The Commerce Insurance Company Estimates Pro Forma Impact of the Latest Massachusetts Residual Market Reform Proposal

Business Wire, Oct 22, 2004

WEBSTER, Mass. -- The Commerce Insurance Company, a wholly owned subsidiary of The Commerce Group, Inc. (NYSE: CGI), is updating its estimate of the financial impact of the proposed reform of the residual market system for personal automobile insurance in Massachusetts to reflect changes in the rules being proposed.

Background of Regulatory Reform; Prior Commerce Disclosure

As we described in our Quarterly Report on Form 10-Q filed for the second quarter of 2004, the Massachusetts Commissioner of Insurance (the "Commissioner") issued a letter in April instructing Commonwealth Automobile Reinsurers ("CAR") to develop and submit to her rules for the reform of the residual market system. On June 29, 2004, CAR proposed to the Commissioner a set of changes to the CAR Rules of Operations (the "Initial Reform Proposal"). Under the Initial Proposal, the first phase of the reform would have been effective for the period from July 1, 2004 through December 31, 2004. Commerce estimated, as we disclosed in our Quarterly Report on Form 10-Q for the period ended June 30, 2004, that we would have incurred additional expenses for the final six months of 2004 of approximately $2.4 million before taxes, and an additional expense in 2005 of approximately $1.2 million before taxes, all attributable to the first phase of the reform, if the Commissioner had adopted all of the rule amendments entirely as proposed by CAR for that phase. At that time, we were unable to estimate the financial impact of the Initial Reform Proposal with respect to the rules proposed for 2005 and beyond. The Commissioner, however, did not approve the Initial Reform Proposal.

Revised Reform Proposal

On August 27, 2004, the Commissioner directed CAR to submit to her a revised proposal for the reform of the residual market system. CAR submitted its revised proposal on September 24 and amended it on October 8, 2004 (together, the "Revised Reform Proposal"). The Commissioner has scheduled a public hearing to be held at the Division of Insurance ("DOI") on October 29, 2004, to hear testimony regarding the Revised Reform Proposal. We cannot predict whether the Commissioner will approve the Revised Reform Proposal in substantially the form as recommended by CAR.

Elimination of All or a Substantial Portion of 2004 Transition.

The Revised Reform Proposal does not include an initial transition phase for the period from July 1, 2004 through December 31, 2004, but the rules in the Revised Reform Proposal may apply for the month of December of 2004 if, during the month of November, the Commissioner approves the rules as proposed.

Accordingly, we now estimate that the proposed reform of the residual market will not result in our incurring $3.6 million of additional total expense before taxes for the eighteen month period ended December 31, 2005, as previously disclosed. Rather, if during November the Commissioner approves the Revised Reform Proposal entirely as recommended by CAR effective December 1, 2004, we estimate that our additional expense, if any, for the next 15 months would be approximately $600,000 before taxes.

Overview of Revised Reform Proposal.

The Revised Reform Proposal would call for the current residual market pool to be divided into two components - the first comprising high loss ratio exclusive representative producers or "ERPs" and the second comprising other than high loss ratio ERP business and business ceded to the residual market from voluntary agents. We expect that all insurers would be required to cede to CAR all business written by the high loss ratio ERPs, including business currently able to be retained voluntarily, although the Proposal does not address this point specifically. CAR would apportion the underwriting results of the high loss ratio ERP pool among all insurers based on each insurer's voluntary agent market share for the previous year. The CAR residual market deficit from other than high loss ratio ERPs and business ceded to the residual market from voluntary agents will result in a smaller pool and be shared by insurers in substantially the same manner as is currently in effect for the total residual market pool. While CAR has proposed different utilization formulas and credit values going forward, we expect that those changes will have no material net impact on Commerce's overall participation ratio for this second pool. For a complete description as to how participation ratios are currently calculated, please refer to our 2003 Annual Report filed on Form 10-K under the CAR section of Part 1, Item 1.

The Revised Reform Proposal would also require, for the period beginning January 1, 2005, that each company with a 2003 market share of 7% or more service the business written by high loss ratio ERPs. In exchange, those servicing carriers would receive an increased expense reimbursement fee and an opportunity to earn bonuses for improvements in the loss ratio of those ERPs. CAR estimates that Commerce's share of the high loss ratio ERP pool will be approximately 39.8%, given that Commerce and five other insurers will service the 2005 business of high loss ratio ERPs. Companies with less than 7% total market share may become servicing carriers if they so request and are approved by the Commissioner. If there are more than six carriers servicing the high loss ratio ERP business, the percentage of this pool that we service will be reduced. Lastly, the Revised Reform Proposal contemplates the introduction of an assigned risk plan beginning in 2006 for a segment of the business and for all business by 2008.