UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Form 10-Q
Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the Quarter Ended Commission File Number
March 31, 1997 1-8233
USF&G CORPORATION
(Exact name of registrant as specified in its charter)
Maryland 52-1220567
(State of Incorporation) (IRS Employer Identification No.)
6225 Smith Avenue, Baltimore, Maryland 21209
(Address of principal executive offices) (zip code)
Telephone: 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 __
The number of shares outstanding of the issuer's common stock as of May 9, 1997:
Common Stock, Par Value $2.50; 110,389,436 shares outstanding.
Page 1 of 24.
<PAGE>
USF&G CORPORATION Contents
PART I FINANCIAL INFORMATION
Item 1. Financial Statements:
Condensed Consolidated Statement of Financial Position 3
Condensed Consolidated Statement of Operations 4
Condensed Consolidated Statement of Cash Flows 5
Notes to Condensed Consolidated Financial Statements 6
Report of Independent Auditors 9
Item 2. Management's Discussion and Analysis of Financial Conditions
and Results of Operations 10
PART II OTHER INFORMATION
Item 1. Legal Proceedings 19
Item 2. Changes in Securities 19
Item 6. Exhibits and Reports on Form 8-K: 19
Exhibit 11 - Computation of Earnings per Share 20
Exhibit 12 - Computation of Ratio of Consolidated Earnings to
Fixed Charges, Distributions on Capital Securities
and Preferred Stock Dividends 21
Exhibit 15 - Letter Regarding Unaudited Interim Financial
Information 22
SIGNATURE 23
<PAGE>
USF&G CORPORATION Condensed Consolidated Statement of Financial Position
(Unaudited)
At March 31 At December 31
(dollars in millions except per share data) 1997 1996
-----------------------------
Assets
Investments:
Fixed maturities:
Available for sale, at market
(cost, 1997, $8,086; 1996, $8,066) $ 8,022 $ 8,164
Common and preferred stocks, at market
(cost, 1997, $20; 1996, $16) 17 16
Short-term investments 511 535
Mortgage loans 471 406
Real estate 554 554
Other invested assets 447 401
-----------------------------
Total investments 10,022 10,076
-----------------------------
Cash 91 73
Accounts, notes and other receivables 890 763
Reinsurance receivables 1,481 1,576
Servicing carrier receivables 667 661
Deferred policy acquisition costs 483 456
Other assets 851 802
-----------------------------
Total assets $14,485 $14,407
-----------------------------
Liabilities
Unpaid losses, loss expenses and policy benefits $ 9,632 $ 9,584
Unearned premiums 1,121 1,113
Corporate debt 478 477
Real estate and other debt 5 5
Other liabilities 1,288 1,159
-----------------------------
Total liabilities 12,524 12,338
-----------------------------
USF&G-obligated mandatorily redeemable preferred
capital securities of subsidiary trusts holding
solely junior subordinated deferrable interest
debentures of USF&G 200 100
-----------------------------
Shareholders' Equity
Preferred stock, par value $50.00
(12,000,000 shares authorized; shares issued,
1997, 1,999,910; 1996, 3,999,910) 100 200
Common stock, par value $2.50
(240,000,000 shares authorized; shares issued,
1997, 112,659,479; 1996, 114,240,489) 282 286
Paid-in capital 1,052 1,091
Net unrealized gains (losses) on investments
and foreign currency (40) 62
Retained earnings 367 330
----------------------------
Total shareholders' equity 1,761 1,969
----------------------------
Total liabilities, capital securities and
shareholders' equity $14,485 $14,407
----------------------------
See Notes to Condensed Consolidated Financial Statements.
<PAGE>
USF&G CORPORATION Condensed Consolidated Statement of Operations (Unaudited)
Three Months Ended March 31
(dollars in millions except per share data) 1997 1996
---------------------------
Revenues
Premiums earned $669 $667
Net investment income 172 180
Other 4 9
---------------------------
Revenues before net realized gains 845 856
Net realized gains on investments -- 11
---------------------------
Total revenues 845 867
---------------------------
Expenses
Losses, loss expenses and policy benefits 516 543
Underwriting, acquisition and operating expenses 252 259
Interest expense 9 10
Facilities exit costs/(sublease income) -- (2)
---------------------------
Total expenses 777 810
---------------------------
Income from operations before income taxes 68 57
Provision for income taxes 21 --
Distributions on USF&G-obligated mandatorily
redeemable preferred capital securities
of subsidiary trusts holding solely junior
subordinated deferrable interest debentures
of USF&G, net of tax 2 --
---------------------------
Net income $ 45 $ 57
---------------------------
Preferred stock dividend requirements 2 5
---------------------------
Net income available to common stock $ 43 $ 52
---------------------------
Primary Earnings Per Share $.37 $.43
---------------------------
Fully Diluted Earnings Per Share .36 .42
---------------------------
Weighted-average shares outstanding (000s):
Primary 117,238 119,633
Fully diluted 122,420 130,450
---------------------------
Dividends declared per common share $ .05 $ .05
---------------------------
See Notes to Condensed Consolidated Financial Statements.
<PAGE>
USF&G CORPORATION Condensed Consolidated Statement of Cash Flows (Unaudited)
Three Months Ended March 31
(in millions) 1997 1996
---------------------------
Operating Activities
Direct premiums collected $ 519 $ 518
Net investment income collected 160 174
Direct losses, loss expenses and
policy benefits paid (399) (420)
Net reinsurance activity (26) 11
Underwriting and operating expenses paid (236) (216)
Interest paid (1) (5)
Income taxes paid (2) --
Other items, net (7) (8)
---------------------------
Net cash provided from operating activities 8 54
---------------------------
Investing Activities
Net (purchases), sales and maturities of
short-term investments 23 (76)
Purchases of fixed maturities available
for sale (646) (218)
Sales of fixed maturities available for sale 562 51
Maturities/repayments of fixed maturities
available for sale 141 260
Purchases of other investments (84) (47)
Sales, maturities and repayments of
other investments 26 89
Purchase of subsidiary (24) --
Purchases of property and equipment (31) (9)
Sales of property and equipment 3 2
---------------------------
Net cash provided from (used in)
investing activities (30) 52
---------------------------
Financing Activities
Deposits for universal life and
investment contracts 128 78
Withdrawals of universal life and
investment contracts (48) (157)
Net borrowings of short-term debt -- 6
Repayments of long-term borrowings -- (21)
Issuance of capital securities 99 --
Issuances of common stock 6 --
Repurchases of common stock (35) --
Redemptions of preferred stock (100) --
Cash dividends paid to shareholders (10) (11)
---------------------------
Net cash provided from (used in)
financing activities 40 (105)
---------------------------
Increase in cash 18 1
Cash at beginning of period 73 119
---------------------------
Cash at end of period $ 91 $ 120
---------------------------
Noncash Transactions
Coinsurance of broker SPDA block:
Surrender activity $ (55) $ --
---------------------------
See Notes to Condensed Consolidated Financial Statements.
<PAGE>
USF&G CORPORATION Notes to Condensed Consolidated Financial Statements
(Unaudited)
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 1996 amounts have been reclassified to conform to the
1997 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 1996 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.
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
month periods ended March 31, 1997 and 1996. 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 SHARE ("EPS")
Primary earnings per 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 included in the 1997
calculation of primary EPS, but not included for 1996 as they were insignificant
in that period. Fully diluted earnings per share assume the conversion of all
securities whose contingent issuance would have a dilutive effect on earnings.
Refer to the computation in Exhibit 11.
In February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 128, "Earnings per Share", which
simplifies the standards for computing EPS. SFAS No. 128 replaces primary EPS
with basic EPS, which excludes common stock equivalents, and requires disclosure
of diluted EPS on the face of the income statement for all entities, such as
USF&G, with complex capital structures. SFAS No. 128 is effective for financial
statements issued for periods ending after December 15, 1997, including interim
periods; however, earlier application is not permitted. The adoption of SFAS No.
128 is not expected to have a material effect on USF&G's EPS computations or
related disclosures.
NOTE 4 RATIO OF CONSOLIDATED EARNINGS TO FIXED CHARGES
For purposes of computing the ratio of consolidated earnings to fixed charges,
distributions on capital securities 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 March 31
(in millions) 1997 1996
---------------------------
Net income $ 45 $ 57
Adjustments to reconcile net income to net
cash provided from operating activities:
Realized gains on investments -- (11)
Depreciation expense 8 7
Facilities exit costs/(sublease income) -- (2)
Provision for taxes 21 --
Change in insurance liabilities 21 31
Change in deferred policy acquisition costs (14) 18
Change in receivables (43) (52)
Change in other liabilities (22) 64
Change in other assets (1) (54)
Other items, net (7) (4)
--------------------------
Net cash provided from operating activities $ 8 $ 54
--------------------------
NOTE 6 UNREALIZED GAINS (LOSSES) ON INVESTMENTS
At March 31, 1997, gross unrealized gains and gross unrealized losses pertaining
to investments in common and preferred stocks totaled $2 million and $5 million,
respectively. In addition, gross unrealized gains and gross unrealized losses on
limited partnerships, foreign currency and other investments totaled $14 million
and $3 million, respectively. At March 31, 1997, there were gross unrealized
gains of $72 million and gross unrealized losses of $136 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 tax effect on net unrealized losses at March 31, 1997 was
a benefit of $21 million. The change in net unrealized gains (losses) on
investments and foreign currency amounted to a loss of $102 million during the
three months ended March 31, 1997, compared with a loss of $186 million during
the three months ended March 31, 1996.
NOTE 7 PROCEEDS FROM SALES OF FIXED MATURITY INVESTMENTS
Proceeds from sales of fixed maturities available for sale during the three
months ended March 31, 1997, were $562 million compared with $51 million for
the three months ended March 31, 1996. Gross gains and gross losses of
$10 million and $15 million, respectively, were realized on 1997 sales.
Gross gains and gross losses of $3 million and $2 million, respectively,
were realized on such sales in the first quarter of 1996.
NOTE 8 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 Section 8, "Legal
Contingencies and Regulation", of Management's Discussion and Analysis of
Financial Condition and Results of Operations in USF&G's 1996 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.
8.1. Workers' compensation litigation
A series of class actions have been filed against the National Council on
Compensation Insurance ("NCCI"), the insurance companies which served as
servicing carriers in various states, and the National Workers' Compensation
Reinsurance Pool ("NWCRP"). The complaints generally allege that the defendants
conspired to fix servicing carrier fees at unreasonably high and noncompetitive
levels thereby allegedly causing inflated deficits in the voluntary market,
excessive expansion of the residual market and excessive contraction of the
voluntary market. The plaintiffs generally seek unspecified compensatory and
punitive damages and in some cases civil penalties, treble damages under state
antitrust laws, and temporary and permanent injunctive relief. Plaintiffs'
counsel in these cases have, from time to time, indicated that similar cases may
be filed in other states. USF&G believes that it has meritorious defenses to
each of the class actions and has determined to defend the actions vigorously.
Each of the currently pending cases is described below.
North Carolina: On November 24, 1993, N.C. Steel, Inc., and six other North
Carolina employers filed a class action captioned N.C. Steel, Inc., et al., v.
National Council on Compensation Insurance, et al., in the General Court of
Justice, Superior Court Division, Wake County, North Carolina against the 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.
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 parties are awaiting the decision of the
North Carolina Supreme Court following a hearing of both issues on March 18,
1997.
South Carolina: On August 22, 1994, the Attorney General of the State of South
Carolina filed a suit captioned State of South Carolina, County of Greenville,
et al., v. National Council on Compensation Insurance, et al., in the County of
Greenville, South Carolina against the NCCI, the NWCRP, USF&G and seven other
insurance companies which served as servicing carriers for the South Carolina
involuntary workers' compensation market. The Attorney General alleges that the
conspiracy occurred for an unspecified period of time prior to January 1994.
Discovery is underway in the case. Each of the parties has filed motions for
summary judgment.
Kansas: On October 7, 1996, a Kansas employer filed a class action captioned
Amundson & Associates Art Studies, Ltd., et al., v. National Council on
Compensation Insurance, et al., in the District Court of Wyndotte County, Kansas
against the NCCI and the insurance companies which acted as servicing carriers
for the Kansas involuntary workers' compensation market. The defendants removed
the case to the United States District Court for the District of Kansas and the
plaintiff has filed a motion to remand the case to the state court. No discovery
has yet occurred.
Tennessee: On December 31, 1996, four Tennessee employers filed a class action
captioned Jo Ann Forman, Inc., et al., v. National Council on Compensation
Insurance, et al., in the Chancery Court of Marion County, Tennessee against the
NCCI, NWCRP and the insurance companies which acted as servicing carriers for
the Tennessee involuntary workers' compensation market. The defendants have
filed a motion to dismiss the case. No discovery has yet occurred.
Missouri: On February 20, 1997, six Missouri employers filed a class action
captioned Atlas Reserve Temporaries, Inc., et al., v. Vanliner Insurance Co., et
al., in the Circuit Court of Cole County, Missouri against the NCCI, USF&G and
other insurance companies which acted as servicing carriers for the Missouri
involuntary workers' compensation market.
No discovery has yet occurred.
8.2. Regulation
USF&G's insurance subsidiaries are subject to extensive regulatory oversight in
the jurisdictions where they do business. 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. It is not possible to predict the
future impact of increasing regulation on USF&G's operations.
<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 March 31, 1997 and the related condensed
consolidated statements of operations and cash flows for the three-month periods
ended March 31, 1997 and 1996. 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, 1996, 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 21, 1997, 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, 1996, 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
May 14, 1997
<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" or the "Corporation") and explains the results of operations for the
quarter ended March 31, 1997. The analysis focuses on the performance of USF&G's
strategic businesses and its investment portfolio. This discussion updates the
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" in the 1996 Annual Report to Shareholders and should be read in
conjunction therewith. The results of operations for the quarter ended March 31,
1997 are compared with those for the same period of 1996 unless otherwise noted.
Financial position at March 31, 1997 is compared with December 31, 1996.
In connection with, and because it desires to take advantage of, the "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: Certain prior-year amounts have been reclassified to conform to the 1997
presentation. A glossary of certain terms used in the discussion can be found in
Section 8; the terms are italicized the first time they appear in the text.
Index
1. Consolidated Results 10
2. Strategic Overview 11
3. Results of Operations 11
4. Reserves and Surplus 14
5. Investments 15
6. Financial Condition 17
7. Liquidity 17
8. Glossary of Terms 18
1.CONSOLIDATED RESULTS
The table below shows the major components of net income.
Three Months Ended March 31
(in millions) 1997 1996
---------------------------
Property/casualty insurance 79 $ 52
Life insurance 14 11
Parent and noninsurance (25) (19)
---------------------------
Income from operations before net realized gains,
facilities exit (costs)/sublease income,
income taxes and distributions on capital
securities 68 44
Net realized gains on investments -- 11
Facilities exit (costs)/sublease income -- 2
Provision for income taxes (21) --
Distributions on capital securities, net of tax (2) --
---------------------------
Net income $ 45 $ 57
---------------------------
The $27 million increase in property/casualty segment results related primarily
to improved underwriting results, including decreased catastrophe losses
incurred during the quarter. Life insurance segment results increased $3 million
for the quarter ended March 31, 1997, mainly due to improved investment spreads.
The loss from parent and noninsurance operations increased in the first quarter
of 1997 when compared with the corresponding period of the prior year due
primarily to changes in the allocation of corporate expenses which had no effect
on consolidated net income.
As of December 31, 1996, USF&G had fully recognized all of its deferred tax
assets. As a result, the Corporation now recognizes income tax expense in its
consolidated statement of operations. The financial statement recognition of tax
expense is not necessarily an appropriate indicator of income taxes to be paid,
however, as the Corporation still has income tax net operating loss
carryforwards available for both regular and alternative minimum tax purposes.
In December 1996 and January 1997, two business trusts wholly owned by USF&G
issued a total of $200 million of USF&G-obligated mandatorily redeemable
preferred capital securities. Accruals for distributions on these securities,
net of tax, totaled $2 million in the first quarter of 1997. Proceeds from the
issuance of the preferred capital securities were used to redeem the $4.10
Series A Convertible Exchangeable Preferred Stock ("Series A Preferred Stock"),
resulting in annual after-tax savings of over $5 million compared with the
dividends on the Series A Preferred Stock.
During 1994, USF&G developed and committed to a plan to consolidate its
Baltimore headquarters facilities. The plan encompassed relocating all USF&G
personnel then residing at the 40-story office building (the "Tower") in
downtown Baltimore to the Corporation's Mount Washington facilities in
Baltimore. The relocation of Tower personnel began in mid-1996 and was completed
in January 1997. In the first quarter of 1996, USF&G renegotiated and extended
sublease terms with several tenants and added one new tenant. The present value
of the additional income to be received over the term of the new leases, $2
million, was recognized in the first quarter of 1996, and is shown as a separate
item captioned "facilities exit costs/(sublease income)" in the Condensed
Consolidated Statement of Operations. As of March 31, 1997, approximately 90
percent of the Tower is sublet.
2. STRATEGIC OVERVIEW
In 1996, USF&G completed its realignment into a portfolio of businesses: the
Commercial Insurance Group ("CIG"), the Family and Business Insurance Group
("FBIG"), the Specialty Businesses, and Life Insurance. The realignment
recognizes the groups' distinctly different strategies of growth and
profitability. As individual businesses, each is able to develop its own
distinct products, distribution channels, technology systems and field
structures, and each is currently in its own stage of development, with a common
focus on long-term strategic positioning.
Further information regarding each group's business and strategy may be found in
the Strategic Overview section of Management's Discussion and Analysis of
Financial Condition and Results of Operations in USF&G's 1996 Annual Report to
Shareholders.
3.RESULTS OF OPERATIONS
3.1. Property/casualty insurance
Property/casualty insurance operations, which consist of CIG, FBIG, and the
Specialty Businesses, accounted for 90 percent of USF&G's revenues before net
realized gains in the first quarter of 1997 compared with 87 percent in the same
period of 1996, and 70 percent of its assets at March 31, 1997 and December 31,
1996. Financial results for this segment were as follows:
Three Months Ended March 31
(in millions) 1997 1996
---------------------------
Net premiums written* $644 $651
Premiums earned* 642 636
Net underwriting loss (31) (40)
Income from operations before net
realized gains, facilities exit costs/
sublease income, income taxes and
distributions on capital securities 79 52
---------------------------
*See Glossary of Terms
A significant measurement of a property/casualty company's underwriting
performance is its combined ratio, which is the sum of its loss ratio and
expense ratio. Consolidated property/casualty ratios, calculated based on
statutory accounting practices and generally accepted accounting principles
("GAAP"), were as follows:
Three Months Ended March 31
1997 1996
---------------------------
Statutory combined ratio 104.3% 105.8%
GAAP combined ratio 104.8 106.3
---------------------------
Income from operations before net realized gains, facilities exit costs/sublease
income, income taxes and distributions on capital securities increased $27
million in the first quarter of 1997 when compared with the first quarter of
1996, due primarily to improved underwriting results and a decrease in other
(nonunderwriting) expenses. The underwriting improvement is primarily
attributable to reduced occurrences in 1997 of catastrophe losses and other
severe weather related losses. Excluding catastrophe losses and a significant
workers' compensation reserve reduction taken in the 1996 period (see below),
underwriting results improved $13 million in the first quarter of 1997 when
compared with the first quarter of 1996. A change in the approach to corporate
allocations was the primary reason for the decrease in other expenses.
Gross catastrophe losses totaled $9 million in the first quarter of 1997,
compared with $36 million in the same period of 1996. These losses, net of ceded
reinsurance, were $9 million and $35 million in the first quarters of 1997 and
1996, respectively. The high level of catastrophe losses incurred in the first
quarter of 1996 was the result of severe winter storms and floods.
CIG
The following table shows underwriting results for CIG:
Three Months Ended March 31
(dollars in millions) 1997 1996
---------------------------
Gross voluntary premiums written $258 $254
Net premiums written 241 247
Underwriting gain (loss) (18) 4
GAAP Underwriting Ratios:
Loss ratio 75.6% 65.9%
Expense ratio 32.1 32.3
Combined ratio 107.7 98.2
---------------------------
Excess & surplus lines and specialized market segments, which represent 41
percent of CIG's first quarter 1997 gross premiums, grew 20 percent and 22
percent, respectively, when compared with the same period in 1996. These
increases were largely offset by a 27 percent decline in gross premiums written
in the defensive segment, as CIG continues to shift its mix of business toward
its typically higher-margin product lines.
In the first quarter of 1996, CIG recorded a $30 million reduction in workers'
compensation reserves as a result of the recognition of the effect on reserve
estimation models of the significant use of structured settlements to close
medical claims. Excluding catastrophe losses and this one-time reserve
adjustment, underwriting results for CIG improved $1 million in the first
quarter of 1997 when compared with the same period in 1996, with a corresponding
0.5 point reduction in the combined ratio. These improvements are the result of
the continued success of CIG's strategies to improve its mix of business and
control expenses.
FBIG
The following table shows underwriting results for FBIG:
Three Months Ended March 31
(dollars in millions) 1997 1996
---------------------------
Gross voluntary premiums written $241 $243
Net premiums written 228 236
Underwriting loss (22) (57)
GAAP Underwriting Ratios:
Loss ratio 75.6% 88.0%
Expense ratio 33.9 35.4
Combined ratio 109.5 123.4
---------------------------
FBIG gross voluntary premiums were relatively flat in the first quarter of 1997
when compared with the same period in 1996, primarily due to intense competition
in the personal lines markets. Management's announcement in the third quarter of
1996 that it will lower the commission rates on most of its personal and some
small commercial business, effective April 1, 1997, also had an adverse impact
on new business writings.
FBIG incurred most of the catastrophe and other severe weather related losses
which adversely impacted the first quarter 1996 loss ratio. Excluding
catastrophes, loss ratios for FBIG were 73.7 and 78.3, respectively, for the
first quarters of 1997 and 1996. Additionally, the expense ratio improved 1.5
points in the first quarter of 1997 when compared with the first quarter of
1996, as a result of continued expense management. This expense ratio
improvement is expected to continue throughout 1997, as FBIG realizes the
operating efficiencies generated by the Centers for Agency Services and expense
savings as a result of the lower commission rates.
Specialty Businesses
USF&G's Specialty Businesses consist of Discover Re Managers, Inc. ("Discover
Re"), which provides insurance, reinsurance and related services to the
alternative risk transfer market, F&G Re, Inc. ("F&G Re"), which manages USF&G's
assumed reinsurance business, and the Surety Group.
Discover Re
The following table shows underwriting results for Discover Re:
Three Months Ended March 31
(dollars in millions) 1997 1996
---------------------------
Gross program premium $26 $22
Net premiums written 4 3
Service fees 3 2
Underwriting gain -- --
GAAP Underwriting Ratios:
Loss ratio 78.9% 78.7%
Expense ratio 14.3 14.6
Combined ratio 93.2 93.3
---------------------------
Discover Re's captive business gross program premiums increased more than 50
percent in the first quarter of 1997 when compared with the first quarter of
1996, resulting in the 15 percent increase in total gross program premium. For
the three months ended March 31, 1997, captive business represented 56 percent
of Discover Re's gross program premium, compared with 43 percent in the
corresponding period of 1996. Management is shifting the program mix toward
captive business which, despite typically retaining less of such premium, is
expected to generate significant fee income compared with the core products.
F&G Re
The following table shows underwriting results for reinsurance assumed through
F&G Re:
Three Months Ended March 31
(dollars in millions) 1997 1996
---------------------------
Net Premiums Written:
Traditional risk $ 80 $ 86
Finite risk 38 43
---------------------------
Total premiums written $ 118 $129
---------------------------
Underwriting gain $ 8 $ 15
---------------------------
GAAP Underwriting Ratios:
Loss ratio 65.6% 59.1%
Expense ratio 28.1 27.9
Combined ratio 93.7 87.0
---------------------------
F&G Re's net premiums written decreased $11 million in the first quarter of 1997
when compared with the same period of the previous year as a result of
competitive pressures in the assumed reinsurance market. Management's adherence
to its underwriting discipline has resulted in the sacrifice of some premium
volume in favor of maintaining the profitability of F&G Re's book of business.
The intense pricing competition is expected to continue throughout 1997.
Surety
The following table shows underwriting results for the Surety Group:
Three Months Ended March 31
(dollars in millions) 1997 1996
---------------------------
Gross voluntary premiums written $60 $41
Net premiums written 53 36
Underwriting gain (loss) 5 (2)
GAAP Underwriting Ratios:
Loss ratio 37.1% 56.3%
Expense ratio 51.5 53.9
Combined ratio 88.6 110.2
---------------------------
Surety's gross premiums written increased 46 percent in the first quarter of
1997 when compared with the same period of the previous year. This increase,
largely in international surety business, was primarily the result of the
inclusion of Afianzadora Insurgentes, S.A. de C.V. ("Afianzadora"), in Surety's
results of operations for the first quarter of 1997. USF&G acquired Afianzadora
in December 1996; therefore, its results were not included in USF&G's 1996
results of operations. Surety's first quarter 1997 underwriting results and loss
ratio improved when compared with the same period in 1996, largely due to the
absence in the 1997 period of large contract surety losses which were incurred
in the first quarter of 1996.
3.2. Life insurance
Life insurance operations consist of the consolidated operations of Fidelity and
Guaranty Life Insurance Company ("F&G Life"), a wholly-owned subsidiary of USF&G
Corporation. F&G Life represented 10 percent of USF&G's revenues before net
realized gains for the first quarter of 1997 compared with 12 percent for the
same period of 1996. F&G Life also represented 30 percent of the assets at March
31, 1997 compared with 29 percent at December 31, 1996. Financial highlights for
F&G Life were as follows:
Three Months Ended March 31
(in millions) 1997 1996
---------------------------
Sales $114 $77
Premiums earned 27 31
Net investment income 58 74
Income from operations before net
realized gains, facilities exit costs/
sublease income, income taxes and
distributions on capital securities $ 14 $11
---------------------------
F&G Life's premiums earned declined in the first quarter of 1997 when compared
with the same period in 1996 due to a reduction in sales of structured
settlement annuities. Structured settlement annuities are sold primarily to the
property/casualty segment to settle insurance claims. The decline in sales of
these annuities resulted from a higher-than-average level of structured
settlement annuities which the property/casualty segment purchased in prior
years as part of its efforts to settle older claims. Net investment income
declined due to a lower asset base created by the transfer of approximately $918
million of F&G Life's fixed maturities to an unaffiliated life insurance company
as part of a coinsurance transaction (see below). Despite the decrease in
premiums earned and net investment income, income for the quarter ended March
31, 1997 increased when compared with the same period in 1996, primarily due to
improved spread management on annuity and universal life products, which yield
higher profit margins on F&G Life's book of business.
Sales
The following table shows life insurance and annuity sales (premiums and
deposits) by distribution system and product type.
Three Months Ended March 31
(in millions) 1997 1996
---------------------------
Distribution System:
Brokerage $ 75 $29
National wholesaler 24 20
Direct structured settlements 11 21
Other 4 7
---------------------------
Total $114 $77
---------------------------
Product Type:
Single premium deferred annuities $70 $23
Tax sheltered annuities 22 20
Structured settlement annuities 11 21
Other annuities 7 9
Life insurance 4 4
---------------------------
Total $114 $77
---------------------------
The growth in sales of single premium deferred annuities ("SPDAs") is primarily
due to management's continued marketing emphasis on its new and existing
products and distribution channels as well as the increased interest rate
environment. Despite this marketing emphasis, demand for its products is
affected by fluctuating interest rates and the relative attractiveness of
alternative investment, annuity or insurance products, as well as its credit
ratings. As a result, there is no assurance that the improved sales trend will
continue. Total life insurance in force was $10.5 billion at March 31, 1997 and
$10.7 billion at December 31, 1996.
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.
In August 1996, F&G Life entered into a coinsurance contract with an
unaffiliated life insurance company whereby F&G Life ceded all of its remaining
block of SPDAs that were originally sold through stock brokerage firms (the
"broker SPDA block"). At the time of the transaction, which removed the accounts
from F&G Life's direct obligations, the broker SPDA block had a current account
value of approximately $964 million. As of March 31, 1997, surrender activity
under the coinsurance contract had reduced the broker SPDA block and the related
reinsurance receivable to $717 million.
Policy surrenders totaled $39 million for the three months ended March 31, 1997,
compared with $141 million for the same period in 1996. Surrender activity has
decreased significantly due primarily to the coinsurance of the broker SPDA
block. This reduced level of surrenders is expected to continue throughout 1997.
4.RESERVES AND SURPLUS
4.1. Mass torts
USF&G categorizes long-term exposures where multiple claims relate to a similar
cause of loss (excluding catastrophes) as "mass torts". Mass tort exposures
include construction defect, 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 mass torts, net of ceded reinsurance,
comprised approximately nine percent and ten percent of total net property/
casualty reserves for unpaid losses and loss expenses at March 31, 1997
and December 31, 1996, respectively.
The following table sets forth selected information for each of the major
categories of mass torts, net of ceded reinsurance.
Construction
(in millions) Defect Environmental Asbestos
--------------------------------------------
Net reserves at
December 31, 1996 $40 $308 $135
Losses incurred 6 6 (4)
Claims paid (4) (9) (1)
---------------------------------------------
Net reserves at
March 31, 1997 $42 $305 $130
---------------------------------------------
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
has not included 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 financial
condition or results of operations.
4.2. Liquidity restrictions
There are certain restrictions on payments of dividends by insurance
subsidiaries that may limit USF&G Corporation's ability to receive funds from
its subsidiaries. Under the Maryland Insurance Code, Maryland insurance
subsidiaries, such as United States Fidelity and Guaranty Company ("USF&G
Company") and F&G Life, must provide the Maryland Insurance Commissioner (the
"Commissioner") with not less than thirty days' prior written notice before
payment of an "extraordinary dividend" to its holding company. "Extraordinary
dividends" are dividends which, together with any dividends paid during the
immediately preceding twelve-month period, would be in excess of ten percent of
the subsidiary's statutory policyholders' surplus as of the prior calendar year
end.
On 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 and subject to the thirty-day
notice period. The application of the thirty-day notice requirement to dividends
of its subsidiaries is not expected to materially affect the liquidity of USF&G
Corporation.
5.INVESTMENTS
USF&G's investment mix continues to reflect a concentration in high-quality
fixed-income securities. Long-term fixed maturities comprised 80 percent of
total investments at March 31, 1997, compared with 81 percent at December 31,
1996. Fixed maturities and total investments have decreased primarily due to a
decline in unrealized gains in the fixed maturities portfolio. The following
table shows the distribution of USF&G's investment portfolio.
At March 31 At December 31
(dollars in millions) 1997 1996
-----------------------------
Total investments $10,022 $10,076
-----------------------------
Fixed maturities 80% 81%
Common and preferred stocks -- --
Short-term investments 5 5
Mortgage loans and real estate 10 10
Other invested assets 5 4
-----------------------------
Total 100% 100%
-----------------------------
5.1. Net investment income
The following table shows the components of net investment income.
Three Months Ended March 31
(dollars in millions) 1997 1996
---------------------------
Net investment income from:
Taxable fixed maturities $140 $164
Tax-exempt fixed maturities 7 1
Common and preferred stocks -- 1
Short-term investments 8 4
Mortgage loans and real estate 17 10
Other investment income, net of
interest expense on funds held 4 4
---------------------------
Total investment income 176 184
Investment expenses (4) (4)
---------------------------
Net investment income $172 $180
---------------------------
Average Annualized Yields:
Total investments 7.0% 6.7%
Fixed maturities 7.3% 7.3%
---------------------------
Investment income for the three months ended March 31, 1997, decreased $8
million, or five percent, when compared with the same period in 1996. Income
from fixed maturities declined primarily due to the decline in F&G Life's fixed
maturities portfolio due to the transfer of fixed maturities to an unaffiliated
life insurance company under the terms of a coinsurance contract (refer to
Section 3.2 of this Analysis). Fluctuations in short-term interest income is a
result of varying short-term interest rates, as well as fluctuations in the
asset balances. Investment income on mortgage loans and real estate for 1997
reflects the strategy of reducing equity real estate holdings and reinvesting
into income-producing commercial mortgage loans. Other investment income
includes $4 million and $5 million in the first quarters of 1997 and 1996,
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 in the property/casualty reinsurance industry.
5.2. Net realized gains on investments
The components of net realized gains include the following:
Three Months Ended March 31
(in millions) 1997 1996
---------------------------
Net Gains (Losses) on Sales:
Fixed maturities $ (5) $ 1
Common and preferred stocks -- --
Mortgage loans and real estate -- 4
Other 5 6
---------------------------
Total net gains from sales -- 11
Impairments -- --
---------------------------
Net realized gains on investments $-- $11
---------------------------
Realized losses on fixed maturities in 1997 relate to the sale of taxable bonds
in order to reinvest the proceeds in tax-exempt bonds. Realized gains of $4
million on mortgage loans and real estate in 1996 is a result of the sale of a
real estate investment. Other realized gains in 1997 and 1996 primarily relate
to USF&G's share of gains from its equity in certain venture capital-type
limited partnerships.
5.3. Unrealized gains (losses)
The components of the changes in unrealized gains (losses) were as follows:
At March 31 At December 31
(in millions) 1997 1996 Change
---------------------------------------
Fixed maturities
available for sale $(64) $ 98 $(162)
Deferred policy acquisition
costs and policy
benefits adjustment (5) (19) 14
Common and preferred stocks (3) -- (3)
Foreign currency and other 11 16 (5)
---------------------------------------
Total unrealized gains (losses)
before taxes (61) 95 (156)
Deferred tax on net unrealized
(gains) losses 21 (33) 54
---------------------------------------
Total unrealized gains (losses),
net of tax $(40) $62 $(102)
---------------------------------------
Fixed maturity investments classified as "available for sale" are recorded at
market value, with the corresponding unrealized gains (losses) reported as a
component of shareholders' equity. Fluctuations in the unrealized gains and
losses on fixed maturities is primarily a result of fluctuating interest rates.
Yields on U.S. Treasuries with 2- to 30-year maturities increased an average of
51 basis points during the three months ended March 31, 1997, which reduced the
unrealized gain on fixed maturities available for sale at December 31, 1996, to
an unrealized loss at March 31, 1997. Unrealized gains and losses on fixed
maturities are partially offset by related changes in the DPAC and policy
benefits adjustment, which reflects assumptions about the effect of potential
sales of fixed maturities available for sale on future amortization of the life
insurance segment's DPAC.
5.4. Fixed maturity investments
The table below details the composition of the fixed maturity portfolio.
At March 31 At December 31
(dollars in millions) 1997 % 1996 %
----------------------------------
Corporate and other invest-
ment grade bonds $4,420 55% $4,673 58%
Mortgage-backed securities 1,505 19 1,464 18
Asset-backed securities 650 8 731 9
Tax-exempt bonds 651 8 316 4
High-yield bonds* 511 6 548 7
U.S. Government bonds 349 4 334 4
----------------------------------
Total fixed maturities at
amortized cost 8,086 100 8,066 100
Total market value of
fixed maturities 8,022 8,164
----------------------------------
Net unrealized
gains (losses) $ (64) $ 98
----------------------------------
Percent market-to-
amortized cost 99% 101%
----------------------------------
*See Glossary of Terms
Fluctuating interest rates, which result in inversely changing bond prices, are
responsible for the decrease in the overall market-to-amortized cost ratio from
December 31, 1996 to March 31, 1997.
While subject to prepayment risk, credit risk related to USF&G's mortgage-backed
securities portfolio at March 31, 1997, is believed to be minimal since 99
percent of such securities have AAA ratings or are collateralized by obligations
of the U.S. Government or its agencies. The net proceeds from sales, maturities
and prepayments in 1997 were predominately reinvested in investment-grade
taxable and tax-exempt bonds. Investment-grade bonds, including debt obligations
of the U.S. Government and its agencies, comprised 94 percent and 93 percent of
the portfolio at March 31, 1997 and December 31, 1996, respectively. The
following table shows the credit quality of the long-term fixed maturity
portfolio at March 31, 1997.
Percent
Market-to-
Amortized Market Amortized
(dollars in millions) Cost Percent Value Cost
-------------------------------------------
U.S. Government and
U.S. Government
Agencies $1,826 22% $1,824 100%
AAA 1,358 17 1,341 99
AA 1,311 16 1,283 98
A 1,977 25 1,958 99
BBB 1,103 14 1,099 100
BB 232 3 234 101
B 278 3 281 101
CCC and lower 1 -- 2 125
-------------------------------------------
Total $8,086 100% $8,022 99%
-------------------------------------------
The information on credit quality in the preceding table is based upon the
higher of the rating assigned to each issue by either Standard & Poor's or
Moody's. Where neither Standard & Poor's nor Moody's has assigned a rating to a
particular fixed maturity issue, classification is based on 1) ratings available
from other recognized rating services; 2) ratings assigned by the National
Association of Insurance Commissioners; or 3) an internal assessment of the
characteristics of the individual security, if no other rating is available.
High-yield investments generally involve a greater degree of risk than
investment-grade securities. Expected returns should, however, compensate for
the added risk. USF&G attempts to minimize the risks associated with high-yield
investments by limiting the exposure to any one issuer and by closely monitoring
the creditworthiness of such issuers. At March 31, 1997, USF&G's five largest
investments in high-yield bonds totaled $66 million in amortized cost and had a
market value of $64 million. USF&G's largest single high-yield bond exposure
represented five percent of the high-yield portfolio and less than one percent
of the total fixed maturity portfolio.
5.5. Real Estate
The table below shows the components of USF&G's real estate portfolio.
At March 31 At December 31
(in millions) 1997 1996
-------------------------------
Mortgage loans $ 471 $406
Equity real estate 554 554
-------------------------------
Total $1,025 $960
-------------------------------
The increase in the real estate portfolio from December 31, 1996 to March 31,
1997 was due to new mortgage loan originations consisting of fixed-rate loans
collateralized by office and apartment properties.
Mortgage loans and real estate 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, analyzed and acted upon if appropriate. 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 were 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.
6.FINANCIAL CONDITION
USF&G's shareholders' equity totaled $1.8 billion at March 31, 1997, compared
with $2.0 billion at December 31, 1996. The decrease is the result of the $102
million decrease in net unrealized gains and the redemption of $100 million, or
50 percent, of the Series A Preferred Stock. The remaining balance of the Series
A Preferred Stock was redeemed on April 14, 1997. Redemptions of the Series A
Preferred Stock were funded by proceeds from the December 1996 and January 1997
issuances of $200 million of USF&G-obligated mandatorily redeemable preferred
capital securities of subsidiary trusts holding solely junior subordinated
deferrable interest debentures of USF&G.
During 1996, USF&G announced a plan to repurchase up to 13.3 million shares of
the Corporation's common stock and common stock equivalents. As of December 31,
1996, 8.6 million shares had been repurchased. During the quarter ended March
31, 1997, USF&G repurchased 2.3 million shares, and, by mid-April 1997, another
2.4 million shares were repurchased and the program was completed. It is
uncertain at this time if, or to what extent, USF&G will expand the repurchase
program beyond those shares already reacquired, except that the Board of
Directors has authorized repurchases reasonably designed to offset the impact of
share issuance pursuant to director and employee incentive compensation
programs. Management and the Board of Directors will continue to evaluate share
repurchases as an alternative use of excess capital and cash flow, depending on
other investment opportunities.
7.LIQUIDITY
Liquidity is a measure of an entity's ability to secure enough cash to meet its
contractual obligations and operating needs. USF&G requires cash primarily to
pay policyholders' claims and benefits, debt and dividend obligations, and
operating expenses. USF&G's sources of cash include cash flow from operations,
credit facilities, marketable securities and sales of other assets. Management
believes that internal and external sources of cash will continue to exceed
USF&G's short-term and long-term operating needs.
7.1. Cash flow
USF&G had cash flow from operations of $8 million and $54 million for the
quarters ended March 31, 1997 and 1996, respectively. This decrease in cash flow
from operations is primarily due to a $37 million reduction in net reinsurance
activity resulting primarily from the expected decline in F&G Re's finite
reinsurance activity in the first quarter of 1997, as well as a $14 million
decrease in net investment income collected following the transfer of
approximately $918 million of F&G Life's fixed maturity investments as part of a
coinsurance contract (refer to Section 3.2 of this Analysis). However, the
coinsurance transaction also reduced F&G Life's exposure to cash outflows for
surrender activity. Consequently, deposits and withdrawals of universal life and
investment contracts had net cash inflows of $80 million in the first quarter of
1997, which for GAAP purposes are classified as financing activities, compared
with net cash outflows of $79 million in the first quarter of 1996.
7.2. Credit facilities
At March 31, 1997, USF&G maintained a $250 million committed, standby credit
facility with a group of foreign and domestic banks. In addition, USF&G
maintained a $150 million multi-currency credit facility. There were no
borrowings against these facilities at March 31, 1997 or December 31, 1996. 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 March 31, 1997 and December 31, 1996.
8. GLOSSARY OF TERMS
Account value: Deferred annuity cash value available to policyholders before the
assessment of surrender charges.
Catastrophe losses: Property/casualty insurance claim losses resulting from a
sudden calamitous event, such as a severe storm, are categorized as
"catastrophes" when they meet certain severity and other criteria determined by
a national organization.
Expense ratio: The ratio of underwriting expenses to net premiums written, if
determined in accordance with statutory accounting practices ("SAP"), or the
ratio of underwriting expenses (adjusted by deferred policy acquisition costs)
to earned premiums, if determined in accordance with GAAP.
High-yield bonds: Fixed maturity investments with credit ratings 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.
Investment spreads: The difference between the interest rates earned on invested
assets and the interest rates credited to policyholders.
Loss ratio: The ratio of incurred losses and loss expenses to earned premiums,
determined in accordance with SAP or GAAP.
Net premiums written: Premiums retained by an insurer, after the assumption and
cession of reinsurance.
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.
Premiums earned: The portion of premiums written applicable to the expired
period of policies.
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. It is not unusual for property/casualty
companies to have underwriting losses that are offset by investment income.
<PAGE>
USF&G CORPORATION Part II. Other Information
ITEM 1.LEGAL PROCEEDINGS
See Note 8.1 of the Notes to Condensed Consolidated Financial Statements
regarding the filing of a lawsuit in the State of Missouri relating to certain
workers' compensation litigation.
ITEM 2.CHANGES IN SECURITIES
(a) On March 11, 1997, the Registrant entered into an Amended and Restated
Rights Agreement with the Bank of New York (the "Rights Agreement") relating to
the Registrant's preferred share purchase rights (the "Rights"). The key
provisions of the amendments extend the expiration date of the Rights Agreement
to October 14, 2007, decrease the exercise price of the Rights to $105, reduce
to 15 percent the ownership threshold at which the Rights issued pursuant to the
Rights Agreement will become exercisable and convert into the right to purchase
common shares with a value equal to twice the exercise price, require
"disinterested directors" of the Board of Directors to approve certain actions
under the Rights Agreement, and permit the Board of Directors to exchange the
Rights for Common Shares under certain circumstances. Reference is made to the
Registrant's Form 8-K filed on March 13, 1997.
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, distributions on
capital securities 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 January 10, 1997, reporting under Item 5,
Other Events, the completion of two preferred capital securities offerings and
the related issuances of the Registrant's debentures, raising $200 million, and
the call for redemption on January 31, 1997, of 2.0 million, or 50 percent, of
its outstanding $4.10 Series A Convertible Exchangeable Preferred Stock.
The Registrant filed a Form 8-K on March 13, 1997, reporting under Item 5, Other
Events, and Item 7, Financial Statements, Pro Forma Financial Information and
Exhibits, an Amended and Restated Rights Agreement between the Registrant and
the Bank of New York, as Rights Agent.
The Registrant filed a Form 8-K on March 26, 1997, reporting under Item 5, Other
Events, the call for redemption on April 14, 1997 of all remaining outstanding
shares of its $4.10 Series A Convertible Exchangeable Preferred Stock.
<PAGE>
USF&G CORPORATION Exhibit 11 - Computation of Earnings Per Share (Unaudited)
Three Months Ended March 31
(dollars in millions except per share data) 1997 1996
---------------------------------
Net Income Available to Common Stock
Primary:
Net income $ 45 $ 57
Less preferred stock dividend
requirements (2) (5)
---------------------------------
Net income available to common stock $ 43 $ 52
---------------------------------
Fully diluted:
Net income $ 45 $ 57
Less preferred stock dividend requirements (2) (4)
Add interest expense on zero coupon
convertible notes 1 1
---------------------------------
Net income available to common stock $ 44 $ 54
---------------------------------
Weighted-Average Shares Outstanding
Primary:
Common shares 113,575,610 119,633,350
Common stock equivalents (A) 3,662,840 --
---------------------------------
Total primary shares 117,238,450 119,633,350
---------------------------------
Fully diluted (B):
Common shares 113,575,610 119,633,350
Common stock equivalents 3,662,840 1,529,202
Assumed conversion of preferred stock -- 2,308,106
Assumed conversion of zero coupon
convertible notes 5,181,588 6,979,647
---------------------------------
Total fully diluted shares 122,420,038 130,450,305
---------------------------------
Earnings Per Share
Primary (A) $.37 $.43
Fully diluted (B) .36 .42
---------------------------------
(A) In 1996, 1,529,202 shares issuable under stock options were not used in the
computation of primary earnings per share presented on the face of the Condensed
Consolidated Statement of Operations because the dilutive effect was not
material.
(B) Fully diluted earnings per share amounts are calculated assuming the
conversion of all securities whose contingent issuance would have a dilutive
effect on earnings.
<PAGE>
USF&G CORPORATION Exhibit 12 - Computation of Ratio of Consolidated Earnings to
Fixed Charges, Distributions on Capital
Securities and Preferred Stock Dividends
(Unaudited)
Three Months Ended March 31
(dollars in millions) 1997 1996
---------------------------
Fixed charges
Interest expense $ 9 $10
Portion of rents representative of interest 2 3
---------------------------
Total fixed charges 11 13
Distributions on capital securities 4 --
Preferred stock dividend requirements (A) 2 5
---------------------------
Combined Fixed Charges, Distributions on
Capital Securities and Preferred Stock Dividends $17 $18
---------------------------
Consolidated Earnings Available
Income from operations before income taxes $68 $57
Adjustment:
Fixed charges 11 13
---------------------------
Consolidated earnings available for fixed charges,
distributions on capital securities and
preferred stock dividends $79 $70
---------------------------
Ratio of Consolidated Earnings to Fixed Charges 7.3 5.2
Ratio of Consolidated Earnings to Combined
Fixed Charges, Distributions on Capital
Securities and Preferred Stock Dividends 4.6 3.9
---------------------------
(A) Preferred stock dividend requirements of $2 million and $5 million in 1997
and 1996, respectively, divided by 100% less the effective income tax rate of
30.2% in 1997 and 0.5% in 1996.
<PAGE>
USF&G CORPORATION Exhibit 15 - Letter Regarding Interim Financial Information
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, 33-65471 and
333-13685 on Form S-3 and Numbers 2-72026, 2-61626, 2-98232, 33-16111, 33-38113,
33-35095, 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 USF&G Corporation, of our report
on the unaudited condensed consolidated interim financial statements of USF&G
Corporation which is in this Quarterly Report (Form 10-Q) for the quarter ended
March 31, 1997.
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 & YOUNGLLP
Baltimore, Maryland
May 14, 1997
<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
/s/DAN L. HALE
Dan L. Hale
Executive Vice President and
Chief Financial Officer
Dated at Baltimore, Maryland
May 14, 1997
<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
EXHIBITS TO QUARTERLY REPORT ON FORM 10-Q
USF&G CORPORATION
For the Quarter Ended Commission File Number
March 31, 1997 1-8233
A copy of all other of the Corporation's Exhibits to the March 31, 1997
Form 10-Q report not included herein may be obtained without charge
upon written request to John F. Hoffen, Jr., corporate secretary,
at the corporate Headquarters:
6225 Smith Avenue
Baltimore, Maryland 21209
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