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
June 30, 1996 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; 117,844,371 shares outstanding as of August 9,
1996.
Page 1 of 26
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USF&G CORPORATION Contents
PART I. Financial Information
Item 1. Financial Statements:
Condensed Consolidated Statement of Financial Position 3
Condensed Consolidated Statements of Operations 4
Condensed Consolidated Statements of Cash Flows 6
Notes to Condensed Consolidated Financial Statements 8
Report of Independent Auditors 11
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 12
PART II. Other Information
Item 6. Exhibits and Reports on Form 8-K 22
Exhibit 11- Computation of Earnings Per Share 23
Exhibit 12- Computation of Ratio of Consolidated Earnings
to Fixed Charges and Preferred Stock Dividends 24
Exhibit 15- Letter Regarding Unaudited Interim Financial
Information 25
Signature 26
<PAGE>
<TABLE>
<CAPTION>
USF&G CORPORATION Condensed Consolidated Statement of Financial Position (Unaudited)
<S> <C> <C>
At June 30 At December 31
(dollars in millions except per share data) 1996 1995
-----------------------------------------------
Assets
Investments:
Fixed maturities available for sale, at market (cost, 1996, $8,924; 1995, $9,118) $ 8,881 $ 9,458
Common and preferred stocks, at market (cost, 1996, $42; 1995, $70) 40 65
Short-term investments 390 288
Mortgage loans 325 254
Real estate 634 653
Other invested assets 485 389
-----------------------------------------------
Total investments 10,755 11,107
-----------------------------------------------
Cash 41 119
Accounts, notes, and other receivables 785 795
Reinsurance receivables 759 604
Servicing carrier receivables 679 699
Deferred policy acquisition costs 501 434
Other assets 905 893
-----------------------------------------------
Total assets $14,425 $14,651
-----------------------------------------------
Liabilities
Unpaid losses, loss expenses, and policy benefits $ 9,607 $ 9,816
Unearned premiums 1,154 1,055
Corporate debt 583 591
Real estate and other debt 16 16
Other liabilities 1,298 1,189
-----------------------------------------------
Total liabilities 12,658 12,667
-----------------------------------------------
Shareholders' Equity
Preferred stock, par value $50.00 (12,000,000 shares authorized;
shares issued, 1996 and 1995, 4,277,460) 213 213
Common stock, par value $2.50 (240,000,000 shares authorized;
shares issued, 1996, 117,954,715; 1995, 119,606,095) 295 299
Paid-in capital 1,169 1,188
Net unrealized gains (losses) on investments and foreign currency (25) 271
Minimum pension liability (100) (100)
Retained earnings 215 113
-----------------------------------------------
Total shareholders' equity 1,767 1,984
-----------------------------------------------
Total liabilities and shareholders' equity $14,425 $14,651
-----------------------------------------------
See Notes to Condensed Consolidated Financial Statements.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
USF&G CORPORATION Condensed Consolidated Statement of Operations (Unaudited)
<S> <C> <C>
Three Months Ended June 30
(dollars in millions except per share data) 1996 1995
----------------------------------------
Revenues
Premiums earned $674 $659
Net investment income 181 182
Other 2 14
----------------------------------------
Revenues before net realized gains 857 855
Net realized gains on investments 1 1
----------------------------------------
Total revenues 858 856
----------------------------------------
Expenses
Losses, loss expenses, and policy benefits 536 551
Underwriting, acquisition, and operating expenses 257 247
Interest expense 10 12
Facilities exit costs/(sublease income) (12) -
----------------------------------------
Total expenses 791 810
----------------------------------------
Income from operations before income taxes 67 46
Provision for income taxes - -
----------------------------------------
Net income $ 67 $ 46
----------------------------------------
Preferred stock dividend requirements 5 7
----------------------------------------
Net income available to common stock $ 62 $ 39
----------------------------------------
Primary Earnings Per Common Share $.52 $.35
----------------------------------------
Fully Diluted Earnings Per Common Share $.50 $.33
----------------------------------------
Weighted average common shares outstanding (000s):
Primary 119,190 110,565
Fully diluted 128,978 130,022
----------------------------------------
Dividends declared per common share $.05 $.05
----------------------------------------
See Notes to Condensed Consolidated Financial Statements.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
USF&G CORPORATION Condensed Consolidated Statement of Operations (Unaudited)
<S> <C> <C>
Six Months Ended June 30
(dollars in millions except per share data) 1996 1995
----------------------------------------
Revenues
Premiums earned $1,341 $1,276
Net investment income 361 367
Other 11 26
----------------------------------------
Revenues before net realized gains 1,713 1,669
Net realized gains on investments 12 5
----------------------------------------
Total revenues 1,725 1,674
----------------------------------------
Expenses
Losses, loss expenses, and policy benefits 1,079 1,069
Underwriting, acquisition, and operating expenses 516 494
Interest expense 20 22
Facilities exit costs/(sublease income) (14) (6)
----------------------------------------
Total expenses 1,601 1,579
----------------------------------------
Income from operations before income taxes 124 95
Provision for income taxes - -
----------------------------------------
Net income $ 124 $ 95
----------------------------------------
Preferred stock dividend requirements 10 15
----------------------------------------
Net income available to common stock $ 114 $ 80
----------------------------------------
Primary Earnings Per Common Share $ .95 $ .73
----------------------------------------
Fully Diluted Earnings Per Common Share $ .91 $ .69
----------------------------------------
Weighted average common shares outstanding (000s):
Primary 119,411 108,870
Fully diluted 129,709 129,996
----------------------------------------
Dividends declared per common share $ .10 $ .10
----------------------------------------
See Notes to Condensed Consolidated Financial Statements.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
USF&G CORPORATION Condensed Consolidated Statement of Cash Flows (Unaudited)
<S> <C> <C>
Three Months Ended June 30
(in millions) 1996 1995
----------------------------------
Operating Activities
Direct premiums collected $ 533 $ 486
Net investment income collected 190 209
Direct losses, loss expenses and policy benefits paid (438) (433)
Net reinsurance activity (34) 1
Underwriting and operating expenses paid (142) (171)
Interest paid (16) (10)
Income taxes paid (3) (2)
Other items, net 5 21
----------------------------------
Net cash provided from operating activities 95 101
----------------------------------
Investing Activities
Net (purchases) sales and maturities of short-term investments (26) 60
Sales of fixed maturities held to maturity - 6
Maturities/repayments of fixed maturities held to maturity - 27
Purchases of fixed maturities available for sale (200) (276)
Sales of fixed maturities available for sale 93 105
Maturities/repayments of fixed maturities available for sale 192 91
Purchases of equities and other investments (100) (42)
Sales, maturities, and repayments of equities and other investments 61 76
Purchases of property and equipment (17) (7)
Disposals of property and equipment - -
----------------------------------
Net cash provided from investing activities 3 40
----------------------------------
Financing Activities
Deposits for universal life and investment contracts 89 90
Withdrawals of universal life and investment contracts (245) (195)
Net borrowings of short-term debt 24 (227)
Long-term borrowings - 228
Repayments of long-term borrowings (11) (15)
Issuances of common stock 3 4
Repurchases of common stock (26) -
Cash dividends paid to shareholders (11) (12)
----------------------------------
Net cash used in financing activities (177) (127)
----------------------------------
(Decrease) increase in cash (79) 14
Cash at beginning of period 120 83
----------------------------------
Cash at end of period $ 41 $ 97
----------------------------------
See Notes to Condensed Consolidated Financial Statements.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
USF&G CORPORATION Condensed Consolidated Statement of Cash Flows (Unaudited)
<S> <C> <C>
Six Months Ended June 30
(in millions) 1996 1995
----------------------------------
Operating Activities
Direct premiums collected $1,052 $1,005
Net investment income collected 364 376
Direct losses, loss expenses and policy benefits paid (858) (878)
Net reinsurance activity (23) 73
Underwriting and operating expenses paid (358) (411)
Interest paid (21) (21)
Income taxes paid (3) (2)
Other items, net (4) 14
----------------------------------
Net cash provided from operating activities 149 156
----------------------------------
Investing Activities
Net (purchases) sales and maturities of short-term investments (102) 150
Sales of fixed maturities held to maturity - 6
Maturities/repayments of fixed maturities held to maturity - 53
Purchases of fixed maturities available for sale (419) (448)
Sales of fixed maturities available for sale 145 132
Maturities/repayments of fixed maturities available for sale 452 166
Purchases of equities and other investments (147) (53)
Sales, maturities, and repayments of equities and other investments 150 143
Purchases of property and equipment (26) (13)
Disposals of property and equipment 2 -
----------------------------------
Net cash provided from investing activities 55 136
----------------------------------
Financing Activities
Deposits for universal life and investment contracts 167 168
Withdrawals of universal life and investment contracts (401) (397)
Net borrowings of short-term debt 29 (227)
Long-term borrowings - 229
Repayments of long-term borrowings (32) (15)
Issuances of common stock 3 4
Repurchases of common stock (26) -
Cash dividends paid to shareholders (22) (26)
----------------------------------
Net cash used in financing activities (282) (264)
----------------------------------
(Decrease) increase in cash (78) 28
Cash at beginning of period 119 69
----------------------------------
Cash at end of period $ 41 $ 97
----------------------------------
See Notes to Condensed Consolidated Financial Statements.
</TABLE>
<PAGE>
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 (collectively, "USF&G").
Intercompany transactions are eliminated in consolidation. Certain 1995 amounts
have been reclassified to conform to the 1996 presentation. The interim
financial statements in this report should be read in conjunction with the
consolidated financial statements and notes thereto in USF&G's 1995 Annual
Report to Shareholders. 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.
Effective January 1, 1996, USF&G adopted Statement of Financial Accounting
Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of". The standard includes a requirement that
impairments in the value of real estate investments be recorded as direct
reductions in the carrying value of those investments. USF&G's prior practice
was to establish valuation allowances for impairment to specific investments
where impairment is deemed other than temporary. The adoption of this standard
did not have a material effect on USF&G's financial statements since existing
valuation allowances were applied against the related impaired investments
reducing the cost basis of those investments.
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 six-month periods ended June 30, 1996 and 1995. 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 and Preferred Stock
Dividends
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 rentals 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 Six Months Ended
June 30 June 30
(in millions) 1996 1995 1996 1995
- ----------------------------------------------------------------
Net income $ 67 $ 46 $124 $ 95
Adjustments to reconcile net income
to net cash provided from operating
activities:
Realized gains on investments (1) (1) (12) (5)
Facilities exit costs/(sublease
income) (12) - (14) (6)
Change in insurance liabilities 100 100 131 127
Change in deferred policy
acquisition costs (17) 9 1 28
Change in receivables (75) (41) (127) (63)
Change in other liabilities (31) 6 33 (3)
Change in other assets 56 (6) 2 (12)
Other items, net 8 (12) 11 (5)
---------------------------
Net cash provided from operating
activities $ 95 $101 $149 $156
---------------------------
Note 6 Unrealized Gains (Losses) on Investments
At June 30, 1996, gross unrealized gains and gross unrealized losses pertaining
to investments in common and preferred stocks totaled $1 million and $3 million,
respectively. In addition, gross unrealized gains and gross unrealized losses on
limited partnerships, foreign currency and other investments totaled $27 million
and $2 million, respectively. At June 30, 1996, there were gross unrealized
gains of $108 million and gross unrealized losses of $151 million pertaining to
fixed maturities available for sale. There were also $5 million of gross
unrealized losses relating to a deferred policy acquisition costs ("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 change in net unrealized gains (losses) on investments
and foreign currency amounted to a loss of $296 million during the six months
ended June 30, 1996, compared with a gain of $203 million during the six months
ended June 30, 1995.
Note 7 Proceeds From Sales of Fixed Maturity Investments
In December 1995, USF&G reclassified all of its fixed maturities previously
classified as "held to maturity" to "available for sale". During the six-month
period ended June 30, 1995, proceeds from sales of fixed maturities held to
maturity were $6 million. The 1995 sales were based on evidence of significant
deterioration of the issuers' creditworthiness. Gross losses of less than $1
million were realized on those sales. Proceeds from sales of fixed maturities
available for sale were $145 million for the six months ended June 30, 1996,
compared with $132 million for the same period in 1995. Gross gains and gross
losses of $5 million and $8 million, respectively, were realized on 1996 sales.
Gross gains and gross losses of $2 million were realized on 1995 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 USF&G's 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 six months ended June 30, 1996 and 1995 includes sublease income of $2
million and $6 million, respectively, recognized as a result of entering into
new or renegotiated sublease agreements. There were no subleases negotiated in
the second quarter of 1996.
In the second quarter of 1996, USF&G recognized a $12 million benefit as a
separate item captioned "facilities exit costs/(sublease income)" in the
Condensed Consolidated Statement of Operations. The benefit relates primarily to
reduced property tax assessments on the Tower resulting from a settlement
reached with the State of Maryland and the City of Baltimore. This adjustment to
the facilities exit cost reserve represents the difference between the present
value of the new property tax assessments estimated to be paid through the end
of the Tower lease, and the present value of the originally estimated property
taxes which were included in the facilities exit costs recognized in 1994.
Note 9 Legal Contingencies
USF&G's insurance subsidiaries are routinely engaged in litigation in the normal
course of their businesses, including defending claims for punitive damages. As
insurers, they defend third-party claims brought against their insureds, as well
as defend themselves against first-party and 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 1995 Annual Report to Shareholders.
In the opinion of management, such contingencies and the contingencies described
below are 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 acted as a servicing carrier in North Carolina between 1990 and
1995. 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 defendants' motion to dismiss
the complaint. The plaintiffs appealed the trial court's dismissal of the case
and on July 16, 1996 the North Carolina Court of Appeals affirmed the dismissal
of the plaintiffs' first claim for relief, which is premised on alleged
excessive rates, but reversed the trial court's decision to dismiss the
plaintiffs' second claim for relief, which is premised on employers allegedly
being improperly shifted from the voluntary market to the assigned risk market
as a result of stricter underwriting caused by high residual market burdens. The
plaintiffs are seeking review of the decision by the North Carolina Supreme
Court with respect to the appellate court's decision to affirm the dismissal of
their first claim for relief, and the defendants may also seek review of the
appellate court's decision not to affirm the dismissal of the plaintiffs' second
claim for relief. 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.
The parties to the litigation have reached a settlement agreement subject to
court approval. The settlement agreement requires the defendants to seek
approval from the Alabama Insurance Department for changes in the Alabama's
workers' compensation system designed to facilitate the depopulation of the
Alabama workers' compensation assigned risk market. In addition, the settlement
calls for the establishment and funding of a special committee to study ways to
improve the management and operation of the Alabama workers' compensation
assigned risk plan, and payment of attorneys fees. A hearing to review the
settlement is scheduled for November 12, 1996. If the settlement is approved,
the impact on USF&G is expected to be immaterial.
Note 10 Subsequent Events
On July 24, 1996, USF&G entered into a definitive agreement to sell its interest
in Chancellor Capital Management, Inc. ("Chancellor"). United States Fidelity
and Guaranty Company, a wholly-owned subsidiary of USF&G Corporation, holds an
approximate 44.5% ownership interest in Chancellor. If the transaction closes in
accordance with the agreement, then USF&G expects to report a realized gain of
approximately $75 million.
Effective August 1, 1996, Fidelity and Guaranty Life Insurance Company ("F&G
Life"), a wholly-owned subsidiary of USF&G Corporation, entered into a
coinsurance contract with an unaffiliated life insurance company to cede a
significant portion of F&G Life's remaining block of single premium deferred
annuities. The block has a current account value of approximately $950 million.
The transaction is not expected to have a material effect on USF&G's earnings.
<PAGE>
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 June 30, 1996 and the related condensed
consolidated statements of operations and cash flows for the three- and
six-month periods ended June 30, 1996 and 1995. 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, 1995, 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 23, 1996, 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, 1995, 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
August 12, 1996
<PAGE>
USF&G CORPORATION Management's Discussion and Analysis of Financial
Condition and Results of Operations
This section provides an assessment of financial results and material changes in
financial position for USF&G Corporation and its subsidiaries (collectively,
"USF&G") and explains the results of operations for the quarter and six months
ended June 30, 1996. 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 of Financial Condition and Results of Operations" in the
1995 Annual Report to Shareholders and should be read in conjunction therewith.
The results of operations for the quarter and six months ended June 30, 1996 are
compared with those for the same periods of 1995 unless otherwise noted.
Financial position at June 30, 1996 is compared with December 31, 1995.
In connection with, and because it desires to take advantage of, the new "safe
harbor" provisions of the Private Securities Litigation Reform Act of 1995,
USF&G cautions readers regarding certain forward-looking statements in the
following discussion and elsewhere in this Form 10-Q and in any other statement
made by, or on the behalf of, USF&G, whether or not in future filings with the
Securities and Exchange Commission. Forward-looking statements are statements
not based on historical information and which relate to future operations,
strategies, financial results, or other developments. Forward-looking statements
are necessarily based upon estimates and assumptions that are inherently subject
to significant business, economic and competitive uncertainties and
contingencies, many of which are beyond USF&G's control and many of which, with
respect to future business decisions, are subject to change. These uncertainties
and contingencies can affect actual results and could cause actual results to
differ materially from those expressed in any forward-looking statements made
by, or on behalf of, USF&G. USF&G disclaims any obligation to update
forward-looking information.
(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 12
2. Property/Casualty Insurance Operations 13
3. Life Insurance Operations 16
4. Parent and Noninsurance Operations 17
5. Investments 17
6. Financial Condition 19
7. Liquidity 19
8. Regulation 20
9. Glossary of Terms 21
1. Consolidated Results
The table below shows the major components of net income.
Three Months Six Months
Ended Ended
June 30 June 30
(in millions) 1996 1995 1996 1995
- ---------------------------------------------------------------
Income from operations before
realized gains, facilities exit
(costs)/sublease income, and
income taxes $54 $45 $ 98 $84
Net realized gains on investments 1 1 12 5
Facilities exit (costs)/sublease
income 12 - 14 6
Provision for income taxes - - - -
-------------------------
Net income $67 $46 $124 $95
-------------------------
The table below shows the components by major business segment of income from
operations before realized gains, facilities exit (costs)/sublease income, and
income taxes.
Three Months Six Months
Ended Ended
June 30 June 30
(in millions) 1996 1995 1996 1995
- ---------------------------------------------------------------
Property/casualty insurance $ 59 $ 59 $111 $115
Life insurance 12 6 23 12
Parent and noninsurance (17) (20) (36) (43)
-------------------------
Income from operations before
realized gains, facilities exit
(costs)/sublease income, and
income taxes $ 54 $ 45 $ 98 $ 84
-------------------------
Property/casualty segment income from operations before realized gains,
facilities exit (costs)/sublease income, and income taxes for the six months
ended June 30, 1996 declined $4 million when compared with the same period of
the previous year. The decline is primarily related to increased catastrophe
losses and other significant weather related losses incurred during the first
quarter of 1996. The continued improvement in the life insurance segment is
principally due to improving profit margins on annuity products. Parent and
noninsurance operations improved primarily due to lower interest expense on
corporate debt and reduced parent company operating expenses.
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 and is generally
proceeding as originally planned. The relocation of the majority of Tower
personnel is expected to be completed by the end of the year.
A $12 million reduction of the facilities exit cost reserve was included in net
income for the quarter ended June 30, 1996. This adjustment relates primarily to
reduced property tax assessments on the Tower resulting from a settlement
reached with the State of Maryland and the City of Baltimore.
Additionally, USF&G recognized $2 million and $6 million of sublease income
related to the Tower in the first quarters of 1996 and 1995, respectively.
2. Property/Casualty Insurance Operations
Property/casualty insurance operations, the principal business segment,
accounted for 87 percent of USF&G's revenues in the second quarter of 1996
compared with 85 percent in the same period of 1995. Financial results for this
segment are as follows:
Three Months Six Months
Ended Ended
June 30 June 30
(in millions) 1996 1995 1996 1995
- -------------------------------------------------------------------
Premiums earned* $ 632 $ 614 $1,268 $1,193
Losses and loss expenses incurred (450) (449) (913) (874)
Underwriting expenses (217) (207) (431) (409)
-------------------------------
Net underwriting loss (35) (42) (76) (90)
Net investment income 109 108 218 219
Other revenues and expenses, net (15) (7) (31) (14)
-------------------------------
Income from operations before
realized gains, facilities exit
(costs)/sublease income, and
income taxes $ 59 $ 59 $ 111 $ 115
-------------------------------
*See Glossary of Terms
Improved underwriting results in the second quarter of 1996 were offset by an
increase in other expenses, related to a swing in foreign currency gains/losses,
resulting in no change in income from operations before realized gains,
facilities exit (costs)/sublease income, and income taxes for the period when
compared with the second quarter of 1995. The underwriting improvement for the
first half of 1996, is attributable to premium growth, and a refinement of
workers' compensation reserves, offset somewhat by significant catastrophe
losses and other severe weather related losses incurred in the first quarter of
1996. Increased policyholders' dividends and foreign currency translation losses
were the primary reasons for the increase in other expenses for the first half
of 1996.
2.1. Premiums
- --------------------------------------------------------------------------------
The following tables show the major components of premiums earned and premiums
written.
Three Months Ended June 30
1996 1995
------------------ -----------------
Premiums Premiums
(in millions) Earned Written Earned Written
- ------------------------------------------------------------------
Voluntary direct:
Commercial lines $332 $380 $313 $357
Personal lines 159 161 159 157
Surety 41 46 39 45
-------------------------------------
Total voluntary direct 532 587 511 559
Ceded reinsurance* (35) (38) (39) (43)
-------------------------------------
Net voluntary 497 549 472 516
Alternative risk transfer* 6 6 6 9
Pools and associations 12 12 20 15
Other premium adjustments (1) (3) - (4)
-------------------------------------
Total primary 514 564 498 536
-------------------------------------
Assumed reinsurance:
Finite risk* 43 53 55 50
Traditional risk 75 67 61 57
-------------------------------------
Total assumed 118 120 116 107
-------------------------------------
Total segment $632 $684 $614 $643
-------------------------------------
*See Glossary of Terms
Six Months Ended June 30
1996 1995
------------------ -------------------
Premiums Premiums
(in millions) Earned Written Earned Written
- ------------------------------------------------------------------
Voluntary direct:
Commercial lines $ 667 $ 725 $ 616 $ 675
Personal lines 316 313 316 306
Surety 78 87 75 85
-------------------------------------
Total voluntary direct 1,061 1,125 1,007 1,066
Ceded reinsurance (69) (67) (76) (84)
-------------------------------------
Net voluntary 992 1,058 931 982
Alternative risk transfer 12 9 12 12
Pools and associations 29 22 36 18
Other premium adjustments - (3) 1 (8)
-------------------------------------
Total primary 1,033 1,086 980 1,004
-------------------------------------
Assumed reinsurance:
Finite risk 79 96 80 98
Traditional risk 156 153 133 138
-------------------------------------
Total assumed 235 249 213 236
-------------------------------------
Total segment $1,268 $1,335 $1,193 $1,240
-------------------------------------
Premiums earned for the quarter ended June 30, 1996 increased $18 million, or
approximately three percent, compared with the same period in 1995. Direct
voluntary premiums written in the second quarter and the first half of 1996 are
$28 million and $59 million higher, respectively, over the same periods of 1995.
The Commercial Insurance Group ("CIG") (refer to Section 2.2 of this Analysis)
has experienced the greatest growth during these periods. The results reflect
the implementation of management's strategy to grow the excess and surplus lines
business and specialty segments such as real estate, technology and
transportation, with the expectations of higher profit margins.
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.
The following tables show underwriting gains (losses) and the statutory loss
ratios by lines of property/casualty insurance.
Three Months Ended June 30
1996 1995
----------------------- ----------------------
Statutory Statutory
(dollars in Underwriting Loss Underwriting Loss
millions) Results Ratio Results Ratio
- -------------------------------------------------------------------
Commercial lines $(28) 74.4% $(32) 77.2%
Personal lines (21) 77.6 (22) 76.5
Surety (1) 47.8 - 33.4
Alternative risk
transfer 1 78.4 - 78.5
----------------------------------------------
Total primary (49) 73.7 (54) 74.3
Assumed reinsurance 14 60.4 12 67.2
----------------------------------------------
Total segment $(35) 71.2% $(42) 73.0%
----------------------------------------------
Voluntary $(38) 71.7% $(40) 72.6%
Involuntary 3 44.0 (2) 86.3
----------------------------------------------
Total segment $(35) 71.2% $(42) 73.0%
----------------------------------------------
Six Months Ended June 30
1996 1995
----------------------- --------------------
Statutory Statutory
(dollars in Underwriting Loss Underwriting Loss
millions) Results Ratio Results Ratio
- -----------------------------------------------------------------
Commercial lines $ (43) 71.6% $ (56) 75.0%
Personal lines (60) 85.0 (48) 77.7
Surety (3) 51.7 1 34.7
Alternative risk
transfer 1 78.5 - 78.0
--------------------------------------------
Total primary (105) 74.5 (103) 73.5
Assumed reinsurance 29 59.8 13 71.2
--------------------------------------------
Total segment $ (76) 71.8% $ (90) 73.1%
--------------------------------------------
Voluntary $ (80) 72.0% $ (79) 72.2%
Involuntary 4 60.0 (11) 107.2
--------------------------------------------
Total segment $ (76) 71.8% $ (90) 73.1%
--------------------------------------------
Consolidated property/casualty underwriting ratios, calculated based on
generally accepted accounting principles ("GAAP") and statutory accounting
practices, are as follows:
Three Months Six Months
Ended Ended
June 30 June 30
(in millions) 1996 1995 1996 1995
- --------------------------------------------------------------
GAAP underwriting
ratios:
Loss ratio 71.2% 73.1% 72.0% 73.2%
Expense ratio* 34.4 33.8 34.0 34.3
Combined ratio 105.6 106.9 106.0 107.5
Statutory underwriting
ratios:
Loss ratio 71.2 73.0 71.8 73.1
Expense ratio 33.3 33.6 33.4 34.1
Combined ratio 104.5 106.6 105.2 107.2
*See Glossary of Terms
Underwriting results improved by $7 million and $14 million for the quarter and
six months ended June 30, 1996, respectively, when compared to the corresponding
periods of 1995. These favorable results are primarily driven by premium growth,
continued overall improvement in the quality and mix of business, and continued
expense management. The primary business' expense ratio decreased 1.7 points in
the second quarter of 1996 compared with the second quarter of 1995. These
improvements were offset by higher catastrophe losses and significant weather
related losses not designated as catastrophes. In addition, 1996 results
benefited from a $30 million reduction in workers' compensation reserves in the
first quarter of 1996. These reductions were made as a result of the significant
use of structured settlements to close medical claims in 1995. Inclusion of
structured settlement payment patterns in the previously existing actuarial
models for workers' compensation reserves tended to overestimate the indicated
reserves. Based upon the results of revised modeling techniques, a refined
estimate of required reserves was developed in the first quarter of 1996. The
favorable results for assumed reinsurance for the first half of 1996 are due to
lower catastrophe losses when compared to the same period of 1995.
Underwriting results in the second quarter and the first half of 1996 included
$19 million and $54 million of net catastrophe losses, respectively, compared
with $15 million and $37 million in the same periods of 1995. The primary
businesses incurred $51 million of catastrophe losses in the first half of 1996,
primarily from severe winter storms and floods. The assumed reinsurance business
incurred most of the first half of 1995's net catastrophe losses, recognizing
estimated losses of $12 million for the January 1995 Kobe, Japan earthquake and
further development of $4 million in losses on the February 1994 Los Angeles
earthquake. The $3 million of catastrophe losses incurred by the assumed
reinsurance business in 1996 are due to development on prior year occurrences
such as Hurricane Marilyn.
Underwriting results showed improvement despite continuing competitive pressures
and the inflationary claims environment. Competitive pressures continue to
affect underwriting results, especially in the pricing of Commercial Lines
products.
During 1995, with the goal of continuing the improvement in underwriting
results, USF&G realigned its product segments based on the basic drivers of its
different businesses, resulting in the formation of the product-driven
Commercial Insurance Group ("CIG") (formerly, Commercial Lines Middle Market
Group) and the distribution-driven Family and Business Insurance Group ("FBIG").
CIG includes the mid- and large-size account standard commercial business, the
specialty commercial segments, and excess and surplus lines. FBIG includes the
personal lines and small-size account commercial business. USF&G's field
operations are being rationalized to fit the distribution strategy of each
group. FBIG will consolidate its premium processing and underwriting operations
into three Centers for Agency Services, while USF&G's branch offices will
primarily support CIG. The following tables show selected financial information
by business group (1995 amounts are estimates, based on actual Commercial and
Personal Lines results).
Three Months Ended June 30
1996 1995*
-----------------------------------------
Direct Statutory Direct Statutory
(dollars in Premiums Loss Premiums Loss
millions) Written Ratio** Written Ratio**
- --------------------------------------------------------------
CIG $281 74.9% $257 76.0%
FBIG 260 76.0 257 74.6
Surety 46 47.8 45 33.4
------------------------------------------
Total $587 73.6% $559 74.3%
------------------------------------------
Six Months Ended June 30
1996 1995*
-----------------------------------------
Direct Statutory Direct Statutory
(dollars in Premiums Loss Premiums Loss
millions) Written Ratio** Written Ratio**
- --------------------------------------------------------------
CIG $ 536 69.7% $ 485 76.0%
FBIG 502 82.1 496 74.6
Surety 87 51.7 85 34.7
------------------------------------------
Total $1,125 74.5% $1,066 73.5%
------------------------------------------
* Statutory loss ratios for CIG and FBIG are estimates for the full year 1995.
** Reflects estimates of certain components such as ceded reinsurance premiums
and losses, loss development for years 1995 and prior, and certain underwriting
expenses.
2.3. Loss reserves
- --------------------------------------------------------------------------------
Reserves for unpaid losses and loss expenses totaled $6.1 billion at June 30,
1996, and approximate the December 31, 1995 position.
USF&G categorizes long-term exposures where multiple claims relate to a similar
cause of loss (excluding catastrophes) as "common circumstance claims". Common
circumstance claim exposures include negligent construction, environmental and
asbestos claims.
Reserves for losses that have been reported and certain legal expenses are
established on the "case basis". Bulk reserves are established in addition to
the case reserves to reflect unreported claims and future development on
reported claims. Total case and bulk reserves for these common circumstance
claims, net of ceded reinsurance, comprise approximately eight percent of total
net property/casualty reserves for unpaid losses and loss expenses at June 30,
1996 and December 31, 1995.
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, 1995 $40 $312 $136
Losses incurred 7 12 2
Claims paid (5) (14) (2)
----------------------------------------
Total case and bulk
reserves at June 30, 1996 $42 $310 $136
----------------------------------------
Management believes that USF&G's reserve position is adequate relative to its
exposure to environmental and asbestos matters. 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 13 percent of USF&G's total
revenues for the first six months of 1996 compared with 14 percent for the same
period of 1995. F&G Life also represents 30 percent of the assets at June 30,
1996 compared with 31 percent at December 31, 1995.
F&G Life's financial results are as follows:
Three Months Six Months
Ended Ended
June 30 June 30
(in millions) 1996 1995 1996 1995
- ---------------------------------------------------------------
Premiums $ 42 $ 45 $ 73 $ 83
Net investment income 73 77 147 154
Policy benefits (86) (102) (166) (195)
Underwriting and operating expenses (17) (14) (31) (30)
-------------------------
Income from operations before
realized gains, facilities exit
(costs)/sublease income, and
income taxes $ 12 $ 6 $ 23 $ 12
-------------------------
Income from operations before realized gains, facilities exit (costs)/sublease
income, and income taxes for the life insurance segment improved $6 million and
$11 million for the quarter and six months ended June 30, 1996 when compared
with the corresponding periods of the previous year. The improvement is
primarily due to improved interest rate spreads which yielded higher profit
margins on the segment's book of business. The spreads between interest credited
on annuity and other products and the income on invested assets are improving as
the older block of low-margin single premium deferred annuities ("SPDAs")
surrenders and is replaced by newer products with higher margins. Premiums
declined mainly due to a reduced level of structured settlement sales in the
quarter and six months ended June 30, 1996, while net investment income declined
due to a reduced asset base created by the surrender of annuities. The decrease
in policy benefits is due primarily to lower interest credited on a smaller
annuity block of business, as well as the resetting of interest rates on new and
renewal annuities.
3.1. Sales
- --------------------------------------------------------------------------------
The following table shows life insurance and annuity sales (premiums and
deposits) by distribution system and product type.
Three Months Six Months
Ended Ended
June 30 June 30
(in millions) 1996 1995 1996 1995
- ---------------------------------------------------------------
Distribution System:
Direct-structured settlements $21 $30 $ 42 $ 53
Brokerage 44 37 73 68
National wholesaler 19 24 38 47
Other 4 8 11 15
-------------------------
Total $88 $99 $164 $183
-------------------------
Product Type:
Structured settlement annuities $21 $30 $ 42 $ 53
Single premium deferred annuities 39 33 62 62
Tax sheltered annuities 18 22 38 43
Other annuities 6 9 15 19
Life insurance 4 5 7 6
-------------------------
Total $88 $99 $164 $183
-------------------------
Sales decreased eleven percent in the second quarter of 1996 when compared with
the same period in 1995. This decrease was spread across various product types,
with the largest decrease occurring in structured settlement annuities. F&G Life
intends to continue to concentrate on the expansion of its existing distribution
channels while also developing other marketing networks. F&G Life is also
continuing the development of selected products, and modifying current product
offerings to meet customer needs. 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. Total life insurance in force was $11.1 billion at June 30, 1996
compared with $11.4 billion at December 31, 1995.
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.
F&G Life's current product offerings have surrender charges that decline from
nine percent in the first policy year to zero percent by the tenth policy year.
Such built-in surrender charges provide protection against premature policy
surrender.
Policy surrenders totaled $224 million and $365 million for the quarter and six
months ended June 30, 1996. This compares with $166 million and $352 million for
the same periods in 1995. Surrender activity on a large block of SPDAs that were
originally sold through major stock brokerage firms represents, on average, 71
percent of total surrenders. Relatively low interest rates and increased
competition from other investment vehicles resulted in the increased surrenders
as more of these stock broker-sold policies reached the expiration of their
surrender charge period in the first six months of 1996 than during the same
period of 1995.
Effective August 1, 1996, F&G Life entered into a coinsurance contract with an
unaffiliated life insurance company to cede 100 percent of the remaining block
of stock broker-sold SPDAs. The block ceded has a current account value of
approximately $950 million. The transaction, which is not expected to have a
material effect on earnings, removes an underperforming block of business that
had significant exposure to changes in current interest rates from F&G Life's
direct obligations. Additionally, the agreement will result in a significant
improvement in cash flow related to reduced surrender activity and will enable
redeployment of capital to other marketing and/or investment opportunities.
4. Parent and Noninsurance Operations
Parent company interest and other unallocated expenses and noninsurance
operations are as follows:
Three Months Six Months
Ended Ended
June 30 June 30
(in millions) 1996 1995 1996 1995
- ---------------------------------------------------------------
Parent Company Expenses:
Interest expense $ (9) $(11) $(19) $(21)
Unallocated expense, net (9) (12) (18) (24)
Noninsurance operations 1 3 1 2
-------------------------
Loss from operations before
realized gains, facilities exit
(costs)/sublease income, and
income taxes $(17) $(20) $(36) $(43)
-------------------------
Parent and noninsurance operations show a decrease in loss from operations
before realized gains, facilities exit (costs)/sublease income, and income
taxes of $3 million and $7 million for the quarter and six months ended June 30,
1996. The decreases are primarily attributable to reduced interest expense due
to the refinancing of corporate debt, and reduced parent company operating
expenses. In the second quarter of 1996, these decreases were partially offset
by the absence of net income from Kepner-Tregoe, Inc., a management consulting
subsidiary, which was sold in March 1996.
5. Investments
At June 30, 1996, USF&G's investment mix is comparable with year-end 1995. Fixed
maturities and total investments have decreased slightly due to a decline in
unrealized gains in the fixed maturities portfolio. The table below shows the
distribution of USF&G's investment portfolio.
(dollars in millions) At June 30, 1996 At December 31, 1995
- ---------------------------------------------------------------
Total investments $10,755 $11,107
--------------------------------------
Fixed maturities 83% 85%
Common and preferred
stocks - 1
Short-term investments 4 3
Mortgage loans and real
estate 9 8
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 Six Months
Ended Ended
June 30 June 30
(dollars in millions) 1996 1995 1996 1995
- ---------------------------------------------------------------
Net investment income from:
Fixed maturities $164 $167 $329 $332
Common and preferred stocks 1 1 2 2
Short-term investments 4 5 8 11
Mortgage loans and real estate 10 12 20 24
Other investment income, net of
interest expense on funds held 5 2 9 7
-------------------------
Total investment income 184 187 368 376
Investment expenses (3) (5) (7) (9)
-------------------------
Net investment income $181 $182 $361 $367
-------------------------
Average annualized yields:
Total investments 6.9% 6.8% 6.8% 6.9%
Fixed maturities 7.3 7.4 7.3 7.4
-------------------------
Investment income for the six months ended June 30, 1996 has decreased $6
million, or two percent, when compared with the same period in 1995. Interest on
short-term investments has decreased due to lower short-term interest rates and
a lower average short-term investment base. Investment income on mortgage loans
and real estate for the first half of 1996 declined primarily due to a lower
investment base, resulting from the sales of certain mortgage loans in 1995.
Other investment income includes $5 million and $7 million for the second
quarter 1996 and 1995, respectively, and $9 million and $15 million for the six
months ended June 30, 1996 and 1995, respectively, of income related to USF&G's
share of earnings from an equity interest in RenaissanceRe Holdings, Ltd.
("RenaissanceRe"), a property reinsurance company in Bermuda. Income from the
investment in RenaissanceRe is subject to volatility and exposure to catastrophe
losses and other risks inherent to the property/casualty reinsurance industry.
Also netted against other investment income is interest credited to funds held
on assumed reinsurance contracts of $5 million and $9 million for the second
quarter 1996 and 1995, respectively, and $11 million and $15 million for the six
months ended June 30, 1996 and 1995, respectively.
5.2. Realized gains (losses)
- --------------------------------------------------------------------------------
The components of net realized gains (losses) include the following:
Three Months Six Months
Ended Ended
June 30 June 30
(in millions) 1996 1995 1996 1995
- ---------------------------------------------------------------
Net gains (losses):
Fixed maturities $(2) $ - $(1) $ -
Common and preferred stocks - - - 2
Mortgage loans and real estate - - 4 1
Other 4 7 10 11
-------------------------
Total net gains (losses) 2 7 13 14
Impairments (1) (6) (1) (9)
-------------------------
Net realized gains $ 1 $ 1 $12 $ 5
-------------------------
Other realized gains primarily relate to USF&G's share of gains from its equity
in certain venture capital-type limited partnerships. Impairments relate to
specific investments and are realized when the decline in fair value is deemed
other than temporary, or when the fair value is significantly less than book
value and it is probable that the investment will be sold before any recovery in
value can occur. Realized gains on mortgage loans and real estate for the six
months ended June 30, 1996 resulted from the sale of properties in the first
quarter of 1996.
5.3. Unrealized gains (losses)
- --------------------------------------------------------------------------------
The components of the changes in unrealized gains (losses) were as follows:
Six Months Ended June 30
(in millions) 1996
- -----------------------------------------------------------
Fixed maturities available for sale $(383)
Deferred policy acquisition costs
and policy benefits adjustment 68
Common and preferred stocks 3
Foreign currency and other 16
---------
Total $(296)
---------
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. Yields on U.S. Treasuries with 2- to 30-year maturities
increased an average of 104 basis points during the first half of 1996, which
reduced the unrealized gain on fixed maturities available for sale from $340
million at December 31, 1995 to an unrealized loss of $43 million at June 30,
1996. This was partially offset by a related change in F&G Life's deferred
policy acquisition costs ("DPAC") and policy benefits adjustment from an
unrealized loss of $73 million at December 31, 1995 to an unrealized loss of $5
million at June 30, 1996. This adjustment is made to reflect assumptions about
the effect of potential asset sales of fixed maturities available for sale on
future DPAC amortization. The change in unrealized gains on other investments
primarily relates to USF&G's share of unrealized gains from its equity interests
in certain venture capital-type limited partnerships.
5.4. Investment portfolios
- --------------------------------------------------------------------------------
The table below details the composition of the fixed maturity portfolio.
At June 30, At December 31,
(dollars in millions) 1996 1995
- -----------------------------------------------------------------
Corporate and other
investment-grade bonds $5,370 60% $5,361 59%
Mortgage-backed securities 1,632 18 1,739 19
Asset-backed securities 926 11 999 11
U.S. Government bonds 367 4 380 4
High-yield bonds* 596 7 599 7
Tax-exempt bonds 33 - 40 -
---------------------------------
Total fixed maturities at
amortized cost 8,924 100% 9,118 100%
Total market value of fixed
maturities 8,881 9,458
---------------------------------
Net unrealized gains (losses) $ (43) $ 340
---------------------------------
Percent market-to-amortized cost 100% 104%
---------------------------------
*See Glossary of Terms
Increasing interest rates, which resulted in declining bond prices, were
responsible for the four percentage point decrease in the fixed maturity
portfolio's overall market-to-amortized cost ratio from December 31, 1995.
The table below shows the components of USF&G's mortgage loan and real estate
investment portfolio.
(in millions) At June 30, 1996 At December 31, 1995
- ---------------------------------------------------------------
Mortgage loans $325 $254
Equity real estate, net 634 653
------------------------------------------
Total $959 $907
------------------------------------------
The increase in mortgage loans from December 31, 1995 is primarily due to new
loan originations in the first half of 1996. This increase was partly offset by
the sale of equity real estate, including three land parcels.
Mortgage loan and real estate investments are evaluated on a quarterly basis as
part of management's asset quality review process. This process ensures that the
financial and operating aspects of a property's performance are closely
monitored and analyzed. Although USF&G anticipates that any sales of real estate
will be in an orderly fashion as and when market conditions permit, if USF&G was
required to dispose of a significant portion of its real estate in the near
term, it is likely that it would recover amounts substantially less than the
related carrying values. 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 $14.4 billion at June 30, 1996, compared with $14.7
billion at December 31, 1995. The decrease is primarily a result of the $296
million decrease in net unrealized gains (losses).
6.2. Debt
- --------------------------------------------------------------------------------
USF&G's corporate debt totaled $583 million at June 30, 1996, compared with $591
million at December 31, 1995. The decrease in debt is a result of the repurchase
of $32 million of Zero Coupon Convertible Subordinated Notes, offset by an
increase in the balance due under the committed credit facility.
In January 1996, $75 million was drawn against the committed credit facility to
repay the balance due upon maturity of the previously outstanding 5 1/2% Swiss
Franc Bonds. During the first half of 1996, another $27 million was drawn
against the facility to fund the repurchase of Zero Coupon Convertible
Subordinated Notes. Subject to market conditions, USF&G plans to refinance or
repurchase other outstanding debt over the next several years.
In April 1996, USF&G entered into a 5-year, $80 million notional principle,
fixed-for-floating interest rate swap. This instrument effectively converts the
7 1/8% Senior Notes to floating rate debt with an effective rate of
approximately 5.6% at June 30, 1996.
6.3. Shareholders' equity
- --------------------------------------------------------------------------------
USF&G's shareholders' equity totaled $1.8 billion at June 30, 1996, compared
with $2.0 billion at December 31, 1995. The decrease is the result of the $296
million decrease in net unrealized gains (losses), the repurchase of $26 million
of the corporation's common stock, and $22 million in common and preferred stock
dividends. Net income of $124 million partly offset these decreases.
6.4. Capital strategy
- --------------------------------------------------------------------------------
In April 1996, USF&G announced a plan to repurchase up to five million shares of
its common stock. The purchases are made from time to time via open market
purchases, block trades, or as otherwise determined by management, and are
funded primarily through excess parent company cash flow. The timing and amount
of purchases depends on market conditions and corporate requirements. Through
August 9, 1996, approximately 2.2 million shares have been repurchased. In
conjunction with the stock repurchase program, USF&G also sold 300,000 put
options on its common stock during the second quarter of 1996. These put options
mature in the third quarter of this year.
7. Liquidity
7.1. Cash flow
- --------------------------------------------------------------------------------
USF&G had cash flow from operations of $95 million and $149 million for the
quarter and six months ended June 30, 1996, respectively. For the corresponding
periods of 1995, cash flow from operations totaled $101 million and $156
million, respectively. USF&G has generated positive cash flow from operations
for eight consecutive quarters generally as a result of premium growth and the
overall improvement in basic underwriting and expense control.
Deposits and withdrawals of universal life and investment contracts, such as
annuities, had net cash outflows of $156 million and $234 million in the second
quarter and first half of 1996, respectively, which is higher than the $105
million and $229 million in the corresponding periods of 1995 due to increased
SPDA surrender activity. As a result of F&G Life ceding a significant portion of
the remaining SPDA block, cash outflows for surrender activity are expected to
decrease in the future (refer to Section 3.2 of this Analysis).
7.2. Credit facilities
- --------------------------------------------------------------------------------
At June 30, 1996, USF&G maintained a $250 million committed credit facility with
a group of foreign and domestic banks. Borrowings outstanding under the credit
facility totaled $102 million at June 30, 1996. There were no borrowings against
the facility at December 31, 1995. The increase in borrowings is a result of
the use of the facility to repay the balance due upon maturity of the 5 1/2%
Swiss Franc Bonds and to repurchase Zero Coupon Convertible Subordinated Notes.
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 June 30, 1996 and December 31, 1995.
In addition, at June 30, 1996, USF&G maintained a $150 million foreign currency
credit facility. There were no borrowings on this credit facility as of June 30,
1996.
7.3. Marketable securities
- --------------------------------------------------------------------------------
USF&G's fixed maturity, common and preferred stocks, and short-term investment
portfolios are liquid and represent substantial sources of cash. The market
value of its fixed maturities investments was $8.9 billion at June 30, 1996,
which represents 99.5 percent of its amortized cost. At June 30, 1996,
investments in common and preferred stocks, which are reported at market value
in the Condensed Consolidated Statement of Financial Position, totaled $40
million. Short-term investments totaled $390 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 and Fidelity
and Guaranty Life Insurance Company, 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 ten
percent of the subsidiary's statutory policyholders' surplus as of the prior
calendar year end. Extraordinary dividends may not be paid until either 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 other 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 December 29, 1995, F&G Life, with the Commissioner's consent, paid
extraordinary dividends to USF&G Corporation. Because any dividends paid during
the immediately preceding twelve-month period are considered when determining
whether future dividends constitute extraordinary dividends, any dividends which
F&G Life would propose to pay in the twelve-month period beginning December 29,
1995, would be deemed extraordinary dividends and subject to the thirty-day
notice period described above. The application of the thirty-day notice
requirement to dividends of F&G Life is not expected to materially affect the
liquidity of USF&G Corporation.
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 1995
Annual Report to Shareholders.
9. Glossary of Terms
Account value: Deferred annuity cash value available to policyholders before the
assessment of surrender charges.
Alternative risk transfer: A form of insurance through which a company
self-insures the predictable frequency portion of its own losses and purchases
insurance for the less frequent, high severity losses that could have a major
financial impact on the company.
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.
Finite risk reinsurance: Reinsurance arrangements providing coverage at lower
margins than traditional risk reinsurance in return for a lower probability of
loss to the reinsurer.
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.
Loss ratio: The ratio of incurred losses and loss 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 certain financial
reinsurance assumed.
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.
Reinsurance: For a consideration, an assuming insurer agrees to indemnify a
ceding insurer against all or part of the loss the latter may sustain under the
policy or policies it has issued. The legal rights of the insured are not
affected by the transaction and the ceding insurer remains liable to the insured
for payment of policy benefits.
Underwriting results: Property/casualty pretax operating results excluding
investment results, policyholders' dividends, and noninsurance activities;
generally, premiums earned less losses and loss expenses incurred and
"underwriting" expenses incurred.
<PAGE>
USF&G CORPORATION Part II. Other Information
Item 4. Submission of Matters to a Vote of Shareholders
(a) The 1996 Annual Meeting of Shareholders was held May 15, 1996.
(b) and (c) The shareholders elected all proposed nominees for directors to a
term of one year. The elections were uncontested and all nominees were currently
directors of USF&G Corporation. The following table provides the voting
tabulation for each nominee:
For Withheld
H. Furlong Baldwin 102,670,603 1,046,720
Michael J. Birck 102,727,768 989,555
Norman P. Blake, Jr. 102,545,940 1,171,383
George L. Bunting, Jr. 102,697,584 1,019,739
Robert E. Davis 102,598,119 1,119,204
Dale F. Frey 102,746,603 970,720
Robert E. Gregory, Jr. 102,788,493 928,830
Robert J. Hurst 101,172,737 2,544,586
Wilbur G. Lewellen 102,708,304 1,009,019
Henry A. Rosenberg, Jr. 102,643,822 1,073,501
Larry P. Scriggins 101,030,684 2,686,639
Anne Marie Whittemore 100,980,834 2,736,489
R. James Woolsey 100,946,019 2,771,304
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.
There were no reports on Form 8-K filed during the second quarter of 1996.
The registrant filed a Form 8-K on July 24, 1996, reporting under Item 5, Other
Events, certain information related to an agreement entered into under which
United States Fidelity and Guaranty Company, a wholly-owned subsidiary of the
registrant, will sell its approximate 44.5% interest in Chancellor Capital
Management, Inc.
<PAGE>
<TABLE>
<CAPTION>
USF&G CORPORATION Exhibit 11 - Computation of Earnings Per Share (Unaudited)
<S> <C> <C>
Six Months Ended June 30
(dollars in millions except per share data) 1996 1995
---------------------------------------
Net Income Available to Common Stock
Primary:
Net income $ 124 $ 95
Less preferred stock dividend requirements (10) (15)
---------------------------------------
Net income available to common stock $ 114 $ 80
---------------------------------------
Fully Diluted:
Net income $ 124 $ 95
Less preferred stock dividend requirements (8) (8)
Add interest expense on convertible notes 2 3
---------------------------------------
Net income available to common stock $ 118 $ 90
---------------------------------------
Weighted Average Shares Outstanding
Primary common shares (A) 119,411,427 108,869,519
---------------------------------------
Fully Diluted (B):
Common shares 119,411,427 108,869,519
Assumed conversion of preferred stock 2,308,106 12,615,617
Assumed exercise of stock options 1,636,528 1,283,417
Assumed conversion of zero coupon convertible subordinated notes 6,352,827 7,227,255
---------------------------------------
Total 129,708,888 129,995,808
---------------------------------------
Earnings Per Common Share
Primary (A) $ .95 $.73
Fully diluted (B) $ .91 $.69
---------------------------------------
(A) Shares issuable under stock options (1,550,319 shares in 1996 and 861,463 in
1995) 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 the Zero Coupon Convertible Subordinated Notes, as well as shares
issuable under stock options. The 1995 calculation also assumes the conversion
of preferred stock series C.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
USF&G CORPORATION Exhibit 12 - Computation of Ratio of Consolidated Earnings to Fixed Charges and Preferred Stock Dividends
<S> <C> <C>
Six Months Ended June 30
(dollars in millions) 1996 1995
--------------------------------------------
Fixed Charges
Interest expense $ 20 $ 22
Portion of rents representative of interest 7 10
--------------------------------------------
Total fixed charges 27 32
Preferred stock dividend requirements (A) 10 15
--------------------------------------------
Combined Fixed Charges and Preferred Stock Dividends $ 37 $ 47
--------------------------------------------
Consolidated Earnings Available for Fixed Charges and Preferred
Stock Dividends
Income from operations before income taxes $124 $ 95
Adjustment:
Fixed charges 27 32
--------------------------------------------
Consolidated earnings available for fixed charges and
preferred stock dividends $151 $127
--------------------------------------------
Ratio of Consolidated Earnings to Fixed Charges 5.5 4.0
Ratio of Consolidated Earnings to Combined Fixed
Charges and Preferred Stock Dividends 4.1 2.7
--------------------------------------------
(A) Preferred stock dividend requirements of $10 million in 1996 and $15 million
in 1995 divided by 100% less the effective income tax rate of 0% in 1996 and
0.6% in 1995.
</TABLE>
<PAGE>
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, 33-63333, and 33-65471
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,
33-59535, 33-64839 and 333-04359 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 June 30, 1996.
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
August 12, 1996
<PAGE>
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
August 12, 1996
<TABLE> <S> <C>
<ARTICLE> 7
<MULTIPLIER> 1000000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> JUN-30-1996
<DEBT-HELD-FOR-SALE> 8881
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 40
<MORTGAGE> 325
<REAL-ESTATE> 634
<TOTAL-INVEST> 10755
<CASH> 41
<RECOVER-REINSURE> 759
<DEFERRED-ACQUISITION> 501
<TOTAL-ASSETS> 14425
<POLICY-LOSSES> 9598
<UNEARNED-PREMIUMS> 1154
<POLICY-OTHER> 9
<POLICY-HOLDER-FUNDS> 95
<NOTES-PAYABLE> 599
0
213
<COMMON> 295
<OTHER-SE> 1259
<TOTAL-LIABILITY-AND-EQUITY> 14425
1341
<INVESTMENT-INCOME> 361
<INVESTMENT-GAINS> 12
<OTHER-INCOME> 11
<BENEFITS> 1079
<UNDERWRITING-AMORTIZATION> 368
<UNDERWRITING-OTHER> 148
<INCOME-PRETAX> 124
<INCOME-TAX> 0
<INCOME-CONTINUING> 124
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 124
<EPS-PRIMARY> 0.95
<EPS-DILUTED> 0.91
<RESERVE-OPEN> 5113
<PROVISION-CURRENT> 994
<PROVISION-PRIOR> (81)
<PAYMENTS-CURRENT> 279
<PAYMENTS-PRIOR> 656
<RESERVE-CLOSE> 5091
<CUMULATIVE-DEFICIENCY> (81)
</TABLE>
