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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period from to .
Commission file number 0-16882
The Commerce Group, Inc.
(Exact name of registrant as specified in its charter)
Massachusetts 04-2599931
(State or other jurisdiction (IRS Employer Identification No.)
of incorporation)
211 Main Street 01570
Webster, Massachusetts (Zip Code)
(Address of principal executive offices)
Registrant's telephone number, including area code: (508) 943-9000
Securities registered pursuant to Section 12(b) of the Act:
Name of each Exchange
Title of each Class on Which Registered
Common Stock, $.50 Par Value Per Share New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
None
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
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 if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-
K or any amendment to this Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of
the registrant as of March 22, 2002, was approximately $868,663,536.
As of March 22, 2002, the number of shares outstanding of the
registrant's common stock (exclusive of treasury shares) was 32,950,452.
DOCUMENTS INCORPORATED BY REFERENCE
Parts I and II of this Form 10-K incorporate by reference information
from the registrant's annual report to stockholders for the fiscal year ended
December 31, 2001 (the "2001 Annual Report"). The 2001 Annual Report, except
for portions thereof, which have been specifically incorporated by reference,
shall not be deemed "filed" as part of this Form 10-K.
Portions of the registrant's definitive Proxy Statement for its annual
meeting of stockholders, which the Company intends to file within 120 days
after the end of the registrant's fiscal year ended December 31, 2001, are
incorporated by reference into Part III hereof as provided therein.
1
TABLE OF CONTENTS
Page
Glossary of Selected Insurance Terms.............................................. 3
Part I
Item 1. Business................................................................ 7
A. General........................................................... 12
B. Commonwealth Automobile Reinsurers................................ 16
C. Marketing......................................................... 17
D. Underwriting...................................................... 20
E. Reinsurance....................................................... 21
F. Settlement of Claims.............................................. 23
G. Loss and Loss Adjustment Expense Reserves......................... 24
H. Operating Ratios.................................................. 28
I. Investments....................................................... 29
J. Regulation........................................................ 32
K. Competition....................................................... 36
L. Other Matters..................................................... 37
Item 2. Properties.............................................................. 38
Item 3. Legal Proceedings....................................................... 39
Item 4. Submission of Matters to a Vote of Security Holders..................... 39
Item 4A. Executive Officers of the Registrant.................................... 39
Part II
Item 5. Market for Registrant's Common Stock and Related Stockholder Matters.... 41
Item 6. Selected Financial Data................................................. 42
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.................................................. 42
Item 7A. Qualitative and Quantitative Disclosures about Market Risk.............. 42
Item 8. Financial Statements and Supplementary Data............................. 42
Item 9. Changes in and Disagreements with Independent Auditors on Accounting
and Financial Disclosure............................................... 42
Part III
Item 10. Directors and Executive Officers of the Registrant...................... 42
Item 11. Executive Compensation.................................................. 42
Item 12. Security Ownership of Certain Beneficial Owners and Management.......... 43
Item 13. Certain Relationships and Related Transactions.......................... 43
Part IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K......... 43
Signatures.............................................................. 44
Index to Financial Statement Schedules.................................. 46
Index to Exhibits....................................................... 57
2
GLOSSARY OF SELECTED INSURANCE TERMS
Affinity group marketing program... In Massachusetts, an "affinity group marketing program"
is any system, design or plan whereby motor vehicle or
homeowner insurance is afforded to employees of an
employer or to members of a trade union, association or
organization in accordance with those provisions of
M.G.L. c. 175, s. 193R, distinguishing such plans from a
"mass-merchandising plan".
Specifically, an affinity group marketing program
contemplates the issuance of such insurance through
other than standard policies that generally preclude
individual underwriting, generally contains an option to
continue coverage by a standard policy upon termination
of employment or membership, restricts cancellation,
requires the continuance of certain participation in
ways not applicable to standard policies, and provides
for the downward modification of rates based upon the
experience of the insured group.
Assumed premiums................... Premiums acquired or allocated to an insurer other than
through its independent agencies.
A.M. Best.......................... A.M. Best Company, Inc. is a rating agency reporting on
the financial condition of insurance companies. A.M.
Best's statistics cited in this Form 10-K are based upon
information voluntarily submitted to it by insurers.
Casualty insurance................. Insurance which is primarily concerned with the losses
of the insured due to injuries to other persons and to
the property of others, and the legal liability imposed
on the insured resulting there from.
Catastrophe, catastrophic loss..... A severe loss, usually involving many risks such as
conflagration, earthquake, windstorm, explosion and
other similar events.
Combined ratio..................... A combination of the underwriting expense ratio and the
loss and LAE ratio determined in accordance with
Statutory Accounting Practices ("SAP"). The underwriting
expense ratio measures the ratio of underwriting
expenses to net premiums written, determined in
accordance with SAP. The loss and LAE ratio measures
the ratio of incurred losses and LAE to earned premiums,
determined in accordance with SAP.
Commissioner....................... The Commissioner of the Division of Insurance of
the Commonwealth of Massachusetts.
Commonwealth Automobile
Reinsurers ("C.A.R.").............. C.A.R. is a Massachusetts mandated reinsurance
mechanism, under which all premiums, expenses and losses
on ceded business are shared by all insurers. It is
similar to a joint underwriting association because a
number of insurers (39 in 2001) act as Servicing
Carriers for the risks it insures.
Direct............................. Refers to premiums, losses, LAE and expenses on policies
which a company writes before accounting for business
ceded and assumed through reinsurance.
3
Direct loss ratio.................. The ratio of direct incurred losses and LAE to direct
earned premiums.
Direct premiums written............ Total premiums for insurance sold to insureds, as
opposed to, and not including, reinsurance premiums.
Domestic insurer................... An insurance company that operates in the state in which
it is licensed.
Earned premiums.................... The portion of net premiums written that is equal to the
expired portion of policies recognized for accounting
purposes as income during a period. Also known as
premiums earned.
Excess of loss reinsurance......... Reinsurance which indemnifies the reinsured against all
or a specified portion of losses under reinsured
policies in excess of a specific dollar amount or
"retention".
Exclusive representative
producer ("ERP")................... A Massachusetts automobile insurance agency which does
not have a voluntary agency automobile insurance
relationship with an insurer, and which is assigned by
C.A.R. to an insurer who is a Servicing Carrier.
Exposure........................... An insurable unit defined as an automobile.
Hard market........................ An insurance market in which the demand for insurance
exceeds the readily available supply and premiums are
relatively high.
Incurred but not reported
reserves ("IBNR").................. Reserves for estimated losses which have been incurred
by insureds but not yet reported to the insurer.
Incurred losses.................... The total losses sustained by an insurance company under
a policy or policies, whether paid or unpaid. Incurred
losses include a provision for IBNR and Salvage and
Subrogation.
Inland marine insurance............ As used by the Company, insurance that provides protec-
tion for specific types of personal property, such as
jewelry, coins and fine arts, over the limits covered in
a standard homeowners insurance policy.
Loss adjustment expenses ("LAE")... The expenses relating to settling claims, including
legal and other fees and the portion of general company
expenses allocated to claim settlement costs.
LAE ratio.......................... The ratio of LAE, net of reinsurance recoveries, to
earned premiums.
Loss and LAE ratio................. The ratio of incurred losses plus LAE, net of
reinsurance recoveries, to earned premiums.
4
Loss reserves...................... Liabilities established by insurers to reflect the esti-
mated cost of claims payments and the related expenses
that the insurer will ultimately be required to pay in
respect of insurance it has written. Reserves are
established for losses and for LAE.
Net premiums written............... Direct premiums written for a given period less premiums
ceded to reinsurers during such period plus premiums
assumed during such period.
Participation ratio................ A Massachusetts insurer's share of the C.A.R. deficit
based upon the insurer's market share of automobile
risks not reinsured through C.A.R., adjusted for
utilization of C.A.R. and credits for voluntarily
writing less desirable under priced business and ceded
exclusions.
Premium-to-surplus ratio........... The ratio of net premiums written to policyholders'
surplus.
Property insurance................. Insurance that indemnifies a person with an insurable
interest in tangible property for loss related to damage
to or loss of use of the subject property.
Pure loss ratio.................... The ratio of net incurred losses, excluding LAE, to pre-
miums earned.
Quota share reinsurance............ Reinsurance in which the reinsured shares a proportion
of the original premiums and losses under the reinsured
policy. Also known as pro rata reinsurance.
Rate deviation..................... A specific state approved departure from an otherwise
applicable state set rate level provided to safe
drivers.
Rate discount...................... A specific state approved discount from an otherwise
applicable state set rate level provided to members of
affinity group marketing programs.
Reinsurance........................ The acceptance by one or more insurers, called rein-
surers, of all or a portion of the risk underwritten by
another insurer who has directly written the coverage.
However, the legal rights of the insured generally are
not affected by the reinsurance transaction and the
insurance company issuing the insurance policy remains
liable to the insured for payment of policy benefits.
Safe Driver Insurance Plan
("SDIP") A program mandated by Massachusetts state law that
encourages safe driving by rewarding drivers who do not
cause an accident, or incur a traffic law violation and
by charging high risk drivers a greater amount of
premiums. Under SDIP, drivers incur surcharge points
for traffic violations and at-fault accidents. Drivers
also earn credit points for each incident free year.
Drivers begin at a starting or neutral SDIP Step 15.
Drivers can earn credits down to SDIP Step 9, the lowest
step for good drivers, and incur surcharge points up to
SDIP Step 35, the highest step for bad drivers. The
SDIP is set to be revenue neutral industry-wide, wherein
credits received by good drivers are offset with
surcharges paid by bad drivers.
5
Servicing Carrier................. An automobile insurer writing business in Massachusetts
which can reinsure risks through C.A.R. while remaining
responsible for servicing the related policies and which
must provide a market for ERPs assigned to it by C.A.R.
Soft market........................ An insurance market in which the supply of insurance
exceeds the current demand and premiums are relatively
low.
Statutory accounting practices Recording transactions and preparing financial state-
ments in accordance with the rules and procedures
prescribed or permitted by an insurer's state insurance
regulatory authority for the purposes of financial
reporting to regulators, which in general reflect a
liquidating, rather than going concern, concept of
accounting.
Statutory surplus.................. The excess of admitted assets over total liabilities
(including loss reserves), determined in accordance with
SAP.
Take-all-comers.................... A phrase used to characterize the Massachusetts personal
automobile insurance system under which all insurers
are required to underwrite and accept virtually all
risks submitted to them.
Underwriting....................... The insurer's process of reviewing applications submit-
ted for insurance coverage, deciding whether to accept
all or part of the coverage requested and determining
the applicable premiums.
Underwriting expenses.............. The aggregate of policy acquisition costs, including
commissions, and the portion of administrative, general
and other expenses attributable to underwriting
operations.
Underwriting expense ratio......... The ratio of underwriting expenses to net premiums writ-
ten determined in accordance with SAP.
Unearned premiums.................. The portion of a premium representing the unexpired
amount of the contract term as of a certain date.
6
PART I
ITEM 1. BUSINESS
The Commerce Group, Inc. (the "Company"), was incorporated in 1976. The
Company is engaged in providing personal and commercial property and
casualty insurance primarily in Massachusetts through its principal
subsidiary, The Commerce Insurance Company ("Commerce"), which was
incorporated in 1971 and began writing business in 1972. The Company's
predominant insurance line is motor vehicle insurance, primarily covering
Massachusetts personal automobiles. The Company also offers commercial
automobile, homeowners, inland marine, fire, general liability and
commercial multi-peril insurance. The Company also writes insurance in
California and Oregon through Commerce West Insurance Company ("Commerce
West"), primarily a personal automobile insurer located in Pleasanton,
California. Additionally, the Company writes insurance through American
Commerce Insurance Company ("American Commerce"), which it acquired on
January 29, 1999. Located in Columbus, Ohio, American Commerce, is a
wholly-owned subsidiary of ACIC Holding Co., Inc. with policies in 26 states
and licenses in several others. In November of 1998, Commerce formed ACIC
Holding Co., Inc., in a joint venture with AAA Southern New England ("AAA
SNE") and invested $90,800,000 to fund the acquisition of the Automobile
Club Insurance Company whose name was changed to American Commerce upon
completion of the acquisition. Commerce invested $90,000,000 in the form of
preferred stock and an additional $800,000 representing an 80% common stock
ownership. AAA SNE invested $200,000 representing a 20% common stock
ownership. The terms of the preferred stock call for Commerce to receive
quarterly cash dividends at the rate of 10% per annum from ACIC Holding,
Co., Inc. In the event cash dividends cannot be paid, additional preferred
stock will be issued. Since 1995, Commerce has maintained an affinity group
marketing relationship with AAA Insurance Agency, Inc., a subsidiary of AAA
SNE. AAA Insurance Agency, Inc. has been a licensed insurance agent of
Commerce since 1985. In addition to the property and casualty insurance
business, the Company originates residential and commercial mortgages,
within Massachusetts and on a limited basis in Connecticut and operates an
insurance agency dealing in a full line of insurance products, including
those of the Company.
The Company's business strategy is to focus its insurance activities
primarily on the personal automobile market. The Company has over 1,042,000
polices in force, over 875,000 throughout the Commonwealth of Massachusetts
and over 167,000 in the 27 states served by Commerce West and American
Commerce. The Company, through Commerce and Citation Insurance Company
("Citation"), wholly-owned subsidiaries of Commerce Holdings, Inc. ("CHI"),
which is a wholly-owned subsidiary of the Company, has been the largest
writer of personal property and casualty insurance in Massachusetts in terms
of market share of direct premiums written since 1990. At year end 2001,
the Company's Massachusetts private passenger automobile market share was
23.3%, up from 22.3% in 2000. The Company is the second largest writer of
Massachusetts homeowners insurance and the third largest writer of
commercial automobile insurance in the Commonwealth. In addition, the
Company's combined insurance companies were also ranked the 26th largest
personal automobile insurance group in the country by A.M. Best, based on
the most recently available direct premium written information.
7
The accompanying table lists direct premiums written for the years ended
December 31, 2001 and 2000 for Massachusetts and other states business:
Direct Premiums Written, Year Ended December 31, 2001 (Dollars in thousands)
Massachusetts All Other States Total % of Total
Personal Automobile...... $ 859,922 $122,320 $ 982,242 85.2%
Homeowners............... 73,254 18,710 91,964 8.0
Commercial Automobile.... 58,088 1,514 59,602 5.2
Other Lines.............. 17,885 714 18,599 1.6
Total........... $1,009,149 $143,258 $1,152,407 100.0%
Direct Premiums Written, Year Ended December 31, 2000 (Dollars in thousands)
Massachusetts All Other States Total % of Total
Personal Automobile...... $ 827,180 $103,496 $ 930,676 86.9%
Homeowners............... 65,662 16,498 82,160 7.7
Commercial Automobile.... 43,243 104 43,347 4.0
Other Lines.............. 14,860 606 15,466 1.4
Total........... $ 950,945 $120,704 $1,071,649 100.0%
The Company attributes its success primarily to its strong
relationships with professional independent agencies that provide quality
business for the Company. Other factors that have been important to its
success include an in-depth understanding of the Massachusetts regulatory
and underwriting environments, an ability to operate efficiently with
economies of scale, advanced information systems, an extensive underwriting
database and, beginning in 1995, the ability to compete in an affinity group
marketing environment.
Because the Company offers its product lines only through independent
agencies, its relationships with those agencies are critical to its
continued success. The Company believes that it is the preferred provider
for most of its agencies and that, as a result of such position, it has
gained access to policyholders with average or above-average underwriting
profit characteristics in its personal and commercial automobile insurance
lines. The Company carefully selects and retains agencies whose premium
growth and loss ratio experience meet the Company's agency criteria, and
devotes substantial resources to fostering and maintaining strong
relationships with its existing agencies. The Company pays its agencies
significant compensation in the form of profit sharing, which is based in
part on the underwriting profits of the agency's business written with the
Company. In addition, the Company occasionally sponsors incentive award
trips to encourage agent profitability and growth. Refer to "Part I Item 1C
- - Marketing" for the details. Based upon agency surveys conducted several
times a year, the Company believes it is attentive to the needs and
requirements of its agencies. The Company emphasizes its commitment to the
Massachusetts insurance market, its responsiveness in servicing claims and
its internal support for agency operations, including direct billing of
insureds, direct claim reporting, on-line inquiry systems for its agents and
by providing competitively priced automobile insurance programs and
products.
Massachusetts Business
The Company's focus on automobile and homeowners insurance primarily in
Massachusetts (over 86% of total direct premiums written) has also been a
factor in its success. The terms, conditions and mandated rates of personal
automobile insurance are subject to extensive regulation. Because the
Company has primarily served the Massachusetts market, it has both an in-
depth understanding of this market and the ability to respond effectively to
shifts in the state's regulatory and underwriting environments. Currently,
the Company is
8
required to accept virtually all automobile insurance business submitted to
it by its agencies. The Company's ability to underwrite this business
profitably, however, depends on its understanding of the risks in the
business as well as its management of reinsurance through C.A.R.
The Company has actively pursued affinity group marketing programs
since 1995. The primary purpose of affinity group marketing programs is to
provide participating groups with a convenient means of purchasing private
passenger automobile insurance through associations and employer groups.
Emphasis is placed on writing larger affinity groups, although accounts with
as few as 25 participants are considered. Affinity groups are eligible for
rate discounts, which must be filed annually with the Division of Insurance.
In general, the Company looks for affinity groups with mature/stable
membership, favorable driving records and below average turnover ratios.
Participants who leave the sponsoring group during the term of the policy
are allowed to maintain the policy until expiration. At expiration, a
regular Commerce policy may be issued through the agency at the insured's
option.
Since the latter part of 1995, Commerce has been a leader in affinity
group marketing through agreements with the four American Automobile
Association Clubs of Massachusetts ("AAA clubs") offering discounts on
private passenger automobile insurance to the clubs' members who reside in
Massachusetts. A 6% discount was approved for policies effective January 1,
2002, which is the same as the discount for 2001. Membership in these clubs
is estimated to represent approximately one-third of the Massachusetts
motoring public, and has been the primary reason for a 62.6% increase in the
number of personal automobile exposures written by Commerce since year-end
1995 (the AAA affinity group program incepted in October of 1995). In 2001,
total direct premiums written attributable to the AAA group business were
$545,496 or 47.3% of the Company's total direct premiums written (63.4% of
the Company's total Massachusetts personal automobile premium), an increase
of 1.8% over 2000. Total exposures attributable to the AAA clubs group
business were 581,455 or 63.3% of total Massachusetts personal automobile
exposures in 2001, as compared to 559,696 or 64.5% in 2000. Of the total
Massachusetts automobile exposures written through the AAA affinity group
program by the Company, approximately 13.0% were written through insurance
agencies owned by the AAA clubs (8.7% of total Massachusetts automobile
exposures). The remaining 87.0% of the AAA group program was written
through the Company's network of independent agents (91.3% of total
Massachusetts automobile exposures).
Massachusetts law allows two years to reach the required group
penetration level of 35%. Commerce has continued to maintain AAA member
participation in excess of 35% through December 31, 2001, when it was
estimated at approximately 40%. The two-year penetration requirement was
waived by the Massachusetts Legislature for 2000, 2001 and 2002. Waiving
the penetration requirements allows insurance companies to continue offering
group discounts without reaching the 35% level.
Commerce and the AAA clubs have agreed that Commerce shall be their
exclusive under-writer of Massachusetts personal automobile group programs.
A rolling three-year contract exists between Commerce and the AAA clubs
which renews automatically and may be terminated upon a minimum of three
years written notice to either party.
Through 2000, the Company has offered its Massachusetts customers safe
driver deviations to drivers with SDIP classifications of either Steps 9 or
10 and to only Step 9 drivers in 2001. Safe driver deviations are rate
discounts based on the customer's driving record and resulting SDIP
classification and must be approved annually by the Commissioner. Steps 9
and 10 are the two best driver SDIP classifications in Massachusetts,
representing drivers with no at fault accidents and not more than one minor
moving vehicle violation in the last six years. In 2002, in response to the
average personal automobile rate decisions over the last several years, the
Company did not file for SDIP Step 9 or Step 10 deviations, for policies
incepting in the 2002 calendar year. During 2001, 55.0% of the Company's
exposures were eligible for Step 9 deviations, versus 55.1% and 14.0%,
eligible for Step 9 and Step 10 deviations in 2000.
9
The Company's other than personal automobile products tend to be
derived from its other two core product lines and therefore have had
relatively predictable risk profiles. The Company offers a preferred risk
homeowners product through Citation, which has an alternative pricing
schedule for selected insureds meeting more restrictive underwriting
guidelines. Citation also provides a separate rating tier for preferred
commercial automobile business. Approximately 17% of the voluntary
commercial automobile premium produced by its voluntary agents in 2001 was
written by Citation. Citation also produced 49.0% of Massachusetts
homeowner business based on direct premiums written. The Company expects
that these secondary rating tiers will continue to assist the Company in
retaining its better commercial automobile and homeowner accounts. The
Company also expects to further increase the percentage of commercial
automobile business that can be retained voluntarily by the Company in 2002
and beyond.
The Company's long-term commitment to providing consistent markets for
Massachusetts independent agencies, coupled with the withdrawal by several
national companies from the Massachusetts personal automobile market, which
occurred during the years 1987 through 1991, has been a significant factor
in enabling the Company to increase and maintain its market share by
contracting with agencies, which meet its agency criteria. The Company
believes that Massachusetts agencies are more likely to seek to develop and
expand relationships with domestic insurers, which, like the Company, have a
long-term commitment to and focus on the Massachusetts personal automobile
market.
During the past few years, the Company has devoted substantial time and
resources to the development of its current information systems, which
enhanced both its underwriting and its agency support. Through the use of
several customized software programs, the Company has the ability to analyze
its internal historical underwriting data and use such information in
making, in the Company's belief, more informed underwriting decisions. In
particular, the Company believes that the amount and extent of detail data
accumulated as a result of its share of the Massachusetts personal
automobile market gives the Company a competitive advantage in determining
which automobile risks to reinsure through C.A.R. The Company's information
systems also enable it to provide extensive support to its agencies. This
support includes a direct billing system, which covers over 98% of the
Company's policyholders, an on-line inquiry system, which allows agencies to
ascertain the status of pending claims and direct bill information and a
system which allows Company agencies to quote premiums for the Company's
three core product lines directly to policyholders. The Company has
developed claims and direct bill inquiry, along with providing agents access
to correspondence, manuals and reports via the Internet. This service is
available to all agents. During 2001, approximately 504 agents had access
to this service, which represents over 90% of all Massachusetts agents.
Other States Business
Direct premiums written in states other than Massachusetts by Commerce
West and American Commerce, increased $22,554,000 or 18.7%. Roughly half of
this growth resulted from an increase of $11,505,000 or 44.5% in personal
automobile direct premiums written by Commerce West. The growth from
Commerce West is primarily attributable to non-standard automobile business.
Commerce West began writing in this segment of the market in late 1999.
Commerce West also began writing commercial automobile in late 2000,
resulting in writings of $1,514,000 in 2001. American Commerce direct
premiums written increased $9,655,000 or 10.2%, primarily due to an increase
in personal automobile premiums of $7,319,000 or 9.4%. American Commerce
also experienced a 13.4% increase in homeowners premiums written. American
Commerce, which writes business in 26 states, wrote greater than 90% of its
business in eleven states.
10
Commerce West premiums and the eleven states with the highest
percentages of premiums written by American Commerce are shown in the
following table:
% of Direct Premiums
Company State Written by State
2001 2000
Commerce West California............ 89.8% 99.1%
Oregon................ 10.2% 0.9%
Total............ 100.0% 100.0%
American Commerce Arizona............... 20.9% 21.5%
Rhode Island.......... 14.3% 10.8%
Ohio.................. 12.6% 11.6%
Oregon................ 10.5% 10.2%
Washington............ 8.0% 8.1%
Oklahoma.............. 7.7% 6.4%
Kentucky.............. 5.9% 5.8%
Indiana............... 4.6% 3.5%
West Virginia......... 2.5% 2.7%
Idaho................. 2.5% 2.4%
Tennessee............. 2.4% 2.2%
Other states.......... 8.1% 14.8%
Total............ 100.0% 100.0%
The decrease in other states for American Commerce is primarily
attributable to business in several states being moved to other insurance
companies affiliated with the ownership of the agencies representing that
business. These and some future moves for business in other states were
anticipated at the time the Company negotiated the acquisition of American
Commerce.
Market Risk: Interest Rate Sensitivity and Equity Price Risk
The Company's investment strategy emphasizes investment yield while
maintaining investment quality. The Company's investment objective
continues to focus on maximizing after-tax investment income through
investing in high quality diversified investments structured to maximize
after-tax investment income while minimizing risk. The Company's funds are
generally invested in securities with maturities intended to provide
adequate funds to pay claims and meet other operating needs without the
forced sale of investments. Periodically, sales have been made from the
Company's fixed maturity portfolio to actively manage portfolio risks,
including credit-related concerns, to optimize tax planning and to realize
gains. This practice will continue in the future.
In conducting investing activities, the Company is subject to, and
assumes, market risk. Market risk is the risk of an adverse financial
impact from changes in interest rates and market prices. The level of risk
assumed by the Company is a function of the Company's overall objectives,
liquidity needs and market volatility.
The Company manages its market risk by focusing on higher quality
equity and fixed income investments, by periodically monitoring the credit
strength of companies in which investments are made, by limiting exposure in
any one investment and by monitoring the quality of the investment portfolio
by taking into account credit ratings assigned by recognized rating
organizations. Of the Company's bonds, 97.9% are rated in either of the two
highest qualities categories provided by the NAIC. Although the Company has
significant holdings of various closed-end preferred stock mutual funds,
these funds are comprised primarily of preferred stocks traded on national
stock exchanges, thus limiting exposure to any one investment.
11
As part of its investing activities, the Company assumes positions in
fixed maturity, equity, short-term and cash equivalents markets. The
Company is, therefore, exposed to the impacts of interest rate changes in
the market value of investments. At December 31, 2001, the Company's
exposure to interest rate changes and equity price risk has been estimated
using sensitivity analysis. The interest rate impact is defined as the
effect of a hypothetical interest rate change of plus-or-minus 200 basis
points on the market value of fixed maturities and preferred stocks. The
equity price risk is defined as a hypothetical change of plus-or-minus 10%
in the fair value of common stocks. Changes in interest rates would result
in unrealized gains or losses in the market value of the fixed maturity and
preferred stock portfolio due to differences between current market rates
and the stated rates for these investments. Based on the results of the
sensitivity analysis at December 31, 2001, the Company's estimated market
exposure for a 200 basis point increase (decrease) in interest rates was
calculated. A 200 basis point increase results in a $83,611,000 decrease in
the market value of the fixed maturities and preferred stocks. A 200 basis
point decrease results in a $47,436,000 increase in the market value of the
same securities. The equity price risk impact at December 31, 2001, based
upon a 10% increase in the fair value of common stocks and preferred stock
mutual funds, would be an increase of $10,746,000 and $31,567,000,
respectively. Based upon a 10% decrease, common stocks and preferred stock
mutual funds would decrease $10,746,000 and $31,567,000, respectively.
Long-term interest rates (30-year Treasury Bond) increased slightly to 5.47%
at December 31, 2001 from 5.46% at December 31, 2000. The preceding
sensitivity analysis does not represent a forecast and should not be relied
upon as being indicative of expected operating results. These hypothetical
estimates are based upon numerous assumptions such as the nature and timing
of interest rate levels including the yield curve shape, prepayments on
loans and securities, reinvestment and replacement of asset and liability
cash flows and others. While assumptions are developed based upon current
economic conditions, the Company cannot provide any assurance as to the
predictive nature of these assumptions. Also, as market conditions vary
from those assumed in the sensitivity analysis, actual results will also
differ due to prepayment and refinancing levels likely deviating from those
assumed and other internal and external variables. Furthermore, the
sensitivity analysis does not reflect actions that management might take in
responding to or anticipating changes in interest rates.
A. General
Insurance Lines
Commerce and Citation, the Company's Massachusetts property and
casualty insurance subsidiaries, currently have a combined A.M. Best's
rating of A+ (Superior). Commerce West, and American Commerce currently
have A.M. Best's ratings of A (Excellent). According to Best's, an insurer
with a Superior rating has achieved superior overall performance and has
shown the strongest ability to meet their policyholder and other contractual
obligations when compared to the norms of the property and casualty
insurance industry. An insurer with an Excellent rating has demonstrated,
in A.M. Best's opinion, excellent overall performance when compared to
standards developed by A.M. Best.
12
The following table compares direct premiums written, net premiums
written and earned premiums for the years ended December 31, 2001 and 2000:
(Dollars in thousands) Years Ended December 31,
2001 2000 $ Change % Change
Direct Premiums Written:
Personal Automobile in Massachusetts...... $ 859,922 $ 827,180 $ 32,742 4.0%
Personal Automobile in All Other States... 122,320 103,496 18,824 18.2%
Commercial Automobile in Massachusetts.... 58,088 43,243 14,845 34.3%
Commercial Automobile in All Other States. 1,514 104 1,410 *
Homeowners in Massachusetts............... 73,254 65,662 7,592 11.6%
Homeowners in All Other States............ 18,710 16,498 2,212 13.4%
Other Lines in Massachusetts.............. 17,885 14,860 3,025 20.4%
Other Lines in All Other States........... 714 606 108 17.8%
Total Direct Premiums Written.......... $1,152,407 $1,071,649 $ 80,758 7.5%
Net Premiums Written:
Personal Automobile in Massachusetts...... $ 864,900 $ 839,394 $ 25,506 3.0%
Personal Automobile in All Other States... 122,256 103,719 18,537 17.9%
Commercial Automobile in Massachusetts.... 60,986 44,848 16,138 36.0%
Commercial Automobile in All Other States. 1,477 104 1,373 *
Homeowners in Massachusetts............... 20,364 17,547 2,817 16.1%
Homeowners in All Other States............ 4,576 (1,658) 6,234 *
Other Lines in Massachusetts.............. 4,236 4,916 (680) (13.8%)
Other Lines in All Other States........... 172 41 131 319.5%
Total Net Premiums Written............. $1,078,967 $1,008,911 $ 70,056 6.9%
Earned Premiums:
Personal Automobile in Massachusetts...... $ 776,552 $ 714,972 $ 61,580 8.6%
Personal Automobile in All Other States... 116,479 100,101 16,378 16.4%
Commercial Automobile in Massachusetts..... 43,008 32,548 10,460 32.1%
Commercial Automobile in All Other States. 711 19 692 *
Homeowners in Massachusetts............... 19,119 17,364 1,755 10.1%
Homeowners in All Other States............ 3,731 4,186 (455) (10.9%)
Other Lines in Massachusetts.............. 3,290 3,434 (144) (4.2%)
Other Lines in All Other States........... 158 162 (4) (2.5%)
Assumed Premiums from C.A.R............... 80,176 81,300 (1,124) (1.4%)
Assumed Premiums from Other than C.A.R.... 428 397 31 7.8%
Total Earned Premiums.................. $1,043,652 $ 954,483 $ 89,169 9.3%
Earned Premiums in Massachusetts.......... $ 841,969 $ 768,318 $ 73,651 9.6%
Earned Premiums-Assumed................... 80,604 81,697 (1,093) (1.3%)
Earned Premiums in All Other States....... 121,079 104,468 16,611 15.9%
Total Earned Premiums.................. $1,043,652 $ 954,483 $ 89,169 9.3%
*Calculation is not meaningful.
13
The Company's principal insurance line is personal automobile
insurance. The Company offers automobile policyholders the following types
of coverage: bodily injury liability coverage, including underinsured and
uninsured motorist coverage, personal injury protection coverage, property
damage liability coverage and physical damage coverage, including fire,
theft and other hazards specified in the policy. In Massachusetts,
policies are written for one-year terms. Personal automobile policies
written by Commerce West and American Commerce outside of Massachusetts
are primarily written for a policy term of six months. The Company's
published liability limits for Massachusetts business written by Commerce
is $500,000 per person for bodily injury, $1,000,000 per accident and
$100,000 for property damage. Liability limits of $100,000 per person
injured, $300,000 per accident and $100,000 for property damage are the
limits most commonly purchased from the Company in Massachusetts. For
California business written by Commerce West, liability limits of $15,000
per person injured and $30,000 per accident are most commonly purchased.
For Oregon business written by Commerce West, liability limits of $25,000
per person insured and $50,000 per accident are most commonly purchased.
For business written by American Commerce, liability limits of $100,000
per person injured and $300,000 per accident are most commonly purchased.
Massachusetts Automobile Business
In Massachusetts, private passenger automobile insurance is subject
to extensive regulation. Owners of registered automobiles are generally
required to maintain certain minimum automobile insurance coverages. With
very limited exceptions, automobile insurers are required by law to issue
a policy to any applicant seeking to obtain such coverages. Companies in
Massachusetts are also assigned agents, known as Exclusive Representative
Producers ("ERPs"), based primarily on market share, that have been unable
to obtain a voluntary contract with an insurance carrier. Marketing and
underwriting strategies for companies operating in Massachusetts are
limited by maximum premium rates and minimum agency commission levels for
personal automobile insurance, both of which are mandated by the
Massachusetts Commissioner of Insurance ("Commissioner"). In
Massachusetts, accident rates, bodily injury claims, and medical care
costs continue to be among the highest in the nation. According to the
Automobile Insurers Bureau of Massachusetts ("A.I.B."), Massachusetts "has
higher than average medical costs and liability claims involving
attorneys". According to the A.I.B., Massachusetts personal automobile
premium per policy, based upon on the latest available premium information
from 1999, was 5th highest in the nation.
During the three-year period from 1999 to 2001, average mandated
Massachusetts personal automobile insurance premium rates decreased an
average of 2.3% per year. The Commissioner approved no rate change in
personal automobile premiums for 2002, as compared to an average rate
decrease of 8.3% in 2001. Coinciding with the 2002 rate decision, the
Commissioner also approved no change in the commission rate agents receive
for selling private passenger automobile insurance from 12.3% in 2001.
State Mandated
Average Commerce Average Rate
Year Rate Change Change Per Exposure
2002 0.0% 5.0%(Estimated)
2001 (8.3%) (1.9%)
2000 0.7% 6.2%
1999 0.7% 9.1%
Although average mandated personal automobile premium rates were
decreased by 8.3% in 2001, the Company's average rate decreased 1.9% per
exposure. The 1.9% decrease for 2001 was primarily the result of the
state mandated average rate decrease offset by decreases in the SDIP
deviations for Step 9 and Step 10 drivers, the two best driver SDIP
classifications in Massachusetts. The Company decrease was also due to
the facts that the rate decision did not anticipate purchases of new
automobiles in the year to which the rate decision applied and, secondly,
the Company's mix of personal automobile business differs from that of the
industry.
14
The 1999 average rate decision was partially driven by corrections
for an industry error that had impacted prior year rate decisions. The
industry error resulted from a miscalculation of industry expense
allowances that had the effect of over-stating rates for 1991 through
1996. Mandated rates for 1997, 1998 and 1999 included an adjustment to
recoup the effects of this error from the industry. The adjustment
included in the rate decision to recoup the error was phased in during
1997, 1998 and 1999. The earned premium impact of this, coupled with the
impact of a previous year imbalance in the SDIP, was approximately $14.0
million for 1999. The earnings per share after-tax impact resulting from
lower earned premiums were estimated at $0.26 for 1999.
The Company also offers homeowners insurance in Massachusetts,
including a very limited amount of policies in designated coastal areas.
The Company's standard homeowners policy is an all risk, replacement cost
insurance policy covering a dwelling and the content contained therein.
The Company's published limits of liability for property damage to a
dwelling are a minimum coverage of $60,000 and a maximum coverage of
$750,000, although some policies over this amount are written on an
exception basis. For personal liability, the minimum coverage is $100,000
and the maximum coverage is $1,000,000. The average dwelling coverage
amount per policy is approximately $175,000, and generally, the average
amount of contents coverage is 70% of the amount of coverage for the
dwelling, with limitations on the amount of coverage per item placed on
securities, cash, jewelry, furs, silverware, computer equipment and
firearms. However, additional coverage for such items can be purchased on
a scheduled personal property basis. The Company also offers $1,000,000,
$2,000,000 and $3,000,000 personal liability umbrella coverage which is
reinsured through American Reinsurance Corporation. Similar coverages are
offered by American Commerce as part of its homeowner business.
The Company offers a preferred homeowners product through Citation,
which has higher policy limits and a lower premium structure and is
designed primarily for homes with above-average market values. The
Company also applies more stringent underwriting criteria by, among other
things, limiting the product to homes with modern electrical systems.
The Company also offers inland marine, fire, general liability and
commercial multi-peril insurance in Massachusetts. Commerce West
predominantly writes private passenger automobile insurance in California
and Oregon through 617 independent insurance agencies and brokers. All
business is underwritten at the Company's headquarters located in
Pleasanton, California. Although primarily writing preferred business,
Commerce West began writing non-standard business in late 1999. American
Commerce predominantly writes private passenger automobile and homeowners
insurance in 26 states exclusively through 36 AAA independent insurance
agencies. Products are similar to those offered by Commerce and Citation.
All business is underwritten at the Company's headquarters located in
Columbus, Ohio. Both Companies target preferred insurance risks.
Mortgage Operations
Insurance companies are authorized to invest in mortgages. The
Company formed Bay Finance Company, Inc. ("Bay Finance") to originate and
service residential and commercial mortgages in Massachusetts and, on a
limited basis, in Connecticut. During fiscal 2001, 2000 and 1999 the
mortgage operations accounted for approximately $3,640,000, or 0.3%,
$5,407,000, or 0.5% and $5,429,000, or 0.6% of the Company's consolidated
total revenues, respectively.
Insurance Agency
Clark-Prout Insurance Agency, Inc. ("Clark-Prout") is a wholly-owned
insurance agency that writes both for the Company and for other insurance
companies. During fiscal 2001, 2000 and 1999, Clark-Prout's revenues
amounted to $629,000, or 0.1%, $717,000, or 0.1% and $803,000, or 0.1% of
the Company's consolidated total revenues, respectively.
15
Segment Information
The information in NOTE O in the Company's 2001 Annual Report is
incorporated herein by reference.
B. Commonwealth Automobile Reinsurers
A significant aspect of the Company's automobile insurance business
relates to its interaction with C.A.R. C.A.R. is a state-mandated
reinsurance mechanism, which enables the Company and the Servicing
Carriers to reinsure any under priced automobile risk. Servicing
Carriers, which are responsible for over 99.0% of total direct premiums
written for personal automobile insurance in Massachusetts, are required
to offer automobile insurance coverage to all eligible applicants pursuant
to "take-all-comers" regulations, but may reinsure under priced business
with C.A.R. In addition, Servicing Carriers are obligated to accept
involuntary agencies, known as ERPs, from C.A.R. and to provide an
automobile insurance market in Massachusetts for those agencies.
C.A.R. maintains separate pools for liability and physical damage
coverage in personal and commercial automobile risks. All companies
writing automobile insurance in Massachusetts share in the underwriting
results of C.A.R. business for their respective product line or lines,
whether or not they are Servicing Carriers. Since its inception, C.A.R.
has annually generated multi-million dollar underwriting losses in both
the personal and commercial pools. Accordingly, each automobile insurer
attempts to develop and implement underwriting strategies that will
minimize its relative share of the C.A.R. deficit while maintaining
acceptable loss ratios on risks not reinsured through C.A.R.
In general, the C.A.R. reinsurance mechanism operates as follows.
Within established time frames, a Servicing Carrier must identify which
policies it wishes to retain and which policies it wishes to cede to
C.A.R. A Servicing Carrier pays to C.A.R. all of the premiums generated
by the policies it has ceded and also reimburses C.A.R. the difference
between standard rates and the reduced premium resulting from affinity
group marketing discounts on policies ceded to C.A.R. C.A.R. reimburses
Servicing Carriers for all losses incurred on account of ceded policies,
although, as with reinsurance generally, reinsurance of a policy through
C.A.R. does not legally discharge the Servicing Carrier from its liability
to the policyholder for the full amount of the policy. In addition,
Servicing Carriers also receive fees for servicing ceded policies based
upon the expense structure established by C.A.R.
An insurer's proportionate share of the C.A.R. deficit is allocated
on the basis of a formula called a participation ratio, which can vary
significantly between the personal and commercial pools, and between
different policy years. Under current regulations, an insurer's share of
the C.A.R. deficit is based upon its market share for retained automobile
risks for the particular pool, adjusted by a utilization formula, such
that, in general, its participation ratio is disproportionately and
adversely affected if its relative use of C.A.R. reinsurance exceeds that
of the Massachusetts industry and favorably affected if its relative use
of C.A.R. reinsurance is less than that of the Massachusetts industry.
The current formula also contains a provision whereby certain high risk
business, if reinsured through C.A.R., is excluded in determining an
insurer's participation ratio. Finally, for the personal automobile
C.A.R. pool, an insurer's participation ratio may be affected by credits
received for not reinsuring through C.A.R. automobile risks in selected
under priced classes and territories. An insurer's participation ratio
will be favorably affected if its relative use of credits exceeds that of
the Massachusetts industry.
Company Private Passenger Participation Ratio for C.A.R. versus Market
Share
Company Participation Company
Year Ratio in C.A.R. Market Share
2001* 16.8% 23.3%
2000 16.9% 22.3%
1999 16.5% 21.3%
*Estimated
16
The Company's objective is to develop and implement underwriting
strategies to obtain the optimum balance between its C.A.R. participation
ratio and the loss ratios on automobile risks not reinsured through C.A.R.
For each automobile risk and certain risk categories, the Company makes a
judgment as to whether the projected impact on the Company's profitability
from retaining the risk outweighs the incremental cost of reinsuring the
risk through C.A.R. In determining the incremental cost of reinsuring a
risk through C.A.R., the Company estimates its participation ratio for a
given period by modeling the anticipated Massachusetts industry-wide
C.A.R. trends. Once the Company estimates its participation ratio, it is
then able to compare the incremental effect on the Company's share of the
C.A.R. deficit of either reinsuring or retaining the particular automobile
risks. Finally, the Company utilizes its internal underwriting database
and internally-developed actuarial reporting and decision support systems
to develop a projected underwriting loss ratio for each risk. It then
compares the impact of the automobile risk on the Company's participation
ratio in order to estimate whether, after taking all C.A.R. and other
factors into account, the Company's profitability will be enhanced by
reinsuring or retaining such risk. The Company believes that, because of
its leading share of the Massachusetts automobile insurance market, it can
utilize statistically credible data for a greater array of underwriting
factors than its competitors, which in turn gives it a competitive
advantage in deciding which automobile risks to reinsure through C.A.R.
The C.A.R. utilization-based participation ratio has been in place
since 1993, and individual companies in the marketplace make minor yearly
changes to find their optimum balance between voluntary and ceded
writings. In 2001, the Company ceded approximately $60,277,000 or 7.0% of
the Company's Massachusetts personal automobile direct premiums written,
compared to $60,038,000, or 7.3% in 2000. The Company's strategy has been
to voluntarily retain more of the types of personal automobile business
that are factored as credits favorably impacting the utilization formula.
These credits result from voluntarily writing business in under-priced
territories and for under-priced risks. As a result of increased
voluntary retention in excess of the industry, the credits impacting the
utilization formula have favorably affected the Company's participation
ratio. As indicated in the above table, this ratio is several percentage
points below the Company's estimated 23.3% share of the Massachusetts
personal automobile market.
Although commercial automobile insurance is a relatively smaller
portion of the Company's total insurance writings, the related commercial
automobile risk selection decisions remain an important element in
determining profitability. In 2001, the Company ceded approximately
$9,062,000 or 15.6% of its Massachusetts commercial automobile direct
premiums written, as compared to $7,414,000 or 17.1% in 2000.
C.A.R. rule changes occur, as C.A.R. adjusts the operations of the
personal and commercial reinsurance mechanisms to address the needs of the
Massachusetts automobile insurance market. Any material change to the
C.A.R. rules in the future will affect the Company. The Company is not
currently aware of any likely future rule changes that could have a
material impact on the Company, but there can be no assurance that such
rule changes will not occur.
C. Marketing
The Company markets its insurance products through a network of
licensed independent agencies, 539 throughout Massachusetts (of which 131
are ERPs), 617 in California and Oregon for Commerce West, and 36 for
American Commerce. The non-ERP independent agencies may also represent
other insurance companies, some of which may compete directly with the
Company. The independent insurance agencies are under contract with the
Company's subsidiaries and must conduct their business according to the
provisions of their contract. Contracts for Massachusetts agencies may be
terminated by the Company upon 180 days' notice to the agency or at will
by the agency.
17
Massachusetts Business
The Company seeks to establish long-term relationships with agencies
that can generate a sizable volume of business with profitable
underwriting characteristics and for which the Company will be among the
top two or three preferred writers of its core products. The Company also
assesses whether the mix of a prospective agency's business will expand
the Company's presence in one or more of its core product lines. In 2001,
each agency representing the Company in Massachusetts produced an average
of approximately $1,893,000 of Company direct premiums written or a 4.3%
increase as compared to 2000. Also in Massachusetts during 2001, 201
agencies produced between $1.0 million and $2.0 million of direct premiums
written, an additional 58 agencies produced between $2.0 million and $3.0
million, an additional 42 agencies produced between $3.0 million and $4.0
million and lastly, an additional 39 agencies produced over $4.0 million.
The Company's three largest agencies produced approximately $67.5, $17.0
and $14.5 million of the Company's Massachusetts direct premiums written,
respectively, or approximately 6.7%, 1.7% and 1.4% in 2001.
Once appointed, each agency's performance is carefully monitored. An
Agency Evaluation Committee, comprised of representatives of the Company's
Marketing, Underwriting and Premium Accounting departments, utilizes a
host of pre-established criterion (loss ratio, premium volume, etc.) to
continuously evaluate agencies. Generally, the Company will counsel an
agency on how to improve its underwriting and profitability before any
agency will be terminated.
Company agencies receive commissions on policies written for the
Company and are eligible to receive contingent commissions through a
profit sharing arrangement. The Commissioner annually establishes a
minimum average direct commission for personal automobile insurance, which
in 2001 was 12.3%. The Company's contingent commissions are tied to the
underwriting profit on policies written by an agency. The Company
generally pays up to 45% of the underwriting profit attributable to the
agency's business. The arrangement for Massachusetts business utilizes a
three year rolling plan, with one third of each of the current and the two
prior years profit or loss calculations, summed to a single amount. This
amount, if positive, is multiplied by the profit sharing rate and paid to
the agent. To qualify for profit sharing, a three-year average loss ratio
of 50% to 55% or better is generally required. C.A.R. credits for
voluntary business written in urban areas or credits for writing youthful
operators on a voluntary basis increase the loss ratio eligibility for
profit sharing up to 55% from 50%. Books of business with no available
credits must achieve a lower loss ratio. In 2001, total commission
expensed by the Company to its agencies amounted to 15.5% of direct
premiums written, of which direct commissions and contingent commissions
constituted 14.1% and 1.4%, respectively, versus total commission expensed
of 16.2%, of which 14.1% was direct and 2.1% was contingent in 2000.
Direct commissions are higher than the personal automobile minimum
commission rates primarily due to higher commission rates on SDIP Step 9
business coupled with higher commissions on other lines of business. In
2001, the Company's expense for contingent commissions was $14.0 million
versus $19.5 million in 2000.
The Company also occasionally sponsors incentive award trips to
encourage and reward agency profitability and growth. In 1998, the
Company initiated the T2000 Sales Incentive Contest. One part of the
measurement period concluded on December 31, 1999 and the other concluded
on May 31, 2000 with agents earning incentive trips, which took place in
April and September of 2000, respectively. The estimated total cost was
approximately $1.3 million of which approximately $45,000 was expensed in
2000 and $571,000 in 1999.
The Company's information systems enable it to provide extensive
support to its agencies. This support includes a direct billing system,
which covers over 98% of the Company's Massachusetts policyholders, an on-
line inquiry system which allows agents to ascertain quickly the status of
pending claims or direct bill information and a system which allows
Company agents to quote many premiums directly to policyholders. The
Company also emphasizes its commitment to enhancing and expanding the role
of its information systems. The Company has provided agencies with the
ability to generate personal automobile policies from their own offices
and continuously explores new options on an ongoing basis. The Company
has also developed Internet connectivity for its independent agents.
18
The Company believes that, because of its compensation arrangements
and by providing a consistent market with emphasis on service, an
increasing number of the Company's agencies will rely on it as their
principal supplier of insurance products. The Company believes that it is
the preferred provider for most of its agencies. Although the Company
believes, based on annual surveys of its agencies, that its relationships
with its independent agencies are excellent, any disruption in these
relationships could adversely affect the Company's business.
Since the latter part of 1995, Commerce has been a leader in affinity
group marketing through agreements with the four American Automobile
Association Clubs of Massachusetts ("AAA clubs") offering discounts on
private passenger automobile insurance to the AAA clubs' members who
reside in Massachusetts. A 6% discount was approved for policies
effective January 1, 2002, which is the same as the discount for 2001.
Membership in these AAA clubs is estimated to represent approximately one-
third of the Massachusetts motoring public, and has been the primary
reason for a 62.6% increase in the number of personal automobile exposures
written by Commerce since year-end 1995 (the AAA affinity group program
incepted in October of 1995). In 2001, total direct premiums written
attributable to the AAA group business were $545,496 or 47.3% of the
Company's total direct premiums written (63.4% of the Company's total
Massachusetts personal automobile premium), an increase of 1.8% over 2000.
Total exposures attributable to the AAA clubs' group business were 581,455
or 63.3% of total Massachusetts personal automobile exposures in 2001, as
compared to 559,696 or 64.5% in 2000. Of the total Massachusetts personal
automobile exposures written through the AAA affinity group program by the
Company, approximately 13.0% were written through insurance agencies owned
by the AAA clubs (8.7% of total Massachusetts automobile exposures). The
remaining 87.0% of the AAA group program was written through the Company's
network of independent agents (91.3% of total Massachusetts automobile
exposures). For additional details, refer to the following table on
discounts and deviations.
AAA Affinity Group Discount and SDIP Deviations 2002* 2001 2000 1999
AAA Affinity Group Discount................. 6.0% 6.0% 6.0% 6.0%
SDIP Step 9 Deviation....................... 0.0% 2.0% 6.0% 8.0%
SDIP Step 10 Deviation...................... 0.0% 0.0% 2.0% 3.0%
Combined AAA Affinity Group Discount and
Step 9 Deviation.......................... 6.0% 7.9% 11.6% 13.5%
Combined AAA Affinity Group Discount and
Step 10 Deviation......................... 6.0% 6.0% 7.9% 8.8%
*For policies with effective dates as of January 1, 2002 or thereafter.
Agreements for the Transfer of Massachusetts Business from Other Companies
in 2002
The Company entered into an agreement on September 28, 2001, with
Berkshire Mutual Insurance Company ("Berkshire") for the transfer of
Massachusetts personal automobile business written by Berkshire to The
Commerce Insurance Company, effective January 1, 2002. Under terms of the
agreement, Commerce agreed to offer agency contracts to independent agencies
that represent Berkshire for personal automobile insurance in Massachusetts.
This will allow agents of Berkshire the opportunity to offer Commerce
automobile insurance policies to their customers whose policies renew in
2002. Commerce will assume all of Berkshire's obligations for future policy
years beyond 2001 under the Massachusetts residual market system, (commonly
known as C.A.R.), including assignment of Berkshire's involuntary agents.
The Company received a cash payment of $7,000,000 from Berkshire in early
January, 2002.
The Company announced the formation of a marketing alliance with Horace
Mann Educators Corporation on October 18, 2001. Under the terms of an
agency agreement between Commerce and Horace Mann Service Corporation
("HMSC"), a licensed brokerage agency in the State of Massachusetts, HMSC
will provide its personal automobile customers with Commerce policies. New
personal automobile policies sold by HMSC will be insured with Commerce,
beginning no later than January 1, 2002 at the policyholder's option. All
personal auto policies currently written by HMSC will convert to Commerce
policies upon renewal in 2002.
19
Other States
Commerce West predominantly writes private passenger automobile
insurance in California and Oregon through 617 independent insurance
agencies and brokers. All business is underwritten at the Company's
headquarters located in Pleasanton, California. Although primarily writing
preferred business, Commerce West began writing non-standard business in
late 1999. American Commerce predominantly writes private passenger
automobile and homeowners insurance in 26 states exclusively through 36 AAA
independent insurance agencies. All business is underwritten at the
Company's headquarters located in Columbus, Ohio. Both Companies target
preferred insurance risks.
D. Underwriting
The Company seeks to achieve an underwriting profit, as measured by a
statutory combined ratio of less than 100%, in each of its three core
product lines, personal automobile, commercial automobile and homeowners
insurance, in both hard and soft markets. The strategy is designed to
achieve consistent profitability with substantial growth in net premiums
written during hard markets and more modest growth during soft markets. All
of the Company's policies have been written on a "claims incurred basis,"
meaning that the Company covers claims based on occurrences that take place
during the policy period.
Agencies are authorized to bind the Company on risks as limited by the
Company's written underwriting rules and practices, which set forth
eligibility rules for various policies and coverages, unacceptable risks,
and maximum and minimum limits of liability. With respect to non-automobile
policies, other than certain umbrella policies, the Company's agencies have
the ability to bind the Company for a limited period, typically 60 days,
during which time the Company reviews all risks to determine whether it will
accept or reject the policy. During this review period, the Company is
obligated to pay any claim, which would be covered under the policy.
Violation of the Company's underwriting rules and practices is grounds for
termination of the agency's contract with the Company.
Massachusetts Business
The Company and each of the approximately 38 other Servicing Carriers
must write all automobile risks submitted to them. Massachusetts personal
automobile insurance rates are fixed annually by the Commissioner. All
companies writing personal automobile policies are required to use such
mandated rates, unless they have received prior approval from the
Commissioner to offer a lower rate. The actual premium paid by a particular
policyholder, however, is adjusted, either up or down, based upon the SDIP
record of the insured operator. Moving violations and accidents for which
the insured was at fault within the most recent six year period are used to
determine each operator's SDIP surcharge or credit. The competitive nature
of the Massachusetts personal automobile insurance market, which began in
1995, continued through 2001.
Prices for Massachusetts commercial automobile insurance policies that
are not reinsured through C.A.R. are set competitively subject to the
Commissioner's authority to disapprove such prices. The rate for commercial
automobile risks reinsured through C.A.R. is mandated by the Commissioner,
except for private passenger type non-fleet business. The Company's rates
for other product lines, including homeowners and commercial lines of
general liability and property insurance, are based in part on loss cost
data from the Insurance Services Office ("ISO"), which is an industry bureau
providing policy forms and rate making data, and in part, on the Company's
own experience and industry price levels.
The Company is not obligated by statute to accept every homeowners risk
submitted to it. Accordingly, risks meeting the Company's underwriting
guidelines are accepted, and all other risks are declined or not renewed.
The Company has established an independent rate level for its homeowners
product line, based on its own loss experience and recognizing the price
levels available in the competitive marketplace. The Company uses ISO
policy forms and has added special coverage features to meet its product
needs. Rates and forms are filed with the Commissioner.
20
Under Massachusetts law, residential property owners are strictly
liable for damages caused by lead poisoning in children under age six
residing in the premises, unless the property owner has a Letter of
Compliance or a Letter of Interim Control (i.e. has taken or is taking
specific measures to prevent lead poisoning). The Company has reduced its
exposure to lead poisoning by (i) excluding from coverage all intra-familial
claims for bodily injury or medical expenses brought by minors living in an
insured's household, (ii) revising its underwriting standards for new and
renewal business to avoid insuring properties with lead poisoning hazards
and (iii) excluding from homeowners and dwelling fire liability coverage all
lead poisoning perils to children under the age of six on policies for
properties built prior to 1978 that contain rental units and where strict
liability for lead poisoning would otherwise apply. Effective on March 1,
1998 a similar exclusion was added to the Business Owners Program. With
regard to the exclusion described in (iii), policyholders may buy a
reinstatement of the excluded coverage through a policy endorsement for an
additional premium, but very few such endorsements have been written. As a
result of these remedial steps and its historical claims experience, the
Company does not believe that its exposure to lead poisoning claims is
material. The Company held reserves in the amount of $1,600,000 and
$1,525,000 for lead paint related claims at December 31, 2001 and 2000,
respectively.
The Company believes that its information systems give it a competitive
advantage in making underwriting decisions, particularly in deciding which
personal automobile risks should be reinsured through C.A.R. Utilizing data
the Company accumulates as a result of its major market presence in the
Massachusetts personal automobile line, the Company believes that its
information systems allow it to make informed risk assessments and to
respond effectively to shifts in the automobile insurance markets and
regulatory environment.
Other States
In keeping with the Company's long-term growth objective to expand
outside Massachusetts, the Company, in 1995, acquired Commerce West, a
personal automobile insurer, located in Pleasanton, California. The Company
formed a joint-venture (ACIC Holding Co., Inc.) in November 1998, and
acquired in January 1999, American Commerce, located in Columbus, Ohio.
Commerce West predominantly writes private passenger automobile insurance in
California and Oregon through 617 independent insurance agencies and
brokers. All business is underwritten at the Company's headquarters located
in Pleasanton, California. Although primarily writing preferred business,
Commerce West began writing non-standard business in late 1999. American
Commerce predominantly writes private passenger automobile and homeowners
insurance in 26 states exclusively through 36 AAA independent insurance
agencies. All business is underwritten at the Company's headquarters
located in Columbus, Ohio. Both Companies target preferred insurance risks.
E. Reinsurance
In addition to participating in C.A.R., the Company reinsures with
other insurance companies on a claims incurred basis, a portion of its
potential liability under the policies it has written, protecting itself
against severe loss under individual policies, or catastrophic occurrences
where a number of claims can produce an extraordinary aggregate loss.
Reinsurance does not legally discharge the Company from its primary
liability to the insured for the full amount of the policies, but it does
make the reinsurer liable to the Company to the extent of the reinsured
portion of any loss ultimately suffered. The Company seeks to utilize
reinsurers, which it considers adequately capitalized and financially able
to meet their respective obligations under reinsurance agreements with the
Company. The Company utilizes a variety of reinsurance mechanisms to
protect itself against loss as described below.
21
Property, Catastrophe and Quota Share Reinsurance
The Company maintains a 75% quota-share reinsurance program, covering
all non-automobile property and liability business, except umbrella
policies. The program is split between American Re-Insurance Company,
Employers Reinsurance Corporation, Hartford Fire Insurance Company and Swiss
Reinsurance America Corporation. The maximum per occurrence dollar recovery
is equal to 250% of the net premiums ceded to the quota share arrangement in
a contract year. The maximum aggregate per year dollar recovery under the
quota share contract is equal to 350% of the net premium ceded to the quota
share arrangement in a contract year. A sliding scale commission, based on
loss ratio, is utilized under this program. This program provides the
Company with sufficient protection for catastrophe coverage so as to enable
the Company to forego pure catastrophe reinsurance coverage, which was
previously tailored in conjunction with the former quota share arrangement.
The table below provides information depicting the approximate recovery
under the quota share contract (described below) at various loss scenarios,
if a single catastrophe were to strike (in thousands):
Net Loss
Total Reinsurance Retained by
Loss Recovery the Company
$ 50,000 $ 37,500 $12,500
100,000 75,000 25,000
150,000 112,500 37,500
200,000 150,000 50,000
250,000 187,500 62,500
Under the above scenario and based on the business subject to the
quota-share reinsurance contract for 2001, the Company has no reinsurance
recoveries for a single event catastrophe in excess of a total loss of
approximately $262.0 million. The level of reinsurance protection increases
(decreases) when the company cedes more (less) premium to the reinsurers.
The Company's estimated total losses on its other than automobile business
for 100 and 250-year hurricanes (including American Commerce) are
approximately $176.0 million and $295.8 million, respectively. The Company
estimates were derived through the services of Swiss Reinsurance America
Corporation who utilized the RMS (Risk Management Solutions) IRAS risk
assessment system. Most property and casualty insurance companies establish
their catastrophe reinsurance programs up to the 100 year storm estimate.
Written premiums ceded in 2001, 2000 and 1999 under the above
referenced program were $78.6 million, $69.4 million and $51.5 million,
respectively. The 13.3% increase in written premiums ceded in 2001 versus
2000 in this program was primarily the result of a $7,592 or 11.6% increase
in Massachusetts homeowner direct premiums written, coupled with a $2,212 or
13.4% increase in direct homeowner writings in states other than
Massachusetts, as previously mentioned. Ceding commission income is
calculated on a ceded earned premium basis.
Casualty Reinsurance
Casualty reinsurance is on an excess of loss basis for any one event or
occurrence with a maximum recovery of $9.0 million over a net retention of
$1.0 million. This coverage is placed with Swiss Reinsurance America
Corporation (rated A++ by A.M. Best).
Personal and commercial liability umbrella policies are reinsured on a
95% quota share basis in regard to limits up to $1.0 million and 100% quota
share basis for limits in excess of $1.0 million but not exceeding $5.0
million for policies with underlying automobile coverage of
$250,000/$500,000 or more. The Company also has personal liability umbrella
reinsurance coverage for policies with underlying automobile coverage of
$100,000/$300,000, on a 65% quota share basis in regard to limits up to $1.0
million and 100% quota share basis for limits in excess of $1.0 million but
not exceeding $3.0 million. These coverages are placed with American Re-
Insurance Company (rated A++ by A.M. Best).
22
Earned premiums and losses and loss adjustment expenses are stated in
the accompanying consolidated financial statements after deductions for
ceded reinsurance. Those deductions for reinsurance other than C.A.R. are
as follows (in thousands):
Years ended December 31,
2001 2000 1999
Income Statement
Written premiums ceded............................ $81,827 $76,946 $ 54,657
Earned premiums ceded............................. 77,226 73,354 55,557
Losses and loss adjustment expenses ceded......... 40,514 30,797 24,240
Balance Sheet
Unpaid losses and loss adjustment expenses........ 28,192 24,726 21,552
Unearned premiums................................. 42,258 36,828 26,813
The Company, as primary insurer, would be required to pay losses in
their entirety in the event that the reinsurers were unable to discharge
their obligations under the reinsurance agreements.
The Company believes that the terms of its reinsurance contracts are
consistent with industry practice in that they contain standard terms with
respect to lines of business covered, limits, retentions, arbitration and
occurrence. Based on its review of its reinsurers' financial statements and
their reputations in the reinsurance marketplace, the Company believes that
its reinsurers are financially sound. The Company had no amount of
reinsurance receivables more than 90 days past due at December 31, 2001.
F. Settlement of Claims
Claims under insurance policies written by the Company are investigated
and settled primarily by claims adjusters employed by the Company. In
Massachusetts, the Company employs a staff of 814 people at its claims
department, located in Webster, Massachusetts. In addition to these
individuals, the Company utilizes the services of approximately 37
independent appraisal firms and 11 independent property adjusting companies
who are strategically located throughout the states of Massachusetts and New
Hampshire. The Company also has a special unit, which investigates
suspected insurance fraud and abuse. If a claim or loss cannot be settled
and results in litigation, the Company retains outside counsel to represent
it. American Commerce employs a staff of 57 people that settle claims at
four regional claims offices strategically located throughout the country.
In addition to these individuals, American Commerce utilizes the services of
approximately 331 independent appraisal firms and 166 independent property
adjusting companies who are also strategically located throughout the
country. Commerce West settles claims at their home office employing a
staff of 31 in the claims department. In addition, Commerce West utilizes
the services of approximately 14 independent appraisal firms strategically
located in California and Oregon.
The Company believes that through its claims staff of experienced
adjusters, appraisers, managers, and administrative staff, it has higher
customer satisfaction than many of its competitors. All claims office staff
members work closely with agents, insureds and claimants with a goal of
settling claims fairly, rapidly and cost effectively.
Certain of the Company's Massachusetts agencies have settlement
authority for claims for other than automobile property losses, which are
less than $2,500. The settlement authority of agencies under automobile
policies is limited to claims for towing.
The Massachusetts Unfair Claims Settlement Practices Act ("Chapter
176D"), and other similar provisions in states in which the Company does
business, prohibits insurers from engaging in certain claim settlement
practices. These include failing to acknowledge and act reasonably promptly
upon communications with respect to claims arising under insurance policies,
refusing to pay claims without conducting a reasonable investigation based
upon all available information, failing to effectuate prompt, fair and
equitable settlements of claims in which liability has become reasonably
clear, and compelling insureds to institute litigation to recover amounts
due under an insurance policy by offering substantially less than the
amounts ultimately recovered in actions brought by such insureds. An
insurer's
23
violation of any of these obligations expressly violates a number of state
laws including the Massachusetts Consumer Protection Act ("Chapter 93A").
Any party, including claimants and insureds, whose rights are affected by an
insurer's violation of Chapter 176D, is entitled to bring a claim against
the insurer under Chapter 93A. Similar provisions exist in other states
where the Company does business.
The damages available under Chapter 93A may not necessarily be related
to the harm caused by the insurer's violation of Chapter 176D. Chapter 93A
provides in effect that the party bringing the Chapter 93A claim will be
entitled, at a minimum, to the amount of the judgment on all claims arising
out of the same underlying occurrence, regardless of the limits of the
policy issued by insurer. Moreover, Chapter 93A permits the court to double
or triple the party's damages if the insurer's violation of Chapter 176D was
willful or knowing. If the underlying policy risk was ceded to C.A.R., the
Company may seek reimbursement from C.A.R. for the damages it will be
obligated to pay if it is found liable under Chapter 93A or amounts paid in
settlement of such claim. Such reimbursement is discretionary and C.A.R.
may not reimburse an insurer if C.A.R. determines that the insurer was
negligent in the handling of such claim and such negligence was the cause of
Chapter 93A liability. Additionally, certain time notification restrictions
apply to these judgments, which if not met, could preclude an insurer from
seeking reimbursement from C.A.R. Accordingly, there can be no assurance
that the Company will be reimbursed in any particular instance involving a
Chapter 93A C.A.R. reinsured claim.
Since 1996, the Company has been expanding a twenty-four (24) hour
claim reporting service in Massachusetts to third-party claimants and
insureds of interested agencies. This service allows customers to report
their first notice of a loss at anytime of the night or day; 365 days a
year, including weekends and holidays. This reporting methodology allows
the Company to improve customer satisfaction by making the initial claim
handling much faster and ultimately reducing indemnity payments such as
rental and storage. As of December 31, 2001, there were 390 Massachusetts
agents who signed up for this claim reporting methodology. This compares to
377 agents as of December 31, 2000. This service is available to all agents
and their use of the service fluctuates on an ongoing basis.
G. Loss and Loss Adjustment Expense Reserves
Unpaid Loss and LAE by their nature are inherently uncertain as to
the ultimate outcome of the estimated amounts. The liability for unpaid
losses and LAE represents Management's best estimate of the ultimate net
cost of all losses and LAE incurred through the balance sheet date. The
estimate for ultimate net cost of all losses incurred through the balance
sheet date includes the adjusted case estimates for losses, incurred but not
reported ("IBNR") losses, salvage and subrogation recoverable and a reserve
for LAE. In arriving at its best estimate, management begins with the
aggregate of individual case reserves and then makes adjustments to these
amounts on a line of business basis. These adjustments to the aggregate
case reserves by line of business are made based on analysis performed by
Management as further described below. The entire liability for unpaid
losses and LAE is also reviewed quarterly and annually by the Company's
Actuarial Department. Liability estimates are continually analyzed and
updated, and therefore, the ultimate liability may be more or less than the
current estimate. The effects of changes in the estimates are included in
the results of operations in the period in which the estimates are revised.
Significant periods of time can elapse between the occurrence of an
insured loss, the reporting of the loss to the insurer and the insurer's
payment of that loss. To recognize liabilities for unpaid losses, insurers
establish reserves as balance sheet liabilities representing estimates of
amounts needed to pay reported and unreported losses and LAE. Quarterly,
the Company reviews these reserves internally. Regulations of the Division
of Insurance require the Company to annually obtain a certification from
either a qualified actuary or an approved loss reserve specialist that its
loss and LAE reserves are reasonable.
24
2. Unpaid Loss and Loss Adjustment Expenses ("LAE")
Unpaid Loss and LAE by their nature are inherently uncertain as to the
ultimate outcome of the estimated amounts. The liability for unpaid losses
and LAE represents Management's best estimate of the ultimate net cost of
all losses and LAE incurred through the balance sheet date. The estimate
for ultimate net cost of all losses incurred through the balance sheet date
includes the adjusted case estimates for losses, incurred but not reported
("IBNR") losses, salvage and subrogation recoverable and a reserve for LAE.
In arriving at its best estimate, management begins with the aggregate of
individual case reserves and then makes adjustments to these amounts on a
line of business basis. These adjustments to the aggregate case reserves by
line of business are made based on analysis performed by Management as
further described below. The entire liability for unpaid losses and LAE is
also reviewed quarterly and annually by the Company's Actuarial Department.
Liability estimates are continually analyzed and updated, and therefore, the
ultimate liability may be more or less than the current estimate. The
effects of changes in the estimates are included in the results of
operations in the period in which the estimates are revised.
The claim cycle begins when a claim is reported to the Company and
claims personnel establish a "case reserve" for the estimated amount of the
ultimate exposure to the Company. The amount of the reserve is primarily
based upon an evaluation of the type of claim involved, the circumstances
surrounding the claim and the policy provisions relating to the loss. This
estimate reflects the informed judgment of such personnel based on general
insurance reserving practices and on the experience and knowledge of the
claims personnel adjusting the claim. During the loss adjustment period,
these case basis estimates are revised as deemed necessary by the Company's
claims department personnel based on subsequent developments and periodic
reviews of the claim.
In accordance with industry practice, the Company also maintains
reserves for estimated IBNR, salvage and subrogation recoverable and LAE.
These reserves are determined on the basis of historical information and the
experience of the Company. Adjustments to these reserves are made
periodically to take into account changes in the volume of business written,
claims frequency and severity, the mix of business, claims processing and
other items that can be expected to affect the Company's liability for
losses and LAE over time.
When reviewing the liability for unpaid losses and LAE, the Company
analyzes historical data and estimates the impact of various factors such
as: (i) payment trends; (ii) loss expense per exposure; (iii) the
historical loss experience of the Company and industry; (iv) frequency and
severity trends; and, (v) legislative enactments, judicial decisions, legal
developments in the imposition of damages, changes and trends in general
economic conditions, including the effects of inflation and recession. This
process assumes that past experience, adjusted for the effects of current
developments and anticipated trends, is an appropriate basis for predicting
future events. There is no precise method, however, for subsequently
evaluating the impact of any specific factor on the adequacy of reserves,
because the eventual development of reserves is affected by many factors.
By using individual estimates of reported claims adjusted for
managements best estimate by line of business and generally accepted
actuarial reserving techniques, the Company estimates the ultimate net
liability for losses and LAE. After taking into account all relevant
factors, management believes that, based on existing information, the
provision for losses and LAE at December 31, 2001 is adequate to cover the
ultimate net cost of losses and claims incurred as of that date. The
ultimate liability, however, may be greater or lower than established
reserves. If the ultimate exposure is greater than (or less than)
management's estimated liability for losses and LAE, based on any of the
factors noted previously, the Company will incur additional expense (income)
which may have a material impact.
For a reconciliation of beginning and ending reserves for losses and
LAE, gross and net of reinsurance, see Note E to the Company's 2001
Consolidated Financial Statements, which is incorporated herein by reference
from pages 52 through 54 of the Company's 2001 Annual Report.
25
Included in the loss reserve methodologies described above, are
liabilities for unpaid claims and claim adjustment expenses for
environmental related claims such as oil spills, mold and lead paint.
Reserves have been established to cover these claims for known losses.
Because of the Company's limited exposure to these types of claims,
management believes they will not have a material impact on the consolidated
financial position of the Company in the future. Loss reserves on
environmental related claims amounted to $4,281,000 and $3,712,000 at
December 31, 2001 and 2000, respectively.
The following table represents the development of reserves, net of
reinsurance, for 1991 through 2001. The top line of the table shows the
reserves at the balance sheet date for each of the indicated years. This
represents the estimated amounts of losses and LAE for claims arising in all
years that were unpaid at the balance sheet date, including losses that had
been incurred but not yet reported to the Company. The upper portion of the
table shows the cumulative amounts paid as of successive years expressed as
a percentage with respect to that year's current reserve liability. The
lower portion of the table shows the re-estimated amount as a percentage of
the previously recorded reserves based on experience as of the end of each
succeeding year, including cumulative payments made since the end of the
respective year. The estimate changes as more information becomes known
about the payments, frequency and severity of claims for individual years.
Favorable loss development exists when the original reserve estimate is
greater than the re-estimated reserves at December 31, 2001.
26
In evaluating the cumulative information in the table, it should be noted that each year's amount includes the
cumulative effects of all changes in amounts for prior periods. This table does not present accident or policy year
development data. Conditions and trends that have affected development of the liability in the past may not
necessarily occur in the future. Accordingly, it is not appropriate to extrapolate future development based on this
table.
Year ended December 31,
2001 2000 1999 1998(1) 1997 1996 1995 1994 1993 1992 1991
(Dollars in thousands)
Reserves for
losses and loss
adjustment
expenses........ $590,334 $585,867 $558,779 $561,239 $529,765 $533,980 $493,910 $455,460 $422,224 $316,264 $228,659
Paid (cumulative)
as a percentage
of current re-
serves as of:
One year later.. 51.8 50.9 47.5 50.7 50.3 48.4 47.6 52.7 51.2 46.3
Two years later. 72.4 70.2 73.7 72.2 70.1 68.2 71.9 77.0 71.4
Three years
later......... 81.4 88.0 84.5 83.9 80.6 82.2 86.2 87.4
Four years
later......... 93.9 92.7 90.5 89.4 88.4 91.3 91.4
Five years later 95.5 95.6 92.6 93.2 94.2 93.6
Six years later. 96.5 95.7 94.3 96.9 95.1
Seven years
later......... 96.1 96.3 97.3 97.2
Eight years
later......... 96.4 98.7 97.4
Nine years
later......... 98.8 98.6
Ten years later. 98.7
Reserves re-estimated
as a percentage of
initial reserves as of:
One year later.. 94.0 92.4 92.9 88.4 84.3 82.2 83.6 83.9 87.2 82.3
Two years later. 90.3 91.9 85.6 79.3 74.1 73.2 75.9 78.6 82.8
Three years
later.......... 91.3 85.1 77.4 71.5 68.9 69.4 73.0 77.1
Four years later 84.7 77.3 69.7 67.8 67.3 68.8 72.2
Five years later 77.1 70.4 66.3 66.4 67.0 68.7
Six years later. 70.1 66.9 65.7 66.7 67.8
Seven years
later......... 66.8 66.2 65.9 67.6
Eight years
later......... 66.1 66.5 67.2
Nine years later 66.4 67.7
Ten years later. 67.5
Redundancy expressed as a
percent of yearend
reserves......... 6.0 9.7 8.7 15.3 22.9 29.9 33.2 33.9 33.6 32.5
(1) The 1998 amount includes an adjustment to add $63,112 in loss and LAE reserves for American Commerce at January 29,1999.
27
H. Operating Ratios
Loss and Underwriting Expense Ratios
Loss and underwriting expense ratios are used to interpret the
underwriting experience of property and casualty insurance companies.
Losses and LAE are stated as a percentage of premiums earned because losses
may occur over the life of a policy. Underwriting expenses on a statutory
basis are stated as a percentage of net premiums written rather than earned
premiums because most underwriting expenses are incurred when policies are
written and are not spread over the policy period. Underwriting profit
margins are reflected by the extent to which the combined loss and
underwriting expense ratios, the combined ratio, is less than 100%. The
combined ratio is considered the best simple index of current underwriting
performance of an insurer. The Company's loss and LAE ratio, underwriting
expense ratio and combined ratio, and the industry combined ratio, on a
statutory basis, are shown in the following table. The Company's ratios
include lines of insurance other than automobile as do the industry combined
ratios for all writers. Data for the property and casualty industry
generally may not be directly comparable to Company data. This is due to
the fact that the Company conducts its business primarily in Massachusetts
where approximately 87.6% of direct premiums are written.
Years Ended December 31,
Company Statutory Ratios 2001 2000 1999 1998 1997
(unaudited)
Loss and LAE Ratio................. 74.7% 71.7% 72.0% 71.6% 71.4%
Underwriting Expense Ratio......... 24.4 25.1 26.5 26.5 25.1
Combined Ratio..................... 99.1% 96.8% 98.5% 98.1% 96.5%
Industry Combined Ratio
(all writers)(1)................... 108.9% 109.7% 104.4% 102.2% 100.1%
(1) Source: A.M. Best's Review Preview (2002), as reported by A.M. Best for
all property and casualty insurance companies and weighted to reflect the
Company's product mix. The 2001 industry information is estimated by A.M.
Best.
Premiums to Surplus Ratio
The following table shows, for the periods indicated, the Company's and
the industry's statutory ratios of net premiums written to policyholders'
surplus. While there is no statutory requirement applicable to the Company
which establishes a permissible net premiums to surplus ratio, guidelines
established by the National Association of Insurance Commissioners ("NAIC")
provide that this ratio should be no greater than 300%.
Years Ended December 31,
2001 2000 1999 1998 1997
(Dollars in thousands)
Net premiums written by the
Company.......................... $1,078,967 $1,008,911 $911,993 $745,048 $741,501
Policyholders' surplus of the
Company's insurance subsidiaries. $ 715,932 $ 660,962 $518,974 $563,503 $516,598
The Company's ratio............... 150.7% 152.6% 175.7% 132.2% 143.5%
Industry ratio(1)................. 120.0% 90.0% 90.0% 80.0% 90.0%
__________________________________
(1) Source: A.M. Best's Review Preview (2002), for all property and casualty insurance
companies. The 2001 industry information is estimated by A.M. Best.
28
I. Investments
Investment income is an important source of revenue for the Company and
the return on its investment portfolio has a material effect on its net
earnings. The Company's investment objective continues to focus on
maximizing after-tax investment income through investing in high quality
securities coupled with acquiring equity investments, which may forgo
current investment yield in favor of potential higher yielding capital
appreciation in the future. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations" incorporated herein by
reference from pages 5 through 29 of the Company's 2001 Annual Report.
The Company's investment portfolio is carried at market value, except
for the closed-end preferred stock mutual funds and other investments which
are carried at equity value. At December 31, 2001, the carrying value of
total investments was $1,498,201,000. Of that amount, 41.8% was invested in
fixed maturities, 16.6% was invested in preferred stocks, 7.2% was invested
in common stocks, 20.6% was invested in closed-end preferred stock mutual
funds, 2.6% was invested in mortgage loans and 1.3% in other investments.
Cash and cash equivalents accounted for the remaining 9.9%.
The focus of management's judgments and estimates relating to
investments involves the potential impairment of investments for other than
temporary declines in market values. Carrying value of investments in fixed
maturities, which include taxable and non-taxable bonds, and investments in
common and preferred stocks, are derived from market prices supplied by the
Company's investment custodian. Unrealized investment gains and losses on
common and preferred stocks and fixed maturities, to the extent that there
is no other than temporary impairment of value, are credited or charged to a
separate component of stockholders' equity, known as "net accumulated other
comprehensive income (loss)", until realized, net of any tax effect. An
impairment in an investment is deemed to be other than temporary when a
security's market value has diminished to less than 75% of cost for two
consecutive quarters. If the contractual terms of the security are being
complied with, management performs a cash flow valuation to determine the
potential impairment of the security. If the security is deemed impaired,
the company adjusts the security's cost to market value through realized
loss based on publicly available information or in the absence of such, to a
value based on cash flow modeling. During 2001, the Company wrote down
$2,665,000 in bonds and preferred stock investments with impairment as
determined by management to be other than temporary. Given the makeup and
quality of the Company's investments, management does not believe that a
more stringent policy would have a material effect on the carrying value of
its investments. When investment securities are sold, the realized gain or
loss is determined based upon specific identification. Fair market value of
fixed maturities and common and preferred stocks are based on quoted market
prices. For other securities held as investments, fair market value equals
quoted market price, if available. If a quoted market price is not
available, fair market value is estimated using quoted market prices for
similar securities. The Company has not invested more than 5% of fixed
maturities in any one state or political subdivision.
The Company's bond portfolio at cost is comprised of Government
National Mortgage Association ("GNMA") and Federal National Mortgage
Association ("FNMA") mortgage backed bonds (15.9%), municipal bonds (62.5%),
corporate bonds (21.6%) and U.S. Treasury bonds (0.0%). Of the Company's
bonds, 97.9% are rated in the two highest quality categories provided by the
NAIC.
During 2001, as required by the Emerging Issues Task Force ("EITF") D-
46, the Company amended its policy in regard to venture capital fund
investments. EITF D-46 requires companies who own more than a 5% share of a
limited partnership to account for these investments on an equity basis.
The operating results of these venture capital fund investments have been
reflected in realized gains and losses. Prior to this change, the operating
results were not material and were therefore reflected in accumulated other
comprehensive income and loss.
29
Beginning in the first quarter of 2001, the Company, in 2001 and prior
years' results, classified its undistributed equity in the earnings and
losses on investments in closed-end preferred stock mutual funds in net
realized investment gains and losses. For the year ended 2000, the
undistributed equity in the earnings and losses of these funds was reported
in net investment income. The Company believes the current year
presentation provides a more appropriate classification for analysis of
ongoing operations of the Company. These investments are valued at original
cost plus the cumulative undistributed equity in earnings and losses of the
funds and adjusted over time by the premium or discount at the time of
purchase to the applicable underlying net asset value of the funds.
The Company's investment policy, determined in accordance with
guidelines established by the Company's Board of Directors, emphasizes
after-tax investment yield while maintaining investment quality. The Board
of Directors reviews and ratifies management's investment decisions on a
quarterly basis. State insurance laws also impose restrictions on the
nature and extent of investments by the Company.
The table below sets forth investments (at cost), net realized gains
(losses), net accumulated other comprehensive income (loss) and the net
investment income and yield thereon for the three years ended December 31,
2001.
Years Ended December 31,
2001 2000 1999
(Dollars in thousands)
Average net investments........................... $1,506,485 $1,395,159 $1,326,098
Net realized gains (losses) on
investments..................................... (10,633) 29,550 (16,378)
Net accumulated other
comprehensive income (loss):
on fixed maturities........................... 7,707 4,054 (14,107)
on preferred stocks........................... (8,481) (15,740) (19,885)
on common stocks.............................. 19,754 28,123 (6,636)
Net investment income before-tax.................. 99,611 96,830 89,789
Net investment income after-tax................... 79,172 79,547 74,970
Net investment income as a
percentage of total average net
investments (at cost)........................... 6.6% 6.9% 6.8%
Net investment income after-tax
as a percentage of total
average net investments
(at cost)....................................... 5.3% 5.7% 5.7%
30
The following table sets forth an analysis of the fair market value (except mortgages
and collateral loans which are at cost and closed-end preferred stock mutual funds and other
investments which are at equity) by the type of investment at December 31, 1999 through
2001:
December 31,
2001 2000 1999
(Dollars in thousands)
Type of Investment
GNMA & FNMA mortgage-backed
bonds.......................................... $ 98,985 $ 67,261 $ 82,613
Corporate bonds................................. 136,506 126,255 42,532
U.S. Treasury bonds and notes................... 105 3,377 3,315
Tax exempt state and
municipal bonds................................ 390,886 473,042 518,878
Total fixed maturities...................... 626,482 669,935 647,338
Preferred stocks................................ 248,101 200,083 211,049
Common stocks................................... 107,458 115,827 77,348
Closed-end preferred
stock mutual funds............................ 309,282 337,733 251,135
Total equity securities......................... 664,841 653,643 539,532
Mortgages and collateral
loans (net of allowance
for possible loan losses)...................... 39,505 51,661 72,451
Cash and cash equivalents....................... 148,630 70,521 22,535
Short-term investments.......................... - - -
Other investments............................... 18,743 26,802 14,139
Total investments........................... $1,498,201 $1,472,562 $1,295,995
The table below sets forth as of December 31, 2001 the composition of the Company's
fixed maturity investments, excluding short-term investments, at market, by time to maturity
at the dates indicated:
Percent of
Fixed
Maturity
Amount Portfolio
Period from December 31, 2001 to maturity: (dollars in thousands)
One year or less............................... $ 1,417 0.2%
More than one year to five years............... 3,001 0.5
More than five years to ten years.............. 5,378 0.9
More than ten years............................ 616,686 98.4
$626,482 100.0%
At December 31, 2001, the Company's fixed income portfolio, which
represented 41.8% of the Company's total invested assets, had a weighted
average stated maturity of approximately 27.3 years versus 26.1 years at
December 31, 2000. The calculation of average stated maturity utilizes the
dollar weighted average of the actual maturity date for a security. In
contrast, the Company's weighted average duration can be significantly less.
At December 31, 2001 the Company's fixed income portfolio had a weighted
average duration of 5.7 years versus 5.1 years at December 31, 2000. The
"duration" of a security is the time-weighted present value of the
security's expected cash flows and is used to measure a security's price
sensitivity to changes in interest rates. The weighted average duration is
short compared to the average stated maturity because of the relatively
large percentage of GNMA and municipal housing bonds in the fixed maturity
portfolio. The duration reflects industry prepayment assumptions. The
municipal housing bonds are similar in nature to GNMAs in that they pay down
principal during the life of the bond. For these types of bonds, investors
are compensated primarily for reinvestment risk rather than credit quality
risk. During periods of significant interest rate volatility, the
underlying mortgages may prepay more quickly or more slowly than
anticipated. If the repayment of principal occurs earlier than
31
anticipated during periods of declining interest rates, investment income
may decline due to the reinvestment of these funds at the lower current
market rates. In regards to municipal bonds, the Bloomberg Financial System,
which was used to calculate the above duration data, utilizes optional call
dates, sinking fund requirements and assumes a non-static prepayment pattern
in deriving these averages.
J. Regulation
General
The Company's primary business is subject to extensive regulation. In
Massachusetts, the Commissioner is appointed by the Governor of
Massachusetts and has broad authority to fix and establish maximum policy
rates and minimum agent commission levels on personal automobile insurance.
In addition, the Commissioner grants and revokes licenses to write
insurance, approves policy forms, sets reserve requirements, determines the
form and content of statutory financial statements and establishes the type
and character of portfolio investments. The Commissioner also approves
company submissions regarding affinity group insurance programs and
corresponding discounts along with SDIP deviations. Consequently, the
policies and regulations set by the Commissioner are an important element of
writing insurance in Massachusetts. In states outside of Massachusetts,
premium rates generally must be filed with, and approved by the Commissioner
of Insurance in that particular state. In general, minimum commissions to
agents are not set by the other states commissioners.
The State Divisions of Insurance are responsible for conducting
periodic examinations of insurance companies. Both Commerce and Citation
were last examined for the five year period ended December 31, 1998.
Commerce West was last examined in 2001 by the California Division of
Insurance for the three year period ended December 31, 1999. American
Commerce was examined in 1999 by the Ohio Division of Insurance for the
three year period ending December 31, 1997. The concluded examinations
produced no material findings. Massachusetts Division of Insurance
regulations provide that insurance companies will be examined every five
years or more frequently as deemed prudent by the Commissioner. California
Division of Insurance regulations provide that insurance companies will be
examined every three years. Ohio Division of Insurance regulations provide
that insurance companies will be examined at least every five years.
Automobile Insurance Regulation Overview
Massachusetts has required compulsory automobile insurance coverage
since 1925. States outside of Massachusetts generally have varying levels
of minimum compulsory insurance. Under current law, all Massachusetts
motorists are required to carry certain minimum coverages mandated by the
State. The Commissioner fixes and establishes, among other things, the
maximum rates insurers may charge for the compulsory personal automobile
coverages. With very limited exceptions, each insurer writing automobile
insurance in Massachusetts must accept all risks submitted to it for the
compulsory coverage, but is permitted to reinsure these risks (including
affinity group marketing insurance risks) through C.A.R.
Compulsory Coverage. Compulsory coverage includes no-fault coverage,
limited bodily injury coverage, property damage coverage and coverage
against uninsured or hit and run motorists. The Massachusetts no-fault
statute provides for personal injury protection ("PIP") coverage, which
entitles a party to be reimbursed directly by the party's own insurer for
certain medical expenses, lost wages and other defined expenses arising from
an automobile accident, up to a specific amount, even if another party
caused the accident.
Rates and Commissions. All Massachusetts personal automobile insurance
rates are fixed and established annually by the Commissioner. Affinity
group marketing insurance programs and safe driver rate deviations must be
annually approved by the Commissioner. For Massachusetts commercial
automobile insurance, the rates for the voluntary market are competitive,
with insurers filing rates for review by the Commissioner based on their own
32
experience. The rates for the Massachusetts commercial automobile risks
reinsured through C.A.R. are fixed and established by the Commissioner
except for non-fleet, private passenger-type automobiles. See Section A-
General for additional information.
In fixing classifications of risks and establishing rates, the
Commissioner must consider numerous factors including driver and automobile
characteristics and the claim rate in the state's designated geographical
territories. These factors are based upon data which are two or more years
old. The insurer adjusts the premiums it charges to a policyholder based
upon the SDIP record of the operator. Moving violations and at-fault
accidents affect each driver's SDIP record. In addition, the Extra Risk
Rating regulations permit insurers to deny or charge surcharged rates for
physical damage coverage to both high risk vehicles and insureds with
excessive prior loss or violation activity.
The Commissioner sets an average minimum direct agency commission rate
for personal automobile insurance, which in 2001 was 12.3%. With respect to
risks reinsured through C.A.R., the maximum amount of commissions that
C.A.R. will reimburse is fixed at that prescribed rate.
Mandatory Underwriting. Massachusetts law specifies that all
individuals holding a valid driver's license are entitled to purchase the
mandatory automobile insurance coverages regardless of their driving
experience or accident record. The Massachusetts Legislature has also
placed certain restraints on insurers' discretion to refuse to renew
automobile insurance policies. Policyholders are entitled to renew except
in cases of fraud, material misrepresentation, revocation or suspension of
an operator's license or nonpayment of premiums. With very limited
exceptions, Servicing Carriers writing automobile insurance in Massachusetts
must accept every automobile risk submitted to them.
Under the Massachusetts system of rate regulation, it is intended that
some personal automobile insurance risks are under priced at the maximum
rate permitted by the Commissioner, and therefore, absent state-
intervention, insurers would not ordinarily choose to write those risks.
The C.A.R. reinsurance program described below is intended to mitigate the
burden imposed by the Massachusetts take-all-comers system by allowing
insurers to transfer the exposure for under priced risks to an industry
pool.
Commonwealth Automobile Reinsurers
General. C.A.R. is a Massachusetts state-mandated reinsurance
mechanism, under which all premiums, expenses and losses on ceded business
are shared by all insurers. It is similar to a joint underwriting
association because a number of insurers (39, including the Company) act as
Servicing Carriers for the risks it insures.
Agencies. In general, agencies licensed to issue automobile insurance
policies are entitled to be assigned to at least one Servicing Carrier.
There are two categories of agencies: those who have voluntary agreements
with one or more Servicing Carriers and those who do not. The latter are
assigned by C.A.R. to a single Servicing Carrier and are known as ERPs.
C.A.R. Operations. All companies writing automobile insurance in
Massachusetts share in the underwriting results of the C.A.R. business for
their respective product line or lines, whether or not they are Servicing
Carriers. An insurer's share of the C.A.R. deficit is allocated on the
basis of a formula called a participation ratio, which can vary
significantly between the personal and commercial pools, and between
different policy years. See "Business-Commonwealth Automobile Reinsurers"
for a detailed discussion of the method of calculating the participation
ratio.
An insurer may terminate its participation in C.A.R. as of the close of
C.A.R.'s fiscal year by surrendering its license to write automobile
policies in Massachusetts. Termination does not discharge or otherwise
affect liability of an insurer incurred prior to termination. A withdrawing
insurer is assessed a share of C.A.R.'s projected deficits for future years
based on the insurer's prior years' participation in C.A.R. The assessment
paid by the withdrawing insurer is redistributed to the remaining insurers
based upon their participation ratios.
33
An insurer can transfer its obligations for its personal insurance
policies to another insurer who formally agrees to assume these obligations.
The transferring insurer is thereby relieved of future C.A.R. obligations
which otherwise would have arisen as a consequence of the business
transferred. See "Business-Commonwealth Automobile Reinsurers."
Insurance Holding Company Structure
As an insurance holding company, the Company is subject to regulation
under the insurance holding company statutes of the states in which any of
its subsidiary insurance companies are domiciled. Because the Company's
subsidiaries are members of an insurance holding company system, they are
required to register with their respective Divisions of Insurance and to
submit reports describing the capital structure, general financial
condition, ownership and management of each insurer and any person or entity
controlling the insurer, the identity of every member of the insurance
holding company system and the material outstanding transactions between the
insurer and its affiliates.
Each member of the insurance holding company system must keep current
the information required to be disclosed by reporting all material changes
or additions within 15 days of the end of the month in which it learns of
such change or addition.
Massachusetts law prohibits a party, which is not a domestic insurer
from acquiring "control" of a domestic insurer or of a company controlling a
domestic insurer without prior approval of the Commissioner. Control is
presumed to exist if a party directly or indirectly holds, owns or controls
more than ten percent of the voting stock of another party, but may be
rebutted by a showing that control does not exist.
In the event of the insolvency, liquidation or other reorganization of
any of the Company's insurance subsidiaries, the creditors and stockholders
of the Company will have no right to proceed against the assets of those
subsidiaries, or to cause the liquidation or bankruptcy of any company under
federal or state bankruptcy laws. State laws govern such liquidation or
rehabilitation proceedings and the Division of Insurance would act as
receiver for the particular company. Creditors and policyholders of the
insurance subsidiaries would be entitled to payment in full from such assets
before the Company, as a stockholder, would be entitled to receive any
distribution there from.
Payment of Dividends
Under Massachusetts' law, insurers may pay cash dividends only from
earnings and statutory surplus, and the insurer's remaining surplus must be
both reasonable in relation to its outstanding liabilities and adequate to
its financial needs.
Protection Against Insurer Insolvency-Massachusetts
All of the insurers writing the types of insurance covered by the
Massachusetts Insurers Insolvency Fund ("M.I.I.F.") are M.I.I.F. members.
M.I.I.F. is obligated to pay any unpaid claim, up to $300,000, against an
insolvent insurer if the claim existed prior to the declaration of
insolvency or arose within 60 days thereafter. M.I.I.F. assesses members
the amounts it deems necessary to pay both its obligations and the expenses
of handling covered claims. Subject to certain limitations, assessments are
made in the proportion that each member's net written premiums for the
preceding calendar year for all property and casualty lines of business bore
to the corresponding net written premiums for all members for the same
period. The statute that established M.I.I.F. also provides for the
recoupment by insurers of amounts paid to M.I.I.F. Historically, the
Commissioner has allowed insurers to recoup the amounts they paid M.I.I.F.
through rate adjustments.
As provided in the statutes, insurance companies which write business
in Massachusetts are assessed for losses attributable to the insolvency of
other insurance companies by the Massachusetts Insurers Insolvency Fund.
From M.I.I.F.'s inception, on August 2, 1972 through December 31, 2001, the
M.I.I.F. has approved assessments totaling $188,071,000,
34
of which the Company's share was approximately $15,686,000. It is
anticipated that there will be additional assessments from time to time
relating to various insolvencies. By statute, no insurer may be assessed in
any year an amount greater than two percent of that insurer's direct
premiums written for the calendar year preceding the assessment. Although
the timing and amounts of any such assessments are not known, based on
existing knowledge, management is of the opinion that such assessments will
not have a material effect on the consolidated financial position of the
Company. According to statute, the assessed insurance companies have the
right to recoup amounts paid to the M.I.I.F., over a reasonable length of
time, through premium rates approved by the Commissioner. M.I.I.F. assessed
the Company $3,111,000 during 2001 and $5,306,000 for the year ended
December 31, 2000 after having no activity for the year ended December 31,
1999. The assessment for 2001 was the result of two insolvencies, The Trust
Insurance Company and Reliance Insurance Company, which accounted for
assessment amounts of $1,244,000 and $1,867,000, respectively. The
assessment for 2000 was primarily the result of two insolvencies, The Trust
Insurance Company and New England Fidelity Insurance Company, which
accounted for assessment amounts of $4,939,000 and $1,205,000, respectively,
offset by refunds for prior year assessments on numerous insurers'
insolvencies.
Protection Against Insurer Insolvency-Other States
Commerce West, domiciled in California, is covered by the California
Insurance Guarantee Association ("C.I.G.A."). American Commerce, domiciled
in Ohio, is covered by the Ohio Guarantee Association ("O.G.A."). Both
companies are also covered by similar Associations in the states where they
do business. These Associations operate similarly to the M.I.I.F. described
earlier. Payments made by American Commerce to the associations that they
are covered under were $125,000 in 2001 and $36,000 in 2000. No payments
were made to these Associations for insolvency assessments by Commerce West
in 2001 and 2000.
Protection Against Insurer Insolvency-NAIC Guidelines
Insurance Regulatory Information System Ratios. The NAIC Insurance
Regulatory Information System ("IRIS") was developed by a committee of state
insurance regulators and is intended primarily to assist state insurance
regulators in executing their statutory mandates to oversee the financial
condition of insurance companies operating in their respective states. IRIS
identifies eleven industry ratios and specifies "usual values" for each
ratio. Departure from the usual values on four or more of the ratios can
lead to inquiries from individual state insurance commissioners as to
certain aspects of an insurer's business. For the year ended December 31,
2001, the Company's consolidated property and casualty operations had no
ratios outside the "usual values".
Risk-Based Capital ("RBC"). In order to enhance the regulation of
insurer insolvency, the NAIC developed a formula and model law to provide
for RBC requirements for property and casualty insurance companies. RBC
requirements are designed to assess capital adequacy and to raise the level
of protection, that statutory surplus provides for policyholder obligations.
The RBC model for property and casualty insurance companies measures three
major areas of risk facing property and casualty insurers: (i) underwriting,
which encompasses the risk of adverse loss development and inadequate
pricing; (ii) declines in asset values arising from credit risk; and, (iii)
other business risks from investments. Insurers having less statutory
surplus than required by the RBC calculation will be subject to varying
degrees of regulatory action, depending on the level of capital inadequacy.
The RBC model formula proposes four levels of regulatory action. The
extent of regulatory intervention and action increases as the percentage of
surplus to RBC falls. The first level, the Company Action Level (as defined
by the NAIC), requires an insurer to submit a plan of corrective actions to
the regulator if surplus falls below 200% of the RBC amount. The Regulatory
Action Level (as defined by the NAIC) requires an insurer to submit a plan
containing corrective actions and permits the Commissioner to perform an
examination or other analysis and issue a corrective order if surplus falls
below 150% of the RBC amount. The Authorized Control Level (as defined by
the NAIC) allows the regulator to rehabilitate or liquidate an insurer in
addition to the aforementioned actions if surplus falls below 100% of the
RBC amount. The fourth action level is the Mandatory Control Level
35
(as defined by the NAIC), which requires the regulator to rehabilitate or
liquidate the insurer if surplus falls below 70% of the RBC amount.
The following table provides the key RBC information for the Company's
insurance subsidiaries, Commerce, Citation, Commerce West, and American
Commerce:
Commerce American
(Dollars in millions) Commerce Citation West Commerce
At December 31, 2001
Statutory surplus............. $ 609 $ 107 $ 28 $ 84
200% RBC Company action level. 184 4 7 20
Statutory surplus in excess
of RBC Company action level. $ 425 $ 103 $ 21 $ 64
RBC amounts................... $ 92 $ 2 $ 4 $ 10
% of surplus to RBC amounts... 662.0% 5,350.0% 700.0% 840.0%
K. Competition
The property and casualty insurance industry is highly cyclical,
characterized by periods of increasing premium rates and limited
underwriting capacity, followed by periods of intensive price competition
and abundant underwriting capacity. This industry also is highly
competitive, with a large number of companies, many of which operate in more
than one state, offering automobile, homeowners, commercial property and
other lines of insurance. Some of the Company's competitors have larger
volumes of business and greater financial resources and some sell insurance
directly to policyholders rather than through independent agents.
Massachusetts
In 2002, in response to the average personal automobile rate decisions
over the last several years, the Company did not file for SDIP Step 9 or
Step 10 deviations, for policies incepting in the 2002 calendar year.
During 2001, 55.0% of the Company's exposures were eligible for Step 9
deviations, versus 55.1% and 14.0%, eligible for Step 9 and Step 10
deviations in 2000.
Because the Company's insurance products are marketed exclusively
through independent agencies, most of whom represent more than one company,
the Company faces competition within each agency. The Company competes for
business within independent agencies by offering a more attractively priced
product to the consumer and by paying agents significant compensation in the
form of commissions and profit sharing, which are based in part on the
underwriting profits or losses of the agency business written with the
Company. The Company also provides a consistent market, the prompt
servicing of policyholder claims and agency support services. Although the
Company believes, based upon regular surveys of its agencies, its
relationships with its independent agencies are excellent, any disruption in
these relationships could adversely affect the Company's business.
The Company believes the Massachusetts regulatory environment, which
fixes maximum personal automobile insurance rates, apportions losses
incurred by C.A.R. and establishes minimum agency commissions, has
discouraged certain companies with more diverse geographic markets and
interests from establishing a presence or expanding their market share in
Massachusetts. Any material change in this situation could adversely affect
the Company's business.
36
Other States
Both Commerce West and American Commerce file and receive approval for
premium rates with the respective divisions of insurance in the states they
do business. Commerce West competes for business by utilizing 617
independent insurance agencies and brokers that offer competitively priced
products and provide quality service. Agents and brokers are offered
compensation in the form of commissions and profit sharing, which are based
in part on the underwriting profits and losses of the agency business
written with Commerce West. American Commerce competes for business by
utilizing 36 AAA owned and operated independent agencies that offer
competitively priced products and provide quality service. The AAA owned
independent agencies are offered compensation in the form of commission and
profit sharing, based primarily on loss ratios, as well as stock options
based on the volume of agency business written with American Commerce.
L. Other Matters
Human Resources
As of December 31, 2001, the Company and its subsidiaries employed
1,780 people. Commerce employed 1,574 people; Commerce West employed 77
people; American Commerce employed 169 people. The Company is not a party to
any collective bargaining agreements and believes its relationship with
employees to be very good.
The Company offers benefits, compensation and employee relations
programs to assure a productive and positive working environment. The
Company monitors job grades and salary scales of peer companies to assure
that its compensation levels and benefits are competitive both within the
property and casualty insurance industry and geographically in the areas its
subsidiaries operate. The Company has been recognized for its progressive
programs designed to meet the needs of a modern-day workforce. On-site
child care has been offered to Massachusetts employees since 1986 making
Commerce one of the first businesses in the region to offer this benefit. A
newly constructed child care center can currently accommodate up to 200
children of our employees. In addition, alternative work schedules, casual
dress, and free parking are also provided.
The Company offers an Employee Stock Ownership Plan ("E.S.O.P.") and
401(k) Plan for the benefit of substantially all employees, including those
of the Company's subsidiaries as discussed in Note I of the Company's Annual
Report. The E.S.O.P. is noncontributory on the part of Participants and
contributions are made at the discretion of the Board of Directors. The
Company is under no obligation to make contributions or maintain the
E.S.O.P. for any length of time, and may completely discontinue or terminate
the E.S.O.P. at any time without liability. Contributions by the Company
and subsidiaries to the E.S.O.P. for the years ended December 31, 2001, 2000
and 1999 were $7,502,000, $5,702,000 and $5,744,000, respectively. The
increase in the contribution in 2001 over 2000 was due primarily to the
inclusion of American Commerce employees into the plan. The E.S.O.P. held
2,989,046 and 3,143,076 shares of the Company's common stock at December 31,
2001 and 2000, respectively. E.S.O.P. participants who are current
employees of the Company or its subsidiaries and who are 100% vested in
their E.S.O.P. accounts can annually elect to transfer out of the E.S.O.P.
up to 100% of their allocated Company stock in the form of an eligible
rollover distribution into another eligible retirement plan, such as a
qualified individual retirement arrangement. Approximately 2,191,000 shares
owned by Participants in the E.S.O.P. at December 31, 2001 are allocated to
the E.S.O.P. accounts of these individuals. E.S.O.P. Participants who are
former employees of the Company may generally elect to withdraw from the
E.S.O.P. the total amount of shares allocated to their accounts at any time.
Approximately 580,000 shares held by the E.S.O.P. at December 31, 2001 are
allocated to the E.S.O.P. accounts of these individuals. The remaining
approximately 219,000 shares held by the E.S.O.P. at December 31, 2001 are
allocated to the E.S.O.P. accounts of Participants who have not yet reached
100% vesting in their account balances. Disposition of these unvested
shares is restricted under the E.S.O.P. The Company pays for administration
of the plan.
37
The 401(k) Plan, implemented in September 1998, enables eligible
employees to contribute up to 15% of eligible compensation on a pre-tax
basis up to the annual maximum limits under federal tax law. The Company
incurs no expenses in the form of matching contributions but does pay for
administration of the Plan. Effective June 1, 2000, the Directors of
American Commerce voted to terminate the American Commerce noncontributory
defined benefit pension plan (the "pension plan") and transition on January
1, 2001 to the E.S.O.P. The payment of the termination liability to
participants from previously funded assets of the pension plan amounted to
$4,558,000 in 2000. All participants of the pension plan were eligible to
retire with full retirement benefits upon attainment of age 65 with 5 years
of participation. Retirement benefits were payable for the life of the
participant with guaranteed payments for 10 years. All retirees had taken
lump-sum payments. American Commerce made contributions to a deposit
administration contract, which provided the pension plan with assets
sufficient to fund pension benefits to pension plan participants. The
deposit administration contract was carried at contract value, which
represented the cost of contributions plus interest and experience refunds.
The pension plan was subject to and exceeded the minimum funding
requirements of ERISA.
Effective January 1, 2001, the Directors of American Commerce voted to
merge the 401(k) plan with the Company's 401(k) Plan. Previously, American
Commerce maintained a separate 401(k) Plan for the benefit of substantially
all of its employees. American Commerce matched 50% of all employee
contributions up to 6% of pay. Both American Commerce and its employees
shared in administration expenses of the plan. American Commerce
contributed $181,000 and $165,000 to the plan in 2000 and 1999,
respectively.
American Commerce maintains a noncontributory post-retirement benefit
plan (the "post-retirement plan") for retirees that includes medical, dental
and life insurance coverages. All participants of the post-retirement plan
are eligible upon attainment of age 55 with 10 years of service or age 65
with 5 years of service. Dental coverage ceases at age 65 and life
insurance coverage decreases based upon the age of the retiree until the
attainment of age 70, at which time retirees are provided a nominal amount
of coverage from age 70 and thereafter. Participant's spouses are also
covered under the post-retirement plan. The cost of post-retirement
medical, dental and life insurance benefits is accrued over the active
service periods of employees to the date they attain full eligibility for
such benefits. It is the policy of American Commerce to pay for post-
retirement benefits as incurred. American Commerce did not contribute to
the plan in 2001 due to the aforementioned merger.
Subsequent to December 31, 2001, the Directors of American Commerce
voted to terminate that portion of the post-retirement plan applicable to
future retirees of American Commerce. Termination will be effective May 1,
2002. Current retirees and employees who retire prior to May 1, 2002 will
remain eligible for post-retirement benefits.
Additional Information
The information called for by this Item and not otherwise provided is
contained in the following pages of the Company's Annual Report which
disclosure is incorporated herein by reference: Pages 42 and 51 for
Deferred Policy Acquisition Costs, pages 57 through 59 for 59 for Deferred
Tax Assets and page 66 for Segment Information.
ITEM 2. PROPERTIES
The Company conducts its Massachusetts operations from approximately
300,000 square feet of space in several buildings, which it owns in Webster,
Massachusetts, which is located approximately 50 miles southwest of Boston.
The Company's principal administrative offices in Webster consist of
recently rehabilitated and newly constructed buildings. Its data processing
and operational departments are housed in modern office buildings on a
separate nine acre site. The Company has a 20,000 square foot child care
center located on a separate seven acre site in Webster, Massachusetts. The
Company operated child care center can provide care for up to 200 children
of employees. During 2001, Commerce purchased a 160,000 square foot
building. Commerce expects to expend approximately $13 million renovating
the building primarily in 2002. Commerce West currently leases
approximately 12,000 square feet of office space in Pleasanton, California.
Commerce West
38
anticipates it will relocate within the next three to four years. Land in
Stockton, California was purchased on June 26, 2001 at an approximate cost
of $1,125,000 as part of this relocation plan. American Commerce conducts
its operations from approximately 40,000 square feet of space in a building
located on a two acre site in Columbus, Ohio. American Commerce also leases
property at three of its four district claims offices. The Company
considers that its properties are in good condition, are well maintained,
and are generally suitable to carry on the Company's business. For
additional information concerning property, see NOTE D to the Company's 2001
Consolidated Financial Statements, which is incorporated herein by reference
from page 52 of the Company's 2001 Annual Report.
ITEM 3. LEGAL PROCEEDINGS
As is common with property and casualty insurance companies, the
Company is a defendant in various legal actions arising from the normal
course of its business, including claims based on Chapter 176D and Chapter
93A. These proceedings are considered to be ordinary to operations or
without foundation in fact. Management is of the opinion that these actions
will not have a material adverse effect on the consolidated financial
position of the Company. In addition to the normal course of business legal
actions noted above, the Company is named as defendant in a purported class
action lawsuit alleging damages as a result of the alleged diminution of
value to vehicles that are involved in accidents. The "diminution of value"
theory asserts that the market value of any vehicle involved in an accident
inevitably and irreparably declines as a result of such accident, even if
all physical damage appears to be repaired completely. This case, entitled
"Elena Given, individually and as a representative of all persons similarly
situated v. The Commerce Insurance Company," filed in 2001, in the Bristol
Superior Court in Massachusetts. The plaintiff has not sought certification
of class action status. The Company is vigorously contesting this suit, but
is currently unable to estimate the potential exposure. The Company and its
outside legal counsel are of the opinion that the Company will prevail in
this case. Another Superior Court judge in Massachusetts ruled, in a
similar case brought by the same plaintiff counsel against another insurer,
that claims for diminution of value are not covered by the Massachusetts
automobile insurance policy. Other insurance companies face similar suits
in cases outside of Massachusetts.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during
the fourth quarter of 2001.
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT
The Company's executive officers are as follows:
Name Age Position with Company
Arthur J. Remillard, Jr. 71 President, Chief Executive Officer, Chairman
of the Board
Gerald Fels 59 Executive Vice President,
Chief Financial Officer, Director
Regan P. Remillard 38 Senior Vice President and Director
Arthur J. Remillard, III 46 Senior Vice President--Policyholder
Benefits, Assistant Clerk, Director
David H. Cochrane 48 Senior Vice President--Underwriting
of Commerce and Citation
Peter J. Dignan 50 Senior Vice President--Marketing and Premium
Accounting of Commerce and Citation
James A. Ermilio 39 Senior Vice President and General Counsel
Joyce B. Virostek 59 Senior Vice President--Management
Information Systems of Commerce and Citation
Joseph J. Staffieri 55 Vice President--Human Resources
Randall V. Becker 41 Treasurer and Chief Accounting Officer
39
Arthur J. Remillard, Jr. has been the President, Chief Executive
Officer and Chairman of the Board of the Company since 1976. Mr. Remillard,
Jr. has been Chief Executive Officer and Chairman of the Board of The
Commerce Insurance Company ("Commerce") since 1972 and President of Commerce
from 1972 to November, 2001. Mr. Remillard, Jr. is also Vice Chairman of
the Governing Committee Review Panel, Chairman of the Budget Committee and a
member of the Personnel Committee of the Commonwealth Automobile Reinsurers
("C.A.R."). Mr. Remillard, Jr. is also Chairman of the Governing Committee
and a member of the Budget Committee, Executive Committee and Nominating
Committee of the Automobile Insurers Bureau of Massachusetts ("A.I.B.").
Gerald Fels, a Certified Public Accountant, was appointed President and
Chief Operating Officer of Commerce in November 2001, and Executive Vice
President of the Company in November, 1989. From 1981 to November, 1989,
Mr. Fels was Senior Vice President of the Company. Mr. Fels was the
Treasurer of the Company from 1976 to 1995 and of Commerce from 1975 to
1995. Mr. Fels has also been Chief Financial Officer of the Company since
1976 and of Commerce since 1975. Mr. Fels is also Treasurer and a director
of American Nuclear Insurers and an Advisory Committee Member of several
investment funds managed by Conning Capital Partners.
Regan P. Remillard was appointed President of American Commerce
Insurance Company in 2001, President of ACIC Holding Co., Inc. in 1998 and
Vice Chairman of the Board and Chief Executive Officer of American Commerce
Insurance Company in 1999. Mr. Remillard has been President of Commerce
West Insurance Company since 1996. Mr. Remillard has been a Senior Vice
President of the Company since 1995. From 1995 to February 2000, Mr.
Remillard was General Counsel of the Company. From 1994 to 1995, Mr.
Remillard was a practicing attorney at Hutchins, Wheeler & Dittmar, a
Massachusetts law firm specializing in corporate law and litigation. From
1989 to 1993, Mr. Remillard was Government Affairs Monitor of the Company.
Mr. Remillard is a member of the Massachusetts Bar.
Arthur J. Remillard, III was appointed Senior Vice President-
Policyholder Benefits in 1988 and has been Assistant Clerk of the Company
since 1982. From 1981 to 1988, Mr. Remillard, III had been Vice President-
Mortgage Operations. In addition, Mr. Remillard, III has also served on the
Board of Governors of the Insurance Fraud Bureau of the A.I.B. since 1991,
the C.A.R. Claims Advisory Committee since 1990 and the A.I.B. Claims
Committee since 1991.
David H. Cochrane has been the Senior Vice President-Underwriting of
Commerce and Citation since 1988. For approximately four years prior to
that, Mr. Cochrane was the Vice President of Financial Services of C.A.R.
Mr. Cochrane has also served on the C.A.R. Market Review Committee since
1988.
Peter J. Dignan was appointed the Senior Vice President-Marketing and
Premium Accounting of Commerce and Citation in 1997. From 1989 to 1997, Mr.
Dignan was Vice President-Premium Accounting Commerce and Citation. From
1987 to 1989 Mr. Dignan was Assistant Vice President-Premiums Accounting of
Commerce and Citation.
Joseph Staffieri has been Vice President of Human Resources of
Commerce Since May of 2001. From May of 1997 through April of 2001, Mr.
Staffieri was the Vice President of Human Resources for Ames Department
Stores.
40
Joyce B. Virostek has been the Senior Vice President--Management
Information Systems of Commerce and Citation since 1988. From 1981 to 1988,
Ms. Virostek had been Vice President of Commerce and Citation in charge of
data processing.
James A. Ermilio was appointed as Senior Vice President of the Company
in May 2001. Mr. Ermilio was also appointed General Counsel of the Company
in February 2000 and was a Vice President of the Company from November 1998
to May 2001. Mr. Ermilio is also Chief Legal Officer and Secretary of
American Commerce Insurance Company and Secretary of ACIC Holding Co., Inc.
Mr. Ermilio had been the Associate General Counsel of the Company since
September 1998. Mr. Ermilio was Counsel for Glaxo Wellcome, Inc.
(subsequently renamed Glaxo Smith Kline, Inc.) from 1993 to September 1998.
Prior to 1993, Mr. Ermilio was an Associate with the law firm of Bingham
Dana. Mr. Ermilio is a member of the Massachusetts and District of Columbia
Bars.
Randall V. Becker, a Certified Public Accountant, has been Treasurer
and Chief Accounting Officer of the Company since 1994. From 1990 to 1994,
Mr. Becker was Assistant Treasurer and Comptroller of the Company. From
1986 to 1990, Mr. Becker was the Director of Internal Audit for the Company.
The only family relationship among the executive officers is that
Arthur J. Remillard, III and Regan P. Remillard are the sons of Arthur J.
Remillard, Jr.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The Company's common stock trades on the NYSE under the symbol "CGI".
The high, low and close prices for shares as quoted in The Boston Globe, of
the Company's common stock for 2001 and 2000 were as follows:
2001 2000
High Low Close High Low Close
First Quarter...... $32.1000 $24.5500 $32.0000 $31.0000 $23.0000 $29.5000
Second Quarter..... 36.9900 30.7500 36.7900 30.8750 26.1250 29.5000
Third Quarter...... 38.3500 33.5500 38.0000 29.4375 25.0625 28.9375
Fourth Quarter..... 40.3500 35.8000 37.6900 29.2500 22.8750 27.1800
As of March 1, 2002 there were 1,053 stockholders of record of the
Company's Common Stock, not including stock held in "Street Name" or held
in accounts for participants of the Company's E.S.O.P.
The Board of Directors of the Company voted to declare four quarterly
dividends to stockholders of record totaling $1.19 per share and $1.15 per
share in 2001 and 2000, respectively. On May 19, 2001, the Board voted to
increase the quarterly stockholder dividend from $0.29 to $0.30 per share
to stockholders of record as of June 4, 2000. Prior to that declaration,
the Company had paid quarterly dividends of $0.29 per share dating back to
May 15, 2000 when the Board voted to increase the dividend from $0.28 to
$0.29 per share.
In May 1999, the Board of Directors of the Company authorized a stock
buy-back program of up to 2,000,000 shares of common stock of the Company.
At December 31, 2001, there are 273,700 shares of common stock authorized
to be purchased under this program. In November 2001, the Board of
Directors approved another stock buy-back program authorizing the purchase
of up to an additional 2,000,000 shares. During the period from January
1, 2001 through December 31, 2001, the Company purchased 622,900 shares of
its own common stock. During 2000, the Company purchased 606,200 shares
of its own common stock under the May 1999 buy-back program. At December
31, 2001, the Company had authority to purchase a total of 2,273,700
additional shares of its common stock under the May 1999 and November 2001
buy-back programs. As of December 31, 2001, the Company holds a total of
4,869,548 shares of treasury stock.
41
A portion of the Company's cash flow consists of dividends received
from CHI, which receives dividends from Commerce and Citation. The
payment of any cash dividends to holders of common stock by the Company
therefore depends on the receipt of dividend payments from CHI. To the
extent Commerce and Citation are restricted from paying dividends to CHI,
CHI will be limited in its ability to pay dividends to the Company. The
payment of dividends by Commerce and Citation is subject to limitations
imposed by Massachusetts law, as discussed under the caption "Payment of
Dividends" in Item 1J of this report.
ITEM 6. SELECTED FINANCIAL DATA
The five-year financial information under the caption "Selected
Consolidated Financial Data" on page 69 of the Company's 2001 Annual
Report is incorporated herein by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The information on pages 5 through 32 of the Company's 2001 Annual
Report is incorporated herein by reference.
ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
The information on pages 28 and 29 of the Company's 2001 Annual
Report is incorporated herein by reference.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's Consolidated Financial Statements for the years ended
December 31, 2001, 2000 and 1999 and the report of its independent
auditors on pages 34 through 68 of the Company's 2001 Annual Report are
incorporated herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH INDEPENDENT AUDITORS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information called for by this Item and not provided in Item 4A
will be contained in the Company's Proxy Statement, which the Company
intends to file within 120 days after the end of the Company's fiscal year
ended December 31, 2001, and such information is incorporated herein by
reference.
ITEM 11. EXECUTIVE COMPENSATION
The information called for by this Item will be contained in the
Company's Proxy Statement, which the Company intends to file within 120
days after the end of the Company's fiscal year ended December 31, 2001
and such information is incorporated herein by reference.
42
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information called for by this Item will be contained in the
Company's Proxy Statement, which the Company intends to file within 120
days after the end of the Company's fiscal year ended December 31, 2001
and such information is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information called for by this Item will be contained in the
Company's Proxy Statement, which the Company intends to file within 120
days after the end of the Company's fiscal year ended December 31, 2001
and such information is incorporated herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
A. (1) The following financial statements have been incorporated
herein by reference from the pages indicated below of the
Company's 2001 Annual Report:
Page
Report of Independent Auditors................................... 34
Consolidated Balance Sheets as of December 31, 2001 and 2000..... 35
Consolidated Statements of Earnings for the years ended
December 31, 2001, 2000 and 1999................................ 36
Consolidated Statements of Stockholders' Equity for the years
ended December 31, 2001, 2000 and 1999.......................... 37
Consolidated Statements of Cash Flows for the years ended
December 31, 2001, 2000 and 1999................................ 38
Consolidated Statements of Cash Flows - Reconciliation of Net
Earnings to Net Cash provided by Operating Activities for the
years ended December 31, 2001, 2000 and 1999.................... 39
Notes to Consolidated Financial Statements....................... 40
(2) The financial statement schedules are listed in the Index to Consolidated
Financial Statement Schedules.
(3) The exhibits are listed in the Index to Exhibits.
B. No reports on Form 8-K were filed during the quarter ended December 31,
2001.
43
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
Dated: March 26, 2002
THE COMMERCE GROUP, INC.
By
ARTHUR J. REMILLARD, JR.
(Arthur J. Remillard, Jr.)
(President, Chief Executive
Officer, Chairman
of the Board and Director)
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed by the following persons on behalf of the
registrant and in the capacities and on the date indicated.
Signature Title
ARTHUR J. REMILLARD, JR. President, Chief Executive Officer, Chairman
(Arthur J. Remillard, Jr.) of the Board and Director
GERALD FELS Executive Vice President, Chief Financial
(Gerald Fels) Officer and Director
ARTHUR J. REMILLARD, III Senior Vice President-Policyholder
(Arthur J. Remillard, III) Benefits, Assistant Clerk and Director
REGAN P. REMILLARD Senior Vice President and Director
(Regan P. Remillard)
JOHN W. SPILLANE Clerk and Director
(John W. Spillane)
RANDALL V. BECKER Treasurer and Chief Accounting Officer
(Randall V. Becker)
HERMAN F. BECKER Director
(Herman F. Becker)
44
Signature Title
JOSEPH A. BORSKI, JR. Director
(Joseph A. Borski, Jr.)
ERIC G. BUTLER Director
(Eric G. Butler)
HENRY J. CAMOSSE Director
(Henry J. Camosse)
DAVID R. GRENON Director
(David R. Grenon)
ROBERT W. HARRIS Director
(Robert W. Harris)
ROBERT S. HOWLAND Director
(Robert W. Howland)
JOHN J. KUNKEL Director
(John J. Kunkel)
RAYMOND J. LAURING Director
(Raymond J. Lauring)
NORMAND R. MAROIS Director
(Normand R. Marois)
SURYAKANT M. PATEL Director
(Suryakant M. Patel)
GURBACHAN SINGH Director
(Gurbachan Singh)
45
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
INDEX TO FINANCIAL STATEMENT SCHEDULES*
Page
Ernst & Young LLP Consent of Independent Auditors............................ 47
Schedules
II Condensed Financial Information of the Registrant as of and for the
years ended December 31, 2001, 2000 and 1999...................... 48
III Supplementary Insurance Information for the years ended
December 31, 2001, 2000 and 1999 ................................. 53
IV Reinsurance for the years ended December 31, 2001, 2000 and 1999... 54
V Valuation and Qualifying Accounts for the years ended
December 31, 2001, 2000 and 1999.................................. 55
X Supplemental Information Concerning Property-Casualty Insurance
Operations for the years ended December 31, 2001, 2000 and 1999.... 56
* Financial statement schedules other than those listed are omitted because they are not
required, not applicable or the required information has been included elsewhere.
46
CONSENT OF INDEPENDENT AUDITORS
To the Board of Directors and Stockholders of
The Commerce Group, Inc.
We consent to the incorporation by reference in this Annual Report
(Form 10-K) of The Commerce Group, Inc. of our report dated January 29,
2002, included in the 2001 Annual Report to Stockholders of The Commerce
Group, Inc.
Our audits also included the financial statement schedules of The
Commerce Group, Inc. listed in Item 14(a). These schedules are the
responsibility of the Company's management. Our responsibility is to
express an opinion based on our audits. In our opinion, the financial
statement schedules referred to above, when considered in relation to the
basic financial statements taken as a whole, present fairly in all material
respects the information set forth therein.
We also consent to the incorporation by reference in the Registration
Statement (Form S-8 No. 333-62367) pertaining to The Commerce Group, Inc.
401(k) Plan of our report dated January 29, 2001, with respect to the
consolidated financial statements incorporated herein by reference, and our
report included in the preceding paragraph with respect to the financial
statement schedules included in this Annual Report (Form 10-K) of The
Commerce Group, Inc.
ERNST & YOUNG LLP
Boston, Massachusetts
March 28, 2002
47
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
SCHEDULE II
CONDENSED FINANCIAL INFORMATION
THE COMMERCE GROUP, INC.
(Parent Company Only)
BALANCE SHEETS
December 31,
(Thousands of Dollars)
2001 2000 1999
ASSETS
Investments:
Investment in Commerce Holdings, Inc.................. $789,437 $758,968 $637,725
Investment in Bay Finance Company, Inc................ 29,179 28,531 27,312
Investment in the Clark-Prout Insurance Agency, Inc... 581 562 488
Total investments................................. 819,197 788,061 665,525
Cash and cash equivalents............................... 11 11 7
Property and equipment, net of accumulated depreciation. 1,182 1,257 1,374
Current income taxes.................................... 1,410 2,861 2,007
Deferred income taxes................................... 972 882 37
Other assets............................................ 1,047 1,329 3,536
Total assets...................................... $823,819 $794,401 $672,486
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Accounts payable and accrued expenses................. $ 11,234 $ 8,552 $ 986
Payable to affiliates................................. 254 3,914 3,437
Other liabilities..................................... 57 54 58
Total liabilities................................. 11,545 12,520 4,481
Stockholders' equity:
Capital stock:
Common stock........................................ 19,000 19,000 19,000
Paid-in capital....................................... 29,621 29,621 29,621
Net accumulated other comprehensive income (loss),
net of income taxes (benefits) of $6,674 in 2001,
$6,372 in 2000 and ($13,277) in 1999................ 12,394 11,833 (24,657)
Retained earnings..................................... 873,671 820,528 727,649
934,686 880,982 751,613
Treasury stock, 4,869,548, 4,246,648 and 3,640,448
shares in 2001, 2000 and 1999, at cost.............. (122,412) (99,101) (83,608)
Total stockholders' equity........................ 812,274 781,881 668,005
Total liabilities and stockholders' equity........ $823,819 $794,401 $672,486
The accompanying notes are an integral part of these condensed financial statements.
48
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
SCHEDULE II
(continued)
CONDENSED FINANCIAL INFORMATION
THE COMMERCE GROUP, INC.
(Parent Company Only)
STATEMENTS OF EARNINGS
Years ended December 31,
(Thousands of Dollars)
2001 2000 1999
Revenues
Dividends received from subsidiaries................. $ 65,835 $ 51,660 $ 56,070
Rent income.......................................... 471 492 513
Total revenues.................................... 66,306 52,152 56,583
Expenses
Depreciation......................................... 241 246 228
Administrative expenses.............................. 5,095 9,667 (897)
Total expenses.................................... 5,336 9,913 (669)
Earnings before income tax benefits and equity in
net earnings of subsidiaries over amounts distributed. 60,970 42,239 57,252
Income tax benefits.................................... (1,549) (3,795) (338)
Earnings before equity in net earnings of subsidiaries
over amounts distributed.............................. 62,519 46,034 57,590
Equity in net earnings of subsidiaries over amounts
distributed........................................... 30,575 86,046 31,086
Net earnings...................................... $ 93,094 $132,080 $ 88,676
The accompanying notes are an integral part of these condensed financial statements.
49
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
SCHEDULE II
(continued)
CONDENSED FINANCIAL INFORMATION
THE COMMERCE GROUP, INC.
(Parent Company Only)
STATEMENTS OF CASH FLOWS
Years ended December 31,
(Thousands of Dollars)
2001 2000 1999
Cash flows from operating activities:
Net earnings........................................... $ 93,094 $132,080 $ 88,676
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Dividends received from consolidated subsidiaries.... 65,835 51,660 56,070
Equity in earnings of consolidated subsidiaries...... (96,410) (137,706) (87,156)
Depreciation and amortization........................ 241 246 228
Other assets, other liabilities and accrued expenses. 2,948 9,717 (8,609)
Balances with affiliates............................. (3,660) 477 40,514
Income taxes (benefits).............................. 1,361 (1,699) (5,857)
Other--net........................................... (113) 94 (141)
Net cash provided by operating activities.......... 63,296 54,869 83,725
Cash flows from investing activities:
Purchase of property and equipment for company use..... (218) (366) (487)
Proceeds from sale of property and equipment........... 184 195 344
Net cash used in investing activities.............. (34) (171) (143)
Cash flows from financing activities:
Dividends paid to stockholders......................... (39,951) (39,201) (38,656)
Purchase of treasury stock............................. (23,311) (15,493) (44,921)
Net cash used in financing activities.............. (63,262) (54,694) (83,577)
Increase in cash and cash equivalents.................... - 4 5
Cash and cash equivalents at beginning of year........... 11 7 2
Cash and cash equivalents at end of year................. $ 11 $ 11 $ 7
The accompanying notes are an integral part of these condensed financial statements.
50
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
SCHEDULE II
(continued)
CONDENSED FINANCIAL INFORMATION
THE COMMERCE GROUP, INC.
(Parent Company Only)
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Thousands of Dollars)
The accompanying condensed financial statements should be read in
conjunction with the Consolidated Financial Statements and the accompanying
notes thereto in the Annual Report.
NOTE A--Dividends
The amounts of cash dividends paid to The Commerce Group, Inc. (Parent
only) were as follows:
2001 2000 1999
Consolidated insurance subsidiaries.............. $65,835 $51,660 $56,070
See Note M to the Consolidated Financial Statements in the Annual
Report for a description of dividend restrictions applicable to the
Company's subsidiaries.
NOTE B--Federal Income Tax Allocation
As a member of a consolidated group for tax purposes, the Company and
its subsidiaries (said parties constituting an "Affiliated Group" as defined
in and for purposes of the Internal Revenue Code) are jointly and severally
liable for federal income taxes of the Affiliated Group and have entered
into an agreement establishing an allocation of tax liability and for
compensation of the respective members of the Affiliated Group for use of
their tax losses and credits.
The method of allocation calls for current taxes to be allocated among
all affiliated companies based on a written tax-sharing agreement. Under
this agreement, allocation is made primarily on a separate return basis with
current payment for losses and other tax items utilized in the consolidated
return. However, to the extent that a payor member of the group has future
net operating losses, which it cannot absorb in the year incurred, other
members within the group will refund payments to the payor.
51
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
SCHEDULE II
(continued)
CONDENSED FINANCIAL INFORMATION
THE COMMERCE GROUP, INC.
(Parent Company Only)
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Thousands of Dollars)
NOTE C--Consolidated Financial Statements
In preparing the consolidated financial statements of the Company and its subsidiaries,
the following amounts have been eliminated:
At December 31,
Balance Sheet 2001 2000 1999
Investment in subsidiaries........ $819,197 $788,061 $665,525
Payable to affiliates............. 254 3,914 3,437
Years Ended December 31,
Statement of Earnings 2001 2000 1999
Dividends from subsidiaries....... $ 65,835 $ 51,660 $ 56,070
Rent income....................... 471 492 513
NOTE D--Reclassification of Prior Year Balances
Certain prior year balances have been reclassified to conform to the
2001 presentation.
Beginning in the first quarter of 2001, the Company, in the 2001 and
prior years' results, classified its undistributed equity in the earnings
and losses on investments in closed-end preferred stock mutual funds in net
realized investment gains and losses. For the year ended 2000, the
undistributed equity in the earnings and losses of these funds was reported
in net investment income. The Company believes the current year
presentation provides a more appropriate classification for analysis of the
on-going operations of the Company. Prior period results previously
reflected in investment income, have been reclassified to realized gains and
losses to conform with current period presentation. For the years ended
December 31, 2001, 2000, and 1999 the Company reflected realized gains
(losses) of $4.6 million, $26.6 million and ($22.4) million, respectively,
as a result of this change. These investments are valued at original cost
plus the cumulative undistributed equity in earnings and losses of the funds
and adjusted over time by the premium or discount at the time of purchase to
the applicable underlying net asset value of the funds.
52
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
SCHEDULE III
SUPPLEMENTARY INSURANCE INFORMATION
Years Ended December 31, 2001, 2000 and 1999
(Thousands of Dollars)
Future
Policy Other
Deferred Benefits, Policy
Policy Claims and Claims and Net
Acquisition Loss Unearned Benefits Premium Investment
Segment Costs Expenses Premiums Payable Revenue Income(1)
2001
Massachusetts's property and
casualty insurance................. $ 105,553 $ 615,495 $516,779 $ 922,573 $ 79,544
Other states property and
casualty insurance................. 11,004 66,129 46,677 None 121,079 13,030
Real estate and commercial lending.. - - - - 3,640
Corporate and other................. - - - - 3,397
Total......................... $ 116,557 $ 681,624 $563,456 $1,043,652 $ 99,611
2000
Massachusetts's property and
casualty insurance................. $ 102,026 $ 615,869 $481,669 $ 849,998 $ 74,544
Other states property and casualty
insurance.......................... 9,279 58,271 38,216 None 104,485 13,458
Real estate and commercial lending.. - - - - 5,407
Corporate and other................. - - - - 3,421
Total......................... $ 111,305 $ 674,140 $519,885 $ 954,483 $ 96,830
1999
Massachusetts's property and
casualty insurance................. $ 90,360 $ 596,339 $423,173 $ 767,686 $ 69,627
Other states property and casualty
insurance.......................... 8,140 63,502 33,922 None 104,144 11,359
Real estate and commercial lending.. - - - - 5,429
Corporate and other................. - - - - 3,374
Total......................... $ 98,500 $ 659,841 $457,095 $ 871,830 $ 89,789
(1) The allocation of net investment income is based upon the specific identification of activity within
the various segments.
53A
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
SCHEDULE III
SUPPLEMENTARY INSURANCE INFORMATION (Continued)
Years Ended December 31, 2001, 2000 and 1999
(Thousands of Dollars)
Benefits, Amortization
Claims, of Deferred
Losses and Policy Other Net
Settlement Acquisition Operating Premiums
Segment Expenses Costs Expenses Written
2001
Massachusetts's property and
casualty insurance................. $675,036 $ 220,635 $ 950,486
Other states property and
casualty insurance................. 102,507 40,235 None 128,481
Real estate and commercial lending.. - , -
Corporate and other................. - - -
Total......................... $777,543 $ 260,870 $1,078,967
2000
Massachusetts's property and
casualty insurance................. $602,789 $ 212,009 $ 906,705
Other states property and casualty
insurance.......................... 83,368 31,248 None 102,206
Real estate and commercial lending.. - - -
Corporate and other................. - - -
Total......................... $686,157 $ 243,257 $1,008,911
1999
Massachusetts's property and
casualty insurance................. $547,004 $ 199,296 $ 806,491
Other states property and casualty
insurance.......................... 78,086 34,364 None 105,502
Real estate and commercial lending.. - - -
Corporate and other................. - - -
Total......................... $625,090 $ 233,660 $ 911,993
53B
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
SCHEDULE IV
REINSURANCE
Years Ended December 31, 2001, 2000 and 1999
(Thousands of Dollars)
Assumed Percentage
Ceded to From of Amount
Gross Other Other Net Assumed
Insurance Premiums Earned Amount Companies Companies Amount to Net
2001
Property and casualty insurance.. $1,112,922 $149,874 $ 80,604 $1,043,652 7.7%
2000
Property and casualty insurance.. $1,015,260 $142,474 $ 81,697 $ 954,483 8.6%
1999
Property and casualty insurance.. $ 911,588 $124,459 $ 84,701 $ 871,830 9.7%
54
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
SCHEDULE V
VALUATION AND QUALIFYING ACCOUNTS
Years Ended December 31, 2001, 2000 and 1999
(Thousands of Dollars)
Net
addition
(reduction)
Balance charged to Balance
beginning costs and at end
of year expenses Deductions(1) of year
2001
Allowance for losses on mortgage loans
and collateral notes receivable........ $ 858 $ (198) $ - $ 660
Allowance for doubtful premium
receivables............................ $1,487 $ 1,079 $(1,001) $1,565
2000
Allowance for losses on mortgage loans
and collateral notes receivable........ $2,127 $(1,269) $ - $ 858
Allowance for doubtful premium
receivables............................ $1,452 $ 985 $ (950) $1,487
1999
Allowance for losses on mortgage loans
and collateral notes receivable........ $2,301 $ (174) $ - $2,127
Allowance for doubtful premium
receivables............................ $1,450 $ 1,249 $(1,247) $1,452
(1) Deductions represent net write-offs of amounts determined to be uncollectible.
55
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
SCHEDULE X
SUPPLEMENTAL INFORMATION CONCERNING
PROPERTY-CASUALTY INSURANCE OPERATIONS
Years Ended December 31, 2001, 2000 and 1999
(Thousands of Dollars)
Claims and Claim Paid
Adjustment Expenses Claims
Affiliation Incurred Related to and Claim
with Current Prior Adjustment
Registrant Year Years Expenses
2001
Consolidated property-casualty
entities.......................... $812,863 $(35,320) $773,076
2000
Consolidated property-casualty
entities.......................... $728,582 $(42,425) $659,069
1999
Consolidated property-casualty
entities.......................... $664,978 $(39,888) $627,550
56
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
INDEX TO EXHIBITS(A)
Exhibit
Number Title
3.1 Articles of Organization, as amended (B)
3.2 By-Laws(B)
4 Stock Certificate(B)
10.6* Form of Stock-Appreciation Right Agreement (B)
10.7* Form of Stock-Appreciation Right and Book Value Award Agreement as amended (C)
10.8* 1994 Management Incentive Plan as amended (D)
10.18* Form of Non-Qualified Stock Option Agreement (E)
10.19* Form of Incentive Stock Option Agreement (E)
10.20* Form of Non-Qualified Stock Option Agreement (E)
10.21* Form of Stock Option Agreement (E)
10.22 Conning Capital Partners VI, L.P., Limited Partnership Agreement (E)
13.1 Annual Report for the year ended December 31, 2001 to Security Holders
22.1 Subsidiaries of the Registrant filed herewith
(A) Exhibits other than those listed are omitted because they are not required or are not
applicable. Copies of exhibits are available without charge by writing to the Assistant
to the President at 211 Main Street, Webster, MA 01570.
(B) Incorporated herein by reference to the exhibit with the same exhibit number, filed as
an exhibit to the Registrant's Registration Statement on Form S-18 (No. 33-12533-B).
(C) Incorporated herein by reference to the exhibit with the same exhibit number, filed as
an exhibit to the Registrant's Form 10-K for the year ended December 31, 1994.
(D) Incorporated herein by reference to the exhibit with the same exhibit number, filed as
an exhibit to the Registrant's Form 10-Q for the period ended September 30, 1997.
(E) Incorporated herein by reference to the exhibit with the same exhibit number, filed as
an exhibit to the Registrant's Form 10-K for the year ended December 31, 1999.
* Denotes management contract or compensation plan or arrangement.
57
2001
annual
report
The
CGI
The Commerce Group, Inc.
211 Main Street, Webster, Massachusetts 01570
64
INDEX TO 2001 ANNUAL REPORT
Page
Financial Highlights............................................ 1
Letter to Stockholders.......................................... 2
Management's Discussion and Analysis of Financial Condition
and Results of Operations...................................... 5
Common Stock Price and Dividend Information..................... 32
Report of Management............................................ 33
Report of Independent Auditors.................................. 34
Consolidated Balance Sheets at December 31, 2001 and 2000....... 35
Consolidated Statements of Earnings for the Years Ended
December 31, 2001, 2000 and 1999............................... 36
Consolidated Statements of Stockholders' Equity for the Years
Ended December 31, 2001, 2000 and 1999......................... 37
Consolidated Statements of Cash Flows for the Years Ended
December 31, 2001, 2000 and 1999............................... 38
Consolidated Statements of Cash Flows - Reconciliation of Net
Earnings to Net Cash Provided by Operating Activities for the
Years Ended December 31, 2001, 2000 and 1999................... 39
Notes to Consolidated Financial Statements...................... 40
Selected Consolidated Financial Data............................ 69
Management's Discussion of the Supplemental Information on
Insurance Operations........................................... 70
Directors....................................................... 76
Officers........................................................ 80
Stockholder Information......................................... 82
FINANCIAL HIGHLIGHTS
(Dollars in Thousands, Except Per Share Amounts)
2001 2000 1999
Direct premiums written......................... $1,152,407 $1,071,649 $ 948,149
Net premiums written............................ $1,078,967 $1,008,911 $ 911,993
Earned premiums................................. $1,043,652 $ 954,483 $ 871,830
Net investment income........................... 99,611 96,830 89,789
Premium finance and service fees................ 17,819 15,227 14,774
Amortization of excess of book value of
subsidiary interest over cost................. 3,389 3,390 3,019
Net realized investment gains (losses).......... (10,633) 29,550 (16,378)
Total revenues............................. $1,153,838 $1,099,480 $ 963,034
Earnings before income taxes and minority
interest...................................... $ 115,425 $ 170,066 $ 104,284
Income taxes.................................... 23,194 38,306 16,667
Net earnings before minority interest........... 92,231 131,760 87,617
Minority interest in net loss of subsidiary..... 863 320 1,059
Net earnings............................... $ 93,094 $ 132,080 $ 88,676
Comprehensive income............................ $ 93,655 $ 168,570 $ 40,730
Net earnings per common share:
Basic......................................... $ 2.77 $ 3.87 $ 2.54
Diluted....................................... $ 2.75 $ 3.87 $ 2.54
Operating earnings (1).......................... $ 98,880 $ 109,631 $ 97,411
Operating earnings per share (1)
Basic......................................... $ 2.94 $ 3.21 $ 2.79
Diluted....................................... $ 2.93 $ 3.21 $ 2.79
Cash dividends paid per share................... $ 1.19 $ 1.15 $ 1.11
Weighted average number of common shares
outstanding:
Basic....................................... 33,608,804 34,121,047 34,940,074
Diluted..................................... 33,794,938 34,121,047 34,940,074
Total investments at market value
and equity value.............................. $1,498,201 $1,472,562 $1,295,995
Total assets.................................... $2,140,082 $2,075,614 $1,878,019
Total liabilities............................... $1,327,808 $1,292,665 $1,208,650
Minority interest............................... - $ 1,068 $ 1,364
Total stockholders' equity...................... $ 812,274 $ 781,881 $ 668,005
Total stockholders' equity per share............ $ 24.52 $ 23.16 $ 19.44
Certain statutory financial ratios (unaudited):
Loss and LAE ratio............................ 74.7% 71.7% 72.0%
Underwriting expense ratio.................... 24.4 25.1 26.5
Combined ratio............................. 99.1% 96.8% 98.5%
Net premiums written to policyholders'
surplus..................................... 150.7% 152.6% 175.7%
(1) The above figures are presented to provide information to the reader due to the amount
of, and fluctuations in, net realized gains and (losses). The amounts noted, which
exclude the after-tax impact of net realized investment gains (losses), are important
measures of corporate performance.
1
THE COMMERCE GROUP, INC.
March 23, 2002
To Our Stockholders:
In 2001, your Company experienced satisfactory financial results for
the 26th consecutive year. From the very first day the funding of The
Commerce Insurance Company was accomplished (April 3, 1972) through
December 31, 2001, we have achieved underwriting profit of $293.4 million
on total premiums written of $10.0 billion. This underwriting profit
represents 2.9% of total premiums written.
In October 2001, the 2002 personal automobile insurance rate decision
was announced by the Massachusetts Insurance Commissioner. Despite the
industry's request for a 7.8% increase, 2002 rates are to remain unchanged
from 2001 rates. Although most companies, including yours, continued to
modify safe driver deviations in response to the 2002 rate decision, the
Massachusetts marketplace remains highly competitive. Throughout these
ongoing competitive times, your Company's share of the Massachusetts
personal automobile market has continued to grow, and at year-end, our
market share was 23.3% up from 22.3% in 2000.
In 2001, direct premiums written in Massachusetts and earned premiums
countrywide surpassed $1 billion for the first time in our history. Your
Company will continue to pursue the goals of growing and expanding
geographically beyond the borders of Massachusetts. In furtherance of
this goal, direct premiums written outside of Massachusetts now represents
12.4% of our total business as compared to 11.3% in 2000.
Your Company has continued to grow and prosper. The Commerce
Insurance Company continues to be the largest writer of Massachusetts
private passenger automobile insurance, the second largest writer of
Massachusetts homeowners insurance, as well as the third largest writer of
Massachusetts commercial automobile insurance. The combined insurance
companies were also ranked as the 26th largest personal automobile
insurance group in the country by A.M. Best Co., based on the most
recently available direct premium written information. Additionally, I am
very pleased to report that your Company again received a group rating of
A+ (Superior) from A.M. Best Co.
Net earnings, written premiums, earned premiums, investment income,
total assets, total stockholders' equity and total stockholders' equity
per share, as illustrated in the bar graph on the facing page, are all at
new highs. For those of you who are interested in the details, I draw
your attention to the pages in this report labeled "Management's
Discussion and Analysis of Financial Condition and Results of Operations".
Behind these numbers are an extremely dedicated group of people: Our
policyholders (represented by over 1,042,000 policies in force); Agents
(1,236); Employees (1,780); Officers (43); Commerce Group Directors (17);
and, of course, our Stockholders (over 5,000, including our Employee Stock
Ownership Plan Participants who now number 1,904).
Property-liability insurance remains a good business to be in and The
Commerce Group, Inc. will continue its efforts to be one of the most
profitable long-term players. Your Company's management continues to
believe that owners' interests are its primary constituency.
2
Our sincere thanks to those who have helped in this building process
especially our Agents, Employees, Officers and Board of Directors. This
diverse force of committed, ethical and hard working people will continue
to build on our past successes and look to the future with excitement and
opportunity. Their individual ingenuity, enthusiasm, dedication and
professionalism will continue to serve our stockholders well.
Your comments or questions regarding this report, or The Commerce
Group, Inc. affairs in general, are solicited as always, at any time.
Arthur J. Remillard, Jr.
President, Chief Executive Officer
and Chairman of the Board
Caring in everything we do.
3
The bar graph on page 3 illustrates the Company's annual total
stockholders' equity per share value and annual total stockholders' equity
per share value including cumulative cash dividends paid per share through
each December 31, year-end, over the most recent fifteen year period. The
X-axis lists the years beginning with 1987 through 2001. The Y-axis lists
the dollar values starting at $0.00 and increasing in one-dollar
increments to $32.00. The graph depicts a total stockholders' equity per
share value in 1987 of $1.40, 1988 of $1.95, 1989 of $2.53, 1990 of $3.36,
1991 of $4.80, 1992 of $7.42, 1993 of $10.09, 1994 of $10.88, 1995 of
$14.96, 1996 of $16.28, 1997 of $18.11, 1998 of $19.72, 1999 of $19.44,
2000 of $23.16, and 2001 of $24.52. The graph also depicts the total
stockholders' equity per share value adjusted to include cumulative
dividends paid per share. The total of these amount to the per share
value in 1987 of $1.40, 1988 of $1.95, 1989 of $2.53, 1990 of $3.36, 1991
of $4.80, 1992 of $7.42, 1993 of $10.09, 1994 of $11.03, 1995 of $15.34,
1996 of $17.47, 1997 of $20.33, 1998 of $23.01, 1999 of $23.84, 2000 of
$28.71, and 2001 of $31.26.
4
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Thousands of Dollars Except Per Share Data)
General
The property and casualty insurance industry continues to remain
highly competitive and inherently volatile in nature. Property and
casualty insurance company results have traditionally been impacted by the
typical forces unique to the industry such as competition, frequency and
severity of losses, the overall economy and the general regulatory
environment in those states in which the insurer operates. Additional
forces are impacting the industry in the form of deregulation, on-line
commerce, price competition, empowered customers and technological
advancement. The terrorists' attacks of September 11 have had a
significant impact on the insurance industry. According to A.M. Best Co.
("A.M. Best"), "the unprecedented events of September 11 have forever
changed the way the insurance industry defines risk. Both property and
liability lines have been exposed to catastrophic risks that cannot be
priced using traditional actuarial methods". A.M. Best goes on to state,
"Against the backdrop of weak financial trends, this new risk environment
has accelerated the hardening of the U.S. property/casualty market".
Given this increased risk environment, A.M. Best "expects to see a renewed
flight to quality that will benefit financially strong insurers". The
financial losses due to this tragedy were significant to the insurance
industry, however, due to the limited exposure that the Company has
outside of Massachusetts, management believes the direct financial impact
to the Company will not be material. Additionally, price competition
remains quite heavy in many areas of the country, although it has improved
in 2001 among independent agency companies in Massachusetts. Beyond
Massachusetts, industry-underwriting results are expected to continue to
deteriorate in the near future which further emphasizes the importance of
competitive advantages gained by affinity marketing and efficient
operations. With these issues on the forefront, The Commerce Group, Inc.
("Company") continues to position itself to respond to the prevailing
forces and conditions in the market. The Company has utilized its strong
agency relationships, a low-cost structure, affinity group alliances and a
1999 joint-venture acquisition all in an effort to keep the Company
responsive in today's competitive environment.
The Company, incorporated in 1976, is a holding company for several
property and casualty insurers, which, through these insurance
subsidiaries, offers predominantly private passenger motor vehicle
insurance along with a broad range of other property and casualty
insurance products. These products are marketed to affinity groups,
individuals, families and businesses through the Company's strong
relationships with professional independent insurance agencies. The
Company writes insurance primarily in the State of Massachusetts through
The Commerce Insurance Company ("Commerce") and Citation Insurance Company
("Citation"), both wholly-owned subsidiaries of Commerce Holdings, Inc.
("CHI").
Additionally, the Company writes insurance in the States of
California and Oregon through Commerce West Insurance Company ("Commerce
West"), a wholly-owned subsidiary of Commerce, located in Pleasanton,
California. The Company also writes insurance through American Commerce
Insurance Company ("American Commerce"), which it acquired in January
1999. Located in Columbus, Ohio, American Commerce is a wholly-owned
subsidiary of ACIC Holding Co., Inc., with policies in 26 states and
licenses in several others.
In November 1998, Commerce formed ACIC Holding Co., Inc., in a joint
venture with AAA Southern New England ("AAA SNE") and invested $90,800 to
fund the January 29, 1999 acquisition of the Automobile Club Insurance
Company whose name was changed to American Commerce upon completion of the
acquisition. Commerce invested $90,000 in the form of preferred stock and
an additional $800 representing an 80% common stock ownership. AAA SNE
invested $200 representing a 20% common stock ownership. The terms of the
preferred stock call for Commerce to receive quarterly cash dividends at
the rate of 10% per annum from ACIC Holding Co., Inc. In the event cash
dividends cannot be paid, additional preferred stock will be issued.
Since the January 29, 1999 acquisition, ACIC Holding Co., Inc. and
American Commerce's results have been consolidated into the Company's
financial statements. Since 1995, Commerce has maintained an affinity
group marketing relationship with AAA Insurance Agency, Inc., a subsidiary
of AAA SNE. AAA Insurance Agency, Inc. has been a licensed insurance
agent of Commerce since 1985.
5
The Company's business strategy remains focused on activities
primarily related to personal automobile insurance. The Company has been
the largest writer of personal property and casualty insurance in the
State of Massachusetts in terms of market share of direct premiums written
since 1990. The Company's share of the Massachusetts personal automobile
market increased to 23.3% in 2001, as exhibited in the table below,
exceeding our nearest competitor, which maintains a 10.8% market share.
Growth of Massachusetts Personal Automobile
Insured Vehicles
Commerce Year-End
Year Industry Commerce Market Share
2001 1.7% 6.1% 23.3%
2000 1.9% 6.5% 22.3%
1999 2.0% 0.6% 21.3%
As mentioned, the Company predominantly writes private passenger
automobile insurance. The following tables indicate that direct premiums
written for private passenger automobile, commercial automobile and
homeowners represented 85.2%, 5.2% and 8.0%, respectively, of the
Company's total direct premiums written in 2001, as compared to 86.9%,
4.0% and 7.7%, respectively, in 2000. Total direct premiums written
increased $80,758 or 7.5% in 2001 over 2000. The 2001 increase was
primarily attributable to a $32,742 or 4.0% increase in Massachusetts
private passenger automobile direct premiums written. This was the result
of a 5.8% increase in written exposures offset by a decrease of 1.9% in
average premiums per exposure. Private passenger premiums written for all
other states increased $18,824 or 18.2%, primarily attributable to an
increase in American Commerce premiums of $7,319 or 9.4%, coupled with an
increase of $11,505 or 44.5% additional premiums from Commerce West.
Direct Premiums Written, Year Ended December 31, 2001
Massachusetts All Other States Total % of Total
Personal Automobile...... $ 859,922 $ 122,320 $ 982,242 85.2%
Commercial Automobile.... 58,088 1,514 59,602 5.2
Homeowners............... 73,254 18,710 91,964 8.0
Other Lines.............. 17,885 714 18,599 1.6
Total........... $1,009,149 $ 143,258 $1,152,407 100.0%
Direct Premiums Written, Year Ended December 31, 2000
Massachusetts All Other States Total % of Total
Personal Automobile...... $ 827,180 $ 103,496 $ 930,676 86.9%
Commercial Automobile.... 43,243 104 43,347 4.0
Homeowners............... 65,662 16,498 82,160 7.7
Other Lines.............. 14,860 606 15,466 1.4
Total........... $ 950,945 $ 120,704 $1,071,649 100.0%
Massachusetts Automobile Business
In Massachusetts, private passenger automobile insurance is subject to
extensive regulation. Owners of registered automobiles are generally required
to maintain certain minimum automobile insurance coverages. With very limited
exceptions, automobile insurers are required by law to issue a policy to any
applicant seeking to obtain such coverages. Companies in Massachusetts are
also assigned agents, known as Exclusive Representative Producers ("ERPs"),
based primarily on market share, that have been unable to obtain a voluntary
contract with an insurance carrier. Marketing and underwriting strategies for
companies operating in Massachusetts are limited by maximum premium rates and
minimum agency commission levels for personal automobile insurance, both of
which are mandated by the
6
Massachusetts Commissioner of Insurance ("Commissioner"). In Massachusetts,
accident rates, bodily injury claims, and medical care costs continue to be
among the highest in the nation. According to the Automobile Insurers Bureau
of Massachusetts ("A.I.B"), Massachusetts "has higher than average medical
costs and liability claims involving attorneys". According to the A.I.B.,
Massachusetts personal automobile premium per policy, based on 1999 premium
information, was 5th highest in the nation.
During the three-year period from 1999 to 2001, average mandated
Massachusetts personal automobile insurance premium rates decreased an average
of 2.3% per year. The Commissioner approved no rate change in personal
automobile premiums for 2002, as compared to an average rate decrease of 8.3%
in 2001. Coinciding with the 2002 rate decision, the Commissioner also
approved no change in the commission rate agents receive for selling private
passenger automobile insurance from 12.3% in 2001.
State Mandated
Average Commerce Average Rate
Year Rate Change Change Per Exposure
2002 0.0% 5.0%(Estimated)
2001 (8.3%) (1.9%)
2000 0.7% 6.2
1999 0.7% 9.1%
Although average mandated personal automobile premium rates decreased
8.3% in 2001, the Company's average rate decreased 1.9% per exposure. The
1.9% decrease for 2001 was primarily the result of the state mandated average
rate decrease offset by decreases in the Safe Driver Insurance Plan ("SDIP")
deviations for Step 9 and Step 10 drivers, the two best driver SDIP
classifications in Massachusetts. The smaller Company decrease was also due
to the facts that the rate decision did not anticipate purchases of new
automobiles in the year to which the rate decision applied and, secondly, the
Company's mix of personal automobile business differs from that of the
industry.
The 1999 average rate decision was partially driven by corrections for an
industry error that had impacted prior year rate decisions. The industry
error resulted from a miscalculation of industry expense allowances that had
the effect of over-stating rates for 1991 through 1996. Mandated rates for
1997, 1998 and 1999 included an adjustment to recoup the effects of this error
from the industry. The adjustment included in the rate decision to recoup the
error was phased in during 1997, 1998 and 1999. The earned premium impact of
this, coupled with the impact of a previous year imbalance in the SDIP, was
approximately $14.0 million for 1999. The earnings per share after-tax impact
resulting from lower earned premiums were estimated at $0.26 for 1999.
The Company's performance in its personal and commercial automobile
insurance lines is integrally tied to its participation in Commonwealth
Automobile Reinsurers ("C.A.R."), a state-mandated reinsurance mechanism,
which permits the Company and most other writers of automobile insurance in
Massachusetts to reinsure any automobile risk that the insurer perceives to be
under-priced at the premium level permitted by the Commissioner. All
companies writing automobile insurance in Massachusetts share in the
underwriting results of C.A.R. business for their respective product line or
lines. Since its inception, C.A.R. has annually generated multi-million
dollar underwriting losses in both its personal and commercial automobile
pools. A company's proportionate share of the C.A.R. personal or commercial
deficit (its participation ratio) is based upon its market share of the auto-
mobile risks for the particular pool, adjusted by a utilization formula such
that, in general, its participation ratio is disproportionately and adversely
affected if its relative use of C.A.R. exceeds that of the industry, and
favorably affected if its relative use of C.A.R. is less than that of the
industry. Automobile insurers attempt to develop and implement underwriting
strategies that will minimize their relative share of the C.A.R. deficit while
maintaining acceptable loss ratios on risks not insured through C.A.R.
Significant changes in the utilization of the C.A.R. private passenger
pooling mechanism are not expected for 2002. Various C.A.R. participation
formula changes have been fully implemented since 1993 with only minor changes
since then. The Company's ERP strategy has been to voluntarily retain more of
the types of private passenger automobile business that are factored as
credits favorably impacting the utilization formula. These credits primarily
result from voluntarily writing business in under-priced territories and for
under-priced risks. As a result of increased voluntary retention in excess of
the industry, the credits impacting the utilization formula have favorably
7
page>
affected the Company's participation ratio. As indicated in the accompanying
table, this ratio is several percentage points below the Company's estimated
23.3% share of the Massachusetts personal automobile market. The Company
continues to expect the marketplace to make minor annual adjustments to find
the optimum balance between voluntary and ceded writings.
Company Private Passenger Participation Ratio for C.A.R. versus Market Share
Company Participation Company
Year Ratio in C.A.R. Market Share
2001* 16.8% 23.3%
2000 16.9% 22.3%
1999 16.5% 21.3%
*Estimated
The percentage of commercial automobile premiums ceded to C.A.R. by the
industry was estimated by the Company to be 24% in 2001. The percentage of
commercial automobile business ceded to C.A.R. by the Company was
approximately 16.0%. C.A.R. depopulation over the last several years,
coupled with C.A.R. rate increases for ceded commercial business, have led to
a reduction in the size of the annual commercial automobile deficits. The
Company intends to continue to respond to the incentives and disincentives
provided by C.A.R. rules as deemed necessary and appropriate.
The Company provides a separate rating tier for preferred Massachusetts
commercial automobile business through Citation. Approximately 17% of the
Massachusetts commercial automobile premiums produced by voluntary agents in
2001 were written by Citation. The Company expects that this secondary rating
tier will continue to assist the Company in retaining its better commercial
automobile accounts, while also further increasing the percentage of
commercial automobile business that can be retained voluntarily by the Company
in 2002 and beyond.
The Company has actively pursued affinity group marketing programs since
1995. The primary purpose of affinity group marketing programs is to provide
participating groups with a convenient means of purchasing private passenger
automobile insurance through associations and employer groups. Emphasis is
placed on writing larger affinity groups, although accounts with as few as 25
participants are considered. Affinity groups are eligible for rate discounts,
which must be filed annually with the Division of Insurance. In general, the
Company looks for affinity groups with mature/stable membership, favorable
driving records and below average turnover ratios. Participants who leave
the sponsoring group during the term of the policy are allowed to maintain the
policy until expiration. At expiration, a regular Commerce policy may be
issued through the agency at the insured's option.
Since the latter part of 1995, Commerce has been a leader in affinity
group marketing through agreements with the four American Automobile
Association Clubs of Massachusetts ("AAA clubs") offering discounts on
private passenger automobile insurance to the clubs' members who reside in
Massachusetts. A 6% discount was approved for policies effective January 1,
2002, which is the same as the discount for 2001. Membership in these clubs
is estimated to represent approximately one-third of the Massachusetts
motoring public, and has been the primary reason for a 62.6% increase in the
number of personal automobile exposures written by Commerce since year-end
1995 (the AAA affinity group program incepted in October of 1995). In 2001,
total direct premiums written attributable to the AAA group business were
$545,496 or 47.3% of the Company's total direct premiums written (63.4% of the
Company's total Massachusetts personal automobile premium), an increase of
1.8% over 2000. Total exposures attributable to the AAA clubs group business
were 581,455 or 63.3% of total Massachusetts personal automobile exposures in
2001, as compared to 559,696 or 64.5% in 2000. Of the total Massachusetts
automobile exposures written through the AAA affinity group program by the
Company, approximately 13.0% were written through insurance agencies owned by
the AAA clubs (8.7% of total Massachusetts automobile exposures). The
remaining 87.0% of the AAA group program was written through the Company's
network of independent agents (91.3% of total Massachusetts automobile
exposures). For additional details, refer to the table found on page 12
entitled "AAA Affinity Group Discount and SDIP Deviations".
8
page>
Massachusetts law allows two years to reach the required group
penetration level of 35%. Commerce has continued to maintain AAA member
participation in excess of 35% through December 31, 2001, when it was
estimated at approximately 40%. The two-year penetration requirement was
waived by the Massachusetts Legislature for 2000, 2001 and 1999. Waiving the
penetration requirements allows insurance companies to continue offering
group discounts without reaching the 35% level.
Commerce and the AAA clubs have agreed that Commerce shall be their
exclusive under-writer of Massachusetts personal automobile group programs.
A rolling three-year contract exists between Commerce and the AAA clubs which
renews automatically and may be terminated upon a minimum of three years
written notice to either party.
Agreements for the Transfer of Massachusetts Business from Other Companies in
2002
The Company entered into an agreement on September 28, 2001, with
Berkshire Mutual Insurance Company ("Berkshire") for the transfer of
Massachusetts personal automobile business written by Berkshire to The
Commerce Insurance Company, effective January 1, 2002. Under terms of the
agreement, Commerce Insurance agreed to offer agency contracts to independent
agencies that represent Berkshire for personal automobile insurance in
Massachusetts. This will allow agents of Berkshire the opportunity to offer
Commerce automobile insurance policies to their customers whose policies renew
in 2002. Commerce will assume all of Berkshire's obligations for future
policy years beyond 2001 under the Massachusetts residual market system,
(commonly known as C.A.R.), including assignment of Berkshire's involuntary
agents. The Company received a cash payment of $7,000 from Berkshire in
early January, 2002.
The Company announced the formation of a marketing alliance with Horace
Mann Educators Corporation on October 18, 2001. Under the terms of an agency
agreement between Commerce and Horace Mann Service Corporation ("HMSC"), a
licensed brokerage agency in the State of Massachusetts, HMSC will provide its
personal automobile customers with Commerce policies. New personal automobile
policies sold by HMSC will be insured with Commerce, beginning no later than
January 1, 2002. At the policyholders option, Massachusetts personal auto
policies currently written by HMSC will convert to Commerce policies upon
renewal in 2002.
Other States Business
Direct premiums written in states other than Massachusetts by Commerce
West and American Commerce, increased $22,554 or 18.7%. Roughly half of this
growth resulted from an increase of $11,505 or 44.5% in personal automobile
direct premiums written by Commerce West. The growth from Commerce West is
primarily attributable to non-standard automobile business. Commerce West
began writing in this segment of the market in late 1999. Commerce West also
began writing commercial automobile in late 2000, resulting in writings of
$1,514 in 2001. American Commerce direct premiums written increased $9,655
or 10.2%, primarily due to an increase in personal automobile premiums of
$7,319 or 9.4%. American Commerce also experienced a 13.4% increase in
homeowners business. American Commerce, which writes business in 26 states,
wrote greater than 90% of its business in eleven states.
9
Commerce West premiums and the eleven states with the highest percentages of premiums
written by American Commerce are shown in the following table:
% of Direct Premiums
Company State Written by State
2001 2000
Commerce West California............ 89.8% 99.1%
Oregon................ 10.2% 0.9
Total............ 100.0% 100.0%
American Commerce Arizona............... 20.9% 21.5%
Rhode Island.......... 14.3% 10.8%
Ohio.................. 12.6% 11.6%
Oregon................ 10.5% 10.2%
Washington............ 8.0% 8.1%
Oklahoma.............. 7.7% 6.4%
Kentucky.............. 5.9% 5.8%
Indiana............... 4.6% 3.5%
West Virginia......... 2.5% 2.7%
Idaho................. 2.5% 2.4%
Tennessee............. 2.4% 2.2%
Other states.......... 8.1% 14.8%
Total............ 100.0% 100.0%
The decrease in other states for American Commerce is primarily
attributable to business in several states being moved to other insurance
companies affiliated with the ownership of the agencies representing that
business. These and some future moves for business in other states were
anticipated at the time the Company negotiated the acquisition of American
Commerce.
Insurance Ratios
Underwriting profit margins are reflected by the extent to which the
combined ratio is less than 100%. This ratio is considered the best
simple index of current underwriting performance of an insurer. During
the five-year period ended December 31, 2001, the property and casualty
insurance industry's combined ratio, as reported by A.M. Best and weighted
to reflect the Company's product mix ("weighted industry average"), has
ranged from a low of 100.1% in 1997 to a high of 109.7% in 2000 on a
statutory accounting principles basis. During this same period of time,
the Company's combined ratio has consistently remained below the weighted
industry average, ranging from a low of 96.5% in 1997 to a high of 99.1%
in 2001. On an average basis, the Company's combined ratio was 97.8% for
the five-year period ended December 31, 2001 compared to a weighted
industry average of 105.1%.
Year Ended December 31,
Company Statutory Ratios 2001 2000 1999 1998 1997
(unaudited)
Loss and LAE Ratio................. 74.7% 71.7% 72.0% 71.6% 71.4%
Underwriting Expense Ratio......... 24.4 25.1 26.5 26.5 25.1
Combined Ratio..................... 99.1% 96.8% 98.5% 98.1% 96.5%
Industry Combined Ratio
(all writers)(1)................... 108.9% 109.7% 104.4% 102.2% 100.1%
(1) Source: Best's Review Preview (2002), as reported by A.M. Best for all property and
casualty insurance companies and weighted to reflect the Company's product mix.
The 2001 industry information is estimated by A.M. Best.
10
Investment Income and Net Realized Investment Gains and Losses
The Company's total revenues were supplemented in fiscal 2001, 2000
and 1999 by net investment income of $99,611, $96,830 and $89,789,
respectively. Beginning in the first quarter of 2001, the Company, in the
2001 and prior years' results, classified its undistributed equity in the
earnings and losses on investments in closed-end preferred stock mutual
funds in net realized investment gains and losses. For the year ended
2000, the undistributed equity in the earnings and losses of these funds
was reported in net investment income. The Company believes the current
year presentation provides a more appropriate classification for analysis
of the on-going operations of the Company. Prior period results
previously reflected in investment income, have been reclassified to
realized gains and losses to conform with current period presentation.
For the years ended December 31, 2001, 2000, and 1999 the Company
reflected realized gains (losses) of $4.6 million, $26.6 million and
($22.4) million, respectively, as a result of this change. These
investments are valued at original cost plus the cumulative undistributed
equity in earnings and losses of the funds and adjusted over time by the
premium or discount at the time of purchase to the applicable underlying
net asset value of the funds. Also in 2001, the Company began to account
for venture capital fund investments on an equity basis. The equity in the
operating results of these funds has been reflected in realized gains and
losses. Prior to this change, the operating results were not material and
were therefore reflected in accumulated other comprehensive income and
loss. For 2001, the Company had a net realized loss of $10.6 million, of
which the largest component, $9.1 million, was attributable to venture
capital fund investments.
Regulatory Matters
General
Although the U.S. federal government does not directly regulate the
insurance industry, federal initiatives often have an impact on the
business. Congress and certain federal agencies continue to investigate
the current condition of the insurance industry (encompassing both life
and health and property and casualty insurance) in the United States in
order to decide whether some form of federal role in the regulation of
insurance companies would be appropriate. Congress conducts hearings
relating, in general, to the solvency of insurers and has proposed federal
legislation from time to time on this and other subjects.
In November 1999, the Gramm-Leach-Bliley Act was signed into law. The
Act (1) repealed the Glass-Steagall Act of 1933, which had prohibited the
merger of banks and securities firms, and (2) substantially modified the
Bank Holding Company Act of 1956, which had the effect of separating
banking and insurance underwriting business. The law contains pro-visions
that govern competition, created safe-harbor protections for specific
state laws and established consumer protections that govern bank-insurance
sales.
At the state level, various forms of automobile insurance reform are
continuously debated. New regulations and legislation are often proposed
with the goal of reducing the need for premium increases. For further
details, please refer to the general discussion on insurance regulation
and premium rates beginning on page 5.
Personal Automobile Insurance
As previously mentioned, since 1995, the Company has been a leader in
affinity group marketing in Massachusetts by providing discounts to
members of the AAA clubs. Membership in these clubs is estimated to
represent approximately one-third of the Massachusetts motoring public.
The Company increased its Massachusetts private passenger automobile
insurance exposures by 5.8%, ending the year with approximately 23.3% of
the Massachusetts private passenger automobile market.
11
Through 2000, the Company offered its Massachusetts customers safe
driver deviations to drivers with SDIP classifications of either Steps 9
or 10 and to only Step 9 drivers in 2001. Safe driver deviations are rate
discounts based on the customer's driving record and resulting SDIP
classification and must be approved annually by the Commissioner. Steps 9
and 10 are the two best driver SDIP classifications in Massachusetts,
representing drivers with no at-fault accidents and not more than one
minor moving vehicle violation in the last six years. The accompanying
table depicts the AAA Affinity Group Discount, SDIP Deviations and their
combined reduction from Massachusetts average mandated rates:
AAA Affinity Group Discount and SDIP Deviations 2002* 2001 2000 1999
AAA Affinity Group Discount................. 6.0% 6.0% 6.0% 6.0%
SDIP Step 9 Deviation....................... 0.0% 2.0% 6.0% 8.0%
SDIP Step 10 Deviation...................... 0.0% 0.0% 2.0% 3.0%
Combined AAA Affinity Group Discount and
Step 9 Deviation.......................... 6.0% 7.9% 11.6% 13.5%
Combined AAA Affinity Group Discount and
Step 10 Deviation......................... 6.0% 6.0% 7.9% 8.8%
*For policies with effective dates as of January 1, 2002 or thereafter.
In 2002, in response to the average personal automobile rate
decisions over the last several years, the Company did not file for SDIP
Step 9 or Step 10 deviations, for policies incepting in the 2002 calendar
year. During 2001, 55.0% of the Company's exposures were eligible for
Step 9 deviations, versus 55.1% and 14.0%, eligible for Step 9 and Step
10 deviations in 2000.
Risk-Based Capital
In order to enhance the regulation of insurer insolvency, the
National Association of Insurance Commissioners ("NAIC") developed a
formula and model law to provide for Risk-Based Capital ("RBC")
requirements for property and casualty insurance companies. RBC
requirements are designed to assess capital adequacy and to raise the
level of protection that statutory surplus provides for policyholder
obligations. The RBC model for property and casualty insurance companies
measures three major areas of risk facing property and casualty insurers:
(i) underwriting, which encompasses the risk of adverse loss development
and inadequate pricing; (ii) declines in asset values arising from credit
risk; and, (iii) other business risks from investments. Insurers having
less statutory surplus than required by the RBC calculation will be
subject to varying degrees of regulatory action, depending on the level
of capital inadequacy.
The RBC model formula proposes four levels of regulatory action.
The extent of regulatory intervention and action increases as the
percentage of surplus to RBC falls. The first level, the Company Action
Level (as defined by the NAIC), requires an insurer to submit a plan of
corrective actions to the regulator if surplus falls below 200% of the
RBC amount. The Regulatory Action Level (as defined by the NAIC)
requires an insurer to submit a plan containing corrective actions and
permits the Commissioner to perform an examination or other analysis and
issue a corrective order if surplus falls below 150% of the RBC amount.
The Authorized Control Level (as defined by the NAIC) allows the
regulator to rehabilitate or liquidate an insurer in addition to the
aforementioned actions if surplus falls below 100% of the RBC amount.
The fourth action level is the Mandatory Control Level (as defined by the
NAIC), which requires the regulator to rehabilitate or liquidate the
insurer if surplus falls below 70% of the RBC amount.
12
The following table provides the key RBC information for the
Company's insurance subsidiaries, Commerce, Citation, Commerce West, and
American Commerce:
Commerce American
(Dollars in millions) Commerce Citation West Commerce
At December 31, 2001
Statutory surplus............. $ 609 $ 107 $ 28 $ 84
200% RBC Company action level. 184 4 7 20
Statutory surplus in excess
of RBC Company action level. $ 425 $ 103 $ 21 $ 64
RBC amounts................... $ 92 $ 2 $ 4 $ 10
% of surplus to RBC amounts... 662.0% 5,350.0% 700.0% 840.0%
Year Ended December 31, 2001 Compared to Year Ended December 31, 2000
Premiums
The following table compares direct premiums written, net premiums
written and earned premiums for the years ended December 31, 2001 and 2000:
Years Ended December 31,
2001 2000 $ Change % Change
Direct Premiums Written:
Personal Automobile in Massachusetts...... $ 859,922 $ 827,180 $ 32,742 4.0%
Personal Automobile in All Other States... 122,320 103,496 18,824 18.2%
Commercial Automobile in Massachusetts.... 58,088 43,243 14,845 34.3%
Commercial Automobile in All Other States. 1,514 104 1,410 *
Homeowners in Massachusetts............... 73,254 65,662 7,592 11.6%
Homeowners in All Other States............ 18,710 16,498 2,212 13.4%
Other Lines in Massachusetts.............. 17,885 14,860 3,025 20.4%
Other Lines in All Other States........... 714 606 108 17.8%
Total Direct Premiums Written.......... $1,152,407 $1,071,649 $ 80,758 7.5%
Net Premiums Written:
Personal Automobile in Massachusetts...... $ 864,900 $ 839,394 $ 25,506 3.0%
Personal Automobile in All Other States... 122,256 103,719 18,537 17.9%
Commercial Automobile in Massachusetts.... 60,986 44,848 16,138 36.0%
Commercial Automobile in All Other States. 1,477 104 1,373 *
Homeowners in Massachusetts............... 20,364 17,547 2,817 16.1%
Homeowners in All Other States............ 4,576 (1,658) 6,234 *
Other Lines in Massachusetts.............. 4,236 4,916 (680) (13.8%)
Other Lines in All Other States........... 172 41 131 319.5%
Total Net Premiums Written............. $1,078,967 $1,008,911 $ 70,056 6.9%
Earned Premiums:
Personal Automobile in Massachusetts...... $ 776,552 $ 714,972 $ 61,580 8.6%
Personal Automobile in All Other States... 116,479 100,101 16,378 16.4%
Commercial Automobile in Massachusetts . 43,008 32,548 10,460 32.1%
Commercial Automobile in All Other States. 711 19 692 *
Homeowners in Massachusetts............... 19,119 17,364 1,755 10.1%
Homeowners in All Other States............ 3,731 4,186 (455) (10.9%)
Other Lines in Massachusetts.............. 3,290 3,434 (144) (4.2%)
Other Lines in All Other States........... 158 162 (4) (2.5%)
Assumed Premiums from C.A.R............... 80,176 81,300 (1,124) (1.4%)
Assumed Premiums from Other than C.A.R.... 428 397 31 7.8%
Total Earned Premiums.................. $1,043,652 $ 954,483 $ 89,169 9.3%
Earned Premiums in Massachusetts.......... $ 841,969 $ 768,318 $ 73,651 9.6%
Earned Premiums-Assumed................... 80,604 81,697 (1,093) (1.3%)
Earned Premiums in All Other States....... 121,079 104,468 16,611 15.9%
Total Earned Premiums.................. $1,043,652 $ 954,483 $ 89,169 9.3%
*Calculation is not meaningful.
13
The $32,742 or 4.0% increase in Massachusetts personal automobile
direct premiums written resulted primarily from increases of 5.8% and 7.1%
in the number of Massachusetts personal automobile exposures for liability
and physical damage coverage, respectively, offset in 2001 by decreases in
rates for the coverage types noted below. The components of these changes
from the previous year for 2001 and 2000 were as follows:
2001 2000
Coverage Type Rate Change (1) Rate Change (1)
Liability:
Bodily Injury................. (2.1%) 1.0%
Personal Injury Protection.... (12.9%) 6.4%
Property Damage to Others..... 1.0% 20.8%
Physical Damage:
Collision..................... (0.1%) 1.7%
Comprehensive................. (7.6%) 2.4%
Total (2)................. (1.9%) 6.2%
(1) Represents change in the Company's average rate per exposure from the Company's
prior year average rate for Massachusetts private passenger automobile premiums.
(2) The total rate change depicted is the result of the weighted average of premiums
written for all coverages divided by liability exposures only, due to the fact that
all exposures are required to carry liability coverage.
The above percentage changes were primarily the result of rate
modifications in the individual coverage components in the 2001 state
mandated rates, offset by changes in the Company's safe driver rate
deviations. The combination of these factors resulted in a 1.9% decrease
in the average personal automobile premium per exposure in 2001. Despite
the 2001 state mandated average rate decrease of 8.3%, the smaller Company
decrease in the average personal automobile premium per exposure was
primarily due to the above noted changes coupled with the fact that the
rate decision does not anticipate purchases of new auto-mobiles in the
year to which the rate decision applies and the Company's mix of personal
automobile business differs from that of the industry. In 2001, the
Company offered its customers safe driver deviations of 2.0% to drivers
with SDIP classifications of Step 9 and 0.0% for Step 10 (6.0% for Step 9
and 2.0% for Step 10 in 2000).
As shown in the table found on page 12, the AAA affinity group
discount for 2001 was established at 6.0%, which was unchanged from 2000.
In 2001, for drivers who qualified, the Company's AAA affinity group
discount and safe driver deviations could be combined for up to a 7.9%
reduction (11.6% in 2000) from state mandated rates.
Other states personal automobile direct premiums written increased
$18,824 or 18.2%, however, an overall depressed rate environment resulted
in diminished underwriting profits. The Company continues to evaluate a
number of its other than Massachusetts state rating structures, has filed
for increases in several states and will seek additional rate increases
where appropriate. Personal automobile direct premiums written by
American Commerce increased $7,319 or 9.4% to $85,124 as compared to
$77,805 due primarily to book rollovers of business from existing agents,
partially offset by decreases in states where the Company is not actively
pursuing writings. Personal automobile direct premiums written from
Commerce West increased $11,505 or 44.5% to $37,196 as compared to
$25,691. Both companies target preferred insurance risks, however
Commerce West's recent growth is attributable to the introduction of a
non-standard auto product in late 2000. Both American Commerce and
Commerce West write predominantly personal automobile insurance. American
Commerce writes personal automobile insurance in 26 states while Commerce
West writes personal automobile insurance in the states of California and
Oregon. Personal automobile policies for both companies are written
primarily for a policy term of six months. Homeowner and other policies
in all states are written primarily for a policy term of one year.
14
Direct premiums written for Massachusetts commercial automobile
insurance increased by $14,845 or 34.3%, due primarily to an increase of
approximately 9.0% in the number of policies written, combined with a
23.5% increase in the average commercial automobile premium per policy.
The increase in premium per policy was attributable to a hardening of the
commercial automobile market, primarily in larger commercial accounts.
The Company experienced an increase of approximately $3,700 from policies
in excess of $50. In addition, rates for other voluntary commercial
automobile policies have increased moderately, combined with an
approximate 10% increase in rates for policies written through C.A.R. The
increased business was attributable to the Company's initiative to expand
writings.
Direct premiums written for Massachusetts homeowners insurance
increased by $7,592 or 11.6% due primarily to a 6.4% increase in the
number of Massachusetts policies written coupled with a 5.0% increase in
the average Massachusetts premium per policy. The increase in business
was primarily attributable to existing and newly appointed agents. Other
states homeowners insurance written by American Commerce increased $2,212
or 13.4% to $18,710 due primarily to book rollovers of business from
existing agents.
The $70,056 or 6.9% increase in net premiums written was primarily
due to the growth in direct premiums written as described above offset by
an increase in premiums ceded to C.A.R. coupled with an increase in
premiums ceded to reinsurers other than C.A.R. Net premiums written for
homeowners in all other states increased $6,234, with net premiums written
of $4,576 in 2001, as compared to ($1,658) in 2000. The reason for
negative written premium in 2000 was due to American Commerce joining the
quota share reinsurance agreement effective January 1, 2000. An unearned
premium transfer of $6,033 occurred effective January 1, 2000, which has a
direct impact to net written premium.
The $89,169 or 9.3% increase in earned premiums during 2001, as
compared to 2000, was primarily due to increases in written exposures for
Massachusetts personal automobile liability and physical damage, coupled
with an increase in earned premium per exposure. The increase in earned
premium per exposure occurs (versus a decrease in written premium per
exposure) because of the time lag in earning the premium once it is
written. This resulted in a $61,580 or 8.6% increase for Massachusetts
personal automobile earned premium.
Investment Income
Net investment income is affected primarily by the composition of the
Company's investment portfolio and yield thereon. The following table
summarizes the composition of the Company's investment portfolio, at cost,
at December 31, 2001 and 2000 (the Company's investment portfolio, at
market and equity is shown in the table on page 25):
Investments, at cost December 31,
% of % of
2001 Invest. 2000 Invest.
GNMA & FNMA mortgage-backed bonds...... $ 98,198 6.7% $ 67,274 4.7%
Corporate bonds........................ 133,506 9.1 130,775 9.1
U.S.Treasury bonds and notes........... 104 - 3,428 0.2
Tax exempt state and municipal bonds... 386,967 26.2 464,404 32.1
Total fixed maturities............. 618,775 42.0 665,881 46.1
Preferred stocks....................... 256,582 17.4 215,823 14.9
Common stocks.......................... 87,704 5.9 87,704 6.1
Closed-end preferred stock mutual funds 294,948 20.0 327,980 22.7
Mortgages and collateral loans (net of
allowance for possible loan losses).. 39,505 2.7 51,661 3.6
Cash and cash equivalents.............. 148,630 10.1 70,521 4.9
Other investments...................... 28,291 1.9 25,475 1.7
Total investments.................. $1,474,435 100.0% $1,445,045 100.0%
15
The Company's investment strategy is to maximize after-tax investment
income through investing in high quality securities coupled with acquiring
equity investments, which may forgo current investment yield in favor of
potential higher yielding capital appreciation in the future.
As depicted in the following table, 2001 net investment income
increased $2,781 or 2.9%, compared to 2000, principally as a result of an
increase in average invested assets (at cost), offset by a decrease in
yield. The decrease in yield is primarily due to lower short-term yields
on larger cash and cash equivalent balances, coupled with an environment
of higher yielding fixed maturities being called. The Company continues
to monitor interest rates on long-term securities and intends to maintain
its high cash position until such time as the Company believes long-term
rates have appropriately firmed. Net investment income as a percentage of
total average investments was 6.6% in 2001 compared to 6.9% for 2000. Net
investment income after tax as a percentage of total average investments
was 5.3% and 5.7% for 2001 and 2000, respectively.
Investment Return Years Ended December 31,
2001 2000
Average month-end investments (at cost)... $1,506,485 $1,395,159
Net investment income before tax.......... 99,611 96,830
Net investment income after-tax........... 79,172 79,547
Net investment income as a percentage
of average net investments (at cost).... 6.6% 6.9%
Net investment income after-tax as a
percentage of average net
investments (at cost)................... 5.3% 5.7%
Premium Finance and Service Fees
Premium finance and service fees increased $2,592 or 17.0% during
2001, as a result of increased premiums as discussed earlier.
Amortization of Excess of Book Value of Subsidiary Interest over Cost
As a result of the acquisition of American Commerce (see
"Management's Discussion and Analysis of Financial Condition and Results
of Operations - General" and "Notes to Consolidated Financial Statements -
NOTES A12 and A17"), the amount representing the excess of the fair value
of the net assets acquired over the purchase price at January 29, 1999 was
$16,947. This amount is being amortized into revenue on a straight-line
basis over a five-year period. The amount amortized into revenue in 2001
was $3,389, compared to $3,390 in 2000.
Investment Gains and Losses
Net realized investment losses totaled $10,633 during 2001 as
compared to gains of $29,550 in 2000. Of the net realized losses during
2001, $9,071 was a result of the Company's venture capital fund
investments. These investments primarily provide seed capital for start-
up companies with emerging high technology initiatives in the financial
services industry. These investments are made in limited partnerships and
the Company's exposure to loss is limited to its actual investment. In
2001, the Company began to account for these investments on an equity
basis. The equity in the operating results of these funds has been
reflected in realized gains and losses. Prior to this change, the
operating results were not material and were therefore reflected in
accumulated other comprehensive income and loss.
Also during 2001, the undistributed operating results of closed-end
preferred stock mutual funds have been reflected in realized gains and
losses.
Year-end December 31, 2000 period results previously reflected in
investment income, have been reclassified to realized gains and losses to
conform with current period presentation. During 2001 and 2000, the
Company reflected realized gains of $4,582 and $26,575, respectively, as a
result of this change.
16
Gross realized gains and losses for the years ended December 31, 2001
and December 31, 2000 were as follows:
2001 2000
Gross Gross Gross Gross
Realized Realized Realized Realized
Gains Losses Gains Losses
Fixed maturities......... $ 957 $ (3,773) $ 223 $ (3,995)
Preferred stocks......... 128 (3,820) 1,748 (462)
Common stocks............ 1,526 (923) 4,370 -
Closed-end preferred
stock mutual funds*.... 5,197 (615) 26,641 (66)
Venture capital fund
investments............ - (9,071) 460 -
Other investments........ - (239) 631 -
Total............... $ 7,808 $ (18,441) $ 34,073 $ (4,523)
* Includes $3,215 in 2001 and $9,260 in 2000, respectively, relating to the amortization
of the net discount, at the time of purchase, of these securities.
Gross accumulated other comprehensive income and losses at December 31, 2001 and
December 31, 2000 were as follows:
December 31, 2001 December 31, 2000
Gross Gross Gross Gross
Accumulated Accumulated Accumulated Accumulated
Other Other Other Other
Comprehensive Comprehensive Comprehensive Comprehensive
Income Losses Income Losses
Fixed maturities......... $ 17,994 $ (10,287) $ 16,247 $ (12,193)
Preferred stocks......... 6,289 (14,770) 999 (16,739)
Common stocks............ 21,590 (1,836) 28,126 (3)
Other investments........ - - 1,327 -
Total............... $ 45,873 $ (26,893) $ 46,699 $ (28,935)
Loss and Loss Adjustment Expenses
Losses and loss adjustment expenses ("LAE") incurred increased
$91,386 or 13.3% in 2001. Massachusetts operations experienced declining
underwriting results primarily due to increased losses in the homeowners
property business and in comprehensive personal automobile, due to more
adverse weather conditions compared to last year. The ratio of net
incurred losses, excluding LAE, to premiums earned ("pure loss ratio") on
Massachusetts personal automobile was 65.4% in 2001 compared to 63.1% in
2000. The commercial automobile pure loss ratio increased to 61.8% in
2001 compared to 59.7% in 2000. This increase was primarily due to higher
bodily injury losses and to higher physical damage losses coupled with
worse experience in the business assumed from C.A.R. during this period.
For Massachusetts homeowners (gross of reinsurance), the pure loss ratio
was 47.6% in 2001 compared to 40.0% in 2000. This increase was the result
of more claims for Massachusetts homeowner business due to less favorable
weather conditions, as compared to last year, primarily during the first
six months of 2001. Pure loss ratios of subsidiaries in other states
increased to 67.5% in 2001 compared to 62.9% in 2000. The loss ratio (on
a statutory basis) for Commerce West and American Commerce was 85.1% and
84.4%, respectively, in 2001, compared to 69.3% and 84.5% respectively, in
2000. The increase in the loss ratio for Commerce West was primarily
attributable to a substantial increase in non-standard automobile writings
with loss ratios that are significantly higher than their regular
business.
17
Policy Acquisition Costs
Policy acquisition costs expensed increased by $17,613 or 7.2% in
2001. As a percentage of net premiums written, the Company's statutory
underwriting expense ratio for 2001 was 24.4% compared to 25.1% in 2000.
The decreased 2001 underwriting expense ratio resulted primarily from a
lower provision for accrued contingent commissions, lower insolvency
assessments and lower expenses due to the continued effects of certain
cost reduction programs. The 2000 underwriting ratio includes a $4,900
charge versus $1,244 in 2001, representing the Company's allocation from
the Massachusetts Insurers Insolvency Fund. The underwriting expense
ratio (on a statutory basis) for Commerce West was 32.7% for 2001 as
compared to 35.8% for 2000. The underwriting expense ratio (on a
statutory basis) for American Commerce, was 32.6% for 2001 compared to
29.3% for 2000.
Income Taxes
The Company's effective tax rate was 20.1% and 22.5% for the years
ended December 31, 2001 and 2000, respectively. In both years the
effective rate was lower than the statutory rate of 35% primarily due to
tax-exempt interest income and the corporate dividends received deduction.
Minority Interest in Net Loss of Subsidiary
As a result of the joint venture with AAA SNE and acquisition of
American Commerce (see "Management's Discussion and Analysis of Financial
Condition and Results of Operations - General" and "Notes to Consolidated
Financial Statements - NOTES A13 and A17"), the Company's interest in ACIC
Holding Co., Inc., through Commerce, a wholly-owned subsidiary of CHI, is
represented by ownership of 80% of the outstanding shares of common stock
at December 31, 2001. AAA SNE maintains a 20% common stock ownership.
The minority interest of $863 included in the consolidated statement of
earnings for 2001 represents 20% of the net loss for ACIC Holding Co.,
Inc., calculated after the $9,582 preferred stock dividend paid to
Commerce, to the extent of the minority interest. This compares to $320
minority interest in net loss of subsidiary after $9,178 in preferred
stock dividends paid to Commerce in 2000. During the third quarter of
2001, the net losses of ACIC Holding Co., Inc. exceeded the minority
interest balance sheet component.
Net Earnings
Net earnings decreased $38,986 or 29.5% to $93,094 during 2001 as
compared to $132,080 in 2000. Operating earnings, which exclude the
after-tax impact of net realized investment gains and losses, decreased
$10,751 or 9.8% to $98,880 ($2.94 per share basic and $2.93 per share
diluted) during 2001 as compared to $109,631 ($3.21 per share basic and
diluted) in 2000, as a result of the factors previously mentioned.
18
Year Ended December 31, 2000 Compared to Year Ended December 31, 1999
Premiums
The following table compares direct premiums, net premiums written
and earned premiums for the years ended December 31, 2000 and 1999:
Years Ended December 31,
2000 1999 Change % Change
Direct Premiums Written:
Personal Automobile in Massachusetts...... $ 827,180 $731,329 $ 95,851 13.1%
Personal Automobile in All Other States... 103,496 92,297* 11,199 12.1%
Commercial Automobile in Massachusetts.... 43,243 36,616 6,627 18.1%
Commercial Automobile in All Other States. 104 - 104 -
Homeowners in Massachusetts............... 65,662 59,981 5,681 9.5%
Homeowners in All Other States............ 16,498 14,378* 2,120 14.7%
Other Lines in Massachusetts.............. 14,860 13,027 1,833 14.1%
Other Lines in All Other States........... 606 521* 85 16.3%
Total Direct Premiums Written.......... $1,071,649 $948,149 $123,500 13.0%
Net Premiums Written:
Personal Automobile in Massachusetts...... $ 839,394 $747,402 $ 91,992 12.3%
Personal Automobile in All Other States... 103,719 91,640* 12,079 13.2%
Commercial Automobile in Massachusetts.... 44,848 38,593 6,255 16.2%
Commercial Automobile in All Other States. 104 - 104 -
Homeowners in Massachusetts............... 17,547 16,304 1,243 7.6%
Homeowners in All Other States............ (1,658) 13,543* (15,201) (112.2%)
Other Lines in Massachusetts.............. 4,916 4,193 723 17.2%
Other Lines in All Other States........... 41 318* (277) (87.1%)
Total Net Premiums Written............. $1,008,911 $911,993 $ 96,918 10.6%
Earned Premiums:
Personal Automobile in Massachusetts...... $ 714,972 $633,746 $ 81,226 12.8%
Personal Automobile in All Other States... 100,101 91,357* 8,744 9.6%
Commercial Automobile in Massachusetts.... 32,548 29,219 3,329 11.4%
Commercial Automobile in All Other States. 19 - 19 -
Homeowners in Massachusetts............... 17,364 16,830 534 3.2%
Homeowners in All Other States............ 4,186 12,032* (7,846) (65.2%)
Other Lines in Massachusetts.............. 3,434 3,190 244 7.6%)
Other Lines in All Other States........... 162 755* (593) (78.5%)
Assumed Premiums from C.A.R............... 81,300 84,356 (3,056) (3.6%)
Assumed Premiums from Other than C.A.R.... 397 345 52 15.1%
Total Earned Premiums.................. $ 954,483 $871,830 $ 82,653 9.5%
Earned Premiums in Massachusetts.......... $ 768,301 $682,985 $ 85,316 12.5%
Earned Premiums-Assumed................... 81,697 84,701 (3,004) (3.5%)
Earned Premiums in All Other States....... 104,485 104,144* 341 0.3%
Total Earned Premiums.................. $ 954,483 $871,830 $ 82,653 9.5%
*Includes eleven-month results of American Commerce since the January 29, 1999 acquisition.
19
The $95,851 or 13.1% increase in Massachusetts personal automobile
direct premiums written resulted primarily from increases of 6.4% and 8.5%
in the number of Massachusetts personal automobile exposures for liability
and physical damage coverage, respectively, coupled in 2000 with increases
in rates for the coverage types noted below. The components of these
changes from the previous year for 2000 and 1999 were as follows:
2000 1999
Coverage Type Rate Change (1) Rate Change (1)
Liability:
Bodily Injury................. 1.0% (1.9%)
Personal Injury Protection.... 6.4% 11.0%
Property Damage to Others..... 20.8% 9.1%
Physical Damage:
Collision..................... 1.7% 25.2%
Comprehensive................. 2.4% 11.7%
Total (2)................. 6.2% 9.1%
(1) Represents change in the Company's average rate per exposure from the Company's
prior year average rate charged for Massachusetts private passenger automobile
premiums.
(2) The total rate change depicted is the result of the weighted average of premiums
written for all coverages divided by liability exposures only, due to the fact that
all exposures are required to carry liability coverage.
The above percentage changes were primarily the result of rate
modifications in the individual coverage components in the 2000 state
mandated average rate increase, combined with changes in the Company's
safe driver rate deviations. The combination of these factors resulted in
a 6.2% increase in the average personal automobile premium per exposure in
2000. Despite the 2000 state mandated average rate increase of only 0.7%,
the Company's increase in the average personal automobile premium per
exposure was primarily due to the above noted changes coupled with the
fact that the rate decision does not anticipate purchases of new
automobiles in the year to which the rate decision applies and the
Company's mix of personal automobile business differs from that of the
industry. In 2000, the Company offered its customers safe driver
deviations of 6.0% to drivers with SDIP classifications of Step 9 and 2.0%
for Step 10 (8.0% for Step 9 and 3.0% for Step 10 in 1999).
As shown in the table found on page 12, the AAA affinity group
discount for 2000 was established at 6.0%, which was unchanged from 1999.
In 2000, for drivers who qualified, the Company's AAA affinity group
discount and safe driver deviations could be combined for up to a 11.6%
reduction (13.5% in 1999) from state mandated rates.
Direct premiums written for commercial automobile insurance increased
by $6,627 or 18.1%, due primarily to an increase of approximately 10.1% in
the number of policies written, combined with a 6.9% increase in the
average commercial automobile premium per policy. The increased business
was attributable to the Company's intention to expand writings coupled
with increased business due to the insolvency of Trust Insurance Company
("Trust"), a former Massachusetts insurance company that was placed in
receivership in 2000. Direct premiums written for homeowners insurance
increased by $7,801 or 10.5% due primarily to a 13.5% increase in the
number of Massachusetts policies written offset by a 3.0% decrease in the
average Massachusetts premium per policy, coupled with an additional month
premium from American Commerce. The increased business was primarily
attributable to the previously mentioned Trust insolvency.
The $96,918 or 10.6% increase in net premiums written was due to the
growth in direct premiums written as described above, offset by a decrease
of premiums assumed from C.A.R. The decrease in premiums assumed from
C.A.R. was the result of fewer premiums ceded to C.A.R. by the servicing
carriers in 2000 as compared to 1999. Premiums ceded to reinsurers other
than C.A.R. increased $22,289 or 40.8% as compared to 1999 as a result of
American Commerce joining the quota-share reinsurance program effective
January 1, 2000 and increases in Massachusetts homeowners premiums.
20
The $82,653 or 9.5% increase in earned premiums during 2000 as
compared to 1999 was primarily due to increases to the average rates per
exposure for Massachusetts personal automobile liability and physical
damage, and the increased business due to the insolvency of Trust
mentioned previously. This resulted in an $85,316 or 12.5% increase for
Massachusetts earned premiums. The remaining changes were attributable to
a $3,004 or 3.5% decrease in earned premiums assumed from C.A.R. offset by
$341, or 0.3% increase in earned premiums from all other states, primarily
attributable to American Commerce whose year to date 2000 results reflect
a full twelve months as compared to eleven months in 1999, offset by the
effect of ceded earned premium to the quota share treaty.
Investment Income
Net investment income is affected primarily by the composition of the
Company's investment portfolio and yield thereon. The following table
summarizes the composition of the Company's investment portfolio, at cost,
at December 31, 2000 and 1999:
Investments, at cost December 31,
% of % of
2000 Invest. 1999 Invest.
GNMA & FNMA mortgage-backed bonds...... $ 67,274 4.7% $ 82,349 6.1%
Corporate bonds........................ 130,775 9.1 45,147 3.3
U.S.Treasury bonds and notes........... 3,428 0.2 3,616 0.3
Tax exempt state and municipal bonds... 464,404 32.1 530,333 39.2
Total fixed maturities............. 665,881 46.1 661,445 48.9
Preferred stocks....................... 215,823 14.9 230,934 17.1
Common stocks.......................... 87,704 6.1 83,984 6.2
Closed-end preferred stock mutual funds 327,980 22.7 267,956 19.8
Mortgages and collateral loans (net of
allowance for possible loan losses).. 51,661 3.6 72,451 5.4
Cash and cash equivalents.............. 70,521 4.9 22,535 1.7
Other investments...................... 25,475 1.7 13,130 0.9
Total investments.................. $1,445,045 100.0% $1,352,435 100.0%
The Company's investment strategy is to maximize after-tax investment
income through high quality securities coupled with acquiring equity
investments, which may forgo current investment yield in favor of
potential higher yielding capital appreciation in the future.
As depicted in the accompanying table, net investment income before
taxes increased $7,041 or 7.8%, compared to 1999, principally as a result
of an increase in average invested assets (at cost). Net investment
income as a percentage of total average investments was 6.9% in 2000
compared to 6.8% in 1999. Net investment income after tax as a percentage
of total average investments was 5.6% in 2000 and 6.3% in 1999.
Investment Return Years Ended December 31,
2000 1999
Average month-end investments (at cost)... $1,395,159 $1,326,098
Net investment income before tax.......... 96,830 89,789
Net investment income after-tax........... 79,547 74,970
Net investment income as a percentage
of average net investments (at cost).... 6.9% 6.8%
Net investment income after-tax as a
percentage of average net
investments (at cost)................... 5.7% 5.7%
Premium Finance and Service Fees
Premium finance and service fees increased $453 or 3.1% during 2000.
21
Amortization of Excess of Book Value of Subsidiary Interest over Cost
As a result of the acquisition of American Commerce (see
"Management's Discussion and Analysis of Financial Condition and Results
of Operations - General" and "Notes to Consolidated Financial Statements -
NOTES A12 and A17"), the amount representing the excess of the fair value
of the net assets acquired over the purchase price at January 29, 1999 was
$16,947. The amount is being amortized into revenues on a straight-line
basis over a five-year period. The amount amortized into revenues in 2000
was $3,390, compared to $3,019 in 1999.
Investment Gains and Losses
During the fourth quarter of 2000, the Company changed its policy in
regard to its investments in certain closed-end preferred stock mutual
funds. On a forward going basis, the Company intends to take a proactive
posture to affect the overall investment performance of these funds. The
Company's ownership position of these various funds at December 31, 2000
range from 23% to 48% of outstanding shares. The level of ownership and
new investment policy requires the company to account for these
investments on an equity basis. The equity method requires that the
investments are to be valued at original cost plus the cumulative equity
in the earnings and losses of the funds and adjusted over time by the
premium or discount at the time of purchase to the applicable underlying
net asset value of the funds. Prior to the policy change, the Company
reported the income on a cash basis, valued the investments at quoted
market prices and recorded the change in quoted market prices through
comprehensive income. The results of prior accounting periods impacted by
this change have been restated.
During 2001, the undistributed operating results of closed-end
preferred stock mutual funds have been reflected in realized gains and
losses. Year-end December 31, 2000 period results previously reflected in
investment income, have been reclassified to realized gains and losses to
conform with current period presentation. During 2000 the Company
reflected a realized gain of $26,575 versus a loss in 1999 of $22,401, as
a result of this change.
Gross realized gains and losses for the years ended December 31, 2000
and December 31, 1999 were as follows:
2000 1999
Gross Gross Gross Gross
Realized Realized Realized Realized
Gains Losses Gains Losses
Fixed maturities.................... $ 223 $ (3,995) $ 458 $ (6,449)
Preferred stocks.................... 1,748 (462) 207 (451)
Closed-end preferred stock mutual
funds............................. 26,641 (66) 1,900 (24,301)
Common stocks....................... 4,370 - 16,080 (5,057)
Venture capital fund investments.... 460 - 888 -
Other investments................... 631 - 347 -
Total.......................... $ 34,073 $ (4,523) $ 19,880 $(36,258)
22
Gross accumulated other comprehensive income and losses for December 31, 2000 and
December 31, 1999 were as follows:
December 31, 2000 December 31, 1999
Gross Gross Gross Gross
Accumulated Accumulated Accumulated Accumulated
Other Other Other Other
Comprehensive Comprehensive Comprehensive Comprehensive
Income Losses Income Losses
Fixed maturities.......... $ 16,247 $ (12,193) $ 5,221 $ (19,328)
Preferred stocks.......... 999 (16,739) 782 (20,667)
Common stocks............. 28,126 (3) 1,305 (7,941)
Other investments......... 1,327 - 1,009 -
Total..................... $ 46,699 $ (28,935) $ 8,317 $ (47,936)
The accumulated other comprehensive income on fixed maturities
increased significantly as a result of the favorable performance in the
bond market due to lower interest rates in 2000. Long-term interest rates
(30-year Treasury Bond) decreased to 5.46% at December 31, 2000 from 6.48%
at December 31, 1999.
Loss and Loss Adjustment Expenses
Losses and loss adjustment expenses ("LAE") incurred increased
$61,067 or 9.8% in 2000. As a percentage of premiums earned, losses and
LAE incurred for 2000 was 71.7% compared to 72.0% in 1999. The Company
experienced higher assumed residual market losses during 2000, which were
offset by improved voluntary loss ratios in Massachusetts. Additionally
in 2000, the loss ratio was adversely impacted by approximately $8,000 of
expense (0.8% of the loss ratio) attributable to the Trust insolvency.
Also included in the 2000 increase in incurred expense is approximately
$6,300 in higher corporate expenses which are allocated to losses and LAE
for book value appreciation rights, director retirement compensation and
state income taxes on non-insurance subsidiaries. The ratio of net
incurred losses, excluding LAE, to premiums earned ("pure loss ratio") on
personal automobile was 63.2% in 2000 compared to 65.1% in 1999. The
decrease to the personal automobile pure loss ratio was primarily due to
an increase in redundancies arising from prior accident years, and
decreases in the cost of adjusting losses. The commercial automobile pure
loss ratio decreased to 59.7% in 2000 compared to 60.3% in 1999. For
homeowners, the pure loss ratio was 40.0% in 2000 compared to 35.9% in
1999. The increase was primarily due to fewer liability redundancies in
2000 compared to 1999. The loss ratio (on a statutory basis) for Commerce
West was 69.3% for 2000 as compared to 71.2% in 1999. The loss ratio (on
a statutory basis) for American Commerce was 84.5% for 2000 as compared to
its eleven-month loss ratio of 75.8% in 1999.
Policy Acquisition Costs
Policy acquisition costs expensed increased by $9,597 or 4.1% in
2000. As a percentage of net premiums written, the Company's statutory
underwriting expense ratio for 2000 was 25.1% compared to 26.5% in 1999.
The decreased 2000 underwriting expense ratio resulted primarily from
lower Massachusetts direct automobile commissions associated with a
decrease in the state mandated minimum commissions, a lower provision for
accrued contingent commissions, and lower expenses due to the continued
effects of certain cost reduction programs, partially offset by the Trust
insolvency assessment. The 2000 underwriting ratio includes a $4,900
charge (0.5% of the underwriting expense ratio) representing the Company's
allocation from the Massachusetts Insurers Insolvency Fund for this
insolvency. Also included in the 2000 increase in policy acquisition
costs expensed is approximately $5,800 in higher corporate expenses which
are allocated to policy acquisition costs for book value appreciation
rights, director retirement compensation and state income taxes on non-
insurance subsidiaries. The underwriting expense ratio (on a statutory
basis) for Commerce West was 35.8% for 2000 as compared to 40.9% for 1999.
The underwriting expense ratio (on a statutory basis) for American
Commerce, was 29.3% for 2000 compared to its eleven-month expense ratio of
31.4% for 1999.
23
Income Taxes
The Company's effective tax rate was 22.5% and 16.0% for the years
ended December 31, 2000 and 1999, respectively. In both years the
effective rate was lower than the statutory rate of 35% primarily due to
tax-exempt interest income and the corporate dividends received deduction.
The higher effective tax rate for 2000 was the result of both the tax-
exempt interest and the dividends received deduction comprising a lesser
portion of earnings before taxes.
Minority Interest in Net Loss of Subsidiary
As a result of the joint venture with AAA SNE and acquisition of
American Commerce (see "Management's Discussion and Analysis of Financial
Condition and Results of Operations - General" and "Notes to Consolidated
Financial Statements - NOTES A13 and A17"), the Company's interest in ACIC
Holding Co., Inc., through Commerce, a wholly-owned subsidiary of CHI, is
represented by ownership of 80% of the outstanding shares of common stock
at December 31, 2000. AAA SNE maintains a 20% common stock ownership.
The minority interest in net loss of subsidiary of $320 included in the
consolidated statement of earnings for 2000 represents 20% of the net loss
for ACIC Holding Co., Inc. calculated after the $9,178 preferred stock
dividend paid to Commerce. This compares to $1,059 minority interest in
net loss of subsidiary after $8,300 in preferred stock dividends paid to
Commerce in 1999.
Net Earnings
Net earnings increased $43,404 or 48.9% to $132,080 during 2000 as
compared to $88,676 in 1999. The net earnings for 2000 were increased by
$20,514, or $0.60 per share and decreased $14,020 or $0.40 per share in
1999 as a result of the Company's change in its policy in regard to its
investment in closed-end preferred stock mutual funds mentioned
previously. Operating earnings, which exclude the after-tax impact of net
realized investment gains, increased $12,220 or 12.5% to $109,631 ($3.21
per share basic and diluted) during 2000 as compared to $97,411 ($2.79 per
share basic and diluted) in 1999, as a result of the factors previously
mentioned.
Liquidity and Capital Resources
The focus of the discussion of liquidity and capital resources is on
the Consolidated Balance Sheets on page 35 and the Consolidated Statements
of Cash Flows on pages 38 and 39. Stockholders' equity increased by
$30,393, or 3.9%, in 2001 as compared to 2000. The increase resulted from
$93,094 in net earnings, and by net increases in other comprehensive
income, net of income tax benefits, on fixed maturities and preferred and
common stocks of $561, offset by dividends paid to stockholders of $39,951
and Treasury Stock purchased of $23,311. Total assets at December 31,
2001 increased $64,468, or 3.1% to $2,140,082 as compared to total assets
of $2,075,614 at December 31, 2000. Invested assets, at market value and
equity, increased $25,639 or 1.7%. Premiums receivable increased $15,641
or 6.8%. The increase in premiums receivable from December 31, 2000, was
primarily attributable to increases in Massachusetts automobile business.
Deferred policy acquisition costs increased $5,252 or 4.7%. Receivable
from reinsurers increased $8,896 or 14.5%, primarily attributable to the
increase in other than automobile business previously discussed. The
deferred income tax asset increased $4,952, mainly as a result of
accounting for certain investments on an equity basis. All other
remaining assets increased $4,088 or 2.2%.
24
The Company's investment portfolio, at market and equity, is shown on the following
table as of December 31, 2001 and 2000 (for investments, at cost, refer to the table found
on page 15):
December 31,
Investments, at market and equity % of % of
2001 Invest. 2000 Invest.
GNMA & FNMA mortgage-backed bonds...... $ 98,985 6.6% $ 67,261 4.6%
Corporate bonds........................ 136,506 9.1 126,255 8.6
U.S. Treasury bonds and notes.......... 105 - 3,377 0.2
Tax exempt state and municipal bonds... 390,886 26.1 473,042 32.1
Total fixed maturities............. 626,482 41.8 669,935 45.5
Preferred stocks....................... 248,101 16.6 200,083 13.6
Common stocks.......................... 107,458 7.2 115,827 7.9
Closed-end preferred stock
mutual funds at equity............... 309,282 20.6 337,733 22.9
Mortgages and collateral loans (net of
allowance for possible loan losses).. 39,505 2.6 51,661 3.5
Cash and cash equivalents.............. 148,630 9.9 70,521 4.8
Other investments...................... 18,743 1.3 26,802 1.8
Total investments.................. $1,498,201 100.0% $1,472,562 100.0%
Comparison of Cost/Market Value of Fixed Maturities for the years ended December 31,
2001
% of Total
Market Cost Difference Based on Cost
GNMA & FNMA mortgage-backed bonds..... $ 98,985 $ 98,198 $ 787 15.9%
Corporate bonds....................... 136,506 133,506 3,000 21.6%
U.S. Treasury bonds and notes......... 105 104 1 0.0%
Tax exempt state and municipal bonds.. 390,886 386,967 3,919 62.5%
Total fixed maturities.............. $ 626,482 $ 618,775 $ 7,707 100.0%
2000
% of Total
Market Cost Difference Based on Cost
GNMA & FNMA mortgage-backed bonds..... $ 67,261 $ 67,274 $ (13) 10.0%
Corporate bonds....................... 126,255 130,775 (4,520) 20.0%
U.S. Treasury bonds and notes......... 3,377 3,428 (51) 1.0%
Tax exempt state and municipal bonds.. 473,042 464,404 8,638 70.0%
Total fixed maturities.............. $ 669,935 $ 665,881 $ 4,054 100.0%
Of the Company's bonds, 97.9% are rated in either of the two highest
quality categories provided by the NAIC.
Comparison of Carrying Value for the years ended December 31,
2001 2000
Market/Equity Market/Equity % of
Value Value Variance Variance
Fixed maturities...................... $ 626,482 $ 669,935 $ (43,453) (6.5%)
Preferred stocks...................... 248,101 200,083 48,018 24.0%
Common stocks......................... 107,458 115,827 (8,369) (7.2%)
Closed-end preferred stock
mutual funds at equity.............. 309,282 337,733 (28,451) (8.4%)
Mortgages and collateral loans
(net of allowance for possible
loan losses)...................... 39,505 51,661 (12,156) (23.5%)
Cash and cash equivalents............. 148,630 70,521 78,109 110.8%
Other investments..................... 18,743 26,802 (8,059) (30.1%)
Total investments................... $1,498,201 $1,472,562 $ 25,639 1.7%
25
Preferred stocks increased $48,018, or 24.0% and common stocks decreased
$8,369, or 7.2%, during 2001. Preferred stock mutual funds at equity,
decreased $28,541 or 8.4% in 2001 compared to 2000. The majority of the
increase in preferred stocks and the corresponding decrease in preferred
stock mutual funds was primarily the result of a newly created trust fund.
In 2001, the trustees of Putnam Dividend Income Fund ("PDI") liquidated the
fund. The Company's pro-rata share of the portfolio securities and cash of
PDI was transferred to a new fund created by the PDI trustees whose ownership
was conveyed to the Company. At December 31, 2001 the fund was consolidated
into the Company's financial statements, totaling $60,869. The majority of
the fund represents investments valued at $59,019 and is included in
preferred stocks and $1,332 in cash and cash equivalents. Other investments
at equity, comprised of venture capital fund investments, decreased $8,059 or
30.1% during 2001 as a result of equity accounting changes mentioned
previously. The Company's strategy continues to focus on maximizing after-
tax investment income through investing in high quality securities coupled
with acquiring equity investments, which may forgo current investment yield
in favor of potential higher yielding capital appreciation in the future.
The Company continues to monitor interest rates on long-term securities and
intends to maintain its high cash position until such time as the Company
believes the long-term rates have appropriately firmed.
The Company's liabilities increased $35,143 or 2.7% to $1,327,808 at
December 31, 2001 as compared to $1,292,665 at December 31, 2000. Loss and
loss adjustment expense reserves comprised 51.3% of the Company's liabilities
at December 31, 2001 compared with 52.2% at December 31, 2000. Unearned
premiums comprised 42.4% of the Company's liabilities at December 31, 2001
compared with 40.2% at December 31, 2000. All other liabilities comprised
6.3% of the Company's liabilities at December 31, 2001, compared with 7.6% at
December 31, 2000. Loss and loss adjustment expense reserves increased
$7,484 or 1.1%. Unearned premiums increased $43,571 or 8.4%, due primarily
to increased business in 2001. Current income taxes decreased $13,988 or
80.4%. The net effect of all other liabilities decreased $4,659 or 5.5%.
Liabilities for unpaid losses and loss adjustment expenses at December 31, 2001 and 2000 consist
of:
2001 2000
Net voluntary unpaid loss and LAE reserves................ $558,635 $544,585
Voluntary salvage and subrogation recoverable............. (73,393) (65,505)
Assumed unpaid loss and LAE reserves from C.A.R........... 125,787 127,631
Assumed salvage and subrogation recoverable from C.A.R.... (20,695) (20,844)
Total voluntary and assumed unpaid loss and LAE reserves 590,334 585,867
Adjustment for ceded unpaid loss and LAE reserves......... 100,290 97,273
Adjustment for ceded salvage and subrogation recoverable.. (9,000) (9,000)
Total unpaid loss and LAE reserves...................... $681,624 $674,140
The primary sources of the Company's liquidity are funds generated
from insurance premiums, net investment income, premium finance and
service fees and the maturing and sale of investments as reflected in the
Consolidated Statements of Cash Flows on pages 38 and 39. The discussion
of these items can be found under "Year Ended December 31, 2001 Compared
to Year Ended December 31, 2000", herein.
The Company's operating activities provided cash of $106,172 in 2001,
as compared to $147,906 in 2000, representing a decrease of $41,734 or
28.2% in 2000. The primary reason for this decrease is that the increase
in premiums collected was outpaced by the increase in losses and LAE paid.
Federal income tax payments increased $10,439 or 35.7% in 2001. Of the
$39,703 in federal tax payments in 2001, $13,985 related to 2000, due to
significant income in the fourth quarter of 2000. Net investment income
received and premium and service fees received increased 8.9% and 17.0%,
respectively.
26
For 2001 net cash flows from investing activities provided cash of
$35,199, as compared to net cash flows used in investing activities of
$45,226 in 2000. The majority of the $80,425 difference was a $54,142
decrease in purchases of fixed maturities, a $38,824 decrease in the
purchase of preferred stock mutual funds, a $5,164 increase from proceeds
from sale of equity securities, a $3,811 decrease in purchases of other
assets, and a $4,974 increase in proceeds from maturity of fixed
maturities. These were offset by a $12,787 increase in the purchase of
equity securities coupled with a $6,790 increase in the purchase of
property and equipment. Investing activities were funded by accumulated
cash and cash provided by operating activities in 2001 and 2000. The
decreased purchases of longer term investments coupled with the
significant increase in cash and cash equivalents were primarily the
result of the low interest rate environment in 2001.
During 2001, Commerce purchased a 160,000 square foot building.
Costs for this building including the land and improvements to date at
December 31, 2001, are $4,932. The Company anticipates expending an
additional $13 million renovating this building, primarily in 2002.
Cash flows used in financing activities totaled $63,262 during 2001
compared to $54,694 during 2000. The 2001 cash flows used in financing
activities consisted of $39,951 in dividends paid to stockholders and
$23,311 used to purchase 622,900 shares of Treasury Stock. The 2000 cash
flows used in financing activities consisted of $39,201 in dividends paid
to stockholders and $15,493 used to purchase 606,200 shares of Treasury
Stock.
The Company's funds are generally invested in securities with
maturities intended to provide adequate funds to pay claims without the
forced sale of investments. The carrying value (at market and equity) of
total investments at December 31, 2001 was $1,498,201. At December 31,
2001, the Company held cash and cash equivalents of $148,630. These funds
provide sufficient liquidity for the payment of claims and other short-
term cash needs. The Company continues to monitor interest rates on long-
term securities and intends to maintain its high cash position until such
time as the Company believes long-term rates have appropriately firmed.
The Company also relies upon dividends from its subsidiaries for its cash
requirements. Every Massachusetts insurance company seeking to make any
dividend or other distributions to its stockholders may, within certain
limitations, pay such dividends and then file a report with the
Commissioner. Dividends in excess of these limitations are called
extraordinary dividends. An extraordinary dividend is any dividend or
other property, whose fair value together with other dividends or
distributions made within the preceding twelve months exceeds the greater
of ten percent of the insurer's surplus as regards to policyholders as of
the end of the preceding year, or the net income of a non-life insurance
company for the preceding year. No pro-rata distribution of any class of
the insurer's own securities is to be included. No Massachusetts
insurance company shall pay an extraordinary dividend or other
extraordinary distribution until thirty days after the Commissioner has
received notice of the intended distribution and has not objected. No
extraordinary dividends were paid in 2001, 2000 or 1999. Similar laws
exist in California and Ohio. No extraordinary dividend was paid by
American Commerce in 2001 or 2000 and no dividends were paid by Commerce
West since its acquisition.
Periodically, sales have been made from the Company's fixed maturity
investment portfolio to actively manage portfolio risks, including credit-
related concerns, to optimize tax planning and to realize gains. This
practice will continue in the future.
Industry and regulatory guidelines suggest that the ratio of a
property and casualty insurer's annual net premiums written to statutory
policyholders' surplus should not exceed 3.00 to 1.00. The Company's
statutory premiums to surplus ratio was 1.51 to 1.00, 1.53 to 1.00, and
1.76 to 1.00 for the years ended December 31, 2001, 2000 and 1999,
respectively.
27
In early 1999, Commerce, invested $90,800 in the joint venture (ACIC
Holding Co., Inc.) to fund the American Commerce acquisition and to
capitalize the joint venture that is owned together with AAA SNE. Of this
$90,800, Commerce invested $90,000 in the form of preferred stock and an
additional $800 representing its 80% common stock ownership. The terms of
the preferred stock call for quarterly cash dividends at the rate of 10%
per annum. In the event cash dividends cannot be paid, additional
preferred stock will be issued. AAA SNE invested $200 representing its
20% common stock ownership. Commerce consolidates ACIC Holding Co., Inc.
and its wholly-owned subsidiary, American Commerce, for financial
reporting and tax purposes. Since 1995, Commerce has maintained an
affinity group marketing relationship with AAA Insurance Agency, Inc., a
subsidiary of AAA SNE. AAA Insurance Agency, Inc. has been an agent of
Commerce since 1985.
In addition to the real estate commitment mentioned earlier, Commerce
has commitments in two venture capital fund investments. These
investments are made in limited partnerships and the Company's exposure to
loss is limited to its actual investment.
In 2000, Commerce entered into a Limited Partnership Agreement with
Conning Partners VI, L.P., a Delaware Limited Partnership. This
partnership agreement required a commitment by the Company to invest up to
$50,000 into the partnership. To date the Company has invested $15,091
into the partnership leaving a balance for funds still committed but not
paid into the partnership of $34,909. The partnership was formed to
operate as an investment fund principally for the purpose of making
investments primarily in equity, equity-related and other securities
issued in expansion financing, start-ups, buy-outs and recapitalization
transactions relating to companies in the areas of insurance, financial
services, e-commerce, healthcare, and related businesses, including,
without limitation, service and technology enterprises supporting such
businesses, in order to realize long-term capital returns, all as
determined and managed by the General Partner for the benefit of the
Partners.
Also in 2000, Commerce entered into a Limited Partnership Agreement
with Distribution Partners Investment Capital, L.P. a Delaware Limited
Partnership. This partnership agreement required a commitment by the
Company to invest up to $3,500 into the partnership. To date the Company
has invested $2,258 into the partnership leaving a balance of $1,242 for
funds still committed. The partnership was formed to operate as an
investment fund principally for the purpose of making investments
primarily in equity and equity-related securities of companies operating
in the area of insurance distribution and distribution related activities,
all as determined and managed by the General Partner for the benefit of
the Partners.
Market Risk: Interest Rate Sensitivity and Equity Price Risk
The Company's investment strategy emphasizes investment yield while
maintaining investment quality. The Company's investment objective
continues to focus on maximizing after-tax investment income through
investing in high quality diversified investments structured to maximize
after-tax investment income while minimizing risk. The Company's funds
are generally invested in securities with maturities intended to provide
adequate funds to pay claims and meet other operating needs without the
forced sale of investments. Periodically, sales have been made from the
Company's fixed maturity portfolio to actively manage portfolio risks,
including credit-related concerns, to optimize tax planning and to realize
gains. This practice will continue in the future.
In conducting investing activities, the Company is subject to, and
assumes, market risk. Market risk is the risk of an adverse financial
impact from changes in interest rates and market prices. The level of
risk assumed by the Company is a function of the Company's overall
objectives, liquidity needs and market volatility.
The Company manages its market risk by focusing on higher quality
equity and fixed income investments, by periodically monitoring the credit
strength of companies in which investments are made, by limiting exposure
in any one investment and by monitoring the quality of the investment
portfolio by taking into account credit ratings assigned by recognized
rating organizations. Although the Company has significant holdings of
various closed-end preferred stock mutual funds, these funds are comprised
primarily of preferred stocks traded on national stock exchanges, thus
limiting exposure to any one investment.
28
As part of its investing activities, the Company assumes positions in
fixed maturity, equity, short-term and cash equivalents markets. The
Company is, therefore, exposed to the impacts of interest rate changes in
the market value of investments. At December 31, 2001, the Company's
exposure to interest rate changes and equity price risk has been estimated
using sensitivity analysis. The interest rate impact is defined as the
effect of a hypothetical interest rate change of plus-or-minus 200 basis
points on the market value of fixed maturities and preferred stocks. The
equity price risk is defined as a hypothetical change of plus-or-minus 10%
in the fair value of common stocks. Changes in interest rates would
result in unrealized gains or losses in the market value of the fixed
maturity and preferred stock portfolio due to differences between current
market rates and the stated rates for these investments. Based on the
results of the sensitivity analysis at December 31, 2001, the Company's
estimated market exposure for a 200 basis point increase (decrease) in
interest rates was calculated. A 200 basis point increase results in an
$83,611 decrease in the market value of the fixed maturities and preferred
stocks. A 200 basis point decrease results in a $47,436 increase in the
market value of the same securities. The equity price risk impact at
December 31, 2001, based upon a 10% increase in the fair value of common
stocks and preferred stock mutual funds, would be an increase of $10,746
and $31,567, respectively. Based upon a 10% decrease, common stocks and
preferred stock mutual funds would decrease $10,746 and $31,567,
respectively. Long-term interest rates (30-year Treasury Bond) increased
slightly to 5.47% at December 31, 2001 from 5.46% at December 31, 2000.
The preceding sensitivity analysis does not represent a forecast and
should not be relied upon as being indicative of expected operating
results. These hypothetical estimates are based upon numerous assumptions
such as the nature and timing of interest rate levels including the yield
curve shape, prepayments on loans and securities, reinvestment and
replacement of asset and liability cash flows and others. While
assumptions are developed based upon current economic conditions, the
Company cannot provide any assurance as to the predictive nature of these
assumptions. Also, as market conditions vary from those assumed in the
sensitivity analysis, actual results will also differ due to prepayment
and refinancing levels likely deviating from those assumed and other
internal and external variables. Furthermore, the sensitivity analysis
does not reflect actions that management might take in responding to or
anticipating changes in interest rates.
Recent Accounting Developments
The NAIC revised the Accounting Practices and Procedures Manual in a
process referred to as Codification. The revised manual became effective
January 1, 2001 for all insurance companies. The domiciliary states of
the Company's insurance subsidiaries have adopted the provisions of the
revised manual. The revised manual has changed certain prescribed
statutory accounting practices and has resulted in changes to the
accounting practices that the Company's insurance subsidiaries use to
prepare their statutory-basis financial statements. The impact of these
changes to the Company's insurance subsidiaries statutory-basis capital
and surplus as of January 1, 2001 had a significant beneficial effect of
approximately $38,737 primarily due to the inclusion of deferred taxes as
an admitted asset. The codification changes had no impact on the
Company's GAAP financial statements.
In June 1998, the FASB issued Statement of Financial Accounting
Standards No. 133 ("SFAS 133"), "Accounting for Certain Derivative
Instruments and Hedging Activities", as amended in June 2000 by Statement
of Financial Accounting Standards No. 138 ("SFAS 138"), "Accounting for
Certain Derivative Instruments and Certain Hedging Activities", which
requires companies to recognize all derivatives as either assets or
liabilities in the balance sheet and measure such instruments at fair
value. SFAS 138 also amended Statement of Financial Accounting Standards
No. 137 ("SFAS 137"), "Accounting for Derivative Instruments and Hedging
Activities - Deferral of the Effective Date of FASB Statement No. 133".
The provisions of SFAS 133 require adoption for fiscal year beginning
after June 15, 2000. The Company had no derivative or hedging activity in
2001, 2000, or 1999. The adoption of these FASBs had no material impact
on the Company's consolidated financial statements.
In September 2000, the FASB issued Statement of Financial Accounting
Standards No. 140 ("SFAS 140"), "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities", which replaced
Statement of Financial Accounting Standards No. 125 ("SFAS 125"),
"Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities". The Statement provides accounting and
reporting standards for transfers and servicing of financial assets and
extinguishments of liabilities. Those standards are based on consistent
application of a "financial components" approach that focuses on control.
Under that approach, after a transfer of financial assets, a company
recognizes the financial and servicing assets it controls and the
liabilities it has
29
incurred, does not recognize financial assets when control has been
surrendered, and does not recognize liabilities when extinguished. The
Statement provides consistent standards for distinguishing transfers of
financial assets that are sales from transfers that are secured
borrowings. The Statement is effective for transfers and servicing of
financial assets and extinguishments of liabilities occurring after March
31, 2001. Adoption of SFAS 140 did not have a material impact on the
Company's consolidated financial statements.
In July 2001, the FASB issued Statements of Financial Accounting
Standards No. 141, "Business Combinations", and No. 142, "Goodwill and
Other Intangible Assets". SFAS No. 141, effective for business
combinations initiated after June 30, 2001, requires that all business
combinations be accounted for under a single method - the purchase method.
Use of the pooling-of-interests method is no longer permitted. SFAS No.
141 also clarifies the criteria to recognize intangible assets separately
from goodwill. SFAS No. 142 requires that goodwill and intangible assets
deemed to have indefinite lives no longer be amortized to earnings, but
instead be reviewed at least annually for impairment. Other intangible
assets will continue to be amortized over their useful lives. SFAS No.
142 will be effective January 1, 2002.
The Company has evaluated the impact of adopting the provisions of
SFAS No. 142 on earnings and financial position for the year ended
December 31, 2002. Effective January 1, 2002, in accordance with SFAS No.
142, the Company will cease amortizing the balance sheet item "excess of
book value of subsidiary interest over cost" which is $5.7 million at year
end 2001. The 2001 impact of the amortization of this resulted in
approximately $0.10 per share of annual operating earnings. Additionally,
the Company will no longer amortize the negative goodwill resulting from
the purchase of preferred stock mutual funds effective January 1, 2002.
The amount of unamortized negative goodwill at year-end is $6.4 million.
The 2001 impact of the amortization of this was $0.10 per share of
earnings classified as capital gains. Both the excess of book value of
subsidiary interest over cost and the negative goodwill on preferred stock
mutual funds will be recognized as income in the first quarter of 2002 and
classified as an extraordinary item. The estimated per share income
impact of this change is $0.34 per share.
Critical Accounting Policies
The preparation of financial statements in conformity with GAAP
requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates. The following
accounting policies, which are derived based on management's judgments and
estimates, are considered critical to the preparation of the Company's
financial statements.
1. Investments
The focus of management's judgments and estimates relating to
investments involves the potential impairment of investments for other
than temporary declines in market values. The carrying value of
investments in fixed maturities, which include taxable and non-taxable
bonds, and investments in common and preferred stocks, are derived from
market prices supplied by the Company's investment custodian. Unrealized
investment gains and losses on common and preferred stocks and fixed
maturities, to the extent that there is no other than temporary impairment
of value, are credited or charged to a separate component of stockholders'
equity, known as "net accumulated other comprehensive income (loss)",
until realized, net of any tax effect. An impairment in an investment is
deemed to be other than temporary, when a security's market value has
diminished to less than 75% of cost for two consecutive quarters. If the
security is deemed impaired the Company adjusts the securities cost to
market value through realized loss based on publicly available or, in the
absence of such, to a value based on cash flow modeling. During 2001, the
Company wrote down $2,665 in bonds and preferred stock investments with
impairment as determined by management to be other than temporary. Given
the makeup and quality of the Company's investments, management does not
believe that a more stringent policy would have a material effect on the
carrying value of its investments.
30
2. Unpaid Loss and Loss Adjustment Expenses ("LAE")
Unpaid Loss and LAE by their nature are inherently uncertain as to
the ultimate outcome of the estimated amounts. The liability for unpaid
losses and LAE represents Management's best estimate of the ultimate net
cost of all losses and LAE incurred through the balance sheet date. The
estimate for ultimate net cost of all losses incurred through the balance
sheet date includes the adjusted case estimates for losses, incurred but
not reported ("IBNR") losses, salvage and subrogation recoverable and a
reserve for LAE. In arriving at its best estimate, management begins with
the aggregate of individual case reserves and then makes adjustments to
these amounts on a line of business basis. These adjustments to the
aggregate case reserves by line of business are made based on analysis
performed by Management as further described below. The entire liability
for unpaid losses and LAE is also reviewed quarterly and annually by the
Company's Actuarial Department. Liability estimates are continually
analyzed and updated, and therefore, the ultimate liability may be more or
less than the current estimate. The effects of changes in the estimates
are included in the results of operations in the period in which the
estimates are revised.
The claim cycle begins when a claim is reported to the Company and
claims personnel establish a "case reserve" for the estimated amount of
the ultimate exposure to the Company. The amount of the reserve is
primarily based upon an evaluation of the type of claim involved, the
circumstances surrounding the claim and the policy provisions relating to
the loss. This estimate reflects the informed judgment of such personnel
based on general insurance reserving practices and on the experience and
knowledge of the claims personnel adjusting the claim. During the loss
adjustment period, these case basis estimates are revised as deemed
necessary by the Company's claims department personnel based on subsequent
developments and periodic reviews of the claim.
In accordance with industry practice, the Company also maintains
reserves for estimated IBNR, salvage and subrogation recoverable and LAE.
These reserves are determined on the basis of historical information and
the experience of the Company. Adjustments to these reserves are made
periodically to take into account changes in the volume of business
written, claims frequency and severity, the mix of business, claims
processing and other items that can be expected to affect the Company's
liability for losses and LAE over time.
When reviewing the liability for unpaid losses and LAE, the Company
analyzes historical data and estimates the impact of various factors such
as: (i) payment trends; (ii) loss expense per exposure; (iii) the
historical loss experience of the Company and industry; (iv) frequency and
severity trends; and, (v) legislative enactments, judicial decisions,
legal developments in the imposition of damages, changes and trends in
general economic conditions, including the effects of inflation and
recession. This process assumes that past experience, adjusted for the
effects of current developments and anticipated trends, is an appropriate
basis for predicting future events. There is no precise method, however,
for subsequently evaluating the impact of any specific factor on the
adequacy of reserves, because the eventual development of reserves is
affected by many factors.
By using individual estimates of reported claims adjusted for
managements best estimate by line of business and generally accepted
actuarial reserving techniques, the Company estimates the ultimate net
liability for losses and LAE. After taking into account all relevant
factors, management believes that, based on existing information, the
provision for losses and LAE at December 31, 2001 is adequate to cover the
ultimate net cost of losses and claims incurred as of that date. The
ultimate liability, however, may be greater or lower than established
reserves. If the ultimate exposure is greater than (or less than)
management's estimated liability for losses and LAE, based on any of the
factors noted previously, the Company will incur additional expense
(income) which may have a material impact.
Forward - Looking Statements
This annual report contains some statements that are not historical
facts and are considered "forward-looking statements" as defined in the
Private Securities Litigation Reform Act of 1995. Such forward-looking
statements involve opinions, assumptions and predictions, and no assurance
can be given that the future results will be achieved since events or
results may differ materially as a result of risks facing the Company.
These include, but are not limited to, those risks and uncertainties in
our business, some of which are beyond the control of the Company, that
are described in the Company's Forms 10-K and 10-Q, Schedules 13D and 13G,
and other documents filed with the SEC, including the
31
possibility of adverse catastrophe experience and severe weather, adverse
trends in claim severity or frequency, adverse state and federal
regulation and legislation, adverse state judicial decisions, litigation
risks, interest rate risk, rate making decisions for private passenger
automobile policies in Massachusetts, potential rate filings outside of
Massachusetts, adverse impacts related to consolidation activities,
heightened competition, as well as the economic, market or regulatory
conditions and risks associated with entry into new markets and
diversification.
Effects of Inflation and Recession
The Company generally is unable to recover the costs of inflation in
its personal automobile insurance line since the premiums it charges are
subject to state regulation. Additionally, the premium rates charged by
the Company for personal automobile insurance are adjusted by the
Commissioner only at annual intervals. Such annual adjustments in premium
rates may lag behind related cost increases. Economic recessions can have
an impact upon the Company, primarily through the policyholder's election
to decrease non-compulsory coverages afforded by the policy and increased
driving, each of which tends to decrease claims.
To the extent inflation and economic recession influence yields on
investments, the Company is also affected. As each of these environments
affect current market rates of return, previously committed investments
may rise or decline in value depending on the type and maturity of
investment.
Inflation and recession must also be considered by the Company in the
creation and review of loss and LAE reserves since portions of these
reserves are expected to be paid over extended periods of time. The
anticipated effect of economic conditions is implicitly considered when
estimating liabilities for losses and LAE. The importance of continually
adjusting reserves is even more pronounced in periods of changing economic
circumstances.
COMMON STOCK PRICE AND DIVIDEND INFORMATION
The Company's common stock trades on the NYSE under the symbol "CGI".
The high, low and close prices for shares, as quoted in The Boston Globe,
of the Company's Common Stock for 2001 and 2000 were as follows:
2001 2000
High Low Close High Low Close
First Quarter...... $32.1000 $24.5500 $32.0000 $31.0000 $23.0000 $29.5000
Second Quarter..... 36.9900 30.7500 36.7900 30.8750 26.1250 29.5000
Third Quarter...... 38.3500 33.5500 38.0000 29.4375 25.0625 28.9375
Fourth Quarter..... 40.3500 35.8000 37.6900 29.2500 22.8750 27.1800
As of March 1, 2002, there were 1,053 stockholders of record of the
Company's Common Stock, not including stock held in "Street Name" or held
in accounts for participants of the Company's Employee Stock Ownership
Plan ("E.S.O.P.").
The Board of Directors of the Company voted to declare four quarterly
dividends to stockholders of record totaling $1.19 per share and $1.15 per
share in 2001 and 2000, respectively. On May 19, 2001, the Board voted to
increase the quarterly stockholder dividend from $0.29 to $0.30 per share
to stockholders of record as of June 4, 2000. Prior to that declaration,
the Company had paid quarterly dividends of $0.29 per share dating back to
May 15, 2000 when the Board voted to increase the dividend from $0.28 to
$0.29 per share.
In May 1999, the Board of Directors of the Company authorized a stock
buy-back program of up to 2,000,000 shares of common stock of the Company.
At December 31, 2001, there are 273,700 shares of common stock authorized
to be purchased under this program. In November 2001, the Board of
Directors approved another stock buy-back program authorizing the purchase
of up to an additional 2,000,000 shares. During the period from January
1, 2001 through December 31, 2001, the Company purchased 622,900 shares of
its own common stock. During 2000, the Company purchased 606,200 shares
of its own common stock under the May 1999 buy-back program. At December
31, 2001, the Company had authority to purchase a total of 2,273,700
additional shares of its common stock under the May 1999 and November 2001
buy-back programs. As of December 31, 2001, the Company holds a total of
4,869,548 shares of treasury stock.
32
REPORT OF MANAGEMENT
The management of the Company is responsible for the consolidated
financial statements and all other information presented in this Annual
Report. The financial statements have been prepared in conformity with
accounting principles generally accepted in the United States
determined by management to be appropriate in the circumstances and
include amounts based on management's informed estimates and judgments.
Financial information presented elsewhere in this Annual Report is
consistent with the financial statements. The appropriateness of data
underlying such financial information is monitored through internal
accounting controls, an internal audit department, independent auditors
and the Board of Directors through its audit committee.
The Company maintains a system of internal accounting controls
designed to provide reasonable assurance to management and the Board of
Directors that assets are safeguarded and that transactions are
executed in accordance with management's authorization and recorded
properly. The system of internal accounting controls is supported by
the selection and training of qualified personnel combined with the
appropriate division of responsibilities.
Management recognizes its responsibility for fostering a strong
ethical climate so that the Company's affairs are conducted according
to the highest standards of personal and corporate conduct. The Board
of Directors has adopted a formal Code of Conduct and Corporate
Compliance Program governing employees and directors. Management
encourages open communication within the Company and requires the
confidential treatment of proprietary information and compliance with
all domestic laws, including those relating to financial disclosure.
The 2001 consolidated financial statements were audited by the
Company's independent auditors, Ernst & Young LLP, in accordance with
auditing standards generally accepted in the United States. In
addition, Ernst & Young LLP performs reviews of the unaudited quarterly
financial statements, prior to the announcement of quarterly earnings.
Management has made available to Ernst & Young LLP all of the Company's
financial records and related data, including reports prepared by the
Internal Audit Department as well as the minutes of stockholders' and
directors' meetings. Furthermore, management believes that all
representations made to Ernst & Young LLP were valid and appropriate.
33
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Stockholders of
The Commerce Group, Inc.
We have audited the accompanying consolidated balance sheets of The
Commerce Group, Inc. and Subsidiaries as of December 31, 2001 and 2000,
and the related consolidated statements of earnings, stockholders' equity
and cash flows for each of the three years in the period ended December
31, 2001. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on
these financial statements based on our audits.
We conducted our audits in accordance with auditing standards
generally accepted in the United States. Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing
the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for
our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
The Commerce Group, Inc. and Subsidiaries at December 31, 2001 and 2000,
and the consolidated results of their operations and their cash flows for
each of the three years in the period ended December 31, 2001, in
conformity with accounting principles generally accepted in the United
States.
ERNST & YOUNG LLP
Boston, Massachusetts
January 29, 2002
34
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31,
(Thousands of Dollars)
2001 2000
ASSETS
Investments (notes A2, A3, and B)
Fixed maturities, at market (cost: $618,775 in 2001 and $665,881
in 2000).......................................................... $ 626,482 $ 669,935
Preferred stocks, at market (cost: $256,582 in 2001 and $215,823
in 2000).......................................................... 248,101 200,083
Common stocks, at market (cost: $87,704 in 2001 and 2000).......... 107,458 115,827
Preferred stock mutual funds, at equity (cost: $294,948 in 2001 and
$327,980 in 2000)................................................. 309,282 337,733
Mortgage loans on real estate and collateral notes receivable
(less allowance for possible loan losses of $660 in 2001
and $858 in 2000)................................................. 39,505 51,661
Cash and cash equivalents.......................................... 148,630 70,521
Other investments (cost: $28,291 in 2001 and $25,475 in 2000)...... 18,743 26,802
Total investments.............................................. 1,498,201 1,472,562
Accrued investment income............................................ 15,539 18,218
Premiums receivable (less allowance for doubtful receivables of
$1,565 in 2001 and $1,487 in 2000)................................. 246,221 230,580
Deferred policy acquisition costs (notes A4 and C)................... 116,557 111,305
Property and equipment, net of accumulated depreciation
(notes A5 and D)................................................... 40,014 34,823
Residual market receivable (note F)
Losses and loss adjustment expenses................................ 81,433 82,450
Unearned premiums.................................................. 44,399 44,791
Due from reinsurers (note F)......................................... 70,450 61,554
Deferred income taxes (notes A9 and G)............................... 16,993 12,041
Receivable for investments sold...................................... 838 -
Non-compete agreement, net of accumulated amortization (note A6)..... 2,479 2,829
Other assets......................................................... 6,958 4,461
Total assets................................................... $2,140,082 $2,075,614
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Unpaid losses and loss adjustment expenses (notes A7, E and F)..... $ 681,624 $ 674,140
Unearned premiums (note A8)........................................ 563,456 519,885
Current income taxes (notes A9 and G).............................. 2,735 13,988
Deferred income (notes A10 and F).................................. 7,015 7,703
Contingent commissions accrued (note A11).......................... 29,724 35,346
Payable for securities purchased................................... - 524
Excess of book value of subsidiary interest over cost (note A12)... 5,719 8,431
Other liabilities and accrued expenses............................. 37,535 32,648
Total liabilities.............................................. 1,327,808 1,292,665
Minority interest (note A13)......................................... - 1,068
Stockholders' Equity (notes B, L, M and N)
Preferred stock, authorized 5,000,000 shares at $1.00 par value;
none issued in 2001 and 2000...................................... - -
Common stock, authorized 100,000,000 shares at $.50 par value;
38,000,000 shares issued in 2001 and 2000......................... 19,000 19,000
Paid-in capital.................................................... 29,621 29,621
Net accumulated other comprehensive income, net of income
taxes of $6,674 in 2001 and $6,371 in 2000........................ 12,394 11,833
Retained earnings.................................................. 873,671 820,528
934,686 880,982
Treasury stock, 4,869,548 shares in 2001 and 4,246,648 shares in
2000, at cost (note A14).......................................... (122,412)
(99,101)
Total stockholders' equity..................................... 812,274 781,881
Total liabilities, minority interest and stockholders' equity.. $2,140,082 $2,075,614
The accompanying notes are an integral part of these consolidated financial statements.
35
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
For the years ended December 31,
(Thousands of Dollars Except Per Share Data)
2001 2000 1999
Revenues
Earned premiums (notes A8 and F)..................... $1,043,652 $ 954,483 $ 871,830
Net investment income (note B)....................... 99,611 96,830 89,789
Premium finance and service fees..................... 17,819 15,227 14,774
Amortization of excess of book value of subsidiary
interest over cost (note A12)...................... 3,389 3,390 3,019
Net realized investment gains (losses) (note B)...... (10,633) 29,550 (16,378)
Total revenues.................................. 1,153,838 1,099,480 963,034
Expenses
Losses and loss adjustment expenses
(notes A7, E and F)................................. 777,543 686,157 625,090
Policy acquisition costs (notes A4 and C)............ 260,870 243,257 233,660
Total expenses.................................. 1,038,413 929,414 858,750
Earnings before income taxes and minority
interest...................................... 115,425 170,066 104,284
Income taxes (notes A9 and G).......................... 23,194 38,306 16,667
Net earnings before minority interest........... 92,231 131,760 87,617
Minority interest in net loss of subsidiary (note A13). 863 320 1,059
NET EARNINGS.................................... $ 93,094 $ 132,080 $ 88,676
COMPREHENSIVE INCOME............................ $ 93,655 $ 168,570 $ 40,730
NET EARNINGS PER COMMON SHARE: (note A15)
BASIC......................................... $ 2.77 $ 3.87 $ 2.54
DILUTED....................................... $ 2.75 $ 3.87 $ 2.54
CASH DIVIDENDS PAID PER SHARE................... $ 1.19 $ 1.15 $ 1.11
WEIGHTED AVERAGE NUMBER OF COMMON
SHARES OUTSTANDING:
BASIC........................................ 33,608,804 34,121,047 34,940,074
DILUTED...................................... 33,794,938 34,121,047 34,940,074
The accompanying notes are an integral part of these consolidated financial statements.
36
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
For the years ended December 31,
(Thousands of Dollars)
Net
Accumulated
Other
Common Paid-in Comprehensive Retained Treasury
Stock Capital Income/(Loss) Earnings Stock Total
Balance January 1, 1999...... $19,000 $29,621 $ 23,289 $677,629 $ (38,687) $710,852
Net earnings................ 88,676 88,676
Other comprehensive income
(loss):
Unrealized holding losses
arising during the period,
net of tax benefits of
$18,833.................. (34,976) (34,976)
Reclassification adjustment,
net of tax benefits of
$6,984.................... (12,970) (12,970)
Other comprehensive(loss).. (47,946) (47,946)
Comprehensive income........ 40,730
Stockholder dividends....... (38,656) (38,656)
Treasury stock purchased.... (44,921) (44,921)
Balance December 31, 1999.... 19,000 29,621 (24,657) 727,649 (83,608) 668,005
Net earnings................ 132,080 132,080
Other comprehensive income:
Unrealized holding gains
arising during the period,
net of taxes of $18,218.. 33,833 33,833
Reclassification adjustment,
net of taxes of $1,431.... 2,657 2,657
Other comprehensive income. 36,490 36,490
Comprehensive income........ 168,570
Stockholder dividends....... (39,201) (39,201)
Treasury stock purchased.... (15,493) (15,493)
Balance December 31, 2000.... 19,000 29,621 11,833 820,528 (99,101) 781,881
Net earnings................ 93,094 93,094
Other comprehensive income
(loss):
Unrealized holding losses
arising during the period,
net of tax benefits of
$634..................... (1,178) (1,178)
Reclassification adjustment,
net of taxes of $936...... 1,739 1,739
Other comprehensive income. 561 561
Comprehensive income........ 93,655
Stockholder dividends....... (39,951) (39,951)
Treasury stock purchased.... (23,311) (23,311)
Balance December 31, 2001.... $19,000 $29,621 $ 12,394 $873,671 $(122,412) $812,274
The accompanying notes are an integral part of these consolidated financial statements.
37
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended December 31,
(Thousands of Dollars)
2001 2000 1999
Cash flows from operating activities
Premiums collected.................................. $1,066,544 $ 977,413 $ 881,472
Net investment income received...................... 101,216 92,962 90,558
Premium finance and service fees received........... 17,819 15,227 14,774
Losses and loss adjustment expenses paid............ (770,841) (660,665) (611,136)
Policy acquisition costs paid....................... (268,863) (247,767) (225,587)
Federal income tax payments......................... (39,703) (29,264) (25,404)
Net cash provided by operating activities......... 106,172 147,906 124,677
Cash flows from investing activities
Proceeds from maturity of fixed maturities.......... 25,779 20,805 46,565
Proceeds from sale of fixed maturities.............. 89,712 97,180 142,562
Proceeds from sale of equity securities............. 50,768 45,604 76,485
Proceeds from sale of preferred stock mutual funds.. 2,945 - -
Proceeds from sale of other investments............. 5,735 - -
Proceeds from sale of mortgages..................... - 20,042 -
Purchase of fixed maturities........................ (71,702) (125,844) (107,664)
Purchase of equity securities....................... (42,774) (29,987) (72,536)
Purchase of preferred stock mutual funds............ (21,200) (60,024) (98,564)
Purchase of other investments....................... (8,074) (11,885) (4,875)
Purchase of subsidiary, net of cash acquired........ - - (77,056)
Payments received on mortgage loans and collateral
notes receivable................................... 14,506 9,141 11,800
Mortgage loans and collateral notes originated...... (2,152) (7,896) (10,911)
Purchase of property and equipment.................. (10,206) (3,416) (2,910)
Other proceeds from investing activities............ 1,862 1,054 2,627
Net cash provided by (used in) investing
activities...................................... 35,199 (45,226) (94,477)
Cash flows from financing activities
Dividends paid to stockholders...................... (39,951) (39,201) (38,656)
Purchase of treasury stock.......................... (23,311) (15,493) (44,921)
Net cash used in financing activities............. (63,262) (54,694) (83,577)
Increase (decrease) in cash and cash equivalents...... 78,109 47,986 (53,377)
Cash and cash equivalents at beginning of year........ 70,521 22,535 75,912
Cash and cash equivalents at end of year.............. $ 148,630 $ 70,521 $ 22,535
The accompanying notes are an integral part of these consolidated financial statements.
38
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Reconciliation of Net Earnings to Net Cash Provided by Operating Activities
For the years ended December 31,
(Thousands of Dollars)
2001 2000 1999
Cash flows from operating activities
Net earnings......................................... $ 93,094 $ 132,080 $ 88,676
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Premiums receivable................................ (15,641) (35,420) (22,399)
Deferred policy acquisition costs.................. (5,252) (12,805) (3,374)
Residual market receivable......................... 1,409 14,419 (1,440)
Due from reinsurers................................ (8,896) (13,189) (4,116)
Losses and loss adjustment expenses................ 7,484 14,299 12,733
Unearned premiums.................................. 43,571 62,790 38,796
Current income taxes............................... (11,253) 3,149 6,909
Deferred income taxes.............................. (5,255) 5,893 (15,647)
Deferred income.................................... (688) 239 516
Contingent commissions............................. (5,622) 1,878 11,401
Other assets, liabilities and accrued expenses..... (323) 6,708 (8,273)
Net realized investment (gains) losses............. 10,633 (29,550) 16,378
Other - net........................................ 2,911 (2,585) 4,517
Net cash provided by operating activities....... $ 106,172 $ 147,906 $ 124,677
The accompanying notes are an integral part of these consolidated financial statements.
39
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars)
NOTE A - Summary of Significant Accounting Policies
1. Basis of Presentation
The consolidated financial statements of The Commerce Group, Inc.
(the "Company") have been prepared in accordance with accounting
principles generally accepted in the United States ("GAAP").
The consolidated financial statements include The Commerce Group,
Inc. and its wholly-owned subsidiaries, Bay Finance Company, Inc., Clark-
Prout Insurance Agency, Inc. and Commerce Holdings, Inc. ("CHI"). The
Commerce Insurance Company ("Commerce") and Citation Insurance Company
("Citation") are wholly-owned subsidiaries of CHI. Commerce West
Insurance Company ("Commerce West") is a wholly-owned subsidiary of
Commerce. American Commerce Insurance Company ("American Commerce") is a
wholly-owned subsidiary of ACIC Holding Co., Inc. ACIC Holding Co., Inc.
is owned jointly with AAA Southern New England ("AAA SNE") with Commerce
maintaining an 80% common stock interest and AAA SNE maintaining a 20%
common stock interest (see NOTE A17). All inter-company transactions and
balances have been eliminated in consolidation. Certain prior year account
balances have been reclassified to conform to the 2001 presentation.
During the fourth quarter of 2000, the Company changed its policy in
regard to its investments in certain closed-end preferred stock mutual
funds. The level of ownership and new investment policy requires the
Company to account for these investments on an equity basis. The results
of prior accounting periods impacted by this change have been restated.
The insurance subsidiaries, Commerce, Citation, Commerce West and
American Commerce, prepare statutory financial statements in accordance
with accounting practices prescribed by the National Association of
Insurance Commissioners ("NAIC"), the Commonwealth of Massachusetts, the
State of California, and the State of Ohio.
The preparation of financial statements in conformity with GAAP
requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
2. Investments
All investment transactions have credit exposure to the extent that a
counter party may default on an obligation to the Company. Credit risk is
a consequence of carrying investment positions. To manage credit risk,
the Company focuses on higher quality fixed-income securities and
preferred stocks, reviews the credit strength of all companies in which it
invests, limits its exposure in any one investment category and monitors
the portfolio quality, taking into account credit ratings assigned by
recognized statistical rating organizations.
The focus of management's judgments and estimates relating to
investments involves the potential impairment of investments for other
than temporary declines in market values. Carrying values of investments
in fixed maturities, which include taxable and non-taxable bonds, and
investments in common and preferred stocks, are derived from market prices
supplied by the Company's investment custodian. Unrealized investment
gains and losses on common and preferred stocks and fixed maturities, to
the extent that there is no other than temporary impairment of value, are
credited or charged to a separate component of stockholders' equity, known
as "net accumulated other comprehensive income (loss)", until realized,
net of any tax effect. An impairment in an investment is deemed to be
other than temporary when a security's market value has diminished to less
than 75% of cost for two consecutive quarters. If the contractual terms
of the security are being complied with, management performs a cash flow
valuation to determine the potential impairment of the security. If the
security is deemed impaired the Company adjusts the securities cost to
market value through realized loss based on publicly available or, in the
absence of such, to a value based on cash flow modeling. During 2001, the
Company wrote down $2,665 in bonds and preferred stock investments with
impairment as determined by management to be other than temporary. Given
the makeup and quality of the Company's investments, management does not
40
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars)
NOTE A - Summary of Significant Accounting Policies (continued)
believe that a more stringent policy would have a material effect on the
carrying value of its investments. When investment securities are sold,
the realized gain or loss is determined based upon specific
identification. Fair market value of fixed maturities and common and
preferred stocks are based on quoted market prices. For other securities
held as investments, fair market value equals quoted market price, if
available. If a quoted market price is not available, fair market value
is estimated using quoted market prices for similar securities. The
Company has not invested more than 5% of fixed maturities in any one state
or political subdivision.
During 2001, as required by the Emerging Issues Task Force ("EITF")
D-46, the Company began accounting for venture capital fund investments in
which it owns more than a 5% interest on the equity method. The operating
results of these venture capital fund investments have been reflected in
realized gains and losses. Prior to this change, the operating results
were not material and were therefore reflected in accumulated other
comprehensive income and loss.
During the fourth quarter of 2000 the Company changed its policy in
regard to investments in certain closed-end preferred stock mutual funds.
From that point forward the Company intends to take a proactive posture to
affect the overall investment performance of these funds. The Company's
level of ownership and new investment policy required the Company to
account for these investments from that point forward on the equity
method. Under the equity method the Company recorded it's share of the
changes in the mutual funds' undistributed net assets in net investment
income. Prior to the fourth quarter of 2000 these investments were
recorded at their fair market value with the changes in value reflected in
accumulated other comprehensive income. With the adoption of the equity
method in the fourth quarter of 2000 all prior periods were restated to
reflect equity method accounting. Beginning in the first quarter of 2001
the Company began recording their equity in the changes in net assets of
closed-end preferred stock mutual funds as a component of realized gains
and losses. All prior periods have been reclassified to permit comparison
with the current year presentation. The Company believes the current year
presentation provides a more appropriate classification for analysis of
ongoing operations of the Company. These investments are valued at
original cost plus the cumulative undistributed equity in earnings and
losses of the funds and adjusted over time by the premium or discount at
the time of purchase to the applicable underlying net asset value of the
funds.
The Company originates and holds mortgage loans on real estate on
properties located in the Commonwealth of Massachusetts and the State of
Connecticut. The Company controls credit risk through credit approvals,
credit limits and monitoring procedures. The Company performs in-depth
credit evaluations on all new mortgage customers. Bad debt expenses have
not been material in recent years.
Mortgage loans on real estate and collateral notes receivable are
stated at the amount of unpaid principal, less an allowance for possible
loan losses. The adequacy of the allowance for possible loan losses is
evaluated on a regular basis by management. Factors considered in
evaluating the adequacy of the allowance include previous loss experience,
current economic conditions and their effect on borrowers and the
performance of individual loans in relation to contract terms. The
provision for possible loan losses charged to operating expenses is based
upon management's judgment of the amount necessary to maintain the
allowance at a level adequate to absorb possible losses. Loan losses are
charged against the allowance when management believes the collectibility
of the principal is unlikely and recoveries are credited to the allowance
when received.
Interest on mortgage loans is included in income as earned based upon
rates applied to principal amounts outstanding. Accrual of interest on
mortgage loans is discontinued either when reasonable doubt exists as to
the full, timely collection of interest or principal, or when a loan
becomes contractually past due more than ninety days. When a loan is
placed on non-accrual status, all unpaid interest previously accrued is
reversed against current period earnings.
41
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars)
NOTE A - Summary of Significant Accounting Policies (continued)
3. Cash and Cash Equivalents
Cash and cash equivalents includes cash currently on hand to cover
operating expenses. The Company invested $82,856 with Fidelity Investment
Government Fund and $59,281 with Provident Institutional Fund. These are
short-term money market investments in government backed securities.
Money is invested on a daily basis. The Company held $17,210 and $13,775
in U.S. Government Repurchase Agreements at various financial institutions
in 2001 and 2000, respectively. The amount of collateral, maintained by
the seller, at the time of purchase and each subsequent business day, is
required to have a market value that is equal to 102% of the resale price.
4. Deferred Policy Acquisition Costs
Policy acquisition costs are calculated by line of business as a
percentage of unearned premiums by multiplying the sum of current
commission rates plus current premium tax rates plus an estimate of the
percentage of other underwriting expenses incurred at the policy issuance.
These costs are deferred and amortized over the period in which the
related premiums are earned, the amount being reduced by any potential
premium deficiency. If any potential premium deficiency exists, it
represents future estimated losses, loss adjustment expenses and
amortization of deferred acquisition costs in excess of the related
unearned premiums. There was no premium deficiency in 2001, 2000 and
1999. In determining whether a premium deficiency exists, the Company
considers anticipated investment income.
5. Property and Equipment
Property and equipment are stated at cost and are depreciated on the
straight line method over the estimated useful lives of the assets using
the following rates:
Percent
Asset Classification Per
Annum
Buildings..................................... 2.5
Building improvements (prior to 1992)......... 2.5
Building improvements (1992 and subsequent)... 5.0
Equipment and office furniture................ 10.0
EDP equipment and copiers..................... 20.0
Automobiles................................... 33.3
Maintenance and repairs are charged to operations; betterments are
capitalized. The cost of property sold or otherwise disposed of and the
accumulated depreciation thereon is eliminated from the related property
and accumulated depreciation accounts and any resulting gain or loss is
credited or charged to income.
6. Non-Compete Agreement
The non-compete agreement of $2,479 represents the unamortized
portion of the purchase price associated with the acquisition of American
Commerce allocated to the arrangement whereby the American Automobile
Association, Inc. ("AAA National") agreed not to compete with American
Commerce prior to February 2009. The cost of $3,500 is being amortized on
a straightline basis over the term of the arrangement. The amount of
accumulated amortization at December 31, 2001 and 2000 was $1,021 and
$671, respectively.
7. Unpaid Loss and Loss Adjustment Expenses
Loss and LAE reserves by their nature are inherently uncertain as to
the ultimate outcome of the estimated amounts. The liability for unpaid
losses and loss adjustment expenses ("LAE") represents the accumulation of
individual case estimates for reported losses and estimates for incurred
but not reported ("IBNR") losses and LAE net of, salvage and subrogation
recoverable. The liability for losses and LAE is intended to cover the
ultimate net cost of all losses and LAE incurred through the balance sheet
date. Liability estimates are continually reviewed and updated, and
therefore, the ultimate liability may be
more or less than the current estimate. The effects of changes in the
estimates are included in the results of operations in the period in which
the estimates are revised.
42
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars)
NOTE A - Summary of Significant Accounting Policies (continued)
8. Premiums
Insurance premiums are recognized as income ratably over the terms of
the policies. Unearned premiums are determined by prorating written
premiums on a daily basis over the terms of the policies. A significant
portion of the Company's Massachusetts premiums written is derived through
the American Automobile Association Clubs of Massachusetts ("AAA clubs")
affinity group marketing program. Of the Company's total direct premiums
written, the portion attributable to the AAA affinity group marketing
program in Massachusetts was $545,496 or 47.3% in 2001, $535,766 or 50.0%
in 2000 and $495,962 or 52.3% in 1999. Of these amounts, 13.0% were
written through insurance agencies owned by the AAA clubs and 87.0% were
written through the Company's network of independent agents in 2001.
9. Income Taxes
The Company uses an asset and liability approach that requires the
recognition of deferred tax assets and liabilities for the expected future
tax consequences of events that have been recognized in the Company's
financial statements or tax returns. In estimating future tax
consequences, the Company generally considers all expected future events
other than changes in the tax law or rates, unless enacted. Valuation
allowances are established when necessary to reduce deferred tax assets to
the amount expected to be realized. No valuation allowance was
established in 2001, 2000 or 1999.
10. Deferred Income
Income consisting of expense reimbursements, which include servicing
carrier fees from Commonwealth Automobile Reinsurers ("C.A.R."), a state-
mandated reinsurance mechanism, on policies written for C.A.R., are
deferred and amortized over the term of the related insurance policies
(see "Notes to Consolidated Financial Statements - NOTE F").
11. Contingent Commissions
In addition to state mandated minimum and other commissions on
policies written, the Company pays certain of its agencies compensation in
the form of profit sharing. This is based, in part, on the underwriting
profits of an individual agent's business written with the Company. The
arrangement for Massachusetts business utilizes a three-year rolling plan,
with one third of the agent's profit or loss for each of the current and
the two prior years' calculations summed to a single amount. This amount,
if positive, is multiplied by the profit sharing commission rate and paid
to the agent. Outside of Massachusetts, Commerce West and American
Commerce each have contingent commission plans tailored to their specific
markets.
12. Excess of Book Value of Subsidiary Interest Over Cost
As a result of the acquisition of American Commerce, the amount
representing the excess of the fair value of the net assets acquired over
the purchase price at the January 29, 1999 acquisition date was $16,947.
The amount is being amortized into revenue on the straight line basis over
a five year period. The amount amortized into income in 2001, 2000 and
1999 was $3,389, $3,390 and $3,019, respectively. See "Notes to
Consolidated Financial Statements - NOTE A17" for treatment of excess of
book value of subsidiary interest over cost ("negative goodwill")
subsequent to December 31, 2001.
43
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars)
NOTE A - Summary of Significant Accounting Policies (continued)
13. Minority Interest in Net Loss of Subsidiary
As a result of the joint venture with AAA SNE and acquisition of
American Commerce, the Company's interest in ACIC Holding Co., Inc.,
through Commerce, a wholly-owned subsidiary of CHI, is represented by
ownership of 80% of the outstanding shares of common stock at December 31,
2001. AAA SNE maintains a 20% common stock ownership. The minority
interest of $863 included in the consolidated statement of earnings for
2001 represents 20% of the net loss for ACIC Holding Co., Inc., calculated
after the $9,582 preferred stock dividend paid to Commerce, to the extent
of the minority interest. This compares to $320 minority interest in the
net loss of ACIC Holding Co., Inc. after $9,178 in preferred stock
dividends paid to Commerce in 2000. During the third quarter of 2001, the
net losses of ACIC Holding Co., Inc. exceeded the minority interest
balance sheet component.
14. Treasury Stock
In May 1999, the Board of Directors of the Company authorized a stock
buy-back program of up to 2,000,000 shares of common stock of the Company.
At December 31, 2001, there are 273,700 shares of common stock authorized
to be purchased under this program. In November 2001, the Board of
Directors approved another stock buy-back program authorizing the purchase
of up to an additional 2,000,000 shares. During the period from January
1, 2001 through December 31, 2001, the Company purchased 622,900 shares of
its own common stock. During 2000, the Company purchased 606,200 shares
of its own common stock under the May 1999 buy-back program. At December
31, 2001, the Company had authority to purchase a total of 2,273,700
additional shares of its common stock under the May 1999 and November 2001
buy-back programs. As of December 31, 2001, the Company holds a total of
4,869,548 shares of treasury stock.
15. Net Earnings Per Common Share
Net earnings per basic common share is computed by dividing net
earnings by the weighted average number of basic common shares
outstanding. The weighted average number of basic common shares
outstanding for the years ended December 31, 2001, 2000 and 1999 were
33,608,804, 34,121,047, and 34,940,074, respectively. Weighted average
number of basic common shares outstanding is determined by taking the
average of the following calculation for a specified period of time: The
daily amount of (1) the total issued outstanding common shares minus (2)
the total Treasury Stock purchased.
Earnings per diluted common share is based on the weighted average
number of diluted common shares outstanding during each period. The
weighted average number of diluted common shares outstanding for the years
ended December 31, 2001, 2000 and 1999 were 33,794,938, 34,121,047 and
34,940,074, respectively. The Company's only potentially dilutive
instruments are stock options outstanding and dilution from these is not
significant.
16. New Accounting Pronouncements
The NAIC revised the Accounting Practices and Procedures Manual in a
process referred to as Codification. The revised manual became effective
January 1, 2001 for all insurance companies. The domiciliary states of
the Company's insurance subsidiaries have adopted the provisions of the
revised manual. The revised manual has changed certain prescribed
statutory accounting practices and has resulted in changes to the
accounting practices that the Company's insurance subsidiaries use to
prepare their statutory-basis financial statements. The impact of these
changes to the Company's insurance subsidiaries statutory-basis capital
and surplus as of January 1, 2001 had a significant beneficial effect of
approximately $38,737 primarily due to the inclusion of deferred taxes as
an admitted asset. The codification changes had no impact on the
Company's GAAP financial statements.
44
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars Except for Per Share Data)
NOTE A - Summary of Significant Accounting Policies (continued)
In June 1998, the FASB issued Statement of Financial Accounting
Standards No. 133 ("SFAS 133"), "Accounting for Certain Derivative
Instruments and Hedging Activities", as amended in June 2000 by Statement
of Financial Accounting Standards No. 138 ("SFAS 138"), "Accounting for
Certain Derivative Instruments and Certain Hedging Activities", which
requires companies to recognize all derivatives as either assets or
liabilities in the balance sheet and measure such instruments at fair
value. SFAS 138 also amended Statement of Financial Accounting Standards
No. 137 ("SFAS 137"), "Accounting for Derivative Instruments and Hedging
Activities - Deferral of the Effective Date of FASB Statement No. 133".
The provisions of SFAS 133 require adoption for fiscal years beginning
after June 15, 2000. The Company had no derivative or hedging activity in
2001, 2000 or 1999. The adoption of these SFASs had no material impact on
the Company's consolidated financial statements.
In September 2000, the FASB issued Statement of Financial Accounting
Standards No. 140 ("SFAS 140"), "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities", which replaced
Statement of Financial Accounting Standards No. 125 ("SFAS 125"),
"Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities". The Statement provides accounting and
reporting standards for transfers and servicing of financial assets and
extinguishments of liabilities. Those standards are based on consistent
application of a "financial components" approach that focuses on control.
Under that approach, after a transfer of financial assets, a company
recognizes the financial and servicing assets it controls and the
liabilities it has incurred, does not recognize financial assets when
control has been surrendered, and does not recognize liabilities when
extinguished. The Statement provides consistent standards for
distinguishing transfers of financial assets that are sales from transfers
that are secured borrowings. The Statement is effective for transfers and
servicing of financial assets and extinguishments of liabilities occurring
after March 31, 2001. Adoption of SFAS 140 did not have a material impact
on the Company's consolidated financial statements.
In July 2001, the FASB issued Statements of Financial Accounting
Standards No. 141, "Business Combinations", and No. 142, "Goodwill and
Other Intangible Assets". SFAS No. 141, effective for business
combinations initiated after June 30, 2001, requires that all business
combinations be accounted for under a single method - the purchase method.
Use of the pooling-of-interests method is no longer permitted. SFAS No.
141 also clarifies the criteria to recognize intangible assets separately
from goodwill. SFAS No. 142 requires that goodwill and intangible assets
deemed to have indefinite lives no longer be amortized to earnings, but
instead be reviewed at least annually for impairment. Other intangible
assets will continue to be amortized over their useful lives. SFAS No.
142 will be effective January 1, 2002.
The Company has evaluated the impact of adopting the provisions of
SFAS No. 142 on earnings and financial position for the year ended
December 31, 2002. Effective January 1, 2002, in accordance with SFAS No.
142, the Company will cease amortizing the balance sheet item "excess of
book value of subsidiary interest over cost" which is $5.7 million at year
end 2001. The 2001 impact of the amortization of this resulted in
approximately $0.10 per share of annual operating earnings. Additionally,
the Company will no longer amortize the negative goodwill resulting from
the purchase of preferred stock mutual funds effective January 1, 2002.
The amount of unamortized negative goodwill at year-end is $6.4 million.
The 2001 impact of the amortization of this was $0.10 per share of
earnings classified as capital gains. Both the excess of book value of
subsidiary interest over cost and the negative goodwill on preferred stock
mutual funds will be recognized as income in the first quarter of 2002 and
classified as an extraordinary item. The estimated per share income
impact for this change is $0.34 per share.
45
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars)
17. Acquisition
In November 1998, Commerce formed ACIC Holding Co., Inc., in a joint
venture with AAA SNE and invested $90,800 to fund the January 29, 1999
acquisition of the Automobile Club Insurance Company, whose name was
changed to American Commerce upon completion of the acquisition. Commerce
invested $90,000 in the form of preferred stock and an additional $800
representing an 80% common stock ownership. AAA SNE invested $200
representing a 20% common stock ownership. The terms of the preferred
stock call for Commerce to receive quarterly cash dividends at the rate of
10% per annum from ACIC Holding, Co., Inc. In the event cash dividends
cannot be paid, additional preferred stock will be issued. During 2001,
96 shares of Class B preferred stock were issued in lieu of the cash
payment of dividends. The acquisition was accounted for as a purchase.
Since the January 29, 1999 acquisition, American Commerce's results have
been consolidated into the Company's financial statements. Since 1995,
Commerce has maintained an exclusive affinity group marketing relationship
with AAA Insurance Agency, Inc., a subsidiary of AAA SNE. AAA Insurance
Agency, Inc. has been a licensed insurance agent of Commerce since 1985.
NOTE B - Investments and Investment Income
1. Fixed Maturities
The amortized cost and estimated fair market value of investments in fixed maturities are as
follows:
Gross Gross
Accumulated Accumulated
Other Other Estimated
Amortized Comprehensive Comprehensive Fair Market
Cost Income Losses Value
At December 31, 2001:
Corporate bonds..................... $ 133,506 $ 7,497 $ (4,497) $ 136,506
U.S. Treasury bonds and notes....... 104 1 - 105
GNMA & FNMA mortgage-backed bonds... 98,198 1,602 (815) 98,985
Obligations of states and
political subdivisions............. 386,967 8,890 (4,971) 390,886
Total.......................... $ 618,775 $ 17,990 $ (10,283) $ 626,482
At December 31, 2000:
Corporate Bonds..................... $ 130,775 $ 1,263 $ (5,783) $ 126,255
U.S. Treasury bonds and notes....... 3,428 86 (137) 3,377
GNMA & FNMA mortgage-backed bonds... 67,274 444 (457) 67,261
Obligations of states and
political subdivisions............. 464,404 14,454 (5,816) 473,042
Total.......................... $ 665,881 $ 16,247 $ (12,193) $ 669,935
46
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars)
NOTE B - Investments and Investment Income (continued)
Proceeds from sales of investments in fixed maturities, gross
gains and gross losses realized on those sales were as follows:
Proceeds Gross Gross
From Realized Realized
Sales Gains Losses
For the year ended December 31, 2001:
Corporate bonds................................... $ 7,343 $ 129 $ (151)
U.S. Treasury bonds and notes..................... - - -
GNMA mortgage-backed bonds........................ - - -
Obligations of states and political subdivisions.. 82,369 694 (1,820)
Total ....................................... $ 89,712 $ 823 $ (1,971)
For the year ended December 31, 2000:
Corporate bonds................................... $ 1,167 $ - $ -
U.S. Treasury bonds and notes..................... - - -
GNMA mortgage-backed bonds........................ - - -
Obligations of states and political subdivisions.. 96,013 198 (2,749)
Total ....................................... $ 97,180 $ 198 $ (2,749)
For the year ended December 31, 1999:
Corporate bonds................................... $ 17,516 $ 102 $ (941)
U.S. Treasury bonds and notes..................... 27,096 8 (842)
GNMA mortgage-backed bonds........................ - - -
Obligations of states and political subdivisions.. 97,950 298 (2,606)
Total ....................................... $142,562 $ 408 $ (4,389)
The amortized cost and approximate fair market value of fixed maturities at December
31, 2001 and 2000, by contractual maturity, are as follows:
2001 2000
Fair Fair
Amortized Market Amortized Market
Cost Value Cost Value
Obligations of states, political subdivisions,
corporate bonds and U.S. Treasury bonds and
notes:
Due in one year or less.................... $ 1,398 $ 1,417 $ 1,201 $ 1,214
Due after one year through five years...... 2,860 3,001 7,650 7,882
Due after five years through ten years..... 5,256 5,378 9,162 9,431
Due after ten years........................ 511,063 517,701 580,594 584,147
520,577 527,497 598,607 602,674
GNMA & FNMA mortgage-backed bonds.......... 98,198 98,985 67,274 67,261
Total fixed maturities.............. $618,775 $626,482 $665,881 $669,935
Expected maturities may differ from contractual maturities because issuers may have
the right to call or prepay obligations.
47
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars)
NOTE B - Investments and Investment Income (continued)
2. Closed-end Preferred Stock Mutual Funds
The following table reflects the shares held, percentage of
ownership, carrying value at equity, book value, market value, and value
of shares at net asset value, by fund at December 31, 2001 and 2000:
December 31, 2001
Fund Carrying Quoted Value of
Fund Shares % of Value Book Market Shares at Net
Symbol(1) Held Ownership at Equity Value Value Asset Value
PGD 2,361,500 28.3% $ 30,225 $ 25,713 $ 29,873 $ 32,258
PPF 2,370,400 32.7% 30,168 26,256 29,275 31,076
PDF 4,685,500 31.3% 44,900 42,400 45,121 45,731
PDT 5,289,700 35.3% 63,035 57,175 58,451 64,111
DIV 3,579,500 36.2% 51,991 49,687 52,798 53,335
PFD 2,981,500 30.3% 42,904 44,803 43,828 42,904
PFO 4,050,043 36.3% 46,059 48,914 47,993 46,251
Total $309,282 $294,948 $307,339 $315,666
December 31, 2000
Fund Carrying Quoted Value of
Fund Shares % of Value Book Market Shares at Net
Symbol(1) Held Ownership at Equity Value Value Asset Value
PGD 1,877,300 22.5% $ 23,478 $ 19,666 $ 22,528 $ 26,695
PPF 2,352,900 32.4% 28,322 26,048 25,882 30,470
PDF 4,638,800 31.0% 46,003 41,966 40,589 47,594
PDT 4,925,100 32.8% 60,453 53,144 52,021 63,091
DIV 3,080,500 31.2% 46,314 42,500 40,239 48,918
PDI(2) 5,253,400 48.5% 52,207 52,583 52,534 54,110
PFD 2,981,500 30.3% 39,834 44,803 36,151 40,012
PFO 3,892,543 34.9% 41,122 47,270 40,385 41,533
Total $337,733 $327,980 $310,329 $352,423
(1) John Hancock Patriot Global Dividend Fund ("PGD"), John Hancock Patriot Preferred Dividend Fund ("PPF"),
John Hancock Patriot Premium Dividend I Fund ("PDF"), John Hancock Patriot Premium Dividend II Fund ("PDT"),
John Hancock Patriot Select Dividend Fund ("DIV"), Putnam Dividend Income Fund ("PDI"), Preferred Income Fund
("PFD"), Preferred Income Opportunity Fund ("PFO").
(2) In 2001, the Trustees of PDI liquidated the fund. The Company's pro-rata share of the portfolio securities and
cash of PDI was transferred to a new fund created by the PDI Trustees whose ownership was conveyed to the
Company. At December 31, 2001 the fund, totaling $60,869, was consolidated into the Company's financial
statements. The majority of the fund represents investments valued at $59,019 and is included in preferred
stocks and $1,332 in cash and cash equivalents.
The difference between the carrying value at equity and the value of
shares at net asset value is negative goodwill created at the time of the
purchase of the shares. SFAS 141, which was implemented on July 1, 2001,
specifically addresses the manner in which to account for negative
goodwill. For purchases prior to July 1, 2001, that created negative
goodwill, the Company continued to amortize the negative goodwill on these
securities through the end of 2001. This negative goodwill was amortized
into realized gains over various periods ranging from 1.25 years to 4
years based on the turnover ratios of the funds. In accordance with SFAS
141, for purchases subsequent to June 30, 2001, the difference between the
cost and net asset value at the time of purchase was recognized as a
realized gain, totaling $614 for 2001.
48
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars)
NOTE B - Investments and Investment Income (continued)
3. Mortgage Loans on Real Estate and Collateral Notes Receivable
At December 31, 2001 and 2000, mortgage loans on real estate and
collateral notes receivable consisted of the following:
December 31,
2001 2000
Residential (1st Mortgages)............ $28,696 $36,496
Residential (2nd Mortgages)............ 83 209
Commercial (1st Mortgages)............. 8,210 12,542
Commercial (2nd Mortgages)............. 33 50
37,022 49,297
Collateral notes receivable............ 3,143 3,222
40,165 52,519
Allowance for possible loan losses..... (660) (858)
Mortgage loans on real estate and
collateral notes receivable....... $39,505 $51,661
Fair value of the Company's mortgage loans on real estate and
collateral notes receivable is estimated by discounting the future cash
flows using the current rates at which similar loans would be made to
borrowers with similar credit and for the same remaining maturities. The
future cash flows associated with certain non-performing loans are
estimated based on expected payments from borrowers either through work
out arrangements or the disposition of collateral. The estimated fair
value of mortgage loans on real estate and collateral notes receivable at
December 31, 2001 and 2000, prior to the allowance for possible loan
losses, was $41,391 and $54,141, respectively.
At December 31, 2001 and 2000 mortgage loans which were on non-
accrual status amounted to $1,118 and $1,357, respectively. The reduction
in interest income associated with non-accrual loans was $99, $118 and
$129 for the years ended December 31, 2001, 2000 and 1999, respectively.
The Company originates and services residential and commercial
mortgages in Massachusetts and Connecticut. The Company's exposure is
generally 80% or less of the appraised value of any collateralized real
property at the time of the loan origination. The ability and willingness
of residential and commercial borrowers to honor their repayment
commitments is generally dependent upon the level of overall economic
activity and real estate values. The Company sold $20,042 of residential
mortgages in 2000 without recourse to an unrelated third party.
A summary of the changes in the allowance for possible loan losses
follows:
Years ended December 31,
2001 2000
Balance, beginning of year......................... $ 858 $ 2,127
Decrease in provision for possible loan losses... (198) (1,269)
Balance, end of year............................... $ 660 $ 858
49
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars)
NOTE B - Investments and Investment Income (continued)
The following table describes mortgage principal balances by maturity,
total mortgages over 90 days past due and total mortgages in foreclosure:
2001 2000
Fixed rate mortgages maturing:
One year or less................................ $ 90 $ 141
More than one year to five years................ 861 742
More than five years to ten years............... 3,366 5,331
Over ten years.................................. 23,375 31,810
Total fixed mortgages...................... $ 27,692 $ 38,024
Adjustable rate mortgages maturing:
One year or less................................ $ - $ -
More than one year to five years................ 87 61
More than five years to ten years............... 419 283
Over ten years.................................. 8,824 10,929
Total adjustable mortgages................. $ 9,330 $ 11,273
Past due over 90 days............................. $ 1,118 $ 1,357
Mortgages in foreclosure, included in past due
over 90 days.................................... $ 184 $ 808
4. Net Investment Income
The components of net investment income were as follows:
Years ended December 31,
2001 2000 1999
Interest on fixed maturities................... $ 45,542 $ 44,766 $ 45,957
Dividends on common and preferred stocks....... 23,768 23,177 23,148
Dividends on preferred stock mutual funds...... 23,165 22,158 15,483
Interest on cash and cash equivalents.......... 5,729 3,555 2,596
Interest on mortgage loans..................... 4,026 5,677 5,908
Other.......................................... 356 84 118
Total investment income............... 102,586 99,417 93,210
Investment expenses............................ 2,975 2,587 3,421
Net investment income................. $ 99,611 $ 96,830 $ 89,789
5. Net Realized Investment Gains (Losses)
Net realized investment gains (losses) were as follows:
Years ended December 31,
2001 2000 1999
Net realized investment gains (losses):
Fixed maturities................................ $ (2,816) $ (3,772) $ (5,991)
Preferred stocks................................ (3,692) 1,286 (244)
Common stocks................................... 603 4,370 11,023
Closed-end preferred stock mutual funds*........ 4,582 26,575 (22,401)
Venture capital fund investments................ (9,071) 460 888
Other........................................... (239) 631 347
Total....................................... $(10,633) $ 29,550 $(16,378)
*Includes $3,215 in 2001 and $9,260 in 2000, respectively, relating to the amortization of
negative goodwill, at the time of purchase, of these securities.
50
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars)
NOTE B - Investments and Investment Income (continued)
6. Other Comprehensive Income (Loss)
Net increases (decreases) in other comprehensive income (loss), less
applicable income tax (expense) benefit, were as follows:
Years ended December 31,
2001 2000 1999
Other comprehensive income (loss):
Fixed maturities................................ $ 3,653 $ 18,161 $(32,892)
Preferred stocks................................ 7,259 4,145 (17,040)
Common stocks................................... (8,369) 34,759 (26,587)
Other........................................... (1,327) 318 634
Impact of minority interest..................... (352) (1,244) 2,122
Total....................................... 864 56,139 (73,763)
Tax benefit (expense)........................... (272) (19,495) 26,560
Impact of minority interest..................... (31) (154) (743)
Total tax benefit (expense)................. (303) (19,649) 25,817
Total other comprehensive income (loss)..... $ 561 $ 36,490 $(47,946)
A summary of net accumulated other comprehensive income (loss) on stocks and fixed
maturity investments in 2001, 2000 and 1999 follows:
Years ended December 31,
2001 2000 1999
Accumulated other comprehensive income......... $ 45,873 $ 46,699 $ 8,317
Accumulated other comprehensive losses......... (26,893) (28,935) (47,936)
Impact of minority interest.................... 88 440 1,685
Total unrealized gains (losses)........... 19,068 18,204 (37,934)
Tax benefit (expense).......................... (6,643) (6,217) 13,867
Impact of minority interest.................... (31) (154) (590)
Total benefit (expense)................... (6,674) (6,371) 13,277
Total..................................... $ 12,394 $ 11,833 $(24,657)
NOTE C - Deferred Policy Acquisition Costs
Policy acquisition costs incurred and amortized to income are as
follows:
Years ended December 31,
2001 2000 1999
Balance, beginning of year............. $111,305 $ 98,500 $ 88,759
Costs deferred during the year......... 266,122 256,062 243,401
Amortization charged to expense........ (260,870) (243,257) (233,660)
Balance, end of year................... $116,557 $111,305 $ 98,500
51
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars)
NOTE D - Property and Equipment
A summary of property and equipment at December 31, is as follows:
2001 2000
Buildings................................. $ 33,013 $ 32,916
Equipment and office furniture............ 36,609 35,185
Building improvements..................... 850 850
70,472 68,951
Less accumulated depreciation....... (38,473) (35,456)
31,999 33,495
Land...................................... 3,476 1,253
Construction in progress.................. 4,539 75
$ 40,014 $ 34,823
Depreciation expense was $4,280, $4,270 and $4,243 for the years
ended December 31, 2001, 2000 and 1999, respectively. Depreciation
expense is allocated evenly between losses and loss adjustment expenses
and policy acquisition costs.
NOTE E - Unpaid Losses and Loss Adjustment Expenses
Liabilities for unpaid losses and loss adjustment expenses at December
31, consist of:
2001 2000
Net voluntary unpaid loss and LAE reserves................ $558,635 $544,585
Voluntary salvage and subrogation recoverable............. (73,393) (65,505)
Assumed unpaid loss and LAE reserves from C.A.R........... 125,787 127,631
Assumed salvage and subrogation recoverable from C.A.R.... (20,695) (20,844)
Total voluntary and assumed unpaid loss and LAE reserves 590,334 585,867
Adjustment for ceded unpaid loss and LAE reserves......... 100,290 97,273
Adjustment for ceded salvage and subrogation recoverable.. (9,000) (9,000)
Total unpaid loss and LAE reserves...................... $681,624 $674,140
Unpaid Loss and LAE by their nature are inherently uncertain as to
the ultimate outcome of the estimated amounts. The liability for unpaid
losses and LAE represents Management's best estimate of the ultimate net cost
of all losses and LAE incurred through the balance sheet date. The estimate
for ultimate net cost of all losses incurred through the balance sheet date
includes the adjusted case estimates for losses, incurred but not reported
("IBNR") losses, salvage and subrogation recoverable and a reserve for LAE.
In arriving at its best estimate, management begins with the aggregate of
individual case reserves and then makes adjustments to these amounts on a
line of business basis. These adjustments to the aggregate case reserves by
line of business are made based on analysis performed by Management as
further described below. The entire liability for unpaid losses and LAE is
also reviewed quarterly and annually by the Company's Actuarial Department.
Liability estimates are continually analyzed and updated, and therefore, the
ultimate liability may be more or less than the current estimate. The
effects of changes in the estimates are included in the results of operations
in the period in which the estimates are revised.
52
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars)
NOTE E - Unpaid losses and Loss Adjustment Expenses (continued)
Significant periods of time can elapse between the occurrence of an
insured loss, the reporting of the loss to the insurer and the insurer's
payment of that loss. To recognize liabilities for unpaid losses, insurers
establish reserves as balance sheet liabilities representing estimates of
amounts needed to pay reported and unreported losses and LAE. Quarterly, the
Company reviews these reserves internally. Regulations of the Division of
Insurance require the Company to annually obtain a certification from either
a qualified actuary or an approved loss reserve specialist that its loss and
LAE reserves are reasonable.
When a claim is reported to the Company, claims personnel establish a
"case reserve" for the estimated amount of the ultimate exposure to the
Company. The amount of the reserve is primarily based upon an evaluation of
the type of claim involved, the circumstances surrounding the claim and the
policy provisions relating to the loss. This estimate reflects the informed
judgment of such personnel based on general insurance reserving practices and
on the experience and knowledge of the claims personnel adjusting the claim.
During the loss adjustment period, these estimates are revised as deemed
necessary by the Company's claims department personnel based on subsequent
developments and periodic reviews of the cases.
In accordance with industry practice, the Company also maintains
reserves for estimated IBNR and LAE net of salvage and subrogation
recoverable. These reserves are determined on the basis of historical
information and the experience of the Company. Adjustments to these reserves
are made periodically to take into account changes in the volume of business
written, claims frequency and severity, the mix of business, claims
processing and other items that can be expected to affect the Company's
liability for losses and LAE over time.
When reviewing the liability for unpaid losses and LAE, the Company
analyzes historical data and estimates the impact of various factors such as
(i) payment trends; (ii) loss expense per exposure; (iii) the historical loss
experience of the Company and industry; (iv) frequency and security trends;
and, (v) legislative enactments, judicial decisions, legal developments in
the imposition of damages, changes and trends in general economic conditions,
including the effects of inflation and recession. This process assumes that
past experience, adjusted for the effects of current developments and
anticipated trends, is an appropriate basis for predicting future events.
There is no precise method, however, for subsequently evaluating the impact
of any specific factor on the adequacy of reserves, because the eventual
development of reserves is affected by many factors.
By using both individual estimates of reported claims and generally
accepted actuarial reserving techniques, the Company estimates the ultimate
net liability for losses and LAE. After taking into account all relevant
factors, management believes that, based on existing information, the
provision for losses and LAE at December 31, 2001 is adequate to cover the
ultimate net cost of losses and claims incurred as of that date. The
ultimate liability, however, may be greater or lower than established
reserves. If the ultimate exposure is greater than (or less than)
management's estimated liability for losses and LAE, based on any of the
factors noted previously, the Company will incur additional expense (income)
which may have a material impact. The Company does not discount to present
value that portion of its loss reserves expected to be paid in future
periods.
Included in the loss reserve methodologies described above, are
liabilities for unpaid claims and claim adjustment expenses for environmental
related claims such as oil spills, mold and lead paint. Reserves have been
established to cover these claims for known losses. Because of the Company's
limited exposure to these types of claims, management believes they will not
have a material impact on the consolidated financial position of the Company
in the future. Loss reserves on environmental related claims amounted to
$4,281 and $3,712 at December 31, 2001 and 2000, respectively.
53
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars)
NOTE E - Unpaid losses and Loss Adjustment Expenses (continued)
The following table sets forth a reconciliation of beginning and
ending reserves for losses and loss adjustment expense, net of reinsurance
deductions from all reinsurers including C.A.R., as shown in the Company's
consolidated financial statements for the periods indicated.
Years ended December 31,
2001 2000 1999
Loss and loss adjustment expense reserves,
beginning of year, prior to effect of ceded
reinsurance recoverable............................. $585,867 $558,779 $498,127
January 29, 1999 American Commerce loss and
loss adjustment expense reserves.................. - - 63,112
Incurred losses and loss adjustment expenses:
Provision for insured events of the current year.. 812,863 728,582 664,978
Decrease in provision for insured events of
prior years...................................... (35,320) (42,425) (39,888)
Total incurred losses and loss adjustment
expenses....................................... 777,543 686,157 625,090
Payments:
Losses and loss adjustment expenses attributable
to insured events of the current year............ 487,918 402,040 383,707
Losses and loss adjustment expenses attributable
to insured events of prior years................. 285,158 257,029 243,843
Total payments.................................. 773,076 659,069 627,550
Loss and loss adjustment expense reserves prior to
effect of ceded reinsurance recoverable.......... 590,334 585,867 558,779
Ceded reinsurance recoverable..................... 91,290 88,273 101,062
Reserves for losses and loss adjustment expenses
at the end of year per financial statements......... $681,624 $674,140 $659,841
The decrease in provision for insured events of prior years represents
redundancies for reserves established for prior year. This decrease in
provision was principally the result of re-estimation of unpaid losses and
loss adjustment expenses principally on the personal automobile, commercial
automobile and homeowners lines of business.
The Company's loss and LAE reserves reflect its share of the aggregate
C.A.R. loss and LAE reserves of the Company and the 38 other writers of
automobile insurance in Massachusetts that participate in C.A.R. ("Servicing
Carriers"). The Company is a defendant in various legal actions arising from
the normal course of its business. These proceedings are considered to be
ordinary to operations or without foundation in fact. Management is of the
opinion that these actions will not have a materially adverse effect on the
consolidated financial statements of the Company.
NOTE F - Reinsurance Activity
The Company has reinsurance contracts for casualty and catastrophe
coverages. These reinsurance arrangements minimize the Company's losses
arising from large risks and protect the Company against numerous losses from
a single occurrence or event. The Company also has a quota share reinsurance
contract on its other than automobile business.
54
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars)
Property, Catastrophe and Quota Share Reinsurance
The Company maintains a 75% quota share reinsurance program, covering
all non-automobile property and liability business, except umbrella policies.
The program is split between American Re-Insurance Company, Employers
Reinsurance Corporation, Hartford Fire Insurance Company and Swiss
Reinsurance America Corporation. The maximum per occurrence dollar recovery
is equal to 250% of the net premiums ceded to the quota share arrangement in
a contract year. The maximum aggregate per year dollar recovery under the
quota share contract is equal to 350% of the net premium ceded to the quota
share arrangement in a contract year. A sliding scale commission, based on
loss ratio, is utilized under this program. This program provides the
Company with sufficient protection for catastrophe coverage so as to enable
the Company to forego pure catastrophe reinsurance coverage, which was
previously tailored in conjunction with the former quota share arrangement.
The table below provides information depicting the approximate recovery
under the quota share contract (described below) at various loss scenarios,
if a single catastrophe were to strike:
Net Loss
Total Reinsurance Retained by
Loss Recovery the Company
$ 50,000 $ 37,500 $12,500
100,000 75,000 25,000
150,000 112,500 37,500
200,000 150,000 50,000
250,000 187,500 62,500
Under the above scenario and based on the business subject to the quota-
share reinsurance contract for 2001, the Company has no reinsurance
recoveries for a single event catastrophe in excess of a total loss of
approximately $262.0 million. The level of reinsurance protection increases
(decreases) when the company cedes more (less) premium to the reinsurers.
The Company's estimated total losses on its other than automobile business
for 100 and 250-year hurricanes (including American Commerce) are
approximately $176.0 million and $295.8 million, respectively. The Company
estimates were derived through the services of Swiss Reinsurance America
Corporation who utilized the RMS (Risk Management Solutions) IRAS risk
assessment system. Most property and casualty insurance companies establish
their catastrophe reinsurance programs up to the 100 year storm estimate.
Written premiums ceded in 2001, 2000 and 1999 under the above referenced
program were $78.6 million, $69.4 million and $51.5 million, respectively.
The 13.3% increase in written premiums ceded in 2001 versus 2000 in this
program was primarily the result of a $7,592 or 11.6% increase in
Massachusetts homeowner direct written premium, coupled with a $2,212 or
13.4% increase in direct homeowner writings in states other than
Massachusetts, as previously mentioned. Ceding commission income is
calculated on a ceded earned premium basis.
Casualty Reinsurance
Casualty reinsurance is on an excess of loss basis for any one event or
occurrence with a maximum recovery of $9.0 million over a net retention of
$1.0 million. This coverage is placed with Swiss Reinsurance America
Corporation (rated A++ by A.M. Best).
Personal and commercial liability umbrella policies are reinsured on a
95% quota share basis in regard to limits up to $1.0 million and 100% quota
share basis for limits in excess of $1.0 million but not exceeding $5.0
million for policies with underlying automobile coverage of $250/$500 or
more. The Company also has personal liability umbrella reinsurance coverage
for policies with underlying automobile coverage of $100/$300, on a 65% quota
share basis in regard to limits up to $1.0 million and 100% quota share basis
for limits in excess of $1.0 million but not exceeding $3.0 million. These
coverages are placed with American Re-Insurance Company (rated A++ by A.M.
Best).
55
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars)
NOTE F - Reinsurance Activity (continued)
Earned premiums and losses and loss adjustment expenses are stated in
the accompanying consolidated financial statements after deductions for ceded
reinsurance. Those deductions for reinsurance other than C.A.R. are as
follows:
Years ended December 31,
2001 2000 1999
Income Statement
Written premiums ceded............................ $81,827 $76,946 $ 54,657
Earned premiums ceded............................. 77,226 73,354 55,557
Losses and loss adjustment expenses ceded......... 40,514 30,797 24,240
Balance Sheet
Unpaid losses and loss adjustment expenses........ 28,192 24,726 21,552
Unearned premiums................................. 42,258 36,828 26,813
The Company, as primary insurer, would be required to pay losses in
their entirety in the event that the reinsurers were unable to discharge
their obligations under the reinsurance agreements.
C.A.R.
C.A.R., a state-mandated reinsurance mechanism, enables the Company and
the other Servicing Carriers to reinsure any automobile risk that the insurer
perceives to be under priced at the premium level permitted by the
Commissioner. Servicing Carriers, who are responsible for over 99.0% of
total direct premiums written for personal automobile insurance in
Massachusetts, are required to offer automobile insurance coverage to all
eligible applicants pursuant to "take-all-comers" regulations, but may
reinsure business with C.A.R.
Since its inception, C.A.R. has annually generated multi-million dollar
underwriting losses in both the personal and commercial pools. The Company
is required to share in the underwriting results of C.A.R. business for its
respective product lines. Under current regulations, the Company's share of
the C.A.R. personal or commercial deficit is based upon its market share for
retained automobile risks for the particular pool, adjusted by a
"utilization" concept, such that, in general, the Company is
disproportionately and adversely affected if its relative use of C.A.R.
reinsurance exceeds that of the industry, and favorably affected if its
relative use of C.A.R. reinsurance is less than that of the industry. The
Company's strategy has been to voluntarily retain more types of private
passenger automobile business that are factored as credits, thereby favorably
impacting the utilization formula. These credits result from voluntarily
writing business in underpriced territories and for underpriced risks. As a
result of increased voluntary retention, in excess of the industry, the
credits impacting the utilization formula have favorably affected the
Company's participation ratio compared to its market share. During 2001,
2000 and 1999, the Company's net participation in the C.A.R. personal
automobile pool approximated 16.8%, 16.9% and 16.5%, respectively, as
reported by C.A.R., compared to the Company's estimated market share in those
years of 23.3%, 22.3% and 21.3%.
56
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars)
Written premiums, earned premiums, losses and LAE incurred, underwriting
expenses incurred and the liabilities for unearned premiums, unpaid losses
and LAE ceded to and assumed from C.A.R. were as follows:
Years ended December 31,
2001 2000 1999
Ceded Assumed Ceded Assumed Ceded Assumed
Income Statement
Written premiums... $ 70,973 $ 79,360 $ 67,451 $ 81,659 $ 68,740 $ 87,241
Earned premiums.... 72,648 80,176 69,120 81,300 68,902 84,356
Losses and LAE.
incurred......... 80,053 108,353 67,987 109,788 81,853 104,273
Underwriting
expenses......... - 28,270 - 28,753 - 28,569
Balance Sheet
Unearned premiums.. 44,399 41,699 44,791 42,515 50,084 42,156
Unpaid losses and
LAE.............. 81,433 105,092 82,450 106,787 91,576 100,680
The Company pays to C.A.R. all of the premiums generated by the policies
it has ceded and C.A.R. reimburses the Company for all losses incurred on
account of ceded policies. In addition, the Company receives a fee for
servicing ceded policies based on the expense structure established by C.A.R.
For the years ended December 31, 2001, 2000 and 1999, these servicing fees
amounted to $17,161, $16,783 and $17,235, respectively.
The Company presents assets and liabilities gross of reinsurance. The
Residual Market Receivable represents the gross amount of reinsurance
recoverable from C.A.R. including unpaid losses, unearned premiums, paid
losses recoverable and unpaid ceded and assumed premiums.
The current C.A.R. utilization-based participation ratio has been in
place for the personal automobile market since 1993. During 2001, 2000 and
1999 the Company's amount of personal automobile exposures it reinsured
through C.A.R. approximated 4.9%, 4.9% and 5.6%, respectively, as compared to
industry averages of 7.7%, 8.4% and 9.6%, respectively.
NOTE G - Income Taxes
The Company and its subsidiaries file a consolidated federal income tax
return.
The federal income tax expense (benefit) consisted of the following:
Years ended December 31,
2001 2000 1999
Current............................ $ 28,571 $ 32,849 $ 26,481
Deferred........................... (5,377) 5,457 (9,814)
$ 23,194 $ 38,306 $ 16,667
57
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars)
NOTE G - Income Taxes (continued)
Deferred taxes arise from temporary differences in the basis of assets
and liabilities for tax and financial statement purposes. The sources of
these differences and the related tax effects of the activities that occurred
consisted of the following:
Years ended December 31,
2001 2000 1999
Unearned premiums.................................. $ (2,428) $ (3,835) $ (2,785)
Discounting of loss reserves....................... 809 (381) (928)
Deferred policy acquisition costs.................. 1,303 4,015 1,251
Salvage and subrogation recoverable................ 81 (116) 272
Tax depreciation in excess of book depreciation.... 180 239 639
Pension liability.................................. - 1,145 (440)
Post-retirement benefits liability................. (246) (424) 120
Equity in earnings (losses) of preferred stock
mutual funds..................................... 264 6,060 (10,487)
Equity in losses of venture capital fund
investments...................................... (3,342) - -
Other.............................................. (1,998) (1,246) 2,544
Deferred income tax.......................... (5,377) 5,457 (9,814)
Other comprehensive income (loss).................. 425 20,084 (26,407)
Deferred taxes at acquisition of American Commerce. - - (4,662)
Change in deferred tax asset................. $ (4,952) $ 25,541 $(40,883)
Realization of a deferred tax asset is dependent on generating
sufficient taxable income in future years. Although realization is not
assured, management believes it is more likely than not that all of the
deferred tax assets will be realized. The amount of the deferred tax asset
considered realizable, however, could be reduced in the near term if
estimates of future taxable income or unrealized gains are reduced.
Deferred tax liabilities (assets) were comprised of the following at
December 31, 2001 and 2000:
2001 2000
Unearned premiums............................................... $(31,477) $(29,049)
Discounting of loss reserves.................................... (20,850) (21,659)
Equity in losses of preferred stock mutual funds................ (3,551) (3,815)
Equity in losses of venture capital fund investments............ (3,342) -
Post-retirement benefits liability of American Commerce......... (1,267) (1,021)
Other........................................................... (4,915) (3,355)
Deferred tax assets....................................... (65,402) (58,899)
Deferred policy acquisition costs............................... 33,847 32,544
Salvage and subrogation recoverable............................. 2,109 2,028
Tax depreciation in excess of book depreciation................. 2,157 1,977
Net accumulated comprehensive income............................ 6,643 6,217
Other........................................................... 3,653 4,092
Deferred tax liabilities.................................. 48,409 46,858
Net deferred tax asset.................................... $(16,993) $(12,041)
58
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars)
NOTE G - Income Taxes (continued)
Federal income tax on income is less than the amount computed by
applying the statutory rate of 35% for the years ended 2001, 2000 and 1999
for the following reasons:
Years ended December 31,
2001 2000 1999
Tax at statutory rate.. $ 40,399 35.0% $ 59,523 35.0% $ 36,499 35.0%
Tax exempt interest.... (7,123) (6.2) (8,314) (4.9) (9,157) (8.8)
Dividends paid to ESOP
participants......... (848) (0.7) (899) (0.5) (785) (0.8)
Dividends received
deduction............ (7,510) (6.5) (8,123) (4.8) (7,560) (7.2)
Amortization of
preferred stock
mutual fund negative
goodwill............. (1,043) (0.9) (3,242) (1.9) (1,909) (1.8)
Other.................. (681) (0.6) (639) (0.4) (421) (0.4)
Tax at effective rate.. $ 23,194 20.1% $ 38,306 22.5% $ 16,667 16.0%
NOTE H - Related-Party Transactions
The Company has made loans to insurance agencies with which Commerce
transacts business on a regular basis. At December 31, 2001, eleven loans
with an aggregate outstanding principal balance of $3,476, were
collateralized by the assets of the agencies, one of these loans with an
outstanding balance of $313 was collateralized by real estate as the primary
collateral and the assets of the agency as secondary collateral. There were
no loans to insurance agencies collateralized solely by real estate. At
December 31, 2000, ten loans with an aggregate outstanding balance of $3,556
were collateralized by the assets of the agencies and one of these loans with
an outstanding balance of $328 was collateralized by real estate as the
primary collateral and the assets of the agency as secondary collateral.
The immediate family of Raymond J. Lauring, a Director of the Company,
owns more than a 10% equity interest in Lauring Construction Company. Mr.
Lauring has no ownership interest in Lauring Construction Company. During
2001, Lauring Construction Company provided construction and construction
management services in connection with a contract for the estimated $13
million renovation of a 160,000 square foot building purchased by the
Company. Terms of the contract provide for a fixed fee of $650 for
supervision and management of the project over the term of the contract.
There were no payments made on the supervision or management services portion
of the contract in 2001. Payments to Lauring Construction Company in 2001
for actual materials used and construction work performed on this project
were $405 and payments for other work unrelated to the project were $31.
NOTE I - Employee Stock Ownership Plan and 401(k) Plan
The Company offers an Employee Stock Ownership Plan ("E.S.O.P.") and
401(k) Plan for the benefit of substantially all employees, including those
of the Company's subsidiaries. The E.S.O.P. is noncontributory on the part
of Participants and contributions are made at the discretion of the Board of
Directors. The company is under no obligation to make contributions or
maintain the E.S.O.P. for any length of time, and may completely discontinue
or terminate the E.S.O.P. at any time without liability. Contributions by
the Company and subsidiaries to the E.S.O.P. for the years ended December 31,
2001, 2000 and 1999 were $7,502, $5,702 and $5,744, respectively. The
increase in the contribution in 2001 over 2000 was primarily due to the
inclusion of American Commerce employees into the plan. The E.S.O.P. held
2,989,046 and 3,143,076 shares of the Company's common stock at December 31,
2001 and 2000, respectively. E.S.O.P. Participants who are current employees
of the Company or its subsidiaries and who are 100% vested in their E.S.O.P.
accounts can annually elect to transfer
59
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars)
NOTE I - Employee Stock Ownership Plan and 401(k) Plan (continued)
out of the E.S.O.P. up to 100% of their allocated Company stock in the form
of an eligible rollover distribution into another eligible retirement plan,
such as a qualified individual retirement arrangement. Approximately
2,191,000 shares owned by Participants in the E.S.O.P. at December 31, 2001
are allocated to the E.S.O.P. accounts of these individuals. E.S.O.P.
Participants who are former employees of the Company may generally elect to
withdraw from the E.S.O.P. the total amount of shares allocated to their
accounts at any time. Approximately 580,000 shares held by the E.S.O.P. at
December 31, 2001 are allocated to the E.S.O.P. accounts of these
individuals. The remaining approximately 219,000 shares held by the E.S.O.P.
at December 31, 2001 are allocated to the E.S.O.P. accounts of Participants
who have not yet reached 100% vesting in their account balances. Disposition
of these unvested shares is restricted under the E.S.O.P. The Company pays
for administration of the E.S.O.P.
The 401(k) Plan, implemented in September 1998, enables eligible
employees to contribute up to 15% of eligible compensation on a pre-tax basis
up to the annual maximum limits under federal tax law. The Company incurs no
expenses in the form of matching contributions but does pay for
administration of the Plan.
NOTE J - American Commerce Pension and Post-Retirement Benefits
Effective June 1, 2000, the Directors of American Commerce voted to
terminate the American Commerce noncontributory defined benefit pension plan
(the "pension plan") and transition on January 1, 2001 to the E.S.O.P. The
payment of the termination liability to participants from previously funded
assets of the pension plan amounted to $4,558 in 2000. All participants of
the pension plan were eligible to retire with full retirement benefits upon
attainment of age 65 with 5 years of participation. Retirement benefits were
payable for the life of the participant with guaranteed payments for 10
years. All retirees had taken lump-sum payments. American Commerce made
contributions to a deposit administration contract, which provided the
pension plan with assets sufficient to fund pension benefits to pension plan
participants. The deposit administration contract was carried at contract
value, which represented the cost of contributions plus interest and
experience refunds. The pension plan was subject to and exceeded the minimum
funding requirements of ERISA.
Effective January 1, 2001, the Directors of American Commerce voted to
merge the 401(k) Plan with the Company's Plan. Previously, American Commerce
maintained a separate 401(k) Plan for the benefit of substantially all of its
employees. American Commerce matched 50% of all employee contributions up to
6% of pay. Both American Commerce and its employees shared in administration
expenses of the plan. American Commerce did not contribute to the plan in
2001 due to the aforementioned merger. Commerce contributed $181 and $165 to
the plan in 2000 and 1999, respectively.
American Commerce maintains a noncontributory post-retirement benefit
plan (the "post-retirement plan") for retirees that includes medical, dental
and life insurance coverages. All participants of the post-retirement plan
are eligible upon attainment of age 55 with 10 years of service or age 65
with 5 years of service. Dental coverage ceases at age 65 and life insurance
coverage decreases based upon the age of the retiree until the attainment of
age 70, at which time retirees are provided a nominal amount of coverage from
age 70 and thereafter. Participants' spouses are also covered under the
post-retirement plan. The cost of post-retirement medical, dental and life
insurance benefits is accrued over the active service periods of employees to
the date they attain full eligibility for such benefits. It is the policy of
American Commerce to pay for post-retirement benefits as incurred.
60
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars)
NOTE J - American Commerce Pension and Post-Retirement Benefits (continued)
The following table shows, as of December 31, 2001 and 2000, the
American Commerce post-retirement benefit plan funded status reconciled with
amounts reported in the consolidated balance sheet and the assumptions used
in determining the actuarial present value of the benefit obligation:
2001 2000
Plan assets at fair value........................... $ - $ -
Accumulated benefit obligation:
Retirees.......................................... 1,448 1,168
Active participants, fully eligible............... 790 893
Active participants, not eligible................. 1,812 2,225
Projected benefit obligation........................ 4,050 4,286
Unfunded status of plan............................. (4,050) (4,286)
Unrecognized prior service costs.................... (17) (20)
Unrecognized net transition obligation.............. 1,087 1,186
Unrecognized net loss (gain)........................ (641) 20
Accrued benefit cost.......................... $(3,621)$(3,100)
Assumptions:
Weighted average discount rate.................... 7.0% 7.0%
Net periodic cost of the American Commerce post-retirement benefit plan
for the period ended December 31, 2001, 2000 and 1999 includes the following
components:
2001 2000 1999
Service cost-benefits earned........................ $ 250 $ 246 $ 238
Interest cost on projected benefit obligation....... 248 265 246
Actual return on plan assets........................ - - -
Amortization of unrecognized net transition
obligation........................................ 99 99 99
Amortization of unrecognized prior service cost..... (3) (3) (3)
Amortization of unrecognized loss (gain)............ (25) - -
Net asset loss deferred for later recognition....... - - -
Net periodic cost................................. $ 569 $ 607 $ 580
The assumed health care cost trend rate for 2001 was 8.5% and 7.25% for
medical and dental, respectively. These rates grade down until the final
trend rates of 6.0% and 5.0% for medical and dental, respectively, are
reached in 2010. A one percentage point increase in the assumed health and
dental cost trend rates increases the sum of the service and interest costs
components of the 2001, 2000 and 1999 periodic post-retirement benefit cost
by 16.3%, 20.4% and 13.0% respectively, and the accumulated post-retirement
benefit obligation as of December 31, 2001, 2000 and 1999 by 16.6%, 17.7% and
14.0%, respectively.
Subsequent to December 31, 2001, the Directors of American Commerce
voted to terminate that portion of the post-retirement plan applicable to
future retirees of American Commerce. Termination will be effective May 1,
2002. Current retirees and employees who retire prior to May 1, 2002 will
remain eligible for post-retirement benefits.
61
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars)
NOTE K - Directors' Retirement Compensation Plan
During 2000, the Company's Directors approved a Directors' Retirement
Compensation Plan (the "Retirement Plan"). The Retirement Plan becomes
effective for each Company Director upon terminating service on the Company's
Board of Directors (the "Board") providing that such termination was not made
under conditions adverse to the Company's interest. Effective with the
annual meeting wherein the Director is not reappointed to the Board, and
provided benefits are not paid until such time as the Director has attained
the age of 65, the Company will pay an annual retirement benefit equal to 50%
of the average annual total compensation of the Director for the immediately
preceding three full years ("the three year average compensation"). The
annual retirement benefit of 50% of the three year average compensation vests
at the rate of 4.0% for each year of Board (or subsidiary) service up to a
maximum of 100% vesting through termination of service. Payments continue
for a maximum of ten years over the remaining life of the terminated
Director, or his or her then spouse, if the Director pre-deceases the spouse.
No payments are to be made after the death of the Director and spouse.
Expenses related to the Retirement Plan in 2001 and 2000 amounted to $178 and
$2,364, respectively. A total of $19 was paid under the Retirement Plan in
2001 and 2000.
NOTE L - Stockholders' Equity
Book Value Awards, Stock Appreciation Rights and Stock Options Program
The Management Incentive Plan approved by the Company's stockholders in
May, 1994 provides for the award of incentive stock options, non-qualified
stock options, book value awards, stock appreciation rights, restricted stock
and performance stock units. Up to 2,500,000 shares of common stock (subject
to increase for anti-dilution adjustments) may be issued under the Plan,
including shares that may be issued pursuant to awards of restricted stock or
upon the exercise of common stock equivalent awards such as stock options and
stock appreciation rights payable in the form of common stock (not in the
form of cash). At the discretion of the compensation committee all
directors, officers and other senior management employees of the Company or
any of its subsidiaries are eligible to participate in this Management
Incentive Plan.
Book value awards issued relating to this Plan totaled 474,541, 496,685
and 447,185 in 2001, 2000 and 1999, respectively. Expenses relating to book
value awards were $1,577, $3,081 and $438 in 2001, 2000 and 1999,
respectively. Grants under the SAR plan ceased in 1999 and were replaced
with the stock option program. No SARs were outstanding at December 31,
2001. Expenses (income) relating to stock appreciation rights were $0, $760
and ($3,159) in 2001, 2000 and 1999, respectively. The outstanding book
value awards entitle the holders to cash payments based upon the extent to
which, if at all, the per share book value exceeds certain thresholds set at
the time the award was granted.
During 2001, 2000 and 1999, the Company granted stock options
("options") totaling 1,184,343, 644,520 and 700,179, respectively, including
the issuance of options previously terminated. The outstanding options
entitle the recipient to purchase the Company's common stock based upon the
extent to which, if at all, the per share market value of the common stock
exceeds certain thresholds set at the time the option was granted.
Unexercised options terminate not later than eight years after the date of
grant.
62
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars Except for Per Share Data)
NOTE L - Stockholder's Equity (continued)
Aggregate liabilities for the combined programs were $2,614 and $2,972
at December 31, 2001 and 2000, respectively.
The following is a summary of the changes in options outstanding under
the Plan:
Weighted
Average
Exercise
Shares Price
Options outstanding at January 1, 1999.... - $ -
Granted January 29, 1999............... 50,000 36.32
Granted April 30, 1999................. 650,179 32.81
Options outstanding at December 31, 1999.. 700,179 33.06
Granted April 5, 2000.................. 644,520 31.59
Terminated............................. (5,888) 32.81
Options outstanding at December 31, 2000.. 1,338,811 32.35
Granted April 6, 2001.................. 1,184,343 30.80
Terminated............................. (80,818) 34.74
Options outstanding at December 31, 2001.. 2,442,336 $ 31.52
No options were exercisable at December 31, 2001, 2000 and 1999.
The estimated weighted average fair value per share of the options was
$5.26 in 2001, $4.16 in 2000 and $3.78 in 1999. Under the provisions of APB
Opinion 25, no expense was recognized for these options in 2001, 2000 or
1999. No options were granted prior to 1999. Had the Company recognized
such expense, the Company's net earnings and earnings per share would have
approximated the pro forma amounts indicated below:
2001 2000 1999
Net earnings:
As reported $ 93,094 $132,080 $ 88,676
Pro forma $ 88,363 $130,180 $ 86,956
Basic earnings per share:
As reported $ 2.77 $ 3.87 $ 2.54
Pro forma $ 2.63 $ 3.81 $ 2.49
Diluted earnings per share:
As reported $ 2.75 $ 3.87 $ 2.54
Pro forma $ 2.61 $ 3.81 $ 2.49
Additionally, the Company granted 250,000 and 1,872,380 options to
certain agents of American Commerce (the "American Commerce Agents' Plan")
in 2001 and 1999, respectively. The right of the recipient to exercise
these options is contingent upon the average volume of other-than-
Massachusetts private passenger automobile and homeowners direct written
premiums placed and maintained with American Commerce for a five year
period specified in the option agreement. If qualified, the recipient may
purchase the Company's common stock at the exercise price for a period of
five years beginning five years after the date of the grant ("the
confirmation date"). Unexercised options terminate not later than ten
years after the date of the grant ("the expiration date"). In conjunction
with meeting specified premium growth levels over the term of the options,
the Company provided "put rights" to the holders of the options granted in
1999. These put rights permit the option holders to require the Company
to purchase the options at the difference between $40.00 less the exercise
price, at any time from and after the confirmation date through and
including the expiration date. Expenses related to these options,
determined in accordance with the fair value accounting provisions of SFAS
No. 123, "Accounting for Stock-Based Compensation", amounted to $2,862 in
2001, $1,307 in 2000 and $1,909 in 1999.
63
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars Except for Per Share Data)
NOTE L - Stockholder's Equity (continued)
The following is a summary of the changes in options outstanding under
the American Commerce Agents' Plan:
Weighted
Average
Exercise
Shares Price
Options outstanding at January 1, 1999.... - $ -
Granted................................ 1,872,380 36.32
Options outstanding at December 31, 1999.. 1,872,380 36.32
Granted................................ - -
Options outstanding at December 31, 2000.. 1,872,380 36.32
Granted................................ 250,000 41.97
Options outstanding at December 31, 2001.. 2,122,380 $ 36.99
No options were exercisable at December 31, 2001, 2000 and 1999.
The fair value of each option granted under the American Commerce
Agents' Plan was estimated on the date of grant using the Black-Scholes
option-pricing model, with the following weighted average assumptions:
December 31,
2001 2000
Dividend yield.................................... 3.16% 4.47%
Volatility........................................ 28.30% 27.10%
Risk-free interest rate........................... 4.04% 5.10%
Expected option life in years..................... 7 7
The estimated weighted average fair value per share of the options
under the American Commerce Agents' Plan was $5.63, $4.48 and $5.28 at
December 31, 2001, 2000 and 1999, respectively.
NOTE M - Net Capital Requirements
The insurance companies included in the consolidated financial
statements are subject to the financial capacity guidelines established by
their respective state Divisions of Insurance. Every Massachusetts
insurance company seeking to make any dividend or other distributions to
its stockholders may, within certain limitations, pay such dividends and
then file a report with the Commissioner. Dividends in excess of these
limitations are called extraordinary dividends. An extraordinary dividend
is any dividend or other property, whose fair value together with other
dividends or distributions made within the preceding twelve months exceeds
the greater of ten percent of the insurer's surplus as regards
policyholders as of the end of the preceding year, or the net income of a
non-life insurance company for the preceding year. No pro-rata
distribution of any class of the insurer's own securities is to be
included. No Massachusetts insurance company shall pay an extraordinary
dividend or other extraordinary distribution until thirty days after the
Commissioner has received notice of the intended distribution and has not
objected. No extraordinary dividends were paid in 2001, 2000 and 1999.
California and Ohio have similar regulations. No extraordinary dividend
was paid by American Commerce in 2001, 2000 and 1999 and no dividends were
paid by Commerce West since its acquisition.
To the extent Commerce and Citation are restricted from paying
dividends to CHI, CHI will be limited in its ability to pay dividends to
the Company. On this basis, the Company's ability to pay dividends to its
stockholders is limited. During 2001, Commerce and Citation paid $55,200
and $10,868 in dividends, respectively to CHI; CHI then paid $65,835 to
the Company in March 2001. During 2000, Commerce and Citation paid
$41,000 and $10,780 in dividends, respectively, to CHI; CHI then paid
$51,660 to the Company in March 2000. Commerce West did not pay dividends
on their common stock in 2001 and 2000. American Commerce paid ACIC
Holding Co., Inc. a dividend of $9,281 in 2001, no dividend was paid in
2000. ACIC Holding Co., Inc. paid Commerce dividends of $9,582 and $9,178
in 2001 and 2000, respectively, on its outstanding preferred stock.
64
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars Except for Per Share Data)
NOTE M - Net Capital Requirements (continued)
The Board of Directors of the Company voted to declare four quarterly
dividends to stockholders of record totaling $1.19 per share and $1.15 per
share in 2001 and 2000, respectively. On May 19, 2001, the Board voted to
increase the quarterly stockholder dividend from $0.29 to $0.30 per share
to stockholders of record as of June 4, 2001. Prior to that declaration,
the Company paid quarterly dividends of $0.29 per share dating back to May
21, 2000 when the Board voted to increase the dividend from $0.28 to $0.29
per share.
NOTE N - Statutory Balances
Following is a GAAP to Statutory reconciliation for both earnings and
policyholders surplus for the combined operations of Commerce, Citation,
Commerce West and American Commerce:
2001 2000 1999
Earnings Equity Earnings Equity Earnings Equity
GAAP............................. $ 95,758 $787,172 $136,425 $756,922 $ 85,242 $635,787
Deferred income taxes (benefits). (5,540) 34,518 6,077 (9,227) (944) (40,634)
Deferred acquisition costs....... (5,252) (116,557) (12,805) (111,305) (3,373) (98,499)
Bonds-book versus market......... - (11,578) - (5,726) - 11,400
Preferred stock-market versus
book............................ - 467 - 1,506 - (528)
Deferred income.................. (692) 6,802 231 7,493 518 7,380
Deferred service fee income
(expense)...................... 1,067 2,765 412 1,698 (804) 2,611
Deferred reinsurance
commissions..................... 1,560 14,834 1,896 13,276 (201) 10,054
Statutory reserve over statement
reserves........................ - (115) - (1,042) - (3,053)
Goodwill in subsidiary........... (290) 1,065 (290) 1,355 (291) 1,645
Pension and post-retirement
benefit......................... 55 1,929 (2,072) 1,875 - 3,408
Yield to worst amortization...... (201) (3,803) - - - -
Non-admitted assets.............. - (8,682) - (4,308) - -
Adjustment for non-insurance
company subsidiary.............. 6,014 6,840 6,021 8,324 8,651 11,727
Equity in earnings (losses) of
preferred stock mutual funds
reflected in GAAP earnings...... (4,583) - (26,575) - - -
Equity in earnings (losses) of
venture capital funds reflected
in GAAP earnings................ 9,548 - - - - -
Equity in earnings (losses) of
Liquidation Special Trust
reflected in GAAP earnings...... (2,561) - - - - -
GAAP restatement of preferred
stock mutual funds.............. - - - - 13,913 (21,371)
Other............................ 135 275 (578) 121 329 (953)
Total adjustments........... (740) (71,240) (27,683) (95,960) 17,798 (116,813)
Statutory........................ $ 95,018 $715,932 $108,742 $660,962 $103,040 $518,974
65
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars)
NOTE O - Segment Information (continued)
The Company has four reportable segments: (1) property and casualty
insurance - Massachusetts; (2) property and casualty insurance - other
than Massachusetts; (3) real estate and commercial lending; and, (4)
corporate and other. The Company's property and casualty insurance
operations are written through Commerce, Citation, Commerce West, and
American Commerce and are marketed to affinity groups, individuals,
families and businesses through the Company's relationships with
professional independent insurance agencies. The Company's real estate
and commercial lending operations are a result of insurance companies
having the authority to invest in mortgages. The Company's wholly-owned
subsidiary, Bay Finance Company, Inc., originates and services residential
and commercial mortgages in Massachusetts and Connecticut. The corporate
and other segment represents the remainder of the Company's activities,
including those of the parent company.
The Company evaluates performance and allocates resources based
primarily on the property and casualty insurance segments, which
represents 99.2% of the Company's total revenue for the past three years.
The accounting policies of the reportable segments are the same as those
described in NOTE A - Summary of Significant Accounting Policies.
Selected information by industry segment for 2001, 2000 and 1999 is
summarized as follows:
Earnings (Losses)
Before Identifiable
Revenue Income Taxes Assets
2001
Property and casualty insurance
Massachusetts.......................... $1,011,318 $120,855 $1,848,333
Other than Massachusetts............... 135,483 (6,730) 245,397
Real estate and commercial lending...... 3,640 3,640 40,466
Corporate and other..................... 3,397 (2,340) 5,886
Consolidated........................ $1,153,838 $115,425 $2,140,082
2000
Property and casualty insurance
Massachusetts.......................... $ 969,624 $164,237 $1,780,724
Other than Massachusetts............... 121,028 7,115 236,240
Real estate and commercial lending...... 5,407 5,407 52,327
Corporate and other..................... 3,421 (6,693) 6,323
Consolidated........................ $1,099,480 $170,066 $2,075,614
1999
Property and casualty insurance
Massachusetts.......................... $ 844,052 $ 97,304 $1,562,975
Other than Massachusetts............... 110,179 3,998 224,017
Real estate and commercial lending...... 5,429 5,429 78,755
Corporate and other..................... 3,374 (2,447) 12,272
Consolidated........................ $ 963,034 $104,284 $1,878,019
NOTE P - Supplement to Consolidated Statements of Cash Flows
During the years ended December 31, 2001 and 2000, the Company did
not acquire any property through foreclosure of mortgages.
66
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars Except for Per Share Data)
NOTE Q - Insolvency Fund Assessments
As provided in the statutes, insurance companies which write business
in Massachusetts are assessed for losses attributable to the insolvency of
other insurance companies by the Massachusetts Insurers Insolvency Fund
("M.I.I.F."). From M.I.I.F.'s inception, on August 2, 1972 through
December 31, 2001, the M.I.I.F. has approved assessments totaling
$188,071, of which the Company's share was approximately $15,686. It is
anticipated that there will be additional assessments from time to time
relating to various insolvencies. By statute, no insurer may be assessed
in any year an amount greater than two percent of that insurer's direct
written premiums for the calendar year preceding the assessment. Although
the timing and amounts of any such assessments are not known, based on
existing knowledge, management is of the opinion that such assessments
will not have a material effect on the consolidated financial position of
the Company. According to statute, the assessed insurance companies have
the right to recoup amounts paid to the M.I.I.F., over a reasonable length
of time, through premium rates approved by the Commissioner. M.I.I.F.
assessed the Company $3,111 during 2001 and $5,306 for the year ended
December 31, 2000 after having no activity for the year ended December 31,
1999. The assessment for 2001 was the result of two insolvencies, The
Trust Insurance Company and Reliance Insurance Company, which accounted
for assessment amounts of $1,244 and $1,867, respectively. The assessment
for 2000 was primarily the result of two insolvencies, The Trust Insurance
Company and New England Fidelity Insurance Company, which accounted for
assessment amounts of $4,939 and $1,205, respectively, offset by refunds
for prior year assessments on numerous insurers' insolvencies.
NOTE R - Commitments
In 2000, Commerce entered into a Limited Partnership Agreement with
Conning Partners VI, L.P., a Delaware Limited Partnership. This
partnership agreement required a commitment by the Company to invest up to
$50,000 into the partnership. To date the Company has invested $15,091
into the partnership leaving a balance for funds still committed but not
paid into the partnership of $34,909. The partnership was formed to
operate as an investment fund principally for the purpose of making
investments primarily in equity, equity-related and other securities
issued in expansion financing, start-ups, buy-outs and recapitalization
transactions relating to companies in the areas of insurance, financial
services, e-commerce, healthcare, and related businesses, including,
without limitation, service and technology enterprises supporting such
businesses, in order to realize long-term capital returns, all as
determined and managed by the General Partner for the benefit of the
Partners.
Also in 2000, Commerce entered into a Limited Partnership Agreement
with Distribution Partners Investment Capital, L.P. a Delaware Limited
Partnership. This partnership agreement required a commitment by the
Company to invest up to $3,500 into the partnership. To date the Company
has invested $2,258 into the partnership leaving a balance of $1,242 for
funds still committed. The partnership was formed to operate as an
investment fund principally for the purpose of making investments
primarily in equity and equity-related securities of companies operating
in the area of insurance distribution and distribution related activities,
all as determined and managed by the General Partner for the benefit of
the Partners.
NOTE S - Legal Proceedings
As is common with property and casualty insurance companies, the
Company is a defendant in various legal actions arising from the normal
course of its business, including claims based on Chapter 176D and Chapter
93A. These proceedings are considered to be ordinary to operations or
without foundation in fact. Management is of the opinion that these
actions will not have a material adverse effect on the consolidated
financial position of the Company. In addition to the normal course of
business legal actions noted above, the Company is named as defendant in a
purported class action lawsuit alleging damages as a result of the alleged
diminution of value to vehicles that are involved in accidents. The
"diminution of value" theory asserts that the market value of any vehicle
involved in an accident inevitably and irreparably declines as a result of
such accident, even if all physical damage appears to be repaired
completely. This case, entitled "Elena Given, individually and as a
representative of all persons similarly situated v. The Commerce Insurance
Company", filed in 2001, in the Bristol Superior Court in Massachusetts.
The plaintiff has not sought certification of class
67
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars Except for Per Share Data)
NOTE S - Legal Proceedings (continued)
action status. The Company is vigorously contesting this
suit, but is currently unable to estimate the potential
exposure. The Company and its outside legal counsel are of the
opinion that the Company will prevail in this case. Another Superior
Court judge in Massachusetts ruled, in a similar case brought by the same
plaintiff counsel against another insurer, that claims for diminution of
value are not covered by the Massachusetts automobile insurance policy.
Other insurance companies face similar suits in cases outside of
Massachusetts.
NOTE T - Quarterly Results of Operations (Unaudited)
An unaudited summary of the Company's 2001 and 2000 quarterly
performance is as follows:
2001 First Second Third Fourth
Quarter Quarter Quarter Quarter
Total revenues................................. $273,428 $289,316 $294,642 $296,452
Net earnings................................... 14,622 28,200 22,139 28,133
Comprehensive income........................... 9,019 39,508 19,823 25,305
Operating earnings (1)......................... 20,480 26,580 23,420 28,400
Net earnings per common share
Basic........................................ 0.43 0.84 0.66 0.85
Diluted...................................... 0.43 0.83 0.65 0.84
Operating earnings per share (1)
Basic........................................ 0.60 0.79 0.70 0.85
Diluted...................................... 0.60 0.78 0.69 0.85
Cash dividends paid per share.................. 0.29 0.30 0.30 0.30
2000 First Second Third Fourth
Quarter(2) Quarter(2) Quarter(2) Quarter(2)
Total revenues................................. $261,898 $251,274 $295,780 $290,528
Net earnings................................... 25,964 14,646 35,974 55,496
Comprehensive income........................... 29,681 19,028 44,921 74,940
Operating earnings (1)......................... 20,554 20,415 17,469 51,193
Net earnings per common share
Basic........................................ 0.76 0.43 1.05 1.63
Diluted...................................... 0.76 0.43 1.05 1.63
Operating earnings per share (1)
Basic........................................ 0.60 0.60 0.51 1.50
Diluted...................................... 0.60 0.60 0.51 1.50
Cash dividends paid per share.................. 0.28 0.29 0.29 0.29
(1) The above figures are presented to provide information to the reader due to the amount
of, and fluctuations in, net realized gains and losses. The amounts noted, which
exclude the after-tax impact of net realized investment gains (losses), are important
measures of corporate performance. Operating earnings per share, basic and diluted, are
calculated identically to net earnings per common, basic and diluted, (see NOTE A15),
with the exception that the number divided by the weighted shares would be operating
earnings.
(2) During 2001 certain amounts were restated due to the change in accounting for closed-end
preferred stock mutual funds to the equity method.
68
SELECTED CONSOLIDATED FINANCIAL DATA
The data below should be read in conjunction with the consolidated
financial statements, related footnotes, and other financial information
included herein. The financial statements for the five years ended
December 31, 2001 have been audited by Ernst & Young LLP. All dollar
amounts set forth in the following tables are in thousands, except per
share data:
Years ended December 31,
2001 2000 1999 1998 1997
Statement of Earnings Data:
Net premiums written.......... $1,078,967 $1,008,911 $ 911,993 $ 745,048 $ 741,501
(Increase) decrease in
unearned premiums............ (35,315) (54,428) (40,163) 572 (11,004)
Earned premiums............... 1,043,652 954,483 871,830 745,620 730,497
Net investment income......... 99,611 96,830 89,789 86,501 80,971
Premium finance and service
fees......................... 17,819 15,227 14,774 13,440 7,074
Amortization of excess of
book value of subsidiary
interest over cost........... 3,389 3,390 3,019 - -
Net realized investment gains
(losses)...................... (10,633) 29,550 (16,378) 7,150 29,963
Total revenues........... 1,153,838 1,099,480 963,034 852,711 848,505
Losses and loss adjustment
expenses..................... 777,543 686,157 625,090 531,429 526,127
Policy acquisition costs...... 260,870 243,257 233,660 196,434 187,491
Total expenses........... 1,038,413 929,414 858,750 727,863 713,618
Earnings before income taxes
and minority interest........ 115,425 170,066 104,284 124,848 134,887
Income taxes.................. 23,194 38,306 16,667 26,583 33,483
Net earnings before minority
interest..................... 92,231 131,760 87,617 98,265 101,404
Minority interest in net loss
of subsidiary............... 863 320 1,059 - -
Net earnings............. $ 93,094 $ 132,080 $ 88,676 $ 98,265 $ 101,404
Comprehensive income..... $ 93,655 $ 168,570 $ 40,730 $ 96,594 $ 103,460
Earnings Per Share Data:
Basic.................... $ 2.77 $ 3.87 $ 2.54 $ 2.73 $ 2.81
Diluted.................. $ 2.75 $ 3.87 $ 2.54 $ 2.73 $ 2.81
Cash dividends paid per
share................... $ 1.19 $ 1.15 $ 1.11 $ 1.07 $ 1.03
Weighted average number of
shares outstanding:
Basic......................... 33,608,804 34,121,047 34,940,074 36,042,652 36,044,679
Diluted....................... 33,794,938 34,121,047 34,940,074 36,042,652 36,044,679
December 31,
2001 2000 1999 1998 1997
Balance Sheet Data:
Total investments............. $1,498,201 $1,472,562 $1,295,995 $1,262,500 $1,246,504
Premiums receivable........... 246,221 230,580 195,160 162,878 169,469
Total assets.................. 2,140,082 2,075,614 1,878,019 1,747,583 1,739,562
Unpaid losses and loss
adjustment expenses.......... 681,624 674,140 659,841 583,996 630,473
Unearned premiums............. 563,456 519,885 457,095 391,424 379,599
Stockholders' equity.......... 812,274 781,881 668,005 710,852 652,824
Stockholders' equity
per share ................... 24.52 23.16 19.44 19.72 18.11
69
MANAGEMENT'S DISCUSSION OF THE SUPPLEMENTAL INFORMATION
ON INSURANCE OPERATIONS
(Thousands of Dollars)
The following tables depict the progress of the insurance operations
of the Company over the past fifteen years. For these years of operation,
net premiums written amounted to $8,358,235. During this period, the
aggregate statutory financial ratios were 68.6% for losses and loss
expenses and 26.1% for underwriting expenses resulting in an aggregate
combined ratio of 94.7%. Total net investment income amounted to $876,134
or 10.5% of net premiums written. Net realized gains were $93,201.
Stockholders' equity was $31,461 at the beginning of 1987 and $787,172, at
the end of 2001, resulting in an average annual increase in excess of
23.9%, excluding dividends. This figure including dividends paid would
have been 26.1%. The progress of the insurance operations during the most
recent five year period, compared to the two previous five year periods,
can best be illustrated by the following comparison:
5-Year Period
1997-01 1992-96 1987-91
Direct premiums written.......................... $4,737,712 $3,110,296 $1,710,049
Net premiums written............................. 4,486,420 2,976,451 895,364
Net investment income............................ 465,687 303,657 106,790
Net realized gains............................... 28,969 50,290 13,942
Stockholders' equity at end of period............ 787,172 550,087 177,225
Statutory Financial Ratios (Unaudited)
Losses and loss expenses to premiums earned.... 70.2% 66.5% 66.8%
Underwriting expenses to net premiums written.. 25.2 27.4 26.6
Combined ratio............................. 95.4% 93.9% 93.4%
Increase in Stockholders' Equity................. 43.1% 210.4% 463.3%
The insurance operations of the Company include the operating results
of Commerce and Citation, along with Commerce's subsidiary companies,
Commerce West and American Commerce. Citation commenced business in 1981
as a wholly-owned subsidiary of Commerce. On December 31, 1989, the
ownership of Citation was transferred to The Commerce Group, Inc. In
September 1993, ownership of both Commerce and Citation was transferred
from The Commerce Group, Inc. to CHI, a subsidiary of The Commerce Group,
Inc. Results of Commerce West are included since its acquisition by
Commerce on August 31, 1995. Results of American Commerce are included
since its acquisition by Commerce on January 29, 1999. The combined
balance sheets of these insurance subsidiaries appear on pages 71 and 72.
The combined statements of earnings of insurance operations appear on
pages 73 and 74. During 2001 certain amounts for years 1996 through 2000
were restated due to the change in accounting for closed-end preferred
stock mutual funds to the equity method, reflected as realized gains or
losses.
70
MANAGEMENT'S DISCUSSION OF THE SUPPLEMENTAL INFORMATION
ON INSURANCE OPERATIONS (continued)
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
COMBINED BALANCE SHEETS OF INSURANCE SUBSIDIARIES
December 31,
(Thousands of Dollars)
2001 2000 1999 1998 1997
ASSETS
Cash and short-term investments..... $ 148,418 $ 70,392 $ 22,410 $ 75,655 $ 238,685
Bonds, at market (at amortized cost
prior to 1993)..................... 626,482 669,935 647,338 619,267 590,597
Preferred stocks, at market (at
amortized cost prior to 1993)...... 248,101 200,083 211,049 197,425 148,499
Common stocks, at market............ 107,458 115,827 77,348 111,482 58,652
Preferred stock mutual funds........ 309,282 337,733 251,135 177,079 123,246
Mortgage loans on real estate....... 26,237 35,340 42,479 46,573 57,425
Other investments................... 18,743 26,802 14,139 7,825 3,783
Premium balances receivable......... 246,095 230,450 195,047 162,704 169,311
Investment income receivable........ 15,460 18,118 14,531 13,544 12,103
Residual market receivable.......... 125,832 127,241 141,660 140,220 161,799
Reinsurance receivable.............. 70,450 61,554 48,365 36,687 18,170
Deferred acquisition costs.......... 116,557 111,305 98,500 88,759 85,264
Current income taxes................ - - - 2,773 -
Deferred income taxes............... 15,797 10,901 37,612 - -
Non-compete agreement............... 2,479 2,829 3,179 - -
Real estate, furniture and equipment 38,764 33,498 27,321 27,885 29,060
Total assets................ $2,116,155 $2,052,008 $1,832,113 $1,707,878 $1,696,594
LIABILITIES
Unpaid losses and loss expenses..... $ 675,978 $ 669,837 $ 659,319 $ 579,174 $ 618,094
Unearned premiums................... 563,456 519,885 457,095 391,424 379,599
Excess of book value of subsidiary
interest over cost................. 5,719 8,431 10,758 - -
Notes payable....................... - - - - -
Deferred income..................... 7,015 7,703 7,464 6,948 7,271
Accounts payable, accrued and other
liabilities........................ 72,998 72,333 48,505 70,558 60,332
Current income taxes................ 3,817 15,829 11,821 - 9,635
Deferred income taxes............... - - - 4,955 9,218
Total liabilities........... 1,328,983 1,294,018 1,194,962 1,053,059 1,084,149
Minority interest................... - 1,068 1,364 - -
STOCKHOLDERS' EQUITY
Capital stock....................... 3,600 3,600 3,600 3,620 3,600
Paid-in capital..................... 45,050 45,050 45,050 45,050 45,050
Retained earnings
Balance, January 1................ 708,272 587,137 606,149 563,795 501,437
Net earnings...................... 95,758 136,425 85,242 95,661 106,718
Other comprehensive income (loss). 560 36,490 (47,948) (1,669) 2,055
Dividends paid.................... (66,068) (51,780) (56,306) (51,638) (46,415)
Balance, December 31................ 738,522 708,272 587,137 606,149 563,795
Total stockholders' equity.. 787,172 756,922 635,787 654,819 612,445
Total liabilities and
stockholders' equity...... $2,116,155 $2,052,008 $1,832,113 $1,707,878 $1,696,594
71
MANAGEMENT'S DISCUSSION OF THE SUPPLEMENTAL INFORMATION
ON INSURANCE OPERATIONS (continued)
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
COMBINED BALANCE SHEETS OF INSURANCE SUBSIDIARIES
December 31,
(Thousands of Dollars)
1996 1995 1994 1993 1992 1991 1990 1989 1988 1987
ASSETS
$ 140,102 $ 52,308 $ 4,560 $ 12,615 $ 25,809 $ 11,190 $ 38,654 $ 84,308 $ 60,885 $ 21,051
716,702 815,277 745,010 649,491 505,565 329,935 242,735 153,621 133,867 116,220
147,680 111,220 85,574 80,059 2,261 869 1,010 1,324 1,606 2,295
63,156 40,359 9,656 47,462 43,545 30,055 4,869 2,900 1,921 1,438
22,727 - - - - - - - - -
45,398 31,404 35,715 42,042 60,697 66,122 56,124 52,244 42,882 15,931
127 - - - 67,876 55,510 57,733 56,713 33,727 19,329
157,673 126,090 101,529 94,333 - - - - - -
12,655 14,440 13,285 10,205 9,710 6,063 4,235 3,093 2,889 2,370
182,213 187,124 198,818 203,312 253,426 254,196 266,440 246,951 184,177 123,725
19,659 21,897 16,892 12,868 365 - - - - -
82,968 67,160 59,066 53,647 55,442 33,981 27,273 22,702 15,699 10,898
- - - - - - - 341 266 -
- 2,100 38,180 - - 883 1,666 - - -
- - - - - - - - - -
26,011 24,642 25,246 22,371 23,183 24,163 25,046 23,118 9,684 8,356
$1,617,071 $1,494,021 $1,333,531 $1,228,405 $1,047,879 $812,967 $725,785 $647,315 $487,603 $321,613
LIABILITIES
$ 644,854 $ 605,791 $ 576,373 $ 550,797 $ 474,800 $416,551 $379,752 $323,020 $256,628 $160,539
367,991 330,454 314,719 283,526 264,567 192,785 175,334 174,345 118,079 84,876
- - - - - - - - - -
- - - - - - 1,662 1,837 2,013 2,204
7,974 8,954 10,451 7,351 8,384 12,918 20,264 23,689 23,307 11,058
41,368 34,351 43,433 16,564 20,863 7,677 21,065 27,513 19,350 14,532
2,726 1,596 10,254 4,867 9,249 5,811 3,542 - - 470
2,071 - - 13,669 4,400 - - 1,623 1,021 1,853
1,066,984 981,146 955,230 876,774 782,263 635,742 601,619 552,027 420,398 275,532
- - - - - - - - - -
STOCKHOLDERS' EQUITY
3,600 3,450 3,450 3,450 3,450 3,450 3,450 3,450 2,350 2,350
45,050 23,700 23,700 8,700 8,700 8,700 8,700 8,700 6,500 6,500
485,725 351,151 339,481 253,466 165,075 112,016 83,138 62,877 37,231 22,611
74,543 110,450 113,892 79,837 91,980 55,214 32,414 21,966 21,837 15,614
6,399 58,919 (77,622) 21,928 9,811 2,545 (86) 645 321 (54)
(65,230) (34,795) (24,600) (15,750) (13,400) (4,700) (3,450) (2,350) (1,034) (940)
501,437 485,725 351,151 339,481 253,466 165,075 112,016 83,138 58,355 37,231
550,087 512,875 378,301 351,631 265,616 177,225 124,166 95,288 67,205 46,081
$1,617,071 $1,494,021 $1,333,531 $1,228,405 $1,047,879 $812,967 $725,785 $647,315 $487,603 $321,613
72
MANAGEMENT'S DISCUSSION OF THE SUPPLEMENTAL INFORMATION
ON INSURANCE OPERATIONS (continued)
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
COMBINED STATEMENTS OF EARNINGS OF INSURANCE OPERATIONS
Years Ended December 31,
(Thousands of Dollars)
2001 2000 1999 1998 1997
Underwriting
Direct premiums written...................$1,152,407 $1,071,649 $948,149 $796,858 $768,649
Net premiums written......................$1,078,967 $1,008,911 $911,993 $745,048 $741,501
Increase (decrease) in unearned
premiums................................. 35,315 54,428 40,163 (572) 11,004
Earned premiums....................... 1,043,652 954,483 871,830 745,620 730,497
Expenses
Losses and loss expenses.................. 776,709 682,805 628,087 533,523 521,775
Underwriting expenses..................... 263,766 251,697 238,458 200,525 185,146
(Increase) decrease in deferred
acquisition costs........................ (5,252) (12,805) (3,374) (3,495) (2,296)
Total expenses........................ 1,035,223 921,697 863,171 730,553 704,625
Underwriting income (loss).................. 8,429 32,786 8,659 15,067 25,872
Net investment income....................... 100,384 96,739 90,028 89,356 89,180
Premium finance fees........................ 17,814 15,221 14,768 13,426 7,056
Amortization of excess of book value
of subsidiary interest over cost........... 3,389 3,390 3,019 - -
Net realized investment gains (losses)...... (10,738) 29,380 (16,325) 4,334 22,318
Earnings before Federal income taxes,
withdrawing companies' settlements
and minority interest................. 119,278 177,516 100,149 122,183 144,426
Other income
Withdrawing companies' settlements........ - - - - -
Earnings before Federal income taxes
and minority interest...................... 119,278 177,516 100,149 122,183 144,426
Federal income taxes........................ 24,383 41,411 15,966 26,522 37,708
Earnings before cumulative effect of
change in accounting principle and
minority interest.......................... 94,895 136,105 84,183 95,661 106,718
Cumulative effect on prior years (to
December 31, 1986) of changing to
different method of accounting for
income taxes............................... - - - - -
Minority interest in net loss of subsidiary. 863 320 1,059 - -
NET EARNINGS..........................$ 95,758 $ 136,425 $ 85,242 $ 95,661 $106,718
Statutory Financial Ratios (Unaudited)
Losses and loss expenses to
premiums earned.......................... 74.7% 71.7% 72.0% 71.6% 71.4%
Underwriting expenses to net
premiums written......................... 24.4 25.1 26.5 26.5 25.1
Combined ratio........................ 99.1% 96.8% 98.5% 98.1% 96.5%
Underwriting profit (loss)............ 0.9% 3.2% 1.5% 1.9% 3.5%
73
MANAGEMENT'S DISCUSSION OF THE SUPPLEMENTAL INFORMATION
ON INSURANCE OPERATIONS (continued)
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
COMBINED STATEMENTS OF EARNINGS OF INSURANCE OPERATIONS
Years Ended December 31,
(Thousands of Dollars)
1996 1995 1994 1993 1992 1991 1990 1989 1988 1987
$731,823 $626,666 $ 625,023 $601,289 $525,495 $429,780 $401,077 $366,492 $304,469 $206,231
$711,570 $603,421 $ 589,197 $563,416 $508,847 $310,999 $219,936 $140,313 $124,923 $ 99,193
42,854 10,831 17,144 14,856 98,353 30,193 34,692 12,655 9,678 13,428
668,716 592,590 572,053 548,560 410,494 280,806 185,244 127,658 115,245 85,765
474,173 367,258 369,764 373,243 271,848 173,901 125,219 88,564 80,203 65,299
194,873 171,892 162,446 147,290 138,669 85,655 55,551 44,181 33,115 25,882
(15,809) (5,723) (5,420) 1,796 (21,462) (6,708) (4,571) (7,003) (4,801) (3,769)
653,237 533,427 526,790 522,329 389,055 252,848 176,199 125,742 108,517 87,412
15,479 59,163 45,263 26,231 21,439 27,958 9,045 1,916 6,728 (1,647)
76,978 71,007 63,119 52,868 39,685 32,661 25,978 21,256 15,999 10,896
9,666 19,246 18,315 16,486 13,734 11,165 10,074 8,095 4,592 3,021
- - - - - - - - - -
(7,863) 720 32,025 13,040 12,368 7,529 74 618 2,298 3,423
94,260 150,136 158,722 108,625 87,226 79,313 45,171 31,885 29,617 15,693
- - - - 43,168 - - - - -
94,260 150,136 158,722 108,625 130,394 79,313 45,171 31,885 29,617 15,693
19,717 39,686 44,830 28,788 38,414 24,099 12,757 9,919 7,780 2,987
74,543 110,450 113,892 79,837 91,980 55,214 32,414 21,966 21,837 12,706
- - - - - - - - - 2,908
- - - - - - - - - -
$ 74,543 $110,450 $ 113,892 $ 79,837 $ 91,980 $ 55,214 $ 32,414 $ 21,966 $ 21,837 $ 15,614
70.9% 62.0% 64.6% 68.0% 66.2% 61.9% 65.7% 68.0% 69.5% 79.4%
27.1 29.0 27.1 25.7 28.1 30.0 26.7 26.3 22.0 22.5
98.0% 91.0% 91.7% 93.7% 94.3% 91.9% 92.4% 94.3% 91.5% 101.9%
2.0% 9.0% 8.3% 6.3% 5.7% 8.1% 7.6% 5.7% 8.5% (1.9%)
74
ORGANIZATIONAL CHART
--------------------------
|The Commerce Group, Inc.|
|A Massachusetts Corp. |
--------------------------
|
|
-------------------------------------------------------------------
| | |
| | |
- --------------------------- -------------------------- ------------------------------
|Bay Finance Company, Inc.| |Commerce Holdings, Inc. | |Clark-Prout Insurance Agency|
|A Massachusetts Corp. | |A Massachusetts Corp. | |A Massachusetts Corp. |
|A wholly-owned subsidiary| |A wholly-owned insurance| |A wholly-owned subsidiary |
- --------------------------- |holding company | ------------------------------
--------------------------
|
|
---------------------------------------------------
| |
| |
-------------------------------- ----------------------------
|The Commerce Insurance Company| |Citation Insurance Company|
|A Massachusetts Corp. | |A Massachusetts Corp. |
|A wholly-owned subsidiary | |A wholly-owned subsidiary |
-------------------------------- ----------------------------
|
|
------------------------------------------
| |
-------------------------- ---------------------------------
|ACIC Holding, Inc. | |Commerce West Insurance Company|
|A Rhode Island Corp. | |A California Corp. |
|An 80% owned holding co.| |A wholly-owned subsidiary |
-------------------------- ---------------------------------
|
|
-------------------------------------
|American Commerce Insurance Company|
|An Ohio Corp. |
|A wholly-owned subsidiary |
-------------------------------------
75
THE COMMERCE GROUP, INC.
DIRECTORS
Herman F. Becker......................... President and owner, Sterling Realty and Huguenot
Development Corporation
Joseph A. Borski, Jr..................... Self-employed Certified Public Accountant
Eric G. Butler........................... Retired Vice President and General Claims Manager
of Commerce and Citation
Henry J. Camosse......................... Retired President, Henry Camosse & Sons Co., Inc.,
a building and masonry supplies company
Gerald Fels.............................. Executive Vice President and Chief Financial
Officer of the Company; President and Chief
Operating Officer of Commerce and Citation
David R. Grenon.......................... Retired CEO, President and Chairman Emeritus of
The Protector Group Insurance Agency, Inc.;
President E-C Realty Corporation
Robert W. Harris......................... Retired Treasurer, H.C. Bartlett Insurance Agency,
Inc.
Robert S. Howland........................ Retired Clerk, H.C. Bartlett Insurance Agency,
Inc.
John J. Kunkel........................... President and Treasurer, Kunkel Buick and GMC
Truck; Treasurer, Kunkel Bus Company
Raymond J. Lauring....................... Retired President, Lauring Construction Company
Normand R. Marois........................ Retired Chairman of the Board, Marois Bros., Inc.,
a contracting firm
Suryakant M. Patel....................... Retired physician who specialized in internal
medicine
Arthur J. Remillard, Jr.................. President, Chief Executive Officer and Chairman
of the Board of the Company
Arthur J. Remillard, III................. Senior Vice President and Assistant Clerk of
the Company; Senior Vice President of Commerce
and Citation in charge of Policyholder Benefits
Regan P. Remillard....................... Senior Vice President of the Company; President
and Secretary of Commerce West Insurance Company;
President of ACIC Holding Co., Inc.; President,
Vice Chairman of the Board and Chief Executive
Officer of American Commerce Insurance Company
Gurbachan Singh.......................... Retired physician who specialized in general
surgery
John W. Spillane......................... Clerk of the Company and practicing attorney
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DIRECTORS OF
COMMERCE HOLDINGS, INC.
The Commerce Insurance Company
Commerce West Insurance Company
Citation Insurance Company
Arthur J. Remillard, Jr........... President and Chairman of the Board of Commerce
Holdings, Inc.; Chief Executive Officer and Chairman
of the Board of The Commerce Insurance Company, Inc.;
Chairman of the Board Commerce West Insurance Company
Gerald Fels....................... President, Chief Operating Officer and Chief
Financial Officer of The Commerce Insurance Company
and Citation Insurance Company; Treasurer, Commerce
Holdings, Inc.; Investment Officer of Commerce West
Insurance Company
Arthur J. Remillard, III (1)...... Senior Vice President and Clerk
Regan P. Remillard................ Senior Vice President; President and Secretary of
Commerce West Insurance Company
James A. Ermilio (1).............. Senior Vice President and General Counsel
David R. Grenon (1)............... Retired CEO, President and Chairman Emeritus of
The Protector Group Insurance Agency, Inc.;
President E-C Realty Corporation
John M. Nelson (1)................ Chairman of Commonwealth National Bank
Suryakant M. Patel (1)............ Retired physician who specialized in internal
medicine
William G. Pike (1)............... Executive Vice President and Chief Financial Officer
of Granite State Bankshares, Inc.
H. Thomas Rowles (1).............. Chairman of the Board of ACIC Holding Co., Inc.;
Chairman of the Board of American Commerce Insurance
Company; Director of AAA Southern New England
Mark A. Shaw (1).................. Treasurer of ACIC Holding Co., Inc.; President, Chief
Executive Officer and Director of AAA Southern New
England
(1) Commerce Holdings, Inc., The Commerce Insurance Company and Citation Insurance Company
only.
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DIRECTORS OF
ACIC Holding Co., Inc.(1)
American Commerce Insurance Company
H. Thomas Rowles.................. Chairman of the Board of ACIC Holding Co., Inc.;
Chairman of the Board of American Commerce Insurance
Company; Director of AAA Southern New England
Regan P. Remillard................ President of ACIC Holding Co., Inc.; President, Vice
Chairman of the Board and Chief Executive Officer of
American Commerce Insurance Company; Senior Vice
President of The Commerce Group, Inc.; President and
Secretary of Commerce West Insurance Company
Mark A. Shaw...................... Treasurer of ACIC Holding Co., Inc.; President,
Chief Executive Officer and Director of AAA Southern
New England
Gerald Fels....................... Executive Vice President and Chief Financial Officer
of The Commerce Group, Inc.
Patrick W. Doherty (2)............ President and Chief Executive Officer of AAA Oklahoma
Terry R. Farias (2)............... President and Chief Executive Officer of AAA Hoosier
Motor Club
Richard S. Hamilton (2)........... President of AAA West Pennsylvania/West
Virginia/South Central Ohio
Charles B. Liekweg (2)............ President and Chief Executive Officer of AAA
Washington
D. James McDowell (2)............. President and Chief Executive Officer of AAA Arizona
Peter C. Ohlheiser (2)............ President of Ohio Motorists Association
Otto T. Wright (2)................ President and Chief Executive Officer of East
Tennessee Automobile Club, Inc.
(1) Incorporated in November, 1998. 80% owned by The Commerce Insurance Company and 20%
owned by AAA Southern New England.
(2) American Commerce Insurance Company only, which was acquired in January 1999.
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DIRECTORS OF
BAY FINANCE COMPANY, INC.
Arthur J. Remillard, Jr.............. President and Chairman of the Board
Gerald Fels.......................... Executive Vice President and Chief Financial Officer
John W. Spillane..................... Clerk and Practicing Attorney
Arthur J. Remillard, III............. Senior Vice President and Assistant Clerk
Regan P. Remillard................... Senior Vice President
DIRECTORS OF
CLARK-PROUT INSURANCE AGENCY, INC.
Arthur J. Remillard, Jr.............. President and Chairman of the Board
Gerald Fels.......................... Executive Vice President and Chief Financial Officer
John W. Spillane..................... Clerk and Practicing Attorney
Arthur J. Remillard, III............. Senior Vice President and Assistant Clerk
Elizabeth M. Edwards................. Vice President
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THE COMMERCE GROUP, INC.
Commerce Holdings, Inc.
The Commerce Insurance Company
Commerce West Insurance Company
ACIC Holding Co., Inc. (1)
American Commerce Insurance Company (2)
Citation Insurance Company
Bay Finance Company, Inc.
Clark-Prout Insurance Agency, Inc.
OFFICERS OF THE COMMERCE GROUP, INC.
President, Chief Executive Officer and Chairman of the Board..... Arthur J. Remillard, Jr.
Executive Vice President and Chief Financial Officer............. Gerald Fels
Senior Vice President and Assistant Clerk........................ Arthur J. Remillard, III
Senior Vice President............................................ Regan P. Remillard
Senior Vice President and General Counsel........................ James A. Ermilio
Vice President................................................... Joseph J. Staffieri
Clerk............................................................ John W. Spillane
Treasurer and Chief Accounting Officer........................... Randall V. Becker
Vice President and Corporate Compliance Officer.................. Robert E. McKenna
Assistant Vice President and Assistant General Counsel........... Thomas D. Jungeberg
Assistant Treasurer.............................................. Thomas A. Gaylord
Officers of Massachusetts Subsidiaries (3)
Chief Executive Officer and Chairman of the Board................ Arthur J. Remillard, Jr.
President, Chief Operating Officer and Chief Financial Officer... Gerald Fels
Senior Vice President and Secretary.............................. Arthur J. Remillard, III
Senior Vice President and General Counsel........................ James A. Ermilio
Senior Vice Presidents........................................... David H. Cochrane
Peter J. Dignan
Regan P. Remillard
Joyce B. Virostek
Vice Presidents.................................................. Elizabeth M. Edwards
Karen A. Lussier
Robert E. McKenna
Michael J. Richards
Angelos Spetseris
Joseph J. Staffieri
Henry R. Whittier, Jr.
Assistant Vice President and Assistant General Counsel........... Thomas D. Jungeberg
Assistant Vice Presidents...................... David P. Antocci James E. Gow
Robert M. Blackmer Susan A. Horan
Stephen R. Clark John V. Kelly
Raymond J. DeSantis Donald G. MacLean
Warren S. Ehrlich Patrick J. McDonald
Richard W. Goodus Robert L. Mooney
Emile E. Riendeau
Treasurer and Chief Accounting Officer........................... Randall V. Becker
Assistant Treasurer.............................................. Thomas A. Gaylord
(1) Incorporated in November, 1998, the common stock of which is 80% owned by The Commerce
Insurance Company and 20% owned by AAA Southern New England.
(2) Acquired by ACIC Holding Co., Inc. in January, 1999.
(3) Massachusetts subsidiaries include Commerce Holdings, Inc., The Commerce Insurance Company,
Citation Insurance Company, Bay Finance Company, Inc. and Clark-Prout Insurance Agency.
Officers often hold positions with several operating subsidiaries. The titles listed
represent their primary office as of March 1, 2002.
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Officers of ACIC Holding Co., Inc.
Chairman of the Board................................................ H. Thomas Rowles
President............................................................ Regan P. Remillard
Treasurer............................................................ Mark A. Shaw
Secretary............................................................ James A. Ermilio
Officers of American Commerce Insurance Company
Chairman of the Board................................................ H. Thomas Rowles
President, Vice Chairman of the Board and Chief Executive Officer.... Regan P. Remillard
Senior Vice President and Chief Financial Officer.................... Michael V. Vrban
General Counsel and Secretary........................................ James A. Ermilio
Treasurer............................................................ Richard B. O'Hara
Vice President....................................................... Gregory S. Clark
Vice President....................................................... Joseph B. Phillips, Jr.
Assistant Vice President............................................. William J. Hafer
Assistant Vice President............................................. Jeffrey B. Alexander
Assistant General Counsel and Assistant Secretary.................... Thomas D. Jungeberg
Officers of Commerce West Insurance Company
Chairman of the Board................................................ Arthur J. Remillard, Jr.
President and Secretary.............................................. Regan P. Remillard
Treasurer and Chief Financial Officer ............................... Michael V. Vrban
Chief Accounting Officer............................................. Albert E. Peters
Investment Officer................................................... Gerald Fels
Vice Presidents...................................................... Michael J. Berryessa
Albert R. Harris
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Stockholder Information
Annual Meeting
The Annual meeting of stockholders will be held at 9:00 a.m. on Friday, May
17, 2002 at the Company's Underwriting Building, 11 Gore Road (Route 16),
Webster, MA.
Form 10-K
Stockholders interested in the detailed information contained in the
Company's annual report on Form 10-K, as filed with the Securities and
Exchange Commission, may obtain a copy without charge, by writing to the
Assistant to the President at 211 Main Street, Webster, MA 01570.
Transfer Agent
The Commerce Group, Inc.
c/o Equiserve Trust Company, N.A.
P.O. Box 43010
Providence, RI 02940-3010
(781) 575-3100 or (800) 733-5001
http://www.equiserve.com
Executive Offices
211 Main Street
Webster, MA 01570
(508) 943-9000
Company Websites
The Commerce Insurance Company http://www.commerceinsurance.com
American Commerce Insurance Company http://www.acilink.com
Bay Finance Company, Inc. http://www.bayfinance.com
Trading of Common Stock
The Company's Common Stock trades on the NYSE under the symbol "CGI".
Independent Auditors
Ernst & Young LLP
200 Clarendon Street
Boston, MA 02116
(617) 266-2000
http://www.ey.com
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