<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): February 26, 1998
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)
(612) 310-7911
----------------------------------
(Registrant's telephone number,
including area code)
N/A
-------------------------------------------------------------
(Former name or former address, if changed since last report)
<PAGE>
Item 5. Other Events.
------------
Filed herewith and incorporated by reference herein are the following
documents for The St. Paul Companies, Inc. and subsidiaries, which are attached
hereto as Exhibit 27, and Exhibits 99(a) through 99(k), which The St. Paul
Companies, Inc. is making available on February 26, 1998:
1) Financial Data Schedule;
2) Management's Discussion and Analysis of Financial Condition
and Results of Operations;
3) Eleven-year Summary of Selected Financial Data;
4) Statement re: Management's Responsibility for Financial
Statements;
5) Independent Auditors' Report;
6) Consolidated Statements of Income for the years ended
December 31, 1997, 1996 and 1995;
7) Consolidated Balance Sheets - December 31, 1997 and 1996;
8) Consolidated Statements of Shareholders' Equity for the
years ended December 31, 1997, 1996 and 1995;
9) Consolidated Statements of Comprehensive Income for the
years ended December 31, 1997, 1996 and 1995;
10) Consolidated Statements of Cash Flows for the years ended
December 31, 1997, 1996 and 1995;
11) Notes to Consolidated Financial Statements; and
12) Consent of Independent Auditors.
Item 7. Exhibits.
--------
An Exhibit Index is included herein.
<PAGE>
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.
THE ST. PAUL COMPANIES, INC.
By /s/ Bruce A. Backberg
---------------------
Bruce A. Backberg
Senior Vice President and
Chief Legal Counsel
Date: February 26, 1998
<PAGE>
EXHIBIT INDEX
-------------
Exhibit
- -------
27 Financial Data Schedule
99 a) Management's Discussion and Analysis of Financial Condition and
Results of Operations;
b) Eleven-year Summary of Selected Financial Data;
c) Statement re: Management's Responsibility for Financial
Statements;
d) Independent Auditors' Report;
e) Consolidated Statements of Income for the years ended
December 31, 1997, 1996 and 1995;
f) Consolidated Balance Sheets - December 31, 1997 and 1996;
g) Consolidated Statements of Shareholders' Equity for the years
ended December 31, 1997, 1996 and 1995;
h) Consolidated Statements of Comprehensive Income for the years
ended December 31, 1997, 1996 and 1995;
i) Consolidated Statements of Cash Flows for the years ended
December 31, 1997, 1996 and 1995;
j) Notes to Consolidated Financial Statements; and
k) Consent of Independent Auditors.
All exhibits filed electronically via EDGAR System.
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 7
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> DEC-31-1997
<DEBT-HELD-FOR-SALE> 12,449,793
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 1,033,920
<MORTGAGE> 0
<REAL-ESTATE> 649,114
<TOTAL-INVEST> 15,036,082
<CASH> 22,660
<RECOVER-REINSURE> 69,693
<DEFERRED-ACQUISITION> 404,274
<TOTAL-ASSETS> 21,500,657
<POLICY-LOSSES> 11,817,633
<UNEARNED-PREMIUMS> 2,379,703
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 782,825
207,000
16,725
<COMMON> 512,162
<OTHER-SE> 4,097,823
<TOTAL-LIABILITY-AND-EQUITY> 21,500,657
4,616,456
<INVESTMENT-INCOME> 886,213
<INVESTMENT-GAINS> 408,110
<OTHER-INCOME> 308,494
<BENEFITS> 3,345,168
<UNDERWRITING-AMORTIZATION> 1,021,623
<UNDERWRITING-OTHER> 833,749
<INCOME-PRETAX> 1,018,733
<INCOME-TAX> 245,510
<INCOME-CONTINUING> 773,223
<DISCONTINUED> (67,750)
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 705,473
<EPS-PRIMARY> 8.28
<EPS-DILUTED> 7.66
<RESERVE-OPEN> 11,673,148
<PROVISION-CURRENT> 3,833,468
<PROVISION-PRIOR> (488,300)
<PAYMENTS-CURRENT> 982,822
<PAYMENTS-PRIOR> 2,228,083
<RESERVE-CLOSE> 11,817,633
<CUMULATIVE-DEFICIENCY> 410,000
</TABLE>
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
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THE ST. PAUL COMPANIES
PRETAX INCOME TOPS $1 BILLION IN 1997;
INVESTMENT GAINS PUSH NET INCOME AND
SHAREHOLDERS' EQUITY TO RECORD HIGHS
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- --------------------------------------------------------------------------------
BY ALMOST ANY MEASURE, 1997 WAS ANOTHER SUCCESSFUL YEAR FOR THE ST. PAUL. PRETAX
INCOME FROM CONTINUING OPERATIONS, WHICH INCLUDED OVER $400 MILLION OF REALIZED
INVESTMENT GAINS, EXCEEDED $1 BILLION FOR THE YEAR, BY FAR THE HIGHEST TOTAL IN
OUR HISTORY. OUR UNDERWRITING OPERATIONS, BENEFITING FROM A SIGNIFICANT
IMPROVEMENT IN THE PERSONAL INSURANCE SEGMENT AND A DECLINE IN CATASTROPHE
LOSSES, RECORDED SOLID RESULTS AMID CHALLENGING MARKET CONDITIONS. AND THE JOHN
NUVEEN COMPANY, OUR ASSET MANAGEMENT-INVESTMENT BANKING OPERATION, POSTED
ANOTHER YEAR OF RECORD EARNINGS. THESE RESULTS COMBINED TO PRODUCE CONSOLIDATED
NET INCOME OF $705 MILLION FOR THE ST. PAUL, MORE THAN $180 MILLION HIGHER THAN
OUR PREVIOUS RECORD ANNUAL TOTAL OF $521 MILLION IN 1995.
The following table summarizes our results for each of the last three
years:
<TABLE>
<CAPTION>
(In millions) Year ended December 31
- --------------------------------------------------------------------------------
1997 1996 1995
<S> <C> <C> <C>
Pretax income (loss):
Underwriting $1,016 $ 686 $ 652
Asset management-
investment banking 93 92 88
Parent company and
consolidating eliminations (90) (79) (71)
- --------------------------------------------------------------------------------
Pretax income from
continuing operations 1,019 699 669
Income tax expense 246 141 131
- --------------------------------------------------------------------------------
Income from
continuing operations 773 558 538
Loss from discontinued operations (68) (108) (17)
- --------------------------------------------------------------------------------
Net income $ 705 $ 450 $ 521
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- --------------------------------------------------------------------------------
Per share $ 7.66 $4.94 $5.70
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</TABLE>
"Operating earnings," which exclude realized investment gains, is a common
measure of an insurance company's results. Our consolidated after-tax operating
earnings from continuing operations totaled $531 million in 1997, compared with
earnings of $415 million and $481 million in 1996 and 1995, respectively.
Our record results in 1997 pushed common shareholders' equity to a new high
of $4.6 billion, an increase of over $620 million from year-end 1996. With 83.7
million shares outstanding at the end of 1997, our book value per common share
was $55.06, an increase of over $7.00 per share since the end of 1996.
We sold our insurance brokerage operation, Minet, to Aon Corporation in
1997. As a result, Minet is classified as a discontinued operation for all years
presented in our financial statements. Proceeds from the sale were approximately
equal to our carrying value of Minet.
<PAGE>
We recorded a $68 million loss on disposal (net of taxes) in 1997, however,
which reflected our commitment for certain costs related to the Minet
divestiture. We also recorded a net loss on disposal in 1996 when we decided to
exit the brokerage business. That provision reduced Minet's carrying value to
our estimate of its net realizable value.
In 1996, pretax income from continuing operations of $699 million was $30
million higher than comparable 1995 income of $669 million. Strong growth in
realized investment gains and investment income more than offset the impact of
over $200 million of catastrophe losses. Net income in 1996 declined $71 million
from 1995, reflecting our provision for the loss on disposal of Minet.
The following table summarizes the source of our consolidated revenues for
the last three years: (Premiums "earned" refer to those premiums we've recorded
as revenue, whereas premiums "written" refer to premiums for policies sold
during the year).
<TABLE>
<CAPTION>
(In millions) Year ended December 31
- --------------------------------------------------------------------------------
1997 1996 1995
<S> <C> <C> <C>
Revenues:
Premiums earned $4,616 $4,448 $3,971
Net investment income 886 807 741
Realized investment gains 408 219 85
Asset management-
investment banking 262 220 221
Other 47 40 38
- --------------------------------------------------------------------------------
Total revenues $6,219 $5,734 $5,056
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- --------------------------------------------------------------------------------
Increase over prior year 8% 13% 16%
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</TABLE>
Our revenue growth rate fell to 8% in 1997, reflecting the competitive
insurance environment which has negatively impacted premium volume. The majority
of the increase in earned premiums in 1997 resulted from our 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 $189 million increase in realized investment gains 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 our Reinsurance and Commercial
segments accounted for the majority of revenue growth over 1995. Northbrook
contributed $214 million of earned premiums and approximately $25 million of
investment income to our consolidated revenues subsequent to its acquisition in
July 1996.
In the following pages, we take an in-depth look at 1997 results produced
by the six distinct business segments that underwrite property-liability
insurance and provide related services for particular market sectors. We also
review the performance of our underwriting operations' investment segment. After
our underwriting discussion, we take a look at the results of our asset
management-investment banking segment, The John Nuveen Company.
<PAGE>
REALIZED GAINS, PERSONAL INSURANCE
IMPROVEMENT AND REDUCED CATASTROPHE
LOSSES PRODUCE STRONG UNDERWRITING EARNINGS
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
COMPETITIVE CONDITIONS THROUGHOUT VIRTUALLY ALL OF THE PROPERTY-LIABILITY
MARKETS IN WHICH WE OPERATE 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, WE HAVE FOCUSED ON PRESERVING OUR
PREMIUM BASE AND THE UNDERLYING QUALITY OF OUR BOOK OF BUSINESS WHILE
SELECTIVELY SEEKING OPPORTUNITIES FOR PREMIUM GROWTH THROUGH NEW PRODUCT
OFFERINGS AND STRATEGIC ACQUISITIONS.
Our underwriting operations recorded pretax earnings of $1.02 billion in 1997,
an increase of $330 million, or 48%, over comparable 1996 earnings of $686
million. The improvement over 1996 was driven by an increase of nearly $200
million in realized investment gains from the sale of investments. In addition,
investment income generated by our portfolio increased by $86 million in 1997.
Underwriting losses declined $36 million in 1997, reflecting a sizable
improvement in our Personal Insurance segment and a relatively average level of
catastrophe losses compared with several recent years. Deterioration in our
International segment and a decline in Medical Services' profitability,
however, partially mitigated these positive developments. Catastrophe losses
totaled $105 million in 1997, compared with $207 million in 1996. The bulk of
our catastrophe experience in 1997 resulted from severe flooding in the Red
River Valley, which forms the border between Minnesota and North Dakota, and
spring storms in the Midwest.
Consolidated written premiums of $4.48 billion in 1997 grew 2% over the
1996 total of $4.40 billion. Premium declines in our Medical Services and
Reinsurance segments were offset by growth in Commercial and Personal Insurance
premiums. The Commercial increase was entirely the result of incremental
premiums provided by Northbrook, which were included in our results for a full
12 months in 1997, compared with just five months in 1996. Without the
additional impact of Northbrook in 1997, our consolidated premium volume would
have been level with 1996.
<PAGE>
Our combined ratio (the combination of a loss ratio and an expense ratio)
was 105.1 in 1997, slightly better than the 1996 ratio of 105.5. The loss ratio
of 72.5, measuring losses and loss adjustment expenses as a percentage of earned
premiums, was 2.1 points better than the 1996 ratio of 74.6. Catastrophe losses
accounted for 2.3 points of our loss ratio in 1997, compared with a 4.6 point
impact in 1996. Our expense ratio, however, which measures underwriting expenses
as a percentage of premiums written, deteriorated 1.7 points to 32.6 in 1997.
The slow rate of premium growth and Northbrook integration costs during the
first half of 1997 negatively impacted our expense ratio in 1997.
1996 VS. 1995 -- Pretax earnings in 1996 of $686 million were 5% ahead of 1995
earnings of $652 million. Underwriting results in 1996 suffered from catastrophe
losses of $207 million, the second-highest total in our history, and an increase
in weather-related, but noncatastrophe loss experience in our Personal Insurance
segment. Catastrophes in 1996 included numerous storms and hurricanes. Strong
investment returns, however, in the form of a three-fold increase in realized
gains and a $64 million increase in investment income, offset the increase in
underwriting losses and resulted in improved earnings over 1995. Written
premiums in 1996 of $4.40 billion grew 4% over 1995 volume of $4.24 billion,
largely due to the $140 million of premiums generated by the Northbrook
acquisition. Our combined ratio in 1996 was almost four points worse than 1995,
reflecting the impact of catastrophe losses on the loss ratio and initial
Northbrook integration costs on the expense ratio.
1998 UNDERWRITING OUTLOOK -- We do not anticipate that market conditions will
improve in the coming year, and in fact, we believe they may deteriorate further
in some industry sectors. In that environment, we will focus on maintaining
discipline in our underwriting decisions while aggressively seeking to identify
and capitalize on new business opportunities. We do not intend to sacrifice
profitability to achieve premium growth. Improving our International results and
maintaining Medical Services' market share will be priorities in 1998. We
believe our proposed merger with USF&G Corporation will enhance our market
presence and efficiency in an increasingly competitive marketplace. If the
merger is completed, we anticipate incurring a pretax restructuring charge of
between $300 million and $500 million in 1998.
The "1998 Outlook" sections of our individual underwriting segment
discussions in the following pages exclude the anticipated impact of the
proposed merger because it had not been approved or consummated at the date of
this report.
<PAGE>
UNDERWRITING RESULTS BY SEGMENT -- The following table summarizes written
premiums, underwriting results and combined ratios for each of our underwriting
business segments for the last three years. Following the table, we take a
closer look at 1997 results for each operation and look ahead to 1998.
<TABLE>
<CAPTION>
(Dollars in millions) Year ended December 31
- ---------------------------------------------------------------------------------------------------
% of 1997 1997 1996 1995
Written Premiums
<S> <C> <C> <C> <C>
WORLDWIDE INSURANCE OPERATIONS
ST. PAUL FIRE AND MARINE
Specialized Commercial
Written premiums 29% $1,282 $1,279 $1,304
Underwriting result $ 28 $ 49 $ (124)
Combined ratio 98.7 96.2 109.0
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Commercial
Written premiums 19% $ 873 $ 778 $ 618
Underwriting result $ (63) $ (60) $ (3)
Combined ratio 109.6 109.9 99.6
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Personal Insurance
Written premiums 17% $ 767 $ 725 $ 673
Underwriting result $ (63) $ (202) $ (33)
Combined ratio 107.9 128.2 104.6
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Medical Services
Written premiums 12% $ 523 $ 586 $ 674
Underwriting result $ 1 $ 55 $ 76
Combined ratio 102.5 91.8 86.6
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TOTAL ST. PAUL FIRE AND MARINE
Written premiums 77% $3,445 $3,368 $3,269
Underwriting result $ (97) $ (158) $ (84)
Combined ratio 104.1 105.3 101.8
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ST. PAUL INTERNATIONAL UNDERWRITING
Written premiums 6% $ 290 $ 267 $ 261
Underwriting result $ (51) $ (21) $ (23)
Combined ratio 117.7 108.1 109.4
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TOTAL WORLDWIDE INSURANCE OPERATIONS
Written premiums 83% $3,735 $3,635 $3,530
Underwriting result $ (148) $ (179) $ (107)
Combined ratio 105.1 105.5 102.4
- ---------------------------------------------------------------------------------------------------
ST. PAUL RE
Written premiums 17% $ 745 $ 761 $ 713
Underwriting result $ (32) $ (37) $ 4
Combined ratio 104.7 105.3 99.1
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TOTAL UNDERWRITING
Written premiums 100% $4,480 $4,396 $4,243
Underwriting result $ (180) $ (216) $ (103)
Combined ratio:
Loss and loss expense ratio 72.5 74.6 72.1
Underwriting expense ratio 32.6 30.9 29.7
- ---------------------------------------------------------------------------------------------------
Combined ratio 105.1 105.5 101.8
- ---------------------------------------------------------------------------------------------------
</TABLE>
Amounts are on a GAAP basis, except for combined ratios, which are not derived
from our GAAP financial statements.
<PAGE>
ST. PAUL FIRE AND MARINE
FIRE AND MARINE IS OUR U.S. INSURANCE UNDERWRITING OPERATION, AND IS COMPOSED OF
FOUR BUSINESS SEGMENTS WHICH UNDERWRITE PROPERTY-LIABILITY INSURANCE AND PROVIDE
INSURANCE-RELATED PRODUCTS AND SERVICES TO COMMERCIAL, PROFESSIONAL AND
INDIVIDUAL CUSTOMERS. FIRE AND MARINE UTILIZES A NETWORK OF INDEPENDENT
INSURANCE AGENTS AND BROKERS TO DELIVER ITS INSURANCE PRODUCTS. IT RANKED AS THE
13TH-LARGEST U.S. PROPERTY-LIABILITY UNDERWRITER BASED ON 1996 PREMIUM VOLUME.
ST. PAUL FIRE AND MARINE
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SPECIALIZED COMMERCIAL
Specialized Commercial is composed of Custom Markets, which serves specific
commercial customer segments (Financial and Professional Services, Ocean Marine,
Public Sector Services, Surplus Lines and Technology), and Major Markets, which
provides specialized products and services for targeted industry groups
(Construction, Surety, Manufacturing, Service Industries, Special Property,
National Programs and Transportation). The results of our limited participation
in insurance pools are also included here.
PREMIUMS -- Written premiums of $1.28 billion in 1997 were level with 1996.
Pricing was under pressure throughout 1997 in virtually every market sector
served by this, our largest business segment. Major Markets' premium volume
increased 6% over 1996, primarily due to new business growth in the
Construction, Transportation and Manufacturing business centers. Written
premiums in Custom Markets, however, were down 3% from 1996. The decline was
centered in Surplus Lines, reflecting the excess capacity plaguing the
commercial marketplace which has lessened demand for this type of coverage.
Public Sector Services premiums in 1997 grew by $15 million, or 30%, as a result
of new business. Our reduced participation in certain insurance pools was
reflected in a $9 million decline in premium volume in that category compared
with 1996.
UNDERWRITING RESULT -- Despite the lack of premium growth in 1997, our
Specialized Commercial segment recorded another year of solid results. The
underwriting profit of $28 million declined from the 1996 profit of $49 million,
however, primarily due to an increase in losses in the Construction and
Transportation business centers. The Technology business center posted
particularly good results in 1997, achieving $29 million in improvement over
1996 due to favorable current and prior-year loss experience. In addition, our
Surety operation recorded strong results in 1997.
<PAGE>
Our second consecutive year of underwriting profitability indicates that we have
been successful to date in balancing the competitive pricing levels with our
stringent underwriting standards.
1996 VS. 1995 -- Premium volume in 1996 was down 2% from the 1995 total of $1.30
billion, primarily due to our withdrawal from several insurance pool
arrangements which had performed poorly for several years. The $47 million
impact of those withdrawals more than offset premium growth in several of our
business centers, including Ocean Marine, Surety, and Financial and Professional
Services. The pool withdrawals also accounted for the majority of the $173
million improvement in underwriting results in 1996. Financial and Professional
Services, and Surety also posted strong results in 1996.
1998 OUTLOOK -- We anticipate that the current market conditions will persist in
1998, exerting additional downward pressure on pricing. In that environment, we
will emphasize our strong commitment to underwriting standards while continuing
to address emerging business opportunities within the framework of our
successful "market niche" underwriting philosophy. The large-account commercial
customer is becoming increasingly more sophisticated, demanding high-quality
services and low costs, and we believe our specialty approach differentiates us
in a marketplace where competitive pressures show no signs of abating.
<PAGE>
ST. PAUL FIRE AND MARINE
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COMMERCIAL
Commercial provides property and liability insurance for a broad range of small
to midsized commercial enterprises. Business coverages marketed include general
liability, workers' compensation, commercial auto and fire, umbrella and excess
liability, and inland marine. Commercial offers tailored coverages and insurance
products for specific customer groups, such as museums, golf courses, colleges
and schools, manufacturers, wholesalers and processors. The small commercial
product line includes our Package Accounts for Commercial Enterprises (PACE)
policies for individuals, groups or franchise operations, including offices,
retailers and family restaurants.
PREMIUMS -- Commercial premiums of $873 million in 1997 were 12% higher than
1996 volume of $778 million. The 1997 total included $230 million of premiums
resulting from our acquisition of Northbrook. Premium volume in 1996 included
$140 million of Northbrook production for the five months subsequent to its
acquisition. Factoring Northbrook out of both years, premiums in 1997 were
virtually level with 1996. Market conditions in the small to midsized commercial
sector remained intensely competitive throughout the year, making it difficult
to retain renewal business and underwrite new business. During this period of
soft pricing, which has persisted for several years and shows no sign of
improving, we have focused on maintaining a quality book of business while
continuing our product development and enhancement efforts.
UNDERWRITING RESULT -- Commercial's underwriting loss of $63 million was
slightly worse than the 1996 loss of $60 million. Losses in 1997 were centered
in our commercial property coverages, largely due to catastrophe losses, which
totaled $42 million in the Commercial segment in 1997. Workers' compensation
results also deteriorated in 1997 due to an increase in the severity of losses.
Catastrophe losses in 1996 were $56 million. The expense ratio of 38.7 in 1997
was almost three points worse than 1996, reflecting the lack of real growth in
underlying premium volume and the impact of Northbrook integration expenses. The
expense ratio improved steadily throughout the year, however, as we began
realizing efficiencies from those integration efforts. Northbrook in its
entirety, including investment returns on assets acquired, made a positive
contribution to our results in 1997.
1996 VS. 1995 -- Virtually all of our 26% premium growth in 1996 resulted from
the mid-year acquisition of Northbrook. Difficult market conditions in 1996 made
premium growth from new business or rate increases difficult. Commercial's
underwriting loss of $60 million in 1996 did not compare favorably to 1995's $3
million loss, reflecting an increase in catastrophe experience and the impact of
Northbrook's underwriting losses, as well as our initial Northbrook integration
costs.
1998 OUTLOOK -- As competition continues to intensify in the commercial market
in 1998, we will strive to identify and eliminate unnecessary expense and
improve productivity while pursuing an effective execution of our business plan.
We plan to develop new products and coverages and enhance several of our
existing ones. With the vast majority of our Northbrook integration efforts
behind us, we expect our expense ratio to improve in 1998.
<PAGE>
ST. PAUL FIRE AND MARINE
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PERSONAL INSURANCE
Personal Insurance provides a broad portfolio of property-liability insurance
products and services for individuals. Through a variety of single line and
package policies, individuals can acquire coverages for personal property, such
as homes, autos and boats, and for personal liability.
PREMIUMS -- Personal Insurance premiums totaled $767 million in 1997, 6% higher
than 1996 volume of $725 million. Rate increases accounted for the majority of
our premium growth in 1997, with new business a lesser factor. Premiums
increased in both our package and single line coverages. Our popular PAK II
package policy generated premiums of $323 million in 1997, a 7% increase over
comparable 1996 premiums of $301 million.
UNDERWRITING RESULT -- The turnaround in Personal Insurance results in 1997 was
one of The St. Paul's major successes of 1997. The underwriting loss of $63
million was vastly improved over the 1996 loss of $202 million. Approximately
$100 million of that reduction reflected the impact of corrective pricing and
underwriting measures implemented to improve our book of business in the wake of
1996's sizable losses. We also benefited from a $39 million decline in
catastrophe losses in 1997. After several years of expense reduction
initiatives, our Personal Insurance expense ratio was 29.3 in 1997, down from
the low 40-point range in the early 1990s.
1996 VS. 1995 -- Written premiums in 1996 grew 8% over 1995, largely the result
of new business in our package products. A significant increase in
weather-related losses and adverse development on previously established
reserves pushed our 1996 underwriting loss to $202 million, much worse than the
1995 loss of $33 million. Catastrophe losses in 1996 were $54 million higher
than the 1995 total.
1998 OUTLOOK -- In 1998, we will strive to sustain and build on the successes
achieved in 1997. Improving the profitability of our personal property lines
will be a major priority. We plan to invest substantial resources in technology
to increase efficiency. Effective marketing and pricing strategies will be vital
in an increasingly competitive marketplace.
ST. PAUL FIRE AND MARINE
- --------------------------------------------------------------------------------
MEDICAL SERVICES
Medical Services offers medical professional liability, property and general
liability insurance to the health care delivery system. Products include
coverages for health care professionals (including physicians and surgeons,
dental professionals and nurses), individual health care facilities (including
hospitals, long-term care facilities and other facilities, such as
laboratories), and entire systems, such as
<PAGE>
hospital networks and managed care systems. Specialized claim and loss control
services are vital components of Medical Services' insurance products. Medical
Services underwrites through three major business lines - health care
professionals, health care facilities and major accounts. Based on 1996 premium
volume, Medical Services ranked as the largest medical liability insurance
underwriter in the United States.
PREMIUMS -- Written premiums of $523 million in 1997 declined 11% from 1996
premiums of $586 million. Competition in the medical liability marketplace,
particularly the health care professionals sector, has intensified over the last
several years as new insurers have entered the market. As a result, new business
opportunities have diminished and downward pressure on renewal pricing has
accelerated. We have focused on preserving our market leadership position during
this soft market cycle, meeting the competition on pricing when appropriate, but
declining business with little potential for acceptable returns. Premium
shortfalls from 1996 were most acute in the health care professionals and health
care facilities lines, while major accounts' volume was virtually level with
1996.
UNDERWRITING RESULT -- Medical Services posted an essentially break-even
underwriting result in 1997 after recording an underwriting profit of $55
million in 1996. The deterioration from 1996 was centered in the health care
facilities line. 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 profitability in
1997. Although insignificant, the $1 million underwriting profit extended
Medical Services' record of consecutive annual profitable results to nine.
1996 VS. 1995 -- The 13% decline in premium volume in 1996 was distorted by our
1995 transition to annual policy terms for some of our physicians and surgeons
business, which resulted in 18 months worth of premiums being recorded for that
business in 1995. Competitive market conditions also pushed prices lower and
limited new business opportunities. The decline in underwriting profitability in
1996 reflected the impact of a sustained period of flat pricing and the
diminishing impact of favorable development on previously established reserves.
1998 OUTLOOK -- We don't anticipate any significant changes in the medical
liability insurance market in 1998. We are continuing to work on a number of
fronts to maintain our market leadership position. We are emphasizing new
product efforts, leveraging our proven ability to serve the sophisticated
risk-transfer needs of the evolving health care delivery system. We are seeking
to expand our relationships with existing customers, major insurance brokers and
independent agents. We expect Medical Services' underwriting results in 1998 to
be impacted by flat pricing, increasing severity and the diminishing impact of
favorable prior-year loss development.
<PAGE>
WORLDWIDE INSURANCE OPERATIONS
- --------------------------------------------------------------------------------
ST. PAUL INTERNATIONAL UNDERWRITING
THE INTERNATIONAL SEGMENT INCLUDES MOST PRIMARY INSURANCE WRITTEN OUTSIDE THE
UNITED STATES. WE HAVE A PRESENCE AS A LICENSED INSURANCE COMPANY IN CANADA,
AND 10 COUNTRIES IN EUROPE, AFRICA AND LATIN AMERICA. OUR INTERNATIONAL
OPERATIONS INCLUDE BUSINESS GENERATED FROM OUR PARTICIPATION IN LLOYD'S OF
LONDON AS AN INVESTOR AND AS THE OWNER OF TWO MANAGING AGENCIES. THIS SEGMENT
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.
PREMIUMS -- Written premiums totaled $290 million in 1997, an increase of 8%
over 1996 volume of $267 million. International insurance markets in 1997 were
characterized by severe price cutting among Lloyd's syndicates and insurers
operating in virtually all countries where St. Paul International Underwriting
has a presence. Premiums of $159 million in our European operations were $15
million ahead of 1996, largely due to the favorable impact of foreign currency
translation. Premium volume of $57 million generated through Lloyd's was down 2%
in 1997, reflecting the impact of declining rates and our strategic decision to
focus on four syndicates that offer prospects for profitable growth. Our
operations in Canada and Ireland recorded modest premium increases in 1997,
primarily resulting from new business.
UNDERWRITING RESULT -- The underwriting loss of $51 million in 1997 was
significantly worse than the 1996 loss of $21 million. Our European operations
accounted for half of the 1997 total, largely due to reserve strengthening for
medical liability and personal coverages in the United Kingdom. Losses recorded
in one of the Lloyd's syndicates in which we are an investor also contributed to
the 1997 underwriting result. In addition, after obtaining 100% ownership of our
Argentina operation in 1997, we restructured its operations and strengthened
reserves for business written prior to our initial investment in 1995. Two
sectors of our International segment, Ireland and commercial operations in the
United Kingdom, posted strong results in 1997.
1996 VS. 1995 -- Premium growth in 1996 was limited to 3% over 1995, reflecting
difficult market conditions throughout international insurance markets.
Underwriting results in 1996 were slightly better than 1995; deterioration in
personal insurance results in the United Kingdom was offset by improvement in
Canada.
1998 OUTLOOK -- We expect improvement in our International segment in 1998 after
disappointing results in 1997. We will continue efforts to adapt our successful
specialty commercial focus to emerging international markets which offer
favorable prospects for long-term growth and profitability. We anticipate
premium growth in our Lloyd's syndicates and Argentina after the structural
changes implemented in 1997. In addition, 1998 premium volume is expected to
benefit from our expanded operations in Botswana and our newly licensed start-up
operation in Mexico.
<PAGE>
REINSURANCE
- --------------------------------------------------------------------------------
ST. PAUL RE
ST. PAUL RE UNDERWRITES REINSURANCE FOR LEADING PROPERTY-LIABILITY INSURANCE
COMPANIES WORLDWIDE, OBTAINING BUSINESS PRIMARILY IN THE BROKER OR INTERMEDIARY
MARKET. ST. PAUL RE WRITES BOTH TREATY AND FACULTATIVE REINSURANCE FOR PROPERTY,
LIABILITY, OCEAN MARINE, SURETY AND CERTAIN SPECIALTY CLASSES OF COVERAGE.
PREMIUMS -- Written premiums of $745 million in 1997 were down 2% from 1996
volume of $761 million. The decrease reflects 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. St. Paul Re utilized a
portion of its securitized reinsurance capacity in 1997, which resulted in a 4%
increase in North American property business. Our reinsurance operation was also
successful in identifying several new business opportunities which mitigated the
impact of soft market conditions on premium volume.
UNDERWRITING RESULT -- St. Paul Re's underwriting loss of $32 million was $5
million less than the 1996 loss of $37 million. Catastrophe losses were not a
factor in our 1997 results, totaling just $3 million, compared with $18 million
in 1996. The deterioration in noncatastrophe underwriting experience in 1997
reflected an increase in losses from casualty reinsurance coverages and an
increase in commission and compensation expenses.
1996 VS. 1995 -- In 1996, St. Paul Re's premium volume benefited from a shift on
the part of some customers to more financially secure reinsurers. An increase in
excess-of-loss business also contributed to the 7% growth in premiums over 1995.
The underwriting loss of $37 million in 1996 reflected an increase in
noncatastrophe loss experience in our North American casualty reinsurance
business. Catastrophe losses in 1996 totaled $18 million, down from 1995's total
of $37 million.
1998 OUTLOOK -- We will continue to focus on profitability objectives in what
promises to be an increasingly difficult marketplace in 1998. We will seek out
new opportunities to increase and diversify our book of business while at the
same time exercising underwriting discipline in our risk selection. We intend to
expand our global presence by establishing offices in new markets that offer
promising growth opportunities.
<PAGE>
UNDERWRITING
- --------------------------------------------------------------------------------
INVESTMENT OPERATIONS
The majority of our funds available for investment are deployed in a widely
diversified portfolio of fixed maturities structured to maximize investment
income while minimizing credit risk. We also invest in equity securities,
venture capital and real estate in an effort to provide for long-term growth in
the value of our investment portfolio and 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.
Our underwriting operations' investment portfolio generated $881 million of
pretax net investment income in 1997, an increase of 11% over 1996 income of
$795 million. The majority of the increase resulted from underlying growth in
our 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 4% of the increase over 1996 pretax investment
income. Our 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 9% over 1995 due to strong investment cash flows
and the acquisition of Northbrook, which added $1.14 billion of high-quality
fixed maturities to our portfolio.
Pretax realized gains from the sale of investments in 1997 totaled a record
$400 million in our underwriting operations, compared with pretax gains of $209
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 $74
million.
The following table provides a look at the composition and carrying value
of our investment segment's portfolio at the end of the last three years,
followed by additional information about each of our major investment classes.
<TABLE>
<CAPTION>
(In millions) December 31
- ------------------------------------------------------------------------------
1997 1996 1995
<S> <C> <C> <C>
Fixed maturities $12,414 $11,908 $10,395
Equities 981 768 659
Real estate 649 694 612
Venture capital 462 586 389
Short-term investments 387 193 318
Other investments 42 43 42
- ------------------------------------------------------------------------------
Total investments $14,935 $14,192 $12,415
- ------------------------------------------------------------------------------
- ------------------------------------------------------------------------------
</TABLE>
FIXED MATURITIES -- Our 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. We manage our bond portfolio conservatively,
investing almost exclusively in investment-grade (BBB or better) securities.
Approximately 96% of our portfolio at the end of 1997 was rated at investment
grade, with the remaining 4%
<PAGE>
consisting of nonrated securities, most of which, in our opinion, would be
considered investment grade if rated.
The primary factors we consider to determine the mix of our taxable and
tax-exempt security purchases are our consolidated tax position and the
relationship between taxable and tax-exempt yields. Taxable bonds accounted for
virtually all of our new investment purchases in 1997 and comprised 58% of our
fixed maturity portfolio at the end of 1997. The bond portfolio in total carried
a weighted average pretax yield of 7.1% at the end of the year and produced
pretax investment income of $813 million in 1997, compared with $740 million and
$672 million in 1996 and 1995, respectively.
We carry bonds on our balance sheet at market value, with the corresponding
appreciation or depreciation recorded in shareholders' equity net of taxes. The
market value of our 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 our bond portfolio totaled $669 million, compared
with $483 million and $682 million at the end of 1996 and 1995, respectively.
A look at the amortized cost of our bonds, which excludes market
appreciation, provides a more accurate barometer of real growth in the
underlying invested asset base. That amortized cost at the end of 1997 was
$11.75 billion, compared with $11.43 billion and $9.72 billion at the end of
1996 and 1995, respectively. The significant growth in 1996 reflected the
addition of $1.14 billion of bonds from the Northbrook acquisition.
EQUITIES -- Our equity holdings consist of a diversified portfolio of common
stocks, which account for 5% of total investments. Sales of equities in 1997
generated pretax realized investment gains of $155 million, compared with gains
of $122 million and $43 million in 1996 and 1995, respectively. The quality of
our portfolio and favorable market conditions combined to generate substantial
growth in both realized and unrealized gains in 1997 and 1996, producing total
returns of 30% and 23% in this investment class for those years, respectively.
The unrealized appreciation included in the carrying value of our equity
portfolio totaled $232 million at the end of 1997, compared with $177 million at
the end of 1996.
REAL ESTATE -- Real estate comprises 5% of our total investments. Our holdings
primarily consist of commercial office and warehouse properties that we own
directly or in which we have a partial interest through joint ventures. Our
properties are geographically distributed throughout the United States. We do
not invest in real estate mortgage loans, but included in our debt outstanding
are two mortgages totaling $15 million on two of our warehouse complexes. Pretax
investment income from real estate totaled $44 million in 1997, compared with
$36 million and $33 million in 1996 and 1995, respectively. Operational cash
flows from our real estate investments were $75 million in 1997, $62 million in
1996, and $60 million in 1995. Sales of real estate investments in 1997
generated pretax realized gains of $35 million.
VENTURE CAPITAL -- Venture capital comprised 2% of our 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 and $38 million in 1995.
The 1997 total included a gain of $129 million on the sale of the stock of
Advanced Fibre Communications, Inc., one of our direct investments. Our
investments in several venture capital partnerships also produced sizable
realized gains and cash flows in 1997. Our 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.
<PAGE>
1998 INVESTMENT OUTLOOK - New funds available for investment will be
predominantly directed toward high-quality bonds in 1998, with new funds
allocated to our other invested asset classes as market conditions warrant. With
the current interest rate and underwriting environments negatively impacting
investment returns and cash flows, we do not expect investment income growth to
exceed the mid-single digit range in 1998.
UNDERWRITING
- --------------------------------------------------------------------------------
LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES
We establish reserves that reflect our estimates of the total losses and loss
adjustment expenses we will ultimately have to pay under insurance and
reinsurance policies. These include losses that have been reported but not
settled and losses that have been incurred but not reported to us (IBNR). Our
loss reserves are not discounted, but they are reduced for estimates of salvage
and subrogation.
For reported losses, we establish reserves on a "case" basis within the
parameters of coverage provided in the insurance policy or reinsurance
agreement. For IBNR losses, we estimate reserves using established actuarial
methods. Both our 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. We take
into account not only monetary increases in the cost of what we insure, but also
changes in societal factors that influence jury verdicts and case law and, in
turn, claim costs.
Subjective judgments as to our ultimate exposure to losses are an integral
and necessary component of our loss reserving process because many of the
coverages we offer involve claims that may not ultimately be settled for many
years after they are incurred. We continually review our reserves, using a
variety of statistical and actuarial techniques to analyze current claim costs,
frequency and severity data, and prevailing economic, social and legal factors.
We adjust reserves established in prior years as loss experience develops and
new information becomes available. Adjustments to previously estimated reserves
are reflected in our financial results in the periods in which they are made.
A reconciliation of our beginning and ending loss and loss adjustment
expense reserves for each of the last three years is included in Note 6 on page
62 of this report. That reconciliation shows that we have recorded reductions in
the loss provision for claims incurred in prior years totaling $488 million,
$252 million and $248 million in 1997, 1996 and 1995, respectively.
The reduction in 1997 was significantly impacted by a change in the way we
assign loss activity to a particular year for a portion of our reinsurance
business. Prior to 1997, loss activity for assumed reinsurance written by our
U.K.-based reinsurance operation was assigned to the year that the underlying
reinsurance contract was written. In 1997, our analysis indicated that an excess
amount of loss activity was being assigned to prior years because of this
practice. As a result, we implemented an improved procedure in 1997 that more
accurately assigns loss activity for this business to the year in which it
occurred. 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.
We did not reclassify the current year/prior year split for 1996 and 1995 to
reflect this new procedure because reliable data to do so was not available.
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 our Medical Services segment, and in general
liability and workers' compensation coverages throughout our Specialized
Commercial and Commercial underwriting segments.
Our 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 our 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 us to reduce our estimate of the ultimate amount
of losses incurred since reserves were initially established.
In addition, our Personal Insurance operation contributed to the increase
in favorable prior year development in 1997 compared with 1996. In 1996,
deterioration in our personal book of business caused us to increase the
provision for losses incurred in prior years. Actual experience in 1997,
however, on previously established reserves resulted in favorable development.
<PAGE>
UNDERWRITING
- --------------------------------------------------------------------------------
ENVIRONMENTAL AND ASBESTOS CLAIMS
We continue to receive claims alleging injuries from environmental pollution or
alleging covered property damages for the cost to clean up polluted sites. We
also receive 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. Our alleged liability for both environmental
and asbestos claims is complicated by significant legal issues, primarily
pertaining to the scope of coverage. In our opinion, court decisions in certain
jurisdictions have tended to broaden insurance coverage beyond the intent of
original insurance policies.
Our 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 our ultimate liability for asbestos claims is equally difficult.
The primary factors influencing our 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 each of the years in the three-year period
ended Dec. 31, 1997. Amounts in the "net" column are reduced by reinsurance
recoverable.
<TABLE>
<CAPTION>
(In millions) 1997 1996 1995
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
GROSS NET Gross Net Gross Net
ENVIRONMENTAL
Beginning reserves $581 $368 $528 $319 $275 $200
Northbrook reserves acquired - - 18 7 - -
Incurred losses 18 32 67 72 59 68
Reserve reallocation - - - - 233 79
Paid losses (36) (27) (32) (30) (39) (28)
- ----------------------------------------------------------------------------------------
Ending reserves $563 $373 $581 $368 $528 $319
- ----------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------
</TABLE>
Many significant environmental claims being brought against the insurance
industry arise out of contamination that occurred 20 to 30 years ago. Since
1970, our commercial general liability policy form has included a specific
pollution exclusion and, since 1986, an industry standard absolute pollution
exclusion for policies underwritten in the United States.
The following table represents a reconciliation of total gross and net
reserve development for asbestos claims for each of the years in the three-year
period ended Dec. 31, 1997.
<TABLE>
<CAPTION>
(In millions) 1997 1996 1995
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
GROSS NET Gross Net Gross Net
ASBESTOS
Beginning reserves $278 $169 $283 $158 $185 $145
Northbrook reserves acquired - - 6 6 - -
Incurred losses 25 (1) 12 18 (13) (9)
Reserve reallocation - - - - 127 34
Paid losses (32) (15) (23) (13) (16) (12)
- ----------------------------------------------------------------------------------------
Ending reserves $271 $153 $278 $169 $283 $158
- ----------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------
</TABLE>
Most of the asbestos claims we have received pertain to policies written
prior to 1986. Since 1986, for policies underwritten in the United States, our
commercial general liability policy has included the industry standard absolute
pollution exclusion, which we believe applies to asbestos claims.
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.
Our reserves for environmental and asbestos losses at Dec. 31, 1997,
represent our best estimate of our ultimate liability for such losses, based on
all information currently available to us. Because of the inherent difficulty in
estimating such losses, however, we cannot give assurances that our ultimate
liability for environmental and asbestos losses will, in fact, match our current
reserves. We continue to evaluate new information and developing loss patterns,
but we believe any future additional loss provisions for environmental and
asbestos claims will not materially impact the results of our operations,
liquidity or financial position.
Total gross environmental and asbestos reserves at Dec. 31, 1997, of $834
million represented approximately 7% of gross consolidated reserves of $11.82
billion.
<PAGE>
NUVEEN EXPANDS THROUGH
ACQUISITIONS; POSTS RECORD EARNINGS FOR
THIRD CONSECUTIVE YEAR
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
ASSET MANAGEMENT-INVESTMENT BANKING
- --------------------------------------------------------------------------------
THE JOHN NUVEEN COMPANY
WE HOLD A 77% INTEREST IN THE JOHN NUVEEN COMPANY (NUVEEN), WHICH COMPRISES OUR
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>
(In millions) Year ended December 31
- ------------------------------------------------------------------------------
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
<PAGE>
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.
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.
TOTAL CAPITALIZATION REACHES $5.6 BILLION;
RECORD NET INCOME PUSHES COMMON EQUITY
TO NEW HIGH OF $4.6 BILLION
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
THE ST. PAUL COMPANIES
- --------------------------------------------------------------------------------
CAPITAL RESOURCES
Capital resources represent those funds deployed or available to be deployed
to support our business operations and consist of shareholders' equity, debt
and monthly income preferred securities. The following table summarizes our
capital resources at the end of the last three years:
<TABLE>
<CAPTION>
(In millions) December 31
- ---------------------------------------------------------------------------------------------------------
1997 1996 1995
<S> <C> <C> <C>
Shareholders' equity:
Common shareholders' equity:
Common stock and retained earnings $3,963 $3,412 $3,165
Unrealized appreciation of investments and other 647 576 554
- ---------------------------------------------------------------------------------------------------------
Total common shareholders' equity 4,610 3,988 3,719
Preferred shareholders' equity 17 16 11
- ---------------------------------------------------------------------------------------------------------
Total shareholders' equity 4,627 4,004 3,730
Debt 783 689 697
Company-obligated mandatorily redeemable
preferred securities of St. Paul Capital L.L.C. 207 207 207
- ---------------------------------------------------------------------------------------------------------
Total capitalization $5,617 $4,900 $4,634
- ---------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------
Ratio of debt to total capitalization 14% 14% 15%
- ---------------------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
Total shareholders' equity grew to $4.63 billion at the end of 1997, an
increase of over $620 million from the end of 1996, which primarily resulted
from our record net income of $705 million in 1997. The after-tax unrealized
appreciation of our investment portfolio increased $60 million over year-end
1996.
Debt outstanding increased by $94 million in 1997, largely due to $85
million of debt issued by Nuveen to purchase securities for its investment
products and for general corporate purposes. We issued $82 million of
medium-term notes in 1997 under a shelf registration statement filed with the
Securities and Exchange Commission in 1996. At the end of 1997, medium-term
notes outstanding totaled $512 million, comprising 65% of our consolidated
debt. These notes bear a weighted average interest rate of 7.1%. We had the
capacity to issue an additional $161 million debt under the shelf
registration at the end of 1997. The maturity of our $100 million, 9 3/8%
notes in June 1997 was funded through a combination of commercial paper and
medium-term note issuances.
Our major capital outlays in 1997 consisted of $154 million of common
dividend payments to shareholders and $27 million for the repurchase of 355,000
of our common shares. We made no major capital improvements in 1997. 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, shareholders' equity grew by almost $300 million, to $4.0 billion,
on the strength of net income of $450 million for the year. Debt outstanding at
the end of 1996 totaled $689 million, down slightly from year-end 1995. We
issued $33 million of medium-term notes in 1996, using the proceeds to pay down
commercial paper debt and for general corporate purposes.
In 1996, we purchased Northbrook Holdings, Inc. from Allstate Insurance
Company for approximately $190 million in cash from internally generated
sources. We paid common shareholder dividends of $144 million in 1996, and
repurchased 1.4 million of our common shares for a total cost of $74 million.
Our capital expenditures in 1995 consisted of common dividend payments of $133
million and share repurchases of $42 million.
In February 1998, The St. Paul's board of directors increased our dividend
rate to $2.00 per share, a 6% increase over the 1997 rate of $1.88 per share.
Our dividend rate has grown at a compound annual rate of 7.4% over the last five
years. The board of directors also rescinded management's authority to
repurchase our common shares.
Our proposed merger with USF&G Corporation in 1998 would be a tax-free
exchange accounted for on a pooling-of-interests basis. We would issue a number
of our common shares having a value to be determined just prior to the USF&G
shareholder vote on the proposed merger. We do not anticipate any major capital
<PAGE>
expenditures associated with the proposed merger in 1998. We expect to incur
a pretax restructuring charge of between $300 million and $500 million in
1998 relating to the merger. We have no plans for any other major capital
expenditures in 1998, but if any were to occur, they would involve
acquisitions of existing businesses. We have no major capital improvements
planned for 1998.
LIQUIDITY
Liquidity refers to our ability to generate sufficient cash flows to meet the
short- and long-term cash requirements of our business operations. Our
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. Our 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. Net positive cash flows
from underwriting and investment activities are used to build the investment
portfolio and thereby increase future investment income.
We believe long-term liquidity requirements beyond 1998 will be adequately
funded by operational cash flows because of the nature of our underwriting
operations, in which premiums are collected and invested in most cases before
related losses are paid. However, our financial strength and relatively
conservative level of debt provide us with the flexibility and capacity to
obtain funds externally through debt or equity financings.
Cash flows from operations were $702 million in 1997, compared with $970
million in 1996 and $906 million in 1995. Our underwriting segment's operational
cash flows in 1997 were down from 1996 levels, reflecting the impact of
insurance loss and loss expense payments growing at a faster rate than written
premiums. Cash flow in 1997 was also impacted by the increase in loss payments
resulting from the runoff of Northbrook loss reserves acquired in 1996. Our cash
outflows in 1997 included approximately $54 million of payments made pursuant to
certain commitments we made in our 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 our business segments.
We are not aware of any current recommendations by regulatory authorities
that, if implemented, might have a material impact on our liquidity, capital
resources or operations.
<PAGE>
THE ST. PAUL COMPANIES
- --------------------------------------------------------------------------------
EXPOSURES TO MARKET RISK
INTEREST RATE RISK -- Our exposure to market risk for changes in interest rates
is concentrated in our investment portfolio and, to a lesser extent, our debt
obligations. We monitor this exposure through periodic reviews of our asset and
liability positions. Our estimates of cash flows, as well as the impact of
interest rate fluctuations relating to our investment portfolio and insurance
reserves, are modeled and reviewed quarterly.
The following table provides information as of Dec. 31, 1997, about our
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. We have assumed that our "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 $ 1,220 6.5%
1999 1,057 7.5
2000 978 8.0
2001 1,279 7.2
2002 1,181 7.1
Thereafter 6,299 6.8
- ------------------------------------------------------------------------------
Total $12,014
- ------------------------------------------------------------------------------
- ------------------------------------------------------------------------------
Market value at Dec. 31, 1997 $12,850
- ------------------------------------------------------------------------------
MEDIUM-TERM NOTES
1998 $ 25 7.9%
1999 20 7.6
2000 - -
2001 46 7.2
2002 49 7.5
Thereafter 372 6.9
- ------------------------------------------------------------------------------
Total $512
- ------------------------------------------------------------------------------
- ------------------------------------------------------------------------------
Fair value at Dec. 31, 1997 $529
- ------------------------------------------------------------------------------
</TABLE>
FOREIGN CURRENCY EXPOSURE -- Our exposure to market risk for changes in
foreign exchange rates is concentrated in our invested assets denominated in
foreign currencies, which, in our case, are predominantly British pounds
sterling. Cash flows from our foreign operations are the primary source of
funds for our purchase of these investments. We purchase these investments 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 our 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>
EQUITY PRICE RISK -- Our portfolio of marketable equity securities, which we
carry on our 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. Our 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. Our holdings are diversified across
industries, and concentrations in any one company or industry are limited by
parameters established by senior management.
<PAGE>
Our portfolio of venture capital investments also has exposure to market
risk, primarily relating to the viability of the various entities in which we
have invested. These investments by their nature involve more risk than our
other investments, and we actively manage our market risk in a variety
of ways. First, we allocate a comparatively small amount of our funds to venture
capital. At the end of 1997, the cost of these investments accounted for only 2%
of our total invested assets. Second, we diversify our investments to avoid
concentration of risk in a particular industry. Third, we perform extensive
research prior to investing in a new venture to gauge prospects for success.
Fourth, we take an active role in the management of most of the entities in
which we have invested. Finally, we generally sell our holdings in these firms
soon after they become publicly traded, thereby reducing our exposure to further
market risk.
The combined total of realized and unrealized investment gains and losses
(total investment gains) of our equity and venture capital portfolios was $283
million, $404 million and $278 million in 1997, 1996 and 1995, respectively. We
have experienced no quarterly declines in total investment gains of our equity
and venture capital portfolios 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, we have been evaluating our financial and operational
computer systems to determine the impact of the Year 2000 issue on those
systems. We have developed and implemented plans to address the required
system modifications. We do not expect the financial impact of making these
modifications to our own systems to be material to our results of operations,
cash flows or consolidated financial position.
We also face potential Year 2000 losses stemming from coverages offered
in insurance policies we have sold to customers. We continue to assess our
exposure to insurance losses arising from those coverages, and we are taking
a number of underwriting actions to address that exposure. Currently, we do
not believe that such losses will be material to our results of operations,
cash flows or consolidated financial position, unless future judicial
interpretations broaden insurance coverage beyond what we believe was the
intent of the original insurance policies.
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.
<PAGE>
<TABLE>
<CAPTION>
ELEVEN-YEAR SUMMARY OF SELECTED FINANCIAL DATA Year ended December 31
- ----------------------------------------------------------------------------------------------------------------------------------
THE ST. PAUL COMPANIES (Dollars in thousands) 1997 1996 1995 1994 1993 1992
CONSOLIDATED
<S> <C> <C> <C> <C> <C> <C>
Revenues from continuing operations $ 6,219,273 $ 5,734,156 $ 5,056,199 $ 4,368,434 $ 4,150,554 $ 4,180,145
Operating earnings from continuing operations 531,085 414,755 481,491 431,040 406,347 99,308
Net income (loss) 705,473 450,099 521,209 442,828 427,609 (156,038)
INVESTMENT ACTIVITY
Net investment income 886,213 807,305 740,912 673,272 639,893 636,930
Realized investment gains (losses), net of taxes 242,138 143,103 56,357 28,962 40,981 101,270)
Change in unrealized appreciation of
investments, net of taxes 60,101 (10,823) 613,843 (574,896) 525,175 (23,815)
OTHER SELECTED FINANCIAL DATA (As of December 31)
Total assets 21,500,657 20,680,976 18,519,294 16,141,739 15,913,554 14,298,616
Debt 782,825 689,141 697,045 616,151 639,729 566,717
Common shareholders' equity 4,609,985 3,987,757 3,719,249 2,732,934 3,005,128 2,202,499
Common shares outstanding 83,727,800 83,198,411 83,975,864 84,202,417 84,714,676 84,118,554
PER COMMON SHARE DATA
Operating earnings from continuing operations* 5.77 4.56 5.26 4.81 4.50 1.06
Net income (loss)* 7.66 4.94 5.70 4.94 4.74 (1.79)
Book value 55.06 47.93 44.29 32.46 35.47 26.18
Year-end market price 82.06 58.63 55.63 44.75 44.94 38.50
Cash dividends declared 1.88 1.76 1.60 1.50 1.40 1.36
OPERATING EARNINGS RETURN ON BEGINNING COMMON EQUITY 13.1% 10.9% 17.3% 14.1% 18.1% 3.6%
NET INCOME RETURN ON BEGINNING COMMON EQUITY 17.5% 11.9% 18.8% 14.5% 19.0% -
- ----------------------------------------------------------------------------------------------------------------------------------
<CAPTION>
Year ended December 31
- ----------------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands) 1997 1996 1995 1994 1993 1992
UNDERWRITING
Written premiums $ 4,479,903 $ 4,396,122 $ 4,243,213 $ 3,623,026 $ 3,178,545 $ 3,142,419
Statutory underwriting result (187,326) (227,070) (152,703) (143,317) (143,599) (557,463)
GAAP underwriting result (180,067) (216,160) (103,045) (113,008) (150,255) (566,886)
Net investment income 880,802 794,901 731,096 674,818 646,396 642,301
Pretax operating earnings 615,445 477,535 577,509 524,742 457,752 20,781
Pretax income 1,015,883 686,084 651,912 560,709 507,181 81,132
Statutory combined ratio:
Loss and loss expense ratio 72.5 74.6 72.1 72.1 72.5 85.6
Underwriting expense ratio 32.6 30.9 29.7 30.2 32.0 32.2
- ----------------------------------------------------------------------------------------------------------------------------------
Combined ratio 105.1 105.5 101.8 102.3 104.5 117.8
- ----------------------------------------------------------------------------------------------------------------------------------
<CAPTION>
Year ended December 31
- ---------------------------------------------------------------------------------------------------------------------
THE ST. PAUL COMPANIES (Dollars in thousands) 1991 1990 1989 1988 1987
CONSOLIDATED
Revenues from continuing operations $ 4,017,548 $ 3,691,811 $ 3,507,117 $ 3,397,564 $ 3,296,241
Operating earnings from continuing operations 388,273 389,985 317,064 353,260 323,550
Net income (loss) 405,062 391,270 398,158 355,257 356,523
INVESTMENT ACTIVITY
Net investment income 635,163 628,359 622,587 568,505 527,317
Realized investment gains (losses), net of taxes 24,258 5,812 59,892 3,354 (5,489)
Change in unrealized appreciation of
investments, net of taxes 55,093 (67,558) 60,045 20,428 (19,959)
OTHER SELECTED FINANCIAL DATA (As of December 31)
Total assets 13,709,649 12,862,538 12,126,981 11,186,778 9,531,050
Debt 486,779 473,829 293,802 417,140 96,576
Common shareholders' equity 2,532,841 2,196,371 2,349,254 2,015,219 1,711,362
Common shares outstanding 85,042,484 84,468,058 98,607,762 92,728,168 92,603,714
PER COMMON SHARE DATA
Operating earnings from continuing operations* 4.33 4.15 3.25 3.67 3.37
Net income (loss)* 4.52 4.16 4.07 3.69 3.72
Book value 29.78 26.00 23.82 21.73 18.48
Year-end market price 36.44 31.38 29.57 21.75 23.00
Cash dividends declared 1.30 1.20 1.10 1.00 0.88
OPERATING EARNINGS RETURN ON BEGINNING COMMON EQUITY 17.3% 16.3% 15.7% 20.6% 22.5%
NET INCOME RETURN ON BEGINNING COMMON EQUITY 18.1% 16.3% 19.8% 20.8% 24.7%
- ---------------------------------------------------------------------------------------------------------------------
<CAPTION>
Year ended December 31
- ---------------------------------------------------------------------------------------------------------------------
(Dollars in thousands) 1991 1990 1989 1988 1987
UNDERWRITING
Written premiums $ 3,233,729 $ 3,052,032 $ 2,807,223 $ 2,690,536 $ 2,704,165
Statutory underwriting result (170,894) (141,751) (207,977) (92,741) (145,061)
GAAP underwriting result (163,782) (120,730) (196,378) (90,209) (127,066)
Net investment income 640,856 629,242 614,119 548,766 498,251
Pretax operating earnings 451,184 457,161 364,352 420,339 358,493
Pretax income 486,063 466,731 456,167 424,187 351,358
Statutory combined ratio:
Loss and loss expense ratio 75.2 73.2 75.7 73.6 76.2
Underwriting expense ratio 29.4 30.0 30.5 30.0 28.9
- ---------------------------------------------------------------------------------------------------------------------
Combined ratio 104.6 103.2 106.2 103.6 105.1
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
*Earnings per share for all years presented is calculated on
a "diluted" basis in accordance with SFAS No. 128.
<PAGE>
MANAGEMENT'S RESPONSIBILITY
FOR FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
SCOPE OF RESPONSIBILITY -- Management prepares the accompanying financial
statements and related information and is responsible for their integrity and
objectivity. The statements were prepared in conformity with generally accepted
accounting principles. These financial statements include amounts that are based
on management's estimates and judgments, particularly our reserves for losses
and loss adjustment expenses. We believe that these statements present fairly
the company's financial position and results of operations and that the other
information contained in the annual report is consistent with the financial
statements.
INTERNAL CONTROLS -- We maintain and rely on systems of internal accounting
controls designed to provide reasonable assurance that assets are safeguarded
and transactions are properly authorized and recorded. We continually monitor
these internal accounting controls, modifying and improving them as business
conditions and operations change. Our internal audit department also
independently reviews and evaluates these controls. We recognize the inherent
limitations in all internal control systems and believe that our systems provide
an appropriate balance between the costs and benefits desired. We believe our
systems of internal accounting controls provide reasonable assurance that errors
or irregularities that would be material to the financial statements are
prevented or detected in the normal course of business.
INDEPENDENT AUDITORS -- Our independent auditors, KPMG Peat Marwick LLP, have
audited the consolidated financial statements. Their audit was conducted in
accordance with generally accepted auditing standards, which includes the
consideration of our internal controls to the extent necessary to form an
independent opinion on the consolidated financial statements prepared by
management.
AUDIT COMMITTEE -- The audit committee of the board of directors, composed
solely of outside directors, oversees management's discharge of its financial
reporting responsibilities. The committee meets periodically with management,
our internal auditors and representatives of KPMG Peat Marwick LLP to discuss
auditing, financial reporting and internal control matters. Both internal
audit and KPMG Peat Marwick LLP have access to the audit committee without
management's presence.
CODE OF CONDUCT -- We recognize our responsibility for maintaining a strong
ethical climate. This responsibility is addressed in the company's written code
of conduct.
/s/ Douglas W. Leatherdale /s/ Paul J. Liska
- ------------------------------ ------------------------------
Douglas W. Leatherdale Paul J. Liska
Chairman, President and Executive Vice President and
Chief Executive Officer Chief Financial Officer
INDEPENDENT AUDITORS' REPORT
- -------------------------------------------------------------------------------
THE BOARD OF DIRECTORS AND SHAREHOLDERS
THE ST. PAUL COMPANIES, INC.:
We have audited the accompanying consolidated balance sheets of The St. Paul
Companies, Inc. and subsidiaries as of December 31, 1997 and 1996, and the
related 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 consolidated financial statements are the
responsibility of the company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
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 consolidated financial statements referred to above
present fairly, in all material respects, the financial position of The St. Paul
Companies, Inc. and subsidiaries at 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.
/s/ KPMG Peat Marwick LLP
- ------------------------------
Minneapolis, Minnesota
January 26, 1998
<PAGE>
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF INCOME Year ended December 31
- ---------------------------------------------------------------------------------------------------------
THE ST. PAUL COMPANIES (In thousands) 1997 1996 1995
<S> <C> <C> <C>
REVENUES
Premiums earned $4,616,456 $4,448,248 $3,971,329
Net investment income 886,213 807,305 740,912
Realized investment gains 408,110 218,525 84,572
Asset management-investment banking 261,715 219,922 221,007
Other 46,779 40,156 38,379
- ---------------------------------------------------------------------------------------------------------
Total revenues 6,219,273 5,734,156 5,056,199
- ---------------------------------------------------------------------------------------------------------
EXPENSES
Insurance losses and loss adjustment expenses 3,345,168 3,318,301 2,864,307
Policy acquisition expenses 1,021,623 975,456 856,979
Operating and administrative 833,749 741,263 665,588
- ---------------------------------------------------------------------------------------------------------
Total expenses 5,200,540 5,035,020 4,386,874
- ---------------------------------------------------------------------------------------------------------
Income from continuing operations before income taxes 1,018,733 699,136 669,325
Income tax expense 245,510 141,278 131,477
- ---------------------------------------------------------------------------------------------------------
INCOME FROM CONTINUING OPERATIONS 773,223 557,858 537,848
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 $ 705,473 $ 450,099 $ 521,209
- ---------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------
BASIC EARNINGS PER COMMON SHARE
Income from continuing operations $ 9.10 $ 6.57 $ 6.26
Loss from discontinued operations (0.82) (1.29) (0.19)
- ---------------------------------------------------------------------------------------------------------
NET INCOME $ 8.28 $ 5.28 $ 6.07
- ---------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------
DILUTED EARNINGS PER COMMON SHARE
Income from continuing operations $ 8.39 $ 6.11 $ 5.88
Loss from discontinued operations (0.73) (1.17) (0.18)
- ---------------------------------------------------------------------------------------------------------
NET INCOME $ 7.66 $ 4.94 $ 5.70
- ---------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------
See notes to consolidated financial statements.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
CONSOLIDATED BALANCE SHEETS December 31
- ------------------------------------------------------------------------------------------
THE ST. PAUL COMPANIES (In thousands) 1997 1996
ASSETS
<S> <C> <C>
Investments:
Fixed maturities $12,449,793 $11,944,085
Equities 1,033,920 808,295
Real estate 649,114 693,910
Venture capital 461,892 586,222
Other investments 41,359 43,311
Short-term investments 400,004 289,793
- ------------------------------------------------------------------------------------------
Total investments 15,036,082 14,365,616
Cash 22,660 37,214
Investment banking inventory securities 130,203 143,594
Reinsurance recoverables:
Unpaid losses 1,893,122 1,890,105
Paid losses 69,693 68,692
Receivables:
Underwriting premiums 1,503,497 1,558,967
Interest and dividends 216,099 213,883
Other 78,360 104,865
Deferred policy acquisition expenses 404,274 401,768
Ceded unearned premiums 192,591 243,663
Deferred income taxes 845,331 908,220
Office properties and equipment 294,705 281,093
Goodwill 408,534 167,338
Other assets 405,506 295,958
- ------------------------------------------------------------------------------------------
TOTAL ASSETS $21,500,657 $20,680,976
- ------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------
LIABILITIES
Insurance reserves:
Losses and loss adjustment expenses $11,817,633 $11,673,148
Unearned premiums 2,379,703 2,566,551
- ------------------------------------------------------------------------------------------
Total insurance reserves 14,197,336 14,239,699
Debt 782,825 689,141
Payables:
Reinsurance premiums 142,554 181,524
Income taxes 274,177 219,081
Accrued expenses and other 587,689 484,062
Other liabilities 682,366 656,649
- ------------------------------------------------------------------------------------------
TOTAL LIABILITIES 16,666,947 16,470,156
- ------------------------------------------------------------------------------------------
Company-obligated mandatorily redeemable preferred
securities of St. Paul Capital L.L.C. 207,000 207,000
- ------------------------------------------------------------------------------------------
SHAREHOLDERS' EQUITY
Preferred:
Convertible preferred stock 137,892 142,131
Guaranteed obligation - PSOP (121,167) (126,068)
- ------------------------------------------------------------------------------------------
TOTAL PREFERRED SHAREHOLDERS' EQUITY 16,725 16,063
- ------------------------------------------------------------------------------------------
Common:
Common stock 512,162 475,710
Retained earnings 3,450,601 2,935,928
Guaranteed obligation - ESOP (8,453) (20,353)
Accumulated other comprehensive income:
Unrealized appreciation of investments 677,069 616,968
Unrealized loss on foreign currency translation (21,394) (20,496)
- ------------------------------------------------------------------------------------------
Total accumulated other comprehensive income 655,675 596,472
- ------------------------------------------------------------------------------------------
TOTAL COMMON SHAREHOLDERS' EQUITY 4,609,985 3,987,757
- ------------------------------------------------------------------------------------------
TOTAL SHAREHOLDERS' EQUITY 4,626,710 4,003,820
- ------------------------------------------------------------------------------------------
TOTAL LIABILITIES, REDEEMABLE PREFERRED SECURITIES
AND SHAREHOLDERS' EQUITY $21,500,657 $20,680,976
- ------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------
See notes to consolidated financial statements.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY Year ended December 31
- ------------------------------------------------------------------------------------------------------------------------
THE ST. PAUL COMPANIES (In thousands) 1997 1996 1995
PREFERRED SHAREHOLDERS' EQUITY
<S> <C> <C> <C>
Series B 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)
- ------------------------------------------------------------------------------------------------------------------------
TOTAL PREFERRED SHAREHOLDERS' EQUITY 16,725 16,063 10,872
- ------------------------------------------------------------------------------------------------------------------------
COMMON SHAREHOLDERS' EQUITY
Common stock:
Beginning of year 475,710 460,458 445,222
Stock issued under stock incentive plans 28,224 18,326 18,522
Stock issued for preferred shares redeemed 8,678 3,067 959
Stock issued for acquisition 1,676 1,664 -
Reacquired common shares (2,126) (7,805) (4,245)
- ------------------------------------------------------------------------------------------------------------------------
End of year 512,162 475,710 460,458
- ------------------------------------------------------------------------------------------------------------------------
Retained earnings:
Beginning of year 2,935,928 2,704,075 2,362,286
Net income 705,473 450,099 521,209
Dividends declared on common stock, $1.88 per share in 1997
($1.76 in 1996 and $1.60 in 1995) (156,692) (145,956) (133,956)
Dividends declared on preferred stock, net of taxes (8,645) (8,664) (8,582)
Reacquired common shares (24,377) (66,412) (37,468)
Tax benefit on employee stock options and awards 3,355 3,819 1,409
Premium on preferred shares redeemed (4,441) (1,033) (823)
- ------------------------------------------------------------------------------------------------------------------------
End of year 3,450,601 2,935,928 2,704,075
- ------------------------------------------------------------------------------------------------------------------------
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 of investments, net of taxes:
Beginning of year 616,968 627,791 13,948
Change for the year 60,101 (10,823) 613,843
- ------------------------------------------------------------------------------------------------------------------------
End of year 677,069 616,968 627,791
- ------------------------------------------------------------------------------------------------------------------------
Unrealized loss on foreign currency translation, net of taxes:
Beginning of year (20,496) (40,781) (44,112)
Currency translation adjustments (898) (5,309) 3,331
Realized loss relating to discontinued operations - 25,594 -
- ------------------------------------------------------------------------------------------------------------------------
End of year (21,394) (20,496) (40,781)
- ------------------------------------------------------------------------------------------------------------------------
TOTAL COMMON SHAREHOLDERS' EQUITY 4,609,985 3,987,757 3,719,249
- ------------------------------------------------------------------------------------------------------------------------
TOTAL SHAREHOLDERS' EQUITY $4,626,710 $4,003,820 $3,730,121
- ------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME Year ended December 31
- ------------------------------------------------------------------------------------------------------------------------
THE ST. PAUL COMPANIES (In thousands) 1997 1996 1995
Net income $ 705,473 $ 450,099 $ 521,209
- ------------------------------------------------------------------------------------------------------------------------
Other comprehensive income, net of taxes:
Change in unrealized appreciation of investments 60,101 (10,823) 613,843
Change in unrealized loss on foreign currency translation (898) 20,285 3,331
- ------------------------------------------------------------------------------------------------------------------------
Other comprehensive income 59,203 9,462 617,174
- ------------------------------------------------------------------------------------------------------------------------
COMPREHENSIVE INCOME $ 764,676 $ 459,561 $1,138,383
- ------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------
See notes to consolidated financial statements.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF CASH FLOWS Year ended December 31
- ------------------------------------------------------------------------------------------------------------------------
THE ST. PAUL COMPANIES (In thousands) 1997 1996 1995
OPERATING ACTIVITIES
<S> <C> <C> <C>
Underwriting:
Net income $ 747,293 $ 551,293 $ 533,776
Adjustments:
Change in net insurance reserves (5,556) 344,259 753,543
Change in underwriting premiums receivable 80,210 (56,347) (217,877)
Depreciation and goodwill amortization 69,826 63,834 58,405
Realized investment gains (400,438) (208,549) (74,403)
Other (57,049) 179,165 (175,106)
- ------------------------------------------------------------------------------------------------------------------------
Total underwriting 434,286 873,655 878,338
- ------------------------------------------------------------------------------------------------------------------------
Asset management-investment banking:
Net income 55,557 56,601 54,746
Adjustments:
Change in inventory securities 13,391 107,453 (103,016)
Change in short-term borrowings 69,500 (25,000) 25,000
Change in short-term investments 70,996 (457) 45,659
Other 14,500 1,489 15,504
- ------------------------------------------------------------------------------------------------------------------------
Total asset management-investment banking 223,944 140,086 37,893
- ------------------------------------------------------------------------------------------------------------------------
Parent company and consolidating eliminations:
Net loss from continuing operations (29,627) (50,036) (50,674)
Adjustments:
Realized investment gains (7,672) (9,976) (10,169)
Other 81,116 15,919 50,758
- ------------------------------------------------------------------------------------------------------------------------
Total parent company and consolidating eliminations 43,817 (44,093) (10,085)
- ------------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 702,047 969,648 906,146
- ------------------------------------------------------------------------------------------------------------------------
Cash outflow resulting from sale of discontinued operations (54,018) - -
- ------------------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES
Purchases of investments (3,022,250) (3,148,120) (2,857,778)
Proceeds from sales and maturities of investments 2,872,065 2,486,056 1,991,357
Change in short-term investments (177,031) 141,647 (6,116)
Change in open security transactions 33,071 (35,556) 6,516
Net purchases of office properties and equipment (57,135) (38,454) (41,614)
Acquisitions (169,145) (184,568) -
Other 2,903 32,504 (56,809)
- ------------------------------------------------------------------------------------------------------------------------
NET CASH USED IN INVESTING ACTIVITIES (517,522) (746,491) (964,444)
- ------------------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES
Dividends paid on common and preferred stock (165,809) (155,268) (144,662)
Proceeds from issuance of debt 195,548 46,220 193,002
Repayment of debt (161,000) (17,711) (125,446)
Repurchase of common shares (26,503) (74,217) (41,714)
Proceeds from issuance of company-obligated mandatorily
redeemable preferred securities of St. Paul Capital L.L.C. - - 207,000
Other 12,703 (10,442) (25,216)
- ------------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES (145,061) (211,418) 62,964
- ------------------------------------------------------------------------------------------------------------------------
INCREASE (DECREASE) IN CASH (14,554) 11,739 4,666
- ------------------------------------------------------------------------------------------------------------------------
Cash at beginning of year 37,214 25,475 20,809
- ------------------------------------------------------------------------------------------------------------------------
CASH AT END OF YEAR $ 22,660 $ 37,214 $ 25,475
- ------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------
See notes to consolidated financial statements.
</TABLE>
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
THE ST. PAUL COMPANIES
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. We record the results of our
foreign underwriting operations on a 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
Minet as a discontinued operation.
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 losses and loss adjustment
expenses. 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.
ACCOUNTING FOR OUR 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 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 statement of income net of
reinsurance, meaning that we reduce our gross losses and loss expenses incurred
by the amounts we will recover under reinsurance contracts.
We establish reserves for the estimated total unpaid cost of losses and
loss 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.
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.
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 ASSET MANAGEMENT-INVESTMENT BANKING SEGMENT
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's core businesses are asset management and surveillance
[the management of its family of mutual funds and exchange-traded (closed-end)
funds, the management of other private investment accounts and the surveillance
of its family of unit investment trusts (UITs)], and the sponsorship and
marketing of both taxable and tax-free mutual funds and UITs. They also provide
municipal and corporate investment banking services and underwrite and trade
municipal bonds. They hold in inventory municipal bonds and UITs that will be
sold to individuals or securities dealers. Those inventory securities are
carried on the balance sheet at market value.
<PAGE>
Nuveen's revenues include advisory fees from asset management, revenues
from the sponsorship and marketing of mutual funds and UITs, fees and revenues
from investment banking services, 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 balance sheet and statement of income for the minority
shareholders' proportionate interest in Nuveen's equity and earnings. Minority
interest expense is recorded in operating and administrative expenses on the
statement of income. 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.
REAL ESTATE -- Our real estate investments primarily consist of commercial
buildings that we own directly or in which we have a partial interest through
joint ventures with other investors.
For direct 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 use the "equity method" of accounting for our 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.
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 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 record a realized loss for the decline on
the statement of income.
UNREALIZED APPRECIATION AND DEPRECIATION OF INVESTMENTS -- 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 of
investments. 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 30 years.
The accumulated amortization of goodwill was $149.0 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
$246.2 million and $217.5 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 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 balance sheets and average
exchange rates for the statements of income.
<PAGE>
SUPPLEMENTAL CASH FLOW INFORMATION
INTEREST AND INCOME TAXES PAID -- We paid interest of $50.9 million in 1997,
$48.4 million in 1996 and $44.5 million in 1995. We paid federal income taxes of
$92.2 million in 1997, $91.5 million in 1996 and $184.4 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 our
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.
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
previous 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.
<TABLE>
<CAPTION>
(In thousands) Year ended December 31
- -----------------------------------------------------------------------------------------------------------------------------
1997 1996 1995
<S> <C> <C> <C>
BASIC
Net income, as reported $705,473 $450,099 $521,209
PSOP preferred dividends declared (net of taxes) (8,645) (8,664) (8,582)
Premium on preferred shares redeemed (4,441) (1,033) (823)
- -----------------------------------------------------------------------------------------------------------------------------
Net income, as adjusted $692,387 $440,402 $511,804
- -----------------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------------
DILUTED
Net income, as reported $705,473 $450,099 $521,209
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)
- -----------------------------------------------------------------------------------------------------------------------------
Net income, as adjusted $706,458 $454,124 $521,955
- -----------------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------------
AVERAGE COMMON SHARES OUTSTANDING
Basic 83,572 83,474 84,385
Diluted 92,261 91,897 91,637
- -----------------------------------------------------------------------------------------------------------------------------
</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 the company-obligated
mandatorily redeemable preferred securities of St. Paul Capital L.L.C. (monthly
income preferred securities).
<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 $ 2,257,397 $ 108,899 $ (1,314) $ 2,364,982
States and political subdivisions 5,071,738 366,737 (169) 5,438,306
Foreign governments 946,317 54,890 (21,933) 979,274
Corporate securities 1,840,337 88,251 (2,617) 1,925,971
Mortgage-backed securities 1,690,048 51,859 (647) 1,741,260
- -------------------------------------------------------------------------------------------------------------------
Total fixed maturities 11,805,837 670,636 (26,680) 12,449,793
Equities 784,269 264,785 (15,134) 1,033,920
Venture capital 324,333 156,205 (18,646) 461,892
- -------------------------------------------------------------------------------------------------------------------
Total $12,914,439 $1,091,626 $(60,460) $13,945,605
- -------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------
<CAPTION>
(In thousands) December 31, 1996
- -------------------------------------------------------------------------------------------------------------------
Gross Gross Estimated
Unrealized Unrealized Market
Cost Appreciation Depreciation Value
Fixed maturities:
U.S. government $ 2,401,760 $ 56,345 $(13,139) $ 2,444,966
States and political subdivisions 4,992,485 300,755 (5,274) 5,287,966
Foreign governments 1,077,869 59,421 (11,684) 1,125,606
Corporate securities 1,546,721 48,262 (8,721) 1,586,262
Mortgage-backed securities 1,466,168 39,452 (6,335) 1,499,285
- -------------------------------------------------------------------------------------------------------------------
Total fixed maturities 11,485,003 504,235 (45,153) 11,944,085
Equities 621,880 193,002 (6,587) 808,295
Venture capital 293,837 308,858 (16,473) 586,222
- -------------------------------------------------------------------------------------------------------------------
Total $12,400,720 $1,006,095 $(68,213) $13,338,602
- -------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
STATUTORY DEPOSITS -- At Dec. 31, 1997, our underwriting operations had
investments in fixed maturities with an estimated market value of $500.4 million
on deposit with regulatory authorities, as required by law.
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 $ 162,634 $ 164,924
Over one year through five years 1,850,065 1,921,026
Over five years through 10 years 4,508,203 4,808,787
Over 10 years 3,594,887 3,813,796
Mortgage-backed securities with
various maturities 1,690,048 1,741,260
- -------------------------------------------------------------------------------
Total $11,805,837 $12,449,793
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
</TABLE>
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 $1,424,249 $1,885,428 $1,829,942
Equities 1,374,980 1,037,185 837,288
Real estate 101,543 114,770 116,925
Venture capital 97,413 94,891 66,247
Other investments 24,065 15,846 7,376
- -------------------------------------------------------------------------------
Total purchases 3,022,250 3,148,120 2,857,778
- -------------------------------------------------------------------------------
PROCEEDS FROM SALES
AND MATURITIES
Fixed maturities:
Sales 522,380 506,999 326,382
Maturities and
redemptions 579,330 730,612 709,104
Equities 1,361,772 1,110,060 836,683
Real estate 154,503 17,608 14,428
Venture capital 250,015 118,011 87,512
Other investments 4,065 2,766 17,248
- -------------------------------------------------------------------------------
Total sales and
maturities 2,872,065 2,486,056 1,991,357
- -------------------------------------------------------------------------------
Net purchases $ 150,185 $ 662,064 $ 866,421
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
</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 $812,470 $738,396 $665,364
Equities 16,241 15,655 14,644
Real estate 44,101 36,260 32,830
Venture capital 352 324 (171)
Other investments (1,248) (2,142) (965)
Short-term investments 25,872 31,008 38,842
- -------------------------------------------------------------------------------
Total 897,788 819,501 750,544
Investment expenses (11,575) (12,196) (9,632)
- -------------------------------------------------------------------------------
Net investment income $886,213 $807,305 $740,912
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
</TABLE>
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 $ 3,233 $ 7,033 $ 3,091
Gross realized losses (5,492) (8,236) (5,728)
- -------------------------------------------------------------------------------
Total fixed maturities (2,259) (1,203) (2,637)
- -------------------------------------------------------------------------------
Equities:
Gross realized gains 208,659 160,639 78,772
Gross realized losses (46,412) (31,282) (29,548)
- -------------------------------------------------------------------------------
Total equities 162,247 129,357 49,224
- -------------------------------------------------------------------------------
Real estate:
Gross realized gains 35,539 2,678 2,305
Gross realized losses (687) (1,267) (474)
- -------------------------------------------------------------------------------
Total real estate 34,852 1,411 1,831
- -------------------------------------------------------------------------------
Venture capital:
Gross realized gains 270,376 109,879 71,412
Gross realized losses (57,713) (23,868) (33,237)
- -------------------------------------------------------------------------------
Total venture capital 212,663 86,011 38,175
- -------------------------------------------------------------------------------
Other investments 607 2,949 (2,021)
- -------------------------------------------------------------------------------
Total pretax realized
investment gains $ 408,110 $ 218,525 $ 84,572
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION
Fixed maturities $ 184,874 $(198,855) $ 742,626
Equities 63,236 25,975 130,247
Venture capital (154,826) 163,110 59,880
- -------------------------------------------------------------------------------
Total change in
pretax unrealized
appreciation 93,284 (9,770) 932,753
Change in deferred taxes (33,183) (1,053) (318,910)
- -------------------------------------------------------------------------------
Total change in
unrealized appreciation,
net of taxes $ 60,101 $ (10,823) $ 613,843
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
</TABLE>
<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 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 minimize our credit risk
by conducting derivative transactions only with reputable, investment-grade
counter parties.
We enter into interest rate swap agreements for the purpose of minimizing
the effect of interest rate fluctuations on some of our debt and investments.
We are party to an interest rate swap agreement that requires us to pay a
fixed rate of 5.6% on $50 million of our outstanding floating rate commercial
paper through 2000. At Dec. 31, 1997 and 1996, the estimated market value of
this swap agreement was an asset of $0.6 million and $1.4 million, respectively.
Note 6
RESERVES FOR LOSSES AND LOSS ADJUSTMENT EXPENSES
RECONCILIATION OF LOSS RESERVES -- The following table represents a
reconciliation of beginning and ending consolidated 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 $11,673,148 $10,247,070 $ 9,423,429
Less reinsurance recoverables
on unpaid losses at
beginning of year (1,890,105) (1,853,817) (1,533,250)
- --------------------------------------------------------------------------------
Net loss and LAE reserves
at beginning of year 9,783,043 8,393,253 7,890,179
Net reserves of acquired
companies - 1,015,826 12,329
- --------------------------------------------------------------------------------
Provision for losses and
LAE for claims incurred:
Current year 3,833,468 3,570,545 3,112,193
Prior years (488,300) (252,244) (247,886)
- -------------------------------------------------------------------------------
Total incurred 3,345,168 3,318,301 2,864,307
- -------------------------------------------------------------------------------
Losses and LAE payments
for claims incurred:
Current year (982,822) (1,101,077) (783,633)
Prior years (2,228,083) (1,839,463) (1,590,701)
- --------------------------------------------------------------------------------
Total paid (3,210,905) (2,940,540) (2,374,334)
- --------------------------------------------------------------------------------
Unrealized foreign
exchange loss (gain) 7,205 (3,797) 772
- --------------------------------------------------------------------------------
Net loss and LAE
reserves at end of year 9,924,511 9,783,043 8,393,253
Plus reinsurance recoverables on
unpaid losses at end of year 1,893,122 1,890,105 1,853,817
- --------------------------------------------------------------------------------
Loss and LAE reserves at
end of year, as reported $11,817,633 $11,673,148 $10,247,070
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
</TABLE>
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 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 $563,000 $373,000 $581,000 $368,000
Asbestos 271,000 153,000 278,000 169,000
- --------------------------------------------------------------------------------
Total environmental
and asbestos
reserves $834,000 $526,000 $859,000 $537,000
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
</TABLE>
<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 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 $245,510 $141,278 $131,477
Expense on
discontinued operations - 401 3,547
Benefit on loss on disposal (35,530) (291,493) -
- --------------------------------------------------------------------------------
Total income tax expense
(benefit) included in
statements of income 209,980 (149,814) 135,024
- --------------------------------------------------------------------------------
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 (3,355) (3,819) (1,409)
Deferred expense (benefit)
for the change in unrealized
appreciation of investments
and unrealized foreign
exchange 32,619 (1,561) 319,195
- --------------------------------------------------------------------------------
Total income tax expense
(benefit) included in
common shareholders'
equity 26,152 (9,006) 313,692
- --------------------------------------------------------------------------------
Total income tax expense
(benefit) included in
financial statements $236,132 $(158,820) $448,716
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
</TABLE>
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 $271,528 $114,035 $182,422
Federal deferred tax benefit (59,857) (1,185) (58,330)
- --------------------------------------------------------------------------------
Total federal income
tax expense 211,671 112,850 124,092
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 $245,510 $141,278 $131,477
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
</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 $356,557 $244,698 $234,264
Increase (decrease) attributable to:
Nontaxable investment
income (98,420) (94,156) (83,395)
Valuation allowance (31,657) (10,519) (20,724)
Other 19,030 1,255 1,332
- --------------------------------------------------------------------------------
Total income
tax expense on
continuing operations $245,510 $141,278 $131,477
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
</TABLE>
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 $ 851,011 $ 808,248
Loss on disposal of insurance
brokerage operations 199,868 370,900
Unearned premium reserves 146,124 172,382
Deferred compensation 77,092 78,006
Alternative minimum
tax credit carryforwards 94,677 3,740
Other 198,916 130,301
- --------------------------------------------------------------------------------
Total gross deferred tax assets 1,567,688 1,563,577
Less valuation allowance (41,222) (72,879)
- --------------------------------------------------------------------------------
Net deferred tax assets 1,526,466 1,490,698
- --------------------------------------------------------------------------------
DEFERRED TAX LIABILITIES
Unrealized appreciation of investments 354,892 325,824
Deferred acquisition costs 134,469 135,455
Real estate 41,036 43,125
Other 150,738 78,074
- --------------------------------------------------------------------------------
Total gross deferred tax liabilities 681,135 582,478
- --------------------------------------------------------------------------------
Deferred income taxes $ 845,331 $ 908,220
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
</TABLE>
<PAGE>
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, and
an increase of $51.8 million in 1996, relating to our foreign underwriting
operations and our provision for loss on disposal of insurance brokerage
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 $11.4 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.
IRS EXAMINATIONS -- The Internal Revenue Service has examined our consolidated
returns through 1992 and is currently examining the years 1993 and 1994. 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.
Note 8
CAPITAL STRUCTURE
The following summarizes our capital structure:
<TABLE>
<CAPTION>
(In thousands) December 31
- --------------------------------------------------------------------------------
1997 1996
<S> <C> <C>
Debt $ 782,825 $ 689,141
Company-obligated mandatorily
redeemable preferred securities
of St. Paul Capital L.L.C. 207,000 207,000
Preferred shareholders' equity 16,725 16,063
Common shareholders' equity 4,609,985 3,987,757
- --------------------------------------------------------------------------------
Total capital $5,616,535 $4,899,961
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Ratio of debt to total capital 14% 14%
- --------------------------------------------------------------------------------
</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
Nuveen short-term
borrowings 69,500 69,500 - -
Real estate mortgages 15,196 15,400 13,220 13,220
Nuveen notes payable 15,000 15,100 - -
Guaranteed ESOP debt 2,780 2,800 13,890 14,000
9 3/8% notes - - 99,994 101,500
- -------------------------------------------------------------------------------------
Total debt $782,825 $800,229 $689,141 $695,830
- -------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------
</TABLE>
FAIR VALUE -- The fair value of our commercial paper and short-term borrowings
approximates their book value 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.
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%.
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 two of our investments. One $13.2 million mortgage bears a
fixed interest rate of 6.7% and matures in November 2000. The other $2.0 million
mortgage bears a fixed rate of 8.1% and matures in February 2002.
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.
<PAGE>
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.
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 issuances
and commercial paper.
INTEREST EXPENSE -- Our interest expense was $51.8 million in 1997, $48.5
million in 1996 and $46.2 million in 1995.
MATURITIES -- The amount of debt that becomes due in each of the next five
years is as follows: 1998, $97.3 million; 1999, $20.0 million; 2000, $28.2
million; 2001, $45.5 million; and 2002, $219.1 million.
COMPANY-OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF ST. PAUL
CAPITAL L.L.C.
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 0.8475 shares of our common stock
(equivalent to a conversion price of $59 per share). The MIPS are redeemable
after May 31, 1999, but we may redeem them before then upon the occurrence of
certain events.
PREFERRED SHAREHOLDERS' EQUITY
The preferred shareholders' equity on our balance sheet 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 our 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 four 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.
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 240 million.
Our cost for reacquired shares in 1997, 1996 and 1995 was $26.5 million,
$74.2 million and $41.7 million, respectively. We reduced our capital stock
account for the cost of these repurchases in proportion to the percentage of
shares reacquired, with the remainder of the cost charged to retained earnings.
In 1997, we issued 20,488 shares of our common stock valued at $1.7 million, and
in 1996 we issued 28,748 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.
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 83,198,411 83,975,864 84,202,417
Shares issued:
Stock incentive plans 750,766 542,169 534,096
Conversion of preferred stock 112,993 56,047 17,543
Acquisition 20,488 28,748 -
Reacquired shares (354,858) (1,404,417) (778,192)
- ------------------------------------------------------------------------------
Outstanding at end of year 83,727,800 83,198,411 83,975,864
- ------------------------------------------------------------------------------
- ------------------------------------------------------------------------------
</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.
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.
<PAGE>
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. underwriting subsidiary. In 1998, $427.5 million will be available for
dividends free from such restrictions. During 1997, we received cash dividends
of $200 million from our U.S. underwriting subsidiary, and a noncash dividend of
a portion of its investment in The John Nuveen Company with a market value of
$211.1 million.
Note 9
RETIREMENT 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
- ------------------------------------------------------------------------------
1997 1996
<S> <C> <C>
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 380,172 shares of our common stock with a market value of $31.2 million
and $22.3 million at Dec. 31, 1997 and 1996, respectively.
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 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 603,627 shares. The
ESOP allocated 498,715 shares in 1996 and 500,834 shares in 1995.
PREFERRED STOCK OWNERSHIP PLAN -- Our Savings Plus Preferred Stock Ownership
Plan (PSOP) allocates preferred shares semiannually 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 our U.S. underwriting subsidiary. 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
four 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 allocation to qualified U.S. employees based on
company performance.
<PAGE>
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.
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>
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.
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 910,000 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 of $11.5 million, $1.9 million and $1.2 million in
1997, 1996 and 1995, respectively.
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 100,000 option shares remained available at year-end for future
grants under our non-U.S. plans.
The following table summarizes the activity for our fixed option plans for
the last three years. All grants were made at the market price on date of grant.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------
Weighted
Option Average
Shares Exercise Price
<S> <C> <C>
Outstanding Jan. 1, 1995 2,974,297 $34.48
Granted 670,050 48.52
Exercised (478,684) 33.11
Canceled (12,667) 38.65
- ---------------------------------------------------------------------------
Outstanding Dec. 31, 1995 3,152,996 37.65
Granted 773,100 54.04
Exercised (441,037) 33.99
Canceled (112,169) 35.92
- ---------------------------------------------------------------------------
Outstanding Dec. 31, 1996 3,372,890 41.95
Granted 744,544 67.43
Exercised (634,346) 35.59
Canceled (32,295) 55.38
- ---------------------------------------------------------------------------
Outstanding Dec. 31, 1997 3,450,793 $48.49
- ---------------------------------------------------------------------------
- ---------------------------------------------------------------------------
</TABLE>
<PAGE>
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 3.2%, 3.3% and 3.5%; expected volatility of 19.0%, 18.9% and 16.9%; risk-free
interest rates of 6.5%, 6.3% and 7.1%; and an expected life of 6.9 years, 7.2
years and 7.2 years.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------
1997 1996 1995
<S> <C> <C> <C>
Options exercisable at
year-end 2,635,294 2,545,540 2,404,446
Weighted average fair value
of options granted
during the year $15.67 $12.27 $10.93
- ------------------------------------------------------------------------------
</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>
$23.50 - 39.00 1,033,544 3.8 years $34.18
39.50 - 48.75 954,400 6.4 years 45.24
49.63 - 63.00 1,032,755 8.4 years 56.50
70.00 - 80.38 430,094 9.4 years 70.82
- ------------------------------------------------------------------------------
$23.50 - 80.38 3,450,793 6.6 years $48.49
- ------------------------------------------------------------------------------
- ------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
Options Exercisable
- ------------------------------------------------------------------------------
Weighted
Range of Number of Average
Exercise Prices Options Exercise Price
- ------------------------------------------------------------------------------
<S> <C> <C>
$23.50 - 39.00 1,033,544 $34.18
39.50 - 48.75 939,900 45.32
49.63 - 63.00 661,850 54.05
70.00 - 80.38 - -
- ------------------------------------------------------------------------------
$23.50 - 80.38 2,635,294 $43.14
- ------------------------------------------------------------------------------
- ------------------------------------------------------------------------------
</TABLE>
VARIABLE STOCK OPTION GRANT
In 1997 and 1996, we made variable option grants of 158,100 and 825,300 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 $100 per share. The remaining options will vest
when our stock price reaches a 20-consecutive-day average of $110 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 $67.13 and $58.75 in
1997 and 1996, respectively. These options may be exercised during the twelve
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 $10.92
and $9.08 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 4 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 700,000 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 21,000 shares remain
available for deferred stock awards at Dec. 31, 1997.
PRO FORMA INFORMATION
Had we calculated compensation expense 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 $705,473 $450,099 $521,209
Pro forma 702,879 445,090 517,750
- ------------------------------------------------------------------------------
BASIC EARNINGS PER SHARE
As reported 8.28 5.28 6.07
Pro forma 8.25 5.22 6.02
- ------------------------------------------------------------------------------
DILUTED EARNINGS PER SHARE
As reported 7.66 4.94 5.70
Pro forma 7.64 4.89 5.66
- ------------------------------------------------------------------------------
</TABLE>
<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.
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 $66.6 million in 1997,
$67.0 million in 1996 and $58.2 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: $49.3 million in 1998, $38.8 million in 1999, $30.7 million in
2000, $21.5 million in 2001, $18.8 million in 2002 and $59.7 million thereafter.
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.
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.
<PAGE>
Note 13
ACQUISITIONS
In 1997 The John Nuveen Company, 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 portfolio investment management firm, in 1997 for a total cost of
approximately $147 million. These acquisitions added $13.8 billion to Nuveen's
assets under management. The cost of these acquisitions was largely composed of
goodwill, which is being amortized over 30 years.
On July 31, 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 Nuveen's acquisitions been completed at the beginning of 1996, or had the
Northbrook acquisition been completed at the beginning of 1995.
Note 14
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.
The largest concentration (approximately 15%) of our total reinsurance
recoverables and ceded unearned premiums was with General Reinsurance
Corporation. That company is rated "A++" by A.M. Best, "Aaa" by Moody's and
"AAA" by Standard & Poor's for its property-liability insurance claims-paying
ability.
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. The effect of assumed and ceded reinsurance on
premiums written, premiums earned and insurance losses and loss adjustment
expenses is as follows:
<TABLE>
<CAPTION>
(In thousands) Year ended December 31
- ---------------------------------------------------------------------------
1997 1996 1995
<S> <C> <C> <C>
PREMIUMS WRITTEN
Direct $3,949,463 $3,945,053 $3,825,517
Assumed 963,989 969,420 1,030,331
Ceded (433,549) (518,351) (612,635)
- ---------------------------------------------------------------------------
Net premiums written $4,479,903 $4,396,122 $4,243,213
- ---------------------------------------------------------------------------
- ---------------------------------------------------------------------------
PREMIUMS EARNED
Direct $4,142,706 $4,001,384 $3,678,190
Assumed 958,108 975,273 934,490
Ceded (484,358) (528,409) (641,351)
- ---------------------------------------------------------------------------
Net premiums earned $4,616,456 $4,448,248 $3,971,329
- ---------------------------------------------------------------------------
- ---------------------------------------------------------------------------
INSURANCE LOSSES AND
LOSS ADJUSTMENT EXPENSES
Direct $3,077,293 $2,851,403 $2,926,261
Assumed 656,927 671,401 743,740
Ceded (389,052) (204,503) (805,694)
- ---------------------------------------------------------------------------
Net insurance losses and
loss adjustment expenses $3,345,168 $3,318,301 $2,864,307
- ---------------------------------------------------------------------------
- ---------------------------------------------------------------------------
</TABLE>
<PAGE>
Note 15
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 accounting principles,
which differ from GAAP. On a statutory accounting basis, our underwriting
operations reported net income of $918.6 million in 1997, $584.0 million in 1996
and $476.3 million in 1995. Statutory surplus (shareholder's equity) of these
operations was $3.3 billion and $3.0 billion as of Dec. 31, 1997 and 1996,
respectively.
Note 16
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. The new
standards do not result in a significant change from our previous segment
disclosures.
We have seven reportable segments in our underwriting operation, which
consist of our investment function, and six strategic underwriting units that
offer different products and services. The underwriting units are managed
separately because each one targets different customers and requires different
marketing strategies. The underwriting units consist of Specialized Commercial,
Commercial, Personal Insurance, Medical Services, St. Paul International
Underwriting and St. Paul Re. 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 results for our six underwriting units; investment income and
realized gains for our investment function; and pretax operating results for the
asset management-investment banking segment. Underwriting assets are reviewed
in total by management for purposes of decision making. We do not allocate
assets to specific underwriting 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. $5,486,544 $5,051,190 $4,435,770
Non-U.S. 732,729 682,966 620,429
- ---------------------------------------------------------------------------
Total revenues $6,219,273 $5,734,156 $5,056,199
- ---------------------------------------------------------------------------
- ---------------------------------------------------------------------------
</TABLE>
MAJOR CUSTOMERS -- A large portion of our property-liability insurance premium
volume originates with insurance brokers. In 1997 and 1996, approximately 18%
and 15%, respectively, of our underwriting operations gross written premium
volume originated with two brokerage firms.
SEGMENT INFORMATION -- The summary on the next page presents revenues and pretax
income from continuing operations for our reportable segments. The revenues of
our asset management-investment banking segment include its investment income.
The table also presents identifiable assets for our underwriting operation in
total and our asset management-investment banking segment.
<PAGE>
<TABLE>
<CAPTION>
(In thousands) Year ended December 31
- -----------------------------------------------------------------------------------------------------------------------------
1997 1996 1995
<S> <C> <C> <C>
REVENUES FROM CONTINUING OPERATIONS
Underwriting:
St. Paul Fire and Marine:
Specialized Commercial $ 1,291,702 $ 1,272,561 $ 1,230,790
Commercial 964,121 862,092 587,016
Personal Insurance 747,449 707,299 655,347
Medical Services 594,186 601,679 605,468
- -----------------------------------------------------------------------------------------------------------------------------
Total St. Paul Fire and Marine 3,597,458 3,443,631 3,078,621
St. Paul International Underwriting 274,968 268,830 237,727
- -----------------------------------------------------------------------------------------------------------------------------
Total Worldwide Insurance Operations 3,872,426 3,712,461 3,316,348
St. Paul Re 744,030 735,787 654,981
- -----------------------------------------------------------------------------------------------------------------------------
Total premiums earned 4,616,456 4,448,248 3,971,329
Net investment income 880,802 794,901 731,096
Realized investment gains 400,438 208,549 74,403
Other 38,502 40,619 37,282
- -----------------------------------------------------------------------------------------------------------------------------
Total underwriting 5,936,198 5,492,317 4,814,110
- -----------------------------------------------------------------------------------------------------------------------------
Asset management-investment banking 268,927 232,347 236,230
- -----------------------------------------------------------------------------------------------------------------------------
Total reportable segments 6,205,125 5,724,664 5,050,340
Parent company and consolidating eliminations 14,148 9,492 5,859
- -----------------------------------------------------------------------------------------------------------------------------
Total revenues $ 6,219,273 $ 5,734,156 $ 5,056,199
- -----------------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------------
INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES
Underwriting:
St. Paul Fire and Marine:
Specialized Commercial $ 28,959 $ 49,186 $ (124,078)
Commercial (62,965) (60,228) (3,668)
Personal Insurance (63,254) (201,815) (33,000)
Medical Services 661 55,179 76,399
- -----------------------------------------------------------------------------------------------------------------------------
Total St. Paul Fire and Marine (96,599) (157,678) (84,347)
St. Paul International Underwriting (51,005) (21,784) (23,188)
- -----------------------------------------------------------------------------------------------------------------------------
Total Worldwide Insurance Operations (147,604) (179,462) (107,535)
St. Paul Re (32,463) (36,698) 4,490
- -----------------------------------------------------------------------------------------------------------------------------
Total GAAP underwriting result (180,067) (216,160) (103,045)
Net investment income 880,802 794,901 731,096
Realized investment gains 400,438 208,549 74,403
Other (85,290) (101,206) (50,542)
- -----------------------------------------------------------------------------------------------------------------------------
Total underwriting 1,015,883 686,084 651,912
- -----------------------------------------------------------------------------------------------------------------------------
Asset management-investment banking:
Pretax income before minority interest 122,170 117,502 113,770
Minority interest (29,553) (25,805) (25,573)
- -----------------------------------------------------------------------------------------------------------------------------
Total asset management-investment banking 92,617 91,697 88,197
- -----------------------------------------------------------------------------------------------------------------------------
Total reportable segments 1,108,500 777,781 740,109
Parent company and consolidating eliminations (89,767) (78,645) (70,784)
- -----------------------------------------------------------------------------------------------------------------------------
Total income from continuing operations before income taxes $ 1,018,733 $ 699,136 $ 669,325
- -----------------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------------
<CAPTION>
(In thousands) December 31
- -----------------------------------------------------------------------------------------------------------------------------
1997 1996 1995
IDENTIFIABLE ASSETS
Underwriting $20,445,079 $19,848,788 $17,541,329
Asset management-investment banking 516,690 356,318 402,512
- -----------------------------------------------------------------------------------------------------------------------------
Total reportable segments 20,961,769 20,205,106 17,943,841
Parent company, consolidating eliminations and discontinued operations 538,888 475,870 575,453
- -----------------------------------------------------------------------------------------------------------------------------
Total assets $21,500,657 $20,680,976 $18,519,294
- -----------------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
Note 17
COMPREHENSIVE INCOME
We adopted the provisions of the 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 composed of our reported net income, changes in the unrealized
appreciation of our investment portfolio and changes in unrealized foreign
currency translation adjustments. SFAS No. 130 requires that we report all
components of comprehensive income. 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 $(314,826) $(132,789) $(182,037)
Less: reclassification adjustment
for realized gains included in
net income 408,110 165,972 242,138
- -----------------------------------------------------------------------------
Net change in unrealized
appreciation of investments 93,284 33,183 60,101
- -----------------------------------------------------------------------------
Unrealized loss on foreign
currency translation (1,462) (564) (898)
- -----------------------------------------------------------------------------
Total other comprehensive
income $ 91,822 $ 32,619 $ 59,203
- -----------------------------------------------------------------------------
- -----------------------------------------------------------------------------
<CAPTION>
(In thousands) Year ended December 31, 1996
- -----------------------------------------------------------------------------
Income
Pretax Tax Effect After-tax
Unrealized appreciation arising
during period $208,755 $76,475 $132,280
Less: reclassification adjustment
for realized gains included in
net income 218,525 75,422 143,103
- -----------------------------------------------------------------------------
Net change in unrealized
appreciation of investments (9,770) 1,053 (10,823)
- -----------------------------------------------------------------------------
Unrealized loss on foreign
currency translation (5,261) 48 (5,309)
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 17,671 (2,614) 20,285
- -----------------------------------------------------------------------------
Total other comprehensive
income $ 7,901 $ (1,561) $ 9,462
- -----------------------------------------------------------------------------
- -----------------------------------------------------------------------------
<CAPTION>
(In thousands) Year ended December 31, 1995
- -----------------------------------------------------------------------------
Income
Pretax Tax Effect After-tax
Unrealized appreciation arising
during period $1,017,325 $347,125 $670,200
Less: reclassification adjustment
for realized gains included in
net income 84,572 28,215 56,357
- -----------------------------------------------------------------------------
Net change in unrealized
appreciation of investments 932,753 318,910 613,843
- -----------------------------------------------------------------------------
Unrealized gain on foreign
currency translation 3,616 285 3,331
- -----------------------------------------------------------------------------
Total other comprehensive
income $ 936,369 $319,195 $617,174
- -----------------------------------------------------------------------------
- -----------------------------------------------------------------------------
</TABLE>
Note 18
SUBSEQUENT EVENT - MERGER AGREEMENT
WITH USF&G CORPORATION
In January 1998, we announced that we had entered into a merger agreement with
USF&G Corporation. The merger, which is subject to the approval of both
companies' shareholders and various regulatory authorities, will be a tax-free
exchange of stock accounted for as a pooling of interests. The combined company
will operate under The St. Paul name and remain based in Saint Paul, Minn. If
the merger is completed, the combined company will become the eighth-largest
property-liability insurance company in the United States, based on 1996 net
written premiums. The merger is expected to be consummated in mid-1998.
Under the terms of the merger agreement, USF&G shareholders will receive
shares of our common stock having a value determined according to an exchange
ratio based on the average price of our stock during a twenty-day trading period
ending on the third day prior to the USF&G shareholder meeting to vote on the
proposed merger. If our average common stock price during that period is between
$74 and $78 per share, USF&G shareholders will receive a fraction of a share in
our common stock equal to $22 divided by our average common stock price for each
USF&G share. If our average common stock price is above $78 per share, USF&G
shareholders will receive 0.2821 of one of our shares for each USF&G share. If
our average common stock price is below $74 per share, USF&G shareholders will
receive 0.2973 of one of our shares for each USF&G share. The total value of
the transaction is expected to be approximately $3.5 billion, which includes the
assumption of USF&G's debt and capital securities.
For the year ended Dec. 31, 1997, USF&G recorded net written premiums of
$2.45 billion, total revenues of $3.40 billion and net income of $193.9 million
($1.72 diluted earnings per share). At Dec. 31, 1997, USF&G's assets totaled
$15.82 billion, including a $10.94 billion investment portfolio.
<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 $1,557,203 $1,620,711 $1,497,048 $1,544,311
Income from continuing operations 192,299 230,524 163,404 186,996
Net income 124,549 230,524 163,404 186,996
Earnings per common share:
Basic:
Income from continuing operations 2.28 2.72 1.91 2.19
Net income 1.46 2.72 1.91 2.19
Diluted:
Income from continuing operations 2.10 2.51 1.77 2.02
Net income 1.37 2.51 1.77 2.02
- --------------------------------------------------------------------------------------------------------------
<CAPTION>
(In thousands) 1996
- --------------------------------------------------------------------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
Revenues $1,329,891 $1,364,474 $1,476,158 $1,563,633
Income from continuing operations 144,411 135,295 114,823 163,329
Net income 128,821 130,053 128,934 62,291
Earnings per common share:
Basic:
Income from continuing operations 1.69 1.59 1.35 1.93
Net income 1.51 1.53 1.52 0.72
Diluted:
Income from continuing operations 1.57 1.48 1.26 1.79
Net income 1.40 1.42 1.42 0.69
- --------------------------------------------------------------------------------------------------------------
<CAPTION>
(In thousands) 1995
- --------------------------------------------------------------------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
Revenues $1,192,755 $1,244,183 $1,270,351 $1,348,910
Income from continuing operations 127,384 118,341 137,108 155,015
Net income 110,596 112,967 142,399 155,247
Earnings per common share:
Basic:
Income from continuing operations 1.49 1.38 1.60 1.80
Net income 1.29 1.31 1.66 1.81
Diluted:
Income from continuing operations 1.42 1.30 1.49 1.67
Net income 1.23 1.24 1.54 1.67
- --------------------------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
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, and No. 333-28915) and
Form S-3 (SEC File No. 33-33931, No. 33-50115, No. 33-58491, and No.
333-06465) of The St. Paul Companies, Inc., of our report dated January 26,
1998, relating to the consolidated balance sheets of The St. Paul Companies,
Inc. and subsidiaries as of December 31, 1997 and 1996, and the related
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, which report appears in the February 26, 1998 Form 8-K of The St.
Paul Companies, Inc.
Minneapolis, Minnesota /s/ KPMG Peat Marwick LLP
February 26, 1998 -------------------------
KPMG Peat Marwick LLP
