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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
Quarterly Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934
For Quarter Ended June 30, 2002 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
of Incorporation) Identification No.)
211 Main Street, Webster, Massachusetts 01570
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (508) 943-9000
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes X No___
As of August 1, 2002, the number of shares outstanding of the
Registrant's common stock (excluding Treasury Shares) was
32,909,423
Page 1 of 30
The Commerce Group, Inc.
Table of Contents
Page No.
Part I - Financial Information
Consolidated Balance Sheets at
June 30, 2002 (Unaudited) and December 31, 2001.................... 3
Consolidated Statements of Earnings for the
Three and Six Months Ended June 30, 2002 and 2001 (Unaudited)...... 4
Consolidated Statements of Cash Flows for the
Six Months Ended June 30, 2002 and 2001 (Unaudited)................ 5
Consolidated Statements of Cash Flows - Reconciliation of Net Earnings
to Net Cash Provided by Operating Activities for the Six Months
Ended June 30, 2002 and 2001 (Unaudited)............................ 6
Notes to Unaudited Consolidated Financial Statements................... 7
Management's Discussion and Analysis................................... 13
Part II - Other Information
Item 4
Results of Votes of Security Holders............................... 25
Item 6
Exhibits and Reports on Form 8-K................................... 26
Signature.............................................................. 27
- - 2 -
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Thousands of Dollars)
June 30, December 31,
2002 2001
(Unaudited)
ASSETS
Investments:
Fixed maturities, at market (cost: $627,754 in 2002 and $618,775 in 2001)............. $ 641,593 $ 626,482
Preferred stocks, at market (cost: $290,573 in 2002 and $256,582 in 2001)............. 288,413 248,101
Common stocks, at market (cost: $85,701 in 2002 and $87,704 in 2001).................. 114,208 107,458
Preferred stock mutual funds, at equity (cost: $296,801 in 2002 and $294,948 in 2001). 298,493 309,282
Mortgage loans on real estate and collateral notes receivable (less allowance for
possible loan losses of $653 in 2002 and $660 in 2001)............................... 34,422 39,505
Cash and cash equivalents.............................................................. 147,981 148,630
Other investments (cost: $35,324 in 2002 and $28,291 in 2001).......................... 22,855 18,743
Total investments.................................................................. 1,547,965 1,498,201
Accrued investment income................................................................ 16,321 15,539
Premiums receivable (less allowance for doubtful receivables of $1,561 in 2002 and
$1,565 in 2001)........................................................................ 331,317 246,221
Deferred policy acquisition costs........................................................ 137,476 116,557
Property and equipment, net of accumulated depreciation.................................. 45,822 40,014
Residual market receivable
Losses and loss adjustment expenses.................................................... 92,569 81,433
Unearned premiums...................................................................... 57,232 44,399
Due from reinsurers...................................................................... 79,063 70,450
Current income taxes..................................................................... 2,324 -
Deferred income taxes.................................................................... 21,869 16,993
Receivable for investments sold.......................................................... - 838
Other assets............................................................................. 13,687 9,437
Total assets....................................................................... $2,345,645 $2,140,082
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Unpaid losses and loss adjustment expenses............................................. $ 738,147 $ 681,624
Unearned premiums...................................................................... 698,411 563,456
Current income taxes................................................................... - 2,735
Deferred income........................................................................ 8,034 7,015
Contingent commissions accrued......................................................... 23,332 29,724
Payable for securities purchased....................................................... 1,577 -
Excess of book value of subsidiary interest over cost.................................. - 5,719
Other liabilities and accrued expenses................................................. 41,578 37,535
Total liabilities.................................................................. 1,511,079 1,327,808
Minority interest........................................................................ 4,449 -
Stockholders' equity
Preferred stock, authorized 5,000,000 shares at $1.00 par value; none issued in
2002 and 2001........................................................................ - -
Common stock, authorized 100,000,000 shares at $.50 par value;
38,217,615 shares issued in 2002 and 38,000,000 in 2001.............................. 19,108 19,000
Paid-in capital........................................................................ 35,895 29,621
Net accumulated other comprehensive income, net of income taxes of
$14,033 in 2002 and $6,674 in 2001................................................... 26,060 12,394
Retained earnings...................................................................... 888,677 873,671
969,740 934,686
Treasury stock 5,308,192 shares in 2002 and 4,869,548 in 2001.......................... (139,623) (122,412)
Total stockholders' equity......................................................... 830,117 812,274
Total liabilities, minority interest and stockholders' equity...................... $2,345,645 $2,140,082
The accompanying notes are an integral part of these consolidated financial statements.
- - 3 -
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
Three and Six Months Ended June 30, 2002 and 2001
(Thousands of Dollars Except Per Share Data)
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
2002 2001 2002 2001
Revenues
Direct premiums written................................... $ 348,212 $ 281,890 $ 731,929 $ 607,488
Assumed premiums.......................................... 34,898 21,613 59,053 38,040
Ceded premiums............................................ (48,614) (38,627) (88,945) (71,480)
Net premiums written.................................. 334,496 264,876 702,037 574,048
Increase in unearned premiums............................. (38,086) (10,013) (124,863) (65,752)
Earned premiums........................................... 296,410 254,863 577,174 508,296
Net investment income..................................... 24,873 25,441 47,791 50,479
Premium finance and service fees.......................... 5,065 4,308 9,997 8,616
Amortization of excess of book value of subsidiary
interest over cost...................................... - 847 - 1,694
Net realized investment gains (losses).................... (31,545) 3,857 (34,992) (6,341)
Other income.............................................. - - 7,000 -
Total revenues....................................... 294,803 289,316 606,970 562,744
Expenses
Losses and loss adjustment expenses....................... 222,110 187,926 437,496 383,304
Policy acquisition costs.................................. 76,308 65,467 140,307 126,598
Total expenses....................................... 298,418 253,393 577,803 509,902
Earnings (loss) before income tax (benefit) and minority
interest........................................... (3,615) 35,923 29,167 52,842
Income tax (benefit)........................................ (3,217) 7,737 5,396 10,257
Changes in accounting principle............................. - - 11,237 -
Net earnings (loss) before minority interest......... (398) 28,186 35,008 42,585
Minority interest in net loss of subsidiary................. 153 14 163 237
NET EARNINGS (LOSS).................................. $ (245) $ 28,200 $ 35,171 $ 42,822
COMPREHENSIVE INCOME................................. $ 9,297 $ 39,508 $ 48,837 $ 48,527
NET EARNINGS (LOSS) PER COMMON SHARE:
BASIC.............................................. $ (0.01) $ 0.84 $ 1.06 $ 1.27
DILUTED............................................ $ (0.01) $ 0.83 $ 1.05 $ 1.27
CASH DIVIDENDS PAID PER COMMON SHARE................. $ 0.31 $ 0.30 $ 0.61 $ .59
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING:
BASIC.............................................. 32,968,368 33,753,352 33,025,426 33,753,352
DILUTED............................................ 33,334,199 33,899,784 33,355,669 33,769,053
The accompanying notes are an integral part of these consolidated financial statements.
- - 4 -
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended June 30, 2002 and 2001
(Thousands of Dollars Except Per Share Data)
(Unaudited)
2002 2001
Cash flows from operating activities:
Premiums collected.................................................... $ 621,840 $533,612
Net investment income received........................................ 45,640 49,174
Premium finance and service fees received............................. 9,997 8,616
Losses and loss adjustment expenses paid.............................. (393,591) (391,421)
Policy acquisition costs paid......................................... (176,030) (150,122)
Federal income tax payments........................................... (22,688) (24,113)
Other income.......................................................... 7,000 -
Net cash provided by operating activities......................... 92,168 25,746
Cash flows from investing activities:
Proceeds from maturity of fixed maturities............................ 19,542 11,032
Proceeds from sale of fixed maturities................................ 58,709 27,122
Proceeds from sale of equity securities............................... 18,511 16,229
Proceeds from sale of preferred stock mutual funds.................... 2,524 2,945
Proceeds from sale of other investments............................... 102 920
Payments received on mortgage loans and collateral notes receivable... 5,712 5,912
Purchase of fixed maturities.......................................... (87,403) (11,680)
Purchase of equity securities......................................... (59,283) (20,865)
Purchase of preferred stock mutual funds.............................. (4,543) (11,401)
Purchase of other investments......................................... (7,188) (263)
Mortgage loans and collateral notes originated........................ (625) (1,084)
Purchase of property and equipment.................................... (8,361) (3,065)
Other investing activities............................................ 480 685
Net cash provided by (used in) investing activities............... (61,823) 16,487
Cash flows from financing activities:
Dividends paid to stockholders........................................ (20,165) (19,914)
Purchase of treasury stock............................................ (17,211) -
Capital stock issued.................................................. 6,382 -
Net cash used in financing activities............................. (30,994) (19,914)
Increase (decrease) in cash and cash equivalents...................... (649) 22,319
Cash and cash equivalents at beginning of period...................... 148,630 70,521
Cash and cash equivalents at the end of period.................... $ 147,981 $ 92,840
The accompanying notes are an integral part of these consolidated financial statements.
- - 5 -
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Reconciliation of Net Earnings to Net Cash Provided by Operating Activities
Six Months Ended June 30, 2002 and 2001
(Thousands of Dollars)
(Unaudited)
2002 2001
Cash flows from operating activities:
Net earnings.......................................................... $ 35,171 $ 42,822
Adjustments to reconcile net earnings to net cash provided by
operating activities:
Premiums receivable................................................. (85,096) (45,987)
Deferred policy acquisition costs................................... (20,919) (9,357)
Residual market receivable.......................................... (23,969) 1,779
Due to/from reinsurers.............................................. (8,613) (5,213)
Losses and loss adjustment expenses................................. 56,523 94
Unearned premiums................................................... 134,955 67,084
Current income taxes................................................ (5,059) (10,415)
Deferred income taxes............................................... (12,233) (3,441)
Deferred income..................................................... 1,019 (1,070)
Contingent commissions.............................................. (6,392) (12,112)
Other assets, liabilities and accrued expenses...................... (740) (3,840)
Net realized investment losses...................................... 34,992 6,341
Changes in accounting principle..................................... (11,237) -
Minority interest................................................... 4,449 650
Other - net......................................................... (683) (1,589)
Net cash provided by operating activities.................... $ 92,168 $ 25,746
The accompanying notes are an integral part of these consolidated financial statements.
- - 6 -
The Commerce Group, Inc. and Subsidiaries
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Thousands of Dollars Except Share, Per Share Data, Ratios
and Other Information)
1. The accompanying unaudited condensed consolidated financial
statements have been prepared in accordance with accounting principles
generally accepted in the United States ("GAAP") for interim financial
information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information
and footnotes required by GAAP for complete financial statements. In the
opinion of management, all adjustments (consisting of normal recurring
accruals) considered necessary for a fair presentation have been included.
Certain previously reported 2001 account balances have been reclassified to
conform to the current period's presentation. Results for the three and
six-month periods ended June 30, 2002 are not necessarily indicative of the
results that may be expected for the year ending December 31, 2002.
The balance sheet at December 31, 2001 has been derived from the
audited financial statements at that date but does not include all of the
information and footnotes required by GAAP for complete financial
statements.
For further information, refer to the consolidated financial
statements and footnotes thereto included in the Company's annual report on
Form 10K for the year ended December 31, 2001 and quarterly report on Form
10-Q for the quarter ended March 31, 2002.
2. This Form 10-Q 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 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 economic,
market or regulatory conditions and risks associated with entry into new
markets and diversification.
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.
The Company previously disclosed in its Annual Report on Form 10-K for
the year ended December 31, 2001 that a purported class action lawsuit was
pending in Massachusetts state court against The Commerce Insurance
Company. The lawsuit, titled "Elena Given, individually and as a
representative of all persons similarly situated v. The Commerce Insurance
Company," alleges damages as a result of the alleged inherent diminished
value to vehicles that are involved in accidents. In April 2002, the trial
judge in that case entered partial summary judgment for the plaintiff on
the issue of whether the Massachusetts automobile policy covers her claim,
ruling that the plaintiff would be entitled to reimbursement under the
policy if the plaintiff were able both to prove that her vehicle suffered
"inherent diminished value" in the accident and to quantify the amount of
such diminution in value.
- - 7 -
The Commerce Group, Inc. and Subsidiaries
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Thousands of Dollars Except Share, Per Share Data, Ratios
and Other Information)
(Continued)
Subsequently, the Massachusetts Division of Insurance issued an
Advisory Ruling in which it stated, among other things, its position that
the policy does not cover claims for "inherent diminished value." In July
of 2002, the trial judge allowed for limited additional discovery in the
case, stayed the trial, and granted the Company's motion to have the
appellate court review the issue of whether the Massachusetts automobile
policy provides coverage for inherent diminished value. The Company will
continue to vigorously contest the plaintiff's claim for diminished value
coverage, relying in part on the Advisory Ruling, and also intends to
vigorously contest any effort to certify the class.
4. Disclosure of Statement of Financial Accounting Standards No. 130
- Reporting Comprehensive Income:
Six Months Ended
June 30,
2002 2001
Net earnings.......................................... $ 35,171 $ 42,822
Other comprehensive income, net of taxes:
Change in unrealized gains, net of income taxes of
$7,244 in 2002 and $3,028 in 2001................. 13,454 5,624
Reclassification adjustment, net of income taxes
of $114 in 2002 and $44 in 2001.................... 212 81
Other comprehensive income............................ 13,666 5,705
Comprehensive income.................................. $ 48,837 $ 48,527
Three Months Ended
June 30,
2002 2001
Net earnings (loss)................................... $ (245) $ 28,200
Other comprehensive income, net of taxes:
Change in unrealized gains, net of income taxes of
$5,154 in 2002 and $5,874 in 2001................. 9,571 10,909
Reclassification adjustment, net of income taxes
(benefit) of ($16) in 2002 and $215 in 2001........ (29) 399
Other comprehensive income............................ 9,542 11,308
Comprehensive income.................................. $ 9,297 $ 39,508
- - 8 -
The Commerce Group, Inc. and Subsidiaries
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Thousands of Dollars Except Share, Per Share Data, Ratios
and Other Information)
(Continued)
5. Disclosure of Statement of Financial Accounting Standards No. 131 -
Disclosures about Segments of an Enterprise and Related Information:
Earnings Before
Income Taxes and Identifiable
Revenue Minority Interest Assets
Six Months Ended June 30, 2002
Property and casualty insurance
Massachusetts...................... $529,519 $ 39,400 $ 2,041,286
Other than Massachusetts........... 75,862 (7,489) 260,578
Real estate and commercial lending... 1,589 1,300 34,991
Corporate and other.................. - (4,044) 8,790
Consolidated...................... $606,970 $ 29,167 $ 2,345,645
Six Months Ended June 30, 2001
Property and casualty insurance
Massachusetts...................... $493,588 $ 50,961 $ 1,853,474
Other than Massachusetts........... 65,525 1,376 239,236
Real estate and commercial lending... 1,933 1,933 47,798
Corporate and other.................. 1,698 (1,428) 5,183
Consolidated...................... $562,744 $ 52,842 $ 2,145,691
Earnings Before
Income Taxes and Identifiable
Revenue Minority Interest Assets
Three Months Ended June 30, 2002
Property and casualty insurance
Massachusetts...................... $255,819 $ 4,288 $ 2,041,286
Other than Massachusetts........... 38,215 (5,954) 260,578
Real estate and commercial lending... 769 613 34,991
Corporate and other.................. - (2,562) 8,790
Consolidated...................... $294,803 $ (3,615) $ 2,345,645
Three Months Ended June 30, 2001
Property and casualty insurance
Massachusetts...................... $252,918 $ 34,850 $ 1,853,474
Other than Massachusetts........... 34,511 1,108 239,236
Real estate and commercial lending... 1,036 1,036 47,798
Corporate and other.................. 851 (1,071) 5,183
Consolidated...................... $289,316 $ 35,923 $ 2,145,691
6. Liabilities for unpaid losses and loss adjustment expenses at June
30, 2002 and December 31, 2001 consist of:
June 30, December 31,
2002 2001
Net voluntary unpaid losses and LAE reserves............. $596,004 $558,635
Voluntary salvage and subrogation recoverable............ (78,493) (73,393)
Assumed unpaid loss and LAE reserves from C.A.R.......... 138,269 125,787
Assumed salvage and subrogation recoverable from C.A.R... (20,695) (20,695)
Total voluntary and assumed unpaid loss and LAE reserves 635,085 590,334
Adjustment for ceded unpaid loss and LAE reserves........ 112,062 100,290
Adjustment for ceded salvage and subrogation recoverable. (9,000) (9,000)
Total unpaid loss and LAE reserves...................... $738,147 $681,624
- - 9 -
The Commerce Group, Inc. and Subsidiaries
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Thousands of Dollars Except Share, Per Share Data, Ratios
and Other Information)
(Continued)
7. Disclosure of Supplemental Information:
Additional supplemental financial information is available on the
Company's website at http://www.commerceinsurance.com, under the "Links"
section of the "News & Investors" tab.
8. Earnings Per Share
Net earnings per basic common share are 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 six
months ended June 30, 2002 and 2001 were 33,025,426 and 33,753,352,
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 are 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 six
months ended June 30, 2002 and 2001 were 33,355,669 and 33,769,053,
respectively. The Company's only potentially dilutive instruments are
stock options outstanding and dilution from these is not significant.
9. Transfer of Business from Berkshire Mutual Insurance Company and
MassWest
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 as mentioned in the
recent 10K filing. In consideration of offering to write the business from
Berkshire, The Commerce Insurance Company received $7.0 million or $0.14
per share (diluted) in early 2002 that was recognized as Other Income
during the first quarter.
The Company entered into an agreement on July 15, 2002, with MassWest
Insurance Company for the transfer of Massachusetts personal automobile
business written by MassWest to The Commerce Insurance Company, effective
November 1, 2002. Under terms of the agreement, Commerce Insurance shall
offer agency contracts to independent agencies that represent MassWest for
personal automobile insurance in Massachusetts. This will allow agents of
MassWest the opportunity to offer Commerce automobile insurance policies to
their customers, who are currently insured by MassWest, beginning with
policies that renew after that date. Commerce will assume all of
MassWest's obligations for future policy years beyond 2002 under the
Massachusetts residual market system, commonly known as C.A.R.
(Commonwealth Automobile Reinsurers), and receive consideration of $2.5
million, from MassWest.
10. Contingency Related to Commonwealth Automobile Reinsurers ("C.A.R.")
Member companies of C.A.R. have joint and several liabilities for
the obligations of C.A.R. If one member of C.A.R. fails to pay its
assessments, the remaining members of C.A.R. will be required to pay the
pro-rata share of the member who fails to pay its obligations. At the
present time, the Company is not aware of any C.A.R. member company who has
failed to meet their obligations.
In a letter to the Massachusetts Insurance Commissioner (the
"Commissioner") dated June 25, 2002, the Massachusetts Attorney General
reported that, based on his examination of available information, he
"believes that the C.A.R. plan for providing access to insurance in the
residual market does not comply with the C.A.R. enabling statute, and must
be changed to produce a fair and equitable market". The Attorney General's
letter describes several factors that he believes support his findings and
which he believes should be corrected in order to comply with Massachusetts
law governing C.A.R.
- - 10 -
The Commerce Group, Inc. and Subsidiaries
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Thousands of Dollars Except Share, Per Share Data, Ratios
and Other Information)
(Continued)
The Attorney General's letter calls on the Commissioner to work with him to
address these issues. It is uncertain whether and to what extent the
issues raised by the Attorney General will be addressed by the
Commissioner. We cannot be certain whether changes, if any, would have an
adverse material impact on the Company.
11. 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 June 30, 2002 and December 31, 2001:
June 30, 2002
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 2,539,900 30.4% $ 31,952 $ 28,006 $ 30,352 $ 31,952
PPF 2,373,800 32.7% 29,103 26,298 28,319 29,103
PDF 4,685,500 31.3% 41,982 42,400 43,716 41,982
PDT 5,431,300 36.2% 60,939 58,750 57,029 60,939
DIV 3,622,400 36.6% 49,880 50,319 49,591 49,880
PFD 2,906,800 29.5% 40,782 43,604 44,328 40,782
PFO 3,933,143 35.3% 43,855 47,424 47,945 43,855
Total $298,493 $296,801 $301,280 $298,493
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
(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"), Preferred Income Fund ("PFD"),
Preferred Income Opportunity Fund ("PFO").
- - 11 -
The Commerce Group, Inc. and Subsidiaries
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Thousands of Dollars Except Share, Per Share Data, Ratios
and Other Information)
(Continued)
12. Change in Accounting Principle
As mentioned in the recent Form 10-K, and March 31, 2002 Form 10-Q
filings, due to the effect of a change in accounting principle related to
SFAS No. 142, the Company recorded income during the six months ended June
30, 2002, net of taxes, of $11,237 or $0.34 per share (diluted). This
amount represents the remaining unamortized negative goodwill related to
preferred stock mutual funds and the remaining excess of book value of
subsidiary interest over cost relating to the 1999 acquisition of American
Commerce Insurance Company. Negative goodwill and the excess of book value
of subsidiary interest over cost occur in an acquisition when the
underlying value of the assets purchased exceed the purchase price. The
subsequent recognition of income that occurs as these items are eliminated
is not a taxable event but instead becomes part of the basis of the
acquired asset.
13. Subsequent Event
Effective July 1, 2002, the Company entered into a retrocessional
reinsurance agreement with one of its quota-share reinsurers who maintains
a one third participation in the Company's 75% quota-share treaty. For a
premium paid to the Company, the Company will indemnify the reinsurer if
the reinsurer incurs a loss for a single event or occurrence over a certain
threshold. Losses assumed by the reinsurer must first exceed $15,000
before a reimbursement will be made, by the Company, to the reinsurer. The
Company's exposure to the reinsurer under this agreement is for a maximum
of $35,000. The threshold translates into a $60,000 total loss event or
occurrence to the Company, $15,000 of which represents the reinsurers 25%
portion of the quota-share treaty.
Also, effective July 1, 2002, the Company amended its quota-share
reinsurance program in the event of terrorist acts. The maximum
reimbursement to the Company from its quota-share reinsurers will be
limited to $50,000 in the event of certain defined terrorist acts. The
Company believes its exposure in excess of this limit to be very remote
based upon the types of coverage offered by the Company. The Company's
main area of business is in the personal lines market and it has no single
retained exposure to commercial risks in excess of $1,000.
- - 12 -
MANAGEMENT'S DISCUSSION AND ANALYSIS
Three months ended June 30, 2002 compared to
three months ended June 30, 2001
(Thousands of Dollars Except Per Share Data)
General
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"), located in Columbus,
Ohio. American Commerce is a wholly-owned subsidiary of ACIC Holding Co.,
Inc. with policies in 25 states and licenses in several others.
Premiums
The following table compares direct premiums written, net premiums
written and earned premiums for the three months ended June 30, 2002 and
2001:
Three Months Ended June 30,
2002 2001 Change % Change
Direct Premiums Written:
Personal Automobile in Massachusetts........ $257,653 $209,966 $ 47,687 22.7%
Personal Automobile in all other states..... 35,771 28,924 6,847 23.7
Commercial Automobile in Massachusetts...... 17,731 14,770 2,961 20.0
Commercial Automobile in all other states... 1,206 172 1,034 601.2
Homeowners in Massachusetts................. 22,300 18,583 3,717 20.0
Homeowners in all other states.............. 7,242 4,840 2,402 49.6
Other lines in Massachusetts................ 6,108 4,477 1,631 36.4
Other lines in all other states............. 201 158 43 27.2
Total Direct Premiums Written............ $348,212 $281,890 $ 66,322 23.5%
Net Premiums Written:
Personal Automobile in Massachusetts........ $265,930 $212,269 $ 53,661 25.3%
Personal Automobile in all other states..... 35,754 28,911 6,843 23.7
Commercial Automobile in Massachusetts...... 21,776 16,398 5,378 32.8
Commercial Automobile in all other states... 1,170 166 1,004 604.8
Homeowners in Massachusetts................. 6,195 5,146 1,049 20.4
Homeowners in all other states.............. 1,753 1,191 562 47.2
Other lines in Massachusetts................ 1,860 762 1,098 144.1
Other lines in all other states............. 58 33 25 75.8
Total Net Premiums Written............... $334,496 $264,876 $ 69,620 26.3%
Earned Premiums:
Personal Automobile in Massachusetts........ $212,921 $191,808 $ 21,113 11.0%
Personal Automobile in all other states..... 35,318 28,445 6,873 24.2
Commercial Automobile in Massachusetts...... 13,375 10,192 3,183 31.2
Commercial Automobile in all other states... 633 154 479 311.0
Homeowners in Massachusetts................. 5,311 4,675 636 13.6
Homeowners in all other states.............. 1,258 1,043 215 20.6
Other lines in Massachusetts................ 1,975 530 1,445 272.6
Other lines in all other states............. 49 38 11 28.9
Assumed Premiums from C.A.R................. 25,493 17,916 7,577 42.3
Assumed Premiums from other than C.A.R...... 77 62 15 24.2
Total Earned Premiums.................... $296,410 $254,863 $ 41,547 16.3%
Earned Premiums in Massachusetts............ $233,582 $207,205 $ 26,377 12.7%
Earned Premiums-Assumed..................... 25,570 17,978 7,592 42.2
Earned Premiums in all other states......... 37,258 29,680 7,578 25.5
Total Earned Premiums.................... $296,410 $254,863 $ 41,547 16.3%
- - 13 -
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Continued)
The $47,687, or 22.7% increase, in Massachusetts personal automobile
direct premiums written during the second quarter of 2002 resulted
primarily from a 4.8% increase in average written premium per written
exposure coupled with a 16.3% increase in the number of exposures written.
Approximately half of the growth in new business was driven by increases
from existing agents and, half from agents representing other companies
(Horace Mann Insurance Company and Berkshire) that have ceased writing
personal automobile business in Massachusetts. The increase in other than
Massachusetts personal automobile and homeowners business was primarily
attributable to book transfers in various states. Additionally, the
increase in homeowners in other states is impacted by contraction of
authority to write homeowner business by competitors.
The Company's increase in Massachusetts commercial automobile and
homeowner premiums is directly related to an effort to increase writings in
this line of business.
The $41,547, or 16.3% increase, in total earned premiums during the
second quarter of 2002 as compared to the second quarter of 2001 was
primarily attributable to increases in personal automobile business,
coupled with the increase in business assumed from C.A.R., which was the
result of increased market share and increased business written through
C.A.R. by the industry.
Investment Income
Net investment income is affected primarily by the composition of the
Company's investment portfolio. The following table summarizes the
composition of the Company's investment portfolio, at cost, at June 30,
2002 and 2001:
June 30,
% of % of
2002 Invest. 2001 Invest.
Fixed maturities (GNMA & FNMA mortgage-
backed bonds, corporate bonds, U.S.
Treasury bonds and notes and tax-
exempt state and municipal bonds)...... $ 627,754 41.4% $ 638,457 44.2%
Preferred stocks......................... 290,573 19.1 270,224 18.7
Common stocks............................ 85,701 5.6 87,703 6.1
Closed-end preferred stock mutual funds.. 296,801 19.6 285,148 19.7
Mortgages and collateral loans (net of
allowance for possible loan losses).... 34,422 2.3 46,937 3.2
Cash and cash equivalents................ 147,981 9.7 92,840 6.4
Other investments........................ 35,324 2.3 24,818 1.7
Total investments.................... $1,518,556 100.0% $1,446,127 100.0%
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.
As depicted in the accompanying table, second quarter 2002 net
investment income decreased $568, or 2.2%, compared to the same period in
2001, principally as a result of a decrease in yield offset by an increase
in average invested assets at cost. The decrease in yield is primarily due
to lower short-term yields on larger cash and cash equivalents balances,
coupled with an environment of lower long-term yields and higher yielding
investment securities 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 6.3% in the second quarter of 2002 compared to 6.8%
for the same period in 2001. After tax net investment income as a
percentage of total average investments was 5.0% and 5.5% in the second
quarter of 2002 and 2001, respectively.
- - 14 -
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Continued)
Investment Return Quarter Ending June 30,
(Dollars in thousands) 2002 2001
Average month-end investments (at cost)... $1,568,410 $1,495,471
Net investment income..................... 24,873 25,441
Net investment income after-tax........... 19,762 20,519
Net investment income as a percentage
of average net investments (at cost).... 6.3% 6.8%
Net investment income after-tax as a
percentage of average net
investments (at cost)................... 5.0% 5.5%
Investment Gains and (Losses)
Net realized investment losses totaled $31,545 during the second
quarter of 2002 as compared to realized investment gains of $3,857 during
the same period in 2001 as detailed below.
Net realized gains (losses) by category for the quarter ended June 30,
are as follows:
June 30, June 30,
2002 2001
* Closed-end preferred stock mutual funds......... $(17,777) $ 5,894
Venture capital fund investments................ (1,043) (1,562)
Bonds........................................... (3,345) 374
Common and preferred stocks..................... (9,311) (989)
Other........................................... (69) 140
Net realized investment losses.............. $(31,545) $ 3,857
*The 2001 amount includes $2,533 relating to the amortization of negative
goodwill, at the time of purchase, of these securities.
The 2002 realized losses were primarily impacted by declines in the
market values of investments held by closed end preferred stock mutual
funds totaling $18,185 and other than temporary declines in the market
value of investments of $11,734.
Loss and Loss Adjustment Expenses
Loss and Loss Adjustment Expenses incurred (on a statutory basis) as a
percentage of insurance premiums earned ("loss ratio") increased to 74.6%
for the second quarter of 2002 compared to 73.5% for the second quarter of
2001. The Company experienced an improvement in its voluntary loss ratio
as a result of a milder winter, however this was offset by: (1) higher
private passenger automobile losses from the Commonwealth Automobile
Reinsurers ("C.A.R") as a result of increased participation from C.A.R. and
higher C.A.R. loss ratios; and (2) higher loss ratios for business outside
of Massachusetts, due to current year loss severity increasing coupled with
lagging growth in earned premium per exposure.
Policy Acquisition Costs
As a percentage of net premiums written, underwriting expenses for the
insurance companies (on a statutory basis) decreased to 24.1% for the
second quarter of 2002 as compared to 24.4% for the same period a year ago.
The improvement was primarily due to a lower mandated Massachusetts
personal automobile commission rate.
Combined Ratios
The combined ratio of losses and expenses (on a statutory basis) was
98.7% in the second quarter of 2002 compared with 97.9% for the same period
a year ago. This resulted in an underwriting profit for the second quarter
of 2002 of 1.3% as compared to a profit of 2.1% for the second quarter of
2001.
- - 15 -
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Continued)
Income Taxes
Income taxes, for the three months ended June 30, 2002, were impacted
by the magnitude of the realized investment losses during the quarter. The
effective tax rate for the six months ended June 30, 2002 was 18.2%, down
from 26.3% for the three months ended March 31, 2002. In both 2002 and
2001, the effective tax rate was also lower than the statutory rate of 35%
due to tax-exempt interest and the corporate dividends received deduction.
Net Earnings (Loss)
During the second quarter of 2002 the company incurred a net loss of
$245 as compared to net earnings of $28,200 for the same period of 2001.
Operating earnings represent net earnings adjusted for certain items the
Company believes are not indicative of operating results. Operating
earnings, which consist of net earnings exclusive of the after-tax impact
of net realized investment losses, were $22,762 or $0.68 per share
(diluted) in the second quarter of 2002, compared to $26,580 or $0.78 per
share (diluted) in the second quarter of 2001.
Pro-Forma Operating Earnings
June 30, June 30,
2002 2001
Pro-Forma Operating Earnings:
Net Earnings (Loss)................................. $ (245) $ 28,200
Less Net Realized (Gains) Losses, Net of Tax Benefit 23,007* (1,620)
Pro-Forma Operating Earnings...................... $ 22,762 $ 26,580
Pro Forma Operating Earnings Per Share (Diluted):
Net Earnings (Loss) Share........................... $ (0.01) $ 0.83
Less Per Share Net Realized (Gains) Losses,
Net of Tax Benefit................................ .69 (0.05)
Pro-Forma Operating Earnings Per Share............ $ 0.68 $ 0.78
*The tax benefit of the realized investment losses is lower than the
calculated statutory rate of 35% by $2.5 million. This is due to the
magnitude of realized investment losses and the effect on the required
calculation of the annualized tax rate as applied to the second quarter
results to pretax earnings.
- - 16 -
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Continued)
Six months ended June 30, 2002 compared to
six months ended June 30, 2001
(Thousands of Dollars Except Per Share Data)
Premiums
The following table compares direct premiums written, net premiums
written and earned premiums for the six months ended June 30, 2002 and
2001:
Six Months Ended June 30,
2002 2001 Change % Change
Direct Premiums Written:
Personal Automobile in Massachusetts........ $558,310 $466,756 $ 91,554 19.6%
Personal Automobile in all other states..... 71,346 60,623 10,723 17.7
Commercial Automobile in Massachusetts...... 38,801 30,069 8,732 29.0
Commercial Automobile in all other states... 1,992 346 1,646 475.7
Homeowners in Massachusetts................. 37,686 32,143 5,543 17.2
Homeowners in all other states.............. 12,540 8,836 3,704 41.9
Other lines in Massachusetts................ 10,906 8,398 2,508 29.9
Other lines in all other states............. 348 317 31 9.8
Total Direct Premiums Written............ $731,929 $607,488 $124,441 20.5%
Net Premiums Written:
Personal Automobile in Massachusetts........ $569,058 $469,234 $ 99,824 21.3%
Personal Automobile in all other states..... 71,314 60,594 10,720 17.7
Commercial Automobile in Massachusetts...... 42,787 30,702 12,085 39.4
Commercial Automobile in all other states... 1,930 337 1,593 472.7
Homeowners in Massachusetts................. 10,783 9,090 1,693 18.6
Homeowners in all other states.............. 3,020 2,172 848 39.0
Other lines in Massachusetts................ 3,038 1,848 1,190 64.4
Other lines in all other states............. 107 71 36 50.7
Total Net Premiums Written............... $702,037 $574,048 $127,989 22.3%
Earned Premiums:
Personal Automobile in Massachusetts........ $417,186 $383,776 $ 33,410 8.7%
Personal Automobile in all other states..... 67,815 55,339 12,476 22.5
Commercial Automobile in Massachusetts...... 26,237 19,634 6,603 33.6
Commercial Automobile in all other states... 1,081 212 869 409.9
Homeowners in Massachusetts................. 10,692 9,312 1,380 14.8
Homeowners in all other states.............. 2,423 2,050 373 18.2
Other lines in Massachusetts................ 3,408 1,485 1,923 129.5
Other lines in all other states............. 93 76 17 22.4
Assumed Premiums from C.A.R................. 48,046 36,270 11,776 32.5
Assumed Premiums from other than C.A.R...... 193 142 51 35.9
Total Earned Premiums.................... $577,174 $508,296 $ 68,878 13.6%
Earned Premiums in Massachusetts............ $457,523 $414,207 $ 43,316 10.5%
Earned Premiums-Assumed..................... 48,239 36,412 11,827 32.5
Earned Premiums in all other states......... 71,412 57,677 13,735 23.8
Total Earned Premiums.................... $577,174 $508,296 $ 68,878 13.6%
- - 17 -
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Continued)
The $91,554, or 19.6% increase, in Massachusetts personal automobile
direct premiums written during the first six months of 2002 resulted
primarily from a 5.7% increase in average written premium per written
exposure coupled with a 12.8% increase in the number of exposures written.
Approximately one third of the growth in new business was driven by
increases from existing agents and, two thirds from agents representing
other companies (Horace Mann Insurance Company and Berkshire) that have
ceased writing personal automobile business in Massachusetts. The increase
in other than Massachusetts personal automobile and homeowners business was
primarily attributable to book transfers in various states. Additionally,
the increase in homeowners in other states is impacted by contraction of
authority to write homeowner business by competitors.
The Company's increase in Massachusetts commercial automobile and
homeowner premiums is directly related to an effort to increase writings in
this line of business.
The $68,878, or 13.6% increase, in total earned premiums during the
first six months of 2002 as compared to the first six months of 2001 was
primarily attributable to increases in personal automobile business,
coupled with an increase in business assumed from C.A.R., which was the
result of increased market share and increased business written through
C.A.R. by the industry.
Investment Income
Net investment income is affected primarily by the composition of the
Company's investment portfolio. The following table summarizes the
composition of the Company's investment portfolio, at cost, at June 30,
2002 and 2001:
June 30,
% of % of
2002 Invest. 2001 Invest.
Fixed maturities (GNMA & FNMA mortgage-
backed bonds, corporate bonds, U.S.
Treasury bonds and notes and tax-
exempt state and municipal bonds)...... $ 627,754 41.4% $ 638,457 44.2%
Preferred stocks......................... 290,573 19.1 270,224 18.7
Common stocks............................ 85,701 5.6 87,703 6.1
Closed-end preferred stock mutual funds.. 296,801 19.6 285,148 19.7
Mortgages and collateral loans (net of
allowance for possible loan losses).... 34,422 2.3 46,937 3.2
Cash and cash equivalents................ 147,981 9.7 92,840 6.4
Other investments........................ 35,324 2.3 24,818 1.7
Total investments.................... $1,518,556 100.0% $1,446,127 100.0%
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.
As depicted in the accompanying table, six month 2002 net investment
income decreased $2,688 or 5.3%, compared to the same period in 2001,
principally as a result of a decrease in yield offset by an increase in
average invested assets at cost. The decrease in yield is primarily due to
lower short-term yields on larger cash and cash equivalents balances,
coupled with an environment of lower long-term yields and higher yielding
investment securities 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 6.1% in the first six months ended June 30, 2002
compared to 6.7% for the same period in 2001. After tax net investment
income as a percentage of total average investments was 4.8% and 5.4% in
the first six months of 2002 and 2001, respectively.
- - 18 -
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Continued)
Investment Return Six Months Ending June 30,
(Dollars in thousands) 2002 2001
Average month-end investments (at cost)... $1,557,120 $1,499,429
Net investment income..................... 47,791 50,479
Net investment income after-tax........... 37,611 40,754
Net investment income as a percentage
of average net investments (at cost).... 6.1% 6.7%
Net investment income after-tax as a
percentage of average net
investments (at cost)................... 4.8% 5.4%
Investment Losses
Net realized investment losses totaled $34,992 during the first six
months of 2002 as compared to $6,341 during the same period in 2001 as
detailed below.
Net realized losses by category for the quarter ended June 30, are as
follows:
June 30, June 30,
2002 2001
* Closed-end preferred stock mutual funds......... $(19,025) $ 2,653
Venture capital fund investments................ (2,974) (8,016)
Bonds........................................... (3,540) 108
Common and preferred stocks..................... (9,367) (1,038)
Other........................................... (86) (48)
Net realized investment losses.............. $(34,992) $ (6,341)
*The 2001 amount includes $331 relating to the amortization of negative
goodwill, at the time of purchase, of these securities.
The 2002 realized losses were primarily impacted by declines in market
values of investments held by closed end preferred stock mutual funds
totaling $19,546 and other than temporary declines in market values of
investments of $11,734.
Loss and Loss Adjustment Expenses
Loss and Loss Adjustment Expenses incurred (on a statutory basis) as a
percentage of insurance premiums earned ("loss ratio") increased to 75.7%
for the first six months of 2002 compared to 75.3% for the first six months
of 2001. The Company experienced an improvement in its voluntary loss
ratio, primarily as a result of a milder winter, however this was offset
by: (1) higher private passenger automobile losses from the Commonwealth
Automobile Reinsurers ("C.A.R") as a result of increased participation from
C.A.R. and higher C.A.R. loss ratios. The estimated impact of the
additional 2002 C.A.R. losses decreased earnings by approximately $0.18 per
diluted share. The Company anticipates similar results from C.A.R. for the
remainder of the year, and (2) higher loss ratios for business outside of
Massachusetts, due to current year loss severity increasing coupled with
lagging growth in earned premium per exposure.
Policy Acquisition Costs
As a percentage of net premiums written, underwriting expenses for the
insurance companies (on a statutory basis) decreased to 22.5% for the first
six months of 2002 as compared to 23.5% for the same period a year ago.
The improvement was primarily due to a lower mandated Massachusetts
personal automobile commission rate.
Combined Ratios
The combined ratio of losses and expenses (on a statutory basis) was
98.2% in the first six months of 2002 compared with 98.8% for the same
period a year ago. This resulted in an underwriting profit for the first
six months of 2002 of 1.8% as compared to 1.2% for the first six months of
2001.
- - 19 -
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Continued)
Income Taxes
The Company's effective tax rate, excluding the change in accounting
principle, was 18.5% for the six months ended June 30, 2002 as compared to
19.4% for the same period in 2001. 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 lower effective
tax rate for 2002 was the result of realized investment losses and tax-
exempt interest and the dividends received deduction comprising a greater
portion of earnings before taxes. The magnitude of the realized investment
losses affected the required calculation of the annualized tax rate as
applied to the second quarter results.
Minority Interest
Effective January 1, 2002, the ownership interests in ACIC Holding
Co., Inc. ("AHC") were recapitalized. At December 31, 2001 Commerce
maintained an 80% common stock interest and AAA Southern New England ("AAA
SNE") maintained a 20% common stock interest in AHC. Additionally, all AHC
preferred stock was owned by Commerce. The recapitalization resulted in
redeeming of all the AHC preferred stock by Commerce in exchange for 3,000
additional shares of AHC common stock. This resulted in Commerce
increasing its AHC common stock interest to 95% with AAA SNE maintaining a
5% AHC common stock interest. The recapitalization also resulted in the
creation of $4.5 million in minority interest for AAA SNE.
Change in Accounting Principle
As mentioned in the recent Form 10-K, and March 31, 2002 Form 10-Q
filings, due to the effect of a change in accounting principle related to
SFAS No. 142, the Company recorded income during the six months ended June
30, 2002, net of taxes, of $11,237 or $0.34 per share (diluted). This
amount represents the remaining unamortized negative goodwill related to
preferred stock mutual funds and the remaining excess of book value of
subsidiary interest over cost relating to the 1999 acquisition of American
Commerce Insurance Company. Negative goodwill and the excess of book value
of subsidiary interest over cost occur in an acquisition when the
underlying value of the assets purchased exceed the purchase price. The
subsequent recognition of income that occurs as these items are eliminated
is not a taxable event but instead becomes part of the basis of the
acquired asset.
Net Earnings
Net earnings decreased $7,651, or 17.9%, to $35,171 during the first
six months of 2002 as compared to $42,822 for the same period a year ago.
Operating earnings represent net earnings adjusted for certain items the
Company believes are not indicative of operating results. Operating
earnings, which consist of net earnings exclusive of the after-tax impact
of net realized investment losses and the income effect of a required
change in accounting principle, were $49,182, or $1.47 per share (diluted),
in the first six months of 2002, compared to $47,060, or $1.39 per share
(diluted), in the first six months of 2001.
- - 20 -
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Continued)
Pro-Forma Operating Earnings
June 30, June 30,
2002 2001
Pro-Forma Operating Earnings:
Net Earnings........................................ $ 35,171 $ 42,822
Less Net Realized Losses, Net of Tax Benefit........ 25,248* 4,238
Less Change in Accounting Principle................. (11,237) -
Pro-Forma Operating Earnings...................... $ 49,182 $ 47,060
Pro Forma Operating Earnings Per Share (Diluted):
Net Earnings Share................................... $ 1.05 $ 1.27
Less Per Share Net Realized Losses,
Net of Tax Benefit................................ .76 .12
Less Per Share Change in Accounting Principle....... (0.34) -
Pro-Forma Operating Earnings Per Share............ $ 1.47 $ 1.39
*The tax benefit of the realized investment losses is lower than the
calculated statutory rate of 35% by $2.5 million. This is due to the
magnitude of realized investment losses and the effect on the required
calculation of the annualized tax rate as applied to the second quarter
results to pretax earnings.
- - 21 -
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Continued)
Liquidity and Capital Resources
The focus of the discussion of liquidity and capital resources is on
the Consolidated Balance Sheets on page 3 and the Consolidated Statements
of Cash Flows on pages 5 and 6. Stockholders' equity increased by $17,843
during the first six months of 2002 as compared to December 31, 2001. The
increase resulted from $35,171 in net earnings coupled with changes in
other comprehensive income, net of income taxes, on fixed maturities and
preferred and common stocks of $13,666 and a $6,382 increase which
resulted from the issuance of capital stock, offset by dividends paid to
stockholders of $20,165 coupled with treasury stock purchases of $17,211.
Total assets at June 30, 2002 increased $205,563 or 9.6% to $2,345,645 as
compared to total assets of $2,140,082 at December 31, 2001. The major
components of this growth are an increase of $85,096 or 34.6% in premiums
receivable, coupled with a $49,764 or 3.3% increase to invested assets, at
market value and equity and a $20,919 or 17.9% increase in deferred policy
acquisition costs. The increase to premiums receivable is attributable to
increased Massachusetts business coupled with the seasonality of the
policy effective dates of the Company's business.
The Company's liabilities totaled $1,511,079 at June 30, 2002 as
compared to $1,327,808 at December 31, 2001. The $183,271 or 13.8%
increase was primarily comprised of an increase of $134,955 or 24.0% in
unearned premiums. The significant increase to the Company's unearned
premium was attributable to the increased business, mentioned previously,
coupled with seasonality of the policy effective dates of the Company's
business.
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 5 and 6.
The Company's operating activities provided cash of $92,168 in the
first six months of 2002, as compared to $25,746 during the same period a
year ago, representing an increase of $66,422 or 258.0%. The primary
reason for this increase is that the increase in premiums collected
outpaced the increase in loss and policy acquisition payments.
For the first six months of 2002 net cash flows from investing
activities used cash of $61,823, as compared to net cash flows provided by
investing activities of $16,487 for the same period in 2001. The majority
of the $78,310 difference was a $75,723 increase in purchases of fixed
maturities coupled with a $38,418 increase in purchases of equity
securities offset by a $40,097 increase in proceeds from fixed maturities.
Investing activities were funded by accumulated cash and cash provided by
operating activities during 2002 and 2001.
Cash flows used in financing activities totaled $30,994 during the
first six months of 2002 compared to $19,914 during the same period a year
ago. The 2002 cash flows used in financing activities consisted of
dividends paid to stockholders of $20,165 and $17,211 used to purchase
438,644 shares of treasury stock under the Company's stock buyback
program, offset by $6,382 which resulted from the issuance of capital
stock. The 2001 cash flows used in financing activities consisted of only
dividends paid to stockholders of $19,914.
- - 22 -
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Continued)
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 June 30, 2002 was $1,547,965. At June 30, 2002, the
Company held cash and cash equivalents of $147,981. 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.
Effective July 1, 2002, the Company entered into a retrocessional
reinsurance agreement with one of its quota-share reinsurers who maintains
a one third participation in the Company's 75% quota-share treaty. For a
premium paid to the Company, the Company will indemnify the reinsurer if
the reinsurer incurs a loss for a single event or occurrence over a
certain threshold. Losses assumed by the reinsurer must first exceed
$15,000 before a reimbursement will be made, by the Company, to the
reinsurer. The Company's exposure to the reinsurer under this agreement
is for a maximum of $35,000. The threshold translates into a $60,000
total loss event or occurrence to the Company, $15,000 of which represents
the reinsurers 25% portion of the quota-share treaty.
Also, effective July 1, 2002, the Company amended its quota-share
reinsurance program in the event of terrorist acts. The maximum
reimbursement to the Company from its quota-share reinsurers will be
limited to $50,000 in the event of certain defined terrorist acts. The
Company believes its exposure in excess of this limit to be very remote
based upon the types of coverage offered by the Company. The Company's
main area of business is in the personal lines market and it has no single
retained exposure to commercial risks in excess of $1,000.
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
annualized statutory premiums to surplus ratio was 1.79 to 1.00 and 1.55
to 1.00 for the period ended June 30, 2002 and 2001, respectively.
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.
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The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Continued)
The Company's exposure to interest rate changes at June 30, 2002 was as
follows: A 200 basis point increase results in a $92,962 decrease in the
market value of the fixed maturities and preferred stocks. A 200 basis
point decrease results in a $52,313 increase in the market value of the
same securities.
Stock Buyback and Dividends
The Company purchased 438,644 shares of Treasury stock under the
buyback program through June 30, 2002 at an average cost of $39.24. At
June 30, 2002, the Company had the authority to purchase approximately
1,835,000 additional shares of common stock under the current Board of
Directors' stock re-purchase authorization.
On June 21, 2002, the Company paid a quarterly dividend of $0.31 to
stockholders of record as of June 1, 2002. The Company increased its
quarterly dividend to stockholders from $0.30 to $0.31 during the second
quarter.
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 may also
have an impact upon the Company, primarily through the policyholder's
election to decrease non-compulsory coverages afforded by the policy and
decreased 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.
Additional Financial Information Available on Company Website
Additional supplemental financial information is available on the
Company's website at http://www.commerceinsurance.com, under the "Links"
section of the "News & Investors" tab.
- - 24 -
The Commerce Group, Inc. and Subsidiaries
PART II - OTHER INFORMATION
ITEM 4. RESULTS OF VOTES OF SECURITY HOLDERS
On May 17, 2002, at the Annual Meeting of the stockholders of the
Company, the number of directors was fixed at 17 and the slate of Directors
as presented in the Annual Proxy was approved. The votes as tabulated by
EquiServe Trust Company were as follows:
Total Vote For Total Vote Withheld
Each Director From Each Director
Herman F. Becker 27,112,908 364,242
Joseph A. Borski, Jr. 27,309,715 167,435
Eric G. Butler 27,324,315 152,835
Henry J. Camosse 27,324,315 152,835
Gerald Fels 25,036,450 2,440,700
David R. Grenon 27,309,715 167,435
Robert W. Harris 27,324,615 152,535
Robert S. Howland 27,322,550 154,600
John J. Kunkel 27,322,150 155,000
Raymond J. Lauring 27,324,165 152,985
Normand R. Marois 27,324,615 152,535
Suryakant M. Patel 27,309,715 167,435
Arthur J. Remillard, Jr. 27,224,490 252,660
Arthur J. Remillard, III 26,179,395 1,297,755
Regan P. Remillard 27,323,050 154,100
Gurbachan Singh 27,324,615 152,535
John W. Spillane 25,030,578 2,446,572
Also, at the Annual Meeting of the Stockholders of the Company, the
proposal of the Amended and Restated Compensation Plan was approved. These
votes were also tabulated by EquiServe Trust Company and the results were
as follows:
FOR AGAINST ABSTAIN
17,394,905 5,599,394 929,381
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The Commerce Group, Inc. and Subsidiaries
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Form 8-K - On April 4, 2002, the Company filed a Form 8-K. The
purpose was to report an incorrect Form 13F received from Deutsche Bank AG,
which was in regards to their percentage of ownership in the Company.
Exhibit 10.23 - Form of Book Value Award Agreement
- - 26 -
The Commerce Group, Inc. and Subsidiaries
STATEMENT UNDER SECTION 906 OF
THE SARBANES-OXLEY ACT OF 2002
The undersigned officers of The Commerce Group, Inc. (the "Company")
hereby certify that, as of the date of this statement, the Company's
quarterly report on Form 10-Q for the quarter ended June 30, 2002 (the
"Report") fully complies with the requirements of section 13(a) of the
Securities Exchange Act of 1934 and that information contained in the
Report fairly presents, in all material respects, the financial condition
and results of the Company as of and for the three- and six-month periods
ended June 30, 2002.
The purpose of this statement is solely to comply with Title 18,
Chapter 63, Section 1350 of the United States Code, as amended by Section
906 of the Sarbanes-Oxley Act of 2002.
Date: August 13, 2002 ARTHUR J. REMILLARD, JR.
Arthur J. Remillard, Jr.
Chief Executive Officer
Date: August 13, 2002 GERALD FELS
Gerald Fels
Chief Financial Officer
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized.
THE COMMERCE GROUP, INC.
RANDALL V. BECKER
Randall V. Becker
Treasurer and
Chief Accounting Officer
- - 27 -
Exhibit 10.23
Form of Book Value Award Agreement
THIS AGREEMENT (the "Agreement") is entered into as of this
20th day of May, 2002, by and between The Commerce Group, Inc., a
Massachusetts corporation with its principal place of business in Webster,
Massachusetts (the "Company"), and [Name] (the "Officer").
Witnesseth:
WHEREAS, the Board of Directors of the Company has adopted and
the stockholders of the Company have approved the Amended and Restated
Incentive Compensation Plan on May 17, 2002 (as amended and/or restated,
the "Plan"), which authorizes the Compensation Committee of the Board of
Directors (the "Committee") to grant various Awards, including Book Value
Awards, to officers of the Company and its subsidiaries;
WHEREAS, the Committee has approved the grant of Book Value
Awards to the Officer, subject to the terms and conditions set forth in
this Agreement;
NOW, THEREFORE, it is agreed as follows:
1. Definitions. Capitalized terms used herein and not
otherwise defined shall have the meaning given to them in the Plan.
1.1 "Book Value" as used herein shall be the
book value of a share of the Company's Common Stock as determined in
accordance with generally accepted accounting principles consistently
applied in the preparation of the Company's published consolidated
financial statements.
1.2 "Adjusted Book Value" or "ABV" as used
herein shall be the Book Value per share of Common Stock as of December 31,
2004 or as of the earlier date referred to in Sections 3 or 5 hereof (the
"BVA Measurement Date"), plus (a) the amount of all cash dividends which
the Officer would have been entitled to receive had the Officer owned
shares of Common Stock equal to the number of Book Value Awards granted
hereunder and held such shares throughout the period beginning January 1,
2002 and ending on the BVA Measurement Date (the "BVA Measurement Period")
and (b) the fair market value per share of Common Stock, as of the date of
distribution, of all distributions of property made by the Company to
holders of Common Stock (other than shares of Common Stock issued by way of
a stock split, stock dividend, combination of shares, recapitalization
(excluding treasury stock transactions) or the like) that the Officer would
have been entitled to receive had the Officer owned shares of Common Stock
equal to the number of Book Value Awards granted hereunder and held such
shares throughout the BVA Measurement Period, and (c) the impact of
treasury stock transactions, calculated as a pro rata share of the excess,
if any, paid by the Company in connection with treasury stock transactions
over the Book Value of the Company as of December 31, 2001, and (d)
excluding changes in unrealized gains or losses in the market value of
preferred stocks or bonds during the BVA Measurement Period. For purposes
of the foregoing calculation of ABV, any such adjustments in Section 1.2
shall be calculated on the basis of the quarterly weighted average of basic
outstanding shares of Common Stock of the Company during the BVA
Measurement Period.
2. Cash-Only Book Value Awards.
2.1 Grants. The Company hereby grants to
the Officer [Awards] Book Value Awards (the "Book Value Awards" or "BVA"),
which represent a fixed number of Stock Units for which the Officer shall
be entitled to receive only a cash payment upon the Settlement Date,
subject to the terms and conditions set forth in this Agreement.
2.2 Settlement Date. Except as expressly
provided in Sections 3.2 and 5 hereof, any cash payment to which the
Officer may be entitled hereunder with respect to the Officer's Book Value
Awards shall be paid by no later than April 30, 2005 (the "Settlement
Date").
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2.3 Cash Settlement. Provided that the
Officer has satisfied the conditions set forth in Section 3 hereof, as
applicable, no later than the Settlement Date the Company shall pay to the
Officer, in cash, an amount per Book Value Award, if any, as calculated in
accordance with the following payment table, rounded to the nearest cent:
The BVA Payment
If the ABV But is The Payment Of the Amount
Exceeds Not More Than Per BVA Is Plus In Excess Of
$29.20 $30.03 $ 0 60% $29.20
$30.03 $30.88 $ 0.50 70% $30.03
$30.88 $31.75 $ 1.10 80% $30.88
$31.75 $32.63 $ 1.79 90% $31.75
$32.63 $33.53 $ 2.58 100% $32.63
$33.53 $34.45 $ 3.48 110% $33.53
$34.45 $35.38 $ 4.49 120% $34.45
$35.38 $36.32 $ 5.60 130% $35.38
$36.32 $37.29 $ 6.83 140% $36.32
$37.29 $38.27 $ 8.18 150% $37.29
$38.27 $39.27 $ 9.66 160% $38.27
$39.27 $40.28 $11.25 170% $39.27
$40.28 $41.32 $12.98 180% $40.28
$41.32 $42.37 $14.84 190% $41.32
$42.37 - $16.84 200% $42.37
3. Condition to Cash Settlement.
3.1 Continuous Employment Requirement. It shall be a
condition to any payment to be made hereunder that throughout the period
beginning on the date hereof and ending on the Settlement Date the Officer
shall have been in the continuous employ of the Company or any of its
subsidiaries as an officer. The Officer shall be deemed to have been in
the continuous employ of the Company or any of its subsidiaries as an
officer through the Settlement Date in the event of (a) death, (b)
retirement from the Company at age 65 or older, or (c) an approved leave
of absence for sickness and/or disability or for any other purpose
approved by the Committee.
3.2. Early Retirement. Notwithstanding Section 3.1, if the
Officer retires from the Company at age 55 through age 64, after
completing at least ten years of service with the Company, then the "BVA
Measurement Date" for such Officer shall be the end of the most recent
fiscal quarter preceding the effective date of such retirement from the
Company, and the Company shall pay to the retiring Officer the amount due,
if any, as calculated in accordance with Section 2.3 above, with such
payment to be made to the retiring Officer within sixty days of the
Officer's retirement effective date.
4. Adjustments for Stock Dividends, Stock Splits, Etc. The Committee
shall appropriately adjust the amounts set forth in this Agreement, in
accordance with the Plan, to the extent necessary to reflect any change in
the number of shares of Common Stock issued after the date hereof and
prior to the BVA Measurement Date by way of any stock dividend, stock
split, combination of shares, recapitalization, stock (including, but not
limited to, treasury stock) issuance, or the like, as applicable.
5. Change in Control.
5.1 Measurement Period and Settlement Date. In the event of
a "Change in Control" (as defined in the Plan) of the Company, for all
purposes hereunder (a) the "BVA Measurement Date" shall mean the date the
Change in Control becomes effective, (b) the "BVA Measurement Period"
shall be the period beginning on January 1, 2002 and ending on the BVA
Measurement Date as defined in this Section 5.1, and (c) the "Settlement
Date" shall mean the date that is one hundred and twenty (120) days after
the BVA Measurement Date as defined in this Section 5.1.
- - 29 -
5.2 Book Value in a Change in Control. For purposes of
calculating the cash payment due upon the Settlement Date under Section
5.1, the Book Value per share of Common Stock (as used in the
determination of ABV) shall be deemed to equal the greater of
(a) the Book Value, as defined in Section 1.1, as reported at
the end of the fiscal quarter next following the "BVA Measurement Date" as
defined in Section 5.1, or
(b) the "fair market value" (as hereinafter defined) of a
share of Common Stock on the BVA Measurement Date as defined in Section
5.1. For purposes of this Section 5, the "fair market value" of the
Common Stock shall be determined based on the daily average of high and
low sale prices of the Common Stock for the five trading days including
and preceding the BVA Measurement Date, as reported by the securities
exchange or automated quotation system on which the Common Stock is listed
on the BVA Measurement Date.
6. No Rights of a Stockholder. Nothing herein shall entitle the Officer
to any voting or other rights of an actual owner of shares of Common
Stock.
7. No Right to Continued Employment. The Officer shall have no right to
continued employment by the Company or any of its subsidiaries by virtue
of this Agreement, and nothing contained herein shall be construed to
limit the Company's right at any time to terminate the Officer's
employment, in accordance with the Company's By-laws, with or without
cause, subject only to those obligations the Company may have for unpaid
salary and/or expenses, in accordance with provisions of law.
8. Non-Transferability. The Awards and any right to receive payment
hereunder shall not be transferable; provided, however, that in the event
of the Officer's death, the Officer's beneficiary shall be entitled to
receive any payment due hereunder.
9. Dispute Resolution. In the event of any dispute regarding the
calculation of the payment due at the Settlement Date under this
Agreement, the matter shall be referred to the Company's independent
public accountants, whose determination shall be final and binding.
IN WITNESS WHEREOF, each of the parties hereto has caused this Agreement
to be duly executed in its name and on its behalf, all as of the date
first above written.
THE COMMERCE GROUP, INC.
CORPORATE
SEAL
By:
Arthur J. Remillard, Jr.
President and
Chief Executive Officer
[Name], the Officer
- - 30 -