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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, 2004,

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)

 

PENNSYLVANIA

23-2934601

(State or other jurisdiction of incorporation or organization)

(I.R.S. Employer Identification No.)

 

 

10 North Highway 31, P.O. Box 278, Pennington, NJ

08534

(Address of principal executive offices)

(Zip Code)

 

 

(609) 737-0426

(Registrant’s telephone number, including area code)

 

 

 

 

(Former name, former address and former fiscal year, if changed since last report)

 

Check whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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 ý       No o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).                                                                                       Yes ý       No ¨

 

State the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

 

 

Number of Shares Outstanding as of October 15, 2004

 

COMMON STOCK (No Par Value)

 

6,810,733

 

(Title of Class)

 

(Outstanding Shares)

 

 

 



 

TABLE OF CONTENTS

 

PART I.  FINANCIAL INFORMATION

 

 

 

 

Item 1.

Financial Statements

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

Item 4.

Controls and Procedures

 

 

 

 

PART II.  OTHER INFORMATION

 

 

 

 

Item 1.

Legal Proceedings

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

Item 3.

Defaults Upon Senior Securities

 

Item 4.

Submission of Matters to a Vote of Security Holders

 

Item 5.

Other Information

 

Item 6.

Exhibits

 

 

 

SIGNATURES

 

 

 

Exhibits:

 

 

Exhibit No.

 

Title

31.1

 

Certification of Chief Executive Officer in accordance with Section 302 of the Sarbanes-Oxley Act of 2002

31.2

 

Certification of Chief Financial Officer in accordance with Section 302 of the Sarbanes-Oxley Act of 2002

32.1

 

Certifications of Chief Executive Officer and Chief Financial Officer in accordance with Section 906 of the Sarbanes-Oxley Act of 2002

 

i



 

Forward-looking Statements

 

Mercer Insurance Group, Inc. (the “Company”) may from time to time make written or oral “forward-looking statements,” including statements contained in the Company’s 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 Company, which are made in good faith by the Company 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 Company’s 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 Company’s 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 Company’s 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 Company competes which are less favorable than expected;

 

                  the effects of weather-related and other catastrophic events;

 

                  the concentration of insured accounts in New Jersey and Pennsylvania;

 

                  the effect of legislative, judicial, economic, demographic and regulatory events in the two states in which we do business;

 

                  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;

 

                  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;

 

1



 

                  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;

 

                  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; and

 

                  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.

 

The Company 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 management’s analysis only as of the date of this report.  The Company 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 Company.

 

2



 

Part I - FINANCIAL INFORMATION

 

Item 1.  Financial Statements

 

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED BALANCE SHEETS
As of September 30, 2004 and December 31, 2003

 

 

 

As of
September 30,
2004

 

As of
December 31,
2003

 

 

 

(Dollars in thousands)

 

 

 

(Unaudited)

 

 

 

ASSETS

 

 

 

 

 

Investments, at fair value:

 

 

 

 

 

Fixed income securities, available-for-sale, at fair value (amortized cost of $94,897 and $46,282, respectively)

 

$

94,494

 

$

46,277

 

Equity securities, at fair value (cost of $16,131 and $15,866,respectively)

 

22,953

 

22,656

 

Short-term investments, at amortized cost, which approximates fair value

 

10,599

 

54,396

 

Total investments

 

128,046

 

123,329

 

Cash and cash equivalents

 

9,123

 

15,350

 

Premiums receivable

 

9,173

 

9,096

 

Reinsurance receivables

 

2,992

 

4,159

 

Prepaid reinsurance premiums

 

1,437

 

1,614

 

Deferred policy acquisition costs

 

7,618

 

7,387

 

Accrued investment income

 

877

 

596

 

Property and equipment, net

 

9,723

 

6,944

 

Goodwill

 

4,673

 

4,673

 

Other assets

 

2,112

 

2,727

 

Total assets

 

$

175,774

 

$

175,875

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Liabilities:

 

 

 

 

 

Losses and loss adjustment expenses

 

$

37,227

 

$

37,261

 

Unearned premiums

 

30,728

 

30,329

 

Accounts payable and accrued expenses

 

7,359

 

7,937

 

Other reinsurance balances

 

13

 

81

 

Other liabilities

 

1,425

 

1,228

 

Deferred income taxes

 

704

 

713

 

Total liabilities

 

77,456

 

77,549

 

Stockholders’ Equity:

 

 

 

 

 

Preferred stock, no par value, authorized 5,000,000 shares, no shares issued and outstanding

 

 

 

Common stock, no par value, authorized 15,000,000 shares, issued 7,060,733 shares, outstanding 6,079,106 and 6,282,233 shares

 

 

 

Additional paid-in capital

 

67,608

 

64,871

 

Accumulated other comprehensive income:

 

 

 

 

 

Unrealized gains in investments, net of deferred income taxes

 

4,237

 

4,478

 

Retained earnings

 

37,033

 

34,612

 

Unearned restricted stock compensation

 

(2,419

)

 

Unearned ESOP shares

 

(5,166

)

(5,635

)

Treasury stock, at cost, 250,000 and -0- shares

 

(2,975

)

 

Total stockholders’equity

 

98,318

 

98,326

 

Total liabilities and stockholders’ equity

 

$

175,774

 

$

175,875

 

 

See accompanying notes to condensed consolidated financial statements.

 

3



 

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
Nine Months Ended September 30, 2004 and 2003

 

 

 

2004

 

2003

 

 

 

(Dollars in thousands, except
shares and per share data)

 

 

 

(Unaudited)

 

Revenue:

 

 

 

 

 

Net premiums earned

 

$

41,617

 

$

34,762

 

Investment income, net of expenses

 

1,933

 

1,221

 

Net realized investment gains

 

439

 

130

 

Other revenue

 

266

 

292

 

Total revenue

 

44,255

 

36,405

 

 

 

 

 

 

 

Expenses:

 

 

 

 

 

Losses and loss adjustment expenses

 

21,103

 

19,600

 

Amortization of deferred policy acquisition costs (related party amounts of $1,120 and $884, respectively)

 

11,509

 

9,396

 

Other expenses

 

8,212

 

6,587

 

Stock conversion expenses

 

 

65

 

Total expenses

 

40,824

 

35,648

 

Income before income taxes and minority interest in income of subsidiary

 

3,431

 

757

 

Income taxes

 

1,010

 

188

 

Income before minority interest in income of subsidiary

 

2,421

 

569

 

Minority interest in income of subsidiary

 

 

(124

)

Net income

 

$

2,421

 

$

445

 

Earnings per common share:

 

 

 

 

 

Basic

 

$

0.39

 

N/A

 

Diluted

 

$

0.38

 

N/A

 

Weighted average shares:

 

 

 

 

 

Basic

 

6,287,602

 

N/A

 

Diluted

 

6,371,562

 

N/A

 

 

See accompanying notes to condensed consolidated financial statements.

 

4



 

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
Three Months Ended September 30, 2004 and 2003

 

 

 

2004

 

2003

 

 

 

(Dollars in thousands, except
shares and per share data)

 

 

 

(Unaudited)

 

Revenue:

 

 

 

 

 

Net premiums earned

 

$

14,032

 

$

12,379

 

Investment income, net of expenses

 

639

 

400

 

Net realized investment gains

 

340

 

167

 

Other revenue

 

86

 

101

 

Total revenue

 

15,097

 

13,047

 

 

 

 

 

 

 

Expenses:

 

 

 

 

 

Losses and loss adjustment expenses

 

6,173

 

6,859

 

Amortization of deferred policy acquisition costs (related party amounts of $457 and $304, respectively)

 

3,867

 

3,325

 

Other expenses

 

3,373

 

2,571

 

Stock conversion expenses

 

 

3

 

Total expenses

 

13,413

 

12,758

 

Income before income taxes and minority interest in income of subsidiary

 

1,684

 

289

 

Income taxes

 

563

 

84

 

Income before minority interest in income of subsidiary

 

1,121

 

205

 

Minority interest in income of subsidiary

 

 

(33

)

Net income

 

$

1,121

 

$

172

 

Earnings per common share:

 

 

 

 

 

Basic

 

$

0.18

 

N/A

 

Diluted

 

$

0.17

 

N/A

 

Weighted average shares:

 

 

 

 

 

Basic

 

6,267,258

 

N/A

 

Diluted

 

6,482,258

 

N/A

 

 

See accompanying notes to condensed consolidated financial statements.

 

5



 

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
Nine months ended September 30, 2004
(Unaudited, dollars in thousands)

 

 

 

Preferred
stock

 

Common
stock

 

Additional
paid-in
capital

 

Accumulated
other
comprehensive
income

 

Retained
earnings

 

Unearned
restricted
stock
compensation

 

Unearned
ESOP
shares

 

Treasury
Stock

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, December 31, 2003

 

$

 

 

64,871

 

4,478

 

34,612

 

 

(5,635

)

 

$

98,326

 

Net income

 

 

 

 

 

 

 

 

 

2,421

 

 

 

 

 

 

 

2,421

 

Unrealized losses on securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized holding gains arising during period, net of related income tax expense of ($25)

 

 

 

 

 

 

 

49

 

 

 

 

 

 

 

 

 

49

 

Less reclassification adjustment for gains included in net income, net of related income tax expense of ($149)

 

 

 

 

 

 

 

(290

)

 

 

 

 

 

 

 

 

(290

)

Other comprehensive loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(241

)

Comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2,180

 

Unearned restricted stock compensation

 

 

 

 

 

2,625

 

 

 

 

 

(2,625

)

 

 

 

 

 

Amortization of restricted stock compensation

 

 

 

 

 

 

 

 

 

 

 

206

 

 

 

 

 

206

 

ESOP shares committed

 

 

 

 

 

112

 

 

 

 

 

 

 

469

 

 

 

581

 

Treasury stock purchased

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(2,975

)

(2,975

)

Balance, September 30, 2004

 

$

 

 

67,608

 

4,237

 

37,033

 

(2,419

)

(5,166

)

(2,975

)

$

98,318

 

 

See accompanying notes to condensed consolidated financial statements.

 

6



 

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended September 30, 2004 and 2003

 

 

 

2004

 

2003

 

 

 

(Dollars in thousands)
(Unaudited)

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

2,421

 

$

445

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Depreciation and amortization of fixed assets

 

1,087

 

974

 

Net amortization of premium or (accretion of discount)

 

67

 

(50

)

Amortization of restricted stock compensation

 

206

 

 

ESOP share commitment

 

581

 

 

Net realized investment gains

 

(439

)

(130

)

Deferred income tax

 

115

 

(234

)

Change in assets and liabilities:

 

 

 

 

 

Premiums receivable

 

(77

)

(2,251

)

Reinsurance receivables

 

1,167

 

(879

)

Prepaid reinsurance premiums

 

177

 

(379

)

Deferred policy acquisition costs

 

(231

)

(963

)

Other assets

 

334

 

(1,522

)

Losses and loss expenses

 

(34

)

3,962

 

Unearned premiums

 

399

 

4,849

 

Other

 

(449

)

(2,413

)

Net cash provided by operating activities

 

5,324

 

1,409

 

Cash flows from investing activities:

 

 

 

 

 

Purchase of fixed income securities, available-for- sale

 

(74,287

)

(23,189

)

Purchase of equity securities

 

(2,532

)

(3,342

)

Sale and maturity of fixed income securities, available-for-sale

 

25,459

 

23,694

 

Sale of equity securities

 

2,857

 

4,424

 

Sale of short-term investments, net

 

43,797

 

 

Purchase of property and equipment

 

(3,870

)

(1,776

)

Net cash used by investing activities

 

(8,576

)

(189

)

Cash flows from financing activities:

 

 

 

 

 

Purchase of treasury stock

 

(2,975

)

 

Net cash used by financing activities

 

(2,975

)

 

Net (decrease) increase in cash and cash equivalents

 

(6,227

)

1,220

 

Cash and cash equivalents at beginning of period

 

15,350

 

7,201

 

Cash and cash equivalents at end of period

 

$

9,123

 

$

8,421

 

Cash paid during the period for:

 

 

 

 

 

Interest

 

$

35

 

$

36

 

Income taxes

 

$

 

$

 

 

See accompanying notes to condensed consolidated financial statements.

 

7



 

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands)
(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.

 

These financial statements should be read in conjunction with the financial statements and notes for the year ended December 31, 2003 included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission.

 

(2)  Segment Information

 

The Company manages its business in three segments: commercial lines insurance, personal lines insurance, and investments.  The commercial lines insurance and personal lines insurance segments are managed based on underwriting results determined in accordance with accounting principles generally accepted in the United States of America, 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.

 

8



 

Financial data by segment is as follows for the nine months ended September 30, 2004 and 2003:

 

 

 

Nine Months Ended September 30

 

 

 

2004

 

2003

 

 

 

(In thousands)

 

Revenues:

 

 

 

 

 

Net premiums earned:

 

 

 

 

 

Commercial lines

 

$

24,150

 

$

18,569

 

Personal lines

 

17,467

 

16,193

 

Total net premiums earned

 

41,617

 

34,762

 

Net investment income

 

1,933

 

1,221

 

Realized investment gains

 

439

 

130

 

Other

 

266

 

292

 

Total revenues

 

44,255

 

36,405

 

Income before income taxes:

 

 

 

 

 

Underwriting income (loss):

 

 

 

 

 

Commercial lines

 

5,384

 

2,568

 

Personal lines

 

(4,591

)

(3,389

)

Total underwriting income (loss)

 

793

 

(821

)

Net investment income

 

1,933

 

1,221

 

Realized investment gains

 

439

 

130

 

Other

 

266

 

227

 

Income before income taxes and minority interest in income of subsidiary

 

$

3,431

 

$

757

 

 

Financial data by segment is as follows for the three months ended September 30, 2004 and 2003:

 

 

 

Three Months Ended September 30

 

 

 

2004

 

2003

 

 

 

(In thousands)

 

Revenues:

 

 

 

 

 

Net premiums earned:

 

 

 

 

 

Commercial lines

 

$

8,295

 

$

6,881

 

Personal lines

 

5,737

 

5,498

 

Total net premiums earned

 

14,032

 

12,379

 

Net investment income

 

639

 

400

 

Realized investment gains

 

340

 

167

 

Other

 

86

 

101

 

Total revenues

 

15,097

 

13,047

 

Income before income taxes:

 

 

 

 

 

Underwriting income (loss):

 

 

 

 

 

Commercial lines

 

1,880

 

899

 

Personal lines

 

(1,261

)

(1,275

)

Total underwriting income (loss)

 

619

 

(376

)

Net investment income

 

639

 

400

 

Realized investment gains

 

340

 

167

 

Other

 

86

 

98

 

Income before income taxes and minority interest in income of subsidiary

 

$

1,684

 

$

289

 

 

(3)  Reinsurance

 

Premiums earned are net of amounts ceded of $6,377 and $7,087 for the nine months ended September 30, 2004 and 2003, respectively, and $2,048 and $2,428 for the three months ended September 30, 2004 and 2003, respectively. Losses and loss adjustment expenses are net of amounts ceded of $451 and $2,122 for the nine months ended September 30, 2004 and 2003, respectively, and $157 and $1,513 for the three months ended September 30, 2004 and 2003, respectively.

 

9



 

(4)  Comprehensive Income

 

The Company’s comprehensive income for the nine month period ended September 30, 2004 and 2003 is as follows:

 

 

 

Nine Months ended
September 30

 

 

 

2004

 

2003

 

 

 

(In thousands)

 

 

 

 

 

 

 

Net income

 

$

2,421

 

$

445

 

Other comprehensive income, net of tax:

 

 

 

 

 

Unrealized gains on securities:

 

 

 

 

 

Unrealized holding gains arising during period, net of related income tax expense of $25, and $566

 

49

 

1,099

 

Less reclassification adjustment for gains included in net income, net of related income tax expense of $149 and $44

 

(290

)

(86

)

 

 

(241

)

1,013

 

Comprehensive Income

 

$

2,180

 

$

1,458

 

 

The Company’s comprehensive income for the three month period ended September 30, 2004 and 2003 is as follows:

 

 

 

Three Months ended
September 30

 

 

 

2004

 

2003

 

 

 

(In thousands)

 

 

 

 

 

 

 

Net income

 

$

1,121

 

$

172

 

Other comprehensive income, net of tax:

 

 

 

 

 

Unrealized gains on securities:

 

 

 

 

 

Unrealized holding gains arising during period, net of related income tax expense of $611, and $89

 

1,186

 

173

 

Less reclassification adjustment for gains included in net income, net of related income tax expense of $116 and $57

 

(224

)

(110

)

 

 

962

 

63

 

Comprehensive Income

 

$

2,083

 

$

235

 

 

(5)  Stock-based Compensation

 

Stock-based compensation plans are accounted for under the provisions of Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. Accordingly, no compensation expense is recognized for fixed stock option grants. Compensation expense would be recorded on the date of a stock option grant only if the current market price of the underlying stock exceeded the exercise price. The following table illustrates the effect on net income and earnings per share as if the provisions of Statement of Financial Accounting Standards (SFAS) No. 123 (as amended by SFAS No. 148), “Accounting for Stock-Based Compensation,” had been applied to all periods presented.

 

10



 

 

 

Nine months ended

 

 

 

September 30,
2004

 

September 30,
2003

 

 

 

(In thousands,
except per share data)

 

Net income, as reported

 

$

2,421

 

$

445

 

Plus: Stock-based employee compensation expense included in reported net income, net of related tax effects

 

136

 

0

 

 

 

 

 

 

 

Less: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects

 

(289

)

0

 

Pro forma net income

 

$

2,268

 

$

445

 

Basic earnings per share:

 

 

 

 

 

As reported

 

$

0.39

 

N/A

 

Pro forma

 

$

0.36

 

N/A

 

Diluted earnings per share:

 

 

 

 

 

As reported

 

$

0.38

 

N/A

 

Pro forma

 

$

0.36

 

N/A

 

 

 

 

Quarter ended

 

 

 

September 30,
2004

 

September 30,
2003

 

 

 

(In thousands,
except per share data)

 

Net income, as reported

 

$

1,121

 

$

172

 

 

 

 

 

 

 

Plus: Stock-based employee compensation expense included in reported net income, net of related tax effects

 

114

 

0

 

 

 

 

 

 

 

Less: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects

 

(246

)

0

 

Pro forma net income

 

$

989

 

$

172

 

Basic earnings per share:

 

 

 

 

 

As reported

 

$

0.18

 

N/A

 

Pro forma

 

$

0.16

 

N/A

 

Diluted earnings per share:

 

 

 

 

 

As reported

 

$

0.17

 

N/A

 

Pro forma

 

$

0.15

 

N/A

 

 

The Company adopted the Mercer Insurance Group, Inc. 2004 Stock Incentive Plan (the Plan) on June 16, 2004. Awards may be made in the form of incentive stock options, nonqualified stock options, restricted stock or any combination to employees and non-employee Directors. The Plan limits 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 authorized in the plan is 876,555 shares, with an annual increase equal to 1% of the shares outstanding at the end of the previous year. 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

 

11



 

incentive stock options, and ten years and 1 month for nonqualified stock options, and the option price may not be less than fair market value on the date of grant. The 2004 grants have vesting periods of 3 or 5 years on restricted stock, incentive stock options, and nonqualified stock options.

 

Information regarding fixed stock option activity in Mercer Insurance Group’s plan is presented below:

 

 

 

Number
of shares

 

Weighted Average
Exercise Price
Per Share

 

 

 

 

 

 

 

Outstanding at December 31, 2003

 

0

 

$

0.00

 

Granted – 2004

 

537,700

 

12.21

 

Exercised – 2004

 

0

 

0.00

 

Forfeited – 2004

 

0

 

0.00

 

 

 

 

 

 

 

Outstanding at September 30, 2004

 

537,700

 

$

12.21

 

 

 

 

 

 

 

Exercisable at:

 

 

 

 

 

September 30, 2004

 

0

 

$

0.00

 

Weighted-average remaining contractual life

 

9.7 years

 

 

 

 

The per share weighted-average fair value of options granted during 2004 was $4.19. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants in 2004: dividend yield of 0%; expected volatility of 20.91%; risk-free interest rate of 4.73%, and an expected life of 6.5 years.

 

Grants of 215,000 shares of restricted stock were awarded to employees and non-employee Directors in 2004.  The weighted average price per share on the grant date was $12.21 per share.

 

(6)  Earnings per Share

 

The computation of basic and diluted earnings per share is as follows:

 

 

 

Nine months ended
September 30,

 

 

 

2004

 

2003

 

 

 

(Dollars in thousands, except per share data)

 

Numerator for basic and diluted earnings per share:

 

 

 

 

 

Net income

 

$

2,421

 

N/A

 

Denominator for basic earnings per share – weighted-average shares outstanding

 

6,287,602

 

N/A

 

Effect of stock incentive plans

 

83,960

 

N/A

 

Denominator for diluted earnings per share

 

6,371,562

 

N/A

 

Basic earnings per share

 

$

0.39

 

N/A

 

Diluted earnings per share

 

$

0.38

 

N/A

 

 

12



 

 

 

Quarter Ended
September 30,

 

 

 

2004

 

2003

 

 

 

(Dollars in thousands, except per share data)

 

Numerator for basic and diluted earnings per share:

 

 

 

 

 

Net Income

 

$

1,121

 

N/A

 

Denominator for basic earnings per share – weight – average shares outstanding

 

6,267,258

 

N/A

 

Effect of stock incentive plans

 

215,000

 

N/A

 

Denominator for diluted earnings per share

 

6,482,258

 

N/A

 

Basic earnings per share

 

$

0.18

 

N/A

 

Diluted earnings per share

 

$

0.17

 

N/A

 

 

Options to purchase 537,700 shares of common stock were not included in the computation of diluted earnings per share for the 3 months and 9 months ended September 30, 2004, because the exercise price of the options was greater than the average market price.

 

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following presents management’s 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 condensed 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

 

THE CONVERSION TRANSACTION AND THE HOLDING COMPANY

 

Mercer Insurance Group, Inc. (the “Company” or the “Holding Company”) is a holding company owning all of the outstanding shares of Mercer Insurance Company, the company resulting from the conversion of Mercer Mutual Insurance Company from the mutual to the stock form of organization on December 15, 2003 (the “Conversion”).  Prior to the Conversion, and since 1844, Mercer Mutual Insurance Company was engaged in the business of selling property and casualty insurance.

 

The Company had no activity prior to the Conversion, and was formed for the purpose of owning all of the stock of Mercer Mutual Insurance Company after the Conversion.  At the time of the Conversion, 6,845,733 shares of Mercer Insurance Group, Inc. were issued (including 502,525 shares issued immediately after the Conversion to acquire the remaining 51% of common stock as well as all manditorily redeemable preferred stock of Franklin Holding Company, Inc., of which Mercer Mutual Insurance Company had acquired 49% for cash in 2001) with net cash proceeds of approximately $53 million received by the Company in exchange for the shares (approximately $27 million of this amount was contributed to the capital of Mercer Insurance Company after the Conversion).  Also included in the total shares are 626,111 shares issued in the Conversion to the Mercer Insurance Group, Inc. Employee Stock Ownership Plan, (the “ESOP”) as to which no cash proceeds were received because the ESOP funded the purchase of these shares with a loan from the Company.  The shares held by the ESOP will be allocated to participant accounts evenly over a ten-year period.  The first annual allocation occurred in December, 2003, in the amount of 62,611 shares, and an additional 46,873 shares were committed in the first three quarters of 2004.

 

13



 

Our Business

 

The Company and its subsidiaries underwrite property and casualty insurance in New Jersey and Pennsylvania.  Our consolidated operating insurance company subsidiaries are:

 

                  Mercer Insurance Company, a Pennsylvania property and casualty stock insurance company offering insurance coverage to businesses and individuals in New Jersey and Pennsylvania,

 

                  Mercer Insurance Company of New Jersey, Inc., a New Jersey property and casualty stock insurance company offering insurance coverage to businesses and individuals in New Jersey; and

 

                  Franklin Insurance Company, a property and casualty stock insurance company offering private passenger automobile and homeowners insurance to individuals located in Pennsylvania.

 

The Company is subject to regulation by the Pennsylvania Insurance Department and the New Jersey Department of Banking and Insurance as its primary regulators because it is the holding company for Mercer Insurance Company, and, indirectly, Mercer Insurance Company of New Jersey, Inc. through its holding company, Queenstown Holding Company, Inc., and Franklin Holding Company, Inc. and its subsidiary, Franklin Insurance Company.

 

We manage our business and report our operating results in three operating segments: commercial lines insurance, personal lines insurance and the investment function.  See Note 2 of the notes to our condensed consolidated financial statements included in this report. However, 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 and general liability and related coverages.  Our personal lines insurance business consists primarily of homeowners (in New Jersey and Pennsylvania) and private passenger automobile (in Pennsylvania only) insurance coverages.  We market both the commercial and personal insurance lines through independent producers.

 

Our income is principally derived from insurance 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.  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 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.

 

14



 

Critical Accounting Policies

 

General.  The Company’s financial statements are prepared in conformity with accounting principles generally accepted in the United States of America (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 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, on a quarterly basis, 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 in-force business to derive a reserve level for each line of business.  This amount, together with reserves required by new reported claims and changes to existing case reserves, is compared to existing reserves to establish the adjustment to reserves that is required.  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.  Because of the nature of our business, which generally provides coverage for short-term risks, loss development is comparatively rapid and historical paid losses have been a reliable predictive measure of future losses.

 

Nevertheless, 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, 2004.  Changes in estimates or differences between estimates and amounts ultimately paid are reflected in current operations.  Loss reserving techniques and assumptions have been consistently applied during the periods presented.

 

15



 

The table below summarizes the effect on net loss reserves and equity in the event of reasonably likely changes in the variables considered in establishing loss and loss adjustment expense reserves.  The range of reasonably likely changes was established based on a review of changes in accident year development by line of business and applied to loss reserves as a whole.  The selected range of changes does not indicate what could be the potential best or worst case or likely scenarios:

 

Adjustment
Change in Loss and
Loss Adjustment
Reserves Net of
Reinsurance

 

Adjusted Loss and
Loss Reserves Net of
Reinsurance as of
September 30,
2004

 

Percentage Change
in Stockholders’
Equity as of
September 30,
2004(1)

 

Adjusted Loss and
Loss Adjustment
Reserves Net of
Reinsurance as of
December 31, 2003

 

Percentage Change
in Stockholders’
Equity as of
December 31, 2003 (1)

 

(Dollars in thousands)

 

-10.0

%

30,047

 

2.2

%

29,003

 

2.2

%

-7.5

%

30,882

 

1.7

%

29,808

 

1.6

%

-5.0

%

31,717

 

1.1

%

30,614

 

1.1

%

-2.5

%

32,551

 

0.6

%

31,419

 

0.5

%

Base

 

33,386

 

 

32,225

 

 

2.5

%

34,221

 

-0.6

%

33,031

 

-0.5

%

5.0

%

35,055

 

-1.1

%

33,836

 

-1.1

%

7.5

%

35,890

 

-1.7

%

34,642

 

-1.6

%

10.0

%

36,725

 

-2.2

%

35,448

 

-2.2

%

 


(1)  Net of Tax

 

The property and casualty industry has incurred substantial aggregate losses from claims related to asbestos-related illnesses, environmental remediation, product and construction defect liability, mold, and other uncertain exposures.  We have not experienced significant losses from these types of claims.

 

The table below summarizes loss and loss adjustment reserves by major line of business:

 

 

 

September 30, 2004

 

December 31, 2003

 

 

 

(Dollars in thousands)

 

Commercial lines:

 

 

 

 

 

Commercial multi-peril

 

$

5,651

 

$

6,998

 

Other liability

 

8,613

 

8,708

 

Workers’ compensation

 

4,716

 

4,684

 

Commercial automobile

 

2,112

 

2,251

 

Fire, allied, inland marine

 

586

 

242

 

 

 

21,678

 

22,883

 

Personal lines:

 

 

 

 

 

Homeowners

 

10,372

 

9,509

 

Personal automobile

 

2,923

 

3,073

 

Fire, allied, inland marine

 

268

 

328

 

Other liability

 

1,885

 

1,400

 

Workers’ compensation

 

101

 

68

 

 

 

15,549

 

14,378

 

Total

 

$

37,227

 

$

37,261

 

 

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.  In the nine months ended September 30, 2004 and 2003, we recorded a pre-tax charge to earnings of $0 and $445,000, respectively, and no charges in

 

16



 

the quarters ended September 30, 2004 and 2003. These charges are primarily with respect to equity securities that we determined under our policy to be other than temporarily impaired.  Adverse investment market conditions, or poor operating results of underlying investments, could result in impairment charges in the future.

 

We generally apply the following standards in determining whether the decline in fair value of an investment is other than temporary:

 

Equities.  If an equity security has a fair value below 50% of cost or remains below 80% of cost for more than three months, a review of the financial condition and prospects of the company is performed by the Investment Committee of the Board of Directors to determine if the decline in fair value is other than temporary.  A specific determination is made for any such security.  Other equity securities in an unrealized loss position not meeting these quantitative thresholds are evaluated considering, among other things, the magnitude and reasons for the decline and the prospects for the fair value of the securities to recover in the near term.  If it is determined that the decline in fair value is judged to be “other than temporary” then the cost basis of the security is written down to “realizable value” and the amount of the write down accounted for as a realized loss.  “Realizable value” is defined as the quoted market price of the security.  Write-down to a value other than the market price requires objective evidence in support of that value.

 

We have one significant non-traded equity security, a non-voting common stock in Excess Reinsurance Company, which is carried at $1.2 million. Its fair value is estimated at the statutory book value as reported to the National Association of Insurance Commissioners (NAIC).  Other non-traded securities, which are not material in the aggregate, are carried at cost.

 

Fixed Income Securities.  A fixed maturity security generally is written down if we are unable to hold it or otherwise intend to sell a security with an unrealized loss, or if it is probable that we will be unable to collect all amounts due according to the contract terms of a debt security not impaired at acquisition.

 

A fixed maturity security review for collectibility is done if any of the following situations occur:

 

                  A review of the financial condition and prospects of the issuer performed by the Investment Committee indicates that the security should be evaluated.

 

                  Moody’s or Standard & Poors rate the security below investment grade.

 

                  The security has a fair value below 70% of amortized cost at quarter end due to deterioration in credit quality.

 

Policy Acquisition Costs.  We defer policy acquisition costs, such as commissions, premium taxes and certain other underwriting expenses that vary with and are directly 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.

 

17



 

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 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

 

Our results of operations are 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, general economic conditions, judicial trends, fluctuations in interest rates and other changes in the investment environment.

 

Our growth in premiums and underwriting results have been, and continue to be, influenced by market conditions.  Pricing in the property and casualty insurance industry historically has been cyclical.  During a soft market cycle, price competition is prevalent and makes it difficult to write and retain properly priced personal and commercial lines business.  Our policy is to maintain our disciplined underwriting and pricing standards during soft markets, even at the expense of premium growth. For more than three years, the industry has enjoyed a hard market with pricing power, however pricing competition has re-appeared in the market, particularly in lines of business which are predominantly property exposures, and pricing power has diminished accordingly.  The cyclicality of the market is difficult to anticipate, and pricing has leveled off consistent with the late stages of a hard market, resulting in slower overall revenue growth than the Company has enjoyed in the last three years.

 

Nine months and three months ended September 30, 2004, compared to nine months and three months ended September 30, 2003

 

For the nine months ended September 30, 2004, the Company had net income of $2.4 million compared to $445,000 for the same period in 2003.  The underwriting gain from our commercial lines segment for the nine months of 2004 increased to $5.4 million from the prior year amount of $2.6 million, but our personal lines segment incurred an underwriting loss of $4.6 million, an increased loss from the loss of $3.4 million in the prior comparable period.  In our investment segment, net investment income increased 58% in the first nine months of 2004 to $1.9 million from $1.2 million, and net realized gains for the first nine months of 2004 were $439,000, as compared to net realized gains of $130,000 for the 2003 period.

 

For the three months ended September 30, 2004, the Company had net income of $1.1 million compared to $172,000 for the same period in 2003.  The underwriting gain from our commercial lines segment for the third quarter of 2004 increased to $1.9 million from the prior year amount of $899,000. The personal lines segment incurred an underwriting loss of $1.3 million in the third quarter of 2004, compared to a loss of $1.3 million in the prior year period.  In our investment segment, net investment income increased 60% in the

 

18



 

third quarter of 2004 to $639,000 from $400,000, and we had a net realized gain for the third quarter of 2004 of $340,000, as compared to a net realized gain of $167,000 for the 2003 period.

 

Total revenues for the first nine months of 2004 were $44.3 million, which was 22% greater than 2003 revenues of $36.4 million.  This increase was due to a $6.9 million, or 20%,  increase in net premiums earned in the first nine months of 2004, an increase in net investment income of $712,000, or 58%, as well as to a realized gain on investments of $439,000 in 2004 as compared to a realized gain of $130,000 in 2003.

 

Total revenues for the third quarter of 2004 were $15.1 million, which was 16% greater than revenues of $13.0 million during the comparable 2003 period.  This increase was due to a $1.7 million, or 13%,  increase in net premiums earned in the third quarter of 2004, an increase in net investment income of $239,000, or 60%, as well as to a realized gain on investments of $340,000 in 2004 as compared to a realized gain of $167,000 during the comparable 2003 period.

 

Direct premiums written increased 3% to $46.9 million in the first nine months of 2004 when compared to 2003, and consisted of $28.1 million of commercial lines premiums, a 6% increase, and $18.8 million of personal lines premiums, a 2% decrease.  Net premiums earned increased by 20% to $41.6 million for the first nine months of 2004 as compared to $34.8 million for the prior year period.  Commercial lines net premiums earned increased 30% to $24.2 million in the first nine months of 2004, and personal lines net premiums earned increased 8% to $17.4 million in 2004.  The overall increases in direct premiums written and net premiums earned are generally attributable to the Company’s focus on growth in our commercial lines business, and a reduction in the amount of reinsurance utilized by the Company.

 

Direct premiums written for the third quarter of 2004 decreased 3% to $14.6 million when compared to 2003, and consisted of $8.0 million of commercial lines premiums, a 1% decrease, and $6.6 million of personal lines premiums, a 5% decrease.  Direct premiums written decreased in the quarter as compared to the same period in 2003 due to increasing competition in the marketplace, particularly in the case of property exposures. Net premiums earned increased by 13% to $14.0 million for the third quarter of 2004 as compared to $12.4 million for the prior year period.  Commercial lines net premiums earned increased 21% to $8.3 million in the third quarter, and personal lines net premiums earned increased 4% to $5.7 million.

 

Consistent with our goal of increasing our commercial lines business, we increased commercial lines direct premiums written in the first nine months of 2004 to 60% of our business, as compared to 58% in the prior year period. Similarly, commercial lines net premium earned increased to 58% of our business, as compared to 53% in the 2003 period. Our direct commercial multi-peril premiums written, the largest component of our commercial lines segment, increased by 6% to $14.3 million in the first nine months of 2004, compared to $13.4 million for the 2003 period. Commercial multi-peril net premiums earned increased by 33% to $12.1 million in 2004, as compared to $9.1 million for the prior year period.  We expect this trend of increasing commercial writings to continue as we target growth in certain types of risks and with selected producers.

 

For the first nine months of 2004, net premiums earned for our homeowners insurance, the largest component of our personal lines segment, increased 9% to $10.1 million, compared to $9.3 million for the 2003 period, while homeowners direct premiums written remained flat at $11.0 million for both periods. The growth in homeowners insurance net premiums earned primarily reflects the reduction in reinsurance utilization initiated by the Company at the beginning of 2004.

 

Personal automobile direct written premiums for the first nine months of 2004, written exclusively in Pennsylvania, decreased 3% to $5.8 million from $6.0 million for the 2003 period.  Net premiums earned for personal automobile increased in the first nine months of 2004 by 7% to $5.4 million, from $5.1 million for the

 

19



 

comparable period in 2003.  Despite the increases in personal lines net premiums earned, our focus is principally on our commercial lines growth.

 

Net investment income increased $712,000, or 58%, to $1.9 million in the first nine months of 2004, as compared to the same period in 2003, due primarily to higher average invested assets.  Net realized gains for the same period in 2004 were $439,000, as compared to a net realized gain of $130,000 in the comparable period in 2003.  In 2004, net realized gains of $439,000 included gains on securities sales of $904,000, and losses on securities sales of $461,000.  The losses from securities sales were comprised of $283,000 from the sale of bonds and $178,000 from the sale of equities.  The following table summarizes the period of time that the equity securities sold at a loss during 2004 had been in a continuous unrealized loss position:

 

PERIOD OF TIME IN AN
UNREALIZED LOSS POSITION

 

Fair Value on Sale Date

 

Realized Loss

 

 

 

(In thousands)

 

 

 

 

 

 

 

0-6 months

 

$

347

 

$

46

 

7-12 months

 

276

 

4

 

More than 12 months

 

122

 

128

 

Total

 

$

745

 

$

178

 

 

The equity securities sold at a loss had been expected to appreciate in value but after reevaluation were sold so that sale proceeds could be reinvested.  The equity securities described above as having been in an unrealized loss position for more than 12 months were part of a larger block of shares in a single issuer, which, taken in the aggregate, were in an unrealized gain position as of June 30, 2004. The equity securities were sold as part of our normal review process intended to reduce exposure to certain issuers and industries, to recognize changing economic conditions, and to facilitate tax planning objectives.

 

The following table summarizes the length of time equity securities with unrealized losses held at September 30, 2004 have been in an unrealized loss position:

 

 

 

 

 

 

 

Length of Unrealized Loss

 

 

 

Fair Value

 

Unrealized
Losses

 

Less than
6 months

 

6 to
12 months

 

Over
12 months

 

 

 

(In thousands)

 

Equity Securities

 

 

 

 

 

 

 

 

 

 

 

More than 80% of cost

 

$

2,304

 

$

133

 

$

105

 

$

28

 

$

0

 

Less than 80% of cost

 

57

 

29

 

29

 

 

 

Total

 

$

2,361

 

$

162

 

$

134

 

$

28

 

$

0

 

 

The estimated fair value and unrealized loss for securities in a temporary unrealized loss position as of September 30, 2004 are as follows :

 

 

 

Less than 12 Months

 

12 Months or Longer

 

Total

 

 

 

Estimated
Fair Value

 

Unrealized
Losses

 

Estimated
Fair Value

 

Unrealized
Losses

 

Estimated
Fair Value

 

Unrealized
Losses

 

 

 

(In thousands)

 

U.S. Treasury securities and obligations of U.S. government corporations and agencies

 

$

7,040

 

$

58

 

$

5,618

 

$

165

 

$

12,658

 

$

223

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Obligations of states and political subdivisions

 

19,395

 

149

 

$

288

 

$

10

 

19,683

 

159

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporate securities

 

9,407

 

111

 

 

 

9,407

 

111

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Mortgage-backed securities

 

18,017

 

225

 

 

 

18,017

 

225

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total fixed maturities

 

53,859

 

543

 

5,906

 

175

 

59,765

 

718

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total equity securities

 

2,361

 

162

 

 

 

2,361

 

162

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total securities in a temporary unrealized loss position

 

$

56,220

 

$

705

 

$

5,906

 

$

175

 

$

62,126

 

$

880

 

 

20



 

The unrealized losses on fixed maturity investments with unrealized losses for less than twelve months were primarily due to changes in the interest rate environment.  The Company has 17 fixed maturity securities with unrealized losses for more than twelve months.  All of the 17 fixed maturity securities with unrealized losses greater than twelve months have fair values greater than 94% of cost.  The Company believes these declines are temporary.

 

There are 13 equity securities that are in an unrealized loss position on September 30, 2004. Eleven of these securities have been in an unrealized loss position for less than six months.  The other 2 equity securities have been in an unrealized loss position for less than twelve months.  The Company believes these declines are temporary.

 

For the first nine months of 2004, we had a GAAP combined ratio (the “combined ratio” is an industry measurement of a company’s underwriting success, and is the sum of the ratios of a company’s loss and loss adjustment expense, and underwriting expenses to net earned premium.  A combined ratio of less than 100% means a company is making an underwriting profit) of 98.1%. The combined ratio for the first nine months of 2004 consisted of a loss and loss adjustment expense ratio of 50.7% and an underwriting expense ratio of 47.4%, compared to a GAAP combined ratio of 102.4%, a loss and loss adjustment expense ratio of 56.4% and an underwriting expense ratio of 46.0% for the same period in 2003. In the third quarter of 2004, we had a GAAP combined ratio of 95.6%, a loss and loss adjustment expense ratio of 44.0% and an underwriting expense ratio of 51.6%, compared to a GAAP combined ratio of 103.0%, a loss and loss adjustment expense ratio of 55.4% and an underwriting expense ratio of 47.6% for the 2003 period.

 

In the commercial lines segment for the first nine months of 2004, we had an underwriting gain of $5.4 million, a combined ratio of 77.7%, a loss and loss adjustment expense ratio of 28.3% and an underwriting expense ratio of 49.4%, compared to an underwriting gain of $2.6 million, a combined ratio of 86.2%, a loss and loss adjustment expense ratio of 37.2% and an underwriting expense ratio of 49.0% for 2003. For the third quarter of 2004, in our commercial lines segment we had an underwriting gain of $1.9 million, a combined ratio of 77.3%, a loss and loss adjustment expense ratio of 25.7% and an underwriting expense ratio of 51.6%, compared to an underwriting gain of $0.9 million, a combined ratio of 86.9%, a loss and loss adjustment expense ratio of 39.2% and an underwriting expense ratio of 47.7% for the 2003 period.

 

In the personal lines segment for the first nine months of 2004, we had an underwriting loss of $4.6 million, a combined ratio of 126.3%, a loss and loss adjustment expense ratio of 81.7% and an underwriting expense ratio of 44.6%, compared to an underwriting loss of $3.4 million, a combined ratio of 120.9%, a loss and loss adjustment expense ratio of 78.4% and an underwriting expense ratio of 42.5% for 2003. For the third quarter of 2004, in our personal lines segment we had an underwriting loss of $1.3 million, a combined ratio of 122.0%, a loss and loss adjustment expense ratio of 70.5% and an underwriting expense ratio of 51.5%, compared to an underwriting loss of $1.3 million, a combined ratio of 123.2%, a loss and loss adjustment expense ratio of 75.7% and an underwriting expense ratio of 47.5% for the 2003 period.

 

21



 

For the first nine months of 2004, net loss and loss adjustment expenses incurred increased overall by $1.5 million, or 8%, to $21.1 million from the 2003 period.  The increase in loss and loss adjustment expenses reflects the increase in commercial and personal lines volume and an increase in the frequency of personal lines losses in the first quarter of 2004. The first quarter’s increase in personal lines losses is attributable to harsher weather conditions as compared to 2003, resulting principally from extremely cold temperatures.  These conditions lead to losses from frozen pipes, structural collapses, more frequent automobile losses and slip-and-fall accidents.  In the third quarter of 2004, net loss and loss adjustment expenses incurred decreased by $686,000, or 10% to $6.2 million from 2003. This decrease in losses and loss adjustment expenses in the quarter reflects favorable claims frequency and severity during the quarter, as compared to the prior year, offset by losses resulting from increased exposures relative to increased premium volume. The favorable claims frequency and severity is due in part to the moderate weather experienced in our operating territory during the second and third quarters of 2004.

 

Underwriting expenses increased by $3.7 million in the first nine months of 2004, or 23%, to $19.7 million from 2003.  This increase was principally attributable to an increase in expenses due to higher amortization of deferred policy acquisition costs resulting from higher premium volume, which includes a charge of $648,000 associated with the commitment of shares to employee participants in the ESOP for 2004, and other expenses, including $206,000 for grants of restricted stock compensation made during 2004, and $150,000 for the cost of professional services incurred in 2004 in connection with Sarbanes / Oxley compliance. No expense was included in the comparable 2003 period for ESOP expense, or for restricted stock compensation or Sarbanes / Oxley compliance. We are currently in the process of converting our information system.  When completed, we expect some costs to moderate as conversion costs and costs associated with operating dual systems will no longer be incurred.  These reduced costs will be offset by some higher staffing costs, but we also should be positioned to expand premium volume without material incremental labor and facility costs in the near term because of increased processing capacity.

 

The Company maintains Agency Profit Sharing plans, which, in addition to base commissions,  annually rewards agents for the growth and profitability of the business they produce while representing the Company. The additional commission is computed only on the aggregate growth and profitability of the book of business they produce each year. The Company does not have any marketing services agreements, placement services agreements, or similar arrangements. The Agency Profit Sharing plan expense accrued for 2004 at September 30, 2004 is $2.0 million, as compared to $1.3 million for the same period in 2003.

 

In the second quarter we began writing new New Jersey accounts in Mercer Insurance Company of New Jersey instead of Mercer Insurance Company, and in the third quarter we began renewing the New Jersey accounts of Mercer Insurance Company in Mercer Insurance Company of New Jersey. By doing so, we will reduce the premium taxes we pay by reducing the New Jersey retaliatory premium tax Mercer Insurance Company has been accruing on its New Jersey accounts since it redomesticated to Pennsylvania in 1997. Mercer Insurance Company of New Jersey will not be subject to the retaliatory tax on its New Jersey business. We had not previously taken this step because only policyholders of Mercer Insurance Company, domiciled in Pennsylvania, had subscription and voting rights in the Conversion. We were examined by the New Jersey Division of Taxation on this issue, and it has billed us for all prior retaliatory tax and related interest, and these amounts have been paid in full. The amounts have been paid under protest, preserving our right to seek a recovery if the retaliatory tax is successfully challenged while the statute of limitations remains open for any refund claim by us.  We are not challenging New Jersey’s position, however other companies have brought similar claims. It is unclear whether any challenge will be successful. After paying the disputed retaliatory taxes to New Jersey for prior periods, an accrual of $300,000 for estimated retaliatory taxes remained which was reversed during the first quarter of 2004 and served to reduce premium tax expense accordingly. The 2003 retaliatory tax was approximately $750,000.

 

22



 

Federal income tax expense was $1.0 million for the first nine months of 2004, an effective rate of 29.4%, compared to $188,000, an effective rate of 24.8%, in 2003.  The increase in the effective tax rate in 2004 is attributable to higher levels of operating profit, offset in part by higher levels of tax-exempt securities holdings.

 

LIQUIDITY AND CAPITAL RESOURCES

 

Our insurance companies generate sufficient funds from their operations and maintain a high degree of liquidity in their investment portfolios.  The primary source of funds to meet the demands of claim settlements and operating expenses are premium collections, investment earnings and maturing investments.  Mercer Insurance Company recently completed an expansion of its existing facilities in Pennington, New Jersey, at a cost of $2.8 million for the structure.  We are also in the process of building an information system platform that will allow our producers the choice of conducting their business through the Internet or through the method they have historically used.  As of September 30, 2004, we have spent $2.9 million on the development of this platform, which includes license fees for software used in the platform.  It is anticipated to be completed in late 2005 or early 2006, at an additional cost of between $0.6 million and $1.0 million.  Mercer Insurance Company possesses sufficient resources for these future expenditures without incurring any debt.

 

Our insurance companies maintain investment and reinsurance programs that are intended to provide sufficient funds to meet their obligations without forced sales of investments.  They 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 Mercer Insurance Group, Inc. is the net proceeds it retained from the Conversion of approximately $25 million, and dividend payments and other fees received from Mercer Insurance Company.  Approximately $3 million of the retained conversion proceeds were used by Mercer Insurance Group, Inc. to complete a stock repurchase of 250,000 shares during the quarter ended September 30, 2004. For a period of three years after the Conversion, Mercer Insurance Company may not declare or pay any dividend to Mercer Insurance Group without the approval of the Pennsylvania Insurance Department.  After this three-year period, Mercer Insurance Company will be restricted by the insurance laws of Pennsylvania as to the amount of dividends or other distributions it may pay to its holding company.  Under Pennsylvania law, there is a maximum amount that may be paid by Mercer Insurance Company during any twelve month period after notice to, but without prior approval of, the Pennsylvania Insurance Department.  This limit is the greater of 10% of Mercer Insurance Company’s statutory surplus as reported on its most recent annual statement filed with the Pennsylvania Insurance Department, or the net income of Mercer Insurance Company for the period covered by such annual statement.

 

If the dividend restrictions imposed on Mercer Insurance Company related to the Conversion were not in effect, then as of December 31, 2003, the amounts available for payment of dividends from Mercer Insurance Company in 2004, without the prior approval of the Pennsylvania Insurance Department would have been approximately $5.8 million.  Similar statutory limitations are imposed on the dividends which may be paid to Mercer Insurance Company by its insurance subsidiaries, and, based on their December 31, 2003 surplus positions, allowable dividends would be restricted to approximately $2 million in the aggregate.

 

Total assets at September 30, 2004 remained approximately equal to total assets at December 31, 2003.  Premium volume increases drove an increase in premium receivables of $77,000, or 1%, and deferred policy acquisition costs of $231,000, or 3%, compared to December 31, 2003.  Reinsurance recoverable on losses and loss expenses decreased $1.2 million, or 28%, due to a higher retention under the Company’s reinsurance agreements. Investments increased $4.7 million, or 4%, to $128.0 million, and cash balances decreased $6.2 million, or 40%, to $9.1 million.  The movement between investments and cash and cash equivalents is due to the nature of the investment vehicles in which cash proceeds of the Conversion were invested while awaiting

 

23



 

longer-term investment, and their classification for financial statement purposes. Accrued investment income increased $281,000, a 47% increase from December 31, 2003, due principally to higher levels of invested assets following receipt of the Conversion proceeds.

 

Contemporaneous with the Conversion, the Company and its subsidiaries engaged a new manager for its fixed income portfolio.  The manager has invested the proceeds of the Conversion and reallocated some portfolio assets with a view to achieving an appropriate duration, targeted at approximately 4 years, and proportionately higher yields, while working to minimize interest rate risk associated with a generally rising interest rate environment.  The manager has retained approximately $10.6 million of the Conversion proceeds in short-term investments at September 30, 2004, which are available for investment in fixed income securities as opportunities arise.

 

Total liabilities at September 30, 2004, were flat with December 31, 2003 at $77.5 million.  An increase of $399,000 in Unearned premium was offset by a decrease in accrued premium taxes of $615,000, as well as a decrease in payables for unsettled securities transactions.

 

Total stockholders’ equity at September 30, 2004, remained flat with December 31, 2003, with net income of $2.4 million and changes in Unearned ESOP shares of $469,000 and Unearned restricted stock compensation of $206,000 being offset by purchases of Treasury stock aggregating $3.0 million.

 

In connection with the Conversion, the ESOP was established, and purchased 626,111 shares from the Company in return for a note bearing interest at 4% on the principal amount of $6.3 million.  Mercer Insurance Company will make annual employee benefit contributions to the ESOP sufficient to repay that loan to the Company.  It is anticipated that the loan will be repaid in 10 equal annual installments, and that, in proportion to annual principal and interest payments, approximately 10% of the original ESOP shares will be allocated annually to employee participants of the ESOP.  An expense charge will be 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 Company’s 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.

 

Mercer Insurance Group adopted a stock-based incentive plan on June 16, 2004, after shareholder approval of the plan at the annual shareholders meeting.  Pursuant to the plan, Mercer Insurance Group may issue 876,555 shares, in the form of incentive stock options, non-qualified stock options or grants of restricted stock. No more than 250,000 of the shares may be issued as grants of restricted stock. In June 2004, the Board of Directors awarded 537,700 incentive stock and non-qualified stock options and 215,000 shares of restricted stock. As of September 30, 2004, the pre-tax expense recognized in the income statement for the current year with respect to restricted stock grants was $206,000.

 

The Board of Directors authorized the Company on June 16, 2004 to repurchase up to 250,000 shares of the Company’s common stock in the open market. The repurchases were to be made from time to time in open market or privately negotiated transactions as, in management’s sole opinion, market conditions warranted. As of September 30, 2004, all 250,000 shares had been repurchased for a total of $3.0 million, or an average of $11.90 per share, a price accretive to the Company’s book value. On October 20, 2004, the Board authorized the repurchase of an additional 250,000 shares. The program will continue until October 20, 2005 or until 250,000 shares are repurchased, whichever occurs first, unless Mercer Insurance Group extends or expands the program. The repurchased shares will be held as treasury shares available for issuance in connection with

 

24



 

Mercer Insurance Group’s 2004 Stock Incentive Plan. Any such stock buyback will be made with funds from the Company, which has adequate resources for such purpose.

 

IMPACT OF INFLATION

 

Inflation increases an insured’s 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.  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 Company was not a party to any unconsolidated arrangement or financial instrument with variable interest entities or other vehicles at September 30, 2004 which would give rise to previously undisclosed market, credit or financing risk.

 

The Company and its subsidiaries have no significant contractual obligations at September 30, 2004.

 

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.

 

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.

 

Credit Risk.  The quality of our interest-bearing investments is generally good. Our fixed maturity securities at September 30, 2004 are all rated BAA or above, with an average rating of AA.

 

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.

 

25



 

There have been no material changes in market risk from the end of the most recent fiscal year ended December 31, 2003, and the information disclosed in connection therewith.

 

Item 4.  Controls and Procedures

 

The Company, under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and the Chief Financial Officer, has evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures. Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer conclude that the Company’s disclosure controls and procedures are effective as of September 30, 2004.  There has been no change in the Company’s internal control over financial reporting that occurred during the quarter ended September 30, 2004 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

Securities and Exchange Commission rules define “disclosure controls and procedures” as controls and other procedures of an issuer that are designed to ensure that information required to be disclosed by the issuer in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time specified in the Commission’s rules and forms.  Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that such information is accumulated and communicated to the issuer’s management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

 

Part II - OTHER INFORMATION

 

Item 1. Legal Proceedings.

 

None

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

 

Period

 

Total Number
of Shares
Purchased

 

Average
Price Paid
per Share

 

Total Number of Shares
Purchased as Part of Publicly
Announced Plans or Programs
(Notes 1 and 2)

 

Maximum Number of Shares
That May Yet Be Purchased
Under The Plans or Programs
(Notes 1 and 2)

 

 

 

 

 

 

 

 

 

July 1-31, 2004

 

None

 

N/A

 

None

 

250,000

 

 

 

 

 

 

 

 

 

 

August 1-31, 2004

 

10,100

 

$

11.94

 

10,100

 

239,900

 

 

 

 

 

 

 

 

 

 

September 1-30, 2004

 

239,900

 

$

11.90

 

239,900

 

None

 

 

 

 

 

 

 

 

 

 

Total

 

250,000

 

$

11.90

 

250,000

 

None

 

Note 1 – On June 16, 2004, the Company’s Board of Directors authorized the repurchase of up to 250,000 shares of its common stock, to be made from time to time in the open market or in privately negotiated

 

26



 

transactions as, in management’s sole opinion, market conditions warranted. The repurchased shares are to be held as treasury shares available for issuance in connection with Mercer Insurance Group’s 2004 Stock Incentive Plan. As of September 30, 2004, 250,000 shares had been repurchased under this authorization, the details of which are shown in the table above.

 

Note 2 – On October 20, 2004, the Company’s Board of Directors authorized the repurchase of up to 250,000 shares of its common stock, in addition to the June 16, 2004 authorization, and under the same terms and conditions. The program will continue until October 20, 2005 or until 250,000 shares are repurchased, whichever occurs first, unless Mercer Insurance Group extends or expands the program. The repurchased shares will be held as treasury shares available for issuance in connection with Mercer Insurance Group’s 2004 Stock Incentive Plan. This repurchase authorization is not reflected in the table above.

 

Item 3. Defaults Upon Senior Securities

 

None

 

Item 4. Submission of Matters to Vote of Security Holders

 

None

 

Item 5. Other Information

 

None

 

Item 6. Exhibits

 

Exhibits

 

Exhibit No.

 

Title

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

 

Certifications of Chief Executive Officer and Chief Financial Officer in accordance with Section 906 of the Sarbanes-Oxley Act of 2002, (filed herewith)

 

27



 

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 12, 2004

By:

/s/Andrew R. Speaker

 

 

 

 Andrew R. Speaker,

 

 

 President and Chief Executive Officer

 

 

 

 

Dated: November 12, 2004

By:

/s/David B. Merclean

 

 

 

 David B. Merclean,

 

 

 Chief Financial Officer

 

28