ---------- ------------- -------- ------------ --------- --------
Balance,
December 31,
2003 31,298,532 $31,299 $156,997 $ 60,450 $350,844 $(2,356) $(24,487) $572,747
--------
Net income 26,221 26,221
Other compre-
hensive loss,
net of tax:
Unrealized
investment
losses, net of
reclassification
adjustment (22,732) (22,732)
--------
Comprehensive
income 3,489
Issuance of
common stock 82,925 82 1,384 1,466
Tax on stock
compensation (110) (110)
Deferred
compensation 2,156 2,156
Cash dividend
paid (10,195) (10,195)
---------- ------- -------- -------- -------- ------- -------- --------
Balance at
June 30,
2004 31,381,457 $31,381 $158,271 $ 37,718 $366,870 $ (200) $(24,487) $569,553
========== ======= ======== ======== ======== ======= ======== ========
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, 2004 AND 2003
(in thousands)
2004 2003
---------- ----------
Cash flows from operating activities:
Net income $ 26,221 $ 6,828
Adjustments to reconcile net income
to net cash provided by operating
activities:
Change in receivables, unearned
premiums and prepaid reinsurance balances (5,813) (3,529)
Change in affiliate balance (10,831) (2,145)
Increase in unpaid losses and
loss settlement expenses 33,306 80,634
Deferred income taxes (32) (4,999)
Increase in deferred policy
acquisition costs (4,891) (9,409)
Amortization and depreciation 2,727 2,069
Loss (gain) on sale of investments (12,547) 366
Other, net (4,286) (10,584)
--------- ---------
Net cash provided by
operating activities 23,854 59,231
--------- ---------
Cash flows from investing activities:
Fixed maturity investments:
Purchases (113,176) (199,021)
Sales or maturities 102,754 119,118
Equity securities:
Purchases (16,106) (4,162)
Sales 16,491 1,923
Net sales (purchases) of short-term investments (16,569) 26,552
Sale (purchase) of property and equipment (379) 448
--------- ---------
Net cash used by investing
activities (26,985) (55,142)
--------- ---------
Cash flows from financing activities:
Issuance of common stock 1,466 6,721
Repayment of debt obligations (520) (475)
Dividend paid (to affiliate, $5,781 and $5,496) (10,195) (9,940)
Purchase of treasury stock 0 (1,877)
--------- ---------
Net cash used by
financing activities (9,249) (5,571)
--------- ---------
Decrease in cash (12,380) (1,482)
Cash at beginning of period 13,430 2,944
--------- ---------
Cash at end of period $ 1,050 $ 1,462
========= =========
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, 2003 included in the
Company's 2003 Annual Report filed with the Securities and Exchange Commission
on Form 10-K.
The affiliate transaction disclosures on the face of the financial
statements are in regards to transactions with Harleysville Mutual Insurance
Company (Mutual). Mutual owns approximately 57% of the outstanding common stock
of Harleysville Group Inc. As used herein, "Harleysville Group" refers to
Harleysville Group Inc. and Subsidiaries.
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 and in proportion to the premiums
earned. The method followed in computing deferred policy acquisition costs
limits the amount of such deferred costs to their estimated realizable value.
The estimation of net realizable value takes into account the premium to be
earned, related investment income over the claim paying period, 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. If the estimation of net realizable value
indicates that the acquisition costs are unrecoverable, further analyses are
completed to determine if a reserve is required to provide for losses that may
exceed the related unearned premiums.
Stock-Based Compensation
Stock-based compensation plans are accounted for under the provisions of
Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued
to Employees," and related interpretations. Accordingly, no compensation
expense is recognized
Page 8
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
(UNAUDITED)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
for fixed stock option grants and an employee stock purchase plan. Compensation
expense would be recorded on the date of a stock option grant only if the
current market price of the underlying stock exceeded the exercise price. The
following table illustrates the effect on net income and earnings per share as
if the provisions of statement of Financial Accounting Standards (SFAS) No. 123
(as amended by SFAS No. 148), "Accounting for Stock-Based Compensation," had
been applied for the three and six months ended June 30, 2004 and 2003:
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
2004 2003 2004 2003
-------- -------- -------- --------
(in thousands,
except per share data)
Net income, as reported $9,728 $10,068 $26,221 $ 6,828
Plus:
Stock-based employee
compensation expense
(benefit) included
in reported net
income, net of
related tax effects 11 (657) 54 (456)
Less:
Total stock-based
employee compensation
benefit (expense)
determined under
fair value based
method for all
awards, net of
related tax effects (703) 3 (1,452) (1,085)
------ ------- ------- -------
Pro forma net income $9,036 $ 9,414 $24,823 $ 5,287
====== ======= ======= =======
Basic earnings
per share:
As reported $ .32 $ .33 $ .88 $ .23
Pro forma $ .30 $ .31 $ .83 $ .18
Diluted earnings
per share:
As reported $ .32 $ .33 $ .87 $ .23
Pro forma $ .30 $ .31 $ .83 $ .17
Page 9
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
(UNAUDITED)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
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,
2004 2003 2004 2003
---------- ---------- --------- --------
(in thousands, except
per share data)
Numerator for basic
and diluted earnings
per share:
Net income $ 9,728 $10,068 $26,221 $ 6,828
======= ======= ======= =======
Denominator for basic
earnings per share --
weighted average
shares outstanding 29,960 30,077 29,960 30,032
Effect of stock
incentive plans 68 271 85 274
------- ------- ------- -------
Denominator for
diluted earnings
per share 30,028 30,348 30,045 30,306
======= ======= ======= =======
Basic earnings
per share $ .32 $ .33 $ .88 $ .23
======= ======= ======= =======
Diluted earnings
per share $ .32 $ .33 $ .87 $ .23
======= ======= ======= =======
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,
2004 2003 2004 2003
------- ------- -------- --------
(in thousands)
Number of options 2,127 1,129 1,635 1,129
===== ===== ===== =====
Page 10
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
(UNAUDITED)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
3 - Reinsurance
Premiums earned are net of amounts ceded of $22,479,000 and $44,057,000 for
the three and six months ended June 30, 2004, respectively, and $18,060,000 and
$34,460,000 for the three and six months ended June 30, 2003, respectively.
Losses and loss settlement expenses are net of amounts ceded of $5,562,000 and
$39,716,000 for the three and six months ended June 30, 2004, respectively, and
$19,641,000 and $37,506,000 for the three and six months ended June 30, 2003,
respectively. Such amounts ceded do not include the reinsurance transactions
with Mutual under the pooling arrangement (described below) which are reflected
on the face of the income statements, but do include reinsurance with
unaffiliated reinsurers and 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 $2,263,000 and $2,216,000
and losses incurred of $(816,000) and $1,018,000, for the three months ended
June 30, 2004 and 2003, respectively. Harleysville Group ceded to Mutual
premiums earned of $4,260,000 and $4,240,000 and losses incurred of $984,000 and
$4,774,000 for the six months ended June 30, 2004 and 2003, respectively.
Pursuant to the terms of a reinsurance pooling agreement with Mutual, each
of the insurance subsidiaries of Harleysville Group Inc. cedes premiums, losses
and expenses on all of their respective business to Mutual which, in turn,
retrocedes to such subsidiaries a specified portion of premiums, losses and
expenses of Mutual and such subsidiaries. Because this agreement does not
relieve Harleysville Group Inc.'s insurance subsidiaries of primary liability as
originating insurers, there is a concentration of credit risk arising from
business ceded to Mutual. However, the reinsurance pooling agreement provides
for the right of offset. Mutual has an A. M. Best rating of "A-" (Excellent).
Page 11
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
(UNAUDITED)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
4 - Cash Flows
There were net cash tax payments of $4,282,000 and $500,000 and cash
interest payments of $3,071,000 and $2,740,000 in the first six months of 2004
and 2003, respectively.
5 - 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,
2004 2003 2004 2003
-------- --------- -------- --------
(in thousands)
Revenues:
Premiums earned:
Commercial lines $163,791 $154,118 $326,111 $302,867
Personal lines 43,861 49,637 88,489 99,717
-------- -------- -------- --------
Total premiums earned 207,652 203,755 414,600 402,584
Net investment income 21,437 21,649 43,079 43,096
Realized investment
gains (losses) 59 67 12,547 (366)
Other 3,671 4,073 8,235 8,593
-------- -------- -------- --------
Total revenues $232,819 $229,544 $478,461 $453,907
======== ======== ======== ========
Income before income taxes:
Underwriting gain (loss):
Commercial lines $(16,358) $ (8,767) $(26,006) $(36,773)
Personal lines 10 (7,848) (4,850) (15,742)
-------- -------- -------- --------
SAP underwriting loss (16,348) (16,615) (30,856) (52,515)
GAAP adjustments 4,865 4,925 4,885 9,021
-------- -------- -------- --------
GAAP underwriting loss (11,483) (11,690) (25,971) (43,494)
Net investment income 21,437 21,649 43,079 43,096
Realized investment
gains (losses) 59 67 12,547 (366)
Other 839 1,504 2,407 3,419
-------- -------- -------- --------
Income before income taxes $ 10,852 $ 11,530 $ 32,062 $ 2,655
======== ======== ======== ========
Page 12
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
(UNAUDITED)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
6 - Comprehensive Income
Comprehensive income for the three and six months ended June 30, 2004 and
2003 consisted of the following (all amounts are net of taxes):
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
2004 2003 2004 2003
-------- -------- -------- --------
(in thousands)
Net income $ 9,728 $10,068 $ 26,221 $ 6,828
Other comprehensive
income (loss):
Unrealized investment
holding gains (losses)
arising during period (25,322) 21,042 (14,601) 16,922
Less:
Reclassification
adjustment for (gains)
losses included
in net income (38) (10) (8,131) 430
-------- ------- -------- -------
Net unrealized investment
gains (losses) (25,360) 21,032 (22,732) 17,352
-------- ------- -------- -------
Comprehensive income (loss) $(15,632) $31,100 $ 3,489 $24,180
======== ======= ======== =======
7 - Pension
Harleysville Group Inc. has a pension plan that covers substantially all
full-time employees. The net periodic pension cost for the plan including
Mutual consists of the following components:
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
2004 2003 2004 2003
-------- -------- -------- --------
(in thousands)
Components of net
periodic pension cost:
Service cost $ 1,992 $ 1,659 $ 3,985 $ 3,317
Interest cost 2,770 2,508 5,540 5,015
Expected return on
plan assets (3,020) (2,485) (6,040) (4,971)
Recognized net
actuarial loss 517 12 1,035 25
Amortization of prior
service cost 53 58 105 116
Net transition amortization 13 13 25 27
------- ------- ------- -------
Net periodic pension cost:
Entire plan $ 2,325 $ 1,765 $ 4,650 $ 3,529
======= ======= ======= =======
Harleysville Group portion $ 1,536 $ 1,241 $ 3,069 $ 2,453
======= ======= ======= =======
Page 13
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
(UNAUDITED)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Harleysville Group's expected portion of the 2004 contribution to the
pension plan is $6,600,000, of which $1,980,000 was made in the first six months
of 2004.
8 - Shareholders' Equity
Various states have adopted the National Association of Insurance
Commissioners (NAIC) risk-based capital (RBC) standards that require insurance
companies to calculate and report statutory capital and surplus needs based on a
formula measuring underwriting, investment and other business risks inherent in
an individual company's operations. These RBC standards have not affected the
operations of Harleysville Group since each of the Company's insurance
subsidiaries has statutory capital and surplus in excess of RBC requirements.
These RBC standards require the calculation of a ratio of total adjusted
capital to Authorized Control Level. Insurers with a ratio below 200% are
subject to different levels of regulatory intervention and action. Based upon
their 2003 statutory financial statements, the ratio of total adjusted capital
to the Authorized Control Level for the Company's nine insurance subsidiaries at
December 31, 2003 ranged from 478% to 609%.
Page 14
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
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; 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.
Overview
The Company's net income is primarily determined by three elements:
- net premium income
- investment income
- amounts paid or reserved to settle insured claims
A number of factors may affect the level of premium income, including:
- limitations on rates arising from the competitive market place
or regulation
- limitation on available business arising from a need to maintain
the quality of underwritten risks
- the Company's ability to maintain its A-("excellent") rating by
A.M. Best
- the ability of the Company to maintain a reputation for efficiency
and fairness in claims administration
Page 15
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
(Continued)
A number of factors may affect the level of investment income, including:
- general interest rate levels
- specific adverse events affecting the issuers of debt obligations
held by the Company
- changes in the prices of equity securities generally and those held
by the Company specifically
Loss and loss settlement expenses are affected by a number of factors,
including:
- the quality of the risks underwritten by the Company
- the nature and severity of catastrophic losses
- the availability, cost and terms of reinsurance
- underlying settlement costs, including medical and legal costs
The Company seeks to manage each of the foregoing to the extent within its
control. Many of the foregoing factors are partially, or entirely, outside of
the control of the Company.
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, 2003
included in the Company's 2003 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
judgment and estimation. The judgments, or the methodology on which the
judgments are made, are reviewed quarterly with the Audit Committee.
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
Page 16
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
(Continued)
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. Generally, 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. However, if the fair value of an
investment declines below its cost and that decline is deemed other than
temporary, the amount of the decline below cost 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 consider, among
other things, 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.
Harleysville Group evaluates its investment portfolio quarterly to
determine if a decline in fair value below cost is other than temporary.
Harleysville Group has written down to fair value, without exception, any equity
security that has declined below cost by more than 20% and maintained such
decline for six months, or by 50% or more, in the quarter in which either such
decline occurred. In some cases, securities that have declined by a lesser
amount or for a shorter period of time are written down if the evaluation
indicates the decline is other-than-temporary. The fair value of equity
securities is based on the closing market value as reported by a national stock
exchange or Nasdaq. The fair value of fixed maturities is based upon data
supplied by an independent pricing service. It can be difficult to determine
the fair value of non-traded securities but Harleysville Group does not own a
material amount of non-traded securities.
Page 17
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 and in
proportion to the premiums earned. The method followed in computing deferred
policy acquisition costs limits the amount of such deferred costs to their
estimated realizable value. The estimation of net realizable value takes into
account the premium to be earned, related investment income over the claim
paying period, 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. If the estimation
of net realizable value indicates that the acquisition costs are unrecoverable,
further analyses are completed to determine if a reserve is required to provide
for losses that may exceed the related unearned premiums.
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.
The application of certain of these critical accounting policies to the
periods ended June 30, 2004 and 2003 is discussed in greater detail below.
Results of Operations
Premiums earned increased $3.9 million and $12.0 million during the three
and six months ended June 30, 2004, respectively. The increases are primarily
due to increases in premiums earned for commercial lines of $9.7 million and
$23.2 million, respectively, partially offset by decreases of $5.8 million and
$11.2 million in personal lines premiums earned for the three and six months
ended June 30, 2004, respectively. The increases in premiums earned for
commercial lines were 6.3% and 7.7% for the three and six months ended June 30,
2004, respectively, primarily due to higher rates partially offset by fewer
policy counts. The decline in policy counts was primarily in the workers
compensation line of business. The declines in premiums earned for personal
lines were 11.6% and 11.3% for the three and six months ended June
Page 18
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
(Continued)
30, 2004, respectively, primarily due to fewer policy counts. The reduction in
personal lines volume was driven primarily by a reduction of personal automobile
business from the continued implementation of more stringent underwriting
processes.
Investment income decreased $0.2 million for the three months ended June
30, 2004 as compared to the same period in the prior year, resulting from a
lower yield on the fixed maturity investment portfolio partially offset by an
increase in invested assets. Investment income was essentially unchanged for the
six months ended June 30, 2004 as compared to the same period in the prior year.
Realized investment gains (losses) increased $12.9 million for the six
months ended June 30, 2004 as compared to the same period in the prior year, and
were essentially unchanged for the three months ended June 30, 2004. The
six-month increase primarily resulted from gains on the sale of two equity
securities in the first quarter of 2004.
Harleysville Group holds securities with unrealized losses at June 30, 2004
as follows:
LENGTH OF UNREALIZED LOSS
-------------------------
UNREALIZED LESS THAN OVER 12
FAIR VALUE LOSS 12 MONTHS MONTHS
----------- ---------- ---------- -------
(in thousands)
Fixed maturities:
U.S. Treasury
securities and
obligations of
U.S. government
corporations
and agencies $109,309 $ 2,748 $ 2,748
Obligations of
states and
political
subdivisions 214,419 4,658 3,423 $1,235
Corporate
securities 116,339 5,799 2,942 2,857
Mortgage-backed
securities 55,517 1,378 1,378
-------- ------- ------- ------
Total fixed
maturities $495,584 $14,583 $10,491 $4,092
======== ======= ======= ======
Equity securities $ 8,118 $ 953 $ 953 $ -
======== ======= ======= ======
Page 19
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
(Continued)
Of the total fixed maturity securities with an unrealized loss at June 30,
2004, securities with a fair value of $330.2 million and an unrealized loss of
$10.6 million are classified as available for sale and are carried at fair value
on the balance sheet while securities with a fair value of $165.4 million and an
unrealized loss of $4.0 million are classified as held to maturity on the
balance sheet and are carried at amortized cost.
There are four positions that comprise the unrealized loss in equity
investments at June 30, 2004. While one of these positions has been below cost
for more than six months, it has had volatile price movements and has not been
significantly below cost for significant continuous amounts of time.
Harleysville Group has been monitoring these securities and it is possible that
some may be written down in the income statement in the future.
There are $47.5 million in fixed maturity securities, at amortized cost,
that at June 30, 2004, had been below amortized cost for over 12 months. Of the
$4.1 million of unrealized losses on such securities, $1.2 million relates to
obligations of states and political subdivisions which carry A or higher debt
ratings and have declined in fair value roughly in line with market interest
rate changes. The remaining $2.9 million of unrealized losses are comprised of
airline enhanced equipment trust certificates (EETC) as follows:
FAIR MATURITY
COST VALUE DATES
------- ------- -----------
(in thousands)
American Airlines $14,371 $12,834 2011
United Airlines 6,956 5,636 2010-2012
------- -------
$21,327 $18,470
======= =======
After the events of September 11, 2001, air travel and the value of these
airlines' EETC securities declined. The EETCs are all "A tranche" holdings,
which means they are in a senior credit position to the underlying airplane
collateral value as compared to B and C tranche holders. At the time of
issuance, the collateral was appraised at approximately twice the value of the A
tranche EETCs. Recent estimates indicate that in a distressed sale scenario,
the value of the collateral would be approximately the same as the EETCs' cost.
At June 30, 2004, the American Airlines EETCs carry an investment grade debt
rating and the market value of both issuers has improved over the past year.
Harleysville Group is participating in certain EETC creditor committees and is
monitoring developments. It is possible that these EETCs may be written down in
the income statement in the future, depending upon developments involving both
the issuers and world events which impact the level of air travel.
Page 20
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
(Continued)
Income before income taxes decreased $0.7 million for the three months
ended June 30, 2004 compared to the same prior year period. The decrease was
primarily due to the decrease in investment income and other income partially
offset by a lower underwriting loss. Income before income taxes increased $29.4
million for the six months ended June 30, 2004 compared to the same prior year
period. The increase was primarily due to a lower underwriting loss and by
greater realized investment gains. The lesser six months underwriting loss was
primarily due to lower catastrophe losses, lesser loss severity and a decrease
in the provision for insured events in prior years. The net provision for
insured events in prior years consists of $3.0 million and $22.1 million of
adverse development ($19.9 million in the workers compensation line in the first
quarter of 2003) for the six months ended June 30, 2004 and 2003, respectively.
An insurance company's statutory combined ratio is a standard measure of
underwriting profitability. This ratio is the sum of (1) the ratio of incurred
losses and loss settlement expenses to net earned premium; (2) the ratio of
expenses incurred for commissions, premium taxes, administrative and other
underwriting expenses to net written premium; and (3) the ratio of dividends to
policyholders to net earned premium. The combined ratio does not reflect
investment income, federal income taxes or other non-operating income or
expense. A ratio of less than 100 percent generally indicates underwriting
profitability. Harleysville Group's statutory combined ratio increased to
105.4% for the three months ended June 30, 2004 from 105.2% for the three months
ended June 30, 2003. Such increase was due to a higher statutory combined ratio
in commercial lines partially offset by a lower statutory combined ratio in
personal lines. Harleysville Group's statutory combined ratio decreased to
106.3% for the six months ended June 30, 2004 from 110.2% for the six months
ended June 30, 2003. Such decrease was due to a lower underwriting loss in both
commercial lines and personal lines.
The statutory combined ratios by line of business for the three and six
months ended June 30, 2004, as compared to the three and six months ended June
30, 2003, were as follows:
Page 21
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
(Continued)
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
2004 2003 2004 2003
------- -------- -------- -------
Commercial:
Automobile 104.7% 94.4% 103.9% 95.1%
Workers compensation 122.2% 120.9% 122.5% 157.1%
Commercial multi-peril 105.5% 105.1% 105.3% 102.0%
Other commercial 95.4% 78.4% 88.5% 81.0%
Total commercial 106.7% 101.7% 105.7% 107.8%
Personal:
Automobile 110.9% 116.1% 114.6% 116.8%
Homeowners 86.0% 113.9% 97.6% 118.7%
Other personal 83.6% 123.8% 112.3% 118.8%
Total personal 100.6% 115.8% 108.4% 117.5%
Total personal and
commercial 105.4% 105.2% 106.3% 110.2%
The following table presents the liability for unpaid losses and loss
settlement expenses by major line of business:
JUNE 30, DECEMBER 31,
2004 2003
---------- -----------
(in thousands)
Commercial:
Automobile $ 234,072 $ 228,356
Workers compensation 296,011 294,750
Commercial multi-peril 342,212 320,607
Other commercial 63,446 59,042
---------- ----------
Total commercial 935,741 902,755
---------- ----------
Personal:
Automobile 109,081 117,034
Homeowners 39,416 41,264
Other personal 1,528 1,607
---------- ----------
Total personal 150,025 159,905
---------- ----------
Total personal and commercial 1,085,766 1,062,660
Plus reinsurance recoverables 167,517 157,317
---------- ----------
Total liability $1,253,283 $1,219,977
========== ==========
Page 22
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
(Continued)
The commercial lines statutory combined ratio increased to 106.7% for the
three months ended June 30, 2004 from 101.7% for the three months ended June 30,
2003 primarily due to higher losses in commercial automobile. The commercial
lines statutory combined ratio decreased to 105.7% for the six months ended June
30, 2004 from 107.8% for the six months ended June 30, 2003 due to lower losses
in workers compensation partially offset by higher losses in commercial
automobile and commercial multi-peril.
The net $3.0 million provision for insured events in prior years for the
six months ended June 30, 2004 was net of $7.1 million of adverse development in
commercial automobile ($4.0 million in the second quarter of 2004) which was
partially offset by favorable development in other commercial and personal
lines. The commercial automobile adverse development was primarily attributable
to the 1999 to 2001 accident years due to loss severity trends that were higher
than the adverse trends noted in this line in recent quarters. These trends
included an increase in litigation on bodily injury cases and a slowing rate of
settlement. The favorable development primarily was attributable to the 2003
accident year.
Of the $19.9 million of first quarter 2003 adverse development in the
provision for insured events in prior years in workers compensation, $16.7
million was attributable to the 1998 to 2001 accident years and the balance was
attributable to other accident years. Such adverse development represented 8.6%
of the December 31, 2002 workers compensation net liability for unpaid losses
and loss settlement expenses.
Harleysville Group had publicly noted adverse loss trends in its workers
compensation line for several quarters during 2002 and 2003. These trends are
consistent with the experience of other companies writing this coverage, many of
which have, during the past two years, made substantial additions to their
reserves for insured events in prior years in this line of insurance. The
change in loss development patterns in 2003 was influenced by a number of
factors. The reorganization of Harleysville Group's claims operations resulted
in more proactive claims management which, in turn, provided more
contemporaneous loss estimates. In addition, economic conditions have hampered
the ability to return injured workers to employment thus extending the estimated
length of disabilities and medical loss cost trends have increased.
The following table presents workers compensation claim count information
for the total pooled business in which Harleysville Group participates and
payment amounts which are Harleysville Group's pooling share of the total pooled
amounts.
Page 23
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
(Continued)
FOR THE SIX MONTHS FOR THE YEAR ENDED
ENDED JUNE 30, 2004 DECEMBER 31, 2003
------------------- ------------------
(dollars in thousands)
Number of claims pending,
beginning period 8,005 8,900
Number of claims reported 5,453 12,952
Number of claims settled or
dismissed (5,990) (13,847)
------- --------
Number of claims pending,
end of period 7,468 8,005
======= ========
Losses paid $37,010 $ 82,003
Loss settlement expenses paid $ 7,957 $ 16,465
Workers compensation losses primarily consist of indemnity and medical
costs for injured workers. The reduction in claim counts reflects the impact of
a reduction in workers compensation exposure as policy counts have declined.
Harleysville Group records the actuarial best estimate of the ultimate
unpaid losses and loss settlement expenses incurred and does not determine an
estimated possible range of loss. Actuarial loss reserving techniques and
assumptions, which rely on historical information as adjusted to reflect current
conditions, have been consistently applied during the periods presented. Changes
in the estimate of the liability for unpaid losses and loss settlement expenses
reflect actual payments and evaluations of new information and data since the
last reporting date. These changes correlate with actuarial trends.
Because of the nature of insurance claims, there are uncertainties inherent
in the estimates of ultimate losses. The aforementioned reorganization of the
claims operation has resulted in new people and processes involved in settling
claims. As a result, more recent statistical data reflects different patterns
than in the past and give rise to uncertainty as to the pattern of future loss
settlements. Litigation on bodily injury liability cases has increased during
the past two years while the rate of settlement has slowed. These changed
patterns give rise to greater uncertainty as to the pattern of future loss
settlements on bodily injury liability claims. There are uncertainties
regarding future loss cost trends particularly related to medical treatments and
automobile repair. Court decisions, regulatory changes and economic conditions
can affect the ultimate cost of claims that occurred in the past. Accordingly,
the ultimate liability for unpaid losses and loss settlement expenses will
likely differ from the amount recorded at June 30, 2004. For every 1% change in
the estimate, the effect on pre-tax income would be $10.9 million.
Page 24
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
(Continued)
The property and casualty industry has had substantial aggregate loss
experience from claims related to asbestos-related illnesses, environmental
remediation, product liability, mold, and other uncertain exposures.
Harleysville Group has not experienced significant losses from such claims.
The personal lines statutory combined ratio decreased to 100.6% and 108.4%
for the three and six months ended June 30, 2004 from 115.8% and 117.5% for the
three and six months ended June 30, 2003. The decreases primarily were due to
generally lower loss frequency, lesser catastrophe losses which affected the
homeowners line and a $0.7 million benefit to personal automobile from the
settlement of a dispute in the second quarter of 2004.
Net catastrophe losses decreased $2.3 million and $3.3 million and losses
ceded under the aggregate catastrophe reinsurance agreement with Mutual
decreased $1.8 million and $3.8 million for the three and six months ended June
30, 2004, respectively, due to less severe catastrophes in the 2004 periods.
A $0.7 million severance charge was incurred during the three months ended
June 30, 2004 related to the consolidation of 80 jobs. This reduction will
result in estimated annual savings of approximately $3.1 million when it is
completed in the second half of 2004. An additional net 60 positions are
planned to be eliminated through attrition in 2004.
The income tax expense for the three and six months ended June 30, 2004
includes a tax benefit of $2.7 million and $5.4 million associated with
tax-exempt interest compared to $2.6 million and $5.1 million in the same prior
year periods.
Effective for one year from July 1, 2004, the Company's subsidiaries and
Mutual and its wholly-owned subsidiaries renewed its catastrophe reinsurance
which provides coverage ranging from 85.0% to 95.0% of up to $155 million in
excess of a retention of $30 million for any given catastrophe excluding
terrorism for commercial lines. Harleysville Group's 2004 pooling share of this
coverage would range from 85.0% to 95.0% of up to $111.6 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 $142.2 million for any catastrophe
involving an insured loss equal to or greater than $185 million. Harleysville
Group's 2004 pooling share of this maximum recovery would be $102.4 million for
any catastrophe involving an insured loss of $133 million or greater. The treaty
includes reinstatement provisions providing for coverage for a second
catastrophe and requiring payment of an additional premium in the event of a
first
Page 25
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
(Continued)
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 of $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 $8.6 million.
Liquidity and Capital Resources
Operating activities provided $23.9 million and $59.2 million of net cash
for the six months ended June 30, 2004 and 2003, respectively. The change
primarily is from lesser underwriting cash flow and a change in the amount of
accounts payable and accrued expenses.
Investing activities used $27.0 million and $55.1 million of net cash for
the six months ended June 30, 2004 and 2003, respectively. The decrease is
primarily due to lower net purchases of fixed maturity investments, partially
offset by an increase in the purchase of short-term investments.
Net cash used by financing activities increased $3.7 million for the six
months ended June 30, 2004 compared to the six months ended June 30, 2003
primarily due to a decrease in the issuance of common stock, an increase in
dividends paid and by the purchase of treasury stock in the 2003 period.
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,
2004, Harleysville Group held cash collateral of $145.5 million related to
securities on loan with a market value of $142.1 million. Harleysville Group's
policy is to require initial collateral of 102% of the market value of loaned
securities plus accrued interest, which is required to be maintained daily by
the borrower at no less than 100% of such market value plus accrued interest
over the life of the loan. Acceptable collateral includes cash and money market
instruments, government securities, A-rated corporate obligations, AAA-rated
asset-backed securities or GIC's and Funding Agreements from issuers rated A or
better. 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.
Page26
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
(Continued)
Harleysville Group Inc. maintained $15.4 million of cash and marketable
securities at June 30, 2004 which is available for general corporate purposes
including dividends, debt service, capital contributions to subsidiaries,
acquisitions and the repurchase of stock. The Company has adopted a stock
purchase plan under which the Company may purchase up to 500,000 shares of
Harleysville Group Inc. common stock. Mutual has authorized purchases of the
common shares of Harleysville Group in an equal amount. As of June 30, 2004,
the Company had repurchased 397,909 shares leaving 102,091 shares authorized to
be repurchased. The Company has no other material commitments for capital
expenditures as of June 30, 2004.
RISK FACTORS
The business, results of operations and financial condition, and therefore
the value of the Harleysville Group's securities, are subject to a number of
risks. Some of those risks are set forth in the Company's annual report on Form
10-K for fiscal year 2003, filed with the Securities and Exchange Commission on
March 12, 2004.
Page 27
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, 2003 to June 30, 2004.
In addition, the Company has maintained approximately the same investment mix
during this period.
Page 28
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures. The Company's chief
executive officer and its chief financial officer, based on their
evaluation of the Company's disclosure controls and procedures (as
defined in Exchange Act Rule 13a-15(e)) have concluded that the
Company's disclosure controls and procedures are adequate and
effective for the purposes set forth in the definition thereof in
Exchange Act Rule 13a-15(e) as of June 30, 2004.
(b) Change in internal control over financial reporting. There was no
change in the Company's internal control over financial reporting that
occurred during the second quarter of 2004 that has materially affected,
or is reasonably likely to materially affect, the Company's internal
control over financial reporting except as noted in the next paragraph.
During 2003, the Company reviewed the processes by which case reserves
for loss and loss settlement expenses are estimated and whether those
processes were being consistently applied. These processes are an
important element in establishing aggregate reserves. Management took
steps in 2003 to improve internal controls in this area, including
hiring a new Senior Vice President to manage the claims function,
reducing turnover rates in the personnel engaged in estimating case
reserves and proactively managing the effects of such turnover,
implementing refinements in the processes which the Company follows
in estimating these reserves, and shifting the internal audit of
compliance with these processes from an internal auditor within the
claims department to the Company's regular internal audit group.
Management expects the effectiveness of these internal controls to
continue to improve in 2004 as a result of these actions and, as part
of our normal actuarial review process, will evaluate the impact of
these changes on a regular basis.
Page 29
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings - None
ITEM 2. Changes in Securities
(e) The Company announced a stock repurchase plan on March 3, 2003.
The Company may purchase up to 500,000 shares of Harleysville
Group Inc. common stock. The plan expires February 26, 2005.
As of June 30, 2004, the Company had repurchased 397,909 shares
leaving 102,091 shares authorized to be repurchased. There
was no activity in the plan during the six months ended June 30,
2004.
ITEM 3. Defaults Upon Senior Securities - None
ITEM 4. Submission of Matters to a Vote of Security Holders - None
The annual meeting of stockholders of Harleysville Group Inc. was
held on April 28, 2004 (the "Annual Meeting" or "Meeting"), with
the following result:
The total number of shares represented at the Annual Meeting in
person or by proxy was 28,294,404 of the 29,994,013 shares of common
stock outstanding and entitled to vote at the Meeting.
On the resolution to elect Lowell R. Beck and Joseph E. McMenamin as
class "A" Directors to serve until the expiration of their respective
terms and until their successors are duly elected, the nominees for
Director received the number of votes set forth opposite their
respective names:
Number of Votes
-----------------------
For Withheld
---------- --------
Lowell R. Beck 28,092,158 202,246
Joseph E. McMenamin 27,865,819 428,585
There were no abstentions or broker non-votes recorded. On the basis
of the above vote, Lowell R. Beck and Joseph E. McMenamin were
elected as class "A" Directors to serve until the expiration of
their respective terms and until their successors are duly elected.
ITEM 5. Other Information - None
Page 30
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
PART II. OTHER INFORMATION
(Continued)
ITEM 6. a. Exhibits
31.1 Certification of Chief Executive Officer Pursuant to Rule
13a-14(a) of the Exchange Act.
31.2 Certification of Chief Financial Officer Pursuant to Rule
13a-14(a) of the Exchange Act.
32.1 Certification of Chief Executive Officer Pursuant to 18
U.S.C. 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer Pursuant to 18
U.S.C. 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
b. Reports on Form 8-K
A Form 8-K dated April 30, 2004 was filed furnishing, under item
12 of Form 8-K, financial results for the first quarter of 2004.
Page 31
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
PART II. OTHER INFORMATION
(Continued)
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 4, 2004 /s/ BRUCE J. MAGEE
-------------------- -----------------------------------
Bruce J. Magee
Senior Vice President and
Chief Financial Officer
(principal financial officer and
principal accounting officer)
Page 32
EXHIBIT (31.1)
CERTIFICATION PURSUANT TO THE SECTION 302
OF THE SARBANES-OXLEY ACT OF 2002
I, Michael L. Browne, certify that:
1. I have reviewed the quarterly report on Form 10-Q of Harleysville Group
Inc.;
2. Based on my knowledge, this 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 report;
3. Based on my knowledge, the financial statements, and other financial
information included in this 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
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-15(e) and 15d(e)) for the registrant
and have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, 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 report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions
about the effectiveness of the disclosure controls and procedures,
as of the end of the period covered by this report based on
such evaluation; and
c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the
registrant's most recent fiscal quarter (the registrant's fourth
fiscal quarter in the case of an annual report) that has materially
affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting; and
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation of internal control over financial reporting,
to the registrant's auditors and the audit committee of the registrant's
board of directors (or persons performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability
to record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Date: August 4, 2004 /s/ MICHAEL L. BROWNE
---------------- -------------------------------------------
Michael L. Browne
Chief Executive Officer and a Director
Page 33
EXHIBIT (31.2)
CERTIFICATION PURSUANT TO THE SECTION 302
OF THE SARBANES-OXLEY ACT OF 2002
I, Bruce J. Magee, certify that:
1. I have reviewed the quarterly report on Form 10-Q of Harleysville Group
Inc.;
2. Based on my knowledge, this 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 report;
3. Based on my knowledge, the financial statements, and other financial
information included in this 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
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-15(e) and 15d(e)) for the registrant
and have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, 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 report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions
about the effectiveness of the disclosure controls and procedures,
as of the end of the period covered by this report based on
such evaluation; and
c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the
registrant's most recent fiscal quarter (the registrant's fourth
fiscal quarter in the case of an annual report) that has materially
affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting; and
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation of internal control over financial reporting,
to the registrant's auditors and the audit committee of the registrant's
board of directors (or persons performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability
to record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Date: August 4, 2004 /s/ BRUCE J. MAGEE
---------------- ----------------------------
Bruce J. Magee
Senior Vice President and
Chief Financial Officer
Page 34
EXHIBIT (32.1)
HARLEYSVILLE GROUP INC.
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 June 30, 2004, as filed with the
Securities and Exchange Commission on the date hereof (the "Report"), I, Michael
L. Browne, 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 based on my knowledge:
(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: August 4, 2004 /s/ MICHAEL L. BROWNE
------------------ --------------------------------------
Michael L. Browne
Chief Executive Officer and a Director
Page 35
EXHIBIT (32.2)
HARLEYSVILLE GROUP INC.
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 June 30, 2004, as filed with the
Securities and Exchange Commission on the date hereof (the "Report"), I, Bruce
J. Magee, Senior Vice President and 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 based on my knowledge:
(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: August 4, 2004 /s/ BRUCE J. MAGEE
------------------ ---------------------------
Bruce J. Magee
Senior Vice President and
Chief Financial Officer
Page 36