<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
FORM 8-K
Current Report
Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
Date of Report (Date of earliest event reported) May 19, 1999
ACE LIMITED
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Cayman Islands 1-11778 98-0091805
- --------------------------------------------------------------------------------
(State or other jurisdiction (Commission I.R.S. Employer
(of Incorporation File Number) Identification No.)
The ACE Building
30 Woodbourne Avenue
Hamilton, Bermuda HM 08
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including are code: (441) 295-5200
--------------
Not Applicable
- --------------------------------------------------------------------------------
(Former name or former address, if changed since last report)
1
<PAGE>
On January 12, 1999, ACE Limited ("ACE") announced that it had signed
an agreement to purchase the U.S. domestic and international property and
casualty insurance business of CIGNA Corporation (the "Acquired Business"). The
closing of the transaction is subject to a number of conditions, including
various regulatory approvals. The transaction is currently expected to close on
or about July 1, 1999.
Included as Exhibit 99.1 to this Current Report on Form 8-K is
condensed consolidated unaudited pro forma financial information for ACE for the
year ended September 30, 1998 and as of and for the three months ended March 31,
1998. Included as Exhibit 99.2 to this Current Report on Form 8-K are audited
financial statements for the Acquired Business for each of the years in the
three-year period ended December 31, 1998.
Item 7. Financial Statements and Exhibits.
(a) Pro Forma Financial Information
See Exhibit 99.1
(b) Audited Financial Statements of Acquired Business
See Exhibit 99.2
(c) Exhibits
2
<PAGE>
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.
Dated: May 19, 1999 ACE LIMITED
By: /s/ Christopher Z. Marshall
----------------------------
Christopher Z. Marshall
Chief Financial Officer
<PAGE>
EXHIBIT INDEX
Exhibit
Number Description
- ------- -----------
99.1 Unaudited pro forma condensed consolidated financial information
of ACE.
99.2 Audited financial statements for the Acquired Business for each
of the years in the three-year period ended December 31, 1998.
<PAGE>
Exhibit 99.1
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL INFORMATION OF ACE
On January 11, 1999, ACE agreed to purchase the international and domestic
property and casualty businesses of CIGNA Corporation for $3.45 billion in cash
(the "Acquisition"). Under the terms of the agreement, ACE will acquire CIGNA's
domestic property and casualty insurance operations and also its international
property and casualty insurance companies and branches, including most of the
accident and health business written through those companies. National
Indemnity Company, a subsidiary of Berkshire Hathaway Inc., will provide $1.25
billion of reinsurance against additional liabilities with respect to insurance
losses and adjustment expense reserves of the acquired businesses. The
acquisition, which is subject to receipt of regulatory approvals and other
customary closing conditions, is expected to be completed on or about July 1,
1999. ACE expects to finance this transaction with a combination of available
cash and bank financing, and intends to refinance with newly issued equity,
debt and preferred and mandatorily convertible securities.
The following unaudited pro forma condensed consolidated balance sheet as of
December 31, 1998 gives effect to the Acquisition as if it had occurred on
December 31, 1998. The unaudited pro forma condensed consolidated statements of
operations for the twelve months ended September 30, 1998 and for the three
months ended December 31, 1998 present operating results of ACE as if the
Acquisition had occurred on October 1, 1997.
The unaudited pro forma condensed consolidated financial statements should be
read in conjunction with the consolidated financial statements of ACE, included
in the Company's Annual Report on Form 10-K for the year ended September 30,
1998, the unaudited consolidated financial statements of ACE included in the
Company's Quarterly Report on Form 10-Q for the quarter ended December 31, 1998
and the audited consolidated financial statements of CIGNA Corporation Property
and Casualty Businesses (CIGNA P&C) for the year ended December 31, 1998 filed
with this report. The pro forma adjustments are based on preliminary estimates,
information currently available and certain assumptions that management
believes are reasonable under the circumstances. The unaudited pro forma
condensed consolidated financial information is not intended to be indicative
of the consolidated results of operations or financial position of ACE that
would have been reported if the CIGNA P&C acquisition had occurred at the dates
indicated or of the consolidated results of future operations or of future
financial position. Certain reclassifications have been made to the historical
financial statements to conform with the pro forma presentation.
The Acquisition has been accounted for as a purchase in accordance with
generally accepted accounting principles. Under purchase accounting, the total
purchase price is allocated to the acquired assets and liabilities based on
their fair values.
1
<PAGE>
Unaudited Pro Forma Condensed Consolidated Balance Sheet
<TABLE>
<CAPTION>
At December 31, 1998
---------------------------------------------------
(In millions)
Pro forma
CIGNA Pro forma combined for CIGNA
ACE P&C Adjustments Notes P&C Acquisition
------ ------- ----------- ----- ------------------
<S> <C> <C> <C> <C> <C>
Total investments and
cash..................... $6,215 $10,073 (3,500) (1)
$ 2,800 (2)
(1,250) (3) $14,338
Reinsurance recoverables.. 1,159 6,470 1,250 (3) 8,879
Premiums receivable....... 348 2,343 -- 2,691
Other assets.............. 577 2,580 118 (4) 3,275
Goodwill.................. 535 405 1,161 (5) 2,101
------ ------- ------- -------
Total assets.............. $8,834 $21,871 $ 579 $31,284
====== ======= ======= =======
Unpaid losses and loss
expenses................. $3,678 $14,836 -- $18,514
Unearned premiums......... 706 1,401 -- 2,107
Bank debt................. 250 -- $ 2,800 (2) 3,050
Other liabilities......... 291 3,643 (230) (4) 3,704
------ ------- ------- -------
Total liabilities......... 4,925 19,880 2,570 27,375
------ ------- ------- -------
Total shareholders'
equity................... 3,909 1,991 230 (4)
118 (4)
(2,339) (6)
3,909
------ ------- ------- -------
Total liabilities and
shareholders equity...... $8,834 $21,871 $ 579 $31,284
====== ======= ======= =======
</TABLE>
- --------
(1) Under the Terms of the Acquisition Agreement by and among CIGNA
Corporation, CIGNA Holdings, Inc and ACE Limited dated January 11, 1999,
ACE will pay a total purchase price of approximately $3.5 billion, which
includes $50 million of estimated transaction related expenses.
(2) ACE currently expects to fund the purchase price with approximately $700
million of cash on hand and $2.8 billion through the issuance of (i)
ordinary shares of ACE; (ii) preferred securities that are mandatorily
convertible into ordinary shares of ACE; (iii) capital securities; and (iv)
senior debt (together the "permanent financing"). Each of these items have
been described in detail elsewhere in this registration statement. ACE will
issue each of the permanent financing instruments either before or after
the closing of the transaction at the time when ACE considers market
conditions to be most favorable for issuance. Accordingly, ACE has secured
interim bank financing in a total amount of $2.8 billion. For purposes of
these pro forma financial statements, it has been assumed that the
transaction is financed with the interim bank financing.
(3) Under the terms of the Acquisition Agreement, CIGNA Corporation agreed to
provide a guarantee to ACE to indemnify against unanticipated increases in
recorded reserves for losses and loss adjustment expenses of certain
subsidiaries being acquired by ACE. CIGNA Corporation has the option to
replace its guarantee with reinsurance obtained from a mutually agreed upon
third party reinsurer. It is expected that, contemporaneous with and
contingent upon the consummation of the acquisition, CIGNA Corporation will
exercise its option and replace its guarantee with reinsurance by directing
certain subsidiaries being acquired to transfer $1.25 billion of
investments to a reinsurer for aggregate coverage of $2.5 billion. Such
coverage is expected to attach at an amount equal to the net recorded
reserves of the certain subsidiaries acquired, on the closing date, minus
$1.25 billion.
2
<PAGE>
(4) Under the terms of the agreement, CIGNA Corporation will:
(a) Forgive certain inter-company indebtedness amounting to approximately
$118 million.
(b) Retain certain net employment and post-employment related liabilities
amounting to approximately $230 million.
(5) Under purchase accounting, the total purchase price is allocated to the
acquired assets and liabilities assumed based on their fair values. Any
excess between the purchase price and the fair value of CIGNA P&C's net
tangible assets will be allocated to goodwill and other identifiable
intangible assets. While it is expected that a certain amount of purchase
price will ultimately be allocated to other identifiable intangible assets
and amortized over the estimated period of benefit, ACE has not completed
the process of identification and valuation of such intangibles. Therefore,
these pro forma financial statements reflect all of the excess purchase
price over net tangible assets as goodwill. Goodwill is expected to be
amortized over 40 years.
(6) To eliminate CIGNA P&C shareholder's equity.
3
<PAGE>
Unaudited Pro Forma Condensed Consolidated Statements of Operations
<TABLE>
<CAPTION>
Three Months Ended December 31, 1998
-----------------------------------------------------------
(In millions of U.S. dollars)
Pro forma
CIGNA Pro forma combined for CIGNA
ACE P&C (1) Adjustments Notes P&C Acquisition
----------- ------- ----------- ------ ------------------
<S> <C> <C> <C> <C> <C>
Net Premiums Written.... $ 154 $ 740 $ 894
----------- ----- -----------
Net Premiums Earned..... 218 763 981
Net investment income... 85 145 $(30) (2),(3) 200
Other revenues.......... -- 77 77
Losses and loss
expenses............... (111) (625) 20 (3) (716)
Acquisition costs and
administrative
expenses............... (69) (394) (463)
Other expenses.......... (9) -- (49) (4),(5) (58)
Income tax.............. (5) 6 11 (6) 12
----------- ----- ---- -----------
Income excluding net
realized gains......... 109 (28) (48) 33
Net realized gains on
investments............ 130 20 150
----------- ----- ---- -----------
Net Income.............. $ 239 $ (8) $(48) $ 183
=========== ===== ==== ===========
Basic earnings per
share, excluding
realized gains......... $ 0.56 $ 0.17
=========== ===========
Basic earnings per
share.................. $ 1.23 $ 0.95
=========== ===========
Weighted average shares
outstanding............ 193,642,270 193,642,270
=========== ===========
Diluted earnings per
share, excluding
realized gains......... $ 0.55 $ 0.17
=========== ===========
Diluted earnings per
share.................. $ 1.21 $ 0.93
=========== ===========
Weighted average shares
outstanding............ 197,349,356 197,349,356
=========== ===========
</TABLE>
- --------
(1) The CIGNA P&C consolidated statements of operations reflect its results of
operations for the three months ended December 31, 1998.
(2) ACE currently expects to fund part of the purchase price with approximately
$700 million of cash on hand. The estimated investment income on this $700
million of the purchase price has been eliminated (based on a yield of 5.8%
that approximates the yield on the ACE portfolio for the fiscal year ended
September 30, 1998).
(3) Under the terms of the Acquisition Agreement, CIGNA Corporation agreed to
provide a guarantee to ACE to indemnify against unanticipated increases in
recorded reserves for losses and loss adjustment expenses of certain
subsidiaries being acquired by ACE. CIGNA Corporation has the option to
replace its guarantee with reinsurance obtained from a mutually agreed upon
third party reinsurer. It is expected that, contemporaneous with and
contingent upon the consummation of the acquisition, CIGNA Corporation will
exercise its option and replace its guarantee with reinsurance by directing
certain subsidiaries being acquired to transfer $1.25 billion of
investments to a reinsurer for aggregate coverage of $2.5 billion. Such
coverage is expected to attach at an amount equal to the net recorded
reserves of the certain subsidiaries acquired, on the closing date, minus
$1.25 billion. The estimated investment income on this $1.25 billion has
been eliminated (based on a yield of 6.5% that approximates the yield on
the applicable portion of the CIGNA P&C portfolio for the fiscal year ended
December 31, 1998). The pro forma adjustment to losses and loss expenses
reflects the estimated historical adverse development recorded during the
period on the guaranteed reserves.
4
<PAGE>
(4) In addition to the $700 million of cash on hand, ACE expects to fund part
of the purchase price with approximately $2.8 billion through the issuance
of (i) ordinary shares of ACE; (ii) preferred securities that are
mandatorily convertible into ordinary shares of ACE; (iii) capital
securities; and (iv) senior debt
(together the "permanent financing"). Each of these items have been
described in detail elsewhere in this registration statement. ACE will
issue each of the permanent financing instruments either before or after
the closing of the transaction at the time when ACE considers market
conditions to be most favorable for issuance. Accordingly, ACE has secured
interim bank financing in a total amount of $2.8 billion. Interest on the
$2.8 billion of bank borrowings which has been calculated at a rate of
approximately 6%.
(5) Any excess between the purchase price and the fair value of CIGNA P&C's
net tangible assets will be allocated to goodwill and other identifiable
intangible assets. While it is expected that a certain amount of purchase
price will ultimately be allocated to other identifiable intangible assets
and amortized over the estimated period of benefit, ACE has not completed
the process of identification and valuation of such intangibles.
Therefore, these pro forma financial statements reflect all of the excess
purchase price over net tangible assets as goodwill. This entry reflects
the amortization of goodwill for the period.
(6) The estimated income tax saving is based on the estimated reduction in net
income before tax as a result of interest expense on the bank debt.
5
<PAGE>
Unaudited Pro Forma Condensed Consolidated Statements of Operations
<TABLE>
<CAPTION>
Year Ended September 30, 1998
------------------------------------------------------------
(In millions of U.S. dollars)
Pro forma
CIGNA Pro forma combined for CIGNA
ACE P&C Adjustments Notes P&C Acquisition
----------- ------- ----------- ------ ------------------
<S> <C> <C> <C> <C> <C>
Net Premiums Written.... $ 881 $ 2,990 $ 3,871
----------- ------- -----------
Net Premiums Earned..... 894 2,957 3,851
Net investment income... 324 590 $(122) (2),(3) 792
Other revenues.......... -- 282 282
Losses and loss
expenses............... (517) (2,247) 81 (3) (2,683)
Acquisition costs and
administrative
expenses............... (271) (1,500) (1,771)
Other expenses.......... (38) -- (197) (4),(5) (235)
Income tax.............. (20) (30) 44 (6) (6)
----------- ------- ----- -----------
Income excluding net
realized gains......... 372 52 (194) 230
Net realized gains on
investments............ 188 22 210
----------- ------- ----- -----------
Net Income.............. $ 560 $ 74 $(194) $ 440
=========== ======= ===== ===========
Basic earnings per
share, excluding
realized gains......... $ 2.01 $ 1.24
=========== ===========
Basic earnings per
share.................. $ 3.02 $ 2.38
=========== ===========
Weighted average shares
outstanding............ 185,130,479 185,130,479
=========== ===========
Diluted earnings per
share, excluding
realized gains......... $ 1.97 $ 1.22
=========== ===========
Diluted earnings per
share.................. $ 2.96 $ 2.32
=========== ===========
Weighted average shares
outstanding............ 189,281,175 189,281,175
=========== ===========
</TABLE>
- --------
(1) The CIGNA P&C consolidated statements of operations reflect its results of
operations for the twelve months ended December 31, 1998.
(2) ACE currently expects to fund part of the purchase price with approximately
$700 million of cash on hand. The estimated investment income on this $700
million of the purchase price has been eliminated (based on a yield of 5.8%
that approximates the yield on the ACE portfolio for the fiscal year ended
September 30, 1998).
(3) Under the terms of the Acquisition Agreement, CIGNA Corporation agreed to
provide a guarantee to ACE to indemnify against unanticipated increases in
recorded reserves for losses and loss adjustment expenses of certain
subsidiaries being acquired by ACE. CIGNA Corporation has the option to
replace its guarantee with reinsurance obtained from a mutually agreed upon
third party reinsurer. It is expected that, contemporaneous with and
contingent upon the consummation of the acquisition, CIGNA Corporation will
exercise its option and replace its guarantee with reinsurance by directing
certain subsidiaries being acquired to transfer $1.25 billion of
investments to a reinsurer for aggregate coverage of $2.5 billion. Such
coverage is expected to attach at an amount equal to the net recorded
reserves of the certain subsidiaries acquired, on the closing date, minus
$1.25 billion. The estimated investment income on this $1.25 billion has
been eliminated (based on a yield of 6.5% that approximates the yield on
the applicable portion of the CIGNA P&C portfolio for the fiscal year ended
December 31, 1998). The pro forma adjustment to losses and loss expenses
reflects the estimated historical adverse development recorded during the
period on the guaranteed reserves.
6
<PAGE>
(4) In addition to the $700 million of cash on hand, ACE expects to fund part
of the purchase price with approximately $2.8 billion through the issuance
of (i) ordinary shares of ACE; (ii) preferred securities that are
mandatorily convertible into ordinary shares of ACE; (iii) capital
securities; and (iv) senior debt (together the "permanent financing"). Each
of these items have been described in detail elsewhere in this registration
statement. ACE will issue each of the permanent financing instruments
either before or after the closing of the transaction at the time when ACE
considers market conditions to be most favorable for issuance. Accordingly,
ACE has secured interim bank financing in a total amount of $2.8 billion.
Interest on the $2.8 billion of bank borrowings which has been calculated
at a rate of approximately 6%.
(5) Any excess between the purchase price and the fair value of CIGNA P&C's net
tangible assets will be allocated to goodwill and other identifiable
intangible assets. While it is expected that a certain amount of purchase
price will ultimately be allocated to other identifiable intangible assets
and amortized over the estimated period of benefit, ACE has not completed
the process of identification and valuation of such intangibles. Therefore,
these pro forma financial statements reflect all of the excess purchase
price over net tangible assets as goodwill. This entry reflects the
amortization of goodwill for the period.
(6) The estimated income tax saving is based on the estimated reduction in net
income before tax as a result of interest expense on the bank debt.
7
<PAGE>
Exhibit 99.2
CIGNA CORPORATION
PROPERTY AND CASUALTY BUSINESSES
COMBINED FINANCIAL STATEMENTS
December 31, 1998, 1997 and 1996
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors of CIGNA Corporation
In our opinion, the accompanying combined balance sheets and the related
combined statements of income, comprehensive income and changes in invested
equity and cash flows present fairly, in all material respects, the financial
position of the CIGNA Corporation property and casualty businesses (the
Business) at December 31, 1998 and 1997, and the results of their operations
and their cash flows for each of the three years in the period ended December
31, 1998, in conformity with generally accepted accounting principles. These
financial statements are the responsibility of the Business's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
generally accepted auditing standards which require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for the
opinion expressed above.
Philadelphia, Pennsylvania
April 2, 1999
F-1
<PAGE>
CIGNA CORPORATION PROPERTY AND CASUALTY BUSINESSES
COMBINED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
For the Years Ended
December 31,
---------------------
1998 1997 1996
------ ------ ------
(In millions)
<S> <C> <C> <C>
Revenues
Premiums and fees...................................... $2,957 $3,154 $3,417
Net investment income.................................. 590 647 688
Other revenues......................................... 282 286 228
Realized investment gains.............................. 22 75 39
------ ------ ------
Total revenues....................................... 3,851 4,162 4,372
------ ------ ------
Losses and expenses
Losses and settlement expenses......................... 2,247 2,220 2,466
Policy acquisition expenses............................ 753 789 859
Other operating expenses............................... 747 779 721
------ ------ ------
Total losses and expenses............................ 3,747 3,788 4,046
------ ------ ------
Income before income taxes............................... 104 374 326
------ ------ ------
Income taxes (benefits):
Current................................................ (14) 15 98
Deferred............................................... 44 117 5
------ ------ ------
Total taxes.......................................... 30 132 103
------ ------ ------
Net income............................................... $ 74 $ 242 $ 223
====== ====== ======
</TABLE>
The Notes to Combined Financial Statements are an integral part of these
statements.
F-2
<PAGE>
CIGNA CORPORATION PROPERTY AND CASUALTY BUSINESSES
COMBINED BALANCE SHEETS
<TABLE>
<CAPTION>
As of December
31,
----------------
1998 1997
------- -------
(In millions)
<S> <C> <C>
ASSETS
Investments:
Fixed maturities, at fair value (amortized cost, $7,951;
$8,319)....................................................$.8,364. $ 8,700
Equity securities, at fair value (cost, $497; $347)........... 566 394
Other long-term investments................................ 35 101
Short-term investments..................................... 66 75
------- -------
Total investments........................................ 9,031 9,270
Cash and cash equivalents.................................... 1,042 793
Accrued investment income.................................... 152 162
Premiums receivable.......................................... 1,725 1,888
Accounts and notes receivable................................ 618 536
Receivables from affiliates.................................. 102 163
Reinsurance recoverables..................................... 6,470 6,386
Deferred policy acquisition costs............................ 339 329
Property and equipment....................................... 237 236
Deferred income taxes........................................ 957 1,033
Goodwill..................................................... 405 443
Other assets................................................. 793 601
------- -------
Total assets............................................. $21,871 $21,840
======= =======
LIABILITIES
Unpaid claims and claim expenses............................. $14,836 $15,136
Unearned premiums............................................ 1,401 1,318
Contractholder deposit funds................................. 257 234
------- -------
Total insurance and contractholder liabilities........... 16,494 16,688
Accounts payable, accrued expenses and other liabilities..... 2,884 2,751
Payables to affiliates....................................... 473 233
Current income taxes......................................... 29 131
------- -------
Total liabilities........................................ 19,880 19,803
------- -------
CONTINGENCIES--NOTE 15
INVESTED EQUITY
Net unrealized appreciation, fixed maturities................ 273 251
Net unrealized appreciation, equity securities............... 72 45
Net translation of foreign currencies........................ (123) (128)
------- -------
Accumulated other comprehensive income....................... 222 168
Other invested equity........................................ 1,769 1,869
------- -------
Total invested equity.................................... 1,991 2,037
------- -------
Total liabilities and invested equity.................... $21,871 $21,840
======= =======
</TABLE>
The Notes to Combined Financial Statements are an integral part of these
statements.
F-3
<PAGE>
CIGNA CORPORATION PROPERTY AND CASUALTY BUSINESSES
COMBINED STATEMENTS OF COMPREHENSIVE INCOME AND
CHANGES IN INVESTED EQUITY
(In millions)
<TABLE>
<CAPTION>
For the years ended December 31,
--------------------------------------------------
1998 1997 1996
---------------- ---------------- ----------------
Compre- Compre- Compre-
hensive Invested hensive Invested hensive Invested
Income Equity Income Equity Income Equity
------- -------- ------- -------- ------- --------
<S> <C> <C> <C> <C> <C> <C>
Accumulated other
comprehensive income,
beginning of year......... $ 168 $ 183 $ 329
Net unrealized appreciation
(depreciation)--fixed
maturities................ $ 22 22 $ 57 57 $(161) (161)
Net unrealized appreciation
(depreciation)--equity
securities................ 27 27 (2) (2) 12 12
---- ---- -----
Net unrealized appreciation
(depreciation) on
investments............... 49 55 (149)
Net translation of foreign
currencies................ 5 5 (70) (70) 3 3
---- ---- -----
Other comprehensive income
(loss).................... 54 (15) (146)
Accumulated other
comprehensive income, end
of year................... 222 168 183
---- ------ ---- ------ ----- ------
Other invested equity,
beginning of year 1,869 1,807 1,228
Net income................. 74 74 242 242 223 223
Net capital contributions
(to) from affiliates...... (174) (180) 356
---- ------ ---- ------ ----- ------
Other invested equity, end
of year................... 1,769 1,869 1,807
---- ------ ---- ------ ----- ------
Total comprehensive income
and invested equity....... $128 $1,991 $227 $2,037 $ 77 $1,990
==== ====== ==== ====== ===== ======
</TABLE>
The Notes to Combined Financial Statements are an integral part of these
statements.
F-4
<PAGE>
CIGNA CORPORATION PROPERTY AND CASUALTY BUSINESSES
COMBINED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
For the years ended
December 31,
-------------------------
1998 1997 1996
------- ------- -------
(In millions)
<S> <C> <C> <C>
Cash flows from operating activities
Net income........................................ $ 74 $ 242 $ 223
Adjustments to reconcile net income to net cash
used in operating activities:
Insurance liabilities........................... (234) (1,341) (677)
Reinsurance recoverables........................ (80) 567 (60)
Premiums, accounts, and notes receivable........ 94 82 (62)
Deferred policy acquisition costs............... (6) (7) 2
Accounts payable, accrued expenses, other
liabilities....................................
and current income taxes....................... (76) 34 409
Affiliate transactions.......................... 11 (29) 23
Deferred income taxes........................... 44 117 5
Realized investment gains....................... (22) (75) (39)
Depreciation and goodwill amortization.......... 79 57 83
Other, net...................................... (175) 97 87
------- ------- -------
Net cash used in operating activities......... (291) (256) (6)
------- ------- -------
Cash flows from investing activities
Proceeds from investments sold:
Fixed maturities................................ 3,381 3,940 4,198
Equity securities............................... 302 222 214
Other (primarily short-term investments)........ 756 1,468 900
Investment maturities and repayments (primarily
fixed maturities)................................ 802 823 914
Investments purchased:
Fixed maturities................................ (3,664) (4,221) (5,146)
Equity securities............................... (450) (309) (204)
Other (primarily short-term investments)........ (676) (1,279) (1,091)
Other, net........................................ (30) (37) (54)
------- ------- -------
Net cash provided by (used in) investing
activities................................... 421 607 (269)
------- ------- -------
Cash flows from financing activities
Net change in contractholder deposit funds........ 14 (19) (32)
Net change in loans payable to affiliates......... 277 (169) (33)
Net capital contributions (to) from affiliates.... (173) (179) 214
------- ------- -------
Net cash provided by (used in) financing
activities................................... 118 (367) 149
------- ------- -------
Effect of foreign currency rate changes on cash and
cash equivalents................................... 1 (46) (11)
------- ------- -------
Net increase (decrease) in cash and cash
equivalent......................................... 249 (62) (137)
Cash and cash equivalents, beginning of year........ 793 855 992
------- ------- -------
Cash and cash equivalents, end of year.............. $ 1,042 $ 793 $ 855
======= ======= =======
Supplemental Disclosure of Cash Information:........
Income taxes paid (refunds received).............. $ 87 $ 93 $ (315)
Interest paid..................................... $ 12 $ 10 $ 11
</TABLE>
The Notes to Combined Financial Statements are an integral part of these
statements.
F-5
<PAGE>
CIGNA CORPORATION PROPERTY AND CASUALTY BUSINESSES
DECEMBER 31, 1998
NOTES TO COMBINED FINANCIAL STATEMENTS
NOTE 1--DESCRIPTION OF BUSINESS
The property and casualty businesses of CIGNA Corporation (CIGNA) consist of
CIGNA's international and domestic property and casualty insurance operations,
as structured for sale to ACE Limited (see below) (the Business). These
operations include INA Corporation, which is an indirect, wholly-owned
subsidiary of CIGNA. These operations also include INA Financial Corporation
(INAFC) and its subsidiaries and CIGNA International Holdings, Ltd. (CIH) and
certain of its subsidiaries, as well as certain other assets and liabilities.
INAFC and CIH are wholly-owned subsidiaries of INA Corporation. The Business
provides property and casualty insurance and related services for customers in
international markets, primarily Europe, the Pacific region, Canada and Latin
America, and in the United States. In international markets, the Business
provides fire, other property, casualty, accident and health, marine and other
specialty lines. In the domestic market, principal product lines include
workers' compensation, commercial packages, casualty (including commercial
automobile and general liability), property and marine and aviation. The
Business includes both ongoing and run-off operations (see Note 11).
Under an acquisition agreement dated January 11, 1999 (the Acquisition
Agreement), CIGNA agreed to sell the Business to ACE Limited (ACE), a Bermuda-
based international property and casualty insurer, for cash proceeds of $3.45
billion. The sale, which is subject to U.S. and international regulatory
approval and other conditions to closing, is expected to be completed by mid-
1999. The assets and liabilities to be transferred to ACE at the time of the
sale will not include certain amounts to be retained, paid or forgiven by CIGNA
under the terms of the Acquisition Agreement. These assets and liabilities
comprise certain amounts payable to affiliates, certain pension and other
postretirement and postemployment benefit liabilities, fixed assets and net
lease liabilities.
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A) Basis of Presentation: The combined financial statements reflect the
assets, liabilities and results of operations of the Business to be sold to ACE
in accordance with the Acquisition Agreement. Under the terms of the
Acquisition Agreement, as more fully described in Note 1, certain assets and
liabilities of the Business will be retained, paid or forgiven by CIGNA at the
time of the sale. These balances and related expenses are included in these
financial statements. For certain constituent companies of the Business, the
Acquisition Agreement provides that a portion of the assets and liabilities
will be sold to ACE, with the remainder to be retained by CIGNA. These assets
and liabilities to be sold are included in these combined financial statements
by specific identification or allocation of equity on the basis of premiums
written or surplus requirements.
These financial statements have been prepared in conformity with generally
accepted accounting principles as though the Business had been operating as a
separate entity throughout the periods presented, and reflect management's
estimates and assumptions, such as those regarding frequency and severity of
claims and loss emergence patterns, that affect the recorded amounts.
Significant estimates used in determining insurance and contractholder
liabilities, related reinsurance recoverables and the deferred tax asset
valuation allowance are discussed throughout the Notes to Combined Financial
Statements. See Note 14 for information regarding general and administrative
expenses. Adjustments have been made to eliminate material transactions among
the combined entities.
B) Recent Accounting Pronouncements: The Business adopted Statement of
Financial Accounting Standards (SFAS) No. 131, "Disclosures about Segments of
an Enterprise and Related Information," as of December 31, 1998. See Notes 11
and 13 for segment and related information.
F-6
<PAGE>
In 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133
requires that derivatives be reported on the balance sheet at fair value.
Changes in fair value are recognized in net income or, for derivatives which
are hedging market risk related to future cash flows, in the accumulated other
comprehensive income section of invested equity. Implementation is required by
the first quarter of 2000, with the cumulative effect of adoption reflected in
net income and accumulated other comprehensive income, as appropriate. The
Business has not determined the effect or timing of implementation of this
pronouncement.
The American Institute of Certified Public Accountants (AICPA) issued
Statement of Position (SOP) 97-3, "Accounting by Insurance and Other
Enterprises for Insurance-Related Assessments," in 1997. SOP 97-3 provides
guidance on the recognition and measurement of liabilities for guaranty fund
and other insurance-related assessments. Implementation is required by the
first quarter of 1999, with the cumulative effect of adopting the SOP reflected
in income in the year of adoption. The estimated reduction of net income from
implementation of this pronouncement is expected to be approximately $85
million.
In 1998, the AICPA issued SOP 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use." SOP 98-1 specifies the types
of costs that must be capitalized and amortized over the software's expected
useful life and the types of costs that must be immediately recognized as
expense. Implementation of this pronouncement is required by the first quarter
of 1999 and is not expected to have a material effect on the Business's results
of operations, liquidity or financial condition.
In 1998, the AICPA issued SOP 98-7, "Deposit Accounting: Accounting for
Insurance and Reinsurance Contracts That Do Not Transfer Insurance Risk." SOP
98-7 provides guidance on the deposit method of accounting for insurance and
reinsurance contracts that do not transfer insurance risk. Implementation is
required by the first quarter of 2000, with the cumulative effect of adopting
the SOP reflected in net income in the year of adoption. The Business has not
determined the effect or timing of implementation of this pronouncement.
C) Financial Instruments: In the normal course of business, the Business
enters into transactions involving various types of financial instruments,
including investments such as fixed maturities and equity securities and off-
balance-sheet financial instruments such as investment commitments and
financial guarantees. These instruments are subject to risk of loss due to
interest rate and market fluctuations and most have credit risk. The Business
evaluates and monitors each financial instrument individually and, where
appropriate, uses certain derivative instruments or obtains collateral or other
forms of security to minimize risk of loss.
Financial instruments subject to fair value disclosure requirements
(insurance contracts, goodwill and taxes are excluded) are carried in the
financial statements at amounts that approximate fair value, except for
contractholder deposit funds (non-insurance products). For these financial
instruments, the fair value was not materially different from the carrying
amount as of December 31, 1998 and 1997. Fair values of off-balance-sheet
financial instruments as of December 31, 1998 and 1997 were not material. Fair
values for financial instruments are estimates that, in many cases, may differ
significantly from the amounts that could be realized upon immediate
liquidation. In cases where market prices are not available, estimates of fair
value are based on discounted cash flow analyses which utilize current interest
rates for similar financial instruments with comparable terms and credit
quality. The fair value of liabilities for contractholder deposit funds was
estimated using the amount payable on demand.
D) Investments: Investments in fixed maturities, which are classified as
available for sale and carried at fair value, include bonds; asset-backed
securities, including collateralized mortgage obligations (CMOs); and
redeemable preferred stocks. Fixed maturities are considered impaired and
written down to fair value when a decline in value is considered to be other
than temporary.
Fixed maturities that are delinquent or restructured to modify basic
financial terms, typically to reduce the interest rate and, in certain cases,
extend the term, are placed on non-accrual status. Net investment income on
such investments is recognized only when payment is received.
F-7
<PAGE>
Equity securities and short-term investments are classified as available-for-
sale. Equity securities, which include common and non-redeemable preferred
stocks, are carried at fair value. Short-term investments are carried at fair
value, which approximates cost.
Realized investment gains and losses result from sales, investment asset
write-downs and changes in valuation reserves. Realized investment gains and
losses are based upon specific identification of the investment assets.
Unrealized investment gains and losses for investments carried at fair value
are included in invested equity, net of deferred income taxes.
See Note 3 (E) for a discussion of the Business's accounting policies for
derivative financial instruments.
E) Cash and Cash Equivalents: Short-term investments with a maturity of three
months or less at the time of purchase are reported as cash equivalents.
F) Reinsurance Recoverables: Reinsurance recoverables are estimates of
amounts to be received from reinsurers. Allowances are established for amounts
estimated to be uncollectible.
G) Deferred Policy Acquisition Costs: Acquisition costs consist of
commissions, premium taxes, direct marketing and other costs, which vary with
and are primarily related to the production of revenues. Acquisition costs are
deferred and amortized over the terms of the insurance policies, except for
direct marketing costs which are amortized over a period of three years.
Deferred policy acquisition costs are reviewed to determine if they are
recoverable from future income, including investment income. If such costs are
estimated to be unrecoverable, they are expensed.
H) Property and Equipment: Property and equipment are carried at cost less
accumulated depreciation. When applicable, cost includes interest and real
estate taxes incurred during construction and other construction-related costs.
Depreciation is calculated principally on the straight-line method based on the
estimated useful lives of the assets. Accumulated depreciation was $416 million
and $399 million at December 31, 1998 and 1997, respectively.
I) Other Assets: Other assets consists of various insurance-related assets,
principally ceded unearned premiums and reinsurance deposits.
J) Goodwill: Goodwill represents the excess of the cost of businesses
acquired over the fair value of their net assets. Goodwill is amortized over
periods of up to 40 years. Goodwill is written down when not recoverable based
on analysis of historical and estimated future income or undiscounted estimated
cash flows of the related businesses. Amortization periods are revised if it is
estimated that the remaining period of benefit of the goodwill has changed.
Accumulated amortization was $918 million and $881 million at December 31, 1998
and 1997, respectively.
K) Unpaid Claims and Claim Expenses: Liabilities for unpaid claims and claim
expenses are estimates of payments to be made on reported claims and incurred
but not reported claims on property and casualty insurance. Estimated amounts
of salvage and subrogation are deducted from the liability for unpaid claims.
L) Unearned Premiums: Premiums are reported as earned on a pro-rata basis
over the contract period. The unexpired portion of these premiums is recorded
as unearned premiums.
M) Other Liabilities: Other liabilities consists principally of
postretirement and postemployment benefits and various insurance-related
liabilities, including amounts related to reinsurance contracts and the present
value of obligations related to a closed book of reinsurance business acquired
in 1984.
N) Translation of Foreign Currencies: Foreign operations primarily utilize
the local currencies as their functional currencies, and assets and liabilities
are translated at the rates of exchange as of the balance sheet
F-8
<PAGE>
date. The translation gain or loss on such functional currencies, net of
applicable taxes, is reflected in invested equity. Revenues and expenses are
translated at average rates of exchange prevailing during the year.
O) Premiums and Fees, Revenues and Related Expenses: Premiums are recognized
as revenue on a pro-rata basis over their contract periods. Losses and
settlement expenses are recognized when incurred. Net investment income is
recognized as earned.
P) Income Taxes: The U.S. companies included in the Business are included in
the consolidated U.S. federal income tax return filed by CIGNA. The non-U.S.
companies included in the Business file tax returns in accordance with
applicable foreign regulations. Taxable income and credits for taxes paid for
certain of the Business's non-U.S. companies are included in the consolidated
tax return amounts attributable to the Business's U.S. companies. Undistributed
earnings of the Business's non-U.S. companies are not considered indefinitely
reinvested and, accordingly, U.S. federal income tax is provided thereon. In
accordance with a tax sharing agreement with CIGNA, the provision for federal
income tax is computed as if the U.S. subsidiaries of CIGNA were filing
separate federal income tax returns, except that benefits arising from tax
credits and net operating and capital losses are allocated to those
subsidiaries producing such benefits to the extent they reduce CIGNA's
consolidated federal income tax liability.
Deferred income taxes are generally recognized when assets and liabilities
have different values for financial statement and tax reporting purposes. See
Note 6 for additional information.
NOTE 3--INVESTMENTS
A) Fixed Maturities: Fixed maturities are net of cumulative write-downs of $9
million and $3 million as of December 31, 1998 and 1997, respectively.
The amortized cost and fair value by contractual maturity periods for fixed
maturities as of December 31, 1998 were as follows:
<TABLE>
<CAPTION>
Amortized Fair
Cost Value
--------- ------
(In millions)
<S> <C> <C>
Due in one year or less....................................... $ 556 $ 560
Due after one year through five years......................... 2,177 2,245
Due after five years through ten years........................ 2,516 2,659
Due after ten years........................................... 1,257 1,383
Asset-backed securities....................................... 1,445 1,517
------ ------
Total..................................................... $7,951 $8,364
====== ======
</TABLE>
Actual maturities could differ from contractual maturities because issuers
may have the right to call or prepay obligations with or without call or
prepayment penalties. Also, the Business may extend maturities in some cases.
F-9
<PAGE>
Gross unrealized appreciation (depreciation) for fixed maturities by type of
issuer was as follows:
<TABLE>
<CAPTION>
Amortized Unrealized Unrealized Fair
Cost Appreciation Depreciation Value
--------- ------------ ------------ ------
(In millions)
<S> <C> <C> <C> <C>
As of December 31, 1998:
Federal government bonds........... $ 251 $ 16 $ -- $ 267
State and local government bonds... 1,179 126 -- 1,305
Foreign government bonds........... 1,283 88 (42) 1,329
Corporate securities............... 3,793 208 (55) 3,946
Asset-backed securities............ 1,445 77 (5) 1,517
------ ---- ----- ------
Total............................ $7,951 $515 $(102) $8,364
====== ==== ===== ======
As of December 31, 1997:
Federal government bonds........... $ 304 $ 10 $ -- $ 314
State and local government bonds... 1,138 146 -- 1,284
Foreign government bonds........... 1,275 58 (38) 1,295
Corporate securities............... 3,941 162 (25) 4,078
Asset-backed securities............ 1,661 74 (6) 1,729
------ ---- ----- ------
Total............................ $8,319 $450 $ (69) $8,700
====== ==== ===== ======
</TABLE>
Asset-backed securities include investments in CMOs as of December 31, 1998
of $730 million carried at fair value (amortized cost, $697 million), compared
with $898 million carried at fair value (amortized cost, $865 million) as of
December 31, 1997. Certain of these securities are backed by Aaa/AAA-rated
government agencies. All other CMO securities have high quality ratings through
use of credit enhancements provided by subordinated securities or mortgage
insurance from Aaa/AAA-rated insurance companies. CMO holdings are concentrated
in securities with limited prepayment, extension and default risk, such as
planned amortization class bonds. The Business had no investments in interest-
only or principal-only CMOs at December 31, 1998 or 1997.
B) Short-Term Investments and Cash Equivalents: At December 31, 1998 and
1997, short-term investments and cash equivalents, in the aggregate, primarily
included debt securities, principally corporate securities of $496 million and
$276 million, respectively; federal government securities of $18 million and
$83 million, respectively; asset-backed securities of $17 million and $10
million, respectively; foreign government securities of $15 million and $38
million, respectively; and state and local government securities of $63 million
at December 31, 1998. There were no state and local government securities at
December 31, 1997.
C) Net Unrealized Appreciation (Depreciation) of Investments: Unrealized
appreciation (depreciation) for investments carried at fair value as of
December 31 were as follows:
<TABLE>
<CAPTION>
1998 1997
----- -----
(In
millions)
<S> <C> <C>
Unrealized appreciation
Fixed maturities.......................................... $ 515 $ 450
Equity securities......................................... 108 88
Other investments......................................... 26 --
----- -----
649 538
----- -----
Unrealized depreciation
Fixed maturities.......................................... (102) (69)
Equity securities......................................... (39) (41)
----- -----
(141) (110)
----- -----
508 428
Less deferred income taxes.................................. 163 132
----- -----
Net unrealized appreciation................................. $ 345 $ 296
===== =====
</TABLE>
F-10
<PAGE>
The components of net unrealized appreciation (depreciation) on investments
for the year ended December 31 were as follows:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- -----
(In millions)
<S> <C> <C> <C>
Unrealized appreciation (depreciation) on securities held, net
of taxes of $36, $60 and $(67), respectively................. $59 $107 $(127)
Less gains realized in net income, net of taxes of $5, $28 and
$12, respectively............................................ 10 52 22
--- ---- -----
Net unrealized appreciation (depreciation).................... $49 $ 55 $(149)
=== ==== =====
</TABLE>
D) Non-Income Producing Investments: At December 31, 1998 and 1997, fixed
maturities with carrying values of $4 million and $3 million, respectively,
were non-income producing during the preceding 12 months.
E) Derivative Financial Instruments: The Business's investment strategy is to
manage the characteristics of investment assets, such as duration, yield,
currency and liquidity, to reflect the underlying characteristics of the
related insurance and contractholder liabilities, which vary among the
Business's principal product lines. In connection with this investment
strategy, the Business's use of derivative instruments, including interest rate
and currency swaps, is generally limited to hedging applications to minimize
market risk.
Hedge accounting treatment requires a probability of high correlation between
the changes in the market value or cash flows of the derivatives and the hedged
assets or liabilities. Under hedge accounting, the changes in market value or
cash flows of the derivatives and the hedged assets or liabilities are
recognized in net income in the same period.
The Business routinely monitors, by individual counterparty, exposure to
credit risk associated with swap contracts and diversifies the portfolio among
approved dealers of high credit quality. The Business manages legal risks by
following industry standardized documentation procedures and by monitoring
legal developments.
Underlying notional or principal amounts associated with derivatives at
December 31 were as follows:
<TABLE>
<CAPTION>
1998 1997
------ ------
(In millions)
<S> <C> <C>
Interest rate swaps........................................ $ 12 $ 19
Currency swaps............................................. $ 15 $ 20
</TABLE>
Under interest rate swaps, the Business agrees with other parties to
periodically exchange the difference between variable rate and fixed rate asset
cash flows to provide stable returns for related liabilities. The Business uses
currency swaps (primarily Canadian dollars and Swiss francs) to match the
currency of investments to that of the associated liabilities. Under currency
swaps, the parties exchange principal and interest amounts in two relevant
currencies using agreed-upon exchange amounts.
The net interest cash flows from interest rate and currency swaps are
recognized currently as an adjustment to net investment income, and the fair
value of these swaps is reported as an adjustment to the related investments.
The effects of interest rate and currency swaps on the components of net
income for 1998, 1997 and 1996 were not material.
As of December 31, 1998 and 1997, the Business's variable interest rate
investments consisted of approximately $111 million and $120 million of fixed
maturities, respectively. As of December 31, 1998 and 1997, the Business's
fixed interest rate investments consisted of $8.3 billion and $8.6 billion,
respectively, of fixed maturities, and $2 million and $8 million, respectively,
of mortgage loans.
F) Other: As of December 31, 1998 and 1997, the Business had no concentration
of investments in a single investee exceeding 10% of invested equity.
F-11
<PAGE>
NOTE 4--INVESTMENT INCOME AND GAINS AND LOSSES
A) Net Investment Income: The components of net investment income for the
year ended December 31 were as follows:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
(In millions)
<S> <C> <C> <C>
Fixed maturities................................................ $573 $617 $668
Equity securities............................................... 9 6 9
Other long-term investments..................................... 11 27 23
Short-term investments.......................................... 39 46 38
---- ---- ----
632 696 738
Less investment expenses........................................ 42 49 50
---- ---- ----
Net investment income........................................... $590 $647 $688
==== ==== ====
</TABLE>
As of December 31, 1998, restructured fixed maturities on non-accrual status
were $11 million. There were no investments on non-accrual status as of
December 31, 1997. If interest on investments on non-accrual status had been
recognized in accordance with their original terms, net income would have been
increased by immaterial amounts in 1998 and 1997 and by $3 million in 1996.
B) Realized Investment Gains and Losses: Realized gains (losses) on
investments for the year ended December 31 were as follows:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
(In millions)
<S> <C> <C> <C>
Fixed maturities......................................... $ 55 $47 $15
Equity securities........................................ (40) 33 19
Other.................................................... 7 (5) 5
---- --- ---
22 75 39
Less income taxes........................................ 8 29 14
---- --- ---
Net realized investment gains............................ $ 14 $46 $25
==== === ===
</TABLE>
Realized investment gains and losses include impairments in the value of
investments, net of recoveries, of $54 million and $5 million in 1998 and 1996,
respectively. There were no impairments in 1997.
Sales of available-for-sale fixed maturities and equity securities for the
year ended December 31 were as follows:
<TABLE>
<CAPTION>
1998 1997 1996
------ ------ ------
(In millions)
<S> <C> <C> <C>
Proceeds from sales............................... $3,683 $4,162 $4,412
Gross gains on sales.............................. $ 92 $ 113 $ 125
Gross losses on sales............................. $ (34) $ (29) $ (88)
</TABLE>
NOTE 5--INVESTED EQUITY AND DIVIDEND RESTRICTIONS
The insurance departments of various jurisdictions in which the Business's
constituent insurance companies are domiciled recognize as net income and
surplus (invested equity) those amounts determined in conformity with statutory
accounting practices prescribed or permitted by the departments, which may
differ from generally accepted accounting principles. As permitted by a state
insurance department, certain of the Business's constituent insurance companies
discount certain asbestos-related and environmental pollution liabilities,
which increased statutory surplus by approximately $197 million and $217
million as of December 31, 1998 and 1997, respectively.
F-12
<PAGE>
As part of the restructuring of its domestic property and casualty
operations, CIGNA contributed $375 million of additional capital to the
Business's run-off operations, of which $250 million was contributed in 1996
and $125 million was contributed in 1995. See Note 11 for additional
information on the restructuring.
Statutory net income for the Business's constituent insurance companies was
$157 million, $188 million and $159 million for 1998, 1997 and 1996,
respectively. Statutory surplus of the Business's constituent insurance
companies was $1.40 billion and $1.39 billion as of December 31, 1998 and 1997,
respectively. Due to significant variations among prescribed accounting
practices of non-U.S. jurisdictions, the non-U.S. components of these amounts
were compiled primarily on the basis of the requirements of the state insurance
department where the Business is principally domiciled.
The Business's U.S. and non-U.S. constituent insurance companies are subject
to various regulatory restrictions that limit the amount of annual dividends or
other distributions, such as loans or cash advances, available to shareholders
without prior approval of the insurance regulatory authorities. The aggregate
maximum dividend distribution that may be made during 1999 without prior
approval is $219 million. The restricted amount of invested equity as of
December 31, 1998 was approximately $1.8 billion. The Business paid dividends
of $101 million, $177 million and $49 million in 1998, 1997 and 1996,
respectively.
NOTE 6--INCOME TAXES
The Business's net deferred tax asset of $957 million and $1.03 billion as of
December 31, 1998 and 1997, respectively, reflects management's belief that
CIGNA's taxable income in future years will be sufficient to realize the net
deferred tax assets of its subsidiaries, including those of the constituent
companies of the Business, based on CIGNA's earnings history and its future
expectations. In determining the adequacy of CIGNA's future taxable income,
management considered the future reversal of its existing taxable temporary
differences and available tax planning strategies that could be implemented, if
necessary.
Management has also considered the realizability of the net deferred tax
asset of the Business as of December 31, 1998 as if the United States companies
included in the Business filed a consolidated federal income tax return
separate from CIGNA for years beginning on January 1, 1998. Management
believes, based on its future expectations, that the Business's earnings in
future years will be sufficient to realize its net deferred tax asset. In
determining the adequacy of future taxable income, management considered the
future reversal of its existing taxable temporary differences and available tax
planning strategies that could be implemented, if necessary.
The Business's deferred tax asset is net of a valuation allowance of $47
million as of December 31, 1998 and 1997. The valuation allowance reflects
management's assessment, based on available information, that it is more likely
than not that a portion of the deferred tax asset for certain foreign
reinsurance operations will not be realized. Adjustments to the valuation
allowance will be made if there is a change in management's assessment of the
amount of the deferred tax asset that is realizable. Adjustments made to the
valuation allowance for 1998, 1997 and 1996 for the Business were immaterial.
CIGNA's federal income tax returns are routinely audited by the Internal
Revenue Service (IRS), and provisions are made in the financial statements in
anticipation of the results of these audits. The IRS has completed its audits
for years through 1993.
In management's opinion, adequate tax liabilities have been established for
all years.
F-13
<PAGE>
The tax effects of temporary differences which give rise to deferred income
tax assets and liabilities as of December 31 were as follows:
<TABLE>
<CAPTION>
1998 1997
------ ------
(In millions)
<S> <C> <C>
Deferred tax assets:
Loss reserve discounting....................................... $ 678 $ 703
Other insurance and contractholder liabilities................. 112 108
Employee and retiree benefit plans............................. 158 155
Investments, net............................................... 9 85
Bad debt expense............................................... 129 120
Foreign tax credits............................................ 68 69
Foreign currency translation................................... 71 75
Other.......................................................... 25 --
------ ------
Deferred tax assets before valuation allowance................. 1,250 1,315
Valuation allowance for deferred tax assets.................... 47 47
------ ------
Deferred tax assets, net of valuation allowance................ 1,203 1,268
------ ------
Deferred tax liabilities:
Policy acquisition expenses.................................... 39 44
Unrealized appreciation on investments......................... 163 132
Other.......................................................... 44 59
------ ------
Total deferred tax liabilities................................. 246 235
------ ------
Net deferred income tax asset................................ $ 957 $1,033
====== ======
</TABLE>
Pre-tax income for the year ended December 31 included the following
components:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
(In millions)
<S> <C> <C> <C>
U.S............................................................ $181 $193 $178
Foreign........................................................ (77) 181 148
---- ---- ----
Total income before income taxes........................... $104 $374 $326
==== ==== ====
</TABLE>
The components of income taxes for the year ended December 31 were as
follows:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
(In millions)
<S> <C> <C> <C>
Current taxes (benefits):
U. S. income.......................................... $(35) $(45) $ 18
Foreign income........................................ 21 60 80
---- ---- ----
(14) 15 98
---- ---- ----
Deferred taxes (benefits):
U. S. income.......................................... 109 119 (12)
Foreign income........................................ (65) (2) 17
---- ---- ----
44 117 5
---- ---- ----
Total income taxes.................................. $ 30 $132 $103
==== ==== ====
</TABLE>
State income taxes were not material in 1998, 1997 or 1996.
F-14
<PAGE>
Total income taxes for the year ended December 31 differs from the amount
computed using the nominal federal income tax rate of 35% for the following
reasons:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
(In millions)
<S> <C> <C> <C>
Tax expense at nominal rate............................. $ 36 $131 $114
Tax-exempt investments.................................. (19) (19) (22)
Amortization of goodwill................................ 13 12 12
Resolved federal tax audit issues....................... -- 8 --
Other................................................... -- -- (1)
---- ---- ----
Total income taxes.................................. $ 30 $132 $103
==== ==== ====
</TABLE>
NOTE 7--POSTRETIREMENT BENEFITS AND CAPITAL ACCUMULATION PLANS
A) Pension and Other Postretirement Benefit Plans: The Business provides
pension and certain health care and life insurance benefits to eligible retired
employees and agents, spouses and other eligible dependents through various
plans sponsored by CIGNA. Pension benefits are provided through a plan
sponsored by CIGNA covering most U.S. employees (the Plan) and by separate
pension plans for various non-U.S. subsidiaries and employees. CIGNA funds the
Plan at least at the minimum amount required by the Employee Retirement Income
Security Act of 1974.
At December 31, 1998 and 1997, the Business's non-U.S. pension plans had
projected benefit obligations of $194 million and $185 million, respectively,
and related assets at fair value of $111 million and $105 million,
respectively. The accumulated benefit obligation as of December 31, 1998 and
1997 related to these plans was $158 million and $152 million, respectively.
The pension liability included in accounts payable, accrued expenses and other
liabilities related to these plans was $62 million and $55 million,
respectively.
Expense for pension benefits for the Business totaled $24 million, $28
million and $37 million for 1998, 1997 and 1996, respectively, including
pension costs allocated to the Business for U.S. employees totaling $18
million, $20 million and $24 million in 1998, 1997 and 1996, respectively.
The liability for postretirement health care and life insurance benefits
included in accounts payable, accrued expenses and other liabilities as of
December 31, 1998 and 1997 was $339 million and $350 million, respectively.
Expense for postretirement benefit plans other than pensions allocated to the
Business was $1 million for both 1998 and 1997 and $6 million for 1996.
B) Capital Accumulation Plans: CIGNA sponsors various capital accumulation
plans in which employee contributions on a pre-tax basis (401(k)) are
supplemented by CIGNA matching contributions. These contributions are invested,
at the election of the employee, in one or more of the following investments:
CIGNA common stock fund, several CIGNA and non-CIGNA mutual funds, and a fixed-
income fund. In addition, beginning in 1999, CIGNA may provide additional
matching contributions, depending on its annual performance, which would be
invested in the CIGNA common stock fund. Expense for such plans allocated to
the Business for U.S. employees totaled $10 million, $7 million and $8 million
for 1998, 1997 and 1996, respectively.
NOTE 8--REINSURANCE
In the normal course of business, the Business's constituent insurance
companies enter into agreements, primarily relating to short-duration
contracts, to assume and cede reinsurance with other insurance companies.
Reinsurance is ceded primarily to limit losses from large exposures and to
permit recovery of a portion of direct losses, although ceded reinsurance does
not relieve the originating insurer of primary liability. The Business
evaluates the financial condition of its reinsurers and monitors concentrations
of credit risk arising from similar geographic regions, activities or economic
characteristics of its reinsurers. As of December 31,
F-15
<PAGE>
1998 and 1997, approximately 5% and 7%, respectively, of reinsurance
recoverables were due from more than 100 syndicates affiliated with Lloyd's of
London.
Failure of reinsurers to indemnify the Business, as a result of reinsurer
insolvencies and disputes, could result in losses. Allowances for uncollectible
amounts were $705 million and $720 million as of December 31, 1998 and 1997,
respectively. Future charges for unrecoverable reinsurance may materially
affect results of operations in future periods; however, such amounts are not
expected to have a material adverse effect on the Business's liquidity or
financial condition.
The effects of reinsurance on net earned premiums and fees from short-
duration contracts for the year ended December 31 were as follows:
<TABLE>
<CAPTION>
1998 1997 1996
------- ------- -------
(In millions)
<S> <C> <C> <C>
Premiums and fees:
Direct....................................... $ 3,994 $ 4,076 $ 4,358
Assumed...................................... 417 530 676
Ceded........................................ (1,454) (1,452) (1,617)
------- ------- -------
Net earned premiums and fees............... $ 2,957 $ 3,154 $ 3,417
======= ======= =======
</TABLE>
The effects of reinsurance on written premiums and fees were not materially
different from the amounts shown in the above table.
Losses and settlement expenses for 1998, 1997 and 1996 were net of
reinsurance recoveries of $1.46 billion, $832 million and $1.25 billion,
respectively.
NOTE 9--PROPERTY AND CASUALTY UNPAID CLAIMS AND CLAIM EXPENSE RESERVES AND
REINSURANCE RECOVERABLES
As described in Note 2(K), the Business establishes loss reserves, which are
estimates of future payments of reported and unreported claims for losses and
related expenses, with respect to insured events that have occurred.
Activity in the reserve for unpaid claims and claim adjustment expenses for
the year ended December 31 was as follows:
<TABLE>
<CAPTION>
1998 1997 1996
------- ------- -------
(In millions)
<S> <C> <C> <C>
Gross reserve--January 1............................... $15,136 $16,529 $17,079
Less reinsurance recoverable........................... 5,374 6,040 6,066
------- ------- -------
Net reserve--January 1................................. 9,762 10,489 11,013
------- ------- -------
Plus incurred claims and claim adjustment expenses:
Provision for insured events of the current year..... 2,049 1,990 2,257
Increase in provision for insured events of prior
years............................................... 177 218 177
------- ------- -------
Total incurred claims and claim adjustment
expenses.......................................... 2,226 2,208 2,434
------- ------- -------
Less payments for claims and claim adjustment expenses
attributable to:
Insured events of the current year................... 910 871 793
Insured events of prior years........................ 1,745 2,064 2,165
------- ------- -------
Total payments for claims and claim adjustment
expenses.......................................... 2,655 2,935 2,958
------- ------- -------
Net reserve--December 31............................... 9,333 9,762 10,489
Plus reinsurance recoverable........................... 5,503 5,374 6,040
------- ------- -------
Gross reserve--December 31............................. $14,836 $15,136 16,529
======= ======= =======
</TABLE>
F-16
<PAGE>
The basic assumption underlying the many traditional actuarial and other
methods used in the estimation of property and casualty loss reserves is that
past experience is an appropriate basis for predicting future events. However,
current trends and other factors that would modify past experience are also
considered. The process of establishing loss reserves is subject to
uncertainties that are normal, recurring and inherent in the property and
casualty business.
Reserving for property and casualty claims continues to be a complex and
uncertain process, requiring the use of informed estimates and judgments. The
Business's estimates and judgments may be revised as additional experience and
other data become available and are reviewed, as new or improved methodologies
are developed or as current law changes. Any such revisions could result in
future changes in estimates of losses or reinsurance recoverables, and would be
reflected in the Business's results of operations for the period in which the
estimates are changed. While the effect of any such changes in estimates of
losses or reinsurance recoverables could be material to future results of
operations, the Business does not expect such changes to have a material effect
on its liquidity or financial condition.
In management's judgment, information currently available has been
appropriately considered in estimating the Business's loss reserves and
reinsurance recoverables.
The Business's reserves for A&E exposures as of December 31 were as follows:
<TABLE>
<CAPTION>
1998 1997
----------- -------------
Gross Net Gross Net
------ ---- ------ ------
(In millions)
<S> <C> <C> <C> <C>
Asbestos.............................................. $ 841 $523 $ 846 $ 509
Environmental......................................... $1,212 $941 $1,404 $1,059
</TABLE>
The Business's reserves for A&E claims are a reasonable estimate of its
liability for these claims, based on currently known facts, reasonable
assumptions where the facts are not known, current law and methodologies
currently available.
Charges to income for increases in the Business's liability for insured
events of prior years (prior year development) for A&E losses and charges for
unrecoverable reinsurance in the aggregate were $160 million, $148 million and
$117 million for 1998, 1997 and 1996, respectively.
Prior year development, other than for A&E claims and charges for
unrecoverable reinsurance, was $17 million, $70 million and $60 million for
1998, 1997 and 1996, respectively.
The Business's operations routinely insure various forms of property,
including large property risks. A major catastrophe could have a material
adverse effect on the Business's results of operations. However, because the
Business, through its risk assessment and accumulation processes, monitors
writings to avoid significant concentrations, it is not likely that the adverse
effect of a major catastrophe would be material to the Business's liquidity or
financial condition.
NOTE 10--LEASES AND RENTALS
Rental expenses for operating leases, principally with respect to buildings,
amounted to $67 million, $70 million and $67 million in 1998, 1997 and 1996,
respectively.
As of December 31, 1998, future net minimum rental payments under non-
cancelable operating leases were approximately $302 million, payable as
follows: 1999--$51 million; 2000--$41 million; 2001--$39 million; 2002--$35
million; 2003--$32 million; and $104 million thereafter.
F-17
<PAGE>
NOTE 11--SEGMENT INFORMATION
Effective December 31, 1995, the domestic property and casualty operations of
the Business were restructured into separate ongoing and run-off operations.
The ongoing operations, which are actively engaged in selling insurance
products and related services, provide commercial insurance and risk management
services. The run-off operations, which do not actively sell insurance
products, manage run-off policies and related claims, including those for A&E
exposures. As part of this restructuring, the ongoing operations assumed $125
million of liabilities, primarily related to employee benefits of the run-off
operations, and committed to contribute an additional $50 million to the run-
off operations on or before December 31, 2001. In addition, the ongoing
operations reinsured up to $800 million of claims of the run-off operations in
the unlikely event that the statutory capital and surplus of the run-off
operations falls below $25 million. The property and casualty restructuring is
being contested in court by certain competitors and policyholders. Although the
Business expects the matter to be in litigation for some time, it expects to
ultimately prevail.
CIGNA's operating segments, which are based on CIGNA's internal reporting
structure, generally reflect differences in products. The Business is reported
in one segment, the property and casualty segment, which includes ongoing and
run-off operations.
The property and casualty segment's ongoing operations comprise international
and domestic operations. International operations provide property and casualty
and accident and health insurance coverages and services outside the United
States. The international property and casualty operations underwrite large and
unique risks for targeted commercial customer markets. The international
accident and health insurance operations provide products that are designed to
meet the insurance needs of individuals and groups outside of the U.S.
insurance markets. Domestic operations provide commercial insurance and risk
management services to U.S. businesses of all sizes and to other groups and
individuals with specialized insurance needs. Products include multi-line and
mono-line insurance coverages and related services for large-risk property and
casualty customers and insurance products and related services for businesses,
groups and individuals with specialized insurance needs and for customers in
the standard insurance market.
Run-off operations primarily reflects current year losses associated with
unearned premiums as of December 31, 1995, prior year development on claim and
claim adjustment expense reserves, and investment activity.
The Business uses operating income (net income excluding after-tax realized
investment results) to measure the financial results of its operations.
Operating income is determined on a basis consistent with the accounting
policies for the combined financial statements. The Business allocates general,
administrative and systems expenses to operations on systematic bases. Income
taxes are generally computed as if each operation were filing a separate income
tax return.
The Business's operations are not materially dependent on one or a few
customers, brokers or agents.
F-18
<PAGE>
Summarized financial information for the Business's operations for the year
ended and as of December 31 was as follows:
<TABLE>
<CAPTION>
1998 1997 1996
------ ------ ------
(In millions)
<S> <C> <C> <C>
International Operations
Premiums and fees and other revenues................... $1,461 $1,552 $1,603
Net investment income.................................. 102 118 118
------ ------ ------
Revenues............................................... $1,563 $1,670 $1,721
Income tax expense..................................... $ 1 $ 62 $ 78
Operating income (loss)................................ $ (13) $ 106 $ 130
Invested assets........................................ $1,938 $1,938 $2,067
Domestic Operations
Premiums and fees and other revenues................... $1,774 $1,862 $1,879
Net investment income.................................. 238 247 268
------ ------ ------
Revenues............................................... $2,012 $2,109 $2,147
Income tax expense..................................... $ 35 $ 52 $ 28
Operating income....................................... $ 85 $ 99 $ 76
Invested assets........................................ $3,542 $3,436 $3,780
Run-off Operations
Premiums and fees and other revenues................... $ 4 $ 26 $ 163
Net investment income.................................. 250 282 302
------ ------ ------
Revenues............................................... $ 254 $ 308 $ 465
Income tax benefits.................................... $ (14) $ (11) $ (17)
Operating loss......................................... $ (12) $ (9) $ (8)
Invested assets........................................ $3,551 $3,896 $4,102
</TABLE>
<TABLE>
<CAPTION>
1998 1997 1996
------ ------ ------
(In millions)
<S> <C> <C> <C>
Realized Investment Gains
Realized investment gains............................... $ 22 $ 75 $ 39
Income tax expense...................................... 8 29 14
------ ------ ------
Realized investment gains, net of taxes................. $ 14 $ 46 $ 25
------ ------ ------
Total
Premiums and fees and other revenues.................... $3,239 $3,440 $3,645
Net investment income................................... 590 647 688
Realized investment gains............................... 22 75 39
------ ------ ------
Total revenues.......................................... $3,851 $4,162 $4,372
Income tax expense...................................... $ 30 $ 132 $ 103
Operating income........................................ $ 60 $ 196 $ 198
Realized investment gains, net of taxes................. 14 46 25
------ ------ ------
Net income.............................................. $ 74 $ 242 $ 223
Invested assets......................................... $9,031 $9,270 $9,949
------ ------ ------
</TABLE>
F-19
<PAGE>
Premiums and fees and other revenues by product type were as follows for the
year ended December 31:
<TABLE>
<CAPTION>
1998 1997 1996
------ ------ ------
(In millions)
<S> <C> <C> <C>
Property.................................................. $ 758 $ 847 $ 866
Accident and health....................................... 457 473 478
Workers' compensation..................................... 457 420 433
Casualty.................................................. 395 400 349
Marine and aviation....................................... 382 393 401
Auto...................................................... 275 282 365
Commercial packages....................................... 184 203 251
Run-off and other......................................... 49 136 274
------ ------ ------
Total premiums and fees................................. 2,957 3,154 3,417
Other revenues.......................................... 282 286 228
------ ------ ------
Total premiums and fees and other revenues............ $3,239 $3,440 $3,645
====== ====== ======
</TABLE>
NOTE 12--COST REDUCTION PLAN
In the fourth quarter of 1998, the Business adopted a cost reduction plan to
restructure certain of its domestic and international operations, which
resulted in a pre-tax charge of $28 million ($18 million after-tax) included
primarily in other operating expenses. For 1998, the operating loss of the
Business's international operations and the operating income of the Business's
domestic operations include pre-tax charges of $10 million and $18 million,
respectively, for this cost reduction plan (see Note 11).
The components of the Business's $18 million after-tax charge for the cost
reduction plan were as follows: severance, $12 million, for costs associated
with nonvoluntary terminations of approximately 400 employees in various
functions and locations; and $6 million, primarily related to vacated lease
space. The cash outlays associated with these initiatives will be substantially
completed by the end of 2000 with most occurring in 1999.
NOTE 13--NON-U.S. OPERATIONS
The Business provides international property and casualty insurance coverages
on a direct and reinsured basis, primarily in Europe, the Pacific region,
Canada and Latin America.
For the year ended December 31, 1998, 1997 and 1996, the change in net
translation of foreign currencies reflects increases (decreases) to invested
equity of $5 million (including taxes of $4 million), $(70) million (including
a tax benefit of $37 million) and $3 million (including a tax benefit of $8
million), respectively.
Premiums and fees and other revenues by geographic location of operations for
the year ended December 31 were as follows:
<TABLE>
<CAPTION>
1998 1997 1996
------ ------ ------
(In millions)
<S> <C> <C> <C>
U.S................................................. $1,760 $1,853 $1,918
Non-U.S.:
Japan............................................. 360 397 428
United Kingdom.................................... 290 298 311
Other............................................. 829 892 988
------ ------ ------
Total non-U.S..................................... 1,479 1,587 1,727
------ ------ ------
Total premiums and fees and other revenues...... $3,239 $3,440 $3,645
====== ====== ======
</TABLE>
F-20
<PAGE>
The Business's aggregate foreign exchange transaction losses and foreign
long-lived assets for the year ended and as of December 31, 1998, 1997 and 1996
were not material.
NOTE 14--RELATED PARTY TRANSACTIONS
CIGNA incurs certain general and administrative expenses on behalf of the
Business. These expenses are either charged directly to the Business for
specific services provided or allocated to the Business. Direct and allocated
general and administrative expenses are included in losses and expenses, and
aggregated $78 million, $69 million and $75 million before tax in 1998, 1997
and 1996, respectively. These amounts do not include expenses allocated for
employee benefit plans as described in Note 7. The various allocation methods
and bases employed by CIGNA are selected based upon the nature of the expense
and other facts and circumstances. Management believes that the terms of the
transactions described below and the methods used by CIGNA to allocate expenses
are reasonable; however, these terms and allocation methods are not necessarily
indicative of the terms and expenses that would have been incurred had the
Business not been affiliated with CIGNA during the periods presented.
At December 31, 1998 and 1997, the Business had interest-bearing notes
receivable from a CIGNA affiliate of $10 million and $31 million, on which
interest income was not material in 1998, 1997 or 1996.
At December 31, 1997, the Business had a mortgage loan receivable from a
CIGNA affiliate of $40 million, which is included in receivables from
affiliates and collateralized by the related real estate property. The loan was
repaid early in 1998. Interest income from this receivable was $3 million in
both 1997 and 1996.
The Business, together with other CIGNA affiliates, has entered into an
investment pooling arrangement, the CIGNA Corporate Liquidity Account (the
Account), for the purpose of maximizing earnings on funds available for short-
term investment. Withdrawals from the Account, up to the total amount of the
Business's investment in the Account, are allowed on a demand basis. The
Business had balances in the Account of $466 million and $328 million as of
December 31, 1998 and 1997, respectively, which are included in short-term
investments or cash and cash equivalents.
The Business held reinsurance recoverables of $211 million and $205 million
at December 31, 1998 and 1997, respectively, related to annuities purchased
from CIGNA life insurance affiliates related to structured settlements with
various claimants, under which periodic claim payments are made by the
affiliates directly to the claimants.
The Business had lines of credit and other credit arrangements with another
CIGNA affiliate totaling $1.2 billion at December 31, 1998 and 1997. Such
borrowings generally are payable on demand with interest rates approximating
CIGNA's average monthly short-term borrowing rate plus 1/4 of 1%. The Business
had borrowings outstanding of $299 million and $178 million as of December 31,
1998 and 1997, respectively, on such credit arrangements, which are included in
payables to affiliates. The related interest expense was $14 million, $8
million and $13 million for 1998, 1997 and 1996, respectively.
Certain non-U.S. insurance companies included in the Business write business
which requires a guarantee that claims will be paid in the event of
nonperformance by the subsidiary. To satisfy this requirement, guarantees have
been obtained from CIGNA for the payment of claims for such policies. At
December 31, 1998 and 1997, liabilities subject to such guarantees were
approximately $171 million. Fees charged by CIGNA for the guarantees were not
material.
Constituent insurance companies of the Business contract with a CIGNA
affiliate to receive medical utilization review services for certain casualty
lines of business, primarily workers' compensation. Expenses associated with
the contract were $51 million, $63 million and $68 million for 1998, 1997 and
1996, respectively.
F-21
<PAGE>
At December 31, 1998, payables to affiliates include a dividend payable to
CIGNA of $91 million declared by constituent companies of the Business on
December 10, 1998 and paid on January 8, 1999. Of this amount, $12 million was
payable from the proceeds of a dividend paid to the Business by an affiliate in
December 1998.
The Business pays or collects certain amounts, including general expenses,
insurance and reinsurance premiums, losses, and loss recoveries on behalf of
CIGNA affiliates. At December 31, 1998 and 1997, receivables from affiliates
include $77 million and $76 million, respectively, and payables to affiliates
include $68 million and $49 million, respectively, in connection with such
payment or collection services.
NOTE 15--CONTINGENCIES
Financial Guarantees
The Business, through its constituent insurance companies, is contingently
liable for various financial guarantees provided in the ordinary course of
business. These are primarily guarantees for the repayment of municipal bond
obligations.
The Business is liable for municipal guarantee business of $720 million and
$816 million at December 31, 1998 and 1997, respectively, which have maturities
of up to 32 years. Such amounts are fully reinsured through a subsidiary of
MBIA Inc., a corporation that guarantees the scheduled payment of principal and
interest for many types of municipal obligations, including general obligation
and special revenue bonds. The nature of this guarantee business is similar to
the reinsurance transactions described in Note 8. Municipal guarantees provide
for payment of debt service only as it becomes due; consequently, an event of
default would not cause an acceleration of scheduled principal and interest
payments. As of December 31, 1998 and 1997, loss reserves and unearned premiums
under these programs were not material.
Although the ultimate outcome of any loss contingencies arising from the
Business's financial guarantees may adversely affect results of operations in
future periods, they are not expected to have a material adverse effect on the
Business's liquidity or financial condition.
Regulatory and Industry Developments
The Business's operations are subject to a changing social, economic, legal,
legislative and regulatory environment that could affect them. Some of the
changes include initiatives to revise the system of funding cleanup of
environmental damages; reinterpret insurance contracts long after the policies
were written to provide coverage unanticipated by the Business; and restrict
insurance pricing and the application of underwriting standards. Some of the
more significant issues are discussed below.
Proposals for Superfund reform remain under consideration by Congress. Any
changes in Superfund relating to (1) assigning responsibility, (2) funding
cleanup costs or (3) establishing cleanup standards could affect the
liabilities of policyholders and insurers. Due to uncertainties associated with
the timing and content of any future Superfund legislation, the effect on the
Business's results of operations, liquidity or financial condition cannot be
reasonably estimated at this time.
In 1998, the National Association of Insurance Commissioners adopted
standardized statutory accounting principles that were adopted by the
Pennsylvania Insurance Department with an effective date of January 1, 2001.
Since these principles have not been adopted by the insurance departments of
other jurisdictions in which the Business's constituent domestic insurance
companies are domiciled and since the NAIC is considering amendments to the
guidance that would also be effective upon implementation, the timing and
effects of implementation have not yet been determined.
The Business is contingently liable for possible assessments under regulatory
requirements pertaining to potential insolvencies of unaffiliated insurance
companies and other insurance-related assessments. Mandatory
F-22
<PAGE>
assessments, which are subject to statutory limits, can be partially recovered
through a reduction in future premium taxes in some states. The Business's
constituent insurance companies recorded pre-tax charges of $28 million, $38
million and $29 million for 1998, 1997 and 1996, respectively, for estimated
guaranty fund assessments and other insurance-related assessments before giving
effect to future premium tax recoveries. In addition, as discussed in Note 2,
the Business expects to record an approximately $85 million reduction of net
income in the first quarter of 1999 to reflect the effect of implementing SOP
97-3 for insurance-related assessments. Although future assessments and
payments may adversely affect results of operations in future periods, such
amounts are not expected to have a material adverse effect on the Business's
liquidity or financial condition.
The eventual effect on the Business of the changing environment in which it
operates remains uncertain.
Litigation
The Business is continuously involved in numerous lawsuits arising, for the
most part, in the ordinary course of business, either as a liability insurer
defending third-party claims brought against its insureds or as an insurer
defending coverage claims brought against it by its policyholders or other
insurers. One such area of litigation involves policy coverage and judicial
interpretation of legal liability for A&E claims.
While the outcome of all litigation involving the Business, including
insurance-related litigation, cannot be determined, litigation (including that
related to A&E claims) is not expected to result in losses that differ from
recorded reserves by amounts that would be material to results of operations,
liquidity or financial condition. Also, reinsurance recoveries related to
claims in litigation, net of the allowance for uncollectible reinsurance, are
not expected to result in recoveries that differ from recorded recoverables by
amounts that would be material to results of operations, liquidity or financial
condition.
F-23
