SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
Quarterly Report pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
for the Quarterly Period Ended September 30, 2008,
or
Transition
report pursuant to Section 13 or 15(d) Of the Exchange
Act
for the Transition Period from
to
No. 000-25425
(Commission File Number)
MERCER INSURANCE GROUP, INC.
(Exact name of Registrant as specified in its charter)
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PENNSYLVANIA
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23-2934601
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(State or other jurisdiction of incorporation or organization)
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(I.R.S. Employer Identification No.)
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10 North Highway 31, P.O. Box 278, Pennington, NJ
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08534
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(Address of principal executive offices)
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(Zip Code)
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(Registrants telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act during the preceding 12 months (or for such
shorter period that the Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes
þ
No
o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer,
a non-accelerated filer, or a smaller reporting company.
See the definitions of large
accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
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Large accelerated filer
þ
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Accelerated filer
o
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Non-accelerated filer
o
(Do not check if a smaller reporting company)
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Smaller Reporting Company
o
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Indicate by check mark if the Registrant is a shell company (as defined in Rule 12b-2 of the Act).
Yes
o
No
þ
Indicate the number of shares outstanding of each of the issuers classes of common stock, as of
the latest practicable date.
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Number of Shares Outstanding as of October 31, 2008
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COMMON STOCK (No Par Value)
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6,453,560
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(Title of Class)
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(Outstanding Shares)
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TABLE OF CONTENTS
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Exhibit No.
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Title
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3.1
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Articles of Incorporation of Mercer Insurance Group, Inc. (incorporated by reference herein to the
Companys Pre-effective Amendment No. 3 on Form S-1, SEC File No. 333-104897.)
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3.2
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Bylaws of Mercer Insurance Group, Inc. (incorporated by reference herein to the Companys Annual Report
on Form 10-K, SEC File No. 000-25425, for the fiscal year ended December 31, 2003.)
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31.1
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Certification of Chief Executive Officer in accordance with Section 302 of the Sarbanes-Oxley Act of 2002
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31.2
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Certification of Chief Financial Officer in accordance with Section 302 of the Sarbanes-Oxley Act of 2002
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32.1
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Certification of Chief Executive Officer in accordance with Section 906 of the Sarbanes-Oxley Act of 2002
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32.2
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Certification of Chief Financial Officer in accordance with Section 906 of the Sarbanes-Oxley Act of 2002
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2
Forward-looking Statements
Mercer Insurance Group, Inc. (the Group) may from time to time make written or oral
forward-looking statements, including statements contained in the Groups filings with the
Securities and Exchange Commission (including this Quarterly Report on Form 10-Q and the exhibits
hereto and thereto), in its reports to shareholders and in other communications by the Group, which
are made in good faith by the Group pursuant to the safe harbor provisions of the Private
Securities Litigation Reform Act of 1995.
These forward-looking statements include statements with respect to the Groups beliefs,
plans, objectives, goals, expectations, anticipations, estimates and intentions, that are subject
to significant risks and uncertainties, and are subject to change based on various factors (some of
which are beyond the Groups control). The words may, could, should, would, believe,
anticipate, estimate, expect, intend, plan and similar expressions are intended to
identify forward-looking statements. The following factors, among others, could cause the Groups
financial performance to differ materially from the plans, objectives, expectations, estimates and
intentions expressed in such forward-looking statements:
future economic conditions in the regional and national markets in which the Group competes which
are less favorable than expected;
the effects of weather-related and other catastrophic events;
the concentration of insured accounts in California, New Jersey and Pennsylvania;
the effect of legislative, judicial, economic, demographic and regulatory events in the seven
states in which we do the majority of our business as of September 30, 2008;
the continuation of an A.M. Best rating in the Excellent category;
the ability to enter new markets successfully and capitalize on growth opportunities either
through acquisitions or the expansion of our producer network;
the ability to obtain regulatory approval for an acquisition, to close the transaction, and
to successfully integrate an acquisition and its operations;
financial market conditions, including, but not limited to, changes in interest rates and the
stock markets causing a reduction of investment income or investment gains, an acceleration
of the amortization of deferred policy acquisition costs, reduction in the value of our
investment portfolio or a reduction in the demand for our products;
the impact of acts of terrorism and acts of war;
the effects of terrorist related insurance legislation and laws;
inflation;
the cost, availability and collectibility of reinsurance;
estimates and adequacy of loss reserves and trends in losses and loss adjustment expenses;
heightened competition, including specifically the intensification of price competition, the
entry of new competitors and the development of new products by new and existing
competitors;
changes in the coverage terms selected by insurance customers, including higher deductibles and
lower limits;
our inability to obtain regulatory approval of, or to implement, premium rate increases;
the potential impact on our reported net income that could result from the adoption of future
accounting standards issued by the Financial Accounting Standards Board or other
standard-setting bodies;
3
the inability to carry out marketing and sales plans, including, among others, development of
new products or changes to existing products and acceptance of the new or revised products
in the market;
unanticipated changes in industry trends and ratings assigned by nationally recognized rating
organizations;
adverse litigation or arbitration results;
the ability to carry out our business plans; or
adverse changes in applicable laws, regulations or rules governing insurance holding companies
and insurance companies, and environmental, tax or accounting matters including limitations
on premium levels, increases in minimum capital and reserves, and other financial viability
requirements, and changes that affect the cost of, or demand for our products.
disruption in world financial markets, which could adversely affect demand for the Companys
products, and credit risk associated with agents, customers, and reinsurers, as well as
adversely affecting the Companys investment portfolio value and investment income.
Disrupted markets could present difficulty if the Company needed to raise additional capital
in the future.
The Group cautions that the foregoing list of important factors is not exclusive. Readers are
also cautioned not to place undue reliance on these forward-looking statements, which reflect
managements analysis only as of the date of this report. The Group does not undertake to update
any forward-looking statement, whether written or oral, that may be made from time to time by or on
behalf of the Group.
4
Part I FINANCIAL INFORMATION
Item 1. Financial Statements
MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
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September 30,
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December 31,
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2008
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2007
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(Dollars in thousands)
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(Unaudited)
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Assets
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Investments:
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Fixed-income securities, available for sale, at fair value
(cost $333,628 and $321,978, respectively)
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$
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328,548
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324,238
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Equity securities, at fair value (cost $12,351 and $12,500,
respectively)
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14,730
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17,930
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Short-term investments, at cost, which approximates fair value
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9,998
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Total investments
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353,276
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342,168
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Cash and cash equivalents
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14,690
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21,580
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Premiums receivable
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39,431
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36,339
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Reinsurance receivables
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89,104
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83,844
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Prepaid reinsurance premiums
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7,460
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9,486
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Deferred policy acquisition costs
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21,202
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20,528
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Accrued investment income
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3,639
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3,582
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Property and equipment, net
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15,357
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13,056
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Deferred income taxes
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11,581
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7,670
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Goodwill
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5,416
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5,416
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Other assets
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3,286
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2,766
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Total assets
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$
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564,442
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546,435
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Liabilities and Equity
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Liabilities:
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Losses and loss adjustment expenses
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$
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298,991
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274,399
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Unearned premiums
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86,271
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88,024
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Accounts payable and accrued expenses
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13,549
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14,622
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Other reinsurance balances
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11,824
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14,734
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Trust preferred securities
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15,571
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15,559
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Advances under line of credit
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3,000
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3,000
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Other liabilities
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2,283
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2,691
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Total liabilities
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431,489
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413,029
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Stockholders Equity:
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Preferred stock, no par value, authorized 5,000,000 shares, no
shares issued and outstanding
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Common stock, no par value, authorized 15,000,000 shares,
issued 7,075,333 shares, outstanding
6,782,691 and 6,717,693 shares, respectively
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Additional paid-in capital
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71,163
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70,394
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Accumulated other comprehensive (loss)/income
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(2,073
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)
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4,896
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Retained earnings
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73,969
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67,613
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Unearned ESOP shares
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(2,662
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)
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(3,131
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)
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Treasury stock, 567,158 and 505,814 shares
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(7,444
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)
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(6,366
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)
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Total stockholders equity
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132,953
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133,406
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Total liabilities and stockholders equity
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$
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564,442
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546,435
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See accompanying notes to consolidated financial statements.
5
MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
Nine Months Ended September 30, 2008 and 2007
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2008
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2007
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(Dollars in thousands, except per share data)
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(Unaudited)
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Revenues:
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Net premiums earned
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$
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115,590
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106,367
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Investment income, net of expenses
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10,173
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9,592
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Net realized investment (losses)/gains
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(2,944
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)
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267
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Other revenue
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1,555
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1,494
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Total revenues
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124,374
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117,720
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Expenses:
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Losses and loss adjustment expenses
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71,564
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65,398
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Amortization of deferred policy acquisition costs (related party
amounts of $805 and $865, respectively)
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31,163
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27,829
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Other expenses
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10,618
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7,530
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Interest expense
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961
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911
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Total expenses
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114,306
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101,668
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Income before income taxes
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10,068
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16,052
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Income taxes
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2,463
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4,697
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Net income
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$
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7,605
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11,355
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Earnings per common share:
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Basic
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$
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1.22
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1.85
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Diluted
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$
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1.19
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1.80
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Weighted average shares:
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Basic
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6,230,476
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6,125,654
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Diluted
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6,382,740
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6,318,029
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See accompanying notes to consolidated financial statements.
6
MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
Three Months Ended September 30, 2008 and 2007
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2008
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2007
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(Dollars in thousands, except per share data)
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(Unaudited)
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Revenues:
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Net premiums earned
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$
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37,869
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37,303
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Investment income, net of expenses
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3,469
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2,880
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Net realized investment losses
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(2,281
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)
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(366
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)
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Other revenue
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536
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587
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Total revenues
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39,593
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40,404
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Expenses:
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Losses and loss adjustment expenses
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22,819
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22,768
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Amortization
of deferred policy acquisition costs (related party amounts of $263 and $287, respectively)
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10,460
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9,870
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Other expenses
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3,776
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3,315
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Interest expense
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328
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300
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Total expenses
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37,383
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36,253
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Income before income taxes
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2,210
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4,151
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Income taxes
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430
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1,139
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Net income
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$
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1,780
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|
|
|
3,012
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Earnings per common share:
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Basic
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$
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0.29
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0.49
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Diluted
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$
|
0.28
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0.47
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Weighted average shares:
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Basic
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6,237,804
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6,174,842
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Diluted
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6,382,413
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6,345,865
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See accompanying notes to consolidated financial statements.
7
MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS EQUITY
Nine Months Ended September 30, 2008
(Unaudited, dollars in thousands)
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|
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|
|
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|
|
|
|
|
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|
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|
|
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|
|
|
|
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|
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Accumulated
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|
|
|
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|
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Additional
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|
other
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Unearned
|
|
|
|
|
|
|
|
|
|
Preferred
|
|
|
Common
|
|
|
paid-in
|
|
|
comprehensive
|
|
|
Retained
|
|
|
ESOP
|
|
|
Treasury
|
|
|
|
|
|
|
stock
|
|
|
stock
|
|
|
capital
|
|
|
income/(loss)
|
|
|
earnings
|
|
|
shares
|
|
|
stock
|
|
|
Total
|
|
Balance, December 31, 2007
|
|
$
|
|
|
|
|
|
|
|
|
70,394
|
|
|
|
4,896
|
|
|
|
67,613
|
|
|
|
(3,131
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)
|
|
|
(6,366
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)
|
|
|
133,406
|
|
Net income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
7,605
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|
|
|
|
|
|
|
|
|
|
|
7,605
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|
Unrealized losses on
securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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Unrealized holding losses arising
during period, net of related
income tax benefit of $4,465
|
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|
|
|
|
|
|
|
|
|
|
|
|
(8,667
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)
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
(8,667
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)
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Less reclassification adjustment for
losses included in net income, net
of related income tax benefit
of $932
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,809
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,809
|
|
Defined benefit pension plan, net of
related income tax benefit of $57
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(111
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(111
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)
|
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|
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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Other comprehensive loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(6,969
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
636
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock compensation plan
amortization
|
|
|
|
|
|
|
|
|
|
|
390
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
390
|
|
Tax benefit from stock
compensation plan
|
|
|
|
|
|
|
|
|
|
|
40
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
40
|
|
ESOP shares committed
|
|
|
|
|
|
|
|
|
|
|
339
|
|
|
|
|
|
|
|
|
|
|
|
469
|
|
|
|
|
|
|
|
808
|
|
Purchase of treasury stock
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1,078
|
)
|
|
|
(1,078
|
)
|
Dividends to stockholders
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1,249
|
)
|
|
|
|
|
|
|
|
|
|
|
(1,249
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, September 30,
2008
|
|
$
|
|
|
|
|
|
|
|
|
71,163
|
|
|
|
(2,073
|
)
|
|
|
73,969
|
|
|
|
(2,662
|
)
|
|
|
(7,444
|
)
|
|
|
132,953
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes to consolidated financial statements.
8
MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended September 30, 2008 and 2007
|
|
|
|
|
|
|
|
|
|
|
2008
|
|
|
2007
|
|
|
|
(Dollars in thousands)
|
|
|
|
(Unaudited)
|
|
Cash flows from operating activities:
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
7,605
|
|
|
|
11,355
|
|
Adjustments to reconcile net income to net cash provided by
operating activities:
|
|
|
|
|
|
|
|
|
Depreciation and amortization of fixed assets
|
|
|
1,760
|
|
|
|
1,605
|
|
Net amortization of premium
|
|
|
1,123
|
|
|
|
938
|
|
Amortization of stock compensation
|
|
|
390
|
|
|
|
876
|
|
ESOP share commitment
|
|
|
808
|
|
|
|
892
|
|
Net realized investment losses/(gains)
|
|
|
2,944
|
|
|
|
(267
|
)
|
Deferred income tax
|
|
|
(321
|
)
|
|
|
(655
|
)
|
Change in assets and liabilities:
|
|
|
|
|
|
|
|
|
Premiums receivable
|
|
|
(3,092
|
)
|
|
|
(5,672
|
)
|
Reinsurance receivables
|
|
|
(5,260
|
)
|
|
|
(5,230
|
)
|
Prepaid reinsurance premiums
|
|
|
2,026
|
|
|
|
6,448
|
|
Deferred policy acquisition costs
|
|
|
(674
|
)
|
|
|
(4,765
|
)
|
Other assets
|
|
|
(784
|
)
|
|
|
(424
|
)
|
Losses and loss adjustment expenses
|
|
|
24,592
|
|
|
|
20,551
|
|
Unearned premiums
|
|
|
(1,753
|
)
|
|
|
10,302
|
|
Other reinsurance balances
|
|
|
(2,910
|
)
|
|
|
(6,084
|
)
|
Other
|
|
|
(1,081
|
)
|
|
|
4,383
|
|
|
|
|
|
|
|
|
Net cash provided by operating activities
|
|
|
25,373
|
|
|
|
34,253
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from investing activities:
|
|
|
|
|
|
|
|
|
Purchase of fixed income securities, available for sale
|
|
|
(50,816
|
)
|
|
|
(54,057
|
)
|
Purchase of equity securities
|
|
|
(2,904
|
)
|
|
|
(2,471
|
)
|
(Purchase)/sale of short-term investments, net
|
|
|
(9,998
|
)
|
|
|
1,949
|
|
Sale and maturity of fixed income securities, available for sale
|
|
|
34,819
|
|
|
|
17,505
|
|
Sale of equity securities
|
|
|
2,981
|
|
|
|
2,777
|
|
Purchase of property and equipment, net
|
|
|
(4,058
|
)
|
|
|
(1,822
|
)
|
|
|
|
|
|
|
|
Net cash used in investing activities
|
|
|
(29,976
|
)
|
|
|
(36,119
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from financing activities:
|
|
|
|
|
|
|
|
|
Purchase of treasury stock
|
|
|
(1,078
|
)
|
|
|
(40
|
)
|
Tax benefit from stock compensation plans
|
|
|
40
|
|
|
|
153
|
|
Proceeds from issuance of common stock
|
|
|
|
|
|
|
40
|
|
Dividends to stockholders
|
|
|
(1,249
|
)
|
|
|
(942
|
)
|
|
|
|
|
|
|
|
Net cash used in financing activities
|
|
|
(2,287
|
)
|
|
|
(789
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net decrease in cash and cash equivalents
|
|
|
(6,890
|
)
|
|
|
(2,655
|
)
|
Cash and cash equivalents at beginning of period
|
|
|
21,580
|
|
|
|
17,618
|
|
|
|
|
|
|
|
|
Cash and cash equivalents at end of period
|
|
$
|
14,690
|
|
|
|
14,963
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash paid during the period for:
|
|
|
|
|
|
|
|
|
Interest
|
|
$
|
934
|
|
|
|
902
|
|
Income taxes
|
|
$
|
2,758
|
|
|
|
4,750
|
|
See accompanying notes to consolidated financial statements.
9
MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(1)
Basis of Presentation
The financial information for the interim periods included herein is unaudited; however, such
information reflects all adjustments which are, in the opinion of management, necessary to a fair
presentation of the financial position, results of operations, and cash flows for the interim
periods. The results of operations for interim periods are not necessarily indicative of results to
be expected for the full year.
Mercer Insurance Group, Inc. (MIG) and subsidiaries (collectively, the Group) includes Mercer
Insurance Company (MIC), its subsidiaries Queenstown Holding Company, Inc. (QHC) and its subsidiary
Mercer Insurance Company of New Jersey, Inc. (MICNJ), Franklin Holding Company, Inc. (FHC) and its
subsidiary Franklin Insurance Company (FIC), and BICUS Services Corporation (BICUS). On October 1,
2005, MIG acquired Financial Pacific Insurance Group, Inc. (FPIG) and its subsidiaries Financial
Pacific Insurance Company (FPIC) and Financial Pacific Insurance Agency (FPIA), which is currently
inactive after having sold the opportunity to solicit renewals to an unrelated agency for a fixed
commission for one year, commencing in October, 2006. FPIG also holds an interest in three
statutory business trusts that were formed for the purpose of issuing Floating Rate Capital
Securities.
The Group, through its property and casualty insurance subsidiaries, provides a wide array of
property and casualty insurance products designed to meet the insurance needs of individuals in New
Jersey and Pennsylvania, and small and medium-sized businesses throughout Arizona, California,
Nevada, New Jersey, New York, Oregon and Pennsylvania.
These consolidated financial statements should be read in conjunction with the consolidated
financial statements and notes for the year ended December 31, 2007 included in the Groups Annual
Report on Form 10-K filed with the Securities and Exchange Commission.
Share-Based Compensation
The Group makes grants of qualified (ISOs) and non-qualified stock options (NQOs), and
non-vested shares (restricted stock) under its stock incentive plan. Stock options are granted at
prices that are not less than market price at the date of grant, and are exercisable over a period
of ten years for ISOs and ten years and one month for NQOs. Restricted stock grants vest over a
period of three or five years.
The Group applies the fair value recognition provisions of Statement of Financial Accounting
Standards (SFAS) No. 123R, Share-Based Payment, using the modified-prospective-transition method.
The after-tax compensation expense recorded in the consolidated statements of earnings for stock
options (net of forfeitures) for the nine months ended September 30, 2008 and 2007 was $163,000 and
$366,000, respectively. The after-tax compensation expense recorded in the consolidated statements
of earnings for restricted stock (net of forfeitures) for the nine months ended September 30, 2008
and 2007 was $142,000 and $277,000, respectively. The after-tax compensation expense recorded in
the consolidated statements of earnings for stock options (net of forfeitures) for the three months
ended September 30, 2008 and 2007 was $55,000 and $54,000, respectively. The after-tax
compensation expense recorded in the consolidated statements of earnings for restricted stock (net
of forfeitures) for the three months ended September 30, 2008 and 2007 was $48,000 and $47,000,
respectively.
As of September 30, 2008, the Group has $0.6 million of unrecognized total compensation cost
related to non-vested stock options and restricted stock. That cost will be recognized over the
remaining weighted-average vesting period of 1.5 years, based on the estimated grant date fair
value.
For the nine months ended September 30, 2008, the Group made no grants of restricted stock and
stock options. In addition, there were no forfeitures of restricted stock and stock options and no
options exercised during the first nine months of 2008.
Fair Value Measurements
In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of
Financial Accounting Standards (SFAS) No. 157,
Fair Value Measurements
(SFAS 157). SFAS 157
defines fair value, establishes a framework for measuring fair
10
value and expands disclosure about fair value measurements. It applies to other pronouncements
that require or permit fair value but does not require any new fair value measurements. The
statement defines fair value as the price that would be received to sell an asset or paid to
transfer a liability in an orderly transaction between market participants at the measurement
date.
SFAS 157 establishes a fair value hierarchy to increase consistency and comparability in fair
value measurements and disclosures. The hierarchy is based on the inputs used in valuation and
gives the highest priority to quoted prices in active markets. The highest possible level should be
used to measure fair value. SFAS 157 is effective for fiscal years beginning after November 15,
2007.
In February 2008, the FASB issued FSP SFAS 157-2,
Effective Date of FASB Statement No. 157
(FSP SFAS 157-2), which delays the effective date of SFAS 157 for all non-financial assets and
non-financial liabilities until January, 2009, except those that are recognized or disclosed at
fair value in the financial statements on a recurring basis (at least annually).
The Group adopted SFAS 157 and FSP SFAS 157-2 effective January 1, 2008. Accordingly, the
provisions of SFAS 157 were not applied to goodwill and other intangible assets held by the Group
and measured annually for impairment testing purposes only. The adoption of SFAS 157, for all other
assets and liabilities held by the Group, did not have a material effect on the Groups results of
operations, financial position or liquidity. The Group will adopt SFAS 157 for non-financial assets
and non-financial liabilities on January 1, 2009 and does not expect the provisions to have a
material effect on its results of operations, financial position or liquidity.
In October 2008, the FASB issued FSP SFAS 157-3,
Determining the Fair Value of a Financial
Asset When the Market For That Asset Is Not Active
(FSP SFAS 157-3), with an immediate effective
date, including prior periods for which financial statements have not been issued. FSP SFAS 157-3
amends SFAS 157 to clarify the application of fair value in inactive markets and allows for the use
of managements internal assumptions about future cash flows with appropriately risk-adjusted
discount rates when relevant observable market data does not exist. The objective of SFAS 157 has
not changed and continues to be the determination of the price that would be received in an orderly
transaction between market participants that is not a forced liquidation or distressed sale at the
measurement date. The adoption of FSP SFAS 157-3 in the third quarter did not have a material
effect on the Groups results of operations, financial position or liquidity.
Fair Value Option for Financial Assets and Financial Liabilities
In February 2007, the FASB issued SFAS No. 159,
The Fair Value Option for Financial Assets and
Financial Liabilities
Including an Amendment of FASB Statement No. 115
(SFAS 159). SFAS 159
permits an entity to irrevocably elect fair value on a contract-by-contract basis for new assets or
liabilities within the scope as the initial and subsequent measurement attribute for those
financial assets and liabilities and certain other items including property and casualty insurance
contracts. Entities electing the fair value option would be required to recognize changes in fair
value in earnings and to expense up-front costs and fees associated with the item for which the
fair value option is elected. Entities electing the fair value option are required to distinguish
on the face of the statement of financial position the fair value of assets and liabilities for
which the fair value option has been elected, and similar assets and liabilities measured using
another measurement attribute. An entity can accomplish this by either reporting the fair value and
non-fair-value carrying amounts as separate line items or aggregating those amounts and disclosing
parenthetically the amount of fair value included in the aggregate amount. The Group adopted SFAS
159 effective January 1, 2008 and the adoption did not have a material effect on the Groups
results of operations, financial position or liquidity. The Group did not elect to measure at fair
value any assets or liabilities that were not otherwise already carried at fair value in accordance
with other accounting pronouncements.
New Accounting Pronouncements
In May 2008, the FASB issued SFAS No. 162,
The Hierarchy of Generally Accepted Accounting
Principles
(SFAS 162) to identify the sources of accounting principles and provide a framework for
selecting the principles to be used in the preparation of financial statements in accordance with
generally accepted accounting principles in the United States. The hierarchy of authoritative
accounting guidance is not expected to change current practice but is expected to facilitate the
FASBs plan to designate as authoritative its forthcoming codification of accounting standards.
This Statement is effective November 15, 2008. The Group does not anticipate any significant
financial statement impact resulting from its adoption of SFAS 162.
In June 2008, the FASB issued FASB Staff Position (FSP) No. EITF 03-6-1,
Determining Whether
Instruments Granted in Share-Based Payment Transactions are Participating Securities (FSP 03-6-1)
.
FSP 03-6-1 addresses the treatment of unvested share-based payment awards containing nonforfeitable
rights to dividends or dividend equivalents in the calculation of earnings per share
11
and is effective for financial statements issued for fiscal years beginning after December 15,
2008, and interim periods within those years. The Group is currently evaluating the impact of FSP
03-6-1 on the calculation of earnings per share.
In June 2007, the Emerging Issues Task Force (EITF) of FASB issued EITF Issue No. 06-11
Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards
(EITF 06-11). EITF
06-11 requires that the tax benefit from dividends or dividend equivalents that are charged to
retained earnings and are paid to employees for equity classified nonvested equity shares,
nonvested equity share units, and outstanding equity share options be recognized as an increase to
additional paid-in capital. EITF 06-11, was effective on a prospective basis beginning with
dividends declared in fiscal years beginning after December 15, 2007, and the Group adopted it in
the first quarter of 2008. The adoption of EITF 06-11 did not have a material impact on the
Groups results of operations or financial condition.
(2)
Segment Information
The Group markets its products through independent insurance agents, which sell commercial
lines of insurance primarily to small to medium-sized businesses and personal lines of insurance to
individuals.
The Group manages its business in three segments: commercial lines insurance (including
surety), personal lines insurance, and investments. The commercial lines insurance and personal
lines insurance segments are managed based on underwriting results determined in accordance with
U.S. generally accepted accounting principles, and the investment segment is managed based on
after-tax investment returns.
Underwriting results for commercial lines and personal lines take into account premiums
earned, incurred losses and loss adjustment expenses, and underwriting expenses. The investments
segment is evaluated by consideration of net investment income (investment income less investment
expenses) and realized gains and losses.
In determining the results of each segment, assets are not allocated to segments and are
reviewed in the aggregate for decision-making purposes.
During 2007, the Group evaluated its methodology for allocating costs to its lines of business
and adopted changes to such methodology in order to more accurately reflect the allocation of joint
costs. This resulted in allocating less joint cost to the personal lines of business and more
joint cost to the commercial lines of business, but with no net change in cost allocated to
personal lines and commercial lines in the aggregate. Previously reported 2007 amounts have been
reclassified below to reflect this change in allocation methodology.
Financial data by segment is as follows:
12
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
|
|
2008
|
|
|
2007
|
|
|
|
(In thousands)
|
|
Revenues:
|
|
|
|
|
|
|
|
|
Net premiums earned:
|
|
|
|
|
|
|
|
|
Commercial lines
|
|
$
|
100,496
|
|
|
$
|
90,287
|
|
Personal lines
|
|
|
15,094
|
|
|
|
16,080
|
|
|
|
|
|
|
|
|
Total net premiums earned
|
|
|
115,590
|
|
|
|
106,367
|
|
Net investment income
|
|
|
10,173
|
|
|
|
9,592
|
|
Net realized investment (losses)/gains
|
|
|
(2,944
|
)
|
|
|
267
|
|
Other revenue
|
|
|
1,555
|
|
|
|
1,494
|
|
|
|
|
|
|
|
|
Total revenues
|
|
$
|
124,374
|
|
|
$
|
117,720
|
|
|
|
|
|
|
|
|
Income before income taxes:
|
|
|
|
|
|
|
|
|
Underwriting income (loss):
|
|
|
|
|
|
|
|
|
Commercial lines
|
|
$
|
2,981
|
|
|
$
|
5,416
|
|
Personal lines
|
|
|
(736
|
)
|
|
|
194
|
|
|
|
|
|
|
|
|
Total underwriting income
|
|
|
2,245
|
|
|
|
5,610
|
|
Net investment income
|
|
|
10,173
|
|
|
|
9,592
|
|
Net realized investment (losses)/gains
|
|
|
(2,944
|
)
|
|
|
267
|
|
Other
|
|
|
594
|
|
|
|
583
|
|
|
|
|
|
|
|
|
Income before income taxes
|
|
$
|
10,068
|
|
|
$
|
16,052
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
|
|
2008
|
|
|
2007
|
|
|
|
(In thousands)
|
|
Revenues:
|
|
|
|
|
|
|
|
|
Net premiums earned:
|
|
|
|
|
|
|
|
|
Commercial lines
|
|
$
|
32,807
|
|
|
$
|
31,975
|
|
Personal lines
|
|
|
5,062
|
|
|
|
5,328
|
|
|
|
|
|
|
|
|
Total net premiums earned
|
|
|
37,869
|
|
|
|
37,303
|
|
|
|
|
|
|
|
|
Net investment income
|
|
|
3,469
|
|
|
|
2,880
|
|
Net realized investment losses
|
|
|
(2,281
|
)
|
|
|
(366
|
)
|
Other revenue
|
|
|
536
|
|
|
|
587
|
|
|
|
|
|
|
|
|
Total revenues
|
|
$
|
39,593
|
|
|
$
|
40,404
|
|
|
|
|
|
|
|
|
Income before income taxes:
|
|
|
|
|
|
|
|
|
Underwriting income:
|
|
|
|
|
|
|
|
|
Commercial lines
|
|
$
|
741
|
|
|
$
|
1,207
|
|
Personal lines
|
|
|
73
|
|
|
|
143
|
|
|
|
|
|
|
|
|
Total underwriting income
|
|
|
814
|
|
|
|
1,350
|
|
Net investment income
|
|
|
3,469
|
|
|
|
2,880
|
|
Net realized investment losses
|
|
|
(2,281
|
)
|
|
|
(366
|
)
|
Other
|
|
|
208
|
|
|
|
287
|
|
|
|
|
|
|
|
|
Income before income taxes
|
|
$
|
2,210
|
|
|
$
|
4,151
|
|
|
|
|
|
|
|
|
13
(3)
Reinsurance
Premiums earned are net of amounts ceded of $16.5 million and $24.9 million for the nine
months ended September 30, 2008 and 2007, respectively and $5.5 million and $7.4 million for the
three months ended September 30, 2008 and 2007, respectively. Losses and loss adjustment expenses
are net of amounts ceded of $14.9 million and $16.2 million for the nine months ended September 30,
2008 and 2007, respectively and $4.3 million and $2.8 million for the three months ended September
30, 2008 and 2007, respectively.
Effective January 1, 2008, the Group renewed its reinsurance coverages with a number of
changes. The retention on any individual property or casualty risk was increased to $850,000 from
$750,000. Pollution coverage written by FPIC is now fully retained with a standard sub-limit of
$150,000 (and up to $300,000 on an exception basis). Prior to 2008, FPIC reinsured 100% of its
pollution coverage, which for the twelve months ended December 31, 2007 represented $1.8 million of
ceded written premium. The Group also purchased an additional $1.0 million of surety coverage
(subject to a 10% retention) which resulted in an increased reinsurance coverage to $4.5 million
from $3.5 million per principal and a maximum retention of $900,000 per principal as compared to
the previous $800,000.
In conjunction with the renewal of the reinsurance program for both 2008 and 2007, the prior
year reinsurance treaties were terminated on a run-off basis, which requires that for policies in
force as of December 31, 2007 and 2006, respectively, these reinsurance agreements continue to
cover losses occurring on these policies in the future. Therefore, the Group will continue to
remit premiums to and collect reinsurance recoverables from the reinsurers on these prior year
treaties as the underlying business runs off.
(4)
Comprehensive Income / (Loss)
The Groups comprehensive income for the nine and three month period ended September 30, 2008
and 2007 is as follows:
|
|
|
|
|
|
|
|
|
|
|
Nine months ended
|
|
|
|
September 30,
|
|
|
|
2008
|
|
|
2007
|
|
|
|
(In thousands)
|
|
Net income
|
|
$
|
7,605
|
|
|
$
|
11,355
|
|
Other comprehensive (loss)/income, net of tax:
|
|
|
|
|
|
|
|
|
Unrealized gains/(losses) on securities:
|
|
|
|
|
|
|
|
|
Unrealized holding (losses)/gains arising during period, net of related income tax
(benefit)/expense of $(4,465) and $462, respectively
|
|
|
(8,667
|
)
|
|
|
897
|
|
Less reclassification adjustment for losses/(gains) included in net income, net of related
income tax (benefit)/expense of $(932) and $161, respectively
|
|
|
1,809
|
|
|
|
(312
|
)
|
Defined benefit pension plan, net of related income tax benefit of $57
|
|
|
(111
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(6,969
|
)
|
|
|
585
|
|
|
|
|
|
|
|
|
Comprehensive income
|
|
$
|
636
|
|
|
$
|
11,940
|
|
|
|
|
|
|
|
|
14
|
|
|
|
|
|
|
|
|
|
|
Three months ended
|
|
|
|
September 30,
|
|
|
|
2008
|
|
|
2007
|
|
|
|
(In thousands)
|
|
Net income
|
|
$
|
1,780
|
|
|
$
|
3,012
|
|
Other comprehensive (loss)/income, net of tax:
|
|
|
|
|
|
|
|
|
Unrealized gains/(losses) on securities:
|
|
|
|
|
|
|
|
|
Unrealized holding (losses)/gains arising during period, net of related income tax
(benefit)/expense of $(2,741) and $1,461, respectively
|
|
|
(5,321
|
)
|
|
|
2,836
|
|
Less reclassification adjustment for losses/(gains) included in net income, net of related
income tax (benefit)/expense of $(722) and $44, respectively
|
|
|
1,404
|
|
|
|
(85
|
)
|
Defined benefit pension plan, net of related income tax benefit of $19
|
|
|
(37
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(3,954
|
)
|
|
|
2,751
|
|
|
|
|
|
|
|
|
Comprehensive (loss)/income
|
|
$
|
(2,174
|
)
|
|
$
|
5,763
|
|
|
|
|
|
|
|
|
(5)
Share-based Compensation
The Group adopted the Mercer Insurance Group, Inc. 2004 Stock Incentive Plan (the Plan) on
June 16, 2004. Awards under the Plan may be made in the form of incentive stock options,
nonqualified stock options, restricted stock or any combination to employees and non-employee
Directors. At adoption, the Plan initially limited to 250,000 the number of shares that may be
awarded as restricted stock, and to 500,000 the number of shares for which incentive stock options
may be granted. The total number of shares initially authorized in the Plan was 876,555 shares,
with an annual increase equal to 1% of the shares outstanding at the end of each year. As of
September 30, 2008, the Plans authorization has been increased under this feature to 1,141,565
shares. The Plan provides that stock options and restricted stock awards may include vesting
restrictions and performance criteria at the discretion of the Compensation Committee of the Board
of Directors. The term of options may not exceed ten years for incentive stock options, and ten
years and one month for nonqualified stock options, and the option price may not be less than fair
market value on the date of grant. The grants made under the plan employ graded vesting over
vesting periods of 3 or 5 years for restricted stock, incentive stock options, and nonqualified
stock option grants, and include only service conditions. Upon exercise, it is anticipated that
newly issued shares will be issued to the option holder.
For the nine months ended September 30, 2008, the Group made no grants of restricted stock and
stock options. In addition, there were no forfeitures of restricted stock and stock options and no
options exercised during the first nine months of 2008.
Information regarding stock option activity in the Groups Plan is presented below:
15
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted Average
|
|
|
|
Number of
|
|
|
Exercise Price
|
|
|
|
Shares
|
|
|
per Share
|
|
Outstanding at December 31, 2007
|
|
|
603,200
|
|
|
$
|
13.24
|
|
Granted - 2008
|
|
|
|
|
|
|
|
|
Exercised - 2008
|
|
|
|
|
|
|
|
|
Forfeited - 2008
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at September 30, 2008
|
|
|
603,200
|
|
|
$
|
13.24
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at:
|
|
|
|
|
|
|
|
|
September 30, 2008
|
|
|
522,533
|
|
|
$
|
12.56
|
|
Weighted-average remaining contractual life
|
|
|
|
|
|
5.9 years
|
Compensation remaining to be recognized for unvested
stock options at September 30, 2008 (millions)
|
|
|
|
|
|
$
|
0.3
|
|
Weighted-average remaining amortization period
|
|
|
|
|
|
1.5 years
|
Aggregate Intrinsic Value of outstanding options,
September 30, 2008 (millions)
|
|
|
|
|
|
$
|
2.3
|
|
Aggregate Intrinsic Value of exercisable options,
September 30, 2008 (millions)
|
|
|
|
|
|
$
|
2.1
|
|
|
|
|
|
|
|
|
|
In determining the expense to be recorded for stock options in the consolidated statements of
earnings, the fair value of each option award is estimated on the date of grant using the
Black-Scholes-Merton option pricing model. The significant assumptions utilized in applying the
Black-Scholes-Merton option pricing model are the risk-free interest rate, expected term, dividend
yield, and expected volatility. The risk-free interest rate is the implied yield currently
available on U.S. Treasury zero-coupon issues with a remaining term equal to the expected term used
as the assumption in the model. The expected term of an option award is based on expected
experience of the awards. The dividend yield is determined by dividing the per-share dividend by
the grant date stock price. The expected volatility is based on the volatility of the Groups stock
price over a historical period.
Information regarding unvested restricted stock activity in the Groups Plan is below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted Average
|
|
|
|
Number of
|
|
|
Fair Value
|
|
|
|
Shares
|
|
|
per Share
|
|
Unvested restricted stock at December 31, 2007
|
|
|
44,584
|
|
|
$
|
14.66
|
|
Granted - 2008
|
|
|
|
|
|
|
|
|
Vested - 2008
|
|
|
(18,125
|
)
|
|
|
12.24
|
|
Forfeited - 2008
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unvested restricted stock at September 30, 2008
|
|
|
26,459
|
|
|
$
|
16.32
|
|
|
|
|
|
|
|
|
Compensation remaining to be recognized for unvested restricted stock at September 30, 2008 (millions)
|
|
|
|
|
|
$
|
0.3
|
|
Weighted-average remaining amortization period
|
|
|
|
|
|
1.2 years
|
16
The computation of basic and diluted earnings per share is as follows:
|
|
|
|
|
|
|
|
|
|
|
Nine months ended
|
|
|
|
September 30,
|
|
|
|
2008
|
|
|
2007
|
|
|
|
(Dollars in thousands, except per share data)
|
|
Numerator for basic and diluted earnings per share:
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
7,605
|
|
|
$
|
11,355
|
|
|
|
|
|
|
|
|
Denominator for basic earnings per share weighted-average shares outstanding
|
|
|
6,230,476
|
|
|
|
6,125,654
|
|
Effect of stock incentive plans
|
|
|
152,264
|
|
|
|
192,375
|
|
|
|
|
|
|
|
|
Denominator for diluted earnings per share
|
|
|
6,382,740
|
|
|
|
6,318,029
|
|
|
|
|
|
|
|
|
Basic earnings per share
|
|
$
|
1.22
|
|
|
$
|
1.85
|
|
|
|
|
|
|
|
|
Diluted earnings per share
|
|
$
|
1.19
|
|
|
$
|
1.80
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended
|
|
|
|
September 30,
|
|
|
|
2008
|
|
|
2007
|
|
|
|
(Dollars in thousands, except per share data)
|
|
Numerator for basic and diluted earnings per share:
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
1,780
|
|
|
$
|
3,012
|
|
|
|
|
|
|
|
|
Denominator for basic earnings per share weighted-average shares outstanding
|
|
|
6,237,804
|
|
|
|
6,174,842
|
|
Effect of stock incentive plans
|
|
|
144,609
|
|
|
|
171,023
|
|
|
|
|
|
|
|
|
Denominator for diluted earnings per share
|
|
|
6,382,413
|
|
|
|
6,345,865
|
|
|
|
|
|
|
|
|
Basic earnings per share
|
|
$
|
0.29
|
|
|
$
|
0.49
|
|
|
|
|
|
|
|
|
Diluted earnings per share
|
|
$
|
0.28
|
|
|
$
|
0.47
|
|
|
|
|
|
|
|
|
The denominator for diluted earnings per share does not include the effect of outstanding
stock options that have an anti-dilutive effect. Options on 40,000 shares were considered to be
anti-dilutive for both the three and nine month periods ended September 30, 2008 and 2007 and were
excluded from the earnings per share calculation.
(7)
Income Taxes
In June 2006, the FASB issued Interpretation No. 48 (FIN 48), Accounting for Uncertainty in
Income Taxes which clarifies the accounting for income tax reserves and contingencies recognized
in an enterprises financial statements in accordance with SFAS No. 109, Accounting for Income
Taxes. FIN 48 also provides guidance on derecognition, classification, interest and penalties,
accounting in interim periods, disclosure, and transition. On January 1, 2007, the Group adopted
FIN 48. As a result of adoption, the Group recognized a previously unrecognized tax benefit of
approximately $0.2 million relating to merger-related expenses for the FPIG acquisition that took
place October 1, 2005. The application of FIN 48 for this unrecognized tax benefit resulted in a
corresponding reduction to goodwill relating to the FPIG acquisition of $0.2 million. The adoption
of FIN 48 did not result in any adjustments to beginning retained earnings, nor did it have a
significant effect on operations, financial condition or liquidity. As of September 30, 2008, the
Group has no unrecognized tax benefits.
(8) Fair Value of Assets and Liabilities
17
Effective January 1, 2008, upon adoption of SFAS 159, the Group did not elect to measure at
fair value any assets or liabilities that were not otherwise already carried at fair value in
accordance with other accounting pronouncements.
In accordance with SFAS 157, the Groups financial assets and financial liabilities measured
at fair value are categorized into three levels, based on the markets in which the assets and
liabilities are traded and the reliability of the assumptions used to determine fair value. These
levels are:
|
|
|
Level 1
-
Valuations based on unadjusted quoted market prices in active markets for
identical assets that the Group has the ability to access. Since the valuations are based
on quoted prices that are readily and regularly available in an active market, valuation of
these securities does not entail a significant amount or degree of judgment.
|
|
|
|
|
Level 2
-
Valuations based on quoted prices for similar assets in active markets; quoted
prices for identical or similar assets in inactive markets; or valuations based on models
where the significant inputs are observable (e.g., interest rates, yield curves, prepayment
speeds, default rates, loss severities, etc.) or can be corroborated by observable market
data.
|
|
|
|
|
Level 3
-
Valuations that are derived from techniques in which one or more of the
significant inputs are unobservable, including broker quotes which are non-binding.
|
The Group uses quoted values and other data provided by a nationally recognized independent
pricing service (pricing service) as inputs into its process for determining fair values of its
investments. The pricing service covers over 99% of all asset classes, fixed-income and equity
securities, domestic and foreign.
The pricing service obtains market quotations and actual transaction prices for securities
that have quoted prices in active markets. Fixed maturities other than U.S. Treasury securities
generally do not trade on a daily basis. For these securities, the pricing service prepares
estimates of fair value measurements for these securities using its proprietary pricing
applications which include available relevant market information, benchmark curves, benchmarking of
like securities, sector groupings and matrix pricing. Additionally, the pricing service uses an
Option Adjusted Spread model to develop prepayment and interest rate scenarios.
Relevant market information, relevant credit information, perceived market movements and
sector news is used to evaluate each asset class. The market inputs utilized in the pricing
evaluation, include but are not limited to: benchmark yields, reported trades, broker/dealer
quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, reference data and
industry and economic events. The extent of the use of each market input depends on the asset
class and the market conditions. Depending on the security, the priority of the use of inputs may
change or some market inputs may not be relevant. For some securities additional inputs may be
necessary.
The pricing service utilized by the Group has indicated that they will only produce an
estimate of fair value if there is objectively verifiable information to produce a valuation. If
the pricing service discontinues pricing an investment, the Group would be required to produce an
estimate of fair value using some of the same methodologies as the pricing service, but would have
to make estimates for market based inputs that are not observable due to market conditions.
The Group reviews its securities measured at fair value and discusses the proper
classification of such investments with industry contacts and others. A review process is performed
on prices received from the pricing service. In addition, a review is performed of the pricing
services processes, practices and inputs, which include any number of financial models, quotes,
trades and other market indicators. Pricing of the portfolio is reviewed on a monthly basis and
securities with changes in prices exceeding defined tolerances are verified to other sources (e.g.
broker, Bloomberg, etc.). Any price challenges resulting from this review are based upon
significant supporting documentation which is provided to the pricing service for their review.
The Group does not adjust quotes or prices obtained from the pricing service without first going
through this process of challenging the price with the pricing service.
The fair value estimates of most fixed maturity investments are based on observable market
information rather than market quotes. Accordingly, the estimates of fair value for such fixed
maturities, other than U.S. Treasury securities, provided by the pricing service are included in
the amount disclosed in Level 2 of the hierarchy. The estimated fair values of U.S. Treasury
securities are included in the amount disclosed in Level 1 as the estimates are based on unadjusted
market prices. The Group determined that Level 2 securities would include corporate bonds,
mortgage-backed securities, municipal bonds, asset-backed securities, certain U.S. government
agencies, non-U.S. government securities, certain short-term securities and investments in mutual
funds.
18
Securities are generally assigned to Level 3 in cases where non-binding broker/dealer quotes
are significant inputs to the valuation and there is a lack of transparency as to whether these
quotes are based on information that is observable in the marketplace.
The Groups Level 3 securities consist of five holdings totalling less than $2.6 million, or
less than 1% of the Groups total investment portfolio. These five securities were valued
primarily through the use of non-binding broker quotes.
Equities that trade on a major exchange are assigned a Level 1. Equities not traded on a major
exchange are assigned a Level 2 or 3 based on the criteria and hierarchy described above.
Short-term investments such as open ended mutual funds where the fund maintains a constant net
asset value of one dollar, money market funds, cash and cash sweep accounts and treasuries bills
are classified as Level 1.
Included in Level 2, Other Liabilities are interest rate swap agreements which the Group is a
party to in order to hedge the floating interest rate on its Trust Preferred Securities, thereby
changing the variable rate exposure to a fixed rate exposure for interest on these obligations. The
estimated fair value of the interest rate swaps is obtained from the third-party financial
institution counterparties.
The table below presents the balances of assets and liabilities measured at fair value on a
recurring basis.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2008
|
|
(in thousands)
|
|
Total
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Investments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed-income securities, available for sale
|
|
$
|
328,548
|
|
|
$
|
6,329
|
|
|
$
|
319,636
|
|
|
$
|
2,583
|
|
Equity securities
|
|
|
14,730
|
|
|
|
13,684
|
|
|
|
1,000
|
|
|
|
46
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
343,278
|
|
|
$
|
20,013
|
|
|
$
|
320,636
|
|
|
$
|
2,629
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other liabilities
|
|
$
|
582
|
|
|
$
|
|
|
|
$
|
582
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
$
|
582
|
|
|
$
|
|
|
|
$
|
582
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net losses included in net income relating
to assets held and liabilities at
September 30, 2008
|
|
$
|
(3,685
|
)
|
|
$
|
(255
|
)
|
|
$
|
(2,865
|
)
|
|
$
|
(565
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The changes in Level 3 assets and liabilities measured at fair value on a recurring basis are
summarized as follows:
|
|
|
|
|
|
|
|
|
|
|
For the Nine Months Ended
|
|
|
|
September 30, 2008
|
|
|
|
Fixed-income
|
|
|
|
|
|
|
securities,
|
|
|
|
|
|
|
available
|
|
|
Equity
|
|
(in thousands)
|
|
for sale
|
|
|
securities
|
|
|
Balance, beginning of period
|
|
$
|
2,399
|
|
|
$
|
823
|
|
Total net (losses)/gains included in net income
|
|
|
(562
|
)
|
|
|
657
|
|
Total net losses included in other comprehensive income
|
|
|
(186
|
)
|
|
|
(682
|
)
|
Purchases, sales, issuances and settlements, net
|
|
|
932
|
|
|
|
(752
|
)
|
|
|
|
|
|
|
|
Balance, end of period
|
|
$
|
2,583
|
|
|
$
|
46
|
|
|
|
|
|
|
|
|
19
|
|
|
|
|
|
|
|
|
|
|
For the Three Months Ended
|
|
|
|
September 30, 2008
|
|
|
|
Fixed-income
|
|
|
|
|
|
|
securities,
|
|
|
|
|
|
|
available
|
|
|
Equity
|
|
(in thousands)
|
|
for sale
|
|
|
securities
|
|
|
Balance, beginning of period
|
|
$
|
3,357
|
|
|
$
|
823
|
|
Total net (losses)/gains included in net income
|
|
|
(562
|
)
|
|
|
657
|
|
Total net losses included in other comprehensive income
|
|
|
(177
|
)
|
|
|
(682
|
)
|
Purchases, sales, issuances and settlements, net
|
|
|
(35
|
)
|
|
|
(752
|
)
|
|
|
|
|
|
|
|
Balance, end of period
|
|
$
|
2,583
|
|
|
$
|
46
|
|
|
|
|
|
|
|
|
For the nine months ended September 30, 2008, there were no assets or liabilities measured at fair
value on a nonrecurring basis.
(9) Retaliatory Tax Refund
As previously disclosed in the Groups SEC filings, the Group paid an aggregate of $3.5
million, including accrued interest, to the New Jersey Division of Taxation (the Division) in
retaliatory premium tax for the years 1999-2004. In conjunction with making such payments, the
Group filed notices of protest with the Division with respect to the retaliatory tax imposed. The
payments were made in response to notices of deficiency issued by the Division to the Group.
Pursuant to the protests, the Group received $4.3 million in 2007 as a reimbursement of
protested payments of retaliatory tax, including accrued interest, previously made by the Group for
the periods 1999-2004. The refund was recorded, after reduction for federal income tax, in the
amount of $2.8 million in the 2007 consolidated statement of earnings, with $2.5 million recorded
in the quarter ended June 30, 2007, and $0.3 million recorded in the quarter ended September 30,
2007. The allocation of the refund to pre-tax earnings included an increase to net investment
income of $720,000, with $687,000 of that amount recognized in the quarter ended June 30, 2007, and
$33,000 recognized in the quarter ended September 30, 2007, for the interest received on the
refund, and $3.6 million as a reduction to Other Expense to recognize the recovery of amounts
previously charged to Other Expense, with $3.1 million of that amount recognized in the quarter
ended June 30, 2007, and $0.5 million recognized in the quarter ended September 30, 2007. This is
a non-recurring item which significantly affects the earnings of both the three and nine month
periods ended September 30, 2007, and performance metrics such as the combined ratio.
20
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
The following presents managements discussion and analysis of our financial condition and
results of operations as of the dates and for the periods indicated. You should read this
discussion in conjunction with the consolidated financial statements and notes thereto included in
this report. This discussion contains forward-looking information that involves risks and
uncertainties. Actual results could differ significantly from these forward-looking statements. See
Forward-Looking Statements.
Overview
Mercer Insurance Group, Inc. (MIG or the Holding Company) is a holding company owning,
directly and indirectly, all of the outstanding shares of our four insurance companies and our
non-insurance subsidiaries (collectively, the Group). Mercer Insurance Company, our oldest
insurance company, has been engaged in the sale of property and casualty insurance since 1844. Our
insurance companies underwrite property and casualty insurance principally in Arizona, California,
New Jersey, New York, Nevada, Oregon, and Pennsylvania and are as follows:
|
|
|
Mercer Insurance Company (MIC), a Pennsylvania property and casualty stock insurance
company offering insurance coverages to businesses and individuals in New Jersey, New York
and Pennsylvania;
|
|
|
|
|
Mercer Insurance Company of New Jersey, Inc. (MICNJ), a New Jersey property and casualty
stock insurance company offering insurance coverages to businesses and individuals located
in New Jersey and businesses located in New York;
|
|
|
|
|
Franklin Insurance Company (FIC), a Pennsylvania property and casualty stock insurance
company offering private passenger automobile and homeowners insurance to individuals
located in Pennsylvania; and
|
|
|
|
|
Financial Pacific Insurance Company (FPIC), a California property and casualty stock
insurance company offering insurance and surety products to small and medium sized
commercial businesses in Arizona, California, Nevada and Oregon, and direct mail surety
products to commercial businesses in various other states.
|
The Groups operating subsidiaries are licensed collectively in twenty-two states, but are
currently focused on doing business in seven states: Arizona, California, Nevada, New Jersey, New
York, Pennsylvania and Oregon. MIC and MICNJ write property and casualty insurance in New York
which only supports existing accounts written in other states. FPIC holds an additional fifteen
state licenses outside of the Groups current focus area. Currently, only direct mail surety is
being written in some of these states.
The Group is subject to regulation by the insurance regulators of each state in which it is
licensed to transact business. The primary regulators are the Pennsylvania Insurance Department,
the California Department of Insurance, and the New Jersey Department of Banking and Insurance,
because these are the regulators for the states of domicile of the Groups insurance subsidiaries,
as follows: MIC (Pennsylvania-domiciled), FPIC (California-domiciled), MICNJ (New
Jersey-domiciled), and FIC (Pennsylvania-domiciled).
The insurance affiliates within the Group participate in a reinsurance pooling arrangement
(the Pool) whereby each insurance affiliates underwriting results are combined and then
distributed proportionately to each participant. Each insurers share in the Pool is based on
their respective statutory surplus from the most recently filed statutory annual statement as of
the beginning of each year.
All insurance companies in the Group have been assigned a group rating of A (Excellent) by
A.M. Best. The Group has been assigned that rating for the past 7 years. An A rating is the
third highest rating of A.M. Bests 16 possible rating categories.
We manage our business and report our operating results in three operating segments:
commercial lines insurance, personal lines insurance and the investment function. Assets are not
allocated to segments and are reviewed in the aggregate for decision-making purposes. Our
commercial lines insurance business consists primarily of multi-peril, general liability,
commercial auto, and related insurance coverages. Our personal lines insurance business consists
primarily of homeowners (in New Jersey and Pennsylvania) and private passenger automobile (in
Pennsylvania only) insurance coverages.
Our income is principally derived from written premiums received from insureds in the
commercial lines (businesses insured) and personal lines (individuals insured) segments, less the
costs of underwriting the insurance policies, the costs of settling and paying claims reported on
the policies, and from investment income reduced by investment expenses and gains or losses on
holdings in our investment portfolio. Written premiums are the total amount of premiums billed to
the policyholder less the amount of premiums returned, generally as a result of cancellations,
during a policy period. Written premiums become premiums earned as the policy ages.
21
In the absence of premium rate changes, if an insurance company writes the same number and mix
of policies each year, written premiums and premiums earned will be equal, and the unearned premium
reserve will remain constant. During periods of growth, the unearned premium reserve will increase,
causing premiums earned to be less than written premiums. Conversely, during periods of decline,
the unearned premium reserve will decrease, causing premiums earned to be greater than written
premiums.
Variability in our income is caused by a variety of circumstances, some within the control of
our companies and some not within our control. Premium volume is affected by, among other things,
the availability and regular flow to our insurance companies of quality, properly-priced risks
being produced by our agents, the ability to retain on renewal existing good-performing accounts,
competition from other insurance companies, regulatory rate approvals, our reputation, and other
limitations created by the marketplace or regulators. Our underwriting costs are affected by, among
other things, the amount of commission and profit-sharing commission we pay our agents to produce
the underwriting risks for which we receive premiums, the cost of issuing insurance policies and
maintaining our customer and agent relationships, marketing costs, taxes we pay to the states in
which we operate on the amount of premium we collect, and other assessments and charges imposed on
our companies by the regulators in the states in which we do business. Our claim and claim
settlement costs are affected by, among other things, the quality of our accounts, severe or
extreme weather in our operating region, the nature of the claim, the regulatory and legal
environment in our territories, inflation in underlying medical and property repair costs, and the
availability and cost of reinsurance. Our investment income and realized gains and losses are
determined by, among other things, market forces, the rates of interest and dividends paid on our
investment portfolio holdings, the credit or investment quality of the issuers and the success of
their underlying businesses, the market perception of the issuers, and other factors such as
ratings by rating agencies and analysts.
Critical Accounting Policies
General.
The Groups financial statements are prepared in conformity with U.S. generally
accepted accounting principles (GAAP). We are required to make estimates and assumptions in certain
circumstances that affect amounts reported in our consolidated financial statements and related
footnotes. We evaluate these estimates and assumptions on an on-going basis based on historical
developments, market conditions, industry trends and other information that we believe to be
reasonable under the circumstances. There can be no assurance that actual results will conform to
our estimates and assumptions, and that reported results of operations will not be materially
adversely affected by the need to make accounting adjustments to reflect changes in these estimates
and assumptions from time to time. We believe the following policies are the most sensitive to
estimates and judgments.
Liabilities for Loss and Loss Adjustment Expenses.
The liability for losses and loss
adjustment expenses represents estimates of the ultimate unpaid cost of all losses incurred,
including losses for claims that have not yet been reported to our insurance companies. The amount
of loss reserves for reported claims is based primarily upon a case-by-case evaluation of the type
of risk involved, knowledge of the circumstances surrounding each claim and the insurance policy
provisions relating to the type of loss. The amounts of loss reserves for unreported claims and
loss adjustment expenses are determined using historical information by line of insurance as
adjusted to current conditions. Inflation is ordinarily implicitly provided for in the reserving
function through analysis of costs, trends and reviews of historical reserving results over
multiple years.
Reserves are closely monitored and are recomputed periodically using the most recent
information on reported claims and a variety of statistical techniques. Specifically, we review, by
line of business, existing reserves, new claims, changes to existing case reserves, and paid losses
with respect to the current and prior accident years. We use historical paid and incurred losses
and accident year data to derive expected ultimate loss and loss adjustment expense ratios by line
of business. We then apply these expected loss and loss adjustment expense ratios to earned premium
to derive a reserve level for each line of business. In connection with the determination of the
reserves, we also consider other specific factors such as recent weather-related losses, trends in
historical paid losses, and legal and judicial trends with respect to theories of liability. Some
of our business relates to coverage for short-term risks, and for these risks loss development is
comparatively rapid and historical paid losses, adjusted for known variables, have been a reliable
predictive measure of future losses for purposes of our reserving. Some of our business relates to
longer-term risks, where the claims are slower to emerge and the estimate of damage is more
difficult to predict. For these lines of business, more sophisticated actuarial methods must be
employed to project an ultimate loss expectation, and then the related loss history must be
regularly evaluated and loss expectations updated, with the possibility of variability from the
initial estimate of ultimate losses. A substantial portion of FPICs business is this type of
longer-tailed casualty business.
Reserves are estimates because there are uncertainties inherent in the determination of
ultimate losses. Court decisions, regulatory changes and economic conditions can affect the
ultimate cost of claims that occurred in the past as well as create uncertainties regarding future
loss cost trends. Accordingly, the ultimate liability for unpaid losses and loss settlement
expenses will likely differ from the amount recorded at September 30, 2008.
22
The table below is a sensitivity chart included to provide the reader with a sense of the
impact a range of differing estimates for unpaid losses and loss adjustment expenses would have on
shareholders equity at September 30, 2008, in the event actual experience differs from the
estimates and assumptions used by management in establishing loss and loss adjustment expense
reserves as of that date. The changes described in the table are not intended to represent the
range of reasonably likely changes to loss reserves and loss adjustment expense reserves in
managements opinion, nor are the changes included in the table intended to depict the best, worst,
or likely scenarios:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Adjusted Loss and
|
|
|
|
|
|
Adjusted Loss and
|
|
|
Change in Loss
|
|
Loss Adjustment
|
|
Percentage
|
|
Loss Adjustment
|
|
Percentage
|
and Loss
|
|
Reserves Net of
|
|
Change in
|
|
Reserves Net of
|
|
Change in
|
Adjustment
|
|
Reinsurance as of
|
|
Equity as of
|
|
Reinsurance as of
|
|
Equity as of
|
Reserves Net of
|
|
September 30,
|
|
September 30,
|
|
December 31,
|
|
December 31,
|
Reinsurance
|
|
2008
|
|
2008 (1)
|
|
2007
|
|
2007 (1)
|
(Dollars in thousands)
|
(10.0)%
|
|
$
|
189,354
|
|
|
|
10.4
|
%
|
|
$
|
172,815
|
|
|
|
9.5
|
%
|
(7.5)%
|
|
|
194,614
|
|
|
|
7.8
|
%
|
|
|
177,616
|
|
|
|
7.1
|
%
|
(5.0)%
|
|
|
199,873
|
|
|
|
5.2
|
%
|
|
|
182,416
|
|
|
|
4.7
|
%
|
(2.5)%
|
|
|
205,133
|
|
|
|
2.6
|
%
|
|
|
187,217
|
|
|
|
2.4
|
%
|
Base
|
|
|
210,393
|
|
|
|
|
|
|
|
192,017
|
|
|
|
|
|
2.5%
|
|
|
215,653
|
|
|
|
(2.6
|
)%
|
|
|
196,817
|
|
|
|
(2.4)
|
%
|
5.0%
|
|
|
220,913
|
|
|
|
(5.2)
|
%
|
|
|
201,618
|
|
|
|
(4.7)
|
%
|
7.5%
|
|
|
226,172
|
|
|
|
(7.8)
|
%
|
|
|
206,418
|
|
|
|
(7.1)
|
%
|
10.0%
|
|
|
231,432
|
|
|
|
(10.4)
|
%
|
|
|
211,219
|
|
|
|
(9.5
|
)%
|
The property and casualty industry has incurred substantial aggregate losses from claims
related to asbestos-related illnesses, environmental remediation, product liability, mold, and
other uncertain exposures. We have not experienced significant losses from these types of claims.
Our subsidiary, FPIC, insures contractors for liability for construction defect risks, among other
risks.
The table below summarizes loss and loss adjustment reserves by major line of business:
23
|
|
|
|
|
|
|
|
|
|
|
September 30,
|
|
|
December 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
|
(In thousands)
|
|
Commercial lines:
|
|
|
|
|
|
|
|
|
Commercial multi-peril
|
|
$
|
217,196
|
|
|
$
|
198,919
|
|
Commercial automobile
|
|
|
43,723
|
|
|
|
37,569
|
|
Other liability
|
|
|
11,103
|
|
|
|
11,854
|
|
Workers compensation
|
|
|
8,187
|
|
|
|
8,279
|
|
Surety
|
|
|
8,160
|
|
|
|
6,818
|
|
Fire, allied, inland marine
|
|
|
367
|
|
|
|
131
|
|
|
|
|
|
|
|
|
|
|
|
288,736
|
|
|
|
263,570
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Personal lines:
|
|
|
|
|
|
|
|
|
Homeowners
|
|
|
7,032
|
|
|
|
7,029
|
|
Personal automobile
|
|
|
1,791
|
|
|
|
2,122
|
|
Other liability
|
|
|
1,273
|
|
|
|
1,142
|
|
Fire, allied, inland marine
|
|
|
111
|
|
|
|
490
|
|
Workers compensation
|
|
|
48
|
|
|
|
46
|
|
|
|
|
|
|
|
|
|
|
|
10,255
|
|
|
|
10,829
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
298,991
|
|
|
$
|
274,399
|
|
|
|
|
|
|
|
|
Investments.
Unrealized investment gains or losses on investments carried at fair value, net
of applicable income taxes, are reflected directly in stockholders equity as a component of
comprehensive income and, accordingly, have no effect on net income. A decline in fair value of an
investment below its cost that is deemed other than temporary is charged to earnings as a realized
loss. We monitor our investment portfolio and review investments that have experienced a decline in
fair value below cost to evaluate whether the decline is other than temporary. These evaluations
involve judgment and consider the magnitude and reasons for a decline and the prospects for the
fair value to recover in the near term. Adverse investment market conditions, or poor operating
results of underlying investments, could result in impairment charges in the future.
The Groups policy on impairment of value of investments is as follows: if a security has a
market value below cost it is considered impaired. For any such security a review of the financial
condition and prospects of the issuing company will be performed by the Investment Committee to
assess whether the decline in market value is other than temporary. If the assessment is that the
decline in market value is other than temporary, the carrying value of the security will be
written down to fair value and the amount of the write-down accounted for as a realized loss.
Fair value is defined as the price that would be received to sell an asset in an orderly
transaction between market participants at the measurement date.
In evaluating the potential impairment of fixed income securities, the Investment Committee
will evaluate relevant factors, including but not limited to the following: the issuers current
financial condition and ability to make future scheduled principal and interest payments, relevant
rating history, analysis and guidance provided by rating agencies and analysts, the degree to which
an issuer is current or in arrears in making principal and interest payments, and changes in price
relative to the market, as well as the Groups ability and intention to hold the security to maturity.
In evaluating the potential impairment of equity securities, the Investment Committee will
evaluate certain factors, including but not limited to the following: the relationship of market
price per share versus carrying value per share at the date of acquisition and the date of
evaluation, the price-to-earnings ratio at the date of acquisition and the date of evaluation, any
rating agency announcements, the issuers financial condition and near-term prospects, including
any specific events that may influence the issuers operations, the independent auditors report on
the issuers financial statements; and any buy/sell/hold recommendations or price projections by
outside investment advisors.
In the first nine months of 2008, we incurred an impairment charge of $3.6 million for
eighteen securities that were determined to be other than temporarily impaired. In the first nine
months of 2007, we incurred an impairment charge of $28,000 for one security that was determined to
be other than temporarily impaired.
24
The ongoing credit crisis and interest rate volatility continued into the third quarter of
2008. The difficult credit conditions worsened in September and inter-bank lending was reduced.
The loss of confidence in the capital markets led to several significant events, including the
nationalization of Fannie Mae and Freddie Mac, the bankruptcy filing of Lehman Brothers, an
agreement for Merrill Lynch to be acquired by Bank of America, among others. The market value of
credit obligations generally declined during the last month of the quarter.
The decline in market values led to reduced valuations for a number of holdings. As a result,
the Group incurred an impairment charge of $2.8 million for 9 fixed income securities and a
preferred stock holding during the third quarter of 2008. The bankruptcy filing of Lehman Brothers
led to a write down of a $1.0 million Lehman Brothers bond to 12.5% of par. In addition, based on
the uncertain outlook for some other banking and finance institutions, five other securities were
determined to be other than temporarily impaired, including both senior unsecured debt and one
preferred equity holding. The continued deterioration of housing market indicators adversely
impacted delinquency and loss severity assumptions, which led to the impairment of two asset backed
security (ABS) home-equity positions and an A-rated CMO holding. Finally, the Group has decided to
take a further write-down on a non-investment grade corporate security (GMAC) due to further market
value declines and an unfavorable outlook by the rating agencies with regard to this credit.
The Group holds no Fannie Mae or Freddie Mac common or preferred shares, nor any equity or
fixed income obligations of AIG or Washington Mutual.
Policy Acquisition Costs.
We defer policy acquisition costs, such as commissions, premium
taxes and certain other underwriting expenses that vary with and are primarily related to the
production of business. These costs are amortized over the effective period of the related
insurance policies. The method followed in computing deferred policy acquisition costs limits the
amount of deferred costs to their estimated realizable value, which gives effect to the premium to
be earned, related investment
income, loss and loss adjustment expenses, and certain other costs expected to be incurred as
the premium is earned. Future changes in estimates, the most significant of which is expected loss
and loss adjustment expenses, may require acceleration of the amortization of deferred policy
acquisition costs.
Reinsurance.
Amounts recoverable from property and casualty reinsurers are estimated in a
manner consistent with the claim liability associated with the reinsured policy. Amounts paid for
reinsurance contracts are expensed over the contract period during which insured events are covered
by the reinsurance contracts.
Ceded unearned premiums and reinsurance balances recoverable on paid and unpaid loss and loss
adjustment expenses are reported separately as assets, instead of being netted with the appropriate
liabilities, because reinsurance does not relieve us of our legal liability to our policyholders.
Reinsurance balances recoverable are subject to credit risk associated with the particular
reinsurer. Additionally, the same uncertainties associated with estimating unpaid loss and loss
adjustment expenses affect the estimates for the ceded portion of these liabilities. We continually
monitor the financial condition of our reinsurers.
Income Taxes.
We use the asset and liability method of accounting for income taxes. Deferred
income taxes are provided and arise from the recognition of temporary differences between financial
statement carrying amounts and the tax bases of our assets and liabilities. A valuation allowance
is provided when it is more likely than not that some portion of the deferred tax asset will not be
realized. The effect of a change in tax rates is recognized in the period of the enactment date.
Results of Operations
The key goal of the Groups business model is the sale of properly priced and underwritten
personal and commercial property and casualty insurance through independent agents and the
investment of the premiums in a manner designed to assure that claims and expenses can be paid
while providing a return on the capital employed. Loss trends and investment performance are
critical factors in the success of the business model.
Our results of operations are also influenced by factors affecting the property and casualty
insurance industry in general. The operating results of the United States property and casualty
insurance industry are subject to significant variations due to competition, weather, catastrophic
events, regulation, the availability and cost of satisfactory reinsurance, general economic
conditions, judicial trends, fluctuations in interest rates and other changes in the investment
environment.
The availability of reinsurance at reasonable pricing is an important part of our business.
Effective, January 1, 2008, the Group increased its retention to $850,000 (from a maximum retention
of $750,000 in 2007) on the casualty, property and workers compensation lines of business.
25
As the
Group increases the net retention of the business it writes, net premiums written and earned will
increase and ceded losses will decrease.
The Group writes homeowners insurance only in New Jersey and Pennsylvania, and personal
automobile insurance only in Pennsylvania. Personal lines insurance is not written in any other
states in which the Group does business.
Nine and three months ended September 30, 2008 compared to nine and three months ended September
30, 2007
The components of income for the first nine months of 2008 and 2007, and the change and
percentage change from year to year, are shown in the charts below. The accompanying narrative
refers to the statistical information displayed in the chart immediately above the narrative.
During 2007, the Group evaluated its methodology for allocating costs to its lines of business and
adopted changes to such methodology in order to more accurately reflect the allocation of joint
costs. This resulted in allocating less joint cost to the personal lines of business and more
joint cost to the commercial lines of business, but with no net change in cost allocated to
personal lines and commercial lines in the aggregate. Previously reported 2007 amounts have been
reclassified below to reflect this change in allocation methodology.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine months ended September 30,
|
|
|
|
|
|
|
|
|
2008 vs. 2007 Income
|
|
2008
|
|
2007
|
|
Change
|
|
% Change
|
|
|
(Dollars in thousands)
|
|
|
|
|
|
|
|
|
Commercial lines underwriting income
|
|
$
|
2,981
|
|
|
$
|
5,416
|
|
|
$
|
(2,435
|
)
|
|
|
(45.0)
|
%
|
Personal lines underwriting (loss)/income
|
|
|
(736
|
)
|
|
|
194
|
|
|
|
(930
|
)
|
|
|
N/M
|
|
Total underwriting income
|
|
|
2,245
|
|
|
|
5,610
|
|
|
|
(3,365
|
)
|
|
|
(60.0)
|
%
|
Net investment income
|
|
|
10,173
|
|
|
|
9,592
|
|
|
|
581
|
|
|
|
6.1
|
%
|
Net realized investment (losses)/gains
|
|
|
(2,944
|
)
|
|
|
267
|
|
|
|
(3,211
|
)
|
|
|
N/M
|
|
Other
|
|
|
1,555
|
|
|
|
1,494
|
|
|
|
61
|
|
|
|
4.1
|
%
|
Interest expense
|
|
|
(961
|
)
|
|
|
(911
|
)
|
|
|
(50
|
)
|
|
|
5.5
|
%
|
Income before income taxes
|
|
|
10,068
|
|
|
|
16,052
|
|
|
|
(5,984
|
)
|
|
|
(37.3)
|
%
|
Income taxes
|
|
|
2,463
|
|
|
|
4,697
|
|
|
|
(2,234
|
)
|
|
|
(47.6)
|
%
|
Net Income
|
|
|
7,605
|
|
|
|
11,355
|
|
|
|
(3,750
|
)
|
|
|
(33.0)
|
%
|
Loss/ LAE ratio (GAAP)
|
|
|
61.9
|
%
|
|
|
61.5
|
%
|
|
|
0.4
|
%
|
|
|
|
|
Underwriting expense ratio (GAAP)
|
|
|
36.1
|
%
|
|
|
33.2
|
%
|
|
|
2.9
|
%
|
|
|
|
|
Combined ratio (GAAP)
|
|
|
98.0
|
%
|
|
|
94.7
|
%
|
|
|
3.3
|
%
|
|
|
|
|
Loss/ LAE ratio (Statutory)
|
|
|
61.9
|
%
|
|
|
61.5
|
%
|
|
|
0.4
|
%
|
|
|
|
|
Underwriting expense ratio (Statutory)
|
|
|
35.9
|
%
|
|
|
31.5
|
%
|
|
|
4.4
|
%
|
|
|
|
|
Combined ratio (Statutory)
|
|
|
97.8
|
%
|
|
|
93.0
|
%
|
|
|
4.8
|
%
|
|
|
|
|
26
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended September 30,
|
|
|
|
|
|
|
|
|
2008 vs. 2007 Income
|
|
2008
|
|
2007
|
|
Change
|
|
% Change
|
|
|
(Dollars in thousands)
|
|
|
|
|
|
|
|
|
Commercial lines underwriting income
|
|
$
|
741
|
|
|
$
|
1,207
|
|
|
$
|
(466
|
)
|
|
|
(38.6)
|
%
|
Personal lines underwriting income
|
|
|
73
|
|
|
|
143
|
|
|
|
(70
|
)
|
|
|
(49.0)
|
%
|
Total underwriting income
|
|
|
814
|
|
|
|
1,350
|
|
|
|
(536
|
)
|
|
|
(39.7)
|
%
|
Net investment income
|
|
|
3,469
|
|
|
|
2,880
|
|
|
|
589
|
|
|
|
20.5
|
%
|
Net realized investment losses
|
|
|
(2,281
|
)
|
|
|
(366
|
)
|
|
|
(1,915
|
)
|
|
|
N/M
|
|
Other
|
|
|
536
|
|
|
|
587
|
|
|
|
(51
|
)
|
|
|
(8.7)
|
%
|
Interest expense
|
|
|
(328
|
)
|
|
|
(300
|
)
|
|
|
(28
|
)
|
|
|
9.3
|
%
|
Income before income taxes
|
|
|
2,210
|
|
|
|
4,151
|
|
|
|
(1,941
|
)
|
|
|
(46.8)
|
%
|
Income taxes
|
|
|
430
|
|
|
|
1,139
|
|
|
|
(709
|
)
|
|
|
(62.2)
|
%
|
Net Income
|
|
|
1,780
|
|
|
|
3,012
|
|
|
|
(1,232
|
)
|
|
|
(40.9)
|
%
|
Loss/ LAE ratio (GAAP)
|
|
|
60.3
|
%
|
|
|
61.0
|
%
|
|
|
(0.7)
|
%
|
|
|
|
|
Underwriting expense ratio (GAAP)
|
|
|
37.6
|
%
|
|
|
35.4
|
%
|
|
|
2.2
|
%
|
|
|
|
|
Combined ratio (GAAP)
|
|
|
97.9
|
%
|
|
|
96.4
|
%
|
|
|
1.5
|
%
|
|
|
|
|
Loss/ LAE ratio (Statutory)
|
|
|
60.3
|
%
|
|
|
61.0
|
%
|
|
|
(0.7)
|
%
|
|
|
|
|
Underwriting expense ratio (Statutory)
|
|
|
37.6
|
%
|
|
|
33.9
|
%
|
|
|
3.7
|
%
|
|
|
|
|
Combined ratio (Statutory)
|
|
|
97.9
|
%
|
|
|
94.9
|
%
|
|
|
3.0
|
%
|
|
|
|
|
(N/M means not meaningful)
As previously disclosed in the Groups SEC filings, the Group paid an aggregate of $3.5
million, including accrued interest, to the New Jersey Division of Taxation (the Division) in
retaliatory premium tax for the years 1999-2004. In conjunction with making such payments, the
Group filed notices of protest with the Division with respect to the retaliatory tax imposed. The
payments were made in response to notices of deficiency issued by the Division to the Group.
The Group received $4.3 million in 2007 as a reimbursement of protested payments of
retaliatory tax, including accrued interest thereon, previously made by the Group for the periods
1999-2004. The refund has been recorded, after reduction for Federal income tax, in the amount of
$2.8 million in the consolidated statement of earnings, with $2.5 million recorded in the quarter
ending June 30, 2007, and $0.3 million recorded in the quarter ended September 30, 2007. The
allocation of the refund to pre-tax earnings included an increase to net investment income of
$720,000, with $687,000 of that amount recognized in the quarter ended June 30, 2007, and $33,000
recognized in the quarter ended September 30, 2007, for the interest received on the refund, and
$3.6 million as a reduction to Other Expense to recognize the recovery of amounts previously
charged to Other Expense, with $3.1 million of that amount recognized in the quarter ended June 30,
2007, and $0.5 million recognized in the quarter ended September 30, 2007. This is a non-recurring
item which significantly affects the earnings of both the three and nine month periods ended
September 30, 2007, and related performance metrics such as the combined ratio.
The Groups GAAP combined ratio for the first nine months of 2008 was 98.0%, as compared to a
combined ratio for the first nine months of 2007 of 94.7%. Excluding the effect of the
non-recurring retaliatory tax refund described above, the GAAP combined ratio for the first nine
months of 2007 was 98.1%. The statutory combined ratio for the first nine months of 2008 and 2007
was 97.8% and 93.0%, respectively. See discussion below relating to commercial and personal lines
performance.
The Groups GAAP combined ratio for the third quarter of 2008 was 97.9%, as compared to a
combined ratio for the third quarter of 2007 of 96.4%. Excluding the effect of the non-recurring
retaliatory tax refund described above, the GAAP combined ratio for the third quarter of 2007 was
97.7%. The statutory combined ratio for the third quarter of 2008 and 2007 was 97.9% and 94.9%,
respectively. See discussion below relating to commercial and personal lines performance.
Net investment income totaled $10.2 million and $9.6 million in the first nine months of 2008
and 2007, respectively, representing an increase of $0.6 million or 6.1%. Net investment income
for the first nine months of 2007 included $720,000 of interest income as a result of the
non-recurring impact of the retaliatory tax refund. Average cash and invested assets totaled $366
million for the first nine months of 2008 as compared to $331 million for the first nine months of
2007, representing an increase of $35 million, driven by operating cash flow. Net investment
income for the third quarter of 2008 increased $0.6 million to $3.5 million for the third quarter
of 2008 as compared to $2.9 million
27
for the third quarter of 2007. The increase is attributable to
the increase in average cash and invested assets.
Net realized investment losses amounted to $2.9 million in the first nine months of 2008,
which is primarily driven by other than temporary impairments on investment securities, a realized
loss on the mark-to-market valuation on the interest rate swaps for the trust preferred securities,
offset in part by realized gains on the sales of investments. Net realized investment gains
amounted to $0.3 million in the first nine months of 2007, which is primarily driven by realized
gains on the sales of investments, offset in part by other than temporary impairments on investment
securities and a realized loss on the mark-to-market valuation on the interest rate swaps for the
trust preferred securities. See discussion of other than temporary impairments on investment
securities in the Critical Accounting Policies section. Other revenue, which is primarily service
charges recorded on insurance premiums, totaled $1.6 million and $1.5 million for the first nine
months of 2008 and 2007, respectively. Interest expense of $1.0 and $0.9 million for the first
nine months of 2008 and 2007, respectively, represents interest expense related to the trust
preferred obligations.
Charts and discussion relating to each of our segments (commercial lines underwriting,
personal lines underwriting, and the investment segment) follow with further discussion below.
Changes have been made to the 2007 presentation of the commercial and personal lines segments to
conform to the revised allocation methodology for commercial and personal lines results referred to
above.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
|
|
|
|
|
|
|
2008 vs. 2007 Revenue
|
|
2008
|
|
2007
|
|
Change
|
|
% Change
|
|
|
(In thousands)
|
|
|
|
|
|
|
|
|
Direct premiums written
|
|
$
|
129,538
|
|
|
$
|
140,506
|
|
|
$
|
(10,968
|
)
|
|
|
(7.8)
|
%
|
Net premiums written
|
|
|
115,863
|
|
|
|
123,116
|
|
|
|
(7,253
|
)
|
|
|
(5.9)
|
%
|
Net premiums earned
|
|
|
115,590
|
|
|
|
106,367
|
|
|
|
9,223
|
|
|
|
8.7
|
%
|
Net investment income
|
|
|
10,173
|
|
|
|
9,592
|
|
|
|
581
|
|
|
|
6.1
|
%
|
Net realized investment (losses)/gains
|
|
|
(2,944
|
)
|
|
|
267
|
|
|
|
(3,211
|
)
|
|
|
N/M
|
|
Other revenue
|
|
|
1,555
|
|
|
|
1,494
|
|
|
|
61
|
|
|
|
4.1
|
%
|
Total revenue
|
|
$
|
124,374
|
|
|
$
|
117,720
|
|
|
$
|
6,654
|
|
|
|
5.7
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
|
|
|
|
|
|
|
2008 vs. 2007 Revenue
|
|
2008
|
|
2007
|
|
Change
|
|
% Change
|
|
|
(In thousands)
|
|
|
|
|
|
|
|
|
Direct premiums written
|
|
$
|
42,161
|
|
|
$
|
47,027
|
|
|
$
|
(4,866
|
)
|
|
|
(10.3)
|
%
|
Net premiums written
|
|
|
37,575
|
|
|
|
41,110
|
|
|
|
(3,535
|
)
|
|
|
(8.6)
|
%
|
Net premiums earned
|
|
|
37,869
|
|
|
|
37,303
|
|
|
|
566
|
|
|
|
1.5
|
%
|
Net investment income
|
|
|
3,469
|
|
|
|
2,880
|
|
|
|
589
|
|
|
|
20.5
|
%
|
Net realized investment losses
|
|
|
(2,281
|
)
|
|
|
(366
|
)
|
|
|
(1,915
|
)
|
|
|
N/M
|
|
Other revenue
|
|
|
536
|
|
|
|
587
|
|
|
|
(51
|
)
|
|
|
(8.7)
|
%
|
Total revenue
|
|
$
|
39,593
|
|
|
$
|
40,404
|
|
|
$
|
(811
|
)
|
|
|
(2.0)
|
%
|
(N/M means not meaningful)
Total revenues for the first nine months of 2008 increased $6.7 million or 5.7% to $124.4
million as compared to $117.7 million in the first nine months of 2007. This increase was due
primarily to an increase in net premiums earned offset in part by an increase in net realized
investment losses. Net premiums earned totaled $115.6 million for the first nine months of 2008 as
compared to $106.4 million for the first nine months of 2007, representing an 8.7% or $9.2 million
increase. Net premiums earned increased 8.7% despite a 5.9% decline in net premiums written, with
the decline in net premiums written caused primarily by the 7.8% decline in direct premiums
written, offset by the positive impact on net premiums written of the change in reinsurance
structure (in 2007 retention increased to $750,000 from $250,000 and $350,000 in 2006 on FPICs
casualty and property lines, respectively, and from $500,000 on MICs, MICNJs and FICs 2006
property, casualty and workers compensation lines, and in 2008 to $850,000 from $750,000). Direct
premiums written included a reduction in audit premium recorded during 2008 which is earned
immediately upon booking (see discussion below for discussion of audit premium and changes in
reinsurance arrangements).
28
Net investment income totaled $10.2 million and $9.6 million for the first nine months of 2008
and 2007, respectively. Net investment income for the first nine months of 2007 was impacted by
the $720,000 non-recurring impact of the retaliatory tax refund. Net realized investment losses
amounted to $2.9 million in the first nine months of 2008 as compared to net realized investment
gains of $0.3 million in the first nine months of 2007. The net realized loss in 2008 is primarily
driven by other than temporary impairments on investment securities, a realized loss on the
mark-to-market valuation on the interest rate swaps for the trust preferred securities, offset in
part by realized gains on the sales of investments. The net realized investment gain in 2007 is
primarily driven by realized gains on the sales of investments, offset in part by other than
temporary impairments on investment securities and a realized loss on the mark-to-market valuation
on the interest rate swaps for the trust preferred securities. See discussion of other than
temporary impairments on investment securities in the Critical Accounting Policies section.
Total revenues for the third quarter of 2008 decreased $0.8 million or 2.0% to $39.6 million
as compared to $40.4 million in the third quarter of 2007. This decrease was due primarily to an
increase in net realized investment losses offset in part by an increase in net premiums earned and
net investment income. Net premiums earned totaled $37.9 million for the third quarter of 2008 as
compared to $37.3 million for the third quarter of 2007, representing a 1.5% or $0.6 million
increase.
Net investment income for the third quarter of 2008 increased $0.6 million to $3.5 million for
the third quarter of 2008 as compared to $2.9 million for the third quarter of 2007. The increase
is primarily attributable to an increase in cash and invested assets. Net realized investment
losses amounted to $2.3 million and $0.4 million in the third quarter of 2008 and 2007,
respectively. The net realized loss in the third quarter of 2008 was primarily driven by other
than temporary impairments on investment securities, a realized loss on the mark-to-market
valuation on the interest rate swaps for the trust preferred securities, offset in part by realized
gains on the sales of investments. The net loss in the third quarter of 2007 was primarily driven
by a realized loss on the mark-to-market valuation on the interest rate swaps for the trust
preferred securities, offset in part by realized gains on the sales of investments. See discussion
of other than temporary impairments on investment securities in the Critical Accounting Policies
section.
In the first nine months of 2008, direct premiums written declined $11.0 million or 7.8% to
$129.5 million as compared to $140.5 million in the first nine months of 2007. In the third
quarter of 2008, direct premiums written declined $4.9 million or 10.3% to $42.2 million as
compared to $47.0 million in the third quarter of 2007. The decline in direct premiums written is
attributable to a more difficult economic environment and competitive market conditions. A decline
in construction related activity and related audit premium in California, increased competition on
large accounts, as well as the return of a number of competitors to the California contractor
market and the East Coast habitational market contributed to this decline.
The decline in audit premium, as compared to the prior year, relates to a general decline in
construction related activity and failing businesses in the construction industry, specifically in
California, driven by a slowdown of the residential housing market. Approximately 50% of FPICs
business (and approximately one-third of the Groups business in total) is related to contractor
liability.
Commercial multiple peril policies constitute a majority of the business written in FPICs
contractor book of business. The premium on these policies is estimated at policy inception based
on a prediction of the volume of the insureds business operations during the policy period. In
addition to endorsing the policy throughout the policy period based on known information, at policy
expiration FPIC conducts an audit of the insureds business operations in order to adjust the
policy premium from an estimate to actual. Contractor liability policy premium tends to vary with
local construction activity as well as changes in the nature of the contractors operations. The
decline in construction related activity and failing businesses in the construction industry has
impacted both the volume of premium for the contractor in-force book of business (and related
exposures) and the related audit premium on expiring policies. Audits, primarily of construction
related policies, generated return premium of $1.7 million in the first nine months of 2008,
representing a decline of $3.9 million as compared to $2.2 million of additional premium that was
generated in the first nine months of 2007. Audits, primarily of construction related policies,
generated return premium of $0.6 million in the third quarter of 2008, representing a decline of
$1.2 million as compared to $0.6 million of additional premium that was generated in the third
quarter of 2007.
The decline in year-to-date direct premiums written reflects a continuing competitive
marketplace and declining levels of economic activity in our operating territories. The current
market is highly competitive, with pricing and coverage competition being seen in virtually all
classes of commercial accounts, package policies, commercial automobile policies and in the
Pennsylvania personal auto market and Pennsylvania and New Jersey homeowners markets, all of which
makes it more challenging to retain our accounts on renewal, or to renew a policy at expiring
premium. Competition also continues on large accounts, particularly in the East Coast habitational
and California construction contracting programs, as competitors aggressively compete for these
higher premium accounts. Pricing in the property and casualty insurance industry historically has
been and remains cyclical. During a soft market cycle, such as the current market conditions, price
competition is prevalent, which makes it challenging to write and retain properly priced personal
and commercial lines business. We continue to work with our agents
29
to target classes of business
and accounts compatible with our underwriting appetite, which includes certain types of religious
institution risks, contracting risks, small business risks and property risks. Despite the pricing
pressures of the marketplace, management maintains a strong focus on its policy of disciplined
underwriting and pricing standards, declining business which it determines is inadequately priced
for its level of risk. In spite of these competitive market conditions, the Groups policy
retention on renewal has been favorable across most product lines.
In the fourth quarter of 2008, a new Businessowners product for California risks is being
introduced. This product will target small to medium sized businesses which have been shown to be
somewhat less price sensitive than larger accounts. This product will also help to balance FPICs
business between property and casualty exposures. Additionally, a new contracting product which
specializes in covering artisan contractors is being developed for Arizona, California, Nevada and
Oregon and is targeted for introduction in early 2009. Artisan contractors primarily provide repair
and maintenance services and this segment tends to experience less severe market fluctuations
compared to the real estate construction industry.
Both the California Businessowners and western states Artisan product will be transacted using
an Internet-based rating process where agents will be able to rate and bind these products, subject
to pre-programmed underwriting criteria. Additionally, Internet-based rating was updated for our
Personal Automobile product in Pennsylvania in the third quarter of 2008. Our New Jersey and
Pennsylvania agents writing Businessowners, Commercial Automobile, Workers Compensation and
Artisan Contractors commercial lines business will begin to use our Internet-based rating
applications, using a staggered implementation strategy starting in the fourth quarter of 2008.
Plans to introduce Internet-based Commercial Automobile rating for our western states are currently
being developed.
Effective January 1, 2008, the Group increased its reinsurance retention to $850,000 (from a
maximum retention of $750,000 in 2007) on the casualty, property and workers compensation lines of
business. Pollution coverage written by FPIC is now fully
retained with a standard sub-limit of $150,000 (and up to $300,000 on an exception basis).
Prior to 2008, FPIC reinsured 100% of its pollution coverage which in the twelve months ended
December 31, 2007 represented $1.8 million of ceded written premium. The Group also purchased an
additional $1.0 million of surety coverage (subject to a 10% retention) which resulted in an
increased reinsurance coverage to $4.5 million from $3.5 million per principal and a maximum
retention of $900,000 per principal as compared to the previous $800,000. The net effect of these
changes in reinsurance arrangements increases net premiums written for the first nine months of
2008.
Growth in Net Investment Income is discussed below.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
|
|
|
|
|
|
|
2008 vs. 2007 Investment Income and Realized Gains
|
|
2008
|
|
2007
|
|
Change
|
|
% Change
|
|
|
(In thousands)
|
|
|
|
|
|
|
|
|
Fixed income securities
|
|
$
|
11,058
|
|
|
$
|
9,627
|
|
|
$
|
1,431
|
|
|
|
14.9
|
%
|
Dividends
|
|
|
254
|
|
|
|
219
|
|
|
|
35
|
|
|
|
16.0
|
%
|
Cash, cash equivalents & other
|
|
|
356
|
|
|
|
1,458
|
|
|
|
(1,102
|
)
|
|
|
(75.6)
|
%
|
Gross investment income
|
|
|
11,668
|
|
|
|
11,304
|
|
|
|
364
|
|
|
|
3.2
|
%
|
Investment expenses
|
|
|
(1,495
|
)
|
|
|
(1,712
|
)
|
|
|
217
|
|
|
|
12.7
|
%
|
Net investment income
|
|
|
10,173
|
|
|
|
9,592
|
|
|
$
|
581
|
|
|
|
6.1
|
%
|
Realized losses fixed income securities
|
|
|
(3,226
|
)
|
|
|
(8
|
)
|
|
$
|
(3,218
|
)
|
|
|
N/M
|
|
Realized gains equity securities
|
|
|
486
|
|
|
|
481
|
|
|
|
5
|
|
|
|
N/M
|
|
Mark-to-market valuation for interest rate swaps
|
|
|
(204
|
)
|
|
|
(206
|
)
|
|
|
2
|
|
|
|
N/M
|
|
Net realized (losses)/gains
|
|
|
(2,944
|
)
|
|
|
267
|
|
|
$
|
(3,211
|
)
|
|
|
N/M
|
|
30
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
|
|
|
|
|
|
|
2008 vs. 2007 Investment Income and Realized Gains
|
|
2008
|
|
2007
|
|
Change
|
|
% Change
|
|
|
(In thousands)
|
|
|
|
|
|
|
|
|
Fixed income securities
|
|
$
|
3,769
|
|
|
$
|
3,209
|
|
|
$
|
560
|
|
|
|
17.5
|
%
|
Dividends
|
|
|
87
|
|
|
|
72
|
|
|
|
15
|
|
|
|
20.8
|
%
|
Cash, cash equivalents & other
|
|
|
103
|
|
|
|
396
|
|
|
|
(293
|
)
|
|
|
(74.0)
|
%
|
Gross investment income
|
|
|
3,959
|
|
|
|
3,677
|
|
|
|
282
|
|
|
|
7.7
|
%
|
Investment expenses
|
|
|
(490
|
)
|
|
|
(797
|
)
|
|
|
307
|
|
|
|
38.5
|
%
|
Net investment income
|
|
|
3,469
|
|
|
|
2,880
|
|
|
$
|
589
|
|
|
|
20.5
|
%
|
Realized losses fixed income securities
|
|
|
(2,767
|
)
|
|
|
(8
|
)
|
|
$
|
(2,759
|
)
|
|
|
N/M
|
|
Realized gains equity securities
|
|
|
640
|
|
|
|
138
|
|
|
|
502
|
|
|
|
N/M
|
|
Mark-to-market valuation for interest rate swaps
|
|
|
(154
|
)
|
|
|
(496
|
)
|
|
|
342
|
|
|
|
N/M
|
|
Net realized losses
|
|
|
(2,281
|
)
|
|
|
(366
|
)
|
|
$
|
(1,915
|
)
|
|
|
N/M
|
|
(N/M means not meaningful)
Net investment income totaled $10.2 million and $9.6 million in the first nine months of 2008
and 2007, respectively, representing an increase of $0.6 million or 6.1%. Net investment income
for the first nine months of 2007 included $720,000 of interest income as a result of the
non-recurring impact of the retaliatory tax refund. Average cash and invested assets totaled $366
million for the first nine months of 2008 as compared to $331 million for the first nine months of
2007, representing an increase of $35 million. The increase in invested assets is driven primarily
by operating cash flow, including the benefits of the 2008 and 2007 reinsurance agreement changes,
which result in less premium being ceded to reinsurers.
In the first nine months of 2008, investment income on fixed income securities increased $1.4
million, or 14.9% to $11.1 million, as compared to $9.6 million in the same period in 2007. This
was driven by an increase in the average investments held in fixed
income securities. The Groups tax equivalent yield (yield adjusted for tax-benefit received on
tax-exempt securities) on fixed income securities remained stable at 5.15% and 5.24% for the first
nine months of 2008 and 2007, respectively.
Dividend income in the nine months ended September 30, 2008 was consistent to that of the same
period in 2007. Interest income on cash and cash equivalents decreased $1.1 million to $0.4 million
for the first nine months of 2008 as compared to $1.5 million for the first nine months of 2007,
primarily as a result of the $720,000 of non-recurring interest received on the retaliatory tax
refund in 2007. Investment expenses decreased 12.7%, or $0.2 million, to $1.5 million for the first
nine months of 2008 from $1.7 million for the first nine months of 2007.
Net investment income for the third quarter of 2008 increased $0.6 million or 20.5% to $3.5
million for the third quarter of 2008 as compared to $2.9 million for the third quarter of 2007.
The increase is attributable to the increase in average cash and invested assets.
Dividend income in the third quarter of 2008 was consistent from that of the same period in
2007. Interest income on cash and cash equivalents decreased $0.3 million to $0.1 million for the
third quarter of 2008 as compared to $0.4 million for the third quarter of 2007. Investment
expenses in the third quarter of 2008 decreased 38.5%, or $0.3 million, to $0.5 million in the
third quarter of 2008 from $0.8 million in the same period in 2007.
Net realized losses for the first nine months of 2008 were $2.9 million, as compared to net
realized gains of $0.3 million in the same period of 2007. In the first nine months of 2008, net
realized losses of $2.9 million included write-downs of securities determined to be other
than-temporarily impaired of $3.6 million, net gains on securities sales of $0.7 million, a loss on
the mark-to-market valuation on the interest rate swaps of $0.2 million. In the first nine months
of 2007, net realized gains of $0.3 million included net gains on securities sales of $0.5 million,
a loss on the mark-to-market valuation on the interest rate swaps of $0.2 million and write-downs
of securities determined to be other than-temporarily impaired of $28,000. Securities determined
to be other-than-temporarily impaired were written down to our estimate of fair market value at the
time of the write-down. See discussion of other than temporary impairments on investment securities
in the Critical Accounting Policies section. The Group has three ongoing interest rate swap
agreements to hedge against interest rate risk on its floating rate trust preferred securities. The
estimated fair value of the interest rates swaps is obtained from the third-party financial
institution counterparties. The Group marks the investments to market using these valuations and
records the change in the economic value of the interest rate swaps as a realized
31
gain or loss in
the consolidated statement of earnings.
The following table sets forth consolidated information concerning our investments.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At September 30, 2008
|
|
|
At December 31, 2007
|
|
|
At December 31, 2006
|
|
|
|
Cost (2)
|
|
|
Fair Value
|
|
|
Cost (2)
|
|
|
Fair Value
|
|
|
Cost (2)
|
|
|
Fair Value
|
|
|
|
(In thousands)
|
|
Fixed income securities (1):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
United States government and
government agencies (3)
|
|
$
|
87,372
|
|
|
$
|
87,957
|
|
|
$
|
84,736
|
|
|
$
|
85,454
|
|
|
$
|
75,683
|
|
|
$
|
74,981
|
|
Obligations of states and
political subdivisions
|
|
|
143,675
|
|
|
|
141,383
|
|
|
|
142,873
|
|
|
|
144,026
|
|
|
|
116,361
|
|
|
|
116,298
|
|
Industrial and miscellaneous
|
|
|
75,319
|
|
|
|
72,815
|
|
|
|
65,109
|
|
|
|
65,208
|
|
|
|
53,298
|
|
|
|
52,717
|
|
Mortgage-backed securities
|
|
|
27,262
|
|
|
|
26,393
|
|
|
|
29,260
|
|
|
|
29,550
|
|
|
|
29,427
|
|
|
|
29,458
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed income securities
|
|
|
333,628
|
|
|
|
328,548
|
|
|
|
321,978
|
|
|
|
324,238
|
|
|
|
274,769
|
|
|
|
273,454
|
|
Equity securities
|
|
|
12,351
|
|
|
|
14,730
|
|
|
|
12,500
|
|
|
|
17,930
|
|
|
|
10,940
|
|
|
|
16,522
|
|
Short-term investments
|
|
|
9,998
|
|
|
|
9,998
|
|
|
|
|
|
|
|
|
|
|
|
7,692
|
|
|
|
7,692
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
355,977
|
|
|
$
|
353,276
|
|
|
$
|
334,478
|
|
|
$
|
342,168
|
|
|
$
|
293,401
|
|
|
$
|
297,668
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
|
In our consolidated financial statements, investments are carried at fair value.
|
|
(2)
|
|
Original cost of equity securities; original cost of fixed income securities adjusted for
amortization of premium and accretion of discount, as well as any impairment write-downs.
|
|
(3)
|
|
Includes approximately $65,704, $57,862 and $48,840 (cost) and $66,177, $58,376 and $48,548
(estimated fair value) of mortgage-backed securities issued by U.S. government agencies as of September 30, 2008 and December 31, 2007 and 2006, respectively.
|
The following table shows our Industrial and miscellaneous fixed income securities and equity
holdings by industry sector:
32
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At September 30, 2008
|
|
|
At December 31, 2007
|
|
|
|
Cost (1)
|
|
|
Fair Value
|
|
|
Cost (1)
|
|
|
Fair Value
|
|
|
|
(In thousands)
|
|
Industrial and miscellaneous
fixed income securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Financial
|
|
$
|
33,968
|
|
|
$
|
32,291
|
|
|
$
|
35,784
|
|
|
$
|
35,603
|
|
Retail specialty
|
|
|
27,574
|
|
|
|
27,242
|
|
|
|
19,434
|
|
|
|
19,601
|
|
Energy
|
|
|
9,679
|
|
|
|
9,273
|
|
|
|
4,298
|
|
|
|
4,355
|
|
Pharmaceutical
|
|
|
2,249
|
|
|
|
2,237
|
|
|
|
2,747
|
|
|
|
2,792
|
|
Information technology
|
|
|
1,849
|
|
|
|
1,772
|
|
|
|
2,846
|
|
|
|
2,857
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
75,319
|
|
|
$
|
72,815
|
|
|
$
|
65,109
|
|
|
$
|
65,208
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Financial
|
|
$
|
3,287
|
|
|
$
|
3,394
|
|
|
$
|
4,364
|
|
|
$
|
6,007
|
|
Retail specialty
|
|
|
4,760
|
|
|
|
5,958
|
|
|
|
4,083
|
|
|
|
6,037
|
|
Energy
|
|
|
1,320
|
|
|
|
1,656
|
|
|
|
953
|
|
|
|
1,620
|
|
Pharmaceutical
|
|
|
1,001
|
|
|
|
1,542
|
|
|
|
840
|
|
|
|
1,379
|
|
Information technology
|
|
|
1,410
|
|
|
|
1,486
|
|
|
|
1,637
|
|
|
|
2,115
|
|
Transportation
|
|
|
573
|
|
|
|
694
|
|
|
|
623
|
|
|
|
772
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
12,351
|
|
|
$
|
14,730
|
|
|
$
|
12,500
|
|
|
$
|
17,930
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
|
Original cost of equity securities; original cost of fixed income securities adjusted
for amortization of premium and accretion of discount, as well as any impairment
write-downs.
|
We continue to maintain a conservative, diversified investment portfolio, with fixed maturity
investments representing 93% of invested assets. As of September 30, 2008, the fixed income
portfolio (including short term) consists of 99.8% investment grade securities, with the remaining
0.2% invested in two corporate securities held with a combined market value of $0.3 million, and
one asset-backed security held with a market value of $0.4 million. The fixed income portfolio has
an average rating of Aa2/AA, an average effective maturity of 5.3 years, and an average tax
equivalent book yield of 5.20%.
Among its portfolio holdings, the Groups only subprime exposure consists of asset-backed
securities (ABS) within the home equity subsector. The ABS home equity subsector totaled $1.1
million (book value) on September 30, 2008, representing 6.5% of the ABS holdings, 1.1% of the
total structured product holdings, and 0.3% of total fixed income holdings. The subprime related
exposure consists of four individual securities, two of which have a 100% credit enhancement, based
on insurance against default as to principal and interest. However, since FGIC and AMBAC have been
downgraded from AAA status, the two insured securities are now rated according to the higher of the
underlying collateral or the monoline rating. One bond is rated Baa1/BB while the other is rated
Aa3/AA. Among the two remaining securities without credit enhancement, one is rated Aaa/AAA and
the other is rated Aa2/AA by
Moodys and S&P, respectively.
The following table presents the Moodys Investor Service (Moodys) and S&Ps ratings of our
fixed maturities portfolio:
33
|
|
|
|
|
|
|
|
|
|
|
September 30,
|
|
December 31,
|
Type/Ratings of Investment (1)(2)
|
|
2008 (3)
|
|
2007 (3)
|
U.S. government and agencies
|
|
|
26.8
|
%
|
|
|
25.8
|
%
|
AAA
|
|
|
26.5
|
%
|
|
|
48.3
|
%
|
AA
|
|
|
28.9
|
%
|
|
|
11.1
|
%
|
A
|
|
|
16.1
|
%
|
|
|
14.4
|
%
|
BBB
|
|
|
1.5
|
%
|
|
|
0.3
|
%
|
BB
|
|
|
0.1
|
%
|
|
|
0.1
|
%
|
B
|
|
|
0.1
|
%
|
|
|
0.0
|
%
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
|
The ratings set forth in this table are based on the ratings assigned by Standard & Poors
Corporation (S&P). If S&Ps ratings were unavailable, the equivalent ratings supplied by
Moodys Investors Services, Inc., Fitch Investors Service, Inc. or the NAIC were used where
available.
|
|
(2)
|
|
The ratings shown above include, where applicable, credit enhancement by monoline bond
insurers (see Item 3 for discussion of credit enhancement on municipal bond holdings)
|
|
(3)
|
|
Represents the fair value of the classification as a percentage of the total fair value of
the portfolio.
|
The estimated fair value and unrealized loss for securities in a temporary unrealized loss
position as of September 30, 2008 are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less than 12 Months
|
|
|
12 Months or Longer
|
|
|
Total
|
|
|
|
Estimated
|
|
|
Unrealized
|
|
|
Estimated
|
|
|
Unrealized
|
|
|
Estimated
|
|
|
Unrealized
|
|
|
|
Fair Value
|
|
|
Losses
|
|
|
Fair Value
|
|
|
Losses
|
|
|
Fair Value
|
|
|
Losses
|
|
|
|
(In Thousands)
|
|
U.S. Treasury securities and
obligations of U.S.
government corporations
and agencies
|
|
$
|
23,060
|
|
|
$
|
183
|
|
|
$
|
960
|
|
|
$
|
30
|
|
|
$
|
24,020
|
|
|
$
|
213
|
|
Obligations of states and
political subdivisions
|
|
|
85,736
|
|
|
|
2,781
|
|
|
|
1,034
|
|
|
|
60
|
|
|
|
86,770
|
|
|
|
2,841
|
|
Corporate securities
|
|
|
53,417
|
|
|
|
2,461
|
|
|
|
2,582
|
|
|
|
188
|
|
|
|
55,999
|
|
|
|
2,649
|
|
Mortgage-backed securities
|
|
|
18,593
|
|
|
|
843
|
|
|
|
1,187
|
|
|
|
102
|
|
|
|
19,780
|
|
|
|
945
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed maturities
|
|
|
180,806
|
|
|
|
6,268
|
|
|
|
5,763
|
|
|
|
380
|
|
|
|
186,569
|
|
|
|
6,648
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total equity securities
|
|
|
4,403
|
|
|
|
723
|
|
|
|
1,225
|
|
|
|
139
|
|
|
|
5,628
|
|
|
|
862
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total securities in a
temporary unrealized loss
position
|
|
$
|
185,209
|
|
|
$
|
6,991
|
|
|
$
|
6,988
|
|
|
$
|
519
|
|
|
$
|
192,197
|
|
|
$
|
7,510
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized losses for fixed maturity securities and equities increased due to further
pressures in the credit and equity markets, with significantly wider credit spreads, particularly
in the banking and finance sectors. The capital markets remained difficult at the end of the third
quarter as participants continued to deleverage and reduce risk in an environment of general
uncertainty and distress. However, broad changes in the overall market or interest rate environment
do not, by themselves, lead to impairment charges and,
therefore, based on our analyses, which includes our review of the credit worthiness of the
issuers, coupled with our ability and intent to hold the securities through maturity and recovery,
securities were not considered other-than-temporarily impaired simply because of significant recent
price volatility. However, future
34
write-downs may become necessary if there are continued
unprecedented market and liquidity disruptions.
Fixed maturity investments with unrealized losses for less than twelve months are primarily
due to changes in the interest rate environment and anomalies in pricing in the current difficult
market. At September 30, 2008 the Group has 10 fixed maturity securities with unrealized losses
for more than twelve months. Of the 10 securities with unrealized losses for more than twelve
months, all of them have fair values of no less than 90% of book value. The Group does not believe
these declines are other than temporary due to the credit quality of the holdings. The Group
currently has the ability and intent to hold these securities until recovery.
In the first nine months of 2008, we incurred an impairment charge of $3.6 million for
eighteen securities that were determined to be other than temporarily impaired. In the first nine
months of 2007, we incurred an impairment charge of $28,000 for one security that was determined to
be other than temporarily impaired. See discussion of recent downgrades and other than temporary
impairments on investment securities in the Critical Accounting Policies section.
There are 28 common stock securities that are in an unrealized loss position at September 30,
2008. All of these securities have been in an unrealized loss position for less than five months.
There are six preferred stock securities that are in an unrealized loss position at September 30,
2008. Two preferred stock securities have been in an unrealized loss position for less than five
months. Four preferred stock securities have been in an unrealized loss position for more than
twelve months. The Group does not believe these declines are other than temporary as a result of
reviewing the circumstances of each such security in an unrealized loss position. The Group
currently has the ability and intent to hold these securities until recovery. However, future
write-downs may become necessary in light of unprecedented market and liquidity disruptions.
Results of our Commercial Lines segment were as follows. During 2007, the Group evaluated its
methodology for allocating costs to its lines of business and adopted changes to such methodology
in order to more accurately reflect the allocation of joint costs. This resulted in allocating
less joint cost to the personal lines of business and more joint cost to the commercial lines of
business, but with no net change in cost allocated to personal lines and commercial lines in the
aggregate. Previously reported 2007 amounts have been reclassified below to reflect this change in
allocation methodology:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
|
|
|
|
|
|
|
2008 vs. 2007 Commercial Lines (CL)
|
|
2008
|
|
2007
|
|
Change
|
|
% Change
|
|
|
(Dollars in thousands)
|
|
|
|
|
|
|
|
|
CL Direct premiums written
|
|
$
|
112,871
|
|
|
$
|
123,245
|
|
|
$
|
(10,374
|
)
|
|
|
(8.4)
|
%
|
CL Net premiums written
|
|
$
|
100,852
|
|
|
$
|
107,812
|
|
|
$
|
(6,960
|
)
|
|
|
(6.5)
|
%
|
CL Net premiums earned
|
|
$
|
100,496
|
|
|
$
|
90,287
|
|
|
$
|
10,209
|
|
|
|
11.3
|
%
|
CL Loss/ LAE expense ratio (GAAP)
|
|
|
61.1
|
%
|
|
|
59.9
|
%
|
|
|
1.2
|
%
|
|
|
|
|
CL Expense ratio (GAAP)
|
|
|
35.9
|
%
|
|
|
34.1
|
%
|
|
|
1.8
|
%
|
|
|
|
|
CL Combined ratio (GAAP)
|
|
|
97.0
|
%
|
|
|
94.0
|
%
|
|
|
3.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
|
|
|
|
|
|
|
2008 vs. 2007 Commercial Lines (CL)
|
|
2008
|
|
2007
|
|
Change
|
|
% Change
|
|
|
(Dollars in thousands)
|
|
|
|
|
|
|
|
|
CL Direct premiums written
|
|
$
|
36,237
|
|
|
$
|
40,871
|
|
|
$
|
(4,634
|
)
|
|
|
(11.3)
|
%
|
CL Net premiums written
|
|
$
|
32,187
|
|
|
$
|
35,598
|
|
|
$
|
(3,411
|
)
|
|
|
(9.6)
|
%
|
CL Net premiums earned
|
|
$
|
32,808
|
|
|
$
|
31,975
|
|
|
$
|
833
|
|
|
|
2.6
|
%
|
CL Loss/ LAE expense ratio (GAAP)
|
|
|
59.9
|
%
|
|
|
61.9
|
%
|
|
|
(2.0)
|
%
|
|
|
|
|
CL Expense ratio (GAAP)
|
|
|
37.7
|
%
|
|
|
34.3
|
%
|
|
|
3.4
|
%
|
|
|
|
|
CL Combined ratio (GAAP)
|
|
|
97.6
|
%
|
|
|
96.2
|
%
|
|
|
1.4
|
%
|
|
|
|
|
In the first nine months of 2008, our commercial lines direct premiums written decreased by
$10.4 million or 8.4% to $112.9 million as compared to direct written premium in the first nine
months of 2007 of $123.2 million. The decline in direct premiums written is attributed to several
factors including a decline in construction related activity and related audit premium in
California, increased competition on large accounts as well as the return of a number of
competitors tothe California contractor market and the East Coast habitational market. Our
35
California contractors book reflects the decreased economic
activity in the California construction market. Since the insurance premiums for these contractors
generally reflect their level of economic activity, the average premium per policy has fallen as
the insureds business has contracted, resulting in lower insurance exposures for these
contractors. The retention levels in this book remain attractive, and policy count is up
year-over-year, despite the decline in direct premium written. See additional discussion above in
the 2008 vs. 2007 Revenue discussion.
In the first nine months of 2008, our commercial lines net premiums earned increased by $10.2
million or 11.3% to $100.5 million as compared to net premiums earned in the first nine months of
2007 of $90.3 million. Net premiums earned increased 11.3% despite a 6.5% decline in net premiums
written, with the decline in net premiums written caused primarily by the 8.4% decline in direct
premiums written, offset by the positive impact on net premiums written of the change in
reinsurance structure (in 2007 retention increased to $750,000 from $250,000 and $350,000 in 2006
on FPICs casualty and property lines, respectively, and from $500,000 on MICs, MICNJs and FICs
2006 property, casualty and workers compensation lines, and in 2008 to $850,000 from $750,000).
Offsetting these factors was the reduction in audit premium recorded in 2008 which is earned
immediately upon booking.
In the third quarter of 2008, our commercial lines direct premiums written decreased by
$4.6 million, or 11.3%, to $36.2 million as compared to direct premiums written in the same period
of 2007 of $40.9 million. Net premiums earned in the same period increased 2.6%, or $0.8 million,
to $32.8 million from $32.0 million in the third quarter of 2007.
In the commercial lines segment for the first nine months of 2008, we had underwriting income
of $3.0 million, a GAAP combined ratio of 97.0%, a GAAP loss and loss adjustment expense ratio of
61.1% and a GAAP underwriting expense ratio of 35.9%, compared to underwriting income of $5.4
million, a GAAP combined ratio of 94.0%, a GAAP loss and loss adjustment expense ratio of 59.9% and
a GAAP underwriting expense ratio of 34.1% in the first nine months of 2007. Our commercial lines
loss ratio for the first nine months of 2008 reflects a higher frequency and claim severity than
the similar period in 2007 for casualty and property lines of business in our West Coast commercial
lines business. The performance of the commercial lines in the first nine months of 2007 was
impacted favorably by the non-recurring retaliatory tax refund.
In the commercial lines segment for the third quarter of 2008, we had underwriting income of
$0.7 million, a GAAP combined ratio of 97.6%, a GAAP loss and loss adjustment expense ratio of
59.9% and a GAAP underwriting expense ratio of 37.7%, compared to underwriting income of $1.2
million, a GAAP combined ratio of 96.2%, a GAAP loss and loss adjustment expense ratio of 61.9% and
a GAAP underwriting expense ratio of 34.3% in the third quarter of 2007. The performance of the
commercial lines in the third quarter of 2007 was impacted favorably by the non-recurring
retaliatory tax refund.
Results of our Personal Lines segment were as follows. During 2007, the Group evaluated its
methodology for allocating costs to its lines of business and adopted changes to such methodology
in order to more accurately reflect the allocation of joint costs. This resulted in allocating
less joint cost to the personal lines of business and more joint cost to the commercial lines of
business, but with no net change in cost allocated to personal lines and commercial lines in the
aggregate. Previously reported 2007 amounts have been reclassified below to reflect this change in
allocation methodology:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
|
|
|
|
|
|
|
2008 vs. 2007 Personal Lines (PL)
|
|
2008
|
|
2007
|
|
Change
|
|
% Change
|
|
|
(Dollars in thousands)
|
|
|
|
|
|
|
|
|
PL Direct premiums written
|
|
$
|
16,667
|
|
|
$
|
17,261
|
|
|
$
|
(594
|
)
|
|
|
(3.4
|
)%
|
PL Net premiums written
|
|
$
|
15,011
|
|
|
$
|
15,304
|
|
|
$
|
(293
|
)
|
|
|
(1.9
|
)%
|
PL Net premiums earned
|
|
$
|
15,094
|
|
|
$
|
16,080
|
|
|
$
|
(986
|
)
|
|
|
(6.1
|
)%
|
PL Loss/ LAE expense ratio (GAAP)
|
|
|
67.3
|
%
|
|
|
70.6
|
%
|
|
|
(3.3
|
)%
|
|
|
|
|
PL Expense ratio (GAAP)
|
|
|
37.6
|
%
|
|
|
28.2
|
%
|
|
|
9.4
|
%
|
|
|
|
|
PL Combined ratio (GAAP)
|
|
|
104.9
|
%
|
|
|
98.8
|
%
|
|
|
6.1
|
%
|
|
|
|
|
36
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
|
|
|
|
|
|
|
2008 vs. 2007 Personal Lines (PL)
|
|
2008
|
|
2007
|
|
Change
|
|
% Change
|
|
|
(Dollars in thousands)
|
|
|
|
|
|
|
|
|
PL Direct premiums written
|
|
$
|
5,924
|
|
|
$
|
6,156
|
|
|
$
|
(232
|
)
|
|
|
(3.8
|
)%
|
PL Net premiums written
|
|
$
|
5,388
|
|
|
$
|
5,512
|
|
|
$
|
(124
|
)
|
|
|
(2.2
|
)%
|
PL Net premiums earned
|
|
$
|
5,061
|
|
|
$
|
5,328
|
|
|
$
|
(267
|
)
|
|
|
(5.0
|
)%
|
PL Loss/ LAE expense ratio (GAAP)
|
|
|
62.8
|
%
|
|
|
55.9
|
%
|
|
|
6.9
|
%
|
|
|
|
|
PL Expense ratio (GAAP)
|
|
|
36.9
|
%
|
|
|
41.4
|
%
|
|
|
(4.5
|
)%
|
|
|
|
|
PL Combined ratio (GAAP)
|
|
|
99.7
|
%
|
|
|
97.3
|
%
|
|
|
2.4
|
%
|
|
|
|
|
Personal lines direct premiums written declined to $16.7 million in the first nine months of
2008 as compared to $17.3 million in the first nine months of 2007, representing a decline of $0.6
million or 3.4%. Personal lines direct premiums written declined to $5.9 million in the third
quarter of 2008 as compared to $6.2 million in the third quarter of 2007, representing a decline of
$0.2 million or 3.8%. Our personal lines have also been impacted by increased competition, similar
to our commercial lines.
In the personal lines segment for the first nine months of 2008, we had an underwriting loss
of $0.7 million, a GAAP combined ratio of 104.9%, a GAAP loss and loss adjustment expense ratio of
67.3% and a GAAP underwriting expense ratio of 37.6%, compared to underwriting income of $0.2
million, a GAAP combined ratio of 98.8%, a GAAP loss and loss adjustment expense ratio of 70.6% and
a GAAP underwriting expense ratio of 28.2% in the first nine months of 2007. Our personal lines
loss ratio for the first nine months of 2007 reflected increased severity, due to large losses
related to a variety of causes including an increase in water and freeze related claims.
In the personal lines segment for the third quarter of 2008, we had underwriting income of
$0.1 million, a GAAP combined ratio of 99.7%, a GAAP loss and loss adjustment expense ratio of
62.8% and a GAAP underwriting expense ratio of 36.9%, compared to underwriting income of $0.1
million, a GAAP combined ratio of 97.3%, a GAAP loss and loss adjustment expense ratio of 55.9% and
a GAAP underwriting expense ratio of 41.4% in the third quarter of 2007. Our personal lines loss
ratio for the third quarter of 2008 and 2007 reflects a frequency and severity of losses reported
within the range of our expectations.
Underwriting Expenses and the Expense Ratio is discussed below.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
|
|
|
|
|
|
|
2008 vs. 2007 Expenses and Expense Ratio
|
|
2008
|
|
2007
|
|
Change
|
|
% Change
|
|
|
(Dollars in thousands)
|
|
|
|
|
|
|
|
|
Amortization of Deferred Acquisition Costs
|
|
$
|
31,163
|
|
|
$
|
27,829
|
|
|
$
|
3,334
|
|
|
|
12.0
|
%
|
As a % of net premiums earned
|
|
|
27.0
|
%
|
|
|
26.2
|
%
|
|
|
0.8
|
%
|
|
|
|
|
Other underwriting expenses
|
|
|
10,618
|
|
|
|
7,530
|
|
|
|
3,088
|
|
|
|
41.0
|
%
|
Underwriting expenses
|
|
|
41,781
|
|
|
|
35,359
|
|
|
$
|
6,422
|
|
|
|
18.2
|
%
|
Underwriting expense ratio
|
|
|
36.1
|
%
|
|
|
33.2
|
%
|
|
|
2.9
|
%
|
|
|
|
|
Underwriting expenses increased by $6.4 million, or 18.2%, to $41.8 million in the first nine
months of 2008, as compared to $35.4 million in the first nine months of 2007. The increase in
underwriting expenses primarily reflects an increase in the amortization of deferred acquisition
costs in 2008 and the inclusion of the non-recurring retaliatory tax refund, which reduced other
underwriting expenses by $3.6 million in the first nine months of 2007. The amortization of
deferred acquisition costs increased in 2008 as compared to 2007 due to the increase in net earned
premium. Underwriting expenses also reflect lower share-based compensation expense under SFAS 123R
and lower net contingent commission expense. Lastly, underwriting expenses are impacted by the
previously discussed changes in the 2008 and 2007 reinsurance program whereby less ceded premium is
being recorded and accordingly less ceding commission is received, which increases underwriting
expenses and net acquisition costs.
Our Federal income tax was as follows:
37
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
|
|
|
|
|
|
|
2008 vs. 2007 Income Taxes
|
|
2008
|
|
2007
|
|
Change
|
|
% Change
|
|
|
(Dollars in thousands)
|
|
|
|
|
|
|
|
|
Income before income taxes
|
|
$
|
10,068
|
|
|
$
|
16,052
|
|
|
$
|
(5,984
|
)
|
|
|
(37.3
|
)%
|
Income taxes
|
|
|
2,463
|
|
|
|
4,697
|
|
|
|
(2,234
|
)
|
|
|
(47.6
|
)%
|
Net income
|
|
|
7,605
|
|
|
|
11,355
|
|
|
$
|
(3,750
|
)
|
|
|
(33.0
|
)%
|
Effective tax rate
|
|
|
24.5
|
%
|
|
|
29.3
|
%
|
|
|
(4.8
|
)%
|
|
|
|
|
Federal income tax expense was $2.5 million and $4.7 million for the first nine months of 2008
and 2007, respectively. The effective tax rate was 24.5% and 29.3% for the first nine months of
2008 and 2007, respectively. The 2007 effective tax rate was impacted by an unusually high amount
of taxable income in the period caused by the retaliatory tax refund, which increased the effective
tax rate. The 2008 effective tax rate was impacted by the higher level of other than temporary
investment impairments and by higher tax-advantaged income (municipal bond interest), which both
reduce the effective tax rate.
LIQUIDITY AND CAPITAL RESOURCES
Our insurance companies generate sufficient funds from their operations and maintain adequate
liquidity in their investment portfolios to fund operations, including the payment of claims. The
primary source of funds to meet the demands of claim settlements and operating expenses are premium
collections, investment earnings and maturing investments.
Our insurance companies maintain investment and reinsurance programs that are intended to
provide sufficient funds to meet their obligations without forced sales of investments. This
requires them to ladder the maturity of their portfolios and thereby maintain a portion of their
investment portfolio in relatively short-term and highly liquid assets to ensure the availability
of funds.
The principal source of liquidity for the Holding Company (which has modest expenses and does
not currently, or for the foreseeable future, need a significant regular source of cash flow to
cover these expenses other than its debt service on its indebtedness to MIC, its quarterly dividend
to shareholders, and the funding necessary for any stock repurchases pursuant to the currently
authorized stock repurchase program) is dividend payments and other fees received from the
insurance subsidiaries, and payments it receives on the 10-year note it received from the ESOP (see
below) when the ESOP purchased shares at the time of the conversion from a mutual to a stock form
of organization (the Conversion). The Holding Company also has access to an existing credit line
under which it can draw up to $5 million dollars.
On April 16, 2008, the Holding Company was authorized by the Board of Directors to repurchase,
at managements discretion, up to 5% of its outstanding stock. Any such purchases will be funded by
the Holding Companys existing resources, dividends from subsidiaries, or the credit line, or any
combination of these resources. As of September 30, 2008, the Holding Company had purchased,
pursuant to the authority granted by the Board on April 16, 2008, a total of 60,000 shares of
outstanding stock at an average cost of $17.53 per share, and is holding the stock as treasury
stock.
The Groups insurance companies are required by law to maintain a certain minimum surplus on a
statutory basis, and are subject to risk-based capital requirements and to regulations under which
payment of a dividend from statutory surplus may be restricted and may require prior approval of
regulatory authorities. Additionally, there is a covenant in the Groups line of credit agreement
that requires the Group to maintain at least 50% of its insurance companies capacity to pay
dividends without state regulation pre-approval.
All dividends from MIC to MIG require prior notice to the Pennsylvania Insurance Department.
All extraordinary dividends require advance approval. A dividend is deemed extraordinary if,
when aggregated with all other dividends paid within the preceding 12 months, the dividend exceeds
the greater of (a) statutory net income (excluding unrealized capital gains) for the preceding
calendar year or (b) 10% of statutory surplus as of the preceding December 31. As of December 31,
2007, the amount available for payment of dividends from MIC in 2008, without the prior approval,
is approximately $6.2 million. In 2005, MIC applied for, and received, approval to pay an
extraordinary dividend of $10 million, which was used in connection with the acquisition of FPIG.
All dividends from FPIC to FPIG (wholly owned by MIG) require prior notice to the California
Department of Insurance. All extraordinary dividends require advance approval. A dividend is
deemed extraordinary if, when aggregated with all other dividends paid
38
within the preceding 12
months, the dividend exceeds the greater of (a) statutory net income (excluding unrealized capital
gains) for the preceding calendar year or (b) 10% of statutory surplus as of the preceding
December 31. As of December 31, 2007, the amount available for payment of dividends from FPIC in
2008, without the prior approval, is approximately $6.0 million.
As part of the funding of the acquisition of FPIG, MIC entered into a loan agreement with
MIG, by which it advanced to MIG on September 30, 2005, a loan of $10 million with a 20-year term
and a fixed interest rate of 4.75%, repayable in 20 equal annual installments. MIG has no special
limitations on its ability to take periodic dividends from its insurance subsidiaries except for
normal dividend restrictions administered by the respective domiciliary state regulators as
described above. The Group believes that the resources available to MIG, will be adequate for it
to meet its obligation under the note to MIC, the line of credit and its other expenses.
MIG began paying quarterly dividends of $0.05 per common share in the second quarter of 2006.
On April 16, 2008, MIGs Board of Directors increased the quarterly dividend from $0.05 per share
of common stock to $0.075 per share of common stock, effective with the payment of the June 27,
2008 dividend. The amount of dividends paid during the first nine months of 2008 and 2007 totaled
$1.2 million and $0.9 million, respectively. The shareholder dividend was funded from the Groups
insurance companies, for which approval was sought and received (where necessary) from each of the
insurance companies primary regulators.
The Group maintains an Employee Stock Ownership Plan (ESOP), which purchased 626,111
shares from the Group at the time of the Conversion in return for a note bearing interest at 4% on
the principal amount of $6,261,110. MIC makes annual contributions to the ESOP sufficient for it to
make its required annual payment under the terms of the loan to the Holding Company. It is
anticipated that approximately 10% of the original ESOP shares will be allocated annually to
employee participants of the ESOP. An expense charge is booked ratably during each year for the
shares committed to be allocated to participants that year, determined with reference to the fair
market value of the Groups stock at the time the commitment to allocate the shares is accrued and
recognized. The issuance of the shares to the ESOP was fully recognized in the Additional Paid-in
Capital account at Conversion, with a contra account entitled Unearned ESOP Shares established in
the Stockholders Equity section of the balance sheet for the unallocated shares at an amount equal
to their original per-share purchase price. Shareholder dividends received on unallocated ESOP
shares are used to pay-down principal and interest owed on the loan to the Holding Company.
The Group adopted a stock-based incentive plan at its 2004 annual meeting of shareholders.
Pursuant to that plan, Mercer Insurance Group may issue a total of 876,555 shares, which amount
will increase automatically each year by 1% of the number of shares outstanding at the end of the
preceding year. At September 30, 2008, the number of shares authorized under the plan has been
increased under this provision to 1,141,565 shares. For the nine months ended September 30, 2008,
the Group made no grants of restricted stock and stock options. In addition, there were no
forfeitures of restricted stock and stock options and no options exercised during the first nine
months of 2008.
Total assets increased 3%, or $18.0 million, to $564.4 million, at September 30,
2008, as compared to $546.4 million at December 31, 2007. The Groups cash and invested assets
increased $4.2 million or 1%, primarily due to net cash provided by operating activities, offset by
declines in market value of securities within the portfolio. Premiums receivable increased $3.1
million or 9%, primarily due to timing differences in the writing and collecting of premium.
Reinsurance receivables increased $5.3 million or 6%, primarily due to an increase in ceded loss
and loss adjustment expense reserves. Prepaid reinsurance premiums decreased $2.0 million or 21%,
primarily due to a change in certain of the Groups reinsurance contracts, whereby fewer unearned
premium reserves are ceded. Property and equipment increased $2.3 million or 18% due to purchases
of hardware and software. Additionally, deferred income taxes increased $3.9 million or 51%, due
to changes in a variety of tax preference items.
Total liabilities increased 4% or $18.5 million, to $431.5 million at September 30, 2008
as compared to $413.0 million at December 31, 2007, primarily as a result of the increase in loss
and loss adjustment expense reserves of $24.6 million or 9%, offset by a decline in unearned
premiums of $1.8 million or 2%, a decline in accounts payable and accrued expenses of $1.1 million
or 7% and a decline in other reinsurance balances of $2.9 million or 20%. Unearned premiums
declined primarily due to the decline in written premium. Accounts payable and accrued expenses
declined primarily due to payments for agents profit sharing, state premium taxes, Group salary
bonuses and retirement funding and other payments normally made after year-end. Other reinsurance
balances declined primarily due to a change in certain of the Groups reinsurance contracts,
whereby fewer premium is ceded.
Total stockholders equity declined $0.4 million, to $133.0 million, at September 30,
2008, from $133.4 million at December 31, 2007, primarily due to net income of $7.6 million, stock
compensation plan amortization of $0.4 million, and ESOP shares committed to be allocated to
participants of $0.8 million, offset by stockholder dividends of $1.2 million, the purchase of
treasury stock of $1.1 million, changes in
39
valuation for the defined benefit pension plan of $0.1
million and changes in unrealized holding gains and losses on securities of $6.9 million.
IMPACT OF INFLATION
Inflation increases an insureds need for property and casualty insurance coverage. Inflation
also increases the cost of claims incurred by property and casualty insurers as property repairs,
replacements and medical expenses increase. These cost increases reduce profit margins to the
extent that rate increases are not implemented on an adequate and timely basis. We establish
property and casualty insurance premiums levels before the amount of losses and loss expenses, or
the extent to which inflation may affect these expenses, are known. Therefore, our insurance
companies attempt to anticipate the potential impact of inflation when establishing rates, and if
inflation is not adequately factored into rates, the rate increases will lag behind increases in
loss costs resulting from inflation. Because inflation has remained relatively low in recent years,
financial results have not been significantly affected by inflation.
Inflation also often results in increases in the general level of interest rates, and,
consequently, generally results in increased levels of investment income derived from our
investments portfolio, although increases in investment income will generally lag behind increases
in loss costs caused by inflation.
OFF BALANCE SHEET COMMITMENTS AND CONTRACTUAL OBLIGATIONS
The Group was not a party to any unconsolidated arrangement or financial instrument with
special purpose entities or other vehicles at September 30, 2008 which would give rise to
previously undisclosed market, credit or financing risk.
The Group has no significant contractual obligations at September 30, 2008, other than its
insurance obligations under its policies of insurance, trust preferred securities interest and
principal, a line of credit obligation, and operating lease obligations. Projected cash
disbursements pertaining to these obligations have not materially changed since December 31, 2007,
and the Group expects to have the resources to pay these obligations as they come due.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
General.
Market risk is the risk that we will incur losses due to adverse changes in market rates and
prices. We have exposure to three principal types of market risk through our investment activities:
interest rate risk, credit risk and equity risk. Our primary market risk exposure is to changes in
interest rates. We have not entered, and do not plan to enter, into any derivative financial
instruments for hedging, trading or speculative purposes, other than the interest rate swap
agreements that hedge the floating rate trust preferred securities which were assumed as part of
the FPIG acquisition.
Interest Rate Risk.
Interest rate risk is the risk that we will incur economic losses due to adverse changes in
interest rates. Our exposure to interest rate changes primarily results from our significant
holdings of fixed rate investments. Fluctuations in interest rates have a direct impact on the
market valuation of these securities. Our available-for-sale portfolio of fixed-income securities
is carried on the balance sheet at fair value. Therefore, an adverse change in market prices of
these securities would result in losses reflected in the balance sheet.
During the quarter ended September 30, 2008,
there were significant disruptions in the financial markets.
A number of large financial institutions failed, were supported by the
United States government or were merged into other organizations.
This market disruption resulted in reduced liquidity in the credit markets
and a widening of credit spreads, which, in turn, lowered the value of our
fixed income portfolio. As a result, the Company had a pre-tax net unrealized loss of
$5.1 million in its fixed income portfolio at September 30, 2008, as compared with a
pre-tax net unrealized gain of $2.3 million at December 31, 2007.
Credit Risk.
The quality of our interest-bearing investments is generally good. Our fixed maturity
securities at September 30, 2008, have an average rating of AA or better.
The credit crisis in 2008 and the disruption in the financial markets
has resulted in recognition of impairment losses in 2008, including the
write-down of a $1 million par value Lehman Brothers security (see discussion
of other than temporary impairments under the Investments section of the Critical
Accounting Policies discussion in Item 2, Managements
Discussion and Analysis of Financial Condition and Results of Operations).
Municipal Bond Holding Exposure.
The overall credit quality, based on weighted average Standard & Poors (S&P) ratings or
equivalent when the S&P rating is not available, of the total $141.4 million municipal fixed income
portfolio is:
40
|
o
|
|
AA+ including insurance enhancement
|
|
|
o
|
|
AA excluding insurance enhancement
|
|
|
|
99% of the underlying ratings are A- or better
|
|
|
|
|
84% of the underlying ratings are AA- or better
|
The municipal fixed income portfolio with insurance enhancement represents $101.3 million, or
72% of the total municipal fixed income portfolio.
|
o
|
|
The average credit quality with insurance enhancement is AA+
|
|
|
o
|
|
The average credit quality of the underlying, excluding insurance enhancement, is AA
|
|
|
o
|
|
Each municipal fixed income investment is evaluated based on its underlying
credit fundamentals, irrespective of credit enhancement provided by bond insurers
|
The municipal fixed income portfolio without insurance enhancement represents $40.1 million,
or 28% of the total municipal fixed income portfolio.
|
o
|
|
The average credit quality of those securities without enhancement is AA+
|
The following represents the Groups municipal fixed income portfolio as of September 30, 2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average Credit
|
|
Market
|
|
% of Total Muni
|
|
Unrealized
|
|
|
Rating
|
|
Value
|
|
Portfolio
|
|
Loss
|
|
|
(dollars in thousands)
|
Uninsured Securities
|
|
AA+
|
|
$
|
40,081,117
|
|
|
|
28
|
%
|
|
$
|
(672,361
|
)
|
Securities with
Insurance
Enhancement
|
|
AA+
|
|
|
101,301,550
|
|
|
|
72
|
%
|
|
|
(1,619,610
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
|
|
|
$
|
141,382,667
|
|
|
|
100
|
%
|
|
$
|
(2,291,971
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Market
|
|
|
|
|
Credit Enhancement
|
|
Value
|
|
|
% of Total
|
|
(dollars in thousands)
|
|
AMBAC
|
|
$
|
10,833,856
|
|
|
|
8
|
%
|
FGIC
|
|
|
28,100,839
|
|
|
|
20
|
%
|
FSA
|
|
|
28,728,327
|
|
|
|
20
|
%
|
MBIA
|
|
|
27,227,677
|
|
|
|
19
|
%
|
No Enhancement
|
|
|
31,773,013
|
|
|
|
23
|
%
|
Other Enhancement
|
|
|
5,811,268
|
|
|
|
4
|
%
|
Escrowed to Maturity
|
|
|
8,907,687
|
|
|
|
6
|
%
|
|
|
|
Grand Total
|
|
$
|
141,382,667
|
|
|
|
100
|
%
|
|
|
|
The following represents the Groups ratings on the municipal fixed income portfolio as of
September 30, 2008:
41
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Municipal
|
|
Total Municipal
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Underlying Rating
|
|
Fixed Income
|
|
Fixed Income
|
|
|
|
|
|
|
|
|
|
|
Insurance
|
|
of Insurance
|
|
Portfolio
|
|
Portfolio
|
|
|
Uninsured
|
|
Enhanced
|
|
Enhanced
|
|
(with Insurance
|
|
(without Insurance
|
|
|
Securities
|
|
Securities
|
|
Securities
|
|
Enhancement)
|
|
Enhancement)
|
|
|
(1)
|
|
(2)
|
|
(3)
|
|
(1) + (2)
|
|
(1) + (3)
|
|
|
(dollars in thousands)
|
S&P or
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
equivalent
|
|
Market
|
|
% of
|
|
Market
|
|
% of
|
|
Market
|
|
% of
|
|
Market
|
|
% of
|
|
Market
|
|
% of
|
ratings
|
|
Value
|
|
Total
|
|
Value
|
|
Total
|
|
Value
|
|
Total
|
|
Value
|
|
Total
|
|
Value
|
|
Total
|
AAA
|
|
$
|
20,845,743
|
|
|
|
52
|
%
|
|
$
|
37,096,474
|
|
|
|
37
|
%
|
|
$
|
11,550,400
|
|
|
|
11
|
%
|
|
$
|
57,942,217
|
|
|
|
41
|
%
|
|
$
|
32,396,143
|
|
|
|
23
|
%
|
AA+
|
|
|
4,010,409
|
|
|
|
10
|
%
|
|
|
20,040,095
|
|
|
|
20
|
%
|
|
|
26,150,711
|
|
|
|
26
|
%
|
|
|
24,050,504
|
|
|
|
17
|
%
|
|
|
30,161,120
|
|
|
|
20
|
%
|
AA
|
|
|
12,896,639
|
|
|
|
32
|
%
|
|
|
35,310,837
|
|
|
|
35
|
%
|
|
|
30,745,394
|
|
|
|
30
|
%
|
|
|
48,207,476
|
|
|
|
34
|
%
|
|
|
43,642,033
|
|
|
|
31
|
%
|
AA-
|
|
|
2,328,326
|
|
|
|
6
|
%
|
|
|
7,618,534
|
|
|
|
8
|
%
|
|
|
17,041,563
|
|
|
|
17
|
%
|
|
|
9,946,860
|
|
|
|
7
|
%
|
|
|
19,369,889
|
|
|
|
14
|
%
|
A+
|
|
|
|
|
|
|
|
|
|
|
202,020
|
|
|
|
0
|
%
|
|
|
6,376,417
|
|
|
|
6
|
%
|
|
|
202,020
|
|
|
|
0
|
%
|
|
|
6,376,417
|
|
|
|
5
|
%
|
A
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5,503,865
|
|
|
|
6
|
%
|
|
|
|
|
|
|
|
|
|
|
5,503,865
|
|
|
|
4
|
%
|
A-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,899,610
|
|
|
|
3
|
%
|
|
|
|
|
|
|
|
|
|
|
2,899,610
|
|
|
|
2
|
%
|
BBB-
|
|
|
|
|
|
|
|
|
|
|
1,033,590
|
|
|
|
1
|
%
|
|
|
1,033,590
|
|
|
|
1
|
%
|
|
|
1,033,590
|
|
|
|
1
|
%
|
|
|
1,033,590
|
|
|
|
1
|
%
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
40,081,117
|
|
|
|
100
|
%
|
|
$
|
101,301,550
|
|
|
|
100
|
%
|
|
$
|
101,301,550
|
|
|
|
100
|
%
|
|
$
|
141,382,667
|
|
|
|
100
|
%
|
|
$
|
141,382,667
|
|
|
|
100
|
%
|
|
|
|
|
|
|
|
|
|
|
|
Average Rating
|
|
AA+
|
|
|
|
|
|
|
AA+
|
|
|
|
|
|
|
AA
|
|
|
|
|
|
|
AA+
|
|
|
|
|
|
|
AA
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The Groups municipal portfolio has experienced ratings migration in 2008 as a result of the
downgrade of the claims paying ratings of nearly all of the monoline insurance companies. There
were no further downgrades during the third quarter of 2008 following the changes during the second
quarter. As of September 30, 2008, AMBAC was rated AA-/Aa3 by S&P and Moodys respectively; MBIA
was rated AA/A2 and FGIC was rated BB/B1. FSA retained its AAA/Aaa ratings but is weakly
positioned in this rating category due to higher risk residential mortgage-backed security exposure
in both its insured book and Financial Products segment.
Insured municipals generally carry two ratings: a standalone rating based on individual
fundamentals and an insured rating based on the claims paying ability of the issuers monoline
insurer (if the issue is insured). The monoline insurers downgrades triggered ratings downgrades
in the Groups insured municipal portfolio during the second quarter of 2008. When the monoline
insurers are downgraded, the ratings on insured municipal bonds are downgraded to the municipality
or revenue bonds underlying credit rating or the insured rating, whichever is higher.
As of September 30, 2008, all of the Groups municipal bonds carry an underlying rating of at
least an A- or better by S&P or Moodys, except $1 million of Puerto Rico Commonwealth bonds due in
2013. These bonds are rated Baa3/BBB-. The bonds were originally rated A3/A due to the insurance
provided by the monoline insurer, FGIC. When FGIC was downgraded, the Puerto Rico municipal bonds
were downgraded to their underlying or standalone rating of Baa3/BBB-, as FGICs rating is lower.
Structured Product Exposure.
The Groups structured product exposure includes commercial mortgage backed securities (CMBS),
residential mortgage backed securities (MBS) and asset backed securities (ABS). The total book
value, as of September 30, 2008, was $90.4 million and represented 27% of the total fixed income
portfolio.
As of September 30, 2008, CMBS holdings totaled $9.4 million (book value), representing 10% of
the total structured product holdings. All CMBS securities are rated Aaa/AAA by either Moodys,
S&P, or Fitch.
As of September 30, 2008, MBS holdings totaled $67.3 million (book value), representing 72% of
the total structured product holdings. The MBS securities consist of both pass-through and
collateralized mortgage obligation (CMO) structures. The pass-throughs are all agency
42
sponsored
securities and have a Aaa/AAA rating. Among the CMOs, a majority are agency sponsored and as a
result, also have a Aaa/AAA rating. The non-agency backed securities represent 15% of the CMO
holdings and 5% of total MBS holdings; five of six of such securities have a Aaa/AAA rating by
Moodys or S&P and one security is rated A by S&P.
As of September 30, 2008, ABS holdings totaled $16.3 million (book value), representing 18% of
the total structured product holdings. The ABS securities consist of a diversified blend of
subsectors including, automobile loan and credit card receivables, equipment financing, home
equity, rate reduction bonds, among other ABS. Outside of three holdings of home equity
(sub-prime), all ABS securities are rated Aaa/AAA by Moodys and S&P.
The ABS home equity subsector (collateral of sub-prime home equity loans) totaled $1.1 million
(book value) on September 30, 2008, representing 6.5% of the ABS holdings and 1.1% of the total
structured product holdings. This subsector exposure consists of four individual securities; two
have a 100% credit enhancement due to insurance. However, since FGIC and AMBAC were downgraded,
the ratings were impacted. The FGIC insured security is now rated as according to the underlying
collateral, or Baa1/BB. The other insured security is rated Aa3/AA based on AMBACs claim paying
ability. Among the two remaining securities without credit enhancement, one is rated Aaa/AAA and
one is rated Aa2/AA by Moodys and S&P, respectively.
There are two sectors where the Group has indirect exposure to subprime securities. These are
the U.S. agency and investment grade corporate sectors. As of September 30, 2008, the Group held
$15.0 million (book value) of agency debt, consisting predominately of Fannie Mae, Federal Home
Loan Bank, Freddie Mac, and Federal Farm Credit Bank securities.
The second sector of the market in which the Group has indirect exposure to subprime
securities is the investment grade corporate market. As of September 30, 2008, the Groups
portfolio held $75.3 million (book value) of corporate bonds. Among the corporate credit exposure,
$28.5 million or 38% of the holdings, were in the financial industry. The banking, brokerage, and
finance sectors of the investment grade corporate market continue to face stresses and challenges.
Although some issuers, particularly banks, will continue to need to strengthen their reserves and
write-off bad debts which will impact their earnings, it is expected that these issuers will
continue to pay principal and interest when due.
Equity Risk.
Equity price risk is the risk that we will incur economic losses due to adverse changes in
equity prices. Our exposure to changes in equity prices primarily results from our holdings of
common stocks, mutual funds and other equities. Our portfolio of equity securities is carried on
the balance sheet at fair value. Therefore, an adverse change in market prices of these securities
would result in losses reflected in the balance sheet.
Approximately 4% of our investment portfolio at September 30, 2008
is comprised of equity securities, down from 5% of the investment portfolio
at December 31, 2007. The decline is due primarily to lower valuations caused
by declines in the volatile equity markets in 2008. The Company had a pre-tax net
unrealized gain of $2.4 million in its equity portfolio at September 30, 2008, as
compared with a pre-tax net unrealized gain of $5.4 million at December 31, 2007.
Investments Outlook
The escalating credit crisis and interest rate volatility continued into the third quarter of
2008. Economic indicators pointed to further signs of deterioration for both the U.S. and global
economies although inflationary pressures lessened and the price of oil and other commodities fell
during the quarter. Furthermore, the difficult credit conditions worsened in September and
interbank lending seized up, as evidenced by a 300+ basis point
widening of the spread of the three-month LIBOR rate over the
three-month T-bill rate.
Modern financial markets have not experienced such a credit crunch as of late and the
implications of a sustained reduction in lending has prompted unprecedented actions by the Federal
Reserve and Federal Government to allay fears and provide liquidity.
For fixed maturity securities, yield and income generation remain the key drivers to our
investment strategy and our overall philosophy is to invest with a long-term horizon and a
buy-and-hold principle. Reliance on independent investment research to avoid potential
difficulties will continue to be a key driver behind our investment decisions. The continued
volatility in fixed income spreads may provide attractive investment opportunities, particularly in
the municipal and corporate bond sector.
With all these risks present, we are increasingly cautious in the equities markets and will
continue to manage through this period of uncertainty by investing in companies with more defensive
characteristics, such as strong balance sheets and reasonable valuations. Other considerations are
favorable long-term corporate performance and attractive relative historical valuations.
43
Item 4. Controls and Procedures
Under the supervision and with the participation of our management, including the President
and Chief Executive Officer and the Senior Vice President and Chief Financial Officer, we have
evaluated the effectiveness of our disclosure controls and procedures as required by Exchange Act
Rule 13a-15(b) as of September 30, 2008. Based on that evaluation, the President and Chief
Executive Officer and the Senior Vice President and Chief Financial Officer have concluded that
these disclosure controls and procedures were effective as of September 30, 2008. There were no
changes in our internal control over financial reporting during the nine months ended September 30,
2008 that have materially affected, or are reasonably likely to materially affect, our internal
control over financial reporting.
Part II OTHER INFORMATION
Item 1. Legal Proceedings.
None
Item 1A. Risk Factors.
During 2008, there have been significant disruptions in the financial and equity markets.
This resulted from, in part, failures of financial institutions on an
unprecedented scale, and caused reduced liquidity in the credit markets and a
widening of credit spreads, which resulted in lowered valuations for fixed income
securities and equity securities held by the Company. If the financial and equity
markets continue their adverse 2008 performance, the Companys business and Stockholders
Equity could be adversely affected.
Please also see risk factors previously disclosed in the registrants Form
10-K for the year ended December 31, 2007.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Number of Shares Purchased as
|
|
Maximum Number of Shares That
|
|
|
Total Number of
|
|
Average Price
|
|
Part of Publicly Announced Plans or
|
|
May Yet Be Purchased Under The
|
Period
|
|
Shares Purchased
|
|
Paid per Share
|
|
Programs (Note 1)
|
|
Plans or Programs (Note 1)
|
July 1-31, 2008
|
|
|
0
|
|
|
|
N/A
|
|
|
|
0
|
|
|
|
303,476
|
|
|
August 1-31, 2008
|
|
|
0
|
|
|
|
N/A
|
|
|
|
0
|
|
|
|
303,476
|
|
|
September 1-30, 2008
|
|
|
35,000
|
|
|
$
|
17.43
|
|
|
|
35,000
|
|
|
|
268,476
|
|
|
Total
|
|
|
35,000
|
|
|
$
|
17.43
|
|
|
|
35,000
|
|
|
|
268,476
|
|
Note 1 On April 16, 2008, the Groups Board of Directors authorized the repurchase of up to 5% of
outstanding common shares of the Group. The repurchased shares will be held as treasury shares
available for issuance in connection with Mercer Insurance Groups 2004 Stock Incentive Plan. In
addition to the shares described above, in June, 2008, the Group purchased 1,344 shares from
employees in connection with the vesting of restricted stock. These repurchases were made to
satisfy tax withholding obligations with respect to those employees and the vesting of their
restricted stock. These shares were purchased at the current market value of the Groups common
stock on the date of purchase, and were not purchased as part of the publicly announced program.
Item 3. Defaults Upon Senior Securities
None
44
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits
Exhibits
|
|
|
Exhibit No.
|
|
Title
|
3.1
|
|
Articles of Incorporation of Mercer Insurance Group, Inc.
(incorporated by reference herein to the Groups Pre-effective
Amendment No. 3 on Form S-1, SEC File No. 333-104897.)
|
|
|
|
3.2
|
|
Bylaws of Mercer Insurance Group, Inc. (incorporated by
reference herein to the Groups Annual Report on Form 10-K,
SEC File No. 000-25425, for the fiscal year ended December 31,
2003.)
|
|
|
|
31.1
|
|
Certification of Chief Executive Officer in accordance with
Section 302 of the Sarbanes-Oxley Act of 2002, (filed
herewith)
|
|
|
|
31.2
|
|
Certification of Chief Financial Officer in accordance with
Section 302 of the Sarbanes-Oxley Act of 2002, (filed
herewith)
|
|
|
|
32.1
|
|
Certification of Chief Executive Officer in accordance with
Section 906 of the Sarbanes-Oxley Act of 2002, (filed
herewith)
|
|
|
|
32.2
|
|
Certification of Chief Financial Officer in accordance with
Section 906 of the Sarbanes-Oxley Act of 2002, (filed
herewith)
|
45
SIGNATURES
In accordance with the requirements of the Exchange Act, the Registrant caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized.
|
|
|
|
|
|
MERCER INSURANCE GROUP, INC. (Registrant)
|
|
|
Dated: November 10, 2008
|
By:
|
/s/ Andrew R. Speaker
|
|
|
|
Andrew R. Speaker,
|
|
|
|
President and Chief Executive Officer
|
|
|
|
|
|
Dated: November 10, 2008
|
By:
|
/s/ David B. Merclean
|
|
|
|
David B. Merclean,
|
|
|
|
Senior Vice President and Chief Financial Officer
|
|
46
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