UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
x
|
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|
For the quarterly period ended March 31, 2012
OR
¨
|
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|
For the transition period from to
Commission File Number: 0-14697
HARLEYSVILLE GROUP INC.
(Exact name of registrant as specified in its charter)
|
|
|
Delaware
|
|
51-0241172
|
(State or other jurisdiction of
|
|
(I.R.S. Employer
|
incorporation or organization)
|
|
Identification No.)
|
355 Maple Avenue, Harleysville, PA 19438-2297
(Address of principal executive offices) (Zip Code)
215-256-5000
(Registrants telephone number, including area code)
N/A
(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 of 1934 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
x
No
¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule
405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes
x
No
¨
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.:
|
|
|
|
|
|
|
Large accelerated filer
|
|
¨
|
|
Accelerated filer
|
|
x
|
|
|
|
|
Non-accelerated filer
|
|
¨
(Do not check if a smaller reporting company)
|
|
Smaller reporting company
|
|
¨
|
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange
Act). Yes
¨
No
x
At April 30, 2012 27,276,942 shares of common stock of Harleysville Group Inc. were outstanding.
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
INDEX
2
Item 1.
|
Financial Statements
|
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
|
|
|
|
|
|
|
|
|
|
|
March 31,
2012
|
|
|
December 31,
2011
|
|
|
|
(Unaudited)
|
|
|
|
|
Assets
|
|
|
|
|
|
|
|
|
Investments:
|
|
|
|
|
|
|
|
|
Fixed maturities:
|
|
|
|
|
|
|
|
|
Held to maturity, at amortized cost (fair value $107,382 and $131,433)
|
|
$
|
101,261
|
|
|
$
|
124,935
|
|
Available for sale, at fair value (amortized cost $2,110,242 and $2,195,221)
|
|
|
2,265,341
|
|
|
|
2,361,971
|
|
Equity securities, at fair value (cost $7 and $7)
|
|
|
7
|
|
|
|
7
|
|
Short-term investments, at cost, which approximates fair value
|
|
|
194,098
|
|
|
|
129,388
|
|
|
|
|
|
|
|
|
|
|
Total investments
|
|
|
2,560,707
|
|
|
|
2,616,301
|
|
Cash
|
|
|
51
|
|
|
|
36
|
|
Premiums receivable
|
|
|
134,446
|
|
|
|
133,277
|
|
Reinsurance recoverables
|
|
|
204,183
|
|
|
|
245,948
|
|
Accrued investment income
|
|
|
23,241
|
|
|
|
25,629
|
|
Deferred policy acquisition costs
|
|
|
94,036
|
|
|
|
101,256
|
|
Prepaid reinsurance premiums
|
|
|
51,200
|
|
|
|
54,753
|
|
Property and equipment, net
|
|
|
12,658
|
|
|
|
12,763
|
|
Deferred income taxes
|
|
|
21,450
|
|
|
|
15,712
|
|
Other assets
|
|
|
62,025
|
|
|
|
61,394
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
3,163,997
|
|
|
$
|
3,267,069
|
|
|
|
|
|
|
|
|
|
|
Liabilities and Shareholders Equity
|
|
|
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
Unpaid losses and loss settlement expenses (affiliate $117,182 and $132,536)
|
|
$
|
1,728,595
|
|
|
$
|
1,789,591
|
|
Unearned premiums (affiliate $(14,552) and $(14,201)
|
|
|
457,432
|
|
|
|
460,768
|
|
Accounts payable and accrued expenses
|
|
|
87,220
|
|
|
|
104,258
|
|
Due to affiliate
|
|
|
19,390
|
|
|
|
40,396
|
|
Debt (affiliate $18,500 and $18,500)
|
|
|
118,500
|
|
|
|
118,500
|
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
|
2,411,137
|
|
|
|
2,513,513
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shareholders equity:
|
|
|
|
|
|
|
|
|
Preferred stock, $1 par value, authorized 1,000,000 shares; none issued
|
|
|
|
|
|
|
|
|
Common stock, $1 par value, authorized 80,000,000 shares; issued 35,513,932 and 35,448,861 shares; outstanding 27,276,942 and
27,246,172 shares
|
|
|
35,514
|
|
|
|
35,449
|
|
Additional paid-in capital
|
|
|
288,251
|
|
|
|
285,585
|
|
Accumulated other comprehensive income
|
|
|
57,085
|
|
|
|
63,571
|
|
Retained earnings
|
|
|
627,979
|
|
|
|
622,973
|
|
Treasury stock, at cost, 8,236,990 and 8,202,689 shares
|
|
|
(255,969
|
)
|
|
|
(254,022
|
)
|
|
|
|
|
|
|
|
|
|
Total shareholders equity
|
|
|
752,860
|
|
|
|
753,556
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and shareholders equity
|
|
$
|
3,163,997
|
|
|
$
|
3,267,069
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes to consolidated financial statements.
3
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
For the three months ended March 31, 2012 and 2011
(dollars in
thousands, except per share data)
|
|
|
|
|
|
|
|
|
|
|
2012
|
|
|
2011
|
|
|
|
|
Revenues:
|
|
|
|
|
|
|
|
|
Premiums earned from affiliate (ceded to affiliate, $204,986 and $201,903)
|
|
$
|
198,463
|
|
|
$
|
199,753
|
|
Investment income, net of investment expense
|
|
|
20,076
|
|
|
|
25,585
|
|
Realized investment gains, net:
|
|
|
|
|
|
|
|
|
Total other-than-temporary impairment losses
|
|
|
|
|
|
|
|
|
Portion of loss recognized in other comprehensive income
|
|
|
|
|
|
|
|
|
Other realized investment gains, net
|
|
|
58
|
|
|
|
15,774
|
|
|
|
|
|
|
|
|
|
|
Total realized investment gains, net
|
|
|
58
|
|
|
|
15,774
|
|
|
|
|
|
|
|
|
|
|
Other income (affiliate $2,149 and $2,213)
|
|
|
4,665
|
|
|
|
4,410
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenues
|
|
|
223,262
|
|
|
|
245,522
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Losses and expenses:
|
|
|
|
|
|
|
|
|
Losses and loss settlement expenses (ceded to affiliate, $140,802 and $152,054)
|
|
|
136,043
|
|
|
|
144,195
|
|
Amortization of deferred policy acquisition costs
|
|
|
50,109
|
|
|
|
52,679
|
|
Other underwriting expenses
|
|
|
30,623
|
|
|
|
20,671
|
|
Interest expense (affiliate $38 and $32)
|
|
|
1,520
|
|
|
|
1,514
|
|
Other expenses
|
|
|
1,283
|
|
|
|
969
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total expenses
|
|
|
219,578
|
|
|
|
220,028
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes
|
|
|
3,684
|
|
|
|
25,494
|
|
|
|
|
Income tax expense (benefit)
|
|
|
(1,322
|
)
|
|
|
7,267
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
5,006
|
|
|
$
|
18,227
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Per common share:
|
|
|
|
|
|
|
|
|
|
|
|
Basic net income
|
|
$
|
.18
|
|
|
$
|
.67
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted net income
|
|
$
|
.18
|
|
|
$
|
.66
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash dividend
|
|
$
|
|
|
|
$
|
.36
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes to consolidated financial statements.
4
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited)
For the three months ended March 31, 2012 and 2011
(in thousands)
|
|
|
|
|
|
|
|
|
|
|
2012
|
|
|
2011
|
|
|
|
|
Net income
|
|
$
|
5,006
|
|
|
$
|
18,227
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other comprehensive income (loss):
|
|
|
|
|
|
|
|
|
Net unrealized investment losses, net of tax benefit of $4,078 and $2,730
|
|
|
(7,573
|
)
|
|
|
(5,069
|
)
|
Recognized net actuarial loss of defined benefit pension plans, net of taxes of $585 and $353
|
|
|
1,087
|
|
|
|
656
|
|
|
|
|
|
|
|
|
|
|
Other comprehensive loss
|
|
|
(6,486
|
)
|
|
|
(4,413
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive income (loss)
|
|
$
|
(1,480
|
)
|
|
$
|
13,814
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes to consolidated financial statements.
5
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS EQUITY
(Unaudited)
For the three months ended March 31, 2012
(dollars in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common Stock
|
|
|
Additional
Paid-in
Capital
|
|
|
Accumulated
Other
Comprehensive
Income
|
|
|
Retained
Earnings
|
|
|
Treasury
Stock
|
|
|
Total
|
|
|
Shares
|
|
|
Amount
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2011
|
|
|
35,448,861
|
|
|
$
|
35,449
|
|
|
$
|
285,585
|
|
|
$
|
63,571
|
|
|
$
|
622,973
|
|
|
$
|
(254,022
|
)
|
|
$
|
753,556
|
|
Net income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5,006
|
|
|
|
|
|
|
|
5,006
|
|
|
|
|
|
|
|
|
|
Other comprehensive loss, net of tax:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized investment losses, net of reclassification adjustment
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(7,573
|
)
|
|
|
|
|
|
|
|
|
|
|
(7,573
|
)
|
Defined benefit pension plans:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Recognized net actuarial loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,087
|
|
|
|
|
|
|
|
|
|
|
|
1,087
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other comprehensive loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(6,486
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1,480
|
)
|
|
|
|
|
|
|
|
|
Issuance of common stock:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Incentive plans
|
|
|
65,071
|
|
|
|
65
|
|
|
|
1,350
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,415
|
|
|
|
|
|
|
|
|
|
Tax benefit from stock compensation
|
|
|
|
|
|
|
|
|
|
|
655
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
655
|
|
|
|
|
|
|
|
|
|
Stock compensation
|
|
|
|
|
|
|
|
|
|
|
661
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
661
|
|
|
|
|
|
|
|
|
|
Purchase of treasury stock, 34,301 shares
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1,947
|
)
|
|
|
(1,947
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at March 31, 2012
|
|
|
35,513,932
|
|
|
$
|
35,514
|
|
|
$
|
288,251
|
|
|
$
|
57,085
|
|
|
$
|
627,979
|
|
|
$
|
(255,969
|
)
|
|
$
|
752,860
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes to consolidated financial statements.
6
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
For the three months ended March 31, 2012 and 2011
(in thousands)
|
|
|
|
|
|
|
|
|
|
|
2012
|
|
|
2011
|
|
|
|
|
Cash flows from operating activities:
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
5,006
|
|
|
$
|
18,227
|
|
Adjustments to reconcile net income to net cash provided by operating activities:
|
|
|
|
|
|
|
|
|
Change in receivables, recoverables, unearned premiums and prepaid reinsurance balances
|
|
|
40,813
|
|
|
|
2,396
|
|
Change in affiliate balance
|
|
|
(21,006
|
)
|
|
|
23,044
|
|
Decrease in unpaid losses and loss settlement expenses
|
|
|
(60,996
|
)
|
|
|
(20,419
|
)
|
Deferred income taxes
|
|
|
(2,245
|
)
|
|
|
5,929
|
|
Decrease in deferred policy acquisition costs
|
|
|
7,220
|
|
|
|
1,656
|
|
Amortization and depreciation
|
|
|
3,277
|
|
|
|
2,551
|
|
Realized investment gains, net
|
|
|
(58
|
)
|
|
|
(15,774
|
)
|
Other, net
|
|
|
(12,975
|
)
|
|
|
(12,701
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(40,964
|
)
|
|
|
4,909
|
|
Cash used by the change in the intercompany pooling agreement
|
|
|
|
|
|
|
(33,014
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash used by operating activities
|
|
|
(40,964
|
)
|
|
|
(28,105
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from investing activities:
|
|
|
|
|
|
|
|
|
Fixed maturity investments:
|
|
|
|
|
|
|
|
|
Purchases
|
|
|
|
|
|
|
(2,026
|
)
|
Sales or maturities
|
|
|
105,687
|
|
|
|
63,457
|
|
Equity securities:
|
|
|
|
|
|
|
|
|
Purchases
|
|
|
|
|
|
|
(117,733
|
)
|
Sales
|
|
|
|
|
|
|
57,508
|
|
Net (purchases) sales of short-term investments
|
|
|
(64,710
|
)
|
|
|
35,949
|
|
Purchase of property and equipment, net
|
|
|
(121
|
)
|
|
|
(24
|
)
|
|
|
|
|
|
|
|
|
|
Net cash provided by investing activities
|
|
|
40,856
|
|
|
|
37,131
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from financing activities:
|
|
|
|
|
|
|
|
|
Issuance of common stock
|
|
|
1,415
|
|
|
|
144
|
|
Purchase of treasury stock
|
|
|
(1,947
|
)
|
|
|
|
|
Dividends paid (to affiliate, $0 and $5,230)
|
|
|
|
|
|
|
(9,544
|
)
|
Excess tax benefits from share-based payment arrangements
|
|
|
655
|
|
|
|
371
|
|
|
|
|
|
|
|
|
|
|
Net cash provided (used) by financing activities
|
|
|
123
|
|
|
|
(9,029
|
)
|
|
|
|
|
|
|
|
|
|
Change in cash
|
|
|
15
|
|
|
|
(3
|
)
|
Cash at beginning of period
|
|
|
36
|
|
|
|
39
|
|
|
|
|
|
|
|
|
|
|
Cash at end of period
|
|
$
|
51
|
|
|
$
|
36
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes to consolidated financial statements.
7
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
(Unaudited)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 the 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, 2011 included in the Companys 2011 Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission (SEC).
The affiliate transaction disclosures on the face of the financial statements relate to transactions with Harleysville Mutual Insurance
Company (the Mutual Company). The Mutual Company owns approximately 53% of the outstanding common stock of Harleysville Group Inc. As used herein, Harleysville Group refers to Harleysville Group Inc. and its subsidiaries and the
Company or HGI refers to Harleysville Group Inc.
2 Merger Agreement
On September 28, 2011, the Mutual Company and HGI entered into an agreement and plan of merger (the Merger Agreement)
with Nationwide Mutual Insurance Company (Nationwide) and a subsidiary of Nationwide (Nationals Sub). Pursuant to the Merger Agreement, the Mutual Company will merge into Nationwide with Nationwide as the surviving Company and the policyholders of
the Mutual Company will become policyholders and members of Nationwide. In addition, Nationals Sub will merge into HGI with HGI as the surviving company and a wholly-owned subsidiary of Nationwide. As a result of the HGI merger, all outstanding
shares of common stock of HGI held by stockholders, other than Nationwide, will be converted into the right to receive $60.00 per share in cash. The Mutual Company has also entered into a voting agreement with Nationwide under which it agreed to
vote its 53% interest in HGI in favor of the merger. The Merger Agreement restricts the Mutual Company, HGI and all affiliates from engaging in certain activities and taking certain actions without Nationwides approval, including among others,
the payment of shareholder dividends by HGI.
The transactions contemplated by the Merger Agreement are subject to customary
closing conditions, including, among others, approvals from stockholders of HGI and members/policyholders of the Mutual Company and Nationwide, the Pennsylvania Insurance Department, the Ohio Insurance Department, and various other regulatory
bodies. In April 2012, approvals were received from the stockholders of HGI, the members/policyholders of the Mutual Company and Nationwide, and all necessary regulatory bodies. The transactions are expected to close May 1, 2012 (the Closing Date).
The Merger Agreement provides certain termination rights. In the event that the agreement is terminated under certain conditions by HGIs Board of Directors, HGI will be required to pay Nationwide a termination fee of $29.6 million and
reimburse Nationwide for its transaction expenses.
3 Change in Pooling Agreement
The Companys property and casualty subsidiaries participate in a pooling agreement with the Mutual Company and
its property and casualty insurance subsidiary, Harleysville Pennland Insurance Company (Pennland), whereby such subsidiaries and Pennland cede to the Mutual Company all of their insurance business and assume from the Mutual Company an amount equal
to their participation in the pooling agreement. All losses and loss settlement expenses and other underwriting expenses are prorated among the parties on the basis of participation in the pooling agreement. The pooling agreement provides for the
allocation of premiums, losses and loss settlement expenses and underwriting expenses between Harleysville Group and the Mutual Company. Harleysville Group is not liable for any losses incurred by its subsidiaries, Harleysville Preferred Insurance
Company and Harleysville Insurance Company of New Jersey, and the Mutual Company prior to January 1, 1986, the date the pooling agreement became effective. The pooling agreement excludes reinsurance premiums, losses, loss settlement expenses
and underwriting expenses voluntarily assumed by the Mutual Company. Harleysville Groups participation in the pool has been 80% since January 1, 2008.
8
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
(Unaudited)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Effective January 1, 2011, the Companys property and casualty subsidiaries
and the Mutual Company and Pennland amended their intercompany pooling agreement as it relates to their workers compensation business. The amendment establishes that the financial results associated with the workers compensation business for
accident years 2011 and following will be retained 100 percent by the Mutual Company. The financial results of this business for prior accident years will continue to be shared between the Companys property and casualty subsidiaries, the
Mutual Company and Pennland under the existing pool participations. Harleysville Group paid cash of $33 million on January 3, 2011 associated with the transfer of the unearned premium liability on the workers compensation business as of
January 1, 2011. Harleysville Groups unearned premium liability decreased by $40 million and Harleysville Group received a ceding commission of $7 million for expenses that were incurred to generate the business ceded to the Mutual
Company, which ceding commission reduced deferred policy acquisition costs.
4 Share-Based Payments
The Company has several share-based compensation plans. The Company measures compensation expense associated with the
plans based on the grant-date fair value of the awards.
The Company has the following share-based compensation plans:
|
|
|
The Amended and Restated Equity Incentive Plan (EIP) provides for awards to key employees in the form of stock options, stock appreciation rights
(SARs), restricted stock, restricted stock units or any combination of the above.
|
|
|
|
The Employee Stock Purchase Plan (ESPP) provides that a participant may elect to have up to 15% of base pay withheld to purchase shares. The purchase
price of the stock is 85% of the lower of the beginning-of-the-subscription period or end-of-the-subscription-period fair market value. There are two subscription periods during each year. In accordance with the terms of the Merger Agreement with
Nationwide described in Note 2 of the Notes to Consolidated Financial Statements, no new subscription period was commenced after the date of the Merger Agreement (September 28, 2011) and the Company will terminate the ESPP effective as of the
Closing Date.
|
|
|
|
The Directors Equity Compensation Plan provides for the grant of equity-based awards to non-employee directors of Harleysville Group Inc. and the
Mutual Company. These awards can be in the form of stock options, deferred stock units or restricted stock.
|
The compensation expense for the various share-based compensation plans that has been charged against income before income taxes was
$661,000 and $1,373,000 for the three months ended March 31, 2012 and 2011, respectively, with a corresponding income tax benefit of $222,000 and $453,000, respectively.
No stock option or restricted stock unit grants were made during the first quarter of 2012. During the first quarter of 2011, 225,760 stock options were granted at a Black Scholes weighted average value
of $6.63 per option. These options vest 33 1/3% per year over a three year period. Restricted stock unit grants of 125,475 units were also made during the first quarter of 2011 and 30,855 of these units include performance conditions. The
weighted average fair value of the grants of the restricted stock units was $37.73 per unit. These awards vest over three years.
In accordance with the terms of the EIP, the Company acquired 34,301 and 86,554 shares of its common stock from employees in connection with stock option exercises and the vesting of restricted stock and
restricted stock units during the first quarter of 2012 and 2011, respectively. The stock was received in payment of the exercise price of the stock options and in satisfaction of withholding taxes due upon exercise or vesting.
9
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
(Unaudited)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
As of March 31, 2012, the Companys total unrecognized compensation cost
related to nonvested share-based compensation arrangements and the weighted average period over which the compensation cost is expected to be recognized is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted Average
|
|
|
Unrecognized Compensation Cost
|
|
|
Period of Recognition
|
|
|
(in thousands)
|
|
|
(in years)
|
Equity incentive plan awards
|
|
$
|
3,039
|
|
|
1.6
|
5 Investments
Fair value accounting guidance defines fair value, establishes a framework for measuring fair value in generally
accepted accounting principles (GAAP), and expands disclosures about fair value measurements.
Fair value measurements are
determined under a three-level hierarchy which gives the highest priority to quoted prices in active markets and the lowest priority to unobservable inputs which are based on the Companys own assumptions. The three levels of the hierarchy are
as follows:
Level 1 Unadjusted quoted market prices for identical assets or liabilities in active markets that the
Company has the ability to access.
Level 2 Inputs other than Level 1 that are based on observable market data. These
include quoted prices for similar assets in active markets, quoted prices for identical assets in inactive markets, inputs other than quoted prices that are observable for the asset or liability and inputs that are derived from or corroborated by
observable market data.
Level 3 Inputs that are unobservable, reflecting the Companys own assumptions.
For investments that have quoted market prices in active markets, the Company uses the quoted market price as fair value and
includes these investments in Level 1 of the fair value hierarchy. The Company classifies U.S. Treasury securities and publicly traded equity securities and equity mutual funds as Level 1. When quoted market prices in active markets are not
available, the Company relies on a pricing service to estimate fair value. The Company classifies its fixed maturity securities other than U.S. Treasury securities and private placements as Level 2. Non-publicly traded equity securities are
classified as Level 3.
The Company utilizes a nationally recognized independent pricing service to obtain fair value
estimates for its fixed maturity holdings because of the detailed process it uses in arriving at a fair value estimate. For fixed maturity securities that have quoted prices in active markets, market quotations are provided. For fixed maturity
securities that do not trade on a daily basis, the independent pricing service prepares estimates of fair value using a wide array of observable inputs including relevant market information, benchmark curves, benchmarking of like securities, sector
groupings and matrix pricing. The observable market inputs that our independent pricing service utilizes include, listed in approximate order of priority: benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets,
benchmark securities, bids, offers and reference data including market research publications. Additionally, the independent pricing service uses an Option Adjusted Spread model to develop prepayment and interest rate scenarios.
When the independent pricing service provides a fair value estimate, the Company uses that estimate. At March 31, 2012, the
independent pricing service provided a fair value estimate for all of the investments classified as Level 1 investments within the fair value hierarchy and approximately 99% of the investments classified as Level 2 estimates within the fair value
hierarchy. The fair value of all Level 2 securities is based on observable market inputs.
10
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
(Unaudited)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
In instances when the independent pricing service is unable to provide a fair value
estimate, the Company attempts to obtain a non-binding fair value estimate from a number of broker/dealers and reviews any fair value estimate reported by an independent business news service. In instances where only one broker/dealer provides a
fair value estimate for a fixed maturity security, the Company uses that estimate. In instances where the Company is able to obtain fair value estimates from more than one broker/dealer, the Company generally uses the lowest or next to lowest fair
value estimate. In instances where neither the independent pricing service nor a broker/dealer is able to provide a fair value estimate, the fair value is based on cash flow analysis and other valuation techniques which utilize significant
unobservable inputs and the Company classifies the fixed maturity investment as a Level 3 investment. Level 3 investments represent less than 1% of the Companys total investment portfolio.
Quotes obtained from third parties are non-binding. The third parties from whom quotes are obtained are knowledgeable market participants
that have a detailed understanding of the sector, the security type and the issuer. The non-binding quotes are fair value estimates based on observable market data utilized by these market participants. The Company does not adjust quotes or prices
obtained from third parties.
Management reviews, on an ongoing basis, the reasonableness of the methodologies employed by the
independent pricing service. As part of the monthly review process, management examines the prices obtained from the independent pricing service. This process routinely involves reviewing any available recent transaction activity reported via
various investment research tools. Additionally, the Company tracks changes in credit ratings of all fixed maturity securities on a monthly basis and performs a more in-depth, quarterly evaluation of fixed income securities that are rated below
single A by Moodys and/or S&P. If as a result of its review, management does not believe that a price received with respect to any particular security is a reasonable estimate of the fair value of the security, it will discuss this with
the independent pricing service to resolve the discrepancy. Management then determines the appropriate level of classification of each investment within the fair value hierarchy based on its evaluation of the inputs used in determining the fair
value.
11
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
(Unaudited)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
The following is a summary of the fair value measurements of applicable Company assets
by level within the fair value hierarchy as of March 31, 2012 and December 31, 2011 (and March 31, 2011 for Level 3 unobservable inputs). These assets are measured at fair value on a recurring basis. There were no transfers to or from
Levels 1 and 2 of the fair value hierarchy in the first quarter of 2012. The Companys policy is to recognize transfers between levels as of the end of the reporting period.
|
|
|
December 31, 2011
|
|
|
|
December 31, 2011
|
|
|
|
December 31, 2011
|
|
|
|
December 31, 2011
|
|
|
|
|
|
|
Fair Value Measurements at Reporting Date Using
|
|
|
March 31, 2012
|
|
|
Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)
|
|
|
Significant
Other
Observable
Inputs
(Level 2)
|
|
|
Significant
Unobservable
Inputs
(Level
3)
|
|
|
|
(in thousands)
|
|
|
|
|
|
|
Fixed maturities available for sale:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasury securities
|
|
$
|
430,222
|
|
|
$
|
430,222
|
|
|
|
|
|
|
|
|
|
Obligations of U.S. government corporations and agencies
|
|
|
8,011
|
|
|
|
|
|
|
$
|
8,011
|
|
|
|
|
|
Obligations of states and political subdivisions
|
|
|
1,124,955
|
|
|
|
|
|
|
|
1,124,955
|
|
|
|
|
|
Corporate securities
|
|
|
442,796
|
|
|
|
|
|
|
|
442,796
|
|
|
|
|
|
Mortgage-backed securities
|
|
|
259,357
|
|
|
|
|
|
|
|
259,357
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total available for sale
|
|
|
2,265,341
|
|
|
|
430,222
|
|
|
|
1,835,119
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
|
|
|
7
|
|
|
|
|
|
|
|
|
|
|
$
|
7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total equity securities
|
|
|
7
|
|
|
|
|
|
|
|
|
|
|
|
7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
2,265,348
|
|
|
$
|
430,222
|
|
|
$
|
1,835,119
|
|
|
$
|
7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2011
|
|
|
|
December 31, 2011
|
|
|
|
December 31, 2011
|
|
|
|
December 31, 2011
|
|
|
|
|
|
|
Fair Value Measurements at Reporting Date Using
|
|
|
December 31, 2011
|
|
|
Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)
|
|
|
Significant
Other
Observable
Inputs
(Level 2)
|
|
|
Significant
Unobservable
Inputs
(Level
3)
|
|
|
|
(in thousands)
|
|
|
|
|
|
|
Fixed maturities available for sale:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasury securities
|
|
$
|
442,324
|
|
|
$
|
442,324
|
|
|
|
|
|
|
|
|
|
Obligations of U.S. government corporations and agencies
|
|
|
8,088
|
|
|
|
|
|
|
$
|
8,088
|
|
|
|
|
|
Obligations of states and political subdivisions
|
|
|
1,159,065
|
|
|
|
|
|
|
|
1,159,065
|
|
|
|
|
|
Corporate securities
|
|
|
457,877
|
|
|
|
|
|
|
|
457,877
|
|
|
|
|
|
Mortgage-backed securities
|
|
|
294,617
|
|
|
|
|
|
|
|
294,617
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total available for sale
|
|
|
2,361,971
|
|
|
|
442,324
|
|
|
|
1,919,647
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
|
|
|
7
|
|
|
|
|
|
|
|
|
|
|
$
|
7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total equity securities
|
|
|
7
|
|
|
|
|
|
|
|
|
|
|
|
7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
2,361,978
|
|
|
$
|
442,324
|
|
|
$
|
1,919,647
|
|
|
$
|
7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
12
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
(Unaudited)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value Measurements Using Significant
Unobservable Inputs (Level
3)
For the Three Months Ended March 31, 2012
|
|
|
|
Fixed Maturities
Available
for Sale
|
|
|
Equity
Securities
|
|
|
Total
|
|
|
|
(in thousands)
|
|
Balance at January 1, 2012
|
|
$
|
|
|
|
$
|
7
|
|
|
$
|
7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at March 31, 2012
|
|
$
|
|
|
|
$
|
7
|
|
|
$
|
7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value Measurements Using Significant
Unobservable Inputs (Level
3)
For the Three Months Ended March 31, 2011
|
|
|
|
Fixed Maturities
Available
for Sale
|
|
|
Equity
Securities
|
|
|
Total
|
|
|
|
(in thousands)
|
|
Balance at January 1, 2011
|
|
$
|
|
|
|
$
|
7
|
|
|
$
|
7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at March 31, 2011
|
|
$
|
|
|
|
$
|
7
|
|
|
$
|
7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The amortized cost and estimated fair value of investments in fixed maturity and equity securities are as
follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2012
|
|
|
Amortized
Cost
|
|
|
Gross
Unrealized
Gains
|
|
|
Gross
Unrealized
Losses
|
|
|
Estimated
Fair
Value
|
|
|
|
(in thousands)
|
|
Held to maturity:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Obligations of U.S. government corporations and agencies
|
|
$
|
266
|
|
|
$
|
15
|
|
|
|
|
|
|
$
|
281
|
|
Obligations of states and political subdivisions
|
|
|
51,011
|
|
|
|
2,220
|
|
|
|
|
|
|
|
53,231
|
|
Corporate securities
|
|
|
49,984
|
|
|
|
3,886
|
|
|
|
|
|
|
|
53,870
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total held to maturity
|
|
|
101,261
|
|
|
|
6,121
|
|
|
|
|
|
|
|
107,382
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Available for sale:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasury securities
|
|
|
424,513
|
|
|
|
6,084
|
|
|
$
|
(375
|
)
|
|
|
430,222
|
|
Obligations of U.S. government corporations and agencies
|
|
|
7,511
|
|
|
|
500
|
|
|
|
|
|
|
|
8,011
|
|
Obligations of states and political subdivisions
|
|
|
1,033,423
|
|
|
|
91,532
|
|
|
|
|
|
|
|
1,124,955
|
|
Corporate securities
|
|
|
400,165
|
|
|
|
42,631
|
|
|
|
|
|
|
|
442,796
|
|
Mortgage-backed securities
|
|
|
244,630
|
|
|
|
14,727
|
|
|
|
|
|
|
|
259,357
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total available for sale
|
|
|
2,110,242
|
|
|
|
155,474
|
|
|
|
(375
|
)
|
|
|
2,265,341
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed maturities
|
|
$
|
2,211,503
|
|
|
$
|
161,595
|
|
|
$
|
(375
|
)
|
|
$
|
2,372,723
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total equity securities
|
|
$
|
7
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
13
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
(Unaudited)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2011
|
|
|
Amortized
Cost
|
|
|
Gross
Unrealized
Gains
|
|
|
Gross
Unrealized
Losses
|
|
|
Estimated
Fair
Value
|
|
|
|
(in thousands)
|
|
Held to maturity:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Obligations of U.S. government corporations and agencies
|
|
$
|
266
|
|
|
$
|
17
|
|
|
|
|
|
|
$
|
283
|
|
Obligations of states and political subdivisions
|
|
|
66,670
|
|
|
|
2,425
|
|
|
|
|
|
|
|
69,095
|
|
Corporate securities
|
|
|
57,999
|
|
|
|
4,082
|
|
|
$
|
(26
|
)
|
|
|
62,055
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total held to maturity
|
|
|
124,935
|
|
|
|
6,524
|
|
|
|
(26
|
)
|
|
|
131,433
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Available for sale:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasury securities
|
|
|
434,308
|
|
|
|
8,016
|
|
|
|
|
|
|
|
442,324
|
|
Obligations of U.S. government corporations and agencies
|
|
|
7,523
|
|
|
|
565
|
|
|
|
|
|
|
|
8,088
|
|
Obligations of states and political subdivisions
|
|
|
1,059,682
|
|
|
|
99,402
|
|
|
|
(19
|
)
|
|
|
1,159,065
|
|
Corporate securities
|
|
|
415,193
|
|
|
|
42,687
|
|
|
|
(3
|
)
|
|
|
457,877
|
|
Mortgage-backed securities
|
|
|
278,515
|
|
|
|
16,102
|
|
|
|
|
|
|
|
294,617
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total available for sale
|
|
|
2,195,221
|
|
|
|
166,772
|
|
|
|
(22
|
)
|
|
|
2,361,971
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed maturities
|
|
$
|
2,320,156
|
|
|
$
|
173,296
|
|
|
$
|
(48
|
)
|
|
$
|
2,493,404
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total equity securities
|
|
$
|
7
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The amortized cost and estimated fair value of fixed maturity securities at March 31, 2012 by
contractual maturity are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
|
|
|
|
|
|
|
|
|
|
|
Amortized
Cost
|
|
|
Estimated
Fair
Value
|
|
|
|
(in thousands)
|
|
Held to maturity:
|
|
|
|
|
|
|
|
|
Due through December 31, 2013
|
|
$
|
31,531
|
|
|
$
|
32,851
|
|
Due 2014 through 2017
|
|
|
59,491
|
|
|
|
63,820
|
|
Due 2018 through 2022
|
|
|
266
|
|
|
|
281
|
|
Due after 2022
|
|
|
9,973
|
|
|
|
10,430
|
|
|
|
|
|
|
|
|
|
|
|
|
|
101,261
|
|
|
|
107,382
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Available for sale:
|
|
|
|
|
|
|
|
|
Due through December 31, 2013
|
|
|
96,232
|
|
|
|
98,265
|
|
Due 2014 through 2017
|
|
|
968,383
|
|
|
|
1,023,034
|
|
Due 2018 through 2022
|
|
|
476,445
|
|
|
|
523,500
|
|
Due after 2022
|
|
|
324,552
|
|
|
|
361,185
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,865,612
|
|
|
|
2,005,984
|
|
|
|
|
|
|
|
|
|
|
Mortgage-backed securities
|
|
|
244,630
|
|
|
|
259,357
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,110,242
|
|
|
|
2,265,341
|
|
|
|
|
|
|
|
|
|
|
Total fixed maturities
|
|
$
|
2,211,503
|
|
|
$
|
2,372,723
|
|
|
|
|
|
|
|
|
|
|
14
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
(Unaudited)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Realized gross gains (losses) from investments were as follows:
|
|
|
|
|
|
|
|
|
|
|
For the Three
Months
Ended March 31,
|
|
|
|
2012
|
|
|
2011
|
|
|
|
(in thousands)
|
|
|
|
|
Fixed maturity securities:
|
|
|
|
|
|
|
|
|
Available for sale:
|
|
|
|
|
|
|
|
|
Gross gains
|
|
$
|
58
|
|
|
$
|
70
|
|
Equity securities:
|
|
|
|
|
|
|
|
|
Gross gains
|
|
|
|
|
|
|
16,499
|
|
Gross losses
|
|
|
|
|
|
|
(795
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Net realized investment gains
|
|
$
|
58
|
|
|
$
|
15,774
|
|
|
|
|
|
|
|
|
|
|
Harleysville Group held securities with unrealized losses at March 31, 2012 and December 31,
2011 as follows:
|
|
|
$183,561
|
|
|
|
$183,561
|
|
|
|
$183,561
|
|
|
|
March 31, 2012
|
|
|
|
|
|
|
|
|
|
Length of
Unrealized Loss
|
|
|
|
Fair Value
|
|
|
Unrealized
Losses
|
|
|
Less Than
12 Months
|
|
|
|
(in thousands)
|
|
|
|
|
|
Fixed maturities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasury securities
|
|
$
|
183,561
|
|
|
$
|
375
|
|
|
$
|
375
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total temporarily impaired securities
|
|
$
|
183,561
|
|
|
$
|
375
|
|
|
$
|
375
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$183,561
|
|
|
|
$183,561
|
|
|
|
$183,561
|
|
|
|
December 31, 2011
|
|
|
|
|
|
|
|
|
|
Length of
Unrealized Loss
|
|
|
|
Fair Value
|
|
|
Unrealized
Losses
|
|
|
Less Than
12 Months
|
|
|
|
(in thousands)
|
|
|
|
|
|
Fixed maturities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Obligations of states and political subdivisions
|
|
$
|
8,976
|
|
|
$
|
19
|
|
|
$
|
19
|
|
|
|
|
|
Corporate securities
|
|
|
7,956
|
|
|
|
29
|
|
|
|
29
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total temporarily impaired securities
|
|
$
|
16,932
|
|
|
$
|
48
|
|
|
$
|
48
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
All of the fixed maturity securities with an unrealized loss at March 31, 2012 are classified as
available for sale and are carried at fair value on the balance sheet.
The unrealized losses on fixed maturity investments
were primarily due to an increase in interest rates on U.S. Treasury Securities rather than a decline in credit quality. Per Harleysville Groups current policy, a fixed maturity security is other than temporarily impaired if the present
value of the cash flows expected to be collected is
15
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
(Unaudited)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
less that the amortized cost of the security or where the securitys fair value is below cost and Harleysville Group intends to sell, or more likely than not will be required to sell, the
security before recovery of its value. Harleysville Group believes, based on its analysis, that these securities are not other than temporarily impaired. However, depending on developments involving both the issuers and worsening economic
conditions, these investments may be written down in the income statement in the future.
There were no impairment charges in
the three months ended March 31, 2012 or 2011.
6 Earnings Per Share
The computation of basic and diluted earnings per share is as follows:
|
|
|
|
|
|
|
|
|
|
|
For the Three
Months
Ended March 31,
|
|
|
|
2012
|
|
|
2011
|
|
|
|
(in thousands, except per share data)
|
|
|
|
|
Numerator for basic and diluted earnings per share:
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
5,006
|
|
|
$
|
18,227
|
|
|
|
|
|
|
|
|
|
|
Denominator for basic earnings per share weighted average shares outstanding
|
|
|
27,599,946
|
|
|
|
27,388,586
|
|
|
|
|
Effect of stock incentive plans
|
|
|
596,415
|
|
|
|
224,179
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator for diluted earnings per share
|
|
|
28,196,361
|
|
|
|
27,612,765
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic earnings per share
|
|
$
|
.18
|
|
|
$
|
.67
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted earnings per share
|
|
$
|
.18
|
|
|
$
|
.66
|
|
|
|
|
|
|
|
|
|
|
The following options to purchase shares of common stock were not included in the computation of diluted
earnings per share because the exercise price of the options was greater than the average market price:
|
|
|
|
|
|
|
For the Three Months
Ended March 31,
|
|
|
2011
|
|
|
(in thousands)
|
Number of options
|
|
105
|
|
|
|
7 Reinsurance
Premiums earned are net of amounts ceded of $33,137,000 and $30,673,000 for the three months ended March 31, 2012
and 2011, respectively. Losses and loss settlement expenses are net of amounts ceded of $1,600,000 and $5,422,000 for the three months ended March 31, 2012 and 2011, respectively. Such amounts ceded do not include the reinsurance transactions
with the Mutual Company under the pooling arrangement (described below) which are reflected on the face of the income statements, but do include reinsurance with unaffiliated reinsurers.
Pursuant to the terms of the reinsurance pooling agreement with the Mutual Company, each of the insurance subsidiaries of Harleysville
Group Inc. and Harleysville Pennland Insurance Company (Pennland), a subsidiary of the Mutual Company, cede premiums, losses and underwriting expenses on all of their respective
16
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
(Unaudited)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
business to the Mutual Company which, in turn, retrocedes to such subsidiaries and Pennland a specified portion of premiums, losses and underwriting expenses of the Mutual Company and such
subsidiaries and Pennland, excluding the financial results associated with workers compensation business for accident years 2011 and following which is retained 100 percent by the Mutual Company. Because this agreement does not relieve Harleysville
Group Inc.s insurance subsidiaries of primary liability as originating insurers, there is a concentration of credit risk arising from business ceded to the Mutual Company. However, the reinsurance pooling agreement provides for the right of
offset. The Mutual Company has an A. M. Best rating of A (Excellent).
8 Cash Flows
There were no cash tax payments in the first quarter of 2012. There were cash tax refunds of $324,000 in the first
quarter of 2011. Cash interest payments of $2,908,000 and $2,907,000 were made in the first quarter of 2012 and 2011, respectively.
9 Segment Information
The performance of the personal lines and commercial lines is evaluated based upon underwriting results as determined
under statutory accounting practices (SAP).
Financial data by segment is as follows:
|
|
|
|
|
|
|
|
|
|
|
For the Three
Months
Ended March 31,
|
|
|
|
2012
|
|
|
2011
|
|
|
|
(in thousands)
|
|
Revenues:
|
|
|
|
|
|
|
|
|
Premiums earned:
|
|
|
|
|
|
|
|
|
Commercial lines
|
|
$
|
144,333
|
|
|
$
|
149,020
|
|
Personal lines
|
|
|
54,130
|
|
|
|
50,733
|
|
|
|
|
|
|
|
|
|
|
Total premiums earned
|
|
|
198,463
|
|
|
|
199,753
|
|
Net investment income
|
|
|
20,076
|
|
|
|
25,585
|
|
Realized investment gains
|
|
|
58
|
|
|
|
15,774
|
|
Other
|
|
|
4,665
|
|
|
|
4,410
|
|
|
|
|
|
|
|
|
|
|
Total revenues
|
|
$
|
223,262
|
|
|
$
|
245,522
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes:
|
|
|
|
|
|
|
|
|
Underwriting loss:
|
|
|
|
|
|
|
|
|
Commercial lines
|
|
$
|
(5,925
|
)
|
|
$
|
(1,864
|
)
|
Personal lines
|
|
|
(4,002
|
)
|
|
|
(6,141
|
)
|
|
|
|
|
|
|
|
|
|
SAP underwriting loss
|
|
|
(9,927
|
)
|
|
|
(8,005
|
)
|
GAAP adjustments
|
|
|
(8,385
|
)
|
|
|
(9,787
|
)
|
|
|
|
|
|
|
|
|
|
GAAP underwriting loss
|
|
|
(18,312
|
)
|
|
|
(17,792
|
)
|
Net investment income
|
|
|
20,076
|
|
|
|
25,585
|
|
Realized investment gains
|
|
|
58
|
|
|
|
15,774
|
|
Other
|
|
|
1,862
|
|
|
|
1,927
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes
|
|
$
|
3,684
|
|
|
$
|
25,494
|
|
|
|
|
|
|
|
|
|
|
The GAAP adjustment of $9,787,000 for the three months ended March 31, 2011 includes the impact on
deferred acquisition costs related to the ceding commission received in January 2011 of $6,998,000 related to the change in the intercompany pooling agreement as described in Note 3 of the Notes to Consolidated Financial Statements. The impact was
all in commercial lines.
17
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
(Unaudited)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
10 Comprehensive Income
Comprehensive income for the three months ended March 31, 2012 and 2011 consisted of the following:
|
|
|
|
|
|
|
|
|
|
|
For the Three
Months
Ended March 31,
|
|
|
|
2012
|
|
|
2011
|
|
|
|
(in thousands)
|
|
|
|
|
Net income
|
|
$
|
5,006
|
|
|
$
|
18,227
|
|
Other comprehensive income:
|
|
|
|
|
|
|
|
|
Unrealized gains (losses) on securities:
|
|
|
|
|
|
|
|
|
Unrealized investment holding gains (losses) arising during period, net of taxes (benefits) of $(4,058) and
$2,791
|
|
|
(7,535
|
)
|
|
|
5,184
|
|
Less:
|
|
|
|
|
|
|
|
|
Reclassification adjustment for gains included in net income, net of taxes of $(20) and $(5,521)
|
|
|
(38
|
)
|
|
|
(10,253
|
)
|
|
|
|
|
|
|
|
|
|
Net unrealized investment losses
|
|
|
(7,573
|
)
|
|
|
(5,069
|
)
|
|
|
|
|
|
|
|
|
|
Defined benefit pension plans:
|
|
|
|
|
|
|
|
|
Recognized net actuarial loss, net of taxes of $585 and $353
|
|
|
1,087
|
|
|
|
656
|
|
|
|
|
|
|
|
|
|
|
Other comprehensive loss
|
|
|
(6,486
|
)
|
|
|
(4,413
|
)
|
|
|
|
|
|
|
|
|
|
Comprehensive income (loss)
|
|
$
|
(1,480
|
)
|
|
$
|
13,814
|
|
|
|
|
|
|
|
|
|
|
Accumulated other comprehensive income at March 31, 2012 and December 31, 2011 consisted of the
following amounts (which are net of tax):
|
|
|
|
|
|
|
|
|
|
|
March 31,
2012
|
|
|
December 31,
2011
|
|
|
|
(in thousands)
|
|
|
|
|
Unrealized investment gains
|
|
$
|
100,814
|
|
|
$
|
108,387
|
|
Defined benefit pension plan net actuarial loss
|
|
|
(43,729
|
)
|
|
|
(44,816
|
)
|
|
|
|
|
|
|
|
|
|
Accumulated other comprehensive income
|
|
$
|
57,085
|
|
|
$
|
63,571
|
|
|
|
|
|
|
|
|
|
|
11 Pension
Harleysville Group Inc. has a frozen pension plan that covers employees hired before January 1, 2006. The net
periodic pension cost for the plan, including the Mutual Company, consists of the following components:
|
|
|
|
|
|
|
|
|
|
|
For the Three
Months
Ended March 31,
|
|
|
|
2012
|
|
|
2011
|
|
|
|
(in thousands)
|
|
Components of net periodic pension cost:
|
|
|
|
|
|
|
|
|
Interest cost
|
|
$
|
2,847
|
|
|
$
|
2,964
|
|
Expected return on plan assets
|
|
|
(2,907
|
)
|
|
|
(3,102
|
)
|
Recognized net actuarial loss
|
|
|
2,462
|
|
|
|
1,641
|
|
|
|
|
|
|
|
|
|
|
Net periodic pension cost:
|
|
|
|
|
|
|
|
|
Entire plan
|
|
$
|
2,402
|
|
|
$
|
1,503
|
|
|
|
|
|
|
|
|
|
|
Harleysville Group portion
|
|
$
|
1,631
|
|
|
$
|
918
|
|
|
|
|
|
|
|
|
|
|
18
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
(Unaudited)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Harleysville Groups expected portion of the 2012 contribution to the pension plan
is $11,580,000. Contributions of $4,710,000 were made in the quarter ended March 31, 2012.
12 Borrowings
Debt is as follows:
|
|
|
|
|
|
|
|
|
|
|
March 31,
2012
|
|
|
December 31,
2011
|
|
|
|
(in thousands)
|
|
|
|
|
Notes, 5.75%, due 2013
|
|
$
|
100,000
|
|
|
$
|
100,000
|
|
Demand term-loan payable to the Mutual Company, LIBOR plus 1.25%, due 2013
|
|
|
18,500
|
|
|
|
18,500
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total debt
|
|
$
|
118,500
|
|
|
$
|
118,500
|
|
|
|
|
|
|
|
|
|
|
The fair value of the notes was $102,690,000 and $103,322,000 at March 31, 2012 and
December 31, 2011, respectively, based on quoted market prices for the same or similar debt. The carrying value of the remaining debt approximates fair value.
In March 2012, the Company and the Mutual Company agreed to amend the terms of the loan agreement related to the $18,500,000 loan from the Mutual Company to HGI. Accordingly, the maturity date of the loan
is now March 18, 2013 and the interest rate is now LIBOR plus 1.25%.
13 Shareholders Equity
Various states have adopted the National Association of Insurance Commissioners (NAIC) risk-based capital (RBC)
standards that require insurance companies to calculate and report statutory capital and surplus needs based on a formula measuring underwriting, investment and other business risks inherent in an individual companys operations. These RBC
standards have not affected the operations of Harleysville Group since each of the Companys insurance subsidiaries has statutory capital and surplus in excess of RBC requirements.
These RBC standards require the calculation of a ratio of total adjusted capital to Authorized Control Level. Insurers with a ratio below
200% are subject to different levels of regulatory intervention and action. Based upon their 2011 statutory financial statements, the ratio of total adjusted capital to the Authorized Control Level for the Companys six insurance subsidiaries
at December 31, 2011 ranged from 406% to 721%.
14 Income Taxes
As of March 31, 2012, Harleysville Group had no material unrecognized tax benefits or accrued interest and
penalties. The Companys policy is to account for interest as a component of interest expense and penalties as a component of other expense. Federal tax years 2007 through 2011 were open for examination as of March 31, 2012.
19
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
(Unaudited)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
15 Contingencies
The Harleysville Group insurance subsidiaries are subject to disputes, including litigation and arbitration, arising in
the ordinary course of their insurance business. The Companys estimates of the costs of settling such matters are reflected in its liability for unpaid losses and loss settlement expenses, and the Company does not believe that the ultimate
outcome of such matters will have a material adverse effect on its financial condition or results of operations. However, adverse outcomes of insurance claims are possible and could negatively impact the Companys financial condition and
results of operations in the future.
Harleysville Group is also subject to other non-insurance claims proceedings, lawsuits
and claims arising in the normal course of business. The Company does not believe that the ultimate liability associated with these claims will have a material adverse effect on its financial condition or results of operations. However, adverse
outcomes are possible and could negatively impact the Companys financial condition and results of operations in the future.
Harleysville Group is also subject to two class action lawsuits in connection with the Merger Agreement with Nationwide described in Note 2 of the Notes to Consolidated Financial Statements. The Company
does not believe that the ultimate liability associated with these lawsuits will have a material adverse effect on its financial condition or results of operations. However, adverse outcomes are possible and could negatively impact the
Companys financial condition and results of operations in the future.
16 New Accounting Standards
In October 2010, the FASB issued ASU 2010-26, Accounting for Costs Associated with Acquiring or Renewing
Insurance Contracts (a consensus of the FASB Emerging Issues Task Force). This ASU amends FASB Accounting Standards Codification (ASC) Topic 944, Financial Services-Insurance, to address which costs related to the acquisition of new or renewal
insurance contracts qualify for deferral. The ASU allows insurance entities to defer costs related to the acquisition of new or renewal insurance contracts that are (1) incremental direct costs of the contract transaction (i.e., would not have
occurred without the contract transaction), (2) a portion of the employees compensation and fringe benefits related to certain activities for successful contract acquisitions, or (3) direct-response advertising costs as defined in
ASC Subtopic 340-20, Other Assets and Deferred Costs Capitalized Advertising Costs. An insurance entity would expense as incurred all other costs related to the acquisition of new or renewal insurance contracts. The amendments in the ASU are
effective for fiscal years, and interim periods within those years, beginning on or after December 15, 2011, and can be applied either prospectively or retrospectively. The Company adopted this guidance prospectively during the first quarter of
2012. During 2012, the Company estimates that pre-tax expenses will increase by approximately $20 million as a lower amount of acquisition costs will be capitalized and amortization of the greater December 31, 2011 balance will continue. During
the first quarter of 2011, acquisition costs of $42.5 million would have been capitalized in accordance with the guidance in this ASU, compared to $52.7 million of acquisition costs which were capitalized during that period.
In May 2011, the FASB issued ASU 2011-04, Fair Value Measurement: Amendments to Achieve Common Fair Value Measurement and
Disclosure Requirements in U.S. GAAP and IFRSs. The amendments in this ASU result in common fair value measurement and disclosure in U.S. GAAP and IFRSs. The amendments change the wording used to describe many of the requirements in U.S. GAAP
for measuring fair value and for disclosing information about fair value measurements. The amendments include: (1) those that clarify the FASBs intent about the application of existing fair value measurement and disclosure requirements;
and (2) those that change a particular principle or requirement for measuring fair value or for disclosing information about fair value measurement. For public entities, the amendments in this ASU are effective during interim and annual periods
beginning after December 15, 2011, and are to be applied prospectively. Early application by public entities is not permitted. The adoption of this ASU did not have a material impact on the Companys results of operations or financial
position.
20
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
(Unaudited)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
In June 2011, the FASB issued ASU 2011-05, Presentation of Comprehensive
Income. Under the amendments in this ASU, an entity has the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of
comprehensive income or in two separate but consecutive statements. In December 2011, the FASB amended this guidance to postpone the requirement to present on the face of the financial statements reclassification adjustments for items that are
reclassified from other comprehensive income to net income where the components of net income and the components of other comprehensive income are presented, and reinstate previous guidance related to such reclassifications. For public entities, the
amendments in this ASU are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011, and are to be applied retrospectively. Early adoption is permitted. The adoption of this ASU did not have a
material impact on the Companys results of operations or financial position.
In September 2011, the FASB issued ASU
2011-08, Testing Goodwill for Impairment. The amendments in this ASU permit an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying
amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test described in ASC Topic 350, Intangibles-Goodwill and Other. Previous guidance under this topic required an entity to test goodwill for
impairment, on at least an annual basis, by comparing the fair value of a reporting unit with its carrying amount. If the fair value of the reporting unit is less than its carrying amount, then the second step of the test must be performed to
measure the amount of the impairment loss, if any. Under the amendments in this ASU, an entity is not required to calculate the fair value of a reporting unit unless the entity determines that it is more likely than not that its fair value is less
than its carrying amount. This ASU is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. The adoption of this ASU did not have a material impact on the Companys results
of operations or financial position.
21
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
Item 2.
Managements Discussion and Analysis of Financial Condition
and Results of Operations
Certain of the statements contained herein (other than statements of historical facts) are forward-looking statements. Such forward-looking statements are made pursuant to the safe harbor provisions of
the Private Securities Litigation Reform Act of 1995 and include estimates and assumptions related to economic, competitive, legislative and regulatory developments. These forward-looking statements are subject to change and uncertainty which are,
in many instances, beyond the Companys control and have been made based upon managements expectations and beliefs concerning future developments and their potential effect on Harleysville Group. There can be no assurance that future
developments will be in accordance with managements expectations or that the effect of future developments on Harleysville Group will be those anticipated by management. Actual financial results, including premium levels and underwriting
results, could differ materially from those anticipated by Harleysville Group depending on the outcome of certain factors, which may include changes in property and casualty loss trends and reserves; the insurance product pricing environment;
changes in applicable law; government regulation and changes therein that may impede the ability to charge adequate rates; performance of and instability in the financial markets; investment losses; fluctuations in interest rates; significant
catastrophe events in the geographic regions where we do business; decreased demand for property and casualty insurance; availability and price of reinsurance; the A.M. Best group rating of Harleysville Group; and the status of labor markets in
which the Company operates.
Overview
The Companys net income is primarily determined by four elements:
|
|
|
investment income and realized investment gains (losses);
|
|
|
|
amounts paid or reserved to settle insured claims; and
|
|
|
|
other income and expense.
|
Variations in premium income are subject to a number of factors, including:
|
|
|
limitations on premium rates arising from the competitive marketplace or regulation;
|
|
|
|
limitations on available business arising from a need to maintain the quality of underwritten risks;
|
|
|
|
the Companys ability to maintain its A (Excellent) group rating by A.M. Best; and
|
|
|
|
the ability of the Company to maintain a reputation for efficiency and fairness in claims administration.
|
Variations in investment income and realized investment gains (losses) are subject to a number of factors, including:
|
|
|
general interest rate levels and financial market conditions;
|
|
|
|
specific adverse events affecting the issuers of debt obligations held by the Company; and
|
|
|
|
changes in the prices of debt and equity securities generally and those held by the Company specifically.
|
Loss and loss settlement expenses are affected by a number of factors, including:
|
|
|
the quality of the risks underwritten by the Company;
|
|
|
|
the nature and severity of catastrophic losses;
|
|
|
|
the availability, cost and terms of reinsurance; and
|
|
|
|
underlying settlement costs, including medical and legal costs.
|
22
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
Managements Discussion and Analysis of Financial Condition
and Results of Operations
(Continued)
Variations in other income and expense are affected by a number of factors, including:
|
|
|
the level of premiums written by the Mutual Company and its subsidiaries which are subject to the management fee;
|
|
|
|
the amount of flood insurance written and ceded to the National Flood Insurance Program; and
|
|
|
|
the interest rate on debt issued by the Company.
|
The Company seeks to manage each of the foregoing to the extent within its control. Many of the foregoing factors are partially, or entirely, outside of the control of the Company.
Critical Accounting Policies and Estimates
The consolidated financial statements are prepared in conformity with U.S. generally accepted accounting principles, which require Harleysville Group to make estimates and assumptions (see Note 1 of the
Notes to Consolidated Financial Statements for the year ended December 31, 2011 included in the Companys 2011 Annual Report on Form 10-K filed with the SEC). Harleysville Group believes that of its significant accounting policies, the
following may involve a higher degree of judgment and estimation. The judgments, or the methodology on which the judgments are made, are reviewed quarterly with the Audit Committee.
Liability for Losses and Loss Settlement Expenses
. The liability for losses and loss settlement expenses represents estimates of
the ultimate unpaid cost of all losses incurred, including losses for claims which have not yet been reported to Harleysville Group. 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 settlement expense reserves are determined utilizing
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. Estimates of the liabilities
are reviewed and updated on a regular basis using the most recent information on reported claims and a variety of actuarial techniques. It is expected that such estimates will be more or less than the amounts ultimately paid when the claims are
settled. Changes in these estimates are reflected in current operations.
Investments
. Generally, unrealized investment
gains or losses on investments carried at fair value, net of applicable income taxes, are reflected directly in shareholders equity as a component of comprehensive income and, accordingly, have no effect on net income. However, if the fair
value of an investment in equity securities declines below its cost and that decline is deemed other than temporary, the amount of the decline below cost is charged to earnings. Per Harleysville Groups current policy, a fixed maturity security
is other than temporarily impaired if the present value of the cash flows expected to be collected is less than the amortized cost of the security or where the securitys fair value is below cost and Harleysville Group intends to sell, or more
likely than not will be required to sell, the security before recovery of its value. If Harleysville Group does not intend to sell, or more likely than not will not be required to sell, a fixed maturity security whose fair value has declined below
its cost, the amount of the decline below cost due to credit-related reasons is charged to earnings and the remaining difference is included in comprehensive income. Harleysville Group monitors its investment portfolio and at least quarterly reviews
investments that have experienced a decline in fair value below cost to evaluate whether the decline is other than temporary. Such evaluations consider, among other things, the magnitude and reasons for a decline, the prospects for the fair value to
recover in the near term and Harleysville Groups intent to retain the investment for a period of time sufficient to allow for a recovery in value. Future adverse investment market conditions, or poor operating results of underlying
investments, could result in an impairment charge in the future.
23
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
Managements Discussion and Analysis of Financial Condition
and Results of Operations
(Continued)
The severe downturn in the public debt and equity markets in recent years, reflecting
uncertainties associated with the mortgage crisis, worsening economic conditions, widening of credit spreads, bankruptcies and government intervention in large financial institutions, has resulted in significant realized and unrealized losses in our
investment portfolio in the past. Depending on market conditions going forward, we could incur additional realized and unrealized losses in future periods.
The fair value of equity securities is based on the closing market value. The fair value of mutual fund holdings is based on the closing net asset value reported by the fund. The fair value of fixed
maturities is based upon data supplied by an independent pricing service. It can be difficult to determine the fair value of non-traded securities, but Harleysville Group does not own a material amount of non-traded securities.
Policy Acquisition Costs
. Currently, policy acquisition costs, such as commissions, premium taxes and certain other underwriting
expenses, that are incremental and directly related to the successful acquisition of insurance contracts are deferred and amortized over the effective period of the related insurance policies and in proportion to the premiums earned. The method
followed in computing deferred policy acquisition costs limits the amount of such deferred costs to their estimated realizable value. The estimation of net realizable value takes into account the premium to be earned, related investment income over
the claim paying period, expected losses and loss settlement 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 losses and loss settlement
expenses, may require adjustments to deferred policy acquisition costs. If the estimation of net realizable value indicates that the deferred acquisition costs are not recoverable, they would be written off and further analyses would be performed to
determine if an additional liability would need to be accrued.
Contingencies
. Besides claims related to its insurance
products, Harleysville Group is subject to proceedings, lawsuits and claims in the normal course of business. Harleysville Group assesses the likelihood of any adverse outcomes to these matters as well as potential ranges of probable losses. There
can be no assurance that actual outcomes will be consistent with those assessments.
The application of certain of these
critical accounting policies to the periods ended March 31, 2012 and 2011 is discussed in greater detail below.
Results of Operations
On September 28, 2011, the Mutual Company and HGI entered into an agreement and plan of merger (the Merger Agreement) with
Nationwide the Mutual Company Insurance Company (Nationwide) and a subsidiary of Nationwide (Nationals Sub). Pursuant to the Merger Agreement, the Mutual Company will merge into Nationwide with Nationwide as the surviving Company and the
policyholders of the Mutual Company will become policyholders and members of Nationwide. In addition, Nationals Sub will merge into HGI with HGI as the surviving company and a wholly-owned subsidiary of Nationwide. As a result of the merger, all
outstanding shares of common stock of HGI held by stockholders, other than Nationwide, will be converted into the right to receive $60.00 per share in cash. The Mutual Company has also entered into a voting agreement with Nationwide under which it
agreed to vote its 53% interest in HGI in favor of the merger. The Merger Agreement restricts the Mutual Company, HGI and all affiliates from engaging in certain activities and taking certain actions without Nationwides approval, including
among others, the payment of shareholder dividends by HGI.
The transactions contemplated by the Merger Agreement are subject
to customary closing conditions, including, among others, approvals from stockholders of HGI and members/policyholders of the Mutual Company and Nationwide, the Pennsylvania Insurance Department, the Ohio Insurance Department, and various other
regulatory bodies. In April 2012, approvals were received from the stockholders of HGI, the members/policyholders of the Mutual Company and Nationwide, and all necessary regulatory bodies. The transactions are expected to close May 1, 2012. The
Merger Agreement provides certain termination rights. In the event that the agreement is terminated under certain conditions by HGIs Board of Directors, HGI will be required to pay Nationwide a termination fee of $29.6 million and reimburse
Nationwide for its transaction expenses.
24
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
Managements Discussion and Analysis of Financial Condition
and Results of Operations
(Continued)
The Companys property and casualty subsidiaries participate in a pooling agreement
with the Mutual Company and its property and casualty insurance subsidiary, Harleysville Pennland Insurance Company (Pennland), whereby such subsidiaries and Pennland cede to the Mutual Company all of their insurance business and assume from the
Mutual Company an amount equal to their participation in the pooling agreement. All losses and loss settlement expenses and other underwriting expenses are prorated among the parties on the basis of participation in the pooling agreement. The
pooling agreement provides for the allocation of premiums, losses and loss settlement expenses and underwriting expenses between Harleysville Group and the Mutual Company. Harleysville Group is not liable for any losses incurred by its subsidiaries,
Harleysville Preferred Insurance Company and Harleysville Insurance Company of New Jersey, and the Mutual Company prior to January 1, 1986, the date the pooling agreement became effective. The pooling agreement excludes reinsurance premiums,
losses, loss settlement expenses and underwriting expenses voluntarily assumed by the Mutual Company. Harleysville Groups participation in the pool has been 80% since January 1, 2008.
Effective January 1, 2011, the Companys property and casualty subsidiaries and the Mutual Company and Pennland amended their
intercompany pooling agreement as it relates to their workers compensation business. The amendment establishes that the financial results associated with the workers compensation business for accident years 2011 and following will be retained 100
percent by the Mutual Company. The financial results of this business for prior accident years will continue to be shared between the Companys property and casualty subsidiaries, the Mutual Company and Pennland under the existing pool
participations. Harleysville Group paid cash of $33 million on January 3, 2011 associated with the transfer of the unearned premium liability on the workers compensation business as of January 1, 2011. Harleysville Groups
unearned premium liability decreased by $40 million and Harleysville Group received a ceding commission of $7 million for expenses that were incurred to generate the business ceded to the Mutual Company, which ceding commission reduced deferred
policy acquisition costs.
Premiums earned decreased $1.3 million, or 0.6%, during the three months ended March 31,
2012 compared to the same period in the prior year primarily due to a decrease of $4.7 million in premiums earned for commercial lines, partially offset by an increase of $3.4 million in premiums earned for personal lines. The decrease in
premiums earned for commercial lines was 3.1%, primarily due to lower exposures. The increase in premiums earned for personal lines was 6.7%, primarily due to higher average premiums.
Investment income decreased $5.5 million for the three months ended March 31, 2012 compared to the same period in the prior
year primarily due to lower invested assets, a lower investment yield on fixed income securities and short-term investments, and lesser dividends on equity securities.
Net realized investment gains decreased $15.7 million for the three months ended March 31, 2012, compared to the three months ended March 31, 2011, primarily due to realized gains on the
sale of equity mutual funds in 2011. There were no impairment charges in the three months ended March 31, 2012 or 2011.
25
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
Managements Discussion and Analysis of Financial Condition
and Results of Operations
(Continued)
Harleysville Group held securities with unrealized losses at March 31, 2012 as
follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Length of
Unrealized Loss
|
|
|
|
Fair Value
|
|
|
Unrealized
Losses
|
|
|
Less Than
12 Months
|
|
|
|
(in thousands)
|
|
|
|
|
|
Fixed maturities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasury securities
|
|
$
|
183,561
|
|
|
$
|
375
|
|
|
$
|
375
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total temporarily impaired securities
|
|
$
|
183,561
|
|
|
$
|
375
|
|
|
$
|
375
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
All of the fixed maturity securities with an unrealized loss at March 31, 2012 are classified as
available for sale and are carried at fair value on the balance sheet.
The unrealized losses on fixed maturity investments
were primarily due to an increase in interest rates on U.S. Treasury Securities rather than a decline in credit quality. Per Harleysville Groups current policy, a fixed maturity security is other than temporarily impaired if the present value
of the cash flows expected to be collected is less than the amortized cost of the security or where the securitys fair value is below cost and Harleysville Group intends to sell, or more likely than not will be required to sell, the security
before recovery of its value. Harleysville Group believes, based on its analysis, that these securities are not other than temporarily impaired. However, depending on developments involving both the issuers and worsening economic conditions, these
investments may be written down in the income statement in the future.
An insurance companys statutory combined ratio
is a standard measure of underwriting profitability. This ratio is the sum of (1) the ratio of incurred losses and loss settlement expenses to net earned premium; (2) the ratio of expenses incurred for commissions, premium taxes,
administrative and other underwriting expenses to net written premium; and (3) the ratio of dividends to policyholders to net earned premium. The combined ratio does not reflect investment income, federal income taxes or other non-operating
income or expense. A ratio of less than 100 percent generally indicates underwriting profitability. Harleysville Groups statutory combined ratio for the three months ended March 31, 2012 was 105.0% compared to 112.3% for the three months
ended March 31, 2011, which includes 4.5% due to the impact of the statutory treatment of the ceding commission received on the unearned premiums ceded to the Mutual Company on January 1, 2011. Excluding the impact of the pool transfer,
the statutory combined ratio was 107.8% for the three months ended March 31, 2011. The 2012 period includes 0.8 points of catastrophe losses. The 2011 period includes unusually severe winter weather resulting in losses not meeting the
catastrophe definition, as well as 4.5 points of catastrophe losses.
26
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
Managements Discussion and Analysis of Financial Condition
and Results of Operations
(Continued)
The statutory combined ratios by line of business for the three months ended
March 31, 2012 and March 31, 2011 are shown below.
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months Ended
March 31,
|
|
|
|
2012
|
|
|
2011
|
|
Commercial:
|
|
|
|
|
|
|
|
|
|
|
Automobile
|
|
|
|
|
107.3
|
%
|
|
|
100.3
|
%
|
Commercial multi-peril
|
|
|
|
|
103.7
|
%
|
|
|
117.6
|
%
|
Other commercial
|
|
|
|
|
108.9
|
%
|
|
|
87.2
|
%
|
Total commercial
|
|
|
|
|
102.8
|
%
|
|
|
113.1
|
%
|
Total commercial excluding the impact of the pool transfer
|
|
|
|
|
|
|
|
|
106.0
|
%
|
|
|
|
|
Personal:
|
|
|
|
|
|
|
|
|
|
|
Automobile
|
|
|
|
|
121.8
|
%
|
|
|
110.7
|
%
|
Homeowners
|
|
|
|
|
102.8
|
%
|
|
|
121.4
|
%
|
Other personal
|
|
|
|
|
75.4
|
%
|
|
|
74.0
|
%
|
Total personal
|
|
|
|
|
110.5
|
%
|
|
|
112.8
|
%
|
|
|
|
|
Total personal and commercial
|
|
|
|
|
105.0
|
%
|
|
|
112.3
|
%
|
|
|
|
|
Total personal and commercial excluding the impact of the pool transfer
|
|
|
|
|
|
|
|
|
107.8
|
%
|
The commercial lines statutory combined ratio decreased to 102.8% for the three months ended
March 31, 2012 from 106.0%, excluding the impact of the pool transfer, for the three months ended March 31, 2011. Catastrophe losses in commercial lines represented 0.8 points of the combined ratio in the three months ended March 31,
2012 compared to 3.7 points in the three months ended March 31, 2011. Favorable development in the workers compensation line of business reduced the commercial lines combined ratio by 2.7 points and 2.5 points for the three months ended
March 31, 2012 and 2011, respectively.
The personal lines statutory combined ratio decreased to 110.5% for the three
months ended March 31, 2012 from 112.8% for the three months ended March 31, 2011. Catastrophe losses in the personal lines represented 0.9 points of the combined ratio in the three months ended March 31, 2012 compared to 6.8 points
in the three months ended March 31, 2011.
27
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
Managements Discussion and Analysis of Financial Condition
and Results of Operations
(Continued)
The following table presents the liability for unpaid losses and loss settlement
expenses by major line of business:
|
|
|
|
|
|
|
|
|
|
|
March 31,
2012
|
|
|
December 31,
2011
|
|
|
|
(in thousands)
|
|
|
|
|
Commercial:
|
|
|
|
|
|
|
|
|
Automobile
|
|
$
|
269,030
|
|
|
$
|
272,590
|
|
Workers compensation
|
|
|
293,349
|
|
|
|
307,453
|
|
Commercial multi-peril
|
|
|
676,140
|
|
|
|
679,849
|
|
Other commercial
|
|
|
147,564
|
|
|
|
144,983
|
|
|
|
|
|
|
|
|
|
|
Total commercial
|
|
|
1,386,083
|
|
|
|
1,404,875
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Personal:
|
|
|
|
|
|
|
|
|
Automobile
|
|
|
89,008
|
|
|
|
87,714
|
|
Homeowners
|
|
|
48,124
|
|
|
|
49,955
|
|
Other personal
|
|
|
3,178
|
|
|
|
2,860
|
|
|
|
|
|
|
|
|
|
|
Total personal
|
|
|
140,310
|
|
|
|
140,529
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total personal and commercial
|
|
|
1,526,393
|
|
|
|
1,545,404
|
|
|
|
|
Plus reinsurance recoverables
|
|
|
202,202
|
|
|
|
244,187
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total liability
|
|
$
|
1,728,595
|
|
|
$
|
1,789,591
|
|
|
|
|
|
|
|
|
|
|
The following table presents the increase (decrease) in the estimated ultimate loss and loss settlement
expenses attributable to insured events of prior years for the three months ended March 31, 2012 by line of business:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accident Years
|
|
|
Total
|
|
|
2011
|
|
|
2010
|
|
|
2009 and
Prior
Years
|
|
|
|
(in thousands)
|
|
|
|
|
|
|
Commercial:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Automobile
|
|
$
|
(1,071
|
)
|
|
$
|
415
|
|
|
$
|
(93
|
)
|
|
$
|
(1,393
|
)
|
Workers compensation
|
|
|
(3,841
|
)
|
|
|
|
|
|
|
804
|
|
|
|
(4,645
|
)
|
Commercial multi-peril
|
|
|
(3,566
|
)
|
|
|
125
|
|
|
|
64
|
|
|
|
(3,755
|
)
|
Other commercial
|
|
|
(1,305
|
)
|
|
|
128
|
|
|
|
(142
|
)
|
|
|
(1,291
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total commercial
|
|
|
(9,783
|
)
|
|
|
668
|
|
|
|
633
|
|
|
|
(11,084
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Personal:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Automobile
|
|
|
1,057
|
|
|
|
(112
|
)
|
|
|
1,861
|
|
|
|
(692
|
)
|
Homeowners
|
|
|
(1,405
|
)
|
|
|
(1,977
|
)
|
|
|
569
|
|
|
|
3
|
|
Other personal
|
|
|
288
|
|
|
|
104
|
|
|
|
70
|
|
|
|
114
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total personal
|
|
|
(60
|
)
|
|
|
(1,985
|
)
|
|
|
2,500
|
|
|
|
(575
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total net development
|
|
$
|
(9,843
|
)
|
|
$
|
(1,317
|
)
|
|
$
|
3,133
|
|
|
$
|
(11,659
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
There was $9.8 million of net favorable development in the provision for insured events of prior
years for the three months ended March 31, 2012, of which $9.7 million was in commercial lines and $0.1 million was in personal lines. The favorable development primarily related to the 2001 through 2009 accident years as a result of
lower than
28
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
Managements Discussion and Analysis of Financial Condition
and Results of Operations
(Continued)
expected claim severity experienced broadly across all lines of business, particularly workers compensation, commercial multi-peril, commercial automobile, and other liability, partially offset
by adverse development in accident year 2010.
There was $13.1 million of net favorable development in the provision for
insured events of prior years for the three months ended March 31, 2011, of which $12.5 million was in commercial lines and $0.6 million was in personal lines. The favorable development primarily related to the 2003 through 2008
accident years as a result of lower than expected claim severity experienced broadly across all lines of business, particularly commercial multi-peril, commercial and personal automobile, and workers compensation, partially offset by adverse
development in accident year 2010.
Harleysville Group records the actuarial best estimate of the ultimate unpaid losses and
loss settlement expenses incurred. The estimate represents the actuarially determined expected amount of future payments on all loss and loss settlement expenses incurred on or before March 31, 2012. Actuarial loss reserving techniques and
assumptions, which rely on historical information as adjusted to reflect current conditions, have been consistently applied, after including consideration of recent case reserve activity, during the periods presented. Changes in the estimate of the
liability for unpaid losses and loss settlement expenses reflect actual payments and evaluations of new information and data since the last reporting date. These changes correlate with actuarial trends.
The following table presents the liability for unpaid losses and loss settlement expenses (LAE) by case and incurred but not reported
(IBNR) reserves by line of business as of March 31, 2012:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Case
|
|
|
IBNR
|
|
|
LAE Liability
|
|
|
IBNR
(Incl. LAE)
|
|
|
Total
Liability
|
|
|
|
(in thousands)
|
|
Commercial:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Automobile
|
|
$
|
89,515
|
|
|
$
|
128,514
|
|
|
$
|
51,001
|
|
|
$
|
179,515
|
|
|
$
|
269,030
|
|
Workers compensation
|
|
|
127,010
|
|
|
|
122,854
|
|
|
|
43,485
|
|
|
|
166,339
|
|
|
|
293,349
|
|
Commercial multi-peril
|
|
|
186,282
|
|
|
|
307,049
|
|
|
|
182,809
|
|
|
|
489,858
|
|
|
|
676,140
|
|
Other commercial
|
|
|
31,579
|
|
|
|
79,893
|
|
|
|
36,092
|
|
|
|
115,985
|
|
|
|
147,564
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total commercial
|
|
|
434,386
|
|
|
|
638,310
|
|
|
|
313,387
|
|
|
|
951,697
|
|
|
|
1,386,083
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Personal:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Automobile
|
|
|
41,719
|
|
|
|
31,271
|
|
|
|
16,018
|
|
|
|
47,289
|
|
|
|
89,008
|
|
Homeowners
|
|
|
15,691
|
|
|
|
23,695
|
|
|
|
8,738
|
|
|
|
32,433
|
|
|
|
48,124
|
|
Other personal
|
|
|
985
|
|
|
|
1,743
|
|
|
|
450
|
|
|
|
2,193
|
|
|
|
3,178
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total personal
|
|
|
58,395
|
|
|
|
56,709
|
|
|
|
25,206
|
|
|
|
81,915
|
|
|
|
140,310
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total net liability
|
|
|
492,781
|
|
|
|
695,019
|
|
|
|
338,593
|
|
|
|
1,033,612
|
|
|
|
1,526,393
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reinsurance recoverables
|
|
|
126,152
|
|
|
|
75,681
|
|
|
|
369
|
|
|
|
76,050
|
|
|
|
202,202
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total gross liability
|
|
$
|
618,933
|
|
|
$
|
770,700
|
|
|
$
|
338,962
|
|
|
$
|
1,109,662
|
|
|
$
|
1,728,595
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reinsurance recoverables were $204.2 million and $245.9 million at March 31, 2012 and
December 31, 2011, respectively. Of these amounts, $99.9 million and $137.7 million, respectively, or 49% and 56%, respectively, of the recoverables were due from governmental bodies, regulatory agencies or quasi-governmental pools
and reinsurance facilities where Harleysville Group believes there is limited credit risk. The remainder of the reinsurance recoverables are
29
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
Managements Discussion and Analysis of Financial Condition
and Results of Operations
(Continued)
principally due from reinsurers rated A- or higher by the A.M. Best Company. Ceded reinsurance contracts do not relieve Harleysville Groups primary obligation to its policyholders.
Consequently, an exposure exists with respect to reinsurance recoverables to the extent that any reinsurer is unable to meet its obligation or disputes the liabilities assumed under the reinsurance contract. From time to time, Harleysville Group may
encounter such disputes with its reinsurers. In addition, the creditworthiness of our reinsurers could deteriorate in the future due to adverse events affecting the reinsurance industry, such as a large number of major catastrophes.
Effective January 1, 2012, the Companys subsidiaries and the Mutual Company and its wholly owned subsidiary renewed the top
layer of its property catastrophe reinsurance program and decreased reinsurance coverage in the layer from 75% to 64.35%. Accordingly, effective January 1, 2012, pursuant to the terms of the property catastrophe treaties, the maximum recovery
would be $357.8 million for any catastrophe involving an insured loss equal to or greater than $525.0 million. Harleysville Groups pooling share of this maximum recovery would be $286.3 million for any catastrophe involving an insured loss of
$420.0 million or greater.
Because of the nature of insurance claims, there are uncertainties inherent in the estimates of
ultimate losses. Harleysville Groups reorganization of its claims operation in recent years has resulted in new people and processes involved in settling claims. As a result, more recent statistical data reflects different patterns than in the
past and gives rise to uncertainty as to the pattern of future loss settlements. There are uncertainties regarding future loss cost trends particularly related to medical treatments and automobile repair. Court decisions, regulatory changes and
economic conditions can affect the ultimate cost of claims that occurred in the past. Accordingly, the ultimate liability for unpaid losses and loss settlement expenses will likely differ from the amount recorded at March 31, 2012.
The property and casualty industry has had substantial aggregate loss experience from claims related to asbestos-related illnesses,
environmental remediation, product liability, mold, and other uncertain exposures. Harleysville Group has not experienced significant losses from such claims.
In the first quarter of 2012, Harleysville Group had income before income taxes of $3.7 million, compared to $25.5 million in the first quarter of 2011. The decrease in income before income
taxes of $21.8 million for the three months ended March 31, 2012, as compared to the same period in 2011, was primarily due to lesser investment income and realized gains in the 2012 period compared to the 2011 period. The increase in other
underwriting expenses in the first quarter of 2012 is primarily due to the adoption of new accounting guidance (ASU 2010-26) related to the capitalization of acquisition costs.
The income tax expense for the three month periods ended March 31, 2012 and 2011 includes a tax benefit of $2.8 million and
$3.4 million, respectively, related to tax-exempt investment income.
Liquidity and Capital Resources
Operating activities used net cash of $41.0 million and $28.1 million for the three months ended March 31, 2012 and 2011,
respectively. The 2011 amount includes $33.0 million paid in connection with the change to the intercompany pooling agreement effective January 1, 2011. The remaining change of $45.9 million is due to a decrease in underwriting cash flow,
including the change in the due to affiliate balance.
Investing activities provided $40.9 million and $37.1 million
of net cash for the three months ended March 31, 2012 and 2011, respectively. The change is primarily due to greater net sales of investments in the 2012 period due to the decrease in cash provided by operating activities, partially offset by
the increase in cash provided by financing activities.
30
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
Managements Discussion and Analysis of Financial Condition
and Results of Operations
(Continued)
Financing activities provided $0.1 million and used $9.0 million of net cash
for the three months ended March 31, 2012 and 2011, respectively. The change is primarily due to the decrease in dividends paid.
Harleysville Groups investment strategy is designed to complement and support the insurance operations. Harleysville Group considers projected cash flow (premiums, investment income, reinsurance
programs, liability payout patterns, general expenses, large seasonal obligations, intercompany transfers, etc.) to assure that sufficient liquidity exists within Harleysville Group and the Mutual Company. Maintaining a regular maturity schedule in
readily marketable securities is an essential part of addressing liquidity. This regular maturity schedule is maintained in all interest rate environments. After-tax yield will be maximized consistent with safety and liquidity considerations by
investment in taxable or tax-exempt securities, depending on Harleysville Groups tax position. Proceeds from the maturities of fixed income securities in the first quarter of 2012 were reinvested in short-term investments.
Harleysville Group Inc. had $30.9 million of cash and marketable securities at March 31, 2012 which is available for general
corporate purposes including dividends, debt service, capital contributions to subsidiaries, acquisitions and the repurchase of stock. On August 6, 2010, the Board of Directors authorized the Company to repurchase up to 800,000 shares of its
outstanding common stock over a two year period in the open market or in privately negotiated transactions. Additionally, the Board authorized the Company to make purchases under the terms of a Rule 10b5-1 trading plan, which allows the Company to
purchase its shares at times when it ordinarily would not be in the market because of self-imposed trading blackout periods, such as the time preceding its quarterly earnings releases, or because its officers are in possession of material,
non-public information. The Company repurchased shares in open market transactions from the public float and did not repurchase shares from the Mutual Company. As of March 31, 2012, the Company had repurchased 245,084 shares under this
authorization, leaving 554,916 shares authorized to be repurchased. Provisions in the Merger Agreement with Nationwide restrict the Company from repurchasing further shares. Harleysville Group has no other material commitments for capital
expenditures as of March 31, 2012.
As a holding company, the Companys principal source of cash for the payment of
dividends is dividends from its insurance subsidiaries. The Companys insurance subsidiaries are subject to state laws that restrict their ability to pay dividends. The Companys insurance subsidiaries did not declare or pay dividends to
the Company in 2012.
The timing of future cash payments associated with unpaid losses and loss settlement expenses and
contractual obligations pursuant to debt agreements is not expected to be materially different from that disclosed in the Companys annual report on Form 10-K for fiscal year 2011.
31
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
Item 3.
Quantitative and Qualitative Disclosure
about Market Risk
Harleysville Groups market risk generally represents the risk of gain or loss that may result from the potential
change in the fair value of Harleysville Groups investment portfolio as a result of fluctuations in prices and interest rates. Harleysville Group attempts to manage its interest rate risk by maintaining an appropriate relationship between the
average duration of the investment portfolio and the approximate duration of its liabilities. Changes to Harleysville Groups market risk since December 31, 2011 are reflected within Managements Discussion and Analysis of Financial
Condition and Results of Operations and within the financial statements contained within this Form 10-Q.
Harleysville Group
has maintained approximately the same duration of its investment portfolio to its liabilities from December 31, 2011 to March 31, 2012.
32
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
Item 4.
Controls and Procedures
(a)
|
Evaluation of disclosure controls and procedures
. Our management, under the supervision and with the participation of the chief executive officer and the chief
financial officer, has evaluated the effectiveness of our disclosure controls and procedures as required by Rule 13a-15(b) or Rule 15d-15(b) of the Securities Exchange Act of 1934, as amended, as of March 31, 2012, which is the end of the
period covered by this quarterly report on Form 10-Q. Based on that evaluation, the chief executive officer and chief financial officer have concluded that these disclosure controls and procedures are effective to provide that (a) material
information relating to us, including our consolidated subsidiaries, is made known to these officers by other employees of us and our consolidated subsidiaries, particularly material information related to the first quarter of 2012, for which this
periodic report is being prepared; and (b) this information is recorded, processed, summarized, evaluated and reported, as applicable, within the time periods specified in the rules and forms of the SEC.
|
(b)
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Change in internal control over financial reporting
. There was no change in the Companys internal control over financial reporting that occurred during the
first quarter of 2012 that has materially affected, or is reasonably likely to materially affect, the Companys internal control over financial reporting.
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33
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
PART II. OTHER INFORMATION
ITEM 1.
|
Legal Proceedings
|
Stockholder Lawsuits
Louisiana Municipal Police Employees Retirement
System v. Harleysville Group Inc., et al.
On October 4, 2011, the Company, the Mutual Company, the Companys
directors, Nationwide and a subsidiary of Nationwide (Merger Sub) were named as defendants in a putative class action complaint in the Court of Chancery of the State of Delaware, captioned
Louisiana Municipal Police Employees Retirement System v.
Harleysville Group Inc., et al.
That action, purportedly brought on behalf of a class of stockholders, alleges that the Companys directors breached their fiduciary duties of care, loyalty, good faith, candor and independence. The complaint
further alleges that the Companys directors, through their acts, transactions and courses of conduct, are attempting to unfairly deprive stockholders of the true value of their investment in the Company. The complaint further alleges that
there exists an imbalance and disparity of knowledge between our directors and our public stockholders which makes it inherently unfair for the Companys directors to benefit from their own interests to the exclusion of maximizing stockholder
value. The complaint further alleges that the Companys directors failed to disclose to the plaintiffs all material information necessary to cast an informed stockholder vote on the proposed transaction. The complaint further alleges that
Nationwide and Merger Sub aided and abetted the claimed breaches of fiduciary duties by our directors. The plaintiff seeks injunctive and other equitable relief, including a request that the court enjoin us from consummating the Merger, as well
as damages, fees and costs. To date, by agreement of the parties, the Company has not filed an answer to this complaint.
Eric H. Berger v. Harleysville Group Inc., et al.
On October 6, 2011, the Company, the Mutual Company, the Companys directors, Nationwide and Merger Sub were named as defendants in a putative class action complaint in the Court of Chancery of
the State of Delaware, captioned
Eric H. Berger v. Harleysville Group Inc., et al.
That action, purportedly brought on behalf of a class of stockholders, alleges that the Companys directors breached their fiduciary duties of care,
loyalty, good faith, candor and independence. The complaint further alleges that the directors, through their acts, transactions and courses of conduct, are attempting to unfairly deprive our stockholders of the true value of their investment in the
Company. The complaint further alleges that there exists an imbalance and disparity of knowledge between the Companys directors and its public stockholders which makes it inherently unfair for the Companys directors to benefit from their
own interests to the exclusion of maximizing stockholder value. The complaint further alleges that the directors failed to disclose to the plaintiffs all material information necessary to cast an informed stockholder vote on the proposed
transaction. The complaint further alleges that Nationwide and Merger Sub aided and abetted the claimed breaches of fiduciary duties by the Companys directors. The plaintiff seeks injunctive and other equitable relief, including a request
that the court enjoin the Company from consummating the Merger, as well as damages, fees and costs. To date, by agreement of the parties, the Company has not filed an answer to this complaint.
Consolidated Stockholder Lawsuits
The plaintiffs in both the
Louisiana Municipal Police Employees Retirement System and the Berger
cases are represented by the same law firm. On October 21, 2011, the Court of
Chancery of Delaware entered an order agreed to by counsel for the plaintiffs and counsel for the Company, the Mutual Company, the Companys directors, Nationwide and Merger Sub consolidating both cases. On January 3, 2012, the plaintiffs
filed their Consolidated Amended Class Action Complaint, which adds allegations about the sale process, asserting that there was not a vigorous enough effort to find other buyers at a higher price together with alleged disclosure shortfalls, all by
reference to the preliminary proxy statement filed by the Company with the SEC on December 23, 2011. To date, by agreement of the parties, the Company has not filed an answer to the Consolidated Amended Class Action Complaint.
Policyholder Lawsuits
After the announcement of the Merger Agreement, the Mutual Company received five letters on behalf of purported policyholders objecting to the merger of the Mutual Company into Nationwide (the Parent
Merger). Six lawsuits were filed against the Mutual Company brought by purported policyholders challenging the proposed transaction. Initially, Nationwide was named as a defendant in three of these suits. Since their initial filing, three of the
lawsuits against the Mutual Company have been dismissed and the remaining three consolidated into one action. For additional procedural history regarding the original policyholder actions, please see the Harleysville Group Definitive Proxy
Statement, filed in March 2012.
On January 20, 2012, pursuant to a Court Order, plaintiffs filed a Consolidated Class
Action and Derivative Complaint (the CCADC) on behalf of the three plaintiffs with continuing lawsuits against the Mutual Company. The CCADC contains nine claims variously stated as being derivative and/or class in nature: (1) declaratory and
injunctive relief contending that the Merger and the Parent Merger (the Mergers) are fundamentally unfair; (2) declaratory and injunctive relief contending that the draft proxy statement for the policyholders-members of the Mutual Company,
which was filed by the Mutual Company with the Pennsylvania Insurance Department on December 23, 2011, is materially misleading; (3) declaratory relief contending that the Merger Agreement prevents the Special Litigation Committee formed
by the Mutual Companys board of directors from performing its authorized function; (4) equitable relief contending that the Mutual Company has been effectively demutualized; (5) breach of duty by the Mutual Companys directors;
(6) aiding and abetting a breach of duty by the Mutual Companys directors, Nationwide and Merger Sub; (7) unjust enrichment against the Mutual Companys directors, the two directors of the Company who are only directors of the
Company, the Mutual Company, Nationwide and Merger Sub; (8) constructive trust against the Mutual Company, Nationwide and Merger Sub; and (9) declaratory and injunctive relief to enjoin enforcement of allegedly unlawful provisions of the
Merger Agreement against Nationwide and the Company. On January 31, 2012, all defendants filed preliminary objections to the CCADC.
In response to the demands and complaints, the Mutual Companys Board of Directors established a Special Litigation Committee to investigate the claims set forth in the demands and complaints and to
determine the most appropriate actions for the Mutual Company to take in response to them. The Special Litigation Committee consists of three newly appointed independent directors of the Mutual Company. None of the members of the Special Litigation
Committee own any stock of the Company. On February 8, 2012, the Court issued an Order which granted the Special Litigation Committees motion to have until March 1, 2012 to issue its report on its investigation.
On March 1, 2012, the Special Litigation Committee issued a report of its investigation, which concluded that: (1) the Mutual
Company directors had fulfilled their fiduciary obligations and had not breached their duties of care and loyalty in negotiating and entering into the Merger Agreement with Nationwide; (2) the Merger Agreement transaction is intrinsically fair
and satisfies the standards of both fair process and fair result; (3) the derivative claims filed by the plaintiffs lack merit; (4) it is in the best interests of the Mutual Company that the plaintiffs derivative claims be dismissed;
(5) the Parent Merger is in the best interests of the Mutual Company, including its policyholders; and (6) substantial delay in the consummation of the Parent Merger would be damaging to the Mutual Company and, therefore, the Parent Merger
should proceed without further disruption. On the same day, the Special Litigation Committee filed a motion to dismiss the derivative claims contained in the CCADC.
Following a hearing held on April 19-20, 2012, on April 23, 2012 the Court issued an Order which (1) denied the plaintiffs motion for preliminary injunction because plaintiffs failed to show they
would be irreparably harmed if the Parent Merger was consummated since any harm the policyholders may suffer can be recompensed with money damages and since plaintiffs failed to show that the proxy statement submitted to members/policyholders
contained false statements of material fact or that material facts were omitted from the proxy statement; (2) determined, at such time, not to impose a constructive trust over the merger consideration to be paid to directors and officers of the
Mutual Company who are defendants under the CCADC; (3) granted, in part, the defendants motion to dismiss for lack of irreparable harm with respect to (a) the plaintiffs request to enjoin the Mutual Company policyholder vote; (b) to
require the Mutual Company to issue a new proxy statement; and (c) to strike certain provisions from the Merger Agreement; and (4) found the Court lacked jurisdiction to impose a constructive trust over the merger consideration to be paid to the
stockholders of the Company who are not parties to the CCADC.
The business, results of operations and financial condition, and therefore the value of Harleysville Groups securities, are subject to a number of risks. Some of those risks are set forth in the
Companys annual report on Form 10-K for fiscal year 2011, filed with the SEC on March 14, 2012. There has been no material change from the risk factors as previously disclosed in the Companys annual report on Form 10-K for the
fiscal year ended December 31, 2011.
ITEM 2.
|
Unregistered Sales of Equity Securities and Use of Proceeds
|
Issuer Purchases of Equity Securities
(1)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Period
|
|
Total Number
of
Shares
Purchased
(2)
|
|
|
Average
Price
Paid Per Share
|
|
|
Total Number of
Shares
Purchased
as Part of Publicly
Announced Plans
or Programs
|
|
|
Maximum
Number
of Shares that May Yet
Be Purchased Under
the Plans or Programs
|
|
|
|
|
|
|
January 1 January 31, 2012
|
|
|
-0-
|
|
|
|
|
|
|
|
-0-
|
|
|
|
554,916
|
|
February 1 February 29, 2012
|
|
|
33,958
|
|
|
$
|
56.75
|
|
|
|
-0-
|
|
|
|
554,916
|
|
March 1 March 31, 2012
|
|
|
343
|
|
|
$
|
57.54
|
|
|
|
-0-
|
|
|
|
554,916
|
|
(1)
|
On August 6, 2010, the Board of Directors authorized the Company to repurchase up to 800,000 shares of its outstanding common stock over a two year period in the
open market or in privately negotiated transactions. Additionally, the Board authorized the Company to make purchases under the terms of a Rule 10b5-1 trading plan, which allows the Company to purchase its shares at times when it ordinarily would
not be in the market because of self-imposed trading blackout periods, such as the time preceding its quarterly earnings releases, or because its officers are in possession of material, non-public information. The Company repurchased shares in open
market transactions from the public float, and did not repurchase shares from the Mutual Company. As of March 31, 2012, the Company had repurchased 245,084 shares under this authorization, leaving 554,916 shares authorized to be repurchased.
Provisions in the Merger Agreement with Nationwide restrict the Company from repurchasing further shares.
|
(2)
|
In accordance with the terms of its Equity Incentive Plan, the Company acquired all of the above shares from employees in connection with the vesting of restricted
stock and restricted stock units. The stock was received in satisfaction of withholding taxes due upon vesting.
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34
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
PART II. OTHER INFORMATION
(Continued)
|
|
|
|
|
|
|
Item 6.
|
|
a.
|
|
Exhibits
|
|
|
|
|
|
|
|
|
10L2*
|
|
Fourth Amendment to Loan Agreement effective March 15, 2012 by and between Harleysville Group Inc. and Harleysville Mutual Insurance Company.
|
|
|
|
|
|
|
|
|
31.1*
|
|
Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
|
|
|
|
|
|
|
|
|
31.2*
|
|
Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
|
|
|
|
|
|
|
|
|
32.1*
|
|
Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
|
|
|
|
|
|
|
|
|
32.2*
|
|
Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
|
|
|
|
|
|
|
|
|
101.INS**
|
|
XBRL Instance Document.
|
|
|
|
|
|
|
|
|
101.SCH**
|
|
XBRL Taxonomy Extension Schema Document.
|
|
|
|
|
|
|
|
|
101.CAL**
|
|
XBRL Taxonomy Extension Calculation Linkbase Document.
|
|
|
|
|
|
|
|
|
101.LAB**
|
|
XBRL Taxonomy Extension Label Linkbase Document.
|
|
|
|
|
|
|
|
|
101.PRE**
|
|
XBRL Taxonomy Extension Presentation Linkbase Document.
|
|
|
|
|
|
|
|
|
101.DEF**
|
|
XBRL Taxonomy Extension Definition Linkbase Document.
|
**
|
Furnished and not filed herewith.
|
35
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized.
|
|
|
|
|
|
|
Harleysville Group Inc.
|
|
|
|
Date: April 30, 2012
|
|
By:
|
|
/s/ ARTHUR E. CHANDLER
|
|
|
|
|
Arthur E. Chandler
Senior
Vice President and
Chief Financial Officer
(principal financial officer)
|
36
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
EXHIBIT INDEX
|
|
|
Exhibit
No.
|
|
Description of Exhibits
|
|
|
10L2*
|
|
Fourth Amendment to Loan Agreement effective March 15, 2012 by and between Harleysville Group Inc. and Harleysville Mutual Insurance Company.
|
|
|
31.1*
|
|
Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
|
|
|
31.2*
|
|
Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
|
|
|
32.1*
|
|
Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
|
|
|
32.2*
|
|
Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
|
|
|
101.INS**
|
|
XBRL Instance Document.
|
|
|
101.SCH**
|
|
XBRL Taxonomy Extension Schema Document.
|
|
|
101.CAL**
|
|
XBRL Taxonomy Extension Calculation Linkbase Document.
|
|
|
101.LAB**
|
|
XBRL Taxonomy Extension Label Linkbase Document.
|
|
|
101.PRE**
|
|
XBRL Taxonomy Extension Presentation Linkbase Document.
|
|
|
101.DEF**
|
|
XBRL Taxonomy Extension Definition Linkbase Document.
|
**
|
Furnished and not filed herewith.
|
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