Edgar Filing: COMMERCE GROUP INC /MA

For the Year Ended

Net premiums written to statutory surplus ratio

1.19 to 1.00

1.18 to 1.00

1.33 to 1.00

UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K

(Mark One)
[X]	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2006

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 001-13672



The Commerce Group, Inc.^SM (Exact name of registrant as specified in its charter)

Massachusetts (State or other jurisdiction of incorporation or organization)			04-2599931 (IRS Employer Identification No.)

211 Main Street Webster, Massachusetts (Address of principal executive offices)			01570 (Zip Code)

Registrant's telephone number, including area code: (508) 943-9000 Securities registered pursuant to Section 12(b) of the Act:

Title of each Class Common stock, $.50 par value per share			Name of each exchange on which registered New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes [X] No [ ]

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes [ ] No [X]

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.
Large accelerated filer [X]		Accelerated filer [ ]		Non-accelerated filer [ ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes [ ] No [X]

The aggregate market value of the voting common equity held by non-affiliates computed by reference to the price at which the common stock was last sold as of June 30, 2006 was $1,607,245,641.

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As of January 31, 2007, the number of shares outstanding of the registrant's common stock (exclusive of treasury shares) was 66,595,083.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant's definitive Proxy Statement for its annual meeting of stockholders, which the registrant intends to file within 120 days after the end of the registrant's fiscal year ended December 31, 2006, are incorporated by reference into Part III hereof as provided therein.

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GLOSSARY OF SELECTED INSURANCE TERMS

Affinity group marketing program	In Massachusetts, an "affinity group marketing program" is any system, design or plan whereby motor vehicle or homeowner insurance is afforded to employees of an employer or to members of a trade union, association or organization in accordance with those provisions of M.G.L. c. 175, s. 193R, distinguishing such plans from a "mass-merchandising plan." Specifically, an affinity group marketing program contemplates the issuance of such insurance through standard policies that generally preclude individual underwriting, contain an option to continue coverage at a standard rate upon termination of employment or membership, restrict cancellation, require the continuance of certain participation in ways not applicable to standard policies, and provide for the downward modification of rates based upon the experience of the insured group.

A.M. Best	A.M. Best Company, Inc. is a rating agency reporting on the financial condition of insurance companies. A.M. Best's statistics cited in this Form 10-K are based upon information voluntarily submitted to it by insurers.

Catastrophe reinsurance	A form of excess of loss reinsurance which, subject to specified limits, indemnifies the ceding company for the amount of loss in excess of a specified retention, with respect to an accumulation of losses resulting from a catastrophic event or series of events.

Combined ratio	A combination of the underwriting expense ratio and the loss and loss adjustment expense ratio. The underwriting expense ratio measures the ratio of underwriting expenses (including corporate expenses) to net premiums written. The loss and LAE ratio measures the ratio of incurred losses and LAE to earned premiums (including corporate expenses).

Commissioner	The Commissioner of the Division of Insurance of the Commonwealth of Massachusetts.

Commonwealth Automobile Reinsurers (CAR)	CAR is a Massachusetts mandated reinsurance mechanism, under which all premiums, expenses and losses on ceded business are shared by all insurers. It is similar to a joint underwriting association because a number of insurers act as Servicing Carriers for the private passenger and/or commercial automobile risks insured.

Deficiency	The shortfall between (1) the current estimated cost of all claim payments and related expenses that an insurer ultimately will be required to pay and (2) the reserves previously established by the insurer for those future payments.

Direct	Refers to premiums, losses, LAE and underwriting expenses on policies which a company writes before accounting for business ceded and assumed through reinsurance.

Direct written premiums	Total premiums for insurance sold to insureds, as opposed to, and not including, assumed reinsurance premiums.

Domestic insurer	An insurance company that operates in the state in which it is incorporated.

Earned premiums	The portion of net premiums written that is equal to the expired portion of policies recognized for accounting purposes as income during a period. Also known as premiums earned.

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Exclusive representative producer (ERP)	A Massachusetts automobile insurance agency which does not have a voluntary agency automobile insurance relationship with an insurer and which is assigned by CAR to an insurer who is a Servicing Carrier.

Exposure	An insurable unit defined as one automobile for a one-year term.

Frequency	The relative incidence of number of claims in relation to an exposure or group of exposures.

Hard market	An insurance market in which the demand for insurance exceeds the readily available supply and premiums are relatively high or increasing.

Incurred losses	The total losses sustained by an insurance company under a policy or policies, whether paid or unpaid. Incurred losses include a provision for losses not yet reported and salvage and subrogation.

Limited servicing carrier	An insurer designated by CAR to write and service commercial automobile policies which are reinsured through CAR. Limited servicing carriers provide a market for commercial automobile policies that no carrier will write voluntarily.

Loss adjustment expenses (LAE)	The expenses relating to settling claims, including legal and other fees and the portion of general corporate expenses allocated to claim settlement costs.

Loss and LAE ratio	The ratio of incurred losses plus LAE (including corporate expenses), net of reinsurance recoveries, to earned premiums.

Loss reserves	Liabilities established by insurers to reflect the estimated cost of claim payments and the related expenses that the insurer will ultimately be required to pay in respect of insurance it has written. Reserves are established for losses and for LAE.

Net premiums written	Direct premiums written for a given period less premiums ceded during such period plus premiums assumed during such period.

Participation ratio	A Massachusetts insurer's share of the CAR results. For private passenger automobile, the participation ratio is based upon the insurer's market share of automobile risks not reinsured through CAR, adjusted for utilization of CAR and credits for voluntarily writing less desirable under-priced business and ceded exclusions.

Premium-to-surplus ratio	The ratio of net premiums written to policyholders' surplus.

Quota share reinsurance	Reinsurance in which the reinsurer shares a proportion of the original premiums and losses under the reinsured policy. Also known as pro-rata insurance.

Redundancy	The excess between (1) the reserves previously established by an insurer and (2) the current estimated cost of all claim payments and related expenses that the insurer ultimately will be required to pay.

Reinsurance	The acceptance by one or more insurers, called reinsurers, of all or a portion of the risk underwritten by another insurer who has directly written the coverage. However, the legal rights of the insured generally are not affected by the reinsurance transaction and the insurance company issuing the insurance policy remains liable to the insured for payment of policy benefits.

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Salvage	The sale of damaged goods for which the insured has been indemnified by the insurance company.

Servicing carrier	An automobile insurer writing business in Massachusetts which can reinsure risks through CAR while remaining responsible for servicing the related private passenger automobile policies and which must provide a market for ERPs assigned to it by CAR.

Severity	The relative magnitude of the dollar amount of a claim or group of claims.

Soft market	An insurance market in which the supply of insurance exceeds the current demand and premiums are relatively low or decreasing.

Statutory surplus	The excess of admitted assets over total liabilities (including loss reserves), determined in accordance with statutory accounting practices.


Subrogation	The substitution of the insurer's right to recover in place of the insured's right to recover from a third party responsible for a loss paid by the insurer.

Take-all-comers	A phrase used to characterize the Massachusetts personal automobile insurance system under which all servicing carriers are required to underwrite and accept virtually all risks submitted to them. Once accepted, an insurer can write the business voluntarily or can cede it to CAR.

Underwriting	The insurer's process of reviewing applications submitted for insurance coverage, deciding whether to accept all or part of the coverage requested, and determining the applicable premiums.

Underwriting expenses	The aggregate of policy acquisition costs, including commissions, and the portion of administrative, general and other expenses attributable to underwriting operations.

Underwriting expense ratio	The ratio of underwriting expenses (including corporate expenses), adjusted for the change in deferred acquisition costs, to net premiums written.

Unearned premiums	The portion of written premium representing the unexpired amount of the contract term as of a certain date.

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Unless otherwise stated, "we," "our," "us" or "the Company" means The Commerce Group, Inc. and its subsidiaries. "Commerce" refers to The Commerce Insurance Company, "Commerce West" refers to Commerce West Insurance Company, "American Commerce" or "ACIC" refers to American Commerce Insurance Company, "Citation" refers to Citation Insurance Company, and "AHC" refers to ACIC Holding Co., Inc. In addition, unless otherwise stated, all references to "year ended" are for our fiscal year which ends December 31. Dollar amounts are in thousands, except per share data and as otherwise noted.

PART I

ITEM 1. BUSINESS

Our principal line of business is writing personal automobile insurance. We were incorporated in 1976. We write insurance through our principal subsidiary, Commerce, which was incorporated in 1971 and began writing business in Massachusetts in 1972 and New Hampshire in 2001. We also write insurance through three other subsidiaries -- Citation, Commerce West and American Commerce. Citation was incorporated in Massachusetts on September 24, 1981. We acquired Commerce West on August 31, 1995 and we acquired American Commerce on January 29, 1999. Citation writes insurance in Massachusetts. Commerce West writes insurance in California, Oregon and Arizona. American Commerce, a wholly-owned subsidiary of AHC, is located in Columbus, Ohio and actively writes insurance in 11 states. We own 95% of AHC's common stock; 5% is owned by AAA Southern New England (AAA SNE).

We provide personal and commercial property and casualty insurance in Massachusetts and, to a lesser extent, in other states. We market our products primarily through our network of independent agents. Our core product line is personal automobile insurance. We also write commercial automobile and homeowners insurance. We have been the largest writer of personal property and casualty insurance in Massachusetts in terms of direct premiums written since 1990. At November 30, 2006, our estimated share of the Massachusetts personal automobile market was 31.2%, up from 29.9% at the end of 2005. Beginning in 2003, we became the largest insurance company writing homeowners insurance in Massachusetts. In 2006, we were the second largest writer of commercial automobile insurance in Massachusetts. On a consolidated basis, we were ranked the 19^th largest personal automobile insurance group in the country by A.M. Best, based on 2005 direct written premium information.

We manage our business in four reporting segments. Our primary business strategy is to focus on the personal automobile market in Massachusetts and the other states where we write business, which comprise our first two reporting segments. An overview of our business is summarized in the table which follows for our two primary segments. Our other segments are "Real Estate and Commercial Lending" and "Corporate and Other." We originate and service residential and commercial mortgages in Massachusetts and Connecticut through Bay Finance Company, Inc., our wholly-owned real estate and commercial lending subsidiary. Our Corporate and Other segment captures activities which are not related to our other segments, including activities of the parent company. For the information about our reportable segments required by this Item and not provided here, please refer to Note P of Notes to Consolidated Financial Statements.

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Insurance Business Overview

Property and Casualty Insurance -
Massachusetts

Property and Casualty Insurance -- Other Than
Massachusetts

Subsidiaries (A.M. Best's rating*)	• Commerce (A+ Superior) • Citation (A+ Superior)	• American Commerce (A+ Superior) • Commerce West (A+ Superior) • Commerce (New Hampshire only)
Insurance Products	• Personal Automobile • Commercial Automobile • Homeowners • Other	• Personal Automobile • Commercial Automobile • Homeowners • Other
Principal Markets	• Massachusetts	• California • Washington • Oklahoma • Rhode Island	• Oregon • Arizona • Ohio • Kentucky
Market Position^(a)	• Largest writer of personal automobile insurance (31.2%) • Largest insurance company writing homeowners insurance • Second largest writer of commercial automobile insurance (13.7%)	American Commerce: • Less than 3% of personal automobile market in several states Commerce West: • Less than 1% of personal automobile market in California
Principal Competitors (personal automobile market share)^(a)	• Safety Insurance Companies (11.2%) • Arbella Insurance Co. (9.6%) • Liberty Mutual (7.8%) • Metropolitan Insurance (7.0%) • Travelers (6.9%)	American Commerce: • Allstate (10.1% of U.S. market) • Travelers (2.2% of U.S. market) Commerce West: • Mercury Insurance (8.6% of California market)
In-force Policies at December 31, 2006	• 1,155,452	American Commerce: • 164,177 Commerce West: • 40,336 Commerce (New Hampshire Only): • 10,140

*	Consolidated rating is based on our Inter-affiliate Pooling Agreement.
(a)	The market share percentages for our Massachusetts segment and our Massachusetts competitors represent the Massachusetts market at November 30, 2006 as reported by CAR. The market share percentages for our Other Than Massachusetts segment were reported by A.M. Best and represent the market share at December 31, 2005.

Our direct premiums written for the years ended December 31, 2006 and 2005 follows (dollars in millions):

	Massachusetts		All Other States		Total		% of Total

	2006	2005	2006	2005	2006	2005	2006	2005


Personal automobile	$1,345	$1,366	$171	$185	$1,516	$1,551	81.3%	82.8%
Homeowners	146	136	43	42	189	178	10.1	9.5
Commercial automobile	102	95	9	10	111	105	6.0	5.6
Other lines	38	39	10	1	48	40	2.6	2.1

Total	$1,631	$1,636	$233	$238	$1,864	$1,874	100.0%	100.0%

Percentage of total	87.5%	87.3%	12.5%	12.7%	100.0%	100.0%

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We attribute our success primarily to the following factors:

	*	our strong relationships with independent insurance agencies that provide us with quality business;

	*	a highly experienced management team with a proven track record;

	*	our in-depth understanding of the Massachusetts regulatory and underwriting environments;

	*	our ability to operate efficiently with significant economies of scale;

	*	our strong relationships with various AAA organizations;

	*	our ability to compete in an affinity group marketing environment;

	*	our advanced information systems with an extensive underwriting database in Massachusetts; and

	*	our history of maintaining a strong financial condition.

Our relationships with our independent insurance agencies are critical to our continued success. We believe that we are the preferred provider for most of our agencies and that, as a result, we have gained access to policyholders with above average underwriting profit characteristics. We focus on selecting and retaining agencies with premium volume and loss ratios that meet our criteria, and we devote substantial resources to maintaining strong relationships with our existing agencies. We pay our agencies significant compensation in the form of profit sharing, which is primarily based on the underwriting profits of each agency's business written with us. In addition, we occasionally sponsor incentive award trips for agents to encourage profitability and growth.

Based on agency surveys that we conduct several times a year, we believe that we are attentive to the needs of our agencies and insureds. We emphasize our commitment to the Massachusetts insurance market by our responsiveness in servicing claims and our internal support for agency operations, including direct billing of insureds, direct claim reporting, agency upload and download systems, on-line inquiry systems for our agents and insureds, and by providing competitively priced automobile and property insurance programs and products.

Massachusetts Business. We believe that a significant factor in our success is our focus on the personal automobile insurance market in Massachusetts, which accounted for $1,345,043, or 72.2% of our total direct premiums written for the year ended December 31, 2006. The terms, conditions, and rates of personal automobile insurance are subject to extensive regulation in Massachusetts. As a consequence of our focus on the Massachusetts market, we have both an in-depth understanding of this market and the ability to respond effectively to shifts in the state's regulatory and underwriting environments. Currently, we are required by law to accept virtually all private passenger automobile insurance business submitted to us by our agencies in Massachusetts. Our ability to underwrite this business profitably, however, depends on our understanding of the risks in the business as well as our management of reinsurance through CAR.

We have actively pursued affinity group marketing programs since 1995. Our affinity group marketing programs provide members of participating groups and associations with a convenient means of purchasing discounted private passenger automobile insurance. We emphasize writing insurance for larger affinity groups, although we consider accounts with as few as 25 participants. Affinity groups are eligible for rate discounts, which must be filed annually with the Massachusetts Division of Insurance. In general, we look for affinity groups with mature, stable membership, favorable driving records and below average turnover ratios. Participants who leave the sponsoring group during the term of the policy are allowed to maintain the policy until expiration. At expiration, we will issue through the agency a non-discounted policy at the insured's option.

As of February 2007, we have entered into long-term marketing agreements with three Massachusetts AAA clubs that extends our business partnership from a minimum of three years to a minimum of twenty years. The largest of these clubs, AAA SNE, has been an agent of Commerce since 1984 and has sponsored a successful affinity marketing program since 1995. Participating agents, including AAA SNE, writing in the AAA Marketing Program in Massachusetts wrote $675,904, or 50.3%, of our Massachusetts direct personal automobile premium.

We believe our long-term commitment to providing consistent markets for Massachusetts insurance agencies is a significant factor in enabling us to increase and maintain our market share by contracting with agencies that meet our agency criteria. We believe that Massachusetts insurance agencies are more likely to seek to develop and expand relationships with

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domestic insurers that, like us, have a long-term commitment to, and focus on, the Massachusetts personal automobile market. According to the most recent data from CAR, in excess of 80% of the Massachusetts personal automobile market is written through independent agents.

Business in Other States. American Commerce predominantly writes private passenger automobile and homeowners insurance in 11 states through 158 independent insurance agencies, 24 of which are owned and operated by AAA clubs. This is an increase from the 21 AAA-owned agencies of a year ago. During 2005, American Commerce began using independent agents in Arizona and Indiana. Products are similar to those offered by us in Massachusetts, although pricing of products is determined on a state-by-state basis. All of ACIC's business is underwritten at its headquarters in Columbus, Ohio. American Commerce primarily targets preferred insurance risks.

In December 2006, we entered into an agreement whereby AHC will acquire SWICO Enterprises, Ltd., the holding company for Hempstead, New York-based property and casualty insurer State-Wide Insurance Company. Through this acquisition, we intend to enter the New York and, eventually, the New Jersey personal lines insurance markets. The transaction, which is subject to regulatory approval and which is expected to close early in the second quarter of 2007, is valued at approximately $55 million. In 2006, State-Wide Insurance had direct written premiums of approximately $38 million.

In February 2005, AAA Arizona, Inc. stopped writing new business with American Commerce. As indicated in the following table, AAA Arizona was American Commerce's largest agent in 2004 in terms of direct written premiums. American Commerce wrote renewal business with AAA Arizona, Inc. through mid-August 2005 for personal automobiles and mid-September 2005 for homeowners. American Commerce now writes business in Arizona through independent agents but no longer markets its products through AAA Arizona. Commerce West began writing business in Arizona through independent agencies in early 2005.

Commerce West predominantly writes preferred private passenger automobile insurance in California. All of Commerce West's business is underwritten at its headquarters in Pleasanton, California. Commerce West also writes standard and non-standard private passenger and commercial automobile business in California and non-standard business in Oregon. Commerce West writes its business through 1,356 independent insurance agencies and brokers in California, Oregon and Arizona.

A listing of direct written premiums for those states in which American Commerce and Commerce West write insurance, and the one state other than Massachusetts in which Commerce writes insurance, for the years ended December 31, follow:

Company	State	2006	2005	2004


American Commerce:	Washington	$ 40,745	$ 36,919	$ 30,583
	Oklahoma	27,955	25,814	23,467
	Rhode Island	25,486	25,299	24,126
	Oregon	20,334	17,026	15,338
	Arizona^(a)	13,244	31,790	49,494
	Ohio	9,947	13,458	18,295
	Kentucky	8,939	9,625	10,166
	Indiana	4,156	4,330	5,364
	Tennessee	3,993	4,299	4,939
	Idaho	3,030	3,283	3,392
	South Dakota	1,164	1,164	1,110
	Other:
	Discontinued states^(b)	316	1,959	5,538
	American Nuclear Insurers (ANI)	8,881	-	-

	Total	$168,190	$174,966	$191,812

Commerce West:	California	$ 51,258	$ 51,500	$ 49,327
	Oregon	1,821	3,399	4,769
	Arizona	3,050	805	-

	Total	$ 56,129	$ 55,704	$ 54,096

Commerce:	New Hampshire	$ 8,539	$ 7,610	$ 7,669

(a)	As noted above, AAA Arizona stopped writing new business with American Commerce in February 2005.
(b)	Represents states from which American Commerce has discontinued writing.

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Inter-Affiliate Pooling Agreement. We implemented an inter-affiliate reinsurance pooling agreement, which we refer to as a "pool" or "pooling agreement," that was effective January 1, 2004. The pool consists solely of our four insurance subsidiary companies. The pool permits each insurance subsidiary to rely on the capacity of the entire pool, rather than its own capital and surplus, and it prevents any one insurance subsidiary from suffering any undue losses, as all insurance subsidiaries will share underwriting profits and losses in proportion to their pool participation percentages. It produces a more uniform and stable underwriting result than the companies would otherwise experience individually, and, we believe, permits a more efficient use of our surplus. We expect the pool to provide greater diversification for each subsidiary, both geographic and, to a lesser extent, by product mix. The pool has permitted all of our insurance subsidiaries to obtain a group rating from each of A.M. Best, Moody's Investors Service and Standard & Poor's.

The pool participation percentage of each insurance subsidiary reflects the ratio of that subsidiary's year end 2003 policyholders' surplus to our aggregate policyholders' surplus. We have used the same pooling percentages in 2004, 2005 and 2006 as follows:

	Commerce Insurance	79.6%
	Citation Insurance	10.0%
	American Commerce	7.2%
	Commerce West	3.2%

Through the pooling agreement, Commerce assumed from all the other insurance subsidiaries all of their combined premiums, losses, loss expenses and underwriting expenses. In addition, Commerce combined this business with its own direct and assumed business, and then ceded back to the other insurance subsidiaries, net of applicable reinsurance, their respective percentage of the combined premiums, losses, loss expenses and underwriting expenses of all of our insurance subsidiaries, including Commerce. Accounts are rendered quarterly with inter-company balances settled within the next quarter. The pool may be terminated in the event of an uncured breach or by mutual agreement of all of the parties.

Our Products

Automobile Insurance Lines. Our principal insurance line is personal automobile insurance. We offer automobile policyholders the following types of coverage: bodily injury liability coverage, including underinsured and uninsured motorist coverage, personal injury protection coverage, property damage liability coverage, collision and comprehensive coverage, including fire, theft and other hazards specified in the policy. In Massachusetts and New Hampshire, our policies have one-year terms. Personal automobile insurance policies written by Commerce West and American Commerce usually have policy terms of six months.

Our published maximum automobile liability limits by state follow (in thousands):

	Maximum Liability Limits			Most Commonly Purchased Limits

	Per Person	Per Accident	Property Damage	Per Person	Per Accident		Property Damage


Commerce and Citation:
Massachusetts personal	$ 500	$1,000	$ 250	$100	$300		$100
New Hampshire personal	250	500	250	100	300		100
Massachusetts voluntary
commercial^(a)	1,000	1,000	500	($1,000 combined single limit)
Commerce West:
California personal	500	500	100	15		30	10
Oregon personal	250	500	100	25		50	10
Arizona personal	250	500	100	15		30	10
California commercial	($1,000 combined single limit)			15		30	10
American Commerce:
Majority of states	1,000	1,000	1,000	100		300	50

___________________
(a)	Our Massachusetts voluntary commercial accounts have a choice between the separate limits indicated and a maximum liability limit of $1,000 for combined single limit, which is the most common choice.

Citation provides a separate rating tier for preferred commercial automobile business and homeowners business. Citation wrote approximately 10% of our Massachusetts commercial automobile premium produced during 2006. We also implemented a separate rating tier within Citation for higher risk commercial automobile business, for April 2006

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policy effective dates. We expect that these secondary rating tiers will continue to assist us in retaining better commercial automobile and homeowner accounts.

Homeowners Insurance. We also offer homeowners insurance in Massachusetts, including policies in company-designated coastal areas, which were less than 3.1% of our total Massachusetts homeowners policies at year end. Our average homeowners policy is an all risk, replacement cost insurance policy covering a dwelling and its contents. Our published limits of liability for property damage to a dwelling in Massachusetts are a minimum coverage of $100, a maximum coverage of $1,000, and the most commonly purchased amounts per policy are between $150 and $300. Some policies over this amount are written after underwriting review. For personal liability, the minimum coverage is $100, the maximum coverage is $1,000 and the most commonly purchased amount per policy in Massachusetts written by Commerce and Citation is $500. Generally, the average amount of contents coverage is 70% of the amount of coverage for the dwelling, with limitations on the amount of coverage per item placed on securities, cash, jewelry, furs, silverware, computer equipment, and firearms. However, additional coverage for such items can be purchased. We also offer personal liability umbrella coverage of $1,000, $2,000, $3,000, $4,000 and $5,000, which is reinsured through Swiss Re America.

We offer a preferred risk homeowners product through Citation, which has an alternative pricing schedule for selected insureds meeting more restrictive underwriting guidelines. Citation produced approximately 55% of our Massachusetts homeowner business during 2006, calculated based on direct premiums written.

American Commerce writes homeowners insurance as well. The maximum liability limit for homeowners insurance written by American Commerce is $750, and the most commonly purchased coverages are between $100 and $200. Commerce West does not write homeowners insurance.

During the first two quarters of 2006, our homeowners business was reinsured through a 75% quota share agreement. That agreement terminated on June 30, 2006. Effective July 1, 2006, we entered into a series of agreements that provide catastrophe reinsurance for our insurance subsidiaries' other-than-automobile property lines of business. Prior to July 1, 2006, we utilized various one-year quota share agreements to reinsure this business. For the period July 1, 2005 to June 30, 2006, we had a 75% quota share agreement, for the period July 1, 2004 to June 30, 2005 it was a 70% agreement and for the period July 1, 2003 to June 30, 2004, 65%. Refer to Note M to the audited consolidated financial statements in this Form 10-K for additional reinsurance information.

Massachusetts Automobile Business

Massachusetts automobile business is the principal component of our Massachusetts property and casualty operations. In each of the last three years, the Commissioner has approved decreases in the state mandated average Massachusetts personal automobile insurance premium rate. The Commissioner approved average decreases of 11.7% in personal automobile premiums for the one-year period beginning April 1, 2007 and 8.7% for the fifteen months beginning January 1, 2006. Coinciding with the 2007 and 2006 rate decisions, the Commissioner also approved the base commission agents receive for selling private passenger automobile insurance. The Commissioner approved no change in commission dollars for 2007 and a 1.5% increase for 2006. The following table shows the state-mandated average rate change, the actual average written premium change per exposure and our average written premium change per exposure as estimated for 2007 and for the three previous years in Massachusetts.

Year	State Mandated Average Rate Change ⁽²⁾	Actual State Average Written Premium Change Per Exposure ⁽²⁾	Commerce Average Written Premium Change Per Exposure


2007 ⁽¹⁾	(11.7)%	NA	(6.4)%
2006	(8.7)%	(5.5)%	(5.6)%
2005	(1.7)%	1.5%	0.4%
2004	2.5%	7.0%	5.8%

(1)	Estimated for Commerce average written premium change per exposure.
(2)	Based on Massachusetts Division of Insurance filings.
NA	Data currently unavailable.

The actual state average written premium change per exposure represents the change in the average premium paid by drivers in Massachusetts, as opposed to the state mandated average rate change. As can be seen above, our average written premium change per exposure corresponds more closely to the actual state average written premium change. The reason for this is that both take into account newer vehicles, as compared to the state mandated average rate change which

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does not consider written premium arising from the mandated rate applied to new vehicle purchases. The 2007 figure also takes into account the fact that the 2007 rate decrease does not take effect until April 1.

The Commissioner approved an 11.7% decrease in the state mandated average personal automobile insurance premium rate for the one-year period beginning April 1, 2007. Management estimates that this will translate into a 6.4% decline in the average written premium per exposure for 2007. We estimate the 2007 net pre-tax impact of the 6.4% decrease in our 2007 average written premium per exposure to be approximately $34,400. The majority of the impact on earned premium will occur during the last quarter of 2007 and the first quarter of 2008 as premiums for policies with 2007 effective dates become earned.

Commonwealth Automobile Reinsurers. A significant aspect of our automobile insurance business relates to our interaction with CAR. CAR enables Commerce and the other participating insurers to reinsure any personal automobile risk that the insurer perceives to be under-priced. CAR is responsible for the administration of the personal and commercial automobile reinsurance mechanisms in Massachusetts. Participating insurers, which are responsible for over 99% of total direct premiums written for personal automobile insurance in Massachusetts, are required to offer automobile insurance coverage to all eligible applicants pursuant to "take-all-comers" requirement, but may reinsure under-priced business with CAR. In addition, participating insurers are obligated to accept private passenger ERPs from CAR and to provide a private passenger automobile insurance market in Massachusetts for those agencies. ERP assignments occur by line of business and may apply to personal automobile only, commercial automobile only, or both lines.

CAR maintains separate pools for personal and commercial automobile risks. All companies writing automobile insurance in Massachusetts share in the underwriting results of CAR business for their respective product line or lines, whether or not they are servicing carriers. CAR has annually generated underwriting losses, primarily in the personal automobile pool. Accordingly, each automobile insurer attempts to develop and implement underwriting strategies that will minimize its relative share of the CAR results while maintaining acceptable loss ratios on risks not reinsured through CAR. The gap between our personal automobile market share and participation ratio has increased from 3.7% for 2005 to 4.2% for 2006.

Massachusetts has considered alternative methods to CAR for structuring the residual or involuntary market. Most recently, in December 2006, the former Commissioner approved rules which would have instituted an assigned risk plan, the Massachusetts Automobile Insurance Plan (MAIP), to provide private passenger automobile insurance for those individuals unable to obtain insurance voluntarily, in place of CAR. An assigned risk plan would place these individuals directly with an assigned insurance company. These regulations were to be effective April 1, 2007 for certain new business, July 1, 2007 for SDIP Point 10 and above new and renewal business and January 1, 2008 for all business except clean-in-three renewals. However, on January 19, 2007, the Acting Commissioner suspended these rules for up to ninety days in order to hear additional comment. A public hearing was held on February 15, 2007. In addition, a new Commissioner was named during February 2007. We are unable to predict the outcome of the hearing or what, if any, changes to the current Massachusetts residual market mechanism may occur or determine the effect of any decision on our financial condition or results of operations.

Effective for January 1, 2006, the Commissioner approved the CAR plan to implement a limited servicing carrier (LSC) program for the commercial automobile residual market. The program is an attempt to streamline the handling of commercial automobile risks by reducing the number of servicing carriers while equalizing access for agents to the residual market. The plan calls for six companies, including Commerce, to be appointed LSCs. All agents were assigned as ERPs to one of the LSCs for processing ceded policies. While only six carriers were appointed LSCs, CAR results will be distributed to the industry based upon retained voluntary market share. We wrote approximately $9.1 million in LSC business in 2006, with approximately $4.1 million of commercial automobile business from newly assigned commercial automobile ERPs, as well as $5.0 million through ERPs who also represented Commerce during 2005.

Our Management's Discussion and Analysis of Financial Condition and Results of Operations in this Form 10-K has additional information about CAR.

Marketing

We market our insurance products exclusively through a network of licensed independent agents in all states, except in California where we also utilize some brokers. As of December 31, 2006, we had 772 agents throughout Massachusetts (of which 214 are ERPs), 52 agents writing business in New Hampshire, 1,356 agents and brokers in California, Oregon and Arizona for Commerce West, and 1,022 agents in 11 states for American Commerce. Our voluntary, private passenger independent agencies may also represent other insurance companies, some of which may compete directly with us. The private passenger ERPs may represent other companies for lines of business other than personal automobile and, for these

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other lines, the ERPs may represent companies that compete with us. Commercial automobile ERPs may have voluntary contracts with Commerce, or with another carrier who competes with us. The independent insurance agencies are under contract with our subsidiaries and must conduct their business according to the provisions of their contracts. Voluntary contracts for Massachusetts agencies may be terminated by us upon 180 days notice to the agency or at will by the agency. Commerce and Citation may extend the termination date for renewal business to 13 months. ERP contracts may be terminated by us with 30 days notice, if the ERP violates CAR rules and our actions are upheld by the CAR Governing Committee.

Massachusetts Business. We seek to establish long-term relationships with voluntary agencies that can generate a sizable volume of business with profitable underwriting characteristics and for which we will be among the top one or two preferred writers of private passenger automobile policies.

The following summarizes the longevity of our voluntary independent agents as of December 31:

	2006	2005


Less than five years	147	157
Five to ten years	91	83
Ten to fifteen years	116	103
More than fifteen years	204	187

We also assess whether the mix of a prospective agency's business will expand our presence in one or more of our core product lines. In 2006, the agencies representing us in Massachusetts produced an average of approximately $2,019 of our direct written premiums per agency, a 3.1% decrease as compared to 2005. Direct premiums written in 2006 and 2005 by our Massachusetts agencies follow:

	No. of Agencies

Premium Range	2006	2005


Under $1,000	286	292
$1,000 to $2,000	254	224
$2,000 to $3,000	104	111
$3,000 to $4,000	49	50
Over $4,000	79	93

Our three largest agencies produced $106,191, $23,499 and $18,576 of our 2006 Massachusetts direct premiums written, or approximately 6.5%, 1.4% and 1.1% of total Massachusetts direct premiums written, respectively.

Included in the total of Massachusetts personal automobile direct premiums written are premiums that were the result of appointments of new agents. During 2006, Commerce had 95 new appointments. Of these new appointments, 20 were voluntary agents resulting in an additional $5.1 million in premiums. The remainder of the new appointments were ERPs assigned to Commerce by CAR. Business obtained from these new ERPs amounted to $59.3 million of personal automobile and $4.1 million of commercial automobile business. In addition, 49 former ERPs accepted voluntary contracts during 2006. These former ERPs produced $70.5 million in premiums during 2006.

We carefully monitor an agency's performance. An Agency Evaluation Committee, composed of representatives of our Marketing, Underwriting, and Premium Accounting departments, uses a host of pre-established criteria (loss ratio, premium volume, business distributions, etc.) to continuously evaluate agencies. Generally, we will counsel an agency on how to improve its underwriting and profitability before we consider terminating the agency. During 2006, we terminated 41 non-ERP agencies. These terminated agencies wrote $23.5 million in premiums during 2006.

Our agencies receive commissions on policies written for us and are eligible to receive additional compensation through a profit sharing arrangement. The Commissioner annually establishes a minimum average direct commission for personal automobile insurance, which in 2006 was 11.8%. For qualified agents, we pay a bonus to increase compensation paid on an agent-by-agent basis, varying the amount based on premium volume, risk distribution, length of time with us, and historical profitability. Our agents' profit sharing is tied to the underwriting profit on policies written by an agency. We generally pay a qualifying agency up to 45% of the rolling three-year underwriting profit attributable to the agency's business. The arrangement for profit sharing on Massachusetts policies utilizes a three-year rolling plan, with one-third of each of the current and the two prior years' profit or loss calculations, summed to a single amount. This amount, if positive, is multiplied by the profit sharing rate and paid to the agent. To qualify for profit sharing, an agent generally must have a three-year average loss ratio of 60% or better. CAR credits for voluntary business written in under-priced territories and

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credits for writing youthful operators on a voluntary basis can increase the loss ratio tolerance for profit sharing. Books of business with limited credits must achieve a lower loss ratio, generally around 55%, to qualify. In 2006, our total commissions to our agencies were 21.6% of direct premiums written, of which direct commissions and profit sharing were 13.9% and 7.7%, respectively, versus total compensation expensed of 20.5%, of which 13.2% was direct commissions and 7.3% was profit sharing in 2005. Direct commissions are higher than the personal automobile minimum commission rates primarily due to negotiated commissions in 2006 to agencies with better performing private passenger automobile books of business, coupled with higher commissions on non-automobile lines of business. In addition, ceded reinsurance commission returned declined to 3.6% of direct premiums written in 2006 from 4.9% in 2005, due to termination of our other-than-automobile quota share agreement. Ceded reinsurance commissions returned reduce commission expense.

We devote substantial time and resources to the development of our information systems, which we believe have enhanced both our underwriting and our agency support. Through the use of several customized software programs, we have the ability to analyze our internal historical underwriting data and use such information in making, in our belief, more informed underwriting decisions. Our information systems also enable us to provide extensive support to our agencies. This support includes a direct billing system, which covers approximately 99% of our policyholders, and an on-line inquiry system, which allows agencies to ascertain the status of pending claims and direct bill information via the Internet. We also have over 225,000 policyholders utilizing Electronic Funds Transfer (EFT) which carry no billing service fees. The system also allows agents on-line access to manuals, reports and forms. We also offer an agency upload for personal and commercial automobile and an agency download product for personal and commercial automobile, as well as homeowners. We expect to expand these offerings from time to time. During 2006, approximately 98% of our agents had access to one or more of these systems. We offer on-line access to insureds for certain premium billing and claim information.

We believe that, because of our compensation arrangements and our emphasis on service, we are the preferred provider for most of our agencies. Although we believe, based on annual surveys of our agencies, that our relationships with our independent agencies are excellent, any disruption in these relationships could adversely affect our business.

Affinity Programs in Massachusetts. Since 1995, we have been a leader in affinity group marketing in Massachusetts by providing discounts to members of the AAA clubs. Based on information provided to us by the AAA clubs operating in Massachusetts, we believe that membership in these clubs represents approximately one-third of the Massachusetts motoring public. In 2006, we increased our total Massachusetts private passenger automobile written insurance exposures by 4.3%, ending 2006 with approximately 31.2% of the Massachusetts private passenger automobile market, up from 29.9% at the end of 2005, primarily as a result of the new ERPs added throughout CAR's redistribution. We estimate a 42% penetration of AAA members in Massachusetts. The AAA Affinity group discount has been established at 5% for 2007. The rate for 2006, 2005 and 2004 was also 5%.

Programs in Other States. Both American Commerce and Commerce West file and seek approval for premium rates with the respective divisions of insurance in the states where they do business. American Commerce competes for business primarily by using AAA-owned and operated independent agencies that offer competitively priced products and provide quality service. The independent agencies are offered compensation in the form of commission and profit sharing, based primarily on loss ratios. In addition, the AAA-owned agencies are also offered stock options and bonuses based on the year-over-year increase in the volume of agency business written with American Commerce. Commerce West competes for business by using independent insurance agencies and brokers that offer competitively priced products and provide quality service. Commerce West offers compensation to agents and brokers in the form of commissions and profit sharing, which are based in part on the underwriting results of the agency business written with us. Commerce offers competitively priced products and commissions to agents in New Hampshire. Profit sharing, based on loss experience, is also offered as an inducement for exceptional business.

During 2006 and 2005, we invested approximately $9,300 and $7,500, respectively, in several software implementation projects for the primary purpose of strengthening our business in states other than Massachusetts. Our largest initiative toward achieving this goal involves a comprehensive upgrade of our information systems. The specific objectives of this upgrade are to:

	*	provide an easy-to-use, stable, robust platform that supports flexible product development and growth of market share;

	*	support independent business decisions and processing needs driven by ACIC and New Hampshire business users;

	*	consolidate processing of our other-than-Massachusetts, multi-state business written through American Commerce, Commerce, and Citation onto one system; and

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	*	enhance data integrity and control mechanisms.

In addition to upgrading to the latest version of our base system software, we will also implement enhanced agency upload capabilities. Specifically, the Agency Port initiative will significantly improve, we believe, our agents' ease of doing business with American Commerce, Commerce and Citation. American Commerce licensed and is implementing the Agency Port web portal for use by its club and agent partners. Commerce and Citation plan to use this product for Massachusetts homeowners as well as Commerce's New Hampshire business. The Agency Port web portal provides automated underwriting and an easy-to-use web-enabled interface for quoting American Commerce products. In the future, this product will also provide for the servicing of ACIC products, as well as the quoting and servicing of Commerce and Citation products. We began this project in late 2005, continued throughout 2006 and completion is expected by 2008.

Underwriting

We seek to achieve an underwriting profit, as measured by a statutory combined ratio of less than 100%, in each of our product lines. Our strategy is designed to achieve consistent profitability with substantial growth in net premiums written during hard markets and growth that is more modest during soft markets and during Massachusetts mandated premium declines. All of our policies have been written on a "claims incurred basis," meaning that we cover claims based on occurrences that take place during the policy period.

Agencies are authorized to bind us on risks as limited by our written underwriting rules and practices, which establish eligibility rules for various policies and coverages, unacceptable risks, and maximum and minimum limits of liability. For non-automobile policies, other than certain umbrella policies, our agencies have the ability to bind us for a limited period, typically 60 days, during which time we review all risks to determine whether we will accept or reject the policy. During this review period, we are obligated to pay any claim that would be covered under the policy. Violation of our underwriting rules and practices is grounds for termination of the agency's contract with us.

In Massachusetts, we and each of the other servicing carriers of CAR must write virtually all private passenger automobile risks submitted to us. Massachusetts personal automobile insurance rates are fixed annually by the Commissioner. All companies writing personal automobile policies are required to use such mandated rates, unless they have received prior approval from the Commissioner to offer a lower rate such as what we have done with our AAA affinity program. The actual premium paid by a particular policyholder, however, is adjusted, either up or down, based upon the driving record of the insured operator. Moving violations and accidents for which the insured was at fault within the most recent six year period are used to determine each operator's safe driver surcharge or credit. For January 1, 2006 policies, the Massachusetts Safe Driver Insurance Plan (SDIP) changed from a "step-based" to a "point-based" system in an attempt to further improve the accuracy, and the clarity to insureds, of the plan.

We set our voluntary Massachusetts commercial automobile insurance rates competitively, subject to the Commissioner's authority to disapprove such rates. CAR files the rates for commercial automobile risks reinsured through CAR, subject to the authority of the Commissioner to disapprove the rates, except for ceded private passenger type non-fleet business which is filed by insurance companies and approved by the Commissioner.

For our business written outside of Massachusetts and other product lines within Massachusetts, including homeowners and commercial lines of general liability and property insurance, rates are based in part on loss cost data from the Insurance Services Office, or ISO, which is an industry bureau providing policy forms and rate making data, and in part, on our own experience and other companies' price levels. We are not obligated by statute to accept every homeowners risk submitted to us. Accordingly, risks meeting our underwriting guidelines are accepted, and all other risks are declined or not renewed. We use ISO policy forms and have added special coverage features to meet our product needs. Rates and forms must be filed with and approved or not disapproved by the insurance commissioner in each state where we do business.

Reinsurance

In addition to participating in CAR, we reinsure with other insurance companies, on a claims incurred basis, a portion of our potential exposure under the policies we have written. The objective of this reinsurance is to mitigate the adverse financial consequences of a severe loss under individual policies, or catastrophic occurrences where a number of claims can produce an extraordinary aggregate loss. Reinsurance does not legally discharge us from our primary liability to the insured for the full amount of the policies, but it does make the reinsurer liable to us to the extent of the reinsured portion of any loss ultimately suffered. We seek to utilize reinsurers that we consider adequately capitalized and financially able to meet their respective obligations under reinsurance agreements with us. We use a variety of reinsurance mechanisms to

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protect ourselves against loss. For additional information, please refer to Note M to the audited consolidated financial statements included in this Form 10-K.

Involuntary Pool

Our insurance subsidiaries are required to participate in various Property Insurance Underwriting Associations, the most significant of which is the Fair Access to Insurance Requirements Plan (FAIR Plan) in Massachusetts. The federal government reinsures those insurers participating in FAIR Plans against excess losses sustained from riots and civil disorders. The Massachusetts FAIR Plan has coastal policies which could result in losses which could be material to the FAIR Plan and participating insurance companies. Effective July 1, 2006, the Massachusetts FAIR Plan began purchasing catastrophe reinsurance; consequently, we have exposure for our proportionate share of catastrophic losses greater than their program. Effective July 1, 2006, we entered into a catastrophe reinsurance program which covers catastrophic losses from the FAIR Plan. See Note M of Notes to Consolidated Financial Statements for further discussions.

American Nuclear Insurers (ANI)

Our insurance subsidiaries are member companies of ANI. ANI is a voluntary association of insurers that provides property insurance protection and nuclear energy liability insurance protection. See Note M of Notes to Consolidated Financial Statements for further details.

Settlement of Claims

Claims under insurance policies written by us are investigated and settled primarily by our claims adjusters at our Webster, Massachusetts headquarters. Commerce also employs investigators to address suspected insurance fraud and abuse. American Commerce settles claims at its home office in Ohio, the Webster, Massachusetts headquarters and three regional claims offices located around the country. In addition to these individuals, American Commerce uses the services of independent appraisal firms and independent property adjusting companies, which are also located around the country. Commerce West settles claims at its home office. In addition, Commerce West uses the services of independent appraisal firms located in California, Oregon and Arizona. If a claim or loss cannot be settled and results in litigation, we retain outside counsel to represent us.

We believe that, based on surveys of our agency force and insureds, through our claims staff of experienced adjusters, appraisers, managers, and administrative staff, we have higher customer satisfaction than many of our competitors. All claims office staff members work closely with agents, insureds and claimants with a goal of settling claims fairly, rapidly and cost effectively.

We have a 24-hour claim reporting service to third-party claimants and insureds of interested agencies. This service allows customers to report their first notice of a loss at any time of the day, 365 days a year. This reporting methodology allows us to improve customer satisfaction by making the initial claim handling much faster and ultimately reducing indemnity payments such as rental and storage.

Loss and Loss Adjustment Expense (LAE) Reserves

The following table represents the development of reserves, net of reinsurance, for 1996 through 2006. The top line of the table shows the reserves at the balance sheet date for each of the indicated years, representing the estimated losses and LAE for claims arising in all years that were unpaid at the balance sheet date, including losses that had been incurred but not yet reported to us. The upper portion of the table shows the cumulative amounts paid as of successive years expressed as a percentage with respect to that year's ending reserve liability. The lower portion of the table shows the re-estimated amount as a percentage of the previously recorded reserves based on experience as of the end of each succeeding year, including cumulative payments made since the end of the respective year. The estimate changes as more information becomes known about the payments and the frequency and severity of claims for individual years. Favorable loss development exists when the original reserve estimate is greater than the re-estimated reserves at December 31, 2006. Favorable development is depicted as a positive number in the line "Redundancy expressed as a percentage of year end reserves." The table shows that we have redundancies in each of the last ten years.

For additional information, please refer to "Critical Accounting Estimates" in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, of this Form 10-K.

In evaluating the cumulative information in the following table, it should be noted that each year's amount includes the cumulative effects of all changes in amounts for prior periods. This table does not present accident or policy year

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development data. Conditions and trends that have affected development of the liability in the past may not necessarily occur in the future. Accordingly, it is not appropriate to extrapolate future development based on the following table.

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Loss and LAE Reserve Development (dollars in millions)

	2006	2005	2004	2003	2002	2001	2000	1999	1998 ⁽¹⁾	1997	1996

Reserves for losses and loss
adjustment expenses	$850.7	$834.7	$830.1	$792.3	$678.3	$594.2	$585.9	$558.8	$561.2	$529.8	$534.0

Paid (cumulative) as a percentage
of current reserves as of:
One year later		48.4%	49.8%	51.9%	52.8%	52.9%	54.0%	52.5%	49.4%	53.7%	52.6%
Two years later			70.6	72.1	73.2	73.9	74.2	74.7	72.9	78.1	75.4
Three years later				85.1	86.2	86.2	85.9	85.9	84.5	93.1	88.2
Four years later					92.1	92.8	93.0	92.1	90.1	99.4	96.9
Five years later						95.9	96.5	96.5	93.1	102.4	99.8
Six years later							97.7	98.3	94.9	103.7	101.0
Seven years later								98.7	95.8	104.7	101.6
Eight years later									96.0	105.2	102.3
Nine years later										105.4	102.7
Ten years later											102.8
Reserves re-estimated as a
percentage of initial reserves as of:
One year later		94.8%	92.6%	92.8%	96.3%	97.6%	94.0%	92.4%	92.9%	88.4%	84.3%
Two years later			90.1	90.7	93.8	93.9	93.7	90.3	91.9	85.6	79.3
Three years later				89.8	92.7	92.7	91.8	90.3	91.3	85.1	77.4
Four years later					92.2	91.6	91.4	89.3	91.3	84.7	77.3
Five years later						91.0	90.6	89.1	88.8	84.4	77.1
Six years later							90.2	87.8	88.8	81.0	76.8
Seven years later								87.6	88.0	80.7	74.5
Eight years later									87.9	80.1	74.2
Nine years later										80.0	73.9
Ten years later											73.8
Redundancy expressed as a
percentage of year end reserves		5.2%	9.9%	10.2%	7.8%	9.0%	9.8%	12.4%	12.1%	20.0%	26.2%

Gross liability, end of year	$971.9	$989.2	$990.3	$957.4	$815.6	$695.2	$684.7	$671.0	$657.0	$639.7	$658.0
Reinsurance recoverables	121.2	154.5	160.2	165.1	137.3	101.0	98.9	112.2	95.8	109.9	124.0

Net liability, end of year	$850.7	$834.7	$830.1	$792.3	$678.3	$594.2	$585.9	$558.8	$561.2	$529.8	$534.0

Gross re-estimated liability - latest	N/A	$903.4	$873.6	$831.1	$780.4	$677.5	$664.7	$617.1	$618.2	$562.8	$576.0
Re-estimated recoverable - latest	N/A	112.4	125.3	119.3	154.6	136.8	136.2	127.6	124.8	138.9	182.0

Net re-estimated liability - latest	N/A	$791.0	$748.3	$711.8	$625.8	$540.7	$528.5	$489.5	$493.4	$423.9	$394.0

(1)	The 1998 amount includes an adjustment to add $63.1 million in loss and LAE reserves related to the purchase of American Commerce at January 29, 1999. For additional information about losses and LAE, gross and net of reinsurance, see Note F to the audited consolidated financial statements included in this Form 10-K.
NA	Not applicable for 2006.

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Included in our loss reserves are liabilities for unpaid claims and claim adjustment expenses for environmental related claims such as lead paint, oil spills and mold. We held reserves in the amount of $2,050 for lead paint related claims at December 31, 2006. Our reserves for environmental claims such as oil spills and mold were $5,177 and $1,384, respectively, at December 31, 2006. These reserves have been established to cover claims for known losses. Because of our limited exposure to these types of claims, we believe they will not have a material impact on our financial position.

Operating Ratios

Loss and Underwriting Expense Ratios. Loss and underwriting expense ratios are used to interpret the underwriting experience of property and casualty insurance companies on a statutory basis. Certain corporate expenses included in our loss adjustment expenses and policy acquisition costs do not impact the statutory loss and LAE ratio or the statutory underwriting ratio because they are not expenses borne by our insurance subsidiaries. Examples include a portion of book value awards (BVA) and incentive awards (IA) expense, Employee Stock Ownership Plan (ESOP) expense and directors' compensation. Underwriting profit margins are reflected by the extent to which the sum of the loss and underwriting expense ratios, which we refer to as the combined ratio, is less than 100%. The combined ratio is considered the best simple index of current underwriting performance of an insurer. The ratios which follow include lines of insurance other than automobile. Data for the property and casualty industry generally may not be directly comparable to our data. This is because we conduct our business primarily in Massachusetts, where approximately 87.5% of our direct premiums were written for the year ended December 31, 2006, and, secondly, we primarily write personal automobile insurance.

	Year Ended December 31,

	2006	2005	2004	2003	2002


Company group statutory ratios (unaudited):
Loss and LAE ratio	59.9%	60.8%	62.8%	73.4%	75.1%
Underwriting expense ratio	29.2%	26.5%	24.9%	22.9%	23.6%

Combined ratio	89.1%	87.3%	87.7%	96.3%	98.7%


Industry combined ratio (all writers) ⁽¹⁾	92.6%	96.0%	94.4%	94.4%	104.5%

(1)	Source: A.M. Best's Review/Preview (January 2007), as reported by A.M. Best for all property and casualty insurance companies and adjusted to reflect our relative product mix. The 2006 industry information is estimated by A.M. Best.

Premiums-to-Surplus Ratio. While there is no regulatory requirement applicable to us which establishes a permissible statutory net premiums-to-surplus ratio, guidelines established by the NAIC provide that this ratio should be no greater than 300%.

The premium-to-surplus ratios for the five years ended 2006 for our industry and us follow (in millions of dollars):

	2006	2005	2004	2003	2002


Net premiums written by us	$1,825.3	$1,736.2	$1,712.5	$1,555.5	$1,313.0
Policyholders' surplus of our
insurance subsidiaries⁽¹⁾	$1,535.7	$1,477.3	$1,290.1	$1,075.1	$ 662.0
Our ratio	118.9%	117.5%	132.8%	144.7%	198.3%
Industry ratio⁽²⁾	90.2%	99.7%	108.5%	117.4%	130.5%

(1)	The increase in policyholders' surplus from 2002 to 2003 was primarily the result of our $300 million debt offering. The proceeds from the offering were used as additional paid-in capital for Commerce.
(2)	Source: A.M. Best's Review/Preview (January 2007), for all property and casualty insurance companies. The 2006 industry information is estimated by A.M. Best.

Investments

Investment income is an important source of revenue for us, and the return on our investment portfolio has a material effect on our net earnings. Our investment strategy emphasizes investment yield while maintaining investment quality. The focus of our investment objectives continues to be maximizing after-tax investment income through investing in high quality diversified investments structured to maximize after-tax investment income while minimizing risk. A secondary objective is to achieve above average after-tax total return. Our funds are generally invested in securities with maturities intended to provide adequate funds to pay claims and meet other operating needs without the forced sale of investments.

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For additional information on our investment income and investment portfolio, please refer to "Management's Discussion and Analysis of Financial Condition and Results of Operations" and Note C to the audited consolidated financial statements included in this Form 10-K.

Regulation

Our business is subject to extensive regulation. In Massachusetts, the Commissioner of Insurance is appointed by the Governor and has broad authority. The Commissioner sets maximum policy rates and establishes minimum agent commission levels on personal automobile insurance. In addition, the Commissioner grants and revokes licenses to write insurance, approves policy forms, sets reserve requirements, determines the form and content of statutory financial statements and establishes the type and character of portfolio investments. The Commissioner also approves company submissions regarding affinity group insurance programs and corresponding discounts along with permitted deviations, such as safe driver deviations. Consequently, the policies and regulations set by the Commissioner are an important element of writing insurance in Massachusetts. In states other than Massachusetts, premium rates generally must be filed with, and approved or not disapproved by the Commissioner of Insurance in that particular state. In general, minimum commissions to agents are not set by the other state commissioners.

State insurance regulators are responsible for conducting periodic examinations of insurance companies. Massachusetts Division of Insurance regulations provide that insurance companies will be examined every five years or more frequently as deemed prudent by the Commissioner. California Department of Insurance regulations provide that insurance companies will be examined every three years. Ohio Department of Insurance regulations provide that insurance companies will be examined at least every five years. Both Commerce and Citation were examined for the five-year period ended December 31, 2003. Commerce West was last examined in 2004 by the California Department of Insurance for the four-year period ended December 31, 2003. American Commerce was examined in 2004 by the Ohio Department of Insurance for the five-year period ended December 31, 2002. These examinations produced no material findings.

At the state level, various forms of automobile insurance reform are continuously debated. In Massachusetts, for example, new regulations and legislation are often proposed with the goal of reducing the need for premium increases or to alter CAR results sharing. See Massachusetts Automobile Business section of Item 1, Business, and Commonwealth Automobile Reinsurers section of Item 7, Management Discussion and Analysis of Financial Condition and Results of Operations, for further discussion.

Although the U.S. federal government does not directly regulate the insurance industry, federal initiatives often have an impact on the industry. Proposed legislation currently exists in Congress, the State Modernization and Regulatory Transparency (SMART) Act, which would force states to comply with uniform standards and resolve disputes, speed up the process of getting new products to the market and move toward a system of market-based rates. Congress and certain federal agencies continue to investigate the current condition of the insurance industry, encompassing both life and health and property and casualty insurance, in the United States in order to decide whether some form of federal role in the regulation of insurance companies would be appropriate. Congress conducts hearings relating, in general, to the solvency of insurers and has proposed federal legislation from time to time on this and other subjects.

Former New York Attorney General Eliot Spitzer and his staff had been challenging two separate but related insurance industry practices -- fraudulent bid fixing and certain contingent commission payments. Mr. Spitzer and his staff took legal action against several companies as a result of these challenges. No such action has been taken against us or any of our subsidiaries by any regulator in regards to these practices, nor do we expect any such action to occur.

Automobile Insurance Regulation Overview. Massachusetts has required compulsory automobile insurance coverage since 1925. States other than Massachusetts generally have varying levels of minimum compulsory insurance. Under current law, all Massachusetts motorists are required to carry certain minimum coverages mandated by the state. With very limited exceptions, each servicing carrier writing private passenger automobile insurance in Massachusetts must accept all risks submitted to the servicing carrier for the compulsory coverage, but is permitted to reinsure these risks (including affinity group marketing insurance risks) through CAR.

Compulsory Coverage. Compulsory coverage includes no-fault coverage, limited bodily injury coverage, property damage coverage and coverage against uninsured or hit and run motorists. The Massachusetts no-fault statute provides for personal injury protection coverage, which entitles a party to be reimbursed directly by the party's own insurer for certain medical expenses, lost wages and other defined expenses arising from an automobile accident, up to a specific amount, even if another party caused the accident.

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Rates and Commissions. Massachusetts personal automobile insurance rates are fixed and generally established annually by the Commissioner. Affinity group marketing insurance programs and permitted deviations must be annually approved by the Commissioner. We set our voluntary Massachusetts commercial automobile insurance rates competitively, subject to the Commissioner's authority to disapprove such rates. CAR files the rate for commercial automobile risks reinsured through CAR, subject to the authority of the Commissioner to disapprove the rates, except for ceded private passenger type non-fleet business which is filed by insurance companies and approved by the Commissioner. For additional information, see "Commonwealth Automobile Reinsurers."

Massachusetts personal automobile premiums charged to a policyholder are adjusted based upon the safe driver rating of the operator. Moving violations and at-fault accidents affect each driver's safe driver rating. In addition, the Extra Risk Rating regulations permit insurers to deny coverage or charge surcharged rates for physical damage coverage to both high risk vehicles and insureds with excessive prior loss or violation activity.

The Commissioner sets an average minimum direct agency commission rate for personal automobile insurance. With respect to risks reinsured through CAR, the maximum amount of commissions that CAR will reimburse the ceding carrier, as part of their expense allowance structure, is fixed at that prescribed rate.

Rates and commissions in states other than Massachusetts are set competitively on a company-by-company and state-by-state basis.

Mandatory Underwriting. With minimal exception, Massachusetts law specifies that all individuals holding a valid driver's license be entitled to purchase the mandatory automobile insurance coverages regardless of their driving experience or accident record. Massachusetts law also places certain restraints on insurers' discretion to refuse to renew automobile insurance policies. Policyholders are generally entitled to renew except in cases of fraud, material misrepresentation, revocation or suspension of an operator's license or nonpayment of premiums. With very limited exceptions, servicing carriers that participate in CAR in Massachusetts must accept every automobile risk submitted to them.

Under the Massachusetts system of rate regulation, some personal automobile insurance risks are purposefully under-priced by the Commissioner, and therefore, absent state-intervention, insurers would not ordinarily choose to write those risks. The CAR reinsurance program described below is intended to mitigate the burden imposed by under-pricing and the Massachusetts take-all-comers system, by allowing insurers to transfer the exposure for under-priced risks to an industry pool, and by granting participation credits for voluntary writing of certain under-priced risks. While credits are required by statute, the detailed credit offer is annually established by CAR and approved by the Commissioner.

Commonwealth Automobile Reinsurers. CAR is a Massachusetts state-mandated reinsurance mechanism, under which all premiums, expenses and losses on ceded business are pooled and shared by all insurers. It is similar to a joint underwriting association because a limited number of insurers participate in the program as servicing carriers. At December 31, 2006, there were a total of 19 companies, including Commerce, that were servicing carriers for the personal automobile pool. At December 31, 2006, six insurers, including Commerce, were limited servicing carriers for the commercial automobile market. See the previous discussion of CAR's new commercial program in the Massachusetts Automobile Business section.

In general, agencies licensed to issue automobile insurance policies are entitled to be assigned to at least one servicing carrier. There are two categories of private passenger agencies: (1) those that have voluntary agreements with one or more servicing carriers, and (2) those that do not. The latter are assigned by CAR, generally to a single servicing carrier and are known as private passenger ERPs. An agent can be an ERP for private passenger automobile or commercial automobile or both.

An insurer may terminate its participation in CAR by surrendering its license to write automobile policies in Massachusetts. Termination does not discharge or otherwise affect liability of an insurer incurred prior to termination. A withdrawing insurer is assessed a share of CAR's projected results for future years based on the insurer's prior years' participation in CAR. The assessment paid by the withdrawing insurer is redistributed to the remaining insurers based on their participation ratios.

An insurer can transfer its obligations for its personal insurance policies to another insurer who formally agrees to assume these obligations. The transferring insurer is thereby relieved of future CAR obligations which otherwise would have arisen as a consequence of the business transferred. As previously noted, additional information about CAR, including regulatory reform, is in Item 7 of this Form 10-K.

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Insurance Holding Company Structure. As an insurance holding company, we are subject to regulation under the insurance holding company statutes of the states in which our subsidiary insurance companies are incorporated. Because our subsidiaries are members of an insurance holding company system, they are required to register with their respective Divisions of Insurance and to submit reports describing:

	*	the capital structure;

	*	general financial condition;

	*	ownership and management of each insurer and any person or entity controlling the insurer;

	*	the identity of every member of the insurance holding company system; and

	*	the material outstanding transactions between the insurer and its affiliates.

California and Ohio have insurance holding company laws similar to those in Massachusetts.

Each member of the insurance holding company system must keep current the information required to be disclosed by reporting all material changes or additions within 15 days of the end of the month in which it learns of such change or addition.

Massachusetts law prohibits a party that is not a domestic insurer from acquiring "control" of a domestic insurer or of a company controlling a domestic insurer without prior approval of the Commissioner. Control is presumed to exist if a party directly or indirectly holds, owns or controls ten percent or more of the voting stock of another party, but may be rebutted by showing that control does not exist. California and Ohio have laws similar to those in Massachusetts.

In the event of the insolvency, liquidation or other reorganization of any of our insurance subsidiaries, our creditors and stockholders will have no right to proceed against the assets of those subsidiaries, or to cause the liquidation or bankruptcy of any company under federal or state bankruptcy laws. State laws govern such liquidation or rehabilitation proceedings and the Division of Insurance would act as receiver for the particular company. Creditors and policyholders of the insurance subsidiaries would be entitled to payment in full from such assets before a stockholder, such as Commerce Holdings in our case, would be entitled to receive any distribution therefrom.

Payment of Dividends. Under Massachusetts law, an insurer may pay cash dividends only from earnings and statutory surplus, and the insurer's remaining surplus must be both reasonable in relation to its outstanding liabilities and adequate in relation to its financial needs. Following the declaration and payment of such dividends, the insurer must file a report with the Commissioner. A Massachusetts insurance company may not pay an extraordinary dividend or distribution unless the insurer gives the Commissioner at least 30 days' prior notice of the declaration and the Commissioner does not disapprove of the plan of payment prior to the date of such payment. An extraordinary dividend or distribution includes any dividend or distribution whose fair market value together with other dividends or distributions made within the preceding 12 months exceeds the greater of 10% of surplus, or net income for the 12 month period ending the 31^st day of December. California and Ohio have laws similar to those in Massachusetts regulating the payment of dividends by insurance companies.

The aggregate amount of dividends calculated in accordance with regulations in Massachusetts, California and Ohio that could have been paid in 2006 from 2006 sources from all of our insurance subsidiaries without prior regulatory approval was approximately $238,122, of which $203,410 was declared and paid during 2006. In addition, previously unused dividend capability for the last eleven years from all of our insurance subsidiaries, which can also be used for dividend issuance without regulatory approval, totaled approximately $219,224.

Protection Against Insurer Insolvency. All insurance companies are required to participate in insurance insolvency fund programs in the states in which they write. For further information, please refer to Note L to the audited consolidated financial statements included in this Form 10-K.

National Association of Insurance Commissioners Guidelines. The NAIC Insurance Regulatory Information System, or IRIS, was developed by a committee of state insurance regulators and is intended primarily to assist state insurance regulators in executing their statutory mandates to oversee the financial condition of insurance companies operating in their respective states. IRIS identifies eleven industry ratios and specifies "usual values" for each ratio. Departure from the "usual values" on four or more of the ratios can lead to inquiries from individual state insurance commissioners as to

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certain aspects of an insurer's business. For the year ended December 31, 2006, our consolidated property and casualty operations had no ratios outside the "usual values."

In order to enhance the regulation of insurer insolvency, the NAIC developed a formula and model law to provide for risk-based capital, or RBC, requirements for property and casualty insurance companies. The model law has since been adopted in all states. RBC requirements are designed to assess capital adequacy and to raise the level of protection that statutory surplus provides for policyholder obligations. The RBC model for property and casualty insurance companies measures three major areas of risk facing property and casualty insurers:

	(1)	underwriting, which encompasses the risk of adverse loss development and inadequate pricing;

	(2)	declines in asset values arising from credit risk; and

	(3)	other business risks from investments.

Insurers having less statutory surplus than required by the RBC calculation will be subject to varying degrees of regulatory action, depending on the level of capital inadequacy. The RBC model formula has four levels of regulatory action. The extent of regulatory intervention and action increases as the percentage of surplus to RBC falls. The first level, defined by the NAIC as the "Company Action Level," requires an insurer to submit a plan of corrective actions to the regulator if surplus falls below 200% of the RBC amount. As indicated in the following table, the RBC level of each of our insurance subsidiaries at December 31, 2006 significantly exceeded the 200% RBC level requirements.

	Commerce	Citation	American Commerce	Commerce West


Statutory surplus	$1,205,881	$139,396	$131,527	$59,238
200% RBC Company Action Level	219,781	25,596	18,491	8,255

Statutory surplus in excess of RBC
Company Action Level	$ 986,100	$113,800	$113,036	$50,983

RBC amounts	$ 109,891	$ 12,798	$ 9,246	$ 4,128

Percent of surplus to RBC amounts	1,097%	1,089%	1,423%	1,435%

Competition

The property and casualty insurance industry is highly cyclical, characterized by periods of increasing premium rates and limited underwriting capacity, followed by periods of intensive price competition and abundant underwriting capacity. This industry also is highly competitive, with a large number of companies, many of which operate in more than one state, offering automobile, homeowners, commercial property and other lines of insurance. Some of our competitors have larger volumes of business and greater financial resources than we have and some sell insurance directly to policyholders rather than through independent agents.

Massachusetts. Our insurance products are marketed exclusively through independent agencies, including ERPs. Because most of our voluntary agencies represent more than one company, we face competition within each of these agencies. We compete for business within independent agencies by offering a more attractively priced product through our AAA discount to the consumer and by paying agents significant compensation in the form of commissions and profit sharing. We also seek to provide a consistent market, prompt servicing of policyholder claims and effective agency support services. We have agreed that we shall be the exclusive underwriter of Massachusetts personal automobile group programs for three AAA clubs, and we have extended our agreements with them from a minimum of three years to a minimum of twenty years.

We believe that the Massachusetts regulatory environment requires a commitment to the market that certain companies have been unwilling to make, and thus have not established a presence or expanded their market share in Massachusetts. We believe that previous proposals to change the Massachusetts personal auto system reflect a desire expressed by some to change the Massachusetts system for regulating automobile insurance to one that is comparable to the regulatory framework in most other states. Any material change to the regulatory environment in Massachusetts could adversely affect our business. For additional information, see "Massachusetts Personal Automobile Insurance" in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, in this Form 10-K.

Other States. We compete with various regional and domestic insurers, national agency companies and direct writers. 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.

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Our Employees

As of December 31, 2006, we employed 2,187 people. Commerce employed 1,851 people; American Commerce employed 246 people; Commerce West employed 90 people; and Citation had no employees. We are not a party to any collective bargaining agreements, and we believe our relationships with our employees are very good.

Information Available on Our Website

We make available, free of charge, on our website (http://www.commerceinsurance.com) our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the United States Securities Exchange Act of 1934 as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission. The following are also posted on our website and are available in print to any stockholder upon request:

	*	Corporate Governance Guidelines
	*	Code of Ethics
	*	Nominating and Corporate Governance Committee Charter
	*	Audit Committee Charter
	*	Compensation Committee Charter
	*	Procedures to Contact Non-Management Directors
	*	Procedures to Contact the Board of Directors
	*	Divisions of Insurance Annual Statements

Executive Officers of the Registrant

The information regarding executive officers called for by regulations of the Securities and Exchange Commission is incorporated by reference from information about our executive officers in Item 10 of this Form 10-K.

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 regulatory environment currently:

	*	requires personal automobile insurers to issue a policy to any eligible applicant who seeks one, known as the "take all comers" requirement,

	*	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,

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	*	apportions losses incurred by the state-mandated residual market run by Commonwealth Automobile Reinsurers, known as CAR,

	*	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. The rates set by the Commissioner affect our results. Future increases in commission rates would also adversely affect our results of operations unless there were corresponding increases in premiums.

Changes in the prevailing legislative or regulatory environment could adversely affect our competitive position. We are unable to predict what, if any, changes that may be approved, or changes to the regulatory system that the Division or CAR 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 adversely affected by changing conditions in the industry.

Approximately 81.3% of our direct premiums written for the year ended December 31, 2006 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 costs. 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 87.5% of our direct premiums written for the year ended December 31, 2006 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 insurers 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. 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,

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terrorist attacks and other man-made catastrophes may produce significant damage over large, heavily populated areas. Although we participate in a 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 $600,000. We would have no reinsurance coverage for terrorist events. 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 or 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 2006 in the event of a catastrophic loss at an insured nuclear facility was $11,000 for domestic risks and $10,000 for foreign risks. For 2007, these exposure amounts increased to $12,000 and $11,000, respectively.

	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, where 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 2006 totaled $675,904, or 36.3% of total direct written premiums or 41.4% of Massachusetts direct written premiums.

In Massachusetts, we are the exclusive underwriter of personal automobile group programs for three AAA clubs. As of February 2007, we have signed agreements to extend our exclusive agreement with these clubs from a minimum of three years to a minimum of twenty years.

Direct premiums written by American Commerce in the top five states in which American Commerce does business, excluding Arizona, represented $124,467, or 74.0% of American Commerce's direct premiums written and 6.7% of our total direct premiums written in 2006. Furthermore, all of American Commerce's 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 SNE 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 SNE. In 2006, that agency wrote the greatest amount of our Massachusetts personal automobile business, accounting for $106,191, or 5.7% of our total direct premiums written. AAA SNE also controls a Rhode Island insurance agency that in 2006 produced $25,486 of direct premiums written for our subsidiary American Commerce, representing 1.4% of our total direct premiums written for that year. In addition, AAA SNE owns a 5% equity interest in ACIC Holding, the holding company of American Commerce that is 95% 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 SNE 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.

	We are a holding company with no direct operations, and our insurance subsidiaries' ability to pay dividends to us is restricted by law.

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As a holding company with no direct operations and whose only significant assets are the capital stock of our subsidiaries, we rely on net investment income, dividends and other permitted payments from our subsidiaries to pay our expenses. Our subsidiaries may not be able to generate cash flow sufficient to pay a dividend or distribute funds to us. In addition, applicable state laws that regulate the payment of dividends by our insurance subsidiaries could prohibit such dividends or distributions. Under Massachusetts law, an insurer may pay cash dividends only from earnings and statutory surplus, and the insurer's remaining surplus must be both reasonable in relation to its outstanding liabilities and adequate in relation to its financial needs. Following the declaration and payment of such dividends, the insurer must file a report with the Commissioner. A Massachusetts insurance company may not pay an extraordinary dividend or distribution unless the insurer gives the Commissioner at least 30 days' prior notice of the declaration and the Commissioner does not disapprove of the plan of payment prior to the date of such payment. An extraordinary dividend or distribution includes any dividend or distribution whose fair market value together with other dividends or distributions made within the preceding 12 months exceeds the greater of 10% of surplus, or net income for the 12 month period ending the 31^st day of December. California and Ohio have laws similar to those in Massachusetts regulating the payment of dividends by insurance companies. If our insurance subsidiaries cannot pay dividends in future periods we may have difficulty servicing our debt, paying dividends on our shares of common stock and meeting our holding company expenses.

	Established competitors with greater resources may make it difficult for us to market our products effectively and offer our products at a profit.

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. The present soft market exacerbates 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 "Commerce" and "Insurance" 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 "Commerce" and "Insurance" in its name or service marks.

Commerce Insurance, which has been writing business in Massachusetts for more than 34 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 broker and agency 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 "Commerce" and "Insurance." In August 2003, Commerce Bancorp filed applications in the United States Patent and Trademark Office (the "PTO") to register the mark Commerce Insurance Services and the mark Commerce C Insurance Services and related design. Moreover, we understand that Commerce Bancorp acquired by assignment from the original owner the federal registration for the mark Commerce that was issued in 1997 for use in connection with "insurance agencies featuring home, accident, life, property, casualty and business insurance".

In May 2005, we began opposing both of the applications filed by Commerce Bancorp in a proceeding before the Trademark Trial and Appeal Board. The Trademark Trial and Appeal Board has suspended the proceeding before it pending resolution of a lawsuit filed by our subsidiary Commerce Insurance in the Federal District Court of Massachusetts against Commerce Bancorp and Commerce Insurance Services on February 22, 2006. In the complaint, Commerce Insurance sought 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, 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 "Commerce" and "Insurance" 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.

On July 13, 2006, the Court held a hearing, at which a judicial stipulation was made on behalf of Commerce Bancorp, Inc. and Commerce Insurance Services that the defendants no longer intended to use the name Commerce Insurance Services, Inc. in Massachusetts. On July 14, 2006, in light of the judicial stipulation made on behalf of the defendants, we withdrew, without prejudice, our pending motion for preliminary injunction. On June 30, 2006, Commerce Bancorp filed an application in the PTO to register the mark Commerce C Banc Insurance Services plus design (the "Design Mark"). On August 29, 2006, Commerce Bancorp filed an application in the PTO to register the mark Commerce Banc Insurance

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Services (the "Word Mark"). The application to register the Design Mark was published for opposition on February 20, 2007, and the application to register the Word Mark was to be published for opposition on February 27, 2007. Commerce intends to oppose these applications.

On October 26, 2006, we filed a Supplemental Complaint in Federal District Court to supplement our claims to include the defendants' intended use of the name Commerce Banc Insurance Services in Massachusetts. The defendants responded on November 9, 2006. The case is proceeding in the United States District Court of Massachusetts, and discovery closes on March 15, 2007. No trial date has been set.

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 "Commerce" and "Insurance."

	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.

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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 2006, 2005 and 2004, we were assessed $1,231, $128 and $6,304, respectively, by the Massachusetts Insurance Insolvency Fund (MIIF) as our portion of these losses. 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 2006, 2005 and 2004, we were (refunded) assessed $(224), $76 and $126, respectively, by these associations.

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 and commercial 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. On the basis of our market share, we are assigned ERPs. 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 program's 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 respective product line or lines. A company's proportionate share of the CAR personal automobile results is based on its market share, adjusted by a utilization formula such that, in general, a company's 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 results is based on a company's voluntary market share. Finally, for the personal automobile CAR pool, an insurer's participation ratio may be affected by credits received for not reinsuring through CAR automobile risks in selected underpriced classes and territories. An insurer's 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.

Massachusetts has considered alternative methods to CAR for structuring the residual or involuntary market. Most recently, in December 2006, the former Commissioner approved rules which would have instituted an assigned risk plan, the Massachusetts Automobile Insurance Plan (MAIP), to provide private passenger automobile insurance for those individuals unable to obtain insurance voluntarily, in place of CAR. An assigned risk plan would place these individuals directly with an assigned insurance company. These rules were to be effective April 1, 2007 for certain new business, July 1, 2007 for SDIP Point 10 and above new and renewal business and January 1, 2008 for all business except clean-in-three renewals. However, on January 19, 2007, the Acting Commissioner suspended these rules for up to ninety days in order to hear additional comment. A public hearing was held on February 15, 2007. In addition, a new Commissioner was named during February 2007. We are unable to predict the outcome of the hearing or what, if any, changes to the current Massachusetts residual market mechanism may occur or determine the effect of any decision on our financial condition or 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

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talented employees. During 2006, Arthur J. Remillard, Jr., our Chairman, President and Chief Executive Officer, retired and was replaced by Gerald Fels, who was then Executive Vice President, as President, Chief Executive Officer and Chairman of the Board. We had employed Mr. Remillard, Jr. and Gerald Fels for approximately 30 years. Randall V. Becker, employed at Commerce since 1986, was elected to succeed Mr. Fels as Chief Financial Officer, effective February 17, 2006. We have employed our eleven executive officers for an average of approximately 15 years.

	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;

	*	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 applicant's credit rating as a factor in making risk selection and pricing decisions;

	*	the availability of coverages that pay different commission levels to agents depending upon premium level; and

	*	coverage for wind versus flood damage.

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. Other than our previously announced expansion into New York and New Jersey through the SWICO acquisition, we do not currently 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 dedicated 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 insurer's ability to compete effectively is its financial strength rating. A.M. Best generally is considered to be a leading authority on insurance company ratings and information. A.M. Best assigns 15 ratings to insurance companies, which currently range from "A++ Superior" to "F in liquidation." A.M. Best has currently assigned each of our insurance subsidiaries a combined "A+ Superior" rating, which is the second highest rating issued by A.M. Best. According to A.M. Best, an insurer with a Superior rating has a superior ability to meet its ongoing obligations to policyholders. Each of the insurance subsidiaries has also been assigned a stable outlook by A.M. 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.

Moody's Investor Services also rates the financial strength of insurance companies, and has assigned an A2 ("Good") rating to Commerce, which is Moody's third highest rating. According to Moody's an insurer with an A2 ("Good") rating offers good financial security, with elements present which suggest a susceptibility to impairment sometime in the future. Moody's 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

<PAGE> 30

lowest. Moody's divides their ratings into "strong" and "weak" companies, with companies in one of the top four rating categories being considered "strong" companies.

Additionally, Standard & Poor's 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 "+" or a "-" to show relative standing within the category. S&P has assigned an "A" rating, its third highest rating, to Commerce and Citation. According to S&P, an insurer with an "A" rating has strong financial security characteristics, but is somewhat more likely to be affected by adverse business conditions than are insurers with higher ratings.

A.M. Best, Moody's 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 A.M. 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 they may 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.

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 reserves.

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 and stockholders' equity.

Our results of operations depend in part on the performance of our invested assets. We had fixed maturity, preferred stock and preferred stock mutual fund investments with a market value of $2.7 billion at December 31, 2006 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 or other liabilities.

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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-maturity investment portfolio includes mortgage-backed and other asset-backed securities. As of December 31, 2006, mortgage-backed securities and other asset-backed securities constituted approximately 14.6% of our cash and invested assets. As with other fixed maturity 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.

We continue to monitor the effects of changing interest rates on the value of our fixed maturity 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, 2006 by 15.4%, or $399,295.

	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 have 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 20% or more of the fund's 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. These 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, 2006, we had investments in three funds, with a carrying value of $141,654, in which we own more than 20% of the funds' shares and therefore account for them under the equity 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 reinsurer's 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 company's 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.

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	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 Technologies and Solutions, Inc. (CGI Tech), to provide rating and policy production data to us for use in underwriting our Massachusetts personal and commercial automobile policies. CGI Tech is a wholly-owned subsidiary of CGI Group, Inc., a provider of information technology services with which we have done business since the 1970s. CGI Tech 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 Tech is no longer able to make the service available, we have the option to license immediately the software used by CGI Tech for a fee of $250.

In the event that CGI Tech 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.

On November 20, 2003, we renewed our service agreement with CGI Tech; the term of the agreement is to run until December 31, 2009. We signed on November 22, 2006 an addendum that provides for CGI Tech to convert to a new processing system, and extends our contract for two years. However, it is contingent on them getting two of their other clients to sign and only one has signed.

If we were to lose the services of CGI Tech 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 periods. 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 of 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.

	An element of our growth and diversification strategy is the acquisition of other property and casualty insurance companies. Any pending or future acquisition we decide to undertake will involve risks.

The acquisition and integration of other similar property and casualty insurance companies is an element of our growth and diversification strategy. This strategy depends on identifying suitable acquisition opportunities and reaching mutually agreeable terms with acquisition candidates. The negotiation of potential acquisitions as well as the integration of acquired businesses could require us to incur significant costs or utilize significant resources. Further, acquisitions may result in dilution for the owners of our common stock, our incurrence of debt and contingent liabilities, and fluctuations in quarterly results. In addition, the businesses and other assets we acquire may not achieve the financial results that we expected.

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ITEM 1B. UNRESOLVED STAFF COMMENTS

We do not have any unresolved written comments regarding our periodic or current reports that were received from the staff of the United States Securities and Exchange Commission not less than 180 days before December 31, 2006.

ITEM 2. PROPERTIES

We conduct our operations for our property and casualty -- Massachusetts segment from approximately 436,000 square feet of space in several buildings that we own in Webster, Massachusetts, which is located approximately 50 miles southwest of Boston. Our data processing and operational departments are housed in modern office buildings. Our property and casualty -- Other than Massachusetts segment consists primarily of the operations of Commerce West and American Commerce. Commerce West currently leases approximately 22,000 square feet of office space in Pleasanton, California. American Commerce conducts its operations from approximately 40,000 square feet of space in a building it owns located on a two acre site in Columbus, Ohio. American Commerce also leases property at three district claims offices.

ITEM 3. LEGAL PROCEEDINGS

As is common with property and casualty insurance companies, we are a defendant in various legal actions arising from the normal course of our business, including claims based on Massachusetts Chapter 176D and Chapter 93A. See "Settlement of Claims." Similar provisions exist in other states where we do business. We consider these proceedings to be ordinary to operations or without foundation in fact. We believe that these actions will not have a material adverse effect on our consolidated financial position.

AAA Arizona

As previously disclosed, in AAA Arizona, Inc. v. American Commerce Insurance Company (United States District Court for the District of Arizona), originally filed on May 16, 2005, AAA Arizona alleges, among other claims, that American Commerce has violated its contract with AAA Arizona by failing to pay approximately $1,700 in profit sharing that AAA Arizona claims to have earned during 2004. AAA Arizona also alleges that American Commerce is interfering with AAA Arizona's relationship with its members. AAA Arizona seeks an order from the court and an award of actual and consequential damages in total of approximately $10,000. We cannot estimate, as of the date of this Form 10-K, the amount of consequential damages that may be awarded to AAA Arizona if it is successful. American Commerce intends to vigorously defend against AAA Arizona's claims unless a reasonable settlement appears appropriate.

Commerce Bancorp.

Commerce Insurance, which has been writing business in Massachusetts for more than 34 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 "Commerce" and "Insurance." In August 2003, Commerce Bancorp filed applications in the United States Patent and Trademark Office (the "PTO") to register the mark Commerce Insurance Services and the mark Commerce C Insurance Services and related design. Moreover, we understand that Commerce Bancorp acquired by assignment from the original owner the federal registration for the mark Commerce that was issued in 1997 for use in connection with "insurance agencies featuring home, accident, life, property, casualty and business insurance".

In May 2005, we began opposing both of the applications filed by Commerce Bancorp in a proceeding before the Trademark Trial and Appeal Board. The Trademark Trial and Appeal Board has suspended the proceeding before it pending resolution of a lawsuit filed by our subsidiary Commerce Insurance in the Federal District Court of Massachusetts against Commerce Bancorp and Commerce Insurance Services on February 22, 2006. In the complaint, Commerce Insurance sought 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, 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 "Commerce" and "Insurance" will create the likelihood of dilution of our Commerce

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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.

On July 13, 2006, the Court held a hearing, at which a judicial stipulation was made on behalf of Commerce Bancorp, Inc. and Commerce Insurance Services that the defendants no longer intended to use the name Commerce Insurance Services, Inc. in Massachusetts. On July 14, 2006, in light of the judicial stipulation made on behalf of the defendants, we withdrew, without prejudice, our pending motion for preliminary injunction. On June 30, 2006, Commerce Bancorp filed an application in the PTO to register the mark Commerce C Banc Insurance Services plus design (the "Design Mark"). On August 29, 2006, Commerce Bancorp filed an application in the PTO to register the mark Commerce Banc Insurance Services (the "Word Mark"). The application to register the Design Mark was published for opposition on February 20, 2007, and the application to register the Word Mark was to be published for opposition on February 27, 2007. Commerce intends to oppose these applications.

On October 26, 2006, we filed a Supplemental Complaint in Federal District Court to supplement our claims to include the defendants' intended use of the name Commerce Banc Insurance Services in Massachusetts. The defendants responded on November 9, 2006. The case is proceeding in the United States District Court of Massachusetts, and discovery closes on March 15, 2007. No trial date has been set.

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 "Commerce" and "Insurance."

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

There were no matters submitted to a vote of security holders during the fourth quarter of 2006.

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PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Our common stock trades on the NYSE under the symbol "CGI." The high, low and close prices for shares of our common stock and quarterly cash dividends paid for 2006 and 2005 follow.

	2006					2005*

	High	Low	Close	Dividend		High	Low	Close	Dividend


First Quarter*	$29.68	$25.77	$26.42		$0.225	$35.00	$28.88	$30.99		$0.165
Second Quarter*	31.07	25.89	29.54		0.250	32.17	28.75	31.06		0.190
Third Quarter	30.97	28.40	30.05		0.250	32.12	26.63	29.01		0.190
Fourth Quarter	32.00	29.17	29.75		0.250	29.76	26.82	28.64		0.190

			Total		$0.975			Total		$0.735

* Restated for the June 2006 two-for-one stock split.

As of January 31, 2007, we had approximately 850 stockholders of record. This number does not include beneficial owners whose shares are held in "street name" or held in accounts for approximately 2,490 participants of our Employee Stock Ownership Plan.

Dividends on shares of our common stock are declared and paid quarterly at the discretion of the Board of Directors. We have paid dividends on our common stock each year since 1994, but there can be no assurance that we will continue to pay dividends in the future or, if dividends are paid, that they will be in amounts similar to dividends that we have paid in recent periods. We currently expect to continue to pay quarterly cash dividends on our common stock in the future.

A portion of our cash flow consists of dividends received from Commerce Holdings, Inc. (CHI), which receives dividends from Commerce and Citation. The payment of any cash dividends to holders of common stock by us therefore depends on the receipt of dividend payments from CHI. To the extent our insurance subsidiaries are restricted from paying dividends, CHI will be limited in its ability to pay dividends to us. The payment of dividends by our insurance subsidiaries is subject to limitations imposed by Massachusetts law for Commerce and Citation, by Ohio law for ACIC and by California law for Commerce West, as discussed in Item 1 of this report under "Regulation."

In November 2001, the Board of Directors authorized a stock buy-back program to purchase 4,000,000 shares of our common stock of which 1,473,868 shares remained to be purchased. In November 2006, the Board of Directors authorized an increase of 3,526,132 shares in the repurchase program to 5,000,000 shares.

At times, we acquire shares of our common stock through transactions which involved the exercise of stock options by our officers. Instead of paying us cash to exercise their stock options, some officers tendered their previously owned shares of common stock in our Company, in accordance with the stock option agreement. The average price paid per share is calculated in accordance with the stock option agreement, and represents the five-day average of our common stock's daily high and low trading prices prior to exercise. The maximum number of shares that may yet be purchased under publicly announced plans are not affected by these transactions as our Board of Directors determined that such transactions do not apply to its stock buy-back authorization. A summary of all treasury stock transactions for the fourth quarter of 2006 follows:

2006 Period	Total Number of Shares	Average Price Paid Per Share	Total Number of Shares Purchased as Part of Publicly Announced Plan	Maximum Number of Shares that May Yet be Purchased Under the Plan


October	-	$ -	-	1,716,600
November	356,795	29.85	356,795	4,885,937
December	701,494	29.93	701,494	4,184,443

We will provide, upon written request and without charge, a copy of this Form 10-K. Requests must be directed to:

	Name:	Randall V. Becker
	Title:	Senior Vice President and Chief Financial Officer
	Address:	211 Main Street
		Webster, MA 01570

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COMMON STOCK PERFORMANCE

The graph below compares the cumulative total stockholder return on the shares of our Common Stock for the last five years with the cumulative total return of the New York Stock Exchange Market Index and a property and casualty industry group established by Value Line (Value Line Property/Casualty Industry Group). The Value Line Property/Casualty Industry Group is composed of 25 companies.

	12/31/01	12/31/02	12/31/03	12/31/04	12/31/05	12/31/06


The Commerce Group, Inc.	$100	$102	$111	$176	$170	$182
Value Line Property/Casualty	$100	$ 94	$115	$126	$138	$154
New York Stock Exchange Market Index	$100	$ 82	$106	$120	$129	$152

This line graph assumes an investment of $100 in our Common Stock, the New York Stock Exchange Market Index and the Value Line Property/Casualty Industry Group on December 31, 2001 and reinvestment of all dividends.

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ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

The data below should be read in conjunction with the consolidated financial statements, related footnotes, and other financial information included herein. All dollar amounts are in thousands, except per share data.

		2006		2005		2004		2003		2002


Statement of Earnings Data
Direct premiums written	$	1,864,153	$	1,874,231	$	1,838,241	$	1,658,969	$	1,406,856
Net premiums written		1,825,278		1,736,191		1,712,543		1,555,499		1,313,014
Earned premiums		1,760,700		1,709,924		1,638,833		1,445,628		1,210,040
Net investment income		143,563		123,211		115,711		92,183		98,466
Net realized investment gains (losses)		16,643		22,907		23,628		76,103		(82,385)
Total revenues		1,949,469		1,884,381		1,806,571		1,640,822		1,257,119
Losses and LAE		1,068,414		1,050,186		1,044,840		1,070,147		909,769
Policy acquisition costs		516,307		463,297		439,232		350,250		295,324
Total expenses		1,603,049		1,531,776		1,502,385		1,421,517		1,205,093
Net earnings		241,535		243,912		214,431		160,943		46,755
Comprehensive income		282,618		220,699		201,751		164,762		59,625

Per Share Data ⁽¹⁾
Net earnings per share -- basic	$	3.57	$	3.63	$	3.27	$	2.51	$	0.71
Net earnings per share -- diluted		3.55		3.60		3.25		2.49		0.71
Cash dividends paid per share		0.975		0.735		0.655		0.635		0.615
Stockholders' equity per share		22.53		19.39		16.75		14.23		12.30

Balance Sheet Data
Total investments	$	3,070,842	$	2,765,329	$	2,527,733	$	2,211,099	$	1,613,439
Premiums receivable		480,605		475,112		459,775		408,894		297,610
Total assets		4,110,869		3,927,010		3,612,243		3,211,286		2,419,073
Unpaid losses and loss adjustment
expenses		971,949		989,196		990,260		957,353		815,626
Unearned premiums		935,385		933,160		902,566		810,462		687,148
Bonds payable		298,589		298,388		298,186		297,984		-
Stockholders' equity		1,503,271		1,305,069		1,116,156		912,211		790,052
Dividends paid		65,986		49,414		43,032		40,641		40,277

Key Performance Ratios
Return on equity		18.5%		21.9%		23.5%		20.4%		5.8%

Loss and LAE ratio		60.7%		61.4%		63.8%		74.0%		75.2%
Underwriting expense ratio		28.5%		27.3%		26.2%		23.5%		24.1%

Combined ratio		89.2%		88.7%		90.0%		97.5%		99.3%

(1)	Adjusted for the June 2006 two-for-one stock split.

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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The purpose of the following discussion and analysis is to provide you with information that will assist you in understanding our financial condition and results of operations as reported in our consolidated financial statements. Therefore, the following should be read in conjunction with our consolidated financial statements in this Form 10-K.

Business Overview

We provide personal and commercial property and casualty insurance primarily in Massachusetts and in other states. Our core product lines are personal automobile, homeowners, and commercial automobile. We market our products exclusively through our network of independent agents in all states, except California, where we use agents and brokers. Our primary business strategy is to focus on the personal automobile insurance market in Massachusetts and to grow and diversify by increasing the proportion of our business written in other states in which we currently have a significant presence, primarily from Commerce West and American Commerce, and by expanding into the New York and New Jersey personal lines markets through the SWICO acquisition.

We manage our business in four reportable segments: property and casualty insurance -- Massachusetts; property and casualty insurance -- other than Massachusetts; real estate and commercial lending; and, corporate and other.

Our ability to capitalize on our business strengths and implement our strategies is subject to particular risks. For a discussion of these risks, see Item 1A, Risk Factors, contained elsewhere in this Form 10-K.

Massachusetts Regulatory Environment and Commonwealth Automobile Reinsurers (CAR)

Overview

The Massachusetts regulatory environment for personal automobile insurance is characterized by the following key principles:

	*	requiring personal automobile insurers to issue a policy to any eligible applicant who seeks one, known as the "take all comers" requirement,

	*	fixing 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,

	*	assigning 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,

	*	apportioning losses incurred by the state-mandated residual market run by CAR,

	*	mandating that higher compulsory and optional coverages be offered to all eligible drivers, and

	*	establishing minimum agency commissions.

A significant aspect of our automobile insurance business relates to our interaction with CAR, which enables us and the other participating servicing carriers to reinsure any automobile risk which is perceived to be under-priced. Since its inception, CAR has annually generated significant underwriting losses, primarily in the personal automobile pool. All companies writing automobile insurance in Massachusetts share in the underwriting results of CAR business for their respective product line or lines.

Member companies of CAR have joint and several liabilities for the obligations of CAR. If one member of CAR fails to pay its assessments, the remaining members will be required to pay the pro-rata share of the member who fails to pay its obligations. As of December 31, 2006, we were not aware of any current CAR member company which has failed to meet its obligations.

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Our Revenues and Expenses

Our revenue principally reflects:

	*	earned premiums, consisting of:

		-	premiums that we receive from sales by our agents of property and casualty insurance policies, primarily personal automobile, homeowners and commercial automobile, which we refer to as direct premiums written, plus

		-	premiums we receive from insurance policies that we assume, primarily from CAR, which we refer to as assumed premiums, less

		-	the portion of our premiums that is ceded to CAR and other reinsurers, which we refer to as ceded premiums, less

		-	the change in the portion of premiums that will not be recognized as income for accounting purposes until a future period, which we refer to as unearned premiums;

	*	investment income that we earn on our invested assets;

	*	premium finance charges and service fee income that we earn in connection with the billing and deferral of premium payments; and

	*	realized investment gains and losses.

Our expenses principally reflect:

	*	incurred losses and loss adjustment expenses (which we sometimes refer to as LAE), including estimates for losses incurred during the period but not yet reported to us and changes in estimates from prior periods related to direct and assumed business, less the portion of those incurred losses and loss adjustment expenses that are ceded to other insurers; and

	*	policy acquisition costs, including agent compensation and general and administrative costs, such as salaries and benefits, and advertising that are not deferred for accounting purposes to a future period.

Our Critical Accounting Policies

The preparation of financial statements in conformity with accounting principals generally accepted in the United States of America (GAAP) requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. We consider the following accounting estimates, which are especially dependent upon our judgments and assumptions, to be critical to the preparation of our financial statements.

Unpaid Losses and Loss Adjustment Expenses. The liability for loss and loss adjustment expenses represents our best estimate of the ultimate net cost of all loss and loss adjustment expenses incurred after reinsurance and amounts estimated to be recoverable through salvage and subrogation. The estimate for the ultimate net cost of all losses incurred through the balance sheet date includes the adjusted case estimates for losses, incurred but not reported (IBNR) losses, salvage and subrogation recoverable and a reserve for LAE. In arriving at our best estimate, we begin with the aggregate of individual case reserves and then make adjustments to these amounts on a line of business basis. The adjustment to the aggregate case reserves by line of business is made based on analyses performed by us. The entire liability for unpaid losses and LAE is also separately reviewed quarterly and annually by our actuarial department. Liability estimates are continually analyzed and updated, and therefore, the ultimate liability may be more or less than the current estimate. The effects of changes in the estimates are included in the results of operations in the period in which the estimates are revised.

The claim cycle begins when a claim is reported to us and claims personnel establish a "case reserve" for the estimated amount of our exposure without regard to injury causality, third party liability or potential recoveries. The amount of the reserve is primarily based upon an evaluation of the type of claim involved, the circumstances surrounding the claim and the policy provisions relating to the loss. This estimate reflects the informed judgment of such personnel based on the experience and knowledge of the claims personnel adjusting the claim. During the loss adjustment period, these case basis

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estimates are revised as deemed necessary by our claims department personnel based on subsequent developments and periodic reviews of the claim.

In accordance with industry practice, we also maintain reserves for estimated IBNR, salvage and subrogation recoverable and LAE. These reserves are determined based on historical information. Imbedded within the historical information are changes in the volume of policies written, claims frequency, severity and payment patterns, the mix of business and claims processing. IBNR reserves are established for claims that have been incurred prior to year end but have not been reported to us until after year end. Our IBNR reserve is derived by analyzing the amount of losses that have been incurred subsequent to a given calendar year end. We aggregate losses incurred for each of the three years after a given calendar year end and determine the percentage of losses to earned premium for that calendar year. We calculate the IBNR reserve by multiplying the appropriate historical percentage of losses by the earned premium for the current year and each of the prior two calendar years. Our calculations are based on historical losses incurred by line of business and coverage type and are modified where appropriate for changes in premium rates. We monitor the percentages for historical patterns and adjust our IBNR reserves as appropriate.

Salvage and subrogation reserves are established in a similar manner to IBNR except that we track actual historical salvage and subrogation receipts as a percentage of loss incurred. In addition, we establish LAE reserves by tracking historical expenses as a percentage of incurred losses.

Our financial management personnel calculate our financial statement loss and LAE reserves independently from those amounts calculated by our actuaries. Our financial management personnel establish our financial statement loss and LAE reserves primarily by reviewing historical loss and LAE data, focusing mainly on payment data. This method of using historical loss payments over discrete periods of time to estimate future losses assumes that the ratio of losses paid in one period to losses paid in an earlier period will remain consistent. This method necessarily assumes that factors that have affected paid losses in the past, such as inflation or the effects of litigation, will remain consistent in the future. Although we review trends for inflation, severity and the effects of litigation, these factors have not caused us to materially modify our loss and LAE reserves. Historical paid loss development methods do not use case reserves to estimate ultimate losses and can be more reliable than the other methods that look to case reserves (such as actuarial methods that use incurred losses) in situations where there are significant changes in how case reserves are established by a company's claims adjusters. However, historical paid loss development methods are more leveraged (meaning that small changes in payments have a larger impact on estimates of ultimate losses) than actuarial methods that use incurred losses because cumulative loss payments take much longer to equal the expected ultimate losses than cumulative incurred amounts. In addition, and for similar reasons, historical paid loss development methods are often slow to react to situations when new or different factors arise than those that have affected paid losses in the past. Because of the nature of our business and the consistent manner in claims settlement, we believe the use of historical payment patterns provides us the most appropriate method for establishing our reserve.

We also review and compare the most recent loss frequency, severity, and payment data to historical trends in an attempt to determine if patterns are remaining consistent or not. We believe they remain consistent. We record our best estimate of the ultimate losses and LAE that we will incur to settle all claims and IBNR at each reporting date, but the actual amount of such losses and LAE cannot be known until all claims are settled. Our financial statement loss and LAE reserves net of reinsurance (prior to the effect of ceded insurance recoverable), based on our best estimate, were established at $850,775 for December 31, 2006.

This process assumes that past experience, adjusted for the effects of current developments and anticipated trends, is an appropriate basis for predicting future events. There is no reasonably precise method, however, for subsequently evaluating the impact of any specific factor on the adequacy of reserves, because the eventual development of reserves is affected by many factors, as noted above.

We utilize an actuarial calculation as a test of reasonableness of our financial statement loss and LAE reserves which were calculated by financial management. Our actuaries calculate their estimate of our liability for loss and LAE reserves using generally accepted actuarial reserving techniques. The reserving techniques employed by our actuaries include incurred loss development and paid loss development for all reviewed lines. For voluntary personal automobile liability, two additional methods were used -- claim count times average severity and exposures times ultimate pure premium. In estimating allocated LAE ("ALAE") reserves, our actuaries used two methods -- paid ALAE development and ratio of paid ALAE to paid loss development. For unallocated LAE ("ULAE") reserve, three methods were used -- paid ULAE development, paid ULAE to paid loss ratio development and calendar year paid ULAE to paid loss and ALAE. An average of these methods is calculated, which is called the indicated ultimate loss. The indicated ultimate loss is then subjected to actuarial judgment which considers other factors, such as the resulting ultimate loss ratio, loss trends, changes to business and the relative value of each of the different methods. A selected ultimate loss amount is then determined. Using the criteria of Actuarial Standard

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of Practice No. 36, a reserve range is then calculated that the actuary judges to be reasonable based upon appropriate actuarial methods and judgment. The actuarial methods utilized are considered standard for property and casualty companies with losses settling over a relatively short period of time, usually within 0 to 3 years (short-tail liability losses). The same basic assumptions and methods were used at both December 31, 2006 and 2005. Our aggregate actuarial estimate for the loss and LAE reserves, on a consolidated basis and net of reinsurance recoverable, ranges from a low of $778,600 to a high of $893,600 as of December 31, 2006 and a low of $764,600 to a high of $877,900 at December 31, 2005.

After taking into account all relevant factors, we believe that, based on existing information, the provision for losses and LAE at December 31, 2006 is adequate to cover the ultimate net cost of losses and claims incurred as of that date. However, loss reserves are estimates and are inherently uncertain; they do not and cannot represent an exact measure of the liability. The ultimate liability may be greater or lower than established reserves. If the ultimate payment is greater than or less than our estimated liability for losses and LAE, we will incur additional expense or income, as appropriate, which may have a material impact on our results of operations. As our business primarily involves losses with a short-tailed liability, our loss and LAE reserves have more predictable development patterns than other property and casualty insurers whose business involves losses with a longer-tailed loss payment pattern.

As we base our estimate of loss and LAE reserves primarily on historical payment experience, the following sensitivity analysis assumes that our historical payment experience was impacted by the stated percentages. The factors which could cause the payment experience to change are not analyzed individually as these factors are imbedded in the historical information. Based upon historical results over the last five years, we show a redundancy for all five years, with a minimum redundancy of 5.2% and a maximum redundancy of 10.2% from the initially established reserves. See page 18 for an analysis of our historical loss and LAE reserve development.

The following sensitivity analysis presents the pro forma effect of a 5.2 and 10.2 percentage point redundancy change in our loss and LAE reserves (prior to the effect of ceded reinsurance recoverable) at December 31, 2006:

Hypothetical Change in Loss and LAE Reserve Estimate	Loss and LAE Reserve Estimate, Net	Pro forma Increase in Net Earnings⁽¹⁾	Pro forma Percentage Increase in Stockholders' Equity⁽¹⁾


No change	$850,775	$ -	-
5.2% decrease	806,535	28,756	1.9%
10.2% decrease	763,996	56,406	3.8%

(1)	Net of income taxes at an assumed rate of 35%.

The hypothetical changes noted above are based on historical experience. Conditions and trends that have affected development of reserves in the past may not necessarily occur in the future. Accordingly, it is not appropriate to extrapolate future development based on the preceding table.

We believe that any additional payments due as a result of the inherent uncertainty of establishing loss and LAE reserves as noted in the sensitivity analysis above would be adequately met by our normal operating cash flow.

The business we assume from CAR is a significant component of our loss and LAE reserves. Our assumed CAR loss and LAE reserves amounted to approximately 13% of our loss and LAE reserves at December 31, 2006 (prior to the effect of ceded reinsurance recoverable). CAR provides information to pool participants on a quarterly basis, one quarter in arrears. CAR provides consolidated results, which consist of all companies' ceded business into the pool, as well as information specific to our company. CAR provides information by line of business on policy year and accident year bases. This information consists of premiums written, unearned premium, earned premium, paid losses, case reserves, IBNR reserves, incurred losses, incurred loss adjustment expenses and underwriting expenses. The starting point for CAR's determination of its loss and LAE reserves is the separate loss and LAE reserves that CAR member companies provide to CAR. CAR then aggregates this information, which is reviewed by CAR's loss reserve committee, comprised of actuaries from member companies. This CAR actuarial committee establishes the total loss and LAE reserves for a given period. Our share of these loss and LAE reserves is derived by multiplying our participation ratio by the total CAR loss and LAE reserves. Management utilizes the information provided by CAR to book the initial amount related to the pool. The consolidated financial results produced by CAR are audited by independent public accountants and we rely on this audit for the incorporation of their reported results into our financial statements. CAR assesses the integrity of premium and claim data submissions by member companies by periodically auditing those member companies. Our actuary also reviews the CAR actuarial committee's work along with total CAR and company loss results for reasonableness.

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The quarterly reports that CAR provides to us are one quarter in arrears when we calculate this component of our financial statement loss and LAE reserves, and therefore, it is necessary for us to make an estimate of the most recent quarter results for CAR. In calculating this estimate we compare the CAR loss and LAE reserve data with historical premium written and earned amounts from CAR. We then utilize the estimated written and earned premiums from CAR for the most recent quarter to calculate losses, LAE and underwriting expenses that would relate to that quarter, and then incorporate that information into our financial results.

CAR results are less predictable and therefore more susceptible to change than our loss reserves because they are comprised of individual ceded business from all CAR member companies which may or may not use similar reserving methodologies and ceding philosophies as we use.

Based on the historical data of the five most recent accident years, CAR had redundancies and deficiencies within its accident years. The deficiencies had a low of 2.7% and a high of 3.8% of the initial reserves, while the redundancies had a low of 4.4% and a high of 16.8% of the initial reserves. These are the percentages utilized in our sensitivity analysis for our loss and LAE reserves related to CAR at December 31, 2006:

Hypothetical Change in Loss and LAE Reserve Estimate	Loss and LAE Reserve Estimate, Net	Pro forma Increase (Decrease) in Net Earnings⁽¹⁾	Pro forma Percentage Increase (Decrease) in Stockholders' Equity⁽¹⁾


3.8% increase	$114,449	$ (2,724)	(0.2)%
2.7% increase	113,236	(1,935)	(0.1)%
No change	110,259	-	-
4.4% decrease	105,408	3,153	0.2 %
16.8% decrease	91,735	12,041	0.8 %

___________________
(1)	Net of income taxes at an assumed rate of 35%.

The hypothetical changes noted above are based on historical experience. Conditions and trends that have affected development of reserves in the past may not necessarily occur in the future. Accordingly, it is not appropriate to extrapolate future development based on the preceding table.

Investments and Other-than-Temporary Impairments. The carrying values of investments in fixed maturities, which include taxable and non-taxable bonds, and investments in common and preferred stocks, are derived from market prices supplied by our investment custodian or, when no price is provided by the custodian, from a third party valuation. Fair market value of fixed maturities and equity securities is based on quoted market prices. Unrealized investment gains and losses on common and preferred stocks and fixed maturities, to the extent that there is no other-than-temporary impairment of value, are credited or charged, net of any tax effect, to a separate component of stockholders' equity, known as "net accumulated other comprehensive income (loss)," until realized.

We review all security holdings on a quarterly basis for potential other-than-temporary impairments due to declines in market value in accordance with GAAP. In general, unrealized losses resulting from an increase in interest rates will not necessarily lead to an other-than-temporary write-down. As part of this process, we consider any significant market decline in the context of the overall market and also in relation to the outlook for the specific issuer of the security and the issuer's industry. Each quarter, we review all securities whose market values have declined below book price. From a quantitative standpoint, we review all securities that have declined more than 20% below book price and have remained so for two consecutive quarters as potentially in need of a write-down. Any other security that we view as impaired for a significant period of time is also a candidate for a write-down, even if the percentage decline is less than 20%. In addition, we perform the following quarterly impairment review of our portfolio:

	*	We review all holdings with an unrealized loss of over $250, or a fair market value that is more than 20% below cost.

	*	We review all holdings with unrealized losses over $100, or a fair market value that is more than 10% below cost, for securities at a continuous loss position period of 12 to 36 months.

	*	We review all securities that have been at a continuous loss position for 36 months or more.

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	*	We review both issue specific data and general market data for all perpetual preferred stocks that have been at a continuous loss position for over 12 months.

	*	Generally, we consider all AAA/AA rated U.S. Government securities with market values less than cost as temporarily impaired due to our intent and ability to hold these securities to full recovery.

	*	We consider market activity between our quarter-end date and earnings release date in our evaluation.

	*	We will consider other-than-temporary the impairment of any security which we do not intend to hold to maturity or full recovery.

If a security is deemed other-than-temporarily impaired, we adjust the security's cost basis to market value through realized loss based on publicly available prices or, in the absence of such information, on a price supplied by a broker. There is a risk that we may assess an other-than-temporary decline in market value as being temporary and, consequently, not charge the impairment to our earnings, which could have a significant impact on our future earnings.

Accrued agents' profit sharing. In addition to state mandated minimum and other commissions on policies written, we pay certain of our agencies compensation in the form of profit sharing under five separate arrangements: one for Commerce and Citation for their Massachusetts agencies; another for Commerce's New Hampshire agencies; one for American Commerce for its agencies; and, two for Commerce West for its agencies. Each of these arrangements entitles qualifying agencies to share in our results based primarily on the underwriting profits of an individual agents' business written with us. Our total obligation under these arrangements is reported on our consolidated balance sheet as "Accrued agents' profit sharing." For segment reporting, our profit sharing expenses are aligned by state; profit sharing expense for our agencies in Massachusetts is included in our Massachusetts segment's earnings; profit sharing expense for our agencies in states other than Massachusetts is included in our Other than Massachusetts segment's earnings.

Approximately 96% of our total profit sharing expense in 2006 was for our Massachusetts agencies under the Commerce and Citation arrangement. Because this one arrangement accounts for nearly all of our profit sharing expense, the following discussion relates only to the Commerce and Citation plan in Massachusetts and excludes the other four profit sharing plans, the accounting for which we don't consider to be a critical accounting policy. The arrangement utilizes a three-year rolling plan, with one third of the agents' profit or loss for each of the current and the two prior years' calculations summed to a single amount. This amount, if positive, is multiplied by a sliding scale profit sharing commission rate and paid to the agent in the second quarter of the following year.

We estimate our current year profit sharing expense each quarter. Our expense calculation at year-end has one critical accounting estimate, as defined by the SEC, which we refer to as the discount factors. The discount factors represent our expected profit sharing payments for the second and third years following the current year's payment, net of attrition related to our agencies' profitability and profit sharing eligibility. We don't use a discount factor for the current year's payment because, subject to some final adjustments, our year-end estimate of our next payment is usually reasonably close to the actual payment amount. However, we know from experience that all of the agencies that are currently profitable, after the first and second years of each rolling three-year cycle, will not remain profitable and be entitled to all of the profit sharing earned during those years. Therefore, we apply discount factors in our accrual calculation to the estimated payment amounts for the latter two years to estimate this attrition in profit sharing eligibility.

We evaluate annually the appropriateness of these discount factors by considering our past experience and other prospective factors that may influence attrition in profit sharing eligibility, such as the pricing and regulatory environments in Massachusetts, current agency experience data, projected results of CAR, and underwriting results. Some of our prospective assumptions that underlie pricing, regulatory, CAR, and other factors are uncertain when we are performing our evaluation. In 2006, we increased our discount factors primarily because our underwriting results continued to be favorable and we expect less future attrition as a result. We believe the change is warranted despite the fact that we are currently in a soft market with significant premium rate decreases in Massachusetts. We believe that although the 2006 and 2007 premium rate reductions scheduled for the next 15 months in Massachusetts will reduce the profitability of our agencies in the state, the

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reductions should not cause a significant number of agencies who are currently profitable under our arrangement to become unprofitable in 2007, although we expect the number to grow in 2008 (two years out). By increasing our discount factors in 2006, we increased our profit sharing expense (Commerce and Citation only) in 2006 by approximately $8,600, which equates to a reduction in diluted EPS of approximately $0.08. The December 31, 2006 factors are 95% payable in one year and 75% payable in two years.

Although the discount factors we used in our 2006 profit sharing estimate resulted from a comprehensive evaluation, our actual future payment results may not agree with these factors due to the uncertainties underlying certain assumptions we had to make. Any expense overage or shortfall will be recognized in our earnings in subsequent years along with our profit sharing estimates for those years. The following table quantifies what the financial effect would have been to our 2006 and 2005 profit sharing expense (Commerce and Citation only), consolidated net earnings (after taxes), and diluted EPS had our discount factors been 500 basis points higher and lower.

		Pro forma
	Pro forma	Change in
	Change in Net	Stockholders'
Expense	Earnings⁽¹⁾	Equity⁽¹⁾

2006:
500 basis points higher	$131,372	$(4,160)	(0.3)%
Actual	124,972	-	-
500 basis points lower	118,572	4,160	0.3 %
2005:
500 basis points higher	126,350	(4,030)	(0.3)%
Actual	120,150	-	-
500 basis points lower	113,950	4,030	0.3 %

(1)	Net of income taxes at an assumed rate of 35%.

Massachusetts Personal Automobile Insurance

Overview. We have been the largest writer of personal property and casualty insurance in Massachusetts in terms of market share of direct premiums written since 1990. Our estimated share of the Massachusetts personal automobile market increased to 31.2% for the year through November 30, 2006, significantly exceeding our two nearest competitors, Safety Insurance Group, Inc. and Arbella Insurance Group, who maintained an estimated 11.2% and 9.6% market shares, respectively.

In Massachusetts, private passenger automobile insurance is subject to extensive regulation. Owners of automobiles are generally required to demonstrate certain minimum automobile insurance coverages as a prerequisite to registering any automobile. With very limited exceptions, private passenger automobile insurers are required by law to issue a policy to any applicant seeking to obtain such coverages, commonly known as the "take all comers" requirement. Marketing and underwriting strategies for companies operating in Massachusetts are limited by maximum premium rates and minimum agency commission levels for personal automobile insurance, both of which are mandated by the Commissioner.

Changes in Premium Rates. In each of the last three years, the Commissioner approved an average mandated Massachusetts personal automobile insurance premium rate decrease. The Commissioner approved average decreases of 11.7% for the one-year period beginning April 1, 2007 and 8.7% for the fifteen months beginning January 1, 2006. Coinciding with the 2006 and 2005 rate decisions, the Commissioner also approved commissions agents receive for selling private passenger automobile insurance. The Commissioner approved no change in commission dollars for 2007 and a 1.5% increase for 2006. The following table shows the state-mandated average rate change, the actual average written premium change per exposure and our average written premium change per exposure as estimated for 2006 and for the three previous years in Massachusetts.

Year	State Mandated Average Rate Change ⁽²⁾		Actual State Average Written Premium Change Per Exposure ⁽²⁾		Commerce Average Written Premium Change Per Exposure


2007⁽¹⁾		(11.7)%		NA		(6.4)%
2006		(8.7)%		(5.5)%		(5.6)%
2005		(1.7)%		1.5 %		0.4 %
2004		2.5 %		7.0 %		5.8 %

(1)	Estimated for Commerce average written premium change per exposure.
(2)	Based on Massachusetts Division of Insurance filings.
NA	Data is currently unavailable.

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Although mandated average personal automobile premium rates decreased 8.7% in 2006, our average written premium per exposure decreased only 5.6%. We believe that the smaller decrease for 2006 as compared to the Commissioner's state mandated average rate resulted primarily from:

	*	the fact that our mix of personal automobile coverage differs from that of the industry; and

	*	changes to our distribution of risks by class, territory and coverage, including changes resulting from the purchase of new, more expensive automobiles, which were not factored into the Commissioner's rate decrease.

The actual state average written premium change per exposure represents the change in the average premium paid by drivers in Massachusetts, as opposed to the state mandated average rate change. As can be seen above, our 2006 average written premium change per exposure corresponds more closely to the actual state average written premium change. The primary reason for this is that both take into account newer vehicles, as compared to the state mandated average rate change, which does not.

The Commissioner approved an 11.7% decrease in state mandated average personal automobile insurance premium rate for the one-year period ending April 1, 2007. Management estimates that this will translate into a 6.4% decline in the average written premium per exposure for the upcoming year. We estimate the 2007 net pre-tax impact of the 6.4% decrease in our 2007 average written premium per exposure to be approximately $34,400. The majority of the impact will occur during the last quarter of 2007 and the first quarter of 2008 as premiums for policies with 2007 effective dates become earned.

Affinity Group Marketing. Since 1995, we have been a leader in affinity group marketing in Massachusetts, through agreements with the three American Automobile Association Clubs operating in Massachusetts, offering discounts on private passenger automobile insurance to the clubs' members who reside in the state. A 5% discount was approved by the Commissioner for policies effective April 1, 2007. This same discount existed in 2006 through April 1, 2007. Based on information provided to us by the AAA clubs operating in Massachusetts, we believe that membership in these clubs represents approximately one-third of the Massachusetts motoring public. The following table presents total direct premiums written attributable to the AAA clubs' group business in Massachusetts for the years ended December 31:

	2006	2005	2004


Total AAA-Massachusetts direct premiums written	$675,904	$725,943	$724,147
Percentage of total direct premiums written	36.3%	38.7%	39.4%
Percentage of Massachusetts direct personal automobile premiums written	50.3%	53.1%	54.6%
Total AAA-Massachusetts exposures	644,600	645,300	643,400
Percentage of Massachusetts exposures	51.5%	53.7%	54.9%

The decreasing percentages since 2004 are attributed to a higher rate of increase in non-affinity group business. Of the total Massachusetts automobile exposures written through the AAA affinity group program by us in 2006, approximately 15.5% were written through insurance agencies owned by the AAA clubs (8.0% of our total Massachusetts automobile exposures). The remaining 84.5% of the AAA group program was written through our network of independent agents.

Our Performance Measures

We evaluate our operations by monitoring key measures of growth and profitability. We measure our growth by examining our direct premiums written as well as increases in exposures and policies. We generally measure our operating results in accordance with GAAP by examining our net earnings, return on equity (ROE), and our loss and LAE, underwriting expense and combined ratios on a consolidated basis. Our key measures include:

	*	Diluted Earnings per Share. Diluted earnings per share is net earnings divided by the weighted average number of common shares outstanding adjusted by the number of additional common shares that would have been outstanding had potentially dilutive common shares been issued and reduced by the number of common shares we could have purchased from the proceeds of those potentially dilutive shares.

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	*	Return on Equity. Return on equity is net earnings divided by stockholders' equity at the beginning of the period.

	*	Direct Premiums Written. Direct premiums written is the sum of the total policy premiums, net of cancellations, associated with policies underwritten and issued by our insurance subsidiaries. We use direct premiums written, which includes premiums that we cede to CAR and other reinsurers, as a measure of the underlying growth of our insurance business from period to period.

	*	Direct Earned Premiums. Direct earned premiums are the portion of direct premiums written over the preceding twelve-month period equal to the expired portion of policies and recognized as revenue during an accounting period.

	*	Net Investment Income. Net investment income represents earnings on our investment portfolio less expenses. We rely on after-tax investment income as a significant source of net earnings although we generally achieve a combined ratio (see below) of less than 100%.

	*	Loss and LAE Ratio. The loss and LAE ratio is the percentage of losses and loss adjustment expenses (including corporate expenses) incurred to earned premiums. We calculate this ratio net of our reinsurance recoveries. We use this ratio as a measure of the overall underwriting profitability of the insurance business we write and to assess the adequacy of our pricing.

	*	Underwriting Expense Ratio. The underwriting expense ratio is the percentage of underwriting expenses (including corporate expenses) incurred to net premiums written. Underwriting expenses are the aggregate of policy acquisition costs, including commissions, and the portion of administrative, general and other expenses attributable to underwriting operations. In addition, underwriting expenses are adjusted for any change in deferred acquisition costs.

	*	Combined Ratio. The combined ratio is the sum of the loss and LAE ratio and the underwriting expense ratio and measures a company's overall underwriting profit. If the combined ratio is at or above 100%, an insurance company cannot be profitable without investment income, and may not be profitable if investment income is insufficient. We use the combined ratio in evaluating our overall underwriting profitability and for comparing our profitability to that of our competitors.

Results of Operations

Our key operating measures for the years ended December 31 follow (dollars in millions, except earnings per share):

	2006	2005	2004


Diluted earnings per share	$ 3.55	$ 3.60	$ 3.25
Return on equity	18.5%	21.9%	23.5%
Direct premiums written	$1,864.2	$1,874.2	$1,838.2
Direct earned premiums	1,847.0	1,849.8	1,753.3
Net investment income	143.6	123.2	115.7
Loss and LAE ratio	60.7%	61.4%	63.8%
Underwriting expense ratio	28.5%	27.3%	26.2%
Combined ratio	89.2%	88.7%	90.0%

Year Ended 2006 Compared to Year Ended 2005

The decrease in earnings in 2006 over 2005 resulted primarily from an increase in our combined ratio in 2006. The increase in the combined ratio can be attributed to an increase in the underwriting ratio, partially offset by a decline in the loss ratio. Also impacting 2006 net earnings was a $20,352 increase in net investment income partially offset by a $6,264 decline in net realized investment gains.

We attribute the improvement in the loss ratio to several factors:

	*	decreases in the current year automobile bodily injury and physical damage claims frequencies;

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	*	continued improvement in the results from CAR due to fewer industry-wide cessions to CAR coupled with lower loss ratio on current year CAR business;

	*	partially offset by reduced favorable voluntary reserve development compared to 2005.

The increase in the underwriting ratio resulted primarily from reduced ceded reinsurance commissions, as a result of the termination of our other-than-automobile quota share agreement at June 30, 2006.

Premium Results

For a detailed breakdown on direct premiums written and earned, see Note P -- Segment Information in Notes to Consolidated Financial Statements.

Massachusetts Segment

We experienced a slight decline in direct premiums written in the Massachusetts segment of 0.3%, with declines in our personal automobile business outweighing growth in homeowners and commercial automobile business. The personal automobile business decline was a result of a 5.6% decline in average written premium per written exposure partially offset by a 4.3% increase in the number of written exposures. Commerce continues to increase its market share in both the voluntary and ERP markets. Approximately 64% of the increase in written exposures resulted from new ERPs and the remaining 36% from continuing agents.

Our year-to-date homeowners growth was the result of a 6.5% increase in average premium per policy partially offset by a 0.5% decrease in the number of policies written. Our year-to-date commercial automobile growth was the result of a 2.8% increase in average premium per policy combined with a 4.3% increase in policies written.

Other Than Massachusetts Segment

Total direct written premiums for the other-than-Massachusetts segment declined $5,422, or 2.3%. The personal automobile decline accounted for the majority of this decrease, primarily as the result of the continued decline in premiums in Arizona due to the loss of AAA Arizona's affinity business in 2005. Direct written premiums from personal automobile policies in Arizona declined $15,633, or 62.6%, primarily due to a decline in policies. We believe Arizona business volumes have now stabilized. American Commerce and Commerce West will continue to write business in Arizona; however, ACIC no longer markets its products through AAA Arizona. Also contributing to the decline in personal automobile direct written premium were a 29.6% drop in Ohio, a 10.2% decline in Idaho and a 10.4% drop in Indiana. Partially offsetting these declines were increases in Oregon (18.9%), Washington (8.6%) and Oklahoma (7.2%). In general, we are lowering rates in states in which we write business in response to competitive pressures as a result of a soft market. Commercial automobile premiums decreased 14.4% while homeowners increased by 0.6%. Other lines increased $9,258 primarily due to $8,881 of direct premiums from ANI, resulting from American Commerce becoming a direct writer of ANI business.

Segment Results

Massachusetts Segment

Revenue increased $75,132, or 4.5%, over the prior year primarily due to increases in earned premium and net investment income. The increase in earned premium resulted from the combination of the earning of 2005's increased personal automobile written premium as well as the earning of the returned unearned premium from the termination of our other-than-automobile quota share agreement. Net investment income increased as both outstanding invested assets and the yield on those assets increased.

Earnings increased $2,986, or 0.8%, over the prior year primarily due to the increases in revenue previously discussed, partially offset by an increased combined ratio. The combined ratio increased due to the factors discussed for the Company as a whole.

Other-than-Massachusetts Segment

Revenues declined $10,279, or 4.5%, over the prior year principally due to declining earned premium as written premium has declined in each of the last two years, as previously discussed. Increases in net investment income were offset by declines in realized investment gains.

<PAGE> 48

Earnings declined $2,612, or 8.1%, over the previous year due to the previously mentioned revenue declines combined with an increased combined ratio. The increased combined ratio resulted from the same factors for the Company as a whole.

Net Investment Income

Our net investment income for the year ended 2006 increased $20,352, or 16.5% compared to 2005. Net investment income is affected by the composition of our investment portfolio and yields on those investments.

The composition of our investment portfolio, at cost, at December 31 follows:

		% of		% of
	2006	Total	2005	Total


Fixed maturities^(a)	$1,961,080	65.5%	$2,037,127	73.6%
Preferred stocks	597,366	20.0	395,099	14.3
Common stocks	97,776	3.3	103,472	3.8
Preferred stock mutual funds	120,990	4.0	88,859	3.2
Mortgages and collateral notes	19,475	0.7	17,801	0.6
Short-term investments	13,414	0.4	-	-
Cash and cash equivalents	141,367	4.7	97,942	3.5
Other investments	43,001	1.4	28,976	1.0

Total investments and cash	$2,994,469	100.0%	$2,769,276	100.0%

(a)	Fixed maturities include mortgage-backed bonds, corporate bonds, U.S. Treasury bonds and notes and tax-exempt state and municipal bonds.

Key measures of net investment income for the years ended December 31 follow:

	Years Ended

	2006	2005


Investment Return:
Average month-end investments (at cost)	$2,874,345	$2,661,190
Net investment income before tax	143,563	123,211
Net investment income after-tax	109,124	95,359
Net investment income as a percentage of average net investments (at cost)	5.0%	4.6%
Net investment income after-tax as a percentage of average net investments (at cost)	3.8%	3.6%

The increase in our net investment income in 2006 was due to the combination of increased invested assets and higher overall yields. The increase in invested assets is primarily attributable to increased operating cash flows. The increase in yields corresponds with the increase in duration of our fixed maturity portfolio which rose to 5.4 years at December 31, 2006 from 4.9 years a year earlier. The increased yield is primarily attributable to the government bond and preferred stock segments, where pre-tax yields increased 100 and 60 basis points, respectively.

Realized Investment Gains and Losses

Net realized investment gains (losses) for the years ended December 31 follow:

	2006	2005	Change


Transaction net gains (losses):
Fixed maturity securities	$ (943)	$21,135	$(22,078)
Equity securities	(856)	4,464	(5,320)
Venture capital funds	9,415	837	8,578
Other investments	42	627	(585)

Transaction net gains	7,658	27,063	(19,405)

Other-than-temporary impairment losses:
Fixed maturity securities	(2,368)	(305)	(2,063)
Equity securities	(1,839)	(4,547)	2,708

Total other-than-temporary impairment losses	(4,207)	(4,852)	645

Equity in earnings of closed-end preferred stock mutual funds	13,192	696	12,496

Net realized investment gains included in net earnings	$16,643	$22,907	$ (6,264)

<PAGE> 49

Total realized gains declined 27.3% in 2006 as compared to 2005. We maintain the flexibility to realize capital gains when we feel it is a benefit for our long-term, after-tax return.

Losses and Loss Adjustment Expenses

Our loss ratio declined to 60.7% for 2006 from 61.4% the prior year. The improvement was the result of several factors, including:

	*	improved current year results, and

	*	a decrease in the current year personal and commercial automobile bodily injury and physical damage claim frequency.

A reconciliation of beginning and ending reserves for losses and loss adjustment expenses for the years ended December 31, net of reinsurance deductions from all reinsurers including CAR, follows:

	2006	2005	2004


Incurred losses and LAE:
Provision for insured events of the current year	$1,112,140	$1,111,583	$1,101,871
Decrease in provision for insured events of prior years	(43,726)	(61,397)	(57,031)

Total incurred losses and LAE	1,068,414	1,050,186	1,044,840


Payments:
Losses and LAE attributable to insured events of the current year	669,495	672,894	637,373
Losses and LAE attributable to insured events of prior years	382,843	372,719	369,684

Total payments	1,052,338	1,045,613	1,007,057

Change in loss and LAE reserves during the year	16,076	4,573	37,783
Loss and LAE reserves prior to the effect of ceded reinsurance
recoverable, beginning of year	834,699	830,126	792,343

Loss and LAE reserves prior to the effect of ceded reinsurance
recoverable, end of year	850,775	834,699	830,126
Ceded reinsurance recoverable	121,174	154,497	160,134

Loss and LAE reserves, end of year	$ 971,949	$ 989,196	$ 990,260

As a result of changes in estimates of insured events in prior years, the provision for loss and LAE decreased $43,726 for the year ended 2006 and $61,397 for the year ended 2005. The favorable development is due primarily to lower than anticipated losses related to the personal automobile liability. Conditions and trends that have affected development in the past may not necessarily occur in the future. Accordingly, it may not be appropriate to extrapolate future redundancies or deficiencies based upon these developments. The amounts we will ultimately incur from loss and loss adjustment expenses could differ materially in the near term from the amounts recorded.

Approximately $43,522 in personal automobile liability redundancies developed for the year ended 2006, with 99% of this amount coming from the 2005, 2004 and 2003 accident years. The primary reason for the redundancies in this area is that claim severity developed better than we anticipated, coupled with significant redundancies from CAR, which approximated 27% of the total automobile liability redundancy. Automobile physical damage had approximately $1,735 in redundancies all related to the 2005 accident year, which were offset by prior period deficiencies. Redundancies related to 2005 were approximately $4,713, of which CAR accounted for 43%. Partially offsetting these redundancies was a $1,895 deficiency in commercial automobile business, primarily related to CAR for the 2005 accident year, and a $236 deficiency in homeowners business. Various redundancies and deficiencies for the other lines of business and accident years combined for the remaining net redundancy of approximately $600.

Management considers many factors, as disclosed in the Critical Accounting Policies section of this report, in establishing its best estimate for loss and LAE reserves. We believe that our loss and LAE reserve estimate is a reasonable assessment of the ultimate future payment amounts necessary to settle all of our insured losses incurred as of December 31, 2006. In addition, we believe the pro forma analysis presented under the Critical Accounting Policies is a reasonable depiction of our sensitivity related to our estimate, based on our reserving methodology and the short-tail nature of the

<PAGE> 50

business that we write. However, the ultimate liability may be greater or less than the established reserves for losses and LAE. If the ultimate payments are greater or less than our estimated liability for losses and LAE, we will either incur additional or less expenses, respectively, in future periods which may have a material effect on our future results of operations.

Policy Acquisition Costs

Our underwriting ratio increased to 28.5% for 2006 from 27.3% in the prior year, primarily as a result of reduced ceded reinsurance commissions. This reduction resulted from the termination of our other-than-automobile quota share agreement. Also contributing to the increase were higher accrued agents' profit sharing and higher 2006 policy year mandated Massachusetts personal automobile commission rates, as well as an increase in our assessment from the Massachusetts Insurance Insolvency Fund. See Note L of Notes to Consolidated Financial Statements for further information. The increase in agents' profit sharing is due to improved underwriting results versus the previous year.

Other

The market price for our common stock and our financial results directly affects our expense related to stock options, book value awards (BVAs) and incentive awards (IAs), respectively. Our stock option expense represents options granted to both employees and American Commerce agents. The majority of this expense is related to options granted to American Commerce agents. An increase in the market value of our stock will increase the expense we recognize for options. Similarly, an increase in our net income will increase the value of, and therefore the expense we recognize for, outstanding BVAs and IAs. We record these expenses in three separate line items on our income statement -- losses and loss adjustment expenses, policy acquisition costs and net investment income. See Note I of Notes to Consolidated Financial Statements for further information. The stock option, BVA and IA expenses recorded in each line item for the years ended December 31 follow:

	2006	2005


Losses and loss adjustment expenses	$18,962	$16,430
Policy acquisition costs	15,849	14,570
Net investment income	126	187

Total stock option, BVA and IA expenses	$34,937	$31,187

Income Taxes

Our overall effective tax rate for the year ended 2006 was 30.0% as compared to 30.6% for 2005. In both years, our effective rate was lower than the statutory rate of 35.0% primarily due to tax-exempt interest and the corporate dividends received deduction. Our effective tax rate decreased in 2006 due to a slightly higher amount of the corporate dividends received deduction and lower profits at the 35% rate.

Recent Accounting Pronouncements

In September 2006, the Financial Accounting Standards Board (FASB) issued Statement No. 158, Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans -- an amendment of FASB Statements No. 87, 88, 106 and 132(R). This Statement requires an employer to recognize the overfunded or underfunded status of a defined benefit plan as an asset or liability in its financial statement and to recognize changes in that funded status in the years in which the changes occur through comprehensive income. This Statement also requires measurement of funded status as of the fiscal year-end, with limited exceptions. The Statement is effective for publicly traded companies for fiscal years ending after December 15, 2006. The adoption of this Statement did not have an impact on our results of operations or financial position.

In September 2006, the FASB also issued Statement No. 157, Fair Value Measurements (FAS 157). The Statement defines fair value, establishes a framework for measuring fair value in GAAP, and expands disclosures about fair value measurements. FAS 157 does not require any new fair value measurements but applies under other financial pronouncements that permit or require fair value measurements. FAS 157 is effective for fiscal years beginning after November 15, 2007 and early application is encouraged. We do not expect the adoption of this Statement to have a material impact on our results of operations or financial position.

In September 2006, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements

<PAGE> 51

(SAB 108). SAB 108 establishes an approach that requires quantification of financial statement errors based on the effects of the error on each of the company's financial statements and related disclosures. This model is referred to as the dual approach, as it requires errors to be quantified for their impact on both the income statement (including reversing effect of prior year misstatements) and the period-end balance sheet. SAB 108 is effective for fiscal year ends after November 15, 2006. The adoption of SAB 108 did not have a material impact on our results of operations or financial position.

In July 2006, the FASB released FIN 48, Accounting for Uncertainty in Income Taxes -- an interpretation of SFAS 109. This interpretation clarifies the accounting for uncertainty in income taxes recognized in accordance with SFAS 109. This interpretation prescribes a recognition threshold and measurement attribute for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. It also provides guidance on derecognition, classification, interest and penalties, interim periods and disclosure. FIN 48 is effective for fiscal years beginning after December 15, 2006. We will adopt FIN 48 as of January 1, 2007 and we expect the adoption to have a negligible impact on our results of operation and financial position.

In March 2006, the FASB issued Statement No. 156, Accounting for Servicing of Financial Assets, an amendment of Statement No. 14 (FAS 156). FAS 156 requires all separately recognized servicing assets and servicing liabilities to be initially measured at fair value, if practicable, and permits an entity to subsequently measure those servicing assets and servicing liabilities at fair value. FAS 156 is effective for fiscal years beginning after September 15, 2006. We do not expect the adoption of FAS 156 to have a material impact on our results of operations or financial position.

In February 2006, the FASB issued Statement No. 155, Accounting for Certain Hybrid Financial Instruments -- an amendment of FASB Statements No. 133 and 140. The Statement permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation. The new Statement also requires companies to identify interests in securitized financial assets that are freestanding derivatives or contain embedded derivatives that would have to be accounted for separately and that interest-only and principal-only strips are not subject to Statement No. 133. This new Statement is effective for fiscal years beginning after September 15, 2006 with early adoption permitted. Although we do not currently have any financial instruments subject to this new Statement, we elected to adopt this Statement effective January 1, 2006 and it had no impact on our financial statements.

In June 2005, the FASB issued Statement No. 154, Accounting Changes and Error Corrections -- A Replacement of APB Opinion No. 20 and FASB Statement No. 3 (FAS 154). The Statement applies to all voluntary changes in accounting principles and requires that such changes be applied retrospectively to prior periods unless doing so is impracticable. The Statement does not change the transition method for new accounting standards where the new pronouncements address transition provisions. The Statement was effective January 1, 2006. FAS 154 did not have an impact on our financial position or results of operations.

The FASB issued in December 2004 revised rules for accounting for stock options and other equity-based remuneration, SFAS No. 123R, Share-Based Payment. We adopted these revised rules in the first quarter of 2006 when they became effective. This change did not impact our results of operations and financial condition for the employee stock options we awarded through 2001 under the Plan because application of the revised rules is on a prospective basis, these awards were fully vested and we have not modified, repurchased or cancelled any of these stock options. The revised rules did not change our accounting for BVAs, IAs and the stock options we award under the American Commerce agents' option Plan.

Year Ended 2005 Compared to Year Ended 2004

The significant increase in earnings in 2005 over 2004 was primarily due to the decrease in our loss ratio. We attribute the improvement in our loss ratio to several factors:

	*	improved current year results and continued favorable prior years' loss development from CAR,

	*	an increase in average earned premium revenue per automobile (see discussion regarding premium results), and

	*	a decrease in the current year personal and commercial automobile bodily injury claim frequency.

These items were partially offset by reduced favorable voluntary loss reserve development compared to 2004.

The effect of our improved loss ratio on 2005 earnings was partially offset by the increase in our underwriting ratio. This increase was driven by a significant increase in our agents' profit sharing expense in 2005 and slightly higher 2005 policy year mandated Massachusetts personal automobile commission rates, both partially offset by a decrease in our

<PAGE> 52

assessment from the Massachusetts Insurance Insolvency Fund. The increase in agents' profit sharing expense is the result of improved underwriting results in 2005 versus 2004.

Premium Results

For a detailed breakdown on direct premiums written and earned, see Note P -- Segment Information in Notes to Consolidated Financial Statements.

Massachusetts Segment

We experienced growth in direct premiums written in the Massachusetts segment of 3.2%, with increases in our personal automobile and homeowners lines of business. Growth in personal automobile business accounted for approximately 75% of the segment's increase. Personal automobile business growth was a result of a 2.2% increase in the number of written exposures coupled with a 0.4% increase in average written premium per written exposure. The agents assigned to us by CAR accounted for 54.4% of the written exposure increase. We believe that voluntary agents are currently very cautious in moving books of business between carriers due to the uncertainties created by CAR reform proposals.

Our year-to-date homeowners growth was from a 10.5% increase in average premium per policy partially offset by a 0.6% decrease in the number of policies written. Our year-to-date commercial automobile decline was from a 2.0% decrease in average premium per policy partially offset by a 0.7% increase in policies written. Average premium per policy has declined due to more competitive pricing in a softening market.

Other Than Massachusetts Segment

Total direct written premiums for the other-than-Massachusetts segment declined $15,297, or 6.0%. The personal automobile decline accounted for the majority of this decrease, primarily as the result of the decline in premiums in Arizona due to the loss of AAA Arizona's affinity business. Direct written premiums from personal automobile policies in Arizona declined $14,400, or 36.6%, and policies in force declined 65.5%. We project an additional decline of $14,000, or 56.5%, during 2006. American Commerce and Commerce West will continue to write business in Arizona; however, ACIC will no longer market its products through AAA Arizona. In general, we are lowering rates in states in which we write business in response to competitive pressures. Commercial automobile premiums increased over 9.0% while homeowners and other lines were basically unchanged. The increase in the commercial automobile category primarily resulted from an 11.9% increase in the number of policies in force at Commerce West.

Net Investment Income

Our net investment income for the year ended 2005 increased $7,500, or 6.5% compared to 2004. Net investment income is affected by the composition of our investment portfolio and yields on those investments.

The composition of our investment portfolio, at cost, at December 31 follows:

		% of		% of
	2005	Total	2004	Total


Fixed maturities^(a)	$2,037,127	73.6%	$1,674,849	67.1%
Preferred stocks	395,099	14.3	421,247	16.9
Common stocks	103,472	3.8	74,865	3.0
Preferred stock mutual funds	88,859	3.2	54,653	2.2
Mortgages and collateral notes	17,801	0.6	15,107	0.6
Cash and cash equivalents	97,942	3.5	220,988	8.9
Other investments	28,976	1.0	32,277	1.3

Total investments	$2,769,276	100.0%	$2,493,986	100.0%

(a)	Fixed maturities include mortgage-backed bonds, corporate bonds, U.S. Treasury bonds and notes and tax-exempt state and municipal bonds.

<PAGE> 53

Key measures of net investment income for the years ended December 31 follow:

	Years Ended

	2005	2004


Investment Return:
Average month-end investments (at cost)	$2,661,190	$2,319,170
Net investment income before tax	123,211	115,711
Net investment income after-tax	95,359	90,756
Net investment income as a percentage of average net investments (at cost)	4.6%	5.0%
Net investment income after-tax as a percentage of average net investments (at cost)	3.6%	3.9%

The increase in our net investment income in 2005 was primarily due to increased invested assets partially offset by lower overall yields. The increase in invested assets is primarily attributable to increased operating cash flows. The decrease in yields corresponds with the decline in duration of our fixed maturity portfolio in which we sold higher yielding investment securities. This is particularly true in the corporate and municipal bonds segments, where pre-tax yields declined 120 and 70 basis points, respectively.

Realized Investment Gains and Losses

Net realized investment gains (losses) for the years ended December 31 follow:

	2005	2004	Change


Transaction net gains (losses):
Fixed maturity securities	$21,135	$ 12,733	$ 8,402
Equity securities	4,464	19,085	(14,621)
Venture capital funds	837	3,668	(2,831)
Other investments	627	(205)	832

Transaction net gains	27,063	35,281	(8,218)

Other-than-temporary impairment losses:
Fixed maturity securities	(305)	(14,189)	13,884
Equity securities	(4,547)	(760)	(3,787)

Total other-than-temporary impairment losses	(4,852)	(14,949)	10,097

Equity in earnings of closed-end preferred stock mutual funds	696	3,296	(2,600)

Net realized investment gains included in net earnings	$22,907	$ 23,628	$ (721)

Total realized gains were relatively flat from 2005 as compared to 2004. Impairment losses decreased by $10,097 but were offset by a $8,218 decline in transaction gains and a $2,600 decline in the equity in earnings of the closed-end preferred stock mutual funds. Once again in 2005, we were able to realize significant investment gains in long duration municipal bonds and asset-backed investments. We maintain the flexibility to realize capital gains when we feel it is a benefit for our long-term, after-tax return.

Losses and Loss Adjustment Expenses

Our loss ratio declined to 61.4% for 2005 from 63.8% the prior year. The improvement was the result of several factors, including:

	*	improved current year results and continued favorable prior years' loss development from CAR,

	*	an increase in average earned premium revenue per automobile, and

	*	a decrease in the current year personal and commercial automobile bodily injury claim frequency.

Redundancies related to prior years for CAR Private Passenger Auto Liability accounted for approximately one-half of the 2.4% decrease in the loss ratio from 2004. These items were partially offset by reduced favorable voluntary loss reserve development compared to 2004.

A reconciliation of beginning and ending reserves for losses and loss adjustment expenses for the years ended December 31, net of reinsurance deductions from all reinsurers including CAR, follows:

<PAGE> 54

	2005	2004	2003


Incurred losses and LAE:
Provision for insured events of the current year	$1,111,583	$1,101,871	$1,095,371
Decrease in provision for insured events of prior years	(61,397)	(57,031)	(25,224)

Total incurred losses and LAE	1,050,186	1,044,840	1,070,147


Payments:
Losses and LAE attributable to insured events of the current year	672,894	637,373	625,803
Losses and LAE attributable to insured events of prior years	372,719	369,684	330,349

Total payments	1,045,613	1,007,057	956,152

Change in loss and LAE reserves during the year	4,573	37,783	113,995
Loss and LAE reserves prior to the effect of ceded reinsurance
recoverable, beginning of year	830,126	792,343	678,348

Loss and LAE reserves prior to the effect of ceded reinsurance
recoverable, end of year	834,699	830,126	792,343
Ceded reinsurance recoverable	154,497	160,134	165,010

Loss and LAE reserves, end of year	$ 989,196	$ 990,260	$ 957,353

As a result of changes in estimates of insured events in prior years, the provision for loss and LAE decreased $61,397 for the year ended 2005 and $57,031 for the year ended 2004. The favorable development is due primarily to lower than anticipated losses related to the personal automobile liability, the automobile physical damage and the commercial multiple peril lines of business. Conditions and trends that have affected development in the past may not necessarily occur in the future. Accordingly, it may not be appropriate to extrapolate future redundancies or deficiencies based upon these developments. The amounts we will ultimately incur from loss and loss adjustment expenses could differ materially in the near term from the amounts recorded.

Approximately $54,370 in personal automobile liability redundancies developed for the year ended 2005, with 92% of this amount coming from the 2004, 2003 and 2002 accident years. The primary reason for the redundancies in this area is that claim severity developed better than we anticipated, coupled with significant redundancies from CAR, which accounted for approximately 41% of the total automobile liability redundancy. Automobile physical damage had approximately $7,447 in redundancies chiefly related to the 2004 accident year, approximately 47% of which was related to CAR. In 2005, we also experienced redundancies of $1,733 for the commercial multiple peril line of business, 62% of which related to the 2004 accident year. Partially offsetting these redundancies was a $3,467 deficiency in commercial automobile business, primarily related to CAR for the 2004 accident year. Various redundancies and deficiencies for the other lines of business and accident years combined for the remaining net redundancy of approximately $1,314.

Policy Acquisition Costs

Our underwriting ratio increased to 27.3% for 2005 from 26.2% in the prior year, primarily as a result of significantly higher accrued agents' profit sharing and slightly higher 2005 policy year mandated Massachusetts personal automobile commission rates, both partially offset by a decrease in our assessment from the Massachusetts Insurance Insolvency Fund. In addition to the increase in agents' profit sharing expense in 2005, policy acquisition cost increases are also due to our premium growth. The increase in agents' profit sharing is due to improved underwriting results versus the previous year. Premium growth results in additional expense in commission, premium tax, and other variable costs. Partially offsetting these increases was a decline in stock option, BVA and IA expense.

Other

The market price for our common stock and our financial results directly affects our expense related to stock options, BVAs and IAs, respectively. We record these expenses in three separate line items on our income statement -- losses and loss adjustment expenses, policy acquisition costs and net investment income. The stock option, BVA and IA expenses recorded in each line item for the years ended December 31 follow:

	2005	2004


Losses and loss adjustment expenses	$16,430	$20,383
Policy acquisition costs	14,570	17,161
Net investment income	187	185

Total stock option, BVA and IA expenses	$31,187	$37,729

<PAGE> 55

Income Taxes

Our overall effective tax rate for the year ended 2005 was 30.6% as compared to 29.3% for 2004. In both years, our effective rate was lower than the statutory rate of 35.0% primarily due to tax-exempt interest and the corporate dividends received deduction. Our effective tax rate increased in 2005 due to improved underwriting results which are taxed at 35%.

Financial Condition

Our financial condition improved significantly in 2006. Our stockholders' equity per share increased 16.2% from $19.39 at December 31, 2005 to $22.53 at December 31, 2006. Our ratio of total liabilities to stockholders' equity decreased 27 percentage points at December 31, 2006 from the prior year end. This decrease is due to a 15.2% increase in equity combined with a 0.6% decline in total liabilities. The increase in equity during 2006 resulted primarily from current year earnings and appreciation in value of available for sale securities, partially offset by dividends paid and common stock repurchased. Total liabilities decreased chiefly as a result of declines in unpaid losses and LAE and accrued expenses partially offset by increased accrued agents' profit sharing.

Total assets increased $183,859, or 4.7%, versus the prior year end. Predictably, as they comprise approximately 75% of total assets, investment growth represented the majority of the increase. Investments increased $305,513, or 11.0%, from operating cash flows, retained net earnings and from market value appreciation. We continue to maintain our cash and fixed maturity investments at levels to both service our liabilities and optimize after-tax returns. Amounts due from reinsurers declined due to the termination of our other-than-automobile quota share agreement. Deferred income taxes decreased primarily due to the resulting deferred tax liability relating to the increase in market value over cost of available for sale securities.

Total unpaid losses and LAE, net of salvage and subrogation, by line of business at December 31, 2006 and 2005 follow (in millions):

2006	Case	IBNR	LAE	Total


Private passenger automobile	$382.0	$132.2	$110.4	$624.6
Commercial automobile	42.0	9.9	11.0	62.9
CAR	147.6	35.0	7.8	190.4
Homeowners	39.4	9.7	8.7	57.8
Other	23.1	8.2	4.9	36.2

Total	$634.1	$195.0	$142.8	$971.9


2005	Case	IBNR	LAE	Total


Private passenger automobile	$367.9	$131.7	$109.4	$609.0
Commercial automobile	39.2	9.9	8.9	58.0
CAR	174.5	40.6	9.5	224.6
Homeowners	40.0	9.8	8.9	58.7
Other	25.3	8.9	4.7	38.9

Total	$646.9	$200.9	$141.4	$989.2

Ceded unpaid losses and LAE recoverable, net of salvage and subrogation, by line of business at December 31, 2006 and 2005 follow (in millions):

	2006	2005


Commercial automobile	$ 0.5	$ 0.4
CAR	80.1	93.5
Homeowners	19.7	34.7
Other	20.9	25.9

Total	$121.2	$154.5

<PAGE> 56

Unpaid losses and LAE reserves net of ceded reinsurance recoverable, by line of business, and the actuarial low and high range estimates at December 31, follow (in millions):

		2006 Actuarial Estimate			2005 Actuarial Estimate

	2006	Low	High	2005	Low	High


Private passenger automobile	$624.6	$575.5	$659.5	$609.0	$553.7	$634.7
Commercial automobile	62.4	52.6	60.3	57.6	50.3	57.7
CAR	110.3	104.7	121.3	131.1	124.5	144.1
Homeowners	38.1	33.4	38.3	24.0	22.7	26.0
Other	15.3	12.4	14.2	13.0	13.4	15.4

Total	$850.7	$778.6	$893.6	$834.7	$764.6	$877.9

Contractual Obligations and Commercial Commitments

Our contractual obligations and commercial commitments as of December 31, 2006 by maturity follow:

		Payments Due by Fiscal Period

Contractual Obligations	Total	2007	2008-09	2010-11	Thereafter


Bond indebtedness principal	$ 300,000	$ -	$ -	$ -	$300,000
Bond indebtedness interest	124,950	17,850	35,700	35,700	35,700
SWICO acquisition	55,000	55,000	-	-	-
Unpaid losses and LAE ^(a)	971,949	468,479	353,789	103,027	46,654
Accrued agents' profit sharing	232,440	119,829	112,611	-	-

Total contractual obligations	$1,684,339	$661,158	$502,100	$138,727	$382,354


		Commitment Expiration

Commercial Commitments^(b)	Total	2007	2008-09	2010-11	Thereafter


Unadvanced loan commitments	$ 7,715	$ -	$ 7,715	-	$ -
Venture capital partnerships	12,254	945	-	-	11,309

Total commercial commitments	$ 19,969	$ 945	$ 7,715	-	$ 11,309

(a)	The liability for unpaid losses and LAE represents the accumulation of individual case estimates for reported losses, adjustments to this amount on a line of business basis and estimates for incurred but not reported losses and LAE, net of salvage and subrogation recoverable. The liability is intended to cover the ultimate net cost of all losses and LAE incurred through the balance sheet date. Payment amounts are estimated, based on payment patterns experienced through 2006.
(b)	Liability is included as of date of final commitment.

During the second quarter of 2006, we entered into an agreement to fund a commercial loan participation of $10,000. As of December 31, 2006, $2,285 of this commitment has been funded and is included in other investments on the consolidated balance sheet. The remaining commitment will be funded through ordinary operating cash flows over the next two years.

We have commitments in two venture capital fund investments. These investments are made in limited partnerships and our exposure to loss is limited to our actual investment. One limited partnership investment required a commitment by us to invest up to $50,000 into the partnership. As of December 31, 2006, we invested $38,691 into the partnership. The partnership was formed to operate as an investment fund principally for the purpose of making investments primarily in equity, equity-related and other securities issued in expansion financing, start-ups, buy-outs and recapitalization transactions relating to companies in the areas of insurance, financial services, e-commerce, healthcare, and related businesses, including, without limitation, service and technology enterprises supporting such businesses.

The other limited partnership interest required a commitment by us to invest up to $3,500 into the partnership. As of December 31, 2006, we invested $2,555 into the partnership. The partnership was formed to operate as an investment fund principally for the purpose of making investments in equity and equity related securities of companies operating in the area of insurance distribution and distribution related activities.

<PAGE> 57

Liquidity and Capital Resources

Liquidity management allows us to meet our cash needs at a reasonable cost under various operating environments. Liquidity is actively managed and reviewed in order to maintain stable, cost-effective funding to meet our operating needs. Liquidity comes from a variety of sources such as cash flow from operating activities and borrowing capacity. Management believes its current liquidity exceeds its operational requirements as of December 31, 2006.

The primary sources of our liquidity are funds generated from insurance premiums, net investment income, premium finance and service fees and the maturing and sale of investments. The primary uses of our liquidity are payment of policy claims, operating costs, interest on our senior notes, purchases of investment securities and treasury stock, and payment of dividends to our stockholders. We believe our capital resources are sufficient toward meeting our short and long-term liquidity needs.

In April 2005, Commerce Insurance became a member of the Federal Home Loan Bank (FHLB) of Boston, providing Commerce Insurance with a significant source of liquidity. The FHLB of Boston, which is one of 12 regional FHLBs, serves as a reserve or central bank for its members within its assigned region. The FHLB of Boston makes loans, which are referred to as advances, to members in accordance with policies and procedures established by its board of directors. These policies and procedures are subject to the regulation and oversight of the Federal Housing Finance Board. All advances from the FHLB of Boston to Commerce Insurance are required to be fully secured by sufficient collateral as determined by the FHLB. We estimate that FHLB membership provides Commerce Insurance with the capacity to borrow approximately $380,000 from the FHLB of Boston. We have not borrowed from the FHLB.

The primary source of liquidity for The Commerce Group (parent company only) is the payment of dividends from its subsidiaries. Its main subsidiary, CHI, is dependent upon dividends from our insurance subsidiaries. The payment of dividends from insurance companies is regulated and limited under the laws of Massachusetts, Ohio and California. See "Payment of Dividends" within the Regulations section of Item 1. Business.

We expect to pay significantly more for agent profit sharing in 2007 than we paid in 2006. We paid approximately $84,000 for agent profit sharing in the second quarter of 2006. Due to our improved underwriting results during 2006, we estimate paying approximately $115,000 in the second quarter of 2007.

Industry and regulatory guidelines suggest that the ratio of a property and casualty insurer's annual net premiums written to statutory policyholders' surplus should not exceed 3.00 to 1.00. The following table presents, on a consolidated basis, our net premiums written to statutory surplus ratio:

Market Risk: Interest Rate Sensitivity and Equity Price Risk

The primary focus of our investment objectives continues to be maximizing after-tax investment income through investing primarily in high-quality diversified fixed maturity investments structured to maximize after-tax investment income while minimizing risk. We generally invest in securities with maturities intended to provide adequate cash flow to pay claims and meet other operating needs without the forced sale of investments. When the appropriate opportunity arises, we will recognize investment gains to increase after-tax total return. We held no derivatives, emerging market securities or hedge funds at December 31, 2006 and 2005.

In conducting investing activities, we are subject to, and assume, market risk. Market risk is the risk of an adverse financial impact from changes in interest rates and market prices. The level of risk assumed by us is a function of our overall objectives, liquidity needs and market volatility.

We manage our market risk by focusing on higher quality equity and fixed maturity investments, by periodically monitoring the credit strength of companies in which investments are made, by limiting exposure in any one investment and by monitoring the quality of the investment portfolio taking into account, among other factors, credit ratings assigned by recognized rating organizations. Of our bonds and preferred stocks, 93% of the market value was rated in either of the two highest quality categories provided by the NAIC as of December 31, 2006, as compared to 91% at December 31, 2005. Although we have significant holdings of various closed-end preferred stock mutual funds, these funds are comprised primarily of preferred and common stocks traded on national stock exchanges, thus limiting exposure to any one obligor.

<PAGE> 58

Interest Rate Sensitivity. As part of our investing activities, we assume positions in fixed maturity, equity, short-term and cash equivalents markets. Therefore, we are exposed to the impacts of changes in the market value of investments resulting from fluctuations in interest rates. We estimate our exposure to interest rate changes and equity price risk using sensitivity analysis. The interest rate impact is defined as the effect of a hypothetical interest rate change of plus-or-minus 100 or 200 basis points on the market value of fixed maturities and preferred stocks.

Changes in interest rates would result in unrealized gains or losses in the market value of the fixed maturity and preferred stock portfolio due to differences between current market rates and the stated rates for these investments. The following table summarizes our interest rate risk, based on the results of the sensitivity analysis at December 31, 2006 and 2005. The table also reflects the changes in market value and stockholders' equity that would be attributable to realized investment gains (losses) that we would recognize under the equity method of accounting with respect to the change in the net asset value of the mutual funds in which we own 20% or more of the shares outstanding. See "Critical Accounting Estimates--Investments and Other-than-Temporary Impairments."

Hypothetical Change in Interest Rates	Estimated Market Value of Fixed Maturity and Preferred Stock Investments	Estimated Increase (Decrease) in Market Value	Hypothetical Percentage Increase (Decrease) in Stockholders' Equity ⁽¹⁾


December 31, 2006:
200 basis point increase	$2,200,033	$(399,295)	(17.3)%
100 basis point increase	2,391,809	(207,519)	(9.0)%
No change	2,599,328	-	-
100 basis point decrease	2,771,057	171,729	7.4%
200 basis point decrease	3,020,565	421,237	18.2%

December 31, 2005:
200 basis point increase	2,138,966	(283,888)	(14.1)%
100 basis point increase	2,285,278	(137,576)	(6.9)%
No change	2,422,854	-	-
100 basis point decrease	2,548,494	125,640	6.3%
200 basis point decrease	2,684,096	261,242	13.0%

(1) Net of income taxes at an assumed rate of 35%.

Our fixed maturity portfolio's weighted average duration (which includes all fixed maturities and preferred stocks) as of December 31, 2006 and 2005 was 5.4 years and 4.9 years, respectively. The "duration" of a security is the time-weighted present value of the security's expected cash flows and is used to measure a security's price sensitivity to changes in interest rates. The duration reflects industry prepayment assumptions. The analytic systems we used to calculate the above duration data utilize optional call dates and sinking fund requirements and assume a non-static prepayment pattern in deriving these averages.

The preceding sensitivity analysis does not represent a forecast and should not be relied upon as being indicative of expected results. These hypothetical estimates are based upon numerous assumptions such as the nature and timing of interest rate levels including the yield curve shape, prepayments on loans and securities, reinvestment and replacement of asset and liability cash flows and other assumptions. While assumptions are developed based upon current economic conditions, we cannot provide any assurance as to the predictive nature of these assumptions. Also, as market conditions vary from those assumed in the sensitivity analysis, actual results will also differ due to prepayment and refinancing levels likely deviating from those assumed and other internal and external variables. Furthermore, the sensitivity analysis does not reflect actions that management might take in responding to or anticipating changes in interest rates.

Equity Price Risk. The equity price risk is defined as a hypothetical change of plus-or-minus 10% in the carrying value of common stocks. This total includes common stocks at market value and those closed-end preferred stock mutual funds carried at equity value. The following table summarizes our equity price risk, based on the results of the sensitivity analysis at December 31, 2006 and 2005:

<PAGE> 59

Hypothetical Change in Market Price	Carrying Value of Common Equity Investments	Increase (Decrease) in Carrying Value	Hypothetical Percentage Increase (Decrease) in Stockholders' Equity ⁽¹⁾


December 31, 2006:
20% price increase	$301,687	$ 50,281	2.2 %
10% price increase	276,547	25,141	1.1 %
No change	251,406	-	-
10% price decrease	226,265	(25,141)	(1.1)%
20% price decrease	201,125	(50,281)	(2.2)%

December 31, 2005:
20% price increase	238,411	39,735	2.0%
10% price increase	218,544	19,868	1.0%
No change	198,676	-	-
10% price decrease	178,808	(19,868)	(1.0)%
20% price decrease	158,941	(39,735)	(2.0)%

(1) Net of income taxes at an assumed rate of 35%.

Effects of Inflation and Recession

We generally are unable to recover the costs of inflation in our personal automobile insurance line since the premiums charged for personal automobile insurance in Massachusetts, our principal business segment, are subject to state regulation. Additionally, the premium rates that we charge for personal automobile insurance in Massachusetts are adjusted by the Commissioner generally at annual intervals. Such annual adjustments in premium rates may lag behind related cost increases. Economic recessions can have an impact upon us, primarily through the policyholder's election to decrease non-compulsory coverages afforded by the policy and decreased driving, each of which tends to decrease claims.

To the extent inflation and economic recession influence yields on investments, we are also affected. As each of these environments affect current market rates of return, previously committed investments may rise or decline in value depending on the type and maturity of investment.

Inflation and recession must also be considered by us in the creation and review of loss and LAE reserves since portions of these reserves are expected to be paid over extended periods of time. The anticipated effect of economic conditions is implicitly considered when estimating liabilities for losses and LAE. The importance of continually adjusting reserves is even more pronounced in periods of changing economic circumstances.

Forward-Looking Statements

This annual report and Form 10-K may contain statements that are not historical fact and constitute "forward-looking statements" within the meaning of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act. Statements about our expectations, beliefs, plans, objectives, assumptions or future events or performance are not historical facts and may be forward-looking. These statements are often, but not always, made through the use of words or phrases such as "anticipates," "estimates," "plans," "projects," "continuing," "ongoing," "expects," "may," "will," "could," "likely," "should," "management believes," "we believe," "we intend," and similar words or phrases. These statements may address, among other things, our strategy for growth, business development, regulatory approvals, market position, expenditures, financial results and reserves. Accordingly, these statements involve estimates, assumptions and uncertainties that could cause actual results to differ materially from those expressed in them. All forward-looking statements are qualified in their entirety by reference to the factors discussed throughout this annual report on Form 10-K and in our Forms 10-Q and other documents filed with the SEC. Among the key factors that could cause actual results to differ materially from forward-looking statements:

	*	the possibility of severe weather, terrorism and other adverse catastrophic experiences;

	*	adverse trends in claim severity or frequency and uncertainties in estimating property and casualty losses;

	*	adverse state and federal regulations and legislation;

	*	adverse judicial decisions;

<PAGE> 60

	*	adverse changes to the laws, regulations and rules governing the residual market system in Massachusetts;

	*	fluctuations in interest rates and the performance of the financial markets in relation to the composition of our investment portfolio;

	*	premium rate making decisions for private passenger automobile policies in Massachusetts;

	*	potential rate filings;

	*	heightened competition;

	*	our concentration of business within Massachusetts and within the personal automobile line of business;

	*	market disruption in Massachusetts, if competitors exit the market or become insolvent;

	*	the cost and availability of reinsurance;

	*	our ability to collect on reinsurance and the solvency of our reinsurers;

	*	the effectiveness of our reinsurance strategies;

	*	telecommunication and information system problems, including failures to implement information technology projects timely and within budget;

	*	our ability to maintain favorable ratings from rating agencies, including A.M. Best, S&P and Moody's;

	*	our ability to attract and retain independent agents;

	*	our ability to retain our affinity relationships with AAA clubs, especially in Massachusetts;

	*	our dependence on a key third party service vendor in Massachusetts;

	*	our dependence on our executive officers; and

	*	the economic, market or regulatory conditions and risks associated with entry into new markets and diversification.

You should not place undue reliance on any forward-looking statement. The risk factors referred to above, as well as those elsewhere in this Annual Report on Form 10-K, could cause actual results or outcomes to differ materially from those expressed in any forward-looking statement made by us or on our behalf (see Part I, Item 1, "Risks Related to Our Business" of this Form 10-K). Further, any forward-looking statement speaks only as of the date on which it is made, and we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events. New factors emerge from time to time, and it is not possible for us to predict which factors will arise. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.

ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK

For the information required by this Item, please refer to "Part II, Item 7, Market Risk: Interest Rate Sensitivity and Equity Price Risk" section (MD&A).

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

REPORT OF MANAGEMENT

Our management is responsible for the consolidated financial statements and all other information presented in this Annual Report on Form 10-K. The financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America determined by management to be appropriate in the circumstances and

<PAGE> 61

include amounts based on management's informed estimates and judgments. Financial information presented elsewhere in this Annual Report on Form 10-K is consistent with the financial statements.

Management's Report on Internal Control Over Financial Reporting

Management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Securities and Exchange Act of 1934. Management assessed the effectiveness of the Company's internal control over financial reporting as of December 31, 2006. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control - Integrated Framework. Based on this assessment, management concluded the Company maintained effective internal control over financial reporting as of December 31, 2006.

Our management's assessment of the effectiveness of the Company's internal control over financial reporting as of December 31, 2006 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears herein.

<PAGE> 62

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Shareholders of
The Commerce Group, Inc.:

We have completed integrated audits of The Commerce Group Inc.'s consolidated financial statements and of its internal control over financial reporting as of December 31, 2006, 2005 and 2004, in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below.

Consolidated financial statements and financial statement schedules

In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)(1) present fairly, in all material respects, the financial position of The Commerce Group, Inc. and its subsidiaries at December 31, 2006 and December 31, 2005, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2006 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the index under Item 15(a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

Internal control over financial reporting

Also, in our opinion, management's assessment, included in Management's Report on Internal Control Over Financial Reporting appearing under Item 8, that the Company maintained effective internal control over financial reporting as of December 31, 2006 based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control - Integrated Framework issued by the COSO. The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management's assessment and on the effectiveness of the Company's internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.

A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.

<PAGE> 63

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

/s/ PricewaterhouseCoopers LLP

Boston, MA
February 27, 2007

<PAGE> 64

THE COMMERCE GROUP, INC. AND SUBSIDIARIES Consolidated Balance Sheets December 31,

ASSETS

(Thousands of Dollars)	2006	2005

Investments and cash (Note C):
Fixed maturities, at market (amortized cost: $1,961,080 and $2,037,127)	$1,993,106	$2,029,173
Preferred stocks, at market (cost: $597,366 and $395,099)	606,222	393,681
Common stocks, at market (cost: $97,776 and $103,472)	109,752	102,344
Preferred stock mutual funds, at equity (cost: $120,990 and $88,859)	141,654	96,332
Mortgage loans on real estate and collateral notes receivable (less allowance for possible loan losses of $58 and $55)	19,417	17,746
Short term investments	13,414	-
Cash and cash equivalents	141,367	97,942
Other investments (cost: $43,001 and $28,976)	45,910	28,111

Total investments and cash	3,070,842	2,765,329
Accrued investment income	23,094	22,267
Premiums receivable (less allowance for doubtful receivables of $2,454 and $2,254)	480,605	475,112
Deferred policy acquisition costs (Note D)	177,852	174,415
Property and equipment, net of accumulated depreciation (Note E)	68,383	61,625
Residual market receivable (Note M)	157,227	191,309
Due from reinsurers (Note M)	53,679	142,923
Deferred income taxes (Note K)	31,420	68,926
Current income taxes	7,796	-
Other assets	39,971	25,104

Total assets	$4,110,869	$3,927,010


LIABILITIES AND STOCKHOLDERS' EQUITY

Liabilities:
Unpaid losses and loss adjustment expenses (Note F)	$ 971,949	$ 989,196
Unearned premiums (Note J)	935,385	933,160
Bonds payable ($300,000 face less discounts of $1,411 and $1,612) (Note G)	298,589	298,388
Current income taxes (Note K)	-	9,601
Deferred income (Note M)	10,913	8,757
Accrued agents' profit sharing (Note H)	232,440	187,760
Other liabilities and accrued expenses	151,363	189,122

Total liabilities	2,600,639	2,615,984

Minority interest (Note A)	6,959	5,957

Commitments and contingencies (Notes H and R)	-	-
Stockholders' equity (Note I):
Preferred stock, authorized 5,000,000 shares at $1.00 par value; none issued	-	-
Common stock, authorized 100,000,000 shares at $0.50 par value; 81,927,916 and 81,831,546 shares issued	40,964	20,458
Paid-in capital	135,033	148,130
Net accumulated other comprehensive income (loss), net of income taxes (benefits) of $18,455 and $(3,649)	34,273	(6,810)
Retained earnings	1,539,056	1,363,507

Total stockholders' equity before treasury stock	1,749,326	1,525,285
Treasury stock, 15,200,437 and 14,525,142 shares, at cost	(246,055)	(220,216)

Total stockholders' equity	1,503,271	1,305,069

Total liabilities, minority interest and stockholders' equity	$4,110,869	$3,927,010

The accompanying notes are an integral part of these consolidated financial statements.

<PAGE> 65

THE COMMERCE GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Earnings
For the years ended December 31,

(Thousands of Dollars, Expect Per Share Data)	2006	2005	2004

Revenues:
Earned premiums (Note J)	$1,760,700	$1,709,924	$1,638,833
Net investment income (Note C)	143,563	123,211	115,711
Premium finance and service fees	28,563	28,339	28,399
Net realized investment gains (Note C)	16,643	22,907	23,628

Total revenues	1,949,469	1,884,381	1,806,571

Expenses:
Losses and loss adjustment expenses (Notes F and M)	1,068,414	1,050,186	1,044,840
Policy acquisition costs (Note D)	516,307	463,297	439,232
Interest expense and amortization of bond fees (Note G)	18,328	18,293	18,313

Total expenses	1,603,049	1,531,776	1,502,385

Earnings before income taxes and minority interest	346,420	352,605	304,186
Income taxes (Note K)	103,994	107,768	89,003

Earnings before minority interest	242,426	244,837	215,183
Minority interest in net earnings of subsidiary (Note A)	(891)	(925)	(752)

Net earnings	$ 241,535	$ 243,912	$ 214,431


Net earnings per common share (Note I):
Basic	$ 3.57	$ 3.63	$ 3.27

Diluted	$ 3.55	$ 3.60	$ 3.25


Cash dividends paid per share	$ 0.975	$ 0.735	$ 0.655

Weighted average number of common shares outstanding:
Basic	67,630,367	67,171,716	65,604,046

Diluted	68,012,769	67,695,330	65,905,428

The accompanying notes are an integral part of these consolidated financial statements.

<PAGE> 66

THE COMMERCE GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
For the years ended December 31,

	Common Stock

(Thousands of Dollars Except Per Share Data)	Shares Outstanding⁽³⁾	Par Value Amount	Paid-in Capital	Net Accumulated Other Comprehensive Income (Loss)		Retained Earnings		Treasury Stock	Total

Balance - January 1, 2004	64,121,400	$19,315	$ 52,090	$ 29,083		$ 997,610		$(185,887)	$ 912,211
Comprehensive income (loss)				(12,680)	(2)	214,431	(1)		201,751
Cash dividends declared on common stock ($0.655 per share)						(43,032)			(43,032)
Options exercised (6,494,826 options)	4,198,102	1,049	82,853						83,902
Treasury stock purchased	(1,674,004)							(38,676)	(38,676)

Balance - December 31, 2004	66,645,498	20,364	134,943	16,403		1,169,009		(224,563)	1,116,156
Comprehensive income (loss)				(23,213)	(2)	243,912	(1)		220,699
Cash dividends declared on common stock ($0.735 per share)						(49,414)			(49,414)
Options exercised (694,352 options)	374,116	94	7,884						7,978
Treasury stock reissued	286,790		5,303					4,347	9,650

Balance - December 31, 2005	67,306,404	20,458	148,130	(6,810)		1,363,507		(220,216)	1,305,069
Comprehensive income				41,083	(2)	241,535	(1)		282,618
Cash dividends declared on common stock ($0.975 per share)						(65,986)			(65,986)
Stock split (2-for-1)		20,458	(20,458)						-
Options exercised (317,492 options)	96,370	48	2,800						2,848
Treasury stock purchased	(1,058,289)							(31,646)	(31,646)
Treasury stock reissued	382,994		4,561					5,807	10,368

Balance - December 31, 2006	66,727,479	$40,964	$135,033	$ 34,273		$1,539,056		$(246,055)	$1,503,271

(1)	Net earnings for the year.
(2)	Net other comprehensive income (loss) for the year. See Note I of Notes to Consolidated Financial Statements.
(3)	Retroactively adjusted for the June 2006 2-for-1 stock split.

The accompanying notes are an integral part of these consolidated financial statements

<PAGE> 67

THE COMMERCE GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the years ended December 31,

(Thousands of Dollars)	2006	2005	2004

Operating activities:
Premiums collected	$1,801,749	$1,709,573	$1,678,313
Net investment income received	141,994	121,279	110,643
Premium finance and service fees received	28,563	28,339	28,399
Losses and loss adjustment expenses paid	(1,030,160)	(1,031,567)	(996,493)
Policy acquisition costs paid	(474,457)	(381,923)	(375,757)
Federal income taxes	(105,988)	(116,354)	(102,756)
Interest paid	(17,850)	(17,850)	(17,850)

Cash from operating activities	343,851	311,497	324,499

Investing activities:
Investment sales, repayments and maturities	2,228,632	2,036,214	2,120,964
Investment purchases	(2,402,930)	(2,412,949)	(2,418,402)
Net activity of short-term investments	(13,414)	-	-
Mortgage loans and collateral notes receipts	3,768	3,984	4,087
Mortgage loans and collateral notes originated	(5,442)	(6,978)	(2,319)
Property and equipment purchases	(15,092)	(15,064)	(6,540)
Other investing activities	1,992	4,300	4,161

Cash for investing activities	(202,486)	(390,493)	(298,049)

Financing activities:
Dividends paid to stockholders	(65,986)	(49,414)	(43,032)
Common stock purchases	(31,646)	-	-
Common stock issued	130	2,437	22,606
Bond issue costs	-	-	(454)
Outstanding checks payable	(438)	2,927	(123)

Cash for financing activities	(97,940)	(44,050)	(21,003)

Increase (decrease) in cash and cash equivalents	43,425	(123,046)	5,447
Cash and cash equivalents at beginning of year	97,942	220,988	215,541

Cash and cash equivalents at end of year	$ 141,367	$ 97,942	$ 220,988


Reconciliation of net earnings to cash from operating activities:
Net earnings	$ 241,535	$ 243,912	$ 214,431
Adjustments to reconcile net earnings to cash from operating activities:
Premiums receivable	(5,493)	(15,404)	(47,746)
Deferred policy acquisition costs	(3,437)	(10,770)	(10,040)
Residual market receivable	34,082	2,309	(874)
Due from reinsurers	89,244	(9,595)	(15,542)
Unpaid losses and loss adjustment expenses	(17,247)	(1,064)	32,907
Unearned premiums	2,225	30,594	92,104
Current income taxes	(17,397)	4,486	(9,976)
Deferred income taxes	15,334	(13,013)	(3,295)
Deferred income	2,156	(1,149)	1,960
Accrued agents' profit sharing	44,680	78,328	71,545
Net realized investment gains	(16,643)	(22,907)	(23,628)
Other assets and other liabilities	(44,169)	15,191	22,620
Other - net	18,981	10,579	33

Cash from operating activities	$ 343,851	$ 311,497	$ 324,499

The accompanying notes are an integral part of these consolidated financial statements.

<PAGE> 68

THE COMMERCE GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Thousands of Dollars, Except for Per Share Data)

Note A - Organization and Basis of Presentation

We provide personal and commercial property and casualty insurance in Massachusetts and, to a lesser extent, in other states. In addition, we originate and service residential and commercial mortgages in Massachusetts and Connecticut. Our primary business is property and casualty insurance in Massachusetts.

Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). Our consolidated financial statements include the accounts of The Commerce Group, Inc. and its subsidiaries, Bay Finance Company, Inc., Clark-Prout Insurance Agency, Inc. and Commerce Holdings, Inc. (CHI). The Commerce Insurance Company (Commerce), Commerce West Insurance Company (Commerce West) and Citation Insurance Company (Citation) are wholly-owned subsidiaries of CHI. American Commerce Insurance Company (American Commerce) is a wholly-owned subsidiary of ACIC Holding Co., Inc. (AHC). AHC is owned jointly with AAA Southern New England (AAA SNE) with CHI maintaining a 95% common stock interest and AAA SNE maintaining a 5% common stock interest. All inter-company transactions and balances have been eliminated in consolidation. Certain prior year account balances have been reclassified to conform to the 2006 presentations.

The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

On May 19, 2006, the Board of Directors approved a two-for-one stock split of our $0.50 par value common stock, effective June 9, 2006. As a result of the split, 40,915,773 additional shares were issued, and paid-in capital was reduced by $20,458. All references in the accompanying financial statements and notes to the number of shares and per-share amounts for prior years have been restated to reflect the stock split.

Note B - Pro Forma Net Earnings

Pro forma net earnings and earnings per share as if we had applied the fair value method of accounting for our stock-based compensation plans accounted for under the intrinsic value method for the years ended December 31 follow:

	2006	2005	2004


Net earnings, as reported	$241,535	$243,912	$214,431
Deduct: Stock-based employee compensation expense determined under fair value method for awards granted in 2001, net of taxes	-	-	452

Pro forma net earnings under fair value accounting	$241,535	$243,912	$213,979

Basic earnings per share:
As reported	$ 3.57	$ 3.63	$ 3.27

Pro forma	$ 3.57	$ 3.63	$ 3.26

Diluted earnings per share:
As reported	$ 3.55	$ 3.60	$ 3.25

Pro forma	$ 3.55	$ 3.60	$ 3.25

All stock option based awards accounted for under the intrinsic value method were earned as of the first quarter of 2004; therefore, no additional expense was required after that date.

Note C - Investments

All investment transactions have credit exposure to the extent that a counter party may default on an obligation. Credit risk is a consequence of carrying investment positions. We manage credit risk by focusing on higher quality fixed-income securities and preferred stocks, reviewing the credit strength of all companies in which we invest, limiting our exposure in any one investment category and monitoring the portfolio quality, taking into account credit ratings assigned by recognized statistical rating organizations.

<PAGE> 69

Carrying values of investments in fixed maturities, which include taxable and non-taxable bonds and investments in common and preferred stocks, are derived from market prices supplied by our investment custodian, or in the few cases where no price is provided by the custodian, we obtain a third party valuation.

We account for venture capital fund investments, which are included in other investments on the consolidated balance sheet, on the equity method. The operating results of these venture capital fund investments have been reflected in realized gains and losses.

All of our investments in fixed maturity and equity securities at December 31, 2006 and 2005 were classified as available-for-sale. Realized gains and losses on available-for-sale securities were determined by using the specific identification method. We have not invested more than 5% of fixed maturities in any one state or political subdivision.

Cash and Cash Equivalents

Cash equivalents include short-term, liquid investments that are readily convertible to known amounts of cash and so near their maturity that they present insignificant risk of changes in value because of changes in interest rates.

The cash and cash equivalent balances at December 31, 2006 and 2005 are grossed up by $41,845 and $42,283, respectively, which represents outstanding checks for which there was no right of offset. These amounts are included in other liabilities and accrued expenses for the respective years.

Short-term Investments

Short-term investments represent investments with a maturity at purchase date of less than one year but more than 90 days. Short-term investments are carried at amortized cost which approximates market value.

Fixed Maturity Securities

Fair market value and amortized cost of our fixed maturity securities at December 31 follow:

	2006		2005

	Fair Market Value	Amortized Cost	Fair Market Value	Amortized Cost


U.S. government and agency	$ 235,599	$ 236,093	$ 273,820	$ 276,386
State and political subdivision	852,941	825,740	732,617	725,556
Corporate	415,799	413,296	550,654	558,191
Mortgage-backed	488,767	485,951	472,082	476,994

Total fixed maturity securities	$1,993,106	$1,961,080	$2,029,173	$2,037,127

The fair market value and amortized cost of fixed maturities, by contractual maturity, at December 31 follow:

	2006		2005

	Fair Market Value	Amortized Cost	Fair Market Value	Amortized Cost


Due in one year or less	$ 35,993	$ 36,095	$ 19,521	$ 19,719
Due after one year through five years	219,485	219,635	394,358	400,456
Due after five years through ten years	299,280	299,981	275,194	278,937
Due after ten years	949,581	919,418	868,018	861,021

	1,504,339	1,475,129	1,557,091	1,560,133
Mortgage-backed	488,767	485,951	472,082	476,994

Total fixed maturities	$1,993,106	$1,961,080	$2,029,173	$2,037,127

Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations. The carrying value of fixed maturities on deposit for state regulating authorities at December 31, 2006 was $7,992.

<PAGE> 70

In February 2006, the FASB issued Statement No. 155, Accounting for Certain Hybrid Financial Instruments - an amendment of FASB Statements No. 133 and 140. The Statement permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation. The new Statement also requires companies to identify interests in securitized financial assets that are freestanding derivatives or contain embedded derivatives that would have to be accounted for separately and that interest-only and principal-only strips are not subject to Statement No. 133. This new Statement is effective for fiscal years beginning after September 15, 2006 with early adoption permitted. Although we do not currently have any financial instruments subject to this new Statement, we elected to adopt this Statement effective January 1, 2006 and it had no impact on our financial statements.

Closed-end Preferred Stock Mutual Funds

We record our equity in the change in net assets of closed-end preferred stock mutual funds for which our ownership is greater than 20% as a component of realized gains and losses. These investments are valued at original cost plus the cumulative undistributed equity in earnings and losses of the fund.

Our closed-end preferred stock mutual fund holdings at December 31, 2006 and 2005 accounted for under the equity method follow:

	Fund Shares Held	% of Ownership	Carrying Value at Equity	Cost	Quoted Market Value


December 31, 2006
PDT⁽¹⁾	6,803,200	45.2%	$ 88,986	$ 74,588	$ 78,033
PGD⁽¹⁾	2,118,000	25.4%	31,219	26,556	27,830
PPF⁽¹⁾	1,499,900	20.7%	21,449	19,846	19,754

			$141,654	$120,990	$125,617

December 31, 2005
PDT⁽¹⁾	6,075,000	40.4%	$ 72,232	$ 66,553	$ 61,661
PGD⁽¹⁾	1,768,200	21.2%	24,100	22,306	21,219

			$ 96,332	$ 88,859	$ 82,880

(1)

John Hancock Patriot Premium Dividend II Fund (PDT), John Hancock Patriot Global Dividend Fund (PGD) and John Hancock Patriot Preferred Dividend Fund (PPF). The quoted market values of these investments are less than carrying value at year end 2006 and 2005. The carrying value is the net asset value of the underlying securities, which would be the value we would receive if the fund liquidates. We intend to hold these investments to recovery.

Mortgage Loans on Real Estate and Collateral Notes Receivable

We originate and hold real estate mortgage loans on properties located in Massachusetts and Connecticut. Mortgage loans are collateralized by the related real estate. Agency loans are generally collateralized by the assets of the agency. We control credit risk through credit approvals, credit limits and monitoring procedures. We perform in-depth credit evaluations on all new mortgage customers. We have not incurred any bad debt expense on mortgage loans during the three years ended 2006.

Our exposure is generally 80% or less of the appraised value of any collateralized real property at the time of the loan origination. The ability and willingness of residential and commercial borrowers to honor their repayment commitments is generally dependent upon the level of overall economic activity and real estate values. During the three years ended 2006, we did not acquire any property through foreclosure of mortgages.

Mortgage loans on real estate and collateral notes receivable are stated at the amount of unpaid principal, less an allowance for possible loan losses. The adequacy of the allowance for possible loan losses is evaluated on a regular basis. Loan losses are charged against the allowance when management believes the collectibility of the principal is unlikely and recoveries are credited to the allowance when received.

Interest on mortgage loans is included in income as earned based upon rates applied to principal amounts outstanding. Accrual of interest on mortgage loans is discontinued either when reasonable doubt exists as to the full, timely collection of interest or principal, or when a loan becomes contractually past due more than 90 days. When a loan is placed on non-accrual status, all unpaid interest previously accrued is reversed against current period earnings. Interest on loans in a non-accrual status is recognized as received.

<PAGE> 71

Mortgage loans on real estate and collateral notes receivable at December 31 follows:

	2006	2005


Residential (1^st Mortgages)	$13,769	$10,995
Residential (2^nd Mortgages)	100	106
Commercial (1^st Mortgages)	4,851	4,888

	18,720	15,989
Collateral notes receivable	755	1,812

	19,475	17,801
Allowance for possible loan losses	(58)	(55)

Mortgage loans on real estate and collateral notes receivable	$19,417	$17,746

Fair value of our mortgage loans on real estate and collateral notes receivable is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit and for the same remaining maturities. The future cash flows associated with certain non-performing loans are estimated based on expected payments from borrowers either through work out arrangements or the disposition of collateral. The estimated fair value of mortgage loans on real estate and collateral notes receivable at December 31, 2006 and 2005, prior to the allowance for possible loan losses, was $20,176 and $19,029, respectively.

At December 31, 2006 and 2005, mortgage loans on non-accrual status totaled $69 and $149, respectively. Allowances of $10 and $13 were established in 2006 and 2005, respectively, for these non-accrual status loans. The reduction in interest income associated with non-accrual loans was $8, $8 and $15 for the years ended December 31, 2006, 2005 and 2004, respectively.

Changes in the allowance for possible loan losses for the years ended December 31 follows:

	2006	2005	2004


Balance, beginning of year	$55	$ 372	$379
Provision for possible loan losses	3	(317)	(7)

Balance, end of year	$58	$ 55	$372

Mortgage principal and collateral notes receivable balances at December 31 follow:

	2006	2005


Fixed rate mortgages and collateral notes maturing:
One year or less	$ 25	$ 18
More than one year to five years	342	810
More than five years to ten years	554	679
Over ten years	12,250	9,750

Total fixed mortgages	13,171	11,257

Adjustable rate mortgages and collateral notes maturing:
One year or less	-	2
More than one year to five years	694	723
More than five years to ten years	255	435
Over ten years	5,355	5,384

Total adjustable mortgages	6,304	6,544

Total mortgages and collateral notes receivable	$19,475	$17,801

<PAGE> 72

Net Investment Income

The components of net investment income for the years ended December 31 follow:

	2006	2005	2004


Interest on fixed maturities	$102,465	$ 87,409	$ 82,052
Dividends on common and preferred stocks	30,247	26,387	25,278
Dividends on preferred stock mutual funds	8,189	8,187	8,342
Interest on short-term investments, cash and cash equivalents	4,261	2,511	1,510
Interest on mortgage loans	1,286	1,306	1,386
Other	128	512	126

Total investment income	146,576	126,312	118,694
Investment expenses	3,013	3,101	2,983

Net investment income	$143,563	$123,211	$115,711

There were no fixed maturity investments outstanding at December 31, 2006 which did not produce income during 2006.

Net Realized Investment Gains

Net realized investment gains for the years ended December 31 follow:

	2006	2005	2004


Transaction gains (losses):
Fixed maturity securities gains	$ 18,667	$ 31,652	$ 40,308
Fixed maturity securities losses	(19,610)	(10,517)	(27,575)
Equity securities gains	6,180	9,320	23,134
Equity securities losses	(7,036)	(4,856)	(4,049)
Venture capital fund gains	10,176	1,013	3,668
Venture capital fund losses	(761)	(176)	-
Other investments gains	61	740	8
Other investments losses	(19)	(113)	(213)

Net transaction gains	7,658	27,063	35,281

Impairment losses:
Fixed maturity securities	(2,368)	(305)	(14,189)
Equity securities	(1,839)	(4,547)	(760)

Total impairment losses	(4,207)	(4,852)	(14,949)

Equity in earnings of closed-end preferred stock mutual funds	13,192	696	3,296

Net realized investment gains included in net earnings	$ 16,643	$ 22,907	$ 23,628

Proceeds from investment sales, calls, maturities and paydowns for the years ended December 31 follow:

	2006	2005	2004


Sales:
Closed-end preferred stock mutual funds	$ -	$ 244	$ -
Equity securities	591,466	457,496	267,624
Fixed maturity securities	1,383,190	1,239,329	1,231,136

Total sales	1,974,656	1,697,069	1,498,760

Calls, maturities and paydowns:
Fixed maturity securities	210,575	282,581	581,246
Equity securities	32,178	46,533	38,895

Total calls, maturities and paydowns	242,753	329,114	620,141

Other:
Venture capital fund investments	11,223	10,031	2,063
Mortgage loans and collateral notes	3,768	3,984	4,087

Total other	14,991	14,015	6,150

Proceeds from sales, calls, maturities and paydowns	$2,232,400	$2,040,198	$2,125,051

<PAGE> 73

Unrealized Investment Gains (Losses)

Gross and net unrealized investment gains and losses, excluding minority interest, from fixed maturity and equity securities at December 31 follow:

	2006		2005

	Gains	Losses	Gains	Losses


Fixed maturity securities:
U.S. government and agency	$ 612	$(1,106)	$ 155	$ (2,721)
State and political subdivision	29,674	(2,473)	12,618	(5,557)
Corporate	5,559	(3,056)	1,634	(9,171)
Mortgage-backed	4,881	(2,065)	1,079	(5,991)

Fixed maturity securities unrealized gains (losses)	$40,726	$(8,700)	$ 15,486	$(23,440)

Equity securities unrealized gains (losses)	$22,109	$(1,277)	$ 5,029	$ (7,575)

Net unrealized gains (losses)	$52,858			$(10,500)

Net unrealized gains (losses) on available-for-sale investments, net of tax, is included in net accumulated other comprehensive income, a component of stockholders' equity.

We review all security holdings on a quarterly basis for potential other-than-temporary declines in market value in accordance with GAAP. In general, unrealized losses resulting from an increase in interest rates will not necessarily lead to an other-than-temporary impairment write-down. As part of this process, we consider any significant market declines in the context of the overall market and also in relation to the outlook for the specific issuer of the security and the issuer's industry. Each quarter, we review all securities whose market values have declined below book price. From a quantitative standpoint, we view all securities that have declined more than 20% below book price and have remained so for two quarters as potentially in need of a write-down. Any other security that we view as impaired for a significant period of time is also a candidate for a write-down, even if the percentage decline is less than 20%. In addition, we perform the following quarterly review of our portfolio:

	*	We review all holdings with an unrealized loss of over $250, or a fair market value that is more than 20% below cost.

	*	We review all holdings with unrealized losses over $100, or a fair market value that is more than 10% below cost, for securities at a continuous loss position period of 12 to 36 months.

	*	We review all securities that have been at a continuous loss position for 36 months or more.

	*	We review both issue specific data and general market data for all perpetual preferred stocks that have been at a continuous loss position for over 12 months.

	*	Generally, we consider all AAA/AA rated U.S. Government securities with market values less than cost as temporarily impaired due to our intent and ability to hold these securities to recovery.

	*	We consider market activity between our quarter-end date and earnings release date in our evaluation.

	*	We will consider other-than-temporary the impairment of any security which we do not intend to hold until maturity or full recovery.

If a security is deemed other-than-temporarily impaired, we adjust the security's cost basis to market value through realized loss based on publicly available prices or, in the absence of such information, on a price supplied by a broker.

<PAGE> 74

Gross unrealized losses on our fixed maturity and equity securities at December 31, 2006 by duration of unrealized loss and by credit quality (for fixed maturity securities) follow:

	Total	0 - 6 Months	7 - 12 Months	13 - 24 Months	Over 24 Months


Total equity and fixed maturity securities:
Number of positions	227	111	20	72	24

Total fair market value	$982,017	$579,355	$96,000	$246,591	$60,071
Total amortized cost	991,994	583,364	97,156	250,050	61,424

Unrealized loss	$ (9,977)	$ (4,009)	$ (1,156)	$ (3,459)	$(1,353)

Unrealized loss percentage to fair market value	1.0%	0.7%	1.2%	1.4%	2.3%


Equity securities:
Number of positions	35	28	3	4	-

Total fair market value	$165,340	$143,116	$ 5,607	$ 16,617	-
Total amortized cost	166,617	144,324	5,645	16,648	-

Unrealized loss	$ (1,277)	$ (1,208)	$ (38)	$ (31)	-

Unrealized loss percentage to fair market value	0.8%	0.8%	0.7%	0.2%	-


Total fixed maturity securities:
Number of positions	192	83	17	68	24

Total fair market value	$816,677	$436,239	$90,393	$229,974	$60,071
Total amortized cost	825,377	439,040	91,511	233,402	61,424

Unrealized loss	$ (8,700)	$ (2,801)	$ (1,118)	$ (3,428)	$(1,353)

Unrealized loss percentage to fair market value	1.1%	0.6%	1.2%	1.5%	2.3%


Investment grade fixed maturity securities:
Number of positions	187	78	17	68	24

Total fair market value	$778,469	$398,031	$90,393	$229,974	$60,071
Total amortized cost	787,019	400,682	91,511	233,402	61,424

Unrealized loss	$ (8,550)	$ (2,651)	$ (1,118)	$ (3,428)	$ (1,353)

Unrealized loss percentage to fair market value	1.1%	0.7%	1.2%	1.5%	2.3%


Below investment grade fixed maturity securities:
Number of positions	5	5	-	-	-

Total fair market value	$ 38,208	$ 38,208	-	-	-
Total amortized cost	38,358	38,358	-	-	-

Unrealized loss	$ (150)	$ (150)	-	-	-

Unrealized loss percentage to fair market value	0.4%	0.4%	-	-	-

Our unrealized losses from below investment grade fixed maturity securities at December 31, 2006 were from corporate securities with a credit quality of BB or were unrated.

We reviewed our investment holdings at December 31, 2006 and 2005 for other-than-temporary declines in market value, in accordance with our previously summarized accounting policy. Based on this analysis, we determined that the impairments represented in the above gross unrealized loss table are temporary. These temporary impairments are primarily due to interest rates and general market conditions. We have the intent and ability to hold to full recovery or maturity these temporarily impaired securities.

In November 2005, the FASB issued Staff Position (FSP) 115-1 and 124-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. This FSP addresses the determination as to when an investment is

<PAGE> 75

impaired, whether that impairment is other-than-temporary, and the measurement of an impairment loss. The guidance in this FSP was applied to reporting periods beginning January 1, 2006. The application of the provisions of this FSP has not had a material impact on our financial statements.

Gross unrealized losses on our equity and fixed maturity securities at December 31, 2005, by duration of unrealized loss and by credit quality (for fixed maturity securities), follow:

	Total	0 - 6 Months	7 - 12 Months	13 - 24 Months	Over 24 Months


Total equity and fixed maturity securities:
Number of positions	408	198	135	70	5

Total fair market value	$1,605,321	$846,546	$522,189	$230,542	$6,044
Total amortized cost	1,636,336	860,721	532,839	236,592	6,184

Unrealized loss	$ (31,015)	$ (14,175)	$ (10,650)	$ (6,050)	$ (140)

Unrealized loss percentage to fair market value	1.9%	1.7%	2.0%	2.6%	2.3%


Equity securities:
Number of positions	59	41	14	3	1

Total fair market value	$ 228,828	$182,722	$ 41,689	$ 3,568	$ 849
Total amortized cost	236,403	189,088	42,823	3,617	875

Unrealized loss	$ (7,575)	$ (6,366)	$ (1,134)	$ (49)	$ (26)

Unrealized loss percentage to fair market value	3.3%	3.5%	2.7%	1.4%	3.1%


Fixed maturity securities:
Number of positions	349	157	121	67	4

Total fair market value	$1,376,493	$663,824	$480,500	$226,974	$5,195
Total amortized cost	1,399,933	671,633	490,016	232,975	5,309

Unrealized loss	$ (23,440)	$ (7,809)	$ (9,516)	$ (6,001)	$ (114)

Unrealized loss percentage to fair market value	1.7%	1.2%	2.0%	2.6%	2.2%


Investment grade fixed maturity securities:
Number of positions	327	142	115	66	4

Total fair market value	$1,290,285	$599,150	$461,041	$224,899	$5,195
Total amortized cost	1,311,280	605,920	469,268	230,783	5,309

Unrealized loss	$ (20,995)	$ (6,770)	$ (8,227)	$ (5,884)	$ (114)

Unrealized loss percentage to fair market value	1.6%	1.1%	1.8%	2.6%	2.2%


Below investment grade fixed maturity securities:
Number of positions	22	15	6	1	-

Total fair market value	$ 86,208	$ 64,674	$ 19,459	$ 2,075	-
Total amortized cost	88,653	65,713	20,748	2,192	-

Unrealized loss	$ (2,445)	$ (1,039)	$ (1,289)	$ (117)	-

Unrealized loss percentage to fair market value	2.8%	1.6%	6.6%	5.6%	-

Note D - Deferred Policy Acquisition Costs

Policy acquisition costs are calculated by line of business as a percentage of unearned premiums by multiplying the sum of current commission rates plus current premium tax rates plus an estimate of the percentage of other underwriting expenses incurred at policy issuance. These costs are deferred and amortized over the period in which the related premiums are earned, the amount being reduced by any potential premium deficiency. If any potential premium deficiency exists, it represents future estimated losses, loss adjustment expenses and amortization of deferred acquisition costs in excess of the

<PAGE> 76

related unearned premiums. There was no premium deficiency in 2006, 2005 and 2004. In determining whether a premium deficiency exists, we consider anticipated investment income on the unearned premium reserve.

Policy acquisition costs incurred and amortized to income follow:

	2006	2005	2004


Balance, January 1	$174,415	$163,645	$153,605
Costs deferred during the year	519,744	474,067	449,272
Amortization charged to expense	(516,307)	(463,297)	(439,232)

Balance, December 31	$177,852	$174,415	$163,645

In September 2005, the AICPA issued a new accounting pronouncement, Statement of Position (SOP) 05-01, Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection with Modifications or Exchanges of Insurance Contracts. This SOP provides guidance on accounting for deferred acquisition costs on internal replacements of insurance and investment contracts other than those specifically described in Statement of Financial Accounting Standards (SFAS) No. 97. Internal replacements are modifications in product benefits, features, rights, or coverages that occur by the exchange of a contract for a new contract, or by amendment, endorsement, or rider to a contract, or by the election of a feature or coverage within a contract. The provisions of this SOP are effective for internal replacements occurring in fiscal years beginning after December 15, 2006. We will adopt this SOP during the first quarter of 2007. Financial statement application of this SOP is prospective and initial application would generally occur as of the beginning of the fiscal year. We believe the adoption of this SOP will not have a material impact on our future financial statements.

Note E - Property and Equipment

Our property and equipment at December 31 follows:

	2006	2005


Buildings	$ 57,709	$ 56,133
EDP equipment and copiers	35,997	34,247
Software	17,236	9,085
Equipment and office furniture	14,086	13,481
Automobiles	1,672	1,781
Building improvements and other	1,900	1,080

	128,600	115,807
Less accumulated depreciation/amortization	(65,869)	(59,473)

	62,731	56,334
Land	5,652	5,291

Property and equipment, net	$ 68,383	$ 61,625

Property and equipment are stated at cost and are depreciated on the straight-line method over the estimated useful lives of the assets using the following rates and lives:

	Percent Per Annum	Useful Life (Years)


Buildings	2.5	40
Building improvements (prior to 1992)	2.5	40
Building improvements (1992 and subsequent)	5.0	20
Equipment and office furniture	10.0	10
Copiers and miscellaneous office equipment	20.0	5
Automobiles	20.0	5
EDP equipment	33.3	3
Software	10.0 - 33.3	3 - 10

Maintenance and repairs are charged to operations; betterments are capitalized. The cost of property sold or otherwise disposed and the accumulated depreciation thereon is eliminated from the related property and accumulated depreciation accounts and any resulting gain or loss is credited or charged to income. We capitalize tangible property and equipment having an economic life of more than one year with a dollar value of $2.5 or greater.

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The cost of computer software developed or obtained for internal use in excess of $150 is capitalized. Amounts below the $150 threshold are expensed in the period the costs are incurred. Capitalized costs are generally amortized on a straight-line basis primarily over a ten-year period, unless another rational basis is more representative of the software's use.

Depreciation and amortization expense was $7,197, $6,091 and $5,975 for the years ended December 31, 2006, 2005 and 2004, respectively. Depreciation and amortization expense is allocated evenly between loss adjustment expenses and policy acquisition costs.

Note F - Unpaid Losses and Loss Adjustment Expenses (LAE)

The liability for unpaid losses and LAE represents our best estimate of the ultimate net cost of all losses and LAE incurred through the balance sheet date. This estimate includes the adjusted case estimates for losses, incurred but not reported losses, salvage and subrogation recoverable and a reserve for LAE. In arriving at our best estimate, we begin with the aggregate of individual case reserves and then make adjustments to these amounts on a line of business basis. These adjustments to the aggregate case reserves by line of business are made based on our analysis as further described below. The entire liability for unpaid losses and LAE is also independently reviewed quarterly and annually for reasonableness by our Actuarial Department. Liability estimates are continually analyzed and updated, and therefore, the ultimate liability may be more or less than the current estimate. The effects of changes in the estimates are included in the results of operations in the period in which the estimates are revised.

Significant time can elapse between the occurrence of an insured loss, the reporting of the loss to the insurer and the insurer's payment of that loss. We recognize liabilities for unpaid losses by establishing reserves as balance sheet liabilities representing estimates of amounts needed to pay reported and unreported losses and LAE. We review these reserves quarterly. Regulations of the Divisions of Insurance require us to obtain a certification annually from either a qualified actuary or an approved loss reserve specialist that our loss and LAE reserves are reasonable.

When a claim is reported to us, we establish a "case reserve" for the estimated amount of our ultimate exposure. The amount of the reserve is primarily based upon an evaluation of the type of claim involved, the circumstances surrounding the claim and the policy provisions relating to the loss. This estimate reflects our informed judgment based on general insurance reserving practices and on our experience and knowledge. During the loss adjustment period, these estimates are revised as deemed necessary based on subsequent developments and periodic reviews of the cases.

In accordance with industry practice, we also maintain reserves for estimated incurred but not reported (IBNR) and LAE net of salvage and subrogation recoverable. These reserves are determined based on historical information and experience. Adjustments to these reserves are made periodically to take into account changes in the volume of business written, claims frequency and severity, the mix of business, claims processing and other items that can be expected to affect our liability for losses and LAE.

When reviewing the liability for unpaid losses and LAE, we analyze historical data and estimate the impact o