| COMMERCE GROUP INC /MA ITEM 1A RISK FACTORS There are various risks involved in investing in the Company, some of which are described below |
| Investors should carefully consider each of the following factors and all of the other financial information in this annual report, including the information incorporated by reference |
| Regulatory or legislative changes to enhance competition in Massachusetts are being considered and, if enacted, could adversely affect our market share and profitability |
| From time to time, the Massachusetts Division of Insurance considers potential changes and reforms to the Massachusetts personal automobile insurance system that would have the goal of enhancing competition |
| Massachusetts is currently the only state that we write business in where personal automobile insurance rates are set by state regulators |
| The Massachusetts Governor has proposed changes to the state laws that include allowing companies to set their own premiums subject to state oversight |
| Insurers would have flexibility in their rates but would be subject to a 15prca maximum annual increase in premiums |
| The Massachusetts regulatory environment currently: * requires personal automobile insurers to issue a policy to any eligible applicant who seeks one, known as the "e take all comers "e law, * fixes maximum personal automobile rates, which has the effect of keeping premiums artificially low on specific high risk segments of the market, such as urban and youthful drivers, effectively imposing higher premiums on lower risk segments, * fixes the SDIP point assignment criteria and rating factors, * assigns certain agents that have not been able to obtain a voluntary contract with another insurer, known as Exclusive Representative Producers, or ERPs, to servicing carriers on the basis of market share, * apportions losses incurred by the state-mandated residual market run by Commonwealth Automobile Reinsurers, known as CAR, 23 * mandates that higher compulsory and optional coverages be offered to all eligible drivers, and * establishes minimum agency commissions |
| Our marketing and underwriting strategies are limited by maximum premium rates and minimum agency commission levels for personal automobile insurance, which are mandated by the Commissioner |
| Rate decisions by the Commissioner are based upon claims experience and other data which are several years old and may not reflect current conditions |
| If the Commissioner sets inadequate premium rates, our results of operations could be adversely affected |
| Future increases in commission rates would also adversely affect our results of operations unless there were corresponding increases in premiums |
| Changes in the prevailing regulatory environment could adversely affect our competitive position |
| We are unable to predict what, if any, changes to the regulatory system the Division may implement and, therefore are unable to determine whether the impact would be favorable or unfavorable to us, and the effect, if any, that it would have on competition, nor can we predict when any changes would take effect |
| We are primarily a personal automobile insurance carrier, and therefore our business may be affected by conditions in the industry |
| Approximately 82dtta8prca of our direct premiums written for the year ended December 31, 2005 were generated from personal automobile insurance policies |
| As a result of our focus on that line of business, negative developments in the economic, competitive or regulatory conditions affecting the personal automobile insurance industry could have a material adverse effect on our results of operations and financial condition |
| Factors that negatively affect cost trends and our profitability include inflation in automobile repair costs, automobile parts costs, used car prices and medical care |
| Increased litigation of claims may also adversely affect loss costs |
| In addition, these developments in the personal automobile insurance industry would have a disproportionate effect on us, compared to insurers that are more diversified across multiple business lines |
| We write a substantial portion of our business in Massachusetts, and therefore our business may be adversely affected by changing conditions and adverse legislative, regulatory and judicial decisions in Massachusetts |
| Approximately 87dtta3prca of our direct premiums written for the year ended December 31, 2005 were generated in Massachusetts |
| Therefore, our revenues and profitability are subject to prevailing regulatory, economic, demographic, competitive and other conditions, including weather-related events as described below, and regulatory and judicial decisions in Massachusetts |
| Changes in any of these conditions or the rendering of an adverse regulatory and judicial decision could make it more costly or difficult for us to conduct our business |
| In addition, these developments would have a disproportionate effect on us, compared to insurers that do not have such a geographic concentration |
| Our financial performance may be materially adversely affected by severe weather conditions or other catastrophic losses |
| We are exposed to the risk of severe weather conditions and other catastrophes |
| Catastrophes can be caused by natural events, such as hurricanes, coastal storms, severe ice or snow storms, tornadoes, windstorms, earthquakes, hailstorms and fires, and man-made events, such as explosions, terrorist attacks or riots |
| The incidence and severity of such catastrophes are inherently unpredictable and our losses from catastrophes could be substantial |
| The occurrence of claims from catastrophic events is likely to result in substantial volatility in our financial condition or results of operations and our ability to write new business |
| This volatility is compounded by accounting regulations that do not permit reinsurers to reserve for such catastrophic events until they occur |
| The occurrence of severe weather conditions is inherently unpredictable |
| There is generally an increase in claims frequency and severity under the personal automobile insurance we write when severe weather occurs because of a higher incidence of vehicular accidents and other insured losses tend to occur as a result of severe weather conditions |
| Except for policies that are covered under the Fair Access to Insurance Requirements Plan in Massachusetts, we do not carry reinsurance for physical damage or comprehensive catastrophic-related losses for our personal or commercial automobile product lines |
| In addition, we have exposure to an increase in claims frequency and severity under the homeowners and other property insurance we write because property damage may result from severe weather conditions |
| Some catastrophes are restricted to small geographic areas; however, hurricanes, coastal storms, tornadoes, winter storms, windstorms, earthquakes, terrorist attacks and other man-made catastrophes may produce significant damage over large, heavily populated areas |
| 24 Although we participate in a quota share reinsurance program to limit our exposure to these types of natural catastrophes, we would have no reinsurance recoveries for a single event catastrophe to the extent that the total loss exceeds dlra484cmam000 |
| This calculation is based on the annual estimated amount of premiums subject to 75prca quota share reinsurance program effective July 1, 2005 |
| Several limitations are included in this program specific to losses related to nuclear, chemical and biological terrorist events |
| Our maximum loss recovery in case of these types of events is estimated at dlra30cmam000 |
| Although we attempt to manage our exposure to such events, a single catastrophic event could affect multiple geographic zones or the frequency or severity of catastrophic events could exceed our estimates |
| As a result, the occurrence of one more catastrophic events could have a material adverse effect on our financial condition or results of operations |
| We are part of a joint underwriting association that provides excess loss coverage to nuclear power plants and related facilities |
| Our maximum exposure in the event of a catastrophic loss at an insured nuclear facility is dlra5cmam000 |
| If we are not able to attract and retain independent agents, our business could be adversely affected |
| We market our insurance primarily through independent agents |
| We must compete with other insurance carriers for the business of these independent agents |
| Additionally, most agents represent more than one company, which means we face competition within each agency |
| Some of our competitors offer a larger variety of products, lower prices for insurance coverage or higher compensation |
| While we believe that the compensation and services we provide to our agents are competitive with other insurers, changes in compensation, services or products offered by our competitors could make it harder for us to attract and retain independent agents to sell our insurance products |
| If our affinity relationship with one or more AAA clubs, especially in Massachusetts, were to be terminated, we would lose a significant avenue for our affinity programs, which would likely lead to a decline in our sales of personal automobile insurance products, that would then adversely affect our business and results of operations |
| Since 1995, we have actively pursued affinity group marketing programs, which provide participating groups with a means of purchasing discounted private passenger automobile insurance through associations and employer groups |
| The AAA affinity program is the largest of these affinity programs |
| This is especially true in Massachusetts |
| In Massachusetts, we are the exclusive underwriter of personal automobile group programs for three AAA clubs |
| We have a rolling three-year contract with each of these AAA clubs that may be terminated by them upon a minimum of two years &apos written notice |
| A significant portion of our Massachusetts premiums written is derived through the AAA affinity program |
| Direct written premiums written through the AAA affinity program during 2005 totaled dlra727cmam200, or 38dtta8prca of total direct written premiums or 44dtta5prca of Massachusetts direct written premiums |
| Direct premiums written by American Commerce in the top five states in which American Commerce does business, excluding Arizona, represented dlra118cmam500, or 67dtta7prca of American Commerceapstas direct premiums written and 6dtta3prca of our total direct premiums written in 2005 |
| Furthermore, all of American Commerceapstas business in each of these states is generated by one or more insurance agencies owned by a single AAA club in that state, with limited exceptions |
| We have particularly significant relationships with AAA Southern New England that are important to various aspects of our business |
| Since 1995 we have maintained an exclusive affinity group marketing relationship with a Massachusetts agency controlled by AAA Southern New England |
| In 2005, that agency wrote the greatest amount of our Massachusetts personal automobile business, accounting for dlra108cmam600, or 5dtta8prca of our total direct premiums written |
| AAA Southern New England also controls a Rhode Island insurance agency that in 2005 produced dlra25cmam200 of direct premiums written for our subsidiary American Commerce, representing 1dtta3prca of our total direct premiums written for that year |
| In addition, AAA Southern New England owns a 5prca equity interest in ACIC Holding, the holding company of American Commerce that is 95prca owned by us |
| Should one or more of the significant AAA clubs elect to terminate its exclusive agreement, we would lose a significant avenue for offering affinity discounts, and we may not be able to achieve comparable sales through different affinity programs or otherwise |
| We also expect that we would lose the business written through any insurance agency owned by an AAA club that elects to terminate its exclusive arrangement with us |
| A termination of relationships with AAA Southern New England agencies could also adversely affect our ability to develop or maintain relationships with other AAA clubs |
| For these reasons, the termination of our exclusive arrangement with one or more of the AAA clubs may have an adverse effect on our business and results of operations |
| Established competitors with greater resources may make it difficult for us to market our products effectively and offer our products at a profit |
| 25 We compete with various regional and domestic insurers, national agency companies and direct writers |
| Some of these competitors have financial resources greater than ours |
| Any of these competitors could undertake actions that could adversely affect our profitability, such as pricing automobile insurance premiums more aggressively or offering greater compensation to independent agencies |
| Our present soft market augments the risk of these competitive actions |
| We may not be able to preclude other companies from engaging in insurance-related business in Massachusetts using the words "e Commerce "e and "e Insurance "e in its name or service marks; and we believe that our business will be harmed if any other company in fact conducts insurance-related business in Massachusetts using the words "e Commerce "e and "e Insurance "e in its name or service marks |
| Commerce Insurance, which has been writing business in Massachusetts for more than 33 years under the names and marks The Commerce Insurance Company and Commerce Insurance Company, holds Massachusetts state registrations for those marks, but no federal registrations |
| We have reason to believe that Commerce Bancorp, Inc |
| a New York Stock Exchange-listed financial services company, and its subsidiary Commerce Insurance Services, Inc |
| d/b/a Commerce Insurance Brokerage Services, both of Cherry Hill, New Jersey, are now in, or are on the verge of entering, Massachusetts to provide a variety of insurance services under variants of the mark Commerce Insurance |
| Commerce Bancorp has acquired or is seeking to acquire federal registrations for marks including the words "e Commerce "e and "e Insurance "e |
| In August 2003, Commerce Bancorp filed applications in the United States Patent and Trademark Office to register the mark Commerce Insu rance Services and the mark Commerce C Insurance Services and related design |
| Moreover, we understand that Commerce Bancorp acquired by assignment from the original owner of a federal registration for the mark Commerce for use in connection with "e insurance agencies featuring home, accident, life, property, casualty and business insurance "e that was issued in 1997 |
| We are opposing Commerce Bancorp in two separate proceedings, one now pending in Federal District Court, and the other before the Trademark Trial and Appeal Board of the United States Patent and Trademark Office |
| On February 22, 2006, our subsidiary Commerce Insurance filed a complaint in the Federal District Court for the District of Massachusetts, seeking preliminary and permanent injunctions and damages against Commerce Bancorp and Commerce Insurance Services for trade name and service mark infringement and unfair competition under federal statutory law and for trade name and service mark infringement and unfair competition under federal statutory law and for trade name and service mark infringement, unfair competition, and dilution under Massachusetts statutory and common law |
| The Commerce Insurance complaint alleges, among other things, that the use in Massachusetts by Commerce Bancorp and Commerce Insurance Services of marks including the words "e Co mmerce "e and "e Insurance "e will create the likelihood of dilution of our Commerce Insurance marks, because our marks (1) are either inherently distinctive or have acquired secondary meaning, and (2) are likely to be confused with the Commerce Bancorp and Commerce Insurance Services use of their marks |
| A hearing is scheduled for March 20, 2006 on our motion for a preliminary injunction |
| In May, 2005, we began opposing both of the applications filed by Commerce Bancorp in a proceeding before the Trademark Trial and Appeal Board |
| We have asked the Trademark Trial and Appeal Board to suspend the proceeding before it, pending resolution of the Federal District Court case |
| We cannot predict whether we will be successful in opposing Commerce Bancorp and Commerce Insurance Services either in Federal District Court or before the Trademark Trial and Appeal Board |
| If our opposition is unsuccessful, we believe that we will continue to be able to use the marks Commerce Insurance, The Commerce Insurance Company and Commerce Insurance Company in Massachusetts, but that our business will be harmed if Commerce Bancorp and Commerce Insurance Services in fact conduct insurance-related business in Massachusetts using the words "e Commerce "e and "e Insurance "e |
| We are subject to comprehensive regulation by Massachusetts as well as the other states in which we operate, and our ability to earn profits may be restricted by changes to these regulations |
| General Regulation |
| We are subject to regulation by government agencies in Massachusetts, as well as in the other states in which we operate, and we must obtain prior approval for certain corporate actions |
| In Massachusetts, for example, we must comply with regulations involving: * mandatory underwriting, commonly known as take-all comers regulations; * transactions between an insurance company and any of its affiliates; * the payment of dividends; * the acquisition of an insurance company or of any company controlling an insurance company; * approval or filing of premium rates and policy forms; * approval of the SDIP and rating factors; * solvency standards; * minimum amounts of capital and surplus that must be maintained; * limitations on types and amounts of investments; * restrictions on the size of risks that may be insured by a single company; * limitations on the right to cancel or choose not to renew policies in some lines; * regulation of the right to withdraw from markets or terminate involvement with agencies; * requirements to participate in residual markets, such as CAR, or other state-mandated insurance pools; * licensing of insurers and agents; * deposits of securities for the benefit of policyholders; and * reporting with respect to financial condition |
| The other states in which we operate have similar regulations |
| In addition, insurance department examiners from Massachusetts, California and Ohio perform periodic financial and market conduct examinations of insurance companies |
| Such regulation is generally intended for the protection of policyholders rather than security holders |
| Massachusetts requires that all licensed property and casualty insurers bear a portion of the losses suffered by some insureds as a result of impaired or insolvent insurance companies |
| In addition, Massachusetts has established an underwriting association in order to ensure that property insurance is available for owners of high risk property who are not able to obtain insurance from private insurers |
| The losses of this underwriting association are shared by all insurers that write property and casualty insurance in Massachusetts |
| We are assessed from time to time to pay those losses |
| The effect of these assessments could reduce our profitability in any given period and limit our ability to grow our business |
| Additionally, Commerce West and American Commerce are domiciled in California and Ohio , respectively, and are both covered by similar associations in the states in which they do business |
| These associations operate similarly to the Massachusetts association described above |
| In 2005, 2004 and 2003, we were assessed dlra76, dlra126 and dlra190, respectively, by these associations |
| 26 We are unable to predict future changes in the political, economic or regulatory environments in Massachusetts and other states |
| We cannot assure you that existing insurance-related laws and regulations will not become more restrictive in the future or that new restrictive laws will not be enacted, and we cannot predict the potential effects on us of any such laws and regulations |
| Commonwealth Automobile Reinsurers Program |
| We are subject to the extensive regulation of the private passenger automobile insurance industry in Massachusetts, and our ability to earn profits may be restricted by these requirements |
| Owners of automobiles are required to demonstrate minimum automobile insurance coverage prior to registration |
| Generally, we are required by law to issue a policy to any applicant who seeks it |
| In addition, we are required to participate in the state-mandated reinsurance program run by CAR, to which we may cede risks that we believe are underpriced and from which we are allocated a portion of the programapstas overall losses |
| Since its inception, CAR has annually generated underwriting losses, primarily in the personal automobile pool |
| All companies underwriting automobile insurance in Massachusetts share in the underwriting results of the CAR business for their respecti ve product line or lines |
| A companyapstas proportionate share of the CAR personal automobile deficit is based on its market share, adjusted by a utilization formula such that, in general, a companyapstas participation ratio is disproportionately and adversely affected if its relative use of CAR reinsurance exceeds that of the industry, and favorably affected if its relative use of CAR reinsurance is less than that of the industry |
| Participation in the CAR commercial automobile deficit is based on a companyapstas voluntary market share |
| Finally, for the personal automobile CAR pool, an insurerapstas participation ratio may be affected by credits received for not reinsuring through CAR automobile risks in selected underpriced classes and territories |
| An insurerapstas participation ratio will be favorably affected if its relative use of credits exceeds that of the Massachusetts industry |
| Credit values are set annually by CAR, and we cannot forecast whether the yearly changes will be beneficial or detrimental to the results of our personal automobile insurance business |
| Member companies of CAR have joint and several liabilities for the obligations of CAR If one member of CAR fails to pay its assessments, each of the remaining members of CAR will be required to pay its pro-rata share of the member who fails to pay its obligations |
| As a result of the concentration of the Massachusetts market for personal automobile insurance, the assessment could have a material adverse effect on our results of operations if one of the leading companies were to fail |
| At the present time, we are not aware of any CAR member company who has failed to meet its obligation |
| Proposals to change certain of CARapstas rules are under consideration |
| For further discussion, see the CAR Regulatory Reform section of Item 7, Managementapstas Discussion and Analysis of Financial Condition and Results of Operations |
| If we unexpectedly lose certain key personnel, or are unable to attract and retain talented employees and executives, our ability to conduct business successfully could be hindered |
| Our future success depends significantly upon the continued contributions of certain key management personnel |
| We do not have employment agreements with any of our executive officers, nor do we have key man life insurance policies covering them |
| The unexpected loss of the services and the institutional knowledge of any one of these officers could adversely affect our business and harm our results of operations and financial condition |
| Additionally, our ability to continue profitable growth and to remain a competitive force in the marketplace depends, in part, on our ability to hire and retain talented employees |
| Arthur J Remillard, Jr, our Chairman, President and Chief Executive Officer, has announced his intention to retire effective July 28, 2006 |
| The Board of Directors has appointed Gerald Fels, our current Executive Vice President, as President, Chief Executive Officer and Chairman of the Board effective upon Mr |
| Remillard, Jr |
| and Gerald Fels for approximately 30 years |
| Randall V Becker, employed at Commerce since 1986, has been elected to succeed Mr |
| Fels as Chief Financial Officer, effective February 17, 2006 |
| We have employed our other executive officers for an average of approximately 16 years each |
| New claim, coverage and regulatory issues in the insurance industry may adversely affect us |
| As insurance industry practices and regulatory, judicial, and consumer conditions change, unexpected and unintended issues related to claims, coverage and underwriting may emerge |
| The issues can have a negative effect on our business by either extending coverage beyond our underwriting intent or by increasing the size of claims |
| Recent examples of emerging claims, coverage and underwriting issues include: * a growing trend of plaintiffs targeting automobile insurers in purported class action litigation relating to claims-handling practices such as total loss evaluation methodology and cases outside of Massachusetts alleging that insureds are entitled to recover the inherent diminution in the value of their vehicles involved in accidents; 27 * increases in the number and size of water damage claims, including those related to expenses for testing and remediation of mold conditions; * the use of an applicantapstas credit rating as a factor in making risk selection and pricing decisions; and * the availability of coverages that pay different commission levels to agents depending upon premium level |
| These and other unforeseen emerging claim, coverage and underwriting issues could negatively affect our results of operations or our methods of doing business |
| We cannot assure you that our diversification strategy will be effective |
| We expect that our primary focus will continue to be our core business in Massachusetts and on enhancing our geographic diversity by increasing the proportion of business that we originate from the other states where we now have a significant presence |
| In addition, we have sought and may continue to seek to take advantage of opportunities that may arise to expand our core business into other states where we believe the independent agent distribution channel is strong or where American Commerce is able to establish new relationships with AAA clubs |
| We do not have expansion plans, other than in the states in which we currently write business |
| As a result of a number of factors, including the difficulties of finding appropriate expansion opportunities and the challenges of operating in an unfamiliar market, we may not be successful in finding opportunities to expand into other states or in taking advantage of opportunities that we may identify |
| We have not ded icated a specific amount of resources toward any of those diversification strategies for states in which we do not have a presence |
| There can be no assurance that any of the aforementioned strategies will ultimately be successful |
| Our failure to maintain a commercially acceptable financial strength rating would significantly and negatively affect our ability to implement our business strategy successfully |
| An important factor in an insurerapstas ability to compete effectively is its financial strength rating |
| AM Best generally is considered to be a leading authority on insurance company ratings and information |
| AM Best assigns 15 ratings to insurance companies, which currently range from "e A++ Superior "e to "e F in liquidation "e |
| AM Best has currently assigned each of our insurance subsidiaries a combined "e A+ Superior "e rating, which is the second highest rating issued by AM Best |
| According to AM Best, an insurer with a Superior rating has, in AM Bestapstas opinion, a superior ability to meet its ongoing obligations to policyholders |
| Each of the insurance subsidiaries has also been assigned a stable outlook by AM Best, which indicates a company is experiencing stable financial/market trends, and there is a low likelihood that its rating will change in the near term |
| Moodyapstas Investor Services also rates the financial strength of insurance companies, and has assigned an A2 ( "e Good "e ) rating to Commerce, which is Moodyapstas third highest rating |
| According to Moodyapstas an insurer with an A2 ( "e Good "e ) rating offers good financial security, with elements present which suggest a susceptibility to impairment sometime in the future |
| Moodyapstas assigns nine ratings to insurance companies, which currently range from Aaa to C, with a numerical modifier in each generic rating classification to refer to the ranking in the group, with 1 being the highest and 3 being the lowest |
| Moodyapstas divides their ratings into "e strong "e and "e weak "e companies, with companies in one of the top four rating categories being considered "e strong "e companies |
| Additionally, Standard & Poorapstas rates the financial strength of insurance companies and assigns eight ratings, which currently range from AAA to CC, and may further modify that rating with a "e + "e or a "e - "e to show relative standing within the category |
| S&P has assigned an "e A "e rating, its third highest rating, to Commerce and Citation |
| According to S&P, an insurer with an "e A "e rating has strong financial security characteristics, but is somewhat more likely to be affected by adverse business conditions than are insurers with higher ratings |
| AM Best, Moodyapstas and S&P base their ratings on factors that concern policyholders and not upon factors concerning investor protection |
| Such ratings are subject to change and are not recommendations to buy, sell or hold securities |
| Any future decrease in the ratings of one of our subsidiaries could adversely affect our competitive position |
| In addition, reinsurance companies and financial institutions use AM Best and other insurance ratings to help assess the financial strength and quality of insurance companies |
| A decline in the ratings of our property and casualty insurance subsidiaries may dissuade a reinsurance company or financial institution from conducting business with us or increase our reinsurance or interest costs |
| Our losses and loss adjustment expenses may exceed our reserves, which could adversely affect our results of operations and financial condition |
| 28 The reserves for losses and loss adjustment expenses, or LAE, that we have established are estimates of amounts needed to pay reported and unreported claims and related expenses based on facts and circumstances known to us as of the time we establish the reserves |
| Reserves are based on historical claims information, industry statistics and other factors |
| The establishment of appropriate reserves is an inherently uncertain process |
| This uncertainty arises from a number of factors, including the difficulty in predicting the rate of inflation and the rate and direction of changes in trends, interpretation of insurance policy provisions by courts, inconsistent decisions in lawsuits regarding coverage and expanded theories of liability |
| In addition, changes in claims settlement practices can lead to changes in loss payment patterns, which are used to estimate reserve levels |
| There can be no assurance that our ultimate liability will not materially exceed our res erves |
| Due to the inherent uncertainty of estimating reserves, it has been necessary, and will over time continue to be necessary, to revise estimated future liabilities as reflected in our reserves for claims and policy expenses |
| If our reserves subsequently are found to be inadequate and therefore must be strengthened, we would be required to treat the amount of such increase as a charge to our earnings in the period that the deficiency is recognized, which would have an adverse effect on our results of operations and financial condition |
| The historical development of reserves for losses and loss adjustment expenses may not necessarily reflect future trends in the development of these amounts |
| Accordingly, it is not appropriate to extrapolate redundancies or deficiencies based on historical information |
| Market fluctuations and changes in interest rates have had, and may continue to have, significant and negative effects on our investment portfolio |
| Our results of operations depend in part on the performance of our invested assets |
| We had fixed income, preferred stock and preferred stock mutual fund investments with a market value of dlra2dtta5 billion at December 31, 2005 that are subject to: * market value risk, which is the risk that our invested assets will decrease in value, due to a change in the prevailing market yields on our investments, an unfavorable change in the liquidity of an investment or an unfavorable change in the financial prospects or a downgrade in the credit rating of the issuer of an investment or one or more other factors; * reinvestment risk, which is the risk that interest rates will decline, an investment will be redeemed and we will not be able to reinvest the proceeds in a comparable investment that provides a yield equal to or greater than the investment which was redeemed; and * liquidity risk, which is the risk that we may have to sell assets at an undesirable time and/or price to provide for payment of claims |
| In addition, our investment portfolio is subject to risks inherent in the domestic and international capital markets |
| The functioning of those markets, the value of our investments and our ability to liquidate investments on short notice may be adversely affected if those markets are disrupted by national or international events including, without limitation, wars, terrorist attacks, recessions or depressions, high inflation or a deflationary environment, the collapse of governments or financial markets, and other factors or events |
| Our fixed-income investment portfolio includes mortgage-backed and other asset-backed securities |
| As of December 31, 2005, mortgage-backed securities and other asset-backed securities constituted approximately 17dtta1prca of our cash and invested assets |
| As with other fixed income investments, the fair value of these securities fluctuates depending on market and other general economic conditions and the interest rate environment |
| Changes in interest rates can expose us to prepayment risks on these investments |
| In periods of declining interest rates, mortgage prepayments generally increase and mortgage-backed securities and other asset-backed securities are paid more quickly, requiring us to reinvest the proceeds at the then current market rates |
| We seek to maintain a proper amount of diversity and liquidity in our portfolio; however, there can be no assurance that we will be successful in this regard |
| If our portfolio were to be impaired by market or issuer-specific conditions to a substantial degree, our liquidity, financial position and financial results could be materially adversely affected |
| Further, our income from these investments could be materially reduced, and write-downs of the value of certain securities could further reduce our profitability |
| In addition, a decrease in value of our investment portfolio could put our subsidiaries at risk of failing to satisfy regulatory capital requirements |
| If we were not at that time able to supplement our capital by issuing debt or equity securities on acceptable terms, our ability to continue growing could be adversely affected |
| 29 We continue to monitor the effects of changing interest rates on the value of our fixed income and preferred stock investments |
| We estimate that a 200 basis point immediate increase in market interest rates would decrease the fair value of those investments at December 31, 2005 by 11dtta7prca, or dlra283cmam888 |
| Our ownership interests in closed-end preferred stock mutual funds may cause our capital gains (losses) and corresponding net earnings to be more volatile than many other similar companies |
| Our net earnings has been significantly affected by our ownership interests in closed-end preferred stock mutual funds that we account for using the equity method of accounting |
| For our investment in any fund in which we own 20prca or more of the fundapstas share, the equity method of accounting requires us to categorize as a realized investment gain or loss the change in the net asset value of that fund as compared to the end of the immediately preceding fiscal quarter |
| Those funds primarily invest in preferred stock and, therefore, an increase in interest rates would cause a significant decrease in the respective net asset values of those funds and, as a direct consequence, a significant increase in the net realized investment losses that we would recognize for those investments |
| As of December 31, 2005, we had investments in two funds, with a carrying value of dlra96cmam332, in which we own more than 20prca of the funds &apos shares and therefore account for them under the e quity method of accounting |
| We may not be able to successfully alleviate risk through reinsurance arrangements, which could cause us to reduce our premiums written in certain lines or could result in losses |
| In order to reduce risk and increase our underwriting capacity, we purchase reinsurance |
| The availability and the cost of reinsurance protection is subject to market conditions, which are outside of our control |
| A catastrophe, even if it primarily affects a geographic area outside of our markets, could significantly limit the availability of reinsurance, which would adversely affect our ability to obtain reinsurance |
| As a result, we may not be able to successfully alleviate risk through these arrangements |
| In addition, we are subject to credit risk with respect to our reinsurance because the ceding of risk to reinsurers does not relieve us of our liability to our policyholders |
| A significant reinsurerapstas insolvency or inability to make payments under the terms of a reinsurance treaty could have a material adverse affect on our results of operations and financial condition |
| Our results may fluctuate due to the highly cyclical nature of the insurance industry |
| Historically, the financial performance of the property and casualty insurance industry has tended to fluctuate in cyclical patterns of soft markets followed by hard markets |
| Although an individual insurance companyapstas financial performance is dependent on its own specific business characteristics, the profitability of most property and casualty insurance companies tends to follow this cyclical market pattern |
| We cannot predict with certainty how long any soft or hard market will last |
| The failure of a key third party service vendor would adversely affect our ability to timely write Massachusetts automobile policies, which would adversely affect our results of operations |
| We use an unrelated third party service vendor, CGI Information Systems & Management Consultants, Inc, to provide rating and policy production data to us for use in underwriting our Massachusetts personal and commercial automobile policies |
| CGI Information Systems is a wholly-owned subsidiary of CGI Group, Inc, a provider of information technology services with which we have done business since the 1970s |
| On November 20, 2003, we renewed our service agreement with CGI Information Systems; the term of the agreement now runs until December 31, 2009 |
| CGI Information Systems may terminate the service agreement only in the event of a material breach of the agreement by us or upon our insolvency |
| The agreement also provides that if CGI Information Systems is no longer able to make the service available, we have the option to license immediately the software used by CGI Information Systems for a fee of dlra250 |
| In the event that CGI Information Systems becomes unable to provide us these services and we were to exercise the option to license the software, we would have to transition either to our own mainframe or to leased computer facilities, which we believe could take up to 30 days and possibly longer, depending primarily on availability of computer hardware and information technology personnel |
| During this period, we would have to process manually renewals and new applications in-house, which would significantly slow our processing time |
| Due to the variables involved, we are unable to estimate the length of the interruption or the expense we would incur in such a case, but we expect that such a disruption would adversely affect our future customer and agency relations and may materially and adversely affect our results of operations |
| 30 If we were to lose the services of CGI Information Systems and determine that licensing their software was not practicable, we do believe that alternative sources for these services would be available |
| We are unable to estimate whether the annual cost for these services would be higher or lower than our costs under the current agreement, though we do not believe that the difference for these services would materially affect our results of operations in future period |
| We expect, however, that a transition to an alternate vendor would take a significant amount of time and expense |
| Due to the variables involved, we are unable to estimate the length of the interruption or the expense we would incur in such a case, but we expect that such an interruption could adversely affect our customer and agency relations, and may materially and adversely affect our results of operations |
| We rely on our information technology and telecommunication systems, and the failure of these systems could materially and adversely affect our business |
| Increasingly, our businesses are dependent on computer and Internet-enabled technology |
| Although we have and test various disaster recovery plans, a sustained shutdown on one or more of our facilities, or a failure of one or more of our information technology, telecommunications or other business systems, could significantly impair our ability to perform our normal functions on a timely basis |
| In addition, because our information technology and telecommunications systems interface with and depend on third party systems, we could experience service denials if demand for such service exceeds capacity or third party systems fail or experience interruptions |
| If sustained or repeated, such a business interruption, systems failure or service denial could result in a deterioration of our ability to write and process new or renewal business, provide customer service, pay claims in a timely manner or perform other necessary corporate functions |
| This could materially and adversely affect our results of operations and future customer relations |
| We maintain insurance on our real property and other physical assets |
| This insurance will not fully compensate us for losses that may occur due to disruptions in service as a result of a computer, data processing or telecommunications system failure that is unrelated to covered property damage, nor will such insurance necessarily compensate us adequately for all losses resulting from covered events |
| Although we have an agreement that provides us with off-site disaster recovery back-up systems, we do not have a contingency plan to relocate employees to an alternate location |