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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the quarterly period ended March 31, 2003
--------------
OR
[ ] Transition Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
Commission File Number 001-13672
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___
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes X No___
As of April 30, 2003, the number of shares outstanding of the
Registrant's common stock (excluding Treasury Shares) was
31,879,835
1
The Commerce Group, Inc.
Table of Contents
Page No.
Part I - Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets at
March 31, 2003 (Unaudited) and December 31, 2002 3
Consolidated Statements of Earnings and Comprehensive Income for the
Three Months Ended March 31, 2003 and 2002 (Unaudited) 4
Consolidated Statements of Cash Flows for the
Three Months Ended March 31, 2003 and 2002 (Unaudited) 5
Consolidated Statements of Cash Flows - Reconciliation of Net Earnings
to Net Cash Provided by Operating Activities for the Three Months
Ended March 31, 2003 and 2002 (Unaudited) 6
Notes to Unaudited Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis
General 12
Results of Operations - Three Months Ended March 31, 2003 13
Liquidity and Capital Resources 17
Forward-Looking Statements 19
Item 3. Quantitative and Qualitative Disclosures about Market Risk 20
Item 4. Controls and Procedures 20
Part II - Other Information
Item 1. Legal Proceedings 21
Item 2. Changes in Securities and Use of Proceeds 21
Item 3. Defaults Upon Senior Securities 21
Item 4. Submission of Matters to a Vote by Security Holders 21
Item 5. Other Information 21
Item 6. Exhibits and Reports on Form 8-K 23
Signature 23
Certifications 24
2
Part I - Financial Information
Item 1. Financial Statements
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Thousands of Dollars)
March 31, December 31,
2003 2002
--------- ------------
(Unaudited)
ASSETS
Investments:
Fixed maturities, at market (cost: $792,829 in 2003 and
$666,910 in 2002) $ 808,990 $ 683,811
Preferred stocks, at market (cost: $293,305 in 2003 and
$301,141 in 2002) 308,678 305,057
Common stocks, at market (cost: $82,958 in 2003 and
$81,602 in 2002) 95,780 99,818
Preferred stock mutual funds, at equity (cost: $292,505
in 2003 and $294,192 in 2002) 274,497 270,616
Mortgage loans on real estate and collateral notes receivable (less
allowance for possible loan losses of $402 in 2003 and $418 in 2002) 22,850 26,754
Cash and cash equivalents 130,949 169,946
Other investments (cost: $37,765 in 2003 and $35,015 in 2002) 23,230 21,068
--------------------------
Total investments 1,664,974 1,577,070
Accrued investment income 14,203 13,959
Premiums receivable (less allowance for doubtful receivables of $1,661
in 2003 and in 2002) 368,989 297,610
Deferred policy acquisition costs 152,554 138,241
Property and equipment, net of accumulated depreciation 52,015 51,509
Residual market receivable 169,540 164,476
Due from reinsurers 102,658 98,403
Current income taxes - 662
Deferred income taxes 29,010 30,728
Receivable for investments sold 5,053 366
Non-compete agreement, net of accumulated amortization 2,042 2,129
Other assets 11,457 7,535
--------------------------
Total assets $2,572,495 $2,382,688
==========================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Unpaid losses and loss adjustment expenses $ 857,162 $ 815,626
Unearned premiums 778,129 687,148
Current income taxes 1,749 -
Deferred income 7,269 8,421
Contingent commissions accrued 28,035 32,550
Payable for securities purchased 63,075 -
Other liabilities and accrued expenses 44,465 44,785
--------------------------
Total liabilities 1,779,884 1,588,530
--------------------------
Minority interest 4,123 4,106
--------------------------
Stockholders' equity
Preferred stock, authorized 5,000,000 shares at $1.00 par value;
none issued in 2003 and 2002 - -
Common stock, authorized 100,000,000 shares at $.50 par value;
38,281,627 shares issued in 2003 and in 2002 19,141 19,141
Paid-in capital 39,570 39,570
Net accumulated other comprehensive income, net of income taxes
of $15,492 in 2003 and $13,603 in 2002 28,769 25,264
Retained earnings 880,297 877,308
--------------------------
967,777 961,283
Treasury stock 6,401,792 shares in 2003 and 6,165,392 in 2002 (179,289) (171,231)
--------------------------
Total stockholders' equity 788,488 790,052
--------------------------
Total liabilities, minority interest and stockholders' equity $2,572,495 $2,382,688
==========================
The accompanying notes are an integral part of these consolidated financial
statements.
3
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
Three Months Ended March 31, 2003 and 2002
(Thousands of Dollars Except Per Share Data)
(Unaudited)
Three Months Ended
March 31,
---------------------------
2003 2002
----------- -----------
(Restated)
Revenues
Direct premiums written $ 448,794 $ 383,717
Assumed premiums 27,983 24,155
Ceded premiums (49,742) (40,331)
---------------------------
Net premiums written 427,035 367,541
Increase in unearned premiums (89,048) (86,777)
---------------------------
Earned premiums 337,987 280,764
Net investment income 22,704 22,904
Premium finance and service fees 6,330 4,932
Net realized investment losses (5,844) (3,447)
Other income - 7,000
---------------------------
Total revenues 361,177 312,153
---------------------------
Expenses
Losses and loss adjustment expenses 274,394 216,576
Policy acquisition costs 69,502 65,019
---------------------------
Total expenses 343,896 281,595
---------------------------
Earnings before income taxes, change in accounting
principle and minority interest 17,281 30,558
Income tax 4,405 7,835
Change in accounting principle net of tax - 11,237
---------------------------
Net earnings before minority interest 12,876 33,960
Minority interest in net loss of subsidiary 44 10
---------------------------
NET EARNINGS $ 12,920 $ 33,970
===========================
COMPREHENSIVE INCOME $ 16,425 $ 38,094
===========================
NET EARNINGS PER COMMON SHARE:
BASIC. $ 0.40 $ 1.03
===========================
DILUTED $ 0.40 $ 1.02
===========================
CASH DIVIDENDS PAID PER COMMON SHARE $ 0.31 $ 0.30
===========================
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING:
BASIC 31,977,554 33,083,119
==========================
DILUTED 32,161,730 33,372,501
==========================
The accompanying notes are an integral part of these consolidated financial
statements.
4
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended March 31, 2003 and 2002
(Thousands of Dollars)
(Unaudited)
2003 2002
--------- ----------
(Restated)
Cash flows from operating activities:
Premiums collected $ 364,884 $ 308,042
Net investment income received 22,529 22,493
Premium finance and service fees received 6,330 4,932
Losses and loss adjustment expenses paid (252,719) (205,855)
Policy acquisition costs paid (89,062) (79,989)
Federal income tax payments (2,165) (3,524)
Other income - 7,000
-----------------------
Net cash provided by operating activities 49,797 53,099
-----------------------
Cash flows from investing activities:
Proceeds from maturity of fixed maturities 32,407 10,310
Proceeds from sale of fixed maturities 47,685 26,086
Proceeds from sale of equity securities 9,124 18,990
Proceeds from sale of preferred stock mutual funds 1,954 229
Payments received on mortgage loans and collateral notes receivable 4,120 3,037
Purchase of fixed maturities (148,834) (73,560)
Purchase of equity securities (12,605) (11,809)
Purchase of preferred stock mutual funds - (1,571)
Purchase of other investments (2,750) (1,416)
Mortgage loans and collateral notes originated (200) (243)
Purchase of property and equipment (1,845) (2,890)
Other investing activities 139 43
-----------------------
Net cash used in investing activities (70,805) (32,794)
-----------------------
Cash flows from financing activities:
Dividends paid to stockholders (9,931) (9,927)
Purchase of treasury stock (8,058) (6,789)
-----------------------
Net cash used in financing activities (17,989) (16,716)
-----------------------
Increase (decrease) in cash and cash equivalents (38,997) 3,589
Cash and cash equivalents at beginning of period 169,946 148,630
-----------------------
Cash and cash equivalents at the end of period $ 130,949 $ 152,219
=======================
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
Three Months Ended March 31, 2003 and 2002
(Thousands of Dollars)
(Unaudited)
2003 2002
-------- ----------
(Restated)
Cash flows from operating activities:
Net earnings $ 12,920 $ 35,416
Adjustments to reconcile net earnings to net cash provided by
operating activities:
Premiums receivable (71,379) (63,679)
Deferred policy acquisition costs (14,313) (13,605)
Residual market receivable (5,064) (5,294)
Due to/from reinsurers (4,255) 2,352
Losses and loss adjustment expenses 41,536 15,801
Unearned premiums 90,981 88,560
Current income taxes 2,411 7,121
Deferred income taxes (171) (2,034)
Deferred income (1,152) 476
Contingent commissions (4,515) 500
Other assets, liabilities and accrued expenses (4,155) (9,552)
Net realized investment losses 5,844 3,447
Change in accounting principle - (11,237)
Minority interest 17 4,169
Other - net 1,092 658
----------------------
Net cash provided by operating activities $ 49,797 $ 53,099
======================
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 Per Share Data)
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
manage-ment, all adjustments (consisting of normal recurring accruals)
considered necessary for a fair presentation have been included. Certain
previously reported 2002 account balances have been reclassified to conform
to the current period's presentation. Results for the three-month period
ended March 31, 2003 are not necessarily indicative of the results that may
be expected for the year ending December 31, 2003.
The balance sheet at December 31, 2002 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 10-K for the year ended December 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,
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 Massachusetts
Chapters 176D and 93A. Similar provisions exist in other states where the
Company does 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 material adverse effect on the consolidated
financial position of the Company.
The Company previously disclosed that a purported class action lawsuit
was pending in Massachusetts state court against The Commerce Insurance
Company ("Commerce"). 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. 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 stayed
7
The Commerce Group, Inc. and Subsidiaries
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Thousands of Dollars Except Per Share Data)
(Continued)
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. During the third quarter of 2002,
the Company applied for direct appellate review of this issue by the Supreme
Judicial Court of Massachusetts ("SJC"), and this application was granted.
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. The Company's and the other insurer's cases were paired
and oral arguments were heard at the SJC on March 4, 2003. A decision is
expected within 120 days of the oral argument. If the SJC agrees with the
Given trial judge's interpretation of the Massachusetts personal automobile
insurance policy, then the case will be remanded to the trial court, where
the Company would vigorously oppose class certification. No reserve has been
established for the potential liability in connection with this case because
the Company is unable to estimate the potential exposure of this purported
class action lawsuit. However, if there is a final decision certifying that
a relatively large class of the Company's policyholders is entitled to
recover damages based upon the inherent diminished value theory, the Company
may have to increase materially its loss and loss adjustment expense
reserves as a result. Other insurance companies face similar suits in cases
outside of Massachusetts.
4. Disclosure of Statement of Financial Accounting Standards No. 130 -
Reporting Comprehensive Income:
Three Months Ended
March 31,
2003 2002
------ ---------
(Restated)
Net earnings $12,920 $33,970
-------------------
Other comprehensive income (loss), net of taxes
(benefits):
Change in unrealized gains, net of income taxes
of $2,778 in 2003 and $2,090 in 2002 5,160 3,883
Reclassification adjustment, net of income taxes
(benefits) of ($891) in 2003 and $130 in 2002 (1,655) 241
-------------------
Other comprehensive income 3,505 4,124
-------------------
Comprehensive income $16,425 $38,094
===================
5. Disclosure of Statement of Financial Accounting Standards No. 131 -
Disclosures about Segments of an Enterprise and Related Information:
Earnings (losses)
Before Income Taxes
Change in Accounting
Principle and Identifiable
Revenue Minority Interest Assets
------- -------------------- ------------
Three Months Ended March 31, 2003
Property and casualty insurance
Massachusetts $311,549 $16,521 $2,249,912
Other than Massachusetts 49,148 (955) 290,072
Real estate and commercial lending 479 479 23,703
Corporate and other 1 1,236 8,808
-----------------------------------------------
Consolidated $361,177 $17,281 $2,572,495
===============================================
Three Months Ended March 31, 2002 (Restated)
Property and casualty insurance
Massachusetts $273,857 $34,486 $1,987,318
Other than Massachusetts 37,647 (1,535) 254,701
Real estate and commercial lending 649 649 37,506
Corporate and other - (3,042) 9,248
-----------------------------------------------
Consolidated $312,153 $30,558 $2,288,773
===============================================
8
The Commerce Group, Inc. and Subsidiaries
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Thousands of Dollars Except Per Share Data)
(Continued)
6. Liabilities for unpaid losses and loss adjustment expenses at March 31,
2003 and December 31, 2002 consist of:
March 31, December 31,
2003 2002
--------- ------------
Net voluntary unpaid losses and LAE $675,218 $650,892
Voluntary salvage and subrogation recoverable (90,689) (88,108)
Assumed unpaid losses and LAE from CAR 146,697 138,355
Assumed salvage and subrogation recoverable from CAR (22,790) (22,790)
-----------------------
Total voluntary and assumed unpaid losses and LAE 708,436 678,349
Adjustment for ceded unpaid losses and LAE 157,726 146,277
Adjustment for ceded salvage and subrogation recoverable (9,000) (9,000)
-----------------------
Total unpaid losses and LAE $857,162 $815,626
=======================
7. SFAS No. 113 "Accounting and Reporting for Reinsurance of Short-Duration
and Long-Duration Contracts" effect:
In accordance with SFAS No. 113, included in the unpaid losses and
loss adjustment expenses and the unearned premiums reported numbers are
amounts for ceded reinsurance recoverable. At March 31, 2003 and December
31, 2002, respectively, $148,726 and $137,277 were included in the unpaid
losses and loss adjustment expense amounts. At March 31, 2003 and December
31, 2002, respectively, $101,733 and $99,802 were included in the unearned
premium liability amounts.
8. 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.
9. 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 three
months ended March 31, 2003 and 2002 were 31,977,554 and 33,083,119,
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 three months
ended March 31, 2003 and 2002 were 32,161,730 and
33,372,501, respectively. The Company's only potentially dilutive
instruments are stock options outstanding and dilution from these is not
significant.
10. 2002 Restatement for Stock Options:
As disclosed in the Company's 2002 Form 10-K in the fourth quarter of
2002 the Company changed its method of accounting for stock options and
began applying variable accounting treatment for stock options issued in
1999 and 2000. Accordingly, the Company restated its 2002 quarterly results.
The impact of the restatement for the three months ended March 31, 2002
resulted in a decrease to net earnings of $1.4 million or $0.04 per diluted
share.
11. Contingency Related to CAR:
Member companies of CAR have joint and several liabilities for the
obligations of CAR. If one member of CAR fails to pay its assessments, the
remaining members of CAR 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 CAR member company who has failed to meet its obligations.
9
The Commerce Group, Inc. and Subsidiaries
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Thousands of Dollars Except Per Share Data)
(Continued)
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 CAR plan for providing access to insurance in the
residual market does not comply with the CAR 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 CAR. 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 a
material impact on the Company.
12. 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 March 31, 2003 and December 31, 2002:
March 31, 2003
--------------
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 2,571,100 30.8% $ 29,336 $ 28,358 $ 29,774 $ 29,336
PPF 2,373,700 32.7% 28,128 26,297 29,695 28,128
PDF 4,696,100 31.3% 37,522 42,489 42,218 37,522
PDT 5,506,500 36.7% 53,413 59,508 56,221 53,413
DIV 3,624,700 36.6% 43,641 50,325 49,658 43,641
PFD 2,740,000 27.3% 39,922 41,064 44,114 39,922
PFO 3,692,243 32.5% 42,535 44,464 47,999 42,535
-----------------------------------------------
Total $274,497 $292,505 $299,679 $274,497
===============================================
December 31, 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 2,571,100 30.8% $ 29,259 $ 28,358 $ 29,568 $ 29,259
PPF 2,373,800 32.7% 26,777 26,298 28,367 26,777
PDF 4,696,100 31.3% 37,851 42,489 39,306 37,851
PDT 5,506,500 36.7% 53,743 59,507 53,413 53,743
DIV 3,635,600 36.7% 44,536 50,492 47,481 44,536
PFD 2,799,500 27.9% 38,185 41,882 42,273 38,185
PFO 3,756,043 33.1% 40,265 45,166 45,861 40,265
-----------------------------------------------
Total $270,616 $294,192 $286,269 $270,616
===============================================
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").
13. Stock-Based Compensation
During 2002, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standard ("SFAS") No. 148, "Accounting for Stock-
Based Compensation-Transition and Disclosure", which provides alternative
methods of accounting for stock-based compensation and amends SFAS No. 123,
"Accounting for Stock-Based Compensation". The Company measures stock-based
compensation expense (for the employee stock options granted in 1999 and
2000) under the variable accounting method in accordance with Accounting
Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to
Employees", and its related interpretations. As allowed by SFAS No. 148, the
Company has elected to continue to apply variable accounting for the stock
options granted in 1999 and 2000. The Company continues to comply with APB
Opinion No.
10
The Commerce Group, Inc. and Subsidiaries
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Thousands of Dollars Except Per Share Data)
(Continued)
13. Stock-Based Compensation (continued)
25 and related interpretations in applying fixed accounting for the employee
stock options granted in 2001. Under the provisions of APB Opinion No. 25,
no expense has been recognized for these 2001 employee stock options in the
first quarter 2003 and 2002. The Company has adopted the disclosure
requirements of SFAS No. 123, as amended by SFAS 148. If compensation
expense for all employee stock options had been measured under the fair
value based method prescribed by SFAS No. 123, as amended, net earnings
would have been changed to the pro-forma amounts set forth below:
Three Months Ended
March 31,
2003 2002
------- -------
Net earnings as reported $12,920 $33,970
Adjust for employee stock-based compensation expense
(income) included in reported net earnings, net of taxes (1,648) 1,446
Adjust for employee stock-based compensation (expense)
determined under the fair value method for all employee
stock options, net of tax (586) (687)
-------------------
Pro-forma net earnings $10,686 $34,729
===================
Basic earnings per share:
As reported $ 0.40 $ 1.03
Pro-forma $ 0.33 $ 1.05
Diluted earnings per share:
As reported $ 0.40 $ 1.02
Pro-forma $ 0.33 $ 1.04
The fair value of each employee stock option is estimated on the date
of the grant using the Black-Scholes option-pricing model with the following
assumptions:
Dividend yield *
Expected volatility 28.9%
Risk-free interest rate 2.64%
Expected option life in years 3
* 0% for Employee stock options granted in 1999 and 2000 and 3.53% for
employee stock options granted in 2001.
14. Reinsurance Changes to Become Effective on July 1, 2003
The Company's 75% quota-share reinsurance agreement, which provides
reinsurance on its other than automobile business, will terminate effective
June 30, 2003. The quota-share program was incepted on July 1, 1998 and
established for a five year period. The Company is currently negotiating for
either a traditional catastrophe excess of loss reinsurance program or a
continuation of the quota-share treaty with modified terms, or a combination
of both. The new program will become effective July 1, 2003. The Company's
100 and 250 year PMLs (probable maximum losses) have been estimated at
approximately $177 million and $287 million, respectively, based on policies
in force at December 31, 2002.
11
Item 2. Management's Discussion and Analysis
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS
(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 auto-mobiles. The Company also offers commercial
automobile, homeowners, inland marine, fire, general liability, commercial
multi-peril and personal and commercial umbrella insurance. The Company also
writes insurance in California and Oregon through Commerce West Insurance
Company ("Commerce West"), located in Pleasanton, California, which
primarily focuses on personal automobile insurance and also writes
commercial automobile insurance. Additionally, the Company writes insurance
through American Commerce Insurance Company ("American Commerce"), which
writes primarily personal automobile insurance and also writes homeowner
insurance. Located in Columbus, Ohio, American Commerce is a wholly-owned
subsidiary of ACIC Holding Co., Inc. with policies in 24 states and licenses
in several others. Through its subsidiaries combined insurance activities,
the Company is ranked as the 26th largest personal automobile insurance
group in the country by A.M. Best, based on the most recently available
direct written premium information.
2002 Restatement for Stock Options
As disclosed in the Company's 2002 Form 10-K, in the fourth quarter of
2002 the Company changes its method of accounting for employee stock options
and began applying variable accounting treatments for employee stock options
in 1999 and 2000. Accordingly, the Company restated its 2002 quarterly
results. The impact of the restatement for the three months ended March 31,
2002 resulted in a decrease to net earnings of $1.4 million or $0.04 per
diluted share.
12
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS
Three months ended March 31, 2003 compared to
three months ended March 31, 2002
(Thousands of Dollars Except Per Share Data)
Results of Operations
Premiums
The following table compares direct premiums written, net premiums
written and earned premiums for the three months ended March 31, 2003 and
2002:
Three Months Ended March 31,
--------------------------------------------
2003 2002 $ Change % Change
-------- -------- -------- --------
Direct Premiums Written:
Personal Automobile (Massachusetts) $341,330 $300,657 $40,673 13.5%
Personal Automobile (All other states) 47,469 35,575 11,894 33.4
Commercial Automobile (Massachusetts) 24,742 21,070 3,672 17.4
Commercial Automobile (All other states) 1,985 786 1,199 152.5
Homeowners (Massachusetts) 18,346 14,598 3,748 25.7
Homeowners (All other states) 7,192 5,298 1,894 35.7
Other lines (Massachusetts) 7,523 5,586 1,937 34.7
Other lines (All other states) 207 147 60 40.8
------------------------------------------
Total Direct Premiums Written $448,794 $383,717 $65,077 17.0%
==========================================
Net Premiums Written:
Personal Automobile (Massachusetts) $342,848 $303,128 $39,720 13.1%
Personal Automobile (All other states) 46,619 35,560 11,059 31.1
Commercial Automobile (Massachusetts) 26,042 21,011 5,031 23.9
Commercial Automobile (All other states) 1,904 760 1,144 150.5
Homeowners (Massachusetts) 5,594 4,391 1,203 27.4
Homeowners (All other states) 1,483 1,267 216 17.0
Other lines (Massachusetts) 2,486 1,375 1,111 80.8
Other lines (All other states) 59 49 10 20.4
------------------------------------------
Total Net Premiums Written $427,035 $367,541 $59,494 16.2%
==========================================
Earned Premiums:
Personal Automobile (Massachusetts) $242,845 $204,265 $38,580 18.9%
Personal Automobile (All other states) 42,237 32,497 9,740 30.0
Commercial Automobile (Massachusetts) 16,032 12,862 3,170 24.6
Commercial Automobile (All other states) 1,376 448 928 207.1
Homeowners (Massachusetts) 6,225 5,160 1,065 20.6
Homeowners (All other states) 1,655 1,165 490 42.1
Other lines (Massachusetts) 1,688 1,654 34 2.1
Other lines (All other states) 61 44 17 38.6
Assumed from CAR 25,230 22,553 2,677 11.9
Assumed (Other) 638 116 522 450.0
------------------------------------------
Total Earned Premiums $337,987 $280,764 $57,223 20.4%
==========================================
Earned Premiums (Massachusetts) $266,790 $223,941 $42,849 19.1%
Earned Premiums (Assumed) 25,868 22,669 3,199 14.1
Earned Premiums (All other states) 45,329 34,154 11,175 32.7
------------------------------------------
Total Earned Premiums $337,987 $280,764 $57,223 20.4%
==========================================
13
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Continued)
The $40,673, or 13.5% increase, in Massachusetts personal automobile
direct premiums written during the first quarter of 2003 resulted primarily
from an 8.2% increase in average written premium per written exposure
coupled with a 4.6% increase in the number of exposures written. The
increase in other than Massachusetts personal automobile and homeowners
business was primarily attributable to book transfers in various states,
increased retention on existing business and additional rate per policy.
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 premium
is directly related to an effort to increase writings in this line of
business and from increases in the average rate per policy. The Company's
increase in Massachusetts homeowner premium is primarily related to an
increased number of agents, fewer carriers writing homeowner business, the
Company's pricing position in the marketplace and agents writing more
homeowner business to achieve a homeowner discount for their customer when
the Company also insures the customer's automobile.
The $57,223, or 20.4% increase, in total earned premiums during the
first quarter of 2003 as compared to the first quarter of 2002 was primarily
attributable to increases in personal automobile business.
Investment Income
Net investment income is affected by the composition of the Company's
investment portfolio and yields on those investments. The following table
summarizes the composition of the Company's investment portfolio, at cost,
at March 31, 2003 and 2002:
March 31,
----------------------------------------------
% of % of
2003 Invest. 2002 Invest.
---------- ------- ---------- -------
Fixed maturities (GNMA & FNMA mortgage-
backed bonds, corporate bonds, U.S.
Treasury bonds and notes and tax-
exempt state and municipal bonds) $ 792,829 48.0% $ 656,127 43.4%
Preferred stocks 293,305 17.7 252,031 16.7
Common stocks 82,958 5.0 87,704 5.8
Preferred stock mutual funds 292,505 17.7 296,518 19.6
Mortgages and collateral loans 23,252 1.4 37,372 2.4
Cash and cash equivalents 130,949 7.9 152,219 10.1
Other investments 37,765 2.3 29,707 2.0
-------------------------------------------
Total investments $1,653,563 100.0% $1,511,678 100.0%
===========================================
The Company's investment objective continues to focus on maximizing
after-tax investment income through investing primarily 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.
14
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Continued)
As depicted in the following table, first quarter 2003 net investment
income decreased $200, or 0.1%, compared to the same period in 2002,
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 coupled with an environment of lower long-term
yields and higher yielding investment securities being called. The Company
continues to monitor interest rates on medium and long-term securities and
intends to maintain its relatively high cash position until such time as the
Company believes medium and long-term rates have appropriately firmed.
During the first quarter the Company purchased approximately $145 million of
U.S. Government agency securities. The Company believes these securities
will have a duration of less than three years. This will allow the Company
to achieve higher yields than cash until longer term investments are
acquired. Net investment income as a percentage of total average investments
was 5.6% in the first quarter of 2003 compared to 5.9% for the same period
in 2002. After tax net investment income as a percentage of total average
investments was 4.5% and 4.6% in the first quarter of 2003 and 2002,
respectively.
Investment Return
Three Months Ended March 31,
----------------------------
2003 2002
---------- ----------
(Restated)
Average month-end investments (at cost) $1,636,849 $1,544,805
Net investment income 22,704 22,904
Net investment income after-tax 18,359 17,849
Net investment income as a percentage
of average net investments (at cost) 5.6% 5.9%
Net investment income after-tax as a
percentage of average net
investments (at cost) 4.5% 4.6%
Investment Gains and (Losses)
Net realized investment losses totaled $5,844 or $0.19 per diluted
share, during the first quarter of 2003 as compared to realized investment
losses of $3,447, or $0.07 per diluted share, during the same period in 2002
as detailed below.
Net realized gains (losses) by category for the three months ended
March 31, are as follows:
2003 2002
-------- -------
Fixed maturities $ 3,373 $ (195)
Preferred stocks 981 (47)
Common stocks 267 (9)
Preferred stock mutual funds 5,569 (1,248)
Venture capital fund investments (588) (1,931)
Other 10 (17)
Other-than-temporary writedowns (15,456) 0
-------------------
Net realized investment losses before tax (5,844) (3,447)
Income tax benefit at 35% (2,045) (1,206)
-------------------
Net realized investment losses after
tax and before impact of valuation
allowance (3,799) (2,241)
Impact of valuation allowance (2,380) 0
-------------------
Net realized investment losses after
tax and after impact of valuation
allowance. $ (6,179) $(2,241)
===================
Per diluted share net realized investment
losses after tax and after tax
impact of valuation allowance per
diluted share $ (0.19) $ (0.07)
15
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Continued)
The 2003 realized losses were primarily impacted by write-downs for
other-than-temporary declines in the market value of certain fixed
maturities and preferred stocks totaling $15,456. The other-than-temporary
writedowns consisted of a municipal bond, Atlanta Housing of $2,433, two
corporate bonds, Fairfax Financial Holdings of $1,461, and Lumbermans Mutual
Insurance of $5,034; as well as two preferred stocks, El Paso Tenn Pipeline
of $6,379 and Touch America Holdings of $149. The Company reviews all
security holdings on a quarterly basis with regards to other-than-temporary
declines in market value pursuant to FASB 115 ("Accounting for Certain
Investments in Debt and Equity Securities") and other applicable guidance.
As part of this process, the Company considers any significant market
declines in the context of the overall market and also in relation to the
outlook for the specific issuer of the security. From a quantitative
standpoint, the Company views all securities that have fallen more than 25%
below book price and have remained so for two quarters as potentially in
need of a writedown. In addition, any other security that the Company views
as impaired for a significant period of time is also a candidate for a
writedown, even if the percentage decline is less than 25%. These write-
downs were offset by improvement in the market values of underlying
securities held by closed-end preferred stock mutual funds, which resulted
in realized gains of $5,569. The Company reflects these improvements through
realized gains because its significant level of ownership requires the use
of the equity method of accounting for these funds. Additionally, the
Company had a $3,867 gain which resulted from the sale of corporate bonds of
another non-affiliated insurance company.
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 81.5%
for the first quarter of 2003 compared to 76.9% for the first quarter of
2002. Due to the severe winter weather experienced in the Northeast, the
Company experienced: (1) an increase in Massachusetts personal automobile
claim frequency of approximately 20% compared to last year and approximately
50% in the Massachusetts homeowner line; (2) higher losses assumed from the
Commonwealth Automobile Reinsurers ("CAR"). In comparison to the prior year,
these factors were somewhat offset by reduced loss ratios for other than
Massachusetts business. The other than Massachusetts loss ratio was 81.2%
for the first three months of 2003 as compared to 89.5% for the same period
a year ago.
Policy Acquisition Costs
As a percentage of net premiums written, underwriting expenses for the
insurance companies (on a statutory basis) decreased to 20.0% for the first
quarter of 2003 as compared to 21.2% for the same period a year ago. The
improvement was primarily due to lower contingent commissions as a result of
the high loss ratios mentioned previously, coupled with premium growth
exceeding growth in underwriting expenses.
Combined Ratios
The combined ratio of losses and expenses (on a statutory basis) was
101.5% in the first quarter of 2003 compared with 98.1% for the same period
a year ago. This resulted in an underwriting loss percentage for the first
quarter of 2003 of 1.5% as compared to a profit of 1.9% for the first
quarter of 2002.
Income Taxes
The effective tax rate for the three months ended March 31, 2003 was
25.5% as compared to 25.6% for the three months ended March 31, 2002. In
both years, the effective rate was lower than the statutory rate of 35%
primarily due to tax-exempt interest and the corporate dividends received
deduction. The 2003 effective rate was also impacted by the increase in the
valuation allowance for realized investment losses.
Net Earnings
During the first quarter of 2003 the company recorded net earnings of
$12,920 as compared to net earnings of $33,970 for the same period of 2002
for reasons mentioned previously.
16
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Continued)
Operating Earnings
Operating earnings, a non-GAAP financial measure, were $17,451, or
$0.54 per diluted share, compared to $26,420 or $0.79 per diluted share for
2002 (as restated). Operating earnings consist of net earnings adjusted to
exclude: (1) the after-tax impact of net realized investment losses; (2) the
after-tax impact of variable accounting stock option treatment; and, (3) for
2002 only, the after-tax effect of a required change in accounting
principles. The Company believes that the items noted above, which are
eliminated in the calculation of operating earnings, are not indicators of
corporate operating performance and, as such, are not measures used by the
Company in managing operations. Operating earnings as defined by the Company
may not be comparable to similarly captioned measurements utilized by other
property and casualty insurance companies. A reconciliation of net earnings
to operating earnings is provided in the tables that follow.
March 31, March 31,
2003 2002
--------- ---------
(Restated)
Reconciliation of net earnings to operating earnings:
Net earnings $ 12,920 $ 33,970
Plus net realized losses, net of tax 6,179 2,241
Less change in accounting principle, net of tax 0 (11,237)
Plus (less) variable accounting stock option
(income) expense, net of tax (1,648) 1,446
---------------------
Operating earnings $ 17,451 $ 26,420
=====================
Reconciliation of net earnings to operating earnings
per diluted share:
Net earnings per diluted share $ 0.40 $ 1.02
Plus net realized losses, net of tax 0.19 0.07
Less SFAS No. 142 change in accounting
principle, net of tax 0.00 (0.34)
Plus (less) variable accounting stock option
(income) expense, net of tax (0.05) 0.04
---------------------
Operating earnings per diluted share $ 0.54 $ 0.79
=====================
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 decreased by $1,564 during
the first three months of 2003 as compared to December 31, 2002. The
decrease resulted from dividends paid to stockholders of $9,931 and treasury
stock purchases of $8,058, offset by net earnings of $12,920 and a $3,505
increase in other comprehensive income, net of income taxes on fixed
maturities and preferred and common stocks. Total assets at March 31, 2003
increased $189,807 or 8.0% to $2,572,495 as compared to total assets of
$2,382,688 at December 31, 2002. Invested assets, at market value and
equity, increased $87,904 or 5.6%. Premiums receivable increased $71,379, or
24.0%. The increase in premiums receivable from December 31, 2002, was
primarily attributable to increases in the Company's business, coupled with
the seasonality of the policy effective dates of the Company's business.
This occurs because the total amount of a policy's premium is recorded as
written premium on the first day the policy is effective, however, the
policy premium is billed over the ensuing year. Deferred policy acquisition
costs increased $14,313 or 10.4% as a result of increased business. The
residual market receivable increased $5,064 or 3.1% over 2002 due to
increased business assumed from CAR.
The Company's liabilities totaled $1,779,884 at March 31, 2003 as
compared to $1,588,530 at December 31, 2002. The $191,354 or 12.0% increase
was primarily comprised of increases in
17
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Continued)
unpaid losses and loss adjustment expenses, unearned premiums and a payable
for securities purchased. The liability for losses and loss adjustment
expense reserves increased $41,536 or 5.1%. Unearned premiums increased
$90,981 or 13.2%, due primarily to the same reason premiums receivable
increased. Payable for securities purchased totaled $63,075 at March 31,
2003 as compared to $0 at December 31, 2002. This was the result of
securities purchased with trade dates in March of 2003 that did not settle
until April of 2003.
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 $49,797 in the
first three months of 2003, as compared to $53,099 during the same period a
year ago, representing a decrease of $3,302 or 6.2%. Premiums collected less
loss and policy acquisition cost payments were approximately $900 higher in
2003 compared to 2002. Due to the severe winter loss payments increased over
20% versus last year. The remaining reasons for the decrease is that the
Company received $7,000 in the first quarter of 2002 for an agreement to
offer to write the business from Berkshire Mutual Insurance Company. This
was partially offset by premium finance and service fees collected which
increased $1,398 or 28.3% primarily as the result of increased business and
a service fee increase on Massachusetts new and renewal business from three
dollars to four dollars per installment payment, for policies with effective
dates of July 1, 2002 and forward.
For the first three months of 2003 and 2002 net cash flows from
investing activities used cash of $70,805 and $32,794, respectively. The
majority of the $38,011 difference was a $75,274 increase in purchases of
fixed maturities coupled with a $9,866 decrease in sales of equity
securities offset by a $43,696 increase in proceeds from fixed maturities.
The vast majority of the purchased securities during 2003 were short
duration securities that act as cash substitutes. During 2003 and 2002,
investing activities were funded by accumulated cash and cash provided by
operating activities.
Cash flows used in financing activities totaled $17,989 during the
first three months of 2003 compared to $16,716 during the same period a year
ago. The 2003 cash flows used in financing activities consisted of dividends
paid to stockholders of $9,931, coupled with $8,058 used to purchase 236,400
shares of treasury stock under the Company's stock buyback program. The 2002
cash flows used in financing activities consisted of dividends paid to
stockholders of $9,927 and $6,789 used to purchase 180,000 shares of
treasury stock under the company's stock buy-program.
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 March 31, 2003 was $1,664,974. At March 31, 2003, the
Company held cash and cash equivalents of $130,949. These funds provide
sufficient liquidity for the payment of claims and other short-term cash
needs. The Company continues to monitor interest rates on medium and long-
term securities and intends to maintain its relatively high cash position
until such time as the Company believes medium and long-term rates have
appropriately firmed.
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 1.42 to 1.00 and 1.70 to
1.00 for the period ended March 31, 2003 and 2002, respectively.
Stock Buyback and Dividends
The Company purchased 236,400 shares of Treasury stock under the
buyback program through March 31, 2003 at an average cost of $34.09. At
March 31, 2003, the Company had the authority to purchase 741,456 additional
shares of common stock under the current Board of Directors' stock re-
purchase authorization.
18
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Continued)
On March 14, 2003, the Company paid a quarterly dividend of $0.31 to
stockholders of record as of February 28, 2003.
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.
Forward-Looking Statements
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 the economic, market or
regulatory conditions and risks associated with entry into new markets and
diversification. The Commerce Group, Inc. is not under any obligation to
(and expressly disclaims any such obligations to) update or alter its
forward-looking statements, whether as a result of new information, future
events or otherwise.
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.
19
The Commerce Group, Inc. and Subsidiaries
Item 3. Quantitative and Qualitative Disclosures about Market 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 and common stocks traded on national stock exchanges, thus
limiting exposure to any one investment. The Company's exposure to interest
rate changes at March 31, 2003 was estimated as follows: A 200 basis point
increase results in a $73,743 decrease in the market value of the fixed
maturities and preferred stocks. A 200 basis point decrease results in a
$46,411 increase in the market value of the same securities.
Item 4. Controls and Procedures
(a) Evaluation of disclosure controls and procedures
Under the supervision and with the participation of our management,
including our Chief Executive Officer and Chief Financial Officer, we
evaluated the effectiveness of the design and operation of our disclosure
controls and procedures (as defined in Rule 13a-14(c) and 15d-14(c) under
the Exchange Act) as of a date (the "Evaluation Date") within 90 days prior
to the filing date of this report. Based upon that evaluation, the Chief
Executive Officer and Chief Financial Officer concluded that, as of the
evaluation date, our disclosure controls and procedures are effective to
ensure that information required to be disclosed in the reports that the
Company files or submits under the Securities Exchange Act of 1934 is
recorded, processed, summarized and reported, within the time periods
specified in the Securities and Exchange Commission's rules and forms.
(b) Changes in internal controls
There have been no significant changes in the Company's internal
controls or in other factors that could significantly affect these controls
subsequent to the evaluation date.
20
The Commerce Group, Inc. and Subsidiaries
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
Please refer to Note 3 located in "Part I, Item 1 - Financial
Statements Notes to Unaudited Consolidated Financial Statements" section.
Item 2. Changes in Securities and Use of Proceeds
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submissions of Matters to a Vote by Security Holders
None
Item 5. Other Information
In accordance with Section 306 of the Sarbanes-Oxley Act of 2002 ("the
Act"), a required communication was sent to Directors and Executive Officers
of the Company as a result of the Company's transfer of recordkeeping
services of The Commerce Group, Inc. Employee Stock Ownership Plan (ESOP) to
Fidelity Investments. The Company initiated a black-out period on all
participants in the ESOP between February 24, 2003 through March 21, 2003.
As a result of the Act, because a blackout period was imposed on a Company
sponsored benefit plan, the attached letter was sent to all Directors and
Executive Officers of the Company providing information required under the
Act.
Pension Black Out Period
To: Directors and Executive Officers
From: Randy Becker
Date: February 21, 2003
Subject: Potential Stock Trading Restrictions from February 24 through
March 21, 2003
As you are probably aware, numerous new laws, rules and regulations have
come into place as a result of the Sarbanes-Oxley Act of 2002 ("the Act").
One of the areas of the Act pertains to situations when a Company imposes a
blackout period on pension plan activity. The Company is imposing a blackout
period on all ESOP participants from February 24, 2003 through March 21,
2003 due to the transfer of the plan administration to Fidelity Investments.
In accordance with Section 306 of the Act, the Company is required by law to
inform its Directors and Executive Officers of the restrictions placed on
them with regard to acquiring or disposing securities during this blackout
period.
For Executive Officers, the Act prohibits purchases of equity securities
during a blackout period if the acquisition is in connection with the
service or employment of the director or executive officer. In Commerce's
case, this prohibition pertains exclusively to Executive Officers in that
they are prohibited from otherwise exercising their rights under the stock
option program during the blackout period.
21
For both Directors and Executive Officers, the Act prohibits the disposition
(sale) of equity securities during a blackout period if the securities
contemplated to be sold were acquired in connection with your service or
employment as a director or executive officer. Examples of this would be:
shares acquired for you by the ESOP, whether currently held in the ESOP or
elsewhere; shares acquired through the management incentive plan, etc.
As a result of the above, prior to engaging in any transaction involving
Company securities, please contact our outside counsel, Gus Alexander of
Nutter, McClennen & Fish LLP at 617-439-2595 to discuss any proposed
transaction.
If you have any questions on the above information, please give me a call at
800-922-8276, extension 4129.
Cc: C. Alexander, Esq., NMF
22
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Reports on Form 8-K - None
Page No.
(b) Exhibit 10.27 - Initial ACIC Agent Option Agreement 26
Exhibit 99.1 - CEO Certification Statement Under Section 906 of
The Sarbanes-Oxley Act of 2002 37
Exhibit 99.2 - CFO Certification Statement Under Section 906 of
The Sarbanes-Oxley Act of 2002 38
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
Dated this 13th day of May, 2003.
23
CERTIFICATIONS
I, Arthur J. Remillard, Jr., certify that:
1. I have reviewed this quarterly report on Form 10-Q of The Commerce
Group, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary in order to make the statements made, in light of the
circumstances under which such statements were made, not misleading
with respect to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation Date");
and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant deficiencies
and material weaknesses.
Date: May 12, 2003
ARTHUR J. REMILLARD, JR.
------------------------------
Arthur J. Remillard, Jr.
Chief Executive Officer
24
CERTIFICATIONS
I, Gerald Fels, certify that:
1. I have reviewed this quarterly report on Form 10-Q of The Commerce
Group, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary in order to make the statements made, in light of the
circumstances under which such statements were made, not misleading
with respect to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation Date");
and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
Date: May 12, 2003
GERALD FELS
------------------------------
Gerald Fels
Chief Financial Officer
25