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, 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; 115,652,747 shares outstanding
as of November 12, 1996.
Page 1 of 27
<PAGE>
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 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 23
Exhibit 11- Computation of Earnings Per Share 24
Exhibit 12- Computation of Ratio of Consolidated Earnings
to Fixed Charges and Preferred Stock Dividends 25
Exhibit 15- Letter Regarding Unaudited Interim
Financial Information 26
Signature 27
<PAGE>
<TABLE>
<CAPTION>
USF&G CORPORATION Condensed Consolidated Statement of Financial Position
(Unaudited)
<S> <C> <C>
At September 30 At December 31
(dollars in millions except per share data) 1996 1995
-----------------------------------------------
Assets
Investments:
Fixed maturities available for sale, at market (cost, 1996, $8,027; 1995, $9,118) $ 7,993 $9,458
Common and preferred stocks, at market (cost, 1996, $41; 1995, $70) 39 65
Short-term investments 369 288
Mortgage loans 340 254
Real estate 627 653
Other invested assets 489 389
-----------------------------------------------
Total investments 9,857 11,107
-----------------------------------------------
Cash 59 119
Accounts, notes, and other receivables 824 795
Reinsurance receivables 1,699 604
Servicing carrier receivables 659 699
Deferred policy acquisition costs 467 434
Other assets 962 893
-----------------------------------------------
Total assets $14,527 $14,651
-----------------------------------------------
Liabilities
Unpaid losses, loss expenses, and policy benefits $ 9,648 $ 9,816
Unearned premiums 1,189 1,055
Corporate debt 530 591
Real estate and other debt 16 16
Other liabilities 1,378 1,189
-----------------------------------------------
Total liabilities 12,761 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, 116,008,813; 1995, 119,606,095) 290 299
Paid-in capital 1,136 1,188
Net unrealized gains (losses) on investments and foreign currency (12) 271
Minimum pension liability (100) (100)
Retained earnings 239 113
-----------------------------------------------
Total shareholders' equity 1,766 1,984
-----------------------------------------------
Total liabilities and shareholders' equity $14,527 $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 September 30
(dollars in millions except per share data) 1996 1995
----------------------------------------
Revenues
Premiums earned $687 $692
Net investment income 177 179
Other 3 11
----------------------------------------
Revenues before net realized gains 867 882
Net realized gains on investments 4 3
----------------------------------------
Total revenues 871 885
----------------------------------------
Expenses
Losses, loss expenses, and policy benefits 561 551
Underwriting, acquisition, and operating expenses 265 272
Interest expense 10 12
Facilities exit costs/(sublease income) - -
----------------------------------------
Total expenses 836 835
----------------------------------------
Income from operations before income taxes 35 50
Provision for income taxes - 1
----------------------------------------
Net income $ 35 $ 49
----------------------------------------
Preferred stock dividend requirements 5 8
----------------------------------------
Net income available to common stock $ 30 $ 41
----------------------------------------
Primary Earnings Per Common Share $.26 $.37
----------------------------------------
Fully Diluted Earnings Per Common Share $.26 $.35
----------------------------------------
Weighted average common shares outstanding (000s):
Primary 117,451 111,541
Fully diluted 117,451 121,087
----------------------------------------
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>
Nine Months Ended September 30
(dollars in millions except per share data) 1996 1995
----------------------------------------
Revenues
Premiums earned $2,028 $1,968
Net investment income 537 546
Other 15 38
----------------------------------------
Revenues before net realized gains 2,580 2,552
Net realized gains on investments 16 7
----------------------------------------
Total revenues 2,596 2,559
----------------------------------------
Expenses
Losses, loss expenses, and policy benefits 1,640 1,620
Underwriting, acquisition, and operating expenses 781 766
Interest expense 30 34
Facilities exit costs/(sublease income) (14) (6)
----------------------------------------
Total expenses 2,437 2,414
----------------------------------------
Income from operations before income taxes 159 145
Provision for income taxes - 1
----------------------------------------
Net income $ 159 $ 144
----------------------------------------
Preferred stock dividend requirements 14 23
----------------------------------------
Net income available to common stock $ 145 $ 121
----------------------------------------
Primary Earnings Per Common Share $ 1.21 $ 1.10
----------------------------------------
Fully Diluted Earnings Per Common Share $ 1.16 $ 1.04
----------------------------------------
Weighted average common shares outstanding (000s):
Primary 118,753 109,770
Fully diluted 129,584 130,662
----------------------------------------
Dividends declared per common share $ .15 $ .15
----------------------------------------
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 September 30
(in millions) 1996 1995
----------------------------------
Operating Activities
Direct premiums collected $ 589 $ 549
Net investment income collected 179 174
Direct losses, loss expenses and policy benefits paid (452) (412)
Net reinsurance activity 16 -
Underwriting and operating expenses paid (199) (145)
Interest paid (2) (1)
Income taxes paid (2) -
Other items, net (12) (6)
----------------------------------
Net cash provided from operating activities 117 159
----------------------------------
Investing Activities
Net (purchases) sales and maturities of short-term investments 21 (113)
Sales of fixed maturities held to maturity - 1
Maturities/repayments of fixed maturities held to maturity - 31
Purchases of fixed maturities available for sale (295) (180)
Sales of fixed maturities available for sale 137 107
Maturities/repayments of fixed maturities available for sale 104 78
Purchases of equities and other investments (22) (20)
Sales, maturities, and repayments of equities and other investments 12 17
Purchases of property and equipment (4) (9)
Disposals of property and equipment - 1
----------------------------------
Net cash provided from investing activities (47) (87)
----------------------------------
Financing Activities
Deposits for universal life and investment contracts 130 69
Withdrawals of universal life and investment contracts (90) (127)
Net borrowings of short-term debt (47) 1
Long-term borrowings - -
Repayments of long-term borrowings (8) (1)
Issuances of common stock 4 1
Repurchases of common stock (31) -
Cash dividends paid to shareholders (10) (15)
----------------------------------
Net cash used in financing activities (52) (72)
----------------------------------
(Decrease) increase in cash 18 -
Cash at beginning of period 41 97
----------------------------------
Cash at end of period $ 59 $ 97
----------------------------------
Non-cash Transactions
Coinsurance of broker SPDA block:
Transfer of investments and other assets in exchange for reinsurance receivables $ 963 $ -
See Notes to Condensed Consolidated Financial Statements.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
USF&G CORPORATION Condensed Consolidated Statement of Cash Flows (Unaudited)
<S> <C> <C>
Nine Months Ended September 30
(in millions) 1996 1995
----------------------------------
Operating Activities
Direct premiums collected $ 1,641 $ 1,554
Net investment income collected 543 550
Direct losses, loss expenses and policy benefits paid (1,310) (1,290)
Net reinsurance activity (7) 73
Underwriting and operating expenses paid (557) (556)
Interest paid (23) (22)
Income taxes paid (5) (2)
Other items, net (16) 8
----------------------------------
Net cash provided from operating activities 266 315
----------------------------------
Investing Activities
Net (purchases) sales and maturities of short-term investments (81) 37
Sales of fixed maturities held to maturity - 7
Maturities/repayments of fixed maturities held to maturity - 84
Purchases of fixed maturities available for sale (714) (628)
Sales of fixed maturities available for sale 282 239
Maturities/repayments of fixed maturities available for sale 556 244
Purchases of equities and other investments (169) (73)
Sales, maturities, and repayments of equities and other investments 162 160
Purchases of property and equipment (30) (22)
Disposals of property and equipment 2 1
----------------------------------
Net cash provided from investing activities 8 49
----------------------------------
Financing Activities
Deposits for universal life and investment contracts 297 237
Withdrawals of universal life and investment contracts (491) (524)
Net borrowings of short-term debt (18) (226)
Long-term borrowings - 228
Repayments of long-term borrowings (40) (15)
Issuances of common stock 7 5
Repurchases of common stock (57) -
Cash dividends paid to shareholders (32) (41)
----------------------------------
Net cash used in financing activities (334) (336)
----------------------------------
(Decrease) increase in cash (60) 28
Cash at beginning of period 119 69
----------------------------------
Cash at end of period $ 59 $ 97
----------------------------------
Non-cash Transactions
Coinsurance of broker SPDA block:
Transfer of investments and other assets in exchange for reinsurance receivables $ 963 $ -
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 nine-month periods ended September 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 Nine Months
Ended Ended
September 30 September 30
(in millions) 1996 1995 1996 1995
- -------------------------------------------------------------
Net income $35 $ 49 $159 $144
Adjustments to reconcile net
income to net cash provided
from operating activities:
Realized gains on investments (4) (3) (16) (7)
Facilities exit costs/(sublease - - (14) (6)
income)
Change in insurance liabilities 18 119 149 246
Change in deferred policy
acquisition costs 39 1 40 29
Change in receivables (25) (130) (152) (193)
Change in other liabilities 146 153 179 150
Change in other assets (52) (15) (50) (27)
Other items, net (40) (15) (29) (21)
--------------------------
Net cash provided from operating
activities $117 $159 $266 $315
--------------------------
Note 6 Unrealized Gains (Losses) on Investments
At September 30, 1996, gross unrealized gains and gross unrealized losses
pertaining to investments in common and preferred stocks 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 $26 million and $3 million, respectively. At September 30,
1996, there were gross unrealized gains of $103 million and gross unrealized
losses of $137 million pertaining to fixed maturities available for sale. There
were also $1 million of gross unrealized gains 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 $283
million during the nine months ended September 30, 1996, compared with a gain of
$210 million during the nine months ended September 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 nine month
period ended September 30, 1995, proceeds from sales of fixed maturities held to
maturity were $7 million. The 1995 sales were based on evidence of significant
deterioration of the issuers' creditworthiness. Gross losses of $1 million were
realized on those sales. Proceeds from sales of fixed maturities available for
sale, which exclude the F&G Life transfer of fixed maturities under a
coinsurance transaction (see Note 10), were $282 million for the nine months
ended September 30, 1996, compared with $239 million for the same period in
1995. Gross gains and gross losses of $5 million and $7 million, respectively,
were realized on 1996 sales. Gross gains of $3 million 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 nine months ended September 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 or third quarters of 1996. On November 1,
1996, USF&G entered into a definitive agreement to sublease 255,000 square feet
of the Tower being vacated by USF&G under the facilities exit plan. Sublease
income of approximately $30 million is expected to be recognized in the fourth
quarter of 1996.
In the second quarter of 1996, USF&G recognized a $12 million benefit under the
caption "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, 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 North Carolina Supreme Court has agreed to
review both decisions. 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 was held on November 12, 1996, and a decision is currently pending.
If the settlement is approved, the impact on USF&G is expected to be immaterial.
Note 10 Significant Events
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 had a current account value of approximately $950 million.
The transaction did not have a material effect on USF&G's earnings.
During the nine months ended September 30, 1996, USF&G repurchased 4.1 million
shares of its common stock. Another 1.2 million common shares were repurchased
between October 1 and November 10, 1996. On October 4, 1996, USF&G repurchased
24,000 shares of its outstanding Series B Cumulative Convertible Preferred Stock
("Series B Stock"), and 20,000 shares of Series B Stock were voluntarily
converted by a shareholder into 166,320 shares of common stock on October 29,
1996.
On October 31, 1996, United States Fidelity and Guaranty Company, a wholly-owned
subsidiary of USF&G Corporation, sold its approximate 44.5% ownership interest
in Chancellor Capital Management, Inc. USF&G expects to report a pre-tax
realized gain of approximately $78 million in the fourth quarter of 1996 as a
result of the sale.
<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 September 30, 1996 and the related condensed
consolidated statements of operations and cash flows for the three- and
nine-month periods ended September 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
November 14, 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 nine months
ended September 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 nine months
ended September 30, 1996 are compared with those for the same periods of 1995
unless otherwise noted. Financial position at September 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 13
2. Property/Casualty Insurance Operations 14
3. Life Insurance Operations 17
4. Parent and Noninsurance Operations 18
5. Investments 18
6. Financial Condition 20
7. Liquidity 21
8. Regulation 22
9. Glossary of Terms 22
1. Consolidated Results
The table below shows the major components of net income.
Three Months Nine Months
Ended Ended
September 30 September 30
(in millions) 1996 1995 1996 1995
- ---------------------------------------------------------------
Income from operations before
realized gains, facilities exit
(costs)/ sublease income,
and income taxes $31 $47 $129 $132
Net realized gains on investments 4 3 16 7
Facilities exit (costs)/sublease
income - - 14 6
Provision for income taxes - (1) - (1)
---------------------------
Net income $35 $49 $159 $144
---------------------------
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 Nine Months
Ended Ended
September 30 September 30
(in millions) 1996 1995 1996 1995
- ---------------------------------------------------------------
Property/casualty insurance $36 $ 61 $147 $176
Life insurance 13 7 36 19
Parent and noninsurance (18) (21) (54) (63)
-------------------------
Income from operations before
realized gains, facilities exit
(costs)/sublease income,
and income taxes $31 $ 47 $129 $132
-------------------------
Property/casualty segment income from operations before realized gains,
facilities exit (costs)/sublease income, and income taxes for the quarter and
nine months ended September 30, 1996 declined when compared with the same
periods of the previous year. The decline is primarily related to increased
catastrophe losses incurred during the first and third quarters of 1996, as well
as other significant weather related losses incurred during the first quarter of
1996. The continued improvement in the life insurance segment is principally due
to sales growth and 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 during the second quarter of 1996. This adjustment related primarily to
reduced property tax assessments on the Tower which resulted 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. There
was no sublease income recognized in the second or third quarters of 1996 or
1995. On November 1, 1996, USF&G entered into a definitive agreement to sublease
255,000 square feet of the Tower being vacated by USF&G under the facilities
exit plan. Sublease income of approximately $30 million is expected to be
recognized in the fourth quarter of 1996.
2. Property/Casualty Insurance Operations
Property/casualty insurance operations, the principal business segment,
accounted for 88 percent of USF&G's revenues in the third quarter of 1996
compared with 85 percent in the same period of 1995. Financial results for this
segment are as follows:
Three Months Nine Months
Ended Ended
September 30 September 30
(in millions) 1996 1995 1996 1995
- -------------------------------------------------------------------
Premiums earned* $ 651 $ 649 $1,919 $ 1,843
Losses and loss expenses incurred (503) (465) (1,416) (1,338)
Underwriting expenses (206) (217) (637) (627)
-------------------------------
Net underwriting loss (58) (33) (134) (122)
Net investment income 112 105 330 324
Other revenues and expenses, net (18) (11) (49) (26)
-------------------------------
Income from operations before
realized gains, facilities exit
(costs)/sublease income,
and income taxes $ 36 $ 61 $147 $176
-------------------------------
*See Glossary of Terms
Underwriting results for the third quarter and nine months ended September 30,
1996 deteriorated due to the impact of catastrophe losses largely related to
Hurricane Fran, which occurred during the third quarter of 1996. Increased
policyholders' dividends and foreign currency translation losses were the
primary reasons for the increase in other expenses for the first nine months of
1996.
2.1. Premiums
- --------------------------------------------------------------------------------
The following tables show the major components of premiums earned and premiums
written.
Three Months Ended September 30
1996 1995
------------------ -----------------
Premiums Premiums
(in millions) Earned Written Earned Written
- ------------------------------------------------------------------
Voluntary direct:
Commercial lines $352 $361 $330 $351
Personal lines 161 171 159 166
Surety 44 47 42 43
-------------------------------------
Total voluntary direct 557 579 531 560
Ceded reinsurance* (33) (34) (42) (36)
-------------------------------------
Net voluntary 524 545 489 524
Alternative risk transfer* 5 8 6 6
Pools and associations 13 10 20 23
Other premium adjustments - (3) (1) (10)
-------------------------------------
Total primary 542 560 514 543
-------------------------------------
Assumed reinsurance:
Finite risk* 41 40 69 63
Traditional risk 68 87 66 75
-------------------------------------
Total assumed 109 127 135 138
-------------------------------------
Total segment $651 $687 $649 $681
-------------------------------------
*See Glossary of Terms
Nine Months Ended September 30
1996 1995
------------------ -----------------
Premiums Premiums
(in millions) Earned Written Earned Written
- ------------------------------------------------------------------
Voluntary direct:
Commercial lines $1,019 $1,086 $ 946 $1,026
Personal lines 477 484 476 472
Surety 122 134 117 128
-------------------------------------
Total voluntary direct 1,618 1,704 1,539 1,626
Ceded reinsurance (102) (101) (117) (120)
-------------------------------------
Net voluntary 1,516 1,603 1,422 1,506
Alternative risk transfer 17 17 18 18
Pools and associations 42 32 56 41
Other premium adjustments - (6) (1) (18)
-------------------------------------
Total primary 1,575 1,646 1,495 1,547
-------------------------------------
Assumed reinsurance:
Finite risk 120 136 149 161
Traditional risk 224 240 199 213
-------------------------------------
Total assumed 344 376 348 374
-------------------------------------
Total segment $1,919 $2,022 $1,843 $1,921
-------------------------------------
Premiums earned for the quarter ended September 30, 1996 remained relatively
unchanged when compared to the same period of the prior year; however, premiums
earned for the nine months ended September 30, 1996 increased $76 million, or
approximately four percent, compared with the same period in 1995. Direct
voluntary premiums written in the third quarter and the first nine months of
1996 are $19 million and $78 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 September 30
1996 1995
----------------------- ----------------------
Underwriting Statutory Underwriting Statutory
(dollars in Results Loss Results Loss
millions) Ratio Ratio
- -------------------------------------------------------------------
Commercial lines $(46) 77.7% $(50) 77.1%
Personal lines (41) 92.9 (13) 73.4
Surety 15 14.0 15 33.8
Alternative risk
transfer 1 78.6 - 78.8
----------------------------------------------
Total primary (71) 77.5 (48) 73.2
Assumed reinsurance 13 75.7 15 65.2
----------------------------------------------
Total segment $(58) 77.2% $(33) 71.5%
----------------------------------------------
Voluntary $(45) 75.3% $(27) 70.7%
Involuntary (13) 182.0 (6) 97.4
----------------------------------------------
Total segment $(58) 77.2% $(33) 71.5%
----------------------------------------------
Nine Months Ended September 30
1996 1995
----------------------- --------------------
Underwriting Statutory Underwriting Statutory
(dollars in Results Loss Results Loss
millions) Ratio Ratio
- -----------------------------------------------------------------
Commercial lines $ (89) 73.7% $(105) 75.7%
Personal lines (101) 87.7 (61) 76.2
Surety 13 37.1 16 34.4
Alternative risk
transfer 2 78.5 - 78.3
--------------------------------------------
Total primary (175) 75.6 (150) 73.4
Assumed reinsurance 41 64.8 28 68.9
--------------------------------------------
Total segment $(134) 73.6% $(122) 72.6%
--------------------------------------------
Voluntary $(125) 73.1% $(105) 71.7%
Involuntary (9) 97.1 (17) 103.4
--------------------------------------------
Total segment $(134) 73.6% $(122) 72.6%
--------------------------------------------
Consolidated property/casualty underwriting ratios, calculated based on
generally accepted accounting principles ("GAAP") and statutory accounting
practices, are as follows:
Three Months Nine Months
Ended Ended
September 30 September 30
(in millions) 1996 1995 1996 1995
- --------------------------------------------------------------
GAAP underwriting
ratios:
Loss ratio 77.2% 71.5% 73.8% 72.6%
Expense ratio* 31.7 33.4 33.2 34.0
Combined ratio 108.9 104.9 107.0 106.6
Statutory underwriting
ratios:
Loss ratio 77.2 71.5 73.6 72.6
Expense ratio 30.9 32.7 32.5 33.6
Combined ratio 108.1 104.2 106.1 106.2
*See Glossary of Terms
Underwriting results deteriorated by $25 million and $12 million for the quarter
and nine months ended September 30, 1996, respectively, when compared to the
corresponding periods of 1995. The unfavorable results are driven by catastrophe
losses incurred during the third quarter, as well as catastrophe and other large
weather related losses incurred during the first quarter of the year.
Underwriting results in the third quarter and the first nine months of 1996
included $45 million and $100 million of net catastrophe losses, respectively,
compared with $4 million and $41 million in the same periods of 1995. The 1996
losses, to date, are the second-highest level of catastrophe losses for both a
quarter and a full year experienced by USF&G, exceeded only by the third quarter
and full year of 1992, which periods included the impact of Hurricane Andrew.
Excluding catastrophe losses, the statutory loss ratios for the quarter and nine
months ended September 30, 1996 were 70.3 percent and 68.4 percent,
respectively, which show improvements of 0.6 points and 2.0 points,
respectively, over the catastrophe-free ratios of the corresponding periods of
1995.
The primary businesses incurred $96 million of catastrophe losses in the first
nine months of 1996, including $31 million from Hurricane Fran in the third
quarter and $33 million from severe winter storms and floods during the first
quarter of the year. The primary business incurred most of the net catastrophe
losses for the first nine months of 1995, recognizing losses of $32 million for
losses related to Hurricane Erin, the April 1995 bombing of the federal building
in Oklahoma City, and from various other hailstorms, tornadoes, and floods.
The effects of catastrophe losses were offset somewhat by premium growth and
continued overall improvement in the quality and mix of business. Continued
expense management is also benefiting underwriting results, as evidenced by the
more than 1 point decrease in the expense ratio for the first nine months of
1996 compared with the corresponding period of 1995. 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 nine months of 1996
are due to lower catastrophe losses when compared to the same period of 1995, as
well as favorable loss experience in the current year due to the shift in the
book of business from finite risk towards traditional risk reinsurance.
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 (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 is consolidating 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 September 30
1996 1995*
-------------------------------------------
Direct Statutory Direct Statutory
(dollars in Premiums Loss Premiums Loss
millions) Written Ratio** Written Ratio**
- ---------------------------------------------------------------
CIG $268 80.7% $258 76.0%
FBIG 264 84.4 259 74.6
Surety 47 14.0 43 33.8
-------------------------------------------
Total $579 77.5% $560 73.2%
-------------------------------------------
Nine Months Ended September 30
1996 1995*
------------------------------------------
Direct Statutory Direct Statutory
(dollars in Premiums Loss Premiums Loss
millions) Written Ratio** Written Ratio**
- ---------------------------------------------------------------
CIG $ 804 73.5% $ 743 76.0%
FBIG 766 82.9 755 74.6
Surety 134 37.1 128 34.4
------------------------------------------
Total $1,704 75.5% $1,626 73.4%
------------------------------------------
* 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 September
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 September
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 10 16 3
Claims paid (9) (17) (3)
----------------------------------------
Total case and bulk reserves
at September 30, 1996 $41 $311 $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 had traditionally
been a primary coverage carrier, having written relatively little high-level
excess coverage; therefore, liability exposures were 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 12 percent of USF&G's total
revenues for the first nine months of 1996 compared with 14 percent for the same
period of 1995. F&G Life also represents 30 percent of the assets at September
30, 1996 compared with 31 percent at December 31, 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 single premium deferred annuities that was originally sold through stock
brokerage firms (the "broker SPDA block"). The broker SPDA block had a current
account value of approximately $950 million. The transaction, which had no
material effect on earnings, removed an underperforming block of business that
had significant exposure to changes in current interest rates from F&G Life's
direct obligations, and enabled the declaration of a $110 million dividend to
USF&G Corporation, thereby redeploying capital to other marketing and/or
investment opportunities.
F&G Life's financial results are as follows:
Three Months Nine Months
Ended Ended
September 30 September 30
(in millions) 1996 1995 1996 1995
- ---------------------------------------------------------------
Premiums $ 36 $ 43 $ 109 $ 125
Net investment income 63 75 210 230
Policy benefits (58) (86) (224) (282)
Underwriting and operating expenses (28) (25) (59) (54)
---------------------------
Income from operations before
realized gains, facilities
exit (costs)/sublease income,
and income taxes $ 13 $ 7 $ 36 $ 19
---------------------------
Income from operations before realized gains, facilities exit (costs)/sublease
income, and income taxes for the life insurance segment improved $6 million and
$17 million for the quarter and nine months ended September 30, 1996 when
compared with the corresponding periods of the previous year. The improvement is
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
blocks of business surrender and are replaced by newer products with higher
margins. Premiums declined mainly due to a reduced level of life contingent
structured settlement annuities sales in the quarter and nine months ended
September 30, 1996, while net investment income declined due to a reduced asset
base created by the surrender of annuities, and by the transfer of invested
assets backing the broker SPDA block. 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 Nine Months
Ended Ended
September 30 September 30
(in millions) 1996 1995 1996 1995
- -----------------------------------------------------------------
Distribution System:
Direct-structured settlements $ 21 $30 $ 63 $82
Brokerage 84 26 157 94
National wholesaler 17 22 56 70
Other 1 5 12 20
---------------------------------
Total $123 $83 $288 $266
---------------------------------
Product Type:
Structured settlement
annuities $ 21 $30 $ 63 $82
Single premium deferred
annuities 77 20 139 81
Tax sheltered annuities 17 20 55 64
Other annuities 6 6 21 26
Life insurance 2 7 10 13
---------------------------------
Total $123 $83 $288 $266
---------------------------------
Sales increased 50 percent in the third quarter of 1996 when compared with the
same period in 1995. This increase was primarily attributable to an increase in
single premium deferred annuities which were sold through the brokerage channel.
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 $10.9 billion at
September 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 $76 million and $441 million for the quarter and nine
months ended September 30, 1996. This compares with $108 million and $461
million for the same periods in 1995. Surrender activity on the broker SPDA
block represents 73 percent of total surrenders for the first nine months of
1996. Relatively low interest rates and increased competition from other
investment vehicles resulted in increased surrenders in the first half of 1996
as more of these stock broker-sold policies reached the expiration of their
surrender charge period than during the first half of 1995. With the removal of
the broker SPDA block during the third quarter of 1996, surrenders decreased
significantly and should continue to do so in the future.
4. Parent and Noninsurance Operations
Parent company interest and other unallocated expenses and noninsurance
operations are as follows:
Three Months Nine Months
Ended Ended
September 30 September 30
(in millions) 1996 1995 1996 1995
- ---------------------------------------------------------------
Parent Company Expenses:
Interest expense $(10) $(11) $(29) $(32)
Unallocated expense, net (9) (11) (27) (35)
Noninsurance operations 1 1 2 4
---------------------------
Loss from operations before
realized gains, facilities exit
(costs)/sublease income,
and income taxes $(18) $(21) $(54) $(63)
---------------------------
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 $9 million for the quarter and nine months ended September 30,
1996. The decreases are primarily attributable to reduced interest expense due
to the refinancing and repayments of corporate debt, and reduced parent company
operating expenses. In the second and third quarters 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 September 30, 1996, USF&G's investment mix is comparable with year-end 1995.
Long-term fixed maturities comprise 81 percent of total investments at September
30, 1996, and 85 percent at December 31, 1995. Fixed maturities and total
investments have decreased due to the transfer of a portion of F&G Life's fixed
maturities, and a decline in unrealized gains in the remaining fixed maturities
portfolio. The transfer of F&G Life's fixed maturities results from the
coinsurance contract to cede F&G Life's broker SPDA block. The fixed maturities
that backed the broker SPDA block reserves were transferred with the related
liabilities to an unaffiliated life insurance company (refer to section 3). The
table below shows the distribution of USF&G's investment portfolio.
At September 30, At December 31,
(dollars in millions) 1996 1995
- ---------------------------------------------------------------
Total investments $9,857 $11,107
----------------------------------------
Fixed maturities 81% 85%
Common and preferred
stocks - 1
Short-term investments 4 3
Mortgage loans and
real estate 10 8
Other invested assets 5 3
----------------------------------------
Total 100% 100%
----------------------------------------
5.1. Net investment income
- --------------------------------------------------------------------------------
The following table shows the components of net investment income.
Three Months Nine Months
Ended Ended
September 30 September 30
(dollars in millions) 1996 1995 1996 1995
- ---------------------------------------------------------------
Net investment income from:
Fixed maturities $154 $165 $483 $497
Common and preferred stocks - 1 2 3
Short-term investments 7 5 15 16
Mortgage loans and real 15 11 35 35
estate
Other investment income, net
of interest expense on
funds held 5 1 14 8
--------------------------------
Total investment income 181 183 549 559
Investment expenses (4) (4) (12) (13)
--------------------------------
Net investment income $177 $179 $537 $546
--------------------------------
Average annualized yields:
Total investments 7.0% 6.9% 6.9% 6.8%
Fixed maturities 7.3 7.4 7.3 7.4
--------------------------------
Investment income for the nine months ended September 30, 1996, has decreased $9
million or two percent when compared with the same period in 1995. Income on
fixed maturities declined for the quarter and nine months ended September 30,
1996, primarily due to the aforementioned decline in F&G Life's fixed maturities
portfolio. Investment income on mortgage loans and real estate for the quarter
ended September 30, 1996, increased primarily due to a higher investment base,
resulting from the fundings of several mortgage loans in 1996. Other investment
income includes $5 million and $6 million for the third quarter 1996 and 1995,
respectively, and $14 million and $21 million for the nine months ended
September 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. Future 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 $4 million and $8 million for the
third quarter 1996 and 1995, respectively, and $15 million and $24 million for
the nine months ended September 30, 1996 and 1995, respectively.
5.2. Realized gains (losses)
- --------------------------------------------------------------------------------
The components of net realized gains (losses) include the following:
Three Months Nine Months
Ended Ended
September 30 September 30
(in millions) 1996 1995 1996 1995
- ---------------------------------------------------------------
Net gains (losses):
Fixed maturities $(1) $ 3 $ (2) $ 3
Common and preferred stocks - - - 2
Mortgage loans and real estate - 1 4 2
Other 5 1 15 12
------------------------------
Total net gains (losses) 4 5 17 19
Impairments - (2) (1) (12)
------------------------------
Net realized gains $ 4 $ 3 $ 16 $ 7
------------------------------
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 nine
months ended September 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:
At September 30, At December 31, Change
(in millions) 1996 1995
- ------------------------------------------------------------------
Fixed maturities
available for sale $(34) $340 $(374)
Deferred policy
acquisition costs
and policy benefits
adjustment 1 (73) 74
Common and preferred
stocks (2) (2) -
Foreign currency
and other 23 6 17
------------------------------------------------
Total $(12) $271 $(283)
------------------------------------------------
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 103 basis points during the nine months ended September
30, 1996, which reduced the unrealized gain on fixed maturities available for
sale at December 31, 1995 to an unrealized loss at September 30, 1996. This was
partially offset by a related change in F&G Life's deferred policy acquisition
costs ("DPAC") and policy benefits adjustment. This 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
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. Fixed Maturity Investments
- --------------------------------------------------------------------------------
The table below details the composition of the fixed maturity portfolio.
At September 30, At December 31,
(dollars in millions) 1996 1995
- ------------------------------------------------------------------
Corporate and other
investment-grade bonds $4,779 59% $5,361 59%
Mortgage-backed securities 1,518 19 1,739 19
Asset-backed securities 770 10 999 11
U.S. Government bonds 376 5 380 4
High-yield bonds* 557 7 599 7
Tax-exempt bonds 27 - 40 -
-----------------------------------
Total fixed maturities at
amortized cost 8,027 100% 9,118 100%
Total market value of fixed
maturities 7,993 9,458
-----------------------------------
Net unrealized gains (losses) $ (34) $ 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:
At September 30, At December 31,
(in millions) 1996 1995
- ---------------------------------------------------------------
Mortgage loans $340 $254
Equity real estate,
net 627 653
------------------------------------------
Total $967 $907
------------------------------------------
The increase in the mortgage loan and real estate portfolio from December 31,
1995, is primarily due to new loan originations 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 $14.5 billion at September 30, 1996, compared with $14.7
billion at December 31, 1995. The decrease is primarily a result of the $283
million decrease in net unrealized gains (losses).
6.2. Debt
- --------------------------------------------------------------------------------
USF&G's corporate debt totaled $530 million at September 30, 1996, compared with
$591 million at December 31, 1995.
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 nine months of 1996, another $40 million was drawn
against the facility to fund the repurchase of Zero Coupon Convertible
Subordinated Notes. During the third quarter of 1996, the Corporation repaid $47
million of the outstanding balance of the committed credit facility. 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 principal,
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 5.7% at September 30, 1996.
6.3. Shareholders' equity
- --------------------------------------------------------------------------------
USF&G's shareholders' equity totaled $1.8 billion at September 30, 1996,
compared with $2.0 billion at December 31, 1995. The decrease is the result of
the $283 million decrease in net unrealized gains (losses), the repurchase of
$68 million of the corporation's common stock, and $32 million in common and
preferred stock dividends. Net income of $159 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. In September 1996, USF&G extended its common stock repurchase
plan to a maximum of eleven million shares. 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 November 10, 1996, approximately 5.3 million shares have
been repurchased.
In conjunction with the stock repurchase program, USF&G also sold 100,000 put
options on its common stock during the third quarter of 1996 and another 500,000
in October and November. These put options mature in the fourth quarter of this
year. An additional 300,000 put options on USF&G's common stock which were sold
during the second quarter expired during the third quarter.
7. Liquidity
7.1. Cash flow
- --------------------------------------------------------------------------------
USF&G had cash flow from operations of $117 million and $266 million for the
quarter and nine months ended September 30, 1996, respectively. For the
corresponding periods of 1995, cash flow from operations totaled $159 million
and $315 million, respectively. USF&G has generated positive cash flow from
operations for nine 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 inflows of $41 million in the third quarter of 1996. For
the nine months ended September 30, 1996, such contracts had net cash outflows
of $194 million. Deposits and withdrawals of universal life and investment
contracts for the quarter and nine months ended September 30, 1995 had net cash
outflows of $105 million and $229 million, respectively. Despite increased SPDA
surrender activity during the first half of 1996, cash flows have improved for
the first nine months of 1996 when compared to the corresponding period of 1995
as a result of F&G Life ceding the broker SPDA block (refer to Section 3 of this
Analysis). Cash flows are expected to continue to benefit in the future from the
F&G Life coinsurance transaction.
7.2. Credit facilities
- --------------------------------------------------------------------------------
At September 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 $55 million at September 30, 1996. There were no
borrowings against the facility at December 31, 1995. The facility has been used
during 1996 to repay the balance due upon maturity of the 5 1/2% Swiss Franc
Bonds and to repurchase Zero Coupon Convertible Subordinated Notes. Repayments
under the facility this year were made with parent company cash. 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, 1996 and December 31, 1995.
In addition, at September 30, 1996, USF&G maintained a $150 million foreign
currency credit facility. There were no borrowings on this credit facility as of
September 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 $8.0 billion at September 30,
1996, which represents 100 percent of its amortized cost. At September 30, 1996,
investments in common and preferred stocks, which are reported at market value
in the Condensed Consolidated Statement of Financial Position, totaled $38
million. Short-term investments totaled $369 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 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 September 30, 1996, 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 September 30,
1996, would be deemed extraordinary dividends.
During 1996, USF&G Company declared $134 million in dividends to USF&G
Corporation. Based on policyholders' surplus of $1,341 million at December 31,
1995, these dividends are at the threshold for qualification as "extraordinary
dividends". Therefore, any future dividends proposed by USF&G Company could be
subject to aggregation with some or all of these 1996 dividends for purposes of
determining whether an extraordinary dividend would occur as described above.
The application of the thirty-day notice requirement to dividends of USF&G
Company and 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 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.
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, agreed to 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>
Nine Months Ended September 30
(dollars in millions except per share data) 1996 1995
---------------------------------------
Net Income Available to Common Stock
Primary:
Net income $ 159 $ 144
Less preferred stock dividend requirements (14) (23)
---------------------------------------
Net income available to common stock $ 145 $ 121
---------------------------------------
Fully Diluted:
Net income $ 159 $ 144
Less preferred stock dividend requirements (12) (12)
Add interest expense on convertible notes 3 5
---------------------------------------
Net income available to common stock $ 150 $ 137
---------------------------------------
Weighted Average Shares Outstanding
Primary common shares (A) 118,753,266 109,769,809
---------------------------------------
Fully Diluted (B):
Common shares 118,753,266 109,769,809
Assumed conversion of preferred stock 2,308,106 11,557,477
Assumed exercise of stock options 2,536,315 2,107,729
Assumed conversion of zero coupon convertible subordinated notes 5,986,552 7,227,255
---------------------------------------
Total 129,584,239 130,662,270
---------------------------------------
Earnings Per Common Share
Primary (A) $1.21 $1.10
Fully diluted (B) $1.16 $1.04
---------------------------------------
(A) Shares issuable under stock options (1,617,297 shares in 1996 and 1,122,655
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
(Unaudited)
<S> <C> <C>
Nine Months Ended September 30
(dollars in millions) 1996 1995
--------------------------------------------
Fixed Charges
Interest expense $ 30 $ 34
Portion of rents representative of interest 11 15
--------------------------------------------
Total fixed charges 41 49
Preferred stock dividend requirements (A) 14 23
--------------------------------------------
Combined Fixed Charges and Preferred Stock Dividends $ 55 $ 72
--------------------------------------------
Consolidated Earnings Available for Fixed Charges and Preferred
Stock Dividends
Income from operations before income taxes $159 $145
Adjustment:
Fixed charges 41 49
--------------------------------------------
Consolidated earnings available for fixed charges and
preferred stock dividends $200 $194
--------------------------------------------
Ratio of Consolidated Earnings to Fixed Charges 4.8 3.9
Ratio of Consolidated Earnings to Combined Fixed
Charges and Preferred Stock Dividends 3.6 2.7
--------------------------------------------
(A) Preferred stock dividend requirements of $14 million in 1996 and $23 million
in 1995 divided by 100% less the effective income tax rate of 0.2% 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 September 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
November 14, 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
November 14, 1996
<TABLE> <S> <C>
<ARTICLE> 7
<MULTIPLIER> 1000000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> SEP-30-1996
<DEBT-HELD-FOR-SALE> 7993
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 39
<MORTGAGE> 340
<REAL-ESTATE> 627
<TOTAL-INVEST> 9857
<CASH> 59
<RECOVER-REINSURE> 1699
<DEFERRED-ACQUISITION> 467
<TOTAL-ASSETS> 14527
<POLICY-LOSSES> 9637
<UNEARNED-PREMIUMS> 1189
<POLICY-OTHER> 11
<POLICY-HOLDER-FUNDS> 90
<NOTES-PAYABLE> 546
0
213
<COMMON> 290
<OTHER-SE> 1263
<TOTAL-LIABILITY-AND-EQUITY> 14527
2028
<INVESTMENT-INCOME> 537
<INVESTMENT-GAINS> 16
<OTHER-INCOME> 15
<BENEFITS> 1640
<UNDERWRITING-AMORTIZATION> 553
<UNDERWRITING-OTHER> 228
<INCOME-PRETAX> 159
<INCOME-TAX> 0
<INCOME-CONTINUING> 159
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 159
<EPS-PRIMARY> 1.21
<EPS-DILUTED> 1.16
<RESERVE-OPEN> 5113
<PROVISION-CURRENT> 1511
<PROVISION-PRIOR> (95)
<PAYMENTS-CURRENT> 494
<PAYMENTS-PRIOR> 913
<RESERVE-CLOSE> 5122
<CUMULATIVE-DEFICIENCY> (95)
</TABLE>
