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
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ________ TO ________.
COMMISSION FILE NUMBER 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 by checkmark whether the registrant is an accelerated filer (as defined
in Rule 12b-2 of the Act). [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of April 30, 2004: 2,114,152 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,
2003 2004
-------- --------
(unaudited)
Assets
Investments:
Fixed maturities:
Available for sale at fair value (amortized cost
$192,315 in 2003 and $202,639 in 2004) 193,805 205,648
Preferred stock at fair value 5,797 5,707
Other long-term investments at fair value 2,167 2,167
Short-term investments 1,118 2,994
-------- --------
Total investments 202,887 216,516
Cash 23 4
Interest due and accrued 1,260 1,258
Premiums receivable, net of allowance for doubtful
accounts of $278 in 2003 and $299 in 2004 16,677 14,766
Deferred policy acquisition costs 8,623 7,332
Reinsurance recoverable on paid and unpaid losses 22,715 20,291
Prepaid reinsurance premiums 3,066 3,759
Income taxes receivable 881 614
Deferred income taxes 4,497 3,976
Other assets 11,637 11,975
-------- --------
Total assets $272,266 $280,491
======== ========
See Notes to the Consolidated Financial Statements
2
MERCHANTS GROUP, INC.
CONSOLIDATED BALANCE SHEET
(in thousands except share amounts)
December 31, March 31,
2003 2004
--------- ---------
(unaudited)
Liabilities and Stockholders' Equity
Liabilities:
Reserve for losses and loss adjustment expenses $ 146,474 $ 141,312
Unearned premiums 36,176 31,930
Payable to affiliate 2,090 9,406
Payable for securities - 10,839
Other liabilities 17,267 15,132
--------- ---------
Total liabilities 202,007 208,619
--------- ---------
Stockholders' equity:
Common stock, 10,000,000 shares authorized, 2,110,152
shares issued and outstanding at December 31, 2003
and 2,114,152 shares issued and outstanding at
March 31, 2004 32 33
Additional paid in capital 35,795 35,878
Treasury stock, 1,139,700 shares at December 31, 2003
and March 31, 2004 (22,766) (22,766)
Accumulated other comprehensive income 750 1,679
Accumulated earnings 56,448 57,048
--------- ---------
Total stockholders' equity 70,259 71,872
--------- ---------
Commitments and contingent liabilities - -
Total liabilities and stockholders' equity $ 272,266 $ 280,491
========= =========
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,
2003 2004
------- -------
(unaudited)
Revenues:
Net premiums earned $16,141 $14,069
Net investment income 2,331 2,054
Net realized investment gains 116 377
Other revenues 33 166
------- -------
Total revenues 18,621 16,666
------- -------
Expenses:
Net losses and loss adjustment expenses 12,917 10,089
Amortization of deferred policy acquisition costs 4,206 3,658
Other underwriting expenses 1,177 1,789
------- -------
Total expenses 18,300 15,536
------- -------
Income before income taxes 321 1,130
Income tax provision 105 319
------- -------
Net income $ 216 $ 811
======= =======
Basic and diluted earnings per share $ .10 $ .38
======= =======
Weighted average shares outstanding:
Basic 2,110 2,112
Diluted 2,113 2,116
See Notes to the Consolidated Financial Statements
4
MERCHANTS GROUP, INC.
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(in thousands)
Three Months
Ended March 31,
2003 2004
------- -------
(unaudited)
Net income $ 216 $ 811
------- -------
Other comprehensive income (loss) before taxes:
Unrealized gains (losses) on securities (751) 1,784
Reclassification adjustment
for gains included in net income (116) (377)
------- -------
Other comprehensive income (loss) before taxes (867) 1,407
Income taxes (benefit) related to items
of other comprehensive income (loss) (335) 478
------- -------
Other comprehensive income (loss) (532) 929
------- -------
Comprehensive income (loss) $ (316) $ 1,740
======= =======
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,
2003 2004
-------- --------
(unaudited)
Common stock:
Beginning of period $ 32 $ 32
Exercise of common stock options - 1
-------- --------
End of period 32 33
-------- --------
Additional paid in capital:
Beginning of period 35,795 35,795
Exercise of common stock options - 83
-------- --------
End of period 35,795 35,878
-------- --------
Treasury stock beginning and end: (22,766) (22,766)
-------- --------
Accumulated other comprehensive income (loss):
Beginning of period 1,937 750
Other comprehensive income (loss) (532) 929
-------- --------
End of period 1,405 1,679
-------- --------
Accumulated earnings:
Beginning of period 52,926 56,448
Net income 216 811
Cash dividends (210) (211)
-------- --------
End of period 52,932 57,048
-------- --------
Total stockholders' equity $ 67,398 $ 71,872
======== ========
See Notes to the Consolidated Financial Statements
6
MERCHANTS GROUP, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(in thousands)
Three Months
Ended March 31,
2003 2004
-------- --------
(unaudited)
Cash flows from operations:
Collection of premiums $ 12,852 $ 11,222
Payment of losses and loss adjustment expenses (14,162) (14,256)
Payment of other underwriting expenses (6,959) (6,274)
Investment income received 2,372 2,115
Investment expenses paid (74) (73)
Income taxes paid (145) (10)
Other 33 166
-------- --------
Net cash used in operations (6,083) (7,110)
-------- --------
Cash flows from investing activities:
Proceeds from fixed maturities sold or matured 34,066 8,330
Purchase of fixed maturities (30,903) (18,284)
Net decrease in preferred stock 1,500 -
Net increase in other long-term investments (30) -
Net (increase) decrease in short-term investments 1,420 (1,876)
Increase in payable for securities - 10,839
Decrease in receivable for securities - 893
-------- --------
Net cash provided by investing activities 6,053 (98)
-------- --------
Cash flows from financing activities:
Settlement of affiliate balances 237 7,316
Exercise of common stock options - 84
Cash dividends (210) (211)
-------- --------
Net cash provided by financing activities 27 7,189
-------- --------
Decrease in cash (3) (19)
Cash:
Beginning of period 9 23
-------- --------
End of period $ 6 $ 4
======== ========
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,
2003 2004
------- -------
(unaudited)
Net income $ 216 $ 811
Adjustments:
Amortization (accretion), net 12 (14)
Realized investment gains (116) (377)
(Increase) decrease in assets:
Interest due and accrued (45) 2
Premiums receivable (1,997) 1,911
Deferred policy acquisition costs 284 1,291
Ceded reinsurance balances receivable 4 2,424
Prepaid reinsurance premiums 171 (693)
Income taxes receivable - 267
Deferred income taxes 24 42
Other assets (252) (1,231)
Increase (decrease) in liabilities:
Reserve for losses and loss adjustment expenses (1,156) (5,162)
Unearned premiums (1,465) (4,246)
Other liabilities (1,763) (2,135)
------- -------
Net cash used in operations $(6,083) $(7,110)
======= =======
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, 2004 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, 2003 and 2004,
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, 2003.
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, 2004, 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, 2003.
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. For diluted earnings per share, the weighted average number of shares
outstanding was increased by the assumed exercise of options for 31,500 and
35,500 shares of common stock in the three month periods ending March 31, 2004
and 2003, respectively, which would have resulted in 4,859 and 2,745 additional
shares outstanding for the three month periods ending March 31, 2004 and 2003,
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, 2004 As Compared to
the Three Months Ended March 31, 2003
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, 2004 were $16,666,000, a
decrease of $1,955,000 or 10% from $18,621,000 for the three months ended March
31, 2003.
Results of operations for the three months ended March 31, 2004 and 2003 reflect
the effects of the Services Agreement and the Reinsurance Pooling Agreement
among 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 2004 in
accordance with the Reinsurance Pooling Agreement is 35%. MMH's share of pooled
premiums earned and losses and LAE was 40% in 2003. The Reinsurance Pooling
Agreement pertains to premiums earned and incurred losses and LAE. Direct
premiums written by MNH and Mutual are not pooled.
Total combined Mutual and MNH or "group-wide" direct premiums written (DWP) for
the three months ended March 31, 2004 were $45,103,000, an increase of
$4,349,000 or 11% from $40,754,000 in 2003. The Company's pro-forma share of
combined direct premiums written in 2004, in accordance with the Reinsurance
Pooling Agreement, was $15,786,000 compared to $16,302,000 in 2003. The table
below shows a comparison of direct premiums written by major category in 2004
and 2003:
Group-wide DWP MNH Pro-forma Share
-------------- -------------------
Three months ended Three months ended
March 31, March 31,
-------- ---------
2004 2003 Variance 2004 2003 Variance
---- ---- -------- ---- ---- --------
(000's omitted) (000's omitted)
Voluntary Personal Lines $12,556 $15,212 (17%) $ 4,395 $ 6,085 (28%)
Voluntary Commercial Lines 31,662 23,682 34% 11,082 9,473 17%
Involuntary 885 1,860 (52%) 309 744 (58%)
------- ------- ------- -------
Total Direct Written Premiums $45,103 $40,754 11% $15,786 $16,302 (3%)
======= ======= ======= =======
The 17% decrease in group-wide voluntary personal lines direct premiums written
resulted from a 21% decrease in private passenger automobile (PPA) direct
premiums written and a 5% decrease in homeowners direct premiums written. The
decrease in PPA direct premiums written is the result of the companies' policy,
implemented in 2002, not to write new policies in certain jurisdictions and of
the approval of the
11
companies' plan to withdraw from the New Jersey PPA market by the New Jersey
Department of Banking and Insurance which was effective in June 2003. As a
result, voluntary PPA policies in force at March 31, 2004 were 26,438, a
decrease of 7,159, or 21%, from 33,597 at March 31, 2003.
Group-wide voluntary commercial lines direct premiums written increased
$7,980,000 or 34% to $31,662,000 for the three months ended March 31, 2004, from
$23,682,000 for the three months ended March 31, 2003. Approximately 60% of this
increase ($4,800,000) resulted from a monoline commercial umbrella program
introduced by Mutual in the fourth quarter of 2003 (the Umbrella Program). The
Umbrella Program is marketed exclusively through one independent agent and
approximately 95% of the premiums related to these policies are reinsured with
an "A+" rated national reinsurer through a quota share reinsurance treaty. There
were no similar direct premiums written in the three months ended March 31, 2003
as the program was initiated during the fourth quarter of 2003.
The remainder of the increase in commercial lines direct premiums written
resulted from period to period increases in every group-wide commercial line of
business. The average premium per group-wide, non-Umbrella Program commercial
lines policy increased 9% from the year earlier period while total non-Umbrella
Program commercial lines policies in force at March 31, 2004 were 31,309,
substantially unchanged from 31,322 at March 31, 2003.
The 52% decrease in group-wide involuntary written premiums, which consist
primarily of involuntary PPA insurance, resulted primarily from a decrease in
group-wide assignments from the New York Automobile Insurance Plan (NYAIP).
NYAIP assignments decreased to $623,000 for the three months ended March 31,
2004 compared to $1,389,000 for the three months ended March 31, 2003. The NYAIP
provides coverage for individuals who are unable to obtain auto insurance in the
voluntary market. Assignments from the NYAIP vary depending upon a company's PPA
market share and the size of the NYAIP. The Company is unable to predict the
volume of future assignments from the NYAIP.
In order to minimize the adverse impact of assignments from the NYAIP, the
Company purchased territorial credits from an unaffiliated insurance company
pursuant to Section 6.A.7. of the NYAIP Manual. The credits against NYAIP
assignments were generated by the other insurance company for writing PPA
business in certain localities in New York with PPA market availability
problems. The other insurance company, by nature of its concentration in PPA
business in "credit" territories, generated more credits than it required to
offset its NYAIP assignments. The credits purchased reduced the Company's share
of the NYAIP. The company believes that the costs of the credits purchased,
which are pooled in accordance with the Reinsurance Pooling Agreement, were
substantially less than the amount the Company would have lost had it written
the additional NYAIP business.
Group-wide total direct premiums written excluding the Umbrella Program
decreased 1% as compared to the year earlier period.
Group-wide pooled net premiums written for 2004 were $37,910,000, a decrease of
$448,000, or 1% from $38,358,000 for the three months ended March 31, 2003. This
decrease resulted from the 1% decrease in non-Umbrella Program group-wide direct
premiums written. The Company's share of 2004 pooled net premiums written was
$9,130,000, a decrease of $5,717,000, or 39%, from $14,847,000 in 2003.
12
The Company's share of pooled net premiums earned in accordance with the
Reinsurance Pooling Agreement for the three months ended March 31, 2004 was
$14,069,000, compared to $16,141,000 for the three months ended March 31, 2003.
This $2,072,000, or 13%, decrease in net premiums earned resulted primarily from
the 5 percentage point decrease in the Company's participation in the
Reinsurance Pooling Agreement.
Net investment income was $2,054,000 for the three months ended March 31, 2004,
a decrease of 12% from $2,331,000 for the three months ended March 31, 2003. The
average pre-tax yield on the investment portfolio decreased 39 basis points to
4.3% for the three months ended March 31, 2004 from the three months ended March
31, 2003. Average invested assets for the three months ended March 31, 2004 were
substantially unchanged from the year earlier period.
Net losses and LAE were $10,089,000 for the three months ended March 31, 2004, a
decrease of $2,828,000, or 22%, from $12,917,000 for the three months ended
March 31, 2003. The loss and LAE ratio decreased to 71.7% for the three months
ended March 31, 2004 from 80.0% for the three months ended March 31, 2003.
Approximately 7.3 percentage points of the decrease in the loss and LAE ratio
relates to an improvement in the loss and LAE ratio for the 2004 accident year
(losses occurring in the first quarter of 2004) compared to the 2003 accident
year (losses occurring in the first quarter of 2003).
The ratio of amortized deferred policy acquisition costs and other underwriting
expenses to net premiums earned increased to 38.7% for the three months ended
March 31, 2004 from 33.3% for the three months ended March 31, 2003. During 2004
the Company recorded as other underwriting expenses $116,000 of amortization of
NYAIP territorial credits (described above), compared to $7,000 in 2003. Other
underwriting expenses also included $344,000 (2.4 percentage points of the
expense ratio) of retrospective commissions related to the Reinsurance Pooling
Agreement. The commissions are owed to Mutual based on a decrease during the
first quarter of 2004 in the estimated cumulative loss and LAE ratio since the
inception of the Reinsurance Pooling Agreement, and primarily represent the
reversal of contingent commissions earned by MNH from Mutual during 2003. There
were no similar amounts either positive or negative, recorded in the first
quarter of 2003. Other underwriting expenses for 2004 also reflect the effect of
a May 2003 change in New York law, which increased the premium tax rate from
1.3% to 2.0%. The impact of this change on 2004 was approximately $68,000 and
added .5 percentage points to the Company's expense ratio. Commissions, premium
taxes and other state assessments that vary directly with the Company's premium
volume represented 18.7% of net premiums earned in the three months ended March
31, 2004 compared to 20.9% in the three months ended March 31, 2003.
The Company's effective income tax rates for the three months ended March 31,
2004 and 2003 were 28.2% and 32.7%, respectively. These rates were calculated
based upon the Company's estimates of the effective income tax rate for each
full year. The decrease in the effective income tax rate was primarily due to an
increase in tax exempt income as a percentage of pre-tax income.
13
Liquidity and Capital Resources
Historically, when 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. Due to
declining written premiums however, the Company's operating activities have
resulted in a use of cash each year since 2001. The Company's decreasing
participation percentage in the pooled business over the remaining years of the
Reinsurance Pooling Agreement will likely result in future 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 payments, are an additional source of
liquidity. Because the duration of the Company's investment portfolio is shorter
than the duration of its liabilities, 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, 2004, the Company
recorded as accumulated other comprehensive income in its Consolidated Balance
Sheet $1,679,000 of unrealized gains, net of taxes, associated with its
investments classified as available for sale.
At March 31, 2004, the Company's portfolio of fixed maturity investments
represented 95.0% of invested assets. Management believes that this level of
fixed maturity investments 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 fixed maturity investments are invested
in mortgage-backed and other asset-backed securities which, in addition to
interest income, provide monthly paydowns of bond principal.
At March 31, 2004 $126,576,000, or 61.6%, 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, 2004 $1,486,000, or .7%, of the Company's investment portfolio was
invested in non-investment grade securities compared to $3,992,000, or 2.0%, at
March 31, 2003.
14
The Company has arranged for a $2,000,000 unsecured credit facility from a bank.
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, 2004 no amount was
outstanding on this loan.
As a holding company, the Company is dependent on cash dividends from MNH to
meet its obligations and to pay any cash dividends. 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
2004 without the prior approval of the New Hampshire Insurance Commissioner is
$5,767,000. MNH paid $1,200,000 of dividends to the Company in 2003. Dividend
payments of $600,000 were made in April 2003 and November 2003. The Company paid
cash dividends to its common stockholders of $.10 per share in the first quarter
of 2004 amounting to $211,000. On May 5, 2004 the Company declared a quarterly
cash dividend of $.10 per share payable on June 4, 2004 to shareholders of
record as of the close of business on May 19, 2004.
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 2004, MNH's
ratio of net premiums written to statutory surplus, annualized for a full year,
was .6 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 Services
Agreement, Mutual provides the Company and MNH with all facilities and personnel
to operate their business. With the exception of the individual who serves as
President of the Company and the Chief Operating Officer of MNH, the only other
officers of the Company or MNH are employees of Mutual whose services are
provided to, and paid for by, the Company and MNH through the Services
Agreement. Also, the operation of MNH's insurance business, which offers
substantially the same lines of insurance as Mutual through the same independent
insurance agents, creates a very close relationship among the Companies.
15
"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. 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;
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 $216,516,000 at March 31, 2004 is subject to
changes in interest rates and to a lesser extent on credit quality. Further,
certain mortgage-backed and asset-backed securities are exposed to accelerated
prepayment risk generally caused by interest rate movements. If interest rates
were to decline, mortgage holders would be more likely to refinance existing
mortgages at lower rates. Acceleration of future repayments could adversely
affect future investment income, if reinvestment of the accelerated receipts was
made in lower yielding securities.
The following table provides information related to the Company's fixed maturity
investments at March 31, 2004. The table presents cash flows of principal
amounts and related weighted average interest rates by expected maturity dates.
The cash flows are based upon the maturity date or, in the case of
mortgage-backed and asset-backed securities, expected payment patterns. Actual
cash flows could differ from those shown in the table.
16
Fixed Maturities
Expected Cash Flows of Principal Amounts ($ in 000's):
TOTAL
Esti-
Amor- mated
There- tized Market
2004 2005 2006 2007 2008 after Cost Value
---- ---- ---- ---- ---- ----- ----- -----
Available for Sale
U.S. Treasury securities and
obligations of U.S.
Government corporations
and agencies $ 0 $ 5,142 $ 0 $ 0 $ 3,007 $ 0 $ 8,149 $ 8,411
Average interest rate 0.0% 3.9% 0.0% 0.0% 3.2% 0.0% --- ---
Obligations of states and
political subdivisions 1,399 8,494 9,632 3,889 15,151 4,985 43,550 43,963
Average interest rate 4.1% 3.2% 3.4% 4.3% 3.9% 4.2% --- ---
Corporate securities 2,169 18,631 0 0 3,237 2,037 26,074 26,698
Average interest rate 5.4% 4.3% 0.0% 0.0% 3.7% 4.8% --- ---
Mortgage & asset
backed securities 22,628 29,285 25,673 16,140 2,869 28,271 124,866 126,576
Average interest rate 5.1% 5.1% 5.1% 5.1% 5.2% 5.3% --- ---
-------- -------- -------- -------- -------- -------- -------- --------
Total $ 26,196 $ 61,552 $ 35,305 $ 20,029 $ 24,264 $ 35,293 $202,639 $205,648
======== ======== ======== ======== ======== ======== ======== ========
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 executive 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 the end of the period covered by this report,
concluded that 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.
There was no change in the Company's internal control over financial
reporting identified in connection with the evaluation required by paragraph (d)
of Rules 13a-15 or 15d-15 under the Securities Exchange Act of 1934 that
occurred during the Company's last fiscal quarter that has materially affected,
or is reasonably likely to materially affect, the Company's internal control
over financial reporting.
17
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 (incorporated by
reference to Exhibit No. 10b to the Company's 2003 Quarterly
Report on Form 10-Q filed on May 14, 2003).
18
(c) Reinsurance Pooling Agreement between Merchants Insurance
Company of New Hampshire, Inc. and Merchants Mutual Insurance
Company effective January 1, 2003 (incorporated by reference
to Exhibit No. 10c to the Company's 2003 Quarterly Report on
Form 10-Q filed on May 14, 2003).
(d) 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).
(e) Endorsement to the Casualty Excess of Loss Reinsurance
agreement between Merchants Mutual Insurance Company,
Merchants Insurance Company of New Hampshire, Inc. and
American Reinsurance Company dated September 29, 2003
(incorporated by reference to Exhibit 10 (f) to the Company's
2003 Quarterly Report on Form 10-Q filed on November 13,
2003).
(f) 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).
(g) Endorsement to the Property Per Risk Excess of Loss
Reinsurance Agreement between Merchants Mutual Insurance
Company, Merchants Insurance Company of New Hampshire, Inc.
and American Reinsurance Company dated September 24, 2003
(incorporated by reference to Exhibit 10(h) to the Company's
2003 Quarterly Report on Form 10-Q filed on November 13,
2003).
(h) Property Catastrophe Excess of Loss Reinsurance Agreement
between Merchants Mutual Insurance Company, Merchants
Insurance Company of New Hampshire, Inc. and the various
reinsurers as identified by the Interest and Liabilities
Agreements attaching to and forming part of this Agreement
(incorporated by reference to Exhibit 10(g) to the Company's
2003 Quarterly Report on Form 10-Q filed on November 13,
2003).
(i) 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 reference to Exhibit 10h to
the Company's 2000 Annual Report on Form 10-K filed on March
28, 2001).
(j) 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).
19
(k) 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).
*(l) 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).
*(m) 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).
*(n) 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).
*(o) 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).
*(p) 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).
*(q) 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.
*(r) 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 27,
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.
20
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.
31 Rule 13a-14(a)/15d-14(a) Certifications (filed herewith)
32(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.
On April 30, 2004, the Company filed a Form 8-K reporting the issuance of a
press release announcing results for the quarter ended March 31, 2004.
On May 6, 2004, the Company filed a Form 8-K reporting the issuance of a press
release announcing the declaration of the Company's regular quarterly common
stock dividend.
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 14, 2004 By:/s/ Kenneth J. Wilson
---------------------
Kenneth J. Wilson
Chief Financial Officer and
Treasurer (duly authorized
officer of the registrant and
chief accounting officer)
21