<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-----------------------
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
---------------------------
Date of Report (Date of earliest
event reported): December 31, 1997
THE ST. PAUL COMPANIES, INC.
------------------------------------------------------
(Exact name of Registrant as specified in its charter)
Minnesota 0-3021 41-0518860
- ----------------------- --------------------- ---------------------
(State of Incorporation) (Commission File Number) (I.R.S. Employer
Identification No.)
385 Washington St., St. Paul, MN 55102
--------------------------------- ------
(Address of principal executive offices) (Zip Code)
(651) 310-7911
----------------------------------
(Registrant's telephone number,
including area code)
N/A
-------------------------------------------------------------
(Former name or former address, if changed since last report)
1
<PAGE>
Item 5. Other Events.
------------------------------------------
Filed herewith are supplemental financial statements and related exhibits for
The St. Paul Companies, Inc. (The St. Paul) as of December 31, 1997 and 1996,
and for each of the years ended December 31, 1997, 1996 and 1995, which
reflect the audited combined results of The St. Paul and USF&G Corporation
(USF&G). The St. Paul merged with USF&G in a pooling-of-interests
transaction consummated on April 24, 1998. The combined company operates
under The St. Paul name and is headquartered in Saint Paul, Minn.
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
By /s/ Bruce A. Backberg
-----------------------------
Bruce A. Backberg
Senior Vice President
and Chief Legal Counsel
Date: October 6, 1998
2
<PAGE>
INDEPENDENT AUDITORS' REPORT
THE BOARD OF DIRECTORS AND SHAREHOLDERS
THE ST. PAUL COMPANIES, INC.:
We have audited the accompanying supplemental consolidated balance sheets of
The St. Paul Companies, Inc. and subsidiaries as of December 31, 1997 and
1996, and the related supplemental consolidated statements of income,
shareholders' equity, comprehensive income and cash flows for each of the
years in the three-year period ended December 31, 1997. These supplemental
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these supplemental
consolidated financial statements based on our audits. We did not audit the
consolidated financial statements of USF&G Corporation, a wholly-owned
subsidiary, which statements reflect total assets constituting 43 percent and
41 percent as of December 31, 1997 and 1996 and total revenues constituting
35 percent, 38 percent and 41 percent for the years ended December 31, 1997,
1996 and 1995, respectively, of the related consolidated totals. Those
statements were audited by other auditors whose report has been furnished to
us, and our opinion, insofar as it relates to the amounts included for USF&G
Corporation, is based solely on the report of the other auditors.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
The supplemental consolidated financial statements give retroactive effect to
the merger of The St. Paul Companies, Inc. and USF&G Corporation on April 24,
1998, which has been accounted for as a pooling of interests as described in
Notes 1 and 13 to the supplemental consolidated financial statements.
Generally accepted accounting principles proscribe giving effect to a
consummated business combination accounted for by the pooling-of-interests
method in financial statements that do not include the date of consummation.
These financial statements do not extend through the date of consummation.
However, they will become the historical consolidated financial statements of
The St. Paul Companies, Inc. and subsidiaries after financial statements
covering the date of consummation of the business combination are issued.
In our opinion, based on our audits and the reports of the other auditors,
the supplemental consolidated financial statements referred to above present
fairly, in all material respects, the financial position of The St. Paul
Companies, Inc. and subsidiaries as of December 31, 1997 and 1996, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1997, in conformity with generally
accepted accounting principles applicable after financial statements are
issued for a period which includes the date of consummation of the business
combination.
/s/ KPMG PEAT MARWICK LLP
- -------------------------
KPMG PEAT MARWICK LLP
Minneapolis, Minnesota
June 30, 1998
3
<PAGE>
REPORT OF INDEPENDENT AUDITORS
Board of Directors
USF&G Corporation
We have audited the consolidated statement of financial position of USF&G
Corporation as of December 31, 1997 and 1996, and the related consolidated
statements of operations, cash flows and shareholders' equity for each of the
three years in the period ended December 31, 1997 included in USF&G
Corporation's Current Report (Form 8-K) dated February 26, 1998, filed with
the Securities and Exchange Commission. These financial statements are the
responsibility of the Corporation's management. Our responsibility is to
express an opinion on these financial statements based on our audits. These
financial statements are not included herein.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of USF&G
Corporation at December 31, 1997 and 1996, and the consolidated results of
its operations and its cash flows for each of the three years in the period
ended December 31, 1997, in conformity with generally accepted accounting
principles.
/s/ ERNST & YOUNG LLP
- ---------------------
ERNST & YOUNG LLP
Baltimore, Maryland
February 20, 1998
4
<PAGE>
THE ST. PAUL COMPANIES
<TABLE>
<CAPTION>
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF INCOME Year ended December 31
- ----------------------------------------------------------------------------------------------------------------------
(In thousands) 1997 1996 1995
<S> <C> <C> <C>
REVENUES
Premiums earned $7,298,100 $7,178,682 $6,637,136
Net investment income 1,577,805 1,512,575 1,474,068
Realized investment gains 423,048 261,989 91,807
Asset management-investment banking 261,715 219,922 221,007
Other 62,511 58,369 90,942
- ----------------------------------------------------------------------------------------------------------------------
Total revenues 9,623,179 9,231,537 8,514,960
- ----------------------------------------------------------------------------------------------------------------------
EXPENSES
Insurance losses and loss adjustment expenses 5,093,521 5,153,565 4,634,188
Life policy benefits 276,848 312,737 376,475
Policy acquisition expenses 1,709,039 1,682,788 1,570,526
Operating and administrative 1,208,063 1,091,349 1,037,029
- ----------------------------------------------------------------------------------------------------------------------
Total expenses 8,287,471 8,240,439 7,618,218
- ----------------------------------------------------------------------------------------------------------------------
Income from continuing operations before income taxes 1,335,708 991,098 896,742
Income tax expense 338,666 150,637 128,711
- ----------------------------------------------------------------------------------------------------------------------
INCOME FROM CONTINUING OPERATIONS 997,042 840,461 768,031
Discontinued operations:
Operating loss, net of taxes - (19,216) (16,639)
Loss on disposal, net of taxes (67,750) (88,543) -
- ----------------------------------------------------------------------------------------------------------------------
Loss from discontinued operations (67,750) (107,759) (16,639)
- ----------------------------------------------------------------------------------------------------------------------
NET INCOME $929,292 $732,702 $751,392
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
BASIC EARNINGS PER COMMON SHARE
Income from continuing operations $ 4.27 $ 3.47 $ 3.15
Loss from discontinued operations (0.30) (0.46) (0.07)
- ----------------------------------------------------------------------------------------------------------------------
NET INCOME $ 3.97 $ 3.01 $ 3.08
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
DILUTED EARNINGS PER COMMON SHARE
Income from continuing operations $ 3.96 $ 3.26 $ 2.96
Loss from discontinued operations (0.27) (0.42) (0.07)
- ----------------------------------------------------------------------------------------------------------------------
NET INCOME $ 3.69 $ 2.84 $ 2.89
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
See notes to supplemental consolidated financial statements.
</TABLE>
5
<PAGE>
THE ST. PAUL COMPANIES
<TABLE>
<CAPTION>
SUPPLEMENTAL CONSOLIDATED BALANCE SHEETS December 31
- ----------------------------------------------------------------------------------------------------------------------
(In thousands) 1997 1996
<S> <C> <C>
ASSETS
Investments:
Fixed maturities $20,945,219 $20,107,863
Equities 1,052,370 823,628
Real estate 985,317 1,247,673
Mortgage loans 640,734 406,377
Venture capital 461,892 586,222
Other investments 923,933 445,442
Short-term investments 970,568 824,733
- ----------------------------------------------------------------------------------------------------------------------
Total investments 25,980,033 24,441,938
Cash 113,175 109,855
Investment banking inventory securities 130,203 143,594
Reinsurance recoverables:
Unpaid losses 3,839,051 3,649,448
Paid losses 128,422 164,618
Ceded unearned premiums 376,343 363,800
Receivables:
Underwriting premiums 2,213,926 2,198,015
Interest and dividends 355,970 354,036
Other 104,727 89,158
Deferred policy acquisition expenses 872,460 857,560
Deferred income taxes 1,213,790 1,411,663
Office properties and equipment 602,381 529,451
Goodwill 618,528 185,250
Other assets 809,819 647,850
- ----------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $37,358,828 $35,146,236
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
LIABILITIES
Insurance reserves:
Losses and loss adjustment expenses $18,153,080 $17,888,536
Future policy benefits 3,816,050 3,552,089
Unearned premiums 3,528,234 3,679,752
- ----------------------------------------------------------------------------------------------------------------------
Total insurance reserves 25,497,364 25,120,377
Debt 1,304,008 1,170,676
Payables:
Reinsurance premiums 258,495 311,552
Income taxes 303,549 167,746
Accrued expenses and other 1,327,549 1,033,485
Other liabilities 1,556,995 1,187,944
- ----------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 30,247,960 28,991,780
- ----------------------------------------------------------------------------------------------------------------------
Company-obligated mandatorily redeemable preferred securities
of subsidiaries 502,700 307,000
- ----------------------------------------------------------------------------------------------------------------------
SHAREHOLDERS' EQUITY
Preferred:
PSOP convertible preferred stock 137,892 142,131
Guaranteed obligation-PSOP (121,167) (126,068)
- ----------------------------------------------------------------------------------------------------------------------
Total PSOP convertible preferred stock 16,725 16,063
Convertible preferred stock - 199,996
- ----------------------------------------------------------------------------------------------------------------------
TOTAL PREFERRED SHAREHOLDERS' EQUITY 16,725 216,059
- ----------------------------------------------------------------------------------------------------------------------
Common:
Common stock 2,057,108 1,895,608
Retained earnings 3,720,140 3,097,261
Guaranteed obligation - ESOP (8,453) (20,353)
Accumulated other comprehensive income:
Unrealized appreciation 845,811 679,381
Unrealized loss on foreign currency translation (23,163) (20,500)
- ----------------------------------------------------------------------------------------------------------------------
Total accumulated other comprehensive income 822,648 658,881
- ----------------------------------------------------------------------------------------------------------------------
TOTAL COMMON SHAREHOLDERS' EQUITY 6,591,443 5,631,397
- ----------------------------------------------------------------------------------------------------------------------
TOTAL SHAREHOLDERS' EQUITY 6,608,168 5,847,456
- ----------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES, REDEEMABLE PREFERRED SECURITIES
AND SHAREHOLDERS' EQUITY $37,358,828 $35,146,236
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
See notes to supplemental consolidated financial statements.
</TABLE>
6
<PAGE>
THE ST. PAUL COMPANIES
<TABLE>
<CAPTION>
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY Year ended December 31
- ----------------------------------------------------------------------------------------------------------------------
(In thousands) 1997 1996 1995
<S> <C> <C> <C>
PREFERRED SHAREHOLDERS' EQUITY PSOP convertible preferred stock:
Beginning of year $142,131 $144,165 $146,102
Redemptions during the year (4,239) (2,034) (1,937)
- ----------------------------------------------------------------------------------------------------------------------
End of year 137,892 142,131 144,165
- ----------------------------------------------------------------------------------------------------------------------
Guaranteed obligation - PSOP:
Beginning of year (126,068) (133,293) (141,567)
Principal payments 4,901 7,225 8,274
- ----------------------------------------------------------------------------------------------------------------------
End of year (121,167) (126,068) (133,293)
- ----------------------------------------------------------------------------------------------------------------------
Convertible preferred stock:
Beginning of year 199,996 213,873 331,395
Conversions during the year (511) (12,677) (116,794)
Redemptions during the year (199,485) (1,200) (728)
- ----------------------------------------------------------------------------------------------------------------------
End of year - 199,996 213,873
- ----------------------------------------------------------------------------------------------------------------------
TOTAL PREFERRED SHAREHOLDERS' EQUITY 16,725 216,059 224,745
- ----------------------------------------------------------------------------------------------------------------------
COMMON SHAREHOLDERS' EQUITY
Common stock:
Beginning of year 1,895,608 1,869,241 1,811,268
Stock issued under stock incentive plans 32,421 32,956 18,522
Stock issued for preferred shares redeemed 8,708 8,338 35,947
Stock issued for acquisition 113,264 1,664 -
Reacquired common shares (13,892) (28,808) (4,245)
Other 20,999 12,217 7,749
- ----------------------------------------------------------------------------------------------------------------------
End of year 2,057,108 1,895,608 1,869,241
- ----------------------------------------------------------------------------------------------------------------------
Retained earnings:
Beginning of year 3,097,261 2,747,556 2,148,080
Net income 929,292 732,702 751,392
Dividends declared on common stock (186,036) (169,360) (156,177)
Dividends declared on preferred stock, net of taxes (10,304) (28,893) (36,559)
Reacquired common shares (114,232) (196,238) (37,468)
Tax benefit on employee stock options and awards 8,211 5,623 459
Premium on preferred shared converted or redeemed (4,052) 5,871 77,829
- ----------------------------------------------------------------------------------------------------------------------
End of year 3,720,140 3,097,261 2,747,556
- ----------------------------------------------------------------------------------------------------------------------
Guaranteed obligation - ESOP:
Beginning of year (20,353) (32,294) (44,410)
Principal payments 11,900 11,941 12,116
- ----------------------------------------------------------------------------------------------------------------------
End of year (8,453) (20,353) (32,294)
- ----------------------------------------------------------------------------------------------------------------------
Unrealized appreciation (depreciation), net of taxes:
Beginning of year 679,381 899,119 (132,496)
Change for the year 166,430 (219,738) 1,031,615
- ----------------------------------------------------------------------------------------------------------------------
End of year 845,811 679,381 899,119
- ----------------------------------------------------------------------------------------------------------------------
Unrealized loss on foreign currency translation, net of taxes:
Beginning of year (20,500) (40,967) (44,812)
Currency translation adjustments (2,663) (5,127) 3,845
Realized loss relating to discontinued operations - 25,594 -
- ----------------------------------------------------------------------------------------------------------------------
End of year (23,163) (20,500) (40,967)
- ----------------------------------------------------------------------------------------------------------------------
Minimum pension liability:
Beginning of year - (100,312) (63,000)
Change for the year - 100,312 (37,312)
- ----------------------------------------------------------------------------------------------------------------------
End of year - - (100,312)
- ----------------------------------------------------------------------------------------------------------------------
TOTAL COMMON SHAREHOLDERS' EQUITY 6,591,443 5,631,397 5,342,343
- ----------------------------------------------------------------------------------------------------------------------
TOTAL SHAREHOLDERS' EQUITY $6,608,168 $5,847,456 $5,567,088
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
See notes to supplemental consolidated financial statements.
</TABLE>
7
<PAGE>
THE ST. PAUL COMPANIES
<TABLE>
<CAPTION>
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME Year ended December 31
- ----------------------------------------------------------------------------------------------------------------------
(In thousands) 1997 1996 1995
<S> <C> <C> <C>
Net income $929,292 $732,702 $751,392
Other comprehensive income, net of taxes:
Change in unrealized appreciation 166,430 (219,738) 1,031,615
Change in unrealized loss on foreign currency translation (2,663) 20,467 3,845
Adjustment for minimum pension liability - 100,312 (37,312)
- ----------------------------------------------------------------------------------------------------------------------
Other comprehensive income (loss) 163,767 (98,959) 998,148
- ----------------------------------------------------------------------------------------------------------------------
COMPREHENSIVE INCOME $1,093,059 $633,743 $1,749,540
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
See notes to supplemental consolidated financial statements.
</TABLE>
8
<PAGE>
THE ST. PAUL COMPANIES
<TABLE>
<CAPTION>
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF CASH FLOWS Year ended December 31
- ----------------------------------------------------------------------------------------------------------------------
(In thousands) 1997 1996 1995
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income $929,292 $732,702 $751,392
Adjustments:
Change in property-liability insurance reserves (95,945) 162,242 1,709,148
Change in reinsurance balances 15,372 208,510 (661,733)
Change in premiums receivable 8,829 (105,395) (244,053)
Change in asset management-investment banking balances 153,887 81,996 (32,357)
Provision for loss on discontinued operations 67,750 88,543 -
Depreciation and amortization 107,981 98,014 83,473
Realized investment gains (423,048) (261,989) (91,807)
Other 83,387 295,033 (208,469)
- ----------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 847,505 1,299,656 1,305,594
- ----------------------------------------------------------------------------------------------------------------------
Cash outflow resulting from sale of discontinued operations (54,018) - -
- ----------------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES
Purchases of investments (5,447,411) (4,567,552) (4,280,987)
Proceeds from sales and maturities of investments 5,228,222 4,188,916 3,388,889
Change in short-term investments (207,245) (107,087) 142,087
Change in open security transactions 28,418 (34,425) (3,312)
Net purchases of office properties and equipment (139,942) (83,564) (66,763)
Acquisitions (235,876) (241,721) -
Other 2,903 32,504 (56,809)
- ----------------------------------------------------------------------------------------------------------------------
NET CASH USED IN INVESTING ACTIVITIES (770,931) (812,929) (876,895)
- ----------------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES
Net deposits (withdrawals) for universal life and
investment contracts 250,669 (97,184) (349,273)
Dividends paid on common and preferred stock (198,489) (199,879) (197,942)
Net short-term borrowings 2,061 (73,959) (227,000)
Proceeds from issuance of debt 195,548 46,220 421,485
Repayment of debt (161,021) (68,573) (167,640)
Redemption of preferred shares (199,485) (1,200) (728)
Repurchase of common shares (128,224) (225,046) (41,713)
Proceeds from issuance of company-obligated mandatorily
redeemable preferred securities of subsidiaries 195,700 100,000 207,000
Other 24,005 (1,509) (18,264)
- ----------------------------------------------------------------------------------------------------------------------
NET CASH USED IN FINANCING ACTIVITIES (19,236) (521,130) (374,075)
- ----------------------------------------------------------------------------------------------------------------------
INCREASE (DECREASE) IN CASH 3,320 (34,403) 54,624
- ----------------------------------------------------------------------------------------------------------------------
Cash at beginning of year 109,855 144,258 89,634
- ----------------------------------------------------------------------------------------------------------------------
CASH AT END OF YEAR $113,175 $109,855 $144,258
- ----------------------------------------------------------------------------------------------------------------------
See notes to supplemental consolidated financial statements.
</TABLE>
9
<PAGE>
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS
ON APRIL 24, 1998, THE ST. PAUL COMPANIES, INC. (THE ST. PAUL) COMPLETED ITS
MERGER WITH USF&G CORPORATION (USF&G) IN A TAX-FREE EXCHANGE OF STOCK
ACCOUNTED FOR AS A POOLING OF INTERESTS. THE COMBINED ORGANIZATION OPERATES
UNDER THE ST. PAUL NAME AND IS HEADQUARTERED OUT OF ST. PAUL, MINN. THE
FOLLOWING DISCUSSION IS BASED ON THE COMBINED RESULTS OF THE ST. PAUL AND
USF&G FOR ALL PERIODS PRESENTED UNLESS OTHERWISE STATED. (SEE NOTE 13
"MERGER WITH USF&G CORPORATION")
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ACCOUNTING PRINCIPLES - We prepare our financial statements in accordance
with generally accepted accounting principles (GAAP). We follow the
accounting standards established by the Financial Accounting Standards Board
(FASB) and the American Institute of Certified Public Accountants.
CONSOLIDATION - We combine our financial statements with those of our
subsidiaries and present them on a consolidated basis. The consolidated
financial statements do not include the results of material transactions
between us and our subsidiaries or among our subsidiaries. Our foreign
underwriting operations' results are recorded on a one-month to one-quarter
lag.
DISCONTINUED OPERATIONS - In 1997, we sold our insurance brokerage operation,
Minet. As a result, the financial statements for all years presented reflect
insurance brokerage results as discontinued operations.
RECLASSIFICATIONS - We reclassified some figures in our 1996 and 1995
financial statements and notes to conform with the 1997 presentation. These
reclassifications had no effect on net income, or common or preferred
shareholders' equity, as previously reported for those years.
USE OF ESTIMATES - We make estimates and assumptions that have an effect on
the amounts that we report in our financial statements. Our most significant
estimates are those relating to our reserves for property-liability losses
and loss adjustment expenses and life policy benefits. We continually review
our estimates and make adjustments as necessary, but actual results could
turn out significantly different than what we envisioned when we made these
estimates.
STOCK SPLIT - In May 1998, we declared a 2-for-1 stock split. All references
in these supplemental financial statements and related notes to per-share
amounts and to the number of shares of common stock reflect the effect of
this stock split on all periods presented unless otherwise noted.
ACCOUNTING FOR OUR PROPERTY-LIABILITY UNDERWRITING OPERATIONS
PREMIUMS EARNED - Premiums on insurance policies are our largest source of
revenue. We reflect the premiums as revenues evenly over the policy terms. We
record the premiums that we have not yet recognized as revenues as unearned
premiums on our supplemental balance sheet.
INSURANCE LOSSES AND LOSS ADJUSTMENT EXPENSES - Losses represent the amounts
we paid or expect to pay to claimants for events that have occurred. The
costs of investigating, resolving and processing these claims are known as
loss adjustment expenses. We record these items on our supplemental statement
of income net of reinsurance, meaning that we reduce our gross losses and
loss adjustment expenses incurred by the amounts we have recovered or will
recover under reinsurance contracts.
We establish reserves for the estimated total unpaid cost of losses and
loss adjustment expenses, which cover events that occurred in 1997 and prior
years. These reserves reflect our estimates of the total cost of claims that
were reported to us, but not yet paid, and the cost of claims incurred but
not yet reported to us (IBNR). Our estimates consider such variables as past
loss experience, current claim trends and the prevailing social, economic and
legal environments. We reduce our loss reserves for estimated amounts of
salvage and subrogation. Estimated amounts recoverable from reinsurers on
unpaid losses and loss adjustment expenses are reflected as assets.
10
<PAGE>
We believe that the reserves we have established are adequate to cover the
ultimate costs of losses and loss adjustment expenses. Final claim payments,
however, may differ from the established reserves, particularly when these
payments may not occur for several years. Any adjustments we make to reserves
are reflected in the results for the year during which the adjustments are
made.
Certain liabilities for unpaid losses and loss expenses related to tabular
workers' compensation and assumed reinsurance coverage are discounted to the
present value of estimated future payments. The total discount reflected on
our supplemental balance sheet was $200.4 million and $160.1 million at Dec.
31, 1997 and 1996, respectively, discounted using rates of up to 3.5% for
workers' compensation and rates up to 8.0% for certain assumed reinsurance
coverage.
POLICY ACQUISITION EXPENSES - The costs directly related to writing an
insurance policy are referred to as policy acquisition expenses and consist
of commissions, state premium taxes and other direct underwriting expenses.
Although these expenses arise when we issue a policy, we defer and amortize
them over the same period as the corresponding premiums are recorded as
revenues.
If deferred policy acquisition expenses were to exceed the sum of unearned
premiums and related anticipated investment income less expected losses and
loss adjustment expenses, we would immediately expense the excess costs.
ACCOUNTING FOR OUR LIFE OPERATIONS
PREMIUMS - Premiums on life insurance policies with fixed and guaranteed
premiums and benefits, and premiums on annuities with significant life
contingencies are recognized when due. Premiums received on universal life
policies and annuity contracts are not recorded as revenues; instead, they
are recognized as deposits on our balance sheet. Policy charges and surrender
penalties are recorded as revenues.
POLICY BENEFITS - Ordinary life insurance reserves are computed under the net
level premium method, which makes no allowance for higher first-year
expenses. A uniform portion of each year's premium is used for calculating
the reserve. The reserves also reflect assumptions we make for future
investment yields, mortality and withdrawal rates. These assumptions reflect
our experience, modified to reflect anticipated trends, and provide for
possible adverse development. Reserve interest rate assumptions are graded
and range from 2.5% to 6.0%.
Universal life and deferred annuity reserves are computed on the
retrospective deposit method, which produces reserves equal to the cash value
of the contracts. Such reserves are not reduced for charges that would be
deducted from the cash value of policies surrendered. Reserves on immediate
annuities with guaranteed payments are computed on the prospective deposit
method, which produces reserves equal to the present value of future benefit
payments.
POLICY ACQUISITION EXPENSES - We consider anticipated policy benefits,
remaining costs of servicing the policies and anticipated investment income
in determining the recoverability of deferred acquisition costs for
interest-sensitive life and annuity products. Life insurance acquisition
costs are amortized based on assumptions consistent with those used for
computing policy benefit reserves. Deferred policy acquisition costs (DPAC)
on ordinary life business are amortized over their assumed premium paying
periods. Universal life and investment annuity acquisition costs are
amortized in proportion to the present value of their estimated gross profits
over the products' assumed durations, which we regularly evaluate and adjust
as appropriate.
ACCOUNTING FOR OUR ASSET MANAGEMENT-INVESTMENT BANKING OPERATIONS
The John Nuveen Company comprises our asset management-investment banking
segment. We held a 77% and 78% interest in Nuveen on Dec. 31, 1997 and 1996,
respectively. Nuveen sponsors and markets tax-free open-end and closed-end
(exchange-traded) managed funds and provides investment advice to and manages
the business affairs of the Nuveen family of managed funds. They also
underwrite and trade municipal bonds and tax-free unit investment trusts
(UITs). They hold in inventory municipal bonds and UITs that will be sold to
individuals or security dealers. Those inventory securities are carried at
market value.
11
<PAGE>
Nuveen's revenues include investment advisory fees, revenues from the
distribution of UITs and managed fund investment products, gains and losses
from the sale of inventory securities, and unrealized gains and losses on
inventory securities held.
We consolidate 100% of Nuveen's assets, liabilities, revenues and
expenses, with reductions on the supplemental balance sheet and supplemental
statement of income for the minority shareholders' proportionate interest in
Nuveen's equity and earnings. Minority interest of $63.1 million and $59.9
million was recorded in other liabilities at the end of 1997 and 1996,
respectively.
Nuveen repurchased and retired 1.8 million and 3.8 million of its common
shares in 1997 and 1996, respectively, for a total cost of $55 million in
1997 and $101 million in 1996. Our proceeds from the Nuveen repurchases
totaled $41 million and $74 million in 1997 and 1996, respectively.
ACCOUNTING FOR OUR INVESTMENTS
FIXED MATURITIES - Our entire fixed maturity investment portfolio is classified
as available-for-sale. Accordingly, we carry that portfolio on our balance sheet
at estimated market value.
EQUITIES - Our equity securities are also classified as available-for-sale and
carried at estimated market value. Investments for which we have significant
influence over the investees' operating and financial policies are accounted for
using the equity method and included in other investments.
SECURITIES LENDING - We participate in a securities lending program whereby
certain securities from our portfolio are loaned to other institutions for short
periods of time. We receive a fee from the borrower in return. Our policy is to
require collateral equal to 102 percent of the market value of the loaned
securities. We maintain full ownership rights to the securities loaned. In
addition, we have the ability to sell the securities while they are on loan. We
have an indemnification agreement with the lending agents in the event a
borrower becomes insolvent or fails to return securities. As of Dec. 31, 1997
and 1996, other investments and other liabilities include $515 million and $128
million, respectively, related to securities lending collateral.
REAL ESTATE AND MORTGAGE LOANS - Our real estate investments include apartments
and office buildings and other commercial land and properties that we own
directly or in which we have a partial interest through joint ventures with
other investors. Our mortgage loan investments consist of fixed-rate loans
collateralized by apartment and office properties.
For direct real estate investments, we carry land at cost and buildings at
cost less accumulated depreciation and valuation adjustments. We depreciate real
estate assets on a straight-line basis over 40 years. Tenant improvements are
amortized over the term of the corresponding lease. The accumulated depreciation
of our real estate investments was $93.0 million and $81.8 million at Dec. 31,
1997 and 1996, respectively. We carry our mortgage loans at unpaid principal
balances less any valuation adjustments. Valuation allowances are recognized for
loans with deterioration in collateral performance that are deemed other than
temporary.
We use the equity method of accounting for our direct real estate joint
ventures, which means we carry these investments at cost, adjusted for our share
of earnings or losses, and reduced by cash distributions from the joint ventures
and valuation adjustments.
VENTURE CAPITAL - We invest in securities of small- to medium-sized companies.
These investments are in the form of limited partnerships or direct ownership.
The limited partnerships are carried at our equity in the estimated market value
of the investments held by these limited partnerships. The securities we own
directly are carried at estimated market value.
12
<PAGE>
REALIZED INVESTMENT GAINS AND LOSSES - We record the cost of each individual
investment so that when we sell any of them, we are able to identify and
record the gain or loss on that transaction on our supplemental statement of
income.
We continually monitor the difference between the cost and estimated
market value of our investments. If any of our investments experience a
decline in value that is other than temporary, we establish a valuation
allowance for the decline and record a realized loss on the supplemental
statement of income.
UNREALIZED APPRECIATION AND DEPRECIATION - For investments we carry at estimated
market value, we record the difference between cost and market, net of deferred
taxes, as a part of common shareholders' equity. This difference is referred to
as unrealized appreciation or depreciation. Unrealized gains or losses on fixed
maturities are offset by an adjustment to life insurance deferred policy
acquisition costs, which is made on a pro forma basis as if the unrealized gains
or losses on those assets that match certain life insurance liabilities were
realized. The change in unrealized appreciation or depreciation during the year
is a component of comprehensive income.
GOODWILL
Goodwill is the excess of the amount we paid to acquire a company over the fair
value of its net assets, reduced by amortization and any subsequent valuation
adjustments. We amortize goodwill over periods of up to 40 years. The
accumulated amortization of goodwill was $153.0 million and $113.3 million at
Dec. 31, 1997 and 1996, respectively.
We monitor the value of our goodwill based on our estimates of discounted
future earnings. If we determine that our goodwill has been impaired, we reduce
its carrying value with a corresponding charge to expenses.
OFFICE PROPERTIES AND EQUIPMENT
We carry office properties and equipment at depreciated cost. We depreciate
these assets on a straight-line basis over the estimated useful lives of the
assets. The accumulated depreciation for office properties and equipment was
$363.8 million and $300.8 million at the end of 1997 and 1996, respectively.
FOREIGN CURRENCY TRANSLATION
We assign functional currencies to our foreign operations, which are
generally the currencies of the local operating environment. Foreign currency
amounts are converted to the functional currency, and the resulting foreign
exchange gains or losses are reflected in the supplemental statement of
income. Functional currency amounts are then translated into U.S. dollars.
The unrealized gain or loss from this translation is recorded as a part of
common shareholders' equity. The change in unrealized foreign currency
translation gain or loss during the year is a component of comprehensive
income. Both the conversion and translation are calculated using current
exchange rates for the supplemental balance sheets and average exchange rates
for the supplemental statements of income.
In highly inflationary economies (e.g., Mexico), the functional currency is
the U.S. dollar. Monetary assets and liabilities are remeasured into U.S.
dollars using exchange rates in effect at the balance sheet date, whereas
nonmonetary balances are remeasured using historical exchange rates. Revenue and
expense accounts are remeasured using the average exchange rates prevailing
during the year for monetary transactions and historical exchange rates for
nonmonetary transactions. Realized gains or losses resulting from remeasurement
are included in the supplemental statement of income.
13
<PAGE>
FACILITIES EXIT COSTS/SUBLEASE INCOME
We committed to a plan to consolidate our field office operations in Baltimore,
Maryland at our Mount Washington facility during 1994. Facilities exit costs
were recorded representing the present value of the rent and other operating
expenses to be incurred under the lease on our principal field office building
through the expiration of the lease in 2009. Potential future sublease income
was not considered, as such income was neither probable nor reasonably estimable
at the time. As additional or extended subleases are subsequently negotiated,
the present value of income to be received over the term of those subleases is
recognized.
SUPPLEMENTAL CASH FLOW INFORMATION
INTEREST AND INCOME TAXES PAID - We paid interest of $81.1 million in 1997,
$85.5 million in 1996 and $82.0 million in 1995. We paid federal income taxes of
$99.3 million in 1997, $96.3 million in 1996 and $189.8 million in 1995. Federal
tax payments in 1995 included $45 million in taxes and interest for a partial
settlement with the IRS regarding certain issues raised in its audit of The St.
Paul Companies, Inc. premerger consolidated tax returns for the years 1991
through 1994.
NONCASH FINANCING ACTIVITIES - The John Nuveen Company issued $45 million of
preferred stock in 1997 to fund a portion of its purchase of Flagship
Resources, Inc. In December 1997, we issued $112 million of common stock in
consideration for our acquisition of TITAN Holdings, Inc. Cash provided from
operating activities in 1997 does not include a $104 million portion of a
coinsurance contract purchased to cede certain structured settlement annuity
obligations (see Note 15 "Reinsurance"). During 1996, we entered into a
coinsurance contract with an unaffiliated life insurance company to cede a
portion of our block of single premium deferred annuities (the "broker SPDA
block"). As part of the noncash transaction, we transferred $932 million of
investments and other assets to the coinsurer, and recorded a reinsurance
receivable of $964 million. Surrender activity reduced the broker SPDA block
and related reinsurance receivable balances to $772 million by Dec. 31, 1996.
14
<PAGE>
NOTE 2 EARNINGS PER COMMON SHARE
In 1997, we adopted the provisions of Statement of Financial Accounting
Standards (SFAS) No. 128, EARNINGS PER SHARE. This statement replaced the
calculation of PRIMARY and FULLY DILUTED earnings per share (EPS) with BASIC and
DILUTED EPS. Basic EPS excludes the dilutive effects of options, warrants and
convertible securities. Diluted EPS is similar to the previously reported fully
diluted EPS. Earnings per share amounts for all years presented were calculated
based on the provisions of SFAS No. 128. Average common shares outstanding for
all periods reflect the impact of the 2-for-1 stock split approved by the board
of directors on May 5, 1998.
<TABLE>
<CAPTION>
(In thousands) Year ended December 31
- ----------------------------------------------------------------------------------------------------------------------
1997 1996 1995
<S> <C> <C> <C>
BASIC
Net income, as reported $929,292 $732,702 $751,392
PSOP preferred dividends declared (net of taxes) (8,645) (8,664) (8,582)
Premium on preferred shares redeemed (4,441) (1,033) (823)
Dividends on preferred stock (1,659) (20,229) (27,978)
- ----------------------------------------------------------------------------------------------------------------------
Net income, as adjusted $914,547 $702,776 $714,009
- ----------------------------------------------------------------------------------------------------------------------
DILUTED
Net income, as reported $929,292 $732,702 $751,392
Additional PSOP expense (net of taxes) due to assumed
conversion of preferred stock (2,647) (3,015) (3,477)
Dividends on monthly income
preferred securities (net of taxes) 8,073 8,073 5,046
Premium on preferred shares redeemed (4,441) (1,033) (823)
Dividends on preferred stock (1,659) (16,400) (16,400)
Interest expense on zero coupon notes 3,143 5,133 6,164
- ----------------------------------------------------------------------------------------------------------------------
Net income, as adjusted $931,761 $725,460 $741,902
- ----------------------------------------------------------------------------------------------------------------------
AVERAGE COMMON SHARES OUTSTANDING
Basic 230,158 233,340 231,664
Diluted 252,285 255,861 256,656
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
Average common shares outstanding for diluted EPS includes the common and
common equivalent shares outstanding for the year and common shares that
would be issuable upon conversion of PSOP preferred stock and other
convertible preferred stock, the company-obligated mandatorily redeemable
preferred securities of St. Paul Capital L.L.C. (monthly income preferred
securities) and zero coupon convertible notes.
15
<PAGE>
NOTE 3 INVESTMENTS
VALUATION OF INVESTMENTS - The following presents the cost, gross unrealized
appreciation and depreciation, and estimated market value of our investments in
fixed maturities, equities and venture capital.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------
(In thousands) December 31, 1997
- ----------------------------------------------------------------------------------------------------------------------
GROSS GROSS ESTIMATED
UNREALIZED UNREALIZED MARKET
COST APPRECIATION DEPRECIATION VALUE
<S> <C> <C> <C> <C>
Fixed maturities:
U.S. government $ 2,754,657 $ 120,750 $ (1,886) $ 2,873,521
States and political subdivisions 6,280,554 419,744 (535) 6,699,763
Foreign governments 1,118,494 66,586 (23,875) 1,161,205
Corporate securities 6,089,142 287,178 (5,613) 6,370,707
Asset-backed securities 692,536 14,946 (400) 707,082
Mortgage-backed securities 3,053,327 80,607 (993) 3,132,941
- ----------------------------------------------------------------------------------------------------------------------
Total fixed maturities 19,988,710 989,811 (33,302) 20,945,219
Equities 804,593 267,889 (20,112) 1,052,370
Venture capital 324,333 156,205 (18,646) 461,892
- ----------------------------------------------------------------------------------------------------------------------
Total $21,117,636 $1,413,905 $(72,060) $22,459,481
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
(In thousands) December 31, 1996
- ----------------------------------------------------------------------------------------------------------------------
Gross Gross Estimated
Unrealized Unrealized Market
Cost Appreciation Depreciation Value
<S> <C> <C> <C> <C>
Fixed maturities:
U.S. government $ 2,736,181 $ 63,494 $ (16,205) $ 2,783,470
States and political subdivisions 5,417,131 306,481 (6,490) 5,717,122
Foreign governments 1,307,920 67,274 (15,528) 1,359,666
Corporate securities 6,428,931 154,798 (59,290) 6,524,439
Asset-backed securities 743,750 11,762 (1,877) 753,635
Mortgage-backed securities 2,917,137 61,232 (8,838) 2,969,531
- ----------------------------------------------------------------------------------------------------------------------
Total fixed maturities 19,551,050 665,041 (108,228) 20,107,863
Equities 637,820 194,983 (9,175) 823,628
Venture capital 293,837 308,858 (16,473) 586,222
- ----------------------------------------------------------------------------------------------------------------------
Total $20,482,707 $1,168,882 $(133,876) $21,517,713
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
STATUTORY DEPOSITS - At Dec. 31, 1997, our property-liability and life
insurance operations had investments in fixed maturities with an estimated
market value of $992.0 million on deposit with regulatory authorities as
required by law.
16
<PAGE>
FIXED MATURITIES BY MATURITY DATE - The following table presents the breakdown
of our fixed maturities by years to maturity. Actual maturities may differ from
those stated as a result of calls and prepayments.
<TABLE>
<CAPTION>
(In thousands) December 31, 1997
- ----------------------------------------------------------------------------------------------------------------------
AMORTIZED ESTIMATED
COST MARKET VALUE
<S> <C> <C>
One year or less $ 401,598 $ 404,708
Over one year through five years 3,939,765 4,062,391
Over five years through 10 years 6,120,903 6,491,265
Over 10 years 5,780,581 6,146,832
Asset-backed securities with
various maturities 692,536 707,082
Mortgage-backed securities with
various maturities 3,053,327 3,132,941
- ----------------------------------------------------------------------------------------------------------------------
Total $19,988,710 $20,945,219
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
During 1995, we reclassified all securities previously classified as
held-to-maturity to available-for-sale. This reclassification was made to
allow maximum flexibility in the management of the investment portfolio
without being restricted by accounting interpretations. The securities had a
total amortized cost of $4.5 billion, with gross unrealized gains of $108
million.
17
<PAGE>
NOTE 4 INVESTMENT TRANSACTIONS
INVESTMENT ACTIVITY - Here is a summary of our investment purchases, sales and
maturities.
<TABLE>
<CAPTION>
(In thousands) Year ended December 31
- ----------------------------------------------------------------------------------------------------------------------
1997 1996 1995
<S> <C> <C> <C>
PURCHASES
Fixed maturities $3,435,901 $3,077,119 $2,945,487
Equities 1,509,774 1,087,951 1,139,288
Real estate and mortgage loans 380,258 291,745 116,925
Venture capital 97,413 94,891 66,247
Other investments 24,065 15,846 13,040
- ----------------------------------------------------------------------------------------------------------------------
Total purchases 5,447,411 4,567,552 4,280,987
- ----------------------------------------------------------------------------------------------------------------------
PROCEEDS FROM SALES
AND MATURITIES
Fixed maturities:
Sales 1,705,234 1,096,544 838,755
Maturities and
redemptions 1,322,330 1,432,263 1,262,104
Equities 1,478,575 1,353,399 1,168,806
Real estate and mortgage loans 467,684 185,742 14,428
Venture capital 250,015 118,011 87,512
Other investments 4,384 2,957 17,284
- ----------------------------------------------------------------------------------------------------------------------
Total sales and
maturities 5,228,222 4,188,916 3,388,889
- ----------------------------------------------------------------------------------------------------------------------
Net purchases $ 219,189 $ 378,636 $ 892,098
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
NET INVESTMENT INCOME - Here is a summary of our net investment income.
<TABLE>
<CAPTION>
(In thousands) Year ended December 31
- ----------------------------------------------------------------------------------------------------------------------
1997 1996 1995
<S> <C> <C> <C>
Fixed maturities $1,405,478 $1,368,654 $1,328,760
Equities 17,357 18,554 19,163
Real estate and mortgage loans 112,944 83,994 78,642
Venture capital 352 324 (171)
Other investments 9,866 17,212 12,547
Short-term investments 57,915 51,371 61,730
- ----------------------------------------------------------------------------------------------------------------------
Total 1,603,912 1,540,109 1,500,671
Investment expenses (26,107) (27,534) (26,603)
- ----------------------------------------------------------------------------------------------------------------------
Net investment income $1,577,805 $1,512,575 $1,474,068
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
18
<PAGE>
REALIZED AND UNREALIZED INVESTMENT GAINS (LOSSES) - The following summarizes our
pretax realized investment gains and losses, and the change in unrealized
appreciation of investments recorded in common shareholders' equity.
<TABLE>
<CAPTION>
(In thousands) Year ended December 31
- ----------------------------------------------------------------------------------------------------------------------
1997 1996 1995
<S> <C> <C> <C>
PRETAX REALIZED
INVESTMENT GAINS (LOSSES)
Fixed maturities:
Gross realized gains $36,233 $23,033 $19,091
Gross realized losses (43,620) (40,037) (26,964)
- ----------------------------------------------------------------------------------------------------------------------
Total fixed maturities (7,387) (17,004) (7,873)
- ----------------------------------------------------------------------------------------------------------------------
Equities:
Gross realized gains 208,978 239,646 82,547
Gross realized losses (46,412) (31,282) (29,548)
- ----------------------------------------------------------------------------------------------------------------------
Total equities 162,566 208,364 52,999
- ----------------------------------------------------------------------------------------------------------------------
Real estate and mortgage loans 45,259 (22,137) (1,807)
Venture capital 212,663 86,011 38,175
Other investments 9,947 6,755 10,313
- ----------------------------------------------------------------------------------------------------------------------
Total pretax realized
investment gains $423,048 $261,989 $91,807
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION
Fixed maturities $399,696 $(440,916) $1,267,201
Equities 61,969 27,981 134,308
Venture capital (154,826) 163,110 59,880
DPAC and policy benefits (50,692) 53,469 (105,664)
Other 136 11,074 (5,200)
- ----------------------------------------------------------------------------------------------------------------------
Total change in pretax
unrealized appreciation 256,283 (185,282) 1,350,525
Change in deferred taxes (89,853) (34,456) (318,910)
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
Total change in unrealized appreciation,
net of taxes $166,430 $(219,738) $1,031,615
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
19
<PAGE>
NOTE 5 DERIVATIVE FINANCIAL INSTRUMENTS
Derivative financial instruments are defined as futures, forward, swap or
option contracts and other financial instruments with similar
characteristics. We have had limited involvement with these instruments for
purposes of hedging against fluctuations in foreign currency exchange rates
and interest rates. All investments, including derivative instruments, have
some degree of market and credit risk associated with them. However, the
market risk on our derivatives substantially offsets the market risk
associated with fluctuations in interest rates. We seek to reduce our credit
risk by conducting derivative transactions only with reputable,
investment-grade counterparties.
We enter into interest rate swap agreements for the purpose of reducing
the effect of interest rate fluctuations on some of our debt and investments.
We purchase foreign exchange forward contracts to minimize the impact of
fluctuating foreign currencies on our results of operations. We use
exchange-traded and over-the-counter catastrophe options and swaps, which are
linked to an index of losses related to natural disasters, as an additional
source of income. Individually, and in the aggregate, the impact of these
transactions on our financial position and results of operations is not
material.
20
<PAGE>
NOTE 6 RESERVES FOR LOSSES, LOSS ADJUSTMENT EXPENSES AND POLICY BENEFITS
RECONCILIATION OF LOSS RESERVES - The following table represents a
reconciliation of beginning and ending consolidated property-liability
insurance loss and loss adjustment expense (LAE) reserves for each of the
last three years.
<TABLE>
<CAPTION>
(In thousands) Year ended December 31
- ----------------------------------------------------------------------------------------------------------------------
1997 1996 1995
<S> <C> <C> <C>
Loss and LAE reserves at
beginning of year,
as reported $17,888,536 $16,559,200 $15,827,113
Less reinsurance recoverables
on unpaid losses at
beginning of year (2,867,732) (2,826,942) (2,536,713)
- ----------------------------------------------------------------------------------------------------------------------
Net loss and LAE reserves
at beginning of year 15,020,804 13,732,258 13,290,400
Net reserves of acquired
companies 140,710 1,033,443 12,329
- ----------------------------------------------------------------------------------------------------------------------
Provision for losses and LAE for claims incurred:
Current year 5,720,662 5,567,703 4,935,727
Prior years (627,141) (414,138) (301,539)
- ----------------------------------------------------------------------------------------------------------------------
Total incurred 5,093,521 5,153,565 4,634,188
- ----------------------------------------------------------------------------------------------------------------------
Losses and LAE payments for claims incurred:
Current year (1,709,512) (1,864,832) (1,418,321)
Prior years (3,453,073) (3,029,833) (2,787,110)
- ----------------------------------------------------------------------------------------------------------------------
Total paid (5,162,585) (4,894,665) (4,205,431)
- ----------------------------------------------------------------------------------------------------------------------
Unrealized foreign
exchange loss (gain) 7,205 (3,797) 772
- ----------------------------------------------------------------------------------------------------------------------
Net loss and LAE reserves at
end of year 15,099,655 15,020,804 13,732,258
Plus reinsurance recoverables on
unpaid losses at end of year 3,053,425 2,867,732 2,826,942
- ----------------------------------------------------------------------------------------------------------------------
Loss and LAE reserves at end of year,
as reported $18,153,080 $17,888,536 $16,559,200
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
LIFE BENEFIT RESERVES - The following table shows our life insurance
operations future policy benefit reserves by type.
<TABLE>
<CAPTION>
(In thousands) December 31
- ----------------------------------------------------------------------------------------------------------------------
1997 1996
<S> <C> <C>
Single Premium Annuities:
Deferred $1,373,519 $1,313,712
Immediate 1,047,744 1,001,294
Other annuities 367,475 610,122
Universal/term/group life 1,027,312 626,961
- ----------------------------------------------------------------------------------------------------------------------
Gross balance 3,816,050 3,552,089
Less reinsurance recoverables 785,626 781,716
- ----------------------------------------------------------------------------------------------------------------------
Total net reserves $3,030,424 $2,770,373
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
21
<PAGE>
ENVIRONMENTAL AND ASBESTOS RESERVES - Our underwriting operations continue to
receive claims under policies written many years ago alleging injuries from
environmental pollution or alleging covered property damages for the cost to
clean up polluted sites. We have also received asbestos claims arising out of
product liability coverages under general liability policies.
The following table summarizes the environmental and asbestos reserves
reflected in our supplemental consolidated balance sheet at Dec. 31, 1997 and
1996. Amounts in the "net" column are reduced by reinsurance.
<TABLE>
<CAPTION>
(In thousands) December 31
- ----------------------------------------------------------------------------------------------------------------------
1997 1996
GROSS NET Gross Net
<S> <C> <C> <C> <C>
Environmental $867,000 $677,000 $889,000 $676,000
Asbestos 397,000 279,000 413,000 304,000
- ----------------------------------------------------------------------------------------------------------------------
Total environmental and asbestos reserves $1,264,000 $956,000 $1,302,000 $980,000
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
22
<PAGE>
NOTE 7 INCOME TAXES
METHOD FOR COMPUTING INCOME TAX EXPENSE - We are required to compute our income
tax expense under the liability method. This means deferred income taxes reflect
what we estimate we will pay or receive in future years. A current tax liability
is recognized for the estimated taxes payable for the current year.
INCOME TAX EXPENSE (BENEFIT) - Income tax expense or benefits are recorded in
various places in our supplemental financial statements. A summary of the
amounts and places follows:
<TABLE>
<CAPTION>
(In thousands) Year ended December 31
- ----------------------------------------------------------------------------------------------------------------------
1997 1996 1995
<S> <C> <C> <C>
STATEMENTS OF INCOME
Expense on
continuing operations $338,666 $150,637 $128,711
Expense on
discontinued operations - 401 3,547
Benefit on loss on disposal (35,530) (291,493) -
- ----------------------------------------------------------------------------------------------------------------------
Total income tax expense
(benefit) included in
supplemental statements
of income 303,136 (140,455) 132,258
- ----------------------------------------------------------------------------------------------------------------------
COMMON SHAREHOLDERS' EQUITY
Benefit for deductions relating to:
Dividends on unallocated
ESOP and PSOP shares (3,112) (3,626) (4,094)
Employee stock options
and awards (8,211) (5,623) (459)
Deferred expense for the
change in unrealized
appreciation and unrealized
foreign exchange 89,232 31,891 319,195
- ----------------------------------------------------------------------------------------------------------------------
Total income tax expense
included in common
shareholders' equity 77,909 22,642 314,642
- ----------------------------------------------------------------------------------------------------------------------
Total income tax expense
(benefit) included in
supplemental financial
statements $381,045 $(117,813) $446,900
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
23
<PAGE>
COMPONENTS OF INCOME TAX EXPENSE - The components of income tax expense on
continuing operations are as follows:
<TABLE>
<CAPTION>
(In thousands) Year ended December 31
- ----------------------------------------------------------------------------------------------------------------------
1997 1996 1995
<S> <C> <C> <C>
Federal current tax expense $281,528 $117,035 $187,422
Federal deferred tax expense (benefit) 23,299 5,174 (66,096)
- ----------------------------------------------------------------------------------------------------------------------
Total federal income
tax expense 304,827 122,209 121,326
Foreign income taxes 19,467 22,074 1,791
State income taxes 14,372 6,354 5,594
- ----------------------------------------------------------------------------------------------------------------------
Total income tax expense on
continuing operations $338,666 $150,637 $128,711
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
OUR TAX RATE IS DIFFERENT FROM THE STATUTORY RATE - Our total income tax
expense on continuing operations differs from the statutory rate of 35% of
pretax income as shown in the following table:
<TABLE>
<CAPTION>
(In thousands) Year ended December 31
- ----------------------------------------------------------------------------------------------------------------------
1997 1996 1995
<S> <C> <C> <C>
Federal income tax expense
at statutory rates $467,498 $346,884 $313,860
Increase (decrease) attributable to:
Nontaxable investment
income (112,420) (96,156) (85,395)
Valuation allowance (31,657) (106,519) (101,724)
Other 15,245 6,428 1,970
- ----------------------------------------------------------------------------------------------------------------------
Total income tax expense on
continuing operations $338,666 $150,637 $128,711
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
24
<PAGE>
MAJOR COMPONENTS OF DEFERRED INCOME TAXES ON OUR BALANCE SHEET - Differences
between the tax basis of assets and liabilities and their reported amounts in
the financial statements that will result in taxable or deductible amounts in
future years are called temporary differences. The tax effects of temporary
differences that give rise to the deferred tax assets and deferred tax
liabilities are presented in the following table:
<TABLE>
<CAPTION>
(In thousands) December 31
- ----------------------------------------------------------------------------------------------------------------------
1997 1996
<S> <C> <C>
DEFERRED TAX ASSETS
Loss reserves $1,122,326 $1,103,691
Loss on disposal of insurance
brokerage operations 199,868 370,900
Unearned premium reserves 198,124 226,382
Net operating loss carryforward 194,267 216,687
Other 555,562 413,360
- ----------------------------------------------------------------------------------------------------------------------
Total gross deferred tax assets 2,270,147 2,331,020
Less valuation allowance (41,222) (72,879)
- ----------------------------------------------------------------------------------------------------------------------
Net deferred tax assets 2,228,925 2,258,141
- ----------------------------------------------------------------------------------------------------------------------
DEFERRED TAX LIABILITIES
Unrealized appreciation of investments 444,892 358,824
Deferred acquisition costs 279,469 281,455
Real estate 65,036 58,125
Other 225,738 148,074
- ----------------------------------------------------------------------------------------------------------------------
Total gross deferred tax liabilities 1,015,135 846,478
- ----------------------------------------------------------------------------------------------------------------------
Deferred income taxes $1,213,790 $1,411,663
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
As of Dec. 31, 1997 we have alternative minimum tax (AMT) credit
carryforwards of approximately $94.7 million which are available to reduce
future federal regular income taxes over an indefinite period. The benefit of
the AMT credit carryforward is included in our net deferred tax assets.
If we believe that all of our deferred tax assets will not result in
future tax benefits, we must establish a "valuation allowance" for the
portion of these assets that we think will not be realized. The net change in
the valuation allowance for deferred tax assets was a decrease of $31.7
million in 1997, which was included in operations, and an increase of $15.8
million in 1996, of which an increase of $60.0 million was included in
shareholders' equity, an increase of $62.3 million was included in
discontinued operations and a decrease of $106.5 million was included in
operations. Based upon a review of our refundable taxes, anticipated future
earnings, and all other available evidence, both positive and negative, we
have concluded it is "more likely than not" that our net deferred tax assets
will be realized.
UNDISTRIBUTED EARNINGS OF SUBSIDIARIES - U.S. income taxes have not been
provided on $30.0 million of our foreign operations' undistributed earnings
as of Dec. 31, 1997, as such earnings are intended to be permanently
reinvested in those operations. Furthermore, any taxes paid to foreign
governments on these earnings may be used as credits against the U.S. tax on
any dividend distributions from such earnings.
We have not provided taxes on approximately $156.4 million of
undistributed earnings related to our majority ownership of The John Nuveen
Company as of Dec. 31, 1997, because we currently do not expect those
earnings to become taxable to us.
25
<PAGE>
NET OPERATING LOSS (NOL) CARRYFORWARDS - At Dec. 31, 1997, we had NOLs remaining
for tax return purposes expiring in 2006. The amount and timing of recognizing
the benefit of these NOLs depends on future taxable income and limitations
imposed by tax laws. The approximate amounts of those NOLs on a regular tax
basis and an AMT basis at Dec. 31, 1997 were $525 million and $393 million,
respectively.
IRS EXAMINATIONS - USF&G's premerger tax returns have not been reviewed by the
Internal Revenue Service (IRS) since 1989, with the exception of the Life Group.
The IRS is currently examining the USF&G Life Group's premerger returns for the
years 1992 and 1993. The IRS has examined the pre-merger The St. Paul's
consolidated returns through 1992 and is currently examining the years 1993
through 1997. We believe that any additional taxes assessed as a result of these
examinations would not materially affect our overall financial position, results
of operations or liquidity.
26
<PAGE>
NOTE 8 CAPITAL STRUCTURE
The following summarizes our capital structure:
<TABLE>
<CAPTION>
(In thousands) December 31
- ----------------------------------------------------------------------------------------------------------------------
1997 1996
<S> <C> <C>
Debt $ 1,304,008 $ 1,170,676
Company-obligated mandatorily
redeemable preferred securities
of subsidiaries 502,700 307,000
Preferred shareholders' equity 16,725 216,059
Common shareholders' equity 6,591,443 5,631,397
- ----------------------------------------------------------------------------------------------------------------------
Total capital $ 8,414,876 $ 7,325,132
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
Ratio of debt to total capital 15% 16%
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
DEBT
Debt consists of the following:
<TABLE>
<CAPTION>
(In thousands) December 31
- ----------------------------------------------------------------------------------------------------------------------
1997 1996
BOOK FAIR Book Fair
VALUE VALUE Value Value
<S> <C> <C> <C> <C>
Medium-term notes $ 511,920 $ 529,000 $ 430,427 $ 435,500
Commercial paper 168,429 168,429 131,610 131,610
8-3/8% senior notes 149,592 159,060 149,475 158,835
7% senior notes 145,225 145,744 145,159 146,601
Zero coupon convertible notes 106,838 122,307 102,188 117,688
7-1/8% senior notes 79,824 82,680 79,800 79,944
Nuveen short-term borrowings 69,500 69,500 - -
Real estate mortgages 19,900 20,491 18,133 18,417
Nuveen notes payable 15,000 15,100 - -
Guaranteed ESOP debt 2,780 2,800 13,890 14,000
Credit facility 35,000 35,000 - -
9-3/8% notes - - 99,994 101,500
- ----------------------------------------------------------------------------------------------------------------------
Total debt $1,304,008 $1,350,111 $1,170,676 $1,204,095
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
FAIR VALUE - The fair values of our commercial paper, credit facility and
short-term borrowings approximate their book values because of their short-term
nature. For our other debt, which has longer terms and fixed interest rates, our
fair value estimate is based on current interest rates available on debt
securities in the market that have terms similar to ours.
MEDIUM-TERM NOTES - The medium-term notes bear interest rates ranging from 5.9%
to 8.4%, with a weighted average rate of 7.1%. Maturities range from five to 15
years after the issuance date.
27
<PAGE>
COMMERCIAL PAPER - Our commercial paper is supported by a $400 million credit
agreement that expires in 2002. The credit agreement requires us to stay
below a certain ratio of debt to equity, maintain a stated amount of common
shareholders' equity and meet certain other requirements. As of year-end
1997, we had not borrowed any funds under the agreement, and we were in
compliance with all of its provisions.
Interest rates on commercial paper issued in 1997 ranged from 5.2% to 6.8%;
in 1996 the range was 5.1% to 6.6%; and in 1995 the range was 5.4% to 6.6%.
8-3/8% SENIOR NOTES - The 8-3/8% senior notes mature in 2001.
7% SENIOR NOTES - The 7% senior notes mature in May 1998.
ZERO COUPON CONVERTIBLE NOTES - The zero coupon convertible notes are
redeemable beginning in 1999 for an amount equal to the original issue price
plus amortized original issue discount. In 1996, we repurchased approximately
$39 million of the zero coupon convertible notes.
7-1/8% SENIOR NOTES - The 7-1/8% senior notes mature in 2005.
NUVEEN SHORT-TERM BORROWINGS - Short-term borrowings at the end of 1997 were
obligations of our asset management-investment banking segment that were
collateralized by some of its inventory securities. These borrowings bear a
weighted average interest rate of 7.4%.
REAL ESTATE MORTGAGES - The real estate mortgages represent a portion of the
purchase price of three of our investments. One $13.2 million mortgage bears a
fixed interest rate of 6.7% and matures in November 2000. A second $2.0 million
mortgage bears a fixed rate of 8.1% and matures in February 2002. The third
mortgage of $4.7 million bears a fixed rate of 8.2% and matures in November
2017. In 1996, we reduced our real estate debt by $11 million as a result of a
deed-in-lieu of foreclosure.
NUVEEN NOTES PAYABLE - Nuveen issued these notes in 1997 for general corporate
purposes. The notes bear an interest rate of 6.8% and mature in August 2000.
GUARANTEED ESOP DEBT - The guaranteed ESOP debt bears an interest rate of 7.95%
and the final principal payment is due March 1, 1998. The ESOP's principal
payments and related interest are funded quarterly through a combination of our
contributions and dividends on shares held by the ESOP. We show this debt as our
liability, because we guaranteed the debt.
CREDIT FACILITY - We maintained two committed, standby credit facilities
totaling $450 million at Dec. 31, 1997. The facility in place for $200 million
will expire in December 1998 and the remaining facility will expire in 2002.
These facilities require us to maintain a minimum net worth and debt-to-capital
ratio. We were in compliance with the provisions contained in these agreements
at Dec. 31, 1997 and 1996.
9-3/8% NOTES - The 9-3/8% notes outstanding at Dec. 31, 1996 matured in June
1997. We funded the maturity through a combination of medium-term note and
commercial paper issuances.
INTEREST EXPENSE - Our interest expense was $86.1 million in 1997, $87.2 million
in 1996 and $90.6 million in 1995.
MATURITIES - The amount of debt that becomes due in each of the next five years
is as follows: 1998, $242.6 million; 1999, $20.1 million; 2000, $28.3 million;
2001, $195.2 million; and 2002, $219.2 million.
28
<PAGE>
COMPANY-OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARIES
In 1995, we issued, through St. Paul Capital L.L.C. (SPCLLC), 4,140,000
company-obligated mandatorily redeemable preferred securities, generating
proceeds of $207 million. These securities are also known as convertible
monthly income preferred securities (MIPS). The MIPS pay a monthly dividend
at an annual rate of 6% of the liquidation preference of $50 per security. We
directly or indirectly own all of the common securities of SPCLLC, a special
purpose limited liability company which was formed for the sole purpose of
issuing the MIPS. We have effectively fully and unconditionally guaranteed
SPCLLC's obligations under the MIPS. The MIPS are convertible into 1.6950
shares of our common stock (equivalent to a conversion price of $29.50 per
share). The MIPS are redeemable after May 31, 1999, but we may redeem them
before then upon the occurrence of certain events.
In December 1996, USF&G Capital I (Capital I), a wholly owned business trust,
issued 100,000 shares of 8.5% Capital Securities, Series A (Series A
Securities), generating proceeds of $100 million. Payments on the Series A
Securities are guaranteed by USF&G Corporation on a subordinated basis, but only
to the extent Capital I has funds available to make such payments. This
guarantee, considered together with the terms of debentures issued by USF&G
Corporation (described below) and an agreement by which USF&G Corporation agrees
to pay other expenses and liabilities of Capital I, constitutes a full and
unconditional subordinated guarantee of Capital I's obligations under the Series
A Securities.
Capital I used the proceeds from the Series A Securities issuance to purchase
$100 million principal amount of USF&G Corporation 8.5% Junior Subordinated
Debentures (Series A Debentures). The Series A Debentures rank junior and
subordinate in right of payment to certain other indebtedness, and mature on
Dec. 15, 2045. Interest payments on the Series A Debentures are deferrable, at
USF&G Corporation's option, at any time for up to five years at a time, and
provided there has not been an event of default. In the event USF&G Corporation
elects to defer interest payments on the Series A Debentures, payments of
distributions on the Series A Securities will likewise be deferred. Interest and
distributions continue to accrue during any payment deferral period.
The Series A Debentures are redeemable under certain circumstances related to
tax events at a price of $1,000 per debenture plus any accrued and unpaid
interest and a "make whole" payment. Proceeds from any redemptions of the Series
A Debentures will be used to redeem a like amount of the Series A Securities.
Additionally, USF&G Corporation has the right, under certain circumstances
related to tax events, to shorten the maturity of the Series A Debentures to a
date no earlier than June 24, 2016, in which case the stated maturity of the
Series A Securities will likewise be affected.
In January 1997, USF&G Capital II (Capital II), a second wholly owned business
trust, issued 100,000 shares of 8.47% Capital Securities, Series B (Series B
Securities), generating proceeds of $100 million. Payments on the Series B
Securities are guaranteed on the same basis as the guarantee of the Series A
Securities.
Capital II used the proceeds from the Series B Securities issuance to
purchase $100 million principal amount of USF&G Corporation's 8.47%
Deferrable Interest Junior Subordinated Debentures, Series B (Series B
Debentures), which mature on Jan. 10, 2027. The Series B Debentures also rank
junior and subordinate to certain other indebtedness, but rank equal with the
Series A Debentures. The Series B Debentures and Series B Securities have
interest/distribution deferral terms similar to those of the Series A
Debentures and Series A Securities, described above.
29
<PAGE>
The Series B Debentures are redeemable at USF&G Corporation's option at
any time beginning in January 2007 at scheduled redemption prices ranging
from $1,042 to $1,000 per debenture, plus any accrued and unpaid interest.
The Series B Debentures are also redeemable prior to January 2007 under
certain circumstances related to tax and other special events. Proceeds from
any redemptions of the Series B Debentures will be used to redeem a like
amount of the Series B Securities. Additionally, USF&G Corporation has the
right, under certain circumstances related to tax events, to shorten the
maturity of the Series B Debentures to a date no earlier than July 10, 2016,
in which case the stated maturity of the Series B Securities will likewise be
affected.
In July 1997, USF&G Capital III (Capital III), a third wholly owned business
trust, issued 100,000 shares of 8.312% Capital Securities, Series C (Series C
Securities), generating proceeds of $100 million. Payments on the Series C
Securities are guaranteed on the same basis as the guarantee of the Series A
and Series B Securities.
Capital III used the proceeds from the Series C Securities issuance to
purchase $100 million principal amount of USF&G Corporation's 8.312% Junior
Subordinated Debentures (Series C Debentures). The Series C Debentures rank
junior and subordinate in right of payment to certain other indebtedness, but
rank equal with the Series A and Series B Securities. The Series C Debentures
and Series C Securities have interest/distribution deferral terms similar to
those of the Series A and Series B Debentures and Series A and Series B
Securities, described above.
The Series C Debentures mature on July 1, 2046, and are redeemable under
certain circumstances related to tax events at a price of $1,000 per
debenture plus any accrued and unpaid interest and a "make whole" payment.
Proceeds from any redemptions of the Series C Debentures will be used to
redeem a like amount of the Series C Securities. Additionally, USF&G
Corporation has the right, under certain circumstances related to tax events,
to shorten the maturity of the Series C Debentures to a date no earlier than
April 8, 2012, in which case the stated maturity of the Series C Securities
will likewise be affected.
In the event we exercise our right to defer interest payments on the
Series A, Series B or Series C Debentures, we will be prohibited from making
payments with respect to any capital debt or securities which rank equal or
junior in right of payment to these debentures, including cash dividends on
our common or preferred stock. In no case may we defer the interest payments
beyond the stated maturity dates of the respective securities.
PREFERRED SHAREHOLDERS' EQUITY
Included in the preferred shareholders' equity on our balance sheet are $16.7
million and $16.1 million at Dec. 31, 1997 and 1996, respectively, which
represents the par value of preferred shares outstanding that we issued to
our Preferred Stock Ownership Plan (PSOP) Trust, less the remaining principal
balance on the PSOP Trust debt. The PSOP Trust borrowed funds from a U.S.
underwriting subsidiary to finance the purchase of the preferred shares, and
we guaranteed the PSOP debt.
The PSOP trust may at any time convert any or all of the preferred shares
into shares of our common stock at a rate of eight shares of common stock for
each preferred share. Our board of directors has reserved a sufficient number
of our authorized common shares to satisfy the conversion of all preferred
shares issued to the PSOP trust and the redemption of preferred shares to
meet employee distribution requirements. Upon the redemption of preferred
shares, we issue shares of our common stock to the trust to fulfill the
redemption obligations.
30
<PAGE>
At Dec. 31, 1996 and 1995, we had 4 million shares of $4.10 Series A
Convertible Exchangeable Preferred Stock (Series A Preferred Stock) issued
and outstanding. During the first half of 1997, we redeemed all of the
remaining outstanding shares of Series A Preferred Stock for $200 million
cash. Holders of 10,277 shares of the Series A Preferred Stock converted
their shares into 6,944 shares of common stock. We had 277,550 shares and 1.3
million shares of $10.25 Series B Cumulative Convertible Preferred Stock
(Series B Preferred Stock) issued and outstanding at Dec. 31, 1996 and 1995,
respectively. During 1996 and 1995, we redeemed 233,550 shares and 832,650
shares, respectively, of Series B Preferred Stock. These shares were
converted into 1.1 million shares and 3.9 million shares, respectively, of
common stock in accordance with the terms of the Series B Preferred Stock.
Holders of an additional 20,000 shares and 189,800 shares of Series B
Preferred Stock voluntarily converted their shares into 93,838 and 902,720
shares, respectively, of our common stock during 1996 and 1995. The holder of
another 24,000 shares of Series B Preferred Stock voluntarily redeemed those
shares for cash during 1996.
COMMON SHAREHOLDERS' EQUITY
COMMON STOCK AND REACQUIRED SHARES - We are governed by the Minnesota
Business Corporation Act. All authorized shares of voting common stock have
no par value. Shares of common stock reacquired are considered unissued
shares. The number of authorized shares of the company is 480 million.
Our cost for reacquired shares in 1997, 1996 and 1995 was $128.1 million,
$225.0 million and $41.7 million, respectively. We reduced our capital stock
account and retained earnings for the cost of these repurchases. In December
1997, we issued approximately 2.9 million shares of common stock valued at
$112 million as partial consideration for our acquisition of Titan. Also in
1997, we issued 40,976 shares of our common stock valued at $1.7 million, and
in 1996 we issued 57,496 shares of our common stock (also valued at $1.7
million), as partial consideration for our acquisition of a Lloyd's of London
managing agency. We issued 1.2 million and 4.8 million shares of common stock
during 1996 and 1995, respectively for the conversion of USF&G Corporation
Series B Preferred Stock. During 1995, we also issued 3.1 million shares of
common stock for the conversion of USF&G Corporation $5.00 Series C
Cumulative Convertible Preferred Stock.
A summary of our common stock activity for the last three years is as
follows:
<TABLE>
<CAPTION>
(Shares) Year ended December 31
- ----------------------------------------------------------------------------------------------------------------------
1997 1996 1995
<S> <C> <C> <C>
Outstanding at beginning
of year 230,851,306 235,433,487 227,539,084
Shares issued:
Stock incentive plans 1,501,532 1,084,338 1,068,192
Conversion of preferred stock 1,223,571 1,824,494 8,382,595
Acquisition 2,918,396 57,496 -
Reacquired shares (3,365,084) (7,548,509) (1,556,384)
- ----------------------------------------------------------------------------------------------------------------------
Outstanding at end of year 233,129,721 230,851,306 235,433,487
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
UNDESIGNATED SHARES - Our articles of incorporation allow us to issue five
million undesignated shares. The board of directors may designate the type of
shares and set the terms thereof. The board designated 50,000 shares as Series A
Junior Participating Preferred Stock in connection with the establishment of our
Shareholder Protection Rights Plan. The board designated 1,450,000 shares as
Series B Convertible Preferred Stock in connection with the formation of our
Preferred Stock Ownership Plan. In 1995, the board designated 41,400 shares as
Series C Cumulative Convertible Preferred Stock in connection with St. Paul
Capital L.L.C.'s issuance of company-obligated mandatorily redeemable preferred
securities.
31
<PAGE>
SHAREHOLDER PROTECTION RIGHTS PLAN - Our Shareholder Protection Rights Plan is
designed to protect the interests of our shareholders in the event of
unsolicited and unfair or coercive attempts to acquire control of the company.
Our shareholders own one right for each common share owned, which would enable
them to initiate specified actions to protect their interests. We may redeem
this right under circumstances specified in the plan.
DIVIDEND RESTRICTIONS - We primarily depend on dividends from our
subsidiaries to pay dividends to our shareholders, service our debt and pay
expenses. Various state laws and regulations limit the amount of dividends we
may receive from our U.S. property-liability underwriting subsidiaries and
our life insurance subsidiary. In 1998, $573.5 million will be available for
dividends free from such restrictions. During 1997, we received cash
dividends of $336 million from our U.S. underwriting subsidiaries, and a
noncash dividend of a portion of our underwriting subsidiary's investment in
The John Nuveen Company with a market value of $211.1 million. We received
cash dividends of $40 million during 1997 from our life insurance subsidiary.
In addition, effective Dec. 17, 1997 our life insurance subsidiary declared
extraordinary dividends payable to us consisting of investments in various
real estate properties totaling $25 million. Consequently, all of the 1997
dividends received from our life insurance subsidiary were deemed
extraordinary, and were paid with the consent of the Maryland insurance
commissioner. Any dividends to be paid by our life insurance subsidiary in
1998 would be deemed extraordinary dividends and would be subject to
additional regulatory approval.
32
<PAGE>
NOTE 9 RETIREMENT PLANS
THE COMPANY'S RETIREMENT PLANS CURRENTLY CONSIST OF THE CONTINUATION OF THE
ST. PAUL COMPANIES, INC.'S AND USF&G CORPORATION'S RESPECTIVE PLANS THAT WERE
IN EFFECT PRIOR TO THE MERGER. ACCORDINGLY, THE FOLLOWING INFORMATION
SUMMARIZES THE PREDECESSOR PLANS. WE ARE CURRENTLY IN THE PROCESS OF
REVIEWING THE BENEFIT PLANS OF BOTH PREDECESSOR INSTITUTIONS TO DETERMINE
WHICH PLANS WILL CONTINUE IN THE COMBINED ORGANIZATION. SHARES UNDER USF&G
CORPORATION PREDECESSOR PLAN REFER TO HISTORICAL AMOUNTS AND DO NOT REFLECT
THE EFFECTS OF THE MERGER WITH THE ST. PAUL OR THE ST. PAUL'S MAY, 1998
2-FOR-1 STOCK SPLIT.
THE ST. PAUL COMPANIES, INC. PREDECESSOR PLANS
PENSION PLANS - We maintain funded defined benefit pension plans for most of
our U.S. employees. Benefits are based on years of service and the employee's
compensation while employed by the company. Pension benefits generally vest
after five years of service.
Our pension plans are noncontributory. This means that employees do not
pay anything into the plans. Our funding policy is to contribute amounts
sufficient to meet the minimum funding requirements of the Employee
Retirement Income Security Act and any additional amounts that may be
necessary. This may result in no contribution being made in a particular year.
Net periodic pension cost for our funded pension plans was $6.0 million,
$9.7 million and $13.9 million for the years 1997, 1996 and 1995,
respectively.
The key components of our pension plans are summarized as follows:
<TABLE>
<CAPTION>
(In thousands) December 31
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
1997 1996
FUNDED STATUS
Accumulated benefit obligation $325,291 $287,334
Projected benefit obligation 418,813 368,158
Plan assets at fair value 514,087 407,404
- ----------------------------------------------------------------------------------------------------------------------
ASSUMPTIONS
Discount rate 6.75% 7.25%
Rate of increase in compensation 3.75 4.00
Expected rate of return on plan assets 10.00 9.00
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
Plan assets are invested primarily in equities and fixed maturities and
included 760,344 shares of our common stock with a market value of $31.2 million
and $22.3 million at Dec. 31, 1997 and 1996, respectively.
33
<PAGE>
EMPLOYEE STOCK OWNERSHIP PLAN - We maintain an ESOP for qualified U.S.
employees. An ESOP trust was formed that borrowed funds to purchase shares of
our stock for future allocation to qualified employees. As the principal of the
ESOP trust loan is paid, a pro rata amount of our common stock is released for
allocation to eligible participants. Dividends we pay on all shares held by the
trust are used to pay the ESOP's obligations. In addition, we make contributions
as needed to meet the ESOP's obligations.
All shares held by the ESOP are considered outstanding for diluted EPS
computations, and dividends paid on all ESOP shares are charged to retained
earnings. Our ESOP expense was reduced by the dividends we paid to the ESOP
trust.
We recorded ESOP expense of $10.5 million, $6.2 million and $7.3 million
for the years 1997, 1996 and 1995, respectively.
The ESOP made its final allocation in 1997 totaling 1.2 million shares.
The ESOP allocated 1.0 million shares in 1996 and 1.0 million shares in 1995.
PREFERRED STOCK OWNERSHIP PLAN - Our Savings Plus Preferred Stock Ownership
Plan (PSOP) allocates preferred shares semi-annually to those employees
participating in our Savings Plus Plan. The allocation is equivalent to 60%
of employees' contributions up to a maximum of 6% of their salary plus shares
equal to the value of dividends on previously allocated shares. To finance
the stock purchase for future allocation to qualified employees, the PSOP
borrowed $150 million at 9.4% from one of our U.S. underwriting subsidiaries.
As the principal and interest of the trust's loan is paid, a pro rata amount
of our preferred stock is released for allocation to participating employees.
Each share pays a dividend of $11.72 annually and is currently convertible
into eight shares of common stock. Dividends on all shares held by the trust
are used to pay the PSOP obligation. In addition to dividends paid to the
trust, we make additional cash contributions to the PSOP as necessary in
order to meet the PSOP's debt obligation.
The common stock equivalent of all shares held by the PSOP is considered
outstanding for diluted EPS computations, and dividends paid on all PSOP
shares are charged to retained earnings. Our PSOP expense was reduced by the
dividends we paid to the PSOP trust.
We recorded PSOP expense of $6.1 million, $7.8 million and $7.3 million
for the years 1997, 1996 and 1995, respectively.
The PSOP allocated 41,810 shares in 1997, 60,803 shares in 1996 and 59,998
shares in 1995. The remaining 631,081 shares at Dec. 31, 1997, will be
released for allocation annually through Jan. 31, 2005.
ESOP/PSOP PLAN MERGER - As of Jan. 1, 1998, the ESOP and PSOP were merged
into The St. Paul Companies Inc. Stock Ownership Plan. The plan will
continue to provide semi-annual matching allocations to employees
participating in our Savings Plus Plan. This match has been enhanced to 100%
of employees' contributions up to a maximum of 4% of their salary.
Additionally, this plan will now provide an annual allocaton to qualified
U.S. employees based on company performance.
POSTRETIREMENT BENEFITS OTHER THAN PENSION - We provide certain health care
and life insurance benefits for retired U.S. employees and their eligible
dependents. We currently anticipate that most of our employees will become
eligible for these benefits if they retire while working for us. The cost of
these benefits is shared with the retiree. The benefits are generally
provided through our employee benefits trust, to which periodic contributions
are made to cover benefits paid during the year. We accrue postretirement
benefits expense during the period of the employee's service.
Net periodic postretirement benefits cost was $12.1 million, $11.4 million
and $11.0 million for the years 1997, 1996 and 1995, respectively.
34
<PAGE>
The key components of our postretirement benefits plans are summarized as
follows:
<TABLE>
<CAPTION>
(In thousands) December 31
- ----------------------------------------------------------------------------------------------------------------------
1997 1996
<S> <C> <C>
FUNDED STATUS
Accumulated postretirement benefit obligation $140,358 $132,086
Plan assets at fair value 18,612 17,107
- ----------------------------------------------------------------------------------------------------------------------
ASSUMPTIONS
Discount rate 7.00% 7.50%
Rate of increase in compensation 3.75 4.00
Expected rate of return on plan assets 9.00 9.00
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
35
<PAGE>
A health care inflation rate of 7% was assumed to change to 6.75% in 1998,
decrease annually to 5% in 2002 and then remain at that level. A 1% increase
in the health care cost trend rate assumption would not have had a material
impact on the accumulated postretirement benefit obligation or the expense
for the year.
USF&G CORPORATION PREDECESSOR PLANS
PENSION PLANS - USF&G has noncontributory retirement plans covering most
regular full-time employees of USF&G and its affiliates. An employee's
pension benefit is based on salary, years of service and Social Security
benefits. USF&G makes contributions to the retirement plans based on amounts
required to be funded under provisions of the Employee Retirement Income
Security Act of 1974, as amended. Net periodic pension cost for our funded
pension plans was $8.4 million, $12.1 million and $12.4 million for the years
1997, 1996 and 1995, respectively.
Plan assets are invested primarily in fixed maturities and equities and
included 77,440 shares of USF&G common stock with a market value of $1.7
million and $1.6 million at Dec. 31, 1997 and 1996, respectively.
The plans' funded status and amounts recognized in the consolidated
financial statements were as follows:
<TABLE>
<CAPTION>
(In thousands) December 31
- ----------------------------------------------------------------------------------------------------------------------
1997 1996
<S> <C> <C>
FUNDED STATUS
Accumulated benefit obligation $410,190 $370,480
Projected benefit obligation 426,971 384,945
Plan assets at fair value 439,172 378,731
- ----------------------------------------------------------------------------------------------------------------------
ASSUMPTIONS
Discount rate 7.00% 7.50%
Rate of increase in compensation 5.00 5.00
Expected rate of return on plan assets 8.50 8.50
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
POSTRETIREMENT BENEFITS OTHER THAN PENSION - USF&G sponsors a defined-dollar
postretirement health care (medical and dental) plan and noncontributory life
insurance plan covering most regular full-time employees of USF&G and its
affiliates. USF&G's contributions and costs are determined based on the
annual salary and the type of coverage elected by covered employees. USF&G's
contributions to the plan are a percentage of plan costs based on age and
service of employees at retirement. Additionally, the plan costs are capped
at projected 1998 cost levels, and retiree contributions are increased for
the total medical costs over the projected levels.
USF&G accrues the cost of health care, life insurance and other retiree
benefits when the employees' services are rendered, and funds the health care
and life insurance benefit costs principally on a pay-as-you-go basis. Net
periodic postretirement benefits cost was $4.4 million for each of the years
1997, 1996 and 1995.
36
<PAGE>
The key components of USF&G postretirement benefits plans are summarized
as follows:
<TABLE>
<CAPTION>
(In thousands) December 31
- ----------------------------------------------------------------------------------------------------------------------
1997 1996
<S> <C> <C>
FUNDED STATUS
Accumulated postretirement benefit obligation $52,076 $50,941
Plan assets at fair value - -
- ----------------------------------------------------------------------------------------------------------------------
ASSUMPTIONS
Discount rate 7.00% 7.50%
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
A health care inflation rate of 7.25% was assumed for 1997 and
1998, and is assumed to decrease to 5.25% in 2003 for participants age 65 or
younger, and 7.0% for 1997 and 1998, decreasing to 5.25% in 2003 for
participants over age 65, and remain at that level thereafter. A 1% increase
in the health care cost trend rate assumption would not have had a material
impact on the accumulated postretirement benefit obligation or the expense
for the year.
37
<PAGE>
NOTE 10 STOCK INCENTIVE PLANS
We have made fixed stock option grants to certain U.S.-based company officers
and outside directors. We also have made separate fixed option grants to
certain employees of our non-U.S. operations. These plans are referred to as
"fixed plans" because the measurement date for determining compensation costs
is fixed on the date of grant. In 1997 and 1996, we also made variable stock
option grants to certain company officers. These were considered "variable"
grants because the measurement date is contingent upon future increases in
the market price of our common stock. At the end of 1997, approximately
1,820,000 shares remained available for grant under our stock incentive plan.
We follow the provisions of Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" and related interpretations in
accounting for our stock option plans. In 1996, we implemented the disclosure
provisions required by SFAS No. 123, "Accounting for Stock-Based
Compensation" for our option plans. SFAS No. 123 requires pro forma net
income and earnings per share information, which is calculated assuming we
had accounted for our stock option plans under the "fair value" method
described in that Statement.
Since the exercise price of our fixed options equals the market price of
our stock on the day the options are granted there is no related compensation
cost. We have recorded compensation cost associated with our variable options
and restricted stock awards, and the former USF&G's Long-Term Incentive
Program, of $17.5 million, $14.9 million and $1.2 million in 1997, 1996 and
1995, respectively.
In connection with the USF&G merger, The St. Paul assumed USF&G's
obligations under four stock option plans and its Long-Term Incentive Plan.
Exercise prices were based on the fair market value of USF&G's common stock
on the date of grant. As a result of the merger, all outstanding options
under the stock option plans were vested and converted into options to
acquire The St. Paul's common stock.
FIXED OPTION GRANTS
U.S.-BASED PLANS - Our fixed option grants for certain U.S.-based company
officers and outside directors give these individuals the right to buy our
stock at the market price on the day the options were granted. Fixed stock
options granted under the stock incentive plan adopted by our shareholders in
May 1994 may be exercised between one and 10 years subsequent to the date of
grant. Options granted under our option plan in effect prior to May 1994 may
be exercised at any time up to 10 years after the grant date.
NON-U.S. PLANS - We also have separate stock option plans for certain
employees of our non-U.S. operations. The options granted under these plans
were priced at the market price of our common stock on the grant date.
Generally, they can be exercised from three to 10 years after the grant date.
Approximately 200,000 option shares remained available at year-end for future
grants under our non-U.S. plans.
38
<PAGE>
The following table summarizes the activity for our fixed option plans for
the last three years. All grants were made at fair value on the date of grant.
<TABLE>
<CAPTION>
Weighted
Option Average
Shares Exercise Price
<S> <C> <C>
Outstanding Jan. 1, 1995 9,282,142 $ 19.23
Granted 2,871,794 24.29
Exercised (1,371,267) 15.48
Canceled (363,542) 29.14
- ----------------------------------------------------------------------------------------------------------------------
Outstanding Dec. 31, 1995 10,419,127 20.47
Granted 3,444,162 26.42
Exercised (1,395,719) 18.21
Canceled (586,775) 23.62
- ----------------------------------------------------------------------------------------------------------------------
Outstanding Dec. 31, 1996 11,880,795 22.60
Granted 3,353,133 34.38
Exercised (2,133,788) 20.07
Canceled (557,329) 31.77
- ----------------------------------------------------------------------------------------------------------------------
Outstanding Dec. 31, 1997 12,542,811 $ 25.76
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
The following table summarizes the options exercisable at the end of the
last three years and the weighted average fair value of options granted
during those years. The fair value of options is estimated on the date of
grant using the Black-Scholes option-pricing model, with the following
weighted-average assumptions used for grants in 1997, 1996 and 1995,
respectively: dividend yield of 2.1%, 2.0% and 2.2%; expected volatility of
20.1%, 22.7% and 22.3%; risk-free interest rates of 6.5%, 6.2% and 7.2%; and
an expected life of 5.4 years, 6.2 years and 6.5 years.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------
1997 1996 1995
<S> <C> <C> <C>
Options exercisable at
year-end 8,174,128 7,186,957 6,336,406
Weighted average fair value
of options granted
during the year $8.88 $7.20 $6.93
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
The following tables summarize the status of fixed stock options
outstanding and exercisable at Dec. 31, 1997:
<TABLE>
<CAPTION>
Options Outstanding
- ----------------------------------------------------------------------------------------------------------------------
Weighted
Average Weighted
Range of Number of Remaining Average
Exercise Prices Options Contractual Life Exercise Price
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
$11.08-19.49 2,266,914 3.3 YEARS $16.40
19.50-28.35 6,755,834 7.0 YEARS 23.92
28.36-37.21 2,211,942 8.6 YEARS 32.06
37.22-51.39 1,237,185 9.2 YEARS 39.94
51.40-54.63 70,936 1.7 YEARS 52.25
- ----------------------------------------------------------------------------------------------------------------------
$11.08-54.63 12,542,811 6.8 YEARS $25.76
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
39
<PAGE>
<TABLE>
<CAPTION>
Options Exercisable
- ----------------------------------------------------------------------------------------------------------------------
Weighted
Range of Number of Average
Exercise Prices Options Exercise Price
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
$11.08-19.49 2,266,914 $16.40
19.50-28.35 5,161,220 23.50
28.36-37.21 671,830 29.15
37.22-51.39 3,228 39.88
51.40-54.63 70,936 52.25
- ----------------------------------------------------------------------------------------------------------------------
$11.08-54.63 8,174,128 $22.25
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
VARIABLE STOCK OPTION GRANT
In 1997 and 1996, we made variable option grants of 316,200 and 1,650,600
shares, respectively, from our 1994 stock incentive plan to certain of our
key officers. One-half of the options will vest when the market price of our
stock reaches a 20-consecutive-day average of $50 per share. The remaining
options will vest when our stock price reaches a 20-consecutive-day average
of $55 per share. The exercise price of each option is equal to the market
price of our stock on the grant date. The weighted average exercise prices
were $33.57 and $29.38 in 1997 and 1996, respectively. These options may be
exercised during the 12 months preceding the Dec.1, 2001 expiration date
provided the stock price targets are achieved.
All of the variable options granted in 1997 and 1996 were outstanding at
Dec. 31, 1997. These options have a remaining contractual life of 3.9 years.
The weighted average fair value of options granted during 1997 and 1996 is
$5.46 and $4.54 per option, respectively. The fair value of the variable
options was estimated on the date of grant using a variable option-pricing
model with the following weighted average assumptions in 1997 and 1996,
respectively: dividend yield of 2.8% and 3.0%; expected volatility of 20.0%
for both years; risk-free interest rate of 6.1% and 5.8%; and an expected
life of 4.6 years and 5.0 years.
RESTRICTED STOCK AND DEFERRED STOCK AWARDS
Up to 20% of the 8 million shares available under our 1994 stock incentive
plan may be granted as restricted stock awards. The stock is restricted
because recipients receive the stock only upon completing a specified
objective or period of employment, generally one to five years. The shares
are considered issued when awarded, but the recipient does not own and cannot
sell the shares during the restriction period. Up to 1,400,000 shares remain
available for restricted stock awards at Dec. 31, 1997.
We also have a Deferred Stock Award Plan for stock awards to non-U.S.
employees. Deferred stock awards are the same as restricted stock awards,
except that shares granted under the deferred plan are not issued until the
vesting conditions specified in the award are fulfilled. Up to 42,000 shares
remain available for deferred stock awards at Dec. 31, 1997.
40
<PAGE>
PRO FORMA INFORMATION
Had we calculated compensation expense on a combined basis for our stock
option grants based on the "fair value" method described in SFAS No. 123, our
net income and earnings per share would have been reduced to the pro forma
amounts as indicated.
<TABLE>
<CAPTION>
(In thousands) Year ended December 31
- ----------------------------------------------------------------------------------------------------------------------
1997 1996 1995
<S> <C> <C> <C>
NET INCOME
As reported $929,292 $732,702 $751,392
Pro forma 914,831 721,209 744,094
- ----------------------------------------------------------------------------------------------------------------------
BASIC EARNINGS PER SHARE
As reported 3.97 3.01 3.08
Pro forma 3.91 2.96 3.05
- ----------------------------------------------------------------------------------------------------------------------
DILUTED EARNINGS PER SHARE
As reported 3.69 2.84 2.89
Pro forma 3.63 2.79 2.86
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
41
<PAGE>
NOTE 11 COMMITMENTS AND CONTINGENCIES
INVESTMENT COMMITMENTS - We have long-term commitments to fund venture
capital and real estate investments totaling $124.8 million as of Dec. 31,
1997. We estimate these commitments will be paid as follows: $47.8 million in
1998; $41.2 million in 1999; $23.0 million in 2000; $10.3 million in 2001; and
$2.5 million in 2002.
FINANCIAL GUARANTEES - We are contingently liable for financial guarantee
exposures ceded through reinsurance agreements with a company in which we
formerly had a minority ownership interest totaling approximately $89 million
as of Dec. 31, 1997. We have also committed to assumption of the first $15
million in losses that may arise as a result of default on certain
mortgage-backed securities.
LEASE COMMITMENTS - A portion of our business activities is carried on in
rented premises. We also enter into leases for equipment, such as office
machines and computers. Our total rental expense was $92 million in 1997,
$107 million in 1996 and $102 million in 1995.
Certain leases are noncancelable, and we would remain responsible for
payment even if we stopped using the space or equipment. On Dec. 31, 1997,
the minimum annual rents for which we would be liable under these types of
leases are as follows: $102 million in 1998, $84 million in 1999, $76 million
in 2000, $71 million in 2001, $49 million in 2002 and $235 million thereafter.
We are also the lessor under various subleases on our office facilities.
The minimum rentals to be received in the future under noncancelable
subleases is $97 million at December 31, 1997.
LEGAL MATTERS - In the ordinary course of conducting business, we and some of
our subsidiaries have been named as defendants in various lawsuits. Some of
these lawsuits attempt to establish liability under insurance contracts
issued by our underwriting operations. Plaintiffs in these lawsuits are
asking for money damages or to have the court direct the activities of our
operations in certain ways.
In connection with our sale of Minet to Aon Corporation in 1997, we agreed
to indemnify Aon against any future professional liability claims for events
that occurred prior to the sale. Included in our 1997 provision for loss on
disposal of Minet was the cost of purchasing insurance to cover a portion of
our exposure to such claims.
It is possible that the settlement of these lawsuits or payments for
Minet-related liability claims may be material to our results of operations
and liquidity in the period in which they occur. However, we believe the
total amounts that we and our subsidiaries will ultimately have to pay in all
of these matters will have no material effect on our overall financial
position.
42
<PAGE>
NOTE 12 DISCONTINUED OPERATIONS
In December 1996, we decided to sell our insurance brokerage, Minet, and in
May 1997, we completed the sale to Aon Corporation. As a result, we accounted
for Minet as a discontinued operation in 1997 and 1996, and restated 1995
results to be consistent with the 1997 and 1996 presentation.
We agreed to indemnify Aon against most of Minet's preclosing liabilities.
Our gross proceeds from the sale to Aon were approximately equal to our
remaining carrying value of Minet at the date of sale.
The following summarizes the discontinued operations for the last three
years:
<TABLE>
<CAPTION>
(In thousands) Year ended December 31
- ----------------------------------------------------------------------------------------------------------------------
1997 1996 1995
<S> <C> <C> <C>
Operating loss, before
income taxes $ - $ (18,815) $(13,092)
Income tax expense - 401 3,547
- ----------------------------------------------------------------------------------------------------------------------
Operating loss, net of taxes - (19,216) (16,639)
- ----------------------------------------------------------------------------------------------------------------------
Loss on disposal, before
income taxes (103,280) (380,036) -
Income tax benefit (35,530) (291,493) -
- ----------------------------------------------------------------------------------------------------------------------
Loss on disposal,
net of taxes (67,750) (88,543) -
- ----------------------------------------------------------------------------------------------------------------------
Loss from discontinued
operations $(67,750) $(107,759) $(16,639)
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
In 1996, we recorded a pretax loss of $380 million on the disposal of
Minet, which represented the estimated difference between the fair value and
the carrying value of Minet by the time we would finalize the sale. That loss
provision encompassed Minet's estimated operating losses through the date of
disposal, the realization of previously unrealized foreign exchange losses,
pension and postretirement curtailment gains, and estimated selling costs.
We also recorded a net $291 million tax benefit in 1996, consisting of a
$353 million tax benefit on the provision for loss on disposal reduced by a
valuation allowance of $62 million. Our federal income tax carrying value of
Minet was substantially higher than our carrying value for financial
statement purposes, so the tax benefit was not proportionate to the pretax
loss.
In 1997, we recorded an additional pretax loss on disposal of $103 million
(with a corresponding tax benefit of $36 million), which resulted primarily
from our agreement to be responsible for certain severance, employee
benefits, future lease commitments and other costs related to Minet.
The net assets of our discontinued operations at Dec. 31, 1996, consisted
of the estimated proceeds we would receive upon disposal, along with the net
tax assets associated with the disposal.
43
<PAGE>
NOTE 13 MERGER WITH USF&G CORPORATION
On April 24, 1998, The St. Paul issued 66,468,572 of its common shares (as
adjusted for the May 6, 1998 two-for-one stock split) in exchange for all of
the outstanding common stock of USF&G Corporation (USF&G), a holding company
for property-liability and life insurance operations. This business
combination has been accounted for as a pooling of interests; accordingly,
the consolidated financial statements for all periods prior to the
combination have been restated to include the accounts and results of
operations of USF&G. There were no material intercompany transactions between
The St. Paul and USF&G prior to the merger.
The following summarizes the results of operations previously reported by The
St. Paul and USF&G, and the combined amounts included in the accompanying
supplemental consolidated financial statements.
<TABLE>
<CAPTION>
(In thousands) Year ended December 31
- ----------------------------------------------------------------------------------------------------------------------
1997 1996 1995
<S> <C> <C> <C>
Total Revenues:
The St. Paul Companies, Inc. $6,219,273 $5,734,156 $5,056,199
USF&G Corporation 3,403,906 3,497,381 3,458,761
- ----------------------------------------------------------------------------------------------------------------------
Combined $9,623,179 $9,231,537 $8,514,960
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
Net Income:
The St. Paul Companies, Inc. $705,473 $450,099 $521,209
USF&G Corporation 193,866 260,977 209,369
- ----------------------------------------------------------------------------------------------------------------------
Combined $899,339 $711,076 $730,578
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
Conforming accounting adjustment,
net of taxes 29,953 21,626 20,814
- ----------------------------------------------------------------------------------------------------------------------
Net income included in accompanying
financial statements $929,292 $732,702 $751,392
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
Prior to the merger, USF&G discounted all of its workers' compensation
reserves to present value, whereas The St. Paul did not discount any of its
loss reserves. Subsequent to the merger, The St. Paul and USF&G on a combined
basis discount only tabular workers' compensation reserves using an interest
rate of up to 3.5%. Since these reserves have an ultimate cost and payment
pattern that are fixed and determinable in accordance with Staff Accounting
Bulletin No. 62, "Discounting by Property-Casualty Insurance Companies," The
St. Paul has determined that the discounting of such reserves is the
preferable accounting treatment. The conforming accounting adjustment in the
preceding table represents the net reduction in insurance losses and loss
adjustment expenses to conform the discounting policies of the two companies
with regard to these reserves.
44
<PAGE>
NOTE 14 ACQUISITIONS
In 1997, we acquired TITAN Holdings, Inc. (Titan), a property-liability
insurance company located in San Antonio, Texas, for $259 million including
assumed debt. Titan specializes in the non-standard automobile and government
entities insurance markets. The transaction resulted in goodwill of
approximately $151 million, which is being amortized over 40 years. The
consideration paid included shares of our common stock, valued at
approximately $112 million. As of Dec. 31, 1997, $47 million in cash payments
were made to reduce debt and cover certain other acquisition-related
expenses. The remaining consideration of $97 million, consisting of cash
payments to Titan's shareholders, was subsequently paid in February, 1998.
In 1997, The John Nuveen Company (Nuveen), our asset management-investment
banking segment, acquired Flagship Resources, Inc., a firm that managed the
assets of both its sponsored and marketed family of mostly tax-free mutual
funds and its private investment accounts, for a total cost of approximately
$72 million, plus as much as an additional $20 million contingent upon
meeting future growth targets. Nuveen also acquired Rittenhouse Financial
Services, Inc., an equity and balanced fund investment management firm, in
1997 for a total cost of approximately $147 million. These acquisitions added
approximately $13.8 billion to Nuveen's assets under management. The cost of
these acquisitions was largely composed of goodwill of $213 million which is
being amortized over 30 years.
In late 1996, we acquired Afianzadora Insurgentes, S.A. de C.V.
(Afianzadora), a surety bond company in Mexico, for $65 million in cash. This
acquisition resulted in goodwill of $18 million, which is being amortized
over 20 years.
In 1996, we acquired Northbrook Holdings, Inc. and its three insurance
subsidiaries from Allstate Insurance Company. Northbrook and its subsidiaries
underwrite various property-liability commercial insurance products
throughout the United States. Our total cost for this acquisition was
approximately $193 million, which was provided from internal funds. We
recorded goodwill of approximately $71 million that we are amortizing over 15
years.
In the Northbrook purchase agreement, we agreed to pay Allstate additional
consideration of up to $50 million in the event a redundancy develops on the
acquired Northbrook reserves between the purchase date and July 31, 2000.
Similarly, Allstate agreed to pay us consideration of up to $100 million in
the event a deficiency develops on those reserves during the same time
period. Any amounts to be paid by either party will depend on the extent of
the redundancy or deficiency and will be determined in accordance with terms
described in the purchase agreement.
All of these acquisitions were accounted for as purchases. As a result,
the acquired companies' results were included in our consolidated results
from the date of purchase. Consolidated results would not have been
materially different had the acquisitions been completed at the beginning of
the year of acquisition.
45
<PAGE>
NOTE 15 REINSURANCE
Our financial statements reflect the effects of assumed and ceded reinsurance
transactions. Assumed reinsurance refers to our acceptance of certain
insurance risks that other insurance companies have underwritten. Ceded
reinsurance means other insurance companies agree to share certain risks with
us. The primary purpose of ceded reinsurance is to protect us from potential
losses in excess of what we are prepared to accept.
We report balances pertaining to reinsurance transactions "gross" on the
balance sheet, meaning that reinsurance recoverables on unpaid losses and
ceded unearned premiums are not deducted from insurance reserves but are
recorded as assets.
We expect the companies to which we have ceded reinsurance to honor their
obligations. In the event these companies are unable to honor their
obligations to us, we will pay these amounts. We have established allowances
for possible nonpayment of amounts due to us.
Additionally, we have been active in the involuntary market as a servicing
carrier whereby we process business for a pool but take no net underwriting
risk because we are directly reimbursed for the cost of processing policies
and settling any related claims. Servicing carrier receivables of $710
million and $661 million associated with this business are included in our
supplemental balance sheet in reinsurance recoverables on unpaid losses at
Dec. 31, 1997 and 1996, respectively.
In August 1996, our life insurance subsidiary entered into a coinsurance
contract with an unaffiliated life insurance company to cede a significant
portion of a block of single premium deferred annuities. As part of the
transaction, our life insurance subsidiary transferred $932 million of
investments and other assets to the coinsurer and recorded a reinsurance
recoverable of $964 million. In December 1997, our life insurance subsidiary
entered into another coinsurance agreement with an unaffiliated life
reinsurance company whereby it transferred approximately $144 million of
investments and other assets to the reinsurer and recorded a reinsurance
recoverable of $131 million. These transactions had no material effect on our
1997 or 1996 net income.
46
<PAGE>
The effect of assumed and ceded reinsurance on premiums written, premiums
earned and insurance losses, loss adjustment expenses and life policy
benefits is as follows:
<TABLE>
<CAPTION>
(In thousands) Year ended December 31
- ----------------------------------------------------------------------------------------------------------------------
1997 1996 1995
<S> <C> <C> <C>
PREMIUMS WRITTEN
Direct $6,340,767 $6,345,860 $6,143,525
Assumed 1,502,887 1,589,900 1,664,494
Ceded (911,117) (901,277) (1,001,379)
- ----------------------------------------------------------------------------------------------------------------------
Net premiums written $6,932,537 $7,034,483 $6,806,640
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
PREMIUMS EARNED
Direct $6,528,712 $6,347,572 $5,931,474
Assumed 1,530,969 1,584,275 1,571,791
Ceded (898,652) (897,737) (1,040,008)
- ----------------------------------------------------------------------------------------------------------------------
Net premiums earned 7,161,029 7,034,110 6,463,257
Life 137,071 144,572 173,879
- ----------------------------------------------------------------------------------------------------------------------
Total premiums earned $7,298,100 $7,178,682 $6,637,136
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
INSURANCE LOSSES, LOSS ADJUSTMENT
EXPENSES AND LIFE POLICY BENEFITS
Direct $4,730,435 $4,539,951 $4,500,910
Assumed 1,011,883 1,043,400 1,179,580
Ceded (648,797) (429,786) (1,046,302)
- ----------------------------------------------------------------------------------------------------------------------
Net insurance losses and
loss adjustment expenses 5,093,521 5,153,565 4,634,188
- ----------------------------------------------------------------------------------------------------------------------
Life policy benefits 276,848 312,737 376,475
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
Total insurance losses, loss adjustment
expenses and life policy benefits $5,370,369 $5,466,302 $5,010,663
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
47
<PAGE>
NOTE 16 STATUTORY ACCOUNTING PRACTICES
Our underwriting operations are required to file financial statements with
state and foreign regulatory authorities. The accounting principles used to
prepare these statutory financial statements follow prescribed or permitted
accounting principles, which differ from GAAP. Prescribed statutory
accounting practices include state laws, regulations and general
administrative rules issued by the state of domicile as well as a variety of
publications and manuals of the National Association of Insurance
Commissioners. Permitted statutory accounting practices encompass all
accounting practices not so prescribed, but allowed by the state of domicile.
At Dec. 31, 1997, permitted property-liability transactions related to the
disposal of certain real property acquired as security increased statutory
surplus by $20 million over what it would have been had prescribed accounting
practices been followed. At Dec. 31, 1997, permitted life insurance
transactions related to the release of capital gains related to a coinsurance
contract and the related establishment of a voluntary investment reserve had
the effect of increasing statutory surplus by $23 million. On a statutory
accounting basis, our property-liability underwriting operations reported net
income of $1.15 billion in 1997, $759.2 million in 1996 and $476.3 million in
1995. Our life insurance operations reported statutory net income of $20.6
million, $27.3 million and $14.7 million in 1997, 1996 and 1995,
respectively. Statutory surplus (shareholder's equity) of our
property-liability underwriting operations was $5.0 billion and $4.6 billion
as of Dec. 31, 1997 and 1996, respectively. Statutory surplus of our life
insurance operation was $195 million and $213 million as of Dec. 31, 1997 and
1996, respectively.
48
<PAGE>
NOTE 17 SEGMENT INFORMATION
In 1997, we implemented the provisions of SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information," which establishes
standards for reporting information about a company's operating segments.
We have four reportable segments in our insurance operations, which
consist of worldwide insurance, reinsurance, property-liability underwriting
investment function, and life insurance. The insurance operations are managed
separately because each one targets different customers and requires
different marketing strategies. We also have an asset management-investment
banking segment, consisting of our majority ownership in The John Nuveen
Company.
The accounting policies of the segments are the same as those described in
the summary of significant accounting policies. We evaluate performance based
on GAAP underwriting result for our property-liability insurance segments,
investment income and realized gains for our investment function, and on
pretax operating results for the life insurance and asset
management-investment banking segments. Property-liability underwriting
assets are reviewed in total by management for purposes of decision making.
We do not allocate assets to these specific underwriting segments. Assets are
specifically identified for our life insurance and asset
management-investment banking segments.
GEOGRAPHIC AREAS - The following summary presents financial data of our
continuing operations based on their location.
<TABLE>
<CAPTION>
(In thousands) Year ended December 31
- ----------------------------------------------------------------------------------------------------------------------
1997 1996 1995
<S> <C> <C> <C>
REVENUES
U.S. $8,820,153 $8,544,996 $7,892,337
Non-U.S. 803,026 686,541 622,623
- ----------------------------------------------------------------------------------------------------------------------
Total revenues $9,623,179 $9,231,537 $8,514,960
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
SEGMENT INFORMATION - The summary on the next page presents revenues and
pretax income from continuing operations for our reportable segments. The
revenues of our life insurance and asset management-investment banking
segments include their respective investment income. The table also presents
identifiable assets for our property-liability underwriting operation in
total, and our life insurance and asset management-investment banking
segments.
Income (loss) from continuing operations before income taxes for 1996
included facilities exit (costs)/income by segment as follows: Worldwide
insurance operations, $(28) million; and other operations, $70 million.
49
<PAGE>
<TABLE>
<CAPTION>
(In thousands) Year ended December 31
- ----------------------------------------------------------------------------------------------------------------------
1997 1996 1995
<S> <C> <C> <C>
REVENUES FROM CONTINUING OPERATIONS
Underwriting:
Worldwide insurance operations $ 5,931,969 $ 5,796,643 $ 5,293,450
Reinsurance 1,229,060 1,237,467 1,170,311
- ----------------------------------------------------------------------------------------------------------------------
Total property-liability
premiums earned 7,161,029 7,034,110 6,463,761
Net investment income 1,323,967 1,236,013 1,169,362
Realized investment gains 412,332 271,483 88,445
Other 47,732 50,338 48,425
- ---------------------------------------------------------------------------------------------------------------------
Total property-liability underwriting 8,945,060 8,591,944 7,769,993
Life insurance 403,821 356,887 480,966
Asset management-investment banking 268,927 232,347 236,230
- ----------------------------------------------------------------------------------------------------------------------
Total reportable segments 9,617,808 9,181,178 8,487,189
Parent company, other operations
and consolidating eliminations 5,371 50,359 27,771
- ----------------------------------------------------------------------------------------------------------------------
Total revenues $ 9,623,179 $ 9,231,537 $ 8,514,960
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES
Underwriting:
Worldwide insurance operations $ (236,722) $ (366,790) $ (275,331)
Reinsurance 3,943 17,322 48,420
- ----------------------------------------------------------------------------------------------------------------------
Total GAAP underwriting result (232,779) (349,468) (226,911)
Net investment income 1,323,967 1,236,013 1,169,362
Realized investment gains 412,332 271,483 88,445
Other (112,935) (208,002) (93,085)
- ----------------------------------------------------------------------------------------------------------------------
Total property-liability underwriting 1,390,585 950,026 937,811
Life insurance 77,995 (8,250) 27,899
Asset management-investment banking 92,617 91,697 88,197
- ----------------------------------------------------------------------------------------------------------------------
Total reportable segments 1,561,197 1,033,473 1,053,907
Parent company, other operations
and consolidating eliminations (225,489) (42,375) (157,165)
- ----------------------------------------------------------------------------------------------------------------------
Total income from continuing
operations before income taxes $ 1,335,708 $ 991,098 $ 896,742
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
<CAPTION>
(In thousands) December 31
- ----------------------------------------------------------------------------------------------------------------------
1997 1996
<S> <C> <C>
IDENTIFIABLE ASSETS
Property-liability underwriting $31,688,474 $30,005,932
Life insurance 4,478,236 4,204,400
Asset managment-investment banking 516,690 356,318
- ----------------------------------------------------------------------------------------------------------------------
Total reportable segments 36,683,400 34,566,650
Parent company, other operations, consolidating
eliminations and discontinued operations 675,428 579,586
- ----------------------------------------------------------------------------------------------------------------------
Total assets $37,358,828 $35,146,236
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
50
<PAGE>
NOTE 18 COMPREHENSIVE INCOME
We adopted the disclosure provisions of SFAS No. 130, "Reporting
Comprehensive Income," in 1997. Comprehensive income is defined as any change
in our equity from transactions and other events originating from nonowner
sources. In our case, those changes are comprised of our reported net income,
changes in unrealized appreciation and changes in unrealized foreign currency
translation adjustments and minimum pension liability. The following
summaries present the components of our comprehensive income, other than net
income, for the last three years.
<TABLE>
<CAPTION>
(In thousands) Year ended December 31, 1997
- ----------------------------------------------------------------------------------------------------------------------
INCOME
PRETAX TAX EFFECT AFTER-TAX
<S> <C> <C> <C>
Unrealized depreciation arising
during period $(156,533) $(77,766) $(78,767)
Less: reclassification adjustment
for realized gains included in
net income 412,816 167,619 245,197
- ----------------------------------------------------------------------------------------------------------------------
Net change in unrealized
appreciation 256,283 89,853 166,430
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
Net change in unrealized loss
on foreign currency translation (3,284) (621) (2,663)
- ----------------------------------------------------------------------------------------------------------------------
Total other comprehensive income $ 252,999 $ 89,232 $ 163,767
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
51
<PAGE>
<TABLE>
<CAPTION>
(In thousands) Year ended December 31, 1996
- ----------------------------------------------------------------------------------------------------------------------
Income
Pretax Tax Effect After-tax
<S> <C> <C> <C>
Unrealized appreciation (depreciation)
arising during period $96,559 $132,039 $ (35,480)
Less: reclassification adjustment
for realized gains included in
net income 281,841 97,583 184,258
- ----------------------------------------------------------------------------------------------------------------------
Net change in unrealized
depreciation (185,282) 34,456 (219,738)
- ----------------------------------------------------------------------------------------------------------------------
Unrealized loss on foreign
currency translation (5,030) 97 (5,127)
Less: reclassification adjustment
for realized loss relating to
discontinued operations (22,932) 2,662 (25,594)
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
Net change in unrealized loss
on foreign currency translation 17,902 (2,565) 20,467
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
Minimum pension liability 100,312 - 100,312
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
Total other comprehensive loss $ (67,068) $ 31,891 $ (98,959)
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
<CAPTION>
(In thousands) Year ended December 31, 1995
- ----------------------------------------------------------------------------------------------------------------------
Income
Pretax Tax Effect After-tax
<S> <C> <C> <C>
Unrealized appreciation arising
during period $1,433,636 $347,125 $1,086,511
Less: reclassification adjustment
for realized gains included in
net income 83,111 28,215 54,896
- ----------------------------------------------------------------------------------------------------------------------
Net change in unrealized
appreciation 1,350,525 318,910 1,031,615
- ----------------------------------------------------------------------------------------------------------------------
Unrealized gain on foreign
currency translation 4,130 285 3,845
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
Minimum pension liability (37,312) - (37,312)
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
Total other comprehensive income $1,317,343 $319,195 $998,148
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
52
<PAGE>
NOTE 19 QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following is an unaudited summary of our quarterly results for the last
three years.
<TABLE>
<CAPTION>
(In thousands) 1997
- ----------------------------------------------------------------------------------------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
<S> <C> <C> <C> <C>
Revenues $2,402,251 $2,493,102 $2,324,290 $2,403,536
Income from continuing operations 237,168 288,942 215,172 255,760
Net income 169,418 288,942 215,172 255,760
Earnings per common share:
Basic:
Income from continuing operations 1.02 1.25 0.92 1.09
Net income 0.72 1.25 0.92 1.09
Diluted:
Income from continuing operations 0.94 1.15 0.86 1.01
Net income 0.67 1.15 0.86 1.01
- ----------------------------------------------------------------------------------------------------------------------
<CAPTION>
(In thousands) 1996
- ----------------------------------------------------------------------------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
<S> <C> <C> <C> <C>
Revenues $2,197,076 $2,222,329 $2,347,496 $2,464,636
Income from continuing operations 206,633 207,417 155,369 271,042
Net income 191,043 202,175 169,480 170,004
Earnings per common share:
Basic:
Income from continuing operations 0.85 0.85 0.64 1.14
Net income 0.78 0.83 0.70 0.70
Diluted:
Income from continuing operations 0.79 0.80 0.60 1.06
Net income 0.73 0.78 0.66 0.66
- ----------------------------------------------------------------------------------------------------------------------
<CAPTION>
(In thousands) 1995
- ----------------------------------------------------------------------------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
<S> <C> <C> <C> <C>
Revenues $2,010,883 $2,099,858 $2,155,538 $2,248,681
Income from continuing operations 181,413 169,354 191,832 225,432
Net income 164,625 163,980 197,123 225,664
Earnings per common share:
Basic:
Income from continuing operations 0.75 0.69 0.78 0.93
Net income 0.68 0.67 0.81 0.93
Diluted:
Income from continuing operations 0.71 0.65 0.73 0.86
Net income 0.64 0.63 0.75 0.86
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
53
<PAGE>
The St. Paul Companies, Inc.
Management's Discussion and Analysis of Financial Condition and Results of
Operations
ON APRIL 24, 1998, THE ST. PAUL COMPANIES, INC. (THE ST. PAUL) COMPLETED ITS
MERGER WITH USF&G CORPORATION (USF&G) IN A TAX-FREE EXCHANGE OF STOCK
ACCOUNTED FOR AS A POOLING OF INTERESTS. THE COMBINED ORGANIZATION OPERATES
UNDER THE ST. PAUL NAME AND IS HEADQUARTERED IN ST. PAUL, MINN. THE
FOLLOWING DISCUSSION IS BASED ON THE COMBINED RESULTS OF THE ST. PAUL AND
USF&G FOR ALL PERIODS PRESENTED UNLESS OTHERWISE STATED.
CONSOLIDATED OVERVIEW
The St. Paul posted pretax earnings from continuing operations of $1.34
billion in 1997, 35% higher than comparable 1996 earnings of $991 million.
The improvement over 1996 was driven by a significant increase in realized
investment gains and a decline in catastrophe losses compared with 1996.
Earnings from the life insurance operations also improved in 1997, and The
John Nuveen Company, The St. Paul's asset management-investment banking
subsidiary, posted its third consecutive year of record results.
The following table summarizes The St. Paul's results for each of the last
three years:
<TABLE>
<CAPTION>
Year Ended December 31
(In millions) 1997 1996 1995
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Pretax income from continuing operations $1,336 $ 991 $ 897
Income tax expense 339 151 129
- ----------------------------------------------------------------------------------------------------
Income from continuing operations 997 840 768
Loss from discontinued operations (68) (107) (17)
- ----------------------------------------------------------------------------------------------------
Net income $ 929 $ 733 $ 751
- ----------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------
Per share $ 3.69 $2.84 $2.89
- ----------------------------------------------------------------------------------------------------
</TABLE>
Income tax expense in 1997 was substantially higher than in 1996 and 1995
due to higher pretax income and the absence of income tax benefits from the
recognition of net operating loss carryforwards.
The St. Paul sold its entire insurance brokerage operation, Minet, to Aon
Corporation in 1997. As a result, Minet is classified as a discontinued
operation for all years presented in the supplemental financial statements.
Proceeds from the sale were approximately equal to Minet's carrying value at
the time of sale.
The St. Paul recorded a $68 million loss on disposal (net of taxes) in
1997, however, which reflected its commitment for certain costs related to
the Minet divestiture. The St. Paul also recorded a net loss on disposal in
1996 when it decided to exit the brokerage business. That provision reduced
Minet's carrying value to The St. Paul's estimate of its net realizable value.
54
<PAGE>
Common shareholders' equity grew to $6.6 billion at the end of 1997, an
increase of $960 million from year-end 1996, which resulted from 1997's
strong net income. With 233.1 million shares outstanding at the end of 1997,
The St. Paul's book value per common share was $28.27, compared with $24.39
on Dec. 31, 1996.
In 1996, pretax income from continuing operations of $991 million
increased nearly $100 million over comparable 1995 income of $897 million.
Strong growth in realized gains and investment income and an increase in life
insurance earnings more than offset the impact of over $300 million of
catastrophe losses.
Income in 1996 benefited from a net reduction of $42 million in expenses
relating to the consolidation of certain branch office locations. In 1994,
The St. Paul decided to exit an office tower it leased in downtown Baltimore
and consolidate its Baltimore operations in a different location. Facilities
exit costs of $183 million recorded in 1994 represented the present value of
the rent and other operating expenses then estimated to be incurred under the
tower lease from the time the tower was vacated through the expiration of its
lease in 2009. These costs 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 terms of
those subleases is recognizable in the period such income becomes probable
and reasonably estimable. In 1996, $54 million of such income was recognized,
as was a $12 million credit related to reduced property tax assessments on
the tower. The St. Paul also recorded $24 million of expenses in 1996
relating to the reorganization of a portion of its branch office system.
The following table summarizes the sources of The St. Paul's consolidated
revenues for the last three years:
<TABLE>
<CAPTION>
Year Ended December 31
(In millions) 1997 1996 1995
- ------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenues:
Insurance premiums earned:
Property-liability $7,161 $7,034 $6,463
Life 137 145 174
Net investment income 1,578 1,513 1,474
Realized investment gains 423 262 92
Asset management-investment banking 262 220 221
Other 62 58 91
- ------------------------------------------------------------------------------------------------------
Total revenues $9,623 $9,232 $8,515
- ------------------------------------------------------------------------------------------------------
Increase over prior year 4% 8% 11%
- ------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------
</TABLE>
55
<PAGE>
The revenue growth rate fell to 4% in 1997, reflecting the competitive
property-liability insurance environment which has negatively impacted
premium volume. The majority of the increase in earned premiums in 1997
resulted from the mid-1996 acquisition of Northbrook Holdings, Inc.
(Northbrook), a commercial insurance underwriting operation, from Allstate
Insurance Company. Northbrook also accounted for approximately $34 million of
incremental investment income in 1997. The $161 million increase in realized
investment gains primarily resulted from sales of venture capital and equity
investments in favorable market conditions. Nuveen's 19% increase in revenues
in 1997 was primarily the result of two acquisitions completed during the
year.
In 1996, an increase in premiums earned in the Reinsurance segment and in
the General Commercial business center accounted for the majority of revenue
growth over 1995. Northbrook contributed $214 million of earned premiums and
approximately $25 million of investment income to consolidated revenues
subsequent to its acquisition in July 1996.
PROPERTY-LIABILITY UNDERWRITING OVERVIEW
Competitive conditions throughout virtually all of the property-liability
markets in which The St. Paul operates persisted, and in many cases,
intensified during 1997. The property-liability industry as a whole has
experienced a prolonged cycle of soft pricing characterized by excess
capacity and stagnant demand in primary insurance markets. During this
period, The St. Paul has focused on preserving its premium base and the
underlying quality of its book of business while selectively seeking
opportunities for premium growth through new product offerings and strategic
acquisitions.
The St. Paul's underwriting operations recorded pretax earnings of $1.39
billion in 1997, an increase of $440 million, or 46%, over comparable 1996
earnings of $950 million. The improvement over 1996 was driven by an increase
of $141 million in realized investment gains, a $117 million improvement in
underwriting results and an $88 million increase in investment income.
Catastrophe losses in 1997 totaled $132 million, compared with $315 million
in 1996 and $187 million in 1995.
The St. Paul's combined ratio (the combination of the loss and expense
ratios) was 103.8 in 1997, over a point better than the 1996 ratio of 105.1.
The loss ratio of 71.1, measuring losses and loss adjustment expenses as a
percentage of earned premiums, was 2.1 points better than the 1996 ratio of
73.2. Catastrophe losses accounted for 1.8 points of the loss ratio in 1997,
compared with a 4.5 point impact in 1996. The expense ratio, however, which
measures underwriting expenses as a percentage of premiums written,
deteriorated to 32.7 in 1997, up from the 1996 expense ratio of 31.9. The
lack of premium growth and Northbrook integration costs negatively impacted
the expense ratio in 1997.
56
<PAGE>
PROPERTY-LIABILITY UNDERWRITING
WORLDWIDE INSURANCE OPERATIONS
The St. Paul's Worldwide Insurance segment consists of its domestic and
international primary underwriting operations. The St. Paul underwrites
property-liability insurance and provides insurance-related products and
services to commercial, professional and individual customers. In the
domestic market, it utilizes a network of independent agents and brokers to
deliver its insurance products. Based on 1996 premium volume, The St. Paul
ranked as the eighth-largest U.S. property-liability underwriter.
The Worldwide Insurance segment consists of the following business centers:
SPECIALIZED COMMERCIAL
The Specialized Commercial business center consists of Custom Markets,
Professional Markets, Medical Services, Major Markets, Surety, and Pools and
Other. CUSTOM MARKETS serves specific commercial customer sub-segments,
including Technology, Surplus Lines, Ocean Marine, and Oil and Gas.
PROFESSIONAL MARKETS provides property and liability coverages for financial
institutions, public entities and professionals, such as lawyers, real estate
agents and insurance agents. MEDICAL SERVICES offers medical professional
liability, property and general liability insurance to the entire health care
delivery system. Based on 1996 premium volume, Medical Services ranked as the
largest medical liability insurance underwriter in the United States. MAJOR
MARKETS provides specialized products and services for targeted industry
groups, which include Construction, Service Industries, Transportation,
Manufacturing, Special Property and National Programs. SURETY underwrites
contract and noncontract surety bonds for construction contractors,
commercial businesses and individuals, which guarantee that third parties
will be indemnified against the nonperformance of contractual obligations.
Based on 1996 written premium volume, The St. Paul's surety operation ranked
as the largest underwriter of surety bonds in the United States. The St.
Paul's Mexican surety operation, Afianzadora Insurgentes, S.A. de C.V.
(Afianzadora), which was acquired in late 1996 and is the largest surety
operation in Mexico, is also included in the Surety business center.
GENERAL COMMERCIAL
The General Commercial business center provides property and liability
insurance for a broad range of small to midsized commercial enterprises.
Coverages include general liability, workers' compensation, commercial auto
and fire, umbrella and excess liability, and inland marine. General
Commercial offers tailored coverages for specific customer groups, such as
museums, golf courses, colleges and schools, manufacturers, wholesalers and
processors. The small commercial product line includes policies for
individuals, groups or franchise operations, including offices, retailers and
family restaurants.
57
<PAGE>
PERSONAL INSURANCE
The Personal Insurance business center provides a broad portfolio of
property-liability insurance products and services for individuals. Through a
variety of single-line and multi-line package policies, individuals can
acquire coverages to protect personal property such as homes, automobiles and
boats, as well as to provide coverage for personal liability. This business
center also includes the Nonstandard Auto line, which provides automobile
insurance products for individuals unable to obtain traditional insurance
coverage based on certain underwriting criteria.
INTERNATIONAL UNDERWRITING
The St. Paul's International operations (International) include most primary
insurance written outside the United States. The St. Paul has a presence as
a licensed insurance company in Canada and 10 countries in Europe, Africa,
and Latin America. International includes business generated from The St.
Paul's participation in Lloyd's of London as an investor and as the owner of
three managing agencies. International also provides coverage for the
non-U.S. risks of U.S. corporate policyholders and foreign-based companies'
exposures in the United States. International offers a range of commercial
and personal products and services tailored to meet the unique needs of
international customers.
The following table summarizes the Worldwide Insurance segment's results for
the last three years:
<TABLE>
<CAPTION>
Year Ended December 31
(Dollars in millions) 1997 1996 1995
- -------------------------------------------------------------------------------------
<S> <C> <C> <C>
Written premiums $5,732 $5,749 $5,554
Underwriting result $(237) $(367) $(275)
Combined ratio 104.8 106.4 104.3
- -------------------------------------------------------------------------------------
</TABLE>
PREMIUMS
Written premiums of $5.73 billion in 1997 were virtually level with the 1996
total. In the Specialized Commercial business center, Custom Markets'
premiums were down slightly from 1996, primarily due to The St. Paul's
withdrawal from the underperforming trucking line of business. Medical
Services' premium volume declined 11% from 1996, reflecting the intensely
competitive conditions in the medical liability marketplace. Surety premiums
grew in 1997 due primarily to new business generated by Afianzadora, acquired
in late 1996, in Mexico. Major Markets' premium volume was up slightly in
1997, due to new business growth in the Construction, Transportation and
Manufacturing sectors.
General Commercial premiums grew in 1997, primarily due to the impact of
Northbrook, which generated premiums of $230 million in 1997, compared with
premiums of $140 million for the five months subsequent to its acquisition in
August 1996. Excluding the impact of Northbrook, General Commercial premiums
declined in 1997, reflecting the competitive conditions in this market sector.
58
<PAGE>
Personal Insurance premiums in total declined in 1997, primarily due to a
new personal lines quota share reinsurance treaty, which resulted in the
ceding of $109 million of premium. Nonstandard Auto premiums in the Personal
Insurance business center increased 21% over 1996, however, reflecting growth
in new business.
International premiums grew 10% in 1997, largely due to the favorable
impact of foreign currency translation. International insurance markets in
1997 were characterized by severe price cutting among Lloyd's syndicates and
insurers operating in virtually all countries where The St. Paul has a
presence.
UNDERWRITING RESULT
The GAAP underwriting result for the Worldwide Insurance segment improved by
$130 million compared with 1996, primarily due to a decline in catastrophe
losses. Catastrophe losses in 1997 totaled $132 million, largely resulting
from severe flooding in the Red River Valley, which forms the border between
Minnesota and North Dakota, spring storms in the Midwest, and various other
storms. In 1996, catastrophe losses of $315 million were largely the result
of severe winter storms, floods, windstorms and several hurricanes, including
Hurricane Fran.
In Specialized Commercial, Medical Services posted an essentially
break-even underwriting result in 1997 after recording an underwriting profit
of $55 million in 1996. Competitive pricing pressures, a reduction in the
magnitude of favorable prior-year loss development, and an increase in the
severity of incurred losses were all contributing factors to the decline in
Medical Services profitability in 1997. The Surety business center posted a
strong increase in profitability in 1997, due to improved loss experience in
domestic contract surety and the addition of Afianzadora, which recorded a $9
million underwriting profit for the year.
General Commercial's underwriting results in 1997 benefited from the
decline in catastrophe losses. Northbrook integration costs and the lack of
real premium growth, however, negatively impacted General Commercial's
expense ratio in 1997. Personal Insurance experienced a dramatic improvement
in results in 1997, attributable primarily to the impact of corrective
pricing and underwriting measures implemented in the wake of sizable losses
in 1996. International's underwriting loss of $53 million in 1997 was $31
million worse than the comparable 1996 result, largely due to reserve
strengthening in Europe.
1996 VS. 1995
Premium volume in 1996 grew by $195 million over 1995, primarily due to the
impact of the Northbrook acquisition, which contributed $140 million of
incremental written premiums in 1996. Medical Services premiums declined by
$88 million in 1996 compared to 1995, reflecting competitive market
conditions. Personal Insurance premiums increased in 1996, primarily the
result of new business.
59
<PAGE>
The underwriting loss of $367 million in 1996 was significantly worse
than the 1995 loss of $275 million. An increase in catastrophe losses and a
deterioration in noncatastrophe loss experience in Personal Insurance were
the primary factors influencing the 1996 result.
PROPERTY-LIABILITY UNDERWRITING
REINSURANCE
The St. Paul's Reinsurance segment consists of St. Paul Re and F&G Re, which
underwrite reinsurance for leading property-liability insurance companies
worldwide, and Discover Re, which underwrites primary insurance and
reinsurance and provides related insurance products and services to the
alternative risk transfer market. St. Paul Re and F&G Re underwrite both
treaty and facultative reinsurance for property, liability, ocean marine,
surety and certain specialty classes of business, and obtain business
primarily in the broker or intermediary market. F&G Re also underwrites
finite risk reinsurance, which provides coverage at lower margins than
traditional reinsurance in return for a lower possibility of loss. Discover
Re provides products for self-insured companies and insurance pools, as well
as ceding to and reinsuring captive insurers.
The following table summarizes the Reinsurance segment's results for each
of the last three years.
<TABLE>
<CAPTION>
Year Ended December 31
(Dollars in millions) 1997 1996 1995
- ----------------------------------------------------------------------------------
<S> <C> <C> <C>
Written premiums $1,200 $1,286 $1,252
Underwriting result $4 $17 $48
Combined ratio 99.0 99.0 96.0
- ----------------------------------------------------------------------------------
</TABLE>
PREMIUMS
Written premiums of $1.2 billion in 1997 declined 6% from the 1996 total,
reflecting very soft market conditions for reinsurance products worldwide.
Plentiful reinsurance capacity and the lack of significant catastrophe losses
in the international arena continued to drive rates down in 1997, making
premium growth difficult. The St. Paul has responded to these conditions by
sacrificing premium volume when necessary to maintain its underwriting
standards. New business opportunities in selected market sectors, however,
partially mitigated the impact of soft market conditions on premium volume.
St. Paul Re utilized a portion of its securitized reinsurance capacity in
1997, contributing to an increase in North American property business.
Discover Re experienced an increase in premium volume in 1997, primarily due
to growth in its captive reinsurance business.
60
<PAGE>
UNDERWRITING RESULT
The Reinsurance segment posted an essentially break-even underwriting result
in 1997, down from 1996's underwriting profit of $17 million. The
deterioration in 1997 was primarily the result of an increase in losses from
casualty reinsurance coverages, an increase in commission expense due to a
shift in business mix, and higher compensation expenses. Catastrophe losses
in the Reinsurance segment in 1997 were down from 1996 levels.
1996 VS. 1995
In 1996, premium volume increased 3% in a very competitive market
environment, reflecting a shift on the part of some customers to more
financially secure reinsurers. An increase in excess-of-loss business also
contributed to premium growth over 1995. The deterioration in underwriting
results in 1996 was largely due to an increase in noncatastrophe loss
experience on North American casualty reinsurance business.
PROPERTY-LIABILITY UNDERWRITING
INVESTMENT OPERATIONS
The majority of funds available for investment are deployed in a widely
diversified portfolio of fixed maturities structured to maximize investment
income while minimizing credit risk. The St. Paul also invests in equity
securities, venture capital, real estate and mortgage loans in an effort to
provide for long-term growth in the value of the investment portfolio, and to
enhance shareholder value. These investment classes have the potential for
higher returns but also involve a greater degree of risk, including less
stable rates of return and less liquidity. New funds available for investment
can be generated by underwriting cash flows, consisting of the excess of
premiums collected over losses and expenses paid, and investment cash flows,
which consist of income on existing investments and proceeds from sales and
maturities of investments.
The property-liability underwriting operations' investment portfolio
generated $1.32 billion of pretax investment income in 1997, an increase of
7% over 1996 income of $1.24 billion. The majority of the increase resulted
from underlying growth in invested assets fueled by investment cash flows
during 1997. The incremental impact of a full year's worth of income on
Northbrook assets acquired in July 1996 accounted for approximately 3% of the
1997 growth rate. Underwriting cash flows in 1997 were negatively impacted by
the combination of negligible premium growth and the increase in insurance
loss payments stemming from the runoff of Northbrook loss reserves acquired
in 1996. Investment income in 1996 grew 6% over 1995 due to strong investment
cash flows and the acquisition of Northbrook, which added $1.14 billion of
high-quality fixed maturities to the portfolio.
61
<PAGE>
Pretax realized gains from the sale of investments in 1997 totaled a
record $412 million in The St. Paul's property-liability underwriting
operations, compared with pretax gains of $271 million in 1996. Most of the
gains in both years originated from sales of venture capital and equity
securities. Pretax realized gains in 1995 were $88 million.
The following table provides a look at the composition and carrying value
of the property-liability investment portfolio at the end of 1997 and 1996,
followed by additional information about each major investment class.
<TABLE>
<CAPTION>
December 31
(In millions) 1997 1996
- ----------------------------------------------------------------------
<S> <C> <C>
Fixed maturities $18,068 $17,456
Equities 1,006 792
Real estate 846 928
Mortgage loans 366 243
Venture capital 462 586
Short-term investments 849 688
Other investments 834 359
- ----------------------------------------------------------------------
Total investments $22,431 $21,052
- ----------------------------------------------------------------------
- ----------------------------------------------------------------------
</TABLE>
FIXED MATURITIES - The fixed maturities portfolio is composed of
high-quality, intermediate-term taxable U.S. government agency and corporate
bonds and tax-exempt U.S. municipal bonds. The St. Paul manages its bond
portfolio conservatively, investing the majority of funds in investment-grade
(BBB or better) securities. Approximately 95% of the portfolio was rated at
investment grade, with the remainder consisting of a limited portfolio of
higher-yielding, noninvestment grade bonds and nonrated securities.
The primary factors considered to determine the mix of taxable and
tax-exempt security purchases are The St. Paul's consolidated tax position
and the relationship between taxable and tax-exempt yields. New investment
purchases in 1997 included both taxable and tax-exempt bonds. Taxable bonds
comprised 65% of the fixed maturity portfolio at the end of 1997, compared
with 35% for tax-exempts. The bond portfolio produced pretax investment
income of $1.2 billion in 1997, compared with $1.1 billion in 1996.
Bonds are carried on the balance sheet at market value, with the
corresponding appreciation or depreciation recorded in shareholders' equity
net of taxes. The market value of bonds fluctuates based on the relationship
between their stated yields and prevailing market yields at any given time.
Movement in market interest rates and anticipated future trends in market
yields can quickly and significantly impact bond market values. At the end of
1997, the pretax unrealized appreciation on the bond portfolio totaled $853
million, compared with $528 million at the end of 1996.
62
<PAGE>
A look at the amortized cost of bond holdings, which excludes market
appreciation, provides a more accurate barometer of real growth in the
underlying invested asset base. The amortized cost at the end of 1997 was
$17.22 billion, compared with $16.93 billion at the end of 1996.
EQUITIES - Equity holdings consist of a diversified portfolio of common
stocks, which accounts for 5% of total investments. Sales of equities in 1997
generated pretax realized investment gains of $155 million, compared with
gains of $201 million in 1996. The quality of the portfolio and favorable
market conditions combined to generate substantial realized and unrealized
gains in 1997 and 1996. Realized gains in 1996 included a $78 million gain on
the sale of The St. Paul's ownership interest in Chancellor Capital
Management, Inc. The unrealized appreciation included in the carrying value
of the equity portfolio totaled $229 million at the end of 1997, compared
with $176 million at the end of 1996.
REAL ESTATE AND MORTGAGE LOANS - Real estate and mortgage loans comprised 6%
of total investments at the end of 1997. Real estate holdings primarily
consist of commercial office and warehouse properties, apartment buildings
and land that are owned directly or in which The St. Paul has a partial
interest through joint ventures. These properties are geographically
distributed throughout the United States. The St. Paul also has a portfolio
of mortgage loans collateralized by income-producing real estate. Pretax
investment income from real estate and mortgage loans totaled $79 million in
1997, compared with $67 million 1996. Real estate investments in 1997
generated net pretax realized gains of $53 million. The St. Paul recorded
impairment adjustments on real estate holdings totaling $21 million and $40
million in 1997 and 1996, respectively.
VENTURE CAPITAL - Venture capital comprised 2% of invested assets at the end
of 1997. These private investments span a variety of industries but are
concentrated in information technology, health care and consumer products.
This asset class produced record pretax realized gains of $213 million in
1997, significantly higher than gains of $86 million in 1996. The 1997 total
included a gain of $129 million on the sale of the stock of Advanced Fibre
Communications, Inc., a direct investment. The St. Paul's investments in
several venture capital partnerships also produced sizable realized gains and
cash flows in 1997. The venture capital portfolio in total produced net
positive cash flows (after new investments) of $216 million in 1997, compared
with $55 million in 1996. The carrying value of the venture capital portfolio
at year-end 1997 included $138 million of unrealized appreciation.
63
<PAGE>
PROPERTY-LIABILITY UNDERWRITING
LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES
The St. Paul establishes reserves that reflect its estimates of the total
losses and loss adjustment expenses it will ultimately have to pay under
insurance policies and reinsurance contracts. These include losses that have
been reported but not settled and losses that have been incurred but not
reported (IBNR). Loss reserves for certain tabular workers' compensation
business and certain assumed reinsurance contracts are discounted and also
are reduced for estimates of salvage and subrogation.
For reported losses, reserves are established on a "case" basis within the
parameters of coverage provided in the insurance policy or reinsurance
agreement. For IBNR losses, reserves are estimated using established
actuarial methods. Both case and IBNR reserve estimates reflect such
variables as past loss experience, social trends in damage awards, changes in
judicial interpretation of legal liability and policy coverages, and
inflation. The St. Paul takes into account not only monetary increases in the
cost of what is insured, but also changes in societal factors that influence
jury verdicts and case law and, in turn, claim costs.
Subjective judgments as to the ultimate exposure to losses are an integral
and necessary component of the loss reserving process because many of the
coverages offered involve claims that may not ultimately be settled for many
years after they are incurred. Reserves are continually reviewed, using a
variety of statistical and actuarial techniques to analyze current claim
costs, frequency and severity data, and prevailing economic, social and legal
factors. Reserves established in prior years are adjusted as loss experience
develops and new information becomes available. Adjustments to previously
estimated reserves are reflected in the financial results in the periods in
which they are made.
A reconciliation of beginning and ending loss and loss adjustment expense
reserves for each of the last three years is included in Note 6 of this
report. That reconciliation shows that The St. Paul has recorded reductions
in the loss provision for claims incurred in prior years totaling $627
million, $414 million and $302 million in 1997, 1996 and 1995, respectively.
The reduction in 1997 was impacted by a change in the way The St. Paul
assigns loss activity to a particular year for a portion of its reinsurance
business. Prior to 1997, loss activity for assumed reinsurance written by The
St. Paul's U.K.-based reinsurance operation was assigned to the year that the
underlying reinsurance contract was written. In 1997, analysis indicated that
an excess amount of loss activity was being assigned to prior years because
of this practice. As a result, The St. Paul implemented an improved procedure
in 1997 that more accurately assigns loss activity for this business to the
year in which it originated. This change had the effect of increasing
favorable development on previously established reserves by approximately
$110 million in 1997. There was no net impact on total incurred losses,
however, because there was a corresponding increase in the provision for
current year loss activity in 1997.
64
<PAGE>
Factoring out the impact of this change, the reduction in prior year
losses was still substantial in 1997, as were the reductions in 1996 and
1995. The favorable development on previously established reserves in the
last several years has been centered in the Medical Services sector, and in
general liability and workers' compensation coverages throughout The St.
Paul's commercial underwriting operations.
The St. Paul's medical liability reserving philosophy has evolved over
many years of writing this unique type of liability business. The frequency
and severity of medical liability claims can change suddenly, but the extent
to which those changes will ultimately affect claim costs may not be known
for several years. The favorable prior year development on general liability
and workers' compensation reserves has largely resulted from improved claim
experience and changes in the legal and regulatory environments in several
areas of the country. These factors caused The St. Paul to reduce its
estimate of the ultimate amount of losses incurred since the time that the
reserves were initially established.
In addition, the personal insurance sector contributed to the increase in
favorable prior year development in 1997 compared with 1996. In 1996,
deterioration in the personal book of business resulted in an increase in the
provision for losses incurred in prior years. Actual experience in 1997,
however, on previously established reserves resulted in favorable development.
65
<PAGE>
PROPERTY-LIABILITY UNDERWRITING
ENVIRONMENTAL AND ASBESTOS CLAIMS
The St. Paul continues to receive claims alleging injuries from environmental
pollution or alleging covered property damages for the cost to clean up
polluted sites. It also receives asbestos injury claims arising out of
product liability coverages under general liability policies. The vast
majority of these claims arise from policies written many years ago. The St.
Paul's alleged liability for both environmental and asbestos claims is
complicated by significant legal issues, primarily pertaining to the scope of
coverage. In The St. Paul's opinion, court decisions in certain jurisdictions
have tended to broaden insurance coverage beyond the intent of original
insurance policies.
The ultimate liability for environmental claims is difficult to estimate
because of these issues. Insured parties have submitted claims for losses not
covered in the insurance policy, and the ultimate resolution of these claims
may be subject to lengthy litigation, making it difficult to estimate our
potential liability. In addition, variables, such as the length of time
necessary to clean up a polluted site and controversies surrounding the
identity of the responsible party and the degree of remediation deemed
necessary, make it difficult to estimate the total cost of an environmental
claim.
Estimating the ultimate liability for asbestos claims is equally
difficult. The primary factors influencing the estimate of the total cost of
these claims are case law and a history of prior claim development, both of
which are still developing.
The following table represents a reconciliation of total gross and net
environmental reserve development for the years ended Dec. 31, 1997 and 1996.
Amounts in the "net" column are reduced by reinsurance recoverable.
<TABLE>
<CAPTION>
1997 1996 1995
(In millions) GROSS NET Gross Net Gross Net
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
ENVIRONMENTAL
Beginning reserves $889 $676 $840 $631 $604 $529
Northbrook reserves acquired - - 18 7 - -
Incurred losses 44 58 87 92 69 78
Reserve reallocation - - - - 233 79
Paid losses (66) (57) (56) (54) (66) (55)
- ----------------------------------------------------------------------------------------------------------------------
Ending reserves $867 $677 $889 $676 $840 $631
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
66
<PAGE>
The following table represents a reconciliation of total gross and net
reserve development for asbestos claims for the years ended Dec. 31, 1997 and
1996.
<TABLE>
<CAPTION>
1997 1996 1995
(In millions) GROSS NET Gross Net Gross Net
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
ASBESTOS
Beginning reserves $413 $304 $421 $294 $310 $270
Northbrook reserves acquired - - 6 6 - -
Incurred losses 22 (5) 18 25 5 7
Reserve reallocation - - - - 127 34
Paid losses (38) (20) (32) (21) (21) (17)
- ------------------------------------------------------------------------------------------------------------------
Ending reserves $397 $279 $413 $304 $421 $294
- ------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
Reserves for environmental and asbestos losses at Dec. 31, 1997 represent
The St. Paul's best estimate of its ultimate liability for such losses, based
on all information currently available. Because of the inherent difficulty in
estimating such losses, however, The St. Paul cannot give assurances that its
ultimate liability for environmental and asbestos losses will, in fact, match
current reserves. The St. Paul continues to evaluate new information and
developing loss patterns, but it believes any future additional loss
provisions for environmental and asbestos claims will not materially impact
the results of its operations, liquidity or financial position.
In 1995, we recorded additional gross reserves of $360 million and
specifically reallocated $113 million of previously recorded net reserves for
North American environmental and asbestos losses on policies written in the
United Kingdom prior to 1980.
Total gross environmental and asbestos reserves at Dec. 31, 1997, of $1.26
billion represented approximately 6% of gross consolidated reserves of $21.97
billion.
67
<PAGE>
LIFE INSURANCE
F&G LIFE
Life insurance products are written through F&G Life, a wholly-owned
subsidiary of The St. Paul. F&G Life's principal products are deferred
annuities (including tax sheltered annuities), structured settlement
annuities, and immediate annuities. In addition to annuities, F&G Life also
markets traditional life insurance products.
In 1996, F&G Life entered into a coinsurance contract (1996 Coinsurance
Contract) with an unaffiliated life insurance company to cede all of the
remaining block of single premium deferred annuities (SPDAs) that were
originally sold through stock brokerage firms (broker SPDA block). In 1997,
another coinsurance contract was entered into with an unaffiliated life
reinsurance company (1997 Coinsurance Contract), whereby F&G Life ceded a
portion of its structured settlement annuities written prior to 1994 to the
coinsurer. These transactions removed from F&G Life's direct obligations
underperforming blocks of business that had significant exposure to changes
in current interest rates. The broker SPDA block was also subject to high
surrender rates. F&G Life's profitability and cash flows improved as a result.
F&G Life represented 4% of The St. Paul's consolidated revenues from
continuing operations in 1997 and 1996, compared with 6% in 1995. F&G Life
also represented 12% of consolidated assets at Dec. 31, 1997 and 1996.
Financial highlights for F&G Life were as follows:
<TABLE>
<CAPTION>
Year Ended December 31
(In millions) 1997 1996 1995
- ----------------------------------------------------------------------------------
<S> <C> <C> <C>
Sales $446 $427 $348
Premiums earned 137 145 174
Net investment income 253 269 306
Operating income 64 49 27
- ----------------------------------------------------------------------------------
</TABLE>
F&G Life's earned premiums continued to decline in 1997, primarily due to
a reduction in sales of life contingent structured settlement annuities.
Structured settlement annuities with life contingencies are recognized as
premiums earned, whereas nonlife contingent contracts are recorded directly
to the balance sheet on a deposit accounting basis. Structured settlement
annuities are sold primarily to property-liability underwriting to settle
insurance claims. The decline in sales of these annuities for 1997 and 1996
resulted from a higher-than-average level of structured settlement annuities
which property-liability underwriting purchased in prior years as part of its
efforts to settle older claims.
68
<PAGE>
The decline in net investment income is primarily due to a lower asset
base created by the transfer of approximately $918 million of F&G Life's
fixed maturities under the 1996 Coinsurance Contract. Despite the decrease in
premiums earned and net investment income, operating income for 1997 and 1996
increased when compared with 1996 and 1995, respectively, primarily due to
improved investment spread management on annuity and universal life products
and strong expense controls. Results for 1995 included $4 million of
transition-related costs, including employee separation costs, as a result of
F&G Life's agreement to outsource its information services and policy
administration.
SALES
The following table shows life insurance and annuity sales (premiums and
deposits) by distribution system and product type.
<TABLE>
<CAPTION>
Year Ended December 31
(In millions) 1997 1996 1995
- ----------------------------------------------------------------------------------------------
<S> <C> <C> <C>
DISTRIBUTION SYSTEM:
Brokerage $268 $255 $125
National wholesaler 91 79 91
Direct structured settlements 74 79 108
Other 13 14 24
- ----------------------------------------------------------------------------------------------
Total $446 $427 $348
- ----------------------------------------------------------------------------------------------
PRODUCT TYPE:
Single premium deferred annuities $248 $231 $112
Tax sheltered annuities 84 78 84
Structured settlement annuities 74 79 108
Other annuities 23 27 30
Life insurance 17 12 14
- ----------------------------------------------------------------------------------------------
Total $446 $427 $348
- ----------------------------------------------------------------------------------------------
</TABLE>
The increase in sales is primarily due to continued efforts to expand new
and existing products and distribution channels. 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 credit ratings. As a result, there is no
assurance that the improved sales trend will continue. Total life insurance
in force was $10.7 billion at Dec. 31, 1997 and 1996.
69
<PAGE>
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 9% in the first policy year to 0% by the tenth policy year. Such
built-in surrender charges discourage surrender in the early years of a
policy.
Policy surrenders totaled $171 million in 1997, compared with $471 million
and $587 million in 1996 and 1995, respectively. Surrender activity decreased
significantly due to the coinsurance of the broker SPDA block. At the time of
the 1996 Coinsurance Contract, the broker SPDA block had a current account
value of approximately $964 million. As of Dec. 31, 1997, surrender activity
under the 1996 Coinsurance Contract had reduced the broker SPDA block benefit
reserves and the related reinsurance recoverables to $634 million.
70
<PAGE>
ASSET MANAGEMENT-INVESTMENT BANKING
THE JOHN NUVEEN COMPANY
The St. Paul holds a 77% interest in The John Nuveen Company (Nuveen), which
comprises the asset management-investment banking segment. Nuveen's core
businesses are asset management; the development, marketing and distribution
of investment products; and municipal and corporate investment banking
services. Nuveen sponsors and markets open-end and closed-end
(exchange-traded) funds as well as individual managed accounts. Nuveen also
provides municipal and corporate investment banking services and underwrites
and trades municipal bonds.
The following table summarizes Nuveen's key financial data for the last
three years:
<TABLE>
<CAPTION>
Year ended December 31
(In millions) 1997 1996 1995
- --------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenues $269 $232 $236
Expenses 146 114 122
- --------------------------------------------------------------------------------------------------------
Pretax earnings 123 118 114
Minority interest (30) (26) (26)
- --------------------------------------------------------------------------------------------------------
The St. Paul's share of pretax earnings $ 93 $ 92 $ 88
- --------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------
Assets under management $49,594 $33,191 $33,042
- --------------------------------------------------------------------------------------------------------
</TABLE>
Nuveen recorded its third consecutive year of record earnings while at
the same time greatly adding to its product line and managed asset base
through two major acquisitions. In January 1997, Nuveen completed its
purchase of Flagship Resources, Inc., a municipal mutual fund sponsor and
asset manager, for cash and preferred stock with a value of approximately $72
million. The addition of Flagship expanded the range of municipal investments
offered to investors and added over $4 billion to assets under management. In
September 1997, Nuveen acquired Rittenhouse Financial Services, Inc., an
equity and balanced account management firm serving affluent investors, for
$147 million. Rittenhouse added $9 billion to Nuveen's managed assets.
The 16% increase in Nuveen's total revenues was largely due to growth in
investment advisory fees resulting from the managed assets acquired during
the year. Those fees totaled $223 million in 1997, 20% higher than comparable
1996 fees of $186 million. Demand for municipal mutual funds and tax-free
unit investment trusts remained low in 1997 due to competition from strong
equity markets and investor concerns about the potential impact of an
expanding economy and the direction of interest rates. The 28% increase in
Nuveen's expenses for the year reflected the impact of the Flagship and
Rittenhouse acquisitions, and increased advertising and promotional expenses
associated with the launch of Nuveen's equity and balanced mutual funds early
in the year.
71
<PAGE>
Assets under management of $49.59 billion at the end of 1997 included
$26.12 billion of exchange-traded products, $11.85 billion of mutual funds
and $11.62 billion of managed accounts. Equity securities accounted for
approximately 23% of Nuveen's total managed assets.
Nuveen utilized a portion of its capital resources to make sizable
repurchases of its common shares in both 1997 and 1996. Shares repurchased in
1997 and 1996, respectively, totaled 1.8 million and 3.8 million, for total
costs of $55 million and $101 million. The repurchases were proportioned
between our holdings and those of minority shareholders to maintain our
ownership interest in Nuveen. Our total proceeds from Nuveen's repurchases
were $41 million and $74 million in 1997 and 1996, respectively.
1996 VS. 1995
Nuveen's pretax earnings in 1996 were slightly higher than comparable 1995
earnings, reflecting the success of expense reduction efforts which more than
offset a $4 million decline in revenues. Investment advisory fees grew by $3
million in 1996 but profits recognized on securities held for sale were down
$5 million due to a generally less favorable interest rate environment in
1996. Assets under management did not grow appreciably in 1996, as the strong
stock market and uncertainty about interest rate movements dampened investor
interest in tax-free investment products.
72
<PAGE>
THE ST. PAUL COMPANIES
CAPITAL RESOURCES
Capital resources represent those funds deployed or available to be deployed
to support The St. Paul's business operations and consist of shareholders'
equity, debt and capital securities. The following table summarizes capital
resources at the end of 1997 and 1996:
<TABLE>
<CAPTION>
December 31
(In millions) 1997 1996
- -----------------------------------------------------------------------------------
<S> <C> <C>
Shareholders' equity:
Common equity:
Common stock and retained earnings $5,777 $4,993
Unrealized appreciation
of investments and other 814 638
- -----------------------------------------------------------------------------------
Total common shareholders' equity 6,591 5,631
Preferred shareholders' equity 17 216
- -----------------------------------------------------------------------------------
Total shareholders' equity 6,608 5,847
Debt 1,304 1,171
Company-obligated mandatorily redeemable
preferred securities of subsidiaries 503 307
- -----------------------------------------------------------------------------------
Total capitalization $8,415 $7,325
- -----------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------
Ratio of debt to
total capitalization 15% 16%
- -----------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------
</TABLE>
Total shareholders' equity grew to $6.6 billion at the end of 1997, an
increase of $761 million from the end of 1996, which primarily resulted from
The St. Paul's net income of $929 million in 1997. The after-tax unrealized
appreciation of The St. Paul's investment portfolio increased $166 million
over year-end 1996.
Debt outstanding increased by $133 million in 1997, due in part to $85
million of debt issued by Nuveen to purchase securities for its investment
products and for general corporate purposes. The St. Paul also issued $82
million of medium-term notes in 1997 under a shelf registration statement
filed with the Securities and Exchange Commission. At the end of 1997,
medium-term notes outstanding totaled $512 million, comprising 39% of
consolidated debt.
Also contributing to the increase in debt outstanding at the end of 1997
was $35 million of new borrowings under The St. Paul's standby credit
facility. These funds were used to refinance outstanding receivables related
to an insurance premium finance company acquired at the end of 1997. The St.
Paul funded the maturity of its $100 million, 9-3/8% notes in June 1997
through the issuance of commercial paper and medium-term notes.
73
<PAGE>
In December 1996, January 1997 and July 1997, three special-purpose
trusts wholly-owned by The St. Paul issued a total of $300 million of
company-obligated mandatorily redeemable preferred capital securities.
Proceeds from the first two issuances, totaling $200 million, were used to
redeem an issue of convertible exchangeable preferred stock issued by USF&G
Corporation. Proceeds from the third issuance were used to repay intercompany
loans and balances outstanding under a standby credit facility.
In December 1997, The St. Paul acquired TITAN Holdings, Inc. (Titan), a
property-liability company in San Antonio, Texas, for a total cost of $259
million, including debt assumed. The Titan purchase was financed through the
issuance of debt and common stock.
The St. Paul's other major capital outlays in 1997 included $198 million
for common and preferred dividend payments to shareholders and $128 million
for common share repurchases. The John Nuveen Company made two significant
acquisitions in 1997 for a total cost of approximately $219 million, which
was funded through a combination of internally generated funds and, to a
lesser extent, the issuance of preferred securities.
In 1996, common shares were issued to redeem all of USF&G Corporation's
outstanding $10.25 Series B Cumulative Convertible Preferred Stock. The St.
Paul repurchased $39 million of USF&G Corporation's Zero Coupon Convertible
Notes in 1996 through the use of corporate cash and borrowings under a credit
facility. Also in 1996, The St. Paul purchased Northbrook Holdings, Inc. from
Allstate Insurance Company for approximately $190 million in cash from
internally generated sources. Shareholder dividend payments totaled $200
million in 1996, and common share repurchases totaled $225 million.
74
<PAGE>
LIQUIDITY
Liquidity refers to The St. Paul's ability to generate sufficient cash flows
to meet the short- and long-term cash requirements of its business
operations. The property-liability underwriting operations' short-term cash
needs primarily consist of paying insurance loss and loss adjustment expenses
and day-to-day operating expenses. Those needs are met through cash receipts
from operations, which consist primarily of insurance premiums collected and
investment income. The investment portfolio is also a source of liquidity,
through the sale of readily marketable fixed maturities, equity securities
and short-term investments, as well as longer-term investments which have
appreciated in value. The net positive cash flows from underwriting and
investment activities are used to build the investment portfolio and thereby
increase future investment income.
The life insurance segment's cash flows consist of deposits and
withdrawals of universal life and investment products, such as annuities,
which are classified as financing activities in The St. Paul's consolidated
statements of cash flows.
The St. Paul believes its long-term liquidity requirements beyond 1998
will be adequately funded by operational cash flows because of the nature of
its underwriting operations, in which premiums are collected and invested in
most cases before related losses are paid. However, the company's financial
strength and relatively conservative level of debt provide it with the
flexibility and capacity to obtain funds externally through debt or equity
financings.
Cash flows from operations were $848 million in 1997, compared with $1.3
billion in both 1996 and 1995. Operational cash flows in 1997 were down from
1996 and 1995 levels, reflecting the impact of insurance loss and loss
expense payments growing at a faster rate than written premiums. Cash flows
in 1997 were also impacted by the increase in loss payments resulting from
the runoff of Northbrook loss reserves acquired in 1996. The St. Paul made
payments of $54 million in 1997 pursuant to certain commitments in the
agreement to sell Minet to Aon Corporation.
Operational cash flows on a consolidated basis in each of the last three
years have been more than adequate to meet the liquidity requirements for
each of the business segments.
The St. Paul is currently not aware of any current recommendations by
regulatory authorities that, if implemented, might have a material impact on
its liquidity, capital resources or operations.
75
<PAGE>
THE ST. PAUL COMPANIES
EXPOSURES TO MARKET RISK
INTEREST RATE RISK - The St. Paul's exposure to market risk for changes in
interest rates is concentrated in its investment portfolio and, to a lesser
extent, its debt obligations. This exposure is monitored through periodic
reviews of asset and liability positions. Estimates of cash flows, as well as
the impact of interest rate fluctuations relating to the investment portfolio
and insurance reserves, are modeled and reviewed quarterly.
The following table provides information as of Dec. 31, 1997 about The St.
Paul's financial instruments that are sensitive to interest rates. The table
presents principal cash flows and related weighted-average interest rates by
expected maturity dates. Actual cash flows may differ from those stated as a
result of calls and prepayments. The St. Paul has assumed that its
"available-for-sale" securities are similar enough to aggregate those
securities for purposes of this disclosure.
<TABLE>
<CAPTION>
(In millions) December 31, 1997
- ----------------------------------------------------------------------------------------
Weighted
Principal Average
Cash Flows Interest Rate
- ----------------------------------------------------------------------------------------
<S> <C> <C>
FIXED MATURITIES AND
SHORT-TERM INVESTMENTS
1998 $ 2,344 7.0%
1999 1,894 7.4
2000 1,668 7.8
2001 2,123 7.4
2002 2,082 7.2
Thereafter 10,667 6.9
- ----------------------------------------------------------------------------------------
Total $ 20,778
- ----------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------
Market value at Dec. 31, 1997 $ 21,916
- ----------------------------------------------------------------------------------------
MEDIUM-TERM NOTES,
ZERO COUPON NOTES AND
SENIOR NOTES
1998 $ 170 7.1%
1999 20 7.6
2000 - -
2001 196 8.1
2002 49 7.5
Thereafter 628 5.0
- ----------------------------------------------------------------------------------------
Total $ 1,063
- ----------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------
Fair value at Dec. 31, 1997 $ 1,039
- ----------------------------------------------------------------------------------------
</TABLE>
76
<PAGE>
FOREIGN CURRENCY EXPOSURE- The St. Paul's exposure to market risk for changes
in foreign exchange rates is concentrated in its invested assets denominated
in foreign currencies, which are predominantly British pounds sterling. Cash
flows from foreign operations are the primary source of funds for the
purchase of these investments. These investments are purchased to hedge
insurance reserves and other liabilities denominated in the same currency,
effectively reducing foreign currency exchange rate exposure.
The following table provides information about The St. Paul's fixed
maturity and short-term investments denominated in British pounds sterling
and presents such information in U.S. dollar equivalents. The table presents
principal cash flows, related weighted-average interest rates by expected
maturity dates and the quoted forward foreign currency exchange rates on
available forward contracts as of Dec. 31, 1997.
<TABLE>
<CAPTION>
(In millions) December 31, 1997
- ---------------------------------------------------------------------------------------------------------------
Forward
Weighted Foreign
Principal Average Currency
Cash Interest Exchange
Flows Rate Rate
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
FIXED MATURITIES AND
SHORT-TERM INVESTMENTS
British pounds sterling:
1998 $ 39 7.6% 1.620
1999 57 6.1 1.607
2000 59 8.9 1.602
2001 71 8.5 1.597
2002 103 7.1 1.591
Thereafter 279 7.8 Various
- ---------------------------------------------------------------------------------------------------------------
Total $608
- ---------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------
Market value
at Dec. 31, 1997 $633
- ---------------------------------------------------------------------------------------------------------------
</TABLE>
77
<PAGE>
EQUITY PRICE RISK - The St. Paul's portfolio of marketable equity securities,
which is carried on the balance sheet at market value, has exposure to price
risk. This risk is defined as the potential loss in market value resulting
from an adverse change in prices. The St. Paul's objective is to earn
competitive relative returns by investing in a diverse portfolio of
high-quality, liquid securities. Portfolio characteristics are analyzed
regularly and market risk is actively managed through a variety of modeling
techniques. Holdings are diversified across industries, and concentrations in
any one company or industry are limited by parameters established by senior
management.
The St. Paul's portfolio of venture capital investments also has exposure
to market risk, primarily relating to the viability of the various entities
in which it has invested. These investments by their nature involve more risk
than other investments, and The St. Paul actively manages its market risk in
a variety of ways. First, a comparatively small amount of funds are allocated
to venture capital. At the end of 1997, the cost of these investments
accounted for only 2% of total invested assets. Second, investments are
diversified to avoid concentration of risk in a particular industry. Third,
The St. Paul performs extensive research prior to investing in a new venture
to gauge prospects for success. Fourth, it takes an active role in the
management of most of the entities in which it has invested. Finally, The St.
Paul generally sells its holdings in these firms soon after they become
publicly traded, thereby reducing exposure to further market risk.
The combined total of realized and change in unrealized investment gains
and losses (total investment gains) of The St. Paul's equity and venture
capital portfolios was $282 million, $485 million and $285 million in 1997,
1996 and 1995, respectively. No quarterly declines in total investment gains
of the equity and venture capital portfolios have occurred in any of these
three years, except for an insignificant decline in the first quarter of 1997.
YEAR 2000 ISSUES
Many computer systems in the world have the potential of being disrupted at
the turn of the century due to programming limitations that may cause them to
recognize the two-digit year code of "00" as the year 1900, instead of 2000.
For several years, The St. Paul has been evaluating its financial and
operational computer systems to determine the impact of the "Year 2000" issue
on those systems. With the completion of the merger with USF&G Corporation,
The St. Paul has further evaluated USF&G's activities to become "Year 2000"
compliant. The St. Paul has developed and implemented plans to address the
required system modifications, and does not expect the financial impact of
making these modifications to be material to its results of operations, cash
flows or consolidated financial position.
78
<PAGE>
The St. Paul also faces potential Year 2000 losses stemming from coverages
offered in insurance policies it has sold to customers. In some instances,
coverage is not provided under the insurance policies, while in other
instances, coverage may be provided under certain circumstances. The company
continues to assess its exposure to insurance claims arising from those
coverages, and it is taking a number of actions to address that exposure,
including individual risk evaluation and classification of high hazard
exposures. Currently, The St. Paul does not believe that such claims will be
material to its results of operations, cash flows or consolidated financial
position.
IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS
In June 1996, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 125, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities," which provides new accounting and reporting standards for
transfers and servicing of receivables and other financial assets and
extinguishments of liabilities. As issued, the standard was effective for
transactions occurring after Dec. 31, 1996, and was to be applied
prospectively. SFAS No. 127, "Deferral of the Effective Date of Certain
Provisions of FASB Statement No. 125," was issued in December 1996, and
deferred for one year both the criteria for determination of a sale versus a
secured borrowing for certain transactions, and new accounting standards for
assets transferred as collateral. Once adopted for transactions occurring
after Dec. 31, 1997, SFAS No. 125 will impact our accounting for
participation in securities lending programs as well as for assets pledged as
collateral; however this impact will primarily be limited to reclassification
on the consolidated balance sheet.
In December 1997, the American Institute of Certified Public Accountants
(AICPA) issued Statement of Position (SOP) No. 97-3, "Accounting by Insurance
and Other Enterprises for Insurance-Related Assessments." The SOP provides
guidance for determining when a liability should be recognized for guaranty
fund and other insurance-related assessments and on the measurement of that
liability. It also provides guidance on when an asset should be recognized
for a portion or all of the liability or paid assessment that can be
recovered through premium tax offsets of policy surcharges. The SOP is
effective for fiscal years beginning after December 31, 1998. The St. Paul
currently intends to adopt the provisions of the SOP in the first quarter of
1999. The cumulative effect of adopting the SOP may be material to The St.
Paul's results of operations in the period it is adopted; however, The St.
Paul cannot at this time reasonably estimate the amount of that cumulative
effect.
In February 1998, the FASB issued SFAS No. 132, "Employers' Disclosures about
Pensions and Other Postretirement Benefits," which standardizes the
disclosure requirements for pensions and other postretirement benefits to the
extent practicable, requires additional information on changes in benefits
obligations and fair values of plan assets, and eliminates certain
disclosures currently required. SFAS No. 132 is effective for fiscal years
beginning after December 15, 1997. The St. Paul will adopt the provisions of
SFAS No. 132 for its 1998 annual financial statements. This adoption is not
expected to materially change The St. Paul's current pension and
postretirement disclosures, and will have no impact on net income in 1998 and
succeeding years.
79
<PAGE>
In March 1998, the AICPA issued SOP No. 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use," which provides
guidance for determining when computer software developed or obtained for
internal use should be capitalized. It also provides guidance on the
amortization of capitalized costs and the recognition of impairment. The SOP
is effective for fiscal years beginning after December 31, 1998. The St. Paul
intends to adopt the provisions of the SOP in the first quarter of 1999. The
St. Paul cannot at this time estimate the potential impact of this SOP on its
financial position or results of operations in the period it is adopted.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which establishes accounting and
reporting standards for derivative instruments and hedging activities. It
requires that an entity recognize all derivatives as either assets or
liabilities in the balance sheet, and measure those instruments at fair
value. SFAS No. 133 is effective for all quarters of fiscal years beginning
after June 15, 1999, and prohibits retroactive application to financial
statements of prior periods. The St. Paul currently intends to implement the
provisions of SFAS No. 133 in the first quarter of the year 2000. The St.
Paul currently has limited involvement with derivative instruments, primarily
for purposes of hedging against fluctuations in interest rates. The St. Paul
cannot at this time reasonably estimate the potential impact of this adoption
on its financial position or results of operations for future periods.
FORWARD-LOOKING STATEMENT DISCLOSURE
This report contains certain forward-looking statements within the meaning
of the Private Litigation Reform Act of 1995. Forward-looking statements are
statements other than historical information or statements of current
condition. Words such as expects, anticipates, intends, plans, believes,
seeks or estimates, or variations of such words, and similar expressions are
also intended to identify forward-looking statements. In light of the risks
and uncertainties inherent in future projections, many of which are beyond
our control, actual results could differ materially from those in the
forward-looking statements. These statements should not be regarded as a
representation that the objectives will be achieved. Risks and uncertainties
include, but are not limited to, the following: general economic conditions
including changes in interest rates and the performance of financial markets;
changes in domestic and foreign laws, regulations and taxes; changes in the
demand for, pricing of, or supply of reinsurance or insurance; catastrophic
events of unanticipated frequency or severity; loss of significant customers;
judicial decisions and rulings; and various other matters. We undertake no
obligation to release publicly the results of any future revisions we may
make to forward-looking statements to reflect events or circumstances after
the date hereof or to reflect the occurrence of unanticipated events.
80
<PAGE>
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Summary of Selected Financial Data
(In millions, except per share data)
<TABLE>
<CAPTION>
Twelve Months Ended December 31
---------------------------------------------
Consolidated 1997 1996 1995 1994 1993
- ------------ ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Revenues from continuing operations $9,623 9,232 8,515 7,678 7,474
Income from continuing operations $997 840 768 728 667
Per common share data:
- ----------------------
Income from continuing operations $3.96 3.26 2.96 2.85 2.66
Cash dividends declared $0.94 0.88 0.80 0.75 0.70
Other selected financial data
(As of December 31):
- -----------------------------
Total assets $37,359 35,146 33,238 30,200 30,120
Debt $1,304 1,171 1,304 1,244 1,267
Capital securities $503 307 207 - -
</TABLE>
81
<PAGE>
EXHIBIT INDEX
-------------
<TABLE>
<CAPTION>
Exhibit
- -------
<S> <C>
(11) Statement re computation of per share earnings ................... (1)
(12) Statement re computation of ratios................................ (1)
(23) Consents of experts and counsel.................................... (1)
a) Consent of KPMG Peat Marwick LLP................................ (1)
b) Consent of Ernst & Young LLP.................................... (1)
(27) Financial Data Schedule
</TABLE>
(1) Filed electronically herewith.
<PAGE>
Exhibit 11
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Computation of Earnings Per Share
(In thousands)
<TABLE>
<CAPTION>
Twelve Months Ended December 31
-----------------------------------------
1997 1996 1995
------ ------ ------
<S> <C> <C> <C>
EARNINGS:
Basic:
Net income as reported $929,292 732,702 751,392
Dividends on preferred stock, net of taxes (10,304) (28,893) (36,560)
Premium on preferred shares redeemed (4,441) (1,033) (823)
-------------- -------------- --------------
Net income available to common shares $914,547 702,776 714,009
-------------- -------------- --------------
-------------- -------------- --------------
Diluted:
Net income as reported $929,292 732,702 751,392
Dividends on preferred stock, net of taxes (1,659) (16,400) (16,400)
Premium on preferred shares redeemed (4,441) (1,033) (823)
Dividends on convertible monthly income
preferred securities, net of taxes 8,073 8,073 5,046
Additional expense due to assumed conversion
of PSOP preferred stock, net of taxes (2,647) (3,015) (3,477)
Interest expense on zero coupon bonds, net of taxes 3,143 5,133 6,164
-------------- -------------- --------------
Net income available to common shares $931,761 725,460 741,902
-------------- -------------- --------------
-------------- -------------- --------------
SHARES:
Basic:
Weighted average common shares outstanding 230,158 233,340 231,664
-------------- -------------- --------------
-------------- -------------- --------------
Diluted:
Weighted average common shares outstanding 230,158 233,340 231,664
Additional dilutive effect of:
Assumed conversion of preferred stock 7,788 9,152 13,657
Assumed conversion of monthly income
preferred securities 7,017 7,017 4,422
Assumed exercise of stock options outstanding 4,399 3,089 2,836
Assumed conversion of zero coupon bonds 2,923 3,263 4,077
-------------- -------------- --------------
Weighted average, as adjusted 252,285 255,861 256,656
-------------- -------------- --------------
-------------- -------------- --------------
EARNINGS PER COMMON SHARE:
Basic $3.97 3.01 3.08
Diluted $3.69 2.84 2.89
</TABLE>
82
<PAGE>
Exhibit 12
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Computation of Ratios
(In thousands)
<TABLE>
<CAPTION>
Twelve Months Ended December 31
-----------------------------------------
1997 1996 1995
------ ------ ------
<S> <C> <C> <C>
EARNINGS:
Income from continuing operations
before income taxes $1,335,708 991,098 896,742
Fixed charges 116,677 126,463 129,726
-------------- -------------- --------------
Income as adjusted $1,452,385 1,117,561 1,026,468
-------------- -------------- --------------
-------------- -------------- --------------
FIXED CHARGES, PREFERRED
DIVIDENDS AND DISTRIBUTIONS ON
CAPITAL SECURITIES:
Fixed charges:
Interest expense $86,202 87,419 90,800
Rent expense (1) 30,475 39,044 38,926
-------------- -------------- --------------
Total fixed charges 116,677 126,463 129,726
Preferred stock dividends 19,810 38,092 46,098
Distributions on capital securities 33,312 12,585 7,763
-------------- -------------- --------------
Total fixed charges, preferred dividends
and distributions on capital securities $169,799 177,140 183,587
-------------- -------------- --------------
-------------- -------------- --------------
Ratio of earnings to fixed charges 12.45 8.84 7.91
-------------- -------------- --------------
-------------- -------------- --------------
Ratio of earnings to combined fixed charges,
preferred dividends and distributions on
capital securities 8.55 6.31 5.59
-------------- -------------- --------------
-------------- -------------- --------------
</TABLE>
(1) Interest portion deemed implicit in total rent expense.
83
<PAGE>
EXHIBIT 23(A)
CONSENT OF INDEPENDENT AUDITORS
The Board of Directors
The St. Paul Companies, Inc.:
We consent to incorporation by reference in the Registration Statements on
Form S-8 (SEC File No. 2-69894, No. 33-15392, No. 33-20516, No. 33-23446, No.
33-23948, No. 33-24220, No. 33-24575, No. 33-26923, No. 33-49273, No.
33-56987, No. 333-01065, No. 333-22329, No. 333-25203, No. 333-28915, No.
333-48121, No. 333-50935, No. 333-50941 and No. 333-50943), Form S-3 (SEC
File No. 33-33931, No. 33-50115, No. 33-58491 and No. 333-06465) and Form S-4
(SEC File No. 333-47007) of The St. Paul Companies, Inc., of our report dated
June 30, 1998, relating to the supplemental consolidated balance sheets of
The St. Paul Companies, Inc. and subsidiaries as of December 31, 1997 and
1996, and the related supplemental consolidated statements of income,
shareholders' equity, comprehensive income and cash flows for each of the
years in the three-year period ended December 31, 1997, and all related
schedules, which report appears in the Form 8-K of The St. Paul Companies,
Inc. dated October 6, 1998. Our report states the consolidated financial
statements of USF&G Corporation, a wholly-owned subsidiary, which statements
reflect total assets constituting 43 percent and 41 percent as of December
31, 1997 and 1996 and total revenues constituting 35 percent, 38 percent and
41 percent for the years ended December 31, 1997, 1996 and 1995,
respectively, of the related consolidated totals were audited by other
auditors whose report has been furnished to us, and our opinion, insofar as
it relates to the amounts included for USF&G Corporation, is based solely on
the report of the other auditors.
Minneapolis, Minnesota /s/ KPMG Peat Marwick LLP
October 6, 1998 -------------------------
KPMG Peat Marwick LLP
<PAGE>
Exhibit 23(B)
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statement
Numbers 33-33931, 33-50115, 33-58491, and 333-06465 on Form S-3, Number
333-47007 on Form S-4, and Numbers 2-69894, 33-15392, 33-20516, 33-23446,
33-23948, 33-24220, 33-24575, 33-26923, 33-49273, 33-56987, 333-01065,
333-22329, 333-25203, 333-28915, 333-48121, 333-50935, 333-50941, and
333-25203 on Form S-8, of The St. Paul Companies, Inc., of our report dated
February 20, 1998, with respect to the consolidated financial statements and
schedules of USF&G Corporation (these financial statements and schedules are
not presented herein) included in The St. Paul Companies, Inc.'s Current
Report (Form 8-K) dated October 6, 1998, filed with the Securities and
Exchange Commission.
/s/ ERNST & YOUNG LLP
----------------------
Ernst & Young LLP
Baltimore, Maryland
October 6, 1998
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 7
<MULTIPLIER> 1,000
<S> <C> <C> <C>
<PERIOD-TYPE> YEAR YEAR YEAR
<FISCAL-YEAR-END> DEC-31-1997 DEC-31-1996 DEC-31-1995
<PERIOD-END> DEC-31-1997 DEC-31-1996 DEC-31-1995
<DEBT-HELD-FOR-SALE> 20,945,219 20,107,863 0
<DEBT-CARRYING-VALUE> 0 0 0
<DEBT-MARKET-VALUE> 0 0 0
<EQUITIES> 1,052,370 823,628 0
<MORTGAGE> 640,734 406,377 0
<REAL-ESTATE> 985,317 1,247,673 0
<TOTAL-INVEST> 25,980,033 24,441,938 0
<CASH> 113,175 109,855 0
<RECOVER-REINSURE> 128,422 164,618 0
<DEFERRED-ACQUISITION> 872,460 857,560 0
<TOTAL-ASSETS> 37,358,828 35,146,236 0
<POLICY-LOSSES> 21,969,130 21,440,625 0
<UNEARNED-PREMIUMS> 3,528,234 3,679,752 0
<POLICY-OTHER> 0 0 0
<POLICY-HOLDER-FUNDS> 0 0 0
<NOTES-PAYABLE> 1,304,008 1,170,676 0
502,700 307,000 0
16,725 16,063 0
<COMMON> 2,057,108 1,895,608 0
<OTHER-SE> 4,534,335 3,735,789 0
<TOTAL-LIABILITY-AND-EQUITY> 37,358,828 35,146,236 0
7,298,100 7,178,682 6,637,136
<INVESTMENT-INCOME> 1,577,805 1,512,575 1,474,068
<INVESTMENT-GAINS> 423,048 261,989 91,807
<OTHER-INCOME> 324,226 278,291 311,949
<BENEFITS> 5,370,369 5,466,302 5,010,663
<UNDERWRITING-AMORTIZATION> 1,709,039 1,682,788 1,570,526
<UNDERWRITING-OTHER> 1,208,063 1,091,349 1,037,029
<INCOME-PRETAX> 1,335,708 991,098 896,742
<INCOME-TAX> 338,666 150,637 128,711
<INCOME-CONTINUING> 997,042 840,461 768,031
<DISCONTINUED> (67,750) (107,759) (16,639)
<EXTRAORDINARY> 0 0 0
<CHANGES> 0 0 0
<NET-INCOME> 929,292 732,702 751,392
<EPS-PRIMARY> 3.97 3.01 3.08
<EPS-DILUTED> 3.69 2.84 2.89
<RESERVE-OPEN> 17,888,536 16,559,200 15,827,113
<PROVISION-CURRENT> 5,720,662 5,567,703 4,935,727
<PROVISION-PRIOR> (627,144) (414,138) (301,539)
<PAYMENTS-CURRENT> 1,709,512 1,864,832 1,418,321
<PAYMENTS-PRIOR> 3,453,073 3,029,833 2,787,110
<RESERVE-CLOSE> 18,153,080 17,888,536 16,559,200
<CUMULATIVE-DEFICIENCY> 0 0 0
</TABLE>
