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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Form 10-Q
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[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ________ TO ________.
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2003
COMMISSION FILE NUMBER 1-9640
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MERCHANTS GROUP, INC.
(Exact name of registrant as specified in its charter)
DELAWARE
(State or other jurisdiction of incorporation or organization)
16-1280763
(I.R.S. Employer Identification No.)
250 MAIN STREET, BUFFALO, NEW YORK
(Address of principal executive offices)
14202
(Zip Code)
716-849-3333
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months, and (2) has been subject to such filing requirements
for the past 90 days. Yes [ x ] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of April 30, 2003: 2,110,152 SHARES OF COMMON STOCK.
1
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
MERCHANTS GROUP, INC.
CONSOLIDATED BALANCE SHEET
(in thousands)
December 31, March 31,
Assets 2002 2003
------ -------- --------
(unaudited)
Investments:
Fixed maturities:
Held to maturity at amortized cost (fair value
$4,259 in 2002 and $3,374 in 2003) $ 4,092 $ 3,260
Available for sale at fair value (amortized cost
$186,302 in 2002 and $184,011 in 2003) 189,476 186,579
Preferred stock at fair value 7,367 5,981
Other long-term investments at fair value 2,042 1,762
Short-term investments 6,420 5,000
-------- --------
Total investments 209,397 202,582
Cash 9 6
Interest due and accrued 1,594 1,639
Premiums receivable, net of allowance for doubtful
accounts of $288 in 2002 and $334 in 2003 14,496 16,493
Deferred policy acquisition costs 8,817 8,533
Ceded reinsurance balances receivable 19,086 19,082
Prepaid reinsurance premiums 1,091 920
Deferred income taxes 4,195 4,505
Other assets 10,031 10,283
-------- --------
Total assets $268,716 $264,043
======== ========
See Notes to the Consolidated Financial Statements
2
MERCHANTS GROUP, INC.
CONSOLIDATED BALANCE SHEET
(in thousands except share amounts)
December 31, March 31,
2002 2003
--------- ---------
(unaudited)
Liabilities and Stockholders' Equity
Liabilities:
Reserve for losses and loss adjustment expenses $ 147,136 $ 145,980
Unearned premiums 35,119 33,654
Payable to affiliate 3,237 3,474
Other liabilities 15,300 13,537
--------- ---------
Total liabilities 200,792 196,645
--------- ---------
Stockholders' equity:
Common stock, 10,000,000 shares authorized, 2,110,152
shares issued and outstanding at December 31, 2002
and March 31, 2003 32 32
Additional paid in capital 35,795 35,795
Treasury stock, 1,139,700 shares at December 31, 2002
and March 31, 2003 (22,766) (22,766)
Accumulated other comprehensive income 1,937 1,405
Accumulated earnings 52,926 52,932
--------- ---------
Total stockholders' equity 67,924 67,398
--------- ---------
Commitments and contingent liabilities -- --
Total liabilities and stockholders' equity $ 268,716 $ 264,043
========= =========
See Notes to the Consolidated Financial Statements
3
MERCHANTS GROUP, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
(in thousands except per share amounts)
Three Months
Ended March 31,
-------------------
2002 2003
------- -------
(unaudited)
Revenues:
Net premiums earned $23,130 $16,141
Net investment income 2,570 2,331
Net realized investment gains 73 116
Other revenues 227 33
------- -------
Total revenues 26,000 18,621
------- -------
Expenses:
Net losses and loss adjustment expenses 17,896 12,917
Amortization of deferred policy acquisition costs 6,129 4,206
Other underwriting expenses 1,735 1,177
------- -------
Total expenses 25,760 18,300
------- -------
Income before income taxes 240 321
Income tax provision 98 105
------- -------
Net income $ 142 $ 216
======= =======
Basic and diluted earnings per share $ .07 $ .10
======= =======
Weighted average shares outstanding:
Basic 2,171 2,110
Diluted 2,174 2,113
See Notes to the Consolidated Financial Statements
4
MERCHANTS GROUP, INC.
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(in thousands)
Three Months
Ended March 31,
------------------------
2002 2003
------- -------
(unaudited)
Net income $ 142 $ 216
------- -------
Other comprehensive loss before taxes:
Unrealized losses on securities (936) (751)
Reclassification adjustment
for gains included in net income (73) (116)
------- -------
Other comprehensive loss before taxes (1,009) (867)
Income tax benefit related to items
of other comprehensive loss (381) (335)
------- -------
Other comprehensive loss (628) (532)
------- -------
Comprehensive loss $ (486) $ (316)
======= =======
See Notes to the Consolidated Financial Statements
5
MERCHANTS GROUP, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(in thousands)
Three Months
Ended March 31,
------------------------
2002 2003
-------- --------
(unaudited)
Common stock, beginning and end $ 32 $ 32
-------- --------
Additional paid in capital, beginning and end: 35,795 35,795
-------- --------
Treasury stock:
Beginning of period (20,332) (22,766)
Purchase of treasury shares (2,434) --
-------- --------
End of period (22,766) (22,766)
-------- --------
Accumulated other comprehensive income (loss):
Beginning of period 1,812 1,937
Other comprehensive income (loss) (628) (532)
-------- --------
End of period 1,184 1,405
-------- --------
Accumulated earnings:
Beginning of period 51,244 52,926
Net income 142 216
Cash dividends (223) (210)
-------- --------
End of period 51,163 52,932
-------- --------
Total stockholders' equity $ 65,408 $ 67,398
======== ========
See Notes to the Consolidated Financial Statements
6
MERCHANTS GROUP, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(in thousands)
Three Months
Ended March 31,
------------------------
2002 2003
-------- --------
(unaudited)
Cash flows from operations:
Collection of premiums $ 20,392 $ 12,852
Payment of losses and loss adjustment expenses (17,591) (14,162)
Payment of other underwriting expenses (8,329) (6,959)
Investment income received 3,032 2,372
Investment expenses paid (78) (74)
Income taxes (paid) recovered 376 (145)
Other 228 33
-------- --------
Net cash used in operations (1,970) (6,083)
-------- --------
Cash flows from investing activities:
Proceeds from fixed maturities sold or matured 17,931 34,066
Purchase of fixed maturities (17,071) (30,903)
Net decrease in preferred stock 149 1,500
Net (increase) decrease in other long-term investments 583 (30)
Net decrease in short-term investments 860 1,420
Increase in receivable for securities (104) --
-------- --------
Net cash provided by investing activities 2,348 6,053
-------- --------
Cash flows from financing activities:
Settlement of affiliate balances 1,129 237
Increase decrease in demand loan, net 400 --
Purchase of treasury stock (2,434) --
Cash dividends (223) (210)
-------- --------
Net cash provided by (used in) financing activities (1,128) 27
-------- --------
Decrease in cash (750) (3)
Cash:
Beginning of period 1,197 9
-------- --------
End of period $ 447 $ 6
======== ========
See Notes to the Consolidated Financial Statements
7
MERCHANTS GROUP, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
RECONCILIATION OF NET INCOME TO NET CASH
USED IN OPERATIONS
(in thousands)
Three Months
Ended March 31,
----------------------
2002 2003
------- -------
(unaudited)
Net income $ 142 $ 216
Adjustments:
Accretion 71 12
Realized investment gains (73) (116)
(Increase) decrease in assets:
Interest due and accrued 314 (45)
Premiums receivable 1,083 (1,997)
Deferred policy acquisition costs 1,062 284
Ceded reinsurance balances receivable (874) 4
Prepaid reinsurance premiums 347 171
Deferred income taxes (15) 24
Other assets 224 (252)
Increase (decrease) in liabilities:
Reserve for losses and loss adjustment expenses 1,562 (1,156)
Unearned premiums (4,355) (1,465)
Other liabilities (1,458) (1,763)
------- -------
Net cash used in operations $(1,970) $(6,083)
======= =======
See Notes to the Consolidated Financial Statements
8
MERCHANTS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Principles of Consolidation and Basis of Presentation
The consolidated balance sheet as of March 31, 2003 and the related consolidated
statements of operations, of comprehensive income, of changes in stockholders'
equity and of cash flows for the three months ended March 31, 2002 and 2003,
respectively, are unaudited. In the opinion of management, the interim financial
statements reflect all adjustments necessary for a fair presentation of
financial position and results of operations. Such adjustments consist only of
normal recurring items. Interim results are not necessarily indicative of
results for a full year.
The consolidated financial statements include the accounts of Merchants Group,
Inc. (the Company), its wholly-owned subsidiary, Merchants Insurance Company of
New Hampshire, Inc. (MNH), and M.F.C. of New York, Inc., an inactive premium
finance company which is a wholly-owned subsidiary of MNH. The accompanying
consolidated financial statements should be read in conjunction with the
following notes and the Notes to Consolidated Financial Statements included in
the Company's Annual Report on Form 10-K for the year ended December 31, 2002.
The consolidated financial statements have been prepared in conformity with
generally accepted accounting principles (GAAP) which differ in some respects
from those followed in reports to insurance regulatory authorities. All
significant intercompany balances and transactions have been eliminated.
2. Related Party Transactions
With the exception of the individual who serves as both the President of the
Company and the Chief Operating Officer of MNH, the Company and MNH have no paid
employees. Under a management agreement dated September 26, 1986 (the Management
Agreement), Merchants Mutual Insurance Company (Mutual), which owned 12.1% of
the Company's common stock at March 31, 2003, provided the Company and MNH with
the facilities, management and personnel required to manage their day-to-day
business through December 31, 2002. All underwriting, administrative, claims and
investment expenses incurred on behalf of Mutual and MNH were shared on an
allocated cost basis. Effective January 1, 2003, the Company, MNH and Mutual
entered into a new agreement (the Services Agreement) for Mutual to provide
underwriting, administrative, claims and investment services to the Company and
MNH and to manage the traditional property and casualty insurance business of
MNH on substantially the same terms as under the Management Agreement. As of
January 1, 2003 MNH and Mutual entered into a reinsurance pooling agreement (the
Reinsurance Pooling Agreement) that provides for the pooling, or sharing, of the
insurance business traditionally written by Mutual and MNH. The Reinsurance
Pooling Agreement applies to premiums earned and losses incurred on or after its
effective date. The terms of these agreements are more fully described in the
Company's Annual Report of Form 10-K for the year ended December 31, 2002.
9
3. Earnings Per Share
Basic and diluted earnings per share were computed by dividing net income by the
weighted average number of shares of common stock outstanding during each
period, increased by the assumed exercise of options for 35,500 shares of common
stock in 2003 and 2002, which would have resulted in 2,745 and 2,660 additional
shares outstanding, respectively, assuming the proceeds to the Company from
exercise were used to purchase shares of the Company's common stock at its
average market value per share during the quarter.
10
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Results of Operations for the Three Months Ended March 31, 2003 As Compared to
the Three Months Ended March 31, 2002
The following discussion should be considered in light of the statements under
the heading "Safe Harbor Statement under the Securities Litigation Reform Act of
1995," at the end of this Item. All capitalized terms used in this Item that are
not defined in this Item have the meanings given to them in Notes to
Consolidated Financial Statements contained in Item 1 of this Form 10-Q, which
is incorporated herein by reference.
Total revenues for the three months ended March 31, 2003 were $18,621,000, a
decrease of $7,379,000 or 28% from $26,000,000 for the three months ended March
31, 2002.
Results of operations for the three months ended March 31, 2003 reflect the
effects of the new Services Agreement and the Reinsurance Pooling Agreement
between the Company and its wholly-owned insurance subsidiary, Merchants
Insurance Company of New Hampshire, Inc. (MNH) and Merchants Mutual Insurance
Company (Mutual), effective January 1, 2003. The Services Agreement calls for
Mutual to provide underwriting, administrative, claims and investment services
to the Company and MNH. The Reinsurance Pooling Agreement provides for the
pooling, or sharing, of insurance business traditionally written by Mutual and
MNH on or after the effective date. MNH's share of pooled (combined Mutual and
MNH) premiums earned and losses and loss adjustment expenses (LAE) for 2003 in
accordance with the Reinsurance Pooling Agreement is 40%. In addition to
comparisons of the Company's share of pooled premiums for 2003 to its unpooled
premiums for the same period in 2002, this item includes comparisons of the
pooled, or combined Mutual and MNH, premiums written for 2003 to the combined
business of Mutual and MNH for the same period in 2002, even though the
companies were not party to a reinsurance pooling agreement in 2002.
The Company's share of pooled direct premiums written in accordance with the
Reinsurance Pooling Agreement for the first quarter of 2003 was $16,302,000.
Direct premiums written by MNH on an unpooled basis for the three months ended
March 31, 2002 were $20,481,000. Pooled direct premiums written for the three
months ended March 31, 2003 decreased 3% from the year earlier period.
The Company's share of pooled voluntary direct premiums written in accordance
with the Reinsurance Pooling Agreement for the three months ended March 31, 2003
was $15,558,000. Voluntary direct premiums written by MNH on an unpooled basis
for the three months ended March 31, 2002 were $19,271,000. Pooled voluntary
direct premiums written for the three months ended March 31, 2003 decreased 4%
from the year earlier period.
The Company's share of pooled voluntary personal lines direct premiums written
in accordance with the Reinsurance Pooling Agreement for the three months ended
March 31, 2003 was $6,085,000. Voluntary personal lines direct premiums written
by MNH on an unpooled basis for the three months ended March 31, 2002 were
$8,730,000. Pooled voluntary personal lines direct written premiums for the
three months ended March 31, 2003 were substantially unchanged from the first
quarter of 2002. Pooled voluntary private
11
passenger automobile (PPA) direct premiums written for the three months ended
March 31, 2003 decreased 2% to $11,447,000, from $11,674,000 for the three
months ended March 31, 2002. On a pooled basis, PPA policies in force have
decreased 7% in the twelve months ended March 31, 2003, while average premium
per PPA policy has increased 12%.
Over the past several years many insurance companies, including the Company and
Mutual, offering PPA in New Jersey have had difficulty earning a profit on PPA
policies. New Jersey is a "take all comers" state, meaning that all PPA policy
applications that meet certain minimum criteria must be accepted and
underwritten by the company that receives the application. As a result, it is
difficult for a company to predict or control its volume of New Jersey PPA
business. Prior to the effective date of the Reinsurance Pooling Agreement, the
Company had no significant exposure to the New Jersey PPA market. The Company
and Mutual have each filed a plan with the New Jersey Department of Banking and
Insurance to withdraw from the New Jersey PPA market. Approval of the plan is
pending.
The Company's share of pooled New Jersey PPA direct premiums written for the
three months ended March 31, 2003 was $1,130,000. New Jersey PPA direct premiums
written by MNH on an unpooled basis for the three months ended March 31, 2002
were $7,000. Pooled New Jersey PPA direct premiums written for the three months
ended March 31, 2003 were $2,825,000, an increase of 18% from $2,390,000 for the
three months ended March 31, 2002.
The Company's share of pooled voluntary commercial lines direct premiums written
in accordance with the Reinsurance Pooling Agreement for the first quarter of
2003 was $9,473,000. Voluntary commercial lines direct premiums written by MNH
on an unpooled basis for the three months ended March 31, 2002 were $10,541,000.
Pooled voluntary commercial lines direct premiums written for the three months
ended March 31, 2003 decreased 7% from the first quarter of 2002. A 27% decrease
in pooled commercial lines policies in force was mostly offset by a 24% increase
in average premium per pooled voluntary commercial lines policy. The increase in
average premium per pooled voluntary commercial lines policy is primarily the
result of rate increases being reflected in average premiums charged.
The Company's share of pooled involuntary direct premiums written in accordance
with the Reinsurance Pooling Agreement for the first quarter of 2003 was
$744,000, a reduction of its exposure to such business as a result of the
Reinsurance Pooling Agreement. Involuntary direct premiums written by MNH on an
unpooled basis for the three months ended March 31, 2002 were $1,361,000. Pooled
involuntary direct premiums written increased 37% for the three months ended
March 31, 2003 compared to the three months ended March 31, 2002. Approximately
50% of this increase resulted from a 19% rate increase effective May 2002 for
policies assigned by the New York Automobile Insurance Plan (NYAIP). Pooled
involuntary direct premiums written, which is comprised primarily of PPA
insurance, accounted for 5% and 3% of all pooled direct written premiums during
the three months ended March 31, 2003 and 2002, respectively.
The Company's share of pooled net premiums written in accordance with the
Reinsurance Pooling Agreement for the three months ended March 31, 2003 was
$14,847,000. Net premiums written for the three months ended March 31, 2002 were
$19,122,000. Pooled net premiums written for the three months ended March 31,
2003 were $38,358,000, a decrease of $1,077,000, or 3% from $39,435,000 for the
three
12
months ended March 31, 2002, primarily due to the aforementioned 3% decrease in
pooled direct premiums written.
The Company's share of pooled net premiums earned in accordance with the
Reinsurance Pooling Agreement for the three months ended March 31, 2003 was
$16,141,000. Net premiums earned for the three months ended March 31, 2002 were
$23,130,000.
Net investment income was $2,331,000 for the three months ended March 31, 2003,
a decrease of 9% from $2,570,000 for the three months ended March 31, 2002. The
average pre-tax yield associated with the investment portfolio decreased 95
basis points to 4.7% for the three months ended March 31, 2003 when compared to
the three months ended March 31, 2002. Average invested assets for the three
months ended March 31, 2003 decreased 4% compared to the year earlier period.
Net losses and LAE, which include the Company's share of pooled 2003 accident
year losses, were $12,917,000 for the three months ended March 31, 2003, a
decrease of $4,979,000, or 28%, from $17,896,000 for the three months ended
March 31, 2002. The loss and LAE ratio increased to 80.0% for the three months
ended March 31, 2003 from 77.4% for the three months ended March 31, 2002.
Approximately 1 percentage point of this increase was due to an increase in
prior accident year losses and LAE related to business assumed from involuntary
markets, principally commercial auto. The remainder of the increase relates to
the current accident year.
The ratio of amortized deferred policy acquisition costs and other underwriting
expenses to net premiums earned decreased to 33.3% for the three months ended
March 31, 2003 from 34.0% for the three months ended March 31, 2002.
Commissions, premium taxes and other state assessments that vary directly with
the Company's premium volume represented 20.9% of net premiums earned in the
three months ended March 31, 2003 compared to 20.3% in the three months ended
March 31, 2002.
The Company's effective income tax rate for the three months ended March 31,
2003 was 32.7%. This rate was calculated based upon the Company's estimate of
its effective income tax rate for all of 2003.
Liquidity and Capital Resources
In developing its investment strategy the Company determines a level of cash and
short-term investments which, when combined with expected cash flow, is
estimated to be adequate to meet expected cash obligations. The decrease in the
Company's net premiums written in 2002 will likely result in continued negative
cash flows from operations. The Company believes that careful management of the
relationship between assets and liabilities will minimize the likelihood that
investment portfolio sales will be necessary to fund insurance operations and
that the effect of any such sale on the Company's stockholders' equity will not
be material.
The Company's objectives with respect to its investment portfolio include
maximizing total return within investment guidelines while protecting
policyholders' surplus and maintaining flexibility. Like other property and
casualty insurers, the Company relies on premiums as a major source of cash, and
therefore liquidity. Cash flows from the Company's investment portfolio, either
in the form of interest or principal
13
payments, are an additional source of liquidity. Because the duration of the
Company's investment portfolio relative to the duration of its liabilities is
closely managed, increases or decreases in market interest rates are not
expected to have a material effect on the Company's liquidity or its results of
operations.
The Company designates newly acquired fixed maturity investments as available
for sale and carries these investments at fair value. Unrealized gains and
losses related to these investments are recorded as accumulated other
comprehensive income within stockholders' equity. At March 31, 2003, the Company
recorded as accumulated other comprehensive income in its Consolidated Balance
Sheet $1,405,000 of unrealized gains, net of taxes, associated with its
investments classified as available for sale. During the three months ended
March 31, 2003 the Company recorded $532,000 of unrealized losses, net of tax,
associated with its available for sale investments as other comprehensive
income.
At March 31, 2003, the Company's portfolio of fixed maturity investments
represented 93.7% of invested assets. Management believes that this level of
bond holdings is consistent with the Company's liquidity needs because it
anticipates that cash receipts from net premiums written and investment income
will enable the Company to satisfy its cash obligations. Furthermore, a portion
of the Company's bond portfolio is invested in mortgage-backed and other
asset-backed securities which, in addition to interest income, provide monthly
paydowns of bond principal.
At March 31, 2003, $94,373,000 or 49.7%, of the Company's fixed maturity
portfolio was invested in mortgage-backed and other asset-backed securities. The
Company invests in a variety of collateralized mortgage obligation ("CMO")
products but has not invested in the derivative type of CMO products such as
interest only, principal only or inverse floating rate securities. All of the
Company's CMO investments have a secondary market and their effect on the
Company's liquidity does not differ from that of other fixed maturity
investments.
At March 31, 2003 $3,992,000, or 2.0%, of the Company's investment portfolio was
invested in non-investment grade securities compared to $8,688,000, or 4.1%, at
March 31, 2002.
The Company has arranged for a $2,000,000 unsecured credit facility from a bank
in the form of a master grid note. Any borrowings under this facility are
payable on demand and carry an interest rate which can be fixed or variable and
is negotiated at the time of each advance. This facility is available for
general working capital purposes and for repurchases of the Company's common
stock. At March 31, 2003, no amount was outstanding on this loan.
As a holding company, the Company is dependent on cash dividends from MNH to
meet its obligations, pay any cash dividends and repurchase its shares. MNH is
subject to New Hampshire insurance laws which place certain restrictions on its
ability to pay dividends without the prior approval of state regulatory
authorities. These restrictions limit dividends to those that, when added to all
other dividends paid within the preceding twelve months, would not exceed 10% of
the insurer's statutory policyholders' surplus as of the preceding December
31st. The maximum amount of dividends that MNH could pay during any twelve month
period ending in 2003 without the prior approval of the New Hampshire Insurance
Commissioner is $5,492,000. MNH paid $3,700,000 of dividends to the Company in
2002. Dividends were paid in
14
February 2002, May 2002 and November 2002, of $2,300,000, $900,000 and $500,000,
respectively. The Company paid cash dividends to its common stockholders of $.10
per share in the first quarter of 2003 amounting to $210,000. On May 7, 2003 the
Company declared a quarterly cash dividend of $.10 per share payable on June 4,
2003 to shareholders of record as of the close of business on May 16, 2003.
Under the Management Agreement and the Services Agreement, Mutual has provided
services and facilities for MNH to conduct its insurance business on a cost
reimbursed basis. The balance in the payable to or receivable from affiliate
account represents the amount owing to or owed by Mutual by or to the Company
for the difference between premiums collected and payments made for losses,
employees, services and facilities by Mutual on behalf of MNH.
Regulatory guidelines suggest that the ratio of a property-casualty insurer's
annual net premiums written to its statutory surplus should not exceed 3 to 1.
MNH has consistently followed a business strategy that would allow it to meet
this 3 to 1 regulatory guideline. For the first three months of 2003, MNH's
ratio of net premiums written to statutory surplus, annualized for a full year,
was 1 to 1.
Relationship with Mutual
The Company's and MNH's business and day-to-day operations are closely aligned
with those of Mutual. This is the result of a combination of factors. Mutual has
had a historical ownership interest in the Company and MNH. Prior to November
1986 MNH was a wholly-owned subsidiary of Mutual. Following the Company's
initial public offering in November 1986 and until a secondary stock offering in
July 1993 the Company was a majority-owned subsidiary of Mutual. Mutual
currently owns 12.1% of the Company's common stock. Under the Management
Agreement, which was effective from 1986 through December 31, 2002, Mutual
provided the Company and MNH with facilities and personnel to conduct the
traditional Merchants insurance business and other services. With the exception
of the individual who serves as both the President of the Company and the Chief
Operating Officer of MNH, the officers of the Company and MNH are paid full time
employees of Mutual whose services are provided under the Services Agreement.
Also, effective January 1, 2003, the Reinsurance Pooling Agreement between MNH
and Mutual provides for MNH to cede all of its net risk on its traditional
insurance business to Mutual and then to assume from Mutual an agreed percentage
(40% in 2003) of the combined traditional insurance business of both MNH and
Mutual. This will create a common underwriting result for MNH and Mutual under
the Reinsurance Pooling Agreement and further align the interests of the
parties.
The Services Agreement and the Reinsurance Pooling Agreement have been approved
by the New Hampshire and New York Insurance Departments.
"Safe Harbor" Statement under the Private Securities Litigation Reform Act of
1995:
With the exception of historical information, the matters and statements
discussed, made or incorporated by reference in this Quarterly Report on Form
10-Q constitute forward-looking statements and are discussed, made or
incorporated by reference, as the case may be, pursuant to the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995.
Forward-looking statements include, without limitation, statements relating to
the Company's plans, strategies, objectives, expectations and intentions.
15
Words such as "believes," "forecasts," "intends," "possible," "expects,"
"anticipates," "estimates," or "plans" and similar expressions are intended to
identify forward looking statements. Such forward-looking statements involve
certain assumptions, risks and uncertainties that include, but are not limited
to, those associated with factors affecting the property-casualty insurance
industry generally, including price competition, the Company's dependence on
state insurance departments for approval of rate increases; size and frequency
of claims, escalating damage awards, natural disasters, fluctuations in interest
rates and general business conditions; the Company's dependence on investment
income; the geographic concentration of the Company's business in the
northeastern United States and in particular in New York, New Hampshire, New
Jersey, Rhode Island, Pennsylvania and Massachusetts; the adequacy of the
Company's loss reserves; the Company's dependence on the general reinsurance
market; government regulation of the insurance industry; exposure to
environmental claims; dependence of the Company on its relationship with Mutual;
the Company's intention to reduce written premium in business segments that it
believes no longer provide a satisfactory return; and the other risks and
uncertainties discussed or indicated in all documents filed by the Company with
the Securities and Exchange Commission. The Company expressly disclaims any
obligation to update any forward-looking statements as a result of developments
occurring after the filing of this report.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Market Risk
Market risk represents the potential for loss due to changes in the fair value
of financial instruments. The market risk related to the Company's financial
instruments primarily relates to its investment portfolio. The value of the
Company's investment portfolio of $202,582,000 at March 31, 2003 is subject to
changes in interest rates and to a lesser extent on credit quality. Further,
certain mortgage-backed and asset-backed securities are exposed to accelerated
prepayment risk generally caused by interest rate movements. If interest rates
were to decline, mortgage holders would be more likely to refinance existing
mortgages at lower rates. Acceleration of future repayments could adversely
affect future investment income, if reinvestment of the accelerated receipts was
made in lower yielding securities.
The following table provides information related to the Company's fixed maturity
investments at March 31, 2003. The table presents cash flows of principal
amounts and related weighted average interest rates by expected maturity dates.
The cash flows are based upon the maturity date or, in the case of
mortgage-backed and asset-backed securities, expected payment patterns. Actual
cash flows could differ from those shown in the table.
16
Fixed Maturities
Expected Cash Flows of Principal Amounts ($ in 000's):
TOTAL
-------------------
Esti-
Amor- mated
There- tized Market
2003 2004 2005 2006 2007 after Cost Value
-------- -------- -------- -------- -------- -------- -------- --------
Held to Maturity
Mortgage & asset backed
securities $ 3,037 $ 223 $ 0 $ 0 $ 0 $ 0 $ 3,260 $ 3,374
Average interest rate 7.3% 7.2% 0.0% 0.0% 0.0% 0.0% -- --
-------- -------- -------- -------- -------- -------- -------- --------
Total $ 3,037 $ 223 $ 0 $ 0 $ 0 $ 0 $ 3,260 $ 3,374
======== ======== ======== ======== ======== ======== ======== ========
Available for Sale
U.S. Treasury securities and
obligations of U.S.
Government corporations
and agencies $ 4,189 $ 0 $ 8,215 $ 0 $ 0 $ 3,009 $ 15,413 $ 15,854
Average interest rate 4.1% 0.0% 3.6% 0.0% 0.0% 3.2% -- --
Obligations of states and
political subdivisions 5,826 1,381 8,620 9,707 3,907 2,293 31,734 32,090
Average interest rate 7.5% 4.1% 3.2% 3.4% 4.3% 3.8% -- --
Corporate securities 19,123 6,874 17,792 0 0 2,710 46,499 47,510
Average interest rate 4.5% 7.8% 4.0% 0.0% 0.0% 13.6% -- --
Mortgage & asset
backed securities 29,308 17,933 13,545 10,622 2,061 17,476 90,945 91,705
Average interest rate 5.4% 5.4% 5.4% 5.4% 5.5% 5.6% -- --
-------- -------- -------- -------- -------- -------- -------- --------
Total $ 58,446 $ 26,188 $ 48,172 $ 20,329 $ 5,968 $ 25,488 $184,011 $186,579
======== ======== ======== ======== ======== ======== ======== ========
The discussion and the estimated amounts referred to above include
forward-looking statements of market risk which involve certain assumptions as
to market interest rates and the credit quality of the fixed maturity
investments. Actual future market conditions may differ materially from such
assumptions. Accordingly, the forward-looking statements should not be
considered projections of future events by the Company.
Item 4. Controls and Procedures
The Company's chief operating officer and chief financial officer, after
evaluating the effectiveness of the Company's "disclosure controls and
procedures" (as defined in Rules 13a-14(c) and 15d-14(c) under the Securities
Exchange Act of 1934) as of a date (the "Evaluation Date") within 90 days before
the filing date of this quarterly report, concluded that as of the Evaluation
Date the Company's disclosure controls and procedures were effective to ensure
that material information relating to the Company was being made known to them
by others within the Company in a timely manner, including the period when this
quarterly report was being prepared.
17
There were no significant changes in the Company's internal controls or, to
the knowledge of the Company's chief operating officer and chief financial
officer, in other factors that could significantly affect the Company's
disclosure controls and procedures subsequent to the Evaluation Date.
18
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
None.
Item 2. Changes in Securities and Use of Proceeds.
None.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information.
None.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits.
Exhibits required by Item 601 of Regulation S-K.
3(a) Restated Certificate of Incorporation (incorporated by reference
to Exhibit No. 3C to Amendment No. 1 to the Company's
Registration Statement No. 33-9188 on Form S-1 Filed on
November 7, 1986.
(b) Restated By-laws (incorporated by reference to Exhibit 3D to
Amendment No. 1 to the Company's Registration Statement
No. 33-9188 on Form S-1 filed on November 7, 1986.
4 Instruments defining the rights of security holders, including
indentures - N/A.
5 Opinion re legality - N/A.
10(a) Management Agreement dated as of September 29, 1986 by and among
Merchants Mutual Insurance Company, Registrant and Merchants
Insurance Company of New Hampshire, Inc. (incorporated by
reference to Exhibit No. 10a to the Company's Registration
Statement (No. 33-9188) on Form S-1 filed on September 30,
1986).
(b) Services Agreement Among Merchants Mutual Insurance Company,
Merchants Insurance Company of New Hampshire, Inc. and Merchants
Group, Inc. dated January 1, 2003 (filed herewith)
19
(c) Reinsurance Pooling Agreement between Merchants Insurance
Company of New Hampshire, Inc. and Merchants Mutual Insurance
Company effective January 1, 2003 (filed herewith).
(d) Agreement of Reinsurance No. 6922 between Merchants Mutual
Insurance Company, Merchants Insurance Company of New Hampshire,
Inc. and General Reinsurance Corporation (incorporated by
reference to Exhibit No. 10e to the Company's Registration
Statement (No. 33-9188) on Form S-1 filed on September 30,
1986).
(e) Agreement of Reinsurance No. 7299 between Merchants Mutual
Insurance Company, Merchants Insurance Company of New Hampshire,
Inc. and General Reinsurance Corporation, (incorporated by
reference to Exhibit No. 10o to the Company's 1987 Annual Report
on Form 10-K (File No. 1-9640) filed on March 19, 1988).
(f) Agreement of Reinsurance dated January 27, 1993, between
Merchants Mutual Insurance Company and Merchants Insurance
Company of New Hampshire, Inc. (incorporated by reference to
Exhibit (3) in the Company's Current Report on Form 8-K (File
No. 1-9640) filed on January 29, 1993).
(g) Agreement of Reinsurance No. 8009 between Merchants Mutual
Insurance Company, Merchants Insurance Company of New Hampshire,
Inc. and General Reinsurance Corporation, (incorporated by
reference to Exhibit 10e to the Company's 1995 Annual Report on
Form 10-K filed on March 28, 1996).
(h) Casualty Excess of Loss Reinsurance Agreement between Merchants
Mutual Insurance Company, Merchants Insurance Company of New
Hampshire, Inc. and American Reinsurance Company (incorporated
by reference to Exhibit 10(f) to the Company's 2002 Annual
Report on Form 10-K filed on March 31, 2002).
(i) Property Per Risk Excess of Loss Reinsurance Agreement between
Merchants Mutual Insurance Company, Merchants Insurance Company
of New Hampshire, Inc. and American Reinsurance Company
(incorporated by reference to Exhibit 10(g) to the Company's
2002 Annual Report on Form 10-K filed on March 31, 2002).
(j) Property Catastrophe Excess of Loss Reinsurance Agreement
between Merchants Mutual Insurance Company, Merchants Insurance
Company of New Hampshire, Inc. and The Subscribing Reinsurers
Executing the Interest and Liabilities Agreements Attached
Hereto, effective January 1, 2002 (incorporated by reference to
Exhibit 10g to the Company's 2002 Quarterly Report on Form 10-Q
filed on November 8, 2002).
(k) Quota Share Reinsurance Treaty Agreement between Merchants
Insurance Company of New Hampshire, Inc. and The Subscribing
Underwriting Members of Lloyd's, London specifically identified
on the schedules attached to this agreement dated January 1,
2000 (incorporated by
20
reference to Exhibit 10h to the Company's 2000 Annual Report on
Form 10-K filed on March 28, 2001).
*(l) Merchants Mutual Capital Accumulation Plan (incorporated by
reference to Exhibit No. 10g to the Company's Registration
Statement (No. 33-9188) on Form S-1 filed on September 30,
1986).
*(m) Merchants Mutual Capital Accumulation Plan, fifth amendment,
effective January 1, 1999 (incorporated by reference to Exhibit
10j to the Company's 2000 Annual Report on Form 10-K filed on
March 28, 2001).
*(n) Merchants Mutual Capital Accumulation Plan Trust Agreement
(restated as of January 1, 1996 (incorporated by reference to
Exhibit 10(i) to the Company's 1996 Annual Report on Form 10-K
(File No. 1-9640) filed on March 28, 1997).
*(o) Merchants Mutual Supplemental Executive Retirement Plan dated as
of December 29, 1989 and Agreement of Trust dated as of December
29, 1989 (incorporated by reference to Exhibit No. 10k to the
Company's 1989 Annual Report on Form 10-K (File No. 1-9640)
filed on March 21, 1990).
*(p) Amendment dated June 10, 1992 to Agreement of Trust under
Merchants Mutual Supplemental Executive Retirement Plan dated as
of December 29, 1989 (incorporated by reference to Exhibit No.
10r to the Company's 1992 Annual Report on Form 10-K (File No.
1-9640) filed on March 31, 1993).
*(q) Merchants Group, Inc. 1986 Stock Option Plan As Amended Through
February 16, 1993 (incorporated by reference to Exhibit No. 10e
to the Company's 1992 Annual Report on Form 10-K (File No.
1-9640) filed on March 31, 1993).
*(r) Form of Amended Indemnification Agreement entered into by
Registrant with each director and executive officer of
Registrant (incorporated by reference to Exhibit No. 10n to
Amendment No. 1 to the Company's Registration Statement on (No.
33-9188) Form S-1 filed on November 7, 1986).
*(s) Merchants Mutual Insurance Company Adjusted Return on Equity
Incentive Compensation Plan January 1, 2000 (incorporated by
reference to Exhibit 10p to the Company's 2000 Annual Report on
Form 10-K filed on March 28, 2001).
*(t) Merchants Mutual Insurance Company Adjusted Return on Equity
Long Term Incentive Compensation Plan January 1, 2000
(incorporated by reference to Exhibit 10q to the Company's 2000
Annual Report on Form 10-K filed on March 28, 2001).
*(u) Amendment No. 1 to Employee Retention Agreement between Robert
M. Zak and Merchants Mutual Insurance Company originally dated
as of May 1, 1999, dated February 6, 2002 (incorporated by
reference to Exhibit 10(s) to the Company's 2002 Annual Report
on Form 10-K filed on March 31, 2003).
21
*(v) Amendment No. 1 to Employee Retention Agreement between Edward
M. Murphy and Merchants Mutual Insurance Company originally
dated as of March 1, 1999, dated February 6, 2002 (incorporated
by reference to Exhibit 10(t) to the Company's 2002 Annual
Report on Form 10-K filed on March 31, 2003).
*(w) Amendment No. 1 to Employee Retention Agreement between Kenneth
J. Wilson and Merchants Mutual Insurance Company originally
dated as of March 1, 1999, dated February 6, 2002 incorporated
by reference to Exhibit 10(u) to the Company's 2002 Annual
Report on Form 10-K filed on March 31, 2003.
*(x) Consulting Agreement between Stephen C. June and Merchants
Insurance Company of New Hampshire, Inc. dated as of May 7, 2001
(incorporated by reference to Exhibit 10t to the Company's 2001
Annual Report on Form 10-K filed on March 21, 2002).
*(y) Employment Agreement between Stephen C. June and Merchants
Insurance Company of New Hampshire, Inc. dated as of April 1,
2002 (incorporated by reference to Exhibit 10u to the Company's
2001 Annual Report on Form 10-K filed on March 21, 2002).
11 Statement re computation of per share earnings - N/A.
12 Statement re computation of ratios - N/A.
15 Letter re unaudited interim financial information - N/A.
18 Letter re change in accounting principles - N/A.
19 Report furnished to security holder - N/A.
22 Published report regarding matters submitted to vote of security
holders - N/A.
23 Consents of experts and counsel - N/A.
24 Power of attorney - N/A.
99(a) Certification Pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002 (Subsections (a) and (b) of Section 1350, Chapter 63 of
Title 18, United States Code) (filed herewith).
* Indicates a management contract or compensation plan or arrangement.
(b) Reports on Form 8-K.
22
On March 7, 2003, the Company filed a Form 8-K reporting that it reached an
agreement in principle with Merchants Mutual Insurance Company whereby Merchants
Mutual Insurance Company would continue to provide management services to the
Company for the Company's traditional insurance business and to pool the
insurance business traditionally written by each company.
SIGNATURES
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.
MERCHANTS GROUP, INC.
(Registrant)
Date: May 13, 2003 By: /s/ Kenneth J. Wilson
------------------------------
Kenneth J. Wilson
Chief Financial Officer and
Treasurer (duly authorized
officer of the registrant and
chief accounting officer)
23
CERTIFICATIONS
I, Robert M. Zak, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Merchants Group,
Inc.
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statement made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by the report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a. designed such disclosure controls and procedures 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 periodic
reports are 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 report (the Evaluation Date); and
c. presented in this report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditor 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
24
6. The registrant's other certifying officers and I have indicated in this
report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: May 13, 2003 By:/s/ Robert M. Zak
-------------------------------------
Robert M. Zak, Senior Vice President
and Chief Operating Officer
(Chief Executive Officer)
25
CERTIFICATIONS
I, Kenneth J. Wilson, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Merchants Group,
Inc.
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statement made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by the report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a. designed such disclosure controls and procedures 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 periodic
reports are 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 report (the Evaluation Date); and
c. presented in this report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditor 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
26
6. The registrant's other certifying officers and I have indicated in this
report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: May 13, 2003 By:/s/ Kenneth J. Wilson
-------------------------------------
Kenneth J. Wilson, Vice President and
Chief Financial Officer
(Chief Financial Officer)
27