<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q/A
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
- - ----- EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1998
or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
- - ----- EXCHANGE ACT OF 1934
For the transition period from _________________ to ___________________
Commission File Number 0-3021
THE ST. PAUL COMPANIES, INC.
--------------------------------------------
(Exact name of Registrant as specified in its charter)
Minnesota 41-0518860
--------- ----------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
385 Washington St., Saint Paul, MN 55102
------------------------------------ -----
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (651) 310-7911
------------------
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports) and (2) has been subject to
such filing requirements for the past 90 days.
Yes X No
----- -----
The number of shares of the Registrant's Common Stock, without par value,
outstanding on August 10, 1998, was 236,102,543.
<PAGE>
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page No.
--------
<S> <C>
PART I. FINANCIAL INFORMATION
Consolidated Statements of Operations (Unaudited), Three
Months and Six Months Ended June 30, 1998 and 1997 3
Consolidated Balance Sheets (Unaudited),
June 30, 1998 and December 31, 1997 4
Consolidated Statements of Shareholders' Equity
(Unaudited), Six Months Ended June 30, 1998 and
Twelve Months Ended December 31, 1997 6
Consolidated Statements of Comprehensive Income
(Unaudited), Six Months Ended June 30, 1998
and 1997 7
Consolidated Statements of Cash Flows (Unaudited),
Six Months Ended June 30, 1998 and 1997 8
Notes to Consolidated Financial Statements (Unaudited) 9
Management's Discussion and Analysis of Financial
Condition and Results of Operations 23
PART II. OTHER INFORMATION
Item 1 through Item 6 38
Signatures 39
EXHIBIT INDEX 40
</TABLE>
<PAGE>
PART I FINANCIAL INFORMATION
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
Unaudited
(In thousands)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30 June 30
------------------------- -------------------------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues:
Premiums earned $1,752,167 1,856,347 3,533,724 3,696,972
Net investment income 397,656 390,331 794,547 780,411
Realized investment gains 135,532 171,384 185,373 267,473
Asset management-
investment banking 74,919 59,755 146,321 118,360
Other 19,407 15,285 43,908 32,137
------------ ------------ ------------ ------------
Total revenues 2,379,681 2,493,102 4,703,873 4,895,353
------------ ------------ ------------ ------------
Expenses:
Insurance losses and loss
adjustment expenses 1,662,018 1,321,084 2,933,872 2,647,041
Life policy benefits 61,994 62,348 121,631 121,636
Policy acquisition expenses 416,998 443,241 850,116 869,870
Operating and administrative 649,198 275,509 958,454 556,643
------------ ------------ ------------ ------------
Total expenses 2,790,208 2,102,182 4,864,073 4,195,190
------------ ------------ ------------ ------------
Income (loss) from continuing
operations before income taxes (410,527) 390,920 (160,200) 700,163
Income tax expense (benefit) (136,724) 101,978 (81,075) 174,053
------------ ------------ ------------ ------------
Income (loss) from
continuing operations (273,803) 288,942 (79,125) 526,110
Loss on disposal of discontinued
operations, net of taxes - - - (67,750)
------------ ------------ ------------ ------------
Net income (loss) ($273,803) 288,942 (79,125) 458,360
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
Basic earnings (loss) per common share:
Income (loss) from continuing operations ($1.18) 1.25 (0.36) 2.26
Loss from discontinued operations - - - (0.30)
------------ ------------ ------------ ------------
Net income (loss) ($1.18) 1.25 (0.36) 1.96
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
Diluted earnings (loss) per common share:
Income (loss) from continuing operations ($1.18) 1.15 (0.36) 2.09
Loss from discontinued operations - - - (0.27)
------------ ------------ ------------ ------------
Net income (loss) ($1.18) 1.15 (0.36) 1.82
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
Dividends declared on common stock 0.25 0.235 0.50 0.47
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
</TABLE>
See notes to consolidated financial statements.
<PAGE>
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
Unaudited
(In thousands)
<TABLE>
<CAPTION>
June 30, December 31,
ASSETS 1998 1997
- - ----------- ---------- ----------
<S> <C> <C>
Investments:
Fixed maturities, at estimated market value $20,843,281 20,945,219
Equities, at estimated market value 1,146,784 1,052,370
Real estate, at cost less accumulated
depreciation of $100,985 (1997; $93,015) 918,524 985,317
Mortgage loans, at cost 702,035 640,734
Venture capital, at estimated market value 491,817 461,892
Other investments 932,599 923,933
Short-term investments, at cost 974,492 970,568
-------------- --------------
Total investments 26,009,532 25,980,033
Cash 129,107 113,175
Investment banking inventory securities 43,602 130,203
Reinsurance recoverables:
Unpaid losses 4,043,507 3,839,051
Paid losses 126,515 128,422
Ceded unearned premiums 343,115 376,343
Receivables:
Underwriting premiums 2,276,459 2,213,926
Interest and dividends 345,512 355,970
Other 137,761 104,727
Deferred policy acquisition expenses 837,490 872,460
Deferred income taxes 1,203,365 1,213,790
Office properties and equipment, at cost
less accumulated depreciation
of $397,536 (1997; $369,414) 532,890 602,381
Goodwill 599,428 618,528
Other assets 834,887 809,819
--------------- ---------------
Total assets $37,463,170 37,358,828
--------------- ---------------
--------------- ---------------
</TABLE>
See notes to consolidated financial statements.
<PAGE>
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Consolidated Balance Sheets (continued)
Unaudited
(In thousands)
<TABLE>
<CAPTION>
June 30, December 31,
LIABILITIES AND SHAREHOLDERS' EQUITY 1998 1997
- - ------------------------------------------------------------ --------------- ------------
<S> <C> <C>
Liabilities:
Insurance reserves:
Losses and loss adjustment expenses $18,646,485 18,153,080
Future policy benefits 3,876,671 3,816,050
Unearned premiums 3,392,302 3,528,234
-------------- --------------
Total insurance reserves 25,915,458 25,497,364
Debt 1,075,895 1,304,008
Payables:
Income taxes 224,717 303,549
Reinsurance premiums 305,611 258,495
Accrued expenses and other 1,473,048 1,327,549
Other liabilities 1,453,391 1,556,995
-------------- --------------
Total liabilities 30,448,120 30,247,960
-------------- --------------
Company-obligated mandatorily redeemable preferred
capital securities of subsidiaries or trusts holding solely
convertible subordinated debentures of the Company 502,700 502,700
-------------- --------------
Shareholders' equity:
Preferred:
Series B convertible preferred stock;
1,450 shares authorized; 945 shares
outstanding (956 shares in 1997) 136,320 137,892
Guaranteed obligation - PSOP (121,167) (121,167)
-------------- --------------
Total preferred shareholders' equity 15,153 16,725
-------------- --------------
Common:
Common stock, 480,000 shares authorized; 235,848
shares outstanding (233,130 shares in 1997) 2,120,746 2,057,108
Retained earnings 3,532,624 3,720,140
Guaranteed obligation - ESOP - (8,453)
Accumulated other comprehensive income:
Unrealized appreciation 866,335 845,811
Unrealized loss on foreign currency translation (22,508) (23,163)
-------------- --------------
Total accumulated other comprehensive income 843,827 822,648
-------------- --------------
Total common shareholders' equity 6,497,197 6,591,443
-------------- --------------
Total shareholders' equity 6,512,350 6,608,168
-------------- --------------
Total liabilities, redeemable preferred
securities and shareholders' equity $37,463,170 37,358,828
-------------- --------------
-------------- --------------
</TABLE>
See notes to consolidated financial statements.
<PAGE>
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Consolidated Statements of Shareholders' Equity
Unaudited
(In thousands)
<TABLE>
<CAPTION>
Six Twelve
Months Ended Months Ended
June 30, December 31,
1998 1997
------------- ------------
<S> <C> <C>
Preferred shareholders' equity:
Series B convertible preferred stock:
Beginning of period $ 137,892 142,131
Redemptions during period (1,572) (4,239)
------------- ------------
End of period 136,320 137,892
------------- ------------
Guaranteed obligation - PSOP:
Beginning of period (121,167) (126,068)
Principal payments - 4,901
------------- ------------
End of period (121,167) (121,167)
------------- ------------
Total preferred shareholders' equity 15,153 16,725
------------- ------------
Common shareholders' equity:
Common stock:
Beginning of period 2,057,108 1,895,608
Stock issued under stock incentive plans 44,110 32,421
Stock issued for preferred shares redeemed 3,777 8,708
Stock issued for acquisitions - 113,264
Reacquired common shares - (13,892)
Other 15,751 20,999
------------- ------------
End of period 2,120,746 2,057,108
------------- ------------
Retained earnings:
Beginning of period 3,720,140 3,097,261
Net income (loss) (79,125) 929,292
Dividends declared on common stock (108,972) (186,036)
Dividends declared on preferred stock, net of taxes (4,269) (10,304)
Reacquired common shares - (114,232)
Premium on preferred shares converted or redeemed (2,205) (4,052)
Other changes during period 7,055 8,211
------------- ------------
End of period 3,532,624 3,720,140
------------- ------------
Guaranteed obligation - ESOP:
Beginning of period (8,453) (20,353)
Principal payments 8,453 11,900
------------- ------------
End of period - (8,453)
------------- ------------
Unrealized appreciation, net of taxes:
Beginning of period 845,811 679,381
Change during the period 20,524 166,430
------------- ------------
End of period 866,335 845,811
------------- ------------
Unrealized loss on foreign currency translation, net of taxes:
Beginning of period (23,163) (20,500)
Currency translation adjustments 655 (2,663)
------------- ------------
End of period (22,508) (23,163)
------------- ------------
Total common shareholders' equity 6,497,197 6,591,443
------------- ------------
Total shareholders' equity $6,512,350 6,608,168
------------- ------------
------------- ------------
</TABLE>
See notes to consolidated financial statements.
<PAGE>
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Consolidated Statements of
Comprehensive Income
Unaudited
(In thousands)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30 June 30
-------------------------- ----------------------
1998 1997 1998 1997
------ ------ ------ ------
(In thousands)
<S> <C> <C> <C> <C>
Net income (loss) $(273,803) 288,942 (79,125) 458,360
---------- ---------- ---------- ----------
Other comprehensive income (loss), net of taxes:
Change in unrealized appreciation (27,881) 198,086 20,524 (113,420)
Change in unrealized loss on
foreign currency translation (4,197) (1,037) 655 5,299
---------- ---------- ---------- ----------
Other comprehensive income (loss) (32,078) 197,049 21,179 (108,121)
---------- ---------- ---------- ----------
Comprehensive income (loss) $(305,881) 485,991 (57,946) 350,239
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
</TABLE>
See notes to consolidated financial statements.
<PAGE>
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Unaudited
(In thousands)
<TABLE>
<CAPTION>
Six Months Ended
June 30
---------------------------------
1998 1997
---- ----
<S> <C> <C>
OPERATING ACTIVITIES
Net income (loss) ($79,125) 458,360
Adjustments:
Change in net property-liability insurance reserves 219,047 (60,548)
Change in insurance premiums receivable (58,182) (62,697)
Change in asset management balances (3,122) 63,063
Realized investment gains (185,373) (267,473)
Provision for loss on disposal of discontinued operations - 67,750
Other 88,038 61,049
------------ -----------
Net Cash Provided by (Used in) Operating Activities (18,717) 259,504
------------ -----------
INVESTING ACTIVITIES
Purchase of investments (2,288,072) (2,887,202)
Proceeds from sales and maturities of investments 2,433,067 2,757,640
Change in short-term investments 16,274 (31,580)
Change in open security transactions 100,849 76,430
Net purchases of office properties and equipment (51,553) (70,691)
Discontinued operations (13,772) (20,284)
Other 22,175 (12,878)
------------ -----------
Net Cash Provided by (Used in) Investing Activities 218,968 (188,565)
------------ -----------
FINANCING ACTIVITIES
Deposits on universal life and investment contracts 180,825 262,013
Withdrawals on universal life and investment contracts (131,020) (106,006)
Dividends paid on common and preferred stock (102,887) (102,734)
Proceeds from issuance of debt 36,190 182,186
Repayment of debt (193,827) (103,155)
Redemption of preferred shares - (199,981)
Repurchase of common shares - (102,004)
Proceeds from issuance of company-obligated mandatorily
redeemable preferred securities of subsidiaries - 98,871
Stock options exercised and other 26,400 18,471
------------ -----------
Net Cash Used in Financing Activities (184,319) (52,339)
------------ -----------
Effect of exchange rate changes on cash - 44
------------ -----------
Increase in cash 15,932 18,644
Cash at beginning of period 113,175 109,855
------------ -----------
Cash at end of period $129,107 128,499
------------ -----------
------------ -----------
</TABLE>
See notes to consolidated financial statements.
<PAGE>
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated
Financial Statements
Unaudited
June 30, 1998
NOTE 1 BASIS OF PRESENTATION
The financial statements include The St. Paul Companies, Inc. and subsidiaries
(The St. Paul), and have been prepared in conformity with generally accepted
accounting principles.
On April 24, 1998, The St. Paul completed its merger with USF&G Corporation
(USF&G) in a tax-free exchange of stock accounted for as a
pooling-of-interests. The unaudited consolidated financial statements for all
current year and prior year periods in this report reflect the combined
accounts and results of operations of The St. Paul and USF&G. The accounting
policies employed by The St. Paul and USF&G prior to the merger were
consistent in all respects except for the method of accounting for certain
workers' compensation loss reserves. See Note 8 on pages 16 and 17 of this
report for further information about the adjustment recorded to conform the
accounting policies of The St. Paul and USF&G with regard to these reserves.
These consolidated financial statements rely, in part, on estimates. In the
opinion of management, all necessary adjustments, consisting of normal
recurring adjustments, have been reflected for a fair presentation of the
results of operations, financial position and cash flows in the accompanying
unaudited consolidated financial statements. The results for the period are
not necessarily indicative of the results to be expected for the entire year.
Some amounts in the 1997 consolidated financial statements have been
reclassified to conform with the 1998 presentation. These reclassifications
had no effect on net income or shareholders' equity, as previously reported.
All references in the consolidated financial statements and related footnotes
to per share amounts and to the number of common shares for both 1998 and
1997 reflect the effect of the 2-for-1 stock split which occurred on May 6,
1998 (See Note 9).
Later in 1998, The St. Paul intends to file with the Securities and Exchange
Commission audited financial statements reflecting the combined accounts and
results of operations of The St. Paul and USF&G as of Dec. 31, 1997 and 1996,
and for the years ended Dec. 31, 1997, 1996 and 1995.
<PAGE>
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated
Financial Statements,
Continued
NOTE 2 EARNINGS (LOSS) PER SHARE
Earnings (loss) per common share (EPS) amounts were calculated by dividing net
income (loss), as adjusted, by the adjusted average common shares outstanding.
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30 June 30
-------------------------- ----------------------
1998 1997 1998 1997
------ ------ ------ ------
(In thousands)
<S> <C> <C> <C> <C>
EARNINGS (LOSS)
Basic:
Net income (loss), as reported ($273,803) 288,942 (79,125) 458,360
Dividends on preferred stock, net of taxes (2,120) (2,168) (4,269) (6,012)
Premium on preferred shares redeemed (1,361) (651) (2,205) (911)
---------- ---------- ---------- ----------
Net income (loss) available to common shares ($277,284) 286,123 (85,599) 451,437
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Diluted:
Net income (loss) available to common shares ($277,284) 286,123 (85,599) 451,437
Effect of dilutive securities:
Convertible preferred stock - 1,502 - 3,017
Zero coupon convertible notes - 779 - 1,542
Convertible monthly income preferred securities - 2,019 - 4,037
---------- ---------- ---------- ----------
Net income (loss) available to common shares ($277,284) 290,423 (85,599) 460,033
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
COMMON SHARES
Basic:
Weighted average common shares outstanding 235,160 229,611 234,670 230,211
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Diluted:
Weighted average common shares outstanding 235,160 229,611 234,670 230,211
Effect of dilutive securities:
Stock options - 4,786 - 4,702
Convertible preferred stock - 8,025 - 7,848
Zero coupon convertible notes - 2,923 - 2,923
Convertible monthly income preferred securities - 7,017 - 7,017
---------- ---------- ---------- ----------
Total 235,160 252,362 234,670 252,701
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
EARNINGS (LOSS) PER SHARE
Basic ($1.18) 1.25 (0.36) 1.96
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Diluted ($1.18) 1.15 (0.36) 1.82
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
</TABLE>
<PAGE>
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated
Financial Statements,
Continued
The assumed exercise of stock options, and the assumed conversion of preferred
stock, zero coupon notes and monthly income preferred securities are each
anti-dilutive to The St. Paul's net income for the three months and six months
ended June 30, 1998. As a result, the potentially dilutive effect of those
securities is not considered in the calculation of EPS amounts for those
periods.
NOTE 3 INVESTMENTS
Investment Activity. A summary of investment transactions is presented
below.
<TABLE>
<CAPTION>
Six Months Ended June 30
--------------------------------
1998 1997
------ ------
(In thousands)
<S> <C> <C>
Purchases:
Fixed maturities $1,145,945 1,878,844
Equities 820,247 721,728
Real estate 36,124 75,187
Mortgage loans 112,454 94,747
Venture capital 85,702 57,222
Other investments 87,600 59,474
------------ ------------
Total purchases 2,288,072 2,887,202
------------ ------------
Proceeds from sales and maturities:
Fixed maturities:
Sales 241,138 1,083,017
Maturities and redemptions 988,904 592,785
Equities 915,194 683,907
Venture capital 42,825 180,973
Real estate 120,306 154,995
Mortgage loans 52,832 12,191
Other investments 71,868 49,772
------------ ------------
Total sales and maturities 2,433,067 2,757,640
------------ ------------
Net purchases (sales) ($144,995) 129,562
------------ ------------
------------ ------------
</TABLE>
<PAGE>
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated
Financial Statements,
Continued
Change in Unrealized Appreciation. The increase (decrease) in unrealized
appreciation recorded in common shareholders' equity was as follows:
<TABLE>
<CAPTION>
Six Months Ended Twelve Months Ended
June 30, 1998 December 31, 1997
----------------- -----------------
(In thousands)
<S> <C> <C>
Fixed maturities $33,231 399,832
Equities 12,039 61,969
Venture capital 11,541 (154,826)
Life deferred policy acquisition
costs and policy benefits (27,798) (50,692)
----------- -----------
Total change in pretax
unrealized appreciation 29,013 256,283
Change in deferred taxes (8,489) (89,853)
----------- -----------
Total change in unrealized
appreciation, net of taxes $20,524 166,430
----------- -----------
----------- -----------
</TABLE>
NOTE 4 INCOME TAXES
The components of income tax expense (benefit) on continuing operations are as
follows:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30 June 30
-------------------------- --------------------------
1998 1997 1998 1997
------ ------ ------ ------
(In thousands)
<S> <C> <C> <C> <C>
Federal current tax expense (benefit) $ (7,025) 102,451 44,468 186,285
Federal deferred tax benefit (134,670) (6,690) (139,945) (24,578)
--------- --------- --------- ---------
Total federal income tax
expense (benefit) (141,695) 95,761 (95,477) 161,707
Foreign income taxes 3,484 4,723 10,382 9,329
State income taxes 1,487 1,494 4,020 3,017
--------- --------- --------- ---------
Total income tax expense
(benefit) on continuing operations $(136,724) 101,978 (81,075) 174,053
--------- --------- --------- ---------
--------- --------- --------- ---------
</TABLE>
<PAGE>
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated
Financial Statements,
Continued
NOTE 5 CONTINGENT LIABILITIES
In the ordinary course of conducting business, the company and some of its
subsidiaries have been named as defendants in various lawsuits. Some of these
lawsuits attempt to establish liability under insurance contracts issued by
those companies. Plaintiffs in these lawsuits are asking for money damages or to
have the court direct the activities of The St. Paul's operations in certain
ways. Although it is possible that the settlement of a contingency may be
material to the company's results of operations and liquidity in the period in
which the settlement occurs, the company believes that the total amounts that it
or its subsidiaries will ultimately have to pay in all of these lawsuits will
have no material effect on its overall financial position.
In some cases, plaintiffs seek to establish coverage for their liability under
environmental protection laws. See "Environmental and Asbestos Claims" in
Management's Discussion and Analysis for information on these claims.
NOTE 6 DEBT
Debt consists of the following:
<TABLE>
<CAPTION>
June 30, December 31,
1998 1997
----------------------- -------------------------
Book Fair Book Fair
Value Value Value Value
------ ------ ------ ------
(In thousands)
<S> <C> <C> <C> <C>
Medium-term notes $511,917 531,400 511,920 529,000
Commercial paper 203,963 203,963 168,429 168,429
8 3/8% senior notes 149,650 159,000 149,592 159,060
Zero coupon convertible notes 108,645 126,500 106,838 122,307
7 1/8% senior notes 79,836 83,700 79,824 82,680
Real estate mortgages 19,884 20,100 19,900 20,491
Nuveen debt 2,000 2,000 84,500 84,600
7% senior notes - - 145,225 145,744
Credit facility - - 35,000 35,000
Guaranteed ESOP debt - - 2,780 2,800
---------- ---------- ---------- ----------
Total debt $1,075,895 1,126,663 1,304,008 1,350,111
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
</TABLE>
<PAGE>
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated
Financial Statements,
Continued
NOTE 7 SEGMENT INFORMATION
In connection with the merger with USF&G, The St. Paul performed a
reassessment of its reportable segments in accordance with SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information." Based
on the merged organizational structure and related operating segment manager
responsibilities, The St. Paul has redefined its reportable segments as
follows:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30 June 30
----------------------- -------------------------
1998 1997 1998 1997
------ ------ ------ ------
(In thousands)
<S> <C> <C> <C> <C>
REVENUES FROM CONTINUING OPERATIONS
Property-Liability Insurance:
Worldwide Insurance Operations $1,463,105 1,490,811 2,919,826 2,987,091
Reinsurance 263,071 339,336 563,657 656,574
------------- ------------ ------------- ------------
Total premiums earned 1,726,176 1,830,147 3,483,483 3,643,665
Net investment income 331,130 326,827 662,893 657,334
Realized investment gains 132,486 168,980 179,976 262,943
Other 15,726 11,523 34,452 25,241
------------- ------------- ------------- ------------
Total property-liability insurance 2,205,518 2,337,477 4,360,804 4,589,183
------------- ------------- ------------- ------------
Life insurance 94,094 86,247 183,959 170,865
------------- ------------- ------------- ------------
Asset management-investment banking 76,344 60,279 148,813 121,401
------------- ------------- ------------- ------------
Total reportable segments 2,375,956 2,484,003 4,693,576 4,881,449
Parent company and eliminations 3,725 9,099 10,297 13,904
------------- ------------- ------------- ------------
Total revenues $2,379,681 2,493,102 4,703,873 4,895,353
------------- ------------- ------------- ------------
------------- ------------- ------------- ------------
</TABLE>
<PAGE>
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated
Financial Statements,
Continued
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30 June 30
----------------------- -------------------------
1998 1997 1998 1997
------ ------ ------ ------
(In thousands)
<S> <C> <C> <C> <C>
INCOME (LOSS) FROM CONTINUING
OPERATIONS BEFORE INCOME TAXES
Property-Liability Insurance:
Worldwide Insurance Operations $(503,682) (64,398) (611,895) (149,463)
Reinsurance 1,867 (1,053) 16,079 1,944
------------- ------------ ------------ ------------
Total GAAP underwriting result (501,815) (65,451) (595,816) (147,519)
Net investment income 331,130 326,827 662,893 657,334
Realized investment gains 132,486 168,980 179,976 262,943
Other (195,350) (23,226) (224,125) (44,763)
------------- ------------- ------------- -------------
Total property-liability insurance (233,549) 407,130 22,928 727,995
------------- ------------- ------------ -------------
Life insurance (32,755) 12,333 (13,737) 25,288
------------- ------------- ------------ -------------
Asset management-investment banking:
Pretax income before minority interest 33,077 28,866 64,527 58,060
Minority interest (7,984) (7,436) (15,817) (13,926)
------------- ------------- ------------- -------------
Total asset management-
investment banking 25,093 21,430 48,710 44,134
------------- ------------- ------------- -------------
Total reportable segments (241,211) 440,893 57,901 797,417
Parent company and eliminations (169,316) (49,973) (218,101) (97,254)
------------- ------------- ------------- -------------
Total income (loss) from continuing
operations before income taxes $ (410,527) 390,920 (160,200) 700,163
------------- ------------- ------------- -------------
------------- ------------- ------------- -------------
</TABLE>
The St. Paul recorded a $291.6 million pretax charge in the second quarter of
1998 related to its merger with USF&G (see Note 8). The charge was recorded in
the following captions of the "Income (Loss) from Continuing Operations Before
Income Taxes" section of the foregoing segment table: $142.4 million in
property-liability insurance - other; $14.1 million in property-liability
insurance - realized gains; $9.4 million in life insurance; and $125.7 million
in parent company and eliminations.
The St. Paul also recorded a $250.0 million pretax charge to increase its loss
reserves in the second quarter of 1998 to reflect the application of The St.
Paul's loss reserving policies to USF&G's loss and loss adjustment expense
reserves subsequent to the merger. The charge is included in the Worldwide
Insurance Operations GAAP underwriting result caption in the foregoing table. In
addition, The St. Paul recorded a $41.0 million pretax charge to write down the
carrying value of its life insurance operation's deferred policy acquisition
costs, which is reflected in the life insurance caption of the above table. See
Note 9 for further discussion of these charges.
<PAGE>
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated
Financial Statements,
Continued
NOTE 8 MERGER WITH USF&G CORPORATION
On April 24, 1998, The St. Paul issued 66,468,572 of its common shares (as
adjusted for the May 6, 1998 two-for-one stock split) in exchange for all of the
outstanding common stock of USF&G Corporation, a holding company for
property-liability and life insurance operations. The transaction was valued at
approximately $3.7 billion, which included the assumption of USF&G's debt and
capital securities. This business combination has been accounted for as a
pooling of interests; accordingly, the consolidated unaudited financial
statements for periods prior to the combination have been restated to include
the accounts and results of operations of USF&G Corporation. There were no
material intercompany transactions between The St. Paul and USF&G prior to the
merger.
The following summarizes the results of operations previously reported by The
St. Paul and USF&G, and the combined amounts included in the accompanying
consolidated financial statements.
<TABLE>
<CAPTION>
Three Months Three Months Six Months
Ended Ended Ended
March 31, 1998 June 30, 1997 June 30, 1997
---------------- --------------- ---------------
(In thousands)
<S> <C> <C> <C>
Total Revenues:
The St. Paul Companies, Inc. $1,467,157 1,620,711 3,177,914
USF&G Corporation 857,035 872,391 1,717,439
------------ ------------ ------------
Combined $2,324,192 2,493,102 4,895,353
------------ ------------ ------------
------------ ------------ ------------
Net Income:
The St. Paul Companies, Inc. $154,000 230,524 355,073
USF&G Corporation 38,113 47,416 92,403
------------ ------------ ------------
Combined 192,113 277,940 447,476
Conforming accounting
adjustment, net of taxes 2,565 11,002 10,884
------------ ------------ ------------
Net income included in
accompanying financial
statements $194,678 288,942 458,360
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
<PAGE>
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Prior to the merger, USF&G discounted all of its workers' compensation reserves
to present value, whereas The St. Paul did not discount any of its loss
reserves. Subsequent to the merger, The St. Paul and USF&G on a combined basis
discount only tabular workers' compensation reserves using an interest rate of
up to 3.5%, a rate which is allowed by all of the states in which The St. Paul
is domiciled. These reserves have an ultimate cost and payment pattern that are
fixed and determinable, and accordingly, may be discounted in accordance with
Staff Accounting Bulletin No. 62, "Discounting by Property-Casualty Insurance
Companies." The St. Paul has determined that the discounting of such reserves is
the preferable accounting treatment in the circumstances because discounting
these reserves more closely matches revenue and expense and more reasonably
portrays the economic impact of the time value of money related to these
reserves. The conforming accounting adjustment in the preceding table represents
the net reduction in insurance losses and loss adjustment expenses to conform
the discounting policies of the two companies with regard to these reserves. The
conforming accounting adjustment resulted in a net decrease of $94 million and
$95 million in the net assets of the combined organization as of June 30, 1998
and Dec. 31, 1997, respectively.
The St. Paul recorded a pretax charge to earnings of $291.6 million ($221.0
million after-tax) in the second quarter related to the merger, primarily
consisting of severance and other employee-related costs, facilities exit costs,
asset impairments and transaction costs. The St. Paul estimates that
approximately 2,000 positions will be eliminated due to the combination of the
two organizations, resulting from efficiencies to be realized by the larger
organization and the elimination of redundant functions. All levels of
employees, from technical staff to senior management, will be affected by the
reductions. The number of positions expected to be reduced by function include
approximately 950 in The St. Paul's property-liability underwriting operation,
350 in claims and 700 in finance and other administrative positions. The
reductions will occur throughout the United States. Through June 30, 1998,
approximately 500 positions had been eliminated, and the cost of termination
benefits paid was $16.7 million. The St. Paul expects to realize annualized
pretax expense savings of approximately $200 million as a result of its plan to
merge the two organizations, primarily due to a reduction in employee salaries
and benefits.
The merger-related charge was determined in accordance with Emerging Issues Task
Force (EITF) Issue No 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity," Statement of
Financial Accounting Standards (SFAS) No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," SFAS No. 5,
"Accounting for Contingencies," and Accounting Principles Board Opinion No. 16,
"Business Combinations."
<PAGE>
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
The following table provides information about the components of the charge
taken in the second quarter, payments made and the balance of accrued amounts
remaining at June 30, 1998.
<TABLE>
<CAPTION>
(in thousands)
Pre-tax
CHARGES TO EARNINGS: Charge
------------
<S> <C>
USF&G corporate headquarters $36,400
Long-lived assets 22,835
Software depreciation acceleration 9,678
Computer leases and equipment 9,600
Other equipment and furniture 7,700
-----------
Subtotal 86,213
-----------
</TABLE>
ACCRUED CHARGES SUBJECT TO ROLLFORWARD:
<TABLE>
<CAPTION>
Reserve at
Pre-tax June 30,
Charge Payments 1998
------------ ------------- -------------
<S> <C> <C> <C>
Executive severance 89,352 $(14,377) $ 74,975
Other severance 52,200 (2,296) 49,904
Branch lease exit costs 34,150 - 34,150
Transaction costs 29,676 (29,316) 360
------------ ------------- ------------
Accruals subject to rollforward 205,378 (45,989) 159,389
------------ ------------- ------------
Total $291,591 $159,389
============ ============
</TABLE>
On The St. Paul's Consolidated Statement of Operations, $268.8 million of the
merger-related charge was recorded in the "Operating and administrative"
expense caption and $22.8 million was recorded in the "Realized investment
gains" revenue caption.
The following discussion provides more information regarding the rationale
for and calculation of each component of the second-quarter merger-related
charge:
USF&G CORPORATE HEADQUARTERS
The Founders Building had been one of USF&G's headquarters buildings in
Baltimore, MD. Upon consummation of the merger, it was determined that the
headquarters for the combined entity would reside in St. Paul, MN, and that a
significant number of personnel working in Baltimore would be terminated,
thus vacating a significant portion of the Founders Building. The St. Paul
developed a plan to lease that space to outside parties and thus categorized
it as an "asset to be held or used" as defined in SFAS No. 121 for purposes
of evaluating the potential impairment of its $64 million carrying value.
That evaluation, based on the anticipated undiscounted future cash flows from
potential lessees, indicated that an impairment in the carrying value had
occurred, and the building was written down by $36 million to its fair value
of $28 million. The writedown is reflected in "Parent company and
eliminations" results. The building continues to be depreciated over its
estimated remaining useful life.
<PAGE>
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
LONG-LIVED ASSETS
Upon consummation of the merger, The St. Paul determined that several of
USF&G's real estate investments were not consistent with The St. Paul's real
estate investment strategy. A plan was developed to sell a number of
apartment buildings and various other miscellaneous holdings, with an
expected disposal date in 1999. In applying the provisions of SFAS No. 121,
it was determined that four of these miscellaneous investments should be
written down to fair value, based on The St. Paul's plan to sell them. Fair
value was determined based on a discounted cash flow analysis, or based on
market prices for similar assets. The impairment writedown is reflected in
the Consolidated Statement of Operations in the "Realized investment gains"
revenue caption. The four investments are as follows:
<TABLE>
<S> <C>
1) Description of investment: Percentage rents retained after sale
of a portfolio of stores to
a third party
Carrying amount: $21.6 million prior to writedown of
$16.6 million, for current
amount of $5.0 million
2) Description of investment: 138-acre land parcel in New Jersey,
with farm buildings being rented out
Carrying amount: $4.9 million prior to write-down of
$2.1 million, for current
amount of $2.8 million
3) Description of investment: Receivable representing cash flow
guarantee payments related to real
estate partnerships.
Carrying amount: $4.8 million prior to writedown of
$1.7 million, for a balance
of $3.1 million.
4) Description of investment: Limited partnership interests in
three citrus groves
Carrying amount: $7.4 million prior to writedown of
$2.4 million, for current
amount of $5.0 million
</TABLE>
These writedowns are reflected in the following operations: $14.1 million in
property-liability investment operations; $6.2 million in parent company and
eliminations; and $2.5 million in life insurance.
ACCELERATION OF SOFTWARE DEPRECIATION
The St. Paul conducted an extensive technology study upon consummation of the
merger as part of the business plan to merge the two companies. The resulting
strategy to standardize technology throughout the combined entity and
maintain one data center in St. Paul, MN, resulted in the identification of
duplicate software applications. As a result, the estimated useful life for
that software was shortened, resulting in an additional charge to earnings.
<PAGE>
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
COMPUTER LEASES AND EQUIPMENT
The technology study also identified redundant computer hardware, resulted in
lease buy-out transactions and disposals of computer equipment.
OTHER EQUIPMENT AND FURNITURE
The decision to combine all corporate headquarters in St. Paul, MN created
excess equipment and furniture in Baltimore, MD. The charge was calculated based
on the book value of assets at that location.
EXECUTIVE SEVERANCE
Represents the obligations The St. Paul will be required to pay in accordance
with the USF&G Senior Executive Severance Plan in place at the time of the
merger. The plan provides for payments to participants in the event the
participant is terminated without cause by the company or for good reason by
the participant within two years of the effective date of a transaction
covered by the plan.
OTHER SEVERANCE
Represents severance and related benefits such as out-placement counseling,
vacation buy-out and medical coverage to be paid to terminated employees not
covered under the USF&G Senior Executive Severance Plan.
BRANCH LEASE EXIT COSTS
As a result of the merger, excess space will be created in several locations
due to the anticipated staff reduction in the combined organization. The
charge for branch lease exit costs was calculated by determining the
percentage of anticipated excess space at each site and the current lease
costs over the remaining lease period. In certain locations, the lease is
expected to be terminated. For leases not expected to be terminated, the
amount of expense included in the charge was calculated as the percentage of
excess space (20% to 100%) times the net of: remaining rental payments plus
capitalized leasehold improvements less actual sub-lease income. No amounts
were discounted to present value in the calculation.
TRANSACTION COSTS
This amount consists of registration fees, costs of furnishing information
to stockholders, consultant fees, investment banker fees, and legal and
accounting fees.
<PAGE>
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
NOTE 9 CHARGES TO INCREASE LOSS RESERVES AND REDUCE THE CARRYING VALUE OF LIFE
INSURANCE DEFERRED ACQUISITION COSTS
In the second quarter, The St. Paul recorded pretax loss and loss adjustment
expenses of $250.0 million to reflect the application of The St. Paul's loss
reserving policies to USF&G's loss and loss adjustment expense reserves
subsequent to the merger. Prior to the merger, both companies, in accordance
with generally accepted accounting principles, recorded their best estimate
of reserves within a range of estimates bounded by a high point and a low
point.
Subsequent to the consummation of the merger in April 1998, The St. Paul
obtained the raw data underlying, and documentation supporting, USF&G's
December 31, 1997 reserve analysis. The St. Paul's actuaries reviewed such
information and concurred with the reasonableness of USF&G's range of
estimates for their reserves. However, applying their judgment and
interpretation to the range, The St. Paul's actuaries, who would be
responsible for setting reserve amounts for the combined entity, concluded
that strengthening the reserves would be appropriate, resulting in the $250
million adjustment. The adjustment was allocated to the following
underwriting business centers: General Commercial ($120 million); Specialized
Commercial ($95 million); and Personal Insurance ($35 million).
Also in the second quarter, The St. Paul recorded a $41.0 million pretax
charge to reflect a writedown in the carrying value of deferred policy
acquisition costs (DPAC) in its life insurance segment. The writedown related
to universal life-type and investment-type contracts which are subject to the
guidance in SFAS No. 97, "Accounting and Reporting by Insurance Enterprises
for Certain Long-Duration Contracts and for Realized Gains and Losses from
the Sale of Investments." According to SFAS No. 97, amortization of DPAC is
based on the present value of estimated gross profits expected to be realized
over the life of the contract. Estimates of expected gross profits used as a
basis for amortization are evaluated regularly and the total amortization to
date should be adjusted if actual experience or other evidence suggests that
earlier estimates should be revised.
The $41.0 million DPAC charge had three components. First, the persistency of
certain in-force business, particularly universal life and flexible premium
annuities, sold through some USF&G distribution channels, had begun to
deteriorate after the USF&G merger announcement. To mitigate this, management
decided, in the second quarter, to increase credited rates on certain
universal life business. This change lowered the estimated future profits on
this business, which, as required under SFAS No. 97, triggered $19.1 million
in accelerated DPAC amortization. Second, the low interest rate environment
during the first half of 1998 led to assumption changes as to the future
"spread" on certain interest sensitive products, lowering gross profit
expectations and triggering a $15.6 million DPAC charge. The remaining $6.3
million charge resulted from a change in annuitization assumptions for
certain tax-sheltered annuity products.
<PAGE>
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
NOTE 10 2-FOR-1 COMMON STOCK SPLIT
The St. Paul's Restated Articles of Incorporation were amended after the vote
of shareholders at the 1998 Annual Meeting of Shareholders on May 5, 1998, to
increase the authorized common shares of the company from 240 million to 480
million. Subsequent to this action, The St. Paul's board of directors
approved a 2-for-1 common stock split. One additional share of common stock
for each outstanding share was issued on May 11, 1998, to shareholders of
record on May 6, 1998.
NOTE 11 DISCONTINUED OPERATIONS
In May 1997, The St. Paul completed the sale of its brokerage operation,
Minet, to Aon Corporation. The St. Paul's gross proceeds from the sale were
approximately equal to its remaining carrying value of Minet. In connection
with the transaction, The St. Paul agreed to indemnify Aon against most
preclosing liabilities of the Minet businesses. The company recorded a net
after-tax loss on disposal of $67.8 million in the first quarter of 1997,
which resulted primarily from The St. Paul's agreement to be responsible for
certain severance, employee benefits, future lease commitments and other
costs relating to Minet.
<PAGE>
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial
Condition and Results of Operations
June 30, 1998
CONSOLIDATED RESULTS
ON APRIL 24, 1998, THE ST. PAUL COMPANIES, INC. (THE ST. PAUL) COMPLETED ITS
MERGER WITH USF&G CORPORATION (USF&G) IN A TAX-FREE EXCHANGE OF STOCK ACCOUNTED
FOR AS A POOLING-OF-INTERESTS. THE COMBINED ORGANIZATION OPERATES UNDER THE ST.
PAUL NAME AND IS HEADQUARTERED IN ST. PAUL, MINN. THE FOLLOWING DISCUSSION IS
BASED ON THE COMBINED RESULTS OF THE ST. PAUL AND USF&G FOR ALL PERIODS
PRESENTED.
The St. Paul incurred a pretax loss from continuing operations of $411 million
in the second quarter of 1998, driven by a pretax charge of $292 million
relating to its merger with USF&G and other charges, totaling $291 million,
relating to property-liability loss reserve strengthening to reflect the
application of The St. Paul's loss reserving policies to USF&G's loss and loss
adjustment expense reserves subsequent to the merger, and the writedown of
deferred policy acquisition expenses in the life insurance segment. Excluding
these charges, The St. Paul's second quarter pretax earnings totaled $172
million in 1998, down from comparable pretax earnings from continuing operations
of $391 million in the same 1997 period. The decline from 1997 primarily
resulted from a significant increase in catastrophe losses and deteriorating
loss experience in several sectors of The St. Paul's property-liability
insurance operations.
The following table summarizes The St. Paul's results for the second quarter and
year-to-date.
<TABLE>
<CAPTION>
Three Months Six Months
Ended June 30 Ended June 30
------------- -------------
(in millions)
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Pretax income (loss):
Property-liability insurance:
GAAP underwriting result $(502) (65) (596) (148)
Net investment income 331 327 663 657
Realized investment gains 132 169 180 263
Other (195) (24) (224) (44)
---- --- ---- ---
Total property-liability insurance (234) 407 23 728
Life insurance (33) 12 (14) 25
Asset management-investment banking 25 21 49 44
Parent and other (169) (49) (218) (97)
--- --- ---- ---
Income (loss) from continuing
operations before income taxes (411) 391 (160) 700
Income tax expense (benefit) (137) 102 (81) 174
----- ---- ---- -----
Income (loss) from
continuing operations (274) 289 (79) 526
Loss from discontinued
operations, net of taxes - - - (68)
----- ----- ----- -----
Net income (loss) $(274) 289 (79) 458
----- ----- ----- -----
----- ----- ----- -----
Diluted net income (loss)
per common share $(1.18) 1.15 (0.36) 1.82
----- ----- ----- -----
----- ----- ----- -----
</TABLE>
<PAGE>
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
CONSOLIDATED RESULTS
CONSOLIDATED REVENUES
<TABLE>
<CAPTION>
Three Months Six Months
Ended June 30 Ended June 30
------------------ -------------------
(in millions) 1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Earned premiums $1,752 1,856 3,534 3,697
Net investment income 398 390 795 780
Realized investment gains 136 171 185 267
Asset management-investment banking 75 60 146 118
Other 19 16 44 33
------- ------- ------- -------
Total revenues $2,380 2,493 4,704 4,895
------- ------- ------- -------
------- ------- ------- -------
</TABLE>
Premiums earned in The St. Paul's insurance operations for the second quarter
and first half of 1998 declined 6% and 4%, respectively, compared with same
periods of 1997. The reduction was centered in the General Commercial business
center of The St. Paul's property-liability operations, where intensely
competitive market conditions over the last 12 months have negatively impacted
business volume and pricing. Life insurance premiums earned were level with the
second quarter of 1997 and down $3 million for the first half of the year.
Realized investment gains for the second quarter and first half of 1998 declined
from gains in the same periods of last year; however, the 1997 totals were
unusually large due to the sale of one venture capital investment in the second
quarter which generated a $129 million gain.
MERGER-RELATED CHARGE
As part of the integration plan to merge The St. Paul and USF&G operations,
management performed a comprehensive review of the operations of the separate
companies. The review identified redundant job functions, staffing levels,
geographical locations, leased space and technology platforms. To address
these redundancies and implement its plan of integration, The St. Paul
recorded a $292 million pretax merger-related charge in the second quarter,
composed of the following components:
- $141 million of severance and other employee-related costs, representing
$89 million to be paid under the USF&G Senior Executive Severance Plan in
effect at the time of the merger, and $52 million of other severance and
related benefits, such as out-placement counseling, vacation buy-out and
medical coverage, for terminated employees not covered under the Senior
Executive Severance Plan. The St. Paul estimates that approximately 2,000
positions will be eliminated (the majority by the end of 1999) due to the
combination of the two organizations, resulting from efficiencies to be
realized by the larger organization and the elimination of redundant
functions. All levels of employees, from technical staff to senior
management, will be affected by the reductions. The total number of
positions expected to be reduced by function include approximately 950 in
the property-liability underwriting operations, 350 in claim and 700 in
finance and other administrative positions. Through June 30, 1998,
approximately 500 positions had been eliminated, and $17 million in
severance and other employee-related costs had been paid.
<PAGE>
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
CONSOLIDATED RESULTS
- $70 million of facilities exit costs, consisting of a $36 million
writedown in the carrying value of a former USF&G headquarters building
in Baltimore, MD and $34 million of expenses related to the consolidation
of redundant branch office locations. The St. Paul determined that the
merger would result in excess space at the Baltimore headquarters
location, and developed a plan to lease that space to outside parties.
Based on an analysis of potential future undiscounted cash flows, The St.
Paul determined that an impairment in the carrying value had occurred and
recorded the $36 million writedown to its estimated fair value.
For certain redundant branch office locations, the lease is expected to
be terminated. For leases not expected to be terminated, the amount of
expense recorded in the second quarter charge was calculated as the
percent of excess space (20% to 100%) times the net of: remaining rental
payments plus capitalized leasehold improvements less actual sub-lease
income. No amounts were discounted to present value in the calculation.
- $30 million of transaction costs, consisting of registration fees, costs
of furnishing information to stockholders, consultant fees, investment
banker fees, and legal and accounting fees.
- $23 million writedown of certain long-lived assets. The St. Paul
determined several of USF&G's real estate investments were not consistent
with The St. Paul's real estate investment strategy, and developed a plan
to sell them, with an expected disposal date in 1999. The St. Paul
determined that four of these investments should be written down to
estimated fair value. The fair value was calculated based on a discounted
cash flow analysis, or market prices for similar assets.
- $10 million of depreciation expense resulting from shortening the
estimated useful life of redundant software.
- $10 million of expense for writedowns and lease buy-outs of redundant
computer equipment.
- $8 million writedown in the carrying value of excess furniture and
equipment in Baltimore, MD created by the merger. The charge was
calculated based on the book value of assets at that location.
On The St. Paul's Consolidated Statement of Operations, $269 million of the
merger-related charge was recorded in the "Operating and administrative" expense
caption and $23 million was recorded in the "Realized investment gains" revenue
caption.
<PAGE>
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
CONSOLIDATED RESULTS
The integration of the two companies is expected to result in annual expense
savings of approximately $200 million, as measured against the combined 1997
pre-merger expenses of The St. Paul and USF&G. The expense savings will
primarily result from the reduction in employee salaries and benefits after the
elimination of redundant positions from the merged organization. No material
increases in other expenses are expected to offset these expense reductions.
However, the merger may result in the loss of business in the property-liability
underwriting business. The amount of business that may be lost is not reasonably
estimable, but it is not expected to materially affect the results of operations
in future periods. As merger-related costs are paid, it is expected to have a
short-term negative impact on operational cash flows.
<PAGE>
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
PROPERTY-LIABILITY INSURANCE
The following summarizes key financial results by property-liability
underwriting operation:
<TABLE>
<CAPTION>
% of Three Months Six Months
1998 Ended June 30 Ended June 30
Written ------------------ ------------------
($ in Millions) Premiums 1998 1997 1998 1997
- - -------------- -------- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Specialized Commercial:
Written Premiums 34% $589 587 1,157 1,146
Underwriting Result ($145) 19 (169) 26
Combined Ratio 127.2 98.7 117.3 99.8
General Commercial
Written Premiums 22% $358 459 746 923
Underwriting Result ($228) (49) (275) (97)
Combined Ratio 161.9 110.6 136.9 112.0
Personal Insurance:
Written Premiums 20% $358 293 692 603
Underwriting Result ($121) (19) (138) (56)
Combined Ratio ------- 135.2 104.3 120.0 107.9
----- ----- ----- -----
Total U.S. Underwriting:
Written Premiums 76% $1,305 1,339 2,595 2,672
Underwriting Result ($494) (49) (582) (127)
Combined Ratio 139.0 104.1 123.7 105.8
International Underwriting:
Written Premiums 7% $122 95 211 148
Underwriting Result ($10) (15) (30) (22)
Combined Ratio ------- 107.6 117.6 114.0 116.0
----- ----- ----- -----
Total Worldwide Insurance Operations:
Written Premiums 83% $1,427 1,434 2,806 2,820
Underwriting Result ($504) (64) (612) (149)
Combined Ratio 136.9 104.7 123.0 106.3
Reinsurance:
Written Premiums 17% $318 393 594 680
Underwriting Result $2 (1) 16 1
Combined Ratio ------- 95.5 96.7 95.9 97.6
---- ---- ---- -----
Total Property-Liability Underwriting:
Written Premiums 100% $1,745 1,827 3,400 3,500
GAAP Underwriting Result ($502) (65) (596) (148)
Statutory Combined Ratio:
Loss and Loss Expense Ratio 96.3 72.2 84.2 72.6
Underwriting Expense Ratio 34.2 30.8 34.4 32.0
----- ----- ----- -----
Combined Ratio 130.5 103.0 118.6 104.6
===== ===== ===== =====
</TABLE>
<PAGE>
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
PROPERTY-LIABILITY INSURANCE
OVERVIEW
The table on the preceding page reflects the impact of a $250 million pretax
provision for losses and loss adjustment expenses recorded in the second quarter
to apply The St. Paul's reserving policies to USF&G's loss reserves subsequent
to the consummation of the merger (the "USF&G loss reserve provision").
Prior to the merger, both companies, in accordance with generally accepted
accounting principles, recorded their best estimate of reserves within a
range of estimates bounded by a high point and a low point. Subsequent to the
consummation of the merger in April 1998, The St. Paul obtained the raw data
underlying, and documentation supporting, USF&G's December 31, 1997 reserve
analysis. The St. Paul's actuaries reviewed such information and concurred
with the reasonableness of USF&G's range of estimates for their reserves.
However, applying their judgment and interpretation to the range, The St.
Paul's actuaries, who would be responsible for setting reserve amounts for
the combined entity, concluded that strengthening the reserves would be
appropriate, resulting in the $250 million adjustment. The adjustment was
allocated to the following business centers in the foregoing table: General
Commercial - $120 million; Specialized Commercial - $95 million; and Personal
Insurance - $35 million.
The following table isolates the impact of catastrophe losses on The St. Paul's
GAAP underwriting results.
<TABLE>
<CAPTION>
Three Months Six Months
Ended June 30 Ended June 30
----------------- ------------------
($ in millions) 1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
GAAP underwriting result ($502) (65) (596) (148)
Statutory combined ratio 130.5 103.0 118.6 104.6
Pretax catastrophe losses $157 70 208 84
Impact on combined ratio 9.1 3.8 6.0 2.3
------ ------ ------ ------
Excluding catastrophes:
GAAP underwriting result ($345) 5 (388) (64)
Statutory combined ratio 121.4 99.2 112.6 102.3
------ ------ ------ ------
------ ------ ------ ------
</TABLE>
The USF&G loss reserve provision accounted for 14.5 and 7.2 points of the
combined ratio for the three months and six months ended June 30, 1998,
respectively. Pretax catastrophe losses of $157 million in the second quarter
resulted from severe storms in the Midwest and Southeast. Several of these
storms occurred in Minnesota, where The St. Paul has a heavy concentration of
business, and in Tennessee, which was one of USF&G's largest markets. The
deterioration in underwriting results excluding the USF&G loss reserve
provision and catastrophes was primarily due to intensely competitive
conditions in several market sectors, particularly the small to midsized
commercial market.
The consolidated expense ratio of 34.2 for the second quarter was negatively
impacted by an increase in commission expenses resulting from efforts to
retain USF&G business during the integration of The St. Paul and USF&G into
one organization.
<PAGE>
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
PROPERTY-LIABILITY INSURANCE
UNDERWRITING RESULTS BY BUSINESS CENTER
SPECIALIZED COMMERCIAL
Written premiums in this business center totaled $589 million in the second
quarter, virtually level with comparable 1997 premiums of $587 million. The
St. Paul's Medical Services operation, which is now included in this business
center, recorded premiums of $85 million for the quarter, down 5% from last
year's second quarter total of $89 million. Medical Services posted a second
quarter underwriting loss of $26 million, compared with a profit of $5
million in the same period of 1997. On a year-to-date basis, Medical
Services' premium volume of $181 million was down 3%, and underwriting
results were $62 million worse than 1997. Accelerating loss costs and a
continuing competitive market environment which has negatively impacted
pricing accounted for the deterioration in Medical Services' results. During
the second quarter, The St. Paul began implementing price increases of 3% to
5% on selected physicians and surgeons' policy renewals.
The remainder of the Specialized Commercial business center posted slight
premium growth over the second quarter and first six months of 1997.
Underwriting results, however, were significantly worse than the second
quarter and first half of 1997, primarily due to $95 million of the USF&G
loss reserve provision, an increase in catastrophe losses and adverse loss
development on prior years' business. The St. Paul's Surety underwriting
operation, which is now the largest in the United States as a result of the
USF&G merger, posted strong growth in net premium volume and a $19 million
underwriting profit for the quarter.
GENERAL COMMERCIAL
Premium volume in this business center declined 22% for the quarter and 19%
for the first half of the year. Prices continue to decline in this market,
reflecting the continuing intense competition for small to midsized
commercial business. The St. Paul does not anticipate that the pricing
environment will improve during the remainder of 1998. The second quarter
underwriting loss of $228 million was severely impacted by $120 million of
the USF&G loss reserve provision, catastrophe losses of $48 million, and a
general deterioration in noncatastrophe prior year loss development across
the book of business. The expense ratio for the quarter of 39.6 was over four
points worse than last year's second quarter, due to the sharp decline in
premium volume, initial merger-related expenses and higher commission
expenses. The expense ratio is expected to improve going forward as
integration efficiencies are realized. On a year-to-date basis, the
underwriting loss of $275 million was $178 million worse than 1997, with the
USF&G loss reserve provision and catastrophe losses of $64 million playing a
large role in the deterioration. Catastrophe losses in the first half of 1997
totaled $19 million.
PERSONAL INSURANCE
Second quarter and year-to-date written premium volume grew 22% and 15%,
respectively, over the same periods of 1997. The majority of the increase in
1998 was due to The St. Paul's acquisition in December 1997 of Titan
Holdings, Inc., a property-liability company which has a substantial book of
nonstandard automobile business. The Personal Insurance business center's
underwriting loss of $121 million for the second quarter was severely
impacted by catastrophe losses of $78 million. For the first half of 1998,
catastrophe losses accounted for $86 million of
<PAGE>
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
PROPERTY-LIABILITY INSURANCE
the underwriting loss of $138 million. Personal Insurance results for the
second quarter and first half of 1998 included $35 million of the USF&G loss
reserve provision. Two May storms in Minnesota resulted in over 11,000
claims, accounting for nearly $50 million of this operation's catastrophe
total.
The nonstandard auto business center, a market in which The St. Paul had
virtually no presence prior to the merger with USF&G, provides automobile
coverage for individuals who are unable to obtain standard coverage due to
their inability to meet certain underwriting criteria. Premiums generated by
this business center totaled $61 million in the second quarter of 1998,
compared with $20 million in the same period of 1997. The core underwriting
profit for the quarter was $1 million, compared with a loss of $1 million in
1997's second quarter.
INTERNATIONAL
The International business center posted premium growth of 29% for the second
quarter and 42% for the first half of 1998, when compared to the same periods
of 1997. New business in Europe, including business generated through The St.
Paul's involvement with Lloyd's of London, was the primary factor
contributing to premium growth in 1998. The Emerging Markets sector of the
International business center also provided premium growth over 1997, due to
new business in Botswana and South Africa. Underwriting results for the
second quarter improved $5 million over the same 1997 period, but
year-to-date results lag $8 million behind the first half of 1997 due to the
impact of severe ice storms in Canada during the first quarter.
REINSURANCE
St. Paul Re was augmented by the addition of F&G Re and Discover Re as a
result of the merger with USF&G. St. Paul Re and F&G Re underwrite both
treaty and facultative reinsurance for property, liability, ocean marine,
surety and certain specialty classes of business. Discover Re provides
products and services to the alternative risk transfer market, and provides
products for self-insured companies and insurance pools, as well as ceding to
and reinsuring captive insurers.
The Reinsurance business center's written premiums of $318 million in the
second quarter were down 19% from the same period of 1997. Premium volume of
$594 million through the first half of 1998 declined 13% from the first six
months of 1997. These sizable declines in 1998 reflect soft global market
conditions for this business center, resulting from excess capacity in
primary reinsurance markets which has reduced the demand for reinsurance
products worldwide.
Despite the premium shortfall from 1997, the Reinsurance business center
posted a year-to-date underwriting profit of $16 million, compared with a
profit of $1 million in the first half of 1997. The lack of catastrophe
losses and favorable loss development for prior underwriting years accounted
for 1998's strong performance. Year-to-date catastrophe losses totaled $5
million in 1998, compared with $7 million in 1997.
<PAGE>
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
PROPERTY-LIABILITY INSURANCE
INVESTMENT OPERATIONS
Pretax investment income in The St. Paul's property-liability operations for
the second quarter and first six months of 1998 was virtually level with the
same periods of 1997. The lack of written premium growth and an increase in
insurance losses paid in recent quarters have resulted in a decline in new
funds available for investment. In addition, market yields on new investments
have continued to decline during the first half of 1998. As a result,
investment income growth has been negligible for the last several quarters.
The merger with USF&G added fixed maturities investments of $5.3 billion (at
cost) to The St. Paul's property-liability operations. The combined fixed
maturities portfolio on June 30, 1998 of $17.1 billion had a market value on
that date of $17.9 billion. Approximately 95% of those investments were rated
at investment grade (BBB or above). The weighted average pretax yield on the
fixed maturities portfolio was 6.8% at June 30, 1998. The USF&G merger also
added lesser amounts of equities, real estate and other investments to The
St. Paul's property-liability operations.
Pretax realized investment gains totaled $133 million in the second quarter,
compared with gains of $169 million in last year's second quarter.
Year-to-date pretax gains in 1998 of $180 million were down from last year's
six-month gains of $263 million. Sales of equity security investments in
favorable market conditions accounted for the majority of 1998's gains. The
sale of a single venture capital investment generated pretax gains of $129
million in the second quarter of 1997.
ENVIRONMENTAL AND ASBESTOS CLAIMS
The St. Paul's property-liability underwriting operations continue to receive
claims alleging injuries from environmental pollution or alleging covered
property damages for the cost to clean up polluted sites. The company also
receives asbestos injury claims arising out of product liability coverages
under general liability policies. The vast majority of these claims arise
from policies written many years ago. The St. Paul's alleged liability for
both environmental and asbestos claims is complicated by significant legal
issues, primarily pertaining to the scope of coverage. In the company's
opinion, court decisions in certain jurisdictions have tended to broaden
insurance coverage beyond the intent of the original policies.
The company's 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 The St. Paul's 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.
<PAGE>
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
ENVIRONMENTAL AND ASBESTOS CLAIMS
Estimating the ultimate liability for asbestos claims is equally difficult.
The primary factors influencing the estimate of the total cost of these
claims are case law and a history of prior claims experience, both of which
are still developing.
The following table represents a reconciliation of total gross and net
environmental reserve development for the six months ended June 30, 1998, and
the years ended Dec. 31, 1997 and 1996. Amounts in the "net" column are
reduced by reinsurance recoverables.
<TABLE>
<CAPTION>
1998
ENVIRONMENTAL (six months) 1997 1996
---------- ---- ----
(in millions) Gross Net Gross Net Gross Net
----- --- ----- --- ----- ---
<S> <C> <C> <C> <C> <C> <C>
Beginning reserves $867 677 889 676 840 631
Reserves acquired - - - - 18 7
Incurred losses 13 15 44 58 87 92
Paid losses (34) (34) (66) (57) (56) (54)
--- --- --- --- --- ---
Ending reserves $846 658 867 677 889 676
--- --- --- --- --- ---
--- --- --- --- --- ---
</TABLE>
Many significant environmental claims currently being brought against
insurance companies arise out of contamination that occurred 20 to 30 years
ago. Since 1970, The St. Paul's 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 the six months ended June 30,
1998, and the years ended Dec. 31, 1997 and 1996:
<TABLE>
<CAPTION>
1998
ASBESTOS (six months) 1997 1996
---------- ---- ----
(in millions) Gross Net Gross Net Gross Net
----- --- ----- --- ----- ---
<S> <C> <C> <C> <C> <C> <C>
Beginning reserves $397 279 413 304 421 294
Reserves acquired - - - - 6 6
Incurred losses 5 3 22 (5) 18 25
Paid losses (12) (7) (38) (20) (32) (21)
--- --- --- --- --- ---
Ending reserves $390 275 397 279 413 304
--- --- --- --- --- ---
--- --- --- --- --- ---
</TABLE>
Most of the asbestos claims the company has received pertain to policies
written prior to 1986. Since 1986, for policies underwritten in the United
States, The St. Paul's commercial general liability policy has included the
industry standard absolute pollution exclusion, which the company believes
applies to asbestos claims.
<PAGE>
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
ENVIRONMENTAL AND ASBESTOS CLAIMS
The St. Paul's reserves for environmental and asbestos losses at June 30,
1998 represent its best estimate of its ultimate liability for such losses,
based on all information currently available. Because of the difficulty
inherent in estimating such losses, however, the company cannot give
assurances that its ultimate liability for environmental and asbestos losses
will, in fact, match current reserves. The company continues to evaluate new
information and developing loss patterns, but it believes any future
additional loss provisions for environmental and asbestos claims will not
materially impact its results of operations, liquidity or financial position.
Total gross environmental and asbestos reserves at June 30, 1998 of $1.24
billion represented approximately 7% of gross consolidated property-liability
reserves of $18.65 billion.
LIFE INSURANCE
The St. Paul's life insurance segment is comprised of Fidelity and Guaranty
Life Insurance Company and subsidiaries ("F&G Life"), acquired in the USF&G
merger. F&G Life underwrites traditional life insurance and annuities, which
are sold throughout the United States through independent agents, managing
general agents and specialty brokerage firms.
F&G Life's pretax loss in the second quarter of 1998 reflected a $41 million
charge to reflect a writedown of the carrying value of deferred policy
acquisition expenses (DPAC) relating to universal life-type and
investment-type contracts. According to generally accepted accounting
principles, DPAC amortization is based on the present value of estimated
gross profits expected to be realized over the life of the contract.
Estimates of expected gross profits used as a basis for amortization are
evaluated regularly and the total amortization to date should be adjusted if
actual experience or other evidences suggests that earlier estimates should
be revised.
The $41 million DPAC charge had three components. First, the persistency of
certain in-force business, particularly universal life and flexible premium
annuities, sold through some USF&G distribution channels, began to
deteriorate after the USF&G merger announcement in April 1998. To mitigate
this, management decided, in the second quarter, to increase credited rates
on certain universal life business. This change lowered the estimated future
profits on this business, which, as required under SFAS No. 97, triggered a
$19 million in accelerated DPAC amortization. Second, the low interest rate
environment during the first half of 1998 led to assumption changes as to the
future "spread" on certain interest sensitive products, lowering gross profit
expectations and triggering a $16 million DPAC charge. The remaining $6
million charge resulted from a change in annuitization assumptions for
certain tax-sheltered annuity products.
F&G Life also recorded a $9 million pretax merger-related charge in the
second quarter, primarily related to severance and facilities exit costs.
<PAGE>
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
LIFE INSURANCE
Highlights of F&G Life's financial performance for the second quarter and six
months of 1998 and 1997 were as follows:
<TABLE>
<CAPTION>
Three Months Six Months
Ended June 30 Ended June 30
------------------- --------------------
(in millions) 1998 1997 1998 1997
----- ----- ----- -----
<S> <C> <C> <C> <C>
Sales (annualized premiums) $71 121 151 235
Premiums earned $26 26 50 53
Policy surrenders $62 42 114 81
Net investment income $67 63 132 121
Pretax earnings (loss), including realized gains $(33) 12 (14) 25
</TABLE>
The decline in sales for the second quarter and first half of 1998 was
primarily due to the significantly lower level of interest rates and its
negative impact on fixed interest rate annuities. The demand for annuity
products is affected by fluctuating interest rates and the relative
attractiveness of alternative investment, annuity or insurance products. In
an effort to balance its portfolio of fixed interest rate annuity products,
F&G Life introduced an equity-indexed annuity in June 1998.
The decline in premiums earned for the first six months of 1998 was largely
due to a reduction in sales of structured settlement annuities, which are
sold primarily to property-liability insurers to settle insurance claims.
Sales of these annuities in the second quarter were adversely impacted by
disruptions caused by the merger with The St. Paul; however, sales are
expected to grow in the second half of 1998 as F&G Life expands these
products into The St. Paul's claim organization.
Deferred annuities and universal life products are subject to surrender by
policyholders. Nearly all of F&G Life's surrenderable annuity policies allow
a refund of the cash value balance less a surrender charge. Surrender
activity increased in 1998 due to an increase in the size and maturity of the
annuity book of business and from competition from alternative investments,
primarily equity-based products.
Net investment income grew in 1998 as a result of an increasing asset base
generated by positive cash flow. Despite the decline in premiums earned,
pretax results for the second quarter and six months of 1998 excluding the
DPAC charge and the merger-related charge were higher than the same periods
of 1997 due to improved investment spread management on annuity and universal
life products and strong expense controls.
Total life insurance in force at June 30, 1998 was $10.74 billion, compared
with $10.49 billion at June 30, 1997.
<PAGE>
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
ASSET MANAGEMENT-INVESTMENT BANKING
The St. Paul's portion of The John Nuveen Company's second quarter 1998
pretax earnings was $25 million, $4 million higher than the same period of
1997. For the first half of 1998, the company's portion of such earnings was
$49 million, compared with $44 million for the first half of 1997. The
company currently owns 77% of Nuveen.
Nuveen's asset management fee revenue of $67 million for the second quarter
was $16 million, or 32% higher than in the same period of 1997. The increase
was primarily due to Nuveen's acquisition of Rittenhouse Financial Services,
Inc., which manages individual equity and balanced accounts for affluent
investors, in September 1997. Year-to-date management fee revenues totaled
$132 million in 1998, compared with $102 million through the first six months
of 1997.
Nuveen's assets under management grew to $52.2 billion at June 30, 1998, an
increase of 5% since year-end 1997.
CAPITAL RESOURCES
The St. Paul's capitalization (debt, redeemable preferred securities and
equity) stood at $8.09 billion at June 30, 1998, down 4% from the year-end
1997 total of $8.41 billion. Common shareholders' equity declined by $94
million in the first half of 1998 as a result of the net loss incurred during
that period.
The merger with USF&G Corporation consummated in April 1998 was a tax-free
exchange of stock accounted for as a pooling of interests. The St. Paul
issued 66.5 million shares of its common stock in exchange for all of the
outstanding common stock of USF&G. The transaction was valued at
approximately $3.7 billion, which included the assumption of USF&G's debt and
capital securities.
Total debt outstanding at the end of June was $1.08 billion, a decline of
$228 million, or 17%, from the Dec. 31, 1997 total of $1.30 billion. The
reduction was driven by the maturity of $145 million of 7% senior notes in
May 1998, which was funded with a combination of internal funds and
commercial paper issuances. In addition, Nuveen's short-term debt outstanding
declined by $83 million from year-end 1997. Approximately 48% of The St.
Paul's debt outstanding at June 30, 1998 consisted of medium-term notes
bearing a weighted average rate of 7.1%. Commercial paper comprised 19% of
The St. Paul's total debt at the mid-point of 1998. Debt as a percentage of
total capitalization at June 30, 1998, was 13%, down from 15% at year-end
1997.
The St. Paul has no plans for major capital expenditures during the remainder
of 1998.
The company's year-to-date pretax loss from continuing operations was
inadequate to cover "fixed charges" by $160.2 million and "combined fixed
charges and preferred stock dividends" by $187.6 million. For the first six
months of 1997, the company's ratio of earnings to fixed charges was 12.05,
and the ratio of earnings to combined fixed charges and preferred stock
dividends was 8.81. Fixed charges consist of interest expense before
reduction for capitalized interest and one-third of rental expense, which is
considered to be representative of an interest factor.
<PAGE>
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
LIQUIDITY
Liquidity refers to the company's ability to generate sufficient funds to
meet the cash requirements of its business operations. Net cash used in
operations was $19 million in the first six months of 1998, compared with
cash provided by operations of $260 million in 1997. The significant decline
in operational cash flows compared with 1997 was the result of an increase in
insurance loss payments due to deteriorating loss experience and severe
catastrophes, a decline in property-liability written premiums, and expenses
paid relating to the merger with USF&G. Despite the negative operational cash
flows in the first half of 1998, The St. Paul's ability to meet its
short-term and long-term liquidity requirements remains intact due to the
high level of readily marketable investment securities in its portfolio which
generate strong levels of investment income, and the prospects for future
profitable growth afforded by the merger with USF&G.
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 the
two-digit year code of "00" to be recognized as the year 1900, instead of
2000. For several years, The St. Paul has been evaluating its financial and
operational computer systems to determine the impact of the "Year 2000" issue
on those systems. With the completion of the merger with USF&G Corporation,
The St. Paul has further evaluated USF&G's activities to become "Year 2000"
compliant. The St. Paul has developed and implemented plans to address the
required system modifications, and does not expect the financial impact of
making these modifications to be material to its results of operations, cash
flows or consolidated financial position.
The St. Paul is coordinating with financial institutions, vendors and other
entities with which it does business to identify and resolve any year 2000
issues.
The St. Paul also faces potential "Year 2000" claims stemming from coverages
offered in insurance policies it has sold to customers. In some instances,
coverage is not provided under the insurance policies, while in other
instances, coverage may be provided under certain circumstances. The company
continues to assess its exposure to insurance claims arising from those
coverages, and it is taking a number of actions to address that exposure,
including individual risk evaluation and classification of high hazard
exposures. Currently, The St. Paul believes that, although payments of such
claims could possibly have an adverse effect on its results of operations
and/or cash flows, they would not have a material adverse effect on its
consolidated financial position.
IMPACT OF ACCOUNTING PRONOUNCEMENTS TO BE ADOPTED IN THE FUTURE
In December 1997, the American Institute of Certified Public Accountants
issued Statement of Position (SOP) No. 97-3, "Accounting by Insurance and
Other Enterprises for Insurance-Related Assessments." The SOP provides
guidance for determining when a liability should be recognized for guaranty
fund and other insurance-related assessments and on the measurement of that
liability. It also provides guidance on when an asset should be recognized
for a portion or all
<PAGE>
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
IMPACT OF ACCOUNTING PRONOUNCEMENTS TO BE ADOPTED IN THE FUTURE
of the liability or paid assessment that can be recovered through premium tax
offsets of policy surcharges. The SOP is effective for fiscal years beginning
after December 31, 1998. The St. Paul currently intends to adopt the
provisions of the SOP in the first quarter of 1999. The cumulative effect of
adopting the SOP may be material to The St. Paul's results of operations in
the period it is adopted; however, The St. Paul cannot at this time
reasonably estimate the amount of that cumulative effect.
In February 1998, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 132, "Employers'
Disclosures about Pensions and Other Postretirement Benefits," which
standardizes the disclosure requirements for pensions and other
postretirement benefits to the extent practicable, requires additional
information on changes in benefits obligations and fair values of plan
assets, and eliminates certain disclosures currently required. SFAS No. 132
is effective for fiscal years beginning after December 15, 1997. The St. Paul
will adopt the provisions of SFAS No. 132 for its 1998 annual financial
statements. This adoption is not expected to materially change The St. Paul's
current pension and postretirement disclosures, and will have no impact on
net income in 1998 and succeeding years.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which establishes accounting and
reporting standards for derivative instruments and hedging activities. It
requires that an entity recognize all derivatives as either assets or
liabilities in the balance sheet, and measure those instruments at fair
value. SFAS No. 133 is effective for all quarters of fiscal years beginning
after June 15, 1999, and prohibits retroactive application to financial
statements of prior periods. The St. Paul currently intends to implement the
provisions of SFAS No. 133 in the first quarter of the year 2000. The St.
Paul currently has limited involvement with derivative instruments, primarily
for purposes of hedging against fluctuations in interest rates. The St. Paul
cannot at this time reasonably estimate the potential impact of this adoption
on its financial position or results of operations for future periods.
FORWARD-LOOKING STATEMENT DISCLOSURE
This report contains certain forward-looking statements within the meaning of
the Private Litigation Reform Act of 1995. Forward-looking statements are
statements other than historical information or statements of current
condition. Words such as expects, anticipates, intends, plans, believes,
seeks or estimates, or variations of such words, and similar expressions are
also intended to identify forward-looking statements. In light of the risks
and uncertainties inherent in future projections, many of which are beyond
The St. Paul's control, actual results could differ materially from those in
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, including the
effects of the merger with USF&G Corporation. The St. Paul undertakes no
obligation to release publicly the results of any future revisions it may
make to forward-looking statements to reflect events or circumstances after
the date hereof or to reflect the occurrence of unanticipated events.
<PAGE>
PART II OTHER INFORMATION
<TABLE>
<S> <C>
Item 1. Legal Proceedings. The information set forth in Note 5 to the
consolidated financial statements is incorporated herein by
reference.
Item 2. Changes in Securities.
Not applicable.
Item 3. Defaults Upon Senior Securities.
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders.
Not applicable.
Item 5. Other Information.
Not applicable.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits. An Exhibit Index is set forth as the last
page in this document.
(b) Reports on Form 8-K.
1) The St. Paul filed a Form 8-K Current Report
dated April 24, 1998, relating to the consummation
of its merger with USF&G Corporation.
2) The St. Paul filed a Form 8-K Current Report
dated April 27, 1998, relating to the
announcement of its financial results for the
quarter ended March 31, 1998.
3) The St. Paul filed a Form 8-K Current Report
dated May 5, 1998, relating to the election
of three former directors of USF&G Corporation to
The St. Paul's board of directors, and
the approval of a two-for-one common stock
split to shareholders of record on May 6, 1998.
4) The St. Paul filed a Form 8-K Current Report
dated May 14, 1998, relating to the
anticipated cost savings to be realized from
the USF&G merger, and the anticipated
second-quarter charge to earnings resulting from
the merger.
5) The St. Paul filed a Form 8-K Current Report
dated May 22, 1998, relating to the expected
pretax catastrophe losses of between $35
million and $40 million resulting from a
May 15, 1998 storm in Minnesota.
<PAGE>
6) The St. Paul filed a Form 8-K Current Report
dated June 8, 1998, relating to the expected
pretax catastrophe losses of between $25
million and $30 million resulting from a
May 30, 1998 storm in Minnesota and the Midwest.
7) The St. Paul filed a Form 8-K Current Report
dated July 8, 1998, relating to the
anticipated total of approximately
$155 million in pretax catastrophe
losses for the second quarter of 1998.
8) The St. Paul filed a Form 8-K Current Report
dated August 3, 1998, relating to the
announcement of its financial results for the
quarter ended June 30, 1998.
</TABLE>
SIGNATURES
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.
(Registrant)
Date: March 29, 1999 By /s/ Bruce A. Backberg
-----------------------------
Bruce A. Backberg
Senior Vice President
and Chief Legal Counsel
(Authorized Signatory)
Date: March 29, 1999 By /s/ Thomas A. Bradley
-----------------------------
Thomas A. Bradley
Senior Vice President
and Corporate Controller
(Principal Accounting Officer)
<PAGE>
EXHIBIT INDEX
----------------------
<TABLE>
<CAPTION>
Method of
Exhibit Filing
- - ------- -----------
<S> <C>
(2) Plan of acquisition, reorganization,
arrangement, liquidation or succession*.............................................
(3) Articles of incorporation and by-laws*................................................
(4) Instruments defining the rights of security holders, including
indentures*.........................................................................
(10) Material contracts*...................................................................
(11) Statement re computation of per share earnings** ..................................... (1)
(12) Statement re computation of ratios**.................................................. (1)
(15) Letter re unaudited interim financial information* .................................
(18) Letter re change in accounting principles**.......................................... (1)
(19) Report furnished to security holders*................................................
(22) Published report regarding matters submitted to
vote of security holders*..........................................................
(23) Consents of experts and counsel*.....................................................
(24) Power of attorney*...................................................................
(27) Financial data schedule**............................................................ (1)
(99) Additional exhibits*................................................................
</TABLE>
* These items are not applicable.
** This exhibit is included only with the copies of this report that are
filed with the Securities and Exchange Commission. However, a copy of the
exhibit may be obtained from the Registrant for a reasonable fee by writing
to Legal Services, The St. Paul Companies, 385 Washington Street, Saint Paul,
MN 55102.
(1) Filed electronically herewith.
<PAGE>
Exhibit 11
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Computation of Earnings Per Share
(In thousands)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30 June 30
----------------------------- --------------------------
1998 1997 1998 1997
----- ----- ----- -----
<S> <C> <C> <C> <C>
EARNINGS:
Basic:
Net income (loss), as reported $(273,803) 288,942 (79,125) 458,360
Dividends on preferred stock, net of taxes (2,120) (2,168) (4,269) (6,012)
Premium on preferred shares redeemed (1,361) (651) (2,205) (911)
----------- ----------- ----------- ----------
Net income (loss) available to common shares $(277,284) 286,123 (85,599) 451,437
=========== =========== =========== ==========
Diluted:
Net income (loss), available to common shares $(277,284) 286,123 (85,599) 451,437
Effect of dilutive securities:
Convertible preferred stock - 1,502 - 3,017
Zero coupon convertible notes - 779 - 1,542
Convertible monthly income preferred securities - 2,019 - 4,037
----------- ----------- ----------- ----------
Net income (loss) available to common shares $(277,284) 290,423 (85,599) 460,033
=========== =========== =========== ==========
COMMON SHARES:
Basic:
Weighted average common shares outstanding 235,160 229,611 234,670 230,211
=========== =========== =========== ==========
Diluted:
Weighted average common shares outstanding 235,160 229,611 234,670 230,211
Effect of dilutive securities::
Stock options - 4,786 - 4,702
Convertible preferred stock - 8,025 - 7,848
Zero coupon convertible notes - 2,923 - 2,923
Convertible monthly income preferred securities - 7,017 - 7,017
----------- ----------- ----------- ----------
Weighted average, as adjusted 235,160 252,362 234,670 252,701
=========== =========== =========== ==========
EARNINGS (LOSS) PER COMMON SHARE:
Basic $(1.18) 1.25 (0.36) 1.96
Diluted $(1.18) 1.15 (0.36) 1.82
</TABLE>
The assumed exercise of stock options, and the assumed conversion of preferred
stock, zero coupon notes and monthly income preferred securities are each
anti-dilutive to The St. Paul's net income for the three months and six months
ended June 30, 1998. As a result, the potentially dilutive effect of those
securities is not considered in the calculation of EPS amounts for those
periods.
<PAGE>
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Exhibit 12
Computation of Ratios
(In thousands, except ratios)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30 June 30
--------------------------- --------------------------
1998 1997 1998 1997
------ ------ ------ ------
<S> <C> <C> <C> <C>
EARNINGS:
Income (loss) before income taxes $(410,527) 390,920 (160,200) 700,163
Add: fixed charges 40,216 31,561 71,652 63,382
---------- --------- --------- ---------
Income (loss), as adjusted $(370,311) 422,481 (88,548) 763,545
========== ========= ========== =========
FIXED CHARGES:
Interest costs $20,841 24,566 44,318 47,811
Rental expense (1) 19,375 6,995 27,334 15,571
---------- --------- --------- ---------
Total fixed charges $40,216 31,561 71,652 63,382
========== ========= ========== =========
FIXED CHARGES AND PREFERRED STOCK DIVIDENDS:
Fixed charges $40,216 31,561 71,652 63,382
PSOP preferred stock dividends 4,255 4,391 8,546 8,815
Dividends on redeemable
preferred securities 9,425 7,381 18,851 14,486
---------- --------- --------- ---------
Total fixed charges and preferred
stock dividends $53,896 43,333 99,049 86,683
========== ========= ========== =========
Ratio of earnings to fixed charges (2) - 13.39 - 12.05
========== ========= ========== =========
Ratio of earnings to combined fixed charges
and preferred stock dividends (2) - 9.75 - 8.81
========== ========= ========== =========
</TABLE>
(1) Interest portion deemed implicit in total rent expense. Amounts for both
periods of 1998 include an $11.4 million provision representative of interest
included in charge for future lease buy-outs recorded in the second quarter
of 1998 as a result of The St. Paul's merger with USF&G Corporation.
(2) The second quarter 1998 loss is inadequate to cover "fixed charges" by
$410.5 million and "combined fixed charges and preferred stock dividends" by
$424.2 million. The year-to-date 1998 loss is inadequate to cover "fixed
charges" by $160.2 million and "combined fixed charges and preferred stock
dividends" by $187.6 million.
<PAGE>
Exhibit 18
August 14, 1998
The St. Paul Companies, Inc.
385 Washington St.
St. Paul, Minnesota 55102
Ladies and Gentlemen:
We have been furnished with a copy of Form 10-Q of The St. Paul Companies,
Inc. for the three months ended June 30, 1998, and have read the Company's
statements contained in Note 8 to the consolidated financial statements
included therein. As stated in Note 8, the Company changed its method of
accounting for certain workers' compensation reserves from an undiscounted to
a discounted basis and states that the newly adopted accounting principle is
preferable in the circumstances because discounting these reserves more
closely matches revenue and expense and more reasonably portrays the economic
impact of the time value of money related to these reserves. These reserves
have an ultimate cost and payment pattern that are fixed and determinable
and, accordingly, may be discounted in accordance with Staff Accounting
Bulletin No. 62, "Discounting by Property-Casualty Insurance Companies."
Prior to the merger of USF&G Corporation and The St. Paul Companies, Inc. in
April of 1998, these companies had different accounting policies relating to
these types of workers' compensation reserves. Therefore, in the merged
entity consolidated financial statements, prior years have been retroactively
restated to apply the preferable accounting method for all periods presented.
In accordance with your request, we have reviewed and discussed with Company
officials the circumstances and business judgment and planning upon which the
decision to make this change in method of accounting was based.
We have not audited any consolidated financial statements of The St. Paul
Companies, Inc. as of any date or for any period subsequent to December 31,
1997, nor have we audited the information set forth in the aforementioned
Note 8 to the consolidated financial statements; accordingly, we do not
express an opinion concerning the factual information contained therein.
With regard to the aforementioned accounting change, authoritative criteria
have not been established for evaluating the preferability of one acceptable
method of accounting over another acceptable method. However, for purposes of
The St. Paul Companies, Inc.'s compliance with the requirements of the
Securities and Exchange Commission, we are furnishing this letter.
Based on our review and discussion, with reliance on management's business
judgment and planning, we concur that the newly adopted method of accounting
is preferable in the Company's circumstances.
Very truly yours,
/s/ KPMG Peat Marwick LLP
- - -----------------------------------
KPMG Peat Marwick LLP
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 7
<RESTATED>
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> 6-MOS 6-MOS
<FISCAL-YEAR-END> DEC-31-1998 DEC-31-1997
<PERIOD-END> JUN-30-1998 JUN-30-1997
<DEBT-HELD-FOR-SALE> 20,843,281 20,265,282
<DEBT-CARRYING-VALUE> 0 0
<DEBT-MARKET-VALUE> 0 0
<EQUITIES> 1,146,784 999,326
<MORTGAGE> 702,035 489,197
<REAL-ESTATE> 918,524 1,141,487
<TOTAL-INVEST> 26,009,532 24,578,469
<CASH> 129,107 128,499
<RECOVER-REINSURE> 126,515 114,804
<DEFERRED-ACQUISITION> 837,490 869,585
<TOTAL-ASSETS> 37,463,170 35,489,254
<POLICY-LOSSES> 22,523,156 21,684,485
<UNEARNED-PREMIUMS> 3,392,302 3,578,692
<POLICY-OTHER> 0 0
<POLICY-HOLDER-FUNDS> 0 0
<NOTES-PAYABLE> 1,075,895 1,249,496
502,700 407,000
15,153 17,998
<COMMON> 2,120,746 1,915,485
<OTHER-SE> 4,376,451 3,911,569
<TOTAL-LIABILITY-AND-EQUITY> 37,463,170 35,489,254
3,533,724 3,696,972
<INVESTMENT-INCOME> 794,547 780,411
<INVESTMENT-GAINS> 185,373 267,473
<OTHER-INCOME> 190,229 150,497
<BENEFITS> 3,055,503 2,768,677
<UNDERWRITING-AMORTIZATION> 850,116 869,870
<UNDERWRITING-OTHER> 958,454 556,643
<INCOME-PRETAX> (160,200) 700,163
<INCOME-TAX> (81,075) 174,053
<INCOME-CONTINUING> (79,125) 526,110
<DISCONTINUED> 0 (67,750)
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (79,125) 458,360
<EPS-PRIMARY> (0.36) 1.96
<EPS-DILUTED> (0.36) 1.82
<RESERVE-OPEN> 0 0
<PROVISION-CURRENT> 0 0
<PROVISION-PRIOR> 0 0
<PAYMENTS-CURRENT> 0 0
<PAYMENTS-PRIOR> 0 0
<RESERVE-CLOSE> 0 0
<CUMULATIVE-DEFICIENCY> 0 0
</TABLE>
