March 8, 1999
Securities and Exchange Commission
Washington, D.C. 20549
Gentlemen:
Pursuant to the requirements of the Securities and Exchange Act of 1934, we are
transmitting herewith the attached Form 8-K.
Should you have any questions regarding the attached Form 8-K, please do not
hesitate to contact me at (972)831-5013.
Sincerely,
/s/Patricia S. Pickard
Controller, TIG Insurance Company
(Principal Accounting Officer)
<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) March 8, 1999
TIG HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
Delaware 1-11856 94-3172455
(State or (Commission File No.) (IRS Employer
other jurisdiction Identification No.)
Incorporation)
65 East 55th Street, 28th Floor, New York, New York 10022 (Address
of principal executive offices) (zip code)
Registrant's telephone number including area code: 212-446-2700
- --------------------------------------------------------------------------------
None
- --------------------------------------------------------------------------------
(Former name or former address, if changed since last report)
<PAGE>
- --------------------------------------------------------------------------------
Item 7. Financial Statements.
(c) Exhibits
Exhibit
No. Description
99.1 Audited Consolidated Financial Statements of TIG Holdings, Inc. as of
December 31, 1998 and 1997, and for each of the three years in the
period ended December 31, 1998.
27 Financial Data Schedule - Insurance Companies, Article 7
of Regulation S-X (34 Act Guide 4).
<PAGE>
SIGNATURES
- --------------------------------------------------------------------------------
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
TIG Holdings. Inc.
----------------------------------
(Registrant)
Date: March 8, 1999 By: /s/William H. Huff, III
(Signature)
Name: William H. Huff, III
Title: Senior Vice President and
General Counsel
<PAGE>
Exhibit Index
Sequentially
Exhibit Numbered
Number Exhibit Pages
99.1 Audited Consolidated Financial Statements of TIG Holdings, Inc. as of
December 31, 1998 and 1997, and for each of the three years in the period
ended December 31, 1998*.
27 Financial Data Schedule - Insurance Companies, Article 7
of Regulation S-X (34 Act Guide 4).
- -----------------------------
*Filed herewith
<PAGE>
TIG Holdings, Inc.
AUDITED CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 1998 and 1997, and
for each of the three years in the period ended
December 31, 1998
<PAGE>
Table of Contents
- -------------------------------------------------------------------------------
Page
Report of Independent Auditors..............................................1
Consolidated Balance Sheets at December 31, 1998 and 1997...................2
Consolidated Statements of Income for each of the three years
in the period ended December 31, 1998 ......................................3
Consolidated Statements of Comprehensive Income for each of
the three years in the period ended December 31, 1998 ......................4
Consolidated Statements of Changes in Shareholders' Equity
for each of the three years in the period ended December 31, 1998 ..........5
Consolidated Statements of Cash Flows for each of the three years
in the period ended December 31, 1998.......................................6
Notes to Consolidated Financial Statements..................................7
- --------------------------------------------------------------------------------
<PAGE>
REPORT OF INDEPENDENT AUDITORS
Board of Directors
TIG Holdings, Inc.
We have audited the accompanying consolidated balance sheets of TIG
Holdings, Inc. and subsidiaries as of December 31, 1998 and 1997, and the
related consolidated statements of income, comprehensive income, shareholders'
equity, and cash flows for each of the three years in the period ended December
31, 1998. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
TIG Holdings, Inc. and subsidiaries at December 31, 1998 and 1997, and the
consolidated 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.
ERNST & YOUNG LLP
Dallas, Texas
February 3, 1999
1
<PAGE>
- --------------------------------------------------------------------------------
TIG HOLDINGS, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31,
--------------------------
(In millions, except share data) 1998 1997
---------------------------------------------------------------------------------------- ----------- --------------
<S> <C> <C>
Assets
Investments:
Fixed maturities, at market (cost: $3,484 in 1998 and $3,725 in 1997) $3,618 $3,874
Short-term and other investments (cost: $276 in 1998 and $316 in 1997) 276 318
---------------------------------------------------------------------------------------- ----------- --------------
Total investments 3,894 4,192
Cash 72 18
Accrued investment income 50 56
Premium receivable (net of allowance of $13 in 1998 and $5 in 1997) 521 453
Reinsurance recoverable on paid losses (net of allowance of $13 in 1998 and $6 82 125
in 1997)
Reinsurance recoverable on unpaid losses (net of allowance of $20 in 1998 and $3 1,998 1,404
in 1997)
Deferred policy acquisition costs 137 155
Prepaid reinsurance premium 188 177
Income taxes 129 140
Other assets 144 147
---------------------------------------------------------------------------------------- ----------- --------------
Total assets $7,215 $6,867
---------------------------------------------------------------------------------------- ----------- --------------
Liabilities
Reserves for:
Losses $3,659 $3,459
Loss adjustment expenses 441 476
Unearned premium 719 738
---------------------------------------------------------------------------------------- ----------- --------------
Total reserves 4,819 4,673
Reinsurance premium payable 80 61
Funds held under reinsurance agreements 564 319
Notes payable 125 122
Other liabilities 350 379
---------------------------------------------------------------------------------------- ----------- --------------
Total liabilities $5,938 $5,554
---------------------------------------------------------------------------------------- ----------- --------------
Mandatory redeemable 8.597% capital securities of subsidiary trust 125 125
Mandatory redeemable preferred stock 25 25
Shareholders' Equity
Common stock - par value $0.01 per share
(authorized: 180,000,000 shares; issued and outstanding:
67,574,664 shares in 1998 and 66,955,288 shares in 1997) 1,274 1,257
Retained earnings 229 253
Accumulated other comprehensive income:
Net unrealized gain on fixed maturity investments, net of taxes 87 98
Net unrealized loss on foreign exchange, net of taxes (2) (2)
---------------------------------------------------------------------------------------- ----------- --------------
1,588 1,606
Treasury stock (16,258,097 shares in 1998 and 15,597,021 shares in 1997) (461) (443)
---------------------------------------------------------------------------------------- ----------- --------------
Total shareholders' equity $1,127 $1,163
---------------------------------------------------------------------------------------- ----------- --------------
Total liabilities and shareholders' equity $7,215 $6,867
---------------------------------------------------------------------------------------- ----------- --------------
</TABLE>
See Notes to Consolidated Financial Statements.
2
<PAGE>
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TIG HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------
(In millions, except share data) 1998 1997 1996
---------------------------------------------------------------------- ----------- ----------- -----------
<S> <C> <C> <C>
Revenues
Net premium earned $1,447 $1,466 $1,539
Net investment income 235 290 290
Net investment and other gain (loss) (12) 1 (4)
---------------------------------------------------------------------- ----------- ----------- -----------
Total revenues 1,670 1,757 1,825
---------------------------------------------------------------------- ----------- ----------- -----------
Losses and expenses
Net losses and loss adjustment expenses incurred 1,041 1,151 1,138
Policy acquisition and other underwriting expenses 502 466 463
Dividends to policyholders 24 14 3
Corporate expenses 81 44 37
Interest expense on long-term debt 23 20 9
Restructuring charges - - 100
---------------------------------------------------------------------- ----------- ----------- -----------
Total losses and expenses 1,671 1,695 1,750
---------------------------------------------------------------------- ----------- ----------- -----------
Income (loss) before income tax benefit (expense) (1) 62 75
Income tax benefit (expense) 9 (10) 4
---------------------------------------------------------------------- ----------- ----------- -----------
Net income $8 $52 $79
---------------------------------------------------------------------- ----------- ----------- -----------
Net income per common share:
Basic $0.13 $0.97 $1.36
Diluted $0.13 $0.94 $1.32
---------------------------------------------------------------------- ----------- ----------- -----------
Dividends per common share $0.60 $0.60 $0.20
---------------------------------------------------------------------- ----------- ----------- -----------
</TABLE>
See Notes to Consolidated Financial Statements.
3
<PAGE>
- --------------------------------------------------------------------------------
TIG HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
<TABLE>
<CAPTION>
Years Ended December 31,
-------------------------------------
(In millions) 1998 1997 1996
- ------------------------------------------------------------------------------------ ----------- ------------ ------------
<S> <C> <C> <C>
Net income $8 $52 $79
Other comprehensive income (loss):
Unrealized gains (losses) on securities, net of reclassification adjustment (17) 71 (88)
Foreign currency translation adjustments - (1) -
- ------------------------------------------------------------------------------------ ----------- ------------ ------------
Other comprehensive income (loss), before income taxes (17) 70 (88)
Provision for income taxes related to other comprehensive income (loss) items 6 (25) 30
- ------------------------------------------------------------------------------------ ----------- ------------ ------------
Other comprehensive income (loss) (11) 45 (58)
Comprehensive income (loss) ($3) $97 $21
- ------------------------------------------------------------------------------------ ----------- ------------ ------------
Other comprehensive income (loss):
Unrealized gain (loss) during year, net of tax expense of $5 $10
Reclassification adjustment, net of tax benefit of $11 (21)
- ------------------------------------------------------------------------------------ -----------
Other comprehensive income (loss) ($11)
- ------------------------------------------------------------------------------------ -----------
</TABLE>
See Notes to Consolidated Financial Statements.
4
<PAGE>
- -------------------------------------------------------------------------------
TIG HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------------
(In millions) 1998 1997 1996
----------------------------------------------------------------------- ------------- ------------- -------------
<S> <C> <C> <C>
Common Stock
Balance at beginning of year $1,257 $1,198 $1,186
Common stock issued 10 42 9
Income tax benefit from stock options exercised - 13 -
Conversion of Class A common stock - - 1
Amortization of unearned compensation 7 4 2
----------------------------------------------------------------------- ------------- ------------- -------------
Balance at end of year 1,274 1,257 1,198
----------------------------------------------------------------------- ------------- ------------- -------------
Class A common stock
Balance at beginning of year - - 1
Conversion of Class A common stock - - (1)
----------------------------------------------------------------------- ------------- ------------- -------------
Balance at end of year - - -
----------------------------------------------------------------------- ------------- ------------- -------------
Retained earnings
Balance at beginning of year 253 234 168
Net income 8 52 79
Common stock dividends (30) (31) (11)
Preferred stock dividends (2) (2) (2)
----------------------------------------------------------------------- ------------- ------------- -------------
Balance at end of year 229 253 234
----------------------------------------------------------------------- ------------- ------------- -------------
Accumulated other comprehensive income
Balance at beginning of year 96 51 109
Change in unrealized gain (loss) on fixed maturity
investments (11) 46 (58)
Change in net unrealized loss on foreign exchange - (1) -
----------------------------------------------------------------------- ------------- ------------- -------------
Balance at end of year 85 96 51
----------------------------------------------------------------------- ------------- ------------- -------------
Treasury stock
Balance at beginning of year (443) (276) (88)
Treasury stock purchased (18) (167) (188)
----------------------------------------------------------------------- ------------- ------------- -------------
Balance at end of year (461) (443) (276)
----------------------------------------------------------------------- ------------- ------------- -------------
Total shareholders' equity at end of year $1,127 $1,163 $1,207
----------------------------------------------------------------------- ------------- ------------- -------------
</TABLE>
See Notes to Consolidated Financial Statements.
5
<PAGE>
- --------------------------------------------------------------------------------
TIG HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------------
(In millions) 1998 1997 1996
----------------------------------------------------------------------- ------------- ------------- -------------
<S> <C> <C> <C>
Operating Activities
Net income $8 $52 $79
Adjustments to reconcile net income to cash provided
by (used in) operating activities:
Changes in:
Accrued investment income 6 1 (1)
Premium receivable (68) (33) (11)
Reinsurance recoverable (551) (265) (43)
Deferred policy acquisition costs 18 (11) -
Prepaid reinsurance premium (11) (72) 6
Income taxes 11 (62) (11)
Loss reserves 200 374 (73)
Loss adjustment expense reserves (35) (44) (53)
Unearned premium reserves (19) 42 (16)
Reinsurance premium payable 19 (27) 19
Funds held under reinsurance agreements 245 64 104
Other assets and other liabilities 54 (9) (26)
Net investment and other (gain) loss 12 (1) 4
Other 20 3 20
----------------------------------------------------------------------- ------------- ------------- -------------
Net cash provided by (used in) operating (91) 12 (2)
activities
----------------------------------------------------------------------- ------------- ------------- -------------
Investing Activities
Purchases of fixed maturity investments (4,091) (2,884) (1,920)
Sales of fixed maturity investments 3,465 2,822 1,907
Maturities and calls of fixed maturity investments 817 365 252
Sale of Independent Agents business - (120) -
Net decrease (increase) in short-term investments and other 42 (169) (28)
Other (51) (6) (5)
----------------------------------------------------------------------- ------------- ------------- -------------
Net cash provided by investing activities 182 8 206
----------------------------------------------------------------------- ------------- ------------- -------------
Financing Activities
Borrowing on line of credit 70 - -
Repayments on line of credit (70) - -
Common stock issued 10 42 9
Income tax benefit from stock options exercised - 13 -
Mandatory redeemable capital securities issued - 125 -
Acquisition of treasury stock (18) (167) (188)
Common stock dividends (30) (31) (11)
Preferred stock dividends (2) (2) (2)
Increase (decrease) in notes payable 3 (1) 3
----------------------------------------------------------------------- ------------- ------------- -------------
Net cash used in financing activities (37) (21) (189)
----------------------------------------------------------------------- ------------- ------------- -------------
Increase (decrease) in cash 54 (1) 15
Cash at beginning of period 18 19 4
----------------------------------------------------------------------- ------------- ------------- -------------
Cash at end of period $72 $18 $19
----------------------------------------------------------------------- ------------- ------------- -------------
</TABLE>
See Notes to Consolidated Financial Statements.
6
<PAGE>
TIG HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE A. DESCRIPTION OF BUSINESS
- --------------------------------------------------------------------------------
TIG Holdings is primarily engaged in the business of property/casualty insurance
and reinsurance through its 14 domestic insurance subsidiaries, collectively
"TIG" or "the Company". Of direct premium written by TIG in 1998, 21% was
written in California, 9% in Florida, 7% in Michigan, 6% in New York, and 5% in
Hawaii. No other geographical area, including foreign operations, accounted for
more than 5% of direct premium written. A description of each operating
segments' principal products follows (see also Note P - Operating Segments).
Reinsurance. TIG's reinsurance operations are conducted through TIG Reinsurance
Company ("TIG Re"). Reinsurance is a form of insurance whereby the reinsurer
(i.e., TIG Re) agrees to indemnify another insurance company (the "ceding
company") for all or a portion of the insurance risks underwritten by the ceding
company under an insurance policy or policies. TIG Re writes both pro rata and
excess of loss coverages. TIG Re provides pro rata coverages when the ceding
company's underwriting capabilities are considered superior and where the
relationship with the ceding company provides an opportunity for long-term
profitability. TIG Re's primary strategy for excess of loss treaties is to take
large participations in working layers of a limited number of programs. By
assuming a significant participation in each treaty, TIG Re exercises
significant control over the terms and structure of each treaty. TIG Re's
predominant source of business is through reinsurance intermediaries. Net
premium written for the Reinsurance division comprised 29%, 36% and 36% of
consolidated net premium written for the years ended December 31, 1998, 1997 and
1996, respectively.
Commercial Specialty. Commercial Specialty coverages provide protection against
property loss and legal liability for injuries to other persons or damage to
their property arising from the policyholder's business operations. Commercial
Specialty primarily develops and markets insurance programs where the nature of
the risk does not lend itself to traditional commercial insurance. Significant
programs include Sports and Leisure, with products for professional and amateur
sports events; Workers' Compensation, which provides liability coverage to
employers for payment of employee benefits associated with employment related
accidents as mandated by state laws; Primary Casualty, which focuses on
commercial auto, professional liability, construction and marine programs;
Excess Casualty which offers lead umbrella and excess umbrella policies; and
participation in three Lloyd's of London syndicates writing marine, UK property
and aviation business. Commercial Specialty products are principally marketed
through large general agents, with which TIG sometimes has exclusive marketing
contracts. Net premium written for the Commercial Specialty division comprised
53%, 41% and 29% of consolidated net premium written for the years ended
December 31, 1998, 1997 and 1996, respectively.
Custom Markets. Custom Markets' principal products are standard automobile,
non-standard automobile, homeowners and small business owner's insurance.
Automobile policies cover liability to third parties for bodily injury and
property damage and physical damage to the insured's own vehicle resulting from
collision or various other causes of loss. Homeowners and small commercial
property policies protect against loss of dwellings/buildings and contents
arising from a variety of perils, as well as liability arising from ownership or
occupancy. Custom Markets' products are distributed through strategic
relationships with general agents ("GAs") and other key distribution partners.
Net premium written for the Custom Markets division comprised 20%, 13% and 6% of
consolidated net premium written for the years ended December 31, 1998, 1997 and
1996, respectively.
7
<PAGE>
TIG HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE B. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
- --------------------------------------------------------------------------------
Basis of Presentation. The consolidated financial statements are prepared in
accordance with generally accepted accounting principles ("GAAP") and include
the accounts of TIG Holdings, Inc. and its subsidiaries. Intercompany
transactions are eliminated in consolidation. Certain reclassifications of prior
years' amounts have been made to conform with the 1998 presentation.
Financial statements prepared in accordance with GAAP requires management to
make estimates and assumptions that affect amounts reported in the financial
statements and accompanying notes. Such estimates and assumptions could change
in the future as more information becomes available, which could impact the
amounts reported and disclosed herein.
Segment Reporting. Effective January 1, 1998, the Company adopted Financial
Accounting Standards Board's ("FASB") Statement of Financial Accounting Standard
No. 131, "Disclosures about Segments of an Enterprise and Related Information
("Statement 131")". Statement 131 superseded FASB Statement No. 14, "Financial
Reporting for Segments of a Business Enterprise". Statement 131 establishes
standards for the way that public business enterprises report information about
operating segments in annual financial statements and requires that those
enterprises report selected information about operating segments in interim
financial reports. Statement 131 also established standards for related
disclosures about products and services, geographic areas, and major customers.
The adoption of Statement 131 did not affect results of operations or financial
position (See Note P - Operating Segments).
Reporting Comprehensive Income. As of January 1, 1998, the Company adopted FASB
Statement of Financial Accounting Standard No. 130, "Reporting Comprehensive
Income" ("Statement 130"). Statement 130 establishes new rules for the reporting
and display of comprehensive income and its components; however, the adoption of
this Statement had no impact on the Company's net income or shareholders'
equity. Statement 130 requires unrealized gains or losses on the Company's
available-for-sale securities and the foreign currency translation adjustments,
which prior to adoption were reported separately in shareholders' equity, to be
included in other comprehensive income. Prior year financial statements have
been presented in conformity with the requirements of Statement 130.
Earnings per Share ("EPS"). In December 1997, the Company adopted FASB Statement
of Financial Accounting Standard No. 128, "Earnings Per Share", which
established a new calculation of EPS. Prior period amounts have been restated to
conform with the new requirements. Basic earnings per share is calculated based
upon the weighted average common shares outstanding during the period. In order
to calculate EPS, unallocated Employee Stock Ownership Plan ("ESOP") shares and
treasury shares are deducted from the outstanding common shares. For diluted
EPS, Class A common stock and common stock options (See Note K - Incentive
Compensation Plans) increase weighted average shares outstanding to the extent
that they are dilutive. To obtain net income attributable to common shareholders
for EPS computations, the annual preferred stock dividend is deducted from net
income. The following schedule presents the calculation of Basic and Diluted
EPS: <TABLE> <CAPTION>
(In millions) 1998 1997 1996
- ------------------------------------------------------------- ---------- --------- ----------
<S> <C> <C> <C>
Numerator:
Net Income $8 $52 $79
Less: Preferred stock dividends 2 2 2
- ------------------------------------------------------------- ---------- --------- ----------
Income available to common shareholders $6 $50 $77
Denominator:
Weighted average shares outstanding for basic EPS 50.9 51.8 56.4
Effect of dilutive options .3 1.7 1.9
- ------------------------------------------------------------- ---------- --------- ----------
Adjusted weighted average shares for diluted EPS 51.2 53.5 58.3
Basic EPS $0.13 $0.97 $1.36
- ------------------------------------------------------------- ---------- --------- ----------
Diluted EPS $0.13 $0.94 $1.32
- ------------------------------------------------------------- ---------- --------- ----------
</TABLE>
8
<PAGE>
TIG HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Investments. Fixed maturity investments are classified as available for sale, as
TIG has no positive intent to hold such securities until maturity, and are
carried at market value. Equity securities and other long term investments are
also carried at market value while short-term investments are carried at cost,
which approximates market value. Market value is based principally upon quoted
market prices. Quoted market prices are available for substantially all fixed
maturity investments and equity securities. The difference between the aggregate
market value and amortized cost of securities, after deferred income tax effect,
is reported in accumulated other comprehensive income as unrealized gain or loss
and, accordingly, has no effect on net income (see Note D - Investments).
Interest on fixed maturity investments is recorded as income when earned and is
adjusted for any amortization of purchase premium or accrual of discount.
Realized gains and losses on the sale of investments are generally determined on
a first-in-first-out basis. Realized losses are recorded when an investment's
fair value is below book value and the decline is considered other than
temporary.
In June 1998, the Financial Accounting Standards Board issued Statement No. 133,
"Accounting for Derivative Instruments and Hedging Activities" ("Statement
133"), which is required to be adopted in years beginning after June 15, 1999.
The Statement permits early adoption as of the beginning of any fiscal quarter
after its issuance. The Company expects to adopt the new Statement effective
January 1, 2000. The Statement will require the Company to recognize all
derivatives on the balance sheet at fair value. Derivatives that are not hedges
must be adjusted to fair value through income. If the derivative is a hedge,
depending on the nature of the hedge, changes in the fair value of derivatives
will either be offset against the change in fair value of the hedged assets,
liabilities, or firm commitments through earnings or recognized in other
comprehensive income until the hedged item is recognized in earnings. The
ineffective portion of a derivative's change in fair value will be immediately
recognized in earnings. The Company has not yet determined what the effect of
Statement 133 will be on the earnings and financial position of the Company.
Stock Compensation. TIG adopted Statement of Financial Accounting Standard No.
123, "Accounting for Stock-Based Compensation" ("Statement 123") effective
January 1, 1996. Statement 123 establishes financial accounting and reporting
standards for stock-based employee compensation plans. TIG elected to continue
to account for employee stock-based compensation as prescribed by APB Opinion
No. 25, "Accounting for Stock Issued to Employees" and to provide pro forma
disclosures in the Notes to Financial Statements of the effects of Statement 123
on net income and earnings per share (see Note K - Incentive Compensation
Plans). There was no effect on net income or earnings per share as a result of
adopting Statement 123.
Recognition of Premium Revenues. Premium, including premium on reinsurance
contracts, is earned principally on a pro rata basis over the terms of the
policies, which are generally not more than one year. Unearned premium
represents the portion of premium written applicable to the unexpired terms of
policies in force.
9
<PAGE>
TIG HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Loss and loss adjustment expense reserves. The liability for loss and loss
adjustment expenses ("LAE") is based on an evaluation of reported losses and on
estimates of incurred but not reported ("IBNR") losses. The reserve liabilities
are determined using estimates of losses for individual claims (case basis
reserves) and statistical projections of reserves for IBNR. Management considers
many factors when setting reserves including: (i) current legal interpretations
of coverage and liability; (ii) economic conditions; and (iii) internal
methodologies which analyze TIG's experience with similar cases, with
information from ceding companies, and with historical trends such as reserving
patterns, loss payments, pending levels of unpaid claims, and product mix. Based
on these considerations, management believes that adequate provision has been
made for TIG's loss and LAE reserves. Actual losses and LAE paid may deviate,
perhaps substantially, from such reserves. Adjustments to the reserves resulting
from subsequent developments or revisions to the estimate are reflected in
results of operations in the period in which such adjustments become known. The
liability is reported net of estimated salvage and subrogation recoverables of
$26 million and $31 million at December 31, 1998 and 1997, respectively. Certain
liabilities for unpaid losses related to long-term workers' compensation
coverage are discounted to present value. The workers' compensation indemnity
reserves subject to discounting and the related discount are as follows:
<TABLE>
<CAPTION>
December 31,
-----------------------------------------
(In millions) 1998 1997
------------------------------------------------------ -------------------- --------------------
<S> <C> <C>
Subject to tabular reserving $263 $231
Discount (3.5% in 1998 and 1997) 40 31
------------------------------------------------------ -------------------- --------------------
Discounted indemnity reserves $223 $200
------------------------------------------------------ -------------------- --------------------
</TABLE>
Deferred Policy Acquisition Costs. Acquisition costs that vary with and are
primarily related to the production of new business consist principally of
commissions, premium taxes, and other expenses incurred at policy issuance and
renewal. The costs are generally deferred and amortized ratably over the terms
of the underlying policies. Anticipated losses, loss expenses, and remaining
costs of servicing the policies are considered in determining the amount of
costs to be deferred. Anticipated investment income is considered in determining
whether a premium deficiency exists. Amortization of deferred policy acquisition
costs totaled $425 million, $391 million and $347 million for the years ended
December 31, 1998, 1997 and 1996, respectively.
Premium Deficiency Recognition. A premium deficiency is recognized for an
operating division when the sum of expected claim costs and claim adjustment
expenses, expected dividends to policyholders, maintenance costs and unamortized
acquisition costs exceeds future earned premiums related to non-cancelable
in-force policies and related anticipated investment income. A premium
deficiency is first recognized by charging unamortized deferred policy
acquisition costs to expense and then accruing a liability for any remaining
deficiency.
Participating Insurance Business. Dividends to policyholders, which relate
primarily to workers' compensation policies, are accrued during the period in
which the related premium is earned. Approximately 7%, 7% and 4% in 1998, 1997
and 1996, respectively, of TIG's total gross written premium was subject to
participation in such dividends.
Other Assets. Property, leasehold improvements and furniture and equipment with
a cost of $44 million and $40 million at December 31, 1998 and 1997,
respectively, are included in other assets. These balances are carried at cost
less accumulated depreciation of $31 million and $24 million at December 31,
1998 and 1997, respectively. Depreciation is computed under the straight-line
method over the estimated useful lives of the assets over periods ranging from
three to ten years. Depreciation expense, including amortization of assets under
capital lease, totaled $9 million in 1998, 1997 and 1996. Goodwill and other
intangible assets with a cost of $21 million are also included in other assets
net of accumulated amortization of $4 million and $3 million at December 31,
1998 and 1997, respectively. These balances are amortized on a straight-line
basis over periods ranging from 10 to 20 years. Amortization expense totaled
$1.4 million, $0.6 million and $0.5 million in 1998, 1997 and 1996. TIG's
accounting policy governing the measurement of goodwill impairment includes an
annual analysis of the recoverability of goodwill as of each balance sheet date.
10
<PAGE>
TIG HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Restructuring Charges. In February 1996, TIG announced the reorganization of its
commercial operations and plans to exit certain lines of business that failed to
meet profitability standards. As a result of this reorganization, TIG took the
following actions: 1) combined its Specialty Commercial and Workers'
Compensation divisions to form a new division called Commercial Specialty; 2)
identified field offices for consolidation and closure; 3) identified lines of
business for non-renewal or cancellation for which 1995 net premium written was
approximately $190 million; 4) formed a run-off division (called "Other Lines")
to administer contractually required policy renewals for run-off lines of
business, and 5) outsourced to third party service providers or otherwise
terminated the responsibilities of approximately 600 employees. The
consolidation/closure of field offices was completed by December 31, 1996,
although various lease obligations remain at December 31, 1998.
TIG recorded a $100 million accrual in first quarter 1996 for estimated
restructuring charges comprised of severance of $17 million, contractual policy
obligations of $37 million, office lease termination of $18 million, furniture,
equipment and capitalized software write-downs of $12 million, and a reserve for
litigation and credit issues related to terminated producers of $16 million. In
1997, TIG re-evaluated the $100 million restructuring charge. Although the total
amount of the restructuring charge remained unchanged, the components were
revised to the following: severance of $13 million; contractual policy
obligations of $43 million; office lease terminations of $16 million; furniture,
equipment and capitalized software write-downs of $10 million; and a reserve for
litigation and credit issues related to terminated producers of $18 million.
Severance costs were less than originally estimated due to the employment of
certain TIG associates by third party service providers. The reduction in
severance was effectively offset by increased costs for contractual policy
obligations associated with outsourcing contracts. The revised estimates for
leases, asset write-downs, and producer credit issues reflect minor adjustments
to original assumptions based on activity through December 31, 1998. Charges
against the restructure accrual of $97 million have been recorded since March
1996 and are comprised of $13 million in severance, $43 million in contractual
policy obligations, $13 million in lease termination costs, $10 million in asset
write-downs and $18 million related to producer credit issues. At December 31,
1998, TIG's exit plan was substantially complete with the remaining restructure
accrual of $3 million projected to be paid out over the next two to three years.
Net premium written for 1998, 1997, and 1996 from lines of business placed in
run-off as a result of the 1996 restructure was ($1) million, $4 million and
$140 million, respectively.
Guaranty Funds and Similar Assessments. TIG is assessed amounts by state
guaranty funds to cover losses of policyholders of insolvent or rehabilitated
insurance companies, by state insurance oversight agencies to cover the
operating expenses of such agencies and by other similar legislated entities.
These mandatory assessments may be partially recovered through a reduction in
future premium taxes in certain states. The Company currently expenses these
assessments as they are levied. Effective January 1, 1999, the Company will be
required to adopt the provisions of AICPA Statement of Position 97-3 ("SOP
97-3"), under which these assessments are required to be accrued in the period
in which they have been incurred. The effects of initially adopting SOP 97-3
will be recorded as the cumulative effect of a change in accounting principle.
TIG has not determined the impact that the adoption of SOP 97-3 will have on its
financial condition or results of operations.
11
<PAGE>
TIG HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE C. SIGNIFICANT TRANSACTIONS AND EVENTS
- --------------------------------------------------------------------------------
Premium Deficiencies Recognition. In third quarter 1998, a contract dispute
arose between the Company and MBNA America Bank, N.A., the producer of an
automobile insurance program within the Custom Markets division ("the MBNA
program"). The dispute related to certain underwriting and pricing changes made
by TIG to produce contractually guaranteed rates of return. In September 1998,
the MBNA program was terminated. The producer elected under the termination
provisions of the agency contract to require TIG to provide a renewal market
through September 1, 1999. As a result, TIG recognized a premium deficiency of
$33 million in third quarter 1998 related to future earned premium from existing
Custom Markets business and mandatory renewals through September 1, 1999, for
the MBNA program. The premium deficiency was recorded in TIG's third quarter
1998 income statement by expensing all Custom Markets deferred policy
acquisition costs, which totaled $19 million, and establishing additional loss
reserves of $14 million. At December 31, 1998, $7 million of this additional
loss reserve remained. Net premium written for the MBNA program was $88 million
and $30 million for the years ended December 31, 1998 and 1997, respectively.
Merger with Fairfax Financial Holdings Limited. On December 3, 1998, the Company
announced the proposed merger of FFHL, Inc., a wholly-owned subsidiary of
Fairfax Financial Holdings Limited (Fairfax), with TIG Holdings, Inc. Fairfax is
a financial services holding company that, through its subsidiaries, is engaged
in property, casualty and life insurance and reinsurance, investment management
and insurance claim management. The merger will be the culmination of an
evaluation of strategic alternatives initiated by the Company's Board of
Directors in an effort to determine the course of action that was in the best
interest of the Company and its stockholders. Under the merger agreement,
Fairfax has agreed to convert each share of common stock of the Company issued
and outstanding as of the date that the Certificate of Merger is filed with the
State of Delaware into the right to receive $16.50 in cash, without interest. On
March 8, 1999, at a Special Meeting of Stockholders of TIG Holdings, Inc., the
stockholders are expected to vote on the merger agreement. The obligations of
the Company and Fairfax to effect the merger are subject, among other things, to
the condition that necessary insurance regulatory approvals shall have been
obtained.
Closing of Offices. During 1998, the Company decided to close its executive
offices in New York City, consolidating corporate functions with its corporate
headquarters in Irving, Texas. In addition, the Company decided to close its
staff counsel offices located throughout the United States and outsource the
supervision of claims litigation previously performed by these offices. In
conjunction with these closings, accruals for lease obligations and severance
and related costs totaling $15 million were recorded as Corporate Expense in
1998.
Sale of Independent Agents Business Unit. On December 31, 1997, TIG sold the
Independent Agents unit of its Retail Division, based in Battle Creek, Michigan,
for $65 million in cash to Nationwide Mutual Insurance Company ("Nationwide").
The purchase price was adjusted for the surplus of TIG Countrywide Insurance
Company ("CIC"), which was included in the sale, after giving effect to certain
transactions. There was no capital gain or loss recognized on the sale. At
closing, TIG entered into several reinsurance arrangements with CIC and ceded
all outstanding loss and LAE reserves, unearned premium reserves and premium
receivables related to the Independent Agents unit at book value. Under the
purchase agreement, Nationwide assumed the risk of loss and LAE reserve
development and receivable collectibility. To allow CIC and Nationwide time to
make appropriate regulatory filings, TIG agreed to continue to write Independent
Agents business and cede such business 100% to CIC for two years, or longer, if
needed. TIG has also agreed to provide transition assistance services to CIC for
the processing of this business for a period of up to two years. Independent
Agents gross premium written for the years ended December 31, 1998, 1997 and
1996 totaled $247 million, $286 million and $299 million, respectively. During
1998, TIG recognized $20 million in ceding commission from the Independent
Agents book of business.
12
<PAGE>
TIG HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE D. INVESTMENTS
- --------------------------------------------------------------------------------
Market Value and Amortized Cost of Invested Assets:
<TABLE>
<CAPTION>
December 31, 1998
----------------------------------------------------------------------
% of
Market Value Amortized Unrealized Unrealized Market
(In millions) Cost Gains Losses Portfolio
------------------------------------- -------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Municipal bonds $564 $522 $42 $ - 14.5%
Mortgage-backed securities 643 635 10 (2) 16.5
United States government bonds 1,574 1,470 106 (2) 40.4
Corporate and other bonds 837 857 20 (40) 21.5
------------------------------------- -------------- ------------- ------------- ------------- -------------
Total fixed maturity 3,618 3,484 178 (44) 92.9
investments
Short-term and other investments 276 276 - - 7.1
------------------------------------- -------------- ------------- ------------- ------------- -------------
Total invested assets $3,894 $3,760 $178 ($44) 100.0%
------------------------------------- -------------- ------------- ------------- ------------- -------------
</TABLE>
<TABLE>
<CAPTION>
December 31, 1997
---------------------------------------------------------------------
% of
Market Amortized Unrealized Unrealized Market
(In millions) Value Cost Gains Losses Portfolio
-------------------------------------- ------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Municipal bonds $637 $596 $42 ($1) 15.2%
Mortgage-backed securities 941 933 11 (3) 22.4
United States government bonds 1,014 941 77 (4) 24.2
Corporate and other bonds 1,282 1,255 41 (14) 30.6
-------------------------------------- ------------- ------------- ------------- ------------- -------------
Total fixed maturity 3,874 3,725 171 (22) 92.4
investments
Short-term and other investments 318 316 3 (1) 7.6
-------------------------------------- ------------- ------------- ------------- ------------- -------------
-------------------------------------- ------------- ------------- ------------- ------------- -------------
Total invested assets $4,192 $4,041 $174 ($23) 100.0%
-------------------------------------- ------------- ------------- ------------- ------------- -------------
</TABLE>
Less than 17% of TIG's portfolio consists of mortgage-backed securities ("MBS")
as of December 31, 1998. United States federal government and government agency
mortgages represent approximately 69% of TIG's exposure to MBS as of December
31, 1998, offering AAA credit quality. A risk inherent to MBS is prepayment risk
related to interest rate volatility. The underlying mortgages may be repaid
earlier or later than originally anticipated, depending on the repayment and
refinancing activity of the underlying mortgage holders. Should this occur, TIG
would receive paydowns on principal amounts which may have been purchased at a
premium or discount, and TIG's investment income would be affected by any
adjustments to amortization resulting from the prepayments. TIG's consolidated
financial results have not been materially impacted by prepayments of MBS. In
addition, interest rate volatility can affect the market value of MBS.
Substantially all MBS held in the portfolio can be actively traded in the public
market.
13
<PAGE>
TIG HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
In the normal course of business, TIG may choose to hedge some of its interest
rate risk with futures contracts and/or interest rate swaps. Alternatively,
derivative financial instruments may also be utilized to enhance prospective
returns. TIG's interest rate swap arrangements generally provide that one party
pays interest at a floating rate in relation to movements in an underlying
index, and the other party pays interest at a fixed rate. While TIG is exposed
to credit risk in the event of nonperformance by the other party, nonperformance
is not anticipated due to the credit rating of the counterparties. There were no
interest rate swaps at December 31, 1998, and $14 million notional face amount
of interest rate swaps at December 31, 1997. From time to time, TIG sells
futures contracts to hedge its interest rate and market exposures on thirty-year
U.S. Treasury bonds. Risks arise from movements in the futures contracts'
values. Futures contracts are carried at market value, with gains and losses
recognized as adjustments to the carrying value of the hedged investment. No
futures contract positions were open at December 31, 1998 or 1997. However,
positions were opened and closed during 1998, 1997 and prior years. The deferral
method has been used to account for these closed futures contracts. Under the
deferral method, gains and losses from derivatives are deferred on the balance
sheet and recognized in earnings in conjunction with the earnings recognition of
the designated items. The deferred loss from futures contracts was $5 million
and $4 million at December 31, 1998 and 1997, respectively.
TIG routinely enters into commitments to purchase securities on a "To Be
Announced" ("TBA") basis for which the interest rate risk remains with TIG until
the date of delivery and payment. Delivery and payment of securities purchased
on a TBA basis can take place a month or more after the date of the transaction.
These securities are subject to market fluctuations during this period and it is
the Company's policy to recognize any gains or losses only when they are
realized. TIG maintains cash and short-term investments with a fair value
exceeding the amount of its TBA purchase commitments. At December 31, 1998,
there were no TBA purchase commitments, compared to TBA commitments of $24
million with a fair value of $26 million at December 31, 1997.
TIG has no material non-income producing investments and has no geographic or
other concentrations of investment risk which have not been disclosed. Invested
assets of TIG, carried at $836 million and $620 million at December 31, 1998 and
1997, respectively, were either on deposit with government agencies as required
by law in various states in which TIG insurance subsidiaries conduct business or
were held as collateral for various business transactions. Invested assets of
TIG's participation in Lloyd's Syndicates totaling $32 million and $8 million at
December 31, 1998, and 1997, respectively including cash of $11 million and $5
million for each respective period are held in trust in accordance with Lloyd's
of London regulations (see Note N - Commitments and Contingencies).
14
<PAGE>
The estimated market value and amortized cost of the portfolio, by contractual
maturity, at December 31, 1998 are presented below. Expected maturities will
differ from contractual maturities as certain borrowers have the right to call
or prepay obligations. <TABLE> <CAPTION>
Market Amortized
(In millions) Value Cost
-------------------------------------------------------- ------------- -------------
<S> <C> <C>
Due in one year or less $133 $133
Due after one year through five years 309 309
Due after five years through ten years 1,137 1,143
Due after ten years 1,396 1,264
Mortgage-backed securities 643 635
-------------------------------------------------------- ------------- -------------
Total fixed maturity investments $3,618 $3,484
-------------------------------------------------------- ------------- -------------
</TABLE>
Components of Net Investment Income
<TABLE>
<CAPTION>
Years Ended December 31,
-------------------------------
(In millions) 1998 1997 1996
----------------------------------------------------- ---------- --------- ----------
<S> <C> <C> <C>
Fixed maturity investments $269 $297 $298
Short-term and other investments 11 8 6
----------------------------------------------------- ---------- --------- ----------
Total gross investment income 280 305 304
Investment expenses, interest and other (45) (15) (14)
----------------------------------------------------- ---------- --------- ----------
Total net investment income $235 $290 $290
----------------------------------------------------- ---------- --------- ----------
</TABLE>
Net Investment and Other Gain (Loss)
<TABLE>
<CAPTION>
Years Ended December 31,
-------------------------------
(In millions) 1998 1997 1996
----------------------------------------------------- ---------- --------- ----------
<S> <C> <C> <C>
Fixed maturity investments
Gross gains $67 $38 $37
Gross losses (75) (22) (41)
Other losses (4) (15) -
----------------------------------------------------- ---------- --------- ----------
Net investment and other gain (loss) before tax (12) 1 (4)
Less related taxes 4 - 1
----------------------------------------------------- ---------- --------- ----------
Net investment and other gain (loss), net of taxes ($8) $1 ($3)
----------------------------------------------------- ---------- --------- ----------
</TABLE>
15
<PAGE>
TIG HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE E. LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES
- --------------------------------------------------------------------------------
Activity in the loss and loss adjustment expense reserve account is summarized
as follows:
<TABLE>
<CAPTION>
(In millions) 1998 1997 1996
-------------------------------------------------------------------------- ------------- -------------- -------------
<S> <C> <C> <C>
Balance January 1, net of reinsurance recoverables $2,531 $2,634 $2,752
Incurred related to:
Current year 1,016 1,076 1,122
Prior year 25 75 16
-------------------------------------------------------------------------- ------------- -------------- -------------
Total losses and LAE incurred 1,041 1,151 1,138
-------------------------------------------------------------------------- ------------- -------------- -------------
Loss and LAE payments related to:
Current year 313 417 374
Prior year 999 837 882
-------------------------------------------------------------------------- ------------- -------------- -------------
Total losses and LAE payments 1,312 1,254 1,256
Retroactive reinsurance assumed 52 - -
-------------------------------------------------------------------------- ------------- -------------- -------------
Balance December 31, net of reinsurance recoverable 2,312 2,531 2,634
Reinsurance recoverable, excluding amounts recoverable on retroactive
reinsurance ceded of $210 million in 1998 1,788 1,404 1,126
-------------------------------------------------------------------------- ------------- -------------- -------------
Gross loss and LAE reserves $4,100 $3,935 $3,760
-------------------------------------------------------------------------- ------------- -------------- -------------
</TABLE>
In 1998, TIG recognized unfavorable prior year loss and LAE reserve development
of $25 million, of which unfavorable development of $24 million was attributable
to TIG Insurance and $1 million of unfavorable development was attributable to
TIG Re. The unfavorable development in TIG Insurance is primarily attributable
to $11 million of development in unallocated LAE costs related to the
termination of programs in Other Lines, unallocated LAE reserve strengthening of
$7 million, and $6 million of unfavorable loss and allocated LAE development.
Retroactive reinsurance assumed represents reserves assumed from third parties
for insurable events that have already occurred in exchange for cash and/or
investment consideration. These reserves relate to new programs in TIG's
workers' compensation lines and Lloyd's Syndicates. No additional premiums or
return premiums have been accrued as a result of prior years affects.
In 1997, TIG recognized unfavorable prior year loss and LAE reserve development
of $75 million, of which unfavorable development of $106 million was
attributable to TIG Re reserve strengthening and favorable development of $31
million was attributable to TIG Insurance. The reserve strengthening by TIG Re
in December 1997 was based on actuarial evaluations of loss data through
September 30, 1997, which incorporated enhancements to TIG Re's actuarial
process and previously unavailable data. This intensive actuarial review
indicated that reserving issues were concentrated in a limited number of large
proportional excess of loss programs, the majority of which were restructured or
non-renewed effective January 1, 1997. TIG Re also increased 1997 accident year
reserves by $39 million as a result of the September 30, 1997 actuarial study.
The total $145 million reserve increase recorded by TIG Re in December 1997 was
net of corporate aggregate stop loss reinsurance coverage, including $40 million
under a 1995 intercompany agreement with TIG Insurance. The favorable prior year
loss reserve development of $31 million for primary lines written by TIG
Insurance was principally attributable to continuing favorable workers'
compensation development. The majority of this favorable development was
reallocated to the 1997 accident year for workers' compensation and various
other lines for statutory reporting purposes. The assumption by TIG Insurance in
Other Lines of $40 million in losses under the aforementioned intercompany
reinsurance agreement was principally offset by a $27 million cession to a
corporate aggregate stop loss reinsurance treaty.
16
<PAGE>
TIG HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
The unfavorable loss and LAE reserve development for prior years in 1996 of $16
million is due primarily to adverse development in Other Lines. In connection
with the February 1996 restructuring, TIG completed a re-evaluation of loss and
LAE reserves related to run-off lines using additional loss development data
received during the first quarter of 1996. This data confirmed adverse loss
development trends observed in the second half of 1995 and was a consideration
in the decision to exit certain lines of business, as discussed at Note B
Summary of Significant Accounting Policies. As a result of this re-evaluation
and management's belief that the restructuring decision will make the claims
settlement process less consistent and more volatile, TIG increased loss and LAE
reserves by $31 million in the first quarter of 1996 for run-off lines,
principally for long haul trucking and large accounts. This reserve
strengthening was partially offset by continuing favorable development of 1993
and prior years' workers' compensation reserves.
TIG's reserves include an estimate of TIG's ultimate liability for
asbestos-related matters, environmental pollution, toxic tort and other
non-sudden and accidental claims for which ultimate values cannot be estimated
using traditional reserving techniques. TIG's environmental claims activity is
predominately from hazardous waste and pollution-related claims arising from
commercial insurance policies. Most of TIG's pollution claims are from small
regional operations or local businesses involved with disposing wastes at dump
sites or having pollution on their own property due to hazardous material use or
leaking underground storage tanks. In connection with the initial public
offering of TIG Holdings' common stock ("IPO"), an affiliate of Transamerica
agreed to pay 75% of up to $119 million of reserve development and newly
incurred claims, up to a maximum reimbursement of $89 million, on policies
written prior to January 1, 1993 with respect to certain environmental claims
involving paid losses and certain LAE in excess of TIG's environmental loss and
LAE reserves at December 31, 1992. At December 31, 1998, the Transamerica
affiliate had incurred no liability under this agreement.
17
<PAGE>
TIG HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE F. REINSURANCE
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Years Ended December 31,
---------------------------------------------------
(In millions) 1998 1997 1996
------------------------------------------------- ---------------- ----------------- ----------------
<S> <C> <C> <C>
Written premium:
Direct $1,367 $1,221 $1,274
Assumed 774 722 650
Ceded (723) (507) (395)
------------------------------------------------- ---------------- ----------------- ----------------
Net $1,418 $1,436 $1,529
------------------------------------------------- ---------------- ----------------- ----------------
Earned premium:
Direct $1,323 $1,232 $1,307
Assumed 840 667 632
Ceded (716) (433) (400)
------------------------------------------------- ---------------- ----------------- ----------------
Net $1,447 $1,466 $1,539
------------------------------------------------- ---------------- ----------------- ----------------
Incurred losses and LAE:
Gross $1,494 $1,751 $1,417
Ceded (453) (600) (279)
------------------------------------------------- ---------------- ----------------- ----------------
Net $1,041 $1,151 $1,138
------------------------------------------------- ---------------- ----------------- ----------------
</TABLE>
TIG reinsures portions of its policy risks with other insurance companies or
underwriters and remains liable under these contracts. Reinsurance is used to
transfer some policy risks such that the amount of individual claims can be
limited to a fixed percentage or amount. Reinsurance is also utilized to limit
the amount of claims related to catastrophes. This strategy allows TIG to insure
larger risks while controlling exposure to large losses. Reinsurance agreements
currently in place are structured on both a treaty basis, where all risks
meeting a certain criteria are automatically reinsured, and on a facultative
basis, where each policy reinsured is separately negotiated. Amounts recoverable
from reinsurers are estimated in a manner consistent with the claim liability
associated with the reinsured policy. As a part of its overall business
strategy, TIG also engages in assumed reinsurance transactions, primarily
through TIG Re, a wholly-owned subsidiary.
Reinsurance contracts do not relieve TIG from its obligations to policyholders.
Failure of reinsurers to honor their obligations could result in losses to TIG;
accordingly, allowances are established for amounts estimated to be ultimately
uncollectible. TIG evaluates the financial condition of its reinsurers and
monitors concentrations of credit risk arising from similar geographic regions,
activities, or economic characteristics of the reinsurers to minimize its
exposure to significant losses from reinsurer insolvencies. At December 31,
1998, TIG held collateral related to reinsurance amounts in the form of letters
of credit totaling $317 million, trust funds totaling $310 million, and funds
held totaling $564 million.
Effective January 1, 1998, the Company entered into a loss portfolio reinsurance
agreement on a funds held basis for loss and LAE reserves of $265 million
related to certain run-off programs. The gain of $22 million was deferred and
will be amortized into income as losses are paid. Amortization of the deferred
gain of $8 million was recorded as a reduction of incurred losses in 1998. The
contract covers 80% of any adverse loss development incurred in excess of $280
million up to a maximum of $343 million. Any additional future benefit from the
contract triggered by adverse loss development will also be deferred and
amortized into income as the related losses are paid. Funds held bear interest
at 1.7% per quarter beginning April 1, 1998. Related funds held interest of $10
million was recorded as a reduction of net investment income in 1998.
Under this reinsurance arrangement, the reinsurer has the right to convert the
treaty to a funds transferred basis from a funds held basis if the S&P rating
for TIG falls below A+. As a result of this provision, and the downgrading of
TIG's rating to below A+, effective January 1, 1999, TIG Insurance established a
trust agreement of $177 million with Norwest Bank for the benefit of the
reinsurer, in lieu of funds transferred.
18
<PAGE>
TIG HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
During 1998, in response to favorable market conditions for obtaining
reinsurance coverage and to mitigate the inherent financial volatility of a
changing book of business, TIG increased the utilization of aggregate stop loss
and other finite reinsurance coverages by entering into several new contracts
with reinsurance providers. In addition to the loss portfolio reinsurance
agreement mentioned above, the Company also purchased finite reinsurance for
workers' compensation programs that allows TIG to stay competitive with other
insurers whose state of domicile allow discounting of workers' compensation loss
reserves. The Company also purchased finite reinsurance to provide aggregate
stop loss coverage for all lines. The pre-tax net benefit provided by these
contracts, including additional interest costs on withheld funds, was $36
million for 1998.
The Company also commuted two reinsurance agreements during 1998. Although there
was no significant impact on the consolidated results of TIG, the commutation of
an intercompany aggregate stop loss treaty between TIG Re and the subsidiary
through which the Company offers its primary coverage resulted in a net benefit
in Other Lines and a net cost in TIG Re of $34 million. In addition, TIG Re
commuted another reinsurance treaty with a third party that generated a net
benefit of $36 million.
In response to favorable pricing conditions and to mitigate volatility in the
Company's exposure to losses in new workers' compensation lines, TIG utilized
reinsurance to reduce its net retention on most of its workers' compensation
lines from $1 million to $100 thousand during 1998.
19
<PAGE>
TIG HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE G. INCOME TAXES
- --------------------------------------------------------------------------------
TIG files a consolidated federal income tax return. At December 31, 1998, TIG
had a net operating loss carryover of $261 million, of which $34 million will
expire in 2008, $96 million will expire in 2009, $6 million will expire in 2011,
$110 million will expire in 2012, and $15 million will expire in 2013.
Additionally, TIG has a $1 million capital loss carryover, which will carry back
to 1997. For the tax years ended December 31, 1998, 1997 and 1996, TIG made tax
payments of $1 million, $40 million (related to the $40 million advance payment
discussed below), and $1 million, respectively.
The components of the income tax asset balance are as follows:
<TABLE>
<CAPTION>
December 31,
----------------------------------
(In millions) 1998 1997
-------------------------------------------------------- ---------------- -----------------
<S> <C> <C>
Current asset $43 $57
Net deferred tax asset 86 83
-------------------------------------------------------- ---------------- -----------------
Total $129 $140
-------------------------------------------------------- ---------------- -----------------
</TABLE>
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
TIG's deferred tax assets and liabilities as of December 31, 1998 and 1997 are
shown in the following table: <TABLE> <CAPTION>
December 31,
----------------------------------
(In millions) 1998 1997
-------------------------------------------------------- ---------------- -----------------
<S> <C> <C>
Deferred tax assets:
Discounting of reserves for losses
and loss adjustment expenses $154 $158
Net operating loss carryforward 91 70
Discounting of unearned premium reserves 35 38
Expense reserves 13 20
Policyholder dividends 10 7
Restructuring and other liabilities 7 5
Postretirement benefits other than pensions 7 8
Capital loss carryforward - 7
Business in force - 7
Other, net 10 8
-------------------------------------------------------- ---------------- -----------------
Total deferred tax assets 327 328
-------------------------------------------------------- ---------------- -----------------
Deferred tax liabilities:
Section 338 - marketable securities 124 130
Deferred policy acquisition costs 44 53
Unrealized gain - marketable securities 48 52
Section 338 - other 25 10
-------------------------------------------------------- ---------------- -----------------
Total deferred tax liabilities 241 245
-------------------------------------------------------- ---------------- -----------------
Net deferred tax asset $86 $83
-------------------------------------------------------- ---------------- -----------------
</TABLE>
20
<PAGE>
TIG HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
In accordance with the provisions of Statement of Financial Accounting Standard
No. 109, "Accounting for Income Taxes", TIG's management has reviewed its
deferred tax asset balance and concluded that it is more likely than not the
entire deferred tax asset will be realized. Management's conclusion is based on
its expectation that sufficient taxable income will be generated in future
periods within the carryforward period. TIG has reported profits in 1997, 1996,
1995 and 1994, and is expected to be profitable in the future. If TIG does not
achieve its anticipated earnings level in future periods but maintains the
earnings level sustained over the past four years and converts all of its
tax-exempt securities into taxable securities, it anticipates that all of its
net operating loss and 90% of its existing deferred tax asset will be utilized
by the year 2002.
Components of the income tax benefit (expense) are as follows:
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------------------
(In millions) 1998 1997 1996
-------------------------------------------------- ----------------- ---------------- -----------------
<S> <C> <C> <C>
Current expense ($4) ($9) ($9)
Deferred benefit (expense) 13 (1) 13
-------------------------------------------------- ----------------- ---------------- -----------------
Total income tax benefit (expense) $9 ($10) $4
-------------------------------------------------- ----------------- ---------------- -----------------
</TABLE>
The exercise of stock options granted under the Company's various stock option
plans gives rise to compensation which is includable in the taxable income of
the applicable employees and deductible by the Company for federal and state
income tax purposes. Such compensation results from increases in the fair market
value of the Company's common stock subsequent to the date of grant of the
applicable exercised stock options. Accordingly, in conformity with Accounting
Principles Board Opinion No. 25, such compensation is not recognized as an
expense for financial accounting purposes and the related tax benefits are taken
directly to Additional Paid-in Capital. Additional Paid-in Capital, which is a
component of Common Stock in the accompanying financial statements, was
increased $13 million during 1997 as a result of the exercise of such options.
Tax benefits from the exercise of stock options by employees were not material
in 1998 and 1996 (see Note K - Incentive Compensation Plans).
21
<PAGE>
TIG HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
The components of benefit (expense) for total deferred income taxes are as
follows:
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------------
(In millions) 1998 1997 1996
--------------------------------------------------------------- ------------- ------------- -------------
<S> <C> <C> <C>
Discounting of reserves for losses and
loss adjustment expenses ($4) ($9) ($5)
Discounting of unearned premium reserves (3) (4) 1
Net operating loss carryforward 21 35 (11)
Expense reserves (7) 17 -
Restructuring charges 2 (15) 16
Capital loss carryforward (7) (10) 3
Business in force (7) (7) (6)
Policyholder dividends 3 1 (4)
Tax liability adjustment - 5 20
Investment book / tax differences 6 (2) (4)
Deferred policy acquisition costs 9 (1) (1)
Other - (11) 4
--------------------------------------------------------------- ------------- ------------- -------------
Total deferred income tax benefit (expense) $13 ($1) $13
--------------------------------------------------------------- ------------- ------------- -------------
</TABLE>
The reconciliation of income tax computed at the U.S. federal statutory rates to
total income tax benefit (expense) is as follows:
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------------
(In millions) 1998 1997 1996
----------------------------------------------------- ------------- ------------- -------------
<S> <C> <C> <C>
Federal income tax expense at statutory rates $ - ($22) ($26)
Tax-exempt investment income 9 9 9
Tax liability adjustment - 5 20
Other - (2) 1
----------------------------------------------------- ------------- ------------- -------------
Total income tax benefit (expense) $9 ($10) $4
----------------------------------------------------- ------------- ------------- -------------
</TABLE>
TIG'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. Following a routine federal income
tax audit by the IRS, in September 1997, the IRS issued a Statutory Notice of
Deficiency for the tax year 1993 and a Revenue Agents Report for 1994 asserting
a tax liability of approximately $170 million excluding interest. The IRS's
asserted tax adjustments principally relate to the acquisition made by TIG under
the Section 338(h)(10) election of April 27, 1993 in conjunction with TIG's IPO
and primarily generate temporary differences by creating income in 1993 with
corresponding deductions in 1993 and future tax years. TIG strongly disagrees
with the IRS's position and, on December 11, 1997, TIG filed a Tax Court
Petition challenging it. In connection with the Statutory Notice of Deficiency
issued by the IRS for the 1993 tax year, TIG made a $40 million advance tax
payment in December 1997 that has been reflected as a current tax asset. While
the timing of cash tax payments may be impacted, management believes that
revisions to TIG's recorded tax liability, if any, arising from the IRS audit
will not materially impact consolidated net income or financial condition.
In March 1996, TIG entered into settlement agreements with the IRS on several
outstanding audit assessments, resulting in a redetermination of certain tax
liabilities related to tax years prior to TIG's initial public offering in April
1993. A $20 million deferred tax benefit was recognized in first quarter of 1996
as a result of the redetermination.
22
<PAGE>
TIG HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE H. FINANCING ARRANGEMENTS
- --------------------------------------------------------------------------------
Notes Payable. In April 1995, TIG Holdings issued $100 million of 8.125% Notes
maturing 2005. Interest is payable on a semi-annual basis, and a lump sum
principal repayment for the non-callable notes is due April 15, 2005. Included
in the restrictive covenants are limitations on the disposition of the stock of
TIG Insurance Company ("TIC"), limitations on liens and conditions on the merger
of the Company. If the merger of the Company with Fairfax is consummated,
management expects these conditions will be met. Interest expensed and paid was
$8 million in 1998, 1997 and 1996. These Notes are the senior debt of the
Company and have liquidation preference over other debt.
Sale - Leaseback. In December 1995, TIG Insurance Company entered into a $50
million credit facility, of which approximately $27 million and $24 million was
outstanding as of December 31, 1998 and 1997. The facility is a direct financing
arrangement with a third party related to the sale and leaseback of certain
fixed assets, excluding data processing equipment. The net book value of these
assets is $23 million at December 31, 1998, and $18 million at December 31,
1997, which includes accumulated depreciation of $24 million and $19 million at
December 31, 1998 and 1997, respectively. The initial draw of $22 million
against the facility in December 1995 is being amortized over 5 years with
interest at 5.9% payable quarterly. Subsequent draws against the facility are
amortized over 5 years and interest, based on a fixed or floating rate, is
payable quarterly. Interest rates during 1998 ranged from 5.9% to 7.7%. Interest
expensed and paid was $1.6 million for 1998 and 1997, and $1.4 million for 1996.
At December 31, 1998, approximate future minimum lease payments under this
facility are as follows:
<TABLE>
<CAPTION>
(In millions) Principal Interest Total
---------------------- --------------------- -------------------- --------------------
<S> <C> <C> <C>
1999 $8.8 $1.5 $10.3
2000 9.1 0.9 10.0
2001 4.7 0.4 5.1
2002 3.0 0.2 3.2
2003 1.4 - 1.4
---------------------- --------------------- -------------------- --------------------
Total $27.0 $3.0 $30.0
---------------------- --------------------- -------------------- --------------------
</TABLE>
Line of Credit. In December 1995 (as amended and restated in 1997), TIG
established an unsecured revolving line of credit with maximum borrowings of
$250 million. Included in the restrictive covenants are limitations on the
disposition of significant subsidiaries of TIG, limitations on liens and
limitations on the merger of the Company. The merger of the Company with Fairfax
(see Note C - Significant Transactions and Events) would create an "event of
default", and as such, the Company intends to terminate the facility prior to
completion of the sale. During the first quarter of 1998, TIG borrowed $70
million against this facility. The full amount of the five year credit facility
was available for general corporate purposes as of December 31, 1998. Interest
of $2.5 million was expensed and paid in 1998. The interest rate on the facility
is determined at the time of each individual borrowing and is based upon a
senior debt ratings grid, currently either LIBOR plus 30 basis points, Prime or
CD rate plus 42.5 basis points. For utilization greater than 50%, the LIBOR and
CD rates increase by 5 basis points.
Capital Securities. In January of 1997, TIG Capital Trust I ("TIG Capital" or
the "Trust"), a statutory business trust created under Delaware law and a trust
subsidiary of TIG Holdings, completed a private offering for $125 million of
8.597% mandatory redeemable capital securities maturing in 2027. TIG Holdings is
the initial holder of 100% of the common securities of TIG Capital. Holders of
the capital securities of the Trust have a preference under certain
circumstances over the holders of common securities of the Trust with respect to
cash distributions and amounts payable on liquidation, redemption, or otherwise.
23
<PAGE>
TIG HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
TIG Holdings issued $128.75 million in 8.597% Junior Subordinated Debentures to
TIG Capital Trust I (including approximately $3.75 million with respect to the
capital contributed to the Trust by TIG Holdings). Included in the restrictive
covenants are conditions on the merger of the Company. If the merger of the
Company with Fairfax is consummated, management expects these conditions will be
met. TIG Holdings guaranteed the payment of distributions and payments on
liquidation or redemption of the capital securities but only in each case to the
extent of funds held by the Trust. The guarantee does not cover payment of
distributions when the Trust does not have sufficient funds to pay such
distributions. The net proceeds received by TIG Holdings from the issuance of
the debentures were used for general corporate purposes including repurchases of
the Company's common stock. Interest expense was $10.7 million and $9.9 million
in 1998 and 1997. Interest paid was $10.7 million and $4.9 million in 1998 and
1997.
24
<PAGE>
TIG HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE I. MANDATORY REDEEMABLE PREFERRED STOCK
- --------------------------------------------------------------------------------
In April 1993, in connection with it's IPO, TIG Holdings issued 250,000 shares
of non-voting mandatory redeemable preferred stock with a cumulative annual cash
dividend rate of $7.75 per share and an aggregate liquidation
preference/redemption value of $25 million plus accrued and unpaid dividends.
The preferred stock must be redeemed on April 27, 2000. With each regular
quarterly dividend declared on the preferred shares, each holder also receives
one non-transferable right (a "Right"). Each Right will constitute the right to
receive an additional amount to the extent that the regular cash dividend to
which the related Right was, in whole or in part, not made out of TIG Holdings'
current or accumulated earnings and profits, as calculated for federal income
tax purposes. In such event, the holder of a Right will be entitled to receive
an amount which, when taken together with the regular cash dividend to which the
Right was related, would cause the net after-tax return to such holder to equal
what the net after-tax return on the mandatory redeemable preferred stock would
have been had the regular cash dividend been paid entirely out of the current or
accumulated earnings and profits of TIG Holdings. During 1998, TIG paid an
additional $1 million in respect to these Rights in connection with dividends
declared on the mandatory redeemable preferred stock during 1997. No additional
payments were required during 1997 and 1996.
If the merger of the company with Fairfax is consummated (see Note C Significant
Transactions and Events), each share of preferred stock that is issued and
outstanding immediately prior to the merger will be converted into the right to
receive one share of preferred stock of the entity surviving the merger, with
the same terms as the original shares.
- --------------------------------------------------------------------------------
NOTE J. SHAREHOLDERS' EQUITY
- --------------------------------------------------------------------------------
Authorized Capital Stock. TIG Holdings' authorized capital stock consists of one
million shares of $0.01 par value Class A convertible common stock, 180 million
shares of $0.01 par value common stock, and 15 million shares of $0.01 par value
preferred stock.
Class A Common Stock. In April 1993, TIG Holdings issued 224,600 shares of Class
A common stock of which 81,191 had been canceled as of April 1996. In accordance
with the terms of their issuance, the remaining 143,409 Class A common shares
were converted to common shares in 1996 (see Note K - Incentive Compensation
Plans). As of December 31, 1998, no shares of Class A common stock are
outstanding.
Subsidiary Dividend Restrictions. Payment of dividends to TIG Holdings by its
insurance subsidiaries is subject to certain restrictions. State insurance laws
limit the amount that may be paid without prior notice or approval by insurance
regulatory authorities. As of December 31, 1998, $96 million of dividends are
currently available for payment to TIG Holdings from its insurance subsidiaries
during 1999 without restriction. Cash dividends paid by the insurance
subsidiaries in 1998, 1997 and 1996 were $175 million, $145 million and $130
million, respectively.
25
<PAGE>
TIG HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE K. INCENTIVE COMPENSATION PLANS
- --------------------------------------------------------------------------------
As of December 31, 1998, the Company has three stock based compensation plans,
which are described below. The Company adopted Statement 123 effective January
1, 1996 and has elected to continue to account for employee stock-based
compensation as prescribed by APB Opinion No. 25 (See Note B - Summary of
Significant Accounting Policies). If the merger of the Company with Fairfax is
consummated (see Note C - Significant Transactions and Events), participants
will become fully vested, cash distributions will be made and these plans will
terminate.
The 1996 Long-Term Incentive Plan. The 1996 Long-Term Incentive Plan (the "1996
Plan") provides for awards of stock options, stock appreciation rights,
restricted stock grants, restricted stock units and/or performance units. The
maximum number of shares of Common Stock for which awards may be granted or paid
out under the 1996 Plan is five million shares plus, effective January 1, 2000,
the Limitation Amount. The "Limitation Amount" is 1.5% of the total number of
issued and outstanding shares of Common Stock as of January 1, 2000, plus,
effective each January 1 thereafter through and including January 1, 2006, 1.5%
of the total number of issued and outstanding shares of Common Stock as of such
January 1. In addition to the shares available for grant as previously
mentioned, two million shares of Common Stock will be available solely for the
grant of awards to employees in connection with acquisitions of other entities
or businesses by the Company. As of December 31, 1998, there were no stock
appreciation rights, restricted stock units or performance units outstanding at
that time. The 1996 Plan was originally to terminate on the date of the
Company's annual meeting of shareholders in 2006; however, if the merger of the
Company with Fairfax is consummated, the plan will be terminated. Thereafter, no
awards may be granted. Stock options under the 1996 Plan typically have a term
of ten years from the date of the grant and vest in equal annual installments
over four years. Restricted stock grants typically vest in equal annual
installments over three years. The weighted average fair value of restricted
stock granted during the year was $31.47.
The 1996 Non-Employee Directors Compensation Program. The 1996 Non-Employee
Directors Compensation Program (the "1996 Program") provides for awards of stock
options and restricted share units. These awards are not to exceed 200,000
shares. As of December 31, 1998, there were 33,873 restricted share units and
stock options representing the right to acquire 67,746 shares of common stock.
Each restricted share unit converts into one share of common stock based upon an
irrevocable election made by each non-employee director. The 1996 Program was to
terminate on the close of business on the date of the Company's annual meeting
of shareholders in 1999; however, if the merger of the Company with Fairfax is
consummated, the program will be terminated at that time. Restricted share units
and stock options granted prior to the date of the annual meeting of
shareholders in 1997 will vest in three substantially equal installments on the
dates of each annual meeting of shareholders in 1997, 1998 and 1999. Restricted
share units and stock options granted on or after the date of the 1997 annual
meeting of shareholders but prior to the date of the 1998 annual meeting of
shareholders will vest in two equal installments on the dates of each annual
meeting of shareholders in 1998 and 1999. Restricted share units and stock
options granted on or after the date of the 1998 annual meeting of shareholders
but prior to the 1999 annual meeting of shareholders were originally to vest in
one installment on the date of the 1999 annual meeting of shareholders. The
maximum term of any stock option granted will be ten years from the date of
grant.
The 1993 Long-Term Incentive Plan. The 1993 Long-Term Incentive Plan (the "1993
Plan") provides for awards of stock options, stock appreciation rights,
restricted stock grants and/or performance units (collectively referred to as
"awards"). These awards are not to exceed 15 million shares in the aggregate. As
of December 31, 1998, there were no stock appreciation rights or performance
units outstanding. The 1993 Plan terminated May 2, 1996, except with respect to
outstanding awards, with the approval of the 1996 Plan. Stock options under the
1993 Plan originally had a term of ten years from the date of grant and vested
in equal annual installments over four years, while restricted stock grants
vested in equal annual installments over three years.
26
<PAGE>
TIG HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
In connection with the IPO, TIG and Transamerica agreed that TIG employees could
surrender their options to purchase Transamerica common stock by May 14, 1993,
and receive options to purchase TIG Holdings common stock, retaining the taxable
spread, vesting schedule and term of the surrendered Transamerica stock options
as of the IPO closing date. Options relating to 820,498 shares of common stock
were issued in connection with this agreement and are included in outstanding
options in the following table.
A summary of the status of the Company's three stock based compensation plans as
of December 31, 1998 and changes during the three years ended December 31, 1998
is presented below: <TABLE> <CAPTION>
Restricted Class A
Shares Shares Options
---------------------------------------------------- --------------- --------------- --------------
<S> <C> <C> <C>
Outstanding at January 1, 1996 28,860 35,793 11,011,182
Granted 110,170 - 1,476,736
Exercised/Earned (25,436) (35,793) (383,594)
Forfeited or canceled (14,380) - (472,089)
---------------------------------------------------- --------------- --------------- --------------
Outstanding at December 31, 1996 99,214 - 11,632,235
---------------------------------------------------- --------------- --------------- --------------
Granted 71,319 - 2,090,117
Exercised/Earned (33,972) - (2,994,788)
Forfeited or canceled (11,268) - (262,820)
---------------------------------------------------- --------------- --------------- --------------
Outstanding at December 31, 1997 125,293 - 10,464,744
---------------------------------------------------- --------------- --------------- --------------
Granted 178,045 - 1,580,832
Exercised/Earned (51,435) - (464,952)
Forfeited or canceled (14,984) - (649,466)
---------------------------------------------------- --------------- --------------- --------------
Outstanding at December 31, 1998 236,919 - 10,931,158
---------------------------------------------------- --------------- --------------- --------------
</TABLE>
The weighted average option exercise price was $25.74, $25.06 and $22.74 for
options outstanding at December 31, 1998, 1997 and 1996 respectively. The
weighted average option exercise price was $30.50 for options granted during
1998, $21.95 for options exercised in 1998 and $29.11 for options forfeited in
1998.
The weighted average fair value of options granted during 1998 was $8.48. The
fair value of each option grant is estimated on the date of grant using the
Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants in 1998, 1997 and 1996, respectively: dividend yield
of 2.95 percent, 1.70 percent and 1.75 percent; expected volatility of .289,
.220, and .201; risk free interest rate of 5 percent, 6 percent and 7 percent
and expected life of 7 years for all years. Because the Company's employee stock
options have characteristics significantly different from those of traded
options, and because changes in the subjective input assumptions can materially
affect the fair value estimate, in management's opinion, the existing models do
not necessarily provide a reliable single measure of the fair value of its
employee stock options. If the merger of the Company with Fairfax is
consummated, all outstanding options will be cancelled.
27
<PAGE>
TIG HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
If the fair value of the stock compensation granted had been accounted for under
SFAS 123, the proforma net loss for 1998 would have been $7.2 million or $0.14
per basic share; net income for 1997 would have been $41.1 million or $0.76 per
basic share or $0.74 per diluted share; and net income for 1996 would have been
$74.5 million or $1.29 per basic share or $1.26 per diluted share. For purposes
of proforma disclosures, the estimated fair value of the stock compensation is
amortized to expense over the stock compensation's vesting period. The effect on
net income of the stock compensation amortization for the years presented above
is not likely to be representative of the effects on reported net income for
future years.
The following table summarizes information about stock options outstanding and
exercisable at December 31, 1998:
<TABLE>
<CAPTION>
Options Outstanding Options Excercisable
----------------------------------------------- ---------------------------------
------------- ---------------- ---------------- ---------------- ----------------
Range of Number Weighted-Avg. Weighted-Avg. Number Weighted-Avg.
Exercise Outstanding Remaining Exercise Exercisable @ Exercise
Prices @ 12/31/98 Contractual Price 12/31/98 Price
Life
- ------------------- ------------- ---------------- ---------------- ---------------- ----------------
<S> <C> <C> <C> <C> <C>
$14.00 to $19.00 290,179 7.6 $17.21 90,179 $16.78
$19.01 to $24.00 6,588,942 4.7 $22.33 6,382,162 $22.37
$24.01 to $29.00 731,475 7.0 $26.15 377,950 $26.09
$29.01 to $34.00 2,813,924 8.6 $32.77 1,045,950 $32.51
$34.01 to $39.00 506,638 8.2 $35.37 419,239 $34.89
- ------------------- ------------- ---------------- ---------------- ---------------- ----------------
$14.00 to $39.00 10,931,158 6.1 $25.74 8,315,480 $24.39
- ------------------- ------------- ---------------- ---------------- ---------------- ----------------
</TABLE>
Total compensation cost recognized in the income statement for stock-based
employee compensation awards was $4.6 million, $1.8 million and $1.0 million for
1998, 1997 and 1996, respectively.
- --------------------------------------------------------------------------------
NOTE L. RETENTION AND SEPARATION PROGRAMS FOR CERTAIN EXECUTIVES
- --------------------------------------------------------------------------------
Special Severance Plan. Under this plan, which became effective as of June 18,
1998, each designated participant (each an officer or key employee) will be
entitled to receive special severance benefits (in lieu of normal severance) if
his or her employment with the Company or its affiliates is terminated under
specified circumstances within two years following a Change in Control of the
Company. The amount of each participant's special severance has been determined
by the Compensation Committee of the Board of Directors. In addition to this
severance benefit, each participant will be entitled to receive an amount equal
to the sum of (x) the unvested portion (if any) of his or her accounts under the
Company's qualified and nonqualified defined contribution plans and (y) the
contributions which the Company would have made or credited to such
participant's plan accounts (based upon the amounts contributed or credited to
such accounts in the year prior to the year in which the participant terminates
employment, or, in the case of qualified and nonqualified savings (401(k))
accounts, based upon the then current employer matching contributions being made
to such accounts) for a specified period following employment termination. The
participant will also be eligible to continue to participate (on the same basis
as if still actively employed) in the Company's health, dental and life
insurance plans for a finite period following employment termination. The
maximum aggregate amount of severance benefits that would be payable in cash
pursuant to this severance plan is approximately $16 million.
Retention and Bonus Plan. In addition, pursuant to a Retention and Bonus Plan
approved by the Board in July 1998, the designated participants are entitled to
certain payments if they continue their employment until the earlier of June 30,
2000 or a Change of Control of the Company. The maximum aggregate amount of
benefits that would be payable in cash pursuant to this plan is approximately $5
million.
28
<PAGE>
TIG HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE M. EMPLOYEE BENEFIT PLANS
- --------------------------------------------------------------------------------
TIG Holdings' employee benefit plans (the "Plans") include the Diversified
Savings and Profit Sharing Plan and the Employee Stock Ownership Plan. TIG
Holdings adopted the ESOP and Profit Sharing Restoration Plans, effective
January 1, 1994, and the Diversified Savings Restoration Plan, effective January
1, 1997. TIG Holdings may amend, terminate, or suspend contributions to the
Plans at any time as it may deem advisable. TIG Holdings is the administrator of
the Plans. Any subsidiary of TIG Holdings participating in the Plans may
withdraw at any time with the consent of the TIG Holdings' Board of Directors.
The Board of Directors of TIG Holdings has fiduciary responsibilities relating
to the interpretation and operation of the Plans.
Diversified Savings and Profit Sharing Plan. As of January 1, 1997, the
Diversified Savings Plan and Profit Sharing Plan were combined into the TIG
Holdings, Inc. Diversified Savings and Profit Sharing Plan (the "DS&PSP"). The
DS&PSP is qualified under Section 401 (a) of the Internal Revenue Code ("IRC")
and the trust established to hold the assets of the DS&PSP is tax-exempt under
Section 501 (a) of the IRC. An employee vests 25% after one year of service, 50%
after two years of service and 100% after three years of service. While the
assets are maintained in a single trust, the record keeping, contributions and
participant qualifications remain as if under two separate plans, the
Diversified Savings Plan (the "DSP") and the Profit Sharing Plan (the "PSP").
The DSP is available to all salaried employees. Most employees who elect to
participate may contribute up to 12% of their pre-tax salary, plus bonuses,
commissions, and overtime pay ("Employee Compensation") for each calendar year.
TIG Holdings administers the DSP and will make matching contributions to the DSP
in an amount equal to 75% of the participant's contribution up to a maximum of
6% of Employee Compensation. Certain IRC required limitations may be imposed for
participants who are treated as "highly compensated employees" for purposes of
the IRC. Generally, an employee vests in the matching employer contributions
based upon years of service. Employer matching contributions were $3 million for
1998, 1997 and 1996.
The PSP benefits eligible employees of TIG Holdings. Eligible employees are
those who either were employed by TIG Holdings on December 31 each year or were
employed during the plan year but died prior to the plan year end. Generally,
each salaried employee is eligible to participate in the PSP. No employee
contributions are permitted to be made to the PSP. The amount of any
contribution for any calendar year made by TIG Holdings will be determined at
the sole discretion of the TIG Holdings' Board of Directors. For 1998, 1997 and
1996 plan years, TIG contributed on behalf of each participant an amount equal
to the sum of (i) two percent of the participant's Employee Compensation, as
defined, for the Plan Year and (ii) four percent of the participant's annual
Employee Compensation in excess of a determined wage base. In addition, if the
merger of the Company with Fairfax is consummated (see Note C - Significant
Transactions and Events), the 1% contribution for the ESOP 1998 plan year will
be contributed to the PSP in 1999. Contributions were $2 million, $2 million and
$1 million for 1998, 1997 and 1996, respectively.
29
<PAGE>
TIG HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Diversified Savings and Profit Sharing Restoration Plan. Effective January 1,
1997, TIG Holdings adopted the TIG Holdings, Inc. Diversified Savings
Restoration Plan and combined it with the existing Profit Sharing Restoration
Plan. The TIG Holdings, Inc. Diversified Savings and Profit Sharing Restoration
Plan (the "DS&PS Restoration Plan") is an unfunded plan for the purpose of
providing deferred compensation for a select group of management or highly
compensated employees whose allocations under the qualified DS&PSP are limited
by the annual restrictions as determined by the Internal Revenue Code. Highly
compensated employees will be eligible for participation immediately upon the
date of hire if annual earnings, including bonus in the year paid, exceed a
specified threshold. The threshold for each year will be the amount of the cap
on compensation that may be taken into account under the qualified plan for that
year, or such greater amount as may be determined by the TIG Holdings, Inc.
Benefits Committee in its discretion. A Participant vests 25% after one year of
service, 50% after two years of service and 100% after three years of service.
Participants' accounts are credited for the difference between the dollar amount
credited to the participants' account under the qualified DS&PSP and the amount
that would have been credited in the absence of the restrictions noted above.
Participants' accounts are adjusted for gains, losses and earnings as if
invested in the same manner as such associate's account under the qualified
DS&PSP. Liabilities due to the participants were approximately $3 million and $2
million as of December 31, 1998 and 1997.
Employee Stock Ownership Plan. Most salaried employees are eligible to
participate in the ESOP. Generally, TIG Holdings will contribute, for each
calendar year, an amount equal to one percent of Employee Compensation, as
defined, on behalf of each participant employed on the last working day of that
year or who was employed but died during the year. Employees who were actively
employed on April 27, 1993 received an initial allocation of 100 shares of TIG
Holdings common stock in which they were immediately fully vested. Effective
January 1, 1995, all active associates who did not previously receive the
initial allocation of shares in 1993 were eligible for 100 shares of TIG
Holdings, Inc. common stock upon attainment of six months of service. These
shares were allocated to the associates' accounts as of the last day of the plan
year. No employee contributions are permitted to be made to the ESOP. An
employee vests 25% after one year of service, 50% after two years of service and
100% after three years of service. In April 1993, the ESOP borrowed $24 million
from TIG Holdings to purchase 1,124,754 newly issued shares of common stock. The
loan obligation of the ESOP is considered unearned employee compensation, and as
such, is recorded as a reduction of TIG Holdings' shareholders' equity. As loan
repayments are made by the ESOP, common stock is released to participant
accounts. Unearned compensation is amortized based on the number of shares
committed to be released and compensation expense is recognized based on the
current market price. Dividends paid on unallocated shares are considered as
employer contributions. Compensation expense of $2 million was recognized in
1997 and 1996, respectively. At December 31, 1998, 189,330 shares are allocated
and 360,752 shares are in suspense. As of December 31, 1998, the market value of
unallocated shares was $6 million. As noted below, no annual contribution was
made to the ESOP plan for the 1998 plan year. Contributions to the ESOP were $1
million and $2 million for 1997 and 1996. A participant's ESOP account will be
distributed in full shares of common stock or cash after termination of service.
If the merger of the Company with Fairfax is consummated, the 1% ESOP 1998 plan
year contribution will be made to the PSP in 1999. The 100 shares allocation
will be terminated as of December 31, 1998, and a cash distribution outside of
the plan will be made to those affected employees in lieu of allocating shares
to their accounts. If the merger of the Company with Fairfax is consummated, TIG
expects to merge the ESOP plan into the DS&PSP.
30
<PAGE>
TIG HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
ESOP Restoration Plan. The TIG Holdings, Inc. ESOP Restoration Plan is an
unfunded plan for the purpose of providing deferred compensation for a select
group of management or highly compensated employees whose allocations under the
qualified ESOP plan are limited by annual restrictions as determined by the
Internal Revenue Code. Highly compensated employees whose allocations under the
qualified plan are limited by the Internal Revenue Code restrictions will be
eligible for participation immediately upon the date of hire if annual earnings,
including bonus in the year paid, exceed a specified threshold. The threshold
for each year will be the amount of the cap on compensation that may be taken
into account under the qualified plan for that year, or such greater amount as
may be determined by the TIG Holdings, Inc. Benefits Committee in its
discretion. A Participant vests 25% after one year of service, 50% after two
years of service and 100% after three years of service. Participants' accounts
are credited in dollar amounts for the difference between the cash value of the
stock that would have been allocated to the participant's account under the
qualified ESOP plan and the cash value of the stock that would have been
allocated in the absence of the restrictions noted above. Participants' accounts
are adjusted for gains, losses and earnings as if invested in the same manner as
such associate's account under the qualified ESOP plan. Liabilities due to the
participants were less than $1 million as of December 31, 1998, 1997 and 1996.
If the merger of the Company with Fairfax is consummated, TIG expects to merge
the ESOP Restoration Plan into the DS&PSP Restoration Plan.
Postretirement Benefits Other Than Pensions. TIG participated in Transamerica's
defined benefit health care plan that provided postretirement benefits to
eligible retirees of Transamerica and affiliates. TIG assumed all liabilities
with respect to its retirees and active employees at the date of the IPO. These
liabilities are a component of the Company's employee healthcare plan, and as
such, no plan assets are specifically identified for this unfunded plan.
Contributions for these contributory plans are adjusted annually. Consideration
for the adjustments include deductibles and coinsurance. Medical benefits are
based on the employee's length of service and age at retirement from the
Company.
A summary of the components of net periodic other postretirement benefit cost is
as follows:
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------------
(In millions) 1998 1997 1996
-------------------------------------------------------- --------------- -------------- ---------------
<S> <C> <C> <C>
Service cost - benefits earned during the period $ - $ - $0.3
Interest cost on projected benefit obligation 1.9 1.7 1.4
Amortization of prior service cost (0.1) (0.1) (0.1)
Amortization of loss 0.3 0.2 -
-------------------------------------------------------- --------------- -------------- ---------------
Net periodic other postretirement benefit cost $2.1 $1.8 $1.6
-------------------------------------------------------- --------------- -------------- ---------------
</TABLE>
31
<PAGE>
TIG HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
The following table sets forth the amounts recognized in the balance sheet for
other postretirement benefit plans:
<TABLE>
<CAPTION>
(In millions) 1998 1997
--------------------------------------------------------------- ---------------- -----------------
<S> <C> <C>
Change in benefit obligation
Benefit obligation at beginning of year $25.6 $20.6
Interest cost 1.9 1.7
Actuarial gain 2.4 5.5
Benefits paid (2.3) (2.2)
--------------------------------------------------------------- ---------------- -----------------
Benefit obligation at end of year $27.6 $25.6
--------------------------------------------------------------- ---------------- -----------------
Funded status ($27.6) ($25.6)
Unrecognized prior service cost (0.5) (0.6)
Unrecognized net actuarial loss 7.3 5.2
--------------------------------------------------------------- ---------------- -----------------
Accrued benefit cost ($20.8) ($21.0)
--------------------------------------------------------------- ---------------- -----------------
Reconciliation of accrued postretirement benefit cost
Accrued benefit cost as of prior year end ($21.0) ($21.3)
Employer contributions during the year 2.3 2.1
Net periodic benefit cost for the year (2.1) (1.8)
--------------------------------------------------------------- ---------------- -----------------
Accrued benefit cost as of year end ($20.8) ($21.0)
--------------------------------------------------------------- ---------------- -----------------
</TABLE>
The weighted average annual assumed rate of increase in the health care cost
trend rate is 6.0 percent for 1998 and will decrease to 5.0 percent in 1999 and
remain at that level thereafter. The health care cost trend rate assumption has
a significant effect on the amounts reported.
Increasing the trend rate by one percentage point would increase the actuarial
present value obligation for postretirement medical benefits as of December 31,
1998, by $2 million, and the aggregate of the service and interest cost
components of net periodic postretirement benefit cost by $0.2 million for 1998.
Decreasing the trend rate by one percentage point would decrease the actuarial
present value obligation for postretirement medical benefits as of December 31,
1998, by $2 million, and the aggregate of the service and interest cost
components of net periodic postretirement benefit cost by $0.2 million for 1998.
The weighted average discount rate used in determining the postretirement
benefit obligation was 7.0% at December 31, 1998 and 1997.
- --------------------------------------------------------------------------------
NOTE N. COMMITMENTS AND CONTINGENCIES
- --------------------------------------------------------------------------------
Leases. Future minimum rental commitments as of December 31, 1998 for all
noncancelable operating leases are as follows:
<TABLE>
<CAPTION>
(In millions)
------------------------------------ -------------------------
<S> <C>
1999 $32
2000 28
2001 19
2002 13
2003 10
Thereafter 38
------------------------------------ -------------------------
140
Sublease rental income 14
------------------------------------ -------------------------
Net commitments $126
------------------------------------ -------------------------
</TABLE>
32
<PAGE>
TIG HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Substantially all of the leases are for rental of office space, the initial
terms of which range from one to 20 years. Total rental expense for 1998, 1997,
and 1996 was $22 million, $18 million and $17 million, respectively. As a result
of the reorganization of TIG's commercial operations in the first quarter of
1996, certain lease termination costs in the amount of $18 million were incurred
and are included in the $100 million restructuring charges recorded in 1996 as
discussed in Note B - Summary of Significant Accounting Policies.
Litigation. TIG's insurance subsidiaries are routinely engaged in litigation in
the normal course of business. As a liability insurer, the Company defends
third-party claims brought against its insureds. As an insurer, the Company
defends against coverage claims. In the opinion of TIG, based upon information
available at the date of this report, no individual item of litigation, or group
of similar items of litigation (including asbestos-related and environmental
pollution matters and the matters referred to below), taken net of reserves
established therefor and giving effect to insurance and reinsurance, is likely
to result in judgments for amounts material to TIG's consolidated results of
operations or financial condition.
On January 11, 1994, a Los Angeles County Superior Court jury returned a verdict
of $28 million for punitive damages against TIG Insurance Company ("TIC") in
Talbot Partners v. Cates Construction, Inc. and TIC (the "Talbot Case"). The
award arose out of TIC's handling of a surety bond claim on a construction
project. On March 28, 1997, the California Court of Appeal reduced the trial
court's punitive damage award to $15 million. On July 23, 1997, the California
Supreme Court granted TIC's petition to review the Court of Appeal's decision.
Management believes that the ultimate liability arising from the Talbot Case
will not materially impact consolidated operating results.
On February 12, 1998, a purported class action complaint, naming TIG and two of
its executive officers as defendants, was filed in the United States District
Court for the Southern District of New York on behalf of persons who purchased
TIG common stock during the period from October 21, 1997 to January 30, 1998,
when TIG announced its fourth quarter 1997 results. The complaint alleges that
TIG violated the federal securities laws by misrepresenting the adequacy of its
underwriting and monitoring standards and its loss reserves, and that three of
its officers and directors sold shares at prices that were artificially inflated
as a result of the alleged misrepresentations. Plaintiffs seek unspecified
monetary damages, including punitive damages. Management believes that the
lawsuit is without merit, and the Company's position will be vigorously
defended.
On July 17, 1998, TIG Premier Insurance Company ("TIG Premier"), a subsidiary of
TIC, filed a complaint and jury demand against MBNA America Bank, N.A. d.b.a.
MBNA Insurance Services ("MBNA") in federal court in the Northern District of
Texas that was based on an agency agreement between TIG Premier and MBNA (the
"Agency Agreement") pursuant to which TIG Premier offered an insurance program
that was marketed by MBNA to its customers. In its complaint, TIG Premier sought
a declaratory relief judgment declaring that TIG could reduce the commission
payable to MBNA and lengthen the 5-year term of the Agency Agreement in order
to, at a minimum, reduce TIG Premier's underwriting losses and improve the
possibility of TIG Premier's achieving the agreed upon 15% minimum rate of
return. On August 19, 1998, TIG filed an amended complaint seeking monetary
damages for MBNA's repudiation and breach of the Agency Agreement, including,
without limitation, the underwriting losses that TIG Premier incurred and the
minimum 15% rate of return over the entire five-year initial term of the Agency
Agreement, in an amount to be determined at trial. In its amended answer, dated
August 31, 1998, MBNA instituted a counterclaim against TIG Premier based on TIG
Premier's alleged breach and repudiation of the Agency Agreement, seeking
damages in an amount not less than $100 million. Management believes that the
liability arising from this case, if any, will not materially impact
the Company's consolidated results of operations or financial condition.
33
<PAGE>
TIG HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
On December 9, 1998, a purported shareholder class action was commenced in the
Delaware Court of Chancery against the Company, its directors and Fairfax. The
complaint alleges, inter alia, that the consideration to be paid pursuant to the
Merger Agreement is unfair and inadequate and that the terms of the Merger
Agreement were arrived at without a full and thorough investigation by the
directors. The complaint seeks injunctive relief, including a judgment enjoining
the transaction, and the award of unspecified compensatory damages. The Company
believes that the action is without merit and intends to defend the action
vigorously.
On December 11, 1997, TIG filed a Tax Court Petition challenging an IRS
Statutory Notice of Deficiency for the tax year 1993 and a Revenue Agents Report
for 1994 (see Note G - Income Taxes).
London Market Activity. Through various indirect subsidiaries, the Company
became a limited liability participant in the Lloyd's of London ("Lloyd's")
market in 1997. As a prerequisite to admittance to the Lloyd's market,
irrevocable letters of credit totaling $123 million, collateralized by $105
million of the Company's investment securities, were provided in favor of the
Society and Council of Lloyd's at December 31, 1997. At December 31, 1998, the
irrevocable letters of credit were collateralized by $137 million of the
Company's investment securities. The letters of credit effectively secure the
syndicate's 1998 results and future contingent obligations of the Company should
the Lloyd's underwriting syndicates in which the Company participates incur net
losses. The Company's contingent liability to the Society and Council of Lloyd's
is limited to the amount of the letters of credit.
34
<PAGE>
TIG HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE O. REGULATORY MATTERS
- --------------------------------------------------------------------------------
Regulatory Risk-Based Capital. The states of domicile of TIG's insurance
subsidiaries impose minimum risk-based capital requirements on insurance
companies which were developed by the National Association of Insurance
Commissioners ("NAIC"). The formulas for determining the amount of risk based
capital specify various weighting factors that are applied to financial balances
or various levels of activity based on the perceived degree of risk. Regulatory
compliance is determined by a ratio of the enterprise's regulatory total
adjusted capital, as defined by the NAIC, to its authorized control level
risk-based capital, as defined by the NAIC. Enterprises below specific trigger
points or ratios are classified within certain levels, each of which requires
specified corrective action. The levels and ratios are as follows:
<TABLE>
<CAPTION>
Ratio of Total Adjusted Capital to
Authorized Control Level Risk-Based
Regulatory Event Capital (Less Than or Equal to)
-------------------------------------- -------------------------------------------
<S> <C>
Company action level 2.0 (or 2.5 with negative trends)
Regulatory action level 1.5
Authorized control level 1.0
Mandatory control level 0.7
-------------------------------------- -------------------------------------------
</TABLE>
At December 31, 1998, the statutory "risk-based" capital for each TIG insurance
subsidiary was such that no action (company or regulatory) would be required. As
of December 31, 1998, TIG was required to maintain minimum capital of $656
million to avoid triggering a company action level regulatory event.
Permitted Statutory Accounting Practices. TIG's statutory-basis financial
statements are prepared in accordance with accounting practices prescribed or
permitted by the domiciliary state insurance department. Currently, "prescribed"
statutory accounting practices are interspersed throughout the state insurance
law and regulations, the NAIC's "Accounting Practices and Procedures Manual" and
a variety of other NAIC publications. "Permitted" statutory accounting practices
encompass all accounting practices that are not prescribed; such practices may
differ from state to state, may differ from company to company within a state,
and may change in the future.
In 1998, the NAIC adopted codified statutory accounting principles
("Codification"). Codification will likely change, to some extent, prescribed
statutory accounting practices and may result in changes to the accounting
practices that TIG uses to prepare its statutory-basis financial statements.
Codification will require adoption by the various states before it becomes the
prescribed statutory basis of accounting for insurance companies domesticated
within those states. Accordingly, before Codification becomes effective for TIG,
the insurance regulatory bodies of states in which TIG writes business must
adopt Codification as the prescribed basis of accounting on which domestic
insurers must report their statutory-basis results to the Insurance Department.
At this time it is anticipated that the State of California, which is the state
of domicile for TIG Insurance Company, the primary insurer for TIG, will adopt
Codification. Management has not yet determined the impact of Codification on
TIG's statutory-basis financial statements.
35
<PAGE>
TIG HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Statutory amounts for TIG's significant insurance subsidiaries are as follows:
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------------
(In millions) 1998 1997 1996
------------------------------------------------------ ------------- ------------- -------------
<S> <C> <C> <C>
Statutory Net Income (Loss):
Primary operations $37 $143 $88
Reinsurance operations 94 (22) 96
------------------------------------------------------ ------------- ------------- -------------
Total $131 $121 $184
------------------------------------------------------ ------------- ------------- -------------
December 31,
-----------------------------------------
(In millions) 1998 1997 1996
------------------------------------------------------ ------------- ------------- -------------
Statutory Surplus:
Primary operations $417 $505 $460
Reinsurance operations 547 508 515
------------------------------------------------------ ------------- ------------- -------------
Total $964 $1,013 $975
------------------------------------------------------ ------------- ------------- -------------
</TABLE>
In June 1993, the California Department of Insurance permitted TIG Insurance
Company ("TIC"), TIG's lead insurer to record a quasi-reorganization of its
statutory capital accounts. This permitted statutory accounting practice differs
from prescribed statutory accounting practice. The effect of the
quasi-reorganization was to increase the earned surplus of TIC to zero from a
negative $285 million and to decrease contributed surplus by the same amount.
This transaction significantly increased TIC's future dividend paying capability
as insurance companies may only pay dividends from earned surplus.
36
<PAGE>
TIG HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE P. OPERATING SEGMENTS
- --------------------------------------------------------------------------------
Management of the Company monitors and evaluates the results of operations based
upon the performance of its three major operating divisions, Reinsurance,
Commercial Specialty and Custom Markets, as well as lines of business that have
been de-emphasized (Other Lines). Reinsurance Operations are conducted through
TIG Re and include those transactions in which TIG Re agrees to indemnify
another insurance company for all or a portion of the insurance risks
underwritten by that company under an insurance policy or policies. Commercial
Specialty generally provides coverage to business and governmental entities,
organizations, associations and individual professionals. Commercial workers'
compensation products provide benefits to employees as mandated by state laws
for payment of benefits associated with employment related accidents, injuries
or illnesses. Custom Markets coverages provide protection to individuals through
non-standard automobile damage and liability programs, homeowners property lines
and small business owners liability programs. Other Lines include both
commercial and personal programs that TIG has identified for non-renewal or
cancellation.
Management evaluates the financial performance of its divisions based upon the
underwriting gain or loss ("underwriting results") generated by each operating
segment. Underwriting results include earned premium less loss and loss
adjustment expenses incurred, policy acquisition and other underwriting expenses
incurred (which includes commissions, premium related expenses and other
acquisition expenses), and policyholder dividends. The accounting policies of
the operating segments are the same as those described in the summary of
significant accounting policies (See Note B of the Consolidated Financial
Statements).
The Company does not maintain separate balance sheet data for each of its
operating segments. Accordingly, management does not review and evaluate the
financial results of its operating segments based upon balance sheet data.
37
<PAGE>
TIG HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
The following tables present the relevant financial results for the operating
segments for each year:
<TABLE>
<CAPTION>
1998
------------------------------------------------------------------------------
Reinsurance Commercial Custom Other
(In millions) Operations Specialty Markets Lines Total
- ------------------------------------- -------------- --------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C> <C>
Net premium earned $491 $702 $276 ($22) $1,447
Net losses and loss adjustment
expenses incurred (331) (499) (239) 28 (1,041)
Policy acquisition and other
underwriting expenses (190) (225) (100) 13 (502)
Dividends to policyholders - (23) - (1) (24)
- ------------------------------------- -------------- --------------- --------------- --------------- ---------------
Net underwriting gain (loss) ($30) ($45) ($63) $18 ($120)
- ------------------------------------- -------------- --------------- --------------- --------------- ---------------
</TABLE>
<TABLE>
<CAPTION>
1997
------------------------------------------------------------------------------
Reinsurance Commercial Custom Other
(In millions) Operations Specialty Markets Lines Total
- ------------------------------------- -------------- --------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C> <C>
Net premium earned $516 $500 $158 $292 $1,466
Net losses and loss adjustment
expenses incurred (505) (323) (108) (215) (1,151)
Policy acquisition and other
underwriting expenses (174) (162) (62) (68) (466)
Dividends to policyholders - (14) - - (14)
- ------------------------------------- -------------- --------------- --------------- --------------- ---------------
Net underwriting gain (loss) ($163) $1 ($12) $9 ($165)
- ------------------------------------- -------------- --------------- --------------- --------------- ---------------
</TABLE>
<TABLE>
<CAPTION>
1996
------------------------------------------------------------------------------
Reinsurance Commercial Custom Other
(In millions) Operations Specialty Markets Lines Total
- ------------------------------------- -------------- --------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C> <C>
Net premium earned $534 $416 $95 $494 $1,539
Net losses and loss adjustment
expenses incurred (386) (289) (55) (408) (1,138)
Policy acquisition and other
underwriting expenses (162) (131) (34) (136) (463)
Dividends to policyholders - (2) - (1) (3)
- ------------------------------------- -------------- --------------- --------------- --------------- ---------------
Net underwriting gain (loss) ($14) ($6) $6 ($51) ($65)
- ------------------------------------- -------------- --------------- --------------- --------------- ---------------
</TABLE>
The following table reconciles the underwriting results for the operating
segments to income before income tax benefit (expense) as reported in the
Consolidated Statements of Income:
<TABLE>
<CAPTION>
(In millions) 1998 1997 1996
- --------------------------------------------------- -------------------- -------------------- --------------------
<S> <C> <C> <C>
Net underwriting loss ($120) ($165) ($65)
Net investment income 235 290 290
Net investment and other gain (loss) (12) 1 (4)
Corporate expenses (81) (44) (37)
Interest expense on long-term debt (23) (20) (9)
Restructuring charges - - (100)
- --------------------------------------------------- -------------------- -------------------- --------------------
Income (loss) before income taxes ($1) $62 $75
- --------------------------------------------------- -------------------- -------------------- --------------------
</TABLE>
38
<PAGE>
TIG HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
The company writes premium primarily in the United States, Canada and Great
Britain, as reflected in the following table:
<TABLE>
<CAPTION>
Net Premiums Written
---------------------------------------------------
(In millions) 1998 1997 1996
------------------------------------------- ---------------- ----------------- ----------------
<S> <C> <C> <C>
United States $1,227 $1,322 $1,496
Great Britain/Lloyd's Syndicates 175 106 29
Canada 9 8 4
Other 7 - -
------------------------------------------- ---------------- ----------------- ----------------
Total $1,418 $1,436 $1,529
------------------------------------------- ---------------- ----------------- ----------------
</TABLE>
A large portion of the Company's premium is produced through Aon Corporation and
its subsidiaries (Aon). Premium produced through Aon accounted for 34%, 32% and
23% of consolidated net premium written for 1998, 1997 and 1996, respectively,
and has been reported throughout the Reinsurance, Commercial Specialty and
Custom Markets segments.
39
<PAGE>
TIG HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE Q. INTERIM FINANCIAL DATA (UNAUDITED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Quarter
------------------------------------------------
(In millions) First Second Third Fourth Total
- --------------------------------------------- ---------- ----------- ------------ ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Summary of Quarterly Results:
Revenues 1998 $427 $435 $439 $369 $1,670
1997 429 435 453 440 1,757
1996 455 457 460 453 1,825
Pre-tax income (loss) 1998 47 43 (75) (16) (1)
1997 54 57 55 (104) 62
1996 (82) 49 53 55 75
Net income (loss) 1998 33 30 (47) (8) 8
1997 36 39 40 (63) 52
1996 (31) 34 37 39 79
- --------------------------------------------- ---------- ----------- ------------ ----------- ----------- -----------
Basic Earnings per Common Share:
Net income (loss) 1998 $0.64 $0.57 ($0.93) ($0.16) $0.13
1997 $0.67 $0.74 $0.77 ($1.24) $0.97
1996 ($0.53) $0.58 $0.67 $0.70 $1.36
Diluted Earnings per Common Share:
Net income 1998 $0.62 $0.56 N/A N/A $0.13
1997 $0.64 $0.72 $0.74 N/A $0.94
1996 N/A $0.56 $0.65 $0.68 $1.32
- --------------------------------------------- ---------- ----------- ------------ ----------- ----------- -----------
</TABLE>
In the first quarter of 1996, an after-tax restructuring charge of $65 million
was taken for costs related to management's decision to restructure operations
(see Note B - Summary of Significant Accounting Policies). In the fourth quarter
of 1997 the Company recognized net unfavorable current and prior year loss and
LAE reserve development of $145 million in its Reinsurance Operations (see Note
E - Loss and Loss Adjustment Expense Reserves) and sold the Independent Agents
unit of its Retail Division (see Note C - Significant Transactions and Events)
as a result of which favorable adjustments of policy acquisition and other
underwriting expenses totaling $8 million were recorded. In the third quarter of
1998, the Company recognized a net charge of $104 million that included $47
million in exit costs relating to the termination of the MBNA program, $38
million in allowances for uncollectible reinsurance recoverable and premium
receivable, $6 million in severance related costs for former employees and $13
million in other operating costs (see Note C - Significant Transactions and
Events). In the fourth quarter of 1998, the Company recognized $10 million in
severance and related charges in conjunction with several staffing changes
initiated at the end of the year.
40
<PAGE>
TIG HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE R. YEAR 2000 (UNAUDITED)
- --------------------------------------------------------------------------------
The Year 2000 issue relates to the ability or inability of systems (including
computer hardware, software and embedded microprocessors) to properly interpret
date information relating to the year 2000 and beyond. Many existing systems,
including many of TIG's existing systems, use only the last two digits to refer
to a year (i.e., "98" is used for 1998). Therefore, these systems may not
properly recognize a year that begins with "20" instead of "19". If not
corrected, these systems could fail or create erroneous results.
Specific information technology systems that are utilized by TIG, and by third
parties with whom TIG has business relationships, include policy, claim and
reinsurance processing and administration, accounting, payroll, financial
reporting, product development, rate and form development and maintenance,
business planning, tax, accounts receivable, accounts payable and numerous word
processing and spreadsheet programs. In addition, TIG and third parties with
which TIG has a business relationship are dependent on many non-information
technology based systems, such as utility, communication and security systems.
TIG's State of Readiness. TIG has conducted an extensive review of its core
processing computer systems, including computer hardware and software vendors,
to identify and address all changes, testing and implementation procedures
required to make such systems Year 2000 complaint. The Company has a coordinated
process to facilitate the necessary changes, testing and implementation
procedures. TIG has completed and implemented all of the required code changes
of its Year 2000 system remediation project. TIG expects necessary third party
software implementation and testing of its computer systems to be completed by
March 31, 1999. TIG will continue testing its internal systems, as well as its
internal systems' abilities to operate with the systems of key third parties,
during the remainder of 1999.
TIG has processing or significant business relationship dependencies with third
parties including, without limitation, general agents, brokers, third party
administrators, banks, general suppliers and facility-related vendors.
Determination of any action required is expected to be completed in the second
quarter of 1999, and TIG will continue to monitor Year 2000 issues relating to
such key third parties during the remainder of 1999. Notwithstanding efforts by
TIG to assess the third party's systems, there can be no guarantee that such
systems will be Year 2000 compliant.
The Cost to Address TIG's Year 2000 Issues. TIG budgeted a total of $10 million
for costs related to Year 2000 system modifications. As of year-end 1998, $9.5
million has been expensed in the year incurred. The remainder (approximately
$500 thousand) will be expensed in 1999. The 1999 amount represents less than
1.5% of the annual TIG Information Systems budget. These costs primarily
represent costs to assess, remediate code, and test such code changes.
In addition to the costs incurred for Year 2000 system modifications, TIG will
incur expenses in ascertaining whether key third parties with which it has a
material relationship are Year 2000 compliant. TIG estimates that such expenses
will not exceed $1.5 million. This amount includes both IT and non IT portions
of this project.
All estimates of future costs related to assessing and achieving Year 2000
compliance are based on management's best estimates and there can be no
guarantee that actual amounts expended will not differ from such estimates.
The Y2K Project has caused no significant deferrals of other IT projects which
in any way impact the financial condition or results of operations of TIG.
41
<PAGE>
TIG HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
The Risks of TIG's Year 2000 Issues. There has not been any material processing
disruptions to date. Internal testing provides TIG with a high level of
confidence that in a most reasonably likely worst case scenario these systems
will not cause material disruption on a forward-looking basis.
The potential losses that TIG policyholders may incur which stem from Year 2000
problems will be business risks which are not insurable under standard property
and casualty policies. A most reasonably likely worst case scenario would
anticipate that it is possible that certain TIG policies may be reformed by
judicial decisions to cover Year 2000 losses, which were not contemplated. TIG
does not believe that such losses will have a material impact on TIG's financial
results. To date, TIG has not incurred any losses relating to Year 2000 claims
under its insurance and reinsurance policies.
Although the Company has taken the actions described above to address the Year
2000 problem, a most reasonable likely worst case scenario indicates that there
is always a possibility that TIG may suffer some disruptions as a result of the
Year 2000 problem.
TIG's Contingency Plans. TIG has a comprehensive contingency plan that addresses
alternatives for solving the Year 2000 problem should the Company's adopted
process prove inadequate. TIG continues to evaluate and modify the plan as
necessary for all of the Company's operations and processes.
42
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
(Replace this text with the legend)
</LEGEND>
<CIK> 0000897430
<NAME> TIG Holdings, Inc.
<MULTIPLIER> 1,000,000
<CURRENCY> US Dollar
<S> <C>
<PERIOD-TYPE> 12-Mos
<FISCAL-YEAR-END> Dec-31-1998
<PERIOD-START> Jan-01-1998
<PERIOD-END> Dec-31-1998
<EXCHANGE-RATE> 1.00
<DEBT-HELD-FOR-SALE> 0
<DEBT-CARRYING-VALUE> 3,618
<DEBT-MARKET-VALUE> 3,618
<EQUITIES> 0
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 3,894
<CASH> 72
<RECOVER-REINSURE> 2,080
<DEFERRED-ACQUISITION> 137
<TOTAL-ASSETS> 7,215
<POLICY-LOSSES> 4,100
<UNEARNED-PREMIUMS> 719
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 125
25
0
<COMMON> 1,274
<OTHER-SE> (147)
<TOTAL-LIABILITY-AND-EQUITY> 7,215
1,447
<INVESTMENT-INCOME> 235
<INVESTMENT-GAINS> (12)
<OTHER-INCOME> 0
<BENEFITS> 1,041
<UNDERWRITING-AMORTIZATION> 425
<UNDERWRITING-OTHER> 101
<INCOME-PRETAX> (1)
<INCOME-TAX> 9
<INCOME-CONTINUING> 8
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 8
<EPS-PRIMARY> 0.13
<EPS-DILUTED> 0.13
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
