UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
Quarterly Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the Quarter Ended Commission File Number
September 30, 1995 1-8233
USF&G CORPORATION
(Exact name of registrant as specified in its charter)
Maryland 52-1220567
(State of incorporation) (IRS employer identification no.)
100 Light Street, Baltimore, Maryland 21202
(Address of principal executive offices and zip code)
(410) 547-3000
(Registrant's telephone number, including area code)
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 twelve (12) months, and (2) has been subject to such filing
requirements for the past 90 days.
Yes x No
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
Common Stock, Par Value $2.50; 119,263,025 shares outstanding as of
November 13, 1995.
USF&G Corporation
Table of Contents
PART I. Financial Information
Item 1. Financial Statements:
Condensed Consolidated Statement of Financial Position 3
Condensed Consolidated Statement of Operations 4
Condensed Consolidated Statement of Cash Flows 6
Notes to Condensed Consolidated Financial Statements 8
Report of Independent Auditors 12
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 13
PART II. Other Information
Item 6. Exhibits and Reports on Form 8-K 25
Exhibit 11- Computation of Earnings Per Share 26
Exhibit 12- Computation of Ratio of Consolidated Earnings
to Fixed Charges and Preferred Stock Dividends 27
Exhibit 15- Letter Regarding Unaudited Interim Financial
Information 28
Signature 29
USF&G Corporation
Condensed Consolidated Statement of Financial Position
At September 30 At December 31
(dollars in millions except per share data) 1995 1994*
Assets
Investments:
Fixed maturities:
Held to maturity, at amortized cost
(market, 1995, $4,576; 1994, $4,284) $ 4,547 $ 4,659
Available for sale, at market (cost, 1995,
$4,581; 1994, $4,265) 4,658 4,081
Common stocks, at market (cost, 1995, $41;
1994, $53) 37 46
Preferred stocks, at market (cost, 1995,
$27; 1994, $26) 27 26
Short-term investments 399 450
Mortgage loans 160 349
Real estate 654 662
Other invested assets 439 288
Total investments 10,921 10,561
Cash 97 69
Accounts, notes, and other receivables 735 741
Reinsurance receivables 757 554
Servicing carrier receivables 699 706
Deferred policy acquisition costs 475 504
Other assets 876 845
Total assets $14,560 $13,980
Liabilities
Unpaid losses, loss expenses, and policy benefits $ 9,842 $ 9,962
Unearned premiums 1,051 968
Corporate debt 603 586
Real estate and other debt 20 42
Other liabilities 1,288 981
Total liabilities 12,804 12,539
Shareholders' Equity
Preferred stock, par value $50.00 (12,000,000
shares authorized; shares issued, 1995, 5,110,110;
1994, 6,627,896) 256 331
Common stock, par value $2.50 (240,000,000 shares
authorized; shares issued, 1995, 112,357,823; 1994,
104,810,794) 281 262
Paid-in capital 1,161 1,104
Net unrealized gains (losses) on investments
and foreign currency 63 (147)
Minimum pension liability (63) (63)
Retained earnings (deficit) 58 (46)
Total shareholders' equity 1,756 1,441
Total liabilities and shareholders' equity $14,560 $13,980
See Notes to Condensed Consolidated Financial Statements.
* 1994 amounts have been restated to reflect mergers with Discover Re Managers,
Inc., and Victoria Financial Corporation. See Note 12.
USF&G Corporation
Condensed Consolidated Statement of Operations (Unaudited)
Three Months Ended September 30
(dollars in millions except per share data) 1995 1994*
Revenues
Premiums earned $ 692 $ 634
Net investment income 179 187
Other 11 14
Revenues before realized gains 882 835
Net realized gains on investments 3 -
Total revenues 885 835
Expenses
Losses, loss expenses, and policy benefits 551 518
Underwriting, acquisition, and operating expenses 272 268
Interest expense 12 10
Facilities exit costs (income) - -
Total expenses 835 796
Income from operations before income taxes 50 39
Provision for income taxes (benefit) 1 (36)
Net income $ 49 $ 75
Preferred stock dividend requirements 8 12
Net income available to common stock $ 41 $ 63
Primary Earnings Per Common Share $.37 $.67
Fully Diluted Earnings Per Common Share $.35 $.58
Weighted average common shares outstanding (000s):
Primary 111,541 94,792
Fully diluted 121,087 125,502
Dividends declared per common share $ .05 $ .05
See Notes to Condensed Consolidated Financial Statements.
* 1994 amounts have been restated to reflect mergers with Discover Re Managers,
Inc., and Victoria Financial Corporation. See Note 12.
USF&G Corporation
Condensed Consolidated Statement of Operations (Unaudited)
Nine Months Ended September 30
(dollars in millions except per share data) 1995 1994*
Revenues
Premiums earned $1,968 $1,828
Net investment income 546 564
Other 38 35
Revenues before realized gains 2,552 2,427
Net realized gains on investments 7 6
Total revenues 2,559 2,433
Expenses
Losses, loss expenses, and policy benefits 1,620 1,576
Underwriting, acquisition, and operating expenses 766 728
Interest expense 34 27
Facilities exit costs (income) (6) -
Total expenses 2,414 2,331
Income from operations before income taxes 145 102
Provision for income taxes (benefit) 1 (71)
Net income $ 144 $ 173
Preferred stock dividend requirements 23 36
Net income available to common stock $ 121 $ 137
Primary Earnings Per Common Share $ 1.10 $ 1.45
Fully Diluted Earnings Per Common Share $ 1.04 $ 1.33
Weighted average common shares outstanding (000s):
Primary 109,770 94,077
Fully diluted 130,662 123,230
Dividends declared per common share $ .15 $ .15
See Notes to Condensed Consolidated Financial Statements.
* 1994 amounts have been restated to reflect mergers with Discover Re Managers,
Inc., and Victoria Financial Corporation. See Note 12.
USF&G Corporation
Condensed Consolidated Statement of Cash Flows (Unaudited)
Three Months Ended September 30
(in millions) 1995 1994*
Operating Activities
Direct premiums collected $ 549 $ 528
Net investment income collected 174 177
Direct losses, loss expenses, and policy benefits
paid (412) (501)
Net reinsurance activity - 10
Underwriting and operating expenses paid (145) (201)
Interest paid (1) 18
Income taxes paid - (3)
Other items, net (6) 15
Net cash provided from operating activities 159 43
Investing Activities
Net sales and maturities of short-term investments (113) 82
Purchases of fixed maturities held to maturity - (33)
Sales of fixed maturities held to maturity 1 10
Maturities/repayments of fixed maturities held to
maturity 31 44
Purchases of fixed maturities available for sale (180) (101)
Sales of fixed maturities available for sale 107 20
Maturities/repayments of fixed maturities available
for sale 78 84
Purchases of equities and other investments (20) (50)
Sales, maturities, and repayments of equities and
other investments 17 37
Purchases of property and equipment (9) (10)
Disposals of property and equipment 1 -
Net cash provided from (used in) investing
activities (87) 83
Financing Activities
Deposits for universal life and investment
contracts 69 68
Withdrawals of universal life and investment
contracts (127) (193)
Net short-term borrowings (repayments) 1 2
Long-term borrowings - -
Repayments of long-term borrowings (1) (1)
Issuances of common stock 1 8
Redemptions of preferred stock - (10)
Cash dividends paid to shareholders (15) (17)
Net cash used in financing activities (72) (143)
Decrease in cash - (17)
Cash at beginning of period 97 85
Cash at end of period $ 97 $ 68
See Notes to Condensed Consolidated Financial Statements.
* 1994 amounts have been restated to reflect mergers with Discover Re Managers,
Inc., and Victoria Financial Corporation. See Note 12.
USF&G Corporation
Condensed Consolidated Statement of Cash Flows (Unaudited)
Nine Months Ended September 30
(in millions) 1995 1994*
Operating Activities
Direct premiums collected $ 1,554 $ 1,509
Net investment income collected 550 552
Direct losses, loss expenses, and policy
benefits paid (1,290) (1,428)
Net reinsurance activity 73 (5)
Underwriting and operating expenses paid (556) (602)
Interest paid (22) -
Income taxes paid (2) (8)
Other items, net 8 22
Net cash provided from operating activities 315 40
Investing Activities
Net (purchases)/sales and maturities of
short-term investments 37 65
Purchases of fixed maturities held to maturity - (384)
Sales of fixed maturities held to maturity 7 60
Maturities/repayments of fixed maturities held
to maturity 84 295
Purchases of fixed maturities available for sale (628) (259)
Sales of fixed maturities available for sale 239 220
Maturities/repayments of fixed maturities
available for sale 244 375
Purchases of equities and other investments (73) (303)
Sales, maturities, and repayments of equities and
other investments 160 282
Purchases of property and equipment (22) (25)
Disposals of property and equipment 1 4
Net cash provided from investing activities 49 330
Financing Activities
Deposits for universal life and investment
contracts 237 174
Withdrawals of universal life and investment
contracts (524) (459)
Net short-term borrowings (repayments) (226) (156)
Long-term borrowings 228 270
Repayments of long-term borrowings (15) (124)
Issuances of common stock 5 35
Redemptions of preferred stock - (10)
Cash dividends paid to shareholders (41) (50)
Net cash used in financing activities (336) (320)
Increase in cash 28 50
Cash at beginning of period 69 18
Cash at end of period $ 97 $ 68
See Notes to Condensed Consolidated Financial Statements.
* 1994 amounts have been restated to reflect mergers with Discover Re Managers,
Inc., and Victoria Financial Corporation. See Note 12.
USF&G Corporation
Notes to Condensed Consolidated Financial Statements
Note 1 Basis of Accounting
The condensed consolidated financial statements are prepared in accordance with
generally accepted accounting principles ("GAAP"). These statements include the
accounts of USF&G Corporation and its subsidiaries ("USF&G"). Intercompany
transactions are eliminated in consolidation. Certain 1994 amounts have been
reclassified to conform to the 1995 presentation. (See also Note 12 regarding
restatements for mergers consummated in the second quarter of 1995.) The
interim financial statements in this report should be read in conjunction with
the consolidated financial statements and notes thereto in USF&G's Annual Report
to Shareholders (Restated) for the year ended December 31, 1994. In the opinion
of management, the accompanying unaudited condensed consolidated financial
statements contain the necessary adjustments, all of which are of a normal
recurring nature for interim period reporting purposes, for a fair presentation
of results for the interim periods.
Note 2 Review of Independent Auditors
USF&G's independent auditors, Ernst & Young LLP, have performed a review of the
condensed consolidated financial statements in this Form 10-Q as to the three
and nine month periods ended September 30, 1995 and 1994. Their limited review
in accordance with standards established by the American Institute of Certified
Public Accountants did not constitute an audit. Accordingly, they do not
express an opinion on this information.
Note 3 Earnings Per Common Share
Primary earnings per common share are based on income, after deduction of
preferred stock dividends, and the weighted average number of common shares
outstanding during the periods. Common stock equivalents were not included as
they were insignificant. Fully diluted earnings per common share assume the
conversion of all securities whose contingent issuance would have a dilutive
effect on earnings. Refer to the computation in Exhibit 11.
Note 4 Ratio of Consolidated Earnings to Fixed Charges
For purposes of computing the ratio of consolidated earnings to fixed charges
and preferred stock dividends, earnings consist of income before considering
income taxes and fixed charges. Fixed charges consist of interest and that
portion of rents that is deemed to be an appropriate interest factor. Refer to
the computation in Exhibit 12.
Note 5 Supplemental Cash Flow Information
The Condensed Consolidated Statement of Cash Flows is presented using the
"direct method," which reports major classes of cash receipts and cash payments.
A reconciliation of net income to net cash provided from operating activities is
as follows:
Three Months Ended Nine Months Ended
September 30 September 30
(in millions) 1995 1994 1995 1994
Operating Activities
Net income $ 49 $ 75 $ 144 $ 173
Adjustments to reconcile net income to net
cash provided from operating activities:
Realized gains on investments (3) - (7) (6)
Change in insurance liabilities 119 (6) 246 55
Change in deferred policy acquisition costs 1 (13) 29 (56)
Change in receivables (130) 19 (193) (49)
Change in other liabilities 153 (1) 150 (78)
Change in other assets (15) (26) (27) (32)
Other items, net (15) (5) (27) 33
Net cash provided from
operating activities $ 159 $ 43 $ 315 $ 40
Note 6 Unrealized Gains (Losses) on Investments
At September 30, 1995, gross unrealized gains and gross unrealized losses
pertaining to equity securities totaled $2 million and $4 million, respectively.
In addition, gross unrealized gains and gross unrealized losses on limited
partnerships, foreign currency and other investments totaled $15 million and $6
million, respectively. At September 30, 1995, there were gross unrealized gains
of $109 million and gross unrealized losses of $32 million pertaining to fixed
maturities available for sale. There were also $21 million of gross unrealized
losses relating to a deferred policy acquisition cost ("DPAC") adjustment. This
DPAC adjustment was made to reflect assumptions about the effect of potential
asset sales of fixed maturities available for sale on future DPAC amortization.
The changes in net unrealized gains (losses) on investments and foreign currency
amount to a gain of $210 million during the nine months ended September 30,
1995, compared with a loss of $299 million during the nine months ended
September 30, 1994.
Note 7 Proceeds From Sales of Fixed Maturity Investments
During the nine month period ended September 30, 1995, proceeds from sales of
fixed maturities held to maturity were $7 million. These sales involved the
entire holdings of one issuer, and the partial holdings of two other issuers and
were based on evidence of significant deterioration of the issuers'
creditworthiness. Gross losses of $1 million were realized on these sales.
During the nine month period ended September 30, 1995, transfers from held to
maturity to available for sale totaled $26 million of amortized cost. These
transfers involved the remaining positions of the two aforementioned issuers,
and the entire holdings of another issuer and were also based on evidence of
significant deterioration of the issuers' creditworthiness. Gross unrealized
losses on these securities totaled $9 million at September 30, 1995. During the
nine month period ended September 30, 1994, proceeds from sales of fixed
maturities held to maturity were $60 million. Such sales involved the entire
holdings of 18 different issuers and were based on evidence of significant
deterioration of the issuers' creditworthiness. Gross gains of less than
$1 million and gross losses of $1 million were realized on these sales.
Proceeds from sales of fixed maturities available for sale were $239 million for
the nine months ended September 30, 1995, compared with $223 million for the
same period in 1994. Gross gains of $3 million and gross losses of $2 million
were realized on 1995 sales. Gross gains and gross losses of $2 million were
realized on 1994 sales.
Note 8 Facilities Exit Costs
During 1994, USF&G committed to a plan to consolidate its home office operations
in Baltimore, Maryland at its Mount Washington facility. Facilities exit costs
of $183 million were recorded in the fourth quarter of 1994, representing the
present value of the rent and other operating expenses to be incurred under the
lease on the Corporation's principal office building ("the Tower") from the time
USF&G vacates the building through the expiration of the lease in 2009.
Facilities exit costs recorded in 1994 did not consider any potential future
sublease income, as such income was neither probable nor reasonably estimable at
that time. To the extent that additional or extended subleases are subsequently
negotiated, the present value of income to be received over the term of those
subleases is recognizable in the period such income becomes probable and
reasonably estimable. Net income for the nine months ended September 30, 1995
includes $6 million of sublease income recognized as a result of USF&G's
renegotiation in the first quarter of 1995 of a sublease with a tenant. The
sublease covers two floors of the Tower already occupied by the tenant and
extends that occupancy through July 2009. No subleases were negotiated in the
second or third quarters of 1995.
Note 9 Legal Contingencies
USF&G's insurance subsidiaries are routinely engaged in litigation in the normal
course of their business, including defending claims for punitive damages. As a
liability insurer, they defend third-party claims brought against their
insureds. As an insurer, they defend themselves against coverage claims.
Additional information regarding contingencies that may arise from insurance
regulatory matters and regulatory litigation matters may be found in the
Regulation section of Management's Discussion and Analysis of Financial
Condition and Results of Operations, as well as in USF&G's Annual Report to
Shareholders (Restated) for the year ended December 31, 1994.
In the opinion of management, such litigation and the litigation described below
is not expected to have a material adverse effect on USF&G's consolidated
financial position, although it is possible that the results of operations in a
particular quarter or annual period would be materially affected by an
unfavorable outcome.
9.1. North Carolina workers' compensation litigation
On November 24, 1993, N.C. Steel, Inc. and six other North Carolina employers
filed a class action in the General Court of Justice, Superior Court Division,
Wake County, North Carolina against the National Council on Compensation
Insurance ("NCCI"), North Carolina Rate Bureau, USF&G and eleven other insurance
companies which served as servicing carriers for the North Carolina involuntary
workers' compensation market. On January 20, 1994, the plaintiffs filed an
amended complaint seeking to certify a class of all employers who purchased
workers' compensation insurance in the State of North Carolina after November
24, 1989. The amended complaint, which is captioned N.C. Steel, Inc., et al., v.
National Council on Compensation Insurance, et al ., alleges that the defendants
conspired to suppress competition with respect to the North Carolina voluntary
and involuntary workers' compensation business, thereby artificially inflating
the rates in such markets and the fees payable to the insurers. The complaint
also alleges that the carriers agreed to improperly deny qualified companies
from acting as servicing carriers, improperly encourage agents to place
employers in the assigned risk pool, and improperly promote inefficient claims
handling. USF&G has acted as a servicing carrier in North Carolina since 1990.
The plaintiffs are pursuing their claims under various legal theories, including
violations of the North Carolina antitrust laws, unlawful conspiracy, breach of
fiduciary duty, breach of implied covenant of good faith and fair dealing,
unfair competition, constructive fraud, and unfair and deceptive trade
practices. The plaintiffs seek unspecified compensatory damages, punitive
damages for the alleged constructive fraud and treble damages under the North
Carolina antitrust laws. On February 14, 1995, the trial court granted the
defendant's motion to dismiss the complaint. The plaintiffs have appealed the
trial court's dismissal of the case. USF&G believes that it has meritorious
defenses and has determined to defend the action vigorously.
9.2. South Carolina workers' compensation litigation
On August 22, 1994, the Attorney General of the State of South Carolina filed
suit in the County of Greenville, South Carolina on behalf of South Carolina
employers that have allegedly been damaged as a result of alleged unfair and
deceptive trade practices. Specifically, the Attorney General alleges that the
NCCI, the National Workers' Compensation Reinsurance Pool, USF&G and seven other
insurance companies which served as servicing carriers for the South Carolina
involuntary workers' compensation market, conspired to fix servicing carrier
fees at unreasonably high and noncompetitive levels in violation of the South
Carolina Uniform Trade Practices Act, allegedly causing inflated deficits in the
involuntary market and an excessive expansion of the residual market. The
Attorney General alleges that the conspiracy occurred for an unspecified period
of time prior to January 1994. The Attorney General has indicated that he
intends to pursue recovery on behalf of all South Carolina employers who have
suffered an ascertainable loss as a result of such alleged conduct, civil
penalties of $5,000 for each willful violation, and temporary and permanent
injunctive relief. USF&G believes that it has meritorious defenses and has
determined to defend the action vigorously.
9.3. Alabama workers' compensation litigation
On September 14, 1994, three Alabama employers filed a class action captioned
Four Way Plant Farm, Inc., et al., v. National Council on Compensation
Insurance, et al., in the Circuit Court of Bullock County, Alabama on behalf of
all Alabama employers that have allegedly been damaged as a result of an alleged
conspiracy by the NCCI, the National Workers' Compensation Reinsurance Pool,
USF&G and numerous other insurance companies which served as servicing carriers
for the Alabama involuntary workers' compensation market, to fix servicing
carrier fees at unreasonably high and noncompetitive levels in violation of
Alabama law. The plaintiffs allege that the conspiracy occurred during the
period January 1, 1985 to January 1, 1994, and caused inflated deficits in the
involuntary market and an alleged excessive expansion of the workers'
compensation residual market. The plaintiffs seek unspecified damages on behalf
of each member of the proposed class action. USF&G believes that it has
meritorious defenses and has determined to defend the action vigorously.
9.4. Proposition 103
In November 1988, voters in the State of California passed Proposition 103,
which required insurers doing business in California to rollback most
property/casualty premium prices in effect between November 1988 and November
1989 to November 1987 levels, less an additional 20 percent discount, unless an
insurer could establish that such rate levels threatened its solvency. The
California Supreme Court subsequently ruled that an insurer does not have to
face insolvency in order to qualify for an exemption from the rollback
requirements and is entitled to a "fair and reasonable return."
The California Insurance Department has adopted regulations establishing a broad
industry-wide formula for implementing Proposition 103, but it is not clear how
these regulations will apply to USF&G, and many issues remain unsettled. The
range of liability to USF&G could be from less than $10 million up to
approximately $31 million, including interest. The ultimate outcome of this
issue is not expected to have a material adverse effect on USF&G's results of
operations or financial position since any such liability is not expected to
materially exceed amounts already reserved.
Note 10 Series B Preferred Stock
During August 1995, 189,800 shares of USF&G's Series B Cumulative Convertible
Preferred Stock ("Series B Stock") were converted into 1.6 million shares of
common stock, and on October 11, 1995, USF&G called for redemption 75 percent,
or 832,650 shares of its remaining outstanding Series B Stock. As a result, on
November 9, the shares of Series B Stock called were converted into 6.9 million
shares of USF&G's common stock. The balance of the shares of Series B Stock are
not subject to redemption prior to June 1996.
Note 11 Subsequent Events
During October 1995, USF&G purchased approximately $4.8 million of its
outstanding 7% Senior Notes. In addition, during November 1995, USF&G purchased
approximately $11 million of the 5 1/2% Swiss Franc Bonds. Both purchases were
accomplished through the use of excess corporate cash.
Note 12 Business Combinations
On April 13, and May 22, 1995, USF&G consummated mergers with Discover Re
Managers, Inc. ("Discover Re"), and Victoria Financial Corporation ("Victoria"),
respectively. In the transactions, USF&G exchanged 5.4 million shares of common
stock, worth approximately $78.5 million, for all of the outstanding equity of
Discover Re, and 3.8 million shares of common stock, worth approximately $59.1
million, for all of the outstanding equity of Victoria. Discover Re provides
insurance, reinsurance and related services to the alternative risk transfer
market. Victoria is an insurance holding company which specializes in
nonstandard auto coverage.
Both of these business combinations are accounted for as poolings-of-interests.
Accordingly, 1994 amounts have been restated to reflect the mergers with
Discover Re and Victoria. A reconciliation of the previously separate
enterprises to the restated results of operations for periods prior to the
mergers are as follows:
<TABLE>
Three Months Ended September 30, 1994 Nine Months Ended September 30, 1994
USF&G USF&G USF&G USF&G
Corporation Corporation Corporation Corporation
As Previously Discover As As Previously Discover As
(in millions) Reported Re Victoria Restated Reported Re Victoria Restated
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues
Premiums earned $ 615 $ 6 $13 $ 634 $1,774 $15 $39 $1,828
Net investment income 186 - 1 187 560 2 2 564
Other 10 2 2 14 28 4 3 35
Revenues before realized gains 811 8 16 835 2,362 21 44 2,427
Net realized gains on investments - - - - 6 - - 6
Total revenues 811 8 16 835 2,368 21 44 2,433
Expenses
Losses, loss expenses, and policy
benefits 505 5 8 518 1,537 12 27 1,576
Underwriting, acquisition, and
operating expenses 259 3 6 268 706 7 15 728
Interest expense 10 (1) 1 10 26 - 1 27
Facilities exit costs (income) - - - - - - - -
Total expenses 774 7 15 796 2,269 19 43 2,331
Income from operations before
income taxes 37 1 1 39 99 2 1 102
Provision for income taxes (benefit) (37) 1 - (36) (71) - - (71)
Net income $ 74 $ - $ 1 $ 75 $ 170 $ 2 $ 1 $ 173
Preferred stock dividend
requirements 12 - - 12 36 - - 36
Net income available to common
stock $ 62 $ - $ 1 $ 63 $ 134 $ 2 $ 1 $ 137
Note: A reconciliation of the previously separate enterprises to the restated
consolidated financial position at December 31, 1994 is disclosed in USF&G's
Form 10-Q for the quarter ended June 30, 1995.
</TABLE>
USF&G Corporation
Report of Independent Auditors
Board of Directors
USF&G Corporation
We have reviewed the accompanying condensed consolidated statement of financial
position of USF&G Corporation as of September 30, 1995 and the related
condensed consolidated statements of operations and cash flows for the three-
month and nine-month periods ended September 30, 1995 and 1994. These financial
statements are the responsibility of the company's management.
We conducted our reviews in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical review
procedures to financial data and making inquiries of persons responsible for
financial and accounting matters. It is substantially less in scope than an
audit conducted in accordance with generally accepted auditing standards, which
will be performed for the full year with the objective of expressing an opinion
regarding the financial statements taken as a whole. Accordingly, we do not
express such an opinion.
Based on our reviews, we are not aware of any material modifications that should
be made to the accompanying condensed consolidated financial statements referred
to above for them to be in conformity with generally accepted accounting
principles.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated statement of financial position of USF&G Corporation
as of December 31, 1994, and the related consolidated statements of operations,
stockholders' equity, and cash flows for the year then ended (not presented
herein) and, in our report dated February 24, 1995, except for Note 1.11, as to
which the date is May 22, 1995, we expressed an unqualified opinion on those
consolidated financial statements. In our opinion, the information set forth in
the accompanying condensed consolidated statement of financial position as of
December 31, 1994, is fairly stated in all material respects, in relation to the
consolidated statement of financial position from which it has been derived.
ERNST & YOUNG LLP
Baltimore, Maryland
November 14, 1995
USF&G Corporation
Management's Discussion and Analysis of Financial Condition and Results
of Operations
This section provides an analysis of financial results and material changes in
financial position for USF&G Corporation and its subsidiaries ("USF&G") for the
quarter ended September 30, 1995. The analysis focuses on the performance of
USF&G's business segments and its investment portfolio. This discussion
updates the "Management's Discussion and Analysis" in the 1994 Annual Report to
Shareholders (Restated) and should be read in conjunction therewith. The
results of operations for the quarter and nine months ended September 30, 1995,
are compared with those for the same periods of 1994, unless otherwise noted.
Financial position at September 30, 1995, is compared with December 31, 1994.
Amounts for 1994 have been restated to reflect mergers with Discover Re
Managers, Inc. ("Discover Re"), and Victoria Financial Corporation ("Victoria"),
which were completed during the second quarter of 1995. Restatement of prior
periods is required due to the application of the pooling-of-interests method
of accounting. (Note: A glossary of certain terms used in the discussion can be
found at the end of this section. The terms are italicized the first time they
appear in text.)
Index
1. Consolidated Results 13
2. Property/Casualty Insurance Operations 14
3. Life Insurance Operations 17
4. Parent and Noninsurance Operations 18
5. Investments 18
6. Financial Condition 21
7. Liquidity 22
8. Regulation 23
9. Glossary of Terms 24
1. Consolidated Results
The table below shows the major components of net income.
Three Months Ended Nine Months Ended
September 30 September 30
(in millions) 1995 1994 1995 1994
Income from operations before
realized gains, facilities exit costs,
and income taxes $47 $ 39 $132 $ 96
Net realized gains on investments 3 - 7 6
Facilities exit (costs) income - - 6 -
Income taxes (1) 36 (1) 71
Net income $49 $ 75 $144 $173
The table below shows the components by major business segment of income from
continuing operations before realized gains, facilities exit costs, and income
taxes.
Three Months Ended Nine Months Ended
September 30 September 30
(in millions) 1995 1994 1995 1994
Property/casualty insurance $ 61 $ 57 $176 $144
Life insurance 7 4 19 12
Parent and noninsurance (21) (22) (63) (60)
Income from operations before
realized gains, facilities exit
costs, and income taxes $ 47 $ 39 $132 $ 96
Income from operations before realized gains, facilities exit costs, and income
taxes for the property/casualty insurance segment increased for the quarter and
nine months ended September 30, 1995, due to continued improvement in
underwriting results. The continued improvement in the life insurance segment
resulted principally from higher product sales and improved profit margins.
During 1994, USF&G developed and committed to a plan to consolidate its
Baltimore headquarters facilities. The plan encompasses relocating all USF&G
personnel currently residing at the 40-story office building ("the Tower") in
downtown Baltimore to the Mount Washington facilities in Baltimore which USF&G
owns. Implementation of the plan began in January 1995. The relocation of
Tower personnel is expected to be substantially completed by the end of 1996.
Activities associated with the relocation are in process and are generally
proceeding as originally planned.
In the first quarter of 1995, USF&G renegotiated and extended the terms of a
sublease with a tenant. The new lease, which covers the two floors of the Tower
already occupied by the tenant, expires in July 2009. The present value of the
additional income to be received over the term of the new lease, $6 million, was
recognized in the first quarter of 1995, and is shown as a separate item
captioned "facilities exit costs (income)" in the condensed consolidated
statement of operations. No subleases were negotiated in the second or third
quarters of 1995; however, management is actively marketing the Tower space to
prospective subtenants.
2. Property/Casualty Insurance Operations
Property/casualty insurance operations, the principal business segment,
accounted for 85 percent of USF&G's revenues in the nine month periods ended
September 30, 1995 and 1994. Financial results for this segment were as follows:
Three Months Ended Nine Months Ended
September 30 September 30
(in millions) 1995 1994 1995 1994
Premiums earned* $ 649 $ 598 $ 1,843 $ 1,724
Losses and loss expenses incurred (465) (425) (1,338) (1,290)
Underwriting expenses (217) (213) (627) (589)
Net underwriting loss (33) (40) (122) (155)
Net investment income 105 106 324 320
Other revenues and expenses, net (11) (9) (26) (21)
Income from operations before
realized gains, facilities exit costs,
and income taxes $ 61 $ 57 $ 176 $ 144
*See Glossary of Terms
Improved underwriting results were the primary reason for the increase in income
from property/casualty operations before realized gains, facilities exit costs,
and income taxes in the third quarter and first nine months of 1995 when
compared with the same periods of 1994. Over the last several years, management
has spent considerable effort improving the overall quality of the book of
business. This improvement in the mix of business along with targeted premium
growth and continued expense management are the primary contributing factors to
the improved underwriting results. Lower catastrophe losses in the first and
third quarters were also a major factor in the improvement in the nine-month
results.
2.1. Premiums earned
Premiums earned totaled $649 million and $1,843 million for the third quarter
and first nine months of 1995, respectively, compared with $598 million and
$1,724 million for the same periods in 1994. The following table shows the
major components of premiums earned and premiums written.
Three Months Ended September 30
1995 1994
Premiums Premiums
(in millions) Written Earned Written Earned
Branch office voluntary production:
Direct $548 $518 $506 $492
Ceded reinsurance (36) (42) (33) (36)
Net branch office voluntary 512 476 473 456
Discover Re and Victoria 18 19 18 19
Pools and associations 23 20 18 29
Other premium adjustments (10) (1) (7) (2)
Total primary 543 514 502 502
Assumed reinsurance:
Finite risk 63 69 53 41
Traditional risk 75 66 67 55
Total assumed 138 135 120 96
Total $681 $649 $622 $598
Nine Months Ended September 30
1995 1994
Premiums Premiums
(in millions) Written Earned Written Earned
Branch office voluntary production:
Direct $1,586 $1,500 $1,491 $1,435
Ceded reinsurance (120) (117) (121) (109)
Net branch office voluntary 1,466 1,383 1,370 1,326
Discover Re and Victoria 58 57 56 54
Pools and associations 41 56 75 89
Other premium adjustments (18) (1) (19) (4)
Total primary 1,547 1,495 1,482 1,465
Assumed reinsurance:
Finite risk 161 149 137 115
Traditional risk 213 199 160 144
Total assumed 374 348 297 259
Total $1,921 $1,843 $1,779 $1,724
Premiums earned for the quarter ended September 30, 1995 increased $51 million,
or 9 percent, compared with the same period in 1994, while premiums earned in
the first nine months of 1995 were $119 million, or 7 percent, higher than in
the first nine months of 1994. The increases are largely attributable to the
increases in branch office voluntary direct premiums and assumed reinsurance
premiums. The year-to-date increases were offset somewhat by first quarter
decreases in premiums from voluntary and involuntary pools and associations as a
result of reduced participation in these markets.
Branch office direct voluntary premiums written in the third quarter of 1995 are
over eight percent higher when compared with the corresponding period of 1994.
Premiums from new business increased 13 percent in the third quarter of 1995,
and retention ratios for both commercial and personal lines improved when
compared to the same period in 1994.
The decline in premiums seen in previous years was largely the result of
management's efforts to eliminate unprofitable business. The growth in 1995 is
occurring in higher margin business segments, particularly middle market
commercial lines, fidelity/surety and assumed reinsurance, which have been
targeted by management to be expanded in a systematic and controlled manner.
The table below shows premiums earned and the statutory loss ratios by lines of
property/casualty insurance.
Three Months Ended September 30
1995 1994
Premiums Statutory Premiums Statutory
(dollars in millions) Earned Loss Ratio Earned Loss Ratio
Commercial Lines $311 76.3% $306 76.7%
Fidelity/Surety 38 46.2 35 37.6
Personal Lines 146 73.1 142 68.9
Discover Re 6 78.8 6 77.2
Victoria 13 76.8 13 66.0
Total primary 514 73.2 502 71.6
Assumed reinsurance 135 65.2 96 69.4
Total $649 71.5% $598 71.2%
Nine Months Ended September 30
1995 1994
Premiums Statutory Premiums Statutory
(dollars in millions) Earned Loss Ratio Earned Loss Ratio
Commercial Lines $ 897 75.8% $ 890 77.3%
Fidelity/Surety 105 39.5 93 33.3
Personal Lines 436 76.4 427 80.7
Discover Re 18 78.3 16 77.2
Victoria 39 74.8 39 70.1
Total primary 1,495 73.4 1,465 75.3
Assumed reinsurance 348 68.9 259 64.2
Total $1,843 72.6% $1,724 73.6%
2.2. Underwriting results
Underwriting results generally represent premiums earned less incurred losses,
loss adjustment expenses, and underwriting expenses. It is not unusual for
property/casualty insurance companies to have underwriting losses that are
offset by investment income.
Underwriting gains (losses) by major business category are as follows:
Three Months Ended Nine Months Ended
September 30 September 30
(in millions) 1995 1994 1995 1994
Commercial Lines $(40) $(40) $ (103) $ (122)
Fidelity/Surety 5 - 14 10
Personal Lines (11) (13) (57) (73)
Discover Re - - - -
Victoria (2) 1 (4) -
Total primary (48) (52) (150) (185)
Assumed reinsurance 15 12 28 30
Net underwriting loss $(33) $(40) $ (122) $ (155)
Consolidated property/casualty underwriting ratios, calculated based on
generally accepted accounting principles ("GAAP") and statutory accounting
practices, are as follows:
Three Months Ended Nine Months Ended
September 30 September 30
1995 1994 1995 1994
GAAP underwriting ratios:
Loss ratio 71.5% 71.3% 72.6% 74.8%
Expense ratio* 33.4 35.6 34.0 34.2
Combined ratio 104.9 106.9 106.6 109.0
Statutory underwriting ratios:
Loss ratio 71.5 71.2 72.6 73.6
Expense ratio 32.7 35.2 33.6 35.0
Combined ratio 104.2 106.4 106.2 108.6
*See Glossary of Terms
Underwriting results improved by $7 million in the third quarter and $33 million
in the first nine months of 1995 when compared with the same periods of 1994.
The results continue to benefit from the overall improvement in the quality and
mix of business and continued emphasis on underwriting discipline. The
improvement in commercial lines underwriting performance in the first nine
months of 1995 resulted from management's targeted business mix strategies,
better quality underwriting and adherence to pricing guidelines, particularly
in the middle markets. Fidelity/surety's underwriting results improved in the
third quarter of 1995, when compared to the same period of 1994, on the strength
of increased premiums and reduced underwriting expenses, as a result of
management's focus on lowering costs and expanding the surety business. In
personal lines, the comparison between third quarter and year-to-date
underwriting results for 1995 and 1994 are primarily effected by catastrophe
losses. Exclusive of catastrophe losses, personal lines incurred underwriting
losses of $9 million and $46 million in the third quarter and first nine months
of 1995, compared with $11 million and $43 million in the same periods of 1994.
Underwriting results in the third quarter and first nine months of 1995 included
$4 million and $41 million of net catastrophe losses, respectively, compared
with $15 million and $65 million in the same periods of 1994. The primary
businesses incurred catastrophe losses of $11 million in the third quarter of
1995, primarily from Hurricane Erin and tornadoes in the south-central United
States. Primary business catastrophe losses for the first nine months of 1995,
which also include various second quarter hailstorms, tornadoes and floods, and
the April bombing of the federal building in Oklahoma City, totaled $32 million,
compared with $57 million in the same period of 1994. The 1994 catastrophe
losses in the primary businesses resulted from severe first quarter snow and ice
storms. The assumed reinsurance business incurred $6 million of catastrophe
losses for Hurricane Luis in the third quarter of 1995, but reduced the reserve
for catastrophe losses from the January Kobe, Japan earthquake by $11 million
in the quarter. Losses from the Kobe earthquake are currently estimated to be
only $1 million. Year-to-date assumed reinsurance net catastrophe losses of $9
million also include further development of $4 million from the February 1994
Los Angeles earthquake, which contributed most of the $8 million of catastrophe
losses incurred by the assumed reinsurance business in the first nine months of
1994.
Underwriting results showed improvement despite continuing competitive
pressures, the inflationary claims environment, and the adverse impact of
involuntary markets. Competitive pressures continue to effect underwriting
results, especially in the pricing of commercial lines products.
2.3. Loss reserves
Reserves for unpaid losses and loss expenses totaled $6.2 billion at September
30, 1995, and approximate the December 31, 1994 position. Exclusive of claims
from catastrophe losses, both pending claims and the number of new claims
reported have decreased 10 percent since the third quarter of 1994.
USF&G categorizes environmental, asbestos and other long term exposures where
multiple claims relate to a similar cause of loss (excluding catastrophes) as
"common circumstance claims." Reserves for losses that have been reported and
certain legal expenses are established on the "case basis." Common circumstance
claims which have emerged, while substantial, are a relatively small portion of
total claim payments and reserves.
The most significant common circumstance claim exposures include negligent
construction, environmental, and asbestos claims. Case reserves for these
exposures are less than two percent of total reserves for unpaid losses and loss
expenses at September 30, 1995. Other common circumstance claim categories
stem from a variety of situations such as lead paint, toxic fumes, breast
implants, sexual molestation and other disparate causes, provisions for which
are included in the total common circumstance case reserves. The following
table sets forth selected information for each of the three primary categories,
net of ceded reinsurance.
Negligent
(in millions) Construction Environmental Asbestos
Total case and bulk reserves at
December 31, 1994 $ 55 $329 $125
Losses incurred - 10 7
Claims (paid) recovered (10) (22) (4)
Total case and bulk reserves at
September 30, 1995 $ 45 $317 $128
Management believes that USF&G's reserve position is adequate relative to its
exposure to environmental and asbestos matters, and compares favorably to other
large property/casualty insurers. USF&G's customer base generally does not
include large manufacturing companies, which tend to incur most of the known
environmental and asbestos exposures. Many of USF&G's environmental claims
relate to small industrial or transportation accidents which individually are
unlikely to involve material exposures. In addition, USF&G has traditionally
been a primary coverage carrier, having written relatively little high-level
excess coverage; therefore, liability exposures are generally restricted to
primary coverage limits.
The level of loss reserves for both current and prior years' claims is
continually monitored and adjusted for changing economic, social, judicial and
legislative conditions, as well as for changes in historical trends as
information regarding such conditions and actual claims develops. Management
believes that loss reserves are adequate, but establishing appropriate reserves,
particularly with respect to environmental, asbestos and other long-term
exposure claims, is highly judgmental and an inherently uncertain process. It
is possible that, as conditions change and claims experience develops,
additional reserves may be required in the future. There can be no assurance
that such adjustments will not have a material adverse effect on USF&G's results
of operations or financial condition.
3. Life Insurance Operations
Life insurance operations ("F&G Life") represent 14 percent of USF&G's total
revenues for the first nine months of 1995 and for the same period of 1994. F&G
Life also represents 31 percent of the assets at September 30, 1995 compared
with 33 percent at December 31, 1994.
F&G Life's financial results were as follows:
Three Months Ended Nine Months Ended
September 30 September 30
(in millions) 1995 1994 1995 1994
Premiums $ 43 $ 36 $ 125 $ 104
Net investment income 75 77 230 241
Other income - 2 - 2
Policy benefits (86) (93) (282) (286)
Underwriting and operating expenses (25) (18) (54) (49)
Income from operations before
realized gains, facilities exit
costs, and income taxes $ 7 $ 4 $ 19 $ 12
Premium increases are resulting from expanded sales and marketing strategies.
Policy benefits decreased in the third quarter 1995 by $7 million over the same
period from the prior year due to decreases in death benefits and liabilities
for future policy benefits, as well as a decrease in interest credited on
accounts due to a lower single premium deferred annuity ("SPDA") base.
Underwriting and operating expenses increased by $7 million from the prior year
quarter due to accelerated amortization of deferred acquisition costs. As
profits improve, primarily due to improved investment spreads, the amortization
of these costs increases proportionately. The third quarter and nine month
declines in net investment income are generally affected by the declining asset
base resulting from annuity surrender activity. In addition, the nine month
1994 amount includes $8 million of net investment income from the sale of a
timberland investment.
In November 1995, F&G Life announced plans for the outsourcing of information
services and policy administration. F&G Life expects to enter into an eight-
year contract which will result in a financial commitment for F&G Life,
primarily based on fixed per policy fees, of approximately $100 million
(projected on current policies in force and future sales estimates).
The expected benefits of the proposed arrangements include higher customer
service levels, reduced time frames to bring products to market, and access
to new technologies, in addition to substantial reductions in per policy
and new issue costs. F&G Life expects to incur up to $3 million of transition
related costs, including separation costs, in the fourth quarter of 1995.
3.1. Sales
The following table shows life insurance and annuity sales (premiums and
deposits) by distribution system and product type.
Three Months Ended Nine Months Ended
September 30 September 30
(in millions) 1995 1994 1995 1994
Distribution System:
Direct-structured settlements $ 30 $ 24 $ 82 $ 59
Property/casualty brokerage 12 10 48 34
National brokerage 11 13 37 30
National wholesaler 22 22 70 50
Senior distribution 3 - 9 -
Other 5 6 20 25
Total $ 83 $ 75 $266 $198
Product Type:
Structured settlement annuities $ 30 $ 24 $ 82 $ 59
Single premium deferred annuities 20 21 81 54
Tax sheltered annuities 20 20 64 44
Other annuities 6 4 26 31
Life insurance 7 6 13 10
Total $ 83 $ 75 $266 $198
Sales increased in the third quarter of 1995 by $8 million over the same period
in 1994. This increase was led by structured settlement annuities, the large
majority of which are sold to structure claims of USF&G's property/casualty
operations. F&G Life has continued to develop and introduce new products in its
structured settlement and SPDA lines as well as modifying current product
offerings to meet customer needs. F&G Life intends to continue to concentrate
on the expansion of its existing distribution channels while also creating and
developing other marketing networks. Despite F&G Life's attention to expanding
its distribution channels and to product development, demand for its products is
affected by fluctuating interest rates and the relative attractiveness of
alternative investment, annuity or insurance products, as well as its credit
ratings. As a result, there is no assurance that the improved sales trend will
continue at the same level. Total life insurance in force was $11.5 billion at
September 30, 1995 and $11.8 billion at December 31, 1994.
3.2. Policy surrenders
Deferred annuities and universal life products are subject to surrender. Nearly
all of F&G Life's surrenderable annuity policies allow a refund of the cash
value balance less a surrender charge. The surrender charge varies by product.
SPDAs, which represent 62 percent of surrenderable business, have surrender
charges that decline from six percent in the first policy year to zero percent
in the seventh and later policy years. Newer products that have been issued
during 1994 and 1995 have surrender charges that decline from nine percent in
the first policy year to zero percent in the tenth and later policy years. Such
built-in surrender charges provide protection against premature policy
surrender.
Policy surrenders totaled $108 million and $461 million for the quarter and nine
months ended September 30, 1995, respectively. This compares with $170 million
and $388 million for the same periods in 1994.
Management has implemented a policy conservation program that provides
policyholders with a competitive renewal option within F&G Life once their
surrender charge period has expired for this block. Due to the fluctuating
interest rate environment, this option was suspended on January 1, 1995, and
subsequently reinstituted as of July 1, 1995. As of September 30, 1995, based
on surrender experience beginning in 1993, policyholders representing
approximately 18 percent of the expiring block had elected this option. An
additional 27 percent of the expiring block was retained under the terms of the
original contract, free of surrender charges and at interest rates which are
adjusted annually.
The total account value of F&G Life's deferred annuities is $2.1 billion, 22
percent of which is surrenderable at current account value (i.e., without
surrender charges). The surrender charge period on $1.0 billion of the large
block of SPDAs expires through the end of 1996, of which $288 million expires
during the remainder of 1995. The experience thus far for $1.1 billion of SPDAs
where the surrender charge period expired in the fourth quarter of 1993 through
the third quarter of 1995 indicates that, on average, 55 percent of the
expiring block may surrender; however, in the future, a larger percentage may
surrender should interest rates trend upward. While this will put pressure on
F&G Life's ability to increase assets, given the relatively high interest rates
credited when these annuities were issued, overall profit margins would continue
to improve as policyholders surrender or rollover to new products with lower
rates. Management believes that F&G Life, with a liquid assets to surrender
value ratio of 136 percent at September 30, 1995, continues to maintain a high
degree of liquidity and has the ability to meet surrender obligations for the
foreseeable future.
4. Parent and Noninsurance Operations
Parent company interest and other unallocated expenses and net results from
noninsurance operations were as follows:
Three Months Ended Nine Months Ended
September 30 September 30
(in millions) 1995 1994 1995 1994
Parent Company Expenses:
Interest expense $ (11) $ (9) $ (32) $ (24)
Unallocated expense, net (11) (17) (35) (37)
Noninsurance Operations 1 4 4 1
Loss from operations before
realized gains, facilities exit
costs, and income taxes $ (21) $ (22) $ (63) $ (60)
The results for parent and noninsurance operations for the nine months ended
September 30, 1995 show an increase in loss from operations of $3 million when
compared to the nine months ended September 30, 1994. This increase is
primarily due to an $8 million increase in interest expense as a result of the
higher short-term interest rate environment and the refinancing of corporate
debt in 1994 and 1995 from floating rates to fixed rates. This increase is
offset by a $2 million decrease in unallocated expenses as well as an
improvement in the results of noninsurance operations of $3 million.
Unallocated expenses for the third quarter of 1995 decreased due to a $9 million
loss incurred on long-term subleases recognized in the corresponding quarter of
1994.
5. Investments
At September 30, 1995, USF&G's investment mix is comparable with year-end 1994.
Long-term fixed maturities comprise 84 percent and 83 percent of total
investments at September 30, 1995 and December 31, 1994, respectively.
The table below shows the distribution of USF&G's investment portfolio.
(dollars in millions) At September 30, 1995 At December 31, 1994
Total investments $10,921 $10,561
Fixed maturities:
Held to maturity 42% 44%
Available for sale 42 39
Total fixed maturities 84 83
Common and preferred stocks 1 1
Short-term investments 4 4
Mortgage loans and real estate 7 9
Other invested assets 4 3
Total 100% 100%
5.1. Net investment income
The following table shows the components of net investment income.
Three Months Ended Nine Months Ended
September 30 September 30
(dollars in millions) 1995 1994 1995 1994
Net investment income from:
Fixed maturities $165 $168 $497 $508
Equity securities 1 6 3 7
Short-term investments 5 3 16 10
Real estate and mortgage loans 11 10 35 44
Other, less expenses (3) - (5) (5)
Total $179 $187 $546 $564
Average yields (annualized): 6.9% 6.9% 6.8% 6.9%
Investment income from fixed maturities has decreased due to an asset base
which declined throughout 1994 in order to meet SPDA surrenders and other cash
flow needs. Average annualized yields on fixed maturities were 7.4 percent and
7.3 percent for the nine months ended September 30, 1995 and 1994, respectively.
Interest on short-term investments has increased due to higher short-term
yields. Investment income from equity securities has decreased due to deferred
dividend income on preferred stock that was recorded in the third quarter of
1994. Other income less expenses declined for the third quarter due to a $4
million increase in interest credited to funds withheld on assumed reinsurance
contracts. Other income less expenses for the nine months ended September 30,
1995 and 1994 includes $21 million and $11 million, respectively, of income
relating to USF&G's share of earnings from an equity interest in Renaissance Re.
Included in investment income on real estate and mortgage loans for the first
nine months of 1994 is $8 million related to timberland investments in F&G Life
which were sold in 1994.
5.2. Realized gains (losses)
The components of net realized gains (losses) include the following:
Three Months Ended Nine Months Ended
September 30 September 30
(in millions) 1995 1994 1995 1994
Net gains (losses) from sales:
Fixed maturities $ 3 $ - $ 3 $ 3
Equity securities - - 2 -
Real estate and other 2 1 14 13
Total net gains 5 1 19 16
Impairments:
Fixed maturities (2) - (2) (1)
Real estate and other - (1) (10) (9)
Total impairments (2) (1) (12) (10)
Net realized gains $ 3 $ - $ 7 $ 6
Real estate and other realized gains of $14 million for the first nine months of
1995 primarily relate to USF&G's equity in the realized gains of certain limited
partnership investments. Realized gains on real estate and other investments
for the first nine months of 1994 resulted from F&G Life's sale of timberland
investments and USF&G's portion of realized gains from investments in limited
partnerships. Provisions for impairment relate to certain investments, declines
in the fair value of which are judged to be other than temporary.
5.3. Unrealized gains (losses)
The components of the changes in unrealized gains (losses) were as follows:
Nine Months Ended
September 30
(dollars in millions) 1995
Fixed maturities available for sale $ 261
Deferred policy acquisition costs adjustment (54)
Equity securities 3
Total $ 210
Fixed maturity investments classified as "available for sale" are recorded at
market value with the unrealized gains (losses) reported as a component of
shareholders' equity. An average interest rate decrease of 171 basis points on
two to 30 year maturities during the first nine months of 1995 reduced the prior
year's unrealized loss on fixed maturities available for sale from $184 million
to an unrealized gain of $77 million at September 30, 1995. This was partially
offset by a related change in F&G Life's DPAC adjustment from the prior year's
unrealized gain of $33 million to an unrealized loss of $21 million at September
30, 1995. This adjustment is made to reflect assumptions about the effect of
potential asset sales of fixed maturities available for sale on future DPAC
amortization.
5.4. Fixed maturity investments
The tables below detail the composition of the fixed maturity portfolio.
(dollars in millions) At September 30, 1995 At December 31, 1994
Corporate investment-grade bonds $5,181 57% $5,031 56%
Mortgage-backed securities 1,964 22 1,921 22
Asset-backed securities 1,023 11 942 11
U.S. Government bonds 309 3 286 3
High-yield bonds* 605 7 616 7
Tax-exempt bonds 46 - 121 1
Other - - 7 -
Total fixed maturities
at amortized cost 9,128 100% 8,924 100%
Total market value of fixed
maturities 9,234 8,365
Net unrealized gains (losses) $ 106 $ (559)
Percent market-to-amortized cost 101% 94%
*See Glossary of Terms
At September 30, 1995 At December 31, 1994
Net Net
Amortized Market Unrealized Amortized Market Unrealized
(in millions) Cost Value Gain Cost Value (Loss)
Fixed maturities:
Held to maturity $4,547 $4,576 $ 29 $4,659 $4,284 $(375)
Available for sale 4,581 4,658 77 4,265 4,081 (184)
Total $9,128 $9,234 $106 $8,924 $8,365 $(559)
Decreasing interest rates, which resulted in rising bond prices, were
responsible for the seven percentage point increase in the fixed maturity
portfolio's overall market-to-amortized cost ratio from December 31, 1994.
Debt obligations of the U.S. Government and its agencies and other investment-
grade bonds comprised 93 and 92 percent of the portfolio at September 30, 1995
and December 31, 1994, respectively. The following table shows the credit
quality of the long-term fixed maturity portfolio as of September 30, 1995.
Percent
Market-to-
Amortized Market Amortized
(dollars in millions) Cost Percent Value Cost
U.S. Government and
U.S. Government Agencies $2,163 24% $2,196 102%
AAA 1,454 16 1,473 101
AA 1,377 15 1,384 100
A 2,511 28 2,546 101
BBB 1,018 10 1,046 103
Below BBB 605 7 589 97
Total $9,128 100% $9,234 101%
USF&G's holdings in high-yield bonds comprised seven percent of the total fixed
maturity portfolio at September 30, 1995 and December 31, 1994. Of the total
high-yield bond portfolio, 70 percent is held by the life insurance segment,
representing 10 percent of F&G Life's total investments.
The table below illustrates the credit quality of USF&G's high-yield bond
portfolio as of September 30, 1995.
Percent
Market-to-
Amortized Market Amortized
(dollars in millions) Cost Percent Value Cost
BB $348 58% $337 97%
B 252 42 247 98
CCC and lower 5 - 5 100
Total $605 100% $589 97%
The information on credit quality in the preceding two tables is based upon the
higher of the rating assigned to each issue of fixed-income maturities by either
Standard & Poor's or Moody's. Where neither Standard & Poor's nor Moody's has
assigned a rating to a particular fixed maturity issue, classification is based
on 1) ratings available from other recognized rating services; 2) ratings
assigned by the NAIC; or 3) an internal assessment of the characteristics of the
individual security, if no other rating is available.
At September 30, 1995, USF&G's five largest investments in high-yield bonds
totaled $100 million in amortized cost and had a market value of $84 million.
None of these investments individually exceeded $30 million. USF&G's largest
single high-yield bond exposure represented five percent of the high-yield
portfolio and 0.3 percent of the total fixed maturity portfolio.
5.5. Real estate
The table below shows the components of USF&G's real estate portfolio.
(in millions) At September 30, 1995 At December 31, 1994
Mortgage loans $ 160 $ 349
Equity real estate 749 760
Reserves (95) (98)
Total $ 814 $1,011
The decrease in real estate from the prior year is primarily due to first
quarter 1995 sales of two properties.
Approximately $140 million of the decrease in mortgage loans from the prior year
is due to the securitization of certain fixed-rate, multi-family mortgages into
commercial mortgage-backed securities backed by the FNMA. These mortgage-backed
securities were classified on the balance sheet as fixed maturities available
for sale at September 30, 1995, and were sold in October, 1995. Also
contributing to the decrease from the prior year is the prepayment of a loan,
and the foreclosure of a loan, which is now included in equity real estate.
USF&G's real estate investment strategy emphasizes diversification by geographic
region and property type. The diversification of USF&G's mortgage loan and real
estate portfolio at September 30, 1995, is as follows:
Geographic Region Type of Property Development Stage
Pacific/Mountain 37% Office 40% Operating property 69%
Midwest 24 Land 31 Land packaging 19
Mid-Atlantic 16 Apartments 15 Land development 12
Southeast 11 Industrial 6
Southwest 6 Retail/other 5
Northeast 6 Hotel 3
Real estate investments are generally appraised at least once every three years.
Appraisals are obtained more frequently under certain circumstances such as
significant changes in property performance or market conditions. All of these
appraisals are performed by professionally certified appraisers.
At September 30, 1995, USF&G's five largest real estate investments had a book
value of $325 million. The largest single investment was a land development
project located in San Diego, California with a book value of $94 million, or
ten percent of the total real estate portfolio.
Mortgage loans and real estate investments not performing in accordance with
contractual terms, or performing significantly below expectation, are
categorized as nonperforming. The level of nonperforming real estate
investments at September 30, 1995 is consistent with December 31, 1994.
The book value of the components of nonperforming real estate are as follows:
(dollars in millions) At September 30, 1995 At December 31, 1994
Real estate acquired through
foreclosure or deed-in-lieu of
foreclosure* $116 $117
Land investments* 56 56
Nonperforming equity investments* 33 35
Total nonperforming real estate $205 $208
Real estate valuation allowance $(95) $(98)
Reserves/nonperforming real estate 46% 47%
*See Glossary of Terms
Valuation allowances are established for impairments of mortgage loans and real
estate equity values based on periodic evaluations of the operating performance
of the properties and their exposure to declines in value. The allowance totaled
$95 million, or 12 percent of the net real estate portfolio at
September 30, 1995, and $98 million, or ten percent of the net real estate
portfolio at December 31, 1994. In light of USF&G's current plans with respect
to the portfolio, management believes the allowance at September 30, 1995
continues to adequately reflect the current condition of the portfolio. Should
deterioration occur in the general real estate market or with respect to
individual properties in the future, or plans with respect to individual
properties change, additional reserves may be required. Prospectively, efforts
will continue to reduce risk and increase yields in the real estate portfolio by
selling equity real estate when it is advantageous to do so and reinvesting the
proceeds in medium-term mortgage loans.
6. Financial Condition
6.1. Assets
USF&G's assets totaled $14.6 billion at September 30, 1995, compared with $14.0
billion at December 31, 1994. The increase is primarily due to a $261 million
increase in the market value of fixed maturity investments available for sale.
In addition, reinsurance receivables and other liabilities increased $203
million due to the reclassification of certain related receivables and payables.
6.2. Debt
USF&G's corporate debt totaled $603 million at September 30, 1995, compared with
$586 million at December 31, 1994. The increase in debt resulted primarily from
$14 million of foreign currency translation adjustments from non-U.S. dollar
denominated debt. As a result of entering into currency forward agreements,
there was no effect on net income from translation of non-U.S. dollar
denominated debt. USF&G's real estate and other debt totaled $20 million at
September 30, 1995 and $42 million at December 31, 1994. The decrease of $22
million since year-end relates to Victoria's line of credit which was repaid in
full during the second quarter of 1995 and the defeasance of $10 million of real
estate bonds during the third quarter of 1995.
During October 1995, USF&G purchased approximately $4.8 million of its
outstanding 7% Senior Notes. In addition, during November 1995, USF&G purchased
approximately $11 million of the 5 1/2% Swiss Franc Bonds. Both purchases were
accomplished through the use of excess corporate cash.
6.3. Shareholders' equity
USF&G's shareholders' equity totaled $1.8 billion at September 30, 1995,
compared with $1.4 billion at December 31, 1994. The increase is primarily the
result of an approximately $261 million increase in unrealized gains on fixed
maturity investments available for sale less a $54 million change in the
related life insurance segment deferred policy acquisition costs adjustment. In
addition, shareholders' equity increased due to net income of $144 million less
$41 million in common and preferred stock dividends for the nine months ended
September 30, 1995.
6.4. Capital transactions
At December 31, 1994, USF&G had outstanding 1.3 million shares of its Series C
Preferred Stock. In February 1995, these shares were converted into
approximately 5.5 million shares of common stock. During the second quarter of
1995, in exchange for all of the outstanding equity of Discover Re and Victoria,
respectively, USF&G issued another 5.4 million and 3.8 million shares of common
stock.
During August 1995, 189,800 shares of USF&G's Series B Cumulative Convertible
Preferred Stock ("Series B Stock") were converted into 1.6 million shares of
common stock, and on October 11, 1995, USF&G called for redemption 75 percent,
or 832,650 shares of its remaining outstanding Series B Stock. As a result, on
November 9, the shares of Series B Stock called were converted into 6.9 million
shares of USF&G's common stock. The balance of the shares of Series B Stock are
not subject to redemption prior to June 1996.
7. Liquidity
7.1. Cash flow from operations
USF&G had cash flow from operations of $159 million and $315 million for the
quarter and nine month periods ended September 30, 1995, compared with cash flow
from operations of $43 million and $40 million for the same periods in 1994.
Cash flow improved over the nine months ended September 30, 1995 primarily due
to a $78 million improvement in net reinsurance activity which relates to an
increase in assumed reinsurance written premium of $77 million over the prior
year. In addition, the increase is due to favorable experience in losses, loss
expenses, and policy benefits paid over the quarter and nine months ended
September 30, 1995.
7.2. Credit facilities
At September 30, 1995, USF&G maintained a $250 million committed credit facility
with a group of foreign and domestic banks. This represents a reduction of the
credit facility from $400 million at December 31, 1994. Management elected to
reduce the size of the facility due to the reduction in borrowings against it
and USF&G's expanded access to capital markets. Borrowings outstanding under
the credit facility, which totaled $215 million at December 31, 1994, were
repaid in full during the second quarter of 1995. The credit agreement contains
restrictive covenants pertaining to indebtedness, tangible net worth, liens and
other matters. USF&G was in compliance with these covenants at September 30,
1995 and December 31, 1994.
In addition, at September 30, 1995, USF&G maintained a $100 million foreign
currency credit facility and a $50 million letter of credit facility. At
September 30, 1995, there were no borrowings on the foreign currency credit
facility; the balance outstanding on the letter of credit facility was $8
million.
7.3. Marketable securities
USF&G's fixed-income, equity security, and short-term investment portfolios are
liquid and represent substantial sources of cash. The market value of its
fixed-income securities was $9.2 billion at September 30, 1995, which represents
101 percent of its amortized cost. At September 30, 1995, equity securities,
which are reported at market value in the balance sheet, totaled $64 million.
Short-term investments totaled $399 million.
7.4. Liquidity restrictions
There are certain restrictions on payments of dividends by insurance
subsidiaries that may limit USF&G Corporation's ability to receive funds from
its subsidiaries. Under the Maryland Insurance Code, Maryland insurance
subsidiaries, such as United States Fidelity and Guaranty Company ("USF&G
Company") and F&G Life, must provide the Maryland Insurance Commissioner (the
"Commissioner") with not less than thirty days' prior written notice before
payment of an "extraordinary dividend" to its holding company. "Extraordinary
dividends" are dividends which, together with any dividends paid during the
immediately preceding twelve month period, would be in excess of 10% of the
subsidiary's statutory policyholders' surplus as of the prior calendar year
end. Extraordinary dividends may not be paid until such thirty day period has
expired and the Commissioner has not disapproved the payment, or the
Commissioner has approved the payment within such period. In addition, ten
days' prior notice of any dividend must be given to the Commissioner prior to
payment, and the Commissioner has the right to prevent payment of such dividend
if it is determined that such payment could impair the insurer's surplus or
financial condition.
Effective June 1, 1995 and with the consent of the Maryland Insurance
Commissioner, USF&G Company, the principal property/casualty subsidiary of
USF&G, declared an extraordinary dividend payable to USF&G Corporation
consisting of all of the issued and outstanding capital stock of F&G Life.
Prior to the payment of such dividend, F&G Life was a wholly-owned subsidiary of
USF&G Company. As a result of such dividend payment, F&G Life is now a direct,
wholly-owned subsidiary of USF&G Corporation. In addition, because any
dividends paid during the immediately preceding twelve month period are
considered when determining whether future dividends constitute extraordinary
dividends, any dividends which USF&G Company would propose to pay in the twelve
month period beginning June 1, 1995 would be deemed extraordinary dividends and
subject to the thirty-day notice period described above. During 1995,
approximately $33 million in dividends are available for payment to USF&G
Corporation from F&G Life without providing the notice required for
extraordinary dividends. As of September 30, 1995 dividends of approximately
$25 million have been paid to USF&G Corporation by F&G Life. The application of
the thirty-day notice requirement to any dividends of USF&G Company is not
expected to materially affect the liquidity of USF&G Corporation. In addition to
the extraordinary dividend paid on June 1, dividends of approximately $83
million have been paid as of September 30, 1995 to USF&G Corporation by USF&G
Company.
8. Regulation
USF&G's insurance subsidiaries are subject to extensive regulatory oversight in
the jurisdictions where they do business. This regulatory structure, which
generally operates through state insurance departments, involves the licensing
of insurance companies and agents, limitations on the nature and amount of
certain investments, restrictions on the amount of single insured risks,
approval of policy forms and rates, setting of capital requirements, limitations
on dividends, limitations on the ability to withdraw from certain lines of
business such as personal lines and workers' compensation, and other matters.
From time to time, the insurance regulatory framework has been the subject of
increased scrutiny. At any one time there may be numerous initiatives within
state legislatures or state insurance departments to alter and, in many cases,
increase state authority to regulate insurance companies and their businesses.
Proposals to adopt a federal regulatory framework have also been discussed. It
is not possible to predict the future impact of increasing state or potential
federal regulation on USF&G's operations. Additional information regarding legal
and regulatory contingencies may be found in Note 9, "Legal Contingencies," to
the condensed consolidated financial statements, as well as in USF&G's Annual
Report to Shareholders (Restated) for the year ended December 31, 1994.
9. Glossary of Terms
Account value: Deferred annuity cash value available to policyholders before
the assessment of surrender charges.
Catastrophe losses: Property/casualty insurance claim losses resulting from a
sudden calamitous event, such as a severe storm, are categorized as
"catastrophes" when they meet certain severity and other criteria determined by
a national organization .
Expense ratio: The ratio of underwriting expenses to net premiums written, if
determined in accordance with statutory accounting practices ("SAP"), or the
ratio of underwriting expenses (adjusted by deferred policy acquisition costs)
to earned premiums, if determined in accordance with GAAP.
High-yield bonds: Fixed maturity investments with a credit rating below the
equivalent of Standard & Poor's "BBB". In addition, nonrated fixed maturities
that, in the judgment of USF&G, have credit characteristics similar to those of
a fixed maturity rated below BBB are considered high-yield bonds.
Involuntary pools and associations: Property/casualty insurance companies are
required by state laws to participate in a number of assigned risk pools,
automobile reinsurance facilities, and similar mandatory plans ("involuntary
market plans"). These plans generally require coverage of less desirable
risks, principally for workers' compensation and automobile liability, that do
not meet the companies' normal underwriting standards. As mandated by
legislative authorities, insurers generally participate in such plans based
upon their shares of the total writings of certain classes of insurance.
Liquid assets to surrender value: GAAP liquid assets (publicly traded bonds,
stocks, cash, and short-term investments) divided by surrenderable policy
liabilities, net of surrender charges. A measure of a life insurance company's
ability to meet liquidity needs in case of policy surrenders.
Loss ratio: The ratio of incurred losses and loss adjustment expenses to earned
premiums, determined in accordance with SAP or GAAP, as applicable. The
difference between SAP and GAAP relates to deposit accounting for GAAP related
to financial reinsurance assumed.
Nonperforming real estate: Mortgage loans and real estate investments that are
not performing in accordance with their contractual terms or that are performing
or projected to perform at an economic level significantly below expectations.
Included in the table of nonperforming real estate are the following terms:
Deed-in-lieu of foreclosure: Real estate to which title has been obtained in
satisfaction of a mortgage loan receivable in order to prevent foreclosure
proceedings.
Land investments: Land investments that are held for future development where,
based on current market conditions, returns are projected to be significantly
below original expectations.
Nonperforming equity investments: Equity investments with cash and GAAP return
on book value less than five percent, but excluding land investments.
Policyholders' surplus: The net assets of an insurer as reported to regulatory
agencies based on accounting practices prescribed or permitted by the National
Association of Insurance Commissioners and the state of domicile.
Premiums earned: The portion of premiums written applicable to the expired
period of policies.
Premiums written: Premiums retained by an insurer.
Underwriting results: Property/casualty pretax operating results excluding
investment results, policyholders' dividends, and noninsurance activities;
generally, premiums earned less losses and loss adjustment expenses incurred and
"underwriting" expenses incurred.
USF&G Corporation
Part II. Other Information
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits.
Exhibit 11. Computation of Earnings per Share.
Exhibit 12. Computation of Ratio of Consolidated Earnings to Fixed Charges and
Preferred Stock Dividends.
Exhibit 15. Letter Regarding Unaudited Interim Financial
Information.
(b) Reports on Form 8-K.
On October 12, 1995, the Registrant filed a Form 8-K, reporting under Item 5,
Other Events, a press release announcing call of shares of Series B Cumulative
Convertible Preferred Stock.
USF&G Corporation
Exhibit 11 - Computation of Earnings Per Share (Unaudited)
Nine Months Ended September 30
(dollars in millions except per share data) 1995 1994*
Net Income Available to Common Stock
Primary:
Net income $ 144 $ 173
Less preferred stock dividend requirements (23) (36)
Net income available to common stock $ 121 $ 137
Fully Diluted:
Net income $ 144 $ 173
Less preferred stock dividend requirements (12) (12)
Add interest expense on convertible notes 5 3
Net income available to common stock $ 137 $ 164
Weighted Average Shares Outstanding
Primary Common Shares 109,769,809 94,077,236
Fully Diluted:
Common shares 109,769,809 94,077,236
Assumed conversion of preferred stock 11,557,477 22,492,438
Assumed exercise of stock options 2,107,729 1,038,797
Assumed conversion of zero coupon
convertible subordinated notes 7,227,255 5,621,198
Total 130,662,270 123,229,669
Earnings Per Common Share
Primary (A) $ 1.10 $ 1.45
Fully Diluted (B) $ 1.04 $ 1.33
*1994 amounts have been restated to reflect mergers with Discover Re Managers,
Inc., and Victoria Financial Corporation, which were completed during the second
quarter of 1995. Restatement of prior periods is required due to the
application of the pooling-of-interests method of accounting.
(A) Shares issuable under stock options (1,122,655 shares in 1995 and 1,038,797
in 1994) have not been used as common stock equivalents in the computation of
primary earnings per common share presented on the face of the Condensed
Consolidated Statement of Operations because the dilutive effect is not
material.
(B) Fully diluted earnings per common share amounts are calculated assuming the
conversion of all securities whose contingent issuance would have a dilutive
effect on earnings. The calculations assume the conversion of preferred stock
series B and C and the zero coupon convertible subordinated notes, as well as
shares issuable under stock options.
USF&G Corporation
Exhibit 12 - Computation of Ratio Consolidated Earnings to Fixed Charges
and Preferred Stock Dividends
Nine Months Ended September 30
(dollars in millions) 1995 1994*
Fixed Charges
Interest expense $ 34 $ 27
Portion of rents representative of interest 15 20
Total fixed charges 49 47
Preferred stock dividend requirements (A) 23 36
Combined Fixed Charges and Preferred Stock Dividends $ 72 $ 83
Consolidated Earnings Available for Fixed Charges and
Preferred Stock Dividends
Income from operations before income taxes $ 145 $102
Adjustment:
Fixed charges 49 47
Consolidated earnings available for fixed charges and
preferred stock dividends $ 194 $149
Ratio of Consolidated Earnings to Fixed Charges 3.9 3.2
Ratio of Consolidated Earnings to Combined Fixed
Charges and Preferred Stock Dividends 2.7 1.8
* 1994 amounts have been restated to reflect mergers with Discover Re Managers,
Inc., and Victoria Financial Corporation, which were completed during the second
quarter of 1995. Restatement of prior periods is required due to the
application of the pooling-of-interests method of accounting.
(A) Preferred stock dividends of $23 million in 1995 and $36 million in 1994
divided by 100% less the effective income tax rate of 0.6% in 1995 and 0% in
1994.
USF&G Corporation
Exhibit 15 - Letter Regarding Unaudited Interim Financial Information
USF&G Corporation
We are aware of the incorporation by reference in the Registration Statement
Numbers 33-20449, 33-9405, 33-33271, 33-21132, 33-51859 and 33-63333 on Form S-3
and Numbers 2-61626, 2-72026, 2-98232, 33-16111, 33-35095, 33-38113, 33-43132,
33-45664, 33-45665, 33-61965, 33-55667, 33-55669, 33-55671 and 33-59535 on Form
S-8 of our report on the unaudited condensed consolidated interim financial
statements of USF&G Corporation which is included in its Form 10-Q for the
quarter ended September 30, 1995.
Pursuant to Rule 436(c) of the Securities Act of 1933, our report is not a part
of the registration statements prepared or certified by accountants within the
meaning of Section 7 or 11 of the Securities Act of 1933.
ERNST & YOUNG LLP
Baltimore, Maryland
November 14, 1995
USF&G Corporation
Signature
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Quarterly Report to be signed on its behalf by
the undersigned, thereunto duly authorized.
USF&G Corporation
By DAN L. HALE
Dan L. Hale
Executive Vice President and
Chief Financial Officer
Dated at Baltimore, Maryland
November 14, 1995
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