2001
annual
report
The
CGI
The Commerce Group, Inc.
211 Main Street, Webster, Massachusetts 01570
INDEX TO 2001 ANNUAL REPORT
Page
Financial Highlights............................................ 1
Letter to Stockholders.......................................... 2
Management's Discussion and Analysis of Financial Condition
and Results of Operations...................................... 5
Common Stock Price and Dividend Information..................... 32
Report of Management............................................ 33
Report of Independent Auditors.................................. 34
Consolidated Balance Sheets at December 31, 2001 and 2000....... 35
Consolidated Statements of Earnings for the Years Ended
December 31, 2001, 2000 and 1999............................... 36
Consolidated Statements of Stockholders' Equity for the Years
Ended December 31, 2001, 2000 and 1999......................... 37
Consolidated Statements of Cash Flows for the Years Ended
December 31, 2001, 2000 and 1999............................... 38
Consolidated Statements of Cash Flows - Reconciliation of Net
Earnings to Net Cash Provided by Operating Activities for the
Years Ended December 31, 2001, 2000 and 1999................... 39
Notes to Consolidated Financial Statements...................... 40
Selected Consolidated Financial Data............................ 69
Management's Discussion of the Supplemental Information on
Insurance Operations........................................... 70
Directors....................................................... 76
Officers........................................................ 80
Stockholder Information......................................... 82
FINANCIAL HIGHLIGHTS
(Dollars in Thousands, Except Per Share Amounts)
2001 2000 1999
Direct premiums written......................... $1,152,407 $1,071,649 $ 948,149
Net premiums written............................ $1,078,967 $1,008,911 $ 911,993
Earned premiums................................. $1,043,652 $ 954,483 $ 871,830
Net investment income........................... 99,611 96,830 89,789
Premium finance and service fees................ 17,819 15,227 14,774
Amortization of excess of book value of
subsidiary interest over cost................. 3,389 3,390 3,019
Net realized investment gains (losses).......... (10,633) 29,550 (16,378)
Total revenues............................. $1,153,838 $1,099,480 $ 963,034
Earnings before income taxes and minority
interest...................................... $ 115,425 $ 170,066 $ 104,284
Income taxes.................................... 23,194 38,306 16,667
Net earnings before minority interest........... 92,231 131,760 87,617
Minority interest in net loss of subsidiary..... 863 320 1,059
Net earnings............................... $ 93,094 $ 132,080 $ 88,676
Comprehensive income............................ $ 93,655 $ 168,570 $ 40,730
Net earnings per common share:
Basic......................................... $ 2.77 $ 3.87 $ 2.54
Diluted....................................... $ 2.75 $ 3.87 $ 2.54
Operating earnings (1).......................... $ 98,880 $ 109,631 $ 97,411
Operating earnings per share (1)
Basic......................................... $ 2.94 $ 3.21 $ 2.79
Diluted....................................... $ 2.93 $ 3.21 $ 2.79
Cash dividends paid per share................... $ 1.19 $ 1.15 $ 1.11
Weighted average number of common shares
outstanding:
Basic....................................... 33,608,804 34,121,047 34,940,074
Diluted..................................... 33,794,938 34,121,047 34,940,074
Total investments at market value
and equity value.............................. $1,498,201 $1,472,562 $1,295,995
Total assets.................................... $2,140,082 $2,075,614 $1,878,019
Total liabilities............................... $1,327,808 $1,292,665 $1,208,650
Minority interest............................... - $ 1,068 $ 1,364
Total stockholders' equity...................... $ 812,274 $ 781,881 $ 668,005
Total stockholders' equity per share............ $ 24.52 $ 23.16 $ 19.44
Certain statutory financial ratios (unaudited):
Loss and LAE ratio............................ 74.7% 71.7% 72.0%
Underwriting expense ratio.................... 24.4 25.1 26.5
Combined ratio............................. 99.1% 96.8% 98.5%
Net premiums written to policyholders'
surplus..................................... 150.7% 152.6% 175.7%
(1) The above figures are presented to provide information to the reader due to the amount
of, and fluctuations in, net realized gains and (losses). The amounts noted, which
exclude the after-tax impact of net realized investment gains (losses), are important
measures of corporate performance.
1
THE COMMERCE GROUP, INC.
March 23, 2002
To Our Stockholders:
In 2001, your Company experienced satisfactory financial results for
the 26th consecutive year. From the very first day the funding of The
Commerce Insurance Company was accomplished (April 3, 1972) through
December 31, 2001, we have achieved underwriting profit of $293.4 million
on total premiums written of $10.0 billion. This underwriting profit
represents 2.9% of total premiums written.
In October 2001, the 2002 personal automobile insurance rate decision
was announced by the Massachusetts Insurance Commissioner. Despite the
industry's request for a 7.8% increase, 2002 rates are to remain unchanged
from 2001 rates. Although most companies, including yours, continued to
modify safe driver deviations in response to the 2002 rate decision, the
Massachusetts marketplace remains highly competitive. Throughout these
ongoing competitive times, your Company's share of the Massachusetts
personal automobile market has continued to grow, and at year-end, our
market share was 23.3% up from 22.3% in 2000.
In 2001, direct premiums written in Massachusetts and earned premiums
countrywide surpassed $1 billion for the first time in our history. Your
Company will continue to pursue the goals of growing and expanding
geographically beyond the borders of Massachusetts. In furtherance of this
goal, direct premiums written outside of Massachusetts now represents 12.4%
of our total business as compared to 11.3% in 2000.
Your Company has continued to grow and prosper. The Commerce
Insurance Company continues to be the largest writer of Massachusetts
private passenger automobile insurance, the second largest writer of
Massachusetts homeowners insurance, as well as the third largest writer of
Massachusetts commercial automobile insurance. The combined insurance
companies were also ranked as the 26th largest personal automobile
insurance group in the country by A.M. Best Co., based on the most recently
available direct premium written information. Additionally, I am very
pleased to report that your Company again received a group rating of A+
(Superior) from A.M. Best Co.
Net earnings, written premiums, earned premiums, investment income,
total assets, total stockholders' equity and total stockholders' equity per
share, as illustrated in the bar graph on the facing page, are all at new
highs. For those of you who are interested in the details, I draw your
attention to the pages in this report labeled "Management's Discussion and
Analysis of Financial Condition and Results of Operations". Behind these
numbers are an extremely dedicated group of people: Our policyholders
(represented by over 1,042,000 policies in force); Agents (1,236);
Employees (1,780); Officers (43); Commerce Group Directors (17); and, of
course, our Stockholders (over 5,000, including our Employee Stock
Ownership Plan Participants who now number 1,904).
Property-liability insurance remains a good business to be in and The
Commerce Group, Inc. will continue its efforts to be one of the most
profitable long-term players. Your Company's management continues to
believe that owners' interests are its primary constituency.
2
Our sincere thanks to those who have helped in this building process
especially our Agents, Employees, Officers and Board of Directors. This
diverse force of committed, ethical and hard working people will continue
to build on our past successes and look to the future with excitement and
opportunity. Their individual ingenuity, enthusiasm, dedication and
professionalism will continue to serve our stockholders well.
Your comments or questions regarding this report, or The Commerce
Group, Inc. affairs in general, are solicited as always, at any time.
Arthur J. Remillard, Jr.
President, Chief Executive Officer
and Chairman of the Board
Caring in everything we do.
3
The bar graph on page 3 illustrates the Company's annual total
stockholders' equity per share value and annual total stockholders' equity
per share value including cumulative cash dividends paid per share through
each December 31, year-end, over the most recent fifteen year period. The
X-axis lists the years beginning with 1987 through 2001. The Y-axis lists
the dollar values starting at $0.00 and increasing in one-dollar increments
to $32.00. The graph depicts a total stockholders' equity per share value
in 1987 of $1.40, 1988 of $1.95, 1989 of $2.53, 1990 of $3.36, 1991 of
$4.80, 1992 of $7.42, 1993 of $10.09, 1994 of $10.88, 1995 of $14.96, 1996
of $16.28, 1997 of $18.11, 1998 of $19.72, 1999 of $19.44, 2000 of $23.16,
and 2001 of $24.52. The graph also depicts the total stockholders' equity
per share value adjusted to include cumulative dividends paid per share.
The total of these amount to the per share value in 1987 of $1.40, 1988 of
$1.95, 1989 of $2.53, 1990 of $3.36, 1991 of $4.80, 1992 of $7.42, 1993 of
$10.09, 1994 of $11.03, 1995 of $15.34, 1996 of $17.47, 1997 of $20.33,
1998 of $23.01, 1999 of $23.84, 2000 of $28.71, and 2001 of $31.26.
4
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Thousands of Dollars Except Per Share Data)
General
The property and casualty insurance industry continues to remain
highly competitive and inherently volatile in nature. Property and
casualty insurance company results have traditionally been impacted by the
typical forces unique to the industry such as competi-tion, frequency and
severity of losses, the overall economy and the general regulatory
environment in those states in which the insurer operates. Additional
forces are impacting the industry in the form of deregulation, on-line
commerce, price competition, empowered customers and technological
advancement. The terrorists' attacks of September 11 have had a
significant impact on the insurance industry. According to A.M. Best Co.
("A.M. Best"), "the unprecedented events of September 11 have forever
changed the way the insurance industry defines risk. Both property and
liability lines have been exposed to catastrophic risks that cannot be
priced using traditional actuarial methods". A.M. Best goes on to state,
"Against the backdrop of weak financial trends, this new risk environment
has accelerated the hardening of the U.S. property/casualty market".
Given this increased risk environment, A.M. Best "expects to see a renewed
flight to quality that will benefit financially strong insurers". The
financial losses due to this tragedy were significant to the insurance
industry, however, due to the limited exposure that the Company has
outside of Massachusetts, management believes the direct financial impact
to the Company will not be material. Additionally, price competition
remains quite heavy in many areas of the country, although it has improved
in 2001 among independent agency companies in Massachusetts. Beyond
Massachusetts, industry-underwriting results are expected to continue to
deteriorate in the near future which further emphasizes the importance of
competitive advantages gained by affinity marketing and efficient
operations. With these issues on the forefront, The Commerce Group, Inc.
("Company") continues to position itself to respond to the prevailing
forces and conditions in the market. The Company has utilized its strong
agency relationships, a low-cost structure, affinity group alliances and a
1999 joint-venture acquisition all in an effort to keep the Company
responsive in today's competitive environment.
The Company, incorporated in 1976, is a holding company for several
property and casualty insurers, which, through these insurance
subsidiaries, offers predominantly private passenger motor vehicle
insurance along with a broad range of other property and casualty
insurance products. These products are marketed to affinity groups,
individuals, families and businesses through the Company's strong
relationships with professional independent insurance agencies. The
Company writes insurance primarily in the State of Massachusetts through
The Commerce Insurance Company ("Commerce") and Citation Insurance Company
("Citation"), both wholly-owned subsidiaries of Commerce Holdings, Inc.
("CHI").
Additionally, the Company writes insurance in the States of
California and Oregon through Commerce West Insurance Company ("Commerce
West"), a wholly-owned subsidiary of Commerce, located in Pleasanton,
California. The Company also writes insurance through American Commerce
Insurance Company ("American Commerce"), which it acquired in January
1999. Located in Columbus, Ohio, American Commerce is a wholly-owned
subsidiary of ACIC Holding Co., Inc., with policies in 26 states and
licenses in several others.
In November 1998, Commerce formed ACIC Holding Co., Inc., in a joint
venture with AAA Southern New England ("AAA SNE") and invested $90,800 to
fund the January 29, 1999 acquisi-tion of the Automobile Club Insurance
Company whose name was changed to American Commerce upon completion of the
acquisition. Commerce invested $90,000 in the form of preferred stock and
an additional $800 representing an 80% common stock ownership. AAA SNE
invested $200 representing a 20% common stock ownership. The terms of the
preferred stock call for Commerce to receive quarterly cash dividends at
the rate of 10% per annum from ACIC Holding Co., Inc. In the event cash
dividends cannot be paid, additional preferred stock will be issued.
Since the January 29, 1999 acquisition, ACIC Holding Co., Inc. and
American Commerce's results have been consolidated into the Company's
financial statements. Since 1995, Commerce has maintained an affinity
group marketing relationship with AAA Insurance Agency, Inc., a subsidiary
of AAA SNE. AAA Insurance Agency, Inc. has been a licensed insurance
agent of Commerce since 1985.
5
The Company's business strategy remains focused on activities
primarily related to personal automobile insurance. The Company has been
the largest writer of personal property and casualty insurance in the
State of Massachusetts in terms of market share of direct premiums written
since 1990. The Company's share of the Massachusetts personal automobile
market increased to 23.3% in 2001, as exhibited in the table below,
exceeding our nearest competitor, which maintains a 10.8% market share.
Growth of Massachusetts Personal Automobile
Insured Vehicles
Commerce Year-End
Year Industry Commerce Market Share
2001 1.7% 6.1% 23.3%
2000 1.9% 6.5% 22.3%
1999 2.0% 0.6% 21.3%
As mentioned, the Company predominantly writes private passenger
automobile insurance. The following tables indicate that direct premiums
written for private passenger automobile, commercial automobile and
homeowners represented 85.2%, 5.2% and 8.0%, respectively, of the Company's
total direct premiums written in 2001, as compared to 86.9%, 4.0% and 7.7%,
re-spectively, in 2000. Total direct premiums written increased $80,758 or
7.5% in 2001 over 2000. The 2001 increase was primarily attributable to a
$32,742 or 4.0% increase in Massachusetts private passenger automobile
direct premiums written. This was the result of a 5.8% increase in written
exposures offset by a decrease of 1.9% in average premiums per exposure.
Private passenger premiums written for all other states increased $18,824
or 18.2%, primarily attributable to an increase in American Commerce
premiums of $7,319 or 9.4%, coupled with an increase of $11,505 or 44.5%
additional premiums from Commerce West.
Direct Premiums Written, Year Ended December 31, 2001
Massachusetts All Other States Total % of Total
Personal Automobile...... $ 859,922 $ 122,320 $ 982,242 85.2%
Commercial Automobile.... 58,088 1,514 59,602 5.2
Homeowners............... 73,254 18,710 91,964 8.0
Other Lines.............. 17,885 714 18,599 1.6
Total........... $1,009,149 $ 143,258 $1,152,407 100.0%
Direct Premiums Written, Year Ended December 31, 2000
Massachusetts All Other States Total % of Total
Personal Automobile...... $ 827,180 $ 103,496 $ 930,676 86.9%
Commercial Automobile.... 43,243 104 43,347 4.0
Homeowners............... 65,662 16,498 82,160 7.7
Other Lines.............. 14,860 606 15,466 1.4
Total........... $ 950,945 $ 120,704 $1,071,649 100.0%
Massachusetts Automobile Business
In Massachusetts, private passenger automobile insurance is subject to
extensive regulation. Owners of registered automobiles are generally
required to maintain certain minimum automobile insurance coverages. With
very limited exceptions, automobile insurers are required by law to issue a
policy to any applicant seeking to obtain such coverages. Companies in
Massachusetts are also assigned agents, known as Exclusive Representative
Producers ("ERPs"), based primarily on market share, that have been unable
to obtain a voluntary contract with an insurance carrier. Marketing and
underwriting strategies for companies operating in Massachusetts are
limited by maximum premium rates and minimum agency commission levels for
personal automobile insurance, both of which are mandated by the
6
Massachusetts Commissioner of Insurance ("Commissioner"). In
Massachusetts, accident rates, bodily injury claims, and medical care costs
continue to be among the highest in the nation. According to the
Automobile Insurers Bureau of Massachusetts ("A.I.B."), Massachusetts "has
higher than average medical costs and liability claims involving
attorneys". According to the A.I.B., Massachusetts personal automobile
premium per policy, based on 1999 premium information, was 5th highest in
the nation.
During the three-year period from 1999 to 2001, average mandated
Massachusetts personal automobile insurance premium rates decreased an
average of 2.3% per year. The Commissioner approved no rate change in
personal automobile premiums for 2002, as compared to an average rate
decrease of 8.3% in 2001. Coinciding with the 2002 rate decision, the
Commissioner also approved no change in the commission rate agents receive
for selling private passenger automobile insurance from 12.3% in 2001.
State Mandated
Average Commerce Average Rate
Year Rate Change Change Per Exposure
2002 0.0% 5.0%(Estimated)
2001 (8.3%) (1.9%)
2000 0.7% 6.2%
1999 0.7% 9.1%
Although average mandated personal automobile premium rates decreased
8.3% in 2001, the Company's average rate decreased 1.9% per exposure. The
1.9% decrease for 2001 was primarily the result of the state mandated
average rate decrease offset by decreases in the Safe Driver Insurance Plan
("SDIP") deviations for Step 9 and Step 10 drivers, the two best driver
SDIP classifications in Massachusetts. The smaller Company decrease was
also due to the facts that the rate decision did not anticipate purchases
of new automobiles in the year to which the rate decision applied and,
secondly, the Company's mix of personal automobile business differs from
that of the industry.
The 1999 average rate decision was partially driven by corrections for
an industry error that had impacted prior year rate decisions. The
industry error resulted from a miscalculation of industry expense
allowances that had the effect of over-stating rates for 1991 through 1996.
Mandated rates for 1997, 1998 and 1999 included an adjustment to recoup the
effects of this error from the industry. The adjustment included in the
rate decision to recoup the error was phased in during 1997, 1998 and 1999.
The earned premium impact of this, coupled with the impact of a previous
year imbalance in the SDIP, was approximately $14.0 million for 1999. The
earnings per share after-tax impact resulting from lower earned premiums
were estimated at $0.26 for 1999.
The Company's performance in its personal and commercial automobile
insurance lines is integrally tied to its participation in Commonwealth
Automobile Reinsurers ("C.A.R."), a state-mandated reinsurance mechanism,
which permits the Company and most other writers of automobile insurance in
Massachusetts to reinsure any automobile risk that the insurer perceives to
be under-priced at the premium level permitted by the Commissioner. All
companies writing automobile insurance in Massachusetts share in the
underwriting results of C.A.R. business for their respective product line
or lines. Since its inception, C.A.R. has annually generated multi-million
dollar underwriting losses in both its personal and commercial automobile
pools. A company's proportionate share of the C.A.R. personal or
commercial deficit (its participation ratio) is based upon its market share
of the auto-mobile risks for the particular pool, adjusted by a utilization
formula such that, in general, its participation ratio is
disproportionately and adversely affected if its relative use of C.A.R.
exceeds that of the industry, and favorably affected if its relative use of
C.A.R. is less than that of the industry. Automobile insurers attempt to
develop and implement underwriting strategies that will minimize their
relative share of the C.A.R. deficit while maintaining acceptable loss
ratios on risks not insured through C.A.R.
Significant changes in the utilization of the C.A.R. private passenger
pooling mechanism are not expected for 2002. Various C.A.R. participation
formula changes have been fully implemented since 1993 with only minor
changes since then. The Company's ERP strategy has been to voluntarily
retain more of the types of private passenger automobile business that are
factored as credits favorably impacting the utilization formula. These
credits primarily result from voluntarily writing business in under-priced
territories and for under-priced risks. As a result of increased voluntary
retention in excess of the industry,
7
the credits impacting the utilization formula have favorably affected the
Company's participation ratio. As indicated in the accompanying table,
this ratio is several percentage points below the Company's estimated 23.3%
share of the Massachusetts personal automobile market. The Company
continues to expect the marketplace to make minor annual adjustments to
find the optimum balance between voluntary and ceded writings.
Company Private Passenger Participation Ratio for C.A.R. versus Market Share
Company Participation Company
Year Ratio in C.A.R. Market Share
2001* 16.8% 23.3%
2000 16.9% 22.3%
1999 16.5% 21.3%
*Estimated
The percentage of commercial automobile premiums ceded to C.A.R. by
the industry was estimated by the Company to be 24% in 2001. The
percentage of commercial automobile business ceded to C.A.R. by the Company
was approximately 16.0%. C.A.R. depopulation over the last several years,
coupled with C.A.R. rate increases for ceded commercial business, have led
to a reduction in the size of the annual commercial automobile deficits.
The Company intends to continue to respond to the incentives and
disincentives provided by C.A.R. rules as deemed necessary and appropriate.
The Company provides a separate rating tier for preferred
Massachusetts commercial automobile business through Citation.
Approximately 17% of the Massachusetts commercial automobile premiums
produced by voluntary agents in 2001 were written by Citation. The Company
expects that this secondary rating tier will continue to assist the Company
in retaining its better commercial automobile accounts, while also further
increasing the percentage of commercial automobile business that can be
retained voluntarily by the Company in 2002 and beyond.
The Company has actively pursued affinity group marketing programs
since 1995. The primary purpose of affinity group marketing programs is to
provide participating groups with a convenient means of purchasing private
passenger automobile insurance through associations and employer groups.
Emphasis is placed on writing larger affinity groups, although accounts
with as few as 25 participants are considered. Affinity groups are
eligible for rate discounts, which must be filed annually with the Division
of Insurance. In general, the Company looks for affinity groups with
mature/stable membership, favorable driving records and below average
turnover ratios. Participants who leave the sponsoring group during the
term of the policy are allowed to maintain the policy until expiration. At
expiration, a regular Commerce policy may be issued through the agency at
the insured's option.
Since the latter part of 1995, Commerce has been a leader in affinity
group marketing through agreements with the four American Automobile
Association Clubs of Massachusetts ("AAA clubs") offering discounts on
private passenger automobile insurance to the clubs' members who reside in
Massachusetts. A 6% discount was approved for policies effective January
1, 2002, which is the same as the discount for 2001. Membership in these
clubs is estimated to represent approximately one-third of the
Massachusetts motoring public, and has been the primary reason for a 62.6%
increase in the number of personal automobile exposures
written by Commerce since year-end 1995 (the AAA affinity group program
incepted in October of 1995). In 2001, total direct premiums written
attributable to the AAA group business
were $545,496 or 47.3% of the Company's total direct premiums written
(63.4% of the Company's total Massachusetts personal automobile premium),
an increase of 1.8% over 2000. Total exposures attributable to the AAA
clubs group business were 581,455 or 63.3% of total Massachusetts personal
automobile exposures in 2001, as compared to 559,696 or 64.5% in 2000. Of
the total Massachusetts automobile exposures written through the AAA
affinity group program by the Company, approximately 13.0% were written
through insurance agencies owned by the AAA clubs (8.7% of total
Massachusetts automobile exposures). The remaining 87.0% of the AAA group
program was written through the Company's network of independent agents
(91.3% of total Massachusetts automobile exposures). For additional
details, refer to the table found on page 12 entitled "AAA Affinity Group
Discount and SDIP Deviations".
8
Massachusetts law allows two years to reach the required group
penetration level of 35%. Commerce has continued to maintain AAA member
participation in excess of 35% through December 31, 2001, when it was
estimated at approximately 40%. The two-year penetration requirement was
waived by the Massachusetts Legislature for 2000, 2001 and 2002. Waiving
the penetration requirements allows insurance companies to continue
offering group discounts without reaching the 35% level.
Commerce and the AAA clubs have agreed that Commerce shall be their
exclusive under-writer of Massachusetts personal automobile group programs.
A rolling three-year contract exists between Commerce and the AAA clubs
which renews automatically and may be terminated upon a minimum of three
years written notice to either party.
Agreements for the Transfer of Massachusetts Business from Other Companies
in 2002
The Company entered into an agreement on September 28, 2001, with
Berkshire Mutual Insurance Company ("Berkshire") for the transfer of
Massachusetts personal automobile business written by Berkshire to The
Commerce Insurance Company, effective January 1, 2002. Under terms of the
agreement, Commerce Insurance agreed to offer agency contracts to
independent agencies that represent Berkshire for personal automobile
insurance in Massachusetts. This will allow agents of Berkshire the
opportunity to offer Commerce automobile insurance policies to their
customers whose policies renew in 2002. Commerce will assume all of
Berkshire's obligations for future policy years beyond 2001 under the
Massachusetts residual market system, (commonly known as C.A.R.), including
assignment of Berkshire's involuntary agents. The Company received a cash
payment of $7,000 from Berkshire in early January, 2002.
The Company announced the formation of a marketing alliance with
Horace Mann Educators Corporation on October 18, 2001. Under the terms of
an agency agreement between Commerce and Horace Mann Service Corporation
("HMSC"), a licensed brokerage agency in the State of Massachusetts, HMSC
will provide its personal automobile customers with Commerce policies. New
personal automobile policies sold by HMSC will be insured with Commerce,
beginning no later than January 1, 2002. At the policy holders option,
Massachusetts personal auto policies currently written by HMSC will convert
to Commerce policies upon renewal in 2002.
Other States Business
Direct premiums written in states other than Massachusetts by Commerce
West and American Commerce, increased $22,554 or 18.7%. Roughly half of
this growth resulted from an increase of $11,505 or 44.5% in personal
automobile direct premiums written by Commerce West. The growth from
Commerce West is primarily attributable to non-standard automobile
business. Commerce West began writing in this segment of the market in
late 1999. Commerce West also began writing commercial automobile in late
2000, resulting in writings of $1,514 in 2001. American Commerce direct
premiums written increased $9,655 or 10.2%, primarily due to an increase in
personal automobile premiums of $7,319 or 9.4%. American Commerce also
experienced a 13.4% increase in homeowners business. American Commerce,
which writes business in 26 states, wrote greater than 90% of its business
in eleven states.
9
Commerce West premiums and the eleven states with the highest percentages of premiums
written by American Commerce are shown in the following table:
% of Direct Premiums
Company State Written by State
2001 2000
Commerce West California............ 89.8% 99.1%
Oregon................ 10.2% 0.9
Total............ 100.0% 100.0%
American Commerce Arizona............... 20.9% 21.5%
Rhode Island.......... 14.3% 10.8%
Ohio.................. 12.6% 11.6%
Oregon................ 10.5% 10.2%
Washington............ 8.0% 8.1%
Oklahoma.............. 7.7% 6.4%
Kentucky.............. 5.9% 5.8%
Indiana............... 4.6% 3.5%
West Virginia......... 2.5% 2.7%
Idaho................. 2.5% 2.4%
Tennessee............. 2.4% 2.2%
Other states.......... 8.1% 14.8%
Total............ 100.0% 100.0%
The decrease in other states for American Commerce is primarily
attributable to business in several states being moved to other insurance
companies affiliated with the ownership of the agencies representing that
business. These and some future moves for business in other states were
anticipated at the time the Company negotiated the acquisition of American
Commerce.
Insurance Ratios
Underwriting profit margins are reflected by the extent to which the
combined ratio is less than 100%. This ratio is considered the best simple
index of current underwriting performance of an insurer. During the five-
year period ended December 31, 2001, the property and casualty insurance
industry's combined ratio, as reported by A.M. Best and weighted to reflect
the Company's product mix ("weighted industry average"), has ranged from a
low of 100.1% in 1997 to a high of 109.7% in 2000 on a statutory accounting
principles basis. During this same period of time, the Company's combined
ratio has consistently remained below the weighted industry average,
ranging from a low of 96.5% in 1997 to a high of 99.1% in 2001. On an
average basis, the Company's combined ratio was 97.8% for the five-year
period ended December 31, 2001 compared to a weighted industry average of
105.1%.
Year Ended December 31,
Company Statutory Ratios 2001 2000 1999 1998 1997
(unaudited)
Loss and LAE Ratio................. 74.7% 71.7% 72.0% 71.6% 71.4%
Underwriting Expense Ratio......... 24.4 25.1 26.5 26.5 25.1
Combined Ratio..................... 99.1% 96.8% 98.5% 98.1% 96.5%
Industry Combined Ratio
(all writers)(1)................... 108.9% 109.7% 104.4% 102.2% 100.1%
(1) Source: Best's Review Preview (2002), as reported by A.M. Best for all property and
casualty insurance companies and weighted to reflect the Company's product mix.
The 2001 industry information is estimated by A.M. Best.
10
Investment Income and Net Realized Investment Gains and Losses
The Company's total revenues were supplemented in fiscal 2001, 2000
and 1999 by net investment income of $99,611, $96,830 and $89,789,
respectively. Beginning in the first quarter of 2001, the Company, in the
2001 and prior years' results, classified its undistributed equity in the
earnings and losses on investments in closed-end preferred stock mutual
funds in net realized investment gains and losses. For the year ended
2000, the undistributed equity in the earnings and losses of these funds
was reported in net investment income. The Company believes the current
year presentation provides a more appropriate classification for analysis
of the on-going operations of the Company. Prior period results previously
reflected in investment income, have been reclassified to realized gains
and losses to conform with current period presentation. For the years
ended December 31, 2001, 2000, and 1999 the Company reflected realized
gains (losses) of $4.6 million, $26.6 million and ($22.4) million,
respectively, as a result of this change. These investments are valued at
original cost plus the cumulative undistributed equity in earnings and
losses of the funds and adjusted over time by the premium or discount at
the time of purchase to the applicable underlying net asset value of the
funds. Also in 2001, the Company began to account for venture capital fund
investments on an equity basis. The equity in the operating results of
these funds has been reflected in realized gains and losses. Prior to this
change, the operating results were not material and were therefore
reflected in accumulated other comprehensive income and loss. For 2001,
the Company had a net realized loss of $10.6 million, of which the largest
component, $9.1 million, was attributable to venture capital fund
investments.
Regulatory Matters
General
Although the U.S. federal government does not directly regulate the
insurance industry, federal initiatives often have an impact on the
business. Congress and certain federal agencies continue to investigate
the current condition of the insurance industry (encompassing both life and
health and property and casualty insurance) in the United States in order
to decide whether some form of federal role in the regulation of insurance
companies would be appropriate. Congress conducts hearings relating, in
general, to the solvency of insurers and has proposed federal legislation
from time to time on this and other subjects.
In November 1999, the Gramm-Leach-Bliley Act was signed into law. The
Act (1) repealed the Glass-Steagall Act of 1933, which had prohibited the
merger of banks and securities firms, and (2) substantially modified the
Bank Holding Company Act of 1956, which had the effect of separating
banking and insurance underwriting business. The law contains pro-visions
that govern competition, created safe-harbor protections for specific state
laws and established consumer protections that govern bank-insurance sales.
At the state level, various forms of automobile insurance reform are
continuously debated. New regulations and legislation are often proposed
with the goal of reducing the need for premium increases. For further
details, please refer to the general discussion on insurance regulation and
premium rates beginning on page 5.
Personal Automobile Insurance
As previously mentioned, since 1995, the Company has been a leader in
affinity group marketing in Massachusetts by providing discounts to members
of the AAA clubs. Membership in these clubs is estimated to represent
approximately one-third of the Massachusetts motoring public. The Company
increased its Massachusetts private passenger automobile insurance
exposures by 5.8%, ending the year with approximately 23.3% of the
Massachusetts private passenger automobile market.
11
Through 2000, the Company offered its Massachusetts customers safe
driver deviations to drivers with SDIP classifications of either Steps 9 or
10 and to only Step 9 drivers in 2001. Safe driver deviations are rate
discounts based on the customer's driving record and resulting SDIP
classification and must be approved annually by the Commissioner. Steps 9
and 10 are the two best driver SDIP classifications in Massachusetts,
representing drivers with no at-fault accidents and not more than one minor
moving vehicle violation in the last six years. The accompanying table
depicts the AAA Affinity Group Discount, SDIP Deviations and their combined
reduction from Massachusetts average mandated rates:
AAA Affinity Group Discount and SDIP Deviations 2002* 2001 2000 1999
AAA Affinity Group Discount................. 6.0% 6.0% 6.0% 6.0%
SDIP Step 9 Deviation....................... 0.0% 2.0% 6.0% 8.0%
SDIP Step 10 Deviation...................... 0.0% 0.0% 2.0% 3.0%
Combined AAA Affinity Group Discount and
Step 9 Deviation.......................... 6.0% 7.9% 11.6% 13.5%
Combined AAA Affinity Group Discount and
Step 10 Deviation......................... 6.0% 6.0% 7.9% 8.8%
*For policies with effective dates as of January 1, 2002 or thereafter.
In 2002, in response to the average personal automobile rate decisions
over the last several years, the Company did not file for SDIP Step 9 or
Step 10 deviations, for policies incepting in the 2002 calendar year.
During 2001, 55.0% of the Company's exposures were eligible for Step 9
deviations, versus 55.1% and 14.0%, eligible for Step 9 and Step 10
deviations in 2000.
Risk-Based Capital
In order to enhance the regulation of insurer insolvency, the National
Association of Insurance Commissioners ("NAIC") developed a formula and
model law to provide for Risk-Based Capital ("RBC") requirements for
property and casualty insurance companies. RBC require-ments are designed
to assess capital adequacy and to raise the level of protection that
statutory surplus provides for policyholder obligations. The RBC model for
property and casualty insurance companies measures three major areas of
risk facing property and casualty insurers: (i) underwriting, which
encompasses the risk of adverse loss development and inadequate pricing;
(ii) declines in asset values arising from credit risk; and, (iii) other
business risks from investments. Insurers having less statutory surplus
than required by the RBC calculation will be subject to varying degrees of
regulatory action, depending on the level of capital inadequacy.
The RBC model formula proposes four levels of regulatory action. The
extent of regulatory intervention and action increases as the percentage of
surplus to RBC falls. The first level, the Company Action Level (as
defined by the NAIC), requires an insurer to submit a plan of corrective
actions to the regulator if surplus falls below 200% of the RBC amount.
The Regulatory Action Level (as defined by the NAIC) requires an insurer to
submit a plan containing corrective actions and permits the Commissioner to
perform an examination or other analysis and issue a corrective order if
surplus falls below 150% of the RBC amount. The Authorized Control Level
(as defined by the NAIC) allows the regulator to rehabilitate or liquidate
an insurer in addition to the aforementioned actions if surplus falls below
100% of the RBC amount. The fourth action level is the Mandatory Control
Level (as defined by the NAIC), which requires the regulator to
rehabilitate or liquidate the insurer if surplus falls below 70% of the RBC
amount.
12
The following table provides the key RBC information for the Company's
insurance subsidiaries, Commerce, Citation, Commerce West, and American
Commerce:
Commerce American
(Dollars in millions) Commerce Citation West Commerce
At December 31, 2001
Statutory surplus............. $ 609 $ 107 $ 28 $ 84
200% RBC Company action level. 184 4 7 20
Statutory surplus in excess
of RBC Company action level. $ 425 $ 103 $ 21 $ 64
RBC amounts................... $ 92 $ 2 $ 4 $ 10
% of surplus to RBC amounts... 662.0% 5,350.0% 700.0% 840.0%
Year Ended December 31, 2001 Compared to Year Ended December 31, 2000
Premiums
The following table compares direct premiums written, net premiums
written and earned premiums for the years ended December 31, 2001 and
2000:
Years Ended December 31,
2001 2000 $ Change % Change
Direct Premiums Written:
Personal Automobile in Massachusetts...... $ 859,922 $ 827,180 $ 32,742 4.0%
Personal Automobile in All Other States... 122,320 103,496 18,824 18.2%
Commercial Automobile in Massachusetts.... 58,088 43,243 14,845 34.3%
Commercial Automobile in All Other States. 1,514 104 1,410 *
Homeowners in Massachusetts............... 73,254 65,662 7,592 11.6%
Homeowners in All Other States............ 18,710 16,498 2,212 13.4%
Other Lines in Massachusetts.............. 17,885 14,860 3,025 20.4%
Other Lines in All Other States........... 714 606 108 17.8%
Total Direct Premiums Written.......... $1,152,407 $1,071,649 $ 80,758 7.5%
Net Premiums Written:
Personal Automobile in Massachusetts...... $ 864,900 $ 839,394 $ 25,506 3.0%
Personal Automobile in All Other States... 122,256 103,719 18,537 17.9%
Commercial Automobile in Massachusetts.... 60,986 44,848 16,138 36.0%
Commercial Automobile in All Other States. 1,477 104 1,373 *
Homeowners in Massachusetts............... 20,364 17,547 2,817 16.1%
Homeowners in All Other States............ 4,576 (1,658) 6,234 *
Other Lines in Massachusetts.............. 4,236 4,916 (680) (13.8%)
Other Lines in All Other States........... 172 41 131 319.5%
Total Net Premiums Written............. $1,078,967 $1,008,911 $ 70,056 6.9%
Earned Premiums:
Personal Automobile in Massachusetts...... $ 776,552 $ 714,972 $ 61,580 8.6%
Personal Automobile in All Other States... 116,479 100,101 16,378 16.4%
Commercial Automobile in Massachusetts . 43,008 32,548 10,460 32.1%
Commercial Automobile in All Other States. 711 19 692 *
Homeowners in Massachusetts............... 19,119 17,364 1,755 10.1%
Homeowners in All Other States............ 3,731 4,186 (455) (10.9%)
Other Lines in Massachusetts.............. 3,290 3,434 (144) (4.2%)
Other Lines in All Other States........... 158 162 (4) (2.5%)
Assumed Premiums from C.A.R............... 80,176 81,300 (1,124) (1.4%)
Assumed Premiums from Other than C.A.R.... 428 397 31 7.8%
Total Earned Premiums.................. $1,043,652 $ 954,483 $ 89,169 9.3%
Earned Premiums in Massachusetts.......... $ 841,969 $ 768,318 $ 73,651 9.6%
Earned Premiums-Assumed................... 80,604 81,697 (1,093) (1.3%)
Earned Premiums in All Other States....... 121,079 104,468 16,611 15.9%
Total Earned Premiums.................. $1,043,652 $ 954,483 $ 89,169 9.3%
*Calculation is not meaningful.
13
The $32,742 or 4.0% increase in Massachusetts personal automobile
direct premiums written resulted primarily from increases of 5.8% and 7.1%
in the number of Massachusetts personal automobile exposures for liability
and physical damage coverage, respectively, offset in 2001 by decreases in
rates for the coverage types noted below. The components of these changes
from the previous year for 2001 and 2000 were as follows:
2001 2000
Coverage Type Rate Change (1) Rate Change (1)
Liability:
Bodily Injury................. (2.1%) 1.0%
Personal Injury Protection.... (12.9%) 6.4%
Property Damage to Others..... 1.0% 20.8%
Physical Damage:
Collision..................... (0.1%) 1.7%
Comprehensive................. (7.6%) 2.4%
Total (2)................. (1.9%) 6.2%
(1) Represents change in the Company's average rate per exposure from the Company's
prior year average rate for Massachusetts private passenger automobile premiums.
(2) The total rate change depicted is the result of the weighted average of premiums
written for all coverages divided by liability exposures only, due to the fact that
all exposures are required to carry liability coverage.
The above percentage changes were primarily the result of rate
modifications in the individual coverage components in the 2001 state
mandated rates, offset by changes in the Company's safe driver rate
deviations. The combination of these factors resulted in a 1.9% decrease
in the average personal automobile premium per exposure in 2001. Despite
the 2001 state mandated average rate decrease of 8.3%, the smaller Company
decrease in the average personal automobile premium per exposure was
primarily due to the above noted changes coupled with the fact that the
rate decision does not anticipate purchases of new auto-mobiles in the year
to which the rate decision applies and the Company's mix of personal
automobile business differs from that of the industry. In 2001, the
Company offered its customers safe driver deviations of 2.0% to drivers
with SDIP classifications of Step 9 and 0.0% for Step 10 (6.0% for Step 9
and 2.0% for Step 10 in 2000).
As shown in the table found on page 12, the AAA affinity group
discount for 2001 was established at 6.0%, which was unchanged from 2000.
In 2001, for drivers who qualified, the Company's AAA affinity group
discount and safe driver deviations could be combined for up to a 7.9%
reduction (11.6% in 2000) from state mandated rates.
Other states personal automobile direct premiums written increased
$18,824 or 18.2%, however, an overall depressed rate environment resulted
in diminished underwriting profits. The Company continues to evaluate a
number of its other than Massachusetts state rating structures, has filed
for increases in several states and will seek additional rate increases
where appropriate. Personal automobile direct premiums written by American
Commerce increased $7,319 or 9.4% to $85,124 as compared to $77,805 due
primarily to book rollovers of business from existing agents, partially
offset by decreases in states where the Company is not actively pursuing
writings. Personal automobile direct premiums written from Commerce West
increased $11,505 or 44.5% to $37,196 as compared to $25,691. Both
companies target preferred insurance risks, however Commerce West's recent
growth is attributable to the introduction of a non-standard auto product
in late 2000. Both American Commerce and Commerce West write predominantly
personal automobile insurance. American Commerce writes personal
automobile insurance in 26 states while Commerce West writes personal
automobile insurance in the states of California and Oregon. Personal
automobile policies for both companies are written primarily for a policy
term of six months. Homeowner and other policies in all states are written
primarily for a policy term of one year.
14
Direct premiums written for Massachusetts commercial automobile
insurance increased by $14,845 or 34.3%, due primarily to an increase of
approximately 9.0% in the number of policies written, combined with a 23.5%
increase in the average commercial automobile premium per policy. The
increase in premium per policy was attributable to a hardening of the
commercial automobile market, primarily in larger commercial accounts. The
Company experienced an increase of approximately $3,700 from policies in
excess of $50. In addition, rates for other voluntary commercial
automobile policies have increased moderately, combined with an approximate
10% increase in rates for policies written through C.A.R. The increased
business was attributable to the Company's initiative to expand writings.
Direct premiums written for Massachusetts homeowners insurance
increased by $7,592 or 11.6% due primarily to a 6.4% increase in the number
of Massachusetts policies written coupled with a 5.0% increase in the
average Massachusetts premium per policy. The increase in business was
primarily attributable to existing and newly appointed agents. Other
states homeowners insurance written by American Commerce increased $2,212
or 13.4% to $18,710 due primarily to book rollovers of business from
existing agents.
The $70,056 or 6.9% increase in net premiums written was primarily due
to the growth in direct premiums written as described above offset by an
increase in premiums ceded to C.A.R. coupled with an increase in premiums
ceded to reinsurers other than C.A.R. Net premiums written for homeowners
in all other states increased $6,234, with net premiums written of $4,576
in 2001, as compared to ($1,658) in 2000. The reason for negative written
premium in 2000 was due to American Commerce joining the quota share
reinsurance agreement effective January 1, 2000. An unearned premium
transfer of $6,033 occurred effective January 1, 2000, which has a direct
impact to net written premium.
The $89,169 or 9.3% increase in earned premiums during 2001, as
compared to 2000, was primarily due to increases in written exposures for
Massachusetts personal automobile liability and physical damage, coupled
with an increase in earned premium per exposure. The increase in earned
premium per exposure occurs (versus a decrease in written premium per
exposure) because of the time lag in earning the premium once it is
written. This resulted in a $61,580 or 8.6% increase for Massachusetts
personal automobile earned premium.
Investment Income
Net investment income is affected primarily by the composition of the
Company's investment portfolio and yield thereon. The following table
summarizes the composition of the Company's investment portfolio, at cost,
at December 31, 2001 and 2000 (the Company's investment portfolio, at
market and equity is shown in the table on page 25):
Investments, at cost December 31,
% of % of
2001 Invest. 2000 Invest.
GNMA & FNMA mortgage-backed bonds...... $ 98,198 6.7% $ 67,274 4.7%
Corporate bonds........................ 133,506 9.1 130,775 9.1
U.S. Treasury bonds and notes.......... 104 - 3,428 0.2
Tax exempt state and municipal bonds... 386,967 26.2 464,404 32.1
Total fixed maturities............. 618,775 42.0 665,881 46.1
Preferred stocks....................... 256,582 17.4 215,823 14.9
Common stocks.......................... 87,704 5.9 87,704 6.1
Closed-end preferred stock mutual funds 294,948 20.0 327,980 22.7
Mortgages and collateral loans (net of
allowance for possible loan losses).. 39,505 2.7 51,661 3.6
Cash and cash equivalents.............. 148,630 10.1 70,521 4.9
Other investments...................... 28,291 1.9 25,475 1.7
Total investments.................. $1,474,435 100.0% $1,445,045 100.0%
15
The Company's investment strategy is to maximize after-tax investment
income through investing in high quality securities coupled with acquiring
equity investments, which may forgo current investment yield in favor of
potential higher yielding capital appreciation in the future.
As depicted in the following table, 2001 net investment income
increased $2,781 or 2.9%, compared to 2000, principally as a result of an
increase in average invested assets (at cost), offset by a decrease in
yield. The decrease in yield is primarily due to lower short-term yields
on larger cash and cash equivalent balances, coupled with an environment of
higher yielding fixed maturities being called. The Company continues to
monitor interest rates on long-term securities and intends to maintain its
high cash position until such time as the Company believes long-term rates
have appropriately firmed. Net investment income as a percentage of total
average investments was 6.6% in 2001 compared to 6.9% for 2000. Net
investment income after tax as a percentage of total average investments
was 5.3% and 5.7% for 2001 and 2000, respectively.
Investment Return Years Ended December 31,
2001 2000
Average month-end investments (at cost)... $1,506,485 $1,395,159
Net investment income before tax.......... 99,611 96,830
Net investment income after-tax........... 79,172 79,547
Net investment income as a percentage
of average net investments (at cost).... 6.6% 6.9%
Net investment income after-tax as a
percentage of average net
investments (at cost)................... 5.3% 5.7%
Premium Finance and Service Fees
Premium finance and service fees increased $2,592 or 17.0% during
2001, as a result of increased premiums as discussed earlier.
Amortization of Excess of Book Value of Subsidiary Interest over Cost
As a result of the acquisition of American Commerce (see
"Management's Discussion and Analysis of Financial Condition and Results
of Operations - General" and "Notes to Consoli-dated Financial Statements
- NOTES A12 and A17"), the amount representing the excess of the fair
value of the net assets acquired over the purchase price at January 29,
1999 was $16,947. This amount is being amortized into revenue on a
straight-line basis over a five-year period. The amount amortized into
revenue in 2001 was $3,389, compared to $3,390 in 2000.
Investment Gains and Losses
Net realized investment losses totaled $10,633 during 2001 as
compared to gains of $29,550 in 2000. Of the net realized losses during
2001, $9,071 was a result of the Company's venture capital fund
investments. These investments primarily provide seed capital for start-
up companies with emerging high technology initiatives in the financial
services industry. These investments are made in limited partnerships and
the Company's exposure to loss is limited to its actual investment. In
2001, the Company began to account for these investments on an equity
basis. The equity in the operating results of these funds has been
reflected in realized gains and losses. Prior to this change, the
operating results were not material and were therefore reflected in
accumulated other comprehensive income and loss.
Also during 2001, the undistributed operating results of closed-end
preferred stock mutual funds have been reflected in realized gains and
losses. Year-end December 31, 2000 period results previously reflected in
investment income, have been reclassified to realized gains and losses to
conform with current period presentation. During 2001 and 2000, the
Company reflected realized gains of $4,582 and $26,575, respectively, as a
result of this change.
16
Gross realized gains and losses for the years ended December 31, 2001 and December 31,
2000 were as follows:
2001 2000
Gross Gross Gross Gross
Realized Realized Realized Realized
Gains Losses Gains Losses
Fixed maturities......... $ 957 $ (3,773) $ 223 $ (3,995)
Preferred stocks......... 128 (3,820) 1,748 (462)
Common stocks............ 1,526 (923) 4,370 -
Closed-end preferred
stock mutual funds*.... 5,197 (615) 26,641 (66)
Venture capital fund
investments............ - (9,071) 460 -
Other investments........ - (239) 631 -
Total............... $ 7,808 $ (18,441) $ 34,073 $ (4,523)
* Includes $3,215 in 2001 and $9,260 in 2000, respectively, relating to
the amortization of the net discount, at the time of purchase, of these
securities.
Gross accumulated other comprehensive income and losses at December 31, 2001 and
December 31, 2000 were as follows:
December 31, 2001 December 31, 2000
Gross Gross Gross Gross
Accumulated Accumulated Accumulated Accumulated
Other Other Other Other
Comprehensive Comprehensive Comprehensive Comprehensive
Income Losses Income Losses
Fixed maturities......... $ 17,994 $ (10,287) $ 16,247 $ (12,193)
Preferred stocks......... 6,289 (14,770) 999 (16,739)
Common stocks............ 21,590 (1,836) 28,126 (3)
Other investments........ - - 1,327 -
Total............... $ 45,873 $ (26,893) $ 46,699 $ (28,935)
Loss and Loss Adjustment Expenses
Losses and loss adjustment expenses ("LAE") incurred increased
$91,386 or 13.3% in 2001. Massachusetts operations experienced declining
underwriting results primarily due to increased losses in the homeowners
property business and in comprehensive personal automobile, due to more
adverse weather conditions compared to last year. The ratio of net
incurred losses, excluding LAE, to premiums earned ("pure loss ratio") on
Massachusetts personal automobile was 65.4% in 2001 compared to 63.1% in
2000. The commercial automobile pure loss ratio increased to 61.8% in
2001 compared to 59.7% in 2000. This increase was primarily due to higher
bodily injury losses and to higher physical damage losses coupled with
worse experience in the business assumed from C.A.R. during this period.
For Massachusetts homeowners (gross of reinsurance), the pure loss ratio
was 47.6% in 2001 compared to 40.0% in 2000. This increase was the result
of more claims for Massachusetts homeowner business due to less favorable
weather conditions, as compared to last year, primarily during the first
six months of 2001. Pure loss ratios of subsidiaries in other states
increased to 67.5% in 2001 compared to 62.9% in 2000. The loss ratio (on
a statutory basis) for Commerce West and American Commerce was 85.1% and
84.4%, respectively, in 2001, compared to 69.3% and 84.5% respectively, in
2000. The increase in the loss ratio for Commerce West was primarily
attributable to a substantial increase in non-standard automobile writings
with loss ratios that are significantly higher than their regular
business.
17
Policy Acquisition Costs
Policy acquisition costs expensed increased by $17,613 or 7.2% in
2001. As a per-centage of net premiums written, the Company's statutory
underwriting expense ratio for 2001 was 24.4% compared to 25.1% in 2000.
The decreased 2001 underwriting expense ratio resulted primarily from a
lower provision for accrued contingent commissions, lower insolvency
assessments and lower expenses due to the continued effects of certain
cost reduction programs. The 2000 underwriting ratio includes a $4,900
charge versus $1,244 in 2001, representing the Company's allocation from
the Massachusetts Insurers Insolvency Fund. The underwriting expense
ratio (on a statutory basis) for Commerce West was 32.7% for 2001 as
compared to 35.8% for 2000. The underwriting expense ratio (on a
statutory basis) for American Commerce, was 32.6% for 2001 compared to
29.3% for 2000.
Income Taxes
The Company's effective tax rate was 20.1% and 22.5% for the years
ended December 31, 2001 and 2000, respectively. In both years the
effective rate was lower than the statutory rate of 35% primarily due to
tax-exempt interest income and the corporate dividends received deduction.
Minority Interest in Net Loss of Subsidiary
As a result of the joint venture with AAA SNE and acquisition of
American Commerce (see "Management's Discussion and Analysis of Financial
Condition and Results of Operations - General" and "Notes to Consolidated
Financial Statements - NOTES A13 and A17"), the Company's interest in ACIC
Holding Co., Inc., through Commerce, a wholly-owned subsidiary of CHI, is
represented by ownership of 80% of the outstanding shares of common stock
at December 31, 2001. AAA SNE maintains a 20% common stock ownership.
The minority interest of $863 included in the consolidated statement of
earnings for 2001 represents 20% of the net loss for ACIC Holding Co.,
Inc., calculated after the $9,582 preferred stock dividend paid to
Commerce, to the extent of the minority interest. This compares to $320
minority interest in net loss of subsidiary after $9,178 in preferred
stock dividends paid to Commerce in 2000. During the third quarter of
2001, the net losses of ACIC Holding Co., Inc. exceeded the minority
interest balance sheet component.
Net Earnings
Net earnings decreased $38,986 or 29.5% to $93,094 during 2001 as
compared to $132,080 in 2000. Operating earnings, which exclude the
after-tax impact of net realized investment gains and losses, decreased
$10,751 or 9.8% to $98,880 ($2.94 per share basic and $2.93 per share
diluted) during 2001 as compared to $109,631 ($3.21 per share basic and
diluted) in 2000, as a result of the factors previously mentioned.
18
Year Ended December 31, 2000 Compared to Year Ended December 31, 1999
Premiums
The following table compares direct premiums, net premiums written
and earned premiums for the years ended December 31, 2000 and 1999:
Years Ended December 31,
2000 1999 Change % Change
Direct Premiums Written:
Personal Automobile in Massachusetts...... $ 827,180 $731,329 $ 95,851 13.1%
Personal Automobile in All Other States... 103,496 92,297* 11,199 12.1%
Commercial Automobile in Massachusetts.... 43,243 36,616 6,627 18.1%
Commercial Automobile in All Other States. 104 - 104 -
Homeowners in Massachusetts............... 65,662 59,981 5,681 9.5%
Homeowners in All Other States............ 16,498 14,378* 2,120 14.7%
Other Lines in Massachusetts.............. 14,860 13,027 1,833 14.1%
Other Lines in All Other States........... 606 521* 85 16.3%
Total Direct Premiums Written.......... $1,071,649 $948,149 $123,500 13.0%
Net Premiums Written:
Personal Automobile in Massachusetts...... $ 839,394 $747,402 $ 91,992 12.3%
Personal Automobile in All Other States... 103,719 91,640* 12,079 13.2%
Commercial Automobile in Massachusetts.... 44,848 38,593 6,255 16.2%
Commercial Automobile in All Other States. 104 - 104 -
Homeowners in Massachusetts............... 17,547 16,304 1,243 7.6%
Homeowners in All Other States............ (1,658) 13,543* (15,201) (112.2%)
Other Lines in Massachusetts.............. 4,916 4,193 723 17.2%
Other Lines in All Other States........... 41 318* (277) (87.1%)
Total Net Premiums Written............. $1,008,911 $911,993 $ 96,918 10.6%
Earned Premiums:
Personal Automobile in Massachusetts...... $ 714,972 $633,746 $ 81,226 12.8%
Personal Automobile in All Other States... 100,101 91,357* 8,744 9.6%
Commercial Automobile in Massachusetts.... 32,548 29,219 3,329 11.4%
Commercial Automobile in All Other States. 19 - 19 -
Homeowners in Massachusetts............... 17,364 16,830 534 3.2%
Homeowners in All Other States............ 4,186 12,032* (7,846) (65.2%)
Other Lines in Massachusetts.............. 3,434 3,190 244 7.6%)
Other Lines in All Other States........... 162 755* (593) (78.5%)
Assumed Premiums from C.A.R............... 81,300 84,356 (3,056) (3.6%)
Assumed Premiums from Other than C.A.R.... 397 345 52 15.1%
Total Earned Premiums.................. $ 954,483 $871,830 $ 82,653 9.5%
Earned Premiums in Massachusetts.......... $ 768,301 $682,985 $ 85,316 12.5%
Earned Premiums-Assumed................... 81,697 84,701 (3,004) (3.5%)
Earned Premiums in All Other States....... 104,485 104,144* 341 0.3%
Total Earned Premiums.................. $ 954,483 $871,830 $ 82,653 9.5%
*Includes eleven-month results of American Commerce since the January 29, 1999 acquisition.
19
The $95,851 or 13.1% increase in Massachusetts personal automobile
direct premiums written resulted primarily from increases of 6.4% and 8.5%
in the number of Massachusetts personal automobile exposures for liability
and physical damage coverage, respectively, coupled in 2000 with increases
in rates for the coverage types noted below. The components of these
changes from the previous year for 2000 and 1999 were as follows:
2000 1999
Coverage Type Rate Change (1) Rate Change (1)
Liability:
Bodily Injury................. 1.0% (1.9%)
Personal Injury Protection.... 6.4% 11.0%
Property Damage to Others..... 20.8% 9.1%
Physical Damage:
Collision..................... 1.7% 25.2%
Comprehensive................. 2.4% 11.7%
Total (2)................. 6.2% 9.1%
(1) Represents change in the Company's average rate per exposure from the Company's
prior year average rate charged for Massachusetts private passenger automobile
premiums.
(2) The total rate change depicted is the result of the weighted average of premiums
written for all coverages divided by liability exposures only, due to the fact that
all exposures are required to carry liability coverage.
The above percentage changes were primarily the result of rate
modifications in the individual coverage components in the 2000 state
mandated average rate increase, combined with changes in the Company's safe
driver rate deviations. The combination of these factors resulted in a
6.2% increase in the average personal automobile premium per exposure in
2000. Despite the 2000 state mandated average rate increase of only 0.7%,
the Company's increase in the average personal automobile premium per
exposure was primarily due to the above noted changes coupled with the fact
that the rate decision does not anticipate purchases of new automobiles in
the year to which the rate decision applies and the Company's mix of
personal automobile business differs from that of the industry. In 2000,
the Company offered its customers safe driver deviations of 6.0% to drivers
with SDIP classifications of Step 9 and 2.0% for Step 10 (8.0% for Step 9
and 3.0% for Step 10 in 1999).
As shown in the table found on page 12, the AAA affinity group
discount for 2000 was established at 6.0%, which was unchanged from 1999.
In 2000, for drivers who qualified, the Company's AAA affinity group
discount and safe driver deviations could be combined for up to a 11.6%
reduction (13.5% in 1999) from state mandated rates.
Direct premiums written for commercial automobile insurance increased
by $6,627 or 18.1%, due primarily to an increase of approximately 10.1% in
the number of policies written, combined with a 6.9% increase in the
average commercial automobile premium per policy. The increased business
was attributable to the Company's intention to expand writings coupled with
increased business due to the insolvency of Trust Insurance Company
("Trust"), a former Massachusetts insurance company that was placed in
receivership in 2000. Direct premiums written for homeowners insurance
increased by $7,801 or 10.5% due primarily to a 13.5% increase in the
number of Massachusetts policies written offset by a 3.0% decrease in the
average Massachusetts premium per policy, coupled with an additional month
premium from American Commerce. The increased business was primarily
attributable to the previously mentioned Trust insolvency.
The $96,918 or 10.6% increase in net premiums written was due to the
growth in direct premiums written as described above, offset by a decrease
of premiums assumed from C.A.R. The decrease in premiums assumed from
C.A.R. was the result of fewer premiums ceded to C.A.R. by the servicing
carriers in 2000 as compared to 1999. Premiums ceded to reinsurers other
than C.A.R. increased $22,289 or 40.8% as compared to 1999 as a result of
American Commerce joining the quota-share reinsurance program effective
January 1, 2000 and increases in Massachusetts homeowners premiums.
20
The $82,653 or 9.5% increase in earned premiums during 2000 as
compared to 1999 was primarily due to increases to the average rates per
exposure for Massachusetts personal automobile liability and physical
damage, and the increased business due to the insolvency of Trust mentioned
previously. This resulted in an $85,316 or 12.5% increase for
Massachusetts earned premiums. The remaining changes were attributable to
a $3,004 or 3.5% decrease in earned premiums assumed from C.A.R. offset by
$341, or 0.3% increase in earned premiums from all other states, primarily
attributable to American Commerce whose year to date 2000 results reflect a
full twelve months as compared to eleven months in 1999, offset by the
effect of ceded earned premium to the quota share treaty.
Investment Income
Net investment income is affected primarily by the composition of the
Company's investment portfolio and yield thereon. The following table
summarizes the composition of the Company's investment portfolio, at cost,
at December 31, 2000 and 1999:
Investments, at cost December 31,
% of % of
2000 Invest. 1999 Invest.
GNMA & FNMA mortgage-backed bonds...... $ 67,274 4.7% $ 82,349 6.1%
Corporate bonds........................ 130,775 9.1 45,147 3.3
U.S.Treasury bonds and notes........... 3,428 0.2 3,616 0.3
Tax exempt state and municipal bonds... 464,404 32.1 530,333 39.2
Total fixed maturities............. 665,881 46.1 661,445 48.9
Preferred stocks....................... 215,823 14.9 230,934 17.1
Common stocks.......................... 87,704 6.1 83,984 6.2
Closed-end preferred stock mutual funds 327,980 22.7 267,956 19.8
Mortgages and collateral loans (net of
allowance for possible loan losses).. 51,661 3.6 72,451 5.4
Cash and cash equivalents.............. 70,521 4.9 22,535 1.7
Other investments...................... 25,475 1.7 13,130 0.9
Total investments.................. $1,445,045 100.0% $1,352,435 100.0%
The Company's investment strategy is to maximize after-tax investment
income through high quality securities coupled with acquiring equity
investments, which may forgo current investment yield in favor of potential
higher yielding capital appreciation in the future.
As depicted in the accompanying table, net investment income before
taxes increased $7,041 or 7.8%, compared to 1999, principally as a result
of an increase in average invested assets (at cost). Net investment income
as a percentage of total average investments was 6.9% in 2000, compared to
6.8% in 1999. Net investment income after tax as a percentage of total
average investments was 5.6% in 2000 and 6.3% in 1999.
Investment Return Years Ended December 31,
2000 1999
Average month-end investments (at cost)... $1,395,159 $1,326,098
Net investment income before tax.......... 96,830 89,789
Net investment income after-tax........... 79,547 74,970
Net investment income as a percentage
of average net investments (at cost).... 6.9% 6.8%
Net investment income after-tax as a
percentage of average net
investments (at cost)................... 5.7% 5.7%
Premium Finance and Service Fees
Premium finance and service fees increased $453 or 3.1% during 2000.
21
Amortization of Excess of Book Value of Subsidiary Interest over Cost
As a result of the acquisition of American Commerce (see "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
General" and "Notes to Consolidated Financial Statements - NOTES A12 and
A17"), the amount representing the excess of the fair value of the net
assets acquired over the purchase price at January 29, 1999 was $16,947.
The amount is being amortized into revenues on a straight-line basis over a
five-year period. The amount amortized into revenues in 2000 was $3,390,
compared to $3,019 in 1999.
Investment Gains and Losses
During the fourth quarter of 2000, the Company changed its policy in
regard to its investments in certain closed-end preferred stock mutual
funds. On a forward going basis, the Company intends to take a proactive
posture to affect the overall investment performance of these funds. The
Company's ownership position of these various funds at December 31, 2000
range from 23% to 48% of outstanding shares. The level of ownership and
new investment policy requires the company to account for these investments
on an equity basis. The equity method requires that the investments are to
be valued at original cost plus the cumulative equity in the earnings and
losses of the funds and adjusted over time by the premium or discount at
the time of purchase to the applicable underlying net asset value of the
funds. Prior to the policy change, the Company reported the income on a
cash basis, valued the investments at quoted market prices and recorded the
change in quoted market prices through comprehensive income. The results
of prior accounting periods impacted by this change have been restated.
During 2001, the undistributed operating results of closed-end
preferred stock mutual funds have been reflected in realized gains and
losses. Year-end December 31, 2000 period results previously reflected in
investment income, have been reclassified to realized gains and losses to
conform with current period presentation. During 2000 the Company
reflected a realized gain of $26,575 versus a loss in 1999 of $22,401, as a
result of this change.
Gross realized gains and losses for the years ended December 31, 2000
and December 31, 1999 were as follows:
2000 1999
Gross Gross Gross Gross
Realized Realized Realized Realized
Gains Losses Gains Losses
Fixed maturities.................... $ 223 $ (3,995) $ 458 $ (6,449)
Preferred stocks.................... 1,748 (462) 207 (451)
Closed-end preferred stock mutual
funds............................. 26,641 (66) 1,900 (24,301)
Common stocks....................... 4,370 - 16,080 (5,057)
Venture capital fund investments.... 460 - 888 -
Other investments................... 631 - 347 -
Total.......................... $ 34,073 $ (4,523) $ 19,880 $(36,258)
22
Gross accumulated other comprehensive income and losses for December
31, 2000 and December 31, 1999 were as follows:
December 31, 2000 December 31, 1999
Gross Gross Gross Gross
Accumulated Accumulated Accumulated Accumulated
Other Other Other Other
Comprehensive Comprehensive Comprehensive Comprehensive
Income Losses Income Losses
Fixed maturities.......... $ 16,247 $ (12,193) $ 5,221 $ (19,328)
Preferred stocks.......... 999 (16,739) 782 (20,667)
Common stocks............. 28,126 (3) 1,305 (7,941)
Other investments......... 1,327 - 1,009 -
Total..................... $ 46,699 $ (28,935) $ 8,317 $ (47,936)
The accumulated other comprehensive income on fixed maturities
increased significantly as a result of the favorable performance in the
bond market due to lower interest rates in 2000. Long-term interest rates
(30-year Treasury Bond) decreased to 5.46% at December 31, 2000 from 6.48%
at December 31, 1999.
Loss and Loss Adjustment Expenses
Losses and loss adjustment expenses ("LAE") incurred increased $61,067
or 9.8% in 2000. As a percentage of premiums earned, losses and LAE
incurred for 2000 was 71.7% compared to 72.0% in 1999. The Company
experienced higher assumed residual market losses during 2000, which were
offset by improved voluntary loss ratios in Massachusetts. Additionally in
2000, the loss ratio was adversely impacted by approximately $8,000 of
expense (0.8% of the loss ratio) attributable to the Trust insolvency.
Also included in the 2000 increase in incurred expense is approximately
$6,300 in higher corporate expenses which are allocated to losses and LAE
for book value appreciation rights, director retirement compensation and
state income taxes on non-insurance subsidiaries. The ratio of net
incurred losses, excluding LAE, to premiums earned ("pure loss ratio") on
personal automobile was 63.2% in 2000 compared to 65.1% in 1999. The
decrease to the personal automobile pure loss ratio was primarily due to an
increase in redundancies arising from prior accident years, and decreases
in the cost of adjusting losses. The commercial automobile pure loss ratio
decreased to 59.7% in 2000 compared to 60.3% in 1999. For homeowners, the
pure loss ratio was 40.0% in 2000 compared to 35.9% in 1999. The increase
was primarily due to fewer liability redundancies in 2000 compared to 1999.
The loss ratio (on a statutory basis) for Commerce West was 69.3% for 2000
as compared to 71.2% in 1999. The loss ratio (on a statutory basis) for
American Commerce was 84.5% for 2000 as compared to its eleven-month loss
ratio of 75.8% in 1999.
Policy Acquisition Costs
Policy acquisition costs expensed increased by $9,597 or 4.1% in 2000.
As a percentage of net premiums written, the Company's statutory
underwriting expense ratio for 2000 was 25.1% compared to 26.5% in 1999.
The decreased 2000 underwriting expense ratio resulted primarily from lower
Massachusetts direct automobile commissions associated with a decrease in
the state mandated minimum commissions, a lower provision for accrued
contingent commissions, and lower expenses due to the continued effects of
certain cost reduction programs, partially offset by the Trust insolvency
assessment. The 2000 underwriting ratio includes a $4,900 charge (0.5% of
the underwriting expense ratio) representing the Company's allocation from
the Massachusetts Insurers Insolvency Fund for this insolvency. Also
included in the 2000 increase in policy acquisition costs expensed is
approximately $5,800 in higher corporate expenses which are allocated to
policy acquisition costs for book value appreciation rights, director
retirement compensation and state income taxes on non-insurance
subsidiaries. The underwriting expense ratio (on a statutory basis) for
Commerce West was 35.8% for 2000 as compared to 40.9% for 1999. The
underwriting expense ratio (on a statutory basis) for American Commerce,
was 29.3% for 2000 compared to its eleven-month expense ratio of 31.4% for
1999.
23
Income Taxes
The Company's effective tax rate was 22.5% and 16.0% for the years
ended December 31, 2000 and 1999, respectively. In both years the
effective rate was lower than the statutory rate of 35% primarily due to
tax-exempt interest income and the corporate dividends received deduction.
The higher effective tax rate for 2000 was the result of both the tax-
exempt interest and the dividends received deduction comprising a lesser
portion of earnings before taxes.
Minority Interest in Net Loss of Subsidiary
As a result of the joint venture with AAA SNE and acquisition of
American Commerce (see "Management's Discussion and Analysis of Financial
Condition and Results of Operations - General" and "Notes to Consolidated
Financial Statements - NOTES A13 and A17"), the Company's interest in ACIC
Holding Co., Inc., through Commerce, a wholly-owned subsidiary of CHI, is
represented by ownership of 80% of the outstanding shares of common stock
at December 31, 2000. AAA SNE maintains a 20% common stock ownership. The
minority interest in net loss of subsidiary of $320 included in the
consolidated statement of earnings for 2000 represents 20% of the net loss
for ACIC Holding Co., Inc. calculated after the $9,178 preferred stock
dividend paid to Commerce. This compares to $1,059 minority interest in
net loss of subsidiary after $8,300 in preferred stock dividends paid to
Commerce in 1999.
Net Earnings
Net earnings increased $43,404 or 48.9% to $132,080 during 2000 as
compared to $88,676 in 1999. The net earnings for 2000 were increased by
$20,514, or $0.60 per share and decreased $14,020 or $0.40 per share in
1999 as a result of the Company's change in its policy in regard to its
investment in closed-end preferred stock mutual funds mentioned previously.
Operating earnings, which exclude the after-tax impact of net realized
investment gains, increased $12,220 or 12.5% to $109,631 ($3.21 per share
basic and diluted) during 2000 as compared to $97,411 ($2.79 per share
basic and diluted) in 1999, as a result of the factors previously
mentioned.
Liquidity and Capital Resources
The focus of the discussion of liquidity and capital resources is on
the Consolidated Balance Sheets on page 35 and the Consolidated Statements
of Cash Flows on pages 38 and 39. Stockholders' equity increased by
$30,393, or 3.9%, in 2001 as compared to 2000. The increase resulted from
$93,094 in net earnings, and by net increases in other comprehensive
income, net of income tax benefits, on fixed maturities and preferred and
common stocks of $561, offset by dividends paid to stockholders of $39,951
and Treasury Stock purchased of $23,311. Total assets at December 31, 2001
increased $64,468, or 3.1% to $2,140,082 as compared to total assets of
$2,075,614 at December 31, 2000. Invested assets, at market value and
equity, increased $25,639 or 1.7%. Premiums receivable increased $15,641
or 6.8%. The increase in premiums receivable from December 31, 2000, was
primarily attributable to increases in Massachusetts automobile business.
Deferred policy acquisition costs increased $5,252 or 4.7%. Receivable
from reinsurers increased $8,896 or 14.5%, primarily attributable to the
increase in other than automobile business previously discussed. The
deferred income tax asset increased $4,952, mainly as a result of
accounting for certain investments on an equity basis. All other remaining
assets increased $4,088 or 2.2%.
24
The Company's investment portfolio, at market and equity, is shown on the following
table as of December 31, 2001 and 2000 (for investments, at cost, refer to the table found
on page 15):
December 31,
Investments, at market and equity % of % of
2001 Invest. 2000 Invest.
GNMA & FNMA mortgage-backed bonds...... $ 98,985 6.6% $ 67,261 4.6%
Corporate bonds........................ 136,506 9.1 126,255 8.6
U.S.Treasury bonds and notes........... 105 - 3,377 0.2
Tax exempt state and municipal bonds... 390,886 26.1 473,042 32.1
Total fixed maturities............. 626,482 41.8 669,935 45.5
Preferred stocks....................... 248,101 16.6 200,083 13.6
Common stocks.......................... 107,458 7.2 115,827 7.9
Closed-end preferred stock
mutual funds at equity............... 309,282 20.6 337,733 22.9
Mortgages and collateral loans (net of
allowance for possible loan losses).. 39,505 2.6 51,661 3.5
Cash and cash equivalents.............. 148,630 9.9 70,521 4.8
Other investments...................... 18,743 1.3 26,802 1.8
Total investments.................. $1,498,201 100.0% $1,472,562 100.0%
Comparison of Cost/Market Value of Fixed Maturities for the years ended December 31,
2001
% of Total
Market Cost Difference Based on Cost
GNMA & FNMA mortgage-backed bonds..... $ 98,985 $ 98,198 $ 787 15.9%
Corporate bonds....................... 136,506 133,506 3,000 21.6%
U.S. Treasury bonds and notes......... 105 104 1 0.0%
Tax exempt state and municipal bonds.. 390,886 386,967 3,919 62.5%
Total fixed maturities.............. $ 626,482 $ 618,775 $ 7,707 100.0%
2000
% of Total
Market Cost Difference Based on Cost
GNMA & FNMA mortgage-backed bonds..... $ 67,261 $ 67,274 $ (13) 10.0%
Corporate bonds....................... 126,255 130,775 (4,520) 20.0%
U.S. Treasury bonds and notes......... 3,377 3,428 (51) 1.0%
Tax exempt state and municipal bonds.. 473,042 464,404 8,638 70.0%
Total fixed maturities.............. $ 669,935 $ 665,881 $ 4,054 100.0%
Of the Company's bonds, 97.9% are rated in either of the two highest quality categories
provided by the NAIC.
Comparison of Carrying Value for the years ended December 31,
2001 2000
Market/Equity Market/Equity % of
Value Value Variance Variance
Fixed maturities...................... $ 626,482 $ 669,935 $ (43,453) (6.5%)
Preferred stocks...................... 248,101 200,083 48,018 24.0%
Common stocks......................... 107,458 115,827 (8,369) (7.2%)
Closed-end preferred stock
mutual funds at equity.............. 309,282 337,733 (28,451) (8.4%)
Mortgages and collateral loans
(net of allowance for possible
loan losses)...................... 39,505 51,661 (12,156) (23.5%)
Cash and cash equivalents............. 148,630 70,521 78,109 110.8%
Other investments..................... 18,743 26,802 (8,059) (30.1%)
Total investments................... $1,498,201 $1,472,562 $ 25,639 1.7%
25
Preferred stocks increased $48,018, or 24.0% and common stocks
decreased $8,369, or 7.2%, during 2001. Preferred stock mutual funds at
equity, decreased $28,541 or 8.4% in 2001 compared to 2000. The majority
of the increase in preferred stocks and the corresponding decrease in
preferred stock mutual funds was primarily the result of a newly created
trust fund. In 2001, the trustees of Putnam Dividend Income Fund ("PDI")
liquidated the fund. The Company's pro-rata share of the portfolio
securities and cash of PDI was transferred to a new fund created by the PDI
trustees whose ownership was conveyed to the Company. At December 31, 2001
the fund was consolidated into the Company's financial statements, totaling
$60,869. The majority of the fund represents investments valued at $59,019
and is included in preferred stocks and $1,332 in cash and cash
equivalents. Other investments at equity, comprised of venture capital
fund investments, decreased $8,059 or 30.1% during 2001 as a result of
equity accounting changes mentioned previously. The Company's strategy
continues to focus on maximizing after-tax investment income through
investing in high quality securities coupled with acquiring equity
investments, which may forgo current investment yield in favor of potential
higher yielding capital appreciation in the future. The Company continues
to monitor interest rates on long-term securities and intends to maintain
its high cash position until such time as the Company believes the long-
term rates have appropriately firmed.
The Company's liabilities increased $35,143 or 2.7% to $1,327,808 at
December 31, 2001 as compared to $1,292,665 at December 31, 2000. Loss and
loss adjustment expense reserves comprised 51.3% of the Company's
liabilities at December 31, 2001 compared with 52.2% at December 31, 2000.
Unearned premiums comprised 42.4% of the Company's liabilities at December
31, 2001 compared with 40.2% at December 31, 2000. All other liabilities
comprised 6.3% of the Company's liabilities at December 31, 2001, compared
with 7.6% at December 31, 2000. Loss and loss adjustment expense reserves
increased $7,484 or 1.1%. Unearned premiums increased $43,571 or 8.4%, due
primarily to increased business in 2001. Current income taxes decreased
$13,988 or 80.4%. The net effect of all other liabilities decreased $4,659
or 5.5%.
Liabilities for unpaid losses and loss adjustment expenses at December 31, 2001 and
2000 consist of:
2001 2000
Net voluntary unpaid loss and LAE reserves................ $558,635 $544,585
Voluntary salvage and subrogation recoverable............. (73,393) (65,505)
Assumed unpaid loss and LAE reserves from C.A.R........... 125,787 127,631
Assumed salvage and subrogation recoverable from C.A.R.... (20,695) (20,844)
Total voluntary and assumed unpaid loss and LAE reserves 590,334 585,867
Adjustment for ceded unpaid loss and LAE reserves......... 100,290 97,273
Adjustment for ceded salvage and subrogation recoverable.. (9,000) (9,000)
Total unpaid loss and LAE reserves...................... $681,624 $674,140
The primary sources of the Company's liquidity are funds generated
from insurance premiums, net investment income, premium finance and service
fees and the maturing and sale of investments as reflected in the
Consolidated Statements of Cash Flows on pages 38 and 39. The discussion
of these items can be found under "Year Ended December 31, 2001 Compared to
Year Ended December 31, 2000", herein.
The Company's operating activities provided cash of $106,172 in 2001,
as compared to $147,906 in 2000, representing a decrease of $41,734 or
28.2% in 2000. The primary reason for this decrease is that the increase
in premiums collected was outpaced by the increase in losses and LAE paid.
Federal income tax payments increased $10,439 or 35.7% in 2001. Of the
$39,703 in federal tax payments in 2001, $13,985 related to 2000, due to
significant income in the fourth quarter of 2000. Net investment income
received and premium and service fees received increased 8.9% and 17.0%,
respectively.
26
For 2001 net cash flows from investing activities provided cash of
$35,199, as compared to net cash flows used in investing activities of
$45,226 in 2000. The majority of the $80,425 difference was a $54,142
decrease in purchases of fixed maturities, a $38,824 decrease in the
purchase of preferred stock mutual funds, a $5,164 increase from proceeds
from sale of equity securities, a $3,811 decrease in purchases of other
assets, and a $4,974 increase in proceeds from maturity of fixed
maturities. These were offset by a $12,787 increase in the purchase of
equity securities coupled with a $6,790 increase in the purchase of
property and equipment. Investing activities were funded by accumulated
cash and cash provided by operating activities in 2001 and 2000. The
decreased purchases of longer term investments coupled with the significant
increase in cash and cash equivalents were primarily the result of the low
interest rate environment in 2001.
During 2001, Commerce purchased a 160,000 square foot building. Costs
for this building including the land and improvements to date at December
31, 2001, are $4,932. The Company anticipates expending an additional $13
million renovating this building, primarily in 2002.
Cash flows used in financing activities totaled $63,262 during 2001
compared to $54,694 during 2000. The 2001 cash flows used in financing
activities consisted of $39,951 in dividends paid to stockholders and
$23,311 used to purchase 622,900 shares of Treasury Stock. The 2000 cash
flows used in financing activities consisted of $39,201 in dividends paid
to stockholders and $15,493 used to purchase 606,200 shares of Treasury
Stock.
The Company's funds are generally invested in securities with
maturities intended to provide adequate funds to pay claims without the
forced sale of investments. The carrying value (at market and equity) of
total investments at December 31, 2001 was $1,498,201. At December 31,
2001, the Company held cash and cash equivalents of $148,630. These funds
provide sufficient liquidity for the payment of claims and other short-term
cash needs. The Company continues to monitor interest rates on long-term
securities and intends to maintain its high cash position until such time
as the Company believes long-term rates have appropriately firmed. The
Company also relies upon dividends from its subsidiaries for its cash
requirements. Every Massachusetts insurance company seeking to make any
dividend or other distributions to its stockholders may, within certain
limitations, pay such dividends and then file a report with the
Commissioner. Dividends in excess of these limitations are called
extraordinary dividends. An extraordinary dividend is any dividend or
other property, whose fair value together with other dividends or
distributions made within the preceding twelve months exceeds the greater
of ten percent of the insurer's surplus as regards to policyholders as of
the end of the preceding year, or the net income of a non-life insurance
company for the preceding year. No pro-rata distribution of any class of
the insurer's own securities is to be included. No Massachusetts insurance
company shall pay an extraordinary dividend or other extraordinary
distribution until thirty days after the Commissioner has received notice
of the intended distribution and has not objected. No extraordinary
dividends were paid in 2001, 2000 or 1999. Similar laws exist in
California and Ohio. No extraordinary dividend was paid by American
Commerce in 2001 or 2000 and no dividends were paid by Commerce West since
its acquisition.
Periodically, sales have been made from the Company's fixed maturity
investment port-folio to actively manage portfolio risks, including credit-
related concerns, to optimize tax planning and to realize gains. This
practice will continue in the future.
Industry and regulatory guidelines suggest that the ratio of a
property and casualty insurer's annual net premiums written to statutory
policyholders' surplus should not exceed 3.00 to 1.00. The Company's
statutory premiums to surplus ratio was 1.51 to 1.00, 1.53 to 1.00, and
1.76 to 1.00 for the years ended December 31, 2001, 2000 and 1999,
respectively.
27
In early 1999, Commerce, invested $90,800 in the joint venture (ACIC
Holding Co., Inc.) to fund the American Commerce acquisition and to
capitalize the joint venture that is owned together with AAA SNE. Of this
$90,800, Commerce invested $90,000 in the form of preferred stock and an
additional $800 representing its 80% common stock ownership. The terms of
the preferred stock call for quarterly cash dividends at the rate of 10%
per annum. In the event cash dividends cannot be paid, additional
preferred stock will be issued. AAA SNE invested $200 representing its 20%
common stock ownership. Commerce consolidates ACIC Holding Co., Inc. and
its wholly-owned subsidiary, American Commerce, for financial reporting and
tax purposes. Since 1995, Commerce has maintained an affinity group
marketing relationship with AAA Insurance Agency, Inc., a subsidiary of AAA
SNE. AAA Insurance Agency, Inc. has been an agent of Commerce since 1985.
In addition to the real estate commitment mentioned earlier, Commerce
has commitments in two venture capital fund investments. These investments
are made in limited partnerships and the Company's exposure to loss is
limited to its actual investment.
In 2000, Commerce entered into a Limited Partnership Agreement with
Conning Partners VI, L.P., a Delaware Limited Partnership. This
partnership agreement required a commitment by the Company to invest up to
$50,000 into the partnership. To date the Company has invested $15,091
into the partnership leaving a balance for funds still committed but not
paid into the partnership of $34,909. The partnership was formed to
operate as an investment fund principally for the purpose of making
investments primarily in equity, equity-related and other securities issued
in expansion financing, start-ups, buy-outs and recapitalization
transactions relating to companies in the areas of insurance, financial
services, e-commerce, healthcare, and related businesses, including,
without limitation, service and technology enterprises supporting such
businesses, in order to realize long-term capital returns, all as
determined and managed by the General Partner for the benefit of the
Partners.
Also in 2000, Commerce entered into a Limited Partnership Agreement
with Distribution Partners Investment Capital, L.P. a Delaware Limited
Partnership. This partnership agreement required a commitment by the
Company to invest up to $3,500 into the partnership. To date the Company
has invested $2,258 into the partnership leaving a balance of $1,242 for
funds still committed. The partnership was formed to operate as an
investment fund principally for the purpose of making investments primarily
in equity and equity-related securities of companies operating in the area
of insurance distribution and distribution related activities, all as
determined and managed by the General Partner for the benefit of the
Partners.
Market Risk: Interest Rate Sensitivity and Equity Price Risk
The Company's investment strategy emphasizes investment yield while
maintaining investment quality. The Company's investment objective
continues to focus on maximizing after-tax investment income through
investing in high quality diversified investments structured to maximize
after-tax investment income while minimizing risk. The Company's funds are
generally invested in securities with maturities intended to provide
adequate funds to pay claims and meet other operating needs without the
forced sale of investments. Periodically, sales have been made from the
Company's fixed maturity portfolio to actively manage portfolio risks,
including credit-related concerns, to optimize tax planning and to realize
gains. This practice will continue in the future.
In conducting investing activities, the Company is subject to, and
assumes, market risk. Market risk is the risk of an adverse financial
impact from changes in interest rates and market prices. The level of risk
assumed by the Company is a function of the Company's overall objectives,
liquidity needs and market volatility.
The Company manages its market risk by focusing on higher quality
equity and fixed income investments, by periodically monitoring the credit
strength of companies in which investments are made, by limiting exposure
in any one investment and by monitoring the quality of the investment
portfolio by taking into account credit ratings assigned by recognized
rating organizations. Although the Company has significant holdings of
various closed-end preferred stock mutual funds, these funds are comprised
primarily of preferred stocks traded on national stock exchanges, thus
limiting exposure to any one investment.
28
As part of its investing activities, the Company assumes positions in
fixed maturity, equity, short-term and cash equivalents markets. The
Company is, therefore, exposed to the impacts of interest rate changes in
the market value of investments. At December 31, 2001, the Company's
exposure to interest rate changes and equity price risk has been estimated
using sensitivity analysis. The interest rate impact is defined as the
effect of a hypothetical interest rate change of plus-or-minus 200 basis
points on the market value of fixed maturities and preferred stocks. The
equity price risk is defined as a hypothetical change of plus-or-minus 10%
in the fair value of common stocks. Changes in interest rates would result
in unrealized gains or losses in the market value of the fixed maturity and
preferred stock portfolio due to differences between current market rates
and the stated rates for these investments. Based on the results of the
sensitivity analysis at December 31, 2001, the Company's estimated market
exposure for a 200 basis point increase (decrease) in interest rates was
calculated. A 200 basis point increase results in an $83,611 decrease in
the market value of the fixed maturities and preferred stocks. A 200 basis
point decrease results in a $47,436 increase in the market value of the
same securities. The equity price risk impact at December 31, 2001, based
upon a 10% increase in the fair value of common stocks and preferred stock
mutual funds, would be an increase of $10,746 and $31,567, respectively.
Based upon a 10% decrease, common stocks and preferred stock mutual funds
would decrease $10,746 and $31,567, respectively. Long-term interest rates
(30-year Treasury Bond) increased slightly to 5.47% at December 31, 2001
from 5.46% at December 31, 2000. The preceding sensitivity analysis does
not represent a forecast and should not be relied upon as being indicative
of expected operating results. These hypothetical estimates are based upon
numerous assumptions such as the nature and timing of interest rate levels
including the yield curve shape, prepayments on loans and securities,
reinvestment and replacement of asset and liability cash flows and others.
While assumptions are developed based upon current economic conditions, the
Company cannot provide any assurance as to the predictive nature of these
assumptions. Also, as market conditions vary from those assumed in the
sensitivity analysis, actual results will also differ due to prepayment and
refinancing levels likely deviating from those assumed and other internal
and external variables. Furthermore, the sensitivity analysis does not
reflect actions that management might take in responding to or anticipating
changes in interest rates.
Recent Accounting Developments
The NAIC revised the Accounting Practices and Procedures Manual in a
process referred to as Codification. The revised manual became effective
January 1, 2001 for all insurance companies. The domiciliary states of the
Company's insurance subsidiaries have adopted the provisions of the revised
manual. The revised manual has changed certain prescribed statutory
accounting practices and has resulted in changes to the accounting
practices that the Company's insurance subsidiaries use to prepare their
statutory-basis financial statements. The impact of these changes to the
Company's insurance subsidiaries statutory-basis capital and surplus as of
January 1, 2001 had a significant beneficial effect of approximately
$38,737 primarily due to the inclusion of deferred taxes as an admitted
asset. The codification changes had no impact on the Company's GAAP
financial statements.
In June 1998, the FASB issued Statement of Financial Accounting
Standards No. 133 ("SFAS 133"), "Accounting for Certain Derivative
Instruments and Hedging Activities", as amended in June 2000 by Statement
of Financial Accounting Standards No. 138 ("SFAS 138"), "Accounting for
Certain Derivative Instruments and Certain Hedging Activities", which
requires companies to recognize all derivatives as either assets or
liabilities in the balance sheet and measure such instruments at fair
value. SFAS 138 also amended Statement of Financial Accounting Standards
No. 137 ("SFAS 137"), "Accounting for Derivative Instruments and Hedging
Activities - Deferral of the Effective Date of FASB Statement No. 133".
The provisions of SFAS 133 require adoption for fiscal year beginning after
June 15, 2000. The Company had no derivative or hedging activity in 2001,
2000, or 1999. The adoption of these FASBs had no material impact on the
Company's consolidated financial statements.
In September 2000, the FASB issued Statement of Financial Accounting
Standards No. 140 ("SFAS 140"), "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities", which replaced
Statement of Financial Accounting Standards No. 125 ("SFAS 125"),
"Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities". The Statement provides accounting and
reporting standards for transfers and servicing of financial assets and
extinguishments of liabilities. Those standards are based on consistent
application of a "financial components" approach that focuses on control.
Under that approach, after a transfer of financial assets, a company
recognizes the financial and servicing assets it controls and the
liabilities it has
29
incurred, does not recognize financial assets when control has been
surrendered, and does not recognize liabilities when extinguished. The
Statement provides consistent standards for distinguishing transfers of
financial assets that are sales from transfers that are secured borrowings.
The Statement is effective for transfers and servicing of financial assets
and extinguishments of liabilities occurring after March 31, 2001.
Adoption of SFAS 140 did not have a material impact on the Company's
consolidated financial statements.
In July 2001, the FASB issued Statements of Financial Accounting
Standards No. 141, "Business Combinations", and No. 142, "Goodwill and
Other Intangible Assets". SFAS No. 141, effective for business
combinations initiated after June 30, 2001, requires that all business
combinations be accounted for under a single method - the purchase method.
Use of the pooling-of-interests method is no longer permitted. SFAS No.
141 also clarifies the criteria to recognize intangible assets separately
from goodwill. SFAS No. 142 requires that goodwill and intangible assets
deemed to have indefinite lives no longer be amortized to earnings, but
instead be reviewed at least annually for impairment. Other intangible
assets will continue to be amortized over their useful lives. SFAS No. 142
will be effective January 1, 2002.
The Company has evaluated the impact of adopting the provisions of
SFAS No. 142 on earnings and financial position for the year ended December
31, 2002. Effective January 1, 2002, in accordance with SFAS No. 142, the
Company will cease amortizing the balance sheet item "excess of book value
of subsidiary interest over cost" which is $5.7 million at year end 2001.
The 2001 impact of the amortization of this resulted in approximately $0.10
per share of annual operating earnings. Additionally, the Company will no
longer amortize the negative goodwill resulting from the purchase of
preferred stock mutual funds effective January 1, 2002. The amount of
unamortized negative goodwill at year-end is $6.4 million. The 2001 impact
of the amortization of this was $0.10 per share of earnings classified as
capital gains. Both the excess of book value of subsidiary interest over
cost and the negative goodwill on preferred stock mutual funds will be
recognized as income in the first quarter of 2002 and classified as an
extraordinary item. The estimated per share income impact of this change
is $0.34 per share.
Critical Accounting Policies
The preparation of financial statements in conformity with GAAP
requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates. The following accounting
policies, which are derived based on management's judgments and estimates,
are considered critical to the preparation of the Company's financial
statements.
1. Investments
The focus of management's judgments and estimates relating to
investments involves the potential impairment of investments for other than
temporary declines in market values. The carrying value of investments in
fixed maturities, which include taxable and non-taxable bonds, and
investments in common and preferred stocks, are derived from market prices
supplied by the Company's investment custodian. Unrealized investment
gains and losses on common and preferred stocks and fixed maturities, to
the extent that there is no other than temporary impairment of value, are
credited or charged to a separate component of stockholders' equity, known
as "net accumulated other comprehensive income (loss)", until realized, net
of any tax effect. An impairment in an investment is deemed to be other
than temporary, when a security's market value has diminished to less than
75% of cost for two consecutive quarters. If the security is deemed
impaired the Company adjusts the securities cost to market value through
realized loss based on publicly available prices or, in the absence of
such, to a value based on cash flow modeling. During 2001, the Company
wrote down $2,665 in bonds and preferred stock investments with impairment
as determined by management to be other than temporary. Given the makeup
and quality of the Company's investments, management does not believe that
a more stringent policy would have a material effect on the carrying value
of its investments.
30
2. Unpaid Loss and Loss Adjustment Expenses ("LAE")
Unpaid Loss and LAE by their nature are inherently uncertain as to the
ultimate outcome of the estimated amounts. The liability for unpaid losses
and LAE represents Management's best estimate of the ultimate net cost of
all losses and LAE incurred through the balance sheet date. The estimate
for ultimate net cost of all losses incurred through the balance sheet date
includes the adjusted case estimates for losses, incurred but not reported
("IBNR") losses, salvage and subrogation recoverable and a reserve for LAE.
In arriving at its best estimate, management begins with the aggregate of
individual case reserves and then makes adjustments to these amounts on a
line of business basis. These adjustments to the aggregate case reserves
by line of business are made based on analysis performed by Management as
further described below. The entire liability for unpaid losses and LAE is
also reviewed quarterly and annually by the Company's Actuarial Department.
Liability estimates are continually analyzed and updated, and therefore,
the ultimate liability may be more or less than the current estimate. The
effects of changes in the estimates are included in the results of
operations in the period in which the estimates are revised.
The claim cycle begins when a claim is reported to the Company and
claims personnel establish a "case reserve" for the estimated amount of the
ultimate exposure to the Company. The amount of the reserve is primarily
based upon an evaluation of the type of claim involved, the circumstances
surrounding the claim and the policy provisions relating to the loss. This
estimate reflects the informed judgment of such personnel based on general
insurance reserving practices and on the experience and knowledge of the
claims personnel adjusting the claim. During the loss adjustment period,
these case basis estimates are revised as deemed necessary by the Company's
claims department personnel based on subsequent developments and periodic
reviews of the claim.
In accordance with industry practice, the Company also maintains
reserves for estimated IBNR, salvage and subrogation recoverable and LAE.
These reserves are determined on the basis of historical information and
the experience of the Company. Adjustments to these reserves are made
periodically to take into account changes in the volume of business
written, claims frequency and severity, the mix of business, claims
processing and other items that can be expected to affect the Company's
liability for losses and LAE over time.
When reviewing the liability for unpaid losses and LAE, the Company
analyzes historical data and estimates the impact of various factors such
as: (i) payment trends; (ii) loss expense per exposure; (iii) the
historical loss experience of the Company and industry; (iv) frequency and
severity trends; and, (v) legislative enactments, judicial decisions, legal
developments in the imposition of damages, changes and trends in general
economic conditions, including the effects of inflation and recession.
This process assumes that past experience, adjusted for the effects of
current developments and anticipated trends, is an appropriate basis for
predicting future events. There is no precise method, however, for
subsequently evaluating the impact of any specific factor on the adequacy
of reserves, because the eventual development of reserves is affected by
many factors.
By using individual estimates of reported claims adjusted for
managements best estimate by line of business and generally accepted
actuarial reserving techniques, the Company estimates the ultimate net
liability for losses and LAE. After taking into account all relevant
factors, management believes that, based on existing information, the
provision for losses and LAE at December 31, 2001 is adequate to cover the
ultimate net cost of losses and claims incurred as of that date. The
ultimate liability, however, may be greater or lower than established
reserves. If the ultimate exposure is greater than (or less than)
management's estimated liability for losses and LAE, based on any of the
factors noted previously, the Company will incur additional expense
(income) which may have a material impact.
Forward - Looking Statements
This annual report contains some statements that are not historical
facts and are considered "forward-looking statements" as defined in the
Private Securities Litigation Reform Act of 1995. Such forward-looking
statements involve opinions, assumptions and predictions, and no assurance
can be given that the future results will be achieved since events or
results may differ materially as a result of risks facing the Company.
These include, but are not limited to, those risks and uncertainties in our
business, some of which are beyond the control of the Company, that are
described in the Company's Forms 10-K and 10-Q, Schedules 13D and 13G, and
other documents filed with the SEC, including the
31
possibility of adverse catastrophe experience and severe weather, adverse
trends in claim severity or frequency, adverse state and federal regulation
and legislation, adverse state judicial decisions, litigation risks,
interest rate risk, rate making decisions for private passenger automobile
policies in Massachusetts, potential rate filings outside of Massachusetts,
adverse impacts related to consolidation activities, heightened
competition, as well as the economic, market or regulatory conditions and
risks associated with entry into new markets and diversification.
Effects of Inflation and Recession
The Company generally is unable to recover the costs of inflation in
its personal automobile insurance line since the premiums it charges are
subject to state regulation. Additionally, the premium rates charged by
the Company for personal automobile insurance are adjusted by the
Commissioner only at annual intervals. Such annual adjustments in premium
rates may lag behind related cost increases. Economic recessions can have
an impact upon the Company, primarily through the policyholder's election
to decrease non-compulsory coverages afforded by the policy and increased
driving, each of which tends to decrease claims.
To the extent inflation and economic recession influence yields on
investments, the Company is also affected. As each of these environments
affect current market rates of return, previously committed investments may
rise or decline in value depending on the type and maturity of investment.
Inflation and recession must also be considered by the Company in the
creation and review of loss and LAE reserves since portions of these
reserves are expected to be paid over extended periods of time. The
anticipated effect of economic conditions is implicitly considered when
estimating liabilities for losses and LAE. The importance of continually
adjusting reserves is even more pronounced in periods of changing economic
circumstances.
COMMON STOCK PRICE AND DIVIDEND INFORMATION
The Company's common stock trades on the NYSE under the symbol "CGI". The high, low
and close prices for shares, as quoted in The Boston Globe, of the Company's Common Stock
for 2001 and 2000 were as follows:
2001 2000
High Low Close High Low Close
First Quarter...... $32.1000 $24.5500 $32.0000 $31.0000 $23.0000 $29.5000
Second Quarter..... 36.9900 30.7500 36.7900 30.8750 26.1250 29.5000
Third Quarter...... 38.3500 33.5500 38.0000 29.4375 25.0625 28.9375
Fourth Quarter..... 40.3500 35.8000 37.6900 29.2500 22.8750 27.1800
As of March 1, 2002, there were 1,053 stockholders of record of the
Company's Common Stock, not including stock held in "Street Name" or held
in accounts for participants of the Company's Employee Stock Ownership Plan
("E.S.O.P.").
The Board of Directors of the Company voted to declare four quarterly
dividends to stockholders of record totaling $1.19 per share and $1.15 per
share in 2001 and 2000, respectively. On May 19, 2001, the Board voted to
increase the quarterly stockholder dividend from $0.29 to $0.30 per share
to stockholders of record as of June 4, 2001. Prior to that declaration,
the Company had paid quarterly dividends of $0.29 per share dating back to
May 15, 2000 when the Board voted to increase the dividend from $0.28 to
$0.29 per share.
In May 1999, the Board of Directors of the Company authorized a stock
buy-back program of up to 2,000,000 shares of common stock of the Company.
At December 31, 2001, there are 273,700 shares of common stock authorized
to be purchased under this program. In November 2001, the Board of
Directors approved another stock buy-back program authorizing the purchase
of up to an additional 2,000,000 shares. During the period from January 1,
2001 through December 31, 2001, the Company purchased 622,900 shares of its
own common stock. During 2000, the Company purchased 606,200 shares of its
own common stock under the May 1999 buy-back program. At December 31,
2001, the Company had authority to purchase a total of 2,273,700 additional
shares of its common stock under the May 1999 and November 2001 buy-back
programs. As of December 31, 2001, the Company holds a total of 4,869,548
shares of treasury stock.
32
REPORT OF MANAGEMENT
The management of the Company is responsible for the consolidated
financial statements and all other information presented in this Annual
Report. The financial statements have been prepared in conformity with
accounting principles generally accepted in the United States determined by
management to be appropriate in the circumstances and include amounts based
on management's informed estimates and judgments. Financial information
presented elsewhere in this Annual Report is consistent with the financial
statements. The appropriateness of data underlying such financial
information is monitored through internal accounting controls, an internal
audit department, independent auditors and the Board of Directors through
its audit committee.
The Company maintains a system of internal accounting controls
designed to provide reasonable assurance to management and the Board of
Directors that assets are safeguarded and that transactions are executed in
accordance with management's authorization and recorded properly. The
system of internal accounting controls is supported by the selection and
training of qualified personnel combined with the appropriate division of
responsibilities.
Management recognizes its responsibility for fostering a strong
ethical climate so that the Company's affairs are conducted according to
the highest standards of personal and corporate conduct. The Board of
Directors has adopted a formal Code of Conduct and Corporate Compliance
Program governing employees and directors. Management encourages open
communication within the Company and requires the confidential treatment of
proprietary information and compliance with all domestic laws, including
those relating to financial disclosure.
The 2001 consolidated financial statements were audited by the
Company's independent auditors, Ernst & Young LLP, in accordance with
auditing standards generally accepted in the United States. In addition,
Ernst & Young LLP performs reviews of the unaudited quarterly financial
statements, prior to the announcement of quarterly earnings. Management
has made available to Ernst & Young LLP all of the Company's financial
records and related data, including reports prepared by the Internal Audit
Department as well as the minutes of stockholders' and directors' meetings.
Furthermore, management believes that all representations made to Ernst &
Young LLP were valid and appropriate.
33
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Stockholders of
The Commerce Group, Inc.
We have audited the accompanying consolidated balance sheets of The
Commerce Group, Inc. and Subsidiaries as of December 31, 2001 and 2000, and
the related consolidated statements of earnings, stockholders' equity and
cash flows for each of the three years in the period ended December 31,
2001. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with auditing standards
generally accepted in the United States. Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures
in the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
The Commerce Group, Inc. and Subsidiaries at December 31, 2001 and 2000,
and the consolidated results of their operations and their cash flows for
each of the three years in the period ended December 31, 2001, in
conformity with accounting principles generally accepted in the United
States.
ERNST & YOUNG LLP
Boston, Massachusetts
January 29, 2002
34
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31,
(Thousands of Dollars)
2001 2000
ASSETS
Investments (notes A2, A3, and B)
Fixed maturities, at market (cost: $618,775 in 2001 and $665,881
in 2000).......................................................... $ 626,482 $ 669,935
Preferred stocks, at market (cost: $256,582 in 2001 and $215,823
in 2000).......................................................... 248,101 200,083
Common stocks, at market (cost: $87,704 in 2001 and 2000).......... 107,458 115,827
Preferred stock mutual funds, at equity (cost: $294,948 in 2001 and
$327,980 in 2000)................................................. 309,282 337,733
Mortgage loans on real estate and collateral notes receivable
(less allowance for possible loan losses of $660 in 2001
and $858 in 2000)................................................. 39,505 51,661
Cash and cash equivalents.......................................... 148,630 70,521
Other investments (cost: $28,291 in 2001 and $25,475 in 2000)...... 18,743 26,802
Total investments.............................................. 1,498,201 1,472,562
Accrued investment income............................................ 15,539 18,218
Premiums receivable (less allowance for doubtful receivables of
$1,565 in 2001 and $1,487 in 2000)................................. 246,221 230,580
Deferred policy acquisition costs (notes A4 and C)................... 116,557 111,305
Property and equipment, net of accumulated depreciation
(notes A5 and D)................................................... 40,014 34,823
Residual market receivable (note F)
Losses and loss adjustment expenses................................ 81,433 82,450
Unearned premiums.................................................. 44,399 44,791
Due from reinsurers (note F)......................................... 70,450 61,554
Deferred income taxes (notes A9 and G)............................... 16,993 12,041
Receivable for investments sold...................................... 838 -
Non-compete agreement, net of accumulated amortization (note A6)..... 2,479 2,829
Other assets......................................................... 6,958 4,461
Total assets................................................... $2,140,082 $2,075,614
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Unpaid losses and loss adjustment expenses (notes A7, E and F)..... $ 681,624 $ 674,140
Unearned premiums (note A8)........................................ 563,456 519,885
Current income taxes (notes A9 and G).............................. 2,735 13,988
Deferred income (notes A10 and F).................................. 7,015 7,703
Contingent commissions accrued (note A11).......................... 29,724 35,346
Payable for securities purchased................................... - 524
Excess of book value of subsidiary interest over cost (note A12)... 5,719 8,431
Other liabilities and accrued expenses............................. 37,535 32,648
Total liabilities.............................................. 1,327,808 1,292,665
Minority interest (note A13)......................................... - 1,068
Stockholders' Equity (notes B, L, M and N)
Preferred stock, authorized 5,000,000 shares at $1.00 par value;
none issued in 2001 and 2000...................................... - -
Common stock, authorized 100,000,000 shares at $.50 par value;
38,000,000 shares issued in 2001 and 2000......................... 19,000 19,000
Paid-in capital.................................................... 29,621 29,621
Net accumulated other comprehensive income, net of income
taxes of $6,674 in 2001 and $6,371 in 2000........................ 12,394 11,833
Retained earnings.................................................. 873,671 820,528
934,686 880,982
Treasury stock, 4,869,548 shares in 2001 and 4,246,648 shares in
2000, at cost (note A14).......................................... (122,412) (99,101)
Total stockholders' equity..................................... 812,274 781,881
Total liabilities, minority interest and stockholders' equity.. $2,140,082 $2,075,614
The accompanying notes are an integral part of these consolidated financial statements.
35
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
For the years ended December 31,
(Thousands of Dollars Except Per Share Data)
2001 2000 1999
Revenues
Earned premiums (notes A8 and F)..................... $1,043,652 $ 954,483 $ 871,830
Net investment income (note B)....................... 99,611 96,830 89,789
Premium finance and service fees..................... 17,819 15,227 14,774
Amortization of excess of book value of subsidiary
interest over cost (note A12)...................... 3,389 3,390 3,019
Net realized investment gains (losses) (note B)...... (10,633) 29,550 (16,378)
Total revenues.................................. 1,153,838 1,099,480 963,034
Expenses
Losses and loss adjustment expenses
(notes A7, E and F)................................. 777,543 686,157 625,090
Policy acquisition costs (notes A4 and C)............ 260,870 243,257 233,660
Total expenses.................................. 1,038,413 929,414 858,750
Earnings before income taxes and minority
interest...................................... 115,425 170,066 104,284
Income taxes (notes A9 and G).......................... 23,194 38,306 16,667
Net earnings before minority interest........... 92,231 131,760 87,617
Minority interest in net loss of subsidiary (note A13). 863 320 1,059
NET EARNINGS.................................... $ 93,094 $ 132,080 $ 88,676
COMPREHENSIVE INCOME............................ $ 93,655 $ 168,570 $ 40,730
NET EARNINGS PER COMMON SHARE: (note A15)
BASIC......................................... $ 2.77 $ 3.87 $ 2.54
DILUTED....................................... $ 2.75 $ 3.87 $ 2.54
CASH DIVIDENDS PAID PER SHARE................... $ 1.19 $ 1.15 $ 1.11
WEIGHTED AVERAGE NUMBER OF COMMON
SHARES OUTSTANDING:
BASIC........................................ 33,608,804 34,121,047 34,940,074
DILUTED...................................... 33,794,938 34,121,047 34,940,074
The accompanying notes are an integral part of these consolidated financial statements.
36
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
For the years ended December 31,
(Thousands of Dollars)
Net
Accumulated
Other
Common Paid-in Comprehensive Retained Treasury
Stock Capital Income/(Loss) Earnings Stock Total
Balance January 1, 1999...... $19,000 $29,621 $ 23,289 $677,629 $ (38,687) $710,852
Net earnings................ 88,676 88,676
Other comprehensive income
(loss):
Unrealized holding losses
arising during the period,
net of tax benefits of
$18,833.................. (34,976) (34,976)
Reclassification adjustment,
net of tax benefits of
$6,984.................... (12,970) (12,970)
Other comprehensive(loss).. (47,946) (47,946)
Comprehensive income........ 40,730
Stockholder dividends....... (38,656) (38,656)
Treasury stock purchased.... (44,921) (44,921)
Balance December 31, 1999.... 19,000 29,621 (24,657) 727,649 (83,608) 668,005
Net earnings................ 132,080 132,080
Other comprehensive income:
Unrealized holding gains
arising during the period,
net of taxes of $18,218.. 33,833 33,833
Reclassification adjustment,
net of taxes of $1,431.... 2,657 2,657
Other comprehensive income. 36,490 36,490
Comprehensive income........ 168,570
Stockholder dividends....... (39,201) (39,201)
Treasury stock purchased.... (15,493) (15,493)
Balance December 31, 2000.... 19,000 29,621 11,833 820,528 (99,101) 781,881
Net earnings................ 93,094 93,094
Other comprehensive income
(loss):
Unrealized holding losses
arising during the period,
net of tax benefits of
$634..................... (1,178) (1,178)
Reclassification adjustment,
net of taxes of $936...... 1,739 1,739
Other comprehensive income. 561 561
Comprehensive income........ 93,655
Stockholder dividends....... (39,951) (39,951)
Treasury stock purchased.... (23,311) (23,311)
Balance December 31, 2001.... $19,000 $29,621 $ 12,394 $873,671 $(122,412) $812,274
The accompanying notes are an integral part of these consolidated financial statements.
37
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended December 31,
(Thousands of Dollars)
2001 2000 1999
Cash flows from operating activities
Premiums collected.................................. $1,066,544 $ 977,413 $ 881,472
Net investment income received...................... 101,216 92,962 90,558
Premium finance and service fees received........... 17,819 15,227 14,774
Losses and loss adjustment expenses paid............ (770,841) (660,665) (611,136)
Policy acquisition costs paid....................... (268,863) (247,767) (225,587)
Federal income tax payments......................... (39,703) (29,264) (25,404)
Net cash provided by operating activities......... 106,172 147,906 124,677
Cash flows from investing activities
Proceeds from maturity of fixed maturities.......... 25,779 20,805 46,565
Proceeds from sale of fixed maturities.............. 89,712 97,180 142,562
Proceeds from sale of equity securities............. 50,768 45,604 76,485
Proceeds from sale of preferred stock mutual funds.. 2,945 - -
Proceeds from sale of other investments............. 5,735 - -
Proceeds from sale of mortgages..................... - 20,042 -
Purchase of fixed maturities........................ (71,702) (125,844) (107,664)
Purchase of equity securities....................... (42,774) (29,987) (72,536)
Purchase of preferred stock mutual funds............ (21,200) (60,024) (98,564)
Purchase of other investments....................... (8,074) (11,885) (4,875)
Purchase of subsidiary, net of cash acquired........ - - (77,056)
Payments received on mortgage loans and collateral
notes receivable................................... 14,506 9,141 11,800
Mortgage loans and collateral notes originated...... (2,152) (7,896) (10,911)
Purchase of property and equipment.................. (10,206) (3,416) (2,910)
Other proceeds from investing activities............ 1,862 1,054 2,627
Net cash provided by (used in) investing
activities...................................... 35,199 (45,226) (94,477)
Cash flows from financing activities
Dividends paid to stockholders...................... (39,951) (39,201) (38,656)
Purchase of treasury stock.......................... (23,311) (15,493) (44,921)
Net cash used in financing activities............. (63,262) (54,694) (83,577)
Increase (decrease) in cash and cash equivalents...... 78,109 47,986 (53,377)
Cash and cash equivalents at beginning of year........ 70,521 22,535 75,912
Cash and cash equivalents at end of year.............. $ 148,630 $ 70,521 $ 22,535
The accompanying notes are an integral part of these consolidated financial statements.
38
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Reconciliation of Net Earnings to Net Cash Provided by Operating Activities
For the years ended December 31,
(Thousands of Dollars)
2001 2000 1999
Cash flows from operating activities
Net earnings......................................... $ 93,094 $ 132,080 $ 88,676
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Premiums receivable................................ (15,641) (35,420) (22,399)
Deferred policy acquisition costs.................. (5,252) (12,805) (3,374)
Residual market receivable......................... 1,409 14,419 (1,440)
Due from reinsurers................................ (8,896) (13,189) (4,116)
Losses and loss adjustment expenses................ 7,484 14,299 12,733
Unearned premiums.................................. 43,571 62,790 38,796
Current income taxes............................... (11,253) 3,149 6,909
Deferred income taxes.............................. (5,255) 5,893 (15,647)
Deferred income.................................... (688) 239 516
Contingent commissions............................. (5,622) 1,878 11,401
Other assets, liabilities and accrued expenses..... (323) 6,708 (8,273)
Net realized investment (gains) losses............. 10,633 (29,550) 16,378
Other - net........................................ 2,911 (2,585) 4,517
Net cash provided by operating activities....... $ 106,172 $ 147,906 $ 124,677
The accompanying notes are an integral part of these consolidated financial statements.
39
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars)
NOTE A - Summary of Significant Accounting Policies
1. Basis of Presentation
The consolidated financial statements of The Commerce Group, Inc. (the
"Company") have been prepared in accordance with accounting principles
generally accepted in the United States ("GAAP").
The consolidated financial statements include The Commerce Group, Inc.
and its wholly-owned subsidiaries, Bay Finance Company, Inc., Clark-Prout
Insurance Agency, Inc. and Commerce Holdings, Inc. ("CHI"). The Commerce
Insurance Company ("Commerce") and Citation Insurance Company ("Citation")
are wholly-owned subsidiaries of CHI. Commerce West Insurance Company
("Commerce West") is a wholly-owned subsidiary of Commerce. American
Commerce Insurance Company ("American Commerce") is a wholly-owned
subsidiary of ACIC Holding Co., Inc. ACIC Holding Co., Inc. is owned
jointly with AAA Southern New England ("AAA SNE") with Commerce maintaining
an 80% common stock interest and AAA SNE maintaining a 20% common stock
interest (see NOTE A17). All inter-company transactions and balances have
been eliminated in consolidation. Certain prior year account balances have
been reclassified to conform to the 2001 presentation. During the fourth
quarter of 2000, the Company changed its policy in regard to its
investments in certain closed-end preferred stock mutual funds. The level
of ownership and new investment policy requires the Company to account for
these investments on an equity basis. The results of prior accounting
periods impacted by this change have been restated.
The insurance subsidiaries, Commerce, Citation, Commerce West and
American Commerce, prepare statutory financial statements in accordance
with accounting practices prescribed by the National Association of
Insurance Commissioners ("NAIC"), the Commonwealth of Massachusetts, the
State of California, and the State of Ohio.
The preparation of financial statements in conformity with GAAP
requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
2. Investments
All investment transactions have credit exposure to the extent that a
counter party may default on an obligation to the Company. Credit risk is
a consequence of carrying investment positions. To manage credit risk, the
Company focuses on higher quality fixed-income securities and preferred
stocks, reviews the credit strength of all companies in which it invests,
limits its exposure in any one investment category and monitors the
portfolio quality, taking into account credit ratings assigned by
recognized statistical rating organizations.
The focus of management's judgments and estimates relating to
investments involves the potential impairment of investments for other than
temporary declines in market values. Carrying values of investments in
fixed maturities, which include taxable and non-taxable bonds, and
investments in common and preferred stocks, are derived from market prices
supplied by the Company's investment custodian. Unrealized investment
gains and losses on common and preferred stocks and fixed maturities, to
the extent that there is no other than temporary impairment of value, are
credited or charged to a separate component of stockholders' equity, known
as "net accumulated other comprehensive income (loss)", until realized, net
of any tax effect. An impairment in an investment is deemed to be other
than temporary when a security's market value has diminished to less than
75% of cost for two consecutive quarters. If the contractual terms of the
security are being complied with, management performs a cash flow valuation
to determine the potential impairment of the security. If the security is
deemed impaired the Company adjusts the securities cost to market value
through realized loss based on publicly available or, in the absence of
such, to a value based on cash flow modeling. During 2001, the Company
wrote down $2,665 in bonds and preferred stock investments with impairment
as determined by management to be other than temporary. Given the makeup
and quality of the Company's investments, management does not
40
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars)
NOTE A - Summary of Significant Accounting Policies (continued)
believe that a more stringent policy would have a material effect on the
carrying value of its investments. When investment securities are sold,
the realized gain or loss is determined based upon specific identification.
Fair market value of fixed maturities and common and preferred stocks are
based on quoted market prices. For other securities held as investments,
fair market value equals quoted market price, if available. If a quoted
market price is not available, fair market value is estimated using quoted
market prices for similar securities. The Company has not invested more
than 5% of fixed maturities in any one state or political subdivision.
During 2001, as required by the Emerging Issues Task Force ("EITF") D-
46, the Company began accounting for venture capital fund investments in
which it owns more than a 5% interest on the equity method. The operating
results of these venture capital fund investments have been reflected in
realized gains and losses. Prior to this change, the operating results
were not material and were therefore reflected in accumulated other
comprehensive income and loss.
During the fourth quarter of 2000 the Company changed its policy in
regard to investments in certain closed-end preferred stock mutual funds.
From that point forward the Company intends to take a proactive posture to
affect the overall investment performance of these funds. The Company's
level of ownership and new investment policy required the Company to
account for these investments from that point forward on the equity method.
Under the equity method the Company recorded it's share of the changes in
the mutual funds' undistributed net assets in net investment income. Prior
to the fourth quarter of 2000 these investments were recorded at their fair
market value with the changes in value reflected in accumulated other
comprehensive income. With the adoption of the equity method in the fourth
quarter of 2000 all prior periods were restated to reflect equity method
accounting. Beginning in the first quarter of 2001 the Company began
recording their equity in the changes in net assets of closed-end preferred
stock mutual funds as a component of realized gains and losses. All prior
periods have been reclassified to permit comparison with the current year
presentation. The Company believes the current year presentation provides
a more appropriate classification for analysis of ongoing operations of the
Company. These investments are valued at original cost plus the cumulative
undistributed equity in earnings and losses of the funds and adjusted over
time by the premium or discount at the time of purchase to the applicable
underlying net asset value of the funds.
The Company originates and holds mortgage loans on real estate on
properties located in the Commonwealth of Massachusetts and the State of
Connecticut. The Company controls credit risk through credit approvals,
credit limits and monitoring procedures. The Company performs in-depth
credit evaluations on all new mortgage customers. Bad debt expenses have
not been material in recent years.
Mortgage loans on real estate and collateral notes receivable are
stated at the amount of unpaid principal, less an allowance for possible
loan losses. The adequacy of the allowance for possible loan losses is
evaluated on a regular basis by management. Factors considered in
evaluating the adequacy of the allowance include previous loss experience,
current economic conditions and their effect on borrowers and the
performance of individual loans in relation to contract terms. The
provision for possible loan losses charged to operating expenses is based
upon management's judgment of the amount necessary to maintain the
allowance at a level adequate to absorb possible losses. Loan losses are
charged against the allowance when management believes the collectibility
of the principal is unlikely and recoveries are credited to the allowance
when received.
Interest on mortgage loans is included in income as earned based upon
rates applied to principal amounts outstanding. Accrual of interest on
mortgage loans is discontinued either when reasonable doubt exists as to
the full, timely collection of interest or principal, or when a loan
becomes contractually past due more than ninety days. When a loan is
placed on non-accrual status, all unpaid interest previously accrued is
reversed against current period earnings.
41
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars)
NOTE A - Summary of Significant Accounting Policies (continued)
3. Cash and Cash Equivalents
Cash and cash equivalents includes cash currently on hand to cover
operating expenses. The Company invested $82,856 with Fidelity Investment
Government Fund and $59,281 with Provident Institutional Fund. These are
short-term money market investments in government backed securities. Money
is invested on a daily basis. The Company held $17,210 and $13,775 in U.S.
Government Repurchase Agreements at various financial institutions in 2001
and 2000, respectively. The amount of collateral, maintained by the
seller, at the time of purchase and each subsequent business day, is
required to have a market value that is equal to 102% of the resale price.
4. Deferred Policy Acquisition Costs
Policy acquisition costs are calculated by line of business as a
percentage of unearned premiums by multiplying the sum of current
commission rates plus current premium tax rates plus an estimate of the
percentage of other underwriting expenses incurred at the policy issuance.
These costs are deferred and amortized over the period in which the related
premiums are earned, the amount being reduced by any potential premium
deficiency. If any potential premium deficiency exists, it represents
future estimated losses, loss adjustment expenses and amortization of
deferred acquisition costs in excess of the related unearned premiums.
There was no premium deficiency in 2001, 2000 and 1999. In determining
whether a premium deficiency exists, the Company considers anticipated
investment income.
5. Property and Equipment
Property and equipment are stated at cost and are depreciated on the
straight-line method over the estimated useful lives of the assets using
the following rates:
Percent
Asset Classification Per Annum
Buildings..................................... 2.5
Building improvements (prior to 1992)......... 2.5
Building improvements (1992 and subsequent)... 5.0
Equipment and office furniture................ 10.0
EDP equipment and copiers..................... 20.0
Automobiles................................... 33.3
Maintenance and repairs are charged to operations; betterments are
capitalized. The cost of property sold or otherwise disposed of and the
accumulated depreciation thereon is eliminated from the related property
and accumulated depreciation accounts and any resulting gain or loss is
credited or charged to income.
6. Non-Compete Agreement
The non-compete agreement of $2,479 represents the unamortized portion
of the purchase price associated with the acquisition of American Commerce
allocated to the arrangement whereby the American Automobile Association,
Inc. ("AAA National") agreed not to compete with American Commerce prior to
February 2009. The cost of $3,500 is being amortized on a straight-line
basis over the term of the arrangement. The amount of accumulated
amortization at December 31, 2001 and 2000 was $1,021 and $671,
respectively.
7. Unpaid Loss and Loss Adjustment Expenses
Loss and LAE reserves by their nature are inherently uncertain as to
the ultimate outcome of the estimated amounts. The liability for unpaid
losses and loss adjustment expenses ("LAE") represents the accumulation of
individual case estimates for reported losses, adjustments to this amount
on a line of business basis and estimates for incurred but not reported
("IBNR") losses and LAE net of, salvage and subrogation recoverable. The
liability for losses and LAE is intended to cover the ultimate net cost of
all losses and LAE incurred through the balance sheet date. Liability
estimates are continually reviewed and updated, and therefore, the ultimate
liability may be more or less than the current
42
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars)
NOTE A - Summary of Significant Accounting Policies (continued)
estimate. The effects of changes in the estimates are included in the
results of operations in the period in which the estimates are revised.
8. Premiums
Insurance premiums are recognized as income ratably over the terms of
the policies. Unearned premiums are determined by prorating written
premiums on a daily basis over the terms of the policies. A significant
portion of the Company's Massachusetts premiums written is derived through
the American Automobile Association Clubs of Massachusetts ("AAA clubs")
affinity group marketing program. Of the Company's total direct premiums
written, the portion attributable to the AAA affinity group marketing
program in Massachusetts was $545,496 or 47.3% in 2001, $535,766 or 50.0%
in 2000 and $495,962 or 52.3% in 1999. Of these amounts, 13.0% were
written through insurance agencies owned by the AAA clubs and 87.0% were
written through the Company's network of independent agents in 2001.
9. Income Taxes
The Company uses an asset and liability approach that requires the
recognition of deferred tax assets and liabilities for the expected future
tax consequences of events that have been recognized in the Company's
financial statements or tax returns. In estimating future tax
consequences, the Company generally considers all expected future events
other than changes in the tax law or rates, unless enacted. Valuation
allowances are established when necessary to reduce deferred tax assets to
the amount expected to be realized. No valuation allowance was established
in 2001, 2000 or 1999.
10. Deferred Income
Income consisting of expense reimbursements, which include servicing
carrier fees from Commonwealth Automobile Reinsurers ("C.A.R."), a state-
mandated reinsurance mechanism, on policies written for C.A.R., are
deferred and amortized over the term of the related insurance policies (see
"Notes to Consolidated Financial Statements - NOTE F").
11. Contingent Commissions
In addition to state mandated minimum and other commissions on
policies written, the Company pays certain of its agencies compensation in
the form of profit sharing. This is based, in part, on the underwriting
profits of an individual agent's business written with the Company. The
arrangement for Massachusetts business utilizes a three-year rolling plan,
with one third of the agent's profit or loss for each of the current and
the two prior years' calculations summed to a single amount. This amount,
if positive, is multiplied by the profit sharing commission rate and paid
to the agent. Outside of Massachusetts, Commerce West and American
Commerce each have contingent commission plans tailored to their specific
markets.
12. Excess of Book Value of Subsidiary Interest Over Cost
As a result of the acquisition of American Commerce, the amount
representing the excess of the fair value of the net assets acquired over
the purchase price at the January 29, 1999 acquisition date was $16,947.
The amount is being amortized into revenue on the straight-line basis over
a five year period. The amount amortized into income in 2001, 2000 and
1999 was $3,389, $3,390 and $3,019, respectively. See "Notes to
Consolidated Financial Statements - NOTE A17" for treatment of excess of
book value of subsidiary interest over cost ("negative goodwill")
subsequent to December 31, 2001.
43
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars)
NOTE A - Summary of Significant Accounting Policies (continued)
13. Minority Interest in Net Loss of Subsidiary
As a result of the joint venture with AAA SNE and acquisition of
American Commerce, the Company's interest in ACIC Holding Co., Inc.,
through Commerce, a wholly-owned subsidiary of CHI, is represented by
ownership of 80% of the outstanding shares of common stock at December 31,
2001. AAA SNE maintains a 20% common stock ownership. The minority
interest of $863 included in the consolidated statement of earnings for
2001 represents 20% of the net loss for ACIC Holding Co., Inc., calculated
after the $9,582 preferred stock dividend paid to Commerce, to the extent
of the minority interest. This compares to $320 minority interest in the
net loss of ACIC Holding Co., Inc. after $9,178 in preferred stock
dividends paid to Commerce in 2000. During the third quarter of 2001, the
net losses of ACIC Holding Co., Inc. exceeded the minority interest balance
sheet component.
14. Treasury Stock
In May 1999, the Board of Directors of the Company authorized a stock
buy-back program of up to 2,000,000 shares of common stock of the Company.
At December 31, 2001, there are 273,700 shares of common stock authorized
to be purchased under this program. In November 2001, the Board of
Directors approved another stock buy-back program authorizing the purchase
of up to an additional 2,000,000 shares. During the period from January 1,
2001 through December 31, 2001, the Company purchased 622,900 shares of its
own common stock. During 2000, the Company purchased 606,200 shares of its
own common stock under the May 1999 buy-back program. At December 31,
2001, the Company had authority to purchase a total of 2,273,700 additional
shares of its common stock under the May 1999 and November 2001 buy-back
programs. As of December 31, 2001, the Company holds a total of 4,869,548
shares of treasury stock.
15. Net Earnings Per Common Share
Net earnings per basic common share is computed by dividing net
earnings by the weighted average number of basic common shares outstanding.
The weighted average number of basic common shares outstanding for the
years ended December 31, 2001, 2000 and 1999 were 33,608,804, 34,121,047
and 34,940,074, respectively. Weighted average number of basic common
shares outstanding is determined by taking the average of the following
calculation for a specified period of time: The daily amount of (1) the
total issued outstanding common shares minus (2) the total Treasury Stock
purchased.
Earnings per diluted common share is based on the weighted average
number of diluted common shares outstanding during each period. The
weighted average number of diluted common shares outstanding for the years
ended December 31, 2001, 2000 and 1999 were 33,794,938, 34,121,047 and
34,940,074, respectively. The Company's only potentially dilutive
instruments are stock options outstanding and dilution from these is not
significant.
16. New Accounting Pronouncements
The NAIC revised the Accounting Practices and Procedures Manual in a
process referred to as Codification. The revised manual became effective
January 1, 2001 for all insurance companies. The domiciliary states of the
Company's insurance subsidiaries have adopted the provisions of the revised
manual. The revised manual has changed certain prescribed
statutory accounting practices and has resulted in changes to the
accounting practices that the Company's insurance subsidiaries use to
prepare their statutory-basis financial statements. The impact of these
changes to the Company's insurance subsidiaries statutory-basis capital and
surplus as of January 1, 2001 had a significant beneficial effect of
approximately $38,737 primarily due to the inclusion of deferred taxes as
an admitted asset. The codification changes had no impact on the Company's
GAAP financial statements.
44
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars Except for Per Share Data)
NOTE A - Summary of Significant Accounting Policies (continued)
In June 1998, the FASB issued Statement of Financial Accounting
Standards No. 133 ("SFAS 133"), "Accounting for Certain Derivative
Instruments and Hedging Activities", as amended in June 2000 by Statement
of Financial Accounting Standards No. 138 ("SFAS 138"), "Accounting for
Certain Derivative Instruments and Certain Hedging Activities", which
requires companies to recognize all derivatives as either assets or
liabilities in the balance sheet and measure such instruments at fair
value. SFAS 138 also amended Statement of Financial Accounting Standards
No. 137 ("SFAS 137"), "Accounting for Derivative Instruments and Hedging
Activities - Deferral of the Effective Date of FASB Statement No. 133".
The provisions of SFAS 133 require adoption for fiscal years beginning
after June 15, 2000. The Company had no derivative or hedging activity in
2001, 2000 or 1999. The adoption of these SFASs had no material impact on
the Company's consolidated financial statements.
In September 2000, the FASB issued Statement of Financial Accounting
Standards No. 140 ("SFAS 140"), "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities", which replaced
Statement of Financial Accounting Standards No. 125 ("SFAS 125"),
"Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities". The Statement provides accounting and
reporting standards for transfers and servicing of financial assets and
extinguishments of liabilities. Those standards are based on consistent
application of a "financial components" approach that focuses on control.
Under that approach, after a transfer of financial assets, a company
recognizes the financial and servicing assets it controls and the
liabilities it has incurred, does not recognize financial assets when
control has been surrendered, and does not recognize liabilities when
extinguished. The Statement provides consistent standards for
distinguishing transfers of financial assets that are sales from transfers
that are secured borrowings. The Statement is effective for transfers and
servicing of financial assets and extinguishments of liabilities occurring
after March 31, 2001. Adoption of SFAS 140 did not have a material impact
on the Company's consolidated financial statements.
In July 2001, the FASB issued Statements of Financial Accounting
Standards No. 141, "Business Combinations", and No. 142, "Goodwill and
Other Intangible Assets". SFAS No. 141, effective for business
combinations initiated after June 30, 2001, requires that all business
combinations be accounted for under a single method - the purchase method.
Use of the pooling-of-interests method is no longer permitted. SFAS No.
141 also clarifies the criteria to recognize intangible assets separately
from goodwill. SFAS No. 142 requires that goodwill and intangible assets
deemed to have indefinite lives no longer be amortized to earnings, but
instead be reviewed at least annually for impairment. Other intangible
assets will continue to be amortized over their useful lives. SFAS No. 142
will be effective January 1, 2002.
The Company has evaluated the impact of adopting the provisions of
SFAS No. 142 on earnings and financial position for the year ended December
31, 2002. Effective January 1, 2002, in accordance with SFAS No. 142, the
Company will cease amortizing the balance sheet item "excess of book value
of subsidiary interest over cost" which is $5.7 million at year end 2001.
The 2001 impact of the amortization of this resulted in approximately $0.10
per share of annual operating earnings. Additionally, the Company will no
longer amortize the negative goodwill resulting from the purchase of
preferred stock mutual funds effective January 1, 2002. The amount of
unamortized negative goodwill at year-end is $6.4 million. The 2001 impact
of the amortization of this was $0.10 per share of earnings classified as
capital gains. Both the excess of book value of subsidiary interest over
cost and the negative goodwill on preferred stock mutual funds will be
recognized as income in the first quarter of 2002 and classified as an
extraordinary item. The estimated per share income impact for this change
is $0.34 per share.
45
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars)
17. Acquisition
In November 1998, Commerce formed ACIC Holding Co., Inc., in a joint
venture with AAA SNE and invested $90,800 to fund the January 29, 1999
acquisition of the Automobile Club Insurance Company, whose name was
changed to American Commerce upon completion of the acquisition. Commerce
invested $90,000 in the form of preferred stock and an additional $800
representing an 80% common stock ownership. AAA SNE invested $200
representing a 20% common stock ownership. The terms of the preferred
stock call for Commerce to receive quarterly cash dividends at the rate of
10% per annum from ACIC Holding, Co., Inc. In the event cash dividends
cannot be paid, additional preferred stock will be issued. During 2001, 96
shares of Class B preferred stock were issued in lieu of the cash payment
of dividends. The acquisition was accounted for as a purchase. Since the
January 29, 1999 acquisition, American Commerce's results have been
consolidated into the Company's financial statements. Since 1995, Commerce
has maintained an exclusive affinity group marketing relationship with AAA
Insurance Agency, Inc., a subsidiary of AAA SNE. AAA Insurance Agency,
Inc. has been a licensed insurance agent of Commerce since 1985.
NOTE B - Investments and Investment Income
1. Fixed Maturities
The amortized cost and estimated fair market value of investments in fixed maturities
are as follows:
Gross Gross
Accumulated Accumulated
Other Other Estimated
Amortized Comprehensive Comprehensive Fair Market
Cost Income Losses Value
At December 31, 2001:
Corporate bonds..................... $ 133,506 $ 7,497 $ (4,497) $ 136,506
U.S. Treasury bonds and notes....... 104 1 - 105
GNMA & FNMA mortgage-backed bonds... 98,198 1,602 (815) 98,985
Obligations of states and
political subdivisions............. 386,967 8,890 (4,971) 390,886
Total.......................... $ 618,775 $ 17,990 $ (10,283) $ 626,482
At December 31, 2000:
Corporate Bonds..................... $ 130,775 $ 1,263 $ (5,783) $ 126,255
U.S. Treasury bonds and notes....... 3,428 86 (137) 3,377
GNMA & FNMA mortgage-backed bonds... 67,274 444 (457) 67,261
Obligations of states and
political subdivisions............. 464,404 14,454 (5,816) 473,042
Total.......................... $ 665,881 $ 16,247 $ (12,193) $ 669,935
46
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars)
NOTE B - Investments and Investment Income (continued)
Proceeds from sales of investments in fixed maturities, gross gains and gross losses
realized on those sales were as follows:
Proceeds Gross Gross
From Realized Realized
Sales Gains Losses
For the year ended December 31, 2001:
Corporate bonds................................... $ 7,343 $ 129 $ (151)
U.S. Treasury bonds and notes..................... - - -
GNMA mortgage-backed bonds........................ - - -
Obligations of states and political subdivisions.. 82,369 694 (1,820)
Total ....................................... $ 89,712 $ 823 $ (1,971)
For the year ended December 31, 2000:
Corporate bonds................................... $ 1,167 $ - $ -
U.S. Treasury bonds and notes..................... - - -
GNMA mortgage-backed bonds........................ - - -
Obligations of states and political subdivisions.. 96,013 198 (2,749)
Total ....................................... $ 97,180 $ 198 $ (2,749)
For the year ended December 31, 1999:
Corporate bonds................................... $ 17,516 $ 102 $ (941)
U.S. Treasury bonds and notes..................... 27,096 8 (842)
GNMA mortgage-backed bonds........................ - - -
Obligations of states and political subdivisions.. 97,950 298 (2,606)
Total ....................................... $142,562 $ 408 $ (4,389)
The amortized cost and approximate fair market value of fixed maturities at December
31, 2001 and 2000, by contractual maturity, are as follows:
2001 2000
Fair Fair
Amortized Market Amortized Market
Cost Value Cost Value
Obligations of states, political subdivisions,
corporate bonds and U.S. Treasury bonds and
notes:
Due in one year or less.................... $ 1,398 $ 1,417 $ 1,201 $ 1,214
Due after one year through five years...... 2,860 3,001 7,650 7,882
Due after five years through ten years..... 5,256 5,378 9,162 9,431
Due after ten years........................ 511,063 517,701 580,594 584,147
520,577 527,497 598,607 602,674
GNMA & FNMA mortgage-backed bonds.......... 98,198 98,985 67,274 67,261
Total fixed maturities.............. $618,775 $626,482 $665,881 $669,935
Expected maturities may differ from contractual maturities because issuers may have
the right to call or prepay obligations.
47
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars)
NOTE B - Investments and Investment Income (continued)
2. Closed-end Preferred Stock Mutual Funds
The following table reflects the shares held, percentage of
ownership, carrying value at equity, book value, market value, and value
of shares at net asset value, by fund at December 31, 2001 and 2000:
December 31, 2001
Fund Carrying Quoted Value of
Fund Shares % of Value Book Market Shares at Net
Symbol(1) Held Ownership at Equity Value Value Asset Value
PGD 2,361,500 28.3% $ 30,225 $ 25,713 $ 29,873 $ 32,258
PPF 2,370,400 32.7% 30,168 26,256 29,275 31,076
PDF 4,685,500 31.3% 44,900 42,400 45,121 45,731
PDT 5,289,700 35.3% 63,035 57,175 58,451 64,111
DIV 3,579,500 36.2% 51,991 49,687 52,798 53,335
PFD 2,981,500 30.3% 42,904 44,803 43,828 42,904
PFO 4,050,043 36.3% 46,059 48,914 47,993 46,251
Total $309,282 $294,948 $307,339 $315,666
December 31, 2000
Fund Carrying Quoted Value of
Fund Shares % of Value Book Market Shares at Net
Symbol(1) Held Ownership at Equity Value Value Asset Value
PGD 1,877,300 22.5% $ 23,478 $ 19,666 $ 22,528 $ 26,695
PPF 2,352,900 32.4% 28,322 26,048 25,882 30,470
PDF 4,638,800 31.0% 46,003 41,966 40,589 47,594
PDT 4,925,100 32.8% 60,453 53,144 52,021 63,091
DIV 3,080,500 31.2% 46,314 42,500 40,239 48,918
PDI(2) 5,253,400 48.5% 52,207 52,583 52,534 54,110
PFD 2,981,500 30.3% 39,834 44,803 36,151 40,012
PFO 3,892,543 34.9% 41,122 47,270 40,385 41,533
Total $337,733 $327,980 $310,329 $352,423
(1) John Hancock Patriot Global Dividend Fund ("PGD"), John Hancock Patriot Preferred Dividend Fund ("PPF"),
John Hancock Patriot Premium Dividend I Fund ("PDF"), John Hancock Patriot Premium Dividend II Fund ("PDT"),
John Hancock Patriot Select Dividend Fund ("DIV"), Putnam Dividend Income Fund ("PDI"), Preferred Income Fund
("PFD"), Preferred Income Opportunity Fund ("PFO").
(2) In 2001, the Trustees of PDI liquidated the fund. The Company's pro-rata share of the portfolio securities and
cash of PDI was transferred to a new fund created by the PDI Trustees whose ownership was conveyed to the
Company. At December 31, 2001 the fund, totaling $60,869, was consolidated into the Company's financial
statements. The majority of the fund represents investments valued at $59,019 and is included in preferred
stocks and $1,332 in cash and cash equivalents.
The difference between the carrying value at equity and the value of
shares at net asset value is negative goodwill created at the time of the
purchase of the shares. SFAS 141, which was implemented on July 1, 2001,
specifically addresses the manner in which to account for negative
goodwill. For purchases prior to July 1, 2001, that created negative
goodwill, the Company continued to amortize the negative goodwill on these
securities through the end of 2001. This negative goodwill was amortized
into realized gains over various periods ranging from 1.25 years to 4 years
based on the turnover ratios of the funds. In accordance with SFAS 141,
for purchases subsequent to June 30, 2001, the difference between the cost
and net asset value at the time of purchase was recognized as a realized
gain, totaling $614 for 2001.
48
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars)
NOTE B - Investments and Investment Income (continued)
3. Mortgage Loans on Real Estate and Collateral Notes Receivable
At December 31, 2001 and 2000, mortgage loans on real estate and
collateral notes receivable consisted of the following:
December 31,
2001 2000
Residential (1st Mortgages)............ $28,696 $36,496
Residential (2nd Mortgages)............ 83 209
Commercial (1st Mortgages)............. 8,210 12,542
Commercial (2nd Mortgages)............. 33 50
37,022 49,297
Collateral notes receivable............ 3,143 3,222
40,165 52,519
Allowance for possible loan losses..... (660) (858)
Mortgage loans on real estate and
collateral notes receivable....... $39,505 $51,661
Fair value of the Company's mortgage loans on real estate and
collateral notes receivable is estimated by discounting the future cash
flows using the current rates at which similar loans would be made to
borrowers with similar credit and for the same remaining maturities. The
future cash flows associated with certain non-performing loans are
estimated based on expected payments from borrowers either through work out
arrangements or the disposition of collateral. The estimated fair value of
mortgage loans on real estate and collateral notes receivable at December
31, 2001 and 2000, prior to the allowance for possible loan losses, was
$41,391 and $54,141, respectively.
At December 31, 2001 and 2000 mortgage loans which were on non-accrual
status amounted to $1,118 and $1,357, respectively. The reduction in
interest income associated with non-accrual loans was $99, $118 and $129
for the years ended December 31, 2001, 2000 and 1999, respectively.
The Company originates and services residential and commercial
mortgages in Massachusetts and Connecticut. The Company's exposure is
generally 80% or less of the appraised value of any collateralized real
property at the time of the loan origination. The ability and willingness
of residential and commercial borrowers to honor their repayment
commitments is generally dependent upon the level of overall economic
activity and real estate values. The Company sold $20,042 of residential
mortgages in 2000 without recourse to an unrelated third party.
A summary of the changes in the allowance for possible loan losses follows:
Years ended December 31,
2001 2000
Balance, beginning of year......................... $ 858 $ 2,127
Decrease in provision for possible loan losses... (198) (1,269)
Balance, end of year............................... $ 660 $ 858
49
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars)
NOTE B - Investments and Investment Income (continued)
The following table describes mortgage principal balances by maturity, total mortgages
over 90 days past due and total mortgages in foreclosure:
2001 2000
Fixed rate mortgages maturing:
One year or less................................ $ 90 $ 141
More than one year to five years................ 861 742
More than five years to ten years............... 3,366 5,331
Over ten years.................................. 23,375 31,810
Total fixed mortgages...................... $ 27,692 $ 38,024
Adjustable rate mortgages maturing:
One year or less................................ $ - $ -
More than one year to five years................ 87 61
More than five years to ten years............... 419 283
Over ten years.................................. 8,824 10,929
Total adjustable mortgages................. $ 9,330 $ 11,273
Past due over 90 days............................. $ 1,118 $ 1,357
Mortgages in foreclosure, included in past due
over 90 days.................................... $ 184 $ 808
4. Net Investment Income
The components of net investment income were as follows:
Years ended December 31,
2001 2000 1999
Interest on fixed maturities................... $ 45,542 $ 44,766 $ 45,957
Dividends on common and preferred stocks....... 23,768 23,177 23,148
Dividends on preferred stock mutual funds...... 23,165 22,158 15,483
Interest on cash and cash equivalents.......... 5,729 3,555 2,596
Interest on mortgage loans..................... 4,026 5,677 5,908
Other.......................................... 356 84 118
Total investment income............... 102,586 99,417 93,210
Investment expenses............................ 2,975 2,587 3,421
Net investment income................. $ 99,611 $ 96,830 $ 89,789
5. Net Realized Investment Gains (Losses)
Net realized investment gains (losses) were as follows:
Years ended December 31,
2001 2000 1999
Net realized investment gains (losses):
Fixed maturities................................ $ (2,816) $ (3,772) $ (5,991)
Preferred stocks................................ (3,692) 1,286 (244)
Common stocks................................... 603 4,370 11,023
Closed-end preferred stock mutual funds*........ 4,582 26,575 (22,401)
Venture capital fund investments................ (9,071) 460 888
Other........................................... (239) 631 347
Total....................................... $(10,633) $ 29,550 $(16,378)
*Includes $3,215 in 2001 and $9,260 in 2000, respectively, relating to the amortization of
negative goodwill, at the time of purchase, of these securities.
50
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars)
NOTE B - Investments and Investment Income (continued)
6. Other Comprehensive Income (Loss)
Net increases (decreases) in other comprehensive income (loss), less
applicable income tax (expense) benefit, were as follows:
Years ended December 31,
2001 2000 1999
Other comprehensive income (loss):
Fixed maturities................................ $ 3,653 $ 18,161 $(32,892)
Preferred stocks................................ 7,259 4,145 (17,040)
Common stocks................................... (8,369) 34,759 (26,587)
Other........................................... (1,327) 318 634
Impact of minority interest..................... (352) (1,244) 2,122
Total....................................... 864 56,139 (73,763)
Tax benefit (expense)........................... (272) (19,495) 26,560
Impact of minority interest..................... (31) (154) (743)
Total tax benefit (expense)................. (303) (19,649) 25,817
Total other comprehensive income (loss)..... $ 561 $ 36,490 $(47,946)
A summary of net accumulated other comprehensive income (loss) on stocks and fixed
maturity investments in 2001, 2000 and 1999 follows:
Years ended December 31,
2001 2000 1999
Accumulated other comprehensive income......... $ 45,873 $ 46,699 $ 8,317
Accumulated other comprehensive losses......... (26,893) (28,935) (47,936)
Impact of minority interest.................... 88 440 1,685
Total unrealized gains (losses)........... 19,068 18,204 (37,934)
Tax benefit (expense).......................... (6,643) (6,217) 13,867
Impact of minority interest.................... (31) (154) (590)
Total benefit (expense)................... (6,674) (6,371) 13,277
Total..................................... $ 12,394 $ 11,833 $(24,657)
NOTE C - Deferred Policy Acquisition Costs
Policy acquisition costs incurred and amortized to income are as
follows:
Years ended December 31,
2001 2000 1999
Balance, beginning of year............. $111,305 $ 98,500 $ 88,759
Costs deferred during the year......... 266,122 256,062 243,401
Amortization charged to expense........ (260,870) (243,257) (233,660)
Balance, end of year................... $116,557 $111,305 $ 98,500
51
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars)
NOTE D - Property and Equipment
A summary of property and equipment at December 31, is as follows:
2001 2000
Buildings................................. $ 33,013 $ 32,916
Equipment and office furniture............ 36,609 35,185
Building improvements..................... 850 850
70,472 68,951
Less accumulated depreciation....... (38,473) (35,456)
31,999 33,495
Land...................................... 3,476 1,253
Construction in progress.................. 4,539 75
$ 40,014 $ 34,823
Depreciation expense was $4,280, $4,270 and $4,243 for the years ended
December 31, 2001, 2000 and 1999, respectively. Depreciation expense is
allocated evenly between losses and loss adjustment expenses and policy
acquisition costs.
NOTE E - Unpaid Losses and Loss Adjustment Expenses
Liabilities for unpaid losses and loss adjustment expenses at December
31, consist of:
2001 2000
Net voluntary unpaid loss and LAE reserves................ $558,635 $544,585
Voluntary salvage and subrogation recoverable............. (73,393) (65,505)
Assumed unpaid loss and LAE reserves from C.A.R........... 125,787 127,631
Assumed salvage and subrogation recoverable from C.A.R.... (20,695) (20,844)
Total voluntary and assumed unpaid loss and LAE reserves 590,334 585,867
Adjustment for ceded unpaid loss and LAE reserves......... 100,290 97,273
Adjustment for ceded salvage and subrogation recoverable.. (9,000) (9,000)
Total unpaid loss and LAE reserves...................... $681,624 $674,140
Unpaid Loss and LAE by their nature are inherently uncertain
as to the ultimate outcome of the estimated amounts. The liability for
unpaid losses and LAE represents Management's best estimate of the
ultimate net cost of all losses and LAE incurred through the balance
sheet date. The estimate for ultimate net cost of all losses incurred
through the balance sheet date includes the adjusted case estimates for
losses, incurred but not reported ("IBNR") losses, salvage and
subrogation recoverable and a reserve for LAE. In arriving at its best
estimate, management begins with the aggregate of individual case
reserves and then makes adjustments to these amounts on a line of
business basis. These adjustments to the aggregate case reserves by
line of business are made based on analysis performed by Management as
further described below. The entire liability for unpaid losses and LAE
is also reviewed quarterly and annually by the Company's Actuarial
Department. Liability estimates are continually analyzed and updated,
and therefore, the ultimate liability may be more or less than the
current estimate. The effects of changes in the estimates are included
in the results of operations in the period in which the estimates are
revised.
52
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars)
NOTE E - Unpaid losses and Loss Adjustment Expenses (continued)
Significant periods of time can elapse between the occurrence of an
insured loss, the reporting of the loss to the insurer and the insurer's
payment of that loss. To recognize liabilities for unpaid losses,
insurers establish reserves as balance sheet liabilities representing
estimates of amounts needed to pay reported and unreported losses and
LAE. Quarterly, the Company reviews these reserves internally.
Regulations of the Division of Insurance require the Company to annually
obtain a certification from either a qualified actuary or an approved
loss reserve specialist that its loss and LAE reserves are reasonable.
When a claim is reported to the Company, claims personnel establish
a "case reserve" for the estimated amount of the ultimate exposure to
the Company. The amount of the reserve is primarily based upon an
evaluation of the type of claim involved, the circumstances surrounding
the claim and the policy provisions relating to the loss. This estimate
reflects the informed judgment of such personnel based on general
insurance reserving practices and on the experience and knowledge of the
claims personnel adjusting the claim. During the loss adjustment
period, these estimates are revised as deemed necessary by the Company's
claims department personnel based on subsequent developments and
periodic reviews of the cases.
In accordance with industry practice, the Company also maintains
reserves for estimated IBNR and LAE net of salvage and subrogation
recoverable. These reserves are determined on the basis of historical
information and the experience of the Company. Adjustments to these
reserves are made periodically to take into account changes in the
volume of business written, claims frequency and severity, the mix of
business, claims processing and other items that can be expected to
affect the Company's liability for losses and LAE over time.
When reviewing the liability for unpaid losses and LAE, the Company
analyzes historical data and estimates the impact of various factors
such as (i) payment trends; (ii) loss expense per exposure; (iii) the
historical loss experience of the Company and industry; (iv) frequency
and security trends; and, (v) legislative enactments, judicial
decisions, legal developments in the imposition of damages, changes and
trends in general economic conditions, including the effects of
inflation and recession. This process assumes that past experience,
adjusted for the effects of current developments and anticipated trends,
is an appropriate basis for predicting future events. There is no
precise method, however, for subsequently evaluating the impact of any
specific factor on the adequacy of reserves, because the eventual
development of reserves is affected by many factors.
By using both individual estimates of reported claims and generally
accepted actuarial reserving techniques, the Company estimates the
ultimate net liability for losses and LAE. After taking into account
all relevant factors, management believes that, based on existing
information, the provision for losses and LAE at December 31, 2001 is
adequate to cover the ultimate net cost of losses and claims incurred as
of that date. The ultimate liability, however, may be greater or lower
than established reserves. If the ultimate exposure is greater than (or
less than) management's estimated liability for losses and LAE, based on
any of the factors noted previously, the Company will incur additional
expense (income) which may have a material impact. The Company does not
discount to present value that portion of its loss reserves expected to
be paid in future periods.
Included in the loss reserve methodologies described above, are
liabilities for unpaid claims and claim adjustment expenses for
environmental related claims such as oil spills, mold and lead paint.
Reserves have been established to cover these claims for known losses.
Because of the Company's limited exposure to these types of claims,
management believes they will not have a material impact on the
consolidated financial position of the Company in the future. Loss
reserves on environmental related claims amounted to $4,281 and $3,712
at December 31, 2001 and 2000, respectively.
53
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars)
NOTE E - Unpaid losses and Loss Adjustment Expenses (continued)
The following table sets forth a reconciliation of beginning and
ending reserves for losses and loss adjustment expense, net of reinsurance
deductions from all reinsurers including C.A.R., as shown in the Company's
consolidated financial statements for the periods indicated.
Years ended December 31,
2001 2000 1999
Loss and loss adjustment expense reserves,
beginning of year, prior to effect of ceded
reinsurance recoverable............................. $585,867 $558,779 $498,127
January 29, 1999 American Commerce loss and
loss adjustment expense reserves.................. - - 63,112
Incurred losses and loss adjustment expenses:
Provision for insured events of the current year.. 812,863 728,582 664,978
Decrease in provision for insured events of
prior years...................................... (35,320) (42,425) (39,888)
Total incurred losses and loss adjustment
expenses....................................... 777,543 686,157 625,090
Payments:
Losses and loss adjustment expenses attributable
to insured events of the current year............ 487,918 402,040 383,707
Losses and loss adjustment expenses attributable
to insured events of prior years................. 285,158 257,029 243,843
Total payments.................................. 773,076 659,069 627,550
Loss and loss adjustment expense reserves prior to
effect of ceded reinsurance recoverable.......... 590,334 585,867 558,779
Ceded reinsurance recoverable..................... 91,290 88,273 101,062
Reserves for losses and loss adjustment expenses
at the end of year per financial statements......... $681,624 $674,140 $659,841
The decrease in provision for insured events of prior years represents
redundancies for reserves established for prior year. This decrease in
provision was principally the result of re-estimation of unpaid losses and
loss adjustment expenses principally on the personal automobile, commercial
automobile and homeowners lines of business.
The Company's loss and LAE reserves reflect its share of the aggregate
C.A.R. loss and LAE reserves of the Company and the 38 other writers of
automobile insurance in Massachusetts that participate in C.A.R.
("Servicing Carriers"). The Company is a defendant in various legal
actions arising from the normal course of its business. These proceedings
are considered to be ordinary to operations or without foundation in fact.
Management is of the opinion that these actions will not have a materially
adverse effect on the consolidated financial statements of the Company.
(See NOTE S - Legal Proceedings.)
NOTE F - Reinsurance Activity
The Company has reinsurance contracts for casualty and catastrophe
coverages. These reinsurance arrangements minimize the Company's losses
arising from large risks and protect the Company against numerous losses
from a single occurrence or event. The Company also has a quota share
reinsurance contract on its other than automobile business.
54
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars)
NOTE F - Reinsurance Activity (continued)
Property, Catastrophe and Quota Share Reinsurance
The Company maintains a 75% quota share reinsurance program, covering
all non-automobile property and liability business, except umbrella
policies. The program is split between American Re-Insurance Company,
Employers Reinsurance Corporation, Hartford Fire Insurance Company and
Swiss Reinsurance America Corporation. The maximum per occurrence dollar
recovery is equal to 250% of the net premiums ceded to the quota share
arrangement in a contract year. The maximum aggregate per year dollar
recovery under the quota share contract is equal to 350% of the net premium
ceded to the quota share arrangement in a contract year. A sliding scale
commission, based on loss ratio, is utilized under this program. This
program provides the Company with sufficient protection for catastrophe
coverage so as to enable the Company to forego pure catastrophe reinsurance
coverage, which was previously tailored in conjunction with the former
quota share arrangement.
The table below provides information depicting the approximate
recovery under the quota share contract (described below) at various loss
scenarios, if a single catastrophe were to strike:
Net Loss
Total Reinsurance Retained by
Loss Recovery the Company
$ 50,000 $ 37,500 $12,500
100,000 75,000 25,000
150,000 112,500 37,500
200,000 150,000 50,000
250,000 187,500 62,500
Under the above scenario and based on the business subject to the
quota share reinsurance contract for 2001, the Company has no reinsurance
recoveries for a single event catastrophe in excess of a total loss of
approximately $262.0 million. The level of reinsurance protection
increases (decreases) when the company cedes more (less) premium to the
reinsurers. The Company's estimated total losses on its other than
automobile business for 100 and 250-year hurricanes (including American
Commerce) are approximately $176.0 million and $295.8 million,
respectively. The Company estimates were derived through the services of
Swiss Reinsurance America Corporation who utilized the RMS (Risk Management
Solutions) risk assessment system. Most property and casualty insurance
companies establish their catastrophe reinsurance programs up to the 100
year storm estimate.
Written premiums ceded in 2001, 2000 and 1999 under the above
referenced program were $78.6 million, $69.4 million and $51.5 million,
respectively. The 13.3% increase in written premiums ceded in 2001 versus
2000 in this program was primarily the result of a $7,592 or 11.6% increase
in Massachusetts homeowner direct written premium, coupled with a $2,212 or
13.4% increase in direct homeowner writings in states other than
Massachusetts, as previously mentioned. Ceding commission income is
calculated on a ceded earned premium basis.
Casualty Reinsurance
Casualty reinsurance is on an excess of loss basis for any one event
or occurrence with a maximum recovery of $9.0 million over a net retention
of $1.0 million. This coverage is placed with Swiss Reinsurance America
Corporation (rated A++ by A.M. Best).
Personal and commercial liability umbrella policies are reinsured on a
95% quota share basis in regard to limits up to $1.0 million and 100% quota
share basis for limits in excess of $1.0 million but not exceeding $5.0
million for policies with underlying automobile coverage of $250/$500 or
more. The Company also has personal liability umbrella reinsurance
coverage for policies with underlying automobile coverage of $100/$300, on
a 65% quota share basis in regard to limits up to $1.0 million and 100%
quota share basis for limits in excess of $1.0 million but not exceeding
$3.0 million. These coverages are placed with American Re-Insurance
Company (rated A++ by A.M. Best).
55
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars)
NOTE F - Reinsurance Activity (continued)
Earned premiums and losses and loss adjustment expenses are stated in
the accompanying consolidated financial statements after deductions for
ceded reinsurance. Those deductions for reinsurance other than C.A.R. are
as follows:
Years ended December 31,
2001 2000 1999
Income Statement
Written premiums ceded............................ $81,827 $76,946 $ 54,657
Earned premiums ceded............................. 77,226 73,354 55,557
Losses and loss adjustment expenses ceded......... 40,514 30,797 24,240
Balance Sheet
Unpaid losses and loss adjustment expenses........ 28,192 24,726 21,552
Unearned premiums................................. 42,258 36,828 26,813
The Company, as primary insurer, would be required to pay losses in
their entirety in the event that the reinsurers were unable to discharge
their obligations under the reinsurance agreements.
C.A.R.
C.A.R., a state-mandated reinsurance mechanism, enables the Company
and the other Servicing Carriers to reinsure any automobile risk that the
insurer perceives to be under-priced at the premium level permitted by the
Commissioner. Servicing Carriers, who are responsible for over 99.0% of
total direct premiums written for personal automobile insurance in
Massachusetts, are required to offer automobile insurance coverage to all
eligible applicants pursuant to "take-all-comers" regulations, but may
reinsure business with C.A.R.
Since its inception, C.A.R. has annually generated multi-million
dollar underwriting losses in both the personal and commercial pools. The
Company is required to share in the underwriting results of C.A.R. business
for its respective product lines. Under current regulations, the Company's
share of the C.A.R. personal or commercial deficit is based upon its market
share for retained automobile risks for the particular pool, adjusted by a
"utilization" concept, such that, in general, the Company is
disproportionately and adversely affected if its relative use of C.A.R.
reinsurance exceeds that of the industry, and favorably affected if its
relative use of C.A.R. reinsurance is less than that of the industry. The
Company's strategy has been to voluntarily retain more types of private
passenger automobile business that are factored as credits, thereby
favorably impacting the utilization formula. These credits result from
voluntarily writing business in under priced territories and for under
priced risks. As a result of increased voluntary retention, in excess of
the industry, the credits impacting the utilization formula have favorably
affected the Company's participation ratio compared to its market share.
During 2001, 2000 and 1999, the Company's net participation in the C.A.R.
personal automobile pool approximated 16.8%, 16.9% and 16.5%, respectively,
as reported by C.A.R., compared to the Company's estimated market share in
those years of 23.3%, 22.3% and 21.3%.
56
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars)
Written premiums, earned premiums, losses and LAE incurred,
underwriting expenses incurred and the liabilities for unearned premiums,
unpaid losses and LAE ceded to and assumed from C.A.R. were as follows:
Years ended December 31,
2001 2000 1999
Ceded Assumed Ceded Assumed Ceded Assumed
Income Statement
Written premiums... $ 70,973 $ 79,360 $ 67,451 $ 81,659 $ 68,740 $ 87,241
Earned premiums.... 72,648 80,176 69,120 81,300 68,902 84,356
Losses and LAE.
incurred......... 80,053 108,353 67,987 109,788 81,853 104,273
Underwriting
expenses......... - 28,270 - 28,753 - 28,569
Balance Sheet
Unearned premiums.. 44,399 41,699 44,791 42,515 50,084 42,156
Unpaid losses and
LAE.............. 81,433 105,092 82,450 106,787 91,576 100,680
The Company pays to C.A.R. all of the premiums generated by the
policies it has ceded and C.A.R. reimburses the Company for all losses
incurred on account of ceded policies. In addition, the Company receives a
fee for servicing ceded policies based on the expense structure established
by C.A.R. For the years ended December 31, 2001, 2000 and 1999, these
servicing fees amounted to $17,161, $16,783 and $17,235, respectively.
The Company presents assets and liabilities gross of reinsurance. The
Residual Market Receivable represents the gross amount of reinsurance
recoverable from C.A.R. including unpaid losses, unearned premiums, paid
losses recoverable and unpaid ceded and assumed premiums.
The current C.A.R. utilization-based participation ratio has been in
place for the personal automobile market since 1993. During 2001, 2000 and
1999 the Company's amount of personal automobile exposures it reinsured
through C.A.R. approximated 4.9%, 4.9% and 5.6%, respectively, as compared
to industry averages of 7.7%, 8.4% and 9.6%, respectively.
NOTE G - Income Taxes
The Company and its subsidiaries file a consolidated federal income
tax return.
The federal income tax expense (benefit) consisted of the following:
Years ended December 31,
2001 2000 1999
Current............................ $ 28,571 $ 32,849 $ 26,481
Deferred........................... (5,377) 5,457 (9,814)
$ 23,194 $ 38,306 $ 16,667
57
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars)
NOTE G - Income Taxes (continued)
Deferred taxes arise from temporary differences in the basis of assets
and liabilities for tax and financial statement purposes. The sources of
these differences and the related tax effects of the activities that
occurred consisted of the following:
Years ended December 31,
2001 2000 1999
Unearned premiums.................................. $ (2,428) $ (3,835) $ (2,785)
Discounting of loss reserves....................... 809 (381) (928)
Deferred policy acquisition costs.................. 1,303 4,015 1,251
Salvage and subrogation recoverable................ 81 (116) 272
Tax depreciation in excess of book depreciation.... 180 239 639
Pension liability.................................. - 1,145 (440)
Post-retirement benefits liability................. (246) (424) 120
Equity in earnings (losses) of preferred stock
mutual funds..................................... 264 6,060 (10,487)
Equity in losses of venture capital fund
investments...................................... (3,342) - -
Other.............................................. (1,998) (1,246) 2,544
Deferred income tax.......................... (5,377) 5,457 (9,814)
Other comprehensive income (loss).................. 425 20,084 (26,407)
Deferred taxes at acquisition of American Commerce. - - (4,662)
Change in deferred tax asset................. $ (4,952) $ 25,541 $(40,883)
Realization of a deferred tax asset is dependent on generating
sufficient taxable income in future years. Although realization is not
assured, management believes it is more likely than not that all of the
deferred tax assets will be realized. The amount of the deferred tax asset
considered realizable, however, could be reduced in the near term if
estimates of future taxable income or unrealized gains are reduced.
Deferred tax liabilities (assets) were comprised of the following at
December 31, 2001 and 2000:
2001 2000
Unearned premiums............................................... $(31,477) $(29,049)
Discounting of loss reserves.................................... (20,850) (21,659)
Equity in losses of preferred stock mutual funds................ (3,551) (3,815)
Equity in losses of venture capital fund investments............ (3,342) -
Post-retirement benefits liability of American Commerce......... (1,267) (1,021)
Other........................................................... (4,915) (3,355)
Deferred tax assets....................................... (65,402) (58,899)
Deferred policy acquisition costs............................... 33,847 32,544
Salvage and subrogation recoverable............................. 2,109 2,028
Tax depreciation in excess of book depreciation................. 2,157 1,977
Net accumulated comprehensive income............................ 6,643 6,217
Other........................................................... 3,653 4,092
Deferred tax liabilities.................................. 48,409 46,858
Net deferred tax asset.................................... $(16,993) $(12,041)
58
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars)
NOTE G - Income Taxes (continued)
Federal income tax on income is less than the amount computed by
applying the statutory rate of 35% for the years ended 2001, 2000 and 1999
for the following reasons:
Years ended December 31,
2001 2000 1999
Tax at statutory rate.. $ 40,399 35.0% $ 59,523 35.0% $ 36,499 35.0%
Tax exempt interest.... (7,123) (6.2) (8,314) (4.9) (9,157) (8.8)
Dividends paid to ESOP
participants......... (848) (0.7) (899) (0.5) (785) (0.8)
Dividends received
deduction............ (7,510) (6.5) (8,123) (4.8) (7,560) (7.2)
Amortization of
preferred stock
mutual fund negative
goodwill............. (1,043) (0.9) (3,242) (1.9) (1,909) (1.8)
Other.................. (681) (0.6) (639) (0.4) (421) (0.4)
Tax at effective rate.. $ 23,194 20.1% $ 38,306 22.5% $ 16,667 16.0%
NOTE H - Related-Party Transactions
The Company has made loans to insurance agencies with which Commerce
transacts business on a regular basis. At December 31, 2001, eleven loans
with an aggregate outstanding principal balance of $3,476, were
collateralized by the assets of the agencies, one of these loans with an
outstanding balance of $313 was collateralized by real estate as the
primary collateral and the assets of the agency as secondary collateral.
There were no loans to insurance agencies collateralized solely by real
estate. At December 31, 2000, ten loans with an aggregate outstanding
balance of $3,556 were collateralized by the assets of the agencies and
one of these loans with an outstanding balance of $328 was collateralized
by real estate as the primary collateral and the assets of the agency as
secondary collateral.
The immediate family of Raymond J. Lauring, a Director of the
Company, owns more than a 10% equity interest in Lauring Construction
Company. Mr. Lauring has no ownership interest in Lauring Construction
Company. During 2001, Lauring Construction Company provided construction
and construction management services in connection with a contract for the
estimated $13 million renovation of a 160,000 square foot building
purchased by the Company. Terms of the contract provide for a fixed fee
of $650 for supervision and management of the project over the term of the
contract. There were no payments made on the supervision or management
services portion of the contract in 2001. Payments to Lauring
Construction Company in 2001 for actual materials used and construction
work performed on this project were $405 and payments for other work
unrelated to the project were $31.
NOTE I - Employee Stock Ownership Plan and 401(k) Plan
The Company offers an Employee Stock Ownership Plan ("E.S.O.P.") and
401(k) Plan for the benefit of substantially all employees, including
those of the Company's subsidiaries. The E.S.O.P. is noncontributory on
the part of Participants and contributions are made at the discretion of
the Board of Directors. The company is under no obligation to make
contributions or maintain the E.S.O.P. for any length of time, and may
completely discontinue or terminate the E.S.O.P. at any time without
liability. Contributions by the Company and subsidiaries to the E.S.O.P.
for the years ended December 31, 2001, 2000 and 1999 were $7,502, $5,702
and $5,744, respectively. The increase in the contribution in 2001 over
2000 was primarily due to the inclusion of American Commerce employees
into the plan. The E.S.O.P. held 2,989,046 and 3,143,076 shares of the
Company's common stock at December 31, 2001 and 2000, respectively.
E.S.O.P. Participants who are current employees of the Company or its
subsidiaries and who are 100% vested in their E.S.O.P. accounts can
annually elect to transfer
60
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars)
NOTE I - Employee Stock Ownership Plan and 401(k) Plan (continued)
out of the E.S.O.P. up to 100% of their allocated Company stock in the
form of an eligible rollover distribution into another eligible retirement
plan, such as a qualified individual retirement arrangement.
Approximately 2,191,000 shares owned by Participants in the E.S.O.P. at
December 31, 2001 are allocated to the E.S.O.P. accounts of these
individuals. E.S.O.P. Participants who are former employees of the
Company may generally elect to withdraw from the E.S.O.P. the total amount
of shares allocated to their accounts at any time. Approximately 580,000
shares held by the E.S.O.P. at December 31, 2001 are allocated to the
E.S.O.P. accounts of these individuals. The remaining approximately
219,000 shares held by the E.S.O.P. at December 31, 2001 are allocated to
the E.S.O.P. accounts of Participants who have not yet reached 100%
vesting in their account balances. Disposition of these unvested shares
is restricted under the E.S.O.P. The Company pays for administration of
the E.S.O.P.
The 401(k) Plan, implemented in September 1998, enables eligible
employees to contribute up to 15% of eligible compensation on a pre-tax
basis up to the annual maximum limits under federal tax law. The Company
incurs no expenses in the form of matching contributions but does pay for
administration of the Plan.
NOTE J - American Commerce Pension and Post-Retirement Benefits
Effective June 1, 2000, the Directors of American Commerce voted to
terminate the American Commerce noncontributory defined benefit pension
plan (the "pension plan") and transition on January 1, 2001 to the
E.S.O.P. The payment of the termination liability to participants from
previously funded assets of the pension plan amounted to $4,558 in 2000.
All participants of the pension plan were eligible to retire with full
retirement benefits upon attainment of age 65 with 5 years of
participation. Retirement benefits were payable for the life of the
participant with guaranteed payments for 10 years. All retirees had taken
lump-sum payments. American Commerce made contributions to a deposit
administration contract, which provided the pension plan with assets
sufficient to fund pension benefits to pension plan participants. The
deposit administration contract was carried at contract value, which
represented the cost of contributions plus interest and experience
refunds. The pension plan was subject to and exceeded the minimum funding
requirements of ERISA.
Effective January 1, 2001, the Directors of American Commerce voted
to merge the 401(k) Plan with the Company's Plan. Previously, American
Commerce maintained a separate 401(k) Plan for the benefit of
substantially all of its employees. American Commerce matched 50% of all
employee contributions up to 6% of pay. Both American Commerce and its
employees shared in administration expenses of the plan. American
Commerce did not contribute to the plan in 2001 due to the aforementioned
merger. Commerce contributed $181 and $165 to the plan in 2000 and 1999,
respectively.
American Commerce maintains a noncontributory post-retirement benefit
plan (the "post-retirement plan") for retirees that includes medical,
dental and life insurance coverages. All participants of the post-
retirement plan are eligible upon attainment of age 55 with 10 years of
service or age 65 with 5 years of service. Dental coverage ceases at age
65 and life insurance coverage decreases based upon the age of the retiree
until the attainment of age 70, at which time retirees are provided a
nominal amount of coverage from age 70 and thereafter. Participants'
spouses are also covered under the post-retirement plan. The cost of
post-retirement medical, dental and life insurance benefits is accrued
over the active service periods of employees to the date they attain full
eligibility for such benefits. It is the policy of American Commerce to
pay for post-retirement benefits as incurred.
60
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars)
NOTE J - American Commerce Pension and Post-Retirement Benefits
(continued)
The following table shows, as of December 31, 2001 and 2000, the
American Commerce post-retirement benefit plan funded status reconciled
with amounts reported in the consolidated balance sheet and the
assumptions used in determining the actuarial present value of the benefit
obligation:
2001 2000
Plan assets at fair value........................... $ - $ -
Accumulated benefit obligation:
Retirees.......................................... 1,448 1,168
Active participants, fully eligible............... 790 893
Active participants, not eligible................. 1,812 2,225
Projected benefit obligation........................ 4,050 4,286
Unfunded status of plan............................. (4,050) (4,286)
Unrecognized prior service costs.................... (17) (20)
Unrecognized net transition obligation.............. 1,087 1,186
Unrecognized net loss (gain)........................ (641) 20
Accrued benefit cost.......................... $(3,621)$(3,100)
Assumptions:
Weighted average discount rate.................... 7.0% 7.0%
Net periodic cost of the American Commerce post-retirement benefit plan for the period
ended December 31, 2001, 2000 and 1999 includes the following components:
2001 2000 1999
Service cost-benefits earned........................ $ 250 $ 246 $ 238
Interest cost on projected benefit obligation....... 248 265 246
Actual return on plan assets........................ - - -
Amortization of unrecognized net transition
obligation........................................ 99 99 99
Amortization of unrecognized prior service cost..... (3) (3) (3)
Amortization of unrecognized loss (gain)............ (25) - -
Net asset loss deferred for later recognition....... - - -
Net periodic cost................................. $ 569 $ 607 $ 580
The assumed health care cost trend rate for 2001 was 8.5% and 7.25%
for medical and dental, respectively. These rates grade down until the
final trend rates of 6.0% and 5.0% for medical and dental, respectively,
are reached in 2010. A one percentage point increase in the assumed health
and dental cost trend rates increases the sum of the service and interest
costs components of the 2001, 2000 and 1999 periodic post-retirement
benefit cost by 16.3%, 20.4% and 13.0% respectively, and the accumulated
post-retirement benefit obligation as of December 31, 2001, 2000 and 1999
by 16.6%, 17.7% and 14.0%, respectively.
Subsequent to December 31, 2001, the Directors of American Commerce
voted to terminate that portion of the post-retirement plan applicable to
future retirees of American Commerce. Termination will be effective May 1,
2002. Current retirees and employees who retire prior to May 1, 2002 will
remain eligible for post-retirement benefits.
61
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars)
NOTE K - Directors' Retirement Compensation Plan
During 2000, the Company's Directors approved a Directors' Retirement
Compensation Plan (the "Retirement Plan"). The Retirement Plan becomes
effective for each Company Director upon terminating service on the
Company's Board of Directors (the "Board") providing that such termination
was not made under conditions adverse to the Company's interest. Effective
with the annual meeting wherein the Director is not reappointed to the
Board, and provided benefits are not paid until such time as the Director
has attained the age of 65, the Company will pay an annual retirement
benefit equal to 50% of the average annual total compensation of the
Director for the immediately preceding three full years ("the three year
average compensation"). The annual retirement benefit of 50% of the three
year average compensation vests at the rate of 4.0% for each year of Board
(or subsidiary) service up to a maximum of 100% vesting through termination
of service. Payments continue for a maximum of ten years over the
remaining life of the terminated Director, or his or her then spouse, if
the Director pre-deceases the spouse. No payments are to be made after the
death of the Director and spouse. Expenses related to the Retirement Plan
in 2001 and 2000 amounted to $178 and $2,364, respectively. A total of $19
was paid under the Retirement Plan in 2001 and 2000.
NOTE L - Stockholders' Equity
Book Value Awards, Stock Appreciation Rights and Stock Options Program
The Management Incentive Plan approved by the Company's stockholders
in May, 1994 provides for the award of incentive stock options, non-
qualified stock options, book value awards, stock appreciation rights,
restricted stock and performance stock units. Up to 2,500,000 shares of
common stock (subject to increase for anti-dilution adjustments) may be
issued under the Plan, including shares that may be issued pursuant to
awards of restricted stock or upon the exercise of common stock equivalent
awards such as stock options and stock appreciation rights payable in the
form of common stock (not in the form of cash). At the discretion of the
compensation committee all directors, officers and other senior management
employees of the Company or any of its subsidiaries are eligible to
participate in this Management Incentive Plan.
Book value awards issued relating to this Plan totaled 474,541,
496,685 and 447,185 in 2001, 2000 and 1999, respectively. Expenses
relating to book value awards were $1,577, $3,081 and $438 in 2001, 2000
and 1999, respectively. Grants under the SAR plan ceased in 1999 and were
replaced with the stock option program. No SARs were outstanding at
December 31, 2001. Expenses (income) relating to stock appreciation rights
were $0, $760 and ($3,159) in 2001, 2000 and 1999, respectively. The
outstanding book value awards entitle the holders to cash payments based
upon the extent to which, if at all, the per share book value exceeds
certain thresholds set at the time the award was granted.
During 2001, 2000 and 1999, the Company granted stock options
("options") totaling 1,184,343, 644,520 and 700,179, respectively,
including the issuance of options previously terminated. The outstanding
options entitle the recipient to purchase the Company's common stock based
upon the extent to which, if at all, the per share market value of the
common stock exceeds certain thresholds set at the time the option was
granted. Unexercised options terminate not later than eight years after
the date of grant.
62
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars Except for Per Share Data)
NOTE L - Stockholder's Equity (continued)
Aggregate liabilities for the combined programs were $2,614 and $2,972
at December 31, 2001 and 2000, respectively.
The following is a summary of the changes in options outstanding under the Plan:
Weighted
Average
Exercise
Shares Price
Options outstanding at January 1, 1999.... - $ -
Granted January 29, 1999............... 50,000 36.32
Granted April 30, 1999................. 650,179 32.81
Options outstanding at December 31, 1999.. 700,179 33.06
Granted April 5, 2000.................. 644,520 31.59
Terminated............................. (5,888) 32.81
Options outstanding at December 31, 2000.. 1,338,811 32.35
Granted April 6, 2001.................. 1,184,343 30.80
Terminated............................. (80,818) 34.74
Options outstanding at December 31, 2001.. 2,442,336 $ 31.52
No options were exercisable at December 31, 2001, 2000 and 1999.
The estimated weighted average fair value per share of the options was $5.26 in 2001,
$4.16 in 2000 and $3.78 in 1999. Under the provisions of APB Opinion 25, no expense was
recognized for these options in 2001, 2000 or 1999. No options were granted prior to 1999.
Had the Company recognized such expense, the Company's net earnings and earnings per share
would have approximated the pro forma amounts indicated below:
2001 2000 1999
Net earnings:
As reported $ 93,094 $132,080 $ 88,676
Pro forma $ 88,363 $130,180 $ 86,956
Basic earnings per share:
As reported $ 2.77 $ 3.87 $ 2.54
Pro forma $ 2.63 $ 3.81 $ 2.49
Diluted earnings per share:
As reported $ 2.75 $ 3.87 $ 2.54
Pro forma $ 2.61 $ 3.81 $ 2.49
Additionally, the Company granted 250,000 and 1,872,380 options to
certain agents of American Commerce (the "American Commerce Agents' Plan")
in 2001 and 1999, respectively. The right of the recipient to exercise
these options is contingent upon the average volume of other-than-
Massachusetts private passenger automobile and homeowners direct written
premiums placed and maintained with American Commerce for a five year
period specified in the option agreement. If qualified, the recipient may
purchase the Company's common stock at the exercise price for a period of
five years beginning five years after the date of the grant ("the
confirmation date"). Unexercised options terminate not later than ten
years after the date of the grant ("the expiration date"). In conjunction
with meeting specified premium growth levels over the term of the options,
the Company provided "put rights" to the holders of the options granted in
1999. These put rights permit the option holders to require the Company to
purchase the options at the difference between $40.00 less the exercise
price, at any time from and after the confirmation date through and
including the expiration date. Expenses related to these options,
determined in accordance with the fair value accounting provisions of SFAS
No. 123, "Accounting for Stock-Based Compensation", amounted to $2,862 in
2001, $1,307 in 2000 and $1,909 in 1999.
63
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars Except for Per Share Data)
NOTE L - Stockholder's Equity (continued)
The following is a summary of the changes in options outstanding under
the American Commerce Agents' Plan:
Weighted
Average
Exercise
Shares Price
Options outstanding at January 1, 1999.... - $ -
Granted................................ 1,872,380 36.32
Options outstanding at December 31, 1999.. 1,872,380 36.32
Granted................................ - -
Options outstanding at December 31, 2000.. 1,872,380 36.32
Granted................................ 250,000 41.97
Options outstanding at December 31, 2001.. 2,122,380 $ 36.99
No options were exercisable at December 31, 2001, 2000, and 1999.
The fair value of each option granted under the American Commerce Agents' Plan was
estimated on the date of grant using the Black-Scholes option-pricing model, with the
following weighted average assumptions:
December 31,
2001 2000
Dividend yield.................................... 3.16% 4.47%
Volatility........................................ 28.30% 27.10%
Risk-free interest rate........................... 4.04% 5.10%
Expected option life in years..................... 7 7
The estimated weighted average fair value per share of the options
under the American Commerce Agents' Plan was $5.63, $4.48 and $5.28 at
December 31, 2001, 2000 and 1999, respectively.
NOTE M - Net Capital Requirements
The insurance companies included in the consolidated financial
statements are subject to the financial capacity guidelines established by
their respective state Divisions of Insurance. Every Massachusetts
insurance company seeking to make any dividend or other distributions to
its stockholders may, within certain limitations, pay such dividends and
then file a report with the Commissioner. Dividends in excess of these
limitations are called extraordinary dividends. An extraordinary dividend
is any dividend or other property, whose fair value together with other
dividends or distributions made within the preceding twelve months exceeds
the greater of ten percent of the insurer's surplus as regards
policyholders as of the end of the preceding year, or the net income of a
non-life insurance company for the preceding year. No pro-rata
distribution of any class of the insurer's own securities is to be
included. No Massachusetts insurance company shall pay an extraordinary
dividend or other extraordinary distribution until thirty days after the
Commissioner has received notice of the intended distribution and has not
objected. No extraordinary dividends were paid in 2001, 2000 and 1999.
California and Ohio have similar regulations. No extraordinary dividend
was paid by American Commerce in 2001, 2000 and 1999 and no dividends were
paid by Commerce West since its acquisition.
To the extent Commerce and Citation are restricted from paying
dividends to CHI, CHI will be limited in its ability to pay dividends to
the Company. On this basis, the Company's ability to pay dividends to its
stockholders is limited. During 2001, Commerce and Citation paid $55,200
and $10,868 in dividends, respectively to CHI; CHI then paid $65,835 to the
Company in March 2001. During 2000, Commerce and Citation paid $41,000 and
$10,780 in dividends, respectively, to CHI; CHI then paid $51,660 to the
Company in March 2000. Commerce West did not pay dividends on their common
stock in 2001 and 2000. American Commerce paid ACIC Holding Co., Inc. a
dividend of $9,281 in 2001, no dividend was paid in 2000. ACIC Holding
Co., Inc. paid Commerce dividends of $9,582 and $9,178 in 2001 and 2000,
respectively, on its outstanding preferred stock.
64
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars Except for Per Share Data)
NOTE M - Net Capital Requirements (continued)
The Board of Directors of the Company voted to declare four quarterly
dividends to stockholders of record totaling $1.19 per share and $1.15 per
share in 2001 and 2000, respectively. On May 19, 2001, the Board voted to
increase the quarterly stockholder dividend from $0.29 to $0.30 per share
to stockholders of record as of June 4, 2001. Prior to that declaration,
the Company paid quarterly dividends of $0.29 per share dating back to May
21, 2000 when the Board voted to increase the dividend from $0.28 to $0.29
per share.
NOTE N - Statutory Balances
Following is a GAAP to Statutory reconciliation for both earnings and
policyholders surplus for the combined operations of Commerce, Citation,
Commerce West and American Commerce:
2001 2000 1999
Earnings Equity Earnings Equity Earnings Equity
GAAP............................. $ 95,758 $787,172 $136,425 $756,922 $ 85,242 $635,787
Deferred income taxes (benefits). (5,540) 34,518 6,077 (9,227) (944) (40,634)
Deferred acquisition costs....... (5,252) (116,557) (12,805) (111,305) (3,373) (98,499)
Bonds-book versus market......... - (11,578) - (5,726) - 11,400
Preferred stock-market versus
book............................ - 467 - 1,506 - (528)
Deferred income.................. (692) 6,802 231 7,493 518 7,380
Deferred service fee income
(expense)...................... 1,067 2,765 412 1,698 (804) 2,611
Deferred reinsurance
commissions..................... 1,560 14,834 1,896 13,276 (201) 10,054
Statutory reserve over statement
reserves........................ - (115) - (1,042) - (3,053)
Goodwill in subsidiary........... (290) 1,065 (290) 1,355 (291) 1,645
Pension and post-retirement
benefit......................... 55 1,929 (2,072) 1,875 - 3,408
Yield to worst amortization...... (201) (3,803) - - - -
Non-admitted assets.............. - (8,682) - (4,308) - -
Adjustment for non-insurance
company subsidiary.............. 6,014 6,840 6,021 8,324 8,651 11,727
Equity in earnings (losses) of
preferred stock mutual funds
reflected in GAAP earnings...... (4,583) - (26,575) - - -
Equity in earnings (losses) of
venture capital funds reflected
in GAAP earnings................ 9,548 - - - - -
Equity in earnings (losses) of
Liquidation Special Trust
reflected in GAAP earnings...... (2,561) - - - - -
GAAP restatement of preferred
stock mutual funds.............. - - - - 13,913 (21,371)
Other............................ 135 275 (578) 121 329 (953)
Total adjustments........... (740) (71,240) (27,683) (95,960) 17,798 (116,813)
Statutory........................ $ 95,018 $715,932 $108,742 $660,962 $103,040 $518,974
65
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars)
NOTE O - Segment Information (continued)
The Company has four reportable segments: (1) property and
casualty insurance - Massachusetts; (2) property and casualty
insurance - other than Massachusetts; (3) real estate and commercial
lending; and, (4) corporate and other. The Company's property and
casualty insurance operations are written through Commerce,
Citation, Commerce West, and American Commerce and are marketed to
affinity groups, individuals, families and businesses through the
Company's relationships with professional independent insurance
agencies. The Company's real estate and commercial lending
operations are a result of insurance companies having the authority
to invest in mortgages. The Company's wholly-owned subsidiary, Bay
Finance Company, Inc., originates and services residential and
commercial mortgages in Massachusetts and Connecticut. The
corporate and other segment represents the remainder of the
Company's activities, including those of the parent company.
The Company evaluates performance and allocates resources based
primarily on the property and casualty insurance segments, which
represents 99.2% of the Company's total revenue for the past three
years. The accounting policies of the reportable segments are the
same as those described in Note A - Summary of Significant
Accounting Policies.
Selected information by industry segment for 2001, 2000 and
1999 is summarized as follows:
Earnings (Losses)
Before Identifiable
Revenue Income Taxes Assets
2001
Property and casualty insurance
Massachusetts.......................... $1,011,318 $120,855 $1,848,333
Other than Massachusetts............... 135,483 (6,730) 245,397
Real estate and commercial lending...... 3,640 3,640 40,466
Corporate and other..................... 3,397 (2,340) 5,886
Consolidated........................ $1,153,838 $115,425 $2,140,082
2000
Property and casualty insurance
Massachusetts.......................... $ 969,624 $164,237 $1,780,724
Other than Massachusetts............... 121,028 7,115 236,240
Real estate and commercial lending...... 5,407 5,407 52,327
Corporate and other..................... 3,421 (6,693) 6,323
Consolidated........................ $1,099,480 $170,066 $2,075,614
1999
Property and casualty insurance
Massachusetts.......................... $ 844,052 $ 97,304 $1,562,975
Other than Massachusetts............... 110,179 3,998 224,017
Real estate and commercial lending...... 5,429 5,429 78,755
Corporate and other..................... 3,374 (2,447) 12,272
Consolidated........................ $ 963,034 $104,284 $1,878,019
NOTE P - Supplement to Consolidated Statements of Cash Flows
During the years ended December 31, 2001 and 2000, the Company did not
acquire any property through foreclosure of mortgages.
66
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars Except for Per Share Data)
NOTE Q - Insolvency Fund Assessments
As provided in the statutes, insurance companies which write business
in Massachusetts are assessed for losses attributable to the insolvency of
other insurance companies by the Massachusetts Insurers Insolvency Fund
("M.I.I.F."). From M.I.I.F.'s inception, on August 2, 1972 through
December 31, 2001, the M.I.I.F. has approved assessments totaling $188,071,
of which the Company's share was approximately $15,686. It is anticipated
that there will be additional assessments from time to time relating to
various insolvencies. By statute, no insurer may be assessed in any year
an amount greater than two percent of that insurer's direct written
premiums for the calendar year preceding the assessment. Although the
timing and amounts of any such assessments are not known, based on existing
knowledge, management is of the opinion that such assessments will not have
a material effect on the consolidated financial position of the Company.
According to statute, the assessed insurance companies have the right to
recoup amounts paid to the M.I.I.F., over a reasonable length of time,
through premium rates approved by the Commissioner. M.I.I.F. assessed the
Company $3,111 during 2001 and $5,306 for the year ended December 31, 2000
after having no activity for the year ended December 31, 1999. The
assessment for 2001 was the result of two insolvencies, The Trust Insurance
Company and Reliance Insurance Company, which accounted for assessment
amounts of $1,244 and $1,867, respectively. The assessment for 2000 was
primarily the result of two insolvencies, The Trust Insurance Company and
New England Fidelity Insurance Company, which accounted for assessment
amounts of $4,939 and $1,205, respectively, offset by refunds for prior
year assessments on numerous insurers' insolvencies.
NOTE R - Commitments
In 2000, Commerce entered into a Limited Partnership Agreement with
Conning Partners VI, L.P., a Delaware Limited Partnership. This
partnership agreement required a commitment by the Company to invest up to
$50,000 into the partnership. To date the Company has invested $15,091
into the partnership leaving a balance for funds still committed but not
paid into the partnership of $34,909. The partnership was formed to
operate as an investment fund principally for the purpose of making
investments primarily in equity, equity-related and other securities issued
in expansion financing, start-ups, buy-outs and recapitalization
transactions relating to companies in the areas of insurance, financial
services, e-commerce, healthcare, and related businesses, including,
without limitation, service and technology enterprises supporting such
businesses, in order to realize long-term capital returns, all as
determined and managed by the General Partner for the benefit of the
Partners.
Also in 2000, Commerce entered into a Limited Partnership Agreement
with Distribution Partners Investment Capital, L.P. a Delaware Limited
Partnership. This partnership agreement required a commitment by the
Company to invest up to $3,500 into the partnership. To date the Company
has invested $2,258 into the partnership leaving a balance of $1,242 for
funds still committed. The partnership was formed to operate as an
investment fund principally for the purpose of making investments primarily
in equity and equity-related securities of companies operating in the area
of insurance distribution and distribution related activities, all as
determined and managed by the General Partner for the benefit of the
Partners.
NOTE S - Legal Proceedings
As is common with property and casualty insurance companies, the
Company is a defendant in various legal actions arising from the normal
course of its business, including claims based on Chapter 176D and Chapter
93A. These proceedings are considered to be ordinary to operations or
without foundation in fact. Management is of the opinion that these
actions will not have a material adverse effect on the consolidated
financial position of the Company. In addition to the normal course of
business legal actions noted above, the Company is named as defendant in a
purported class action lawsuit alleging damages as a result of the alleged
diminution of value to vehicles that are involved in accidents. The
"diminution of value" theory asserts that the market value of any vehicle
involved in an accident inevitably and irreparably declines as a result of
such accident, even if all physical damage appears to be repaired
completely. This case, entitled "Elena Given, individually and as a
representative of all persons similarly situated v. The Commerce Insurance
Company", filed in 2001, in the Bristol Superior Court in Massachusetts.
The plaintiff has not sought certification of class
67
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(Thousands of Dollars Except for Per Share Data)
NOTE S - Legal Proceedings (continued)
action status. The Company is vigorously contesting this suit, but is
currently unable to estimate the potential exposure. The Company and its
outside legal counsel are of the opinion that the Company will prevail in
this case. Another Superior Court judge in Massachusetts ruled, in a
similar case brought by the same plaintiff counsel against another insurer,
that claims for diminution of value are not covered by the Massachusetts
automobile insurance policy. Other insurance companies face similar suits
in cases outside of Massachusetts.
NOTE T - Quarterly Results of Operations (Unaudited)
An unaudited summary of the Company's 2001 and 2000 quarterly
performance is as follows:
2001 First Second Third Fourth
Quarter Quarter Quarter Quarter
Total revenues................................. $273,428 $289,316 $294,642 $296,452
Net earnings................................... 14,622 28,200 22,139 28,133
Comprehensive income........................... 9,019 39,508 19,823 25,305
Operating earnings (1)......................... 20,480 26,580 23,420 28,400
Net earnings per common share
Basic........................................ 0.43 0.84 0.66 0.85
Diluted...................................... 0.43 0.83 0.65 0.84
Operating earnings per share (1)
Basic........................................ 0.60 0.79 0.70 0.85
Diluted...................................... 0.60 0.78 0.69 0.85
Cash dividends paid per share.................. 0.29 0.30 0.30 0.30
2000 First Second Third Fourth
Quarter(2) Quarter(2) Quarter(2) Quarter(2)
Total revenues................................. $261,898 $251,274 $295,780 $290,528
Net earnings................................... 25,964 14,646 35,974 55,496
Comprehensive income........................... 29,681 19,028 44,921 74,940
Operating earnings (1)......................... 20,554 20,415 17,469 51,193
Net earnings per common share
Basic........................................ 0.76 0.43 1.05 1.63
Diluted...................................... 0.76 0.43 1.05 1.63
Operating earnings per share (1)
Basic........................................ 0.60 0.60 0.51 1.50
Diluted...................................... 0.60 0.60 0.51 1.50
Cash dividends paid per share.................. 0.28 0.29 0.29 0.29
(1) The above figures are presented to provide information to the reader due to the amount
of, and fluctuations in, net realized gains and losses. The amounts noted, which
exclude the after-tax impact of net realized investment gains (losses), are important
measures of corporate performance. Operating earnings per share, basic and diluted, are
calculated identically to net earnings per common, basic and diluted, (see NOTE A15),
with the exception that the number divided by the weighted shares would be operating
earnings.
(2) During 2001 certain amounts were restated due to the change in accounting for closed-end
preferred stock mutual funds to the equity method.
68
SELECTED CONSOLIDATED FINANCIAL DATA
The data below should be read in conjunction with the consolidated
financial statements, related footnotes, and other financial information
included herein. The financial statements for the five years ended
December 31, 2001 have been audited by Ernst & Young LLP. All dollar
amounts set forth in the following tables are in thousands, except per
share data:
Years ended December 31,
2001 2000 1999 1998 1997
Statement of Earnings Data:
Net premiums written.......... $1,078,967 $1,008,911 $ 911,993 $ 745,048 $ 741,501
(Increase) decrease in
unearned premiums............ (35,315) (54,428) (40,163) 572 (11,004)
Earned premiums............... 1,043,652 954,483 871,830 745,620 730,497
Net investment income......... 99,611 96,830 89,789 86,501 80,971
Premium finance and service
fees......................... 17,819 15,227 14,774 13,440 7,074
Amortization of excess of
book value of subsidiary
interest over cost........... 3,389 3,390 3,019 - -
Net realized investment gains
(losses)...................... (10,633) 29,550 (16,378) 7,150 29,963
Total revenues........... 1,153,838 1,099,480 963,034 852,711 848,505
Losses and loss adjustment
expenses..................... 777,543 686,157 625,090 531,429 526,127
Policy acquisition costs...... 260,870 243,257 233,660 196,434 187,491
Total expenses........... 1,038,413 929,414 858,750 727,863 713,618
Earnings before income taxes
and minority interest........ 115,425 170,066 104,284 124,848 134,887
Income taxes.................. 23,194 38,306 16,667 26,583 33,483
Net earnings before minority
interest..................... 92,231 131,760 87,617 98,265 101,404
Minority interest in net loss
of subsidiary............... 863 320 1,059 - -
Net earnings............. $ 93,094 $ 132,080 $ 88,676 $ 98,265 $ 101,404
Comprehensive income..... $ 93,655 $ 168,570 $ 40,730 $ 96,594 $ 103,460
Earnings Per Share Data:
Basic.................... $ 2.77 $ 3.87 $ 2.54 $ 2.73 $ 2.81
Diluted.................. $ 2.75 $ 3.87 $ 2.54 $ 2.73 $ 2.81
Cash dividends paid per
share................... $ 1.19 $ 1.15 $ 1.11 $ 1.07 $ 1.03
Weighted average number of
shares outstanding:
Basic......................... 33,608,804 34,121,047 34,940,074 36,042,652 36,044,679
Diluted....................... 33,794,938 34,121,047 34,940,074 36,042,652 36,044,679
December 31,
2001 2000 1999 1998 1997
Balance Sheet Data:
Total investments............. $1,498,201 $1,472,562 $1,295,995 $1,262,500 $1,246,504
Premiums receivable........... 246,221 230,580 195,160 162,878 169,469
Total assets.................. 2,140,082 2,075,614 1,878,019 1,747,583 1,739,562
Unpaid losses and loss
adjustment expenses.......... 681,624 674,140 659,841 583,996 630,473
Unearned premiums............. 563,456 519,885 457,095 391,424 379,599
Stockholders' equity.......... 812,274 781,881 668,005 710,852 652,824
Stockholders' equity
per share ................... 24.52 23.16 19.44 19.72 18.11
69
MANAGEMENT'S DISCUSSION OF THE SUPPLEMENTAL INFORMATION
ON INSURANCE OPERATIONS
(Thousands of Dollars)
The following tables depict the progress of the insurance operations
of the Company over the past fifteen years. For these years of operation,
net premiums written amounted to $8,358,235. During this period, the
aggregate statutory financial ratios were 68.6% for losses and loss
expenses and 26.1% for underwriting expenses resulting in an aggregate
combined ratio of 94.7%. Total net investment income amounted to $876,134
or 10.5% of net premiums written. Net realized gains were $93,201.
Stockholders' equity was $31,461 at the beginning of 1987 and $787,172, at
the end of 2001, resulting in an average annual increase in excess of
23.9%, excluding dividends. This figure including dividends paid would
have been 26.1%. The progress of the insurance operations during the most
recent five year period, compared to the two previous five year periods,
can best be illustrated by the following comparison:
5-Year Period
1997-01 1992-96 1987-91
Direct premiums written.......................... $4,737,712 $3,110,296 $1,710,049
Net premiums written............................. 4,486,420 2,976,451 895,364
Net investment income............................ 465,687 303,657 106,790
Net realized gains............................... 28,969 50,290 13,942
Stockholders' equity at end of period............ 787,172 550,087 177,225
Statutory Financial Ratios (Unaudited)
Losses and loss expenses to premiums earned.... 70.2% 66.5% 66.8%
Underwriting expenses to net premiums written.. 25.2 27.4 26.6
Combined ratio............................. 95.4% 93.9% 93.4%
Increase in Stockholders' Equity................. 43.1% 210.4% 463.3%
The insurance operations of the Company include the operating results
of Commerce and Citation, along with Commerce's subsidiary companies,
Commerce West and American Commerce. Citation commenced business in 1981
as a wholly-owned subsidiary of Commerce. On December 31, 1989, the
ownership of Citation was transferred to The Commerce Group, Inc. In
September 1993, ownership of both Commerce and Citation was transferred
from The Commerce Group, Inc. to CHI, a subsidiary of The Commerce Group,
Inc. Results of Commerce West are included since its acquisition by
Commerce on August 31, 1995. Results of American Commerce are included
since its acquisition by Commerce on January 29, 1999. The combined
balance sheets of these insurance subsidiaries appear on pages 71 and 72.
The combined statements of earnings of insurance operations appear on pages
73 and 74. During 2001 certain amounts for years 1996 through 2000 were
restated due to the change in accounting for closed-end preferred stock
mutual funds to the equity method, reflected as realized gains or losses.
70
MANAGEMENT'S DISCUSSION OF THE SUPPLEMENTAL INFORMATION
ON INSURANCE OPERATIONS (continued)
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
COMBINED BALANCE SHEETS OF INSURANCE SUBSIDIARIES
December 31,
(Thousands of Dollars)
2001 2000 1999 1998 1997
ASSETS
Cash and short-term investments..... $ 148,418 $ 70,392 $ 22,410 $ 75,655 $ 238,685
Bonds, at market (at amortized cost
prior to 1993)..................... 626,482 669,935 647,338 619,267 590,597
Preferred stocks, at market (at
amortized cost prior to 1993)...... 248,101 200,083 211,049 197,425 148,499
Common stocks, at market............ 107,458 115,827 77,348 111,482 58,652
Preferred stock mutual funds........ 309,282 337,733 251,135 177,079 123,246
Mortgage loans on real estate....... 26,237 35,340 42,479 46,573 57,425
Other investments................... 18,743 26,802 14,139 7,825 3,783
Premium balances receivable......... 246,095 230,450 195,047 162,704 169,311
Investment income receivable........ 15,460 18,118 14,531 13,544 12,103
Residual market receivable.......... 125,832 127,241 141,660 140,220 161,799
Reinsurance receivable.............. 70,450 61,554 48,365 36,687 18,170
Deferred acquisition costs.......... 116,557 111,305 98,500 88,759 85,264
Current income taxes................ - - - 2,773 -
Deferred income taxes............... 15,797 10,901 37,612 - -
Non-compete agreement............... 2,479 2,829 3,179 - -
Real estate, furniture and equipment 38,764 33,498 27,321 27,885 29,060
Total assets................ $2,116,155 $2,052,008 $1,832,113 $1,707,878 $1,696,594
LIABILITIES
Unpaid losses and loss expenses..... $ 675,978 $ 669,837 $ 659,319 $ 579,174 $ 618,094
Unearned premiums................... 563,456 519,885 457,095 391,424 379,599
Excess of book value of subsidiary
interest over cost................. 5,719 8,431 10,758 - -
Notes payable....................... - - - - -
Deferred income..................... 7,015 7,703 7,464 6,948 7,271
Accounts payable, accrued and other
liabilities........................ 72,998 72,333 48,505 70,558 60,332
Current income taxes................ 3,817 15,829 11,821 - 9,635
Deferred income taxes............... - - - 4,955 9,218
Total liabilities........... 1,328,983 1,294,018 1,194,962 1,053,059 1,084,149
Minority interest................... - 1,068 1,364 - -
STOCKHOLDERS' EQUITY
Capital stock....................... 3,600 3,600 3,600 3,620 3,600
Paid-in capital..................... 45,050 45,050 45,050 45,050 45,050
Retained earnings
Balance, January 1................ 708,272 587,137 606,149 563,795 501,437
Net earnings...................... 95,758 136,425 85,242 95,661 106,718
Other comprehensive income (loss). 560 36,490 (47,948) (1,669) 2,055
Dividends paid.................... (66,068) (51,780) (56,306) (51,638) (46,415)
Balance, December 31................ 738,522 708,272 587,137 606,149 563,795
Total stockholders' equity.. 787,172 756,922 635,787 654,819 612,445
Total liabilities and
stockholders' equity...... $2,116,155 $2,052,008 $1,832,113 $1,707,878 $1,696,594
71
MANAGEMENT'S DISCUSSION OF THE SUPPLEMENTAL INFORMATION
ON INSURANCE OPERATIONS (continued)
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
COMBINED BALANCE SHEETS OF INSURANCE SUBSIDIARIES
December 31,
(Thousands of Dollars)
1996 1995 1994 1993 1992 1991 1990 1989 1988 1987
ASSETS
$ 140,102 $ 52,308 $ 4,560 $ 12,615 $ 25,809 $ 11,190 $ 38,654 $ 84,308 $ 60,885 $ 21,051
716,702 815,277 745,010 649,491 505,565 329,935 242,735 153,621 133,867 116,220
147,680 111,220 85,574 80,059 2,261 869 1,010 1,324 1,606 2,295
63,156 40,359 9,656 47,462 43,545 30,055 4,869 2,900 1,921 1,438
22,727 - - - - - - - - -
45,398 31,404 35,715 42,042 60,697 66,122 56,124 52,244 42,882 15,931
127 - - - 67,876 55,510 57,733 56,713 33,727 19,329
157,673 126,090 101,529 94,333 - - - - - -
12,655 14,440 13,285 10,205 9,710 6,063 4,235 3,093 2,889 2,370
182,213 187,124 198,818 203,312 253,426 254,196 266,440 246,951 184,177 123,725
19,659 21,897 16,892 12,868 365 - - - - -
82,968 67,160 59,066 53,647 55,442 33,981 27,273 22,702 15,699 10,898
- - - - - - - 341 266 -
- 2,100 38,180 - - 883 1,666 - - -
- - - - - - - - - -
26,011 24,642 25,246 22,371 23,183 24,163 25,046 23,118 9,684 8,356
$1,617,071 $1,494,021 $1,333,531 $1,228,405 $1,047,879 $812,967 $725,785 $647,315 $487,603 $321,613
LIABILITIES
$ 644,854 $ 605,791 $ 576,373 $ 550,797 $ 474,800 $416,551 $379,752 $323,020 $256,628 $160,539
367,991 330,454 314,719 283,526 264,567 192,785 175,334 174,345 118,079 84,876
- - - - - - - - - -
- - - - - - 1,662 1,837 2,013 2,204
7,974 8,954 10,451 7,351 8,384 12,918 20,264 23,689 23,307 11,058
41,368 34,351 43,433 16,564 20,863 7,677 21,065 27,513 19,350 14,532
2,726 1,596 10,254 4,867 9,249 5,811 3,542 - - 470
2,071 - - 13,669 4,400 - - 1,623 1,021 1,853
1,066,984 981,146 955,230 876,774 782,263 635,742 601,619 552,027 420,398 275,532
- - - - - - - - - -
STOCKHOLDERS' EQUITY
3,600 3,450 3,450 3,450 3,450 3,450 3,450 3,450 2,350 2,350
45,050 23,700 23,700 8,700 8,700 8,700 8,700 8,700 6,500 6,500
485,725 351,151 339,481 253,466 165,075 112,016 83,138 62,877 37,231 22,611
74,543 110,450 113,892 79,837 91,980 55,214 32,414 21,966 21,837 15,614
6,399 58,919 (77,622) 21,928 9,811 2,545 (86) 645 321 (54)
(65,230) (34,795) (24,600) (15,750) (13,400) (4,700) (3,450) (2,350) (1,034) (940)
501,437 485,725 351,151 339,481 253,466 165,075 112,016 83,138 58,355 37,231
550,087 512,875 378,301 351,631 265,616 177,225 124,166 95,288 67,205 46,081
$1,617,071 $1,494,021 $1,333,531 $1,228,405 $1,047,879 $812,967 $725,785 $647,315 $487,603 $321,613
72
MANAGEMENT'S DISCUSSION OF THE SUPPLEMENTAL INFORMATION
ON INSURANCE OPERATIONS (continued)
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
COMBINED STATEMENTS OF EARNINGS OF INSURANCE OPERATIONS
Years Ended December 31,
(Thousands of Dollars)
2001 2000 1999 1998 1997
Underwriting
Direct premiums written...................$1,152,407 $1,071,649 $948,149 $796,858 $768,649
Net premiums written......................$1,078,967 $1,008,911 $911,993 $745,048 $741,501
Increase (decrease) in unearned
premiums................................. 35,315 54,428 40,163 (572) 11,004
Earned premiums....................... 1,043,652 954,483 871,830 745,620 730,497
Expenses
Losses and loss expenses.................. 776,709 682,805 628,087 533,523 521,775
Underwriting expenses..................... 263,766 251,697 238,458 200,525 185,146
(Increase) decrease in deferred
acquisition costs........................ (5,252) (12,805) (3,374) (3,495) (2,296)
Total expenses........................ 1,035,223 921,697 863,171 730,553 704,625
Underwriting income (loss).................. 8,429 32,786 8,659 15,067 25,872
Net investment income....................... 100,384 96,739 90,028 89,356 89,180
Premium finance fees........................ 17,814 15,221 14,768 13,426 7,056
Amortization of excess of book value
of subsidiary interest over cost........... 3,389 3,390 3,019 - -
Net realized investment gains (losses)...... (10,738) 29,380 (16,325) 4,334 22,318
Earnings before Federal income taxes,
withdrawing companies' settlements
and minority interest................. 119,278 177,516 100,149 122,183 144,426
Other income
Withdrawing companies' settlements........ - - - - -
Earnings before Federal income taxes
and minority interest...................... 119,278 177,516 100,149 122,183 144,426
Federal income taxes........................ 24,383 41,411 15,966 26,522 37,708
Earnings before cumulative effect of
change in accounting principle and
minority interest.......................... 94,895 136,105 84,183 95,661 106,718
Cumulative effect on prior years (to
December 31, 1986) of changing to
different method of accounting for
income taxes............................... - - - - -
Minority interest in net loss of subsidiary. 863 320 1,059 - -
NET EARNINGS..........................$ 95,758 $ 136,425 $ 85,242 $ 95,661 $106,718
Statutory Financial Ratios (Unaudited)
Losses and loss expenses to
premiums earned.......................... 74.7% 71.7% 72.0% 71.6% 71.4%
Underwriting expenses to net
premiums written......................... 24.4 25.1 26.5 26.5 25.1
Combined ratio........................ 99.1% 96.8% 98.5% 98.1% 96.5%
Underwriting profit (loss)............ 0.9% 3.2% 1.5% 1.9% 3.5%
73
MANAGEMENT'S DISCUSSION OF THE SUPPLEMENTAL INFORMATION
ON INSURANCE OPERATIONS (continued)
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
COMBINED STATEMENTS OF EARNINGS OF INSURANCE OPERATIONS
Years Ended December 31,
(Thousands of Dollars)
1996 1995 1994 1993 1992 1991 1990 1989 1988 1987
$731,823 $626,666 $ 625,023 $601,289 $525,495 $429,780 $401,077 $366,492 $304,469 $206,231
$711,570 $603,421 $ 589,197 $563,416 $508,847 $310,999 $219,936 $140,313 $124,923 $ 99,193
42,854 10,831 17,144 14,856 98,353 30,193 34,692 12,655 9,678 13,428
668,716 592,590 572,053 548,560 410,494 280,806 185,244 127,658 115,245 85,765
474,173 367,258 369,764 373,243 271,848 173,901 125,219 88,564 80,203 65,299
194,873 171,892 162,446 147,290 138,669 85,655 55,551 44,181 33,115 25,882
(15,809) (5,723) (5,420) 1,796 (21,462) (6,708) (4,571) (7,003) (4,801) (3,769)
653,237 533,427 526,790 522,329 389,055 252,848 176,199 125,742 108,517 87,412
15,479 59,163 45,263 26,231 21,439 27,958 9,045 1,916 6,728 (1,647)
76,978 71,007 63,119 52,868 39,685 32,661 25,978 21,256 15,999 10,896
9,666 19,246 18,315 16,486 13,734 11,165 10,074 8,095 4,592 3,021
- - - - - - - - - -
(7,863) 720 32,025 13,040 12,368 7,529 74 618 2,298 3,423
94,260 150,136 158,722 108,625 87,226 79,313 45,171 31,885 29,617 15,693
- - - - 43,168 - - - - -
94,260 150,136 158,722 108,625 130,394 79,313 45,171 31,885 29,617 15,693
19,717 39,686 44,830 28,788 38,414 24,099 12,757 9,919 7,780 2,987
74,543 110,450 113,892 79,837 91,980 55,214 32,414 21,966 21,837 12,706
- - - - - - - - - 2,908
- - - - - - - - - -
$ 74,543 $110,450 $ 113,892 $ 79,837 $ 91,980 $ 55,214 $ 32,414 $ 21,966 $ 21,837 $ 15,614
70.9% 62.0% 64.6% 68.0% 66.2% 61.9% 65.7% 68.0% 69.5% 79.4%
27.1 29.0 27.1 25.7 28.1 30.0 26.7 26.3 22.0 22.5
98.0% 91.0% 91.7% 93.7% 94.3% 91.9% 92.4% 94.3% 91.5% 101.9%
2.0% 9.0% 8.3% 6.3% 5.7% 8.1% 7.6% 5.7% 8.5% (1.9%)
74
ORGANIZATIONAL CHART
--------------------------
|The Commerce Group, Inc.|
|A Massachusetts Corp. |
--------------------------
|
|
-------------------------------------------------------------------
| | |
| | |
--------------------------- -------------------------- ------------------------------
|Bay Finance Company, Inc.| |Commerce Holdings, Inc. | |Clark-Prout Insurance Agency|
|A Massachusetts Corp. | |A Massachusetts Corp. | |A Massachusetts Corp. |
|A wholly-owned subsidiary| |A wholly-owned insurance| |A wholly-owned subsidiary |
--------------------------- |holding company | ------------------------------
--------------------------
|
|
---------------------------------------------------
| |
| |
-------------------------------- ----------------------------
|The Commerce Insurance Company| |Citation Insurance Company|
|A Massachusetts Corp. | |A Massachusetts Corp. |
|A wholly-owned subsidiary | |A wholly-owned subsidiary |
-------------------------------- ----------------------------
|
|
------------------------------------------
| |
-------------------------- ---------------------------------
|ACIC Holding, Inc. | |Commerce West Insurance Company|
|A Rhode Island Corp. | |A California Corp. |
|An 80% owned holding co.| |A wholly-owned subsidiary |
-------------------------- ---------------------------------
|
|
-------------------------------------
|American Commerce Insurance Company|
|An Ohio Corp. |
|A wholly-owned subsidiary |
-------------------------------------
75
THE COMMERCE GROUP, INC.
DIRECTORS
Herman F. Becker......................... President and owner, Sterling Realty and Huguenot
Development Corporation
Joseph A. Borski, Jr..................... Self-employed Certified Public Accountant
Eric G. Butler........................... Retired Vice President and General Claims Manager
of Commerce and Citation
Henry J. Camosse......................... Retired President, Henry Camosse & Sons Co., Inc.,
a building and masonry supplies company
Gerald Fels.............................. Executive Vice President and Chief Financial
Officer of the Company; President and Chief
Operating Officer of Commerce and Citation
David R. Grenon.......................... Retired CEO, President and Chairman Emeritus of
The Protector Group Insurance Agency, Inc.;
President E-C Realty Corporation
Robert W. Harris......................... Retired Treasurer, H.C. Bartlett Insurance Agency,
Inc.
Robert S. Howland........................ Retired Clerk, H.C. Bartlett Insurance Agency,
Inc.
John J. Kunkel........................... President and Treasurer, Kunkel Buick and GMC
Truck; Treasurer, Kunkel Bus Company
Raymond J. Lauring....................... Retired President, Lauring Construction Company
Normand R. Marois........................ Retired Chairman of the Board, Marois Bros., Inc.,
a contracting firm
Suryakant M. Patel....................... Retired physician who specialized in internal
medicine
Arthur J. Remillard, Jr.................. President, Chief Executive Officer and Chairman
of the Board of the Company
Arthur J. Remillard, III................. Senior Vice President and Assistant Clerk of
the Company; Senior Vice President of Commerce
and Citation in charge of Policyholder Benefits
Regan P. Remillard....................... Senior Vice President of the Company; President
and Secretary of Commerce West Insurance Company;
President of ACIC Holding Co., Inc.; President,
Vice Chairman of the Board and Chief Executive
Officer of American Commerce Insurance Company
Gurbachan Singh.......................... Retired physician who specialized in general
surgery
John W. Spillane......................... Clerk of the Company and practicing attorney
76
DIRECTORS OF
COMMERCE HOLDINGS, INC.
The Commerce Insurance Company
Commerce West Insurance Company
Citation Insurance Company
Arthur J. Remillard, Jr........... President and Chairman of the Board of Commerce
Holdings, Inc.; Chief Executive Officer and Chairman
of the Board of The Commerce Insurance Company, Inc.;
Chairman of the Board Commerce West Insurance Company
Gerald Fels....................... President, Chief Operating Officer and Chief
Financial Officer of The Commerce Insurance Company
and Citation Insurance Company; Treasurer, Commerce
Holdings, Inc.; Investment Officer of Commerce West
Insurance Company
Arthur J. Remillard, III (1)...... Senior Vice President and Clerk
Regan P. Remillard................ Senior Vice President; President and Secretary of
Commerce West Insurance Company
James A. Ermilio (1).............. Senior Vice President and General Counsel
David R. Grenon (1)............... Retired CEO, President and Chairman Emeritus of
The Protector Group Insurance Agency, Inc.;
President E-C Realty Corporation
John M. Nelson (1)................ Chairman of Commonwealth National Bank
Suryakant M. Patel (1)............ Retired physician who specialized in internal
medicine
William G. Pike (1)............... Executive Vice President and Chief Financial Officer
of Granite State Bankshares, Inc.
H. Thomas Rowles (1).............. Chairman of the Board of ACIC Holding Co., Inc.;
Chairman of the Board of American Commerce Insurance
Company; Director of AAA Southern New England
Mark A. Shaw (1).................. Treasurer of ACIC Holding Co., Inc.; President, Chief
Executive Officer and Director of AAA Southern New
England
(1) Commerce Holdings, Inc., The Commerce Insurance Company and Citation Insurance Company
only.
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DIRECTORS OF
ACIC Holding Co., Inc.(1)
American Commerce Insurance Company
H. Thomas Rowles.................. Chairman of the Board of ACIC Holding Co., Inc.;
Chairman of the Board of American Commerce Insurance
Company; Director of AAA Southern New England
Regan P. Remillard................ President of ACIC Holding Co., Inc.; President, Vice
Chairman of the Board and Chief Executive Officer of
American Commerce Insurance Company; Senior Vice
President of The Commerce Group, Inc.; President and
Secretary of Commerce West Insurance Company
Mark A. Shaw...................... Treasurer of ACIC Holding Co., Inc.; President,
Chief Executive Officer and Director of AAA Southern
New England
Gerald Fels....................... Executive Vice President and Chief Financial Officer
of The Commerce Group, Inc.
Patrick W. Doherty (2)............ President and Chief Executive Officer of AAA Oklahoma
Terry R. Farias (2)............... President and Chief Executive Officer of AAA Hoosier
Motor Club
Richard S. Hamilton (2)........... President of AAA West Pennsylvania/West
Virginia/South Central Ohio
Charles B. Liekweg (2)............ President and Chief Executive Officer of AAA
Washington
D. James McDowell (2)............. President and Chief Executive Officer of AAA Arizona
Peter C. Ohlheiser (2)............ President of Ohio Motorists Association
Otto T. Wright (2)................ President and Chief Executive Officer of East
Tennessee Automobile Club, Inc.
(1) Incorporated in November, 1998. 80% owned by The Commerce Insurance Company and 20%
owned by AAA Southern New England.
(2) American Commerce Insurance Company only, which was acquired in January 1999.
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DIRECTORS OF
BAY FINANCE COMPANY, INC.
Arthur J. Remillard, Jr.............. President and Chairman of the Board
Gerald Fels.......................... Executive Vice President and Chief Financial Officer
John W. Spillane..................... Clerk and Practicing Attorney
Arthur J. Remillard, III............. Senior Vice President and Assistant Clerk
Regan P. Remillard................... Senior Vice President
DIRECTORS OF
CLARK-PROUT INSURANCE AGENCY, INC.
Arthur J. Remillard, Jr.............. President and Chairman of the Board
Gerald Fels.......................... Executive Vice President and Chief Financial Officer
John W. Spillane..................... Clerk and Practicing Attorney
Arthur J. Remillard, III............. Senior Vice President and Assistant Clerk
Elizabeth M. Edwards................. Vice President
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THE COMMERCE GROUP, INC.
Commerce Holdings, Inc.
The Commerce Insurance Company
Commerce West Insurance Company
ACIC Holding Co., Inc. (1)
American Commerce Insurance Company (2)
Citation Insurance Company
Bay Finance Company, Inc.
Clark-Prout Insurance Agency, Inc.
OFFICERS OF THE COMMERCE GROUP, INC.
President, Chief Executive Officer and Chairman of the Board..... Arthur J. Remillard, Jr.
Executive Vice President and Chief Financial Officer............. Gerald Fels
Senior Vice President and Assistant Clerk........................ Arthur J. Remillard, III
Senior Vice President............................................ Regan P. Remillard
Senior Vice President and General Counsel........................ James A. Ermilio
Vice President................................................... Joseph J. Staffieri
Clerk............................................................ John W. Spillane
Treasurer and Chief Accounting Officer........................... Randall V. Becker
Vice President and Corporate Compliance Officer.................. Robert E. McKenna
Assistant Vice President and Assistant General Counsel........... Thomas D. Jungeberg
Assistant Treasurer.............................................. Thomas A. Gaylord
Officers of Massachusetts Subsidiaries (3)
Chief Executive Officer and Chairman of the Board................ Arthur J. Remillard, Jr.
President, Chief Operating Officer and Chief Financial Officer... Gerald Fels
Senior Vice President and Secretary.............................. Arthur J. Remillard, III
Senior Vice President and General Counsel........................ James A. Ermilio
Senior Vice Presidents........................................... David H. Cochrane
Peter J. Dignan
Regan P. Remillard
Joyce B. Virostek
Vice Presidents.................................................. Elizabeth M. Edwards
Karen A. Lussier
Robert E. McKenna
Michael J. Richards
Angelos Spetseris
Joseph J. Staffieri
Henry R. Whittier, Jr.
Assistant Vice President and Assistant General Counsel........... Thomas D. Jungeberg
Assistant Vice Presidents...................... David P. Antocci James E. Gow
Robert M. Blackmer Susan A. Horan
Stephen R. Clark John V. Kelly
Raymond J. DeSantis Donald G. MacLean
Warren S. Ehrlich Patrick J. McDonald
Richard W. Goodus Robert L. Mooney
Emile E. Riendeau
Treasurer and Chief Accounting Officer........................... Randall V. Becker
Assistant Treasurer.............................................. Thomas A. Gaylord
(1) Incorporated in November, 1998, the common stock of which is 80% owned by The Commerce
Insurance Company and 20% owned by AAA Southern New England.
(2) Acquired by ACIC Holding Co., Inc. in January, 1999.
(3) Massachusetts subsidiaries include Commerce Holdings, Inc., The Commerce Insurance Company,
Citation Insurance Company, Bay Finance Company, Inc. and Clark-Prout Insurance Agency.
Officers often hold positions with several operating subsidiaries. The titles listed
represent their primary office as of March 1, 2002.
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Officers of ACIC Holding Co., Inc.
Chairman of the Board................................................ H. Thomas Rowles
President............................................................ Regan P. Remillard
Treasurer............................................................ Mark A. Shaw
Secretary............................................................ James A. Ermilio
Officers of American Commerce Insurance Company
Chairman of the Board................................................ H. Thomas Rowles
President, Vice Chairman of the Board and Chief Executive Officer.... Regan P. Remillard
Senior Vice President and Chief Financial Officer.................... Michael V. Vrban
General Counsel and Secretary........................................ James A. Ermilio
Treasurer............................................................ Richard B. O'Hara
Vice President....................................................... Gregory S. Clark
Vice President....................................................... Joseph B. Phillips, Jr.
Assistant Vice President............................................. William J. Hafer
Assistant Vice President............................................. Jeffrey B. Alexander
Assistant General Counsel and Assistant Secretary.................... Thomas D. Jungeberg
Officers of Commerce West Insurance Company
Chairman of the Board................................................ Arthur J. Remillard, Jr.
President and Secretary.............................................. Regan P. Remillard
Treasurer and Chief Financial Officer ............................... Michael V. Vrban
Chief Accounting Officer............................................. Albert E. Peters
Investment Officer................................................... Gerald Fels
Vice Presidents...................................................... Michael J. Berryessa
Albert R. Harris
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Stockholder Information
Annual Meeting
The Annual meeting of stockholders will be held at 9:00 a.m. on Friday, May
17, 2002 at the Company's Underwriting Building, 11 Gore Road (Route 16),
Webster, MA.
Form 10-K
Stockholders interested in the detailed information contained in the
Company's annual report on Form 10-K, as filed with the Securities and
Exchange Commission, may obtain a copy without charge, by writing to the
Assistant to the President at 211 Main Street, Webster, MA 01570.
Transfer Agent
The Commerce Group, Inc.
c/o Equiserve Trust Company, N.A.
P.O. Box 43010
Providence, RI 02940-3010
(781) 575-3100 or (800) 733-5001
http://www.equiserve.com
Executive Offices
211 Main Street
Webster, MA 01570
(508) 943-9000
Company Websites
The Commerce Insurance Company http://www.commerceinsurance.com
American Commerce Insurance Company http://www.acilink.com
Bay Finance Company, Inc. http://www.bayfinance.com
Trading of Common Stock
The Company's Common Stock trades on the NYSE under the symbol "CGI".
Independent Auditors
Ernst & Young LLP
200 Clarendon Street
Boston, MA 02116
(617) 266-2000
http://www.ey.com
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