Harleysville Group Reports Second Quarter 2007 Results

Harleysville Group Inc. (NASDAQ:HGIC) today reported diluted operating income of $0.81 per share for the second quarter of 2007, compared to $0.64 per share in the second quarter of 2006. In 2007, operating income includes a benefit of $0.06 per share resulting from the gain on the company’s sale of its office building in Traverse City, Mich. For the six-month periods, the company reported diluted operating income of $1.51 per share in 2007 and $1.26 per share in 2006. Operating income is a non-GAAP financial measure defined by the company as net income excluding after-tax realized gains and losses on investments, and the cumulative effect of an accounting change, net of income tax. "We had a very good quarter, as we continued to generate results that track with our key long-term objectives,” commented Michael L. Browne, Harleysville Group’s president and chief executive officer. "Our operating income increased by 27 percent to $0.81 per share—marking our 10th consecutive quarter of double-digit percentage earnings growth. Our second quarter statutory combined ratio improved by 2.3 points to 96.5 percent. With that improvement in underwriting profitability, our GAAP operating return on equity also grew to 13.6 percent. At the same time, we continue to maintain our solid capital base and strong balance sheet, a modest debt-to-capital ratio of 14 percent2, a high-quality investment portfolio, and a premium-to-surplus ratio of 1.4 to 1—all of which provide the sound financial foundation for us to write our agents’ best business. The strength of our capital position and our confidence in the future are further evidenced by the board’s approval to increase our quarterly dividend by 32 percent, or $0.06 per share, to $1.00 on an annual basis. We also completed a 5 percent share repurchase program in July, and today announced an additional 5 percent stock buyback.” The company reported diluted net income of $0.82 per share in the second quarter of 2007, compared to $1.43 per share in the second quarter of 2006. There was $0.01 per share of realized gains in the second quarter of 2007, compared to $0.79 per share in the second quarter of 2006. The majority of the realized gains in the second quarter of last year was the result of the company reducing its risk exposure from the possibility of adverse events in the equity markets by reducing its holding of equity investments by approximately $120 million as part of its efforts to manage enterprise-wide risk during last year’s volatile catastrophe reinsurance renewal season. For the six-month periods, diluted net income was $1.54 per share in 2007 and $2.13 per share in 2006. For the six months, the company reported $0.03 per share of realized investment gains in 2007, compared to $0.84 per share in 2006. The first six months of 2006 also included an after-tax benefit of $0.03 per share for the cumulative effect of a change in accounting principle resulting from the adoption of Statement of Financial Accounting Standards No. 123R, "Share-Based Payment.” This statement requires that the cost resulting from all share-based payment transactions be recognized in the financial statements. Second quarter net written premiums were $219.1 million in 2007, compared to $218.9 million in the same period in 2006. Net written premiums through six months were $426.2 million in 2007 and $427.8 million in 2006. Harleysville Group’s overall statutory combined ratio was 96.5 percent in the second quarter of 2007, compared to 98.8 percent in the second quarter of 2006. For the six months, the statutory combined ratio was 97.2 percent in 2007, versus 99.0 percent in 2006. Second quarter pretax investment income increased 12 percent to $27.9 million, while after-tax investment income grew 8 percent in the second quarter to $20.0 million. For the six months, pretax investment income was up 13 percent to $55.3 million, while after-tax investment income rose 8 percent to $39.5 million. Operating cash flow through six months was $82.9 million, compared to $77.4 million in the first six months of 2006. Commercial lines -- Net written premiums in commercial lines were $181.0 million in the second quarter of 2007, which is unchanged from the same period in 2006. For the six months, net written premiums declined by 1 percent to $355.8 million. The commercial lines statutory combined ratio was 97.5 percent in the second quarter of 2007, versus 100.6 percent in the second quarter of 2006. For the six months, the statutory combined ratio was 97.7 percent in 2007, compared to 100.9 percent in 2006. Personal lines -- Net written premiums in personal lines increased by 1 percent to $38.1 million in the second quarter of 2007. For the six months, net written premiums also rose by 1 percent to $70.3 million. Harleysville Group’s personal lines statutory combined ratio was 92.0 percent in the second quarter of 2007, versus 90.5 percent during the second quarter of 2006. For the six months, the statutory combined ratio was 95.1 percent in 2007, compared to 90.0 percent in 2006. Outlook -- "As we continue through 2007, and look ahead to 2008, we expect the market to remain challenging. However, we are positioned well for future earnings growth based on our use of predictive modeling, and on the fact that our expense ratio is improving, our pricing is holding steady, and our retention ratios have improved and remain strong,” Browne said. "Going forward, our goal is to be creative and opportunistic, while staying keenly focused on the basics of our business, as we seek to consistently produce the kind of quality results we are reporting today—improving earnings, profitable underwriting and operating ROE greater than 12 percent—while always maintaining a healthy balance sheet. And, with agency relationships that are second to none, we’re confident that our partnership with our agents positions us to continue to improve our results going forward.” Webcast -- The company will host a live Webcast tomorrow, August 2, 2007, at 8 a.m. (ET) to discuss its second quarter results. The Webcast and a replay will be available from the Investors section of the company’s Web site (www.harleysvillegroup.com). GAAP and non-GAAP financial measures -- The company uses a non-GAAP financial measure called "operating income” that management believes is useful to investors because it illustrates the performance of normal, ongoing operations, which is important in understanding and evaluating the company’s financial condition and results of operations. While this measure is utilized by investors to evaluate performance, it is not a substitute for the U.S. GAAP financial measure of net income. Therefore, a reconciliation of this non-GAAP financial measure to the U.S. GAAP financial measure of net income is provided following the Consolidated Statements of Income contained in this release. Management also uses operating income for, among other things, goal setting, determining employee and senior management compensation, and evaluating performance. Corporate profile -- Harleysville Insurance is a leading regional provider of insurance products and services for small and mid-sized businesses, as well as for individuals, and ranks among the top 60 U.S. property/casualty insurance groups based on net written premiums. Harleysville Mutual Insurance Company owns 53 percent of Harleysville Group Inc. (NASDAQ: HGIC), a publicly traded holding company for nine regional property/casualty insurance companies collectively rated A- (Excellent) by A.M. Best Company. Harleysville Group is a member of the Nasdaq Global Select Market, which represents the top third of all NASDAQ-listed companies and has the highest initial listing standards of any exchange in the world based on financial and liquidity requirements. Harleysville Group has paid a dividend every quarter since the company went public, and was one of 3 percent of public companies recognized with a 2007 Mergent Dividend Achiever Award for its long-term history of dividend increases. Harleysville Insurance—which distributes its products exclusively through independent insurance agencies and reflects that commitment to its agency force by being a Trusted Choice® company partner—currently operates in 32 eastern and midwestern states. Further information can be found on the company’s Web site at www.harleysvillegroup.com. 1 "Statutory combined ratio” is a non-GAAP measure of underwriting profitability and is based on numbers determined under statutory accounting practices as filed with state insurance regulators. It is the sum of the ratio of losses to premiums earned plus the ratio of underwriting expenses to premiums written. A ratio of less than 100 percent indicates underwriting profitability. 2 Excludes the effects of SFAS No. 115. 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 and legislative developments. These forward-looking statements are subject to change and uncertainty that are, in many instances, beyond the company’s control and have been made based upon management’s expectations and beliefs concerning future developments and their potential effect on Harleysville Group Inc. There can be no assurance that future developments will be in accordance with management’s expectations so that the effect of future developments on Harleysville Group will be those anticipated by management. Actual financial results including operating return on equity, premium growth 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; catastrophe losses; the insurance product pricing environment; changes in applicable law; government regulation and changes therein that may impede the ability to charge adequate rates; changes in accounting principles; performance of the financial markets; fluctuations in interest rates; availability and price of reinsurance; and the status of the labor markets in which the company operates.   Harleysville Group Inc. and Subsidiaries FINANCIAL HIGHLIGHTS   Quarter ended June 30   Six months ended June 30 (in thousands, except per share data)     2007     2006     2007     2006 OPERATING RESULTS                 Diluted earnings per common share: Operating income* $ 0.81 $ 0.64 $ 1.51 $ 1.26 Realized gains, net of income taxes 0.01 0.79 0.03 0.84 Cumulative effect of accounting change, net of income taxes                 0.03 Net income   $ 0.82   $ 1.43   $ 1.54   $ 2.13 Cash dividends per common share   $ 0.19   $ 0.175   $ 0.38   $ 0.35   FINANCIAL CONDITION       June 30, 2007       December31, 2006 Assets $ 2,989,427 $ 2,990,984 Shareholders' equity $ 715,532 $ 712,162 Per common share       $ 22.97       $ 22.49                         CONSOLIDATED STATEMENTS OF INCOME   Quarter ended June 30   Six months ended June 30 (in thousands, except per share data)     2007     2006     2007     2006 REVENUES: Premiums earned $ 207,395 $ 209,320 $ 412,773 $ 417,665 Investment income, net of investment expense 27,947 24,847 55,344 48,942 Realized investment gains 678 38,072 1,302 40,282 Other income     6,321     4,299     9,819     9,186 Total revenues     242,341     276,538     479,238     516,075 LOSSES AND EXPENSES: Losses and loss settlement expenses 131,411 135,049 262,562 271,038 Amortization of deferred policy acquisition costs 51,953 53,467 103,849 106,071 Other underwriting expenses 18,299 19,564 36,580 39,555 Interest expense 1,789 1,731 3,554 3,441 Other expenses     1,340     1,340     2,613     2,355 Total expenses     204,792     211,151     409,158     422,460 Income before income taxes and cumulative effect of accounting change 37,549 65,387 70,080 93,615 Income taxes     11,114     20,657     20,743     28,177 Income before cumulative effect of accounting change 26,435 44,730 49,337 65,438 Cumulative effect of accounting change, net of income taxes                 942 Net income   $ 26,435   $ 44,730   $ 49,337   $ 66,380 Weighted average number of shares outstanding: Basic 31,658,553 30,830,502 31,644,462 30,736,332 Diluted     32,089,782     31,298,063     32,098,175     31,216,098 Per common share: Basic earnings before cumulative effect of accounting change $ 0.84 $ 1.45 $ 1.56 $ 2.13 Basic cumulative effect of accounting change $ 0.03 Basic earnings $ 0.84 $ 1.45 $ 1.56 $ 2.16   Diluted earnings before cumulative effect of accounting change $ 0.82 $ 1.43 $ 1.54 $ 2.10 Diluted cumulative effect of accounting change $ 0.03 Diluted earnings   $ 0.82   $ 1.43   $ 1.54   $ 2.13   RECONCILIATION TO OPERATING INCOME : Net income $ 26,435 $ 44,730 $ 49,337 $ 66,380 Less cumulative effect of accounting change, net of income taxes 942 Less realized investment gains, net of income taxes     441     24,747     847     26,184 Operating income   $ 25,994   $ 19,983   $ 48,490   $ 39,254   These financial figures are unaudited. *Operating income is a non-GAAP financial measure defined by the company as net income excluding after-tax realized gains and losses on investments and the cumulative effect of accounting change, net of income taxes.   Harleysville Group Inc. and Subsidiaries CONSOLIDATED BALANCE SHEETS         (in thousands, except share data)   June 30, 2007*   December 31, 2006 ASSETS Investments: Fixed maturities: Held to maturity, at amortized cost (fair value $331,618 and $381,835) $ 335,150 $ 382,457   Available for sale, at fair value (amortized cost $1,809,574 and $1,717,651) 1,790,614 1,722,874   Equity securities, at fair value (cost $65,246 and $62,932) 76,976 71,446 Short-term investments, at cost, which approximates fair value     67,773       72,237   Total investments     2,270,513       2,249,014   Cash 146 227 Premiums in course of collection 152,593 147,445 Reinsurance receivable 177,797 167,199 Accrued investment income 26,361 25,823 Deferred policy acquisition costs 104,395 102,317 Prepaid reinsurance premiums 36,110 37,242 Property and equipment, net 13,575 16,690 Deferred income taxes 61,617 60,643 Securities lending collateral 90,596 124,755 Due from affiliate 5,716 Other assets     55,724       53,913   Total assets   $ 2,989,427     $ 2,990,984   LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Unpaid losses and loss settlement expenses $ 1,527,079 $ 1,493,645 Unearned premiums 456,004 443,738 Accounts payable and accrued expenses 79,170 98,184 Securities lending obligation 90,596 124,755 Debt 118,500 118,500 Due to affiliate     2,546       Total liabilities     2,273,895       2,278,822   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 33,423,319 and 33,060,600 shares; outstanding 31,153,287 and 31,662,691 shares   33,423 33,061 Additional paid-in capital 205,214 197,607 Accumulated other comprehensive income (loss) (13,252 ) 14 Retained earnings 543,172 505,967 Treasury stock, at cost, 2,270,032 and 1,397,909 shares     (53,025 )     (24,487 ) Total shareholders' equity     715,532       712,162   Total liabilities and shareholders' equity   $ 2,989,427     $ 2,990,984   *These financial figures are unaudited.   Harleysville Group Inc. and Subsidiaries SUPPLEMENTARY FINANCIAL ANALYSTS' DATA     Quarter ended June 30   Six months ended June 30 (dollars in thousands)     2007       2006       2007       2006   Net premiums written*   $ 219,141     $ 218,910     $ 426,171     $ 427,826   Statutory surplus*           $ 618,953     $ 602,681     Pretax investment income $ 27,947 $ 24,847 $ 55,344 $ 48,942 Related federal income taxes     7,997       6,429       15,813       12,462   After-tax investment income   $ 19,950     $ 18,418     $ 39,531     $ 36,480                       SEGMENT INFORMATION                     Quarter ended June 30   Six months ended June 30 (dollars in thousands)     2007       2006       2007       2006   Revenues: Premiums earned: Commercial lines $ 171,662 $ 172,725 $ 341,875 $ 344,812 Personal lines     35,733       36,595       70,898       72,853   Total premiums earned 207,395 209,320 412,773 417,665 Net investment income 27,947 24,847 55,344 48,942 Realized investment gains 678 38,072 1,302 40,282 Other     6,321       4,299       9,819       9,186   Total revenues   $ 242,341     $ 276,538     $ 479,238     $ 516,075       Income before income taxes and cumulative effect of accounting change: Underwriting gain (loss): Commercial lines $ 1,245 ($3,936 ) $ 3,337 ($7,536 ) Personal lines     2,109       3,140       3,683       8,259   SAP underwriting gain (loss)     3,354       (796 )     7,020       723   GAAP adjustments     2,378       2,036       2,762       278   GAAP underwriting gain     5,732       1,240       9,782       1,001   Net investment income 27,947 24,847 55,344 48,942 Realized investment gains 678 38,072 1,302 40,282 Other     3,192       1,228       3,652       3,390   Income before income taxes and cumulative effect of accounting change   $ 37,549     $ 65,387     $ 70,080     $ 93,615     Income taxes on net investment income $ 7,997 $ 6,429 $ 15,813 $ 12,462 Income taxes on remaining gain before cumulative effect of accounting change 3,117 14,228 4,930 15,715 Total income taxes on income before cumulative effect of accounting change   $ 11,114     $ 20,657     $ 20,743     $ 28,177     Effective tax rate on: Net investment income 28.6 % 25.9 % 28.6 % 25.5 % Income before cumulative effect of accounting change     29.6 %     31.6 %     29.6 %     30.1 %   These financial figures are unaudited. *Statutory data is a non-GAAP measure. Because it is prepared in accordance with statutory accounting rules as defined by the National Association of Insurance Commissioners' Accounting Practices and Procedures Manual, a reconciliation to GAAP is not required.   Harleysville Group Inc. and Subsidiaries STATUTORY DATA BY LINE OF BUSINESS*     Quarter ended June 30   Six months ended June 30 (dollars in thousands)     2007       2006       2007       2006     Net premiums written:   Commercial: Automobile $ 51,469 $ 55,115 $ 101,590 $ 109,092 Workers' compensation 23,637 22,836 50,284 49,110 Commercial multi-peril 86,087 85,380 165,987 163,217 Other commercial 19,830 17,858 37,985 36,514                   Total commercial   $ 181,023     $ 181,189     $ 355,846     $ 357,933     Personal: Automobile $ 17,781 $ 18,407 $ 34,308 $ 36,155 Homeowners 17,889 16,895 31,549 29,429 Other personal 2,448 2,419 4,468 4,309                   Total personal   $ 38,118     $ 37,721     $ 70,325     $ 69,893     Total personal and commercial   $ 219,141     $ 218,910     $ 426,171     $ 427,826       Statutory combined ratios:   Commercial: Automobile 93.2 % 97.2 % 92.9 % 99.2 % Workers' compensation 111.7 % 118.8 % 112.1 % 118.0 % Commercial multi-peril 99.2 % 101.2 % 99.7 % 100.6 % Other commercial 81.0 % 82.6 % 82.7 % 84.6 %   Total commercial     97.5 %     100.6 %     97.7 %     100.9 %   Personal: Automobile 97.4 % 99.5 % 100.9 % 100.1 % Homeowners 90.3 % 82.1 % 91.1 % 80.1 % Other personal 60.8 % 70.2 % 78.1 % 69.2 %   Total personal     92.0 %     90.5 %     95.1 %     90.0 %   Total personal and commercial statutory combined ratio     96.5 %     98.8 %     97.2 %     99.0 %   GAAP combined ratio     97.2 %     99.4 %     97.6 %     99.8 %   Losses paid   $ 124,334     $ 112,298     $ 236,021     $ 218,148     Net catastrophe losses incurred   $ 4,507     $ 4,228     $ 6,575     $ 7,055     These financial figures are unaudited. *Statutory data is a non-GAAP measure. Because it is prepared in accordance with statutory accounting rules as defined by the National Association of Insurance Commissioners' Accounting Practices and Procedures Manual, a reconciliation to GAAP is not required.