-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, LCgSTpzRpcuoeVvLLi8+fBbePwKX9q6miGFd01sa0jzQDpgdm2PRC3hMiPCAUzJ0 c+Xx4OtSH2lFXChBPOu+4w== 0000950157-97-000460.txt : 19970930 0000950157-97-000460.hdr.sgml : 19970930 ACCESSION NUMBER: 0000950157-97-000460 CONFORMED SUBMISSION TYPE: 8-K PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 19970929 ITEM INFORMATION: ITEM INFORMATION: FILED AS OF DATE: 19970929 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: SALOMON INC CENTRAL INDEX KEY: 0000200245 STANDARD INDUSTRIAL CLASSIFICATION: SECURITY BROKERS, DEALERS & FLOTATION COMPANIES [6211] IRS NUMBER: 221660266 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 8-K SEC ACT: SEC FILE NUMBER: 001-04346 FILM NUMBER: 97686925 BUSINESS ADDRESS: STREET 1: SEVEN WORLD TRADE CNTR STREET 2: 28TH FLOOR CITY: NEW YORK STATE: NY ZIP: 10048 BUSINESS PHONE: 2127837000 MAIL ADDRESS: STREET 1: SEVEN WORLD TRADE CENTER STREET 2: 29TH FLOOR CITY: NEW YORK STATE: NY ZIP: 10048 FORMER COMPANY: FORMER CONFORMED NAME: PHIBRO CORP DATE OF NAME CHANGE: 19820526 FORMER COMPANY: FORMER CONFORMED NAME: ENGELHARD MINERALS & CHEMICALS CORP DATE OF NAME CHANGE: 19811104 8-K 1 FORM 8-K ========================================================================== 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): September 24, 1997 SALOMON INC (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 1-4346 22-1660266 (STATE OR OTHER JURISDICTION (COMMISSION (I.R.S. EMPLOYER OF INCORPORATION OR ORGANIZATION) FILE NUMBER) IDENTIFICATION NUMBER) SEVEN WORLD TRADE CENTER NEW YORK, NEW YORK 10048 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) (212) 783-7000 (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) (FORMER NAME OR FORMER ADDRESS, IF CHANGED SINCE LAST REPORT) ========================================================================== ITEM 5. OTHER EVENTS On September 24, 1997, Salomon Inc (the "Registrant") and Travelers Group Inc. ("Travelers") announced that they had entered into an Agreement and Plan of Merger dated as of September 24, 1997 (the "Merger Agreement"), pursuant to which a wholly owned subsidiary of Travelers will merge (the "Merger") with and into the Registrant. Under the terms of the Merger Agreement, each share of the common stock, par value $1.00 per share, of the Registrant will be exchanged for 1.13 shares of the common stock, par value $.01 per share, of Travelers, each share of preferred stock of the Registrant will be converted into a share of a substantially identical series of preferred stock of Travelers and the Registrant will become a wholly owned subsidiary of Travelers. The transaction will be a tax-free exchange and will be accounted for on a "pooling of interests" basis. The Merger, which is expected to be completed in late 1997, is subject to customary closing conditions, including certain regulatory approvals (including under the Hart-Scott-Rodino Antitrust Improvements Act) and the approval of the Registrant's stockholders. After the Merger, the Registrant and Smith Barney Holdings Inc. ("Smith Barney") will merge. Travelers' Annual Report on Form 10-K for the year ended December 31, 1996, which includes the consolidated financial statements and schedules of Travelers and its subsidiaries as of December 31, 1996 and 1995 and for each of the three years in the period ended December 31, 1996, is being filed as Exhibit 99.01 to this Form 8-K and is incorporated by reference herein. Travelers' Quarterly Report on Form 10-Q for the quarter ended June 30, 1997, which includes the unaudited condensed consolidated financial statements of Travelers and its subsidiaries as of June 30, 1997 and for the six-month periods ended June 30, 1997 and 1996, is being filed as Exhibit 99.02 to this Form 8-K and is incorporated by reference herein. Smith Barney's Annual Report on Form 10-K for the year ended December 31, 1996, which includes the consolidated financial statements of Smith Barney and its subsidiaries as of December 31, 1996 and 1995 and for each of the three years in the period ended December 31, 1996, is being filed as Exhibit 99.03 to this Form 8-K and is incorporated in by reference herein. Smith Barney's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997, which includes the unaudited condensed consolidated financial statements of Smith Barney and its subsidiaries as of June 30, 1997 and for the six-month periods ended June 30, 1997 and 1996, is being filed as Exhibit 99.04 to this Form 8-K and is incorporated by reference herein. Unaudited Pro Forma Condensed Combined Financial Statements for Travelers which give effect to the Merger are being filed as Exhibit 99.05 to this Form 8-K and are incorporated by reference herein. Unaudited Pro Forma Condensed Combined Financial Statements for Smith Barney which give effect to the merger of the Registrant and Smith Barney are being filed as Exhibit 99.06 to this Form 8-K and are incorporated by reference herein. ITEM 7. FINANCIAL STATEMENTS, PRO FORMA FINANCIAL INFORMATION AND EXHIBITS (a) Financial Statements of Businesses Acquired. See Exhibits 99.01, 99.02, 99.03 and 99.04 attached hereto and incorporated by reference herein. (b) Pro Forma Financial Information. See Exhibits 99.05 and 99.06 attached hereto and incorporated by reference herein. (c) Exhibits. 23.01 Consent of KPMG Peat Marwick LLP 23.02 Consent of Coopers & Lybrand L.L.P. 99.01 Annual Report on Form 10-K for the year ended December 31, 1996 of Travelers Group Inc. 99.02 Quarterly Report on Form 10-Q for the quarter ended June 30, 1997 of Travelers Group Inc. 99.03 Annual Report on Form 10-K for the year ended December 31, 1996 of Smith Barney Holdings Inc. 99.04 Quarterly Report on Form 10-Q for the quarter ended June 30, 1997 of Smith Barney Holdings Inc. 99.05 Unaudited Pro Forma Condensed Combined Statement of Financial Position as of June 30, 1997, and Unaudited Pro Forma Condensed Combined Statements of Income for the six months ended June 30, 1997 and 1996 and for each of the years in the three-year period ended December 31, 1996 of Travelers Group Inc. 99.06 Unaudited Pro Forma Condensed Combined Statement of Financial Condition as of June 30, 1997, and Unaudited Pro Forma Condensed Combined Statements of Operations for the six months ended June 30, 1997 and 1996 for each of the years in the three-year period ended December 31, 1996 of Smith Barney Holdings Inc. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized. SALOMON INC, Date: September 29, 1997 by /s/ JEROME H. BAILEY ------------------------------- Name: Jerome H. Bailey Title: Chief Financial Officer EXHIBIT INDEX EXHIBIT DESCRIPTION 23.01 Consent of KPMG Peat Marwick LLP 23.02 Consent of Cooper & Lybrand L.L.P. 99.01 Annual Report on Form 10-K for the year ended December 31, 1996 of Travelers Group Inc. 99.02 Quarterly Report on Form 10-Q for the quarter ended June 30, 1997 of Travelers Group Inc. 99.03 Annual Report on Form 10-K for the year ended December 31, 1996 of Smith Barney Holdings Inc. 99.04 Quarterly Report on Form 10-Q for the quarter ended June 30, 1997 of Smith Barney Holdings Inc. 99.05 Unaudited Pro Forma Condensed Combined Statement of Financial Position as of June 30, 1997, and Unaudited Pro Forma Condensed Combined Statements of Income for the six months ended June 30, 1997 and 1996 and for each of the years in the three-year period ended December 31, 1996 of Travelers Group Inc. 99.06 Unaudited Pro Forma Condensed Combined Statement of Financial Condition as of June 30, 1997, and Unaudited Pro Forma Condensed Combined Statements of Operations for the six months ended June 30, 1997 and 1996 for each of the years in the three-year period ended December 31, 1996 of Smith Barney Holdings Inc. EX-23.01 2 CONSENT OF INDEPENDENT CERT. PUB. ACCTS. EXHIBIT 23.01 CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS The Board of Directors Travelers Group Inc.: We consent to the incorporation by reference in the registration statements on Form S-3 (Nos. 33-40600, 33-41932, 33-48199, 33-49136, 33-57922, 33-51269, 33-54929, 33-56481, 333-01807, 333-02897, 333-11881) and on Form S-8 (No. 33-55250) of Salomon Inc of our reports dated January 17, 1997, with respect to the consolidated financial statements and related financial statement schedules incorporated by reference or included in the December 31, 1996 annual report on Form 10-K of Travelers Group Inc., which reports appear in the Form 8-K of Salomon Inc dated September 29, 1997. KPMG Peat Marwick LLP New York, New York September 29, 1997 EX-23.02 3 CONSENT OF INDEPENDENT ACCOUNTANTS EXHIBIT 23.02 CONSENT OF INDEPENDENT ACCOUNTANTS We consent to the incorporation by reference in the Registration Statements of Salomon Inc on: Form S-3 Registration Statement No. 33-40600, Form S-3 Registration Statement No. 33-41932, Form S-3 Registration Statement No. 33-48199, Form S-3 Registration Statement No. 33-49136, Form S-3 Registration Statement No. 33-57922, Form S-3 Registration Statement No. 33-51269, Form S-3 Registration Statement No. 33-54929, Form S-3 Registration Statement No. 33-56481, Form S-3 Registration Statement No. 333-01807, Form S-3 Registration Statement No. 333-02897, Form S-3 Registration Statement No. 333-11881, and Form S-8 Registration Statement No. 33-55250; previously filed with the Securities and Exchange Commission of our report dated January 15, 1997 on our audits of the consolidated financial statements and financial statement schedules of Smith Barney Holdings Inc. and Subsidiaries (the "Company") as of December 31, 1996 and 1995 and for the three years in the period ended December 31, 1996, which report is included in the Annual Report on Form 10-K of the Company for the fiscal year ended December 31, 1996 and which appears in the Form 8-K of Salomon Inc dated September 29, 1997. Coopers & Lybrand L.L.P. New York, New York September 29, 1997. EX-99.01 4 ANNUAL REPORT ON FORM 10-K EXHIBIT 99.01 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ----------------- FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1996 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ______ to ______ ---------------- Commission file number 1-9924 ---------------- TRAVELERS GROUP INC. (Exact name of registrant as specified in its charter) Delaware 52-1568099 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 388 Greenwich Street, New York, New York 10013 (Address of principal executive offices) (Zip Code) (212) 816-8000 (Registrant's telephone number, including area code) ---------------- Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which registered ------------------- ----------------------------------------- Common Stock, par value New York Stock Exchange and $ .01 per share Pacific Stock Exchange Depositary Shares, each New York Stock Exchange representing 1/10 of a share of 8.125% Cumulative Preferred Stock, Series A Depositary Shares, each New York Stock Exchange representing 1/2 of a share of 9.25% Preferred Stock, Series D 7 3/4% Notes Due June 15, 1999 New York Stock Exchange 1998 Warrants to Purchase Common Stock New York Stock Exchange 8% Trust Preferred Securities of New York Stock Exchange Subsidiary Trust (and registrant's guaranty with respect thereto) 7 3/4% Trust Preferred Securities of New York Stock Exchange Subsidiary Trust (and registrant's guaranty with respect thereto) 7 5/8% Trust Preferred Securities of New York Stock Exchange Subsidiary Trust (and registrant's guaranty with respect thereto) Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] The aggregate market value of the voting stock held by nonaffiliates of the registrant as of March 5, 1997 was approximately $34.2 billion. As of March 5, 1997, 641,379,081 shares of the registrant's Common Stock, par value $.01 per share, were outstanding. DOCUMENTS INCORPORATED BY REFERENCE Certain portions of the registrant's Annual Report to Stockholders for the fiscal year ended December 31, 1996 are incorporated by reference into Part II of this Form 10-K. Certain portions of the registrant's Proxy Statement for the 1997 Annual Meeting of Stockholders to be held on April 23, 1997 are incorporated by reference into Part III of this Form 10-K. TRAVELERS GROUP INC. Annual Report on Form 10-K For Fiscal Year Ended December 31, 1996 ------------------------------ TABLE OF CONTENTS Form 10-K Item Number Page - ----------- ---- Part I ------ 1. Business...................................................................1 2 Properties................................................................82 3. Legal Proceedings.........................................................83 4. Submission of Matters to a Vote of Security Holders.......................86 Part II ------- 5. Market for Registrant's Common Equity and Related Stockholder Matters.............................................86 6. Selected Financial Data...................................................87 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.....................................87 8. Financial Statements and Supplementary Data...............................87 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.....................................87 Part III -------- 10. Directors and Executive Officers of the Registrant........................87 11. Executive Compensation....................................................87 12. Security Ownership of Certain Beneficial Owners and Management..........................................................88 13. Certain Relationships and Related Transactions............................88 Part IV ------- 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.............................................................88 Exhibit Index.............................................................89 Signatures ...............................................................94 Index to Consolidated Financial Statements and Schedules.................F-1 PART I ------ Item 1. BUSINESS. THE COMPANY Travelers Group Inc. (the "Company") is a financial services holding company engaged, through its subsidiaries, principally in four business segments: (i) Investment Services; (ii) Consumer Finance Services; (iii) Property & Casualty Insurance Services; and (iv) Life Insurance Services. On April 2, 1996, Travelers Property Casualty Corp. (formerly Travelers/Aetna Property Casualty Corp.) ("TAP"), an indirect majority-owned subsidiary of the Company that was formed in January 1996 to hold the property and casualty insurance subsidiaries (collectively, "Travelers P&C") of The Travelers Insurance Group Inc. ("TIGI"), purchased from Aetna Services Inc. (formerly Aetna Life and Casualty Company) ("Aetna") all of the outstanding capital stock of The Aetna Casualty and Surety Company ("Aetna Casualty") and The Standard Fire Insurance Company ("Standard Fire"), Aetna's property and casualty insurance subsidiaries (collectively, "Aetna P&C"), for approximately $4.16 billion in cash. The acquisition of Aetna P&C (the "Acquisition") was treated as a purchase and, accordingly, the Company's consolidated financial statements include the results of Aetna P&C's operations only from the date of the Acquisition. As part of the financing of the Acquisition, TAP sold approximately 33 million shares of its Class A Common Stock (representing approximately 9% of its outstanding common stock at that time) to four private investors, including Aetna. TIGI acquired approximately 328 million shares of TAP's Class B Common Stock in exchange for its contribution of the outstanding capital stock of The Travelers Indemnity Company ("Travelers Indemnity") and a capital contribution of approximately $1.14 billion. In April 1996, TAP sold in a public offering approximately 39 million shares of its Class A Common Stock (representing approximately 9.75% of its outstanding common stock at that time). The Company indirectly owns approximately 82% of TAP's outstanding common stock. For additional information about the Acquisition, the public offering and other related transactions, see Note 2 of Notes to Consolidated Financial Statements. During 1996, the Company continued and expanded the marketing of its financial products through the various distribution channels offered by its subsidiaries, primarily the independent agents of Primerica Financial Services (the "PFS sales force") and the Financial Consultants of Smith Barney Inc. The PFS sales force, which primarily sells life insurance and mutual funds, now also sells personal lines property-casualty insurance offered by Travelers Indemnity, a subsidiary of TAP. Through this program, over 6,300 members of the PFS sales force are now licensed to sell automobile and homeowners insurance products under the Secure-SM- name. The program, which began in 1994 and continues to experience growth in applications and policies, is now available in 37 states. See "Property & Casualty Insurance 1 Services -- Personal Lines." The PFS sales force has become the largest distributor of The Concert Series-SM-, a group of mutual funds offered by Smith Barney, with 1996 sales of approximately $458 million. See "Life Insurance Services -- Primerica Financial Services." The $.M.A.R.T.-SM- and $.A.F.E.-SM- loan programs, under which members of the PFS sales force solicit applications for loans underwritten by Commercial Credit Company ("CCC"), generated net receivables of over $1.5 billion at December 31, 1996. See "Consumer Finance Services -- Consumer Finance." Qualified Smith Barney Financial Consultants offer individual products, primarily variable annuities, of Travelers Life and Annuity. These products include, among others, Vintage Life-R- and Vintage Annuity-SM-, single premium variable universal life products, and Travelers Target Maturity-R-, a market value adjusted fixed annuity. The Company has also created a subsidiary to facilitate the cross-marketing of the Company's products among its subsidiaries and to offer a bundled group of those products for sale to employees of other companies through a directed sales effort. The periodic reports of CCC, Smith Barney Holdings Inc. ("SB Holdings"), TAP, The Travelers Insurance Company and The Travelers Life and Annuity Company, subsidiaries of the Company that make filings pursuant to the Securities Exchange Act of 1934, as amended (the "Exchange Act"), provide additional business and financial information concerning those companies and their consolidated subsidiaries. The principal executive offices of the Company are located at 388 Greenwich Street, New York, New York 10013; telephone number 212-816-8000. This discussion of the Company's business is organized as follows: (i) a description of each of the Company's four business segments; (ii) a description of the Corporate and Other Operations segment; and (iii) certain other information. A glossary of insurance terms is included beginning on page 70. INVESTMENT SERVICES The Company's Investment Services segment includes the operations of SB Holdings and its subsidiaries. As used herein, unless the context otherwise requires, "Smith Barney" refers to SB Holdings and its consolidated subsidiaries. Smith Barney SB Holdings provides investment banking, asset management, brokerage and other financial services through its subsidiaries. Its principal operating subsidiary is Smith Barney Inc. ("SBI"), an investment banking, securities trading and brokerage firm that traces its origins back to 1873. Smith Barney operates through approximately 450 offices throughout the United States, and 17 offices in 15 foreign countries. With approximately 10,400 Financial 2 Consultants, the Company believes that Smith Barney is currently the second largest domestic brokerage firm in the United States. Investment Banking and Securities Brokerage Smith Barney is an investment banking and securities trading and brokerage firm serving United States and foreign corporations, governments and institutional and individual investors. Its business includes securities, options and commodities brokerage for domestic and international institutional and individual clients; underwriting and distribution of securities; arranging for the private placement of securities; assisting in mergers and acquisitions and providing other financial advisory services; market making and trading in corporate debt and equity, United States government and agency, mortgage-related and municipal securities and foreign exchange, futures and forward contracts; customer financing activities; securities lending activities; investment management and advisory services; securities research; and other related activities. Smith Barney's investment banking services include the underwriting of debt and equity issues for United States and foreign corporations and for state, local and other governmental and government-sponsored authorities. Smith Barney frequently acts as managing underwriter in corporate and public securities offerings. Smith Barney also acts as a private placement agent for various clients, and as such helps to place securities for clients with large institutions and other qualified investors. Smith Barney also provides financial advice to investment banking clients on a wide variety of transactions including mergers and acquisitions, exchanges of securities and corporate restructurings. Smith Barney executes securities brokerage transactions on all major United States securities exchanges and distributes a wide variety of financial products. It makes inter-dealer markets and trades as principal in corporate debt and equity securities, primarily of United States corporate issuers, United States and foreign government, and agency securities, mortgage-related securities, whole loans, municipal and other tax-exempt securities, commercial paper and other money market instruments as well as emerging market debt securities. The firm carries inventories of securities to facilitate sales to customers and other dealers and with a view to realizing trading gains. SBI is one of the leading dealers in municipal securities and is a "Primary Dealer" in United States government securities, as designated by the Federal Reserve Bank of New York. Its daily trading inventory positions in United States government and agency securities are financed largely through the use of repurchase agreements pursuant to which Smith Barney sells the securities and simultaneously agrees to repurchase them at a future date. Smith Barney also acts as an intermediary between borrowers and lenders of short-term funds utilizing repurchase and reverse repurchase agreements. Smith Barney uses derivative financial instruments to facilitate customer transactions and to manage exposure to interest rate, currency and market risk. In addition, for its own account Smith Barney engages in a limited manner in certain arbitrage activities, which primarily seek to benefit from temporary price discrepancies that occur with respect to 3 related securities or to the same security on different markets. Smith Barney also engages in the borrowing and lending of securities. The Smith Barney network of Financial Consultants also sells Travelers Life and Annuity individual products, primarily variable annuities. See "Life Insurance Services - -- Travelers Life and Annuity." Smith Barney executes transactions in large blocks of exchange-listed stocks, usually with institutional investors, and often acts as principal to facilitate these transactions. It makes markets, buying and selling as principal, in common stocks, convertible preferred stocks, warrants and other securities traded on the NASDAQ system or otherwise in the over-the-counter market. Smith Barney also maintains trading positions in equity options, convertible securities, debt options, foreign exchange and commodities instruments. It executes significant client transactions in both listed and unlisted options and in foreign exchange, and often acts as principal to facilitate these transactions. Smith Barney also sells various types of structured securities on both a principal and an agency basis. The firm's securities trading and investment activities involve significant risk in that the values of positions carried in its trading and investment accounts are subject to market fluctuations. Smith Barney engages in a variety of financial techniques designed to manage this risk. Customer Financing Customers' securities transactions are executed on either a cash or margin basis. Federal regulations prescribe the minimum original margin that must be deposited by securities purchasers, and exchange regulations prescribe the minimum margins that must be maintained by customers. Smith Barney imposes margin maintenance requirements that are equal to or exceed those required by exchange regulations. Such requirements are intended to reduce the risk assumed by Smith Barney that a market decline will reduce the value of a customer's collateral below the amount of the customer's indebtedness before the collateral can be sold. Substantially all transactions in commodities futures contracts are on margin subject to individual exchange regulations. Margin, in the case of commodities futures contracts, is primarily funded in the form of cash or United States Treasury securities. Commodities transactions involve substantial risk, principally because of low margin requirements permitted by the exchanges. Income earned on financing customers' securities transactions provides Smith Barney with an additional source of income. Credit losses may arise as a result of this financing activity; however, to date, such losses have not been material. 4 Asset Management Smith Barney provides discretionary and non-discretionary asset management and consulting services to a wide array of mutual funds and institutional and individual investors, with respect to domestic and foreign equity and debt securities, municipal bonds, money market instruments, and related options and futures contracts. Smith Barney typically receives ongoing fees from its asset management and consulting clients, generally stated as a percentage of the client's assets with respect to which Smith Barney's services are rendered. At December 31, 1996, such client assets in the aggregate exceeded $111.8 billion, as compared to approximately $96.2 billion at December 31, 1995 and approximately $78.0 billion at December 31, 1994. At December 31, 1996, Smith Barney sponsored 59 mutual funds (open-end investment companies) with aggregate assets of approximately $69.7 billion distributed through its sales force of Financial Consultants. Of these, ten are taxable and tax-exempt money market funds, with assets of approximately $41.2 billion. At December 31, 1995, aggregate assets in Company-sponsored mutual funds were approximately $61.6 billion, of which approximately $35.6 billion related to money market funds, compared to aggregate assets in such funds at December 31, 1994 of approximately $50.6 billion, $28.6 billion of which related to money market funds. A wholly owned subsidiary of SB Holdings serves as investment manager to these mutual funds, as well as to twelve closed-end investment companies, the shares of which are listed for trading on one or more securities exchanges. At December 31, 1996 and December 31, 1995, assets of these closed-end funds aggregated approximately $2.8 billion, as compared to approximately $2.5 billion at December 31, 1994. The open-end and closed-end funds sponsored and managed by Smith Barney have various investment objectives, including growth, growth and income, taxable income and tax-exempt income. In addition, at December 31, 1996, Smith Barney managed 25 mutual fund portfolios serving as funding vehicles for variable annuity contracts, with aggregate assets of approximately $2.3 billion. At December 31, 1995 and December 31, 1994, aggregate assets in the mutual fund portfolios managed by the Company were approximately $1.8 billion and $1.4 billion, respectively. This includes six mutual fund portfolios that are investment options for the Travelers Universal variable annuity contracts. Smith Barney also sponsors and manages nine mutual funds domiciled outside the U.S. which are offered to Smith Barney's non-resident alien client base. At December 31, 1996, these off-shore funds had aggregate assets of approximately $1.2 billion, as compared to approximately $980 million at December 31, 1995 and approximately $780 million at December 31, 1994. In 1996, Smith Barney launched The Concert Series-SM-, a group of mutual funds that invests in various Smith Barney mutual funds instead of directly in stocks, bonds or other securities. The Concert Series-SM- simplifies the process of investing and enables investors to achieve a broad diversification of their investments. The Concert Series-SM- is sold through Smith Barney Financial Consultants and the PFS sales force. 5 In addition to these proprietary funds, Smith Barney also sells through its Financial Consultants a large number of mutual funds sponsored and managed by unaffiliated entities. Smith Barney receives commissions and other sales and service revenues from this activity. Smith Barney also sponsors and oversees the portfolios of a large number of unit investment trusts, which are unmanaged investment companies, the portfolios of which are generally static. Such unit investment trusts may hold domestic and foreign equity and debt securities, including municipal bonds. Certain trusts are sponsored and overseen solely by Smith Barney; other trusts are jointly sponsored through a syndicate of major broker-dealers of which Smith Barney is a member. At December 31, 1996, outstanding unit trust assets held by Smith Barney clients exceeded $8.6 billion, as compared to approximately $7.2 billion at December 31, 1995 and approximately $6.4 billion at December 31, 1994. Smith Barney's asset management units provide separate account discretionary investment management services to a wide variety of individual and institutional clients, including private and public retirement plans, endowments, municipalities and other institutions. Client relationships may be introduced through Smith Barney's network of Financial Consultants or independent from such network (e.g., through traditional pension plan consultants unaffiliated with the Company). Assets under Smith Barney's management exceeded $24.0 billion at December 31, 1996, as compared to approximately $20.4 billion at December 31, 1995 and approximately $15.7 billion at December 31, 1994. Smith Barney's Consulting Group ("CG") provides a variety of investment management and consulting services to institutional and individual clients. CG sponsors a number of different "wrap fee" programs, in which CG and Smith Barney typically provide: an analysis of the client's financial situation, investment needs and risk tolerance; a recommendation that the client retain one or more investment management firms (which may be affiliated or unaffiliated with Smith Barney); ongoing monitoring of the performance and suitability of the investment manager(s) retained; securities execution and custody; and client reporting and recordkeeping. In such programs, the client generally pays a single bundled fee for the services provided. CG also provides traditional investment management consulting services to institutions, including assisting clients in formulating investment objectives and policies and in selecting investment management firms for the day-to-day management of client portfolios. CG's programs and services generally are delivered through Smith Barney Financial Consultants, many of whom specialize in such programs and services. As of December 31, 1996, Smith Barney provided consulting services with respect to client assets aggregating approximately $49.1 billion, excluding the TRAK-R- program described below, as compared to approximately $39.1 billion at December 31, 1995 and approximately $29.7 billion at December 31, 1994. Smith Barney's TRAK-R- program provides clients with non-discretionary asset allocation advice based on the client's identification of investment objectives and risk tolerances. TRAK-R- clients include both individuals and institutions, including participant- 6 directed 401(k) plans. Clients can choose to allocate assets among the CG Capital Markets funds, a series of 13 mutual funds each corresponding to a particular asset class and investment style, or from among the selected fund offerings of 28 no-load or load-waived mutual fund families (including Smith Barney's family of funds) corresponding to the same asset class and investment style criteria. At December 31, 1996, TRAK-R- assets exceeded $6.6 billion, as compared to approximately $4.8 billion at December 31, 1995 and approximately $3.3 billion at December 31, 1994. Smith Barney also offers a separate offshore TRAK-R- program to non-resident alien clients, which includes client investment in a series of asset class/investment style funds domiciled outside the United States. Miscellaneous Activities Certain of the Company's subsidiaries are chartered as trust companies and provide a full range of fiduciary services with a particular emphasis on personal trust services. Another subsidiary offers a broad range of trustee services for qualified retirement plans, with particular emphasis on the 401(k) plan market. Each of these trust companies is subject to the supervision of the state banking authority where it was chartered and uses the distribution network of SBI to market its services. Although these trust companies are subsidiaries of the Company and not of SB Holdings, their results are included with Smith Barney for segment reporting purposes. Smith Barney provides certain advisory and support services to the trust companies and receives fees for such services. In 1996, Smith Barney formed a joint venture with the Korea Exchange Bank. The venture, a brokerage and underwriting company based in Seoul, South Korea, that is owned 49% by Smith Barney, is engaged in the securities brokerage and underwriting business in the Korean markets. The venture is licensed with the Korea Ministry of Finance and Economy to conduct securities activities in Korea. General Competition The businesses in which Smith Barney is engaged are highly competitive. The principal factors affecting competition in the investment banking and securities brokerage industry are the quality and ability of professional personnel and the relative prices of services and products offered. In addition to competition from other investment banking firms, both domestic and international, and securities brokerage companies and discount securities brokerage operations, including regional firms in the United States, there has been increasing competition from other sources, such as commercial banks, insurance companies and other major companies that have entered the investment banking and securities brokerage industry, in many cases through acquisitions. Certain of those competitors may have greater capital and other resources than Smith Barney. The Federal Reserve Board has substantially removed the barrier originally erected by the Glass-Steagall Act restricting investment banking activities of 7 commercial banks and their affiliates, by permitting certain commercial banks to engage, through affiliates, in the underwriting of and dealing in certain types of securities, subject to certain limitations. Proposed legislation has been introduced in Congress from time to time that would modify certain other provisions of the Glass-Steagall Act and other laws and regulations affecting the financial services industry. The potential impact of such legislation on the Company's businesses cannot be predicted at this time. Competitors of Smith Barney's mutual funds and asset management operations include a large number of mutual fund management and sales companies and asset management firms. Competition in mutual fund sales and investment management is based on investment performance, service to clients and product design. Regulation Certain of the Company's subsidiaries are registered as broker-dealers and as investment advisers with the Securities and Exchange Commission (the "Commission") and as futures commission merchants and as commodity pool operators with the Commodity Futures Trading Commission ("CFTC"). SBI and The Robinson-Humphrey Company, Inc., an investment banking and financial services subsidiary of SBI ("R-H"), are members of the New York Stock Exchange, Inc. (the "NYSE") and other principal United States securities exchanges, as well as the National Association of Securities Dealers, Inc. ("NASD") and the National Futures Association ("NFA"), a not-for-profit membership corporation which has been designated as a registered futures association by the CFTC. SBI and R-H are registered as broker-dealers in all 50 states, the District of Columbia and Puerto Rico, and in addition are registered as investment advisers in certain states that require such registration. SBI is also a reporting dealer to the Federal Reserve Bank of New York, a member of the principal United States futures exchanges and a registered broker-dealer in Guam. Both SBI and R-H are subject to extensive regulation, primarily for the benefit of their customers, including minimum capital requirements, which are promulgated and enforced by, among others, the Commission, the CFTC, the NFA, the NYSE, various self-regulatory organizations of which SBI and R-H are members and the securities administrators of the 50 states, the District of Columbia and Puerto Rico and, in SBI's case, Guam. The Commission and the CFTC also require certain registered broker-dealers (including SBI) to maintain records concerning certain financial and securities activities of affiliated companies that may be material to the broker-dealer, and to file certain financial and other information regarding such affiliated companies. Smith Barney's operations abroad, described in this paragraph, are conducted through various subsidiaries. Its activities in the United Kingdom, which include investment banking, trading, brokerage and asset management services, are subject to the Financial Services Act 1986, which regulates organizations that conduct investment businesses in the United Kingdom (including imposing capital and liquidity requirements), and to the rules of the Securities and Futures Authority and the Investment Management Regulatory Organization. Smith Barney is a member of the International Petroleum Exchange, the London Metals 8 Exchange and the London International Financial Futures and Options Exchange and, as such, is subject to the rules and regulations of those Exchanges. In Ireland, a Smith Barney subsidiary that sponsors commodities-related pooled investment funds is subject to the supervision of the Central Bank of Ireland. In France, Smith Barney operates as a regulated securities house and an authorized mutual fund manager. Smith Barney is a licensed securities company in Japan and, as such, its activities in Japan are subject to Japanese law applicable to securities firms. Smith Barney is also a member of the Tokyo Stock Exchange and the Osaka Stock Exchange, and its activities in Japan are therefore subject to the rules and regulations of those Exchanges. Smith Barney conducts securities and commodities businesses in Singapore and Hong Kong that are regulated by the Monetary Authority of Singapore and the Hong Kong Securities and Futures Commission, respectively. Smith Barney also is a member of the Singapore International Monetary Exchange and is a "B license holder" with the Zurich Stock Exchange. Additionally, certain subsidiaries of SB Holdings are licensed as an "international dealer," an "international adviser" and an "investment dealer" with the Ontario Securities Commission, and as broker-dealers with the Securities Board of The Netherlands. Smith Barney's representative offices in Mexico City, Mexico, Paris, France, Beijing, People's Republic of China, Manama, Bahrain and Taipei, Taiwan are also subject to the jurisdiction of local financial services regulatory authorities. Smith Barney also operates a private trust services business that is licensed as a bank and trust company in the Cayman Islands, and is subject to the regulation of the Director of Financial Services, Banks & Trust Companies Supervision Department of the Cayman Islands. In connection with the mutual funds business, Smith Barney must comply with regulations of a number of regulatory agencies and organizations, including the Commission and the NASD. The Company, through Smith Barney, is the indirect parent of investment advisers registered and regulated under the Investment Advisers Act of 1940, and of companies that distribute shares of mutual funds pursuant to distribution agreements subject to regulation under the Investment Company Act of 1940. Under those Acts, the advisory contracts between the Company's investment adviser subsidiaries and the mutual funds they serve ("Affiliated Funds"), as well as the mutual fund distribution agreements, would automatically terminate upon an assignment of such contracts by the investment adviser or the fund distribution company, as the case may be. Such an assignment would be presumed to have occurred if any party were to acquire more than 25% of the Company's voting securities. Continuation of advisory and distribution relationships under these circumstances could be achieved only by obtaining consent to the assignment from the shareholders of the Affiliated Funds involved. In addition, SBI and the Affiliated Funds are subject to certain restrictions in their dealings with each other. For example, SBI may act as broker to an Affiliated Fund in a transaction involving an exchange-traded security only when that fund maintains procedures that govern, among other things, the execution price of the transaction and the commissions paid; SBI may not, however, conduct principal transactions with an Affiliated Fund. Further, an Affiliated Fund may acquire securities during the existence of an underwriting where SBI is a principal underwriter only in certain limited situations. 9 SBI and R-H are members of the Securities Investor Protection Corporation ("SIPC"), which, in the event of liquidation of a broker-dealer, provides protection for customers' securities accounts held by the firm of up to $500,000 for each eligible customer, subject to a limitation of $100,000 for claims for cash balances. In addition, Smith Barney has purchased additional coverage of up to $150 million for eligible customers, approximately $50 million of which is from a subsidiary of the Company. As registered broker-dealers, SBI and R-H are subject to the Commission's net capital rule, Rule 15c3-1 (the "Net Capital Rule"), promulgated under the Exchange Act. SBI and R-H compute net capital under the alternative method of the Net Capital Rule which requires the maintenance of minimum net capital, as defined. A member of the NYSE may be required to reduce its business if its net capital is less than 4% of aggregate debit balances (as defined) and may also be prohibited from expanding its business or paying cash dividends if resulting net capital would be less than 5% of aggregate debit balances. Furthermore, the Net Capital Rule does not permit withdrawal of equity or subordinated capital if the resulting net capital would be less than 5% of such debit balances. The Net Capital Rule also limits the ability of broker-dealers to transfer large amounts of capital to parent companies and other affiliates. Under the Net Capital Rule, equity capital cannot be withdrawn from a broker-dealer without the prior approval of the Commission in certain circumstances, including when net capital after the withdrawal would be less than (i) 120% of the minimum net capital required by the Net Capital Rule, or (ii) 25% of the broker-dealer's securities position "haircuts," i.e., deductions from capital of certain specified percentages of the market value of securities to reflect the possibility of a market decline prior to disposition. In addition, the Net Capital Rule requires broker-dealers to notify the Commission and the appropriate self-regulatory organization two business days before a withdrawal of excess net capital if the withdrawal would exceed the greater of $500,000 or 30% of the broker-dealer's excess net capital, and two business days after a withdrawal that exceeds the greater of $500,000 or 20% of excess net capital. Finally, the Net Capital Rule authorizes the Commission to order a freeze on the transfer of capital if a broker-dealer plans a withdrawal of more than 30% of its excess net capital and the Commission believes that such a withdrawal would be detrimental to the financial integrity of the firm or would jeopardize the broker-dealer's ability to pay its customers. For additional information on the Net Capital Rule, see Note 14 of Notes to Consolidated Financial Statements. 10 CONSUMER FINANCE SERVICES The Company's Consumer Finance Services segment includes consumer lending services conducted primarily under the name "Commercial Credit," as well as credit-related insurance and credit card services. CCC's predecessor was founded in 1912. Consumer Finance As of December 31, 1996, Consumer Finance Services maintained 859 loan offices in 44 states, including servicing centers for loans sold through the PFS sales force. The Company owns two state-chartered banks headquartered in Newark, Delaware, which generally limit their activities to offering credit card services nationwide. Loans to consumers by the Consumer Finance Services unit include real estate-secured loans, both fixed and variable rate secured and unsecured personal loans and fixed rate loans to finance consumer goods purchases. Credit card loans are discussed below. CCC's loan offices are generally located in small to medium-sized communities in suburban or rural areas, and are managed by individuals who generally have considerable consumer lending experience. The primary market for CCC's consumer loans consists of households with an annual income of $20,000 to $50,000. The number of active loan customers (excluding credit card customers) was approximately 1,333,000 at December 31, 1996, as compared to approximately 1,275,000 at December 31, 1995 and approximately 1,177,000 at December 31, 1994. In 1996, CCC created an agency that performs appraisals, sells title insurance and provides other closing-related services for CCC's real-estate loans. Two CCC loan programs solicit applications for loans exclusively through the PFS sales force. During 1996, CCC converted 27 of its loan offices to servicing centers for the loan products sold through the PFS sales force. At December 31, 1996, the total loans outstanding generated from this program were $1.524 billion, or approximately 19% of CCC's total loans outstanding, as compared to $1.258 billion, or approximately 17%, at December 31, 1995 and $1.107 billion, or approximately 16%, at December 31, 1994. See "Life Insurance Services -- Primerica Financial Services." The average amount of cash advanced per real estate-secured loan made was approximately $35,800 in 1996, $26,300 in 1995 and $28,400 in 1994. The average amount of cash advanced per personal loan made was approximately $4,250 in 1996 and $4,200 in each of 1995 and 1994. The average real estate-secured loan size increased in 1996 due to marketing initiatives that attracted customers for higher balance loans, particularly in first mortgage programs. The average annual yield for loans in 1996 was 15.24%, as compared to 15.64% in 1995 and 15.41% in 1994. The average annual yield for real estate-secured loans in 1996 was 12.13%, as compared to 12.33% in 1995 and 12.20% in 1994, and for personal loans it was 19.95% in 1996, as compared to 20.23% in 1995 and 20.20% in 1994. The average yield for real estate-secured loans has been affected by the normal run-off of older, higher 11 yielding loans and growth in lower yielding, higher quality loans, while the average yield for personal loans has been affected by the industry trends associated with rising personal bankruptcies. Consumer Finance Services' average net interest margin for loans was 8.64% in 1996, 8.79% in 1995 and 8.76% in 1994. CCC's delinquency and charge-off rates reached historically low levels in 1994 and rose in 1995 and 1996, consistent with recent industry trends. This increase in delinquencies and charge-offs reflects a continued high level of personal bankruptcies, a national trend that shows no indication of reversing itself. See "-- Delinquent Receivables and Loss Experience." Analysis of Consumer Finance Receivables For an analysis of consumer finance receivables, net of unearned finance charges ("Consumer Finance Receivables"), see Note 9 of Notes to Consolidated Financial Statements. Delinquent Receivables and Loss Experience Due to the nature of the finance business, some customer delinquency and loss is unavoidable. The management of the consumer finance business attempts to control customer delinquencies through careful evaluation of each borrower's application and credit history at the time the loan is made or acquired, and appropriate collection activity. An account is considered delinquent for financial reporting purposes when a payment is more than 60 days past due, based on the original or extended terms of the contract. The delinquency and loss experience on real estate-secured loans is generally more favorable than on personal loans. The following table sets forth the ratio of receivables delinquent for 60 days or more on a contractual basis (i.e., more than 60 days past due) to gross receivables outstanding: Ratio of Receivables Delinquent 60 Days or More to Gross Receivables Outstanding (1) Real Estate- Personal Secured Credit Sales Total As of December 31, Loans Loans Cards Finance Consumer - ------------------ ----- ----- ----- ------- -------- 1996 3.42% 1.50% 1.44% 2.27% 2.38% 1995 2.89% 1.42% 1.40% 2.17% 2.14% 1994 2.40% 1.48% 1.05% 1.79% 1.88% - ---------- (1) The receivable balance used for these ratios is before the deduction of unearned finance charges and excludes accrued interest receivable. Receivables delinquent 60 days or more include, for all periods presented, accounts in the process of foreclosure. 12 The following table sets forth the ratio of net charge-offs to average Consumer Finance Receivables. For all periods presented, the ratios shown give effect to all deferred origination costs. Ratio of Net Charge-Offs to Average Consumer Finance Receivables Real Estate- Year Ended Personal Secured Credit Sales Total December 31, Loans Loans Cards Finance Consumer - ------------------ ----- ----- ----- ------- -------- 1996 5.46% 0.50% 2.75% 3.34% 2.91% 1995 4.01% 0.64% 2.04% 2.46% 2.28% 1994 3.50% 0.82% 1.83% 2.03% 2.08% The following table sets forth information regarding the ratio of allowance for losses to Consumer Finance Receivables: Ratio of Allowance For Losses to Consumer Finance Receivables As of December 31, ------------------ 1996 2.97% 1995 2.66% 1994 2.64% Credit-Related Insurance American Health and Life Insurance Company ("AHL"), a subsidiary of CCC, underwrites or arranges for credit-related insurance, which is offered to customers of the consumer finance business. AHL has an A+ (superior) rating from A.M. Best Company ("A.M. Best"), whose ratings may be revised or withdrawn at any time. At a minimum, credit life insurance covers the declining balance of unpaid indebtedness. Credit disability insurance provides monthly benefits during periods of covered disability. Credit property insurance covers the loss of property given as security for loans. Other insurance products offered or arranged for by AHL primarily include auto single interest and involuntary unemployment insurance. Most of AHL's products are single premium, which premiums are earned over the related contract period. See "Life Insurance Services" for information concerning life insurance other than credit-related insurance. 13 The following table sets forth gross written insurance premiums, net of refunds, for consumer finance customers: Consumer Finance Insurance Premiums Written (in millions) Year Ended December 31, ----------------------- 1996 1995 1994 ---- ---- ---- Premiums written by AHL and its affiliates Writings for consumer finance: Credit life $ 42.7 $ 41.8 $ 43.3 Credit disability and other 63.1 61.4 66.7 Credit property and other 18.0 4.1 3.0 ------ ------ ------ Total $123.8 $107.3 $113.0 ====== ====== ====== Premiums written by other insurance companies Credit property and other $ 42.9 $ 51.6 $ 52.8 ====== ====== ====== Net premiums written began to increase in late 1996 compared to 1995 primarily due to growth in loan receivables. Net premiums written were relatively flat in early 1996 and 1995 compared to 1994 primarily due to slower growth in loan receivables. Credit Card Services The Travelers Bank, a subsidiary of CCC, is a state-chartered bank located in Newark, Delaware, which provides credit card services, including upper market gold credit card services, to individuals and to affinity groups (such as nationwide professional associations and fraternal organizations). The Travelers Bank USA, another state-chartered bank subsidiary of CCC, is not subject to certain regulatory restrictions relating to cross-marketing activities to which The Travelers Bank is subject. See "-- Regulation." These banks generally limit their activities to credit card operations. The following table sets forth aggregate information regarding credit cards issued by The Travelers Bank and The Travelers Bank USA. Credit Cardholders and Total Outstandings (outstandings in millions) As of, or for the year ended, December 31, ------------------------------------------ 1996 1995 1994 ---- ---- ---- Approximate total credit cardholders 791,000 753,000 621,000 Approximate gold credit cardholders 642,000 615,000 519,000 Total outstandings $907.1 $761.8 $712.5 Average annual yield 11.82% 12.51% 11.88% 14 The primary market for the banks' credit cards consists of households with annual incomes of $40,000 and above. The banks offer deposit-taking services (which as to The Travelers Bank USA are limited to deposits of at least $100,000 per account). At December 31, 1996, deposits of unaffiliated entities were $81.9 million, as compared to $97.9 million at December 31, 1995 and $73.3 million at December 31, 1994. The decrease in the average annual yield in 1996 primarily resulted from the offering of promotional rates in 1996 to encourage the transfer of credit card balances to the Company's banks. Competition The consumer finance business competes with banks, savings and loan associations, credit unions, credit card issuers and other consumer finance companies. Additionally, substantial national financial services networks have been formed by major brokerage firms, insurance companies, retailers and bank holding companies. Some competitors have substantial local market positions; others are part of large, diversified organizations. Deregulation of banking institutions has greatly expanded the consumer lending products permitted to be offered by these institutions, and because of their long-standing insured deposit base, many of them are able to offer financial services on very competitive terms. The Company believes that it is able to compete effectively with such institutions. In particular, the Company believes that the diversity and features of the products it offers, personal service, and cultivation of repeat and referral business support and strengthen its competitive position in its Consumer Finance Services businesses. Regulation Most consumer finance activities are subject to extensive federal and state regulation, including examination and review by state authorities of consumer finance offices. Personal loan, real estate-secured loan and sales finance laws generally require licensing of the lender, limitations on the amount, duration and charges for various categories of loans, adequate disclosure of certain contract terms and limitations on certain collection practices and creditor remedies. Federal consumer credit statutes primarily require disclosure of credit terms in consumer finance transactions. CCC's banks, which must undergo periodic examination, are subject to additional regulations relating to capitalization, leverage, reporting, dividends and permitted asset and liability products. These banks are also covered by the Competitive Equality Banking Act of 1987 (the "Banking Act"), which, with respect to The Travelers Bank, restricts cross-marketing of products by or of certain affiliates. CCC's banks are also subject to the Community Reinvestment Act, which assesses the bank's record in helping to meet the credit needs of low and moderate income persons in such bank's delineated community, and the Fair Credit Reporting Act, which is aimed at ensuring the accuracy and 15 fairness of the mechanism by which consumer credit and other information on consumers is assembled and evaluated. The Company believes that it complies in all material respects with applicable regulations. See "Insurance Services - General -- Regulation" at the end of the description of the Life Insurance Services segment for a discussion of the regulatory factors governing the insurance businesses of CCC. The Real Estate Settlement Procedures Act of 1974 ("RESPA") covers real estate loans secured by residential real estate. Generally, RESPA requires disclosure of certain information to customers and regulates the receipt or payment of fees or charges for services performed. Proposed legislation has been introduced in Congress that would modify certain laws and regulations affecting the financial services industry. The potential impact of such legislation on the Company's businesses cannot be predicted at this time. PROPERTY & CASUALTY INSURANCE SERVICES This segment includes the operations of TAP and its subsidiary and affiliated property-casualty insurance companies, all of which are collectively referred to herein as "TAP." TAP provides a wide range of commercial and personal property and casualty insurance products and services to businesses, government units, associations and individuals. As described above, on April 2, 1996, TAP acquired Aetna P&C. The Company's results of operations for periods prior to April 2, 1996 do not include the results of Aetna P&C. See Notes 2 and 4 of Notes to Consolidated Financial Statements. For informational purposes, the premium and certain other operational information provided below includes Aetna P&C's businesses prior to the Acquisition. Commercial Lines TAP is the third largest writer of commercial lines insurance in the United States based on 1995 direct written premiums published by A.M. Best, after giving effect to the Acquisition and recent industry consolidation. TAP's Commercial Lines offers a broad array of property and casualty insurance and insurance-related services. Commercial Lines is organized into four marketing and underwriting groups that are designed to focus on a particular client base or industry segment to provide products and services that specifically address customers' needs: National Accounts, primarily serving large national corporations; Commercial Accounts, serving mid-size businesses; Select Accounts, serving small businesses and individuals with commercial exposures; and Specialty Accounts, providing a variety of specialty coverages. TAP also has a dedicated group within Commercial Lines that serves the construction industry. TAP distributes its commercial products through approximately 4,600 brokers and independent agencies located throughout the United States. The commercial coverages marketed by TAP include workers' compensation, general liability (including product liability), commercial multi-peril, commercial automobile, property 16 (including fire and allied lines) and several other miscellaneous coverages. TAP also underwrites specialty coverages through three separate units, Travelers Specialty, Gulf Specialty and Bond Specialty, which have historically focused on unique risks that typically require specialized underwriting. Coverages offered by Travelers Specialty include general liability for selected product liability risks, medical malpractice and umbrella and excess liability. Coverages offered by Gulf Specialty include directors' and officers' liability and errors and omissions insurance for various professions, umbrella insurance, insurance for municipalities, hard to place coverages sold on an excess and surplus lines basis and fidelity and surety coverage. Coverages offered by Bond Specialty include fidelity and surety, fiduciary liability insurance, directors' and officers' and other professional liability insurance and other related coverages such as kidnap and ransom and mail insurance. In addition, TAP offers various risk management services, generally including claims settlement, loss control and engineering services, to businesses that choose to self-insure certain exposures, to state funds and insurance carriers that participate in state involuntary workers' compensation pools and to employers seeking to manage workers' compensation medical and disability costs. In 1996, Commercial Lines generated combined net written premiums of $4.7 billion and combined premium equivalents of $2.7 billion. As used herein, unless the context otherwise requires, "combined" refers to the operations of both Travelers P&C and Aetna P&C, without regard to the date of the Acquisition. Selected Product and Market Information The following table sets forth by product line and market net written premiums and premium equivalents for Commercial Lines for the periods indicated. For a description of the product lines and markets referred to in the table below, see "-- Product Lines" and "-- Principal Markets and Methods of Distribution," respectively. Over the past several years, National Accounts customers have moved increasingly from traditional insurance coverages to service-type products, primarily for workers' compensation coverage and to a lesser extent in general liability and commercial automobile coverages. These types of products include risk management services such as claims settlement, loss control and engineering. The volume of business handled by TAP in servicing relationships is measured by "premium equivalents." Premium equivalents do not represent actual premium revenues. Premium equivalents are determined in the pricing process and represent TAP's estimates of premiums that its customers would have been charged under a fully insured arrangement, based on expected losses associated with non-risk-bearing components of each account. Because the Acquisition occurred on April 2, 1996, the Company's results of operations for periods prior to April 2, 1996 do not include the results of Aetna P&C. Accordingly, premium and other operational information provided for TAP's combined businesses prior to such time is for informational purposes only. 17 Combined Net Written Premiums and Premium Equivalents
Percentage of Total Net Written Premiums and Year Ended December 31, Premium Equivalents -------------------------------- Year Ended December 31, 1996 1995 1994 1996 ---- ---- ---- ---- (Dollars in millions) Net written premiums by product line: Workers' compensation $1,223 $1,312 $1,675 16.5% General liability 836 815 941 11.3 Commercial multi-peril 1,223 1,188 1,119 16.5 Commercial automobile 806 888 932 10.9 Property 342 457 441 4.6 Fidelity and surety 215 233 209 2.9 Other 45 251 164 0.7 ------ ------ ------ ---- Net written premiums (1) $4,690 $5,144 $5,481 63.4% Premiums equivalents (2) 2,712 3,458 2,990 36.6 ------ ------ ------ ---- Total Commercial Lines $7,402 $8,602 $8,471 100.0% ====== ====== ====== =====
Percentage of Total Net Written Premiums and Year Ended December 31, Premium Equivalents -------------------------------- Year Ended December 31, 1996 1995 1994 1996 ---- ---- ---- ---- (Dollars in millions) Net written premiums and premium equivalents by market: National Accounts $3,499 $4,550 $4,463 47.3% Commercial Accounts 1,812 1,962 2,159 24.5 Select Accounts 1,412 1,466 1,293 19.1 Specialty Accounts 679 624 556 9.1 ------ ------ ------ ----- Total Commercial Lines (2) $7,402 $8,602 $8,471 100.0% ====== ====== ====== =====
- ---------- (1) The decreases in net written premiums during the periods shown reflect the highly competitive marketplace and TAP's selective underwriting practices. (2) Premium equivalents for the year ended December 31, 1994 are provided for Travelers P&C only. Historically, Aetna P&C did not track premium equivalents and such amounts are not available for that period. The decreases in premium equivalents during the periods shown reflect a depopulation of involuntary pools as the loss experience of workers' compensation improves and insureds move to voluntary markets, TAP's selective renewal activity to address the competitive pricing environment and its continued success in lowering workers' compensation losses of customers. 18 Product Lines TAP writes a broad range of commercial property and casualty insurance for risks of all sizes. The core products in TAP's Commercial Lines are as follows: Workers' Compensation provides coverage for employers' liability for injuries to employees under common law as well as the obligation of an employer under state or federal law to provide its employees with specified benefits for work-related injuries, deaths and diseases, regardless of fault. In addition to the liability exposure that may arise under common law, there are typically four types of benefits payable under workers' compensation policies: medical benefits, disability benefits, death benefits and vocational rehabilitation benefits. Workers' compensation policies are often written in conjunction with other commercial policies. TAP offers two types of workers' compensation products: (i) insurance products, including guaranteed cost policies, in which policy premiums charged are fixed and do not vary as a result of the insured's loss experience, and loss sensitive plans, including retrospectively rated policies, in which premiums are adjusted based on actual loss experience of the insured during the policy period, and large deductible plans, in which the customer bears the insurance risk up to its deductible amount, and (ii) service programs, which are generally sold to TAP's larger National Accounts, where TAP receives fees for providing loss prevention, risk management, claims administration and benefit administration services to organizations pursuant to service agreements. TAP also participates in state assigned risk pools servicing workers' compensation policies as a servicing carrier and pool participant. TAP emphasizes managed care cost containment strategies (which involve employers, employees and care providers in a cooperative effort that focuses on the injured employee's early return to work), cost-effective quality care, and customer service in this market. Workers' compensation comprehensive claim and managed care cost containment services are integrated through TAP's claims management system to maximize cost savings on both service delivery and loss payout. For the year ended December 31, 1996, TAP's workers' compensation line generated $1.2 billion of combined net written premiums and $2.2 billion of combined premium equivalents. General Liability provides coverage for liability exposures including bodily injury and property damage arising from products sold and general business operations. General liability also includes coverage for directors' and officers' liability arising in their official capacities, fiduciary liability for trustees and sponsors of pension, health and welfare and other employee benefit plans, errors and omissions insurance for employees, agents, professionals and others arising from acts or failures to act under specified circumstances, as well as medical malpractice, umbrella and excess insurance. For the year ended December 31, 1996, TAP's general liability line generated $836 million of combined net written premiums and $299 million of combined premium equivalents. Commercial Multi-Peril provides a combination of property and liability coverage for businesses and business property for damages such as that caused by fire, wind, hail, water, theft and vandalism, and protects businesses from financial loss due to business interruption. 19 It also insures businesses against third-party liability from accidents occurring on their premises or arising out of their operations, such as injuries sustained from products sold. For the year ended December 31, 1996, TAP's commercial multi-peril line generated $1.2 billion of combined net written premiums. Commercial Automobile provides coverage for businesses against losses incurred from personal bodily injury, bodily injury to third parties, property damage to an insured's vehicle, and property damage to other vehicles and other property resulting from the ownership, maintenance or use of automobiles and trucks in a business. For the year ended December 31, 1996, TAP's commercial automobile line generated $806 million of combined net written premiums and $240 million of combined premium equivalents. Property provides coverage for loss or damage to buildings, inventory and equipment from natural disasters, including hurricanes, windstorms, earthquakes, hail, explosions, severe winter weather and other events such as theft and vandalism, fires and storms and financial loss due to business interruption. Property also includes inland marine, which provides coverage for goods in transit and unique, one-of-a-kind exposures. For the year ended December 31, 1996, TAP's property line generated $342 million of combined net written premiums. Fidelity and Surety provides fidelity insurance coverage which protects an insured for loss due to embezzlement or misappropriation of funds by an employee. Surety is a three-party agreement whereby the insurer agrees to pay a second party or make complete an obligation in response to the default, acts or omissions of a third party. Surety is generally provided for construction performance, legal matters such as appeals, trustees in bankruptcy and probate and other performance bonds. For the year ended December 31, 1996, TAP's fidelity and surety line generated $215 million of combined net written premiums. Other coverages include boiler and machinery insurance, which provides coverage for loss or damage resulting from the malfunction of boilers and machinery, as well as miscellaneous assumed reinsurance. For the year ended December 31, 1996, these other coverages generated $45 million of combined net written premiums. Principal Markets and Methods of Distribution Commercial Lines is organized into four marketing groups that are designed to focus on a particular client base or industry segment to provide products and services that specifically address customers' needs: National Accounts, primarily serving large national corporations; Commercial Accounts, serving mid-size businesses; Select Accounts, serving small businesses; and Specialty Accounts, providing a variety of specialty coverages. TAP also has a dedicated group within Commercial Lines that serves the construction industry. TAP distributes its commercial products primarily through approximately 4,600 brokers and independent agencies located throughout the United States that are serviced by 99 20 field offices. TAP seeks to establish relationships with well-established, independent insurance agencies and brokers. In selecting new independent agencies and brokers to distribute TAP's products, TAP considers each agency's or broker's profitability, financial stability, staff experience and strategic fit with TAP's operating and marketing plans. Once an agency or broker is appointed, TAP carefully monitors its performance. National Accounts National Accounts serves large companies, as well as employee groups, associations and franchises. National Accounts also includes TAP's alternative market business (the "Alternative Market"), which primarily covers workers' compensation products and services to voluntary and involuntary state pools. National Accounts customers typically generate annual direct written premiums and premium equivalents of over $1 million per account and generally select products under retrospectively rated plans, large self-insured retentions or some other loss-responsive arrangement. National Accounts programs involve both traditional insurance (risk transfer) and risk service (claims settlement, loss control and risk management). Customers are usually national in scope and range in size from businesses with sales of approximately $10 million per year to Fortune 2000 corporations. Products are marketed through national brokers and regional agents with offices throughout the United States. Based on combined net written premiums of $874 million and combined premium equivalents of $2.6 billion, National Accounts constituted approximately 47% of the Commercial Lines business in 1996. National Accounts customers often demand risk service programs where the ultimate cost is based on their own loss experience. Programs offered by TAP include claims settlement, loss control and risk management services and are generally offered in connection with a retrospectively rated insurance policy, a large deductible plan or a self-insured program. Workers' compensation accounted for approximately 76% of the products sold in 1996 to National Accounts customers, based on combined net written premiums and premium equivalents. The Alternative Market business of National Accounts sells claims and policy management services to workers' compensation and automobile assigned risk plans, self-insurance pools throughout the United States and to niche voluntary markets. Since 1993, most state assigned workers' compensation risk plan contracts have been awarded through a formal state-by-state bid process. Contracts, which are generally for three-year terms, are awarded by state agencies based on quality of service and price. TAP has emerged as the largest workers' compensation assigned risk plan servicing insurer in the industry with approximately 28% share of the market in 1996. Assigned risk plan contracts generated approximately $456 million in combined premium equivalents in 1996 for TAP. TAP also services self-insurance groups, sells excess workers' compensation coverage to these groups and markets various workers' compensation specialty programs. Self-insurance groups and these specialty programs generated combined net written premiums 21 and premium equivalents of $89 million in 1996. National Accounts also participates in various involuntary assigned risk pools, which provide insurance coverage to individuals or other entities that otherwise are unable to purchase such coverage in the voluntary market. Participation in these pools in most states is generally in proportion to voluntary writings of related lines of business in that state. Commercial Accounts Commercial Accounts sells a broad range of property and casualty insurance products through a large network of independent agents and brokers. Commercial Accounts targets businesses with 75 to 1,000 employees that generate between $50,000 and $1 million in annual direct written premiums and premium equivalents. TAP offers a full line of products to its Commercial Accounts customers, with an emphasis on guaranteed cost products. TAP also offers retrospectively rated or large deductible programs to these customers. Based on combined net written premiums of $1.7 billion and combined premium equivalents of $87 million, Commercial Accounts constituted approximately 25% of the Commercial Lines business in 1996. Commercial Accounts targets certain industries in which TAP has claims, engineering and underwriting expertise and to which TAP has established dedicated operations. Industry segments include from the manufacturing sector: advanced technology, metal products, mineral products, plastic and rubber products manufacturing and wood products. Also targeted are colleges and universities, transportation, retail, financial, property management and the wholesale industry. TAP continues to develop new industry-targeted programs both on a national and local level. Specific industry knowledge enables TAP to select, as customers, better managed companies in an industry segment, to tailor specialized coverages for those companies, and to link price to the individual exposure and to control risk. Instead of relying on rating bureaus to establish rates for products, TAP generally uses its proprietary data, which it has compiled from many years of data generated by its extensive underwriting and pricing experience. Accordingly, subject to applicable state insurance regulations, prices are derived from those proprietary rates and numerous variables that apply to specific risks. TAP believes that relying on extensive proprietary data to assess individual risk characteristics, rather than relying on data from industry rating bureaus, provides it with a competitive advantage in pricing and underwriting commercial risks. TAP uses components of this approach specifically in connection with loss control and claims management processing. Through a network of field offices, TAP's marketing and underwriting specialists, who have point of sale authority, work closely with local brokers and agents to tailor insurance coverage to individual customer needs. Construction. TAP has established dedicated operations that exclusively target the construction industry, providing insurance and risk management services for virtually all areas of construction, including general contractors, heavy construction (including street and road) and special trade contractors, except artisan or smaller trade contractors. TAP offers all product lines to midsize and national customers in the construction market, including both 22 guaranteed cost and loss-responsive products, with general liability, workers' compensation, commercial auto, commercial property and inland marine coverages. The dedicated construction operations provide specialized service and underwriting, with local market expertise and national capability, that enable TAP to tailor specialized coverages, have competitive pricing and control risk. This includes local underwriters who understand their state's laws and claim climates, engineering and loss control specialists, professional claim management and legal personnel with extensive construction experience. Construction's products are distributed through independent agents and brokers throughout the United States. Select Accounts Select Accounts serves individuals who have commercial exposures and firms typically with one to 75 employees, typically generating up to $50,000 in annual direct written premiums per account. Products offered to Select Accounts are generally guaranteed cost policies, often a packaged product covering property and liability exposures. Products are sold through independent agents, who are often the same agents that sell TAP's Commercial Accounts and Personal Lines products. Based on combined net written premiums of $1.4 billion, Select Accounts constituted approximately 19% of the Commercial Lines business in 1996. Personnel in TAP's field offices and other points of local service, which are located throughout the United States, work closely with agents to ensure a strong local presence in the marketplace. TAP utilizes a marketing and underwriting approach based on agency automation and defined underwriting criteria. Agency automation allows agents access to TAP's price quotation and policy issuance systems and enables agents to provide faster and more cost-effective service to customers with supervision and underwriting control. Agents that do not utilize the automated quotation and policy issuance systems work with TAP's sales and marketing representatives who have point of sale authority. Agents serving Select Accounts are given greater control and discretion over underwriting decisions, within predefined parameters, than brokers selling to larger accounts. Because underwriting criteria and pricing tend to be more standardized for smaller businesses, Select Accounts uses a standard industry classification (S.I.C.) based process to allow agents and field marketing representatives to make underwriting and pricing decisions within predetermined classifications. Business in other classes is subject to consultative review by in-house underwriters. TAP believes that its breadth of products, highly qualified field staff and its technology offer distinct competitive advantages. Specialty Accounts Specialty Accounts markets products to national, midsize and small customers, as well as individuals, and distributes them through both wholesale brokers and retail agents and brokers throughout the United States. TAP's fast response time on underwriting decisions, industry expertise and quality service are important to maintaining relationships with Specialty Accounts insureds and producers. TAP believes that it has a competitive advantage with 23 respect to many of these products based on its reputation for clear, timely decision-making, underwriting and industry expertise and strong producer and customer relationships as well as its ability to cross-sell with National Accounts, Commercial Accounts and Select Accounts. Based on combined net written premiums of $679 million, Specialty Accounts constituted approximately 9% of the Commercial Lines business in 1996. TAP has three separate marketing and underwriting groups within Specialty Accounts: Travelers Specialty provides a broad range of products targeting risks that do not fall within the underwriting guidelines of the other Commercial Lines segments and that require highly specialized underwriting. The core products include general liability for select product liability risks, umbrella and excess liability, medical malpractice, various types of professional liability, errors and omissions liability, primary and excess property, and various coverages that target the transportation industry. Gulf Specialty focuses on many non-traditional lines of business with a particular emphasis on the financial services market. Products include directors' and officers' liability insurance, errors and omissions coverage for bankers, investment counselors and mutual fund advisors, and fidelity and surety coverage for related classes. In addition, Gulf Specialty offers errors and omissions coverage for professionals and non-professionals such as lawyers, architects and engineers, insurance agents, podiatrists and chiropractors. Gulf Specialty also writes umbrella coverage for various industries, provides insurance products to the entertainment industry and to municipalities and provides insurance products for other industry specific programs. In addition, Gulf Specialty has developed a book of excess and surplus lines business through its non-admitted company. Bond Specialty's range of products includes fidelity and surety bonds, directors' and officers' and other professional liability insurance, fiduciary liability insurance and other related coverages. The customer base ranges from large financial services companies and commercial entities to small businesses and individuals. Products and services are distributed primarily through agents and brokers. Bond is organized around four broad customer segments: Financial Services, Construction, National Risk (customers with more than $500 million in revenues) and Commercial Risk (companies with less than $500 million in revenues and individuals). Bond's agency agreement with Executive Risk Management Associates ("ERMA"), a partnership owned by Executive Risk, Inc., was restructured effective January 1, 1997. The restructured agreement replaces the prior exclusive underwriter status of ERMA for directors' and officers' liability insurance written by Aetna Casualty with a non-exclusive agreement. 24 Pricing and Underwriting Pricing levels for property and casualty insurance products by Commercial Lines are generally developed based upon the frequency and severity of estimated losses, the expenses of producing business and administering claims, and a reasonable allowance for profit. TAP's strategy emphasizes a profit-oriented approach rather than a premium volume or market share-oriented approach to underwriting. TAP's National Accounts business, which sells primarily risk management services and loss sensitive products, continues to be very competitive on price. Commercial Accounts and Select Accounts primarily sell guaranteed cost products. A significant portion of Commercial Lines business is written with retrospectively rated insurance policies as well as large deductible policies in which the ultimate cost of insurance for a given policy year is dependent on the loss experience of the insured. Retrospectively rated policies are primarily used in workers' compensation coverage. Although the payment terms and long-term nature of the loss development reduces insurance risk, it introduces some additional credit risk. Receivables from holders of retrospectively rated and large deductible policies totaled approximately $755 million at December 31, 1996. Collateral, primarily letters of credit and, to a lesser extent, cash collateral, is generally requested for contracts that provide for deferred collection of ultimate premiums. The amount of collateral requested is predicated upon the creditworthiness of the customer and the nature of the insured risks. Commercial Lines continually monitors the credit exposure on individual accounts and the adequacy of collateral. Under certain workers' compensation insurance contracts with deductible features, TAP is obligated to pay the claimant the full amount of the claim. TAP is subsequently reimbursed by the contractholder for the deductible amount, and is subject to credit risk until such reimbursement is made. At December 31, 1996, contractholder receivables and payables were approximately $1.8 billion. TAP has developed an underwriting methodology that incorporates underwriting, claims, engineering, actuarial and product development disciplines for particular industries. This approach is designed to maintain high quality underwriting and pricing discipline. This approach utilizes proprietary data gathered and analyzed by TAP with respect to its Commercial Lines business over many years. The underwriters and engineers use this information to assess and evaluate risks prior to quotation. This information provides specialized knowledge about industry segments and catastrophe management and helps analyze risk based on account characteristics and pricing parameters designed to ensure that TAP does not compromise its underwriting integrity. This process is linked with strong underwriting interaction and review at TAP's and agents' locations. TAP is also a member of and participates in the underwriting operations of insurance and reinsurance pools and associations, several of which make independent underwriting decisions on behalf of their members. These pools insure specialized risks such as exposures related to the aviation and nuclear power industries. 25 TAP continually reviews its exposure to catastrophic losses and attempts to mitigate such exposure. See "Insurance Services - General -- Reinsurance." TAP uses sophisticated computer modeling techniques to assess underwriting risks and renewal of business in catastrophe-prone areas. Geographic Distribution The following table shows the distribution of Commercial Lines' direct written premiums for the states that accounted for the majority of combined premium volume for the year ended December 31, 1996: State % of Total ----- ---------- New York 13.5% California 8.8 Texas 5.9 Massachusetts 5.9 Pennsylvania 4.5 Florida 4.5 New Jersey 4.1 Illinois 4.0 Connecticut 3.7 North Carolina 3.1 All Others (1) 42.0 ------ Total 100.0% ====== - ---------- (1) No other single state accounted for 3.0% or more of the total combined direct written premiums written in 1996 by TAP. Personal Lines TAP is the largest writer of personal lines insurance through independent agents and the seventh largest writer of personal lines insurance overall in the United States based on 1995 direct written premiums published by A.M. Best, after giving effect to the Acquisition and recent industry consolidation. In 1996, Personal Lines generated combined net written premiums of approximately $2.7 billion. Personal Lines primarily offers personal automobile and homeowners insurance. Personal Lines distributes products primarily through approximately 5,000 independent agents located throughout the United States. TAP is also pursuing a number of initiatives to broaden its distribution of Personal Lines products, including targeted marketing to affinity groups, employee groups and other sponsoring organizations and establishing co- 26 marketing arrangements with other insurers. In 1994, TAP began a pilot program to market personal automobile and homeowners insurance through the independent agents of Primerica Financial Services ("PFS"), a unit of Travelers Group. The product is sold under the name Secure-SM-, and the program has expanded to reach 37 states. Over 6,300 PFS agents were licensed to sell Secure-SM- products by the end of 1996, and approximately 5,000 new automobile and homeowners policies are now being sold through this program each month. Selected Product Information The following table sets forth by product line net written premiums for Personal Lines for the periods indicated. For a description of the product lines referred to in the table below, see "-- Product Lines." Because the Acquisition occurred on April 2, 1996, the Company's results of operations for periods prior to April 2, 1996 do not include the results of Aetna P&C. Accordingly, premium and other operational information provided for TAP's combined businesses prior to such time is for informational purposes only. Combined Net Written Premiums
Percentage of Total Net Written Premiums Year Ended December 31, Year Ended -------------------------------- December 31, 1996 1995 1994 1996 ---- ---- ---- ---- (Dollars in millions) Net written premiums by product line: Personal automobile $1,851 $1,822 $1,969 69.2% Homeowners and other 824 721 773 30.8 ------ ------ ------ ----- Total Personal Lines $2,675 $2,543 $2,742 100.0% ====== ====== ====== =====
Product Lines TAP writes virtually all types of property and casualty insurance covering personal risks. Personal Lines had approximately 4.2 million policies in force at December 31, 1996. The primary coverages in Personal Lines are personal automobile and homeowners insurance sold to individuals. Personal Automobile provides coverage for liability to others for both bodily injury and property damage and for physical damage to an insured's own vehicle from collision and various other perils. In addition, many states require policies to provide first-party personal injury protection, frequently referred to as no-fault coverage. For the year ended December 31, 1996, TAP's personal automobile policies generated $1.9 billion of combined net written premiums. 27 Homeowners and Other provides protection against losses to dwellings and contents from a wide variety of perils, as well as coverage for liability arising from ownership or occupancy. TAP writes homeowners insurance for dwellings, condominiums, mobile homes and rental property contents. Other products include coverage for boats, personal articles such as jewelry, and umbrella liability protection. For the year ended December 31, 1996, TAP's homeowners and other policies generated $824 million of combined net written premiums. Principal Markets and Methods of Distribution Personal Lines products are distributed primarily through approximately 5,000 independent agents located throughout the United States, supported by a network of 23 field marketing offices and five customer service centers. The principal markets for Personal Lines insurance are in states along the East Coast, in the South, and in the Midwest. In the states of Florida, New Jersey and Massachusetts, TAP operates stand-alone domestic companies to enhance its competitive capability in these highly regulated markets. Separate business units within Personal Lines market to affinity groups and through the sales force of PFS. Insurance companies generally market personal automobile and homeowners insurance through one of two distribution systems: independent agents or direct writing. The independent agents that distribute TAP's Personal Lines products usually represent several unrelated property and casualty companies. In contrast, direct writing companies operate either by mail or through exclusive agents or sales representatives. Due in part to the expense advantage that direct writers may have relative to companies using independent agents, the direct writing companies have gradually expanded their market share in recent years. Personal Lines continues to focus on the independent agency distribution system, recognizing the service and underwriting advantages the agent can deliver. In addition to its agency distribution system, TAP is pursuing a number of initiatives to broaden its distribution of Personal Lines products, including targeted marketing to affinity groups, employee groups and other sponsoring organizations and establishing co-marketing arrangements with other insurers. In 1994, TAP began writing personal automobile and homeowners insurance through the independent agents of PFS in order to broaden the distribution of its Personal Lines products. This program is now available in 37 states. In 1995, Aetna P&C entered into a marketing agreement with GEICO to write the majority of GEICO's homeowners business, and to receive referrals from GEICO for new homeowners business. This agreement added historically profitable business and helped geographically diversify the homeowners line of business. New business referrals began in July 1995 and, on January 1, 1996, Personal Lines began writing renewal policies. This marketing agreement provides for limits on Personal Lines' obligation to write new and renewal business in certain catastrophe-prone areas. TAP believes that its focus on service, including prompt and efficient claims handling, a high level of automation and development of long-term relationships with 28 individual agents gives it a competitive advantage in the Personal Lines market. In addition, TAP is leveraging its service, claims handling and automation experience in the expansion of its distribution channels through its PFS and affinity marketing initiatives. Pricing and Underwriting Pricing for personal automobile insurance is driven by changes in the relative frequency of claims and by inflation in the cost of automobile repairs, medical care and litigation of liability claims. As a result, the profitability of the business is largely dependent on promptly identifying and rectifying disparities between premium levels and expected claim costs, and obtaining approval of the state regulatory authorities for indicated rate increases. Premiums charged for physical damage coverage reflect insured car values and, accordingly, premium levels are somewhat related to the volume of new car sales. Pricing in the homeowners business is also driven by changes in the frequency of claims and by inflation in building supplies, labor costs and household possessions. Most homeowners policies offer (but do not require) automatic increases in coverage to reflect growth in replacement costs and property values. In addition to the normal risks associated with any multiple peril coverage, the profitability and pricing of homeowners insurance is affected by the incidence of natural disasters, particularly hurricanes, winter storms, earthquakes and tornadoes. The high level of catastrophe losses in recent years has resulted in a reduced availability of homeowners insurance and has led to higher prices for homeowners policies in some markets. In order to reduce its exposure to catastrophe losses, TAP has limited the writing of new homeowners business and selectively non-renewed existing homeowners business in certain markets, tightened underwriting standards and implemented price increases in certain hurricane-prone areas, subject to restrictions imposed by insurance regulatory authorities. In California, TAP has introduced an endorsement that reduces its exposure to catastrophic earthquake claims by increasing the deductible and limiting other policy coverages in the event of an earthquake loss. TAP uses computer modeling techniques to assess its level of exposure to loss in catastrophe-prone areas. Changes to methods of marketing and underwriting in coastal areas of Florida and New York and in California are subject to state-imposed restrictions, the general effect of which is to make it more difficult for an insurer to reduce exposures. Insurers writing property-casualty policies are generally unable to increase rates until some time after the costs associated with coverage have increased, primarily as a result of state insurance rate regulation laws. The pace at which an insurer can change rates in response to competition or to increased costs depends, in part, on whether the applicable rate regulation law requires prior approval of a rate increase or notification to the regulator either before or after a rate increase is imposed. In states having prior approval laws, a rate must be approved by the regulator before it may be used by the insurer. In states having "file-and-use" laws, the insurer must file the rate with the regulator, but does not need to wait for approval before using it. A "use-and-file" law requires an insurer to file rates within a certain period of time 29 after the insurer begins using the new rate. Approximately one-half of the states, including New York and Pennsylvania, require prior approval of rate increases. Underwriting of Personal Lines products is conducted primarily by independent agents. Agents underwrite Personal Lines policies under strict underwriting guidelines established and monitored by TAP. Each agent is assigned to a specific employee of TAP or team of employees responsible for working with the agent on business plan development, marketing, and overall growth and profitability. TAP uses agency level management information to analyze and understand results and to identify problems and opportunities. Geographic Distribution The following table shows the distribution of Personal Lines' direct written premiums for the states that accounted for the majority of combined premium volume for the year ended December 31, 1996: State % of Total ----- ---------- New York 23.2% Pennsylvania 9.0 New Jersey 8.6 Florida 8.5 Texas 8.3 Massachusetts 6.9 Connecticut 6.1 Virginia 3.8 All others (1) 25.6 ------ Total 100.0% ====== - ---------- (1) No other single state accounted for 3.0% or more of the total combined direct written premiums written in 1996 by TAP. Claims Administration TAP employs approximately 8,900 claims employees located throughout the United States. These employees include telephone and road adjusters, appraisers, litigation specialists, staff attorneys, regional and home office management and support staff. TAP handles over 90% of its claims internally and employs external adjusters primarily where geographic location makes it impractical to use TAP's own adjusters. TAP has an investigative unit that handles claims that TAP suspects may be fraudulent. TAP also employs a staff of lawyers who are responsible for the management of TAP's claims litigation. TAP's 30 claims handlers include professionals with the technical expertise necessary to deal with more complex coverage, liability and damage issues. In its handling of claims, TAP strives to balance customer expectations of service with its business objectives of effectively managing loss exposure and controlling claims expense. In an effort to resolve claims efficiently, TAP matches claims settlement authority to the ability of its claims personnel and matches its in-house expertise with the issues involved in the claim. TAP's workers' compensation claim adjudication process is being re-engineered to encompass a higher level of nursing/medical intervention, a more effective use of preferred provider networks to better manage medical and lost-time claims, and a renewed emphasis on prompt and thorough investigations. TAP's new Personal Lines claims workstation implemented in 1995 and workers' compensation claim workstation implemented in 1994 have improved the speed and quality of both Personal Lines and Commercial Lines claims service, and have helped loss payout performance. Use of technology such as VRUs (voice response units) has lowered the cost of settling claims and shortened the time to claim payment. The claim department also provides automated feedback from claim handlers to underwriters to help with risk assessment and accurate pricing information. Since the date of the Acquisition, significant progress has been made in converting all of TAP's claims processing to this technology. In Personal Lines, all new automobile and homeowners notices are now entered into TAP's claims database through the new workstation which provides access to data for both Aetna P&C and Travelers P&C sourced customers through one professional claim workstation. In Commercial Lines workers' compensation, all first reports of injury have been converted to the new telephone reporting system and a conversion of all open claims to utilize the new workstation is under way. The home office claims department periodically conducts internal file reviews of claims offices to monitor adherence to claims policies and procedures, the adequacy of case reserves, claims loss control, claims expense control, productivity and service standards. Regional claims management periodically audits sample files of claims representatives as part of their supervisory process. Environmental, asbestos and cumulative injury claims are segregated from other claims and are handled separately by TAP's Special Liability Group, a special unit staffed by dedicated legal, claim, finance and engineering professionals. See "-- Environmental, Asbestos and Cumulative Injury Claims." Reserves Property and casualty claim reserves are established to account for the estimated ultimate costs of claims and claim adjustment expenses for claims that have been reported but not yet settled and claims that have been incurred but not reported. TAP establishes reserves by line of business, coverage and year. 31 The process of estimating claim reserves is imprecise due to a number of variables. These variables are affected by both internal and external events such as changes in claims handling procedures, inflation, judicial trends and legislative changes. Many of these items are not directly quantifiable, particularly on a prospective basis. Additionally, there may be significant reporting lags between the occurrence of the insured event and the time it is actually reported to the insurer. TAP continually refines reserve estimates in a regular ongoing process as experience develops and further claims are reported and settled. TAP reflects adjustments to reserves in the results of operations in the periods in which the estimates are changed. In establishing reserves, TAP takes into account estimated recoveries for reinsurance, salvage and subrogation. TAP derives estimates for unreported claims and development on reported claims principally from actuarial analyses of historical patterns of claims development by accident year for each line of business and market segment. Similarly, TAP derives estimates of unpaid claim adjustment expenses principally from actuarial analyses of historical development patterns of the relationship of claim adjustment expenses to losses for each line of business and market segment. For a description of TAP's reserving methods for environmental and asbestos claims, see "-- Environmental, Asbestos and Cumulative Injury Claims." Discounting. The liability for losses for certain long-term disability payments under workers' compensation insurance and workers' compensation excess insurance has been discounted using a maximum interest rate of 5%. At December 31, 1996, 1995 and 1994 the combined amounts of discount for TAP were $1.012 billion, $1.206 billion and $1.120 billion, respectively. For a reconciliation of beginning and ending property and casualty insurance claims and claim adjustment expense reserves of the Company for each of the last three years, see Note 11 of Notes to Consolidated Financial Statements. The following table sets forth the year-end reserves from 1986 through 1996 and the subsequent changes in those reserves, presented on a combined basis for Travelers P&C and Aetna P&C. The data in the table are presented in accordance with reporting requirements of the Commission. Care must be taken to avoid misinterpretation by those unfamiliar with such information or familiar with other data commonly reported by the insurance industry. The following data is not accident year data, but rather a display of 1986-1996 year-end reserves and the subsequent changes in those reserves. For instance, the "cumulative deficiency or redundancy" shown in the following table for each year represents the aggregate amount by which original estimates of reserves as of that year-end have changed in subsequent years. Accordingly, the cumulative deficiency for a year relates only to reserves at that year-end and such amounts are not additive. Expressed another way, if the original reserves at the end of 1986 included $4 million for a loss that is finally settled in 1996 for $5 million, the $1 million deficiency (the excess of the actual 32 settlement of $5 million over the original estimate of $4 million) would be included in the cumulative deficiencies in each of the years 1986-1995 shown in the following table. Certain factors may distort the re-estimated reserves and cumulative deficiency or redundancy shown in the following table. For example, a substantial portion of the cumulative deficiencies in each of the years 1986-1996 arises from claims on policies written prior to the mid-1970s involving liability exposures such as environmental, asbestos and cumulative injury claims. In the post-1984 period, TAP has developed more stringent underwriting standards and policy exclusions and has significantly contracted or terminated the writing of such risks. See "-- Environmental, Asbestos and Cumulative Injury Claims." General conditions and trends that have affected the development of these liabilities in the past will not necessarily recur in the future. Other factors that affect the data in the following table include the discounting of workers' compensation reserves and the use of retrospectively rated insurance policies. To the extent permitted under applicable accounting practices, workers' compensation reserves are discounted to reflect the time value of money, due to the relatively long time period over which these claims are to be paid. Apparent deficiencies will continue to occur as the discount on these workers' compensation reserves is accreted at the appropriate interest rates. Also, a significant portion of National Accounts business is underwritten with retrospectively rated insurance policies in which the ultimate loss experience is primarily borne by the insured. Increases in loss experience result in an increase in reserves, and an offsetting increase in amounts recoverable from insureds. These amounts recoverable mitigate the impact of the cumulative deficiencies but are not reflected in the following table. Retrospective rating is particularly significant for National Accounts business for workers' compensation, and to a lesser extent in general liability and commercial automobile coverages. This mechanism affords TAP a significant financial protection against adverse development on a large block of net reserves. Because of these and other factors, it is difficult to develop meaningful extrapolation of estimated future redundancies or deficiencies in loss reserves from the data in the following table. The differences between the reserves for claims and claim adjustment expenses shown in the following table, which is prepared in accordance with GAAP, and those reported in the annual statements of TAP filed with state insurance departments, which are prepared in accordance with statutory accounting practices, were: $14 million, $(7) million and $(26) million for the years 1996, 1995 and 1994, respectively. 33
Year Ended December 31, 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 --------------------------------------------------------------------------------------- (Dollars in millions) Reserves for claims and claim adjustment expenses originally estimated: $14,076 $16,241 $17,851 $19,401 $20,182 $20,694 $21,454 $21,223 $21,272 $21,675 $21,816 Cumulative amounts paid as of: One year later 4,006 4,914 5,263 5,480 5,476 5,080 5,064 4,609 4,415 3,887 Two years later 6,963 8,152 8,553 8,949 9,020 8,639 8,363 7,812 7,190 Three years later 9,218 10,407 10,911 11,447 11,660 11,100 10,887 9,949 Four years later 10,779 12,036 12,643 13,390 13,450 13,097 12,586 Five years later 11,941 13,273 14,064 14,717 14,986 14,430 Six years later 12,868 14,370 15,051 15,964 16,058 Seven years later 13,745 15,129 16,031 16,815 Eight years later 14,373 15,963 16,751 Nine years later 15,117 16,598 Ten years later 15,683 Reserves re-estimated as of: One year later 14,443 16,780 18,204 19,629 20,358 21,178 21,645 21,458 22,101 22,095 Two years later 15,173 17,268 18,589 19,908 21,087 21,704 22,087 22,567 22,522 Three years later 15,738 17,696 19,056 20,676 21,820 22,397 23,303 23,031 Four years later 16,278 18,210 19,795 21,459 22,728 23,731 24,004 Five years later 16,755 18,967 20,595 22,501 24,133 24,547 Six years later 17,501 19,737 21,641 23,964 24,960 Seven years later 18,312 20,788 23,069 24,790 Eight years later 19,328 22,206 23,865 Nine years later 20,770 22,946 Ten years later 21,388 Cumulative deficiency 7,312 6,705 6,014 5,389 4,778 3,853 2,550 1,808 1,250 420 Gross liability--end of year $30,657 $29,967 Reinsurance and deductible recoverables 8,982 8,151 --------------- Net liability--end of year $21,675 $21,816 =============== Gross reestimated liability--latest $30,656 Reestimated reinsurance and deductible recoverables--latest 8,561 ------- Net reestimated liability--latest $22,095 ======= Gross cumulative deficiency (redundancy) $(1) =======
Statutory Combined Ratio and Other Information The following table sets forth the statutory loss and LAE ratios, underwriting expense ratios and combined ratios for the periods indicated for the Company. The statutory combined ratio is an industry measurement of the results of property and casualty insurance underwriting. This ratio is the sum of the ratio of incurred losses and loss adjustment expenses to net premiums earned (the "loss and LAE ratio"), the ratio of underwriting expenses incurred to net premiums written (the "underwriting expense ratio") and, where applicable, the ratio of dividends to policyholders to net premiums earned. A combined ratio under 100% generally indicates an underwriting profit; a combined ratio over 100% generally indicates an underwriting loss. However, investment income, federal income taxes and other non-underwriting income (e.g., service fee income) or expenses are not reflected in the combined ratio. The profitability of property and casualty insurance 34 companies depends on income from underwriting, investment and service operations. Lines of business where claims are paid out over a longer period of time, such as workers' compensation, also provide investment income over a longer period of time and therefore can be profitable at higher combined ratios than lines where claims are paid out over a shorter period. Insurers with a high proportion of long-tail policies will generally have higher combined ratios than insurers with more short-tail business. The ratios shown in the table below are computed based upon statutory accounting practices, not GAAP. For information on GAAP combined ratios, see Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations." Statutory Combined Ratios Year Ended December 31, ------------------------------------ 1996 1995 1994 -------- -------- -------- Commercial Lines: Loss and LAE ratio 95.6% 80.6% 100.0% Underwriting expense ratio 32.5 24.4 24.7 Combined ratio before policyholder dividends 128.1 (1) 105.0 124.7 (2) Combined ratio 128.8 106.3 123.0 Personal Lines: Loss and LAE ratio 68.7 74.5 71.0 Underwriting expense ratio 28.9 29.9 29.4 Combined ratio 97.6 (3) 104.4 100.4 Total: Loss and LAE ratio 85.2 78.2 88.7 Underwriting expense ratio 31.2 26.4 26.5 Combined ratio before policyholder dividends 116.4 104.6 115.2 Combined ratio 116.9 105.4 114.1 - ---------- (1) Includes the effect of charges associated with the Acquisition and also includes statutory charges made to conform accounting policies and TAP strategies in connection with the Acquisition (but not for GAAP reporting purposes due to purchase accounting). The combined ratio excluding such charges was 109.3%. (2) Includes statutory reserve increases for environmental claims and a reduction of ceded reinsurance balance amounting to $225 million by TAP. The combined ratio excluding this item was 114.2%. (3) Includes the effect of TAP's review of reserves associated with the Acquisition. The combined ratio excluding this item was 100.1%. 35 The following table sets forth information regarding the premium to surplus ratios of TAP. For informational purposes only, the table includes Aetna P&C for all periods presented. Schedule of Premium to Surplus Ratios (Statutory Basis)(1) Year Ended December 31, --------------------------------- 1996 1995 1994 -------- -------- --------- (Dollars in millions) Net written premiums $7,343 $7,701 $7,981 Capital and surplus 5,423 5,231 4,659 Ratio of net written premiums to capital and surplus 1.35x 1.47x 1.71x - ---------- (1) Including accident and health business. Environmental, Asbestos and Cumulative Injury Claims Environmental, asbestos and cumulative injury claims are segregated from other claims and are handled separately by TAP's Special Liability Group, a special unit staffed by dedicated legal, claim, finance and engineering professionals. Environmental Claims As a result of various state and federal regulatory efforts aimed at environmental remediation, the insurance industry has been, and continues to be, involved in extensive litigation involving policy coverage and liability issues. The Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA") was first enacted in 1980, and significantly expanded in 1984. CERCLA enables private parties and the federal and state governments to take action with respect to releases and threatened releases of hazardous substances and to recover their response costs from certain liable parties or such parties may be ordered to undertake remedial action directly. Liability under CERCLA may be joint and several with other responsible persons. In addition to the regulatory pressures, TAP believes that certain court decisions have expanded insurance coverage beyond the original intent of the insurers and insureds, frequently involving policies that were issued prior to the mid-1970s. The results of court decisions affecting the industry's coverage positions continue to be inconsistent. Accordingly, the ultimate responsibility and liability for environmental remediation costs remain uncertain. TAP continues to receive claims alleging liability exposures arising out of insureds' alleged disposition of toxic substances. These claims when submitted rarely indicate the monetary amount being sought by the claimant from the insured and TAP does not keep track of the monetary amount being sought in those few claims which indicated such a monetary 36 amount. TAP's review and investigation of environmental claims includes an assessment of the probable liability, available coverage, judicial interpretations and historical value of similar claims. In addition, the unique facts presented in each claim are evaluated individually and collectively. Due consideration is given to the many variables presented in each claim, such as: the nature of the alleged activities of the insured at each site; the allegations of environmental damage at each site; the number of sites; the total number of potentially responsible parties at each site; the nature of environmental harm and the corresponding remedy at a site; the nature of government enforcement activities at each site; the ownership and general use of each site; the overall nature of the insurance relationship between TAP and the insured; the identification of other insurers; the potential coverage available, if any; the number of years of coverage, if any; the obligation to provide a defense to insureds, if any; and the applicable law in each jurisdiction. TAP's reserves for environmental claims are not established on a claim-by-claim basis. An aggregate bulk reserve is carried for all of TAP's environmental claims that are in the dispute process, until the dispute is resolved. This bulk reserve is established and adjusted based upon the aggregate volume of in-process environmental claims and TAP's experience in resolving such claims. Environmental loss and loss expense reserves of TAP at December 31, 1996 were $1.242 billion, net of reinsurance of $127 million. Approximately 12% of such loss and loss expense reserves (i.e., approximately $146 million) were case reserves for resolved claims. The balance, approximately 88% of the net aggregate reserve (i.e., approximately $1.096 billion), is carried in a bulk reserve and includes incurred but not yet reported environmental claims for which TAP has not received any specific claims. The duration of TAP's investigation and review of such claims and the extent of time necessary to determine an appropriate estimate, if any, of the value of the claim to TAP, varies significantly and is dependent upon a number of factors. These factors include, but are not limited to, the cooperation of the insured in providing claim information, the pace of underlying litigation or claim processes, the pace of coverage litigation between the insured and TAP and the willingness of the insured and TAP to negotiate, if appropriate, a resolution of any dispute between them pertaining to such claims. Since the foregoing factors vary from claim to claim and insured by insured, TAP cannot provide a meaningful average of the duration of an environmental claim. However, based upon TAP's experience in resolving such claims, the duration may vary from months to several years. The property and casualty insurance industry does not have a standard method of calculating claim activity for environmental losses. Generally for environmental claims, Travelers P&C establishes a claim file for each insured on a per site, per claimant basis. If there is more than one claimant such as a federal and a state agency, this method will result in two claims being set up for a policyholder at that one site. Similarly, if one hundred claimants file a lawsuit against ten policyholders alleging injury as a result of the discharge of wastes or pollutants, one thousand claims would be established. Travelers P&C adheres to this method 37 of calculating claim activity on all environmental-related claims, whether such claims are tendered on primary, excess or umbrella policies. As of December 31, 1996, Travelers P&C had approximately 30,800 pending environmental-related claims tendered by 664 active policyholders. The pending environmental-related claims represent federal or state EPA-type claims as well as plaintiffs' claims alleging bodily injury and property damage due to the discharge of waste or pollutants. In 1996, the pending inventory increased by approximately 20,000 claims as a result of several lawsuits being filed in the states of Louisiana and Texas. These lawsuits, filed against one or more policyholders of Travelers P&C, allege that the plaintiffs were injured or damaged as a result of either alleged waste disposal or the alleged release of deleterious substances from ongoing business operations which have taken place near the plaintiffs' residences. Claims of this nature have historically been considered in the level of TAP's environmental reserves. To date, in total Travelers P&C has resolved environmental-related claims on behalf of 1,628 policyholders. TAP is preparing a claims system conversion which when completed will apply Travelers P&C's method of establishing claim files to Aetna P&C's environmental-related claims. TAP anticipates that this process should be completed in 1997. As of December 31, 1996, Aetna P&C had pending environmental-related claims tendered by approximately 948 active policyholders. Approximately 129 of these 948 active policyholders are also included in the 664 active Travelers P&C policyholders. Aetna P&C's policyholders, like those of Travelers P&C, have tendered both EPA-type claims and individual claims alleging injury or damage as a result of the discharge of wastes or pollutants. To date, Aetna P&C has resolved environmental-related claims on behalf of 1,870 policyholders. To date, TAP generally has been successful in resolving its coverage litigation and continues to reduce its potential exposure through favorable settlements with certain insureds. These settlement agreements with certain insureds are based on the variables presented in each piece of coverage litigation. Generally the settlement dollars paid in disputed coverage claims are a percentage of the total coverage sought by such insureds. In addition, with respect to settlement of many of the environmental claims, the agreement between TAP and the insured extinguishes any obligation TAP may have under any policy issued to the insured for future environmental liabilities risks. This form of settlement is commonly referred to as a "buy-back" of policies for future environmental liability risks. Additional provisions of these agreements include the appropriate indemnities and hold harmless provisions to protect TAP. TAP's general purpose in executing such agreements is to reduce its potential environmental exposure and eliminate both the risks presented by coverage litigation with the insured and the cost of such litigation. 38 Asbestos Claims In the area of asbestos claims, TAP believes that the property and casualty insurance industry has suffered from judicial interpretations that have attempted to maximize insurance availability from both a coverage and liability standpoint far beyond the intent of the contracting parties. These policies generally were issued prior to the 1980s. TAP continues to receive asbestos claims alleging insureds' liability from claimants' asbestos-related injuries. These claims, when submitted, rarely indicate the monetary amount being sought by the claimant from the insured and TAP does not keep track of the monetary amount being sought in those few claims which indicated such a monetary amount. Originally the cases involved mainly plant workers and traditional asbestos manufacturers and distributors. However, in the mid-1980s, a new group of plaintiffs, whose exposure to asbestos was less direct and whose injuries were often speculative, began to file lawsuits in increasing numbers against the traditional defendants as well as peripheral defendants who had produced products that may have contained small amounts of some form of encapsulated asbestos. These claims continue to arise and on an individual basis generally involve smaller companies with smaller limits of potential coverage. Also, there has emerged a group of non-product claims by plaintiffs, mostly independent labor union workers, mainly against companies, alleging exposure to asbestos while working at these companies' premises. In addition, various insurers, including TAP, remain defendants in an action brought in Philadelphia regarding potential consolidation and resolution of future asbestos bodily injury claims. In summary, various classes of asbestos defendants, such as major product manufacturers, peripheral and regional product defendants as well as premises owners, are tendering asbestos-related claims to the industry. Because each insured presents different liability and coverage issues, TAP evaluates those issues on an insured-by-insured basis. TAP's evaluations have not resulted in any meaningful data from which an average asbestos defense or indemnity payment may be determined. The varying defense and indemnity payments made by TAP on behalf of its insureds have also precluded TAP from deriving any meaningful data by which it can predict whether its defense and indemnity payments for asbestos claims (on average or in the aggregate) will remain the same or change in the future. Based upon TAP's experience with asbestos claims, the duration period of an asbestos claim from the date of submission to resolution is approximately two years. At December 31, 1996, asbestos claims reserves of TAP were $1.073 billion, net of reinsurance of $370 million. Approximately 25% of the net aggregate reserve (i.e., approximately $263 million) is for pending asbestos claims. The balance, approximately 75% (i.e., approximately $810 million), of the net asbestos reserves represents incurred but not yet reported losses for which TAP has not received any specific claims. 39 Uncertainty Regarding Adequacy of Environmental and Asbestos Reserves It is difficult to estimate the reserves for environmental and asbestos-related claims due to the vagaries of court coverage decisions, plaintiffs' expanded theories of liability, the risks inherent in major litigation and other uncertainties. Conventional actuarial techniques are not used to estimate such reserves. For environmental claims, TAP estimates its financial exposure and establishes reserves based upon an analysis of its historical claim experience and the facts of the individual underlying claims. The unique facts presented in each claim are evaluated individually and collectively. Due consideration is given to the many variables presented in each claim, as discussed above. The following factors are evaluated in projecting the ultimate reserve for asbestos-related claims: available insurance coverage; limits and deductibles; an analysis of each policyholder's potential liability; jurisdictional involvement; past and projected future claim activity; past settlement values of similar claims; allocated claim adjustment expense; potential role of other insurance, and applicable coverage defenses, if any. Once the gross ultimate exposure for indemnity and allocated claim adjustment expense is determined for a policyholder by policy year, a ceded projection is calculated based on any applicable facultative and treaty reinsurance. In addition, a similar review is conducted for asbestos property damage claims. However, due to the relatively minor claim volume, these reserves have remained at a constant level. As a result of these processes and procedures, the reserves carried for environmental and asbestos claims at December 31, 1996 are the Company's best estimate of ultimate claims and claim adjustment expenses based upon known facts and current law. However, the environment surrounding the final resolution of these claims continues to change. Currently, it is not possible to predict changes in the legal and legislative environment and their impact on the future development of asbestos and environmental claims. Such development will be affected by future court decisions and interpretations and changes in Superfund and other legislation. Because of these future unknowns, additional liabilities may arise for amounts in excess of the current reserves. These additional amounts, or a range of these additional amounts, cannot now be reasonably estimated, and could result in a liability exceeding reserves by an amount that would be material to the Company's operating results in a future period. However, the Company believes that it is not likely that these claims will have a material adverse effect on the Company's financial condition or liquidity. Cumulative Injury Other Than Asbestos Cumulative injury other than asbestos ("CIOTA") claims are generally submitted to TAP under general liability policies and often involve an allegation by a claimant against an insured that the claimant has suffered injuries as a result of long-term or continuous exposure 40 to potentially harmful products or substances. Such potentially harmful products or substances include, but are not limited to, lead paint, pesticides, pharmaceutical products, silicone-based personal products, solvents and other deleterious substances. Due to claimants' allegations of long-term bodily injury in CIOTA claims, numerous complex issues regarding such claims are presented. The claimants' theories of liability must be evaluated, evidence pertaining to a causal link between injury and exposure to a substance must be reviewed, the potential role of other causes of injury must be analyzed, the liability of other defendants must be explored, and assessment of a claimant's damages must be made and the law of the jurisdiction must be applied. In addition, TAP must review the number of policies issued by TAP to the insured and whether such policies are triggered by the allegations, the terms and limits of liability of such policies, the obligations of other insurers to respond to the claim, and the applicable law in each jurisdiction. To the extent disputes exist between TAP and a policyholder regarding the coverage available for CIOTA claims, TAP resolves the disputes, where feasible, through settlements with the policyholder or through coverage litigation. Generally, the terms of a settlement agreement set forth the nature of TAP's participation in resolving CIOTA claims, the scope of coverage to be provided by TAP and contain the appropriate indemnities and hold harmless provisions to protect TAP. These settlements generally eliminate uncertainties for TAP regarding the risks extinguished, including the risk that losses would be greater than anticipated due to evolving theories of tort liability or unfavorable coverage determinations. TAP's approach also has the effect of determining losses at a date earlier than would have occurred in the absence of such settlement agreements. On the other hand, in cases where future developments are favorable to insurers, this approach could have the effect of resolving claims for amounts in excess of those that would ultimately have been paid had the claims not been settled in this manner. No inference should be drawn that because of TAP's method of dealing with CIOTA claims, its reserves for such claims are more conservatively stated than those of other insurers. Aetna P&C did not distinguish CIOTA from other general liability claims or treat CIOTA claims as a special class of claims. In addition, there were substantial differences in claim approach and resolution between TAP and Aetna P&C regarding CIOTA claims. During the second quarter, TAP completed its review of Aetna P&C's exposure to CIOTA claims in order to determine an appropriate level of reserves using TAP's approach as described above. Based on the results of that review, TAP's general liability insurance reserves were increased $360 million, net of reinsurance ($234 million after tax). At December 31, 1996, CIOTA claims reserves of TAP were $1.114 billion, net of reinsurance of $446 million. Approximately 19% of the net aggregate reserve (i.e., approximately $215 million) is for pending CIOTA claims. The balance, approximately 81% 41 (i.e., approximately $899 million), of the net CIOTA reserves represents incurred but not yet reported losses for which TAP has not received any specific claims. Insurance Pools Most of TAP's insurance subsidiaries are members of one of three separate intercompany property and casualty reinsurance pooling arrangements: the Travelers Indemnity pool, the Aetna Insurance pool and the Gulf pool. Each of these insurance pools permits the participating companies to rely on the capacity of the entire pool rather than on its own capital and surplus. Under the arrangements of each insurance pool, the members share substantially all insurance business that is written and prorate the combined premiums, losses and expenses. Competition and Regulation For a description of competition and regulation relating to the Company's property and casualty insurance business, see "Insurance Services - General" at the end of the description of the Life Insurance Services segment. Investments For information on the investment portfolios of the Company's property and casualty insurance business, see "Insurance Services - General" at the end of the description of the Life Insurance Services segment. LIFE INSURANCE SERVICES The Company's Life Insurance Services segment includes the operations of The Travelers Insurance Company ("TIC"), which was incorporated in 1863, The Travelers Life and Annuity Company ("TLAC"), Transport Life Insurance Company ("Transport Life") and its affiliates through the end of the third quarter of 1995 (collectively, "Travelers Life and Annuity") and the Primerica Financial Services group of companies ("PFS"), including Primerica Life Insurance Company ("Primerica Life"). On September 29, 1995, the Company distributed all of the outstanding shares of common stock of Transport Holdings Inc., the indirect parent of Transport Life, to the Company's stockholders. With $43.0 billion of assets at December 31, 1996, the Company believes that TIC, TLAC and Primerica Life together constitute one of the largest stock life insurance groups in the United States as measured by assets. For information concerning the Company's credit-related insurance businesses, see "Consumer Finance Services." 42 Primerica Financial Services Principal Markets and Methods of Distribution The business operations of PFS involve the sale of insurance, mutual funds and other financial products, and consist of an affiliated group of companies engaged in (i) the underwriting and administration of individual term life insurance throughout the United States and in Canada and (ii) securities brokerage, consisting primarily of mutual fund sales. The PFS sales force, composed of more than 86,000 independent agents, primarily markets term life insurance of Primerica Life and certain other products of subsidiaries of the Company, including certain loans offered by the Company's consumer finance subsidiaries and other products approved by the Company. The domestic PFS sales force also sells certain property-casualty insurance products of TAP and mutual funds offered by Smith Barney. Because the great majority of the domestic licensed sales force works on a part-time basis, a substantial portion of the sales force is inactive from time to time. Primerica Life and its subsidiaries, Primerica Life Insurance Company of Canada and National Benefit Life Insurance Company ("NBL"), primarily offer individual term life insurance. NBL provides statutory disability benefits in New York, as well as direct response student term life insurance nationwide. Primerica Life and its subsidiaries together are licensed to sell and market term life insurance in all 50 states, the District of Columbia, Canada, Puerto Rico, Guam, the U.S. Virgin Islands and the Northern Mariana Islands. For information concerning PFS Investments Inc. ("PFS Investments"), see "-- Mutual Funds and Asset Management." Premium revenues, net of reinsurance, for PFS for the years ended December 31, 1996, 1995 and 1994 were $1.030 billion, $1.012 billion and $962 million, respectively. The increase in premium revenues in recent years is primarily attributable to the retention of in force business and the increase in average premium per new policy sold. See "Insurance Services - General -- Reinsurance" for a discussion of reinsurance. 43 Life Insurance in Force The following table provides a reconciliation of beginning and ending life insurance in force for Primerica Life and subsidiaries, and related statistical data for 1994-1996. (in millions of dollars, except as noted) Year Ended December 31, -------------------------------------- 1996 1995 1994 ---- ---- ---- In force beginning of year $ 348,169 $ 334,972 $ 317,403 Additions 52,039 53,045 57,389 Terminations(1) (40,330) (39,848) (39,820) --------- -------- -------- In force end of year $ 359,878 $ 348,169 $ 334,972 ========= ========== ========= The amounts in force at end of year are before reinsurance ceded in the following amounts $ 134,330 $ 117,647 $ 94,930 ========= ========= ========= At end of year: Number of policies in force PFS 2,141,800 2,115,600 2,075,600 NBL other individual lines 418,437 398,988 396,717 Average size of policy in force (in dollars) PFS $ 164,694 $ 161,125 $ 157,739 NBL other individual lines 17,055 18,154 19,078 - ---------- (1) Includes terminations due to death, surrenders and lapses. AIDS-related claims, net of reinsurance, as a percentage of total net life claims paid by Primerica Life in 1996, 1995 and 1994, were 5.9%, 7.1% and 7.1%, respectively. Management believes that current pricing and reserves make adequate provision for AIDS-related claim experience. Mutual Funds and Asset Management PFS Investments is a registered broker-dealer through which the PFS sales force markets mutual funds and variable annuities. For the years ended December 31, 1996, 1995 and 1994, PFS' total mutual fund sales were $2.327 billion, $1.551 billion and $1.622 billion, respectively. The PFS sales force began marketing Smith Barney mutual funds through a 44 separate distribution arrangement with PFS Distributors, Inc. in mid-1995 and in March 1996 began selling The Concert Series-SM-. The Concert Series-SM- is a group of mutual funds that invests in various Smith Barney mutual funds instead of directly in stocks, bonds or other securities. Sales of Smith Barney mutual funds accounted for approximately 24% and 2%, respectively, of PFS' total mutual fund sales in 1996 and 1995. At December 31, 1996, approximately 27,500 independent agent members of the PFS sales force (including approximately 2,600 licensed in Canada only) were also independent registered securities representatives of PFS Investments and/or PFSL Investments Canada Ltd. PFS Investments is also the exclusive retail distributor of the Common Sense-R- Trust mutual funds,(1) and certain of the Company's subsidiaries provide underwriting, transfer agency and custodial services to these funds. Sales of shares of the Common Sense-R- Trust funds accounted for approximately 27%, 39% and 42%, respectively, of total mutual funds sales by PFS for 1996, 1995 and 1994. In December 1994, the Company sold American Capital Management & Research, Inc., a mutual fund company and the co-sponsor of the Common Sense-R- Trust funds, to The Van Kampen Merritt Companies, Inc. ("VKM") and purchased an equity interest in VKM's parent company. In October 1996, VKM's parent was sold, and in connection with such sale, the Company sold its equity interest in that company. Travelers Life and Annuity Principal Products Travelers Life and Annuity offers fixed and variable deferred annuities, payout annuities and term, universal and variable life and long-term care insurance to individuals and small businesses. It also provides group pension products, including guaranteed investment contracts, and group annuities to employer-sponsored retirement and savings plans. Travelers Life and Annuity views market specialization and distribution diversification as critical components of profitability. It has updated its individual product portfolio to include a range of competitively priced fixed and variable annuity, term, universal and variable life and long-term care insurance products for its customers. Individual accumulation fixed and variable annuities, group annuities and pension plan products are used for retirement funding purposes. Variable annuities permit policyholders to direct retirement funds into a number of separate accounts which offer various investment options. Individual payout annuities are used for structuring settlements of certain indemnity claims and making other payments to policyholders over a period of time. Guaranteed investment contracts, which provide a guaranteed return on investment, continue to be a popular investment choice for employer-sponsored retirement and savings - ---------- (1) Common Sense is a registered trademark of Van Kampen/American Capital Asset Management, Inc. ("VK/ACAM"). 45 plans. Group annuities purchased by employer sponsored plans fulfill retirement obligations to individual employees. Individual life insurance provides protection against financial loss due to death. Life insurance is also used to meet estate, business planning and retirement needs. Long-term care insurance provides income and asset protection against the high costs of care associated with home health, assisted living and nursing home care. Travelers Life and Annuity ceased writing disability income insurance in the first quarter of 1995. The following table sets forth written premiums, net of reinsurance, and deposits for the Travelers Life and Annuity unit. Premiums and Deposits (in millions) Year Ended December 31, --------------------------- 1996 1995 1994 ---- ---- ---- Premiums Individual life $ 122 $ 124 $ 124 Long-term care 128 88 61 Individual accident and health(1) 24 200 273 Payout annuities 76 90 92 ----- ----- ----- Total premiums 350 502 550 ----- ----- ----- Deposits Universal life insurance 169 149 162 Annuities Individual fixed accumulation 621 692 569 Individual variable accumulation(2) 1,370 956 693 Individual payout 44 38 26 Guaranteed investment contracts(3) 764 681 347 Group separate accounts and managed funds(4) 276 362 747 Other fixed funds 186 115 119 Corporate-owned life insurance(5) 30 91 - ----- ----- ----- Total deposits 3,460 3,084 2,663 ----- ----- ----- Total premiums and deposits $3,810 $3,586 $3,213 ===== ===== ===== - ---------- (1) The declines in 1995 and 1996 reflect the Company's distribution of Transport Holdings Inc., the indirect parent of Transport Life Insurance Company, to the Company's stockholders in September 1995. (2) The increase in individual variable accumulation deposits reflects successful introduction of variable annuities in the Smith Barney distribution network and other distribution initiatives. (3) In 1994, TIC adopted a more selective approach to issuing new contracts. The 1996 and 1995 increases reflect successful implementation of the new strategy with both existing and new customers, and also was helped by ratings upgrades during those years. (4) The 1996, 1995 and 1994 deposits include $146 million, $200 million and $512 million, respectively, of deposits relating to the transfer in house of pension fund assets previously managed externally. 46 (5) TIC is not currently marketing corporate owned life insurance. 1996 and 1995 deposits are attributable to contracts previously issued by the Company's Managed Care and Employee Benefits Operations ("MCEBO") (which were sold in 1995) and transferred to Travelers Life and Annuity effective January 1, 1995. For 1994, the premiums and deposits on this business were $187 million and were reported in the Company's MCEBO unit. For information about reinsurance, see "Insurance Services - General - -- Reinsurance." Principal Markets and Methods of Distribution TIC is licensed to sell and market its individual products in all 50 states, the District of Columbia, Puerto Rico, Guam, the Bahamas and the U.S. and British Virgin Islands. TLAC is licensed to sell and market life and annuity products in 43 states and the District of Columbia. Individual products are primarily marketed through The Copeland Companies ("Copeland"), an indirect wholly owned subsidiary of TIC, Smith Barney Financial Consultants and a core group of approximately 500 independent agencies. Copeland is a captive sales organization of personal retirement planning specialists focused primarily on the qualified periodic deferred annuity marketplace, and accounted for approximately 39% of total individual deferred annuity production in 1996 and 1995. Smith Barney's Financial Consultants distribute Travelers Life and Annuity's non-qualified deferred annuities and individual life and long-term care products. Smith Barney's share of Travelers Life and Annuity's total individual deferred annuity production increased from 33% in 1995 to 38% in 1996. The core group of over 500 professional life insurance agencies sold the majority of the individual life and long term care business in 1996 and 1995 and accounted for 23% and 27%, respectively, of individual annuity premiums and deposits. Tower Square Securities, Inc. ("Tower Square Securities"), a wholly owned subsidiary of TIC, is an introducing broker-dealer offering a full line of brokerage services. Tower Square Securities facilitates the sale of individual variable life and annuity insurance products by the independent agents of TIC. TIC has also begun expanding the sale of its individual life and long-term care products through other distribution networks. To accomplish this, TIC has entered into strategic alliances with a select number of established producers. In 1996, TIC acquired Travelers Net Plus, a long-term care specialty distributor that markets primarily through targeted direct mailing. TIC also formed TowerMark, a joint venture focused on recruiting and supporting agencies serving high-end estate planning customers. Group pension products and annuities are marketed by Travelers Life and Annuity's salaried staff directly to plan sponsors and are also placed through independent consultants and investment advisers. The major factors affecting the pricing of these contracts are the economics of the capital markets, primarily the interest rate environment, the availability of appropriate investments and surplus required to support this business. The pricing of products 47 and services also reflects charges for expenses, mortality, profit and other relevant financial factors such as credit risk. Life Insurance in Force The following table provides a reconciliation of beginning and ending Travelers Life and Annuity life insurance in force and related statistical data on a statutory basis for 1994 through 1996. (in millions of dollars, except as noted) Year Ended December 31, ------------------------------------ 1996 1995 1994 ---- ---- ---- In force beginning of year $ 49,179 $ 48,998 $ 44,909 Additions(1) 6,566 6,153 9,265 Terminations(2) (5,336) (5,972) (5,176) ------- ------- ------- In force end of year $ 50,409 $ 49,179 $ 48,998 ======= ======= ======= The amounts in force at end of year are before reinsurance ceded in the following amounts $ 19,474 $ 16,806 $ 6,575 ======= ======= ======= At end of year: Number of policies in force(1) (3) 545,682 563,286 606,089 Average size of policy in force (in dollars) $ 92,371 $ 87,307 $ 80,843 - ---------- (1) The 1995 decline reflects the de-emphasis of sales of certain lower-margin life insurance products. (2) Includes terminations due to death, surrenders and lapses. 1995 terminations also include policy terminations attributable to the distribution of Transport Holdings Inc. to the Company's stockholders. (3) The decline in 1996 and 1995 reflects the gradual run-off of old whole life policies written several years ago at relatively low levels of per policy insurance coverage. This was particularly offset by the sale of term and universal life policies with significantly higher levels of insurance coverage. Insurance Reserves and Contractholder Funds As life, long-term care and disability income insurance and annuity premiums are received, Travelers Life and Annuity establishes policy benefit reserves that reflect the present value of expected future obligations, net of the present value of expected future net premiums. These reserves generally reflect long-term fixed obligations to policyholders and are based on assumptions as to interest rates, future mortality, morbidity, persistency and expenses, with provision for adverse deviation. Policy benefit reserves, which give appropriate recognition to reinsurance, are established based on factors derived from past experience. 48 Contractholder funds arise from the issuance of individual life contracts that include an identifiable investment component, individual deferred annuities and certain individual payout annuity contracts. Contractholder funds generally are equal to deposits received and interest credited less withdrawals, mortality charges and administrative expenses. Contractholder funds also include receipts from the issuance of pension investment contracts. AIDS-related claims paid by Travelers Life and Annuity in 1996, 1995 and 1994 were 3.4%, 1.6% and 2.1%, respectively, as a percentage of total life claims paid, and 0.4%, 0.3% and 1.5%, respectively, as a percentage of total health claims paid. Management believes that current pricing and reserves make adequate provision for AIDS-related claim experience. Competition and Regulation For a description of competition and regulation relating to the Company's life insurance businesses, see "Insurance Services - General." Investments For information on the investment portfolios of the Company's life insurance businesses, see "Insurance Services - General." INSURANCE SERVICES - GENERAL Ratings Insurance companies are rated by rating agencies to provide both industry participants and insurance consumers with meaningful information on specific insurance companies. Higher ratings generally indicate financial stability and a strong ability to pay claims. These ratings are based upon factors relevant to policyholders and are not directed toward protection of investors. Such ratings are neither a rating of securities nor a recommendation to buy, hold or sell any security and may be revised or withdrawn at any time. Ratings focus primarily on the following factors: capital resources, financial strength, demonstrated management expertise in the insurance business, credit analysis, systems development, market segment position and growth opportunities, marketing, sales conduct practices, investment operations, minimum policyholders' surplus requirements and capital sufficiency to meet projected growth, as well as access to such traditional capital as may be necessary to continue to meet standards for capital adequacy. The following table summarizes the current claims-paying and financial strength ratings of the Company's subsidiaries, including Aetna Casualty and Surety Company of America ("Aetna C&S of America"), and insurance pools by A.M. Best, Duff & Phelps 49 Corp., Moody's Investor's Service Inc. and Standard & Poor's Ratings Group. The table also presents the position of each rating in the applicable agency's rating scale.
Moody's A.M. Best Duff & Investor's Standard Company Phelps Corp. Service Inc. & Poor's ------- ------------ ------------ -------- TIC A (3rd of 15) AA- (4th of 18) A1 (5th of 19) AA- (4th of 18) TLAC A (3rd of 15) AA- (4th of 18) A1 (5th of 19) AA- (4th of 18) Primerica Life A (3rd of 15) AA (3rd of 18) Aa3 (4th of 19) AA (3rd of 18) Travelers Indemnity pool(1) A (3rd of 15) AA- (4th of 18) A1 (5th of 19) A+ (5th of 18) Aetna Insurance pool(2) A- (4th of 15) A+ (5th of 18) A1 (5th of 19) A+ (5th of 18) Gulf pool(3) A+(2nd of 15) - - AA (3rd of 18) Aetna C&S of America A (3rd of 15) A+ (5th of 18) A1 (5th of 19) A+ (5th of 18)
- ------------------------------ (1) The Travelers Indemnity Pool consists of The Travelers Indemnity Company, The Phoenix Insurance Company, The Charter Oak Fire Insurance Company, The Travelers Indemnity Company of Connecticut, The Travelers Indemnity Company of America, The Travelers Indemnity Company of Missouri, The Travelers Indemnity Company of Illinois, TravCo Insurance Company and The Travelers Home and Marine Insurance Company. (2) The Aetna Insurance Pool consists of The Aetna Casualty and Surety Company, The Standard Fire Insurance Company, Aetna Casualty & Surety Company of Illinois, The Farmington Casualty Company, The Automobile Insurance Company of Hartford, Connecticut, Aetna Casualty Company of Connecticut, Aetna Commercial Insurance Company, Aetna Insurance Company, Aetna Insurance Company of Illinois and Aetna Personal Security Insurance Company. (3) The Gulf pool consists of Gulf Insurance Company, Gulf Underwriters Insurance Company, Select Insurance Company, Atlantic Insurance Company and Gulf Group Lloyds. Reinsurance The Company reinsures a portion of the risks it underwrites in an effort to control its exposure to losses, stabilize earnings and protect surplus. The Company cedes to reinsurers a portion of these risks and pays premiums based upon the risk and exposure of the policies subject to such reinsurance. Reinsurance is subject to collectibility in all cases and to aggregate loss limits. Although the reinsurer is liable to the Company to the extent of the reinsurance ceded, the Company remains primarily liable as the direct insurer on all risks reinsured. Reinsurance recoverables are reported after allowances for uncollectible amounts. The Company also holds collateral, including escrow funds and letters of credit, under certain reinsurance agreements. The Company monitors the financial condition of reinsurers on an ongoing basis, and reviews its reinsurance arrangements periodically. Reinsurers are selected based on their financial condition, business practices and the price of their product offerings. For additional information concerning reinsurance, see Note 12 of Notes to Consolidated Financial Statements. Property and Casualty Insurance TAP utilizes a variety of reinsurance agreements to control its exposure to large property and casualty losses. TAP utilizes the following types of reinsurance: (i) facultative reinsurance, in which reinsurance is provided for all or a portion of the insurance provided by a single policy and each policy reinsured is separately negotiated; (ii) treaty reinsurance, in 50 which reinsurance is provided for a specified type or category of risks; and (iii) catastrophe reinsurance, in which the ceding company is indemnified for an amount of loss in excess of a specified retention with respect to losses resulting from a catastrophic event. TAP's top five reinsurers, except Lloyd's of London ("Lloyd's") (which is not rated), are rated "A" or higher by A.M. Best. The ratings and reinsurance recoverable at December 31, 1996 follow (in millions): Reinsurance Reinsurer Recoverable A.M. Best Rating of Reinsurer - -------------------------------------------------------------------------------- General Reinsurance Corporation $ 483 A++ highest of 15 ratings American Re-Insurance Company 262 A+ 2nd highest of 15 ratings Executive Risk Indemnity Inc. 193 A 3rd highest of 15 ratings Employers Reinsurance Corporation 96 A++ highest of 15 ratings NAC Reinsurance Corporation 75 A 3rd highest of 15 ratings As of December 31, 1996, TAP had ceded to Lloyd's and General Reinsurance Corporation, two reinsurers with which TAP does the most business, approximately $488 million and $483 million, respectively, of insurance losses and loss adjustment expenses. In 1996, Lloyd's restructured its operations with respect to claims for years prior to 1993. The Company is in arbitration with underwriters at Lloyd's in New York State to enforce reinsurance contracts with respect to recoveries for certain asbestos claims that constitute a portion of the total reinsurance recoverable referred to above. The dispute involves the ability of the Company to aggregate asbestos claims under a market agreement between Lloyd's and the Company or under the applicable reinsurance treaties. See Item 3, "Legal Proceedings." The outcome of the arbitration referred to above is uncertain and the impact, if any, on collectibility of amounts recoverable by TAP from Lloyd's cannot be quantified at this time. The Company believes that it is not likely that the outcome could have a material adverse effect on the Company's operating results, financial condition or liquidity. TAP participates in pools with other insurers to provide capacity for unique and high-valued risks such as exposures related to the aviation and nuclear power industries. TAP's maximum net exposure to this type of business at December 31, 1996 was $29 million per risk. For policies written on or after January 1, 1997, the exposure was reduced to $15 million per risk. At December 31, 1996, TAP had $9.7 billion in reinsurance recoverables. Of this amount, $4.2 billion is for pools and associations which relate primarily to workers' compensation service business and have the strength of the participating insurance companies on a joint basis supporting these cessions. Of the remaining $5.5 billion ceded to reinsurers at December 31, 1996, $497 million was environmental and asbestos-related and the remainder principally reflects reinsurance in support of ongoing business. In addition, at December 31, 51 1996, $465 million was collateralized by letters of credit against the asset. The descriptions below relate to reinsurance arrangements of TAP in effect at January 1, 1997. Net Retention Policy. Currently, for third-party liability, including automobile no-fault, the reinsurance agreements used by Commercial Accounts, Select Accounts and Construction limit the net retention to a maximum of $4 million per insured, per occurrence. For Travelers Specialty, the reinsurance agreements for third-party liability, including professional and healthcare liability, limit TAP's net retention to a maximum of $4 million per policy, per occurrence. Gulf Specialty utilizes various reinsurance mechanisms and has limited its net retention to $4 million for any line of business. For commercial property insurance, there is a $5 million maximum retention per insured with 100% reinsurance coverage for risks with higher limits. The reinsurance agreement in place for workers' compensation policies written by Commercial Accounts, Select Accounts, Construction, Travelers Specialty and some segments of Alternative Markets covers 100% of each loss between $2 million and $10 million. For National Accounts, reinsurance arrangements are typically tiered, or layered, such that only levels of risk acceptable to TAP are retained. The reinsurance agreement in place for Personal Lines umbrella policies covers 100% of each loss between $1 million and $5 million. The reinsurance agreements in place for Personal Lines property policies covers 100% of each loss between $1 million and $6 million. For surety protection, Bond has reinsurance coverage for 95% of up to $50 million of liability in excess of $50 million of liability. In addition, Bond's accident year results are protected by an aggregate excess of loss treaty that provides 93.85% of approximately $52 million of reinsurance coverage in excess of a $119 million retention. Catastrophe Reinsurance. TAP utilizes reinsurance agreements with nonaffiliated reinsurers to control its exposure to losses resulting from one occurrence. For the accumulation of net property losses arising out of one occurrence, reinsurance agreements cover 75% of total losses between $250 million and $650 million. For multiple workers' compensation losses arising from a single occurrence, reinsurance agreements cover 100% of losses between $10 million and $250 million and, for workers' compensation losses caused by property perils, reinsurance agreements cover 75% of losses between $250 million and $650 million. For commercial property insurance sold through Commercial Accounts, Select Accounts, Construction and certain National Accounts, 10% of all losses are reinsured in 1997, subject to an occurrence limitation of $275 million. For Personal Lines homeowners insurance, in 1997, 25% of losses in states along the East Coast are reinsured up to a maximum recovery of $180 million per occurrence. The covered territory of this Homeowners Quota Share includes Maine, New Hampshire, Massachusetts, Rhode Island, Connecticut, New York, New Jersey, Delaware, Maryland, Virginia, North Carolina, South Carolina, Georgia, Florida and Washington, D.C. 52 Reinsurance Fund TAP also participates in the Florida Hurricane Catastrophe Fund ("FHCF"), which is a state-mandated catastrophe reinsurance fund. FHCF is primarily funded by premiums from insurance companies that write residential property business in Florida and, if insufficient, assessments on insurance companies that write other property and casualty insurance, excluding workers' compensation. FHCF's resources are limited to these contributions and to its borrowing capacity at the time of a significant catastrophe. There can be no assurance that these resources will be sufficient to meet the obligations of FHCF. The Company's recovery of less than contracted amounts from FHCF could have a material adverse effect on the Company's results of operations in the event of a significant catastrophe in Florida. Life Insurance The Company's policy is to obtain reinsurance on individual life policies for amounts above certain retention limits, which limits vary with age and underwriting classification. During 1996, most new business was reinsured under an 80%/20% quota share reinsurance program. Effective January 1, 1997, for Primerica Life and its subsidiaries new business is reinsured under a 90%/10% quota share reinsurance program. Retention on life insurance risks after reinsurance remains up to a maximum of $1.5 million per insured for an ordinary life risk, depending on the subsidiary involved, the type of policy, the year of issue and the age of the insured. Other reinsurance arrangements are made from time to time to cede or assume existing blocks of business. Competition and Other Factors Affecting Growth Property and Casualty Insurance The property and casualty insurance industry is highly competitive in the areas of price, service, product offerings, agent relationships and, in the case of personal property and casualty business, method of distribution (i.e., use of independent agents, captive agents and/or salaried employees). There are approximately 3,400 property-casualty insurance companies in the United States. Of those companies, approximately 800 operate in all or most states and write the vast majority of the business in the industry while approximately 2,600 offer one or more personal or commercial lines property-casualty products similar to those marketed by TAP. In addition, an increasing amount of commercial risks are covered by purchaser self-insurance, large deductibles, risk-purchasing groups, risk-retention groups and captive companies. Commercial Lines. The insurance industry is represented in the commercial lines marketplace by many insurance companies of varying size. The industry is comprised of small 53 local firms, large regional firms and large national firms, as well as self-insurance programs or captive insurers. Market competition works to set the price charged for insurance products and the level of service provided within the insurance regulatory framework. Growth is driven by a company's ability to provide insurance and services at a price that is reasonable and acceptable to the customer. In addition, the marketplace is affected by available capacity of the insurance industry as measured by policyholders' surplus. Surplus expands and contracts primarily in conjunction with profit levels generated by the industry. Growth in premium and service business is also measured by a company's ability to retain existing customers and to attract new customers. The National Accounts market is highly competitive. Competition is based primarily on quality and service and, to a lesser extent, on the basis of price. National Accounts business is generally written through national brokers and regional agents. The Company also competes for state contracts to provide claims and policy management services. These contracts, which generally have three-year terms, are selected by state agencies through a bid process based on quality of service and price. The Company has emerged as the largest assigned risk plan service insurer in the industry with approximately 28% of the market in 1996. The Commercial Accounts market is highly competitive. Commercial Accounts business has historically been written through independent agents and brokers, although some companies use direct writing. Competitors in this market are primarily national property-casualty insurance companies willing to write most classes of business using traditional products and pricing and, to a lesser extent, regional insurance companies and companies that have developed niche programs for specific industry segments. Companies compete on price, product offerings, response time in policy issuance and claim and loss prevention services. Additionally, reduced overhead and improved efficiency through automation and response time to customer needs are key to success in this market. The Construction market has become a focused industry segment for several large insurance companies. Construction market business is written through agents and brokers. Insurance companies compete in this market based upon price, product offering and claims service. The Company utilizes its specialized underwriters and engineers who have extensive experience and knowledge of the construction industry to work with agents and brokers to compete effectively in this market. The Select Accounts market is highly competitive and is typically written through independent agents and, to a lesser extent, regional brokers. Both national and regional property-casualty insurance companies compete in the Select Accounts market which is generally comprised of low risk, "main street" business customers. Risks are underwritten and priced using standard industry practices and a combination of proprietary and standard industry product offerings. Competition in this market is primarily based on price, product offerings and response time in policy services. The Company has established a strong 54 marketing relationship with its distribution network and has provided it with defined underwriting policies, competitive prices and efficient automated environments. The market in which Specialty Accounts competes includes small to mid-sized niche companies that target certain lines of insurance and larger, multi-line companies that focus on various segments of the Specialty Accounts market. Specialty Accounts business is generally written through wholesale brokers and retail agents and brokers throughout the United States. Gulf Specialty derives a competitive advantage through its underwriting practices, low expense levels and broad product offering base. Bond Specialty's reputation for clear, timely decision-making, underwriting and industry expertise and strong producer and customer relationships as well as its ability to offer its customers a full range of financial services products, enable it to compete effectively. Its ability to cross-sell Bond products to customers of National Accounts, Commercial Accounts, Select Accounts and through other Travelers Group units provides further competitive advantages for the Company. Personal Lines. Personal lines insurance is written by hundreds of insurance companies of varying sizes. Although national companies write the majority of the business, the Company also faces competition from local or regional companies which often have a competitive advantage because of their expense structure or because they specialize in providing coverage to particular risk groups. The Company believes that the principal competitive factors are price, service, perceived stability of the insurer and name recognition. The Company also competes for business within each of the independent agencies representing it, because these agencies also offer policies of competing independent agency companies. At the agency level, the Company believes that competition is primarily based on the level of service, including claims handling, level of automation and the development of long-term relationships with the individual agents. The Company also competes with insurance companies that use captive agents or salaried employees to sell their products. Because these companies generally pay lower commissions than independent agency companies, they may be able to generate business at a lower cost than the Company. Due to this expense advantage, the direct writing companies have gradually expanded their market share in recent years. However, in addition to its traditional independent agency distribution, Personal Lines is pursuing a number of initiatives to broaden its distribution of Personal Lines products, including marketing through the PFS sales force, marketing to affinity groups and establishing co-marketing arrangements with other insurers. Life Insurance The Company's life insurance businesses compete with national, regional and local insurance companies. Competition is based upon price, product design and services rendered to producers and policyholders. The insurance industry is extremely competitive, in both price and services, and no single insurer is dominant. The recent trend of consolidations in the industry has added to the competitive environment. Travelers Life and Annuity believes that its focus on market specialization and its diversified distribution network help it to 55 compete effectively. PFS competes in the market by focusing on supplying an integrated range of financial products to the middle-income market through a formalized needs-based sales program. In January 1995, the U.S. Supreme Court ruled that national banks may sell annuities. To date, the decision has not had a significant impact on the Company's annuity sales. Savings banks also compete directly in the sale of life insurance in Connecticut, Massachusetts and New York. Competition for the savings dollar arises from entities such as banks, investment advisors, mutual funds and other financial institutions. PFS Investments is registered as a broker-dealer with the Commission, and in all 50 states, the District of Columbia, Puerto Rico, the Virgin Islands and Guam. Tower Square Securities is registered as a broker-dealer with the Commission, and in all 50 states, Puerto Rico and the District of Columbia. Similarly, Copeland Equities, Inc., a subsidiary of Copeland, is registered as a broker-dealer with the Commission, in 49 states and the District of Columbia. Each is subject to extensive regulation by those agencies and the securities administrators of those jurisdictions, primarily for the benefits of its customers, including minimum capital and licensing requirements. PFS Investments faces competition not only from large financial services firms offering products and services that cross traditional business boundaries, but also from insurance companies, including other subsidiaries of the Company, offering life insurance products with investment features. Regulation State Regulation The Company's insurance subsidiaries are subject to regulation and supervision in the various states and jurisdictions in which they transact business. The extent of regulation varies but generally has its source in statutes that delegate regulatory, supervisory and administrative authority to a department of insurance of each state. The regulation, supervision and administration relate, among other things, to the standards of solvency that must be met and maintained, the licensing of insurers and their agents, the nature of and limitations on investments, premium rates, restrictions on the size of risks that may be insured under a single policy, reserves and provisions for unearned premiums, losses and other obligations, deposits of securities for the benefit of policyholders, approval of policy forms and the regulation of market conduct including underwriting and claims practices. In addition, many states have enacted variations of competitive rate-making laws which allow insurers to set certain premium rates for certain classes of insurance without having to obtain the prior approval of the state insurance department. State insurance departments also conduct periodic examinations of the affairs of insurance companies and require the filing of annual and other reports relating to the financial condition of companies and other matters. 56 At the present time, the Company's insurance subsidiaries are collectively licensed to transact insurance business in all states, the District of Columbia, Guam, Puerto Rico, and the U.S. Virgin Islands, as well as Canada, the United Kingdom and the Northern Mariana Islands. Although the Company is not regulated as an insurance company, it is the owner of the capital stock of its insurance subsidiaries and as such is subject to state insurance holding company statutes, as well as certain other laws, of each of the states of domicile of its insurance subsidiaries. All holding company statutes, as well as certain other laws, require disclosure and, in some instances, prior approval of material transactions between an insurance company and an affiliate. The holding company statutes, as well as certain other laws, also require, among other things, prior approval of an acquisition of control of a domestic insurer and the payment of extraordinary dividends or distributions. The Company's insurance subsidiaries are subject to various state statutory and regulatory restrictions in each company's state of domicile, which limit the amount of dividends or distributions by an insurance company to its stockholders. The ability of TIC and subsidiaries of TAP to pay dividends to the Company in the future will depend on their statutory surplus, future earnings and regulatory restrictions. A maximum of $507 million of statutory surplus is available in 1997 for dividends from TIC to its parent without prior approval of the Connecticut Insurance Department. Dividend payments to TAP from its insurance subsidiaries are limited to $647 million in 1997 without prior approval of the Connecticut Insurance Department. The Company's principal insurance subsidiaries are domiciled in Connecticut and Massachusetts. The insurance holding company law of Connecticut requires notice to, and approval by, the state insurance commissioner for the declaration or payment of any dividend, which together with other distributions made within the preceding twelve months, exceeds the greater of (i) 10% of the insurer's surplus or (ii) the insurer's net income for the twelve-month period ending the preceding December 31st, in each case determined in accordance with statutory accounting practices. Such declaration or payment is further limited by adjusted unassigned funds (surplus), as determined in accordance with statutory accounting practices. The insurance holding company laws of other states in which the Company's insurance subsidiaries are domiciled generally contain similar (although in certain instances somewhat more restrictive) limitations on the payment of dividends. Virtually all states require insurers licensed to do business in their state to bear a portion of the loss suffered by certain insureds as a result of the insolvency of other insurers. Depending upon state law, insurers can be assessed an amount that is generally equal to between 1% and 2% of premiums written for the relevant lines of insurance in that state each year to pay the claims of an insolvent insurer. Most of these payments are recoverable through premium rates, premium tax credits or policy surcharges. Significant increases in assessments could limit the ability of the Company's insurance subsidiaries to recover such assessments through tax credits. In addition, there have been some legislative efforts to limit 57 or repeal the tax offset provisions, which efforts, to date, have been generally unsuccessful. These assessments may increase or decrease in the future depending upon the rate of insolvencies of insurance companies. The Company also participates in FHCF, which is a state-mandated catastrophe reinsurance fund that provides reimbursement to insurers for a portion of their future catastrophic hurricane losses. FHCF is primarily funded by premiums from the insurance companies that write residential property business in Florida and, if insufficient, assessments on insurance companies that write other property and casualty insurance in Florida, excluding workers' compensation. FHCF's resources are limited to these contributions and to its borrowing capacity at the time of a significant catastrophe in Florida. The Company's insurance subsidiaries are also required to participate in various involuntary assigned risk pools, principally involving workers' compensation and automobile insurance, which provide various insurance coverages to individuals or other entities that otherwise are unable to purchase such coverage in the voluntary market. Participation in these pools in most states is generally in proportion to voluntary writings of related lines of business in that state. The underwriting results of these pools traditionally have been unprofitable, although the effect of their performance has been partially mitigated in certain lines of insurance by the states' allowance of increases in rates for business voluntarily written by pool participants in such states. Earned premiums related to such pools and assigned risks for the Company were $379 million, $315 million and $509 million in 1996, 1995 and 1994, respectively. The related underwriting losses for the Company were $39 million, $152 million and $300 million in 1996, 1995 and 1994, respectively. Proposed legislation and regulatory changes have been introduced in the states from time to time that would modify certain laws and regulations affecting the financial services industry, including the provisions governing relationships among insurance companies and agents, investment banks and commercial banks. The potential impact of such legislation on the Company's businesses cannot be predicted at this time. In addition to state insurance laws, the Company's insurance subsidiaries are also subject to general business and corporation laws, state securities laws, consumer protection laws, fair credit reporting acts and other laws. The insurance industry generally is exempt from federal antitrust laws because of the application of the McCarran-Ferguson Act. Insurance Regulations Concerning Change of Control Many state insurance regulatory laws intended primarily for the protection of policyholders contain provisions that require advance approval by state agencies of any change in control of an insurance company that is domiciled (or, in some cases, having such substantial business that it is deemed to be commercially domiciled) in that state. The Company owns, directly or indirectly, certain property and casualty insurance companies domiciled in the States of Connecticut, Florida, Georgia, Illinois, Indiana, Massachusetts, 58 Missouri, New Jersey and Texas and certain life insurance companies domiciled in Connecticut, Massachusetts and Georgia. "Control" is generally presumed to exist through the ownership of 10% or more of the voting securities of a domestic insurance company or of any company that controls a domestic insurance company. Any purchaser of shares of Common Stock representing 10% or more of the voting power of the Company will be presumed to have acquired control of the Company's domestic insurance subsidiaries unless, following application by such purchaser in each insurance subsidiary's state of domicile, the relevant Insurance Commissioner determines otherwise. In addition, many state insurance regulatory laws contain provisions that require prenotification to state agencies of a change in control of a nondomestic admitted insurance company in that state. While such prenotification statutes do not authorize the state agency to disapprove the change of control, such statutes do authorize issuance of a cease and desist order with respect to the nondomestic admitted insurer if certain conditions exist such as undue market concentration. Any future transactions that would constitute a change in control of the Company would generally require prior approval by the insurance departments of the states in which the Company's insurance subsidiaries are domiciled or commercially domiciled and may require preacquisition notification in those states that have adopted preacquisition notification provisions and in which such insurance subsidiaries are admitted to transact business. Such requirements may deter, delay or prevent certain transactions affecting the control of or the ownership of Common Stock, including transactions that could be advantageous to the stockholders of the Company. Insurance Regulatory Information System The NAIC has developed a set of financial relationships or "tests" called the Insurance Regulatory Information System ("IRIS") that were designed for early identification of companies that may require special attention by insurance regulatory authorities. These tests were developed primarily to assist state insurance departments in executing their statutory mandate to oversee the financial condition of insurance companies. Insurance companies submit data on an annual basis to the NAIC, which in turn analyzes the data using ratios covering twelve categories of financial data with defined "usual ranges" for each category. Falling outside the usual range of IRIS ratios is not considered a failing result; rather, unusual values are viewed as part of the regulatory early monitoring system. Furthermore, in some years, it may not be unusual for financially sound companies to have several ratios with results outside the usual ranges. An insurance company may fall out of the usual range for one or more ratios because of specific transactions that are in themselves immaterial. Generally, an insurance company will become subject to regulatory scrutiny if it falls outside the usual ranges of four or more of the ratios. In normal years, 15% of the companies included in the IRIS system are expected by the NAIC to be outside the usual range on four or more ratios. 59 In each of the last three years certain of the Company's subsidiaries have been outside of the usual range for certain IRIS ratios. In all such instances, the regulators have been satisfied upon follow-up that there is no solvency problem. It is possible that similar events could occur this year, and management believes that the resolution would be the same. No regulatory action has been taken by any state insurance department or the NAIC with respect to IRIS ratios of any of the Company's insurance subsidiaries for the three years ended December 31, 1996. For 1996, Travelers Indemnity did not have any IRIS ratios outside the usual range. However, both the two-year overall operating ratio and the two-year reserve development to surplus ratios were outside the usual range for Aetna Casualty and Standard Fire because of actions taken during 1996 and 1995 to strengthen reserves for environmental and asbestos-related claims. In addition, the change in writings ratio produced an unusual value for Standard Fire and the estimated current reserve deficiency to surplus ratio was outside the usual range for Aetna C&S of America, both as a result of management's decision in 1995 to combine its two intercompany pooling arrangements (one for Personal Lines and one for Commercial Lines) into one pool. If these two ratios were recalculated to have all items reflect the new agreement, the ratios would not produce unusual values. Concurrent with the change in the intercompany pooling arrangements, capital was reallocated among Aetna P&C insurers, which resulted in an unusual value in the change in surplus ratio for Standard Fire. Risk-Based Capital (RBC) Requirements In order to enhance the regulation of insurer solvency, the NAIC has adopted a formula and model law to implement RBC requirements for life insurance companies and most property and casualty insurance companies, which is designed to assess minimum capital requirements and to raise the level of protection that statutory surplus provides for policyholder obligations. The RBC requirements are to be used as early warning tools by the NAIC and states to identify companies that merit further regulatory action. For these purposes, an insurer's surplus is measured in relation to its specific asset and liability profiles. A company's risk-based capital is calculated by applying factors to various asset, premium and reserve items, where the factor is higher for those items with greater underlying risk and lower for less risky items. The RBC formula for property-casualty insurance companies measures four major areas of risk facing property and casualty insurers: (i) underwriting, which encompasses the risk of adverse loss developments and inadequate pricing; (ii) declines in asset values arising from credit risk; (iii) declines in asset values arising from investment risks; and (iv) off-balance sheet risk arising from adverse experience from non-controlled assets, guarantees for affiliates or other contingent liabilities and reserve and premium growth. Pursuant to the law, insurers having less statutory surplus than that required by the RBC calculation will be subject to varying degrees of regulatory action, depending on the level of capital inadequacy. 60 The RBC formula for life insurance companies calculates baseline life risk-based capital as a mathematical combination of amounts for the following four categories of risk: (i) asset risk (i.e., the risk of asset default); (ii) insurance risk (i.e., the risk of adverse mortality and morbidity experience); (iii) interest rate risk (i.e., the risk of loss due to changes in interest rates); and (iv) business risk (i.e., normal business and management risk). The RBC law provides for four levels of regulatory action. The extent of regulatory intervention and action increases as the level of surplus to RBC falls. The first level, the Company Action Level (as defined by the NAIC), requires an insurer to submit a plan of corrective actions to the regulator if surplus falls below 200% of the RBC amount. The Regulatory Action Level (as defined by the NAIC) requires an insurer to submit a plan containing corrective actions and permits the relevant Insurance Commissioner to perform an examination or other analysis and issue a corrective order if surplus falls below 150% of the RBC amount. The Authorized Control Level (as defined by the NAIC) allows the relevant Insurance Commissioner to rehabilitate or liquidate an insurer in addition to the aforementioned actions if surplus falls below 100% of the RBC amount. The fourth action level is the Mandatory Control Level (as defined by the NAIC) which requires the relevant Insurance Commissioner to rehabilitate or liquidate the insurer if surplus falls below 70% of the RBC amount. Based on the foregoing formula, at December 31, 1996, the RBC ratios of the Company's insurance subsidiaries were in excess of levels that would require company or regulatory action. The formulas have not been designed to differentiate among adequately capitalized companies which operate with higher levels of capital. Therefore, it is inappropriate and ineffective to use the formulas to rate or to rank such companies. At December 31, 1996, all of the Company's life and property-casualty insurance companies had adjusted capital in excess of amounts requiring regulatory action at any of the four levels. Federal Regulation Although the federal government does not directly regulate the business of insurance, other than flood insurance, federal initiatives often have an impact on the insurance industry. Legislation has been introduced in Congress during the past several sessions that, if enacted, would result in substantially greater federal regulation of the insurance business. Current and proposed federal measures that may affect the property and casualty industry may include possible changes to CERCLA and the tax laws governing property and casualty insurance companies, proposed limits to product liability lawsuits and other tort reform proposals. In addition, proposed legislation has been introduced in Congress from time to time that would modify certain laws and regulations affecting the financial services industry, including the provisions regarding affiliations among insurance companies, investment banks and commercial banks. 61 It is not possible to predict whether such proposed legislation will be enacted, what form such legislation might take when enacted, or the potential effects of such legislation on the Company and its competitors. Certain variable life insurance and individual and group variable annuities, as well as modified guaranteed annuities, and their related separate accounts are subject to regulation by the Commission. Investments This section discusses the investment portfolios of the businesses described in the Company's insurance services segments. Insurance company investments must comply with applicable laws and regulations which prescribe the kind, quality and concentration of investments. In general, these laws and regulations permit investments, within specified limits and subject to certain qualifications, in federal, state and municipal obligations, corporate bonds, preferred and common equity securities, real estate mortgages and real estate. At December 31, 1996, the investment holdings of the companies included in the insurance services segments were composed primarily of fixed maturities. At December 31, 1996, approximately 96.1% in total dollar amount of the fixed maturities portfolios of such companies had investment grade ratings. The remaining investments are principally mortgage loans and real estate, discussed below, policy loans and other investments. For additional information regarding these investment portfolios, see Note 5 of Notes to Consolidated Financial Statements and the discussion of Asset Quality in the Property & Casualty Insurance Services Segment discussion in Item 7 of this Form 10-K, "Management's Discussion and Analysis of Financial Condition and Results of Operations." Consistent with the nature of related contract obligations, the invested assets attributable to group insurance and individual life, accident and health and financial services are primarily long-term fixed income investments such as corporate debt securities, mortgage and asset-backed securities and mortgage loans. A small portion of the invested assets related to these operations is in preferred and common stocks and real estate equity investments. The property-casualty fixed maturities portfolios (principally bonds) are shifted from time to time to respond to the changing economic outlook, insurance underwriting results and the resultant changes in the federal income tax position of the Company and its subsidiaries. Cash available for investment is principally derived from operating activities and investment income. In addition, cash becomes available for investment from prepayment, maturity and sale of investments. In recent years, the underperforming mortgage loan and real estate portfolios have been significantly reduced. See "-- Mortgage Loans and Real Estate Held for Sale." Different investment policies have been developed for various lines of 62 business based on the product requirements, the type and term of the liabilities associated with these products, regulatory requirements and tax treatment of the businesses in which each company is engaged. Mortgage Loans and Real Estate Held for Sale At December 31, 1996, the mortgage loan and real estate held for sale portfolios of the businesses included in the Company's insurance services segments consisted of approximately $3.8 billion and $695 million, respectively. Mortgage loans and real estate held for sale at December 31, 1996 include $811 million and $136 million, respectively, from the Acquisition. At December 31, 1995 and 1994, the mortgage loan portfolio consisted of approximately $4.0 billion and $5.4 billion, respectively, and the real estate held for sale portfolio consisted of approximately $321 million and $418 million, respectively. The Company has continued a program of disposing of its real estate investments and expediting the payoff of certain mortgage loans and reinvesting the proceeds to obtain current market yields. See Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" for additional information. The Company's accelerated liquidation strategy for foreclosed real estate and certain mortgage loans has mitigated the negative impact that these underperforming portfolios have had on the Company's investment income and the Company believes that continuation of this strategy will have similar mitigating effects. The Company expects that approximately half of maturing commercial mortgage loans in its portfolio will be refinanced, restructured or foreclosed. Restructured loans are defined as loans the terms of which have been changed from the original contract generally by lowering the pay rate of interest in the early years after modification. Loans which have pay rates of interest after modification that are equal to or above market rates are not included in the underperforming mortgage loan inventory. At December 31, 1996, 1995 and 1994, approximately $91 million, $252 million and $511 million, or 2%, 6% and 9%, respectively, of the combined mortgage loan portfolio of the Company was classified as underperforming. Underperforming mortgage loans include delinquent loans, loans in the process of foreclosure and loans modified at interest rates below market. For information regarding the principal balance of mortgage loans at December 31, 1996 by contractual maturity, see Note 5 of Notes to Consolidated Financial Statements. Actual maturities will differ from contractual maturities because borrowers may have the right to prepay loans with or without prepayment premiums. Unscheduled payments and sales of mortgage loans were $1.0 billion in 1996, $1.0 billion in 1995 and $1.3 billion in 1994. The average remaining life of these mortgages is six years. Real estate management evaluates the portfolio on an ongoing basis, assessing the probabilities of loss with respect to a comprehensive series of projections, including a host of 63 variables relating to the borrower, the property, the term of the loan, the tenant composition, rental rates, other supply and demand factors, and overall economic conditions. The following table summarizes by property type the mortgage loan portfolio and real estate held for sale included in the investment portfolios of the Company as of December 31, 1996, 1995 and 1994. For information summarizing the geographic distribution of the mortgage loan portfolio and real estate assets, see Note 5 of Notes to Consolidated Financial Statements. (in millions) Property Type: Mortgage Loans Real Estate - -------------- -------------- ----------- 1996 1995 1994 1996 1995 1994 ------ ------ ------ ------ ------ ------ Commercial: Office $1,698 $1,551 $2,141 $ 190 $ 177 $ 224 Apartment 467 654 1,112 68 8 9 Hotel 244 594 642 299 47 79 Retail 518 449 623 60 42 46 Industrial 158 181 228 31 9 13 Other 41 45 108 34 26 33 ------ ------ ------ ------ ------ ------ Total commercial 3,126 3,474 4,854 682 309 404 Agricultural 686 574 562 13 12 14 ------ ------ ------ ------ ------ ------ Total $3,812 $4,048 $5,416 $ 695 $ 321 $ 418 ====== ====== ====== ====== ====== ====== Derivatives See the section entitled "End User Activity" in Note 19 of Notes to Consolidated Financial Statements for a discussion of the policies and transactions related to derivatives of the Company. CORPORATE AND OTHER OPERATIONS In addition to its four business segments, the Company's Corporate and Other segment consists of unallocated expenses and earnings primarily related to interest, corporate administration, and certain corporate investments. In 1995 and through the date of sale in 1996, this segment also includes the Company's interest in RCM Capital Management, a California Limited Partnership ("RCM"). In June 1996, the Company sold 100% of its interest in RCM, which provides investment management services, to Dresdner Bank AG. Assets under management by RCM were $26.2 billion at December 31, 1995 and $22.5 billion at December 31, 1994. 64 In October 1995, the Company completed the sale to United HealthCare Corporation of its 48.25% interest in The MetraHealth Companies, Inc. ("MetraHealth"). MetraHealth was formed in January 1995 as a joint venture of the group medical insurance businesses of the Company and Metropolitan Life Insurance Company ("MetLife"). The Company received $831 million in cash from the sale of its interest in MetraHealth. During 1996, the Company received a contingency payment (based on MetraHealth's 1995 results) and recognized a gain in 1996 of $31 million after tax ($48 million pre-tax). In January 1995, the Company completed the sale of its group life and related businesses to MetLife. The purchase price for the group life business was $350 million. In connection with the sale, the Company agreed to cede to MetLife 100% of its risks in the businesses sold on an indemnity reinsurance basis, effective January 1, 1995. All of the businesses sold to MetLife or contributed to MetraHealth were included in the Company's Managed Care and Employee Benefits Operations in 1994. These operations have been accounted for as a discontinued operation. In 1995 and 1996 the Company's discontinued operations reflect the medical insurance business not yet transferred, the gains from the sales of these businesses and, in 1995, its equity interest in the earnings of MetraHealth. See Note 3 of Notes to Consolidated Financial Statements. OTHER INFORMATION General Business Factors In the judgment of the Company, no material part of the business of the Company and its subsidiaries is dependent upon a single customer or group of customers, the loss of any one of which would have a materially adverse effect on the Company, and no one customer or group of affiliated customers accounts for as much as 10% of the Company's consolidated revenues. At December 31, 1996, the Company had approximately 56,200 full-time and 2,700 part-time employees. Source of Funds For a discussion of the Company's sources of funds and maturities of the long-term debt of the Company's subsidiaries, see Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources," and Note 10 of Notes to Consolidated Financial Statements. 65 Taxation For a discussion of tax matters affecting the Company and its operations, see Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," and Notes 1 and 13 of Notes to Consolidated Financial Statements. Financial Information about Industry Segments For financial information regarding industry segments of the Company, see Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," and Note 4 of Notes to Consolidated Financial Statements. Executive Officers of the Company The current executive officers of the Company are indicated below. Periods of offices held include offices with the Company's predecessor, CCC, and unless stated otherwise all offices listed below are with the Company. Ages are given as of March 5, 1997. Officer Name Age Positions Since ---- --- --------- ------- Sanford I. Weill 63 Chairman of the Board 1986 and Chief Executive Officer James Dimon 40 President and Chief 1986 Operating Officer of the Company; Chairman and Chief Executive Officer of SB Holdings and SBI Jeffrey B. Lane 54 Vice Chairman 1996 Robert I. Lipp 58 Vice Chairman of the Company; 1986 Chairman of the Board, President and Chief Executive Officer of TAP Jon C. Madonna 53 Vice Chairman of the Company; 1997 Vice Chairman of TAP Joseph J. Plumeri II 53 Vice Chairman of the Company; 1994 Chief Executive Officer of PFS Michael A. Carpenter 49 Executive Vice President 1995 of the Company; Chairman, President and Chief Executive Officer of TIC and TLAC Irwin Ettinger 58 Executive Vice President 1987 and Chief Accounting Officer Charles O. Prince, III 47 Executive Vice President, 1986 General Counsel and Secretary Steven D. Black 44 Vice Chairman and Chief 1996* Operating Officer of SB Holdings and SBI 66 Officer Name Age Positions Since ---- --- --------- ----- Charles J. Clarke 61 Chairman and Chief Executive 1995* Officer-Commercial Lines of TAP Donald R. Cooper 56 Chief Actuary 1995 Peter M. Dawkins 58 Chairman, President and 1992* Chief Executive Officer of Travelers Group Diversified Distribution Services, Inc. Jay S. Fishman 44 Senior Vice President of the 1991 Company; Vice Chairman of TAP and President and Chief Operating Officer of TAP's Commercial Lines Marjorie Magner 47 President and Chief Operating 1996* Officer of CCC Heidi G. Miller 43 Senior Vice President and 1992 Chief Financial Officer Marc P. Weill 40 Senior Vice President and 1991 Chief Investment Officer Robert B. Willumstad 51 Chairman and Chief Executive 1993* Officer of CCC - ---------------- * Indicates date that such officer became a member of the Company's Planning Group. Sanford I. Weill has been a director of the Company since 1986. He has been Chairman of the Board and Chief Executive Officer of the Company and its predecessor, CCC, since 1986; he was also its President from 1986 until 1991. He was President of American Express Company from 1983 to 1985; Chairman of the Board and Chief Executive Officer of American Express Insurance Services, Inc. from 1984 to 1985; Chairman of the Board and Chief Executive Officer, or a principal executive officer, of Shearson Lehman Brothers Inc. from 1965 to 1984; Chairman of the Board of Shearson Lehman Brothers Holdings Inc. from 1984 to 1985; and a founding partner of Shearson's predecessor partnership from 1960 to 1965. Mr. Weill has been a director of TAP since 1996. Mr. Weill's son, Marc P. Weill, is a Senior Vice President and an executive officer of the Company. Mr. Weill is Chairman of the Board of Trustees of Carnegie Hall, and a director of the Baltimore Symphony Orchestra. Mr. Weill is a member of the Board of Governors of New York Hospital and is Chairman of the Board of Overseers of Cornell University Medical College. He is on the Board of Overseers of Memorial Sloan-Kettering Cancer Center. He is a member of Cornell University's Johnson Graduate School of Management Advisory Board and a Board of Trustees Fellow. Mr. Weill is Chairman of the National Academy Foundation, whose member programs include the Academy of Finance, the Academy of Travel and Tourism and the Academy of Public Service. 67 Mr. Dimon has been a director of the Company since September 1991. He is President and Chief Operating Officer of the Company. He is also Chairman of the Board, Chief Executive Officer and a member of the executive committee of SBI. Mr. Dimon has been a director of TAP since 1996. From May 1988 to June 1995, he was Chief Financial Officer of the Company. From May 1988 to September 1991, he was Executive Vice President of the Company. Mr. Dimon was Chief Operating Officer of SBI until January 1996 and was Senior Executive Vice President and Chief Administrative Officer of SBI from 1990 to 1991. He is also Chief Executive Officer and Chairman of the Board of SB Holdings. From March 1994 to January 1996, he was Chief Operating Officer of SB Holdings. From 1986 to 1988, Mr. Dimon was Senior Vice President and Chief Financial Officer of CCC, the Company's predecessor. From 1982 to 1985, he was a Vice President of American Express Company and Assistant to the President, Sanford I. Weill. Mr. Dimon is a trustee of New York University Medical Center and a director of the Center on Addiction and Substance Abuse and the National Association of Securities Dealers, Inc. Mr. Lane has been a Vice Chairman of the Company since January 1996. He has served as a Director of SBI from January 1991 through March 1996 and as a Director of SB Holdings from November 1993. Mr. Lane served as Vice Chairman of SBI from January 1991 through January 1996 and as Vice Chairman of SB Holdings from November 1993 through January 1996. He joined the Company in 1990. Prior to joining the Company in 1990, Mr. Lane was President and Chief Operating Officer of Shearson Lehman Brothers Inc. Mr. Lipp has been a director of the Company since 1991 and is a Vice Chairman of the Company. Mr. Lipp has been Chairman of the Board, Chief Executive Officer and President of TAP since January 1996. Mr. Lipp has been Chairman of the Board and Chief Executive Officer of The Travelers Insurance Group Inc. since December 1993. From 1991 to 1993, he was Chairman and Chief Executive Officer of CCC. From April 1986 through September 1991, he was an Executive Vice President of the Company and its corporate predecessor. Prior to joining the Company in 1986, he was a President and a director of Chemical New York Corporation and Chemical Bank where he held senior executive positions for more than five years prior thereto. Mr. Lipp is a director of The New York City Ballet, Wadsworth Atheneum and the Massachusetts Museum of Contemporary Art and Chairman of Dance-On Inc., a private foundation. Mr. Madonna joined the Company in February 1997 as Vice Chairman, and also serves as Vice Chairman of TAP. Prior to joining the Company, Mr. Madonna was Chairman of KPMG International since October 1995. From 1990 to 1996, he was Chairman and Chief Executive Officer of KPMG Peat Marwick LLP. Mr. Plumeri has been a Vice Chairman of the Company since July 1994 and has been Chairman and Chief Executive Officer of PFS since April 1996. He joined the Company in August 1993, serving as President of SBI from that time through July 1994. Mr. Plumeri had worked for Shearson Lehman Brothers Inc. or its predecessors for over 25 years, in various 68 positions of increasing responsibility, until SBI acquired certain businesses from Shearson Lehman Brothers Holdings Inc. ("SLB"). At that time, Mr. Plumeri was a Managing Partner of SLB, and from 1990 until September 1992 he served as President of SLB's Private Client Group. Mr. Carpenter has been an Executive Vice President of the Company since July 1995 and also serves as Chairman, Chief Executive Officer and President of TIC and TLAC. From January 1989 to June 1994, Mr. Carpenter was Chairman of the Board, President and Chief Executive Officer of Kidder, Peabody Group, Inc., an investment banking and brokerage company that was a wholly owned subsidiary of General Electric Company. Prior thereto, he served as Executive Vice President of General Electric Capital Corporation and Vice President of General Electric Company. Mr. Ettinger has been an Executive Vice President of the Company since January 1996. Prior to joining CCC as Senior Vice President in October 1987, he was Partner in charge of the Tax Department of Arthur Young and Company's New York offices. Mr. Prince has been General Counsel of the Company or its predecessor since 1983, and served as a Senior Vice President from 1986 until January 1996, when he became an Executive Vice President. Mr. Black has been Vice Chairman of SB Holdings since November 1993 and Vice Chairman of SBI since July 1993. He was elected Chief Operating Officer of those companies in January 1996. He is also a member of the executive committee and a director of each of SB Holdings and SBI. Mr. Black has served as the head of Smith Barney's Capital Markets Division from 1991 to January 1996, and has served in several positions at Smith Barney since 1974. Mr. Clarke has been Chairman and Chief Executive Officer--Commercial Lines of TAP since January 1996, and Chairman of the Company's Property-Casualty Commercial Lines since 1990. Mr. Clarke has served in various positions at Travelers P&C since 1958. Mr. Cooper has been Chief Actuary of the Company since March 1995 and has been Vice Chairman of Travelers Insurance Holdings Inc. since October 1990. He also serves as Chairman of the Board of both AHL and Resource Deployment, Inc., subsidiaries of the Company. Mr. Dawkins has been Chairman, President and Chief Executive Officer of Travelers Group Diversified Distribution Services, Inc. since August 1996. In addition, he has been a director of Travelers Group Exchange, Inc. since September 1996 and became its Chief Executive Officer in January 1997. Mr. Dawkins joined the Company in 1991 as Chairman and Chief Executive Officer of Primerica Financial Services, Inc., and served in that capacity until August 1996. 69 Mr. Fishman has been a Senior Vice President of the Company since October 1991. In January 1996, he became Vice Chairman and Chief Administrative Officer of TAP and since October 1996 he has been President and Chief Operating Officer of TAP's Commercial Lines. He has also served as Vice Chairman of TIGI since September 1995 and as Chief Financial Officer of that company since December 1993. Mr. Fishman was Treasurer of the Company from October 1991 to December 1993. Prior thereto, he held various other positions with the Company and its subsidiaries since 1989, when he joined the Company from Shearson Lehman Brothers Inc., where he was Senior Vice President of Merchant Banking. Ms. Magner has been President of CCC since June 1993 and became its Chief Operating Officer in December 1995. Ms. Magner joined CCC in May 1987, and served as Chief Administrative Officer from 1993 to 1996. From 1991 to 1993, she was Executive Vice President, Marketing and Operations of CCC. Ms. Miller has been Chief Financial Officer and Senior Vice President of the Company since June 1995. She also serves as Chief Credit Officer of SBI, a position she has held since September 1994. Ms. Miller joined the Company in February 1992 as a Vice President. Prior thereto, she was a Managing Director in the Emerging Markets Division of Chemical Bank, a position she held from 1987 to 1992. Marc P. Weill has been a Senior Vice President and Chief Investment Officer of the Company since January 1992. He also serves as a director, Chairman of the Board and President of Travelers Asset Management International Corporation, a registered investment advisor. Mr. Weill has held various other positions with the Company and its subsidiaries since January 1991. He is the son of Sanford I. Weill. Mr. Willumstad has been Chairman and Chief Executive Officer of CCC since June 1993 and has been with that company since 1987. From 1989 until assuming his current position, he served as President of the Consumer Finance Services unit of the Company. Mr. Willumstad is a member of the U.S. Region Board of Directors of MasterCard International. GLOSSARY OF INSURANCE TERMS Accident year ................ The annual accounting period in which loss events occurred, regardless of when the losses are actually reported, booked or paid. Adjusted unassigned surplus... Unassigned surplus as of the most recent statutory annual report reduced by twenty-five percent of that year's unrealized appreciation in value or revaluation of assets or unrealized profits on investments, as defined in such report. 70 Admitted insurer.............. A company licensed to transact insurance business within a state. Alternative market............ The segment of the insurance market which has developed in response to volatility in cost and availability of traditional commercial insurance coverage and consists of various risk financing mechanisms, including self insurance, captive insurance companies, risk retention groups and residual market business. Annuity....................... A contract that pays a periodic income benefit for the life of a person (the annuitant), the lives of two or more persons or for a specified period of time. Assigned risk pools........... Reinsurance pools which cover risks for those unable to purchase insurance in the voluntary market because the risk is too great or rate inadequacy has reduced the supply of insurance. The costs of the risks associated with these pools are charged back to insurance carriers in proportion to their direct writings. Assumed reinsurance........... Insurance liabilities acquired from a ceding company. Assumption reinsurance........ A transaction whereby the ceding company transfers its entire obligation under the policy to the reinsurer, who becomes directly liable to the policyholder in all respects, including collecting premiums and paying benefits. See "Reinsurance." Attachment point.............. The amount of losses above which excess of loss reinsurance becomes operative. Broker........................ One who negotiates contracts of insurance or reinsurance on behalf of an insured party, receiving a commission from the insurer or reinsurer for placement and other services rendered. Capacity...................... The percentage of surplus, or the dollar amount of exposure, that an insurer or reinsurer is willing to place at risk. Capacity may apply to a single risk, a program, a line of business or an entire book of business. Capacity may be constrained by legal restrictions, corporate restrictions or indirect restrictions. Captive company............... An insurance company formed to insure the risks of its parent entity or entities. 71 Case reserves................. Loss reserves, established with respect to specific, individual reported claims. Casualty insurance............ Insurance which is primarily concerned with the losses caused by injuries to third persons (i.e., not the insured) and the legal liability imposed on the insured resulting therefrom. It includes, but is not limited to, employers' liability, workers' compensation, public liability, automobile liability, personal liability and aviation liability insurance. It excludes certain types of losses that by law or custom are considered as being exclusively within the scope of other types of insurance, such as fire or marine. Catastrophe................... A severe loss, usually involving risks such as fire, earthquake, windstorm, explosion and other similar events. Catastrophe loss.............. Loss and directly identified loss adjustment expenses from catastrophes. Catastrophe reinsurance....... A form of excess of loss property reinsurance which, subject to a specified limit, indemnifies the ceding company for the amount of loss in excess of a specified retention with respect to an accumulation of losses resulting from a catastrophic event. The actual reinsurance document is called a "catastrophe cover." Cede; ceding company.......... When an insurer reinsures its liability with another insurer (a "cession"), it "cedes" business and is referred to as the "ceding company." Ceded reinsurance............. Risks transferred to another company as reinsurance. See "Reinsurance." Claim......................... Request by an insured for indemnification by an insurance company for loss incurred from an insured peril. Claim adjustment expense...... See "Loss adjustment expense." Claims and claim adjustment expense..................... See "Loss and loss adjustment expenses." Claims and claim adjustment expense reserves............ See "Loss reserves." 72 Clash cover................... An excess of loss agreement with a retention higher than the limits on any one reinsured policy. The agreement is thus only exposed to loss when two or more policies (perhaps from different lines of business) are involved in a common occurrence in an amount greater than the clash cover retention. Also known as contingency cover. Combined ratio................ The sum of the loss and LAE ratio, the underwriting expense ratio and, where applicable, the ratio of dividends to policyholders to net premiums earned. A combined ratio under 100% generally indicates an underwriting profit. A combined ratio over 100% generally indicates an underwriting loss. Commercial lines.............. The various kinds of insurance which are written for businesses. Commutation agreement......... An agreement between a reinsurer and a ceding company whereby the reinsurer pays an agreed upon amount in exchange for a complete discharge of all obligations, including future obligations, between the parties for reinsurance losses incurred. Contractholder funds.......... Receipts from the issuance of universal life, pension investment and certain individual annuity contracts. Such receipts are considered deposits on investment contracts that do not have substantial mortality or morbidity risks. Deductible.................... The amount of loss that an insured retains. Deferred acquisition costs.... Commissions and premium taxes and, for certain life insurance lines, other origination costs, which vary with and are primarily related to the production of new business, are deferred and amortized to achieve a matching of revenues and expenses when reported in financial statements prepared in accordance with GAAP. Defined contribution plans.... Type of pension plan in which the contribution rate is certain but the retirement benefit is variable. Deposits and other considerations.............. Consist of cash deposits and charges for mortality risk and expenses associated with universal life insurance, annuities and group pensions. 73 Direct written premiums....... The amounts charged by a primary insurer to insureds in exchange for coverages provided in accordance with the terms of an insurance contract. Earned premiums or premiums earned...................... That portion of property-liability premiums written that applies to the expired portion of the policy term. Earned premiums are recognized as revenues under both SAP and GAAP. Excess liability.............. Additional casualty coverage above the first layer. Excess loss coverage.......... Coverage which indemnifies the person for that portion of the loss (arising out of a loss occurrence) which is in excess of the deductible. Excess of loss reinsurance.... Reinsurance that indemnifies the reinsured against all or a specified portion of losses under reinsured policies in excess of a specified dollar amount or "retention." Expense ratio................. See "Underwriting expense ratio." Extra contractual obligations losses...................... Losses incurred by an insurer, beyond those that would have been incurred as specified in the insurance agreement with an insured, due to monetary awards required by a court of law against the insurer for its negligence to or bad faith in dealing with its insured. Facultative reinsurance....... The reinsurance of all or a portion of the insurance provided by a single policy. Each policy reinsured is separately negotiated. Fidelity and surety programs.. Insurance which guarantees performance of an obligation or indemnifies for loss due to embezzlement or wrongful abstraction of money, securities or other property. Fiduciary accounts............ Accounts held on behalf of others. General account............... All an insurer's assets other than those allocated to separate accounts. Guaranteed cost insurance..... Premium charged on a prospective basis which may be fixed or adjustable on a specified rating basis but never on the basis of loss experience in the period of coverage. 74 Guaranteed cost products...... An insurance policy where the premiums charged will not be adjusted for actual loss experience during the covered period. Guaranteed investment contracts (GICs)............ Group contracts sold to pension plans, profit sharing plans and funding agreements that guarantee a stated interest rate for a specified period of time. Guaranty fund................. State-regulated mechanism which is financed by assessing insurers doing business in those states. Should insolvencies occur, these funds are available to meet some or all of the insolvent insurer's obligations to policyholders. Incurred but not reported ("IBNR") reserves........... Reserves for estimated losses and LAE which have been incurred but not yet reported to the insurer. Indemnity reinsurance......... A transaction whereby the reinsurer agrees to indemnify the ceding company against all or part of the loss that the latter may sustain under the policies it issued that are being reinsured. The ceding company remains primarily liable as the direct insurer on all risks ceded. See "Reinsurance." Inland marine................. A broad type of insurance generally covering articles that may be transported from one place to another, as well as bridges, tunnels and other instrumentalities of transportation. It includes goods in transit (generally other than transoceanic) and may include policies for movable objects such as personal effects, personal property, jewelry, furs, fine art and others. Insurance..................... Mechanism for contractually shifting burdens of a number of risks by pooling them. Involuntary business (alternative market)........ Risks that are not insurable in the voluntary market due to either the level of risk or pricing. Alternative markets are largest for lines in which state governments or other agencies mandate coverage such as workers' compensation. Generally states provide residual market plans that are designed to allocate the underwriting experience for these coverages in proportion to a given carrier's market share. 75 IRIS ratios................... Financial ratios calculated by the NAIC to assist state insurance departments in monitoring the financial condition of insurance companies. Large deductible policy...................... An insurance policy where the customer assumes at least $25,000 or more of each loss. Life contingencies............ Contingencies affecting the duration of life of an individual or a group of individuals. Long-term care................ Coverage for extended stays in a nursing home or home health services. Loss.......................... An occurrence that is the basis for submission and/or payment of a claim. Losses may be covered, limited or excluded from coverage, depending on the terms of the policy. Loss adjustment expense ("LAE")..................... The expenses of settling claims, including legal and other fees and the portion of general expenses allocated to claim settlement costs. Loss and LAE ratio............ For SAP it is the ratio of incurred losses and loss adjustment expenses to net premiums earned. For GAAP it is the ratio of incurred losses and loss adjustment expenses to net premiums earned plus fee income. Loss ratios................... See "Combined ratio." Loss reserves................. Liabilities established by insurers and reinsurers to reflect the estimated cost of claims incurred that the insurer or reinsurer will ultimately be required to pay in respect of insurance or reinsurance it has written. Reserves are established for losses and for LAE, and consist of case reserves and IBNR reserves. Losses and loss adjustment expenses.................... The sum of losses incurred and loss adjustment expenses. Losses incurred............... The total losses sustained by an insurance company under a policy or policies, whether paid or unpaid. Incurred losses includes a provision for IBNR. 76 Morbidity..................... The rate at which people become diseased, mentally or physically, or physically impaired. Mortality..................... The rate at which people die. Multi-peril policies.......... Refers to policies which cover both property and third party liability exposures. National Association of Insurance Commissioners ("NAIC").................... An organization of the insurance commissioners or directors of all 50 states and the District of Columbia organized to promote consistency of regulatory practice and statutory accounting standards throughout the United States. Net written premiums.......... Direct written premiums plus assumed reinsurance less premiums ceded to reinsurers. Non-admitted coverage......... Insurance coverage written in a given state by an insurer not licensed in that state. Novation...................... A transaction in which the original direct insurer's obligations are completely extinguished, resulting in no further exposure to loss arising on the business novated. Personal lines................ Types of insurance written for individuals or families, rather than for businesses. Policy loan................... A loan made by an insurance company to a policyholder on the security of the cash value of the policy. Policy loans offset benefits payable to policyholders. Pool.......................... An organization of insurers or reinsurers through which particular types of risks are underwritten with premiums, losses and expenses being shared in agreed percentages. Premium equivalents........... Premium equivalents represent estimates of premiums that customers would have been charged under a fully insured arrangement, based on expected losses associated with non-risk-bearing components of each account, as determined in the pricing process. Premium equivalents are indicative of the volume of business handled by an insurer in servicing relationships. Premium equivalents do not represent actual premium revenues. 77 Premiums...................... The amount charged during the year on policies and contracts issued, renewed or reinsured by an insurance company. Producer...................... Contractual entity which directs insureds to the insurer for coverage. See "Broker." Property insurance............ Insurance that provides coverage to a person with an insurable interest in tangible property for that person's property loss, damage or loss of use. Quota share reinsurance....... Reinsurance wherein the insurer cedes an agreed fixed percentage of liabilities, premiums and losses for each policy covered on a pro rata basis. Rate of renewal/retention ratio....................... Current period renewal accounts or policies as a percentage of expired accounts or policies. Rates......................... Amounts charged per unit of insurance. Reinsurance................... The practice whereby one insurer, called the reinsurer, in consideration of a premium paid to such insurer, agrees to indemnify another insurer, called the ceding company, for part or all of the liability assumed by the ceding company under one or more policies or contracts of insurance which it has issued. Reinsurance agreement......... A contract specifying the terms of a reinsurance transaction. Reinsurance pools and associations................ Mechanisms established to aggregate insurance, and then distribute results to participants in the mechanism. The pool or association performs rating, loss adjustment and engineering services for certain exposures. In some cases, they are established to absorb business that will not be written voluntarily by insurers. Residual market (involuntary business)................... Insurance market which provides coverage for risks unable to purchase insurance in the voluntary market either because the risk is too great or rate inadequacy has reduced the supply of insurance. Residual markets are frequently created by state legislation either because of lack of available coverage such as property coverage in a windstorm prone area or protection of the accident victim as in the case of workers' 78 compensation. The costs of the residual market are usually charged back to the direct insurance carriers in proportion to the carriers' voluntary market shares for the type of coverage involved. Retention..................... The amount of exposure an insurance company retains on any one risk or group of risks. Retrospective premiums........ Premiums related to retrospectively rated policies. Retrospective rating.......... A plan or method which permits adjustment of the final premium or commission on the basis of actual loss experience, subject to certain minimum and maximum limits. Risk-based capital ("RBC").... A measure adopted by the NAIC for assessing the minimum statutory capital and surplus requirements of insurers. Risk retention................ The amount or portion of a risk an insurer retains for its own account after ceded reinsurance. Losses above the stated retention level are collectible from the reinsurer. The retention level may be stated as a percentage or dollar amount. Salvage....................... The amount of money an insurer recovers through the sale of property transferred to the insurer as a result of a loss payment. Second injury fund............ The employer of an injured, impaired worker is responsible only for the workers' compensation benefit for the most recent injury; the second injury fund would cover the cost of any additional benefits for aggravation of a prior condition. The cost is shared by the insurance industry, funded through assessments to insurance companies based on either premiums or losses. Self-insured retentions....... That portion of the risk retained by a person for its own account. Separate accounts............. Funds for which investment income and investment gains and losses accrue directly to, and investment risk is borne by, the contractholders. The assets of these separate accounts are legally segregated and not subject to claims that arise out of any other business of the insurance company. 79 Servicing carrier............. An insurance company that provides, for a fee, various services including policy issuance, claims adjusting and customer service for insureds in a reinsurance pool. Standard policy forms......... Self-contained pre-printed policy language used when a large number of insureds face similar loss exposures. Statutory accounting practices ("SAP")..................... The rules and procedures prescribed or permitted by United States state insurance regulatory authorities for recording transactions and preparing financial statements. Statutory accounting practices generally reflect a modified going concern basis of accounting. Statutory surplus............. As determined under SAP, the amount remaining after all liabilities, including loss reserves, are subtracted from all admitted assets. Admitted assets are assets of an insurer prescribed or permitted by a state to be recognized on the statutory balance sheet. Statutory surplus is also referred to as "surplus" or "surplus as regards policyholders" for statutory accounting purposes. Structured settlements........ Periodic payments to an injured person or survivor for a determined number of years or for life, typically in settlement of a claim under a liability policy, usually funded through the purchase of an annuity. Subrogation................... A principle of law incorporated in insurance policies, which enables an insurance company, after paying a loss to its insured, to recover the amount of the loss from another who is legally liable for it. Surrender value............... The amount of money, usually the legal reserve under the policy, less sometimes a surrender charge, which an insurance company will pay to a policyholder who cancels a policy. This value may be used as collateral for a loan. Third party liability......... A liability owed to a claimant (or "third party") who is not one of the two parties to the insurance contract. Insured liability claims are referred to as third party claims. Treaty reinsurance............ The reinsurance of a specified type or category of risks defined in a reinsurance agreement (a "treaty") between a primary insurer or other reinsured and a reinsurer. Typically, in treaty reinsurance, the primary insurer or reinsured is 80 obligated to offer and the reinsurer is obligated to accept a specified portion of all such type or category of risks originally written by the primary insurer or reinsured. Umbrella coverage............. A form of insurance protection against losses in excess of amounts covered by other liability insurance policies or amounts not covered by the usual liability policies. Unassigned funds (surplus).... The undistributed and unappropriated amount of statutory surplus. Underwriter................... An employee of an insurance company who examines, accepts or rejects risks and classifies accepted risks in order to charge an appropriate premium for each accepted risk. The underwriter is expected to select business that will produce an average risk of loss no greater than that anticipated for the class of business. Underwriting.................. The insurer's or reinsurer's process of reviewing applications for insurance coverage, and the decision whether to accept all or part of the coverage and determination of the applicable premiums; also refers to the acceptance of such coverage. Underwriting expense ratio.... For SAP it is the ratio of underwriting expenses incurred to net premiums written. For GAAP it is the ratio of underwriting expenses incurred to net premiums written plus fee income. Underwriting profit or underwriting loss........... The pre-tax profit or loss experienced by a property and casualty insurance company after deducting loss and loss adjustment expenses and operating expenses from net earned premiums. This profit or loss calculation includes reinsurance assumed and ceded but excludes investment income. Unearned premium.............. The portion of premiums written that is allocable to the unexpired portion of the policy term. Voluntary market.............. The market in which a person seeking insurance obtains coverage without the assistance of residual market mechanisms. Wholesale broker.............. An independent or exclusive agent that represents both admitted and non admitted insurers in market areas which include standard, non-standard, specialty and excess and 81 surplus lines of insurance. The wholesaler does not deal directly with the insurance consumer. The wholesaler deals with the retail agent or broker. Workers' compensation......... A system (established under state laws) under which employers provide insurance for benefit payments to their employees for work-related injuries, deaths and diseases, regardless of fault. Item 2. PROPERTIES. The Company's executive offices are located in New York City. Offices and other properties used by the Company's subsidiaries are located throughout the United States. A few subsidiaries have offices located in foreign countries. Most office locations and other properties are leased on terms and for durations which are reflective of commercial standards in the communities where such offices and other properties are located. As of December 31, 1996, leasehold interests of the Company's property-casualty insurance subsidiaries included a total of approximately 6,650,000 square feet of office space at about 302 locations throughout the United States. In addition, TIC owns buildings containing approximately 1,500,000 square feet of office space located in Hartford, Connecticut and vicinity, serving as the home office for TIC and TAP, and TAP leases approximately 1,030,000 square feet of such office space under a ten-year lease that expires on April 1, 2006. TAP also rents from Aetna approximately 373,000 square feet of office space at City Place, located in Hartford, Connecticut, under an eight-year sublease that expires in 2004, and approximately 225,000 square feet of office space in Windsor, Connecticut, under a two-year lease that expires in 1998 and is renewable by TAP for up to two additional three-year terms. The Company's life insurance units also lease approximately 606,000 square feet of office space at about 24 locations throughout the United States, under various leases. TIC and/or TIGI lease two other buildings in Hartford, Connecticut with an aggregate of approximately 707,500 square feet, most of which is subleased to third parties. TIC also owns a building in Norcross, Georgia that is occupied by its information systems department. SBI owns two office buildings in New York City, which total approximately 627,000 square feet. Most of SBI's other offices are located in leased premises, the leases for which expire at various times. SBI leases two buildings, located at 388 and 390 Greenwich Street and totaling approximately 2,300,000 square feet, through 1999. SBI has a purchase option with respect to these properties. A few other offices and certain warehouse space are owned, none of which is material to the Company's financial condition or operations. The Company owns 26 acres of 82 land in North Castle, New York, on which it is constructing an executive conference and planning center, anticipated to be completed in May 1997. The Company believes its properties are adequate and suitable for its business as presently conducted and are adequately maintained. For further information concerning leases, see Note 18 of Notes to Consolidated Financial Statements. Item 3. LEGAL PROCEEDINGS. This section describes the major pending legal proceedings, other than ordinary routine litigation incidental to the business, to which the Company or its subsidiaries is a party or of which any of their property is subject. Certain additional matters may be described in the periodic reports filed under the Exchange Act by certain subsidiaries of the Company. Smith Barney For information concerning several purported class action lawsuits filed against SBI in connection with three funds managed by Hyperion Capital Management Inc., see the descriptions that appear in the fourth paragraph on page 26 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993, the first paragraph under the heading "Smith Barney" on page 65 of the Company's Annual Report on Form 10-K for the year ended December 31, 1995 and the first paragraph on page 34 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996, which descriptions are incorporated by reference herein. A copy of the pertinent paragraphs of such filings is included as an exhibit to this Form 10-K. Plaintiffs' petition for a rehearing en banc was denied in January 1997. For information concerning actions filed against a number of broker-dealers, including SBI, relating to trading practices on the National Association of Securities Dealers Automated Quotation system, see the descriptions that appear in the third paragraph on page 16 of the Quarterly Report on Form 10-Q of SB Holdings for the quarter ended September 30, 1994 and the last full paragraph on page 65 of the Company's Annual Report on Form 10-K for the year ended December 31, 1995, which descriptions are incorporated by reference herein. A copy of the pertinent paragraphs of such filing is included as an exhibit to this Form 10-K. In March 1996, plaintiffs filed a motion for class certification. For information concerning a complaint seeking equitable relief that was filed by the U.S. Department of Justice, naming 24 major brokerage firms, including SBI, see the description that appears in the first paragraph on page 35 of the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1996, which description is incorporated by reference herein. A copy of the pertinent paragraph of such filing is included as an exhibit to this Form 10-K. 83 TAP For information concerning a case filed by certain subsidiaries of the Company involving certain reinsurance contracts with Lloyd's, see the description that appears in the paragraph that begins on page 2 and ends on page 3 of the Company's Current Report on Form 8-K dated March 1, 1994, which description is incorporated by reference herein. A copy of the pertinent paragraph of such filing is included as an exhibit to this Form 10-K. Hearings before the American Arbitration Association began in the second half of 1996 and are expected to continue into the second quarter of 1997. For information concerning actions filed against several insurance companies and industry organizations relating to service fee charges and premium calculations on certain workers' compensation insurance, see the descriptions that appear in the paragraph that begins on page 90 and ends on page 91 of the Prospectus dated April 22, 1996 of TAP, the second paragraph on page 35 of the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1996 and the second paragraph on page 34 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996, which descriptions are incorporated by reference herein. A copy of the pertinent paragraphs of such filings is included as an exhibit to this Form 10-K. In NC Steel, Inc. v. NCCI, plaintiffs and defendants have appealed to the North Carolina State Supreme Court. In November 1996, Amundson & Associates Art Studio v. NCCI, et al. was removed to the U.S. District Court for the District of Kansas. In December 1996, a purported class action entitled Forman, Inc. v. NCCI, et al. was filed in Chancery Court, Marion County, Tennessee, with allegations similar to those in NC Steel and seeking unspecified monetary damages. In January 1997, two additional purported class actions, each entitled El Chico Restaurants, Inc. v. The Aetna Casualty and Surety Company, et al., were filed in Chancery Court, Davidson County, Tennessee, and Superior Court, Richmond County, Georgia, respectively, with allegations similar to those in Weatherford Roofing Company v. Employers National Insurance Company, which was settled in mid-1996. Plaintiffs seek unspecified monetary damages. In February 1997, one action was removed to the U.S. District Court for the Middle District of Tennessee and the other action was removed to the U.S. District Court for the Southern District of Georgia. Also in January 1997, a purported class of Texas workers' compensation insureds filed a petition to intervene in a lawsuit pending since 1995 in District Court, Travis County, Texas, entitled Travelers Indemnity Company of Connecticut v. Texas Workers Compensation Insurance Facility. The pending lawsuit arose out of a fee dispute between certain subsidiaries of the Company and the administration of the Texas assigned risk pool. The proposed class challenges both the fees paid to servicing carriers for the pool from 1991 to 1993 and certain premium calculations on certain workers' compensation policies from 1991 forward. The Company believes it has meritorious defenses to these actions and intends to contest the allegations. In the ordinary course of business, certain of TAP's subsidiaries receive claims asserting alleged injuries and damages from asbestos and other hazardous waste and toxic 84 substances. The environment surrounding the final resolution of these claims continues to change. Currently, it is not possible to predict changes in the legal and legislative environment and their impact on the future development of asbestos and environmental claims. Such development will be affected by future court decisions and interpretations and changes in Superfund and other legislation. Because of these future unknowns, additional liabilities may arise for amounts in excess of the current reserves. These additional amounts, or a range of these additional amounts, cannot now be reasonably estimated, and could result in a liability exceeding reserves by an amount that would be material to the Company's operating results in a future period. However, the Company believes that it is not likely that these claims will have a material adverse effect on the Company's financial condition or liquidity. Other For information concerning a purported class action filed against Primerica Financial Services Inc. ("PFSI"), a subsidiary of the Company, in connection with the purchase by individuals of interests in oil and gas rights owned by Basic Energy and Affiliated Resources Inc. ("BEAR") and a related complaint filed by the National Association of Securities Dealers, Inc., see the descriptions that appear in the second paragraph on page 30 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1995, the fourth paragraph on page 25 of the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1996 and the third paragraph on page 34 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996, which descriptions are incorporated by reference herein. A copy of the pertinent paragraphs of such filings is included as an exhibit to this Form 10-K. In McNeely v. BEAR, the parties have reached a settlement, subject to court approval. The Company and various subsidiaries have also been named as defendants in various matters incident to and typical of the businesses in which they are engaged. These include numerous civil actions, arbitration proceedings and other matters in which SBI and R-H have been named, arising in the normal course of business out of activities as a broker and dealer in securities, as an underwriter, as an investment banker or otherwise. These also include numerous matters in which the Company's insurance subsidiaries are named, arising in the normal course of their business. In the opinion of the Company's management, none of these actions is expected to have a material adverse effect on the consolidated financial condition of the Company and its subsidiaries. 85 Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. Not applicable. PART II ------- Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. The Company's common stock is listed on the NYSE and the Pacific Stock Exchange under the symbol "TRV." The high and low sale prices, as reported on the consolidated transaction reporting system, for the common stock of the Company for the periods indicated, and the dividends per share, are set forth below. In January 1996, the Company's Board of Directors declared a three-for-two split in the Company's common stock, paid in the form of a 50% stock dividend in May 1996. In October 1996, the Company's Board of Directors declared a four-for-three split in the Company's common stock, paid in the form of a 33 1/3% stock dividend in November 1996. Both splits combined are the equivalent of a two-for-one stock split. All amounts have been adjusted to give retroactive effect to the two stock splits effected in 1996.
1995 1996 1997 ----------------------------------------- ----------------------------------------- -------- 1st Q 2nd Q 3rd Q 4th Q 1st Q 2nd Q 3rd Q 4th Q 1st Q* -------- -------- -------- -------- -------- -------- -------- -------- -------- Common Stock Price High $ 19.938 $ 22.500 $ 26.688 $ 31.938 $ 32.250 $ 34.313 $ 37.406 $ 47.500 $ 58.375 Low $ 16.188 $ 18.938 $ 22.000 $ 24.438 $ 28.500 $ 28.250 $ 29.063 $ 36.844 $ 43.750 Dividends per Share of Common Stock $ .10 $ .10 $ .10 $ .10 $ .1125 $ .1125 $ .1125 $ .1125 $ .15
- ------------------------------- * Through March 5, 1997. At March 5, 1997, the Company had approximately 55,100 common stockholders of record. This figure does not represent the actual number of beneficial owners of common stock because shares are frequently held in "street name" by securities dealers and others for the benefit of individual owners who may vote the shares. For information on dividend restrictions in certain long-term loan and credit agreements of the Company and its subsidiaries, as well as restrictions on the ability of certain of the Company's subsidiaries to transfer funds to the Company in the form of cash dividends or otherwise, see Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations." 86 Item 6. SELECTED FINANCIAL DATA. See "Five-Year Summary of Selected Financial Data" on page 32 of the Company's 1996 Annual Report to Stockholders (the "1996 Annual Report"), included as part of Exhibit 13 to this Form 10-K and incorporated herein by reference. Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" beginning on page 33 of the 1996 Annual Report, included as part of Exhibit 13 to this Form 10-K and incorporated herein by reference. Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. See Index to Consolidated Financial Statements and Schedules on page F-1 hereof. There is also incorporated by reference herein in response to this Item the material under the caption "Selected Quarterly Financial Data (unaudited)" on page 77 of the 1996 Annual Report, which material is included as part of Exhibit 13 to this Form 10-K. Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. PART III -------- Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. For information on the directors of the Company, see the material under the caption "Election of Directors," in the definitive Proxy Statement for the Company's Annual Meeting of Stockholders to be held on April 23, 1997, filed with the Securities and Exchange Commission (the "Proxy Statement"), incorporated herein by reference. For information on executive officers, see Item 1, "Business -- Other Information -- Executive Officers of the Company" herein. Item 11. EXECUTIVE COMPENSATION. See the material under the caption "Executive Compensation" of the Proxy Statement, incorporated herein by reference. 87 Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. See the material under the captions "Voting Rights," "Security Ownership of Certain Beneficial Owners" and "Security Ownership of Management" of the Proxy Statement, incorporated herein by reference. Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. See the material under the captions "Election of Directors" and "Executive Compensation" of the Proxy Statement, incorporated herein by reference. PART IV ------- Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. (a) Documents filed as a part of the report: (1) Financial Statements. See Index to Consolidated Financial Statements and Schedules on page F-1 hereof. (2) Financial Statement Schedules. See Index to Consolidated Financial Statements and Schedules on page F-1 hereof. (3) Exhibits: See Exhibit Index. (b) Reports on Form 8-K: No reports on Form 8-K were filed during the fourth quarter of 1996. 88 EXHIBIT INDEX ------------- Exhibit Filing Number Description of Exhibit Method - ------ ---------------------- ------ 3.01 Restated Certificate of Incorporation of Travelers Group Inc. (formerly The Travelers Inc.) (the "Company"), Certificate of Designation of Cumulative Adjustable Rate Preferred Stock, Series Y, and Certificate of Amendment to the Restated Certificate of Incorporation, incorporated by reference to Exhibit 3.01 to Amendment No. 1 to the Company's Registration Statement on Form S-4 (No. 333-00737). 3.02 By-Laws of the Company as amended through January 24, 1996, incorporated by reference to Exhibit 3.02 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1995 (File No. 1-9924) (the "Company's 1995 10-K"). 10.01* Employment Protection Agreement, dated as of December 31, 1987, between the Company (as successor to Commercial Credit Company ("CCC")) and Sanford I. Weill, incorporated by reference to Exhibit 10.03 to CCC's Annual Report on Form 10-K for the fiscal year ended December 31, 1987 (File No. 1-6594). 10.02.1* Travelers Group Stock Option Plan (as amended and Electronic restated as of April 24, 1996). 10.02.2* Amendment No. 14 to the Travelers Group Stock Option Plan, incorporated by reference to Exhibit 10.01 to the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 1996 (File No. 1-9924) (the "Company's September 30, 1996 10-Q"). 10.03* Travelers Group 1996 Stock Incentive Plan (as Electronic amended through November 22, 1996). 10.04* Retirement Benefit Equalization Plan of the Electronic Company (as amended and restated as of January 1, 1994). 89 Exhibit Filing Number Description of Exhibit Method - ------ ---------------------- ------ 10.05* Letter Agreement between Joseph A. Califano, Jr. and the Company, dated December 14, 1988, incorporated by reference to Exhibit 10.21.1 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1988 (File No. 1-9924). 10.06* Travelers Group Inc. Amended and Restated Compensation Plan for Non-Employee Directors, incorporated by reference to Exhibit 10.02 to the Company's September 30, 1996 10-Q. 10.07.1* Supplemental Retirement Plan of the Company, incorporated by reference to Exhibit 10.23 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990 (File No. 1-9924). 10.07.2* Amendment to the Company's Supplemental Retirement Plan, incorporated by reference to Exhibit 10.06.2 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993 (File No. 1-9924) (the "Company's 1993 10-K"). 10.08* The Travelers Inc. Executive Performance Compensation Plan, effective April 27, 1994, incorporated by reference to Exhibit 10.07 to the Company's 1995 10-K. 10.09* Travelers Group Capital Accumulation Plan (as amended through September 25, 1996), incorporated by reference to Exhibit 10.03 to the Company's September 30, 1996 10-Q. 10.10* Agreement dated December 21, 1993 between the Company and Edward H. Budd, incorporated by reference to Exhibit 10.22 to the Company's 1993 10-K. 10.11* The Travelers Inc. Deferred Compensation and Partnership Participation Plan, incorporated by reference to Exhibit 10.31 to the Company's Annual Report on Form 10-K/A-1 for the fiscal year ended December 31, 1994 (File No. 1-9924). 90 Exhibit Filing Number Description of Exhibit Method - ------ ---------------------- ------ 10.12.1 Stock Purchase Agreement dated as of November 28, 1995, between The Travelers Insurance Group Inc. and Aetna Life and Casualty Company, incorporated by reference to Exhibit 10.1 to the Annual Report on Form 10-K of Aetna Life and Casualty Company for the fiscal year ended December 31, 1995 (File No. 1-5704). 10.12.2 Assignment of Stock Purchase Agreement, dated as of March 22, 1996, between Travelers Property Casualty Corp. (formerly Travelers/Aetna Property Casualty Corp.) ("TAP") and The Travelers Insurance Group Inc., incorporated by reference to Exhibit 2.2 to Amendment No. 5 of the Registration Statement on Form S-1 of TAP (No. 333-2254). 10.12.3 Amendment to Stock Purchase Agreement, dated as of April 2, 1996, between TAP and Aetna Casualty and Surety Company, incorporated by reference to Exhibit 10.01 to the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 1996 (File No. 1-9924) (the "Company's March 31, 1996 10-Q"). 10.13* The Travelers Corporation 1984 Management Incentive Plan, as amended effective January 1, 1991, incorporated by reference to Exhibit 10(c) to the Annual Report on Form 10-K of The Travelers Corporation ("old Travelers") for the fiscal year ended December 31, 1990 (File No. 1-5799). 10.14* The Travelers Corporation Supplemental Benefit Plan, effective December 20, 1992, incorporated by reference to Exhibit 10(d) to the Annual Report on Form 10-K of old Travelers for the fiscal year ended December 31, 1992 (File No. 1-5799). 10.15* The Travelers Corporation TESIP Restoration and Non-Qualified Savings Plan, effective January 1, 1991, incorporated by reference to Exhibit 10(e) to the Annual Report on Form 10-K of old Travelers for the fiscal year ended December 31, 1991 (File No. 1-5799). 91 Exhibit Filing Number Description of Exhibit Method - ------ ---------------------- ------ 10.16* The Travelers Corporation Directors' Deferred Compensation Plan, as amended November 7, 1986, incorporated by reference to Exhibit 10(d) to the Annual Report on Form 10-K of old Travelers for the fiscal year ended December 31, 1986 (File No. 1-5799). 10.17* Employment Agreement dated as of December 30, 1994, between SBI and Joseph J. Plumeri II, incorporated by reference to Exhibit 10.30 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (File No. 1-9924). 10.18 Letter Agreement, dated as of January 13, 1997, Electronic between the Company and Jon C. Madonna. 10.19* Travelers Property Casualty Corp. Capital Accumulation Plan (as amended through September 1, 1996), incorporated by reference to Exhibit 10.01 to the Quarterly Report on Form 10-Q of Travelers Property Casualty Corp. (formerly Travelers/Aetna Property Casualty Corp.) for the fiscal quarter ended September 30, 1996 (File No. 1-14328). 11.01 Computation of Earnings Per Share. Electronic 12.01 Computation of Ratio of Earnings to Fixed Charges. Electronic 13.01 Pages 32 through 78 of the 1996 Annual Report to Electronic Stockholders of the Company (pagination of exhibit does not correspond to pagination in the 1996 Annual Report to Stockholders). 21.01 Subsidiaries of the Company. Electronic 23.01 Consent of KPMG Peat Marwick LLP, Independent Electronic Certified Public Accountants. 24.01 Powers of Attorney. Electronic 27.01 Financial Data Schedule. Electronic 99.01 The fourth paragraph on page 26 of the Company's Electronic September 30, 1993 10-Q, the first paragraph under the heading "Smith Barney" on page 65 of the Company's 1995 10-K and the first paragraph on page 34 of the Company's September 30, 1996 10-Q. 92 Exhibit Filing Number Description of Exhibit Method - ------ ---------------------- ------ 99.02 The third paragraph on page 16 of the Quarterly Electronic Report on Form 10-Q of Smith Barney Holdings Inc. for the fiscal quarter ended September 30, 1994 and the last full paragraph on page 65 of the Company's 1995 10-K. 99.03 The first paragraph on page 35 of the Company's Electronic Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 1996 (the "Company's June 30, 1996 10-Q"). 99.04 The paragraph that begins on page 2 and ends on Electronic page 3 of the Company's Current Report on Form 8-K dated March 1, 1994. 99.05 The paragraph that begins on page 90 and ends on Electronic page 91 of the Prospectus dated April 22, 1996 of TAP, the second paragraph on page 35 of the Company's June 30, 1996 10-Q and the second paragraph on page 34 of the Company's September 30, 1996 10-Q. 99.06 The second paragraph on page 30 of the Company's Electronic Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 1995, the fourth paragraph on page 25 of the Company's March 31, 1996 10-Q and the third paragraph on page 34 of the Company's September 30, 1996 10-Q. The total amount of securities authorized pursuant to any instrument defining rights of holders of long-term debt of the Company does not exceed 10% of the total assets of the Company and its consolidated subsidiaries. The Company will furnish copies of any such instrument to the Commission upon request. The financial statements required by Form 11-K for 1996 for the Company's employee savings plan will be filed as an exhibit by amendment to this Form 10-K pursuant to Rule 15d-21 of the Securities Exchange Act of 1934, as amended. Copies of any of the exhibits referred to above will be furnished at a cost of $.25 per page (although no charge will be made for the 1996 Annual Report on Form 10-K) to security holders who make written request therefor to Corporate Communications and Investor Relations Department, Travelers Group Inc., 388 Greenwich Street, New York, New York 10013. - ---------- * Denotes a management contract or compensatory plan or arrangement required to be filed as an exhibit pursuant to Item 14(c) of Form 10-K. 93 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 26th day of March, 1997. TRAVELERS GROUP INC. (Registrant) By: /s/ Sanford I. Weill ........................................ Sanford I. Weill, Chairman of the Board and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities indicated on the 26th day of March, 1997. Signature Title --------- ----- /s/ Sanford I. Weill .................................. Chairman of the Board, Chief Sanford I. Weill Executive Officer (Principal Executive Officer) and Director /s/ Heidi G. Miller .................................. Senior Vice President and Chief Heidi G. Miller Financial Officer (Principal Financial Officer) /s/ Irwin Ettinger .................................. Executive Vice President and Chief Irwin Ettinger Accounting Officer (Principal Accounting Officer) * .................................. Director C. Michael Armstrong * .................................. Director Kenneth J. Bialkin 94 Signature Title --------- ----- * .................................. Director Edward H. Budd * .................................. Director Joseph A. Califano, Jr. * .................................. Director Douglas D. Danforth * .................................. Director Robert F. Daniell /s/ James Dimon .................................. Director James Dimon * .................................. Director Leslie B. Disharoon * .................................. Director Gerald R. Ford * .................................. Director Ann Dibble Jordan 95 Signature Title --------- ----- * .................................. Director Robert I. Lipp * .................................. Director Dudley C. Mecum * .................................. Director Andrall E. Pearson * .................................. Director Frank J. Tasco * .................................. Director Linda J. Wachner * .................................. Director Joseph R. Wright, Jr. * .................................. Director Arthur Zankel *By: /s/ James Dimon .................................. James Dimon Attorney-in-fact 96 Travelers Group Inc. and Subsidiaries INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES* --------------------------------- Incorporated By Reference from the Company's 1996 Annual Report to Page Stockholders at Herein Page Indicated ------ -------------- Independent Auditors' Report F-2 78 Consolidated Statement of Income for the year ended December 31, 1996, 1995 and 1994 49 Consolidated Statement of Financial Position at December 31, 1996 and 1995 50 Consolidated Statement of Changes in Stockholders' Equity for the year ended December 31, 1996, 1995 and 1994 51 Consolidated Statement of Cash Flows for the year ended December 31, 1996, 1995 and 1994 52 Notes to Consolidated Financial Statements 53-77 Schedules: Schedule I - Condensed Financial Information of Registrant (Parent Company only) F-3 - F-6 Schedule III - Supplementary Insurance Information F-7 Schedule IV - Reinsurance F-8 *Schedules not listed are omitted as not applicable or not required by Regulation S-X. Independent Auditors' Report ---------------------------- The Board of Directors and Stockholders Travelers Group Inc.: Under date of January 17, 1997, we reported on the consolidated statement of financial position of Travelers Group Inc. and subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of income, changes in stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 1996, as contained in the 1996 annual report to stockholders. These consolidated financial statements and our report thereon are incorporated by reference in the annual report on Form 10-K for the year 1996. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related financial statement schedules as listed in the accompanying index. These financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statement schedules based on our audits. In our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein. /s/ KPMG Peat Marwick LLP New York, New York January 17, 1997 F-2 SCHEDULE I Travelers Group Inc. (Parent Company Only) Condensed Financial Information of Registrant (In millions of dollars) Condensed Statement of Income Year Ended December 31, ---------------------------------- 1996 1995 1994 -------- -------- -------- Revenues $ 1 $ (5) $ 3 -------- -------- -------- Expenses: - --------- Interest 162 129 120 Other 126 104 87 -------- -------- -------- Total 288 233 207 -------- -------- -------- Pre-tax loss (287) (238) (204) Income tax benefit 103 85 82 -------- -------- -------- Loss before equity in net income of subsidiaries (184) (153) (122) Equity in net income of subsidiaries from continuing operations 2,484 1,781 1,279 Equity in net income of subsidiaries from discontinued operations 31 206 169 -------- -------- -------- Net income $ 2,331 $ 1,834 $ 1,326 ======== ======== ======== The condensed financial statements should be read in conjunction with the consolidated financial statements and notes thereto and the accompanying notes to the condensed financial information of Registrant. F-3 SCHEDULE I Travelers Group Inc. (Parent Company Only) Condensed Financial Information of Registrant (In millions of dollars) Condensed Statement of Financial Position
December 31, --------------------- 1996 1995 -------- -------- Assets - ------ Investment in subsidiaries at equity $ 15,741 $ 13,743 Advances to and receivables from subsidiaries 88 220 Cost of acquired businesses in excess of net assets 436 493 Other-principally investments 650 237 -------- -------- $ 16,915 $ 14,693 ======== ======== Liabilities - ----------- Junior Subordinated Debentures, held by subsidiary Trusts $ 1,026 $ -- Long-term debt 1,903 2,042 Advances from and payables to subsidiaries -- 262 Other liabilities 546 285 -------- -------- 3,475 2,589 -------- -------- Redeemable preferred stock, held by subsidiary 226 226 -------- -------- ESOP Preferred stock - Series C 164 235 Guaranteed ESOP obligation (35) (67) -------- -------- 129 168 -------- -------- Stockholders' equity - -------------------- Preferred stock ($1.00 par value; authorized shares: 30 million), at aggregate liquidation value 675 800 Common stock ($.01 par value; authorized shares: 1.5 billion; issued shares: 1996 - 743,082,134 and 1995 - 736,303,838) 7 7 Additional paid-in capital 7,217 6,782 Retained earnings 7,452 5,503 Treasury stock, at cost (1996 - 105,503,401 shares; 1995 - 103,848,847 shares) (2,446) (1,835) Unrealized gain (loss) on investment securities 469 756 Other, principally unearned compensation (289) (303) -------- -------- 13,085 11,710 -------- -------- $ 16,915 $ 14,693 ======== ========
The condensed financial statements should be read in conjunction with the consolidated financial statements and notes thereto and the accompanying notes to the condensed financial information of Registrant. F-4 SCHEDULE I Travelers Group Inc. (Parent Company Only) Condensed Financial Information of Registrant (In millions of dollars) Condensed Statement of Cash Flows
Year Ended December 31, ---------------------------------- 1996 1995 1994 -------- -------- -------- Cash flows from operating activities - ------------------------------------ Net income $ 2,331 $ 1,834 $ 1,326 Adjustments to reconcile net income to cash provided by operating activities: Equity in net income of subsidiaries (2,515) (1,987) (1,448) Dividends received from subsidiaries, net 1,808 508 1,409 Advances (to) from subsidiaries, net (130) (147) (411) Other, net 316 217 377 -------- -------- -------- Net cash provided by (used in) operating activities 1,810 425 1,253 -------- -------- -------- Cash flows from investing activities - ------------------------------------ Capital contribution to subsidiary (1,140) -- -- Other investments, primarily short-term, net (408) (198) -- -------- -------- -------- Net cash provided by (used in) investing activities (1,548) (198) -- -------- -------- -------- Cash flows from financing activities - ------------------------------------ Dividends paid (382) (341) (267) Stock tendered for payment of withholding taxes (201) (94) (42) Treasury stock acquired (593) (418) (543) Issuance of long-term debt -- 700 -- Issuance of junior subordinated debentures 1,026 -- -- Payments and redemptions of long-term debt (100) -- (93) Net change in short-term borrowings -- (101) (228) Redemption of redeemable preferred stock (held by subsidiary) -- (35) (100) Other, net (12) 62 20 -------- -------- -------- Net cash provided by (used in) financing activities (262) (227) (1,253) -------- -------- -------- Change in cash $ -- $ -- $ -- -------- -------- -------- Supplemental disclosure of cash flow information: - ------------------------------------------------- Cash paid during the period for interest $ 157 $ 112 $ 102 ======== ======== ======== Cash received during the period for taxes $ 263 $ 155 $ 268 ======== ======== ========
The condensed financial statements should be read in conjunction with the consolidated financial statements and notes thereto and the accompanying notes to the condensed financial information of Registrant. F-5 SCHEDULE I Notes to Condensed Financial Statements of Registrant 1. Basis of Presentation --------------------- The accompanying financial statements include the accounts of Travelers Group Inc. (the Parent) and on an equity basis its subsidiaries and affiliates and should be read in conjunction with the Consolidated Financial Statements and notes thereto. 2. Supplementary Disclosure of Non-Cash Investing and Financing Activities ----------------------------------------------------------------------- During 1994, the Parent issued $261 million of redeemable preferred stock to various subsidiaries in exchange for an equivalent value of Travelers Group Inc. common stock previously held by these subsidiaries. This activity was recorded as a non-cash capital contribution to subsidiaries by the Parent. During 1995, $35 million of this redeemable preferred stock was repurchased and retired. F-6 SCHEDULE III TRAVELERS GROUP INC. AND SUBSIDIARIES Supplementary Insurance Information (In millions of dollars)
Value of insurance in force and Future policy deferred benefits, Other policy policy losses, claims claims and Net acquisition and loss Unearned benefits Premium investment Segment costs expenses premiums payable Revenue income - -------- ----------------------------------------------------------------------------------- 1996 ---- Life Insurance Services $ 2,127 $ 9,263 $ 9 $ 536 $ 1,404 $ 1,888 P&C Insurance Services 426 30,175 3,554 -- 6,050 1,658 Consumer Finance Services* 10 12 346 49 155 41 Corporate and Other -- -- -- -- 24 37 -------------------------------------------------------------------------------- Total $ 2,563 $ 39,450 $ 3,909 $ 585 $ 7,633 $ 3,624 -------------------------------------------------------------------------------- 1995 ---- Life Insurance Services $ 1,953 $ 8,035 $ 9 $ 496 $ 1,537 $ 1,836 P&C Insurance Services 202 14,758 1,827 -- 3,300 744 Consumer Finance Services* 17 16 330 51 139 38 Corporate and Other -- 1,323 -- 75 1 7 -------------------------------------------------------------------------------- Total $ 2,172 $ 24,132 $ 2,166 $ 622 $ 4,977 $ 2,625 ================================================================================ 1994 ---- Life Insurance Services $ 1,923 $ 9,115 $ 103 $ 1,248 $ 1,539 $ 1,617 P&C Insurance Services 221 14,374 1,853 -- 3,498 644 Consumer Finance Services* 19 15 320 56 115 31 Corporate and Other -- -- -- -- (8) 9 -------------------------------------------------------------------------------- Total $ 2,163 $ 23,504 $ 2,276 $ 1,304 $ 5,144 $ 2,301 ================================================================================ Amortization Benefits, of deferred claims, policy losses acquisition costs and and value Other settlement of insurance operating Premiums Segment expenses in force expenses written - -------- ------------------------------------------------------- 1996 ---- Life Insurance Services $ 2,002 $ 280 $ 345 $ 1,416 P&C Insurance Services 5,283 905 1,406 6,360 Consumer Finance Services* 50 7 21 182 Corporate and Other 31 -- 49 4 --------------------------------------------------- Total $ 7,366 $ 1,192 $ 1,821 $ 7,962 --------------------------------------------------- 1995 ---- Life Insurance Services $ 2,173 $ 283 $ 406 $ 1,367 P&C Insurance Services 2,806 512 632 3,607 Consumer Finance Services* 51 8 2 161 Corporate and Other (13) -- 69 132 --------------------------------------------------- Total $ 5,017 $ 803 $ 1,109 $ 5,267 =================================================== 1994 ---- Life Insurance Services $ 2,091 $ 276 $ 341 $ 1,539 P&C Insurance Services 3,114 532 615 3,824 Consumer Finance Services* 43 4 22 172 Corporate and Other (21) -- 77 -- --------------------------------------------------- Total $ 5,227 $ 812 $ 1,055 $ 5,535 ===================================================
* Includes credit life insurance operations. F-7 SCHEDULE IV Travelers Group Inc. and Subsidiaries Reinsurance (In millions of dollars)
Column A Column B Column C Column D Column E Column F % of Ceded to Assumed Amount Gross Other From other Net Assumed Year ended December 31, 1996 Amount Companies Companies Amount To Net - ---------------------------- ---------- ---------- ---------- ---------- ---------- Life insurance in force $ 413,351 $ (154,021) $ 150 $ 259,480 0.06% ========== ========== ========== ========== ========== Premiums Life insurance $ 1,523 $ (296) $ 6 1,233 0.5% Accident and health insurance 400 (98) 2 304 0.7% Property and casualty insurance 7,239 (1,806) 663 6,096 10.9% ---------- ---------- ---------- ---------- $ 9,162 $ (2,200) $ 671 $ 7,633 ---------- ---------- ---------- ---------- Year ended December 31, 1995 - ---------------------------- Life insurance in force $ 400,622 $ (134,828) $ 139 $ 265,933 0.05% ========== ========== ========== ========== ========== Premiums Life insurance $ 1,496 $ (272) $ 1 $ 1,225 0.1% Accident and health insurance 497 (87) 2 412 0.5% Property and casualty insurance 4,302 (1,412) 450 3,340 13.5% ---------- ---------- ---------- ---------- $ 6,295 $ (1,771) $ 453 $ 4,977 ========== ========== ========== ========== Year ended December 31, 1994 - ---------------------------- Life insurance in force $ 527,964 $ (106,024) $ 4,284 $ 426,224 1.01% ========== ========== ========== ========== ========== Premiums Life insurance $ 1,484 $ (288) $ -- $ 1,196 -% Accident and health insurance 513 (89) 1 425 0.2% Property and casualty insurance 4,630 (1,529) 422 3,523 12.0% ---------- ---------- ---------- ---------- $ 6,627 $ (1,906) $ 423 $ 5,144 ========== ========== ========== ==========
F-8 EXHIBIT INDEX ------------- Exhibit Filing Number Description of Exhibit Method - ------ ---------------------- ------ 3.01 Restated Certificate of Incorporation of Travelers Group Inc. (formerly The Travelers Inc.) (the "Company"), Certificate of Designation of Cumulative Adjustable Rate Preferred Stock, Series Y, and Certificate of Amendment to the Restated Certificate of Incorporation, incorporated by reference to Exhibit 3.01 to Amendment No. 1 to the Company's Registration Statement on Form S-4 (No. 333-00737). 3.02 By-Laws of the Company as amended through January 24, 1996, incorporated by reference to Exhibit 3.02 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1995 (File No. 1-9924) (the "Company's 1995 10-K"). 10.01* Employment Protection Agreement, dated as of December 31, 1987, between the Company (as successor to Commercial Credit Company ("CCC")) and Sanford I. Weill, incorporated by reference to Exhibit 10.03 to CCC's Annual Report on Form 10-K for the fiscal year ended December 31, 1987 (File No. 1-6594). 10.02.1* Travelers Group Stock Option Plan (as amended and Electronic restated as of April 24, 1996). 10.02.2* Amendment No. 14 to the Travelers Group Stock Option Plan, incorporated by reference to Exhibit 10.01 to the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 1996 (File No. 1-9924) (the "Company's September 30, 1996 10-Q"). 10.03* Travelers Group 1996 Stock Incentive Plan (as Electronic amended through November 22, 1996). 10.04* Retirement Benefit Equalization Plan of the Electronic Company (as amended and restated as of January 1, 1994). Exhibit Filing Number Description of Exhibit Method - ------ ---------------------- ------ 10.05* Letter Agreement between Joseph A. Califano, Jr. and the Company, dated December 14, 1988, incorporated by reference to Exhibit 10.21.1 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1988 (File No. 1-9924). 10.06* Travelers Group Inc. Amended and Restated Compensation Plan for Non-Employee Directors, incorporated by reference to Exhibit 10.02 to the Company's September 30, 1996 10-Q. 10.07.1* Supplemental Retirement Plan of the Company, incorporated by reference to Exhibit 10.23 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990 (File No. 1-9924). 10.07.2* Amendment to the Company's Supplemental Retirement Plan, incorporated by reference to Exhibit 10.06.2 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993 (File No. 1-9924) (the "Company's 1993 10-K"). 10.08* The Travelers Inc. Executive Performance Compensation Plan, effective April 27, 1994, incorporated by reference to Exhibit 10.07 to the Company's 1995 10-K. 10.09* Travelers Group Capital Accumulation Plan (as amended through September 25, 1996), incorporated by reference to Exhibit 10.03 to the Company's September 30, 1996 10-Q. 10.10* Agreement dated December 21, 1993 between the Company and Edward H. Budd, incorporated by reference to Exhibit 10.22 to the Company's 1993 10-K. 10.11* The Travelers Inc. Deferred Compensation and Partnership Participation Plan, incorporated by reference to Exhibit 10.31 to the Company's Annual Report on Form 10-K/A-1 for the fiscal year ended December 31, 1994 (File No. 1-9924). Exhibit Filing Number Description of Exhibit Method - ------ ---------------------- ------ 10.12.1 Stock Purchase Agreement dated as of November 28, 1995, between The Travelers Insurance Group Inc. and Aetna Life and Casualty Company, incorporated by reference to Exhibit 10.1 to the Annual Report on Form 10-K of Aetna Life and Casualty Company for the fiscal year ended December 31, 1995 (File No. 1-5704). 10.12.2 Assignment of Stock Purchase Agreement, dated as of March 22, 1996, between Travelers Property Casualty Corp. (formerly Travelers/Aetna Property Casualty Corp.) ("TAP") and The Travelers Insurance Group Inc., incorporated by reference to Exhibit 2.2 to Amendment No. 5 of the Registration Statement on Form S-1 of TAP (No. 333-2254). 10.12.3 Amendment to Stock Purchase Agreement, dated as of April 2, 1996, between TAP and Aetna Casualty and Surety Company, incorporated by reference to Exhibit 10.01 to the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 1996 (File No. 1-9924) (the "Company's March 31, 1996 10-Q"). 10.13* The Travelers Corporation 1984 Management Incentive Plan, as amended effective January 1, 1991, incorporated by reference to Exhibit 10(c) to the Annual Report on Form 10-K of The Travelers Corporation ("old Travelers") for the fiscal year ended December 31, 1990 (File No. 1-5799). 10.14* The Travelers Corporation Supplemental Benefit Plan, effective December 20, 1992, incorporated by reference to Exhibit 10(d) to the Annual Report on Form 10-K of old Travelers for the fiscal year ended December 31, 1992 (File No. 1-5799). 10.15* The Travelers Corporation TESIP Restoration and Non-Qualified Savings Plan, effective January 1, 1991, incorporated by reference to Exhibit 10(e) to the Annual Report on Form 10-K of old Travelers for the fiscal year ended December 31, 1991 (File No. 1-5799). Exhibit Filing Number Description of Exhibit Method - ------ ---------------------- ------ 10.16* The Travelers Corporation Directors' Deferred Compensation Plan, as amended November 7, 1986, incorporated by reference to Exhibit 10(d) to the Annual Report on Form 10-K of old Travelers for the fiscal year ended December 31, 1986 (File No. 1-5799). 10.17* Employment Agreement dated as of December 30, 1994, between SBI and Joseph J. Plumeri II, incorporated by reference to Exhibit 10.30 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (File No. 1-9924). 10.18 Letter Agreement, dated as of January 13, 1997, Electronic between the Company and Jon C. Madonna. 10.19* Travelers Property Casualty Corp. Capital Accumulation Plan (as amended through September 1, 1996), incorporated by reference to Exhibit 10.01 to the Quarterly Report on Form 10-Q of Travelers Property Casualty Corp. (formerly Travelers/Aetna Property Casualty Corp.) for the fiscal quarter ended September 30, 1996 (File No. 1-14328). 11.01 Computation of Earnings Per Share. Electronic 12.01 Computation of Ratio of Earnings to Fixed Charges. Electronic 13.01 Pages 32 through 78 of the 1996 Annual Report to Electronic Stockholders of the Company (pagination of exhibit does not correspond to pagination in the 1996 Annual Report to Stockholders). 21.01 Subsidiaries of the Company. Electronic 23.01 Consent of KPMG Peat Marwick LLP, Independent Electronic Certified Public Accountants. 24.01 Powers of Attorney. Electronic 27.01 Financial Data Schedule. Electronic 99.01 The fourth paragraph on page 26 of the Company's Electronic September 30, 1993 10-Q, the first paragraph under the heading "Smith Barney" on page 65 of the Company's 1995 10-K and the first paragraph on page 34 of the Company's September 30, 1996 10-Q. 99.02 The third paragraph on page 16 of the Quarterly Electronic Report on Form 10-Q of Smith Barney Holdings Inc. for the fiscal quarter ended September 30, 1994 and the last full paragraph on page 65 of the Company's 1995 10-K. Exhibit Filing Number Description of Exhibit Method - ------ ---------------------- ------ 99.03 The first paragraph on page 35 of the Company's Electronic Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 1996 (the "Company's June 30, 1996 10-Q"). 99.04 The paragraph that begins on page 2 and ends on Electronic page 3 of the Company's Current Report on Form 8-K dated March 1, 1994. 99.05 The paragraph that begins on page 90 and ends on Electronic page 91 of the Prospectus dated April 22, 1996 of TAP, the second paragraph on page 35 of the Company's June 30, 1996 10-Q and the second paragraph on page 34 of the Company's September 30, 1996 10-Q. 99.06 The second paragraph on page 30 of the Company's Electronic Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 1995, the fourth paragraph on page 25 of the Company's March 31, 1996 10-Q and the third paragraph on page 34 of the Company's September 30, 1996 10-Q. The total amount of securities authorized pursuant to any instrument defining rights of holders of long-term debt of the Company does not exceed 10% of the total assets of the Company and its consolidated subsidiaries. The Company will furnish copies of any such instrument to the Commission upon request. The financial statements required by Form 11-K for 1996 for the Company's employee savings plan will be filed as an exhibit by amendment to this Form 10-K pursuant to Rule 15d-21 of the Securities Exchange Act of 1934, as amended. Copies of any of the exhibits referred to above will be furnished at a cost of $.25 per page (although no charge will be made for the 1996 Annual Report on Form 10-K) to security holders who make written request therefor to Corporate Communications and Investor Relations Department, Travelers Group Inc., 388 Greenwich Street, New York, New York 10013. - ---------- * Denotes a management contract or compensatory plan or arrangement required to be filed as an exhibit pursuant to Item 14(c) of Form 10-K. Exhibit 11.01 Travelers Group Inc. and Subsidiaries Computation of Earnings Per Share (In millions, except for per share amounts) Year ended December 31, -------------------------------- 1996 1995 1994 -------- -------- -------- Earnings: Income from continuing operations $ 2,300 $ 1,628 $ 1,157 Discontinued operations 31 206 169 -------- -------- -------- Net income $ 2,331 $ 1,834 $ 1,326 Preferred dividends - series A (24) (24) (24) Preferred dividends - series B (3) (7) (7) Preferred dividends - series C (31) (18) (17) Preferred dividends - series D (35) (35) (35) -------- -------- -------- (93) (84) (83) Income applicable to common stock $ 2,238 $ 1,750 $ 1,243 ======== ======== ======== Average shares: Common 611.7 612.8 630.8 Warrants 3.3 1.1 -- Assumed exercise of dilutive stock options 10.6 9.1 6.2 Incremental shares - Capital Accumulation Plan 13.2 11.8 7.0 -------- -------- -------- 638.8 634.8 644.0 ======== ======== ======== Earnings Per Share: Continuing operations $ 3.45 $ 2.43 $ 1.67 Discontinued operations 0.05 0.33 0.26 -------- -------- -------- $ 3.50 $ 2.76 $ 1.93 ======== ======== ======== Earnings per common share is computed after recognition of preferred stock dividend requirements and is based on the weighted average number of shares outstanding during the period after consideration of the dilutive effect of common stock warrants and stock options and the incremental shares assumed issued under the Capital Accumulation Plan and other restricted stock plans. Fully diluted earnings per common share, assuming conversion of all outstanding convertible preferred stock and the maximum dilutive effect of common stock equivalents have not been presented because the effects are not material. The fully diluted earnings per common share computation for the years ended December 31, 1996, 1995 and 1994 would entail adding the number of shares issuable on conversion of the dilutive convertible preferred stock (5.0 million, 14.0 million and 6.8 million shares, respectively) and the incremental dilutive effect of common stock equivalents (7.3 million, 10.5 million and 3.2 million shares, respectively) to the number of shares included in the earnings per common share calculation (resulting in 651.1 million, 659.3 million and 654.0 million shares, respectively) and eliminating the dividend requirements of the dilutive convertible preferred stock ($11 million, $21 million and $7 million, respectively). All current and prior year information has been restated to reflect the three-for-two stock split paid on May 24 and the four-for-three stock split paid on November 22, 1996. Exhibit 12.01 Travelers Group Inc. and Subsidiaries Computation of Ratio of Earnings to Fixed Charges ALL COMPANIES CONSOLIDATED (In millions of dollars)
Year ended December 31, ------------------------------------------------------ 1996 1995 1994 1993 1992 - --------------------------------------------------------------------------------------------------------------------------- Income from continuing operations before income taxes, minority interests and cumulative effect of accounting changes ............ $ 3,398 $ 2,521 $ 1,874 $ 1,523 $ 1,188 Elimination of undistributed equity earnings ..................... -- -- -- (116) (26) Pre-tax minority interest ........................................ -- -- -- (32) -- Add: Interest ....................................................... 2,259 1,956 1,284 707 674 Interest portion of rentals .................................... 107 104 134 61 38 -------- -------- -------- -------- -------- Income available for fixed charges .............................. $ 5,764 $ 4,581 $ 3,292 $ 2,143 $ 1,874 ======== ======== ======== ======== ======== Fixed charges: Interest ....................................................... $ 2,259 $ 1,956 $ 1,284 $ 707 $ 674 Interest portion of rentals .................................... 107 104 134 61 38 -------- -------- -------- -------- -------- Fixed charges .................................................... $ 2,366 $ 2,060 $ 1,418 $ 768 $ 712 ======== ======== ======== ======== ======== Ratio of earnings to fixed charges ............................... 2.44x 2.22x 2.32x 2.79x 2.63x ======== ======== ======== ======== ========
Exhibit 13.01 Travelers Group Inc. and Subsidiaries FIVE-YEAR SUMMARY OF SELECTED FINANCIAL DATA (In millions of dollars, except per share amounts)
1996 1995 1994 1993 1992 ---------- ---------- ---------- ---------- ---------- Year Ended December 31, (1) - --------------------------- Total revenues $ 21,345 $ 16,583 $ 14,943 $ 6,797 $ 5,125 ========== ========== ========== ========== ========== Income from continuing operations $ 2,300 $ 1,628 $ 1,157 $ 951 $ 756 Discontinued operations 31 206 169 -- -- Cumulative effect of accounting changes (2) -- -- -- (35) (28) ========== ========== ========== ========== ========== Net income $ 2,331 $ 1,834 $ 1,326 $ 916 $ 728 ========== ========== ========== ========== ========== Return on average common stockholders' equity (3) 19.9% 18.3% 15.6% 18.4% 20.6% At December 31, (1) - ------------------- Total assets $ 151,067 $ 113,916 $ 114,641 $ 101,290 $ 24,151 Long-term debt $ 11,327 $ 9,190 $ 7,075 $ 6,991 $ 3,951 Redeemable preferred securities of subsidiary trusts $ 1,900 -- -- -- -- Stockholders' equity (4) $ 13,085 $ 11,710 $ 8,640 $ 9,326 $ 4,229 Per common share data (5): - ------------------------- Income from continuing operations $ 3.45 $ 2.43 $ 1.67 $ 1.94 $ 1.67 Discontinued operations 0.05 0.33 0.26 -- -- Cumulative effect of accounting changes -- -- -- (0.07) (0.06) ---------- ---------- ---------- ---------- ---------- Net income $ 3.50 $ 2.76 $ 1.93 $ 1.87 $ 1.61 ========== ========== ========== ========== ========== Cash dividends per common share (5) $ 0.450 $ 0.400 $ 0.288 $ 0.245 $ 0.181 Book value per common share (5) $ 19.47 $ 17.25 $ 12.39 $ 13.03 $ 8.85 Book value per common share, excluding FAS No. 115 adjustment (4,5) $ 18.73 $ 16.06 $ 14.47 Other data: - ----------- Average number of common shares and equivalents (millions) (5) 638.8 634.8 644.0 475.6 445.6 Year-end common shares outstanding (millions) (5) 637.6 632.5 633.0 654.2 444.0 Number of full-time employees 56,200 47,600 52,000 60,000 16,000
(1) The results of Aetna P&C are included only from the date of acquisition, April 2, 1996. Results of operations prior to 1994 exclude the amounts of The Travelers Corporation (old Travelers), except that results for 1993 include the Company's equity in earnings relating to the 27% interest purchased in December 1992. Results of operations include the Shearson Businesses from July 31, 1993, the date of acquisition (see Note 2 of Notes to Consolidated Financial Statements). Data relating to financial position for 1992 exclude old Travelers and the Shearson Businesses. (2) Cumulative effect of accounting changes in 1993 represent a change in accounting for postretirement benefits other than pensions and a change in accounting for postemployment benefits. Cumulative effect of accounting changes in 1992 represent a change in accounting for income taxes. (3) The return on average common stockholders' equity is calculated using income before the cumulative effect of accounting changes after deducting preferred stock dividend requirements. (4) Stockholders' equity at December 31, 1996 and 1995 reflects $469 million and $756 million, respectively, of net unrealized gains on investment securities and at December 31, 1994 reflects $1.3 billion of net unrealized losses on investment securities, pursuant to the adoption of FAS No. 115 "Accounting for Certain Investments in Debt and Equity Securities" in 1994. (5) During 1996 the Company's Board of Directors declared stock splits payable in the form of stock dividends (three-for-two in January and four-for-three in October), which combined are the equivalent of a two-for-one stock split. Prior years' information has been restated to reflect the stock splits. Travelers Group Inc. and Subsidiaries MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL CONDITION and RESULTS of OPERATIONS Consolidated Results of Operations
Year Ended December 31, ------------------------------------ (In millions, except per share amounts) 1996 1995 1994 - ----------------------------------------------------------------------------------------------- Revenues $ 21,345 $ 16,583 $ 14,943 ========== ========== ========== Income from continuing operations $ 2,300 $ 1,628 $ 1,157 Income from discontinued operations 31 206 169 ========== ========== ========== Net income $ 2,331 $ 1,834 $ 1,326 ========== ========== ========== Earnings per share*: Continuing operations $ 3.45 $ 2.43 $ 1.67 Discontinued operations 0.05 0.33 0.26 ========== ========== ========== Net income $ 3.50 $ 2.76 $ 1.93 ========== ========== ========== Weighted average number of common shares outstanding and common stock equivalents* 638.8 634.8 644.0 ===============================================================================================
* During 1996 the Company's Board of Directors declared a three-for-two stock split in January and a four-for-three stock split in October (both payable in the form of stock dividends), which combined are the equivalent of a two-for-one stock split. Prior years' information has been restated to reflect the stock splits. Overview Consolidated results of operations include the accounts of Travelers Group Inc. (TRV) and its subsidiaries (collectively, the Company). As discussed in Note 2 of Notes to Consolidated Financial Statements, on April 2, 1996, Travelers Property Casualty Corp. (formerly Travelers/Aetna Property Casualty Corp.) (TAP), an indirect majority-owned subsidiary of TRV, acquired the domestic property and casualty insurance subsidiaries of Aetna Services Inc. (formerly Aetna Life and Casualty Company) (Aetna P&C) for approximately $4.16 billion in cash. This acquisition was financed in part by the issuance by TAP of common stock resulting in a minority interest in TAP of approximately 18%. The acquisition was accounted for under the purchase method of accounting and, accordingly, the consolidated financial statements include the results of Aetna P&C's operations only from the date of acquisition. TAP also owns The Travelers Indemnity Company (Travelers Indemnity). Travelers Indemnity along with Aetna P&C, are the primary vehicles through which the Company engages in the property and casualty insurance business. Results of Operations Income from continuing operations for the year ended December 31, 1996 was $2.300 billion compared to $1.628 billion in 1995 and $1.157 billion in 1994. Included in income from continuing operations for the years ended December 31, 1996, 1995 and 1994 are net after-tax gains (losses) of $70 million, $74 million and $(4) million, respectively, as follows: 2 1996 - ---- o $346 million (after minority interest) charge for reserve adjustments and restructuring costs related to the acquisition of Aetna P&C; o $363 million gain from the sale of Class A Common Stock by TAP; o $26 million net gain from the disposition of investment advisory affiliates; and o $27 million (after minority interest) of reported investment portfolio gains. 1995 - ---- o $13 million provision for loss on disposition of an affiliate; and o $87 million of reported investment portfolio gains. 1994 - ---- o $79 million gain on the sales of subsidiaries and affiliates; and o $83 million of reported investment portfolio losses. Excluding these items, income from continuing operations for 1996 increased $676 million to $2.230 billion, or 44%, over 1995, primarily reflecting improved performance at Smith Barney, the inclusion of the property and casualty business acquired from Aetna Services Inc. and increased earnings in the Life Insurance segment. On the same basis, income from continuing operations for 1995 increased $393 million to $1.554 billion, or 34%, over 1994, reflecting improved performance at all operating units, particularly at Smith Barney. The following discussion presents in more detail each segment's operating performance. Investment Services
Year Ended December 31, ------------------------------------------------------------------------------ 1996 1995 1994 ------------------------------------------------------------------------------ Net Net Net (millions) Revenues Income Revenues Income Revenues Income - --------------------------------------------------------------------------------------------------------------------- Smith Barney (1) $ 7,802 $ 889 $ 6,808 $ 599 $ 5,534 $ 390 Mutual funds and asset management -- -- -- -- 156 32 - --------------------------------------------------------------------------------------------------------------------- Total Investment Services $ 7,802 $ 889 $ 6,808 $ 599 $ 5,690 $ 422 =====================================================================================================================
(1) Net income for 1994 includes a $21 million after-tax gain from the sale of the interest in HG Asia. In 1994 mutual funds and asset management sub-segment included the limited partnership interest in RCM Capital Management, a California Limited Partnership (RCM) and the operations of American Capital Management & Research, Inc. (American Capital) through its date of sale in December 1994. RCM is reported as part of Corporate and Other in 1995 and through its date of sale in 1996. Smith Barney Earnings for 1996 increased 48% to $889 million compared to $599 million in 1995. This increase is attributable to continued strength in the financial markets in 1996 as the Dow Jones Industrial Average reached record levels throughout the year as well as improved performance in most product categories. Return on equity reached 34.5% for 1996, up from 24.7% for 1995 and 16.4% for 1994 (excluding the $21 million gain on HG Asia) and continues to be among the highest of Smith Barney's industry peer group. Pre-tax profit margins increased to 23.2% for 1996 compared to 18.9% in 1995 and 13.5% in 1994. Excluding the $21 million gain in 1994, Smith 2 Barney's 1995 earnings increased 63% over 1994 reflecting an improved operating environment in the securities markets during 1995. Smith Barney Revenues Year Ended December 31, - -------------------------------------------------------------------------------- (millions) 1996 1995 1994 - -------------------------------------------------------------------------------- Commissions $ 2,250 $ 2,008 $ 1,800 Asset management fees 1,349 1,052 941 Investment banking 1,148 847 680 Principal trading 990 1,016 900 Interest income, net* 419 377 329 Other income 139 134 114 - -------------------------------------------------------------------------------- Net revenues* $ 6,295 $ 5,434 $ 4,764 ================================================================================ * Net of interest expense of $1,507 million, $1,374 million and $770 million in 1996, 1995 and 1994, respectively. Revenues included in the consolidated statement of income are before deductions for interest expense. Revenues, net of interest expense, rose 16% to $6.295 billion for 1996 compared to $5.434 billion in 1995. Revenues, net of interest expense rose 14% in 1995 compared to $4.764 billion in 1994. Commission revenues increased 12% in 1996 to $2.250 billion, primarily as a result of higher activity in listed and over-the-counter securities, as well as increased insurance and annuity sales. Commission revenues increased by 12% to $2.008 billion in 1995 compared to $1.800 billion in 1994. The increase reflects higher activity in listed and over-the-counter securities and options markets, offset by declines in futures and mutual funds. Annualized retail gross production per Financial Consultant in 1996 rose 16% to $354,000. Smith Barney currently has approximately 10,400 registered Financial Consultants working out of 450 domestic retail offices. Asset management fees rose 28% in 1996 to a record $1.349 billion, reflecting growth in money market funds, mutual funds, institutional managed accounts, retail WRAP accounts, and other fee-based businesses. Internally managed assets reached a record $111.8 billion at year-end 1996, up 16% from 1995. Asset management fees were $1.052 billion in 1995 compared to $941 million in 1994. At December 31, 1995, Smith Barney had internally managed assets of $96.2 billion, up from $78.0 billion at year-end 1994. The increase in asset management revenues in 1995 also reflects fees associated with bringing in-house all the administrative functions for proprietary mutual funds and money funds during the latter part of 1995. Investment banking revenues increased 36% to $1.148 billion for 1996, reflecting strong volume in high grade debt, high yield and public finance underwritings. Investment banking revenues increased 25% to $847 million in 1995 compared to $680 million in 1994, reflecting strong volume in equity, unit trust, high yield and high grade corporate debt underwritings, as well as merger and acquisition fees. Principal trading revenues during 1996 decreased 3% to $990 million for the year compared to the 1995 period, largely as a result of a decline in taxable fixed income trading revenues and was partially offset by gains in equity trading. Principal trading revenues increased 13% to $1.016 billion in 1995 compared to $900 million in 1994, with particularly strong results in equities and taxable fixed income offset by a decline in municipal trading revenues. Net interest income reached $419 million in 1996, up 11% from the 1995 period. The increase is primarily due to increased margin lending to clients and increased taxable fixed income inventories. Net interest income was $377 million in 1995, up from $329 million in 1994, as a result of higher levels of interest-earning net assets. 3 Total expenses, excluding interest, increased 10% to $4.832 billion in 1996 as compared to $4.406 billion in 1995. This increase was primarily a result of higher production-related employee compensation and benefits expense which increased 10% to $3.522 billion in 1996 compared to $3.193 billion in 1995. Expenses other than interest and employee compensation and benefits were $1.310 billion in 1996 compared to $1.213 billion in 1995. The firm continues to focus on controlling fixed expenses, and currently has one of the industry's lowest ratios of non-compensation expense to net revenues, which stood at 20.8% for 1996. The number of non-production related employees decreased 3% during 1996. Total expenses, excluding interest, increased 7% to $4.406 billion in 1995 as compared to $4.118 billion in 1994. This increase was driven by higher production-related Financial Consultant compensation and other employee compensation and benefits expense, which increased 8% to $3.193 billion in the 1995 period, as compared to $2.953 billion in 1994. Expenses other than interest and employee compensation and benefits were $1.213 billion in the 1995 period compared to $1.165 billion in 1994. However, during 1995 the number of non-production employees and the level of fixed expenses continued the downward trend that began in the fourth quarter of 1994. Assets Under Management At December 31, ----------------------- (billions) 1996 1995 - -------------------------------------------------------------------------------- Smith Barney $ 111.8 $ 96.2 Travelers Life and Annuity (1) 21.5 22.1 - -------------------------------------------------------------------------------- Total Assets Under Management $ 133.3 $ 118.3 ================================================================================ (1) Part of the Life Insurance Services segment. Asset Quality -- Smith Barney's assets at December 31, 1996 were approximately $51.2 billion, consisting primarily of highly liquid marketable securities and collateralized receivables. About 49% of these assets were related to collateralized financing transactions where U.S. Government and mortgage-backed securities are bought, borrowed, sold and lent in generally offsetting amounts. Another 24% represented inventories of securities primarily needed to meet customer demand. A significant portion of the remainder of the assets represented receivables from brokers, dealers and customers that relate to securities transactions in the process of being settled. The carrying values of the majority of Smith Barney's securities inventories are adjusted daily to reflect current prices. See Notes 1, 6, 7 and 8 of Notes to Consolidated Financial Statements for a further description of these assets. See Note 19 of Notes to Consolidated Financial Statements for a description of Smith Barney's activities in derivative financial instruments, which it uses primarily to facilitate customer transactions. At December 31, 1996 Smith Barney's exposure to high-yield positions and "bridge" loans was not material. Smith Barney's assets to equity ratio at December 31, 1996 was 18.6 to 1 compared to 16.6 to 1 at December 31, 1995. Management believes this is a conservative leverage level and one that allows for the prospects for future growth. Smith Barney's assets are financed through a number of sources including long and short-term credit facilities, the financing transactions described above and payables to brokers, dealers and customers. Outlook -- Smith Barney's business is significantly affected by the levels of activity in the securities markets, which in turn are influenced by the level and trend of interest rates, the general state of the economy and the national and worldwide political environments, among other factors. An increasing interest rate environment could have an adverse impact on Smith Barney's businesses, including commissions (which are linked in part to the economic attractiveness of securities relative to time deposits) and investment banking (which is affected by the relative benefit to corporations and public entities of issuing public debt and/or equity versus other avenues for 4 raising capital). A declining interest rate environment could favorably influence Smith Barney's business. Smith Barney's asset management business provides a more predictable and steady income stream than its other businesses. Smith Barney continues to maintain tight expense controls which management believes will help the firm weather periodic downturns in market conditions. Consumer Finance Services
Year Ended December 31, ------------------------------------------------------------------------------ 1996 1995 1994 - ------------------------------------------------------------------------------------------------------------- Net Net Net (millions) Revenues Income Revenues Income Revenues Income - ------------------------------------------------------------------------------------------------------------- Consumer Finance Services $ 1,411 $ 223 $ 1,354 $ 246 $ 1,239 $ 227 =============================================================================================================
Despite strong growth in receivables during the second half of 1996, net income in 1996 was lower than 1995, as expected, driven by a higher provision for loan losses reflecting industry trends associated with personal bankruptcies. Consumer finance receivables rose to $8.071 billion at December 31, 1996, a 12% increase from year-end 1995. This growth occurred primarily in real estate loan and personal loan products generated by Commercial Credit's branch office network and through Primerica Financial Services (PFS). Consumer Finance net income in 1995 increased by 9% over 1994, primarily reflecting a 7% increase in average receivables outstanding highlighted by an 11% increase in personal loan average receivables outstanding, which is the highest margin product line. While total interest margin increased from the 1995 period due to the increase in the portfolio, average net interest margin declined 15 basis points in 1996 to 8.64% from 8.79% in 1995, reflecting a decline to 15.24% from 15.64% in the average yield, partially offset by a decrease in cost of funds. The decline in average yield was due to the run-off of older, higher yielding real estate loans, growth in lower yielding higher quality first mortgage real estate loans and higher levels of non-accruing personal loans. The average yield on receivables outstanding was 15.41% in 1994, and average net interest margin was 8.76%. Consumer Finance borrows from the corporate treasury operations of Commercial Credit Company (CCC), a major holding company subsidiary of TRV that raises funds externally. For fixed rate loan products, Consumer Finance is charged agreed-upon rates that generally have been set within a narrow range and approximated 7% in 1996, 1995 and 1994. For variable rate loan products, Consumer Finance is charged rates based on prevailing short-term rates. CCC's actual cost of funds may be higher or lower than rates charged to Consumer Finance, with the difference reflected in the Corporate and Other segment. Delinquencies in excess of 60 days rose to 2.38% at December 31, 1996 compared to 2.14% at December 31, 1995, versus the historically low level of 1.88% in 1994. Correspondingly, the charge-off rate, which had been at record low levels in 1994, moved higher in 1996 and 1995 -- reaching 2.91% in 1996 and 2.28% in 1995 versus 2.08% in 1994. This increase in delinquencies and charge-offs reflects a continued high level of personal bankruptcies, a national trend that shows no indication of reversing itself. The allowance for credit losses as a percentage of net outstandings was 2.97% at year-end 1996 compared to 2.66% at year-end 1995 and 2.64% at year-end 1994. The total number of offices at year-end 1996 stood at 859, which includes the addition of 10 offices from the first quarter 1996 acquisition of Hawaii-based Servco Financial Corp. During the year the Company completed its conversion of 27 existing retail offices into $.M.A.R.T.-SM- Solution Centers -- devoted exclusively to servicing the segment's growing business of underwriting real estate loans for PFS. 5 As of, or for, the Year Ended December 31, ------------------------- 1996 1995 1994 ------------------------- Allowance for credit losses as a % of net outstandings 2.97% 2.66% 2.64% Charge-off rate for the year 2.91% 2.28% 2.08% 60 + days past due on a contractual basis as a % of gross consumer finance receivables at year-end 2.38% 2.14% 1.88% Insurance subsidiaries of the Company provide credit life, health and property insurance to Consumer Finance customers. Premiums earned were $155 million in 1996, $139 million in 1995 and $115 million in 1994. The increase in premiums year-over-year is the result of growth in receivables and expanded availability of certain products in additional states. Asset Quality -- Consumer Finance assets totaled approximately $9.1 billion at December 31, 1996, of which $7.9 billion, or 87%, represented the net consumer finance receivables (including accrued interest and the allowance for credit losses). These receivables were predominantly residential real estate-secured loans and personal loans. Receivable quality depends on the likelihood of repayment. The Company seeks to reduce its risks by focusing on individual lending, making a greater number of smaller loans than would be practical in commercial markets, and maintaining disciplined control over the underwriting process. The Company has a geographically diverse portfolio as described in Note 9 of Notes to Consolidated Financial Statements. The Company believes that its loss reserves on the consumer finance receivables are appropriate given current circumstances. If the charge-off and delinquency rates continue to increase, the Company would anticipate increasing the loss reserves. Of the remaining Consumer Finance assets, approximately $755 million were investments of insurance subsidiaries, including $629 million of fixed income securities and $69 million of short-term investments with a weighted average quality rating of A1. Outlook -- The Consumer Finance results during 1996 continued to be influenced by a higher level of loan losses, as a result of a higher level of personal bankruptcies. Also, near-term earnings for Consumer Finance are expected to be affected by establishing reserves on new business and a higher level of expenses, as the Company implements additional investments in marketing, training and systems enhancements in order to capitalize on future growth opportunities. Consumer Finance is also affected by the interest rate environment and general economic conditions. Although the lower interest rate environment, should it continue, is not expected to have a material effect on Consumer Finance yields, it has resulted in modest downward pressure on interest rates charged on new receivables secured by real estate. For the Company overall, however, these trends would be offset by the lower costs of funds in such an environment. From time to time low interest rates combined with aggressive competitor pricing may increase the likelihood of prepayments of mortgages loans. This impact has been mitigated by a number of programs instituted by the Company including those designed to attract first mortgage business. Continued low interest rates could result in a reduction of the interest rates that CCC charges Consumer Finance on borrowed funds. 6 Life Insurance Services
Year Ended December 31, ------------------------------------------------------------------------------ 1996 1995 1994 - -------------------------------------------------------------------------------------------------------------------- Net Net Net (millions) Revenues Income Revenues Income Revenues Income - -------------------------------------------------------------------------------------------------------------------- Travelers Life and Annuity (1) $ 2,339 $ 371 $ 2,502 $ 330 $ 2,198 $ 211 Primerica Financial Services (2) 1,426 282 1,356 251 1,290 210 - -------------------------------------------------------------------------------------------------------------------- Total Life Insurance Services $ 3,765 $ 653 $ 3,858 $ 581 $ 3,488 $ 421 ====================================================================================================================
(1) Net income includes $11 million, $48 million and $1 million of reported investment portfolio gains in 1996, 1995 and 1994, respectively. (2) Net income includes $9 million, $20 million and $7 million of reported investment portfolio gains in 1996, 1995 and 1994, respectively, and in 1996 a portion of the gain ($4 million) from the disposition of RCM. Travelers Life and Annuity Travelers Life and Annuity consists of annuity, life and health products marketed by The Travelers Insurance Company (TIC) under the Travelers name and the individual accident and health operations of Transport Life (through September 29, 1995 -- the date of spin-off). Among the range of products offered are individual universal and term life and long-term care insurance, payout annuities and fixed and variable deferred annuities to individuals and small businesses and group pension deposit products, including guaranteed investment contracts and annuities for employer-sponsored retirement and savings plans. These products are primarily marketed through The Copeland Companies (Copeland), an indirect wholly owned subsidiary of TIC, Smith Barney Financial Consultants and a core group of approximately 500 independent agencies. The majority of the annuity business and a substantial portion of the life business written by Travelers Life and Annuity is accounted for as investment contracts, with the result that the premium deposits collected are not included in revenues. Earnings before portfolio gains increased 28% to $360 million in 1996, compared to $282 million in 1995 and 34% from 1995 to 1994. Improved earnings during 1996 were largely driven by strong investment income, reflecting repositioning of the investment portfolio over the past year. In addition, earnings benefited from the reinvestment of the proceeds from the sale of the Company's interest in MetraHealth in the 1995 fourth quarter, partially offset by the loss of earnings from Transport Life, which was spun off to TRV stockholders in September 1995. Also offsetting this increase were higher expenses, a portion of which relates to higher corporate expense allocations of amounts previously absorbed in other segments. Earnings growth attributable to strong sales of recently introduced products -- including less capital-intensive variable life insurance and annuities -- was partially offset by the gradual decline in the amount of higher margin business written several years ago. Improved sales through Copeland, Smith Barney Financial Consultants, and a nationwide network of independent agents, reflect the ongoing effort to build market share by strengthening relationships in key distribution channels. Future sales should also benefit from Standard & Poor's recently announced upgrading of The Travelers Insurance Company's claims paying ability to AA- ("Excellent"). Deferred annuity policyholder account balances and benefit reserves grew to $13.2 billion at year-end 1996, up from $11.3 billion at year-end 1995 and $9.5 billion at year-end 1994. Net written premiums and deposits, which benefited in 1996 from a continuation of the strong fourth quarter 1995 Smith Barney marketing initiative, were $1.991 billion in 1996 compared to $1.649 billion in 1995 and $1.262 billion in 1994 (excluding Transport Life). Payout and group annuity account balances and reserves declined to $10.9 billion at year-end 1996, compared to $12.0 billion at year-end 1995 and $13.6 billion at year-end 1994, reflecting run-off of low margin guaranteed 7 investment contracts written in prior years. Net written premiums and deposits (excluding those of affiliates) rose to $1.201 billion in 1996 from $1.085 billion in 1995 and $818 million in 1994. Net written premiums and deposits for individual life insurance rose 17% in 1996 to $291.4 million from $249.3 million in 1995 and $282 million in 1994 (excluding Transport Life, which was spun off in September 1995). Life insurance in force was $50.4 billion at December 31, 1996, up from $49.2 billion at year-end 1995 and $48.4 billion at year-end 1994 (excluding Transport Life). Net written premiums for the growing Long Term Care insurance line reached $127.7 million for 1996 compared to $88.2 million in 1995 and $61.3 million in 1994. Outlook -- Travelers Life and Annuity should benefit from growth in the aging population who are becoming more focused on the need to accumulate adequate savings for retirement, to protect these savings and to plan for the transfer of wealth to the next generation. Travelers Life and Annuity is well-positioned to take advantage of the favorable long-term demographic trends through its strong financial position, widespread brand name recognition and broad array of competitive life, annuity and long-term care insurance products sold through the three established distribution channels. However, competition in both product pricing and customer service is intensifying. While there has been some consolidation within the industry, other financial services organizations are increasingly involved in the sale and/or distribution of insurance products. Deregulation of the banking industry, including possible reform of restrictions on entry into the insurance business, will likely accelerate this trend. Also, the annuities business is interest sensitive, and swings in interest rates could influence sales and retention of in force policies. In order to strengthen its competitive position, Travelers Life and Annuity expects to maintain a current product portfolio, further diversify its distribution channels, and retain its healthy financial position through strong sales growth and maintenance of an efficient cost structure. Primerica Financial Services Earnings before portfolio gains and the gain on disposition of RCM increased 16% over 1995 and 14% from 1995 to 1994. This growth reflects higher sales of mutual funds and consumer loans as well as continued growth in life insurance in force and improving life insurance margins. New term life insurance sales were $52.0 billion in face amount for 1996, compared to $53.0 billion in 1995, and $57.4 billion in 1994. The number of policies issued was 247,600 in 1996, compared to 266,600 in 1995, and 299,400 in 1994, consistent with the industry-wide downturn in new life insurance sales for these periods. During this time, PFS has focused upon the strategic expansion of its business beyond life insurance and now offers a greater variety of financial products and services, delivered through its sales force. Life insurance in force at year-end 1996 reached $359.9 billion, up from $348.2 billion at year-end 1995 and $335.0 billion at year-end 1994, and continued to reflect good policy persistency. PFS has traditionally offered mutual funds to customers as a means to invest the relative savings realized through the purchase of term life insurance as compared to traditional whole life insurance. Sales of mutual funds were $2.327 billion in 1996 compared to $1.551 billion in 1995 and $1.622 billion in 1994. Approximately 37% of initial U.S. sales in 1996 were from the Smith Barney products, predominantly the Concert Series-SM- which PFS first introduced to its market in March 1996. Loan receivables from the $.M.A.R.T. (real-estate loans) and $.A.F.E. (personal loans) products of Consumer Finance, which are reflected in the assets of Consumer Finance, continued to advance during the year and were $1.524 billion at December 31, 1996 compared to $1.258 billion at December 31, 1995, and $1.107 billion at December 31, 1994. PFS's Secure property and casualty insurance product (automobile and homeowners insurance) -- issued through Travelers Property Casualty Corp. -- continues to experience healthy growth in applications and policies and currently has been introduced in 37 states. More than 6,300 agents are licensed to sell this product. 8 Outlook -- Over the last few years, programs including sales and product training were begun that are designed to maintain high compliance standards, increase the number of producing agents and customer contacts and, ultimately, increase production levels. Additionally, increased effort has been made to provide all PFS customers full access to all PFS marketed lines. Insurance in force is continuing to grow and the number of producing agents is stable. A continuation of these trends could positively influence future operations. PFS continues to expand cross-selling with other Company subsidiaries of products such as loans, mutual funds and, most recently, property and casualty insurance (automobile and homeowners). Property & Casualty Insurance Services
Year Ended December 31, ---------------------------------------------------------------------------------- 1996 1995 1994 - ------------------------------------------------------------------------------------------------------------------------ Net Net Net (millions) Revenues Income Revenues Income Revenues Income - ------------------------------------------------------------------------------------------------------------------------ Commercial Lines (1) $ 5,528 $ 215 $ 3,063 $ 343 $ 3,058 $ 146 Personal Lines (2) 2,685 281 1,482 110 1,480 103 Financing Costs and Other 11 (87) -- -- -- -- Minority Interest -- (47) -- -- -- -- - ------------------------------------------------------------------------------------------------------------------------ Total Property & Casualty Insurance Services $ 8,224 $ 362 $ 4,545 $ 453 $ 4,538 $ 249 ========================================================================================================================
(1) Net income includes $21 million and $36 million of reported investment portfolio gains in 1996 and 1995, respectively, and $73 million of reported investment portfolio losses in 1994 and $453 million of charges in 1996 related to the acquisition of Aetna P&C. (2) Net income includes $5 million of reported investment portfolio losses in 1996, $6 million of reported investment portfolio gains in 1995 and $18 million of reported investment portfolio losses in 1994. 1996 also benefits from $31 million of adjustments related to the acquisition of Aetna P&C. 1994 also includes a $19 million gain from the sale of Bankers and Shippers Insurance Company. Segment earnings include the property and casualty operations of Aetna P&C for periods subsequent to April 2, 1996. Certain production statistics related to Aetna P&C operations are provided for comparative purposes for periods prior to April 2, 1996 and are not reflected in such prior period revenues or operating results. As previously indicated, TAP incurred charges during 1996 related to the acquisition and integration of Aetna P&C. These charges resulted primarily from anticipated costs of the merger and the application of Travelers strategies, policies and practices to Aetna P&C reserves. The charges include: o $229.1 million after tax and minority interest ($430 million before tax and minority interest) in reserve increases, net of reinsurance, related primarily to cumulative injury claims other than asbestos (CIOTA); o $98.6 million after tax and minority interest ($185 million before tax and minority interest) in provisions for reinsurance recoverable and other receivables; and o $18.7 million after tax and minority interest ($35 million before tax and minority interest) provision for lease and severance costs of Travelers Indemnity related to the restructuring plan for the merger. Commercial Lines Earnings before portfolio gains/losses and acquisition-related charges increased 111% to $647 million in 1996 from $307 million in 1995, primarily reflecting income from the acquisition of Aetna P&C, the emerging benefits of expense reduction initiatives associated with the integration of the two companies and strong investment 9 income. Earnings before portfolio gains/losses increased 40% to $307 million in 1995 compared to $219 million in 1994. The improvement relative to 1994 primarily resulted from an increase in net investment income and improved loss trends in the workers' compensation line. Commercial Lines net written premiums were $4.084 billion in 1996 (excluding a one-time adjustment associated with a reinsurance transaction) compared to $2.309 billion in 1995 and $2.391 billion in 1994. Premium equivalents for 1996 were $2.596 billion compared to $2.821 billion in 1995 and $2.990 billion in 1994. Premium equivalents, which are associated largely with National Accounts, represent estimates of premiums that customers would have been charged under a fully insured arrangement and do not represent actual premium revenues. On a combined total basis including Aetna P&C (for periods prior to April 2, 1996 for comparative purposes only), Commercial Lines net written premiums for 1996 totaled $4.690 billion, compared to $5.144 billion for 1995 and $5.481 billion in 1994. These decreases reflect the highly competitive marketplace and the Company's selective underwriting. On the same combined total basis, premium equivalents for 1996 totaled $2.712 billion, compared to $3.458 billion in 1995. The decrease in premium equivalents reflects a depopulation of involuntary pools as the loss experience of workers' compensation improves and insureds move to voluntary markets, the Company's selective renewal activity to address the competitive pricing environment and its continued success in lowering workers' compensation losses of customers. Premium equivalents of $2.990 billion for 1994 does not include Aetna P&C. (Historically, Aetna P&C did not track premium equivalents and such amounts are not available for 1994). A significant component of Commercial Lines is National Accounts, which works with national brokers and regional agents providing insurance coverages and services, primarily workers' compensation, mainly to large corporations. National Accounts also includes the alternative market business which covers primarily workers' compensation products and services. National Accounts' net written premiums for 1996 (excluding a one-time adjustment associated with a reinsurance transaction) were $803 million compared to $703 million in 1995 and $835 million in 1994. The 1996 increase reflects the acquisition of Aetna P&C, partially offset by the Company's selective renewal activity and the highly competitive marketplace. The 1995 decline reflects selective renewal activity in response to the competitive pricing environment and the highly competitive marketplace. National Account premium equivalents were $2.526 billion in 1996 compared to $2.779 billion in 1995 and $2.959 billion in 1994. The decrease in premium equivalents in 1996 and 1995 reflects a depopulation of involuntary pools as the loss experience of workers' compensation improves and insureds move to voluntary markets, the Company's selective renewal activity in response to the competitive pricing environment and its continued success in lowering workers' compensation losses of customers. On a combined total basis including Aetna P&C (for periods prior to April 2, 1996 for comparative purposes only), National Accounts net written premiums of $874 million in 1996 decreased $318 million from 1995. Net written premiums of $1.192 billion in 1995 decreased $312 million from 1994. The 1996 and 1995 decreases reflect the Company's selective renewal activity and the highly competitive marketplace. On the same combined total basis, National Accounts premium equivalents of $2.625 billion for 1996 were $733 million below 1995. The decrease in premium equivalents in 1996 reflects a depopulation of involuntary pools as the loss experience of workers' compensation improves and insureds move to voluntary markets, the Company's selective renewal activity to address the competitive pricing environment and its continued success in lowering workers' compensation losses of customers. For 1996 National Accounts new business, including both premiums and premium equivalents, was $389 million compared to $444 million in 1995 and $325 million in 1994. This decrease, despite the Aetna acquisition, is due to the highly competitive marketplace. The National Accounts business retention ratio dropped to 82% in 1996 from 84% in 1995 and 88% in 1994. The new business and retention ratio declines in 1996 reflect the Company's selective renewal activity and the highly competitive marketplace. 10 Commercial Accounts serves mid-sized businesses through a network of independent agents and brokers. Commercial Accounts' net written premiums were $1.485 billion in 1996 compared to $730 million in 1995 and $791 million in 1994. The increase in 1996 compared to 1995 reflects the acquisition of Aetna P&C, marginally offset by the highly competitive market, where Commercial Accounts has continued to be more selective in renewal activity. Programs designed to leverage underwriting experience in specific industries have demonstrated continued growth. Commercial Accounts premium equivalents were $69 million in 1996 compared to $41 million in 1995 and $31 million in 1994. On a combined total basis including Aetna P&C (for periods prior to April 2, 1996 for comparative purposes only), Commercial Accounts net written premiums of $1.725 billion for 1996 were $137 million below 1995 premium levels, which were $266 million below 1994 premium levels. The decrease in 1996 and 1995 in net written premiums is due to the highly competitive marketplace, the Company's selective underwriting and the continued softness in guaranteed cost products. The decrease in 1995 compared to 1994 in net written premiums was partly offset by the continued growth in Commercial Accounts' industry-specific programs and in retrospectively rated policies and other loss-responsive products. On the same combined total basis, Commercial Accounts premium equivalents of $87 million in 1996 were $13 million below 1995 due to the competitive marketplace. During 1996, new business in Commercial Accounts was $360 million compared to $269 million in 1995 and $207 million in 1994. The 1996 increase in new businesses is due to the acquisition of Aetna P&C. The Commercial Accounts business retention ratio was 72% in 1996 compared to 73% in 1995 and 79% in 1994. These retention ratios reflect Commercial Accounts selective underwriting policy. Commercial Accounts continues to focus on industry specific programs which meet strict underwriting guidelines. Select Accounts serves small businesses through a network of independent agents. Select Accounts net written premiums were $1.191 billion in 1996 compared to $542 million in 1995 and $466 million in 1994. The increase in 1996 reflects the acquisition of Aetna P&C. On a combined total basis including Aetna P&C (for periods prior to April 2, 1996 for comparative purposes only), Select Accounts net written premiums of $1.412 billion for 1996 were $54 million lower than 1995. This decrease reflects the highly competitive marketplace and the Company's selective underwriting. Select Accounts net written premiums of $1.466 billion for 1995 were $173 million above 1994 premium levels, due primarily to an increase in new business. New premium business in Select Accounts was $276 million in 1996 compared to $131 million in 1995 and $112 million in 1994. The 1996 increase in new premium business is due to the acquisition of Aetna P&C. The Select Accounts business retention ratio was 78% in 1996 compared to 75% in 1995 and 73% in 1994. The increase in the 1996 business retention ratio reflects the industry and product line expertise of the combined company. Specialty Accounts markets products to national, midsize and small customers and distributes them through both wholesale brokers and retail agents and brokers throughout the United States. Specialty Accounts net written premiums were $605 million in 1996 compared to $334 million in 1995 and $299 million in 1994. The growth in 1996 is primarily attributable to the acquisition of the Aetna P&C Bond business, the net written premiums of which were $210 million since the date of acquisition. On a combined total basis including Aetna P&C (for periods prior to April 2, 1996 for comparative purposes only), Specialty Accounts net written premiums for 1996 were $679 million compared to $624 million in 1995, and was $556 million in 1994. The 1996 increase compared to 1995 is due to increases in directors' and officers' liability insurance and errors and omissions coverages. Catastrophe losses, net of tax and reinsurance, were $31 million in 1996 compared to $7 million in 1995 and $30 million in 1994. Catastrophe losses in 1996 were primarily due to Hurricane Fran and December storms on the West Coast. The 1994 catastrophe losses were due to winter storms in the first quarter of 1994. 11 The statutory combined ratio for Commercial Lines for 1996 was 128.1% compared to 105.0% in 1995 and 124.7% in 1994. The GAAP combined ratio for Commercial Lines for 1996 was 125.4% compared to 102.2% in 1995 and 107.9% in 1994. GAAP combined ratios for Commercial Lines differ from statutory combined ratios primarily due to differences in reporting of revenues and expenses related to service business, including servicing of residual market pools and deductible policies. In addition, in 1996, GAAP combined ratios for Commercial Lines differ from statutory combined ratios due to certain purchase accounting adjustments recorded in connection with the Aetna P&C acquisition resulting in a charge to statutory expenses, but not GAAP expenses. The increase in the 1996 statutory and GAAP combined ratios for Commercial Lines compared to 1995 was primarily attributable to the charges taken in 1996 related to the acquisition and integration of Aetna P&C. Excluding these amounts, the statutory and GAAP combined ratios before policyholder dividends for 1996 would have been 109.3% and 109.6%, respectively. The increase in the 1996 statutory and GAAP combined ratios excluding acquisition-related charges compared to the 1995 statutory and GAAP combined ratios is primarily due to the inclusion in 1996 of Aetna P&C's results. Aetna P&C historically has had a higher underwriting expense ratio, partially offset by a lower loss and LAE ratio, that reflects the mix of business including the favorable effect of the lower loss and LAE ratio of the Bond business. The 1994 statutory combined ratio includes a statutory charge of $225 million for reserve increases for environmental claims and for a reduction of ceded reinsurance balances. Excluding this charge, the statutory combined ratio for 1994 was 114.2%. The improvement in the 1995 combined ratios compared to the adjusted 1994 combined ratios was due to the first quarter 1994 catastrophe losses and favorable loss development in certain workers' compensation lines and residual markets in 1995. Personal Lines Earnings before portfolio gains/losses and acquisition-related adjustments increased 145% to $255 million in 1996 from $104 million in 1995, primarily reflecting the post-acquisition results of operations of Aetna P&C, approximately $70 million of favorable prior year loss development in personal automobile bodily injury lines, the continued benefit of expense reduction initiatives and higher net investment income. Earnings before portfolio gains/losses were $104 million in 1995 compared to $102 million in 1994. Expense reduction initiatives and higher net investment income contributed to the increase in earnings in 1995 relative to 1994, largely offset by benefits from favorable prior year loss reserve development in 1994 in the personal automobile line of business. In addition, 1994 benefited from a one-time contribution of $9 million from the favorable resolution of the New Jersey Market Transition Facility (MTF) deficit as well as earnings from Bankers and Shippers Insurance Company (Bankers and Shippers) which was sold in October 1994. Net written premiums for 1996 were $2.359 billion, compared to $1.298 billion in 1995 and $1.433 billion in 1994. The 1996 increase compared to 1995 primarily reflects the acquisition of Aetna P&C and, to a lesser extent, growth in target markets, partially offset by reductions due to catastrophe management strategies. The 1995 decline of $135 million compared to 1994 was attributable to the sale of Bankers and Shippers in October 1994. Excluding Bankers and Shippers business, net written premiums for 1995 were up approximately 8% from 1994, reflecting reduced reinsurance ceded and targeted growth in sales through independent agents. On a combined total basis including Aetna P&C (for periods prior to April 2, 1996 for comparative purposes only), Personal Lines net written premiums for 1996 totaled $2.675 billion, up $132 million from $2.543 billion in 1995. This increase on a combined basis reflects continued growth in targeted automobile and homeowners markets, partially offset by reductions due to catastrophe management strategies. Catastrophe losses, net of taxes and reinsurance, were $58 million in 1996 compared to $12 million in 1995 and $26 million in 1994. Catastrophe losses in 1996 were primarily due to Hurricane Fran, as well as severe first quarter winter storms and second quarter hail and wind storms. Catastrophe losses in 1994 were primarily due to the severe winter storms in the Northeast during the first quarter. 12 The statutory combined ratio for Personal Lines in 1996 was 97.6% compared to 104.4% in 1995 and 100.4% in 1994. The GAAP combined ratio for Personal Lines in 1996 was 94.9% compared to 103.6% in 1995 and 100.5% in 1994. In 1996, GAAP combined ratios for Personal Lines differ from statutory combined ratios primarily due to certain purchase accounting adjustments recorded in connection with the Aetna P&C acquisition resulting in a charge to statutory expenses, but not GAAP expenses. The 1996 statutory and GAAP combined ratios for Personal Lines include a benefit resulting from the Company's review of reserves associated with the acquisition of Aetna P&C. Excluding this item, the 1996 statutory and GAAP combined ratios were 100.1% and 97.4%, respectively. The decrease in the 1996 statutory and GAAP combined ratios excluding this item is predominantly due to the favorable prior year loss development, primarily in the automobile bodily injury line, partially offset by higher catastrophe losses. The lower ratio in 1994 compared to 1995 was primarily due to the benefit of favorable loss reserve development and the favorable resolution of the MTF deficit in 1994. Financing Costs and Other The primary component for 1996 was interest expense of $77 million after tax, reflecting financing costs associated with the acquisition of Aetna P&C. Outlook -- Property & Casualty A variety of factors continue to affect the property and casualty insurance market and the Company's core business outlook, including the competitive pressures affecting pricing and profitability, inflation in the cost of medical care, litigation and losses from involuntary markets. Commercial Lines will continue to focus on its core product lines and markets, with particular emphasis on both product and industry specialization. This includes specific industry program marketing efforts in Commercial Accounts and product offerings in Specialty Accounts. In most of Commercial Lines, pricing did not improve in 1996. For Commercial Accounts and Select Accounts, the soft underwriting cycle continues to pressure the pricing of guaranteed cost products, as pricing trends have not kept pace with loss cost inflation in recent years. The Company's focus is to retain existing profitable business and obtain new accounts where it can maintain its selective underwriting policy. National Accounts premiums are primarily loss sensitive and therefore less affected by these pricing pressures. The market for National Accounts guaranteed cost products is very competitive and has resulted in a decline in the Company's new business. The Company will continue to adhere to strict guidelines to maintain high quality underwriting. The Company's adherence to its selective underwriting criteria has had an adverse effect on premium levels during the last two years and, if the competitive pressures on pricing do not improve in 1997, it may continue to affect future premium levels unfavorably. The Company believes that the competitive pricing environment for Commercial Lines is not likely to improve in 1997. Personal Lines strategy includes the control of operating expenses to improve competitiveness and profitability, growth in sales through independent agents in target markets, expansion of alternative marketing channels to broaden the distribution of Personal Lines products, and a reduction of exposure to catastrophe losses. In order to reduce its exposure to catastrophe losses, the Company has limited the writing of new homeowners business and selectively non-renewed existing homeowners business in certain markets, tightened underwriting standards and implemented price increases in certain hurricane-prone areas, subject to restrictions imposed by insurance regulatory authorities, and introduced new policy forms in certain markets to limit the Company's exposure to earthquake losses. The property and casualty insurance industry in the United States continues to consolidate. The Company's strategic objectives are to enhance its position as a consistently profitable market leader and to become a low-cost provider of property and casualty insurance in the United States, as the industry consolidates. 13 In relation to the Company's objective of being a low-cost provider of property and casualty insurance, cost reductions and enhanced productivity efforts are expected to continue. These efforts include reducing overhead expenses, integrating Aetna P&C to make it more consistent with the decentralized, streamlined structure of the Company, and eliminating redundant expenses between the two companies. The Company is approximately two-thirds of the way toward its objective of achieving $300 million in annual cost savings in the first two years after the Aetna P&C acquisition. Environmental Claims The Company continues to receive claims alleging liability exposures arising out of insureds' alleged disposition of toxic substances. These claims when submitted rarely indicate the monetary amount being sought by the claimant from the insured and the Company does not keep track of the monetary amount being sought in those few claims which indicated such a monetary amount. The Company's review and investigation of such claims includes an assessment of the probable liability, available coverage, judicial interpretations and historical value of similar claims. In addition, the unique facts presented in each claim are evaluated individually and collectively. Due consideration is given to the many variables presented in each claim, such as: the nature of the alleged activities of the insured at each site; the allegations of environmental damage at each site; the number of sites; the total number of potentially responsible parties at each site; the nature of environmental harm and the corresponding remedy at a site; the nature of government enforcement activities at each site; the ownership and general use of each site; the overall nature of the insurance relationship between the Company and the insured; the identification of other insurers; the potential coverage available, if any; the number of years of coverage, if any; the obligation to provide a defense to insureds, if any; and the applicable law in each jurisdiction. The Company's reserves for environmental claims are not established on a claim-by-claim basis. An aggregate bulk reserve is carried for all of the Company's environmental claims that are in the dispute process until the dispute is resolved. This bulk reserve is established and adjusted based upon the aggregate volume of in-process environmental claims and the Company's experience in resolving such claims. At December 31, 1996, approximately 12% of the net environmental loss reserve (i.e., approximately $146 million) consists of case reserve for resolved claims. The balance, approximately 88% of the net aggregate reserve (i.e. approximately $1.096 billion), is carried in a bulk reserve and includes incurred but not yet reported environmental claims for which the Company has not received any specific claims. The following table displays activity for environmental losses and loss expenses and reserves for the three years ended December 31, 1996. 14 Environmental Losses (millions) 1996 1995 1994 -------- -------- -------- Beginning reserves: Direct $ 454 $ 482 $ 504 Ceded (50) (11) (13) -------- -------- -------- Net 404 471 491 Acquisition of Aetna P&C: Direct 968 -- -- Ceded (39) -- -- Incurred losses and loss expenses: Direct 114 117 54 Ceded (52) (61) (5) Losses paid: Direct 167 145 76 Ceded (14) (22) (7) -------- -------- -------- Ending reserves: Direct 1,369 454 482 Ceded (127) (50) (11) ======== ======== ======== Net $ 1,242 $ 404 $ 471 ======== ======== ======== The duration of the Company's investigation and review of such claims and the extent of time necessary to determine an appropriate estimate, if any, of the value of the claim to the Company, varies significantly and is dependent upon a number of factors. These factors include, but are not limited to, the cooperation of the insured in providing claim information, the pace of underlying litigation or claim processes, the pace of coverage litigation between the insured and the Company and the willingness of the insured and the Company to negotiate, if appropriate, a resolution of any dispute between them pertaining to such claims. Since the foregoing factors vary from claim to claim and insured by insured, the Company cannot provide a meaningful average of the duration of an environmental claim. However, based upon the Company's experience in resolving such claims, the duration may vary from months to several years. The industry does not have a standard method of calculating claim activity for environmental losses. Generally for environmental claims, Travelers Indemnity and its subsidiaries (Travelers P&C) establishes a claim file for each insured on a per site, per claimant basis. If there is more than one claimant such as a federal and a state agency, this method will result in two claims being set up for a policyholder at that one site. Similarly, if one hundred claimants file a lawsuit against ten policyholders alleging injury as a result of the discharge of wastes or pollutants, one thousand claims would be established. Travelers P&C adheres to this method of calculating claim activity on all environmental- related claims, whether such claims are tendered on primary, excess or umbrella policies. As of December 31, 1996, Travelers P&C had approximately 30,800 pending environmental-related claims tendered by 664 active policyholders. The pending environmental-related claims represent federal or state EPA-type claims as well as plaintiffs' claims alleging bodily injury and property damage due to the discharge of waste or pollutants. In 1996, the pending inventory increased by approximately 20,000 claims as a result of several lawsuits being filed in the states of Louisiana and Texas. These lawsuits filed against one or more policyholders of Travelers P&C allege that the plaintiffs were injured or damaged as a result of either alleged waste disposal or the alleged release of deleterious substances from ongoing business operations, which have taken 15 place near the plaintiffs' residences. Claims of this nature have historically been considered in the level of environmental reserves. To date, in total Travelers P&C has resolved environmental-related claims on behalf of 1,628 policyholders. The Company is preparing a claims system conversion which when completed will apply Travelers P&C's method of establishing claim files to Aetna P&C's environmental-related claims. The Company anticipates that this process should be completed in 1997. As of December 31, 1996, Aetna P&C had pending environmental-related claims tendered by approximately 948 active policyholders. Approximately 129 of these 948 active policyholders are also included in the 664 active Travelers P&C policyholders. Aetna P&C's policyholders, like those of Travelers P&C, have tendered both EPA-type claims and individual claims alleging injury or damage as a result of the discharge of wastes or pollutants. To date, Aetna P&C has resolved environmental-related claims on behalf of 1,870 policyholders. To date, the Company generally has been successful in resolving its coverage litigation and continues to reduce its potential exposure through favorable settlements with certain insureds. These settlement agreements with certain insureds are based on the variables presented in each piece of coverage litigation. Generally the settlement dollars paid in disputed coverage claims are a percentage of the total coverage sought by such insureds. In addition, with respect to settlement of many of the environmental claims, the agreement between the Company and the insured extinguishes any obligation the Company may have under any policy issued to the insured for future environmental liabilities risks. This form of settlement is commonly referred to as a "buy-back" of policies for future environmental liability risks. Additional provisions of these agreements include the appropriate indemnities and hold harmless provisions to protect the Company. The Company's general purpose in executing such agreements is to reduce its potential environmental exposure and eliminate both the risks presented by coverage litigation with the insured and the cost of such litigation. Asbestos Claims In the area of asbestos claims, the Company believes that the property and casualty insurance industry has suffered from judicial interpretations that have attempted to maximize insurance availability from both a coverage and liability standpoint far beyond the intent of the contracting parties. These policies generally were issued prior to the 1980s. The Company continues to receive asbestos claims alleging insureds' liability from claimants' asbestos-related injuries. These claims, when submitted, rarely indicate the monetary amount being sought by the claimant from the insured and the Company does not keep track of the monetary amount being sought in those few claims which indicated such a monetary amount. Originally the cases involved mainly plant workers and traditional asbestos manufacturers and distributors. However, in the mid-1980s, a new group of plaintiffs, whose exposure to asbestos was less direct and whose injuries were often speculative, began to file lawsuits in increasing numbers against the traditional defendants as well as peripheral defendants who had produced products that may have contained small amounts of some form of encapsulated asbestos. These claims continue to arise and on an individual basis generally involve smaller companies with smaller limits of potential coverage. Also, there has emerged a group of non-product claims by plaintiffs, mostly independent labor union workers, mainly against companies, alleging exposure to asbestos while working at these companies' premises. In addition, various insurers, including the Company, remain defendants in an action brought in Philadelphia regarding potential consolidation and resolution of future asbestos bodily injury claims. In summary, various classes of asbestos defendants, such as major product manufacturers, peripheral and regional product defendants as well as premises owners, are tendering asbestos-related claims to the industry. Because each insured presents different liability and coverage issues, the Company evaluates those issues on an insured-by-insured basis. The Company's evaluations have not resulted in any meaningful data from which an average asbestos defense or indemnity payment may be determined. The varying defense and indemnity payments made by the Company on behalf of its insureds also have precluded the Company from deriving any meaningful data by which it can predict 16 whether its defense and indemnity payments for asbestos claims (on average or in the aggregate) will remain the same or change in the future. Based upon the Company's experience with asbestos claims, the duration period of an asbestos claim from the date of submission to resolution is approximately two years. At December 31, 1996, approximately 25% of the net aggregate reserve (i.e., approximately $263 million) is for pending asbestos claims. The balance, approximately 75% (i.e., approximately $810 million) of the net asbestos reserves represents incurred but not yet reported losses for which the Company has not received any specific claims. The following table displays activity for asbestos losses and loss expenses and reserves for the three years ended December 31, 1996. In general, the Company posts case reserves for pending asbestos claims within approximately 30 business days of receipt of such claims. Asbestos Losses (millions) 1996 1995 1994 -------- -------- -------- Beginning reserves: Direct $ 695 $ 702 $ 775 Ceded (293) (319) (381) -------- -------- -------- Net 402 383 394 Acquisition of Aetna P&C: Direct 801 -- -- Ceded (121) -- -- Incurred losses and loss expenses: Direct 120 109 67 Ceded (35) (66) (16) Losses paid: Direct 173 116 140 Ceded (79) (92) (78) -------- -------- -------- Ending reserves: Direct 1,443 695 702 Ceded (370) (293) (319) ======== ======== ======== Net $ 1,073 $ 402 $ 383 ======== ======== ======== The largest reinsurer of the Company's asbestos risks is Lloyd's of London (Lloyd's). In 1996, Lloyd's restructured its operations with respect to claims for years prior to 1993. The Company is in arbitration with underwriters at Lloyd's in New York State to enforce reinsurance contracts with respect to recoveries for certain asbestos claims. The dispute involves the ability of the Company to aggregate asbestos claims under a market agreement between Lloyd's and the Company or under the applicable reinsurance treaties. The outcome of the arbitration referred to above is uncertain and the impact, if any, on collectibility of amounts recoverable by the Company from Lloyd's cannot be quantified at this time. However, the Company believes that it is not likely that the outcome of this matter could have a material adverse effect on the Company's results of operations, financial condition or liquidity. 17 Uncertainty Regarding Adequacy of Environmental and Asbestos Reserves It is difficult to estimate the reserves for environmental and asbestos-related claims due to the vagaries of court coverage decisions, plaintiffs' expanded theories of liability, the risks inherent in major litigation and other uncertainties. Conventional actuarial techniques are not used to estimate such reserves. For environmental claims, the Company estimates its financial exposure and establishes reserves based upon an analysis of its historical claim experience and the facts of the individual underlying claims. The unique facts presented in each claim are evaluated individually and collectively. Due consideration is given to the many variables presented in each claim, as discussed above. The following factors are evaluated in projecting the ultimate reserve for asbestos-related claims: available insurance coverage; limits and deductibles; an analysis of each policyholder's potential liability; jurisdictional involvement; past and projected future claim activity; past settlement values of similar claims; allocated claim adjustment expense; potential role of other insurance, and applicable coverage defenses, if any. Once the gross ultimate exposure for indemnity and allocated claim adjustment expense is determined for a policyholder by policy year, a ceded projection is calculated based on any applicable facultative and treaty reinsurance. In addition, a similar review is conducted for asbestos property damage claims. However, due to the relatively minor claim volume, these reserves have remained at a constant level. As a result of these processes and procedures, the reserves carried for environmental and asbestos claims at December 31, 1996 are the Company's best estimate of ultimate claims and claim adjustment expenses based upon known facts and current law. However, the environment surrounding the final resolution of these claims continues to change. Currently, it is not possible to predict changes in the legal and legislative environment and their impact on the future development of asbestos and environmental claims. Such development will be affected by future court decisions and interpretations and changes in Superfund and other legislation. Because of these future unknowns, additional liabilities may arise for amounts in excess of the current reserves. These additional amounts, or a range of these additional amounts, cannot now be reasonably estimated, and could result in a liability exceeding reserves by an amount that would be material to the Company's operating results in a future period. However, the Company believes that is not likely that these claims will have a material adverse effect on the Company's financial condition or liquidity. Cumulative Injury Other Than Asbestos (CIOTA) Claims CIOTA claims are generally submitted to the Company under general liability policies and often involve an allegation by a claimant against an insured that the claimant has suffered injuries as a result of long-term or continuous exposure to potentially harmful products or substances. Such potentially harmful products or substances include, but are not limited to, lead paint, pesticides, pharmaceutical products, silicone-based personal products, solvents and other deleterious substances. Due to claimants' allegations of long-term bodily injury in CIOTA claims, numerous complex issues regarding such claims are presented. The claimant's theories of liability must be evaluated, evidence pertaining to a causal link between injury and exposure to a substance must be reviewed, the potential role of other causes of injury must be analyzed, the liability of other defendants must be explored, and assessment of a claimant's damages must be made and the law of the jurisdiction must be applied. In addition, the Company must review the number of policies issued by the Company to the insured and whether such policies are triggered by the allegations, the terms and limits of liability of such policies, the obligations of other insurers to respond to the claim, and the applicable law in each jurisdiction. To the extent disputes exist between the Company and a policyholder regarding the coverage available for CIOTA claims, the Company resolves the disputes, where feasible, through settlements with the policyholder or through coverage litigation. Generally, the terms of a settlement agreement set forth the nature of the Company's participation in resolving CIOTA claims and the scope of coverage to be provided by the Company and contain the appropriate indemnities and hold harmless provisions to protect the Company. These settlements generally eliminate uncertainties for the Company regarding the risks extinguished, including the risk that losses would be greater than anticipated due 18 to evolving theories of tort liability or unfavorable coverage determinations. The Company's approach also has the effect of determining losses at a date earlier than would have occurred in the absence of such settlement agreements. On the other hand, in cases where future developments are favorable to insurers, this approach could have the effect of resolving claims for amounts in excess of those that would ultimately have been paid had the claims not been settled in this manner. No inference should be drawn that because of the Company's method of dealing with CIOTA claims, its reserves for such claims are more conservatively stated than those of other insurers. Aetna P&C did not distinguish CIOTA from other general liability claims or treat CIOTA claims as a special class of claims. In addition, there were substantial differences in claims approach and resolution between the Company and Aetna P&C regarding CIOTA claims. During the second quarter, the Company completed its review of Aetna P&C's exposure to CIOTA claims in order to determine an appropriate level of reserves using the Company's approach as described above. Based on the results of that review, the Company's general liability insurance reserves were increased $360 million, net of reinsurance ($192 million after tax and minority interest). At December 31, 1996, approximately 19% of the net aggregate reserve (i.e., approximately $215 million) is for pending CIOTA claims. The balance, approximately 81% (i.e., approximately $899 million) of the net CIOTA reserves represents incurred but not yet reported losses for which the Company has not received any specific claims. The following table displays activity for CIOTA losses and loss expenses and reserves for the three years ended December 31, 1996. In general, the Company posts case reserves for pending CIOTA claims within approximately 30 business days of receipt of such claims. CIOTA Losses (millions) 1996 1995 1994 -------- -------- -------- Beginning reserves: Direct $ 374 $ 375 $ 377 Ceded -- -- -- -------- -------- -------- Net 374 375 377 Acquisition of Aetna P&C: Direct 709 -- -- Ceded (293) -- -- Incurred losses and loss expenses: Direct 565 21 16 Ceded (155) -- -- Losses paid: Direct 88 22 18 Ceded (2) -- -- -------- -------- -------- Ending reserves: Direct 1,560 374 375 Ceded (446) -- -- ======== ======== ======== Net $ 1,114 $ 374 $ 375 ======== ======== ======== 19 Outlook - Industry Changes in the general interest rate environment affect the return received by the insurance subsidiaries on newly invested and reinvested funds. While a rising interest rate environment enhances the returns available, it reduces the market value of existing fixed maturity investments and the availability of gains on disposition. A decline in interest rates reduces the returns available on investment of funds but could create the opportunity for realized investment gains on disposition of fixed maturity investments. As required by various state laws and regulations, the Company's insurance subsidiaries are subject to assessments from state-administered guaranty associations, second injury funds and similar associations. Management believes that such assessments will not have a material impact on the Company's results of operations, financial condition or liquidity. Certain social, economic and political issues have led to an increased number of legislative and regulatory proposals aimed at addressing the cost and availability of certain types of insurance. While most of these provisions have failed to become law, these initiatives may continue as legislators and regulators try to respond to public availability and affordability concerns and the resulting laws, if any, could adversely affect the Company's ability to write business with appropriate returns. The National Association of Insurance Commissioners (NAIC) adopted risk-based capital (RBC) requirements for life insurance companies and for property and casualty insurance companies. The RBC requirements are to be used as early warning tools by the NAIC and states to identify companies that merit further regulatory action. The formulas have not been designed to differentiate among adequately capitalized companies that operate with levels of capital higher than RBC requirements. Therefore, it is inappropriate and ineffective to use the formulas to rate or to rank such companies. At December 31, 1996 and 1995, all of the Company's life and property & casualty companies had adjusted capital in excess of amounts requiring any regulatory action. Asset Quality - The investment portfolio of the insurance services segments which include both Life Insurance and Property & Casualty Insurance totaled approximately $55 billion, representing 61% of total insurance services' assets of approximately $90 billion. Because the primary purpose of the investment portfolio is to fund future policyholder benefits and claims payments, the Company employs a conservative investment philosophy. The fixed maturity portfolio totaled $43 billion, comprised of $36 billion of publicly traded fixed maturities and $7 billion of private fixed maturities. The weighted average quality ratings of the segment's publicly traded fixed maturity portfolio and private fixed maturity portfolio at December 31, 1996 were Aa3 and Baa1, respectively. Included in the fixed maturity portfolio was approximately $1.7 billion of below investment grade securities. Investments in venture capital investments, highly leveraged transactions, and specialized lendings were not material in the aggregate. The insurance services segment makes investments in collateralized mortgage obligations (CMOs). Such CMOs typically have high credit quality, offer good liquidity, and provide a significant advantage in yield and total return compared to U.S. Treasury securities. The investment strategy of the Insurance Services segment is to purchase CMO tranches that are protected against prepayment risk, including planned amortization class (PAC) tranches. Prepayment protected tranches are preferred because they provide stable cash flows in a variety of scenarios. The segment does invest in other types of CMO tranches if a careful assessment indicates a favorable risk/return tradeoff; however, it does not purchase residual interests in CMOs. At December 31, 1996, the segment held CMOs with a market value of $4.6 billion. Approximately 84% of CMO holdings are fully collateralized by GNMA, FNMA or FHLMC securities, and the balance is fully collateralized by portfolios of individual mortgage loans. In addition, the segment held $3.7 billion of GNMA, FNMA or FHLMC mortgage-backed pass-through securities. Virtually all of these securities are rated AAA. At December 31, 1996, real estate and mortgage loan investments totaled $4.5 billion. Most of these investments are included in the investment portfolio of the insurance companies. The Company is continuing its strategy to 20 dispose of these real estate assets and some of the mortgage loans and to reinvest the proceeds to obtain current market yields. At December 31, mortgage loan and real estate portfolios consisted of the following: (millions) 1996 1995 -------- -------- Current mortgage loans $ 3,721 $ 3,796 Underperforming mortgage loans 91 252 -------- -------- Total mortgage loans 3,812 4,048 -------- -------- Real estate held for sale 695 321 ======== ======== Total mortgage loans and real estate $ 4,507 $ 4,369 ======== ======== Mortgage loans and real estate held for sale at December 31, 1996 include $811 million and $136 million, respectively, from the Aetna P&C acquisition. Underperforming mortgage loans include delinquent loans, loans in the process of foreclosure and loans modified at interest rates below market terms. The new terms typically defer a portion of contract interest payments to varying future periods. The accrual of interest is suspended on all restructured loans, and interest income is reported only as payment is received. Of the total real estate held for sale, $134 million is underperforming. For further information relating to investments, see Note 5 of Notes to Consolidated Financial Statements. Corporate and Other
Year Ended December 31, -------------------------------------------------------------------------- 1996 1995 1994 -------------------------------------------------------------------------- Net Net Net Income Income Income (millions) Revenues (Expense) Revenues (Expense) Revenues (Expense) - ---------------------------------------------------------------------------------------------------------- Net expenses (1) $ (211) $ (238) $ (201) Net gain (loss) on sale of stock of subsidiaries and affiliates 384 (13) 39 - ---------------------------------------------------------------------------------------------------------- Total Corporate and Other $ 143 $ 173 $ 18 $ (251) $ (12) $ (162) ==========================================================================================================
(1) Includes $9 million and $23 million, respectively, of reported investment portfolio losses in 1996 and 1995. Corporate and Other consists of corporate staff and treasury operations, certain corporate income and expenses that have not been allocated to the operating subsidiaries, and certain intersegment eliminations. The decrease in net expenses (before reported portfolio losses) in 1996 over 1995 is primarily attributable to lower staff expenses in the corporate segment including the allocation of additional expenses to other operating segments offset by increased interest costs associated with higher debt levels in 1996. The increase in net expenses (before reported portfolio losses) in 1995 over 1994 is primarily attributable to increased interest costs borne at the corporate level resulting from higher average short-term borrowing rates in 21 1995 when compared to 1994 as well as a shift in debt mix to higher levels of senior long-term debt over the course of 1995. Discontinued Operations Year Ended December 31, -------------------------------------- (millions) 1996 1995 1994 -------------------------------------- Net Income Net Income Net Income - -------------------------------------------------------------------------------- Operations $ -- $ 76 $ 160 Gain on disposition 31 130 9 - -------------------------------------------------------------------------------- Total Discontinued Operations $ 31 $ 206 $ 169 ================================================================================ As discussed in Note 3 of Notes to Consolidated Financial Statements, all of the businesses sold to Metropolitan Life Insurance Company (MetLife) or contributed to The MetraHealth Companies, Inc. (MetraHealth) have been classified as discontinued operations. In 1995, the Company's results reflect the medical business not yet transferred, plus its equity interest in the earnings of MetraHealth. Gain on disposition in 1995 represents a gain of $20 million from the sale in January of the Company's group life insurance business to MetLife, and a gain of $110 million (not including a contingency payment based on 1995 results which was received by the Company in 1996) from the sale in October of the Company's interest in MetraHealth to United HealthCare Corporation. During 1996 the Company received the contingency payment recognizing an after tax gain of $31 million. Gain on disposition in 1994 represents the gain from the sale in December of the group dental insurance business to MetLife. Liquidity and Capital Resources TRV services its obligations primarily with dividends and other advances that it receives from subsidiaries. The subsidiaries' dividend paying abilities are limited by certain covenant restrictions in credit agreements and/or by regulatory requirements. TRV believes it will have sufficient funds to meet current and future commitments. Each of TRV's major operating subsidiaries finances its operations on a stand-alone basis consistent with its capitalization and ratings. Travelers Group Inc. (TRV) TRV issues commercial paper directly to investors and maintains unused credit availability under committed revolving credit agreements at least equal to the amount of commercial paper outstanding. TRV, CCC and TIC have an agreement with a syndicate of banks to provide $1.0 billion of revolving credit, to be allocated to any of TRV, CCC or TIC. The participation of TIC in this agreement is limited to $250 million. The revolving credit facility consists of a five-year revolving credit facility which expires in June 2001. At December 31, 1996, $250 million was allocated to TRV, $650 million was allocated to CCC, and $100 million to TIC. At December 31, 1996 there were no borrowings outstanding under this facility. Under this facility the Company is required to maintain a certain level of consolidated stockholders' equity (as defined in the agreement). The Company exceeded this requirement by approximately $4.3 billion at December 31, 1996. As of December 31, 1996, TRV had unused credit availability of $250 million under the five-year revolving credit facility. TRV may borrow under its revolving credit facilities at various interest rate options and compensates the banks for the facilities through commitment fees. 22 In October 1996, Travelers Capital I, a subsidiary trust of TRV, issued $400 million of 8.00% Trust Preferred Securities in a public offering. These Trust Preferred Securities, which are fully and unconditionally guaranteed by TRV, have a liquidation value of $25 per Trust Preferred Security and are mandatorily redeemable under certain circumstances. In December 1996, Travelers Capital II, a subsidiary trust of TRV, issued $400 million of 7 3/4% Trust Preferred Securities in a public offering and Travelers Capital III, a subsidiary trust of TRV, issued $200 million of 7 5/8% Trust Preferred Securities in a public offering. These Trust Preferred Securities, which are fully and unconditionally guaranteed by TRV, have a liquidation value of $1,000 per Trust Preferred Security and are mandatorily redeemable under certain circumstances. TRV as of March 4, 1997 had $1.0 billion available for debt offerings under its shelf registration statements. Commercial Credit Company (CCC) CCC also issues commercial paper directly to investors and maintains unused credit availability under committed revolving credit agreements at least equal to the amount of commercial paper outstanding. As of December 31, 1996, CCC had unused credit availability of $2.150 billion under five-year revolving credit facilities, including the $650 million referred to above. CCC may borrow under its revolving credit facilities at various interest rate options and compensates the banks for the facilities through commitment fees. CCC is limited by covenants in its revolving credit agreements as to the amount of dividends and advances that may be made to TRV or its affiliated companies. At December 31, 1996, CCC would have been able to remit $308 million to its parent under its most restrictive covenants. During 1996 and through March 4, 1997 CCC completed the following long-term debt offerings, leaving $550 million available for debt offerings and $400 million available for trust preferred security offerings under its shelf registration statements: o 5 7/8% Notes due January 15, 2003...................... $200 million o 5.55% Notes due February 15, 2001..................... $200 million o 6 5/8% Notes due November 15, 2006..................... $200 million o 6.20% Notes due November 15, 2001..................... $200 million In addition to the long-term debt offerings above, in October 1996 CCC, through a private placement, issued $200 million of 6.45% Notes due October 18, 2006 which by their terms can be put to CCC at par on October 18, 1999. Travelers Property Casualty Corp. (TAP) On April 2, 1996, Travelers Property Casualty Corp. (TAP), an indirect majority-owned subsidiary of the Company, purchased from Aetna Services Inc. all of the outstanding capital stock of The Aetna Casualty and Surety Company (ACSC) and The Standard Fire Insurance Company (SFIC) (collectively, Aetna P&C) for approximately $4.16 billion in cash. TAP also owns Travelers Indemnity. Travelers Indemnity along with Aetna P&C are the primary vehicles through which the Company engages in the property and casualty insurance business. See Note 2 of Notes to Consolidated Financial Statements regarding the financing of the Aetna P&C purchase. In addition to financing the Aetna P&C purchase, in September 1996 TAP sold in a public offering $200 million of 6 3/4% Notes due September 1, 1999 and in October an additional $200 million of 6 1/4% Notes due October 1, 1999 and in November an additional $150 million of 6 3/4% Notes due November 15, 2006. As discussed in Note 2 of Notes to Consolidated Financial Statements, during the first quarter of 1996 TAP entered into a five-year revolving credit facility in the amount of $2.65 billion with a syndicate of banks. The Credit Facility was used to finance in part the purchase of Aetna P&C. All borrowings under the Credit Facility have been repaid in full. The Credit Facility was subsequently amended to extend the maturity to December 2001 and reduce the amount 23 available to $500 million, none of which is currently utilized. Under the Credit Facility TAP is required to maintain a certain level of consolidated stockholders' equity (as defined in the agreement). At December 31, 1996, this requirement was exceeded by approximately $2.8 billion. TAP also issues commercial paper directly to investors and maintains unused credit availability under the committed revolving credit agreement at least equal to the amount of commercial paper outstanding. TAP's insurance subsidiaries are subject to various regulatory restrictions that limit the maximum amount of dividends available to be paid to their parent without prior approval of insurance regulatory authorities. Dividend payments to TAP from its insurance subsidiaries are limited to $647 million in 1997 without prior approval of the Connecticut Insurance Department. TAP as of March 4, 1997, had $750 million available for debt offerings under its shelf registration statement. Smith Barney Holdings Inc. (Smith Barney) Smith Barney funds its day-to-day operations through the use of commercial paper, collateralized and uncollateralized bank borrowings (both committed and uncommitted), internally generated funds, repurchase transactions, and securities lending arrangements. The volume of Smith Barney's borrowings generally fluctuates in response to changes in the amount of reverse repurchase transactions outstanding, the level of securities inventories, customer balances and securities borrowing transactions. Smith Barney has a $1.0 billion revolving credit agreement with a bank syndicate that extends through May 1999, and has a $500 million, 364-day revolving credit agreement with a bank syndicate that extends through May 1997. Any amounts outstanding on the 364-day revolving credit agreement's termination date of May 1997 are due in May 1998. As of December 31, 1996, there were no borrowings outstanding under either facility. Smith Barney also has substantial borrowing arrangements consisting of facilities that it has been advised are available, but where no contractual lending obligation exists. Smith Barney, through its subsidiary Smith Barney Inc., issues commercial paper directly to investors. As a policy, Smith Barney maintains sufficient borrowing power of unencumbered securities to cover uncollateralized borrowings and uncollateralized letters of credit. In addition, Smith Barney monitors its leverage and capital ratios on a daily basis. Smith Barney is limited by covenants in its revolving credit facility as to the amount of dividends that may be paid to TRV. At December 31, 1996, Smith Barney would have been able to remit approximately $659 million to TRV under its most restrictive covenants. During 1996 and through March 4, 1997 Smith Barney completed the following long-term debt offerings leaving $1.0 billion available for debt offerings under its shelf registration statements: o 5 7/8% Notes due February 1, 2001................... $250 million o S&P 500 Equity Linked Notes due August 13, 2001...... $40 million o 7 1/8% Notes due October 1, 2006.................... $200 million o 6 5/8% Notes due November 15, 2003.................. $200 million Securities Borrowed, Loaned and Subject to Repurchase Agreements Smith Barney engages in "matched book" transactions in government and mortgage-backed securities as well as "conduit" transactions in corporate equity and debt securities. These transactions are similar in nature. A "matched book" transaction involves a security purchased under an agreement to resell (i.e., reverse repurchase transaction) and simultaneously sold under an agreement to repurchase (i.e., repurchase transaction). A "conduit" transaction involves the borrowing of a security from a counterparty and the simultaneous lending of the security to another counterparty. These transactions are reported gross in the Consolidated Statement of Financial Position and typically yield interest spreads, generally ranging from 10 to 30 basis points. The interest spread results from the net of interest received on the reverse repurchase or security borrowed transaction and the interest paid on the 24 corresponding repurchase or security loaned transaction. Interest rates charged or credited in these activities are usually based on current Federal Funds rates but can fluctuate based on security availability and other market conditions. The size of balance sheet positions resulting from these activities can vary significantly, depending primarily on levels of activity in the bond markets, but would have a relatively smaller impact on net income. The Travelers Insurance Company (TIC) At December 31, 1996, TIC had $21.9 billion of life and annuity product deposit funds and reserves. Of that total, $11.6 billion is not subject to discretionary withdrawal based on contract terms. The remaining $10.3 billion is for life and annuity products that are subject to discretionary withdrawal by the contractholder. Included in the amount that is subject to discretionary withdrawal are $1.7 billion of liabilities that are surrenderable with market value adjustments. Also included are an additional $5.4 billion of the life insurance and individual annuity liabilities which are subject to discretionary withdrawals, and have an average surrender charge of 5.0%. In the payout phase, these funds are credited at significantly reduced interest rates. The remaining $3.2 billion of liabilities are surrenderable without charge. More than 11% of these relate to individual life products. These risks would have to be underwritten again if transferred to another carrier, which is considered a significant deterrent against withdrawal by long-term policyholders. Insurance liabilities that are surrendered or withdrawn are reduced by outstanding policy loans and related accrued interest prior to payout. Scheduled maturities of guaranteed investment contracts (GICs) in 1997, 1998, 1999, 2000 and 2001 are $1.4 billion, $482 million, $459 million, $218 million and $66 million, respectively. At December 31, 1996, the interest rates credited on GICs had a weighted average rate of 6.25%. TIC issues commercial paper to investors and maintains unused committed, revolving credit facilities at least equal to the amount of commercial paper outstanding. As of December 31, 1996, TIC had unused credit availability of $100 million under the joint five-year revolving credit facility referred to above. TIC is subject to various regulatory restrictions that limit the maximum amount of dividends available to its parent without prior approval of the Connecticut Insurance Department. A maximum of $507 million of statutory surplus is available in 1997 for such dividends without Department approval. Deferred Income Taxes The Company has a net deferred tax asset which relates to temporary differences that are expected to reverse as net ordinary deductions. The Company will have to generate approximately $5.9 billion of taxable income, before the reversal of the temporary differences, primarily over the next 10 to 15 years, to realize the remainder of the deferred tax asset. Management expects to realize the remainder of the deferred tax asset based upon its expectation of future taxable income, after the reversal of these deductible temporary differences, of at least $1.5 billion annually. Future Application of Accounting Standards In June 1996, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 125 (FAS No. 125), "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." FAS No. 125 provides accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities. These standards are based on consistent application of a financial-components approach that focuses on control. Under that approach, after a transfer of financial assets, an entity recognizes the financial and servicing assets it controls and the liabilities it has incurred, derecognizes financial assets when control has been surrendered and derecognizes liabilities when extinguished. FAS No. 125 provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings. The requirements of FAS No. 125 are effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after December 31, 1996, and are to be applied prospectively. However, in December 1996 the FASB issued FAS No. 127, "Deferral of the Effective Date of Certain Provisions of FASB Statement No. 125," which delays until January 1, 1998 the effective date for certain provisions. The adoption of the provisions of this statement effective January 1, 1997 will not have a material impact on results of 25 operations, financial condition or liquidity and the Company is currently evaluating the impact of the provisions whose effective date has been delayed until January 1, 1998. 26 Travelers Group Inc. and Subsidiaries Consolidated Statement of Income (In millions of dollars, except per share amounts)
Year Ended December 31, 1996 1995 1994 - --------------------------------------------------------------------------------------------- Revenues Insurance premiums $ 7,633 $ 4,977 $ 5,144 Commissions and fees 3,422 2,874 2,526 Interest and dividends 5,549 4,355 3,401 Finance related interest and other charges 1,163 1,119 1,030 Principal transactions 990 1,016 900 Asset management fees 1,349 1,052 1,010 Other income 1,239 1,190 932 - --------------------------------------------------------------------------------------------- Total revenues 21,345 16,583 14,943 - --------------------------------------------------------------------------------------------- Expenses Policyholder benefits and claims 7,366 5,017 5,227 Non-insurance compensation and benefits 3,768 3,442 3,241 Insurance underwriting, acquisition and operating 3,013 1,912 1,867 Interest 2,259 1,956 1,284 Provision for consumer finance credit losses 260 171 152 Other operating 1,678 1,544 1,524 - --------------------------------------------------------------------------------------------- Total expenses 18,344 14,042 13,295 - --------------------------------------------------------------------------------------------- Gain (loss) on sale of subsidiaries and affiliates 397 (20) 226 - --------------------------------------------------------------------------------------------- Income before income taxes and minority interest 3,398 2,521 1,874 Provision for income taxes 1,051 893 717 Minority interest, net of income taxes 47 -- -- - --------------------------------------------------------------------------------------------- Income from continuing operations 2,300 1,628 1,157 - --------------------------------------------------------------------------------------------- Discontinued operations, net of income taxes: Income from operations (net of taxes of $17 and $87) -- 76 160 Gain on disposition (net of taxes of $17, $66 and $19) 31 130 9 - --------------------------------------------------------------------------------------------- Income from discontinued operations 31 206 169 - --------------------------------------------------------------------------------------------- Net income $ 2,331 $ 1,834 $ 1,326 ============================================================================================= Net income per share of common stock and common stock equivalents: Continuing operations $ 3.45 $ 2.43 $ 1.67 Discontinued operations 0.05 0.33 0.26 - --------------------------------------------------------------------------------------------- Net income per share of common stock and common stock equivalents $ 3.50 $ 2.76 $ 1.93 ============================================================================================= Weighted average number of common shares outstanding and common stock equivalents (in millions) 638.8 634.8 644.0 =============================================================================================
See Notes to Consolidated Financial Statements. 27 Travelers Group Inc. and Subsidiaries Consolidated Statement of Financial Position (In millions of dollars)
December 31, 1996 1995 - --------------------------------------------------------------------------------------------------------------------- Assets Cash and cash equivalents (including $1,256 and $1,072 segregated under federal and other brokerage regulations) $ 1,868 $ 1,866 Investments and real estate held for sale: Fixed maturities, primarily available for sale at market value 43,998 30,712 Equity securities, at market value 1,157 856 Mortgage loans 3,812 4,048 Real estate held for sale 695 321 Policy loans 1,910 1,888 Short-term and other 5,173 3,140 - --------------------------------------------------------------------------------------------------------------------- Total investments and real estate held for sale 56,745 40,965 - --------------------------------------------------------------------------------------------------------------------- Securities borrowed or purchased under agreements to resell 25,280 19,601 Brokerage receivables 7,305 6,559 Trading securities owned, at market value 12,465 8,984 Net consumer finance receivables 7,885 7,092 Reinsurance recoverables 10,234 6,461 Value of insurance in force and deferred policy acquisition costs 2,563 2,172 Cost of acquired businesses in excess of net assets 2,933 1,928 Separate and variable accounts 9,023 6,949 Other receivables 4,869 3,564 Other assets 9,897 7,775 - --------------------------------------------------------------------------------------------------------------------- Total assets $ 151,067 $ 113,916 ===================================================================================================================== Liabilities Investment banking and brokerage borrowings $ 3,217 $ 2,955 Short-term borrowings 1,557 1,468 Long-term debt 11,327 9,190 Securities loaned or sold under agreements to repurchase 24,449 20,619 Brokerage payables 5,809 4,403 Trading securities sold not yet purchased, at market value 8,378 4,563 Contractholder funds 13,621 14,535 Insurance policy and claims reserves 43,944 26,920 Separate and variable accounts 8,949 6,916 Accounts payable and other liabilities 14,702 10,469 - --------------------------------------------------------------------------------------------------------------------- Total liabilities 135,953 102,038 - --------------------------------------------------------------------------------------------------------------------- ESOP Preferred stock - Series C (net of note guarantee of $35 and $67) 129 168 - --------------------------------------------------------------------------------------------------------------------- TRV-obligated mandatorily redeemable preferred securities of subsidiary trusts holding solely junior subordinated debt securities of TRV 1,000 -- - --------------------------------------------------------------------------------------------------------------------- TAP-obligated mandatorily redeemable preferred securities of subsidiary trusts holding solely junior subordinated debt securities of TAP 900 -- - --------------------------------------------------------------------------------------------------------------------- Stockholders' equity Preferred stock ($1.00 par value; authorized shares: 30 million), at aggregate liquidation value 675 800 Common stock ($.01 par value; authorized shares: 1.5 billion; issued shares: 1996 - 743,082,134 and 1995 - 736,303,838) 7 7 Additional paid-in capital 7,217 6,782 Retained earnings 7,452 5,503 Treasury stock, at cost (1996 - 105,503,401 shares and 1995 - 103,848,847 shares) (2,446) (1,835) Unrealized gain (loss) on investment securities 469 756 Other, principally unearned compensation (289) (303) - --------------------------------------------------------------------------------------------------------------------- Total stockholders' equity 13,085 11,710 - --------------------------------------------------------------------------------------------------------------------- Total liabilities and stockholders' equity $ 151,067 $ 113,916 =====================================================================================================================
See Notes to Consolidated Financial Statements. 28 Travelers Group Inc. and Subsidiaries Consolidated Statement of Changes in Stockholders' Equity (In millions of dollars)
Amounts Shares (in thousands) ---------------------------------- ----------------------------------- Year Ended December 31, 1996 1995 1994 1996 1995 1994 ---------------------------------- ----------------------------------- Preferred stock at aggregate liquidation value Balance, beginning of year $ 800 $ 800 $ 800 11,200 11,200 11,200 Conversion of Series B preferred stock to common stock (125) (2,500) - -------------------------------------------------------------------------------------------- ----------------------------------- Balance, end of year 675 800 800 8,700 11,200 11,200 ============================================================================================ =================================== Common stock and additional paid-in capital Balance, beginning of year 6,789 6,659 6,570 736,304 736,352 736,534 Conversion of Series B preferred stock to common stock 125 6,802 Issuance of shares pursuant to employee benefit plans 355 130 85 Other (45) 4 (24) (48) (182) - -------------------------------------------------------------------------------------------- ----------------------------------- Balance, end of year 7,224 6,789 6,659 743,082 736,304 736,352 ============================================================================================ =================================== Retained earnings Balance, beginning of year 5,503 4,199 3,140 Net income 2,331 1,834 1,326 Common dividends (287) (255) (181) Preferred dividends (95) (86) (86) Distribution of Transport Holdings Inc. shares (189) - -------------------------------------------------------------------------------------------- Balance, end of year 7,452 5,503 4,199 - -------------------------------------------------------------------------------------------- Treasury stock, at cost Balance, beginning of year (1,835) (1,553) (1,121) (103,849) (103,369) (82,309) Issuance of shares pursuant to employee benefit plans, net of shares tendered for payment of option exercise price and withholding taxes (18) 136 111 15,679 17,928 10,636 Treasury stock acquired (593) (418) (543) (17,333) (18,408) (31,752) Other 56 - -------------------------------------------------------------------------------------------- ----------------------------------- Balance, end of year (2,446) (1,835) (1,553) (105,503) (103,849) (103,369) ============================================================================================ =================================== Unrealized gain (loss) on investment securities Balance, beginning of year 756 (1,319) 30 Net change in unrealized gains and losses on investment securities, net of tax (287) 2,075 (1,349) - -------------------------------------------------------------------------------------------- Balance, end of year 469 756 (1,319) - -------------------------------------------------------------------------------------------- Other, principally unearned compensation Balance, beginning of year (303) (146) (93) Net issuance of restricted stock (305) (221) (190) Restricted stock amortization 206 175 136 Adjustment for minimum pension liability, net of tax 114 (114) Net translation adjustments, net of tax (1) 3 1 - -------------------------------------------------------------------------------------------- Balance, end of year (289) (303) (146) - -------------------------------------------------------------------------------------------- Total common stockholders' equity and common shares outstanding 12,410 10,910 7,840 637,579 632,455 632,983 ============================================================================================ =================================== Total stockholders' equity $ 13,085 $ 11,710 $ 8,640 ============================================================================================
See Notes to Consolidated Financial Statements. 29 Travelers Group Inc. and Subsidiaries Consolidated Statement of Cash Flows (In millions of dollars)
Year Ended December 31, 1996 1995 1994 - ------------------------------------------------------------------------------------------------------------------------------------ Cash flows from operating activities Income from continuing operations before income taxes and minority interest $ 3,398 $ 2,521 $ 1,874 Adjustments to reconcile income from continuing operations before income taxes and minority interest to net cash provided by (used in) operating activities: Amortization of deferred policy acquisition costs and value of insurance in force 1,192 803 812 Additions to deferred policy acquisition costs (1,388) (858) (994) Depreciation and amortization 342 304 297 Provision for consumer finance credit losses 260 171 152 Changes in: Trading securities, net 334 (1,821) (572) Securities borrowed, loaned and repurchase agreements, net (1,849) 4,590 (363) Brokerage receivables net of brokerage payables 660 (1,725) 724 Insurance policy and claims reserves (309) 686 350 Other, net 269 (508) (1,707) Net cash flows provided by (used in) operating activities of discontinued operations -- (415) 323 - ------------------------------------------------------------------------------------------------------------------------------------ Net cash provided by operations 2,909 3,748 896 Income taxes paid (572) (563) (378) - ------------------------------------------------------------------------------------------------------------------------------------ Net cash provided by operating activities 2,337 3,185 518 - ------------------------------------------------------------------------------------------------------------------------------------ Cash flows from investing activities Consumer loans originated or purchased (3,410) (2,748) (2,789) Consumer loans repaid or sold 2,534 2,245 2,094 Purchases of fixed maturities and equity securities (29,246) (18,123) (9,057) Proceeds from sales of investments and real estate: Fixed maturities available for sale and equity securities 23,471 12,864 4,149 Mortgage loans 200 739 402 Real estate and real estate joint ventures 257 256 955 Proceeds from maturities of investments: Fixed maturities 3,586 2,723 3,319 Mortgage loans 1,050 693 1,301 Other investments, primarily short-term, net (325) (408) (58) Contingent consideration payment for the Shearson Businesses (110) (76) (69) Business acquisition (4,160) -- -- Business divestments 196 -- 679 Other, net (334) (236) (284) Net cash flows provided by (used in) investing activities of discontinued operations 48 1,623 (303) - ------------------------------------------------------------------------------------------------------------------------------------ Net cash provided by (used in) investing activities (6,243) (448) 339 - ------------------------------------------------------------------------------------------------------------------------------------ Cash flows from financing activities Dividends paid (382) (341) (267) Issuance of preferred stock of subsidiaries 1,900 -- -- Subsidiary's sale of Class A common stock 1,453 -- -- Treasury stock acquired (593) (418) (543) Stock tendered for payment of withholding taxes (201) (94) (42) Issuance of long-term debt 2,940 3,525 1,150 Payments and redemptions of long-term debt (768) (1,375) (1,033) Net change in short-term borrowings (including investment banking and brokerage borrowings) 351 (2,431) 865 Contractholder fund deposits 2,493 2,707 1,958 Contractholder fund withdrawals (3,262) (3,755) (3,358) Other, net (23) 84 30 Net cash flows provided by financing activities of discontinued operations -- -- 84 - ------------------------------------------------------------------------------------------------------------------------------------ Net cash provided by (used in) financing activities 3,908 (2,098) (1,156) - ------------------------------------------------------------------------------------------------------------------------------------ Change in cash and cash equivalents 2 639 (299) Cash and cash equivalents at beginning of period 1,866 1,227 1,526 - ------------------------------------------------------------------------------------------------------------------------------------ Cash and cash equivalents at end of period $ 1,868 $ 1,866 $ 1,227 - ------------------------------------------------------------------------------------------------------------------------------------ Supplemental disclosure of cash flow information: Cash paid during the period for interest $ 2,221 $ 1,930 $ 1,227 ====================================================================================================================================
See Notes to Consolidated Financial Statements. 30 Travelers Group Inc. and Subsidiaries Notes to Consolidated Financial Statements 1. Summary of Significant Accounting Policies ------------------------------------------ Basis of Presentation Principles of Consolidation. The consolidated financial statements include the accounts of Travelers Group Inc. (TRV) and its subsidiaries (collectively, the Company). On April 2, 1996, Travelers Property Casualty Corp. (formerly Travelers/Aetna Property Casualty Corp.) (TAP), an indirect majority-owned subsidiary of the Company, purchased from Aetna Services Inc. (formerly Aetna Life and Casualty Company) (Aetna), all of the outstanding capital stock of The Aetna Casualty and Surety Company (ACSC) and The Standard Fire Insurance Company (SFIC) (collectively, Aetna P&C) for approximately $4.16 billion in cash. The acquisition was accounted for under the purchase method of accounting and, accordingly, the consolidated financial statements include the results of Aetna P&C's operations only from the date of acquisition. TAP also owns The Travelers Indemnity Company (Travelers Indemnity). Travelers Indemnity along with Aetna P&C are the primary vehicles through which the Company engages in the property and casualty insurance business. Unconsolidated entities in which the Company has at least a 20% interest are accounted for on the equity method. The minority interest in 1996 represents the interest in TAP held by the private and public investors. (See Note 2.) Significant intercompany transactions and balances have been eliminated. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Certain reclassifications have been made to prior years' financial statements to conform to the current year's presentation. Accounting Changes FAS 121. Effective January 1, 1996, the Company adopted Statement of Financial Accounting Standards (FAS) No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." This statement establishes accounting standards for the impairment of long-lived assets and certain identifiable intangibles to be disposed of. This statement requires a write down to fair value when long-lived assets to be held and used are impaired. The statement also requires that long-lived assets to be disposed of (e.g. real estate held for sale) be carried at the lower of cost or fair value less cost to sell, and does not allow such assets to be depreciated. The adoption of this standard did not have a material impact on results of operations, financial condition or liquidity. FAS 123. In October 1995, the Financial Accounting Standards Board (FASB) issued FAS No. 123, "Accounting for Stock-Based Compensation." FAS No. 123 establishes financial accounting and reporting standards for stock-based employee compensation plans as well as transactions in which an entity issues its equity instruments to acquire goods or services from non-employees. This statement defines a fair value-based method of accounting for employee stock options or similar equity instruments, and encourages all entities to adopt this method of accounting for all employee stock compensation plans. However, it also allows an entity to continue to measure compensation cost for those plans using the intrinsic value-based method of accounting prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (Opinion 25). Entities electing to remain with the accounting method prescribed in Opinion 25 must make pro forma disclosures of net income and earnings per share, as if the fair value-based method of accounting defined by FAS No. 123 had been applied. FAS No. 123 is applicable to fiscal years beginning after December 15, 1995. The Company has elected to continue to account for its stock-based compensation plans using the accounting method prescribed by Opinion 25 and has 31 Notes to Consolidated Financial Statements (continued) included in the Notes to Consolidated Financial Statements the pro forma disclosures required by FAS No. 123. (See Note 15.) Accounting Policies Cash and cash equivalents include cash on hand, cash segregated under federal and brokerage regulations and short-term highly liquid investments with maturities of three months or less when purchased, other than those held for sale in the ordinary course of business. These short-term investments are carried at cost plus accrued interest, which approximates market value. Investments are owned principally by the insurance subsidiaries. Fixed maturities include bonds, notes and redeemable preferred stocks. Equity securities include common and non-redeemable preferred stocks. Fixed maturities classified as "held to maturity" represent securities that the Company has both the ability and the intent to hold until maturity and are carried at amortized cost. Fixed maturity securities classified as "available for sale" and equity securities are carried at market values that are based primarily on quoted market prices or if quoted market prices are not available, discounted expected cash flows using market rates commensurate with the credit quality and maturity of the investment. The difference between amortized cost and market values of such securities net of applicable income taxes is reflected as a component of stockholders' equity. Real estate held for sale is carried at the lower of cost or fair value less estimated costs to sell. Fair value was established at the time of foreclosure by internal analysis or external appraisers, using discounted cash flow analyses and other acceptable techniques. Thereafter, an allowance for losses on real estate held for sale is established if the carrying value of the property exceeds its current fair value less estimated costs to sell. There was no such allowance at December 31, 1996 or 1995. Mortgage loans are carried at amortized cost. A mortgage loan is considered impaired when it is probable that the Company will be unable to collect principal and interest amounts due. For mortgage loans that are determined to be impaired, a reserve is established for the difference between the amortized cost and fair value of the underlying collateral. In estimating fair value, the Company uses interest rates reflecting the higher returns required in the current real estate financing market. Impaired loans were not significant at December 31, 1996 and 1995. Policy loans are carried at unpaid balances which do not exceed the net cash surrender value of the related insurance policies. Short-term investments, consisting primarily of money market instruments and other debt issues purchased with a maturity of less than one year, are carried at cost plus accrued interest which approximates market. Realized gains and losses on sales of investments and unrealized losses considered to be other than temporary, determined on a specific identification basis, are included in other income. Accrual of income is suspended on fixed maturities or mortgage loans that are in default, or on which it is likely that future interest payments will not be made as scheduled. Interest income on investments in default is recognized only as payment is received. Investments included in the Consolidated Statement of Financial Position that were non-income producing for the preceding 12 months were not significant. The cost of acquired businesses in excess of net assets (goodwill) is being amortized on a straight-line basis principally over a 40-year period. The carrying amount is regularly reviewed for indicators of impairment in value, which in the view of management are other than temporary. Impairments are recognized in operating results if a permanent diminution in value is deemed to have occurred. Income taxes have been provided for in accordance with the provisions of FAS No. 109, "Accounting for Income Taxes." The Company and its wholly owned domestic non-life insurance subsidiaries file a consolidated federal income tax return. All but one of the life insurance subsidiaries are included in their own consolidated federal income tax return. Deferred income taxes result from temporary differences between the tax basis of assets and liabilities and their recorded amounts for financial reporting purposes. Income taxes are not provided for on the Company's life insurance subsidiaries' retained earnings designated as "policyholders' surplus" because such taxes will become payable only to the extent such retained earnings are distributed as a dividend or exceed limits prescribed by federal law. Distributions are not contemplated from this 32 Notes to Consolidated Financial Statements (continued) portion of the life insurance companies' retained earnings, which aggregated $971 million (subject to a tax effect of $340 million) at December 31, 1996. Subsidiary stock issuance. The Company recognizes gains (losses) on sales of stock by subsidiaries. For the year ended December 31, 1996, included in net income is a gain of $363 million from the sale by TAP of 18% of its common stock. Earnings per common share is computed after recognition of preferred stock dividend requirements and is based on the weighted average number of shares outstanding during the period after consideration of the dilutive effect of common stock warrants and stock options and the incremental shares assumed issued under the Capital Accumulation Plan and other restricted stock plans. Fully diluted earnings per common share, assuming conversion of all outstanding convertible preferred stock, notes, debentures and the maximum dilutive effect of common stock equivalents, has not been presented because the effects are not material. The fully diluted earnings per common share computation for the years ended December 31, 1996, 1995 and 1994 would entail adding the additional common stock equivalents (7 million, 10 million and 3 million shares, respectively) and the assumed conversion of the convertible preferred stock (5 million, 14 million and 7 million shares, respectively) to the number of shares included in the earnings per common share calculation (resulting in a total of 651 million, 659 million and 654 million shares, respectively) and the elimination of the convertible preferred stock dividends ($11 million, $21 million and $7 million, respectively). During 1996 the Company's Board of Directors declared a three-for-two stock split in January and a four-for-three stock split in October (both payable in the form of stock dividends), which combined are the equivalent of a two-for-one stock split. Prior years' information has been restated to reflect the stock splits. Financial Instruments -- Disclosures. Included in the Notes to Consolidated Financial Statements are various disclosures relating to financial instruments having off-balance sheet risk. These disclosures indicate the magnitude of the Company's involvement in such activities, and reflect the instruments at their face, contract or notional amounts. The Notes to Consolidated Financial Statements also include various disclosures relating to the methods and assumptions used to estimate fair value of each material type of financial instrument. The carrying value of short-term financial instruments approximates fair value because of the relatively short period of time between the origination of the instruments and their expected realization. The carrying value of receivables and payables arising in the ordinary course of business approximates fair market value. The fair value assumptions were based upon subjective estimates of market conditions and perceived risks of the financial instruments at a certain point in time. Disclosed fair values for financial instruments do not reflect any premium or discount that could result from offering for sale at one time the Company's entire holdings of a particular financial instrument. Potential taxes and other expenses that would be incurred in an actual sale or settlement are not reflected in amounts disclosed. Derivative Financial Instruments. Information concerning derivative financial instruments and the accounting policies related thereto is included in Note 19. Future Application of Accounting Standards In June 1996, the FASB issued FAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." FAS No. 125 provides accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities. These standards are based on consistent application of a financial-components approach that focuses on control. Under that approach, after a transfer of financial assets, an entity recognizes the financial and servicing assets it controls and the liabilities it has incurred, derecognizes financial assets when control has been surrendered and derecognizes liabilities when extinguished. FAS No. 125 provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings. The requirements of FAS No. 125 are effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after December 31, 1996, and are to be applied 33 Notes to Consolidated Financial Statements (continued) prospectively. However, in December 1996 the FASB issued FAS No. 127, "Deferral of the Effective Date of Certain Provisions of FASB Statement No. 125" which delays until January 1, 1998 the effective date for certain provisions. Earlier or retroactive application is not permitted. The adoption of the provisions of this statement effective January 1, 1997 will not have a material impact on results of operations, financial condition or liquidity and the Company is currently evaluating the impact of the provisions whose effective date has been delayed until January 1, 1998. INVESTMENT SERVICES Commissions related to security transactions, underwriting revenues and related expenses are recognized in income on the trade date. Management and investment advisory fees are recorded as income for the period in which the services are performed. Securities borrowed and securities loaned are recorded at the amount of cash advanced or received. With respect to securities loaned, the Company receives cash collateral in an amount in excess of the market value of securities loaned. The Company monitors the market value of securities borrowed and loaned on a daily basis with additional collateral obtained as necessary. Repurchase and resale agreements are treated as collateralized financing transactions and are carried at the amounts at which the securities will be subsequently reacquired or resold, including accrued interest, as specified in the respective agreements. The Company's policy is to take possession of securities purchased under agreements to resell. The market value of securities to be repurchased and resold is monitored, and additional collateral is requested where appropriate to protect against credit exposure. Trading securities are carried at market value. Included in income are realized and unrealized gains and losses on trading securities and proprietary futures, forward and option contracts. Other assets include the value of management advisory contracts, which is being amortized on the straight-line method over periods ranging from twelve to twenty years. INSURANCE SERVICES Premiums from long-duration contracts, principally life insurance, are earned when due. Premiums from short-duration insurance contracts are earned over the related contract period. Short-duration contracts include primarily property and casualty, credit life and accident and health policies, including estimated ultimate premiums on retrospectively rated policies. Benefits and expenses are associated with premiums by means of the provision for future policy benefits, unearned premiums and the deferral and amortization of policy acquisition costs. Value of insurance in force represents the actuarially determined present value of anticipated profits to be realized from life and accident and health business on insurance in force at the date of the Company's acquisition of its insurance subsidiaries using the same assumptions that were used for computing related liabilities where appropriate. The value of insurance in force acquired prior to December 31, 1993 is amortized over the premium paying periods in relation to anticipated premiums. The value of insurance in force relating to the acquisition of The Travelers Corporation (old Travelers) was the actuarially determined present value of the projected future profits discounted at interest rates ranging from 14% to 18% for the business acquired. The value of the business in force is amortized over the contract period using current interest crediting rates to accrete interest and using amortization methods based on the specified products. Traditional life insurance is amortized over the period of anticipated premiums; universal life in relation to estimated gross profits; and annuity contracts employing a level 34 Notes to Consolidated Financial Statements (continued) yield method. The value of insurance in force is reviewed periodically for recoverability to determine if any adjustment is required. Deferred policy acquisition costs for the life business represent the costs of acquiring new business, principally commissions, certain underwriting and agency expenses and the cost of issuing policies. Deferred policy acquisition costs for traditional life business are amortized over the premium-paying periods of the related policies, in proportion to the ratio of the annual premium revenue to the total anticipated premium revenue. Deferred policy acquisition costs of other business lines are generally amortized over the life of the insurance contract or at a constant rate based upon the present value of estimated gross profits expected to be realized. For certain property and casualty lines, acquisition costs (commissions and premium taxes) have been deferred to the extent recoverable from future earned premiums and are amortized ratably over the terms of the related policies. Deferred policy acquisition costs are reviewed to determine if they are recoverable from future income, including investment income, and, if not recoverable, are charged to expense. All other acquisition expenses are charged to operations as incurred. Separate and variable accounts primarily represent funds for which investment income and investment gains and losses accrue directly to, and investment risk is borne by, the contractholders. Each account has specific investment objectives. The assets of each account are legally segregated and are not subject to claims that arise out of any other business of the Company. The assets of these accounts are generally carried at market value. Amounts assessed to the contractholders for management services are included in revenues. Deposits, net investment income and realized investment gains and losses for these accounts are excluded from revenues, and related liability increases are excluded from benefits and expenses. Other receivables include receivables related to retrospectively rated policies on property-casualty business, net of allowance for estimated uncollectible amounts. Insurance policy and claims reserves represent liabilities for future insurance policy benefits. Insurance reserves for traditional life insurance, annuities, and accident and health policies have been computed based upon mortality, morbidity, persistency and interest assumptions applicable to these coverages, which range from 2.5% to 10%, including adverse deviation. These assumptions consider Company experience and industry standards and may be revised if it is determined that future experience will differ substantially from that previously assumed. Property-casualty reserves include (1) unearned premiums representing the unexpired portion of policy premiums, and (2) estimated provisions for both reported and unreported claims incurred and related expenses. The reserves are adjusted regularly based on experience. Included in the insurance policy and claims reserves in the Consolidated Statement of Financial Position at December 31, 1996 and 1995 are $1.568 billion and $778 million, respectively, of property-casualty loss reserves related to workers' compensation that have been discounted using an interest rate of 5%. In determining insurance policy and claims reserves, the Company carries on a continuing review of its overall position, its reserving techniques and its reinsurance. Reserves for property-casualty insurance losses represent the estimated ultimate cost of all incurred claims and claim adjustment expenses. Since the reserves are based on estimates, the ultimate liability may be more or less than such reserves. The effects of changes in such estimated reserves are included in the results of operations in the period in which the estimates are changed. Such changes may be material to the results of operations and could occur in a future period. Contractholder funds represent receipts from the issuance of universal life, pension investment and certain individual annuity contracts. Such receipts are considered deposits on investment contracts that do not have substantial mortality or morbidity risk. Account balances are increased by deposits received and interest credited and are reduced by withdrawals, mortality charges and administrative expenses charged to the contractholders. Calculations of contractholder account balances for investment contracts reflect lapse, withdrawal and interest rate assumptions (ranging from 3.8% to 8.6%) based on contract provisions, the Company's experience and industry 35 Notes to Consolidated Financial Statements (continued) standards. Contractholder funds also include other funds that policyholders leave on deposit with the Company. The fair value of these contracts is determined by discounting expected cash flows at an interest rate commensurate with the Company's credit risk and the expected timing of cash flows. Permitted Statutory Accounting Practices. The Company's insurance subsidiaries are domiciled principally in Connecticut and Massachusetts and prepare statutory financial statements in accordance with the accounting practices prescribed or permitted by the insurance departments of those states. Prescribed statutory accounting practices include a variety of publications of the National Association of Insurance Commissioners as well as state laws, regulations, and general administrative rules. The impact of any accounting practices not so prescribed on statutory surplus is not material. CONSUMER FINANCE SERVICES Finance related interest and other charges are recognized as income using the constant yield method. Allowances for losses are established by direct charges to income in amounts sufficient to maintain the allowance at a level management determines to be adequate to cover losses in the portfolio. The allowance fluctuates based upon continual review of the loan portfolio and current economic conditions. For financial reporting purposes, finance receivables are considered delinquent when they are 60 days or more contractually past due. Income stops accruing on finance receivables when they are 90 days contractually past due. If payments are made on a finance receivable that is not accruing income, and the receivable is no longer 90 days contractually past due, the accrual of income resumes. Finance receivables are charged against the allowance for losses when considered uncollectible. Personal loans are considered uncollectible when payments are six months contractually past due and six months past due on a recency of payment basis. Loans that are twelve months contractually past due regardless of recency of payment are charged off. Recoveries on losses previously charged to the allowance are credited to the allowance at the time of recovery. Consideration of whether to proceed with foreclosure on loans secured by real estate begins when a loan is 60 days past due on a contractual basis. Real estate credit losses are recognized when the title to the property is obtained. Fees received and direct costs incurred for the origination of loans are deferred and amortized over the contractual lives of the loans as part of interest income. The remaining unamortized balances are reflected in interest income at the time that the loans are paid in full, renewed or charged off. 2. Business Acquisitions --------------------- Acquisition of Aetna P&C As discussed in Note 1, on April 2, 1996 TAP purchased from Aetna all of the outstanding capital stock of ACSC and SFIC. To finance the purchase price and transaction costs of $4.16 billion and capital contributions of $710 million to Aetna P&C, TAP borrowed $2.65 billion from a syndicate of banks under a five-year revolving credit facility (the Credit Facility) and sold approximately 33 million shares of its Class A Common Stock representing approximately 9% of its outstanding common stock (at that time) to four private investors, including Aetna, for an aggregate of $525 million. The Travelers Insurance Group Inc. (TIGI), a wholly owned subsidiary of the Company, acquired approximately 328 million shares of Class B Common Stock of TAP in exchange for contributing the outstanding capital stock of Travelers Indemnity and a capital contribution of approximately $1.14 billion. In addition, TRV purchased from TAP $540 million of Series Z Preferred Stock of TAP. Approximately $18 million of the purchase price was funded through the settlement of receivables from Aetna. On April 23, 1996, TAP sold in a public offering approximately 39 million shares of its Class A Common Stock, representing approximately 9.75% of its outstanding common stock, for total proceeds of $928 million. During the second quarter TAP sold in public offerings $700 million in long-term notes (see Note 10) and through subsidiary trusts $900 million in Trust Preferred Securities (see Note 14). The aggregate proceeds from the above offerings of $2.528 billion, together with the proceeds from the issuance by TAP of approximately $700 million of commercial 36 Notes to Consolidated Financial Statements (continued) paper, were used to repay in full the borrowings under the Credit Facility and to redeem in full TAP's Series Z Preferred Stock. The assets and liabilities of Aetna P&C are reflected in the Consolidated Statement of Financial Position at December 31, 1996 on a fully consolidated basis at management's best estimate of their fair values at the acquisition date, based on currently available information. Evaluation and appraisal of assets and liabilities is continuing and allocation of the purchase price may be adjusted. The excess of the purchase price over the estimated fair value of net assets is approximately $1.16 billion and is being amortized over 40 years. During 1996, TAP recorded charges related to the acquisition and integration of Aetna P&C. These charges resulted primarily from anticipated costs of the acquisition and the application of TAP's strategies, policies and practices to Aetna P&C reserves and include: $229.1 million after tax and minority interest ($430 million before tax and minority interest) in reserve increases, net of reinsurance, related primarily to cumulative injury claims other than asbestos (CIOTA); $98.6 million after tax and minority interest ($185 million before tax and minority interest) in provisions for reinsurance recoverable and other receivables; and an $18.7 million after tax and minority interest ($35 million before tax and minority interest) provision for lease and severance costs of Travelers Indemnity related to the restructuring plan for the acquisition. In addition the Company recognized a gain of $363 million (before and after tax) from the issuance of shares of Class A Common Stock by TAP and such gain is not reflected in the pro forma financial information below. The unaudited pro forma condensed results of operations presented below assume the above transactions had occurred at the beginning of each of the periods presented: (in millions expect per share amounts) 1996 1995 ---------------------------------------------------------------------- Revenues $ 22,945 $ 21,890 Income from continuing operations $ 2,062 $ 1,227 Net income $ 2,093 $ 1,433 Continuing operations $ 3.08 $ 1.80 Net income $ 3.13 $ 2.13 Excluding the charges discussed above associated with the acquisition of Aetna P&C, which total $346.4 million after tax and minority interest, pro forma income from continuing operations and net income would have been $2.41 billion and $2.44 billion, respectively, or $3.62 per share and $3.67 per share, respectively, for the year ended December 31, 1996. Historical results of Aetna P&C in 1995 include charges of $1.085 billion ($705 million after tax) representing an addition to environmental-related and asbestos-related claims reserves. The above unaudited pro forma condensed financial information is not necessarily indicative either of the results of operations that would have occurred had this transaction been consummated at the beginning of the periods presented or of future operations of the combined companies. 37 Notes to Consolidated Financial Statements (continued) Supplemental Information to the Consolidated Statement of Cash Flows Relating to the Acquisition of Aetna P&C (millions) 1996 -------- Assets and liabilities of business acquired: Invested assets $ 13,899 Reinsurance recoverables and other assets 10,409 Insurance policy and claim reserves (18,240) Other liabilities (1,908) -------------------------------------------------------------------- Cash payment related to business acquisition $ 4,160 ==================================================================== Acquisition of Shearson Business In July 1993, Smith Barney acquired the domestic retail brokerage and asset management businesses (the Shearson Businesses) of Shearson Lehman Brothers Holdings Inc., a subsidiary of American Express Company (American Express). In addition to the amounts paid in 1993, Smith Barney has agreed to pay American Express additional amounts that are contingent upon the new unit's performance (Contingent Consideration), consisting of up to $50 million per year for three years based on Smith Barney's revenues and 10% of Smith Barney's after-tax profits in excess of $250 million per year over a five-year period. Contingent Consideration paid during 1996, 1995 and 1994 amounted to $110 million, $76 million and $69 million, respectively. The 1996 payment includes a final payout of Contingent Consideration based on revenues. The Contingent Consideration is being accounted for prospectively, as additional purchase price, which will result in amortization over periods of up to 20 years. 3. Disposition of Subsidiaries and Discontinued Operations ------------------------------------------------------- During 1996, gains on sale of subsidiaries and affiliates totaled $397 million pre-tax and consisted of the sale in April of approximately 18% of TAP ($363 million) and a net gain from the disposition of certain investment advisory affiliates, including RCM Capital Management, a California Limited Partnership (RCM) ($34 million). During 1994, gains on sale of subsidiaries and affiliates totaled $226 million pre-tax and consisted of the sale in December of American Capital Management & Research Inc. (American Capital) ($162 million), the sale in November of Smith Barney's investment in HG Asia Holdings Ltd. ($34 million), and the sale in October of Bankers and Shippers Insurance Company ($30 million). Transport Spin-off On September 29, 1995, the Company made a pro rata distribution to the Company's stockholders of shares of Class A Common Stock, $.01 par value per share, of Transport Holdings Inc. (Holdings), which at the time was a wholly owned subsidiary of the Company, and the indirect owner of Transport Life Insurance Company. The results of Holdings were included in income from continuing operations through September 29, 1995, the spin-off date. Discontinued Operations In December 1994, the Company sold its group dental insurance business to Metropolitan Life Insurance Company (MetLife) for $52 million and recognized an after-tax gain of $9 million ($28 million pre-tax), and on January 3, 1995 the Company sold its group life business as well as its related non-medical group insurance businesses to MetLife for $350 million and recognized in the first quarter of 1995 an after-tax gain of $20 million ($31 million pre-tax). In connection with the sale, The Travelers Insurance Company (TIC) ceded 100% of its risks in the group life and related businesses to MetLife on an indemnity reinsurance basis, effective January 1, 1995. In connection with the reinsurance transaction, TIC transferred assets with a fair market value of approximately $1.5 billion to MetLife, equal to the statutory reserves and other liabilities transferred. 38 Notes to Consolidated Financial Statements (continued) On January 3, 1995, TIC and MetLife, and certain of their affiliates, formed The MetraHealth Companies, Inc. (MetraHealth) joint venture by contributing their medical businesses to MetraHealth, in exchange for shares of common stock of MetraHealth. No gain was recognized upon the formation of the joint venture. Upon formation of the joint venture TIC and its affiliates owned 50% of the outstanding capital stock of MetraHealth, and the other 50% was owned by MetLife and its affiliates. In March 1995, MetraHealth acquired HealthSpring, Inc. for common stock of MetraHealth, resulting in a reduction in the participation of the Company and MetLife in the MetraHealth venture to 48.25% each. In October 1995, the Company completed the sale of its ownership in MetraHealth to United HealthCare Corporation. Gross proceeds to the Company in 1995 were $831 million in cash, and the Company recognized a gain in 1995 of $110 million after tax ($165 million pre-tax). During 1996 the Company received a contingency payment (based on MetraHealth's 1995 results) and recognized a gain in 1996 of $31 million after tax ($48 million pre-tax). Both of these gains are reflected in discontinued operations. All of the businesses sold to MetLife or contributed to MetraHealth have been accounted for as a discontinued operation. Revenues from discontinued operations for the years ended December 31, 1995 and 1994 amounted to $1.040 billion and $3.522 billion, respectively. Revenues in 1996 were immaterial. 4. Business Segment Information ---------------------------- The Company is a diversified financial services company engaged in investment services, life and property and casualty insurance services and consumer finance. The following table presents certain information regarding these industry segments:
(millions) 1996 1995 1994 ---------- ---------- ---------- Revenues Investment Services $ 7,802 $ 6,808 $ 5,690 Life Insurance Services 3,765 3,858 3,488 Property & Casualty Insurance Services 8,224 4,545 4,538 Consumer Finance Services 1,411 1,354 1,239 Corporate and Other 143 18 (12) ---------- ---------- ---------- $ 21,345 $ 16,583 $ 14,943 ========== ========== ========== Income from continuing operations before income taxes and minority interest Investment Services $ 1,463 $ 1,028 $ 732 Life Insurance Services 1,009 893 651 Property & Casualty Insurance Services 512 595 307 Consumer Finance Services 343 378 356 Corporate and Other 71 (373) (172) ---------- ---------- ---------- $ 3,398 $ 2,521 $ 1,874 ========== ========== ==========
39 Notes to Consolidated Financial Statements (continued) Income from continuing operations Investment Services $ 889 $ 599 $ 422 Life Insurance Services 653 581 421 Property & Casualty Insurance Services (after minority interest of $47 in 1996) 362 453 249 Consumer Finance Services 223 246 227 Corporate and Other 173 (251) (162) ---------- ---------- ---------- $ 2,300 $ 1,628 $ 1,157 ========== ========== ========== Identifiable assets Investment Services $ 51,245 $ 40,976 $ 45,618 Life Insurance Services 40,329 37,912 33,151 Property & Casualty Insurance Services 49,779 23,647 22,007 Consumer Finance Services 9,061 8,196 7,729 Corporate and Other 653 3,185 6,136 ---------- ---------- ---------- $ 151,067 $ 113,916 $ 114,641 ========== ========== ==========
The Investment Services segment consists of investment banking, securities brokerage, asset management and other financial services provided through Smith Barney and its subsidiaries for all years presented, and in 1994 only, the investment management services provided by RCM (sold in June 1996) and the mutual fund management and distribution services provided through American Capital (sold in December 1994, see Note 3). The Life Insurance Services segment includes individual and group life insurance, accident and health insurance, annuities and investment products, which are offered primarily through The Travelers Insurance Company, The Travelers Life and Annuity Company and Primerica Financial Services (PFS). The Property & Casualty Insurance Services segment provides property-casualty insurance, including workers' compensation, liability, automobile, property and commercial multi-peril to businesses and other institutions and automobile and homeowners insurance to individuals. Property-casualty insurance policies are issued primarily by subsidiaries of the Company's newly formed majority-owned subsidiary Travelers Property Casualty Corp. and its property-casualty insurance subsidiaries, including Travelers Indemnity, Gulf Insurance Company, ACSC and SFIC. The Consumer Finance Services segment includes consumer lending (including secured and unsecured personal loans, real estate-secured loans and consumer goods financing) and credit cards. Also included in this segment are credit-related insurance services provided through American Health and Life Insurance Company (AHL) and its affiliate. Corporate and Other consists of corporate staff and treasury operations, certain corporate income and expenses that have not been allocated to the operating subsidiaries, including gains and losses from the sale of stock of subsidiaries and affiliates. RCM, the remaining component of what were the Mutual Funds and Asset Management operations in 1994, is reported as part of Corporate and Other in 1995 and through its date of sale in 1996. 40 Notes to Consolidated Financial Statements (continued) Cumulative effect of accounting changes, and capital expenditures for property, plant and equipment and related depreciation expense are not material to any of the business segments. Intersegment sales and international operations are not significant. For gains and special charges included in each segment, see "Results of Operations" discussion in Management's Discussion and Analysis of Financial Condition and Results of Operations. 5. Investments ----------- Fair values of investments in fixed maturities are based on quoted market prices or dealer quotes or, if these are not available, discounted expected cash flows using market rates commensurate with the credit quality and maturity of the investment. The amortized cost and estimated market values of investments in fixed maturities were as follows:
December 31, 1996 Gross Unrealized Amortized ----------------------- Market (millions) Cost Gains Losses Value -------- -------- -------- -------- Available for sale: Mortgage-backed securities-principally obligations of U.S. Government agencies $ 8,416 $ 146 $ (38) $ 8,524 U.S. Treasury securities and obligations of U.S. Government corporations and agencies 3,757 102 (11) 3,848 Obligations of states and political subdivisions 5,254 124 (31) 5,347 Debt securities issued by foreign governments 1,161 41 (4) 1,198 Corporate securities 24,636 462 (70) 25,028 ---------------------------------------------------- $ 43,224 $ 875 $ (154) $ 43,945 ==================================================== Held to maturity, principally mortgage-backed securities $ 53 $ 9 $ -- $ 62 ====================================================
41 Notes to Consolidated Financial Statements (continued)
December 31, 1995 Gross Unrealized Amortized ----------------------- Market (millions) Cost Gains Losses Value -------- -------- -------- -------- Available for sale: Mortgage-backed securities-principally obligations of U.S. Government agencies $ 5,936 $ 169 $ (20) $ 6,085 U.S. Treasury securities and obligations of U.S. Government corporations and agencies 2,653 195 -- 2,848 Obligations of states and political subdivisions 3,993 110 (11) 4,092 Debt securities issued by foreign governments 433 20 -- 453 Corporate securities 16,569 619 (22) 17,166 ---------------------------------------------------- $ 29,584 $ 1,113 $ (53) $ 30,644 ==================================================== Held to maturity, principally mortgage-backed securities $ 68 $ 11 $ -- $ 79 ====================================================
The amortized cost and estimated market value at December 31, 1996 by contractual maturity are shown below. Actual maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Estimated (millions) Amortized Market Cost Value -------- -------- Due in one year or less $ 2,003 $ 2,012 Due after one year through five years 10,962 11,095 Due after five years through ten years 10,249 10,409 Due after ten years 11,594 11,905 -------- -------- 34,808 35,421 Mortgage-backed securities 8,469 8,586 -------- -------- $ 43,277 $ 44,007 ======== ======== Realized gains and losses on fixed maturities for the years ended December 31, were as follows: (millions) 1996 1995 1994 ------ ------ ------ Realized gains Pre-tax $ 231 $ 157 $ 52 ------ ------ ------ After-tax $ 150 $ 102 $ 34 ------ ------ ------ Realized losses Pre-tax $ 361 $ 244 $ 201 ------ ------ ------ After-tax $ 235 $ 159 $ 131 ------ ------ ------ Net realized gains on equity securities and other investments, after-tax, amounted to $120 million, $155 million and $18 million for the years ended December 31, 1996, 1995 and 1994, respectively. Net unrealized gains (losses) on equity securities at December 31, 1996 and 1995 were $44 million and $97 million, respectively. 42 Notes to Consolidated Financial Statements (continued) The Company had industry concentrations of corporate bonds and short-term investments at December 31 as follows: (millions) 1996 1995 -------- -------- Finance $ 4,399 $ 2,342 Banking $ 4,252 $ 2,138 Electric utilities $ 2,268 $ 1,582 Oil and gas $ 1,533 $ 1,362 At December 31, significant concentrations of mortgage loans and real estate were for properties located in highly populated areas in the states listed below: Mortgage Loans Real Estate ------------------ ------------------ (millions) 1996 1995 1996 1995 ------ ------ ------ ------ California $ 811 $1,121 $ 393 $ 51 New York $ 390 $ 429 $ -- $ 49 Florida $ 283 $ 323 $ 49 $ 17 Texas $ 283 $ 300 $ 36 $ 56 Massachusetts $ 276 $ 111 $ 17 $ 4 Illinois $ 182 $ 203 $ 81 $ 58 Virginia $ 247 $ 194 $ -- $ -- Other mortgage loan and real estate investments are dispersed throughout the United States, with no combined holdings in any other state exceeding $200 million. Aggregate annual maturities on mortgage loans are as follows: (millions) Past maturity $ 82 1997 462 1998 438 1999 538 2000 556 2001 277 Thereafter 1,459 -------- $ 3,812 ======== 43 Notes to Consolidated Financial Statements (continued) 6. Securities Borrowed, Loaned and Subject to Repurchase Agreements ---------------------------------------------------------------- Securities borrowed or purchased under agreements to resell, at their respective carrying values, consisted of the following at December 31: (millions) 1996 1995 -------- -------- Resale agreements $ 16,345 $ 12,087 Deposits paid for securities borrowed 8,935 7,514 -------- -------- $ 25,280 $ 19,601 ======== ======== Securities loaned or sold under agreements to repurchase, at their respective carrying values, consisted of the following at December 31: (millions) 1996 1995 -------- -------- Repurchase agreements $ 19,650 $ 17,183 Deposits received for securities loaned 4,799 3,436 -------- -------- $ 24,449 $ 20,619 ======== ======== The resale and repurchase agreements represent collateralized financing transactions used to generate net interest income and facilitate trading activity. These instruments are short-term in nature (usually 30 days or less) and are collateralized principally by U.S. Government and mortgage-backed securities. The carrying amounts of these instruments approximate fair value because of the relatively short period of time between the origination of the instruments and their expected realization. Deposits paid for securities borrowed (securities borrowed) and deposits received for securities loaned (securities loaned) are recorded at the amount of cash advanced or received. Securities borrowed transactions require the Company to deposit cash with the lender. With respect to securities loaned, the Company receives cash collateral in an amount generally in excess of the market value of securities loaned. The Company monitors the market value of securities borrowed and securities loaned daily, and additional collateral is obtained as necessary. Substantially all of the Company's securities borrowed contracts are with other brokers and dealers, commercial banks and institutional clients. Substantially all of the Company's securities loaned contracts are with other brokers and dealers. 7. Brokerage Receivables and Brokerage Payables -------------------------------------------- The Company has receivables and payables for financial instruments purchased from and sold to brokers and dealers and customers. The Company is exposed to risk of loss from the inability of brokers and dealers or customers to pay for purchases or to deliver the financial instrument sold, in which case the Company would have to sell or purchase the financial instruments at prevailing market prices. The Company seeks to protect itself from the risks associated with customer activities by requiring customers to maintain margin collateral in compliance with regulatory and internal guidelines. Margin levels are monitored daily, and customers deposit additional collateral as required. Where customers cannot meet collateral requirements, the Company will liquidate sufficient underlying financial instruments to bring the customer into compliance with the required margin level. 44 Notes to Consolidated Financial Statements (continued) Exposure to credit risk is impacted by market volatility, which may impair the ability of clients to satisfy their obligations to the Company. Credit limits are established and closely monitored for customers and brokers and dealers engaged in forward and futures and other transactions deemed to be credit-sensitive. Brokerage receivables and brokerage payables, which arise in the normal course of business, consisted of the following at December 31: (millions) 1996 1995 -------- -------- Receivables from customers $ 6,981 $ 6,048 Receivables from brokers and dealers 324 511 -------- -------- Total brokerage receivables $ 7,305 $ 6,559 ======== ======== Payables to customers $ 5,588 $ 4,176 Payables to brokers and dealers 221 227 -------- -------- Total brokerage payables $ 5,809 $ 4,403 ======== ======== 8. Trading Securities ------------------ Trading securities at market value consisted of the following at December 31:
1996 1995 ----------------------- ------------------------ Securities Securities Sold Sold (millions) Securities Not Yet Securities Not Yet Owned Purchased Owned Purchased ----- --------- ----- --------- Obligations of U.S. Government and agencies $ 6,564 $ 7,388 $ 4,224 $ 3,493 Corporate debt 2,841 348 2,019 385 State and municipal obligations 818 6 698 10 Commercial paper and other short-term debt 958 2 815 1 Corporate convertibles, equities and other securities 1,284 634 1,228 674 -------- -------- -------- -------- $ 12,465 $ 8,378 $ 8,984 $ 4,563 ======== ======== ======== ========
Carrying values are based on quoted market prices or dealer quotes. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities. Securities sold not yet purchased must ultimately be acquired in the marketplace at the then prevailing prices. Accordingly, these transactions may result in market risk since the ultimate purchase price may exceed the amount recognized in the financial statements. 45 Notes to Consolidated Financial Statements (continued) 9. Consumer Finance Receivables ---------------------------- Consumer finance receivables, net of unearned finance charges of $635 million and $690 million at December 31, 1996 and 1995, respectively, consisted of the following: (millions) 1996 1995 -------- -------- Real estate-secured loans $ 3,457 $ 2,957 Personal loans 3,200 3,051 Credit cards 907 762 Sales finance and other 507 468 -------- -------- Consumer finance receivables 8,071 7,238 Accrued interest receivable 54 47 Allowance for credit losses (240) (193) -------- -------- Net consumer finance receivables $ 7,885 $ 7,092 ======== ======== An analysis of the allowance for credit losses on consumer finance receivables at December 31, was as follows:
(millions) 1996 1995 1994 -------- -------- -------- Balance, January 1 $ 193 $ 182 $ 168 Provision for consumer finance credit losses 260 171 152 Amounts written off (245) (188) (163) Recovery of amounts previously written off 26 27 25 Allowance on receivables purchased 6 1 -- -------- -------- -------- Balance, December 31 $ 240 $ 193 $ 182 -------- -------- -------- Net outstandings $ 8,071 $ 7,238 $ 6,885 -------- -------- -------- Allowance for credit losses as a % of net outstandings 2.97% 2.66% 2.64% ======== ======== ========
Contractual maturities of receivables before deducting unearned finance charges and excluding accrued interest were as follows:
Receivables Outstanding Due (millions) December 31, Due Due Due Due After 1996 1997 1998 1999 2000 2000 -------- -------- -------- -------- -------- -------- Real-estate secured loans $ 3,505 $ 193 $ 199 $ 211 $ 252 $ 2,650 Personal loans 3,710 1,137 996 747 431 399 Credit cards 905 67 63 58 53 664 Sales finance and other 586 343 117 57 46 23 -------- -------- -------- -------- -------- -------- $ 8,706 $ 1,740 $ 1,375 $ 1,073 $ 782 $ 3,736 -------- -------- -------- -------- -------- -------- Percentage 100% 20% 16% 12% 9% 43% ======== ======== ======== ======== ======== ========
Contractual terms average 16 years on real estate-secured loans (excluding call provisions) and 4 years on personal loans. Experience has shown that a substantial amount of the receivables will be renewed or repaid prior to contractual maturity dates. Accordingly, the foregoing tabulation should not be regarded as a forecast of future cash collections. The Company has a geographically diverse consumer finance loan portfolio. At December 31, the distribution by state was as follows: 46 Notes to Consolidated Financial Statements (continued) 1996 1995 ------ ------ Ohio 11% 12% North Carolina 9% 10% Pennsylvania 6% 7% California 6% 5% South Carolina 6% 6% Texas 5% 5% Tennessee 5% 5% All other states* 52% 50% ------ ------ 100% 100% ====== ====== * In 1996 none of the remaining states individually accounts for more than 5% of total consumer finance receivables. The estimated fair value of the consumer finance receivables portfolio depends on the methodology selected to value such portfolio (i.e., exit value versus entry value). Exit value represents a valuation of the portfolio based upon sales of comparable portfolios which takes into account the value of customer relationships and the current level of funding costs. Under the exit value methodology, the estimated fair value of the receivables portfolio at December 31, 1996 is approximately $671 million above the recorded carrying value. Entry value is determined by comparing the portfolio yields to the yield at which new loans are being originated. Under the entry value methodology, the estimated fair value of the receivables portfolio at December 31, 1996 is approximately equal to the aggregate carrying value due to the increase in variable rate receivables whose rates are periodically reset and the fact that the average yield on fixed rate receivables is approximately equal to that on new fixed rate loans made at year-end 1996. Fair values included in Note 20 are based on the exit value methodology. 10. Debt ---- Investment banking and brokerage borrowings Investment banking and brokerage borrowings consisted of the following at December 31: (millions) 1996 1995 -------- -------- Commercial paper $ 3,028 $ 2,401 Uncollateralized borrowings 189 399 Collateralized borrowings -- 155 -------- -------- $ 3,217 $ 2,955 ======== ======== Weighted average interest rate at end of period 5.74% 5.86% Investment banking and brokerage borrowings are short-term and include commercial paper, collateralized borrowings and uncollateralized borrowings used to finance Smith Barney's operations, including the securities settlement process. The collateralized and uncollateralized borrowings bear interest at fluctuating rates based primarily on the Federal Funds interest rate. Smith Barney has a commercial paper program that consists of both discounted and interest bearing paper. Smith Barney also has substantial borrowing arrangements consisting of facilities that it has been advised are available, but where no contractual lending obligation exists. At December 31, 1995, the market value of the securities pledged as collateral for short-term brokerage borrowings was $171 million. 47 Notes to Consolidated Financial Statements (continued) Short-term borrowings At December 31, short-term borrowings consisted of commercial paper outstanding with weighted average interest rates as follows:
1996 1995 ---------------------------- ----------------------------- (millions) Outstanding Interest Rate Outstanding Interest Rate ----------- ------------- ----------- ------------- Commercial Credit Company $ 1,482 5.55% $ 1,394 5.86% Travelers Property Casualty Corp. 25 5.64% -- -- The Travelers Insurance Company 50 5.53% 74 5.84% -------- -------- $ 1,557 $ 1,468 ======== ========
TRV, Commercial Credit Company (CCC), TAP and The Travelers Insurance Company (TIC) issue commercial paper directly to investors. Each maintains unused credit availability under its respective bank lines of credit at least equal to the amount of its outstanding commercial paper. Each may borrow under its revolving credit facilities at various interest rate options and compensates the banks for the facilities through commitment fees. TRV, CCC and TIC have an agreement with a syndicate of banks to provide $1.0 billion of revolving credit, to be allocated to any of TRV, CCC or TIC. The participation of TIC in this agreement is limited to $250 million. The revolving credit facility consists of five-year revolving credit facility which expires in June 2001. At December 31, 1996, $250 million was allocated to TRV, $650 million was allocated to CCC, and $100 million was allocated to TIC. Under this facility, the Company is required to maintain a certain level of consolidated stockholders' equity (as defined in the agreement). At December 31, 1996, this requirement was exceeded by approximately $4.3 billion. At December 31, 1996 there were no borrowings outstanding under this facility. At December 31, 1996, CCC also had a committed and available revolving credit facility on a stand-alone basis of $1.5 billion, which expires in 2001. CCC is limited by covenants in its revolving credit agreements as to the amount of dividends and advances that may be made to its parent or its affiliated companies. At December 31, 1996, CCC would have been able to remit $308 million to the parent under its most restrictive covenants. As discussed in Note 2, during the first quarter of 1996 TAP entered into a five-year revolving credit facility in the amount of $2.65 billion with a syndicate of banks. The Credit Facility was used to finance in part the purchase of Aetna P&C. All borrowings under the Credit Facility have been repaid in full. The Credit Facility was subsequently amended to extend the maturity to December 2001 and reduce the amount available to $500 million, none of which is currently utilized. Under the Credit Facility TAP is required to maintain a certain level of consolidated stockholders' equity (as defined in the agreement). At December 31, 1996, this requirement was exceeded by approximately $2.8 billion. The carrying value of short-term borrowings approximates fair value. 48 Notes to Consolidated Financial Statements (continued) Long-term debt At December 31, long-term debt was as follows:
Weighted Average (millions) Coupon Rate Maturities 1996 1995 ----------- ---------- ---- ---- Travelers Group Inc. Senior Notes 7.34% 1997-2025 $ 1,848 $ 1,948 Other(a) 55 94 Commercial Credit Company Senior Notes 7.09% 1997-2025 5,750 5,200 Smith Barney Holdings Inc. Senior Notes 6.64% 1997-2006 2,369 1,875 Travelers Property Casualty Corp. Senior Notes 6.83% 1999-2026 1,250 -- Other(b) (1) -- The Travelers Insurance Group Inc. Other(c) 56 73 -------- -------- Total Senior Notes $ 11,217 $ 9,023 Other 110 167 -------- -------- $ 11,327 $ 9,190 ======== ========
(a) Unamortized premium of $20 million in 1996 and $27 million in 1995; and an ESOP note guarantee of $35 million in 1996 and $67 million in 1995. (b) Unamortized discount. (c) Principally 12% GNMA/FNMA-collateralized obligations. Smith Barney has a $1.0 billion revolving credit agreement with a bank syndicate that extends through May 1999, and has a $500 million, 364-day revolving credit agreement with a bank syndicate that extends through May 1997. Any amounts outstanding on the 364-day revolving credit agreement's termination date of May 1997 are due in May 1998. As of December 31, 1996, there were no borrowings outstanding under either facility. Smith Barney is limited by covenants in its revolving credit facility as to the amount of dividends that may be paid to TRV. At December 31, 1996, Smith Barney would have been able to remit approximately $659 million to TRV under its most restrictive covenants. Aggregate annual maturities for the next five years on long-term debt obligations (based on final maturity dates) excluding principal payments on the ESOP loan obligation and the 12% GNMA/FNMA-collateralized obligations, are as follows:
(millions) 1997 1998 1999 2000 2001 Thereafter (a) -------- -------- -------- -------- -------- -------------- Travelers Group Inc. $ 185 $ 250 $ 100 $ 200 $ -- $ 1,113 Commercial Credit Company 350 300 350 750 700 3,300 Smith Barney Holdings Inc. 200 150 350 500 294 875 Travelers Property Casualty Corp. -- -- 400 -- 500 350 -------- -------- -------- -------- -------- -------- $ 735 $ 700 $ 1,200 $ 1,450 $ 1,494 $ 5,638 ======== ======== ======== ======== ======== ========
(a) Includes $450 million redeemable at option of holders during 1999 at face amount. 49 Notes to Consolidated Financial Statements (continued) The fair value of the Company's long-term debt is estimated based on the quoted market price for the same or similar issues or on current rates offered to the Company for debt of the same remaining maturities. At December 31, 1996 the carrying value and the fair value of the Company's long-term debt were: (millions) Carrying Fair Value Value -------- -------- Travelers Group Inc. $ 1,903 $ 1,926 Commercial Credit Company 5,750 5,888 Smith Barney Holdings Inc. 2,369 2,374 Travelers Property Casualty Corp. 1,249 1,246 The Travelers Insurance Group Inc. 56 62 -------- -------- $ 11,327 $ 11,496 ======== ======== 11. Insurance Policy and Claims Reserves ------------------------------------ Insurance policy and claims reserves consisted of the following at December 31: (millions) 1996 1995 -------- -------- Benefit and loss reserves: Property-casualty $ 29,967 $ 14,715 Accident and health 928 754 Life and annuity 8,555 8,663 Unearned premiums 3,909 2,166 Policy and contract claims 585 622 -------- -------- $ 43,944 $ 26,920 ======== ======== The table below is a reconciliation of beginning and ending property-casualty reserve balances for claims and claim adjustment expenses for the years ended December 31:
(millions) 1996 1995 1994 -------- -------- -------- Claims and claim adjustment expense reserves at beginning of year $ 14,715 $ 13,872 $ 13,805 Less reinsurance recoverables on unpaid losses 4,613 3,621 3,615 -------- -------- -------- Net balance at beginning of year 10,102 10,251 10,190 -------- -------- -------- Provision for claims and claim adjustment expenses for claims arising in the current year 4,827 2,898 3,201 Estimated claims and claim adjustment expenses for claims arising in prior years 192 (227) (248) Increase for purchase of Aetna P&C 11,752 -- -- -------- -------- -------- Total increases 16,771 2,671 2,953 -------- -------- -------- Claims and claim adjustment expense payments for claims arising in: Current year 1,858 887 989 Prior years 3,199 1,933 1,903 -------- -------- -------- Total payments 5,057 2,820 2,892 -------- -------- -------- Net balance at end of year 21,816 10,102 10,251 Plus reinsurance recoverables on unpaid losses 8,151 4,613 3,621 -------- -------- -------- Claims and claim adjustment expense reserves at end of year $ 29,967 $ 14,715 $ 13,872 -------- -------- --------
50 Notes to Consolidated Financial Statements (continued) In 1996 estimated claims and claim adjustment expenses for claims arising in prior years included $238 million of net favorable development in certain Commercial Lines and Personal Lines coverages. Also in 1996, estimated claims and claim adjustment expenses for claims arising in prior years included $430 million within Commercial Lines related to acquisition-related charges primarily related to CIOTA, insurance products involving financial guarantees, and assumed reinsurance. In addition, as a result of the Company's review of Aetna P&C's insurance reserves, Commercial Lines reserves were increased by $60 million and Personal Lines reserves were decreased by $60 million. In 1995, estimated claims and claim adjustment expenses for claims arising in prior years included favorable loss development in certain workers' compensation, general liability and commercial auto lines of approximately $150 million; however, since the business to which it relates is subject to premium adjustments on retrospectively rated policies, the net impact on results of operations is not significant. In addition, in 1995 estimated claims and claim adjustment expenses for claims arising in prior years included favorable loss development in Personal Lines of approximately $60 million. In 1994, estimated claims and claim adjustment expenses for claims arising in prior years included favorable loss development in Personal Lines automobile and homeowners coverage of $100 million, offset by unfavorable development of $100 million for Commercial Lines asbestos and environmental claims from 1985 and prior. In addition, in 1994 Commercial Lines experienced favorable prior year loss development in workers' compensation, other liability and commercial automobile product lines in its National Accounts business for post-1985 accident years. This favorable development amounted to $261 million; however, since the business to which it relates is subject to premium adjustments on retrospectively rated policies, the net impact on results of operations is not significant. The property-casualty claims and claim adjustment expense reserves include $2.315 billion and $806 million for asbestos and environmental related claims net of reinsurance at December 31, 1996 and 1995, respectively. It is difficult to estimate the reserves for environmental and asbestos-related claims due to the vagaries of court coverage decisions, plaintiffs' expanded theories of liability, the risks inherent in major litigation and other uncertainties. Conventional actuarial techniques are not used to estimate such reserves. For environmental claims, the Company estimates its financial exposure and establishes reserves based upon an analysis of its historical claim experience and the facts of the individual underlying claims. More specifically, the unique facts presented in each claim are evaluated individually and collectively. Due consideration is given to the many variables presented in each claim, as discussed above. The following factors are evaluated in projecting the ultimate reserve for asbestos-related claims: available insurance coverage; limits and deductibles; an analysis of each policyholder's potential liability; jurisdictional involvement; past and projected future claim activity; past settlement values of similar claims; allocated claim adjustment expense; potential role of other insurance, and applicable coverage defenses, if any. Once the gross ultimate exposure for indemnity and allocated claim adjustment expense is determined for a policyholder by policy year, a ceded projection is calculated based on any applicable facultative and treaty reinsurance. In addition, a similar review is conducted for asbestos property damage claims. However, due to the relatively minor claim volume, these reserves have remained at a constant level. As a result of these processes and procedures, the reserves carried for environmental and asbestos claims at December 31, 1996 are the Company's best estimate of ultimate claims and claim adjustment expenses, based upon known facts and current law. However, the conditions surrounding the final resolution of these claims continues to change. Currently, it is not possible to predict changes in the legal and legislative environment and their impact on the future development of asbestos and environmental claims. Such development will be impacted by future court 51 Notes to Consolidated Financial Statements (continued) decisions and interpretations and changes in Superfund and other legislation. Because of these future unknowns, additional liabilities may arise for amounts in excess of the current reserves. These additional amounts, or a range of these additional amounts, cannot now be reasonably estimated, and could result in a liability exceeding reserves by an amount that would be material to the Company's operating results in a future period. However, the Company believes that it is not likely that these claims will have a material adverse effect on the Company's financial condition or liquidity. The Company has a geographic exposure to catastrophe losses in certain North Atlantic states, California and South Florida. Catastrophes can be caused by various events including hurricanes, windstorms, earthquakes, hail, severe winter weather, explosions and fires, and the incidence and severity of catastrophes are inherently unpredictable. The extent of losses from a catastrophe is a function of both the total amount of insured exposure in the area affected by the event and the severity of the event. Most catastrophes are restricted to small geographic areas; however, hurricanes and earthquakes may produce significant damage in large, heavily populated areas. The Company generally seeks to reduce its exposure to catastrophe through individual risk selection and the purchase of catastrophe reinsurance. 12. Reinsurance ----------- The Company's insurance operations participate in reinsurance in order to limit losses, minimize exposure to large risks, provide additional capacity for future growth and effect business-sharing arrangements. Life reinsurance is accomplished through various plans of reinsurance, primarily coinsurance, modified coinsurance and yearly renewable term. Property-casualty reinsurance is placed on both a quota-share and excess of loss basis. The property-casualty insurance subsidiaries also participate as a servicing carrier for, and a member of, several pools and associations. Reinsurance ceded arrangements do not discharge the insurance subsidiaries or the Company as the primary insurer, except for cases involving a novation. 52 Notes to Consolidated Financial Statements (continued) Reinsurance amounts included in the Consolidated Statement of Income were: Ceded to (millions) Gross Other Net Amount Companies Amount -------- --------- -------- Year ended December 31, 1996 ---------------------------- Premiums Life insurance $ 1,529 $ (296) $ 1,233 Accident and health insurance 402 (98) 304 Property-casualty insurance 7,902 (1,806) 6,096 -------- -------- -------- $ 9,833 $ (2,200) $ 7,633 ======== ======== ======== Claims incurred $ 8,389 $ (1,892) $ 6,497 ======== ======== ======== Year ended December 31, 1995 ---------------------------- Premiums Life insurance $ 1,497 $ (272) $ 1,225 Accident and health insurance 499 (87) 412 Property-casualty insurance 4,752 (1,412) 3,340 -------- -------- -------- $ 6,748 $ (1,771) $ 4,977 ======== ======== ======== Claims incurred $ 5,806 $ (1,726) $ 4,080 ======== ======== ======== Year ended December 31, 1994 ---------------------------- Premiums Life insurance $ 1,484 $ (288) $ 1,196 Accident and health insurance 514 (89) 425 Property-casualty insurance 5,052 (1,529) 3,523 -------- -------- -------- $ 7,050 $ (1,906) $ 5,144 ======== ======== ======== Claims incurred $ 5,725 $ (1,328) $ 4,397 ======== ======== ======== Reinsurance recoverables, net of valuation allowance, at December 31 include amounts recoverable on unpaid and paid losses and were as follows: (millions) 1996 1995 -------- -------- Reinsurance Recoverables ------------------------ Life business $ 1,521 $ 1,804 Property-casualty business: Pools and associations 4,160 2,775 Other reinsurance 4,553 1,882 -------- -------- $ 10,234 $ 6,461 ======== ======== Included in Life business reinsurance recoverables at December 31, 1996 and 1995 is approximately $720 million and $929 million, respectively, of receivables from MetLife in connection with the sale of the group life business. 53 Notes to Consolidated Financial Statements (continued) 13. Income Taxes ------------ The provision for income taxes attributable to income from continuing operations (before minority interest) for the years ended December 31 was as follows: (millions) 1996 1995 1994 -------- -------- -------- Current: Federal $ 697 $ 745 $ 271 Foreign 33 19 22 State 114 110 80 -------- -------- -------- 844 874 373 -------- -------- -------- Deferred: Federal 221 24 335 Foreign 1 2 1 State (15) (7) 8 -------- -------- -------- 207 19 344 -------- -------- -------- $ 1,051 $ 893 $ 717 ======== ======== ======== The reconciliation of the federal statutory income tax rate to the Company's effective income tax rate applicable to income from continuing operations (before minority interest) for the years ended December 31 was as follows:
1996 1995 1994 ------ ------ ------ Federal statutory rate 35.0% 35.0% 35.0% Limited taxability of investment income (2.9) (3.1) (3.5) State and foreign income taxes (net of federal income tax benefit) 1.9 2.7 2.7 Issuance of stock by subsidiary (3.9) -- -- Sale of subsidiaries -- -- 2.9 Other, net 0.8 0.8 1.2 ------ ------ ------ Effective income tax rate 30.9% 35.4% 38.3% ====== ====== ======
Tax benefits allocated directly to stockholders' equity for the years ended December 31, 1996, 1995 and 1994 were $175 million, $82 million and $35 million, respectively. Deferred income taxes at December 31 related to the following: (millions) 1996 1995 -------- -------- Deferred tax assets: Differences in computing policy reserves $ 2,036 $ 1,161 Deferred compensation 350 295 Employee benefits 212 266 Investments 14 -- Other deferred tax assets 878 760 -------- -------- Gross deferred tax assets 3,490 2,482 -------- -------- Valuation allowance 100 100 -------- -------- Deferred tax assets after valuation allowance 3,390 2,382 -------- -------- 54 Notes to Consolidated Financial Statements (continued) Deferred tax liabilities: Deferred policy acquisition costs and value of insurance in force (719) (610) Investment management contracts (246) (249) Investments -- (90) Fixed assets (117) (48) Other deferred tax liabilities (238) (296) -------- -------- Gross deferred tax liabilities (1,320) (1,293) -------- -------- Net deferred tax asset $ 2,070 $ 1,089 ======== ======== As a result of the acquisition of old Travelers, a valuation allowance of $100 million was established in 1993 to reduce the net deferred tax asset on investment losses to the amount that, based upon available evidence, is more likely than not to be realized. The $100 million valuation allowance is sufficient to cover any capital losses on investments that may exceed the capital gains able to be generated in the life insurance group's consolidated federal income tax return based upon management's best estimate of the character of the reversing temporary differences. Reversal of the valuation allowance is contingent upon the recognition of future capital gains or a change in circumstances which causes the recognition of the benefits to become more likely than not. The initial recognition of any benefit produced by the reversal of the valuation allowance will be recognized by reducing goodwill. The net deferred tax asset, after the valuation allowance of $100 million, relates to temporary differences that are expected to reverse as net ordinary deductions. The Company will have to generate approximately $5.9 billion of taxable income, before the reversal of these temporary differences, primarily over the next 10-15 years, to realize the remainder of the deferred tax asset. Management expects to realize the remainder of the deferred tax asset based upon its expectation of future taxable income, after the reversal of these deductible temporary differences, of at least $1.5 billion annually. The Company has reported pre-tax financial statement income from continuing operations exceeding $2.5 billion, on average, over the last three years and has had taxable income of approximately $1.5 billion, on average, over the same period of time. At December 31, 1996, the Company has no ordinary or capital loss carryforwards. 14. Preferred Stock and Stockholders' Equity ---------------------------------------- Preferred stock The following table sets forth the Company's preferred stock outstanding at December 31: 1996 1995 ------------------------ ------------------------ Liquidation Carrying Carrying Preference Number Value Number Value Per Share of Shares (millions) of Shares (millions) ----------- ------------------------ ------------------------ Series A $ 250 1,200,000 $ 300 1,200,000 $ 300 Series B $ 50 -- -- 2,500,000 125 Series D $ 50 7,500,000 375 7,500,000 375 ---------------------- ---------------------- 8,700,000 $ 675 11,200,000 $ 800 ====================== ====================== Series C $53.25 3,085,612 $ 164 4,406,431 $ 235 ====================== ====================== Series A In July 1992 the Company sold in a public offering 12.0 million depositary shares, each representing 1/10th of a share of 8.125% Cumulative Preferred Stock, Series A (Series A Preferred), at an offering price of $25 per depositary share. The Series A Preferred has cumulative dividends payable quarterly and a liquidation preference equivalent to $25 per depositary share plus accrued and accumulated unpaid dividends. On or after July 28, 1997, 55 Notes to Consolidated Financial Statements (continued) the Company may, at its option, redeem the Series A Preferred, in whole or in part, at any time at a redemption price of $25 per depositary share plus dividends accrued and unpaid to the redemption date. Series B During 1996, $125 million of liquidation value of the 5.50% Convertible Preferred Stock Series B (Series B Preferred) representing 2,499,945 shares of Series B Preferred was converted into 6,802,432 shares of common stock. Each share of the Series B Preferred was converted into 2.72109 shares of TRV common stock at a conversion price of $18.375 per share. The remaining 55 shares were redeemed for cash at $51.925 per share plus accrued and unpaid dividends. Series C In connection with the acquisition of The Travelers Corporation (old Travelers) in 1993, the Company converted the old Travelers $4.53 Series A ESOP Convertible Preference Stock which was issued to prefund old Travelers' matching obligations under its Employee Stock Ownership Plan (ESOP) into $4.53 Series C Convertible Preferred Stock (Series C Preferred) of the Company with a stated value and a liquidation preference of $53.25 per share. The Series C Preferred is convertible into one share of Travelers Group Inc. common stock for each $32.98 of stated value of Series C Preferred, subject to antidilution adjustments in certain circumstances. Each share of Series C Preferred is entitled to 2.61 votes on election of directors and all other matters submitted to a vote of stockholders. Dividends on the Series C Preferred are cumulative and accrue in the amount of $4.53 per annum per share. The Series C Preferred is redeemable at the option of the Company on or after January 1, 1998 (or earlier at the option of the holder under certain limited circumstances) at a redemption price of $53.25 per share plus accrued and unpaid dividends thereon to the date fixed for redemption. Series D Also in connection with the Company's acquisition of old Travelers, 7.5 million shares of 9 1/4% Series B Preference Stock of old Travelers were converted into 7.5 million shares of 9 1/4% Series D Preferred Stock (Series D Preferred) of the Company with a stated value and liquidation preference of $50 per share. The Series D Preferred is held in the form of depositary shares, with two depositary shares representing each preferred share. Annual dividends of $4.625 per share ($2.3125 per depositary share) are payable quarterly. Dividends are cumulative from the date of issue. The Series D Preferred is not redeemable prior to July 1, 1997. On and after July 1, 1997, the Series D Preferred is redeemable at the Company's option at a price of $50 per share (equivalent to $25 per depositary share), plus accrued and unpaid dividends, if any, to the redemption date. Mandatorily redeemable preferred securities of subsidiary trusts During 1996 the Company formed the following statutory business trusts under the laws of the state of Delaware. Each trust exists for the exclusive purposes of (i) issuing Trust Securities (both common and preferred) representing undivided beneficial interests in the assets of the Trust; (ii) investing the gross proceeds of the Trust Securities in Junior Subordinated Deferrable Interest Debentures (Subordinated Debentures) of its parent; and (iii) engaging in only those activities necessary or incidental thereto. These Subordinated Debentures and the related income effects are eliminated in the consolidated financial statements. At December 31, 1996 the following preferred securities of subsidiary trusts were outstanding: 56 Notes to Consolidated Financial Statements (continued) Liquidation Interest (in millions) Value Rate -------- -------- Travelers Capital I $ 400 8.00% Travelers Capital II 400 7 3/4% Travelers Capital III 200 7 5/8% -------- Total TRV obligated $ 1,000 -------- Travelers P&C Capital I $ 800 8.08% Travelers P&C Capital II 100 8.00% -------- Total TAP obligated $ 900 -------- In October 1996 Travelers Capital I, a wholly owned subsidiary trust of TRV, issued 16 million 8% Trust Preferred Securities (the TRV I 8% Preferred Securities) with a liquidation preference of $25 per TRV I 8% Preferred Security to the public and 494,880 common securities to TRV, the proceeds of which were invested by Travelers Capital I in $412 million of 8% Junior Subordinated Deferrable Interest Debentures due 2036 issued by TRV (the TRV 8% Debentures). The $412 million of TRV 8% Debentures is the sole asset of Travelers Capital I. The TRV 8% Debentures mature on September 30, 2036 and are redeemable by TRV in whole or in part at any time after October 7, 2001. Travelers Capital I will use the proceeds from any such redemption to redeem a like amount of TRV I 8% Preferred Securities and common securities. Distributions on the TRV I 8% Preferred Securities and common securities are cumulative and payable quarterly in arrears. In December 1996 Travelers Capital II, a wholly owned subsidiary trust of TRV, issued 400 thousand 7 3/4% Trust Preferred Securities (the TRV II 7 3/4% Preferred Securities) with a liquidation preference of $1,000 per TRV II 7 3/4% Preferred Security to the public and 12,372 common securities to TRV, the proceeds of which were invested by Travelers Capital II in $412 million of 7 3/4% Junior Subordinated Deferrable Interest Debentures due 2036 issued by TRV (the TRV 7 3/4% Debentures). The $412 million of TRV 7 3/4% Debentures is the sole asset of Travelers Capital II. The TRV 7 3/4% Debentures mature on December 1, 2036 and are redeemable by TRV in whole or in part at any time after December 1, 2006. Travelers Capital II will use the proceeds from any such redemption to redeem a like amount of TRV II 7 3/4% Preferred Securities and common securities. The redemption price for TRV II 7 3/4% Preferred Securities and common securities for the ten year period beginning on December 1, 2006 is an amount representing a premium over the liquidation amount per TRV 7 3/4% Preferred Securities and common securities which declines annually to 100% of such liquidation amount for the period from December 1, 2016 and thereafter. Distributions on the TRV II 7 3/4% Preferred Securities and common securities are cumulative and payable semi-annually in arrears. In December 1996 Travelers Capital III, a wholly owned subsidiary trust of TRV, issued 200 thousand 7 5/8% Trust Preferred Securities (the TRV III 7 5/8% Preferred Securities; and collectively with the TRV I 8% Preferred Securities and the TRV II 7 3/4% Preferred Securities, the TRV Preferred Securities) with a liquidation preference of $1,000 per TRV III Preferred Security to the public and 6,186 common securities to TRV, the proceeds of which were invested by Travelers Capital III in $206 million of 7 5/8% Junior Subordinated Deferrable Interest Debentures due 2036 issued by TRV (the TRV 7 5/8% Debentures; and collectively with the TRV 8% Debentures and the TRV 7 3/4% Debentures, the TRV Debentures). The $206 million of TRV 7 5/8% Debentures is the sole asset of Travelers Capital III. The TRV 7 5/8% Debentures mature on December 1, 2036. Distributions on the TRV III 7 5/8% Preferred Securities and common securities are cumulative and payable semi-annually in arrears. TRV has guaranteed, on a subordinated basis, distributions and other payments due on each series of TRV Preferred Securities. The obligations of TRV with respect to the TRV Debentures, when considered together with certain undertakings of TRV with respect to Travelers Capital I, Travelers Capital II and Travelers Capital III, constitute full and unconditional guarantees by TRV of Travelers Capital I's, Travelers Capital II's and Travelers 57 Notes to Consolidated Financial Statements (continued) Capital III's obligations under the respective TRV Preferred Securities. The TRV Preferred Securities are classified in the Consolidated Statement of Financial Position as "TRV-obligated mandatorily redeemable preferred securities of subsidiary trusts holding solely junior subordinated debt securities of TRV" at their liquidation value of $1.0 billion. TRV has the right, at any time, to defer payments of interest on the TRV Debentures and consequently the distributions on the TRV Preferred Securities and common securities would be deferred (though such distributions would continue to accrue with interest thereon since interest would accrue on the TRV Debentures) during any such extended interest payment period. TRV cannot pay dividends on its preferred and common stocks during such deferments. Distributions on the TRV Preferred Securities have been classified as interest expense in the Consolidated Statement of Income. In April 1996 Travelers P&C Capital I, a wholly owned subsidiary trust of TAP, issued 32 million 8.08% Trust Preferred Securities (the TAP I 8.08% Preferred Securities) with a liquidation preference of $25 per TAP I 8.08% Preferred Security to the public and 989,720 common securities to TAP, the proceeds of which were invested by Travelers P&C Capital I in $825 million of 8.08% Junior Subordinated Deferrable Interest Debentures due 2036 issued by TAP (the TAP 8.08% Debentures). The TAP 8.08% Debentures mature on April 30, 2036 and are redeemable by TAP in whole or in part at any time after April 30, 2001. Travelers P&C Capital I will use the proceeds from any such redemption to redeem a like amount of TAP I 8.08% Preferred Securities and common securities. Distributions on the TAP I 8.08% Preferred Securities and common securities are cumulative and payable quarterly in arrears. In May 1996 Travelers P&C Capital II, a wholly owned subsidiary trust of TAP issued 4 million 8% Trust Preferred Securities (the TAP II 8% Preferred Securities; and together with the TAP I 8.08% Preferred Securities, the TAP Preferred Securities) with a liquidation value of $25 per TAP II 8% Preferred Security to the public and 123,720 common securities to TAP, the proceeds of which were invested by Travelers P&C Capital II in $103 million of 8% Junior Subordinated Deferrable Interest Debentures issued by TAP (the TAP 8% Debentures; and together with the TAP 8.08% Debentures, the TAP Debentures). The TAP 8% Debentures mature on May 15, 2036 and are redeemable by TAP in whole or in part at any time after May 15, 2001. Travelers P&C Capital II will use the proceeds from any such redemption to redeem a like amount of TAP II 8% Preferred Securities and common securities. Distributions on the TAP II 8% Preferred Securities and common securities are cumulative and payable quarterly in arrears. TAP has guaranteed, on a subordinated basis, distributions and other payments due on each series of TAP Preferred Securities. The obligations of TAP with respect to the TAP Debentures when considered together with certain undertakings of TAP with respect to Travelers P&C Capital I and Travelers P&C Capital II constitute full and unconditional guarantees by TAP of Travelers P&C Capital I's and Travelers P&C Capital II's obligations under the respective TAP Preferred Securities. The TAP Preferred Securities are classified in the Consolidated Statement of Financial Position as "TAP-obligated mandatorily redeemable preferred securities of subsidiary trusts holding solely junior subordinated debt securities of TAP" at their liquidation value of $900 million. TAP has the right, at any time, to defer payments of interest on the TAP Debentures and consequently the distributions on the TAP Preferred Securities and common securities would be deferred (though such distributions would continue to accrue with interest thereon since interest would accrue on the TAP Debentures during any such extended interest payment period.) TAP cannot pay dividends on its common stock during such deferments. Distributions on the TAP Preferred Securities have been classified as interest expense in the Consolidated Statement of Income. Stockholders' equity Common stock The Company has outstanding warrants to purchase shares of its common stock at an exercise price of $19.50 per common share, exercisable until July 31, 1998. These warrants are publicly traded and at December 31, 1996 and 1995 outstanding warrants would enable holders to purchase 7,496,518 shares and 7,498,532 shares, respectively, of common stock of the Company. 58 Notes to Consolidated Financial Statements (continued) At December 31, 1996, 12,478,593 shares of authorized common stock were reserved for convertible securities and warrants. Subsidiary capital The combined insurance subsidiaries' statutory capital and surplus at December 31, 1996 and 1995 was $9.046 billion and $5.873 billion, respectively, and is subject to certain restrictions imposed by state insurance departments as to the transfer of funds and payment of dividends. The combined insurance subsidiaries' net income, determined in accordance with statutory accounting practices, for the years ended December 31, 1996, 1995 and 1994 was $843 million (which includes $285 million for Aetna P&C in the first quarter of 1996), $745 million and $228 million, respectively. TIC is subject to various regulatory restrictions that limit the maximum amount of dividends available to its parent without prior approval of the Connecticut Insurance Department. A maximum of $507 million of statutory surplus is available in 1997 for such dividends without the prior approval of the Connecticut Insurance Department. TAP's insurance subsidiaries are subject to various regulatory restrictions that limit the maximum amount of dividends available to be paid to their parent without prior approval of insurance regulatory authorities. Dividend payments to TAP from its insurance subsidiaries are limited to $647 million in 1997 without prior approval of the Connecticut Insurance Department. Smith Barney's broker-dealer subsidiaries are subject to the Uniform Net Capital Rule of the Securities and Exchange Commission. At December 31, 1996, the aggregate net capital of such broker-dealer subsidiaries was $1.216 billion, exceeding the net capital requirement by $1.060 billion. See Note 10 for additional restrictions on stockholders' equity. 15. Incentive Plans --------------- The Company's stock option plans provide for the granting of stock options to officers and key employees of the Company and its participating subsidiaries. Options are granted at the fair market value of the Company's common stock at the time of grant for a period of ten years. Generally, options vest over a five-year period and are exercisable only if the optionee is employed by the Company. The plans also permit an employee exercising an option to be granted new options (reload options) in an amount equal to the number of common shares used to satisfy the exercise price and the withholding taxes due upon exercise. The reload options are granted for the remaining term of the related original option and vest over a six-month period. At December 31, 1996, 108,828,002 shares were available for future grant under option plans. Information with respect to stock options granted under the Company's option plans is as follows:
1996 1995 1994 -------------------------- ------------------------- ------------------------- Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Shares Price Shares Price Shares Price ----------- -------- ----------- -------- ---------- -------- Outstanding, beginning of year 47,735,420 $ 18.79 48,347,562 $ 15.39 44,667,410 $ 14.09 Granted-original 5,596,973 $ 32.30 9,215,824 $ 21.48 8,652,225 $ 18.05 Granted-reload 20,513,592 $ 36.26 15,023,586 $ 24.62 3,613,475 $ 17.90 Forfeited (2,711,385) $ 18.23 (3,034,670) $ 17.10 (2,774,856) $ 15.92 Exercised (28,141,204) $ 23.85 (21,816,882) $ 16.61 (5,810,692) $ 10.69 ----------- ----------- ---------- Outstanding, end of year 42,993,396 $ 25.61 47,735,420 $ 18.79 48,347,562 $ 15.39 ========== ========== ========== Exercisable at year end 9,300,384 9,844,860 16,898,566
59 Notes to Consolidated Financial Statements (continued) The following table summarizes information about stock options outstanding at December 31, 1996:
Options Outstanding Options Exercisable --------------------------------------------- -------------------------- Weighted Weighted Weighted Range of Average Average Average Exercise Number Remaining Exercise Number Exercise Prices Outstanding Contractual Life Price Exercisable Price ------- ----------- ---------------- --------- ----------- ---------- $0-$10 1,659,282 3.8 years $ 7.26 1,527,947 $ 7.06 $10-$20 17,755,103 6.9 years $ 16.12 5,209,117 $ 16.29 $20-$30 5,425,784 7.7 years $ 24.83 1,152,007 $ 24.52 $30-$40 14,686,768 6.6 years $ 35.30 1,409,258 $ 32.46 $40-$50 3,466,459 5.7 years $ 43.19 2,055 $ 43.30 ---------- ---------- $0-$50 42,993,396 6.7 years $ 25.61 9,300,384 $ 18.25 ========== ==========
The Company applies Opinion 25 and related interpretations in accounting for its stock-based compensation plans. Since stock options under the Company's plans are issued at fair market value on the date of award, no compensation cost has been recognized for these awards. FAS No. 123 provides an alternative to Opinion 25 whereby fair values may be ascribed to options using a valuation model and amortized to compensation cost over the vesting period of the options. Had the Company applied FAS No. 123 in accounting for stock options, net income and net income per share would have been the pro forma amounts indicated below:
1996 1995 ------------------------- ------------------------- In millions Per Share In millions Per Share ----------- --------- ----------- --------- Net income, as reported $ 2,331 $ 3.50 $ 1,834 $ 2.76 FAS No. 123 pro forma adjustments after-tax and minority interest (51) (.08) (18) (.03) -------- -------- -------- -------- Net income, pro forma $ 2,280 $ 3.42 $ 1,816 $ 2.73 ======== ======== ======== ========
The pro forma adjustments relate to options granted during 1996 and 1995 for which a fair value on the date of grant was determined using the Black-Scholes option pricing model. No effect has been given to options granted prior to 1995. FAS No. 123 requires that reload options be treated as separate grants from the related original option grants. Under the Company's reload program, upon exercise of an option, employees generally tender previously owned shares to pay the exercise price and related tax withholding, and receive a reload option covering the same number of shares rendered for such purposes. New reload options vest over a six month period and are only granted if the Company's stock price has increased at least twenty percent over the exercise price of the option being reloaded. Reload options are intended to encourage employees to exercise options at an earlier date and to retain the shares so acquired, in furtherance of the Company's long-standing policy of encouraging increased employee stock ownership. The result of this program is that employees generally will exercise options as soon as they are able and, therefore, these options have shorter expected lives. Shorter option lives result in lower valuations using the Black-Scholes option model. However, such values are expensed more quickly due to the shorter vesting period of 60 Notes to Consolidated Financial Statements (continued) reload options. In addition, since reload options are treated as separate grants, the existence of the reload feature in the Company's plan results in a greater number of options being valued. Shares received through option exercises under the Company's reload program are subject to restrictions on sale. Discounts (as measured by the estimated cost of protection) have been applied to the fair value of options granted to reflect these sale restrictions. The weighted average fair value of options granted during 1996 and 1995 was $4.50 and $3.30 per share, respectively. The weighted average expected life of reload options was approximately 1 year for 1996 and 1995. The weighted average expected life of original grants was approximately 3 years for 1996 and 1995. Valuation and related assumption information are presented below: Weighted averages for options granted during -------------------------------------------- 1996 1995 ------ ------ Valuation assumptions: Expected volatility 28.5% 27.4% Risk-free interest rate 5.58% 6.06% Expected annual dividends per share $ 0.55 $ 0.48 Expected annual forfeitures 5% 5% The Company, through its Capital Accumulation Plan and other restricted stock programs, issues shares of the Company's common stock in the form of restricted stock to participating officers and other key employees. The restricted stock generally vests after a two or three-year period. Except under limited circumstances, during this period the stock cannot be sold or transferred by the participant, who is required to render service to the Company during the restricted period. Participants may elect to receive part of their awards in restricted stock and part in stock options. Unearned compensation expense associated with the restricted stock grants represents the market value of the Company's common stock at the date of grant and is recognized as a charge to income ratably over the vesting period. At December 31, 1996, 48,905,632 shares were available for future grant under these plans. Information with respect to restricted stock awards is as follows:
1996 1995 1994 ----------- ----------- ----------- Shares awarded 11,427,382 13,966,710 10,601,103 Weighted average fair market value per share $ 30.20 $ 18.00 $ 19.36 After-tax compensation cost charged to earnings (in millions) $ 134 $ 114 $ 88
16. Pension Plans ------------- The Company has a noncontributory defined benefit pension plan covering the majority of its U.S. employees. Benefits for this plan are based on an account balance formula. Under this formula, each employee's accrued benefit can be expressed as an account that is credited with amounts based upon the employee's pay, length of service and a specified interest rate, all subject to a minimum benefit level. This plan is funded in accordance with the Employee Retirement Income Security Act of 1974 and the Internal Revenue Code. Certain non-U.S. employees of the Company are covered by noncontributory defined benefit plans. These plans are funded based upon local laws. The following is a summary of the components of pension expense for the Company's defined benefit plan for the years ended December 31: 61 Notes to Consolidated Financial Statements (continued) (millions) 1996 1995 1994 ------ ------ ------ Service cost $ 74 $ 81 $ 105 Interest cost 190 195 173 Actual return on plan assets (228) (388) (66) Net amortization and deferral (1) 165 (161) ------ ------ ------ Net periodic pension cost $ 35 $ 53 $ 51 ====== ====== ====== The following table sets forth the funded status of the Company's defined benefit plan at December 31:
(millions) 1996 1995 -------- -------- Actuarial present value of benefit obligation: Vested benefits $ 2,594 $ 2,713 Non-vested benefits 70 52 -------- -------- Accumulated benefit obligation 2,664 2,765 Effect of future salary increases 48 37 -------- -------- Projected benefit obligation 2,712 2,802 Plan assets at fair value 2,718 2,638 -------- -------- Projected benefit obligation in excess of or (less than) plan assets (6) 164 Unrecognized transition asset 1 2 Unrecognized prior service benefit 12 14 Unrecognized net (loss) (71) (228) Adjustment to recognize minimum liability -- 175 -------- -------- Accrued pension liability (prepaid pension cost) $ (64) $ 127 ======== ======== Actuarial assumptions: Weighted average discount rate 7.50% 7.25% Weighted average rate of compensation increase 4.50% 4.50% Expected long-term rate of return on plan assets 9.00% 9.25%
Plan assets are held in various separate accounts and the general account of The Travelers Insurance Company, a subsidiary of the Company, and certain investment trusts. These accounts and trusts invest in stocks, U.S. Government bonds, corporate bonds, mortgage loans and real estate. 17. Postretirement Benefits ----------------------- The Company provides postretirement health care, life insurance and survival income benefits to certain eligible retirees. These benefits relate primarily to former unionized employees of predecessor companies, certain employees of Smith Barney and former employees of old Travelers. Other retirees are generally responsible for most or all of the cost of these benefits (while retaining the benefits of group coverage and pricing). The Company generally funds its share of the cost of postretirement benefits on a pay-as-you-go basis. However, the Company has made contributions to a survivor income plan, the assets of which are currently invested in a major insurance company's general investment portfolio. The following is a summary of the components of net periodic postretirement benefit cost for the years ended December 31: 62 Notes to Consolidated Financial Statements (continued) (millions) 1996 1995 1994 ---- ---- ---- Service cost $ 1 $ 2 $ 3 Interest cost 25 34 33 Net amortization and deferral (10) (1) -- ---- ---- ---- Net periodic postretirement benefit cost $ 16 $ 35 $ 36 ==== ==== ==== The following table sets forth the funded status of the Company's postretirement benefit plans at December 31: (millions) 1996 1995 ------ ------ Accumulated postretirement benefit obligation: Retirees $ 304 $ 396 Other fully eligible plan participants 31 40 Other active plan participants 9 13 ------ ------ 344 449 Plan assets at fair value 4 4 ------ ------ Accumulated postretirement benefit obligation in excess of plan assets 340 445 Unrecognized net gain 129 37 Unrecognized prior service benefit (cost) 5 6 ------ ------ Accrued postretirement benefit liability $ 474 $ 488 ====== ====== For measurement purposes, the annual rate of increase in the per capita cost of covered health care benefits ranged from 12.7% in 1996, decreasing gradually to 5.5% by the year 2003 and remaining at that level thereafter. The health care cost trend rate assumption affects the amounts reported. To illustrate, increasing the assumed health care cost trend rates by one percentage point in each year would increase the accumulated postretirement benefit obligation as of December 31, 1996 by approximately $12 million. The impact on net periodic postretirement benefit cost of such an increase would not be material. The weighted average discount rates used in determining the accumulated postretirement benefit obligation were 7.50% and 7.25% at December 31, 1996 and 1995, respectively. For certain plans associated with Smith Barney and old Travelers, the weighted average assumed rate of compensation increase was approximately 3.5% for both 1996 and 1995. For other plans, no assumptions have been made for rate of compensation increases, since active employees are responsible for the full cost of these benefits upon retirement. 18. Lease Commitments ----------------- Rentals Rental expense (principally for offices and computer equipment) was $320 million, $319 million and $403 million for the years ended December 31, 1996, 1995 and 1994, respectively. Future minimum annual rentals under noncancellable operating leases are as follows: 63 Notes to Consolidated Financial Statements (continued) (millions) 1997 $ 332 1998 267 1999 209 2000 138 2001 101 Thereafter 545 ------- $ 1,592 ======= Future sublease rental income of approximately $218 million will partially offset these commitments. The Company and certain of Smith Barney's subsidiaries together have an option to purchase the buildings presently leased for Smith Barney's executive offices and New York City operations at the expiration of the lease term. 19. Derivative Financial Instruments -------------------------------- The Company uses derivative financial instruments in the normal course of business for end user and, in the case of Smith Barney, trading purposes. Derivatives are financial instruments, which include forwards, futures, options and swaps, whose value is based upon an underlying asset, index or reference rate. A derivative contract may be traded on an exchange or over-the-counter (OTC). Exchange-traded derivatives are standardized and include futures and certain option contracts listed on exchanges. OTC derivative contracts are individually negotiated between contracting parties and include forwards, swaps, and certain options including interest rate caps, floors and swaptions. Derivatives are subject to various risks similar to those related to the underlying financial instruments, including market, credit and liquidity risk. The risks of derivatives should not be viewed in isolation but rather should be considered on an aggregate basis along with risks related to the Company's non-derivative trading and other activities. Forwards represent commitments to exchange currencies or to purchase or sell other financial instruments at specified prices on specified future dates. Futures contracts are similar to forwards; however, major exchanges act as intermediaries and require daily cash settlement and collateral deposits. As a writer of certain option contracts, Smith Barney receives a fee to become obligated to buy or sell financial instruments at a specified price for a period of time at the holder's option. As a writer of interest rate options, Smith Barney receives a fee to become obligated to pay the holder at specified future dates the amount, if any, by which specified market interest rates exceed or fall below specified reference rates applied to a notional amount. In the case of swaptions, Smith Barney is obligated to enter into an interest rate swap at specified terms or cancel an existing swap, at the holder's option. Purchased options give Smith Barney the right, but not the obligation, to buy or sell financial instruments at a specified price for a period of time. Interest rate swaps require the exchange of periodic cash payments based on a notional principal amount and agreed-upon fixed or floating rates. Generally, no cash is exchanged at the outset of the contract and no principal payments are made by either party. Market Risk. Market risk is the potential for change in value caused by fluctuations in interest rates, foreign exchange rates, or market prices of an underlying financial instrument or index. Market risk is directly influenced by the volatility and liquidity in the markets in which the related underlying assets are traded. The Company seeks to control market risk related to trading financial instruments by measuring and monitoring risk limits across trading activities. In many cases, derivative financial instruments are used to hedge other on-and off-balance sheet transactions. Credit Risk. Credit risk is the possibility that a loss may occur due to the failure of a counterparty to perform according to the terms of a contract. The Company's exposure to the credit risk associated with counterparty 64 Notes to Consolidated Financial Statements (continued) non-performance is limited to the net replacement cost of OTC contracts (including options held) in a gain position. Options written do not give rise to counterparty credit risk since they obligate the Company (not its counterparty) to perform. Exchange-traded financial instruments such as futures and certain options generally do not give rise to significant counterparty exposure due to the margin requirements of the individual exchanges. For significant transactions, the Company's credit review process includes an evaluation of the counterparty's creditworthiness, periodic review of credit standing and obtaining collateral and various credit enhancements in certain circumstances. Smith Barney establishes credit limits for its trading derivative counterparties by product type, taking into account the perceived risk associated with each product. The usage and resultant exposure from these credit limits are then monitored regularly by management. Liquidity Risk. Liquidity risk is the possibility that the Company may not be able to rapidly adjust the size of its derivative positions in times of high volatility and financial stress at a reasonable cost. The liquidity of derivative products is correlated to the liquidity of the underlying cash instrument. As with non-derivative financial instruments, the Company's valuation policies for derivatives include consideration of liquidity factors. Trading Activity Smith Barney trades both derivative and cash financial instruments. While trading activities are primarily generated by client order flow, Smith Barney also takes proprietary positions in interest rate, foreign exchange, debt, equity and commodity instruments based on expectations of future market movements and conditions. Smith Barney's trading strategies rely on the joint management of its client-driven and proprietary transactions, along with the hedging and financing of these positions. This strategy helps reduce market risk and volatility in principal trading revenues. The following is a summary of principal trading revenues by product category for the years ended December 31: (millions) 1996 1995 1994 ------ ------ ------ Equities $ 493 $ 459 $ 392 Taxable fixed-income 257 305 239 Municipals 189 216 248 Foreign exchange, and other derivative financial instruments 51 36 21 ------ ------ ------ $ 990 $1,016 $ 900 ====== ====== ====== The revenue amounts presented include gains and losses from cash instruments and related derivatives, including swaps, forwards, futures and options. Equity revenues include realized and unrealized gains and losses on market making and trading, primarily in over-the-counter, listed and convertible securities and options. Taxable fixed-income revenues include realized and unrealized gains and losses on market making and trading, primarily in U.S. Government and agencies obligations, mortgage and asset-backed securities and corporate debt and preferred securities net of hedges in financial futures, options on financial futures and forward contracts. Municipal revenues include realized and unrealized gains and losses in market making and trading municipal and tax-exempt securities. Foreign exchanges revenues include realized and unrealized gains and losses in currency forward and options contracts. 65 Notes to Consolidated Financial Statements (continued) Other derivative financial instrument revenues include realized and unrealized gains and losses on swaps, caps, floors, swaptions, net of related hedges, including financial futures and options, and non-derivative (or cash) financial instruments. All derivatives used for trading purposes relate to Smith Barney, and are primarily used to facilitate customer transactions. Smith Barney also uses derivatives to limit its net exposure to loss from market risk related to derivative and non-derivative inventory positions. Smith Barney's derivative contracts are generally short-term, with a weighted average maturity of approximately 7.5 months at December 31, 1996 and 7 months at December 31, 1995. The gross notional or contractual amounts of these instruments do not represent the exposure to possible loss or future cash payments, but rather reflect the extent of the Company's involvement in these instruments. At December 31, Smith Barney had outstanding trading derivatives with notional values as follows:
Contract or Notional Amount Contract or Notional Amount 1996 1995 ----------------------- ---------------------- (millions) Purchase Sell Purchase Sell -------- -------- -------- -------- "To be announced" mortgage-backed securities $ 10,997 $ 11,490 $ 6,907 $ 7,479 Forward and futures contracts: Foreign currency forwards 13,081 14,174 6,127 7,568 Foreign currency futures 1,469 520 1,458 11 Financial futures 467 3,110 2,889 493 Interest rate and other 150 -- -- 297 Precious metals and commodities 362 370 474 473 -------- -------- -------- -------- $ 26,526 $ 29,664 $ 17,855 $ 16,321 ======== ======== ======== ======== (millions) Held Written Held Written -------- -------- -------- -------- Options: Foreign currency $ 5,849 $ 5,511 $ 3,266 $ 3,502 Exchange-traded 1,295 1,128 2,201 62 Interest rate caps, floors and swaptions 2,035 2,571 550 1,197 OTC debt and equity 756 682 210 207 -------- -------- -------- -------- $ 9,935 $ 9,892 $ 6,227 $ 4,968 ======== ======== ======== ======== (millions) Open Contracts Open Contracts -------------- -------------- Interest rate and other swaps $ 5,393 $ 2,305 ======== ========
"To be Announced" Mortgage-Backed Securities. Smith Barney trades mortgage-backed "to be announced" mortgage pools ("TBAs") to facilitate customer transactions and to hedge proprietary inventory positions. At December 31, 1996, over $9.0 billion and at December 31, 1995, over $5.7 billion each of purchase and sale positions represent offsetting purchases and sales of the same security, and substantially all of the contract values were for settlement within 60 days. Foreign Currency Contracts. In its role as a market intermediary, Smith Barney acts as a principal in foreign currency forward and options contracts, primarily to facilitate customer transactions. These transactions expose 66 Notes to Consolidated Financial Statements (continued) the firm to foreign exchange rate risk, which is generally hedged by entering into foreign currency forward, futures and options contracts with inverse market risk profiles. At December 31, 1996 and 1995, approximately 81% and 83% respectively of the contract values of foreign currency derivative instruments were for settlement within 90 days, and related primarily to major currencies such as the Japanese yen, German mark and British pound. Written foreign currency options consist of $2.373 billion and $3.138 billion of put and call contracts, respectively, at December 31, 1996 and $1.799 billion and $1.703 billion of put and call contracts, respectively, at December 31, 1995. Financial Futures and Options on Financial Futures Contracts. Smith Barney trades financial futures contracts and options on financial futures, primarily to hedge other proprietary inventory positions. Precious Metals Contracts. Forward precious metals contracts are entered into to facilitate customer transactions, and are transacted in the London Bullion Market, which is used globally for hedging and trading purposes. Smith Barney may use precious metals futures as hedges of its forward inventory to reduce market risk. Interest Rate Products. Smith Barney enters into interest rate swaps, caps, floors and swaptions as part of its proprietary trading strategy, which it hedges with financial futures and options on financial futures. Trading derivative instruments are carried at market value with changes in market value reported in principal transactions revenues in the Consolidated Statement of Income. The fair value of a derivative contract represents the amount Smith Barney would have to pay a third party to assume its obligations under the contract or the amount a third party would pay to receive Smith Barney's benefits under the contract. Smith Barney's OTC derivative financial instruments, principally forwards, options, and swaps, are generally marked-to-market by pricing models based on the present value of future cash flows. These adjustments are integral components of the mark-to-market process. The trading gains and losses on these derivative financial instruments, should not be viewed on an individual basis, but rather as a component of Smith Barney's overall trading results, as these instruments are frequently hedges of, or hedged by, other on/off-balance sheet financial instruments. The fair value of Smith Barney's trading derivative instruments as recorded in the Consolidated Statement of Financial Position and the average fair value for each year based on month-end balances are as follows:
Average Fair Value Fair Value Based on Month-end Balances at for the Year Ended December 31, 1996 December 31, 1996 ---------------------------- ---------------------------- (millions) Assets Liabilities Assets Liabilities ----------- ----------- ----------- ----------- "To be announced" mortgage-backed securities $ 46 $ 25 $ 47 $ 45 Forward contracts: Foreign currency 296 261 321 272 Interest rate and other -- -- 1 -- Precious metals 5 4 5 5 Options: Foreign currency 73 75 60 65 Exchange-traded 5 7 10 9 Interest rate caps, floors and swaptions 41 33 26 20 OTC debt and equity 35 29 29 15 Interest rate and other swaps 16 47 19 46 ------ ------ ------ ------ $ 517 $ 481 $ 518 $ 477 ====== ====== ====== ======
67 Notes to Consolidated Financial Statements (continued)
Average Fair Value Fair Value Based on Month-end Balances at for the Year Ended December 31, 1995 December 31, 1995 ---------------------------- ---------------------------- (millions) Assets Liabilities Assets Liabilities ----------- ----------- ----------- ----------- "To be announced" mortgage-backed securities $ 45 $ 38 $ 40 $ 39 Forward contracts: Foreign currency 156 101 273 242 Interest rate and other 7 -- 3 1 Precious metals 5 5 12 12 Options: Foreign currency 39 48 73 74 Exchange-traded 9 6 11 10 Interest rate caps, floors and swaptions 62 39 40 27 OTC debt and equity 66 13 34 13 Interest rate and other swaps 37 90 34 59 ------ ------ ------ ------ $ 426 $ 340 $ 520 $ 477 ====== ====== ====== ======
The fair values do not include receivables or payables related to exchange traded futures contracts. Fair values for certain exchange-traded derivatives, principally futures and certain options, are based on quoted market prices. Futures contracts are settled in cash daily and therefore the receivable or payable is limited to one day's price move. End User Activity In the normal course of business the Company also employs certain derivative financial instruments as an end user to manage various risks. Fair values were determined by reference to quoted market prices or, for interest rate swaps, estimated based upon the payments either party would have to make to terminate the swap. The notional and fair values of end user derivatives at December 31, were as follows:
1996 Notional Value Fair Value ------------------ -------------------- (millions) Open Contracts Asset Liability -------------- ----- --------- Interest rate swaps: Pay a fixed rate, receive a floating rate $ 871 Pay a floating rate, receive a fixed rate 373 Currency swap 15 Interest rate caps 40 ------ ------ ------ $1,299 $ 17 $ 15 ====== ====== ====== Purchase Sell -------- ---- Foreign currency forwards $ 15 $ 114 $ 2 $ 4 Financial futures 580 111 -- -- ------ ------ ------ ------ $ 595 $ 225 $ 2 $ 4 ====== ====== ====== ======
68 Notes to Consolidated Financial Statements (continued)
1995 Notional Value Fair Value ----- ------------------ -------------------- (millions) Open Contracts Asset Liability -------------- ----- --------- Interest rate swaps: Pay a fixed rate, receive a floating rate $ 511 Pay a floating rate, receive a fixed rate 70 Currency swap 15 ------ $ 596 $ 3 $ 3 ====== ====== ====== Purchase Sell -------- ---- Foreign currency forwards $ 56 $ 150 $ 4 $ 5 Financial futures 256 64 -- -- ------ ------ ------ ------ $ 312 $ 214 $ 4 $ 5 ====== ====== ====== ======
Certain of the Company's subsidiaries employ swap contracts to manage interest rate risk related to variable rate obligations, limiting the Company's net exposure to interest rate movements to an acceptable level. Under these swaps the Company at December 31, 1996 and 1995 has fixed $475 million of its short-term or variable rate obligations at an average rate of 5.21%. The swaps are accounted for as hedges of the related liabilities and unrealized gains and losses are not recorded in the Consolidated Statement of Financial Position. Periodic receipts or payments are accrued as adjustments to expense. In addition, the Company utilizes swaps to manage the differing interest rate and/or currency risk profiles of its subsidiaries' liabilities and related fixed income investment portfolio. These swaps are marked-to-market and recorded as either other assets or other liabilities with changes in value recorded as an adjustment to stockholders' equity where unrealized gains and losses on the related debt securities are recorded. Certain subsidiaries employ forwards to hedge their exposure to foreign exchange rate risk related to the net investment in foreign branches and foreign currency denominated investments. These forwards are marked-to-market and recorded as other assets or liabilities in the Consolidated Statement of Financial Position. Changes in value related to forwards hedging the net investment in foreign subsidiaries are recorded as an adjustment to stockholders' equity where related translation adjustments are recorded. Changes in value related to forwards hedging foreign investments in U.S. portfolios are recorded as other income where the related translation adjustments to the underlying investments are recorded and such amounts were not significant in 1996 or 1995. The Company hedges expected cash flows related to certain customer deposits and investment maturities, redemptions and sales against adverse changes in market interest rates with financial futures contracts. These contracts are marked-to-market and recorded as other liabilities in the Consolidated Statement of Financial Position. Realized gains or losses are recorded as an adjustment to the cost basis of the related asset when acquired. 20. Fair Value of Financial Instruments ----------------------------------- The following table summarizes the fair value and carrying amount of the Company's financial instruments at December 31, 1996 and 1995. Contractholder funds amounts exclude certain insurance contracts not within the scope of FAS No. 107, "Disclosure About Fair Value of Financial Instruments." The fair value assumptions were based upon subjective estimates of market conditions and perceived risks of the financial instruments at a certain point in time as disclosed further in various notes to the consolidated financial statements. Disclosed fair values for financial instruments do not reflect any premium or discount that could result from offering for sale at one time the 69 Notes to Consolidated Financial Statements (continued) Company's entire holdings of a particular financial instrument. Potential taxes and other expenses that would be incurred in an actual sale or settlement are not reflected in amounts disclosed.
1996 1995 ----------------------------- ------------------------------ (millions) Carrying Amount Fair Value Carrying Amount Fair Value --------------- ---------- --------------- ---------- Assets: Investments $ 56,745 $ 56,754 $ 40,965 $ 40,976 Securities borrowed or purchased under agreements to resell 25,280 25,280 19,601 19,601 Trading securities owned 12,465 12,465 8,984 8,984 Net consumer finance receivables 7,885 8,556 7,092 7,745 Separate accounts with guaranteed returns 1,114 1,118 1,527 1,591 Derivatives: Trading 517 517 426 426 End User 2 19 4 7 Liabilities: Long-term debt 11,327 11,496 9,190 9,478 Securities loaned or sold under agreements to repurchase 24,449 24,449 20,619 20,619 Trading securities sold not yet purchased 8,378 8,378 4,563 4,563 Contractholder funds: With defined maturities 1,671 1,665 2,449 2,460 Without defined maturities 9,085 8,841 9,282 9,016 Separate accounts with guaranteed returns 1,017 899 1,475 1,408 Derivatives: Trading 481 481 340 340 End User 4 19 5 8
21. Commitments ----------- Guarantees of Securities of Other Issuers TAP underwrote insurance guaranteeing the securities of other issuers, primarily corporate and industrial revenue bond issuers. The aggregate gross amount of guarantees of principal and interest for such securities was $8.285 billion and $1.730 billion at December 31, 1996 and 1995, respectively. Reserves for the financial guarantee business, which includes reserves for defaults, incurred but not reported losses and unearned premiums, totaled $71 million at December 31, 1996 and were not significant at December 31, 1995. It is not practicable to estimate a fair value for these financial guarantees because there is no quoted market price for such contracts, it is not practicable to reliably estimate the timing and amount of all future cash flows due to the unique nature of each of these contracts, and TAP no longer writes such guarantees. Included in the gross amounts are financial guarantees representing TAP's participation in the Municipal Bond Insurance Association's guarantee of municipal bond obligations of $7.556 billion and $1.603 billion at December 31, 1996 and 1995, respectively. The bonds are generally rated A or above, and TAP's participation has been reinsured. 70 Notes to Consolidated Financial Statements (continued) At December 31, 1996, the scheduled maturities for these guarantees, net of TAP's participation in the municipal bond guarantee pools, are $142 million, $250 million, $8 million, $13 million and $316 million for 1997, 1998, 1999, 2000 and 2001 and thereafter, respectively. Credit Cards The Company provides bank and private label credit card services through CCC and its subsidiaries. These services are provided to individuals and to affinity groups nationwide. At December 31, 1996 and 1995 total credit lines available to credit cardholders were $6.622 billion and $5.870 billion, respectively. Other Commitments At December 31, 1996 and 1995 Smith Barney had borrowed securities having a market value of $2.085 billion and $451 million, respectively, against which it had pledged securities having a market value of $2.132 billion and $459 million, respectively. In addition, Smith Barney had obtained letters of credit aggregating $147 million and $119 million at December 31, 1996 and 1995, respectively, of which $147 million and $112 million, respectively, was used to satisfy various collateral and deposit requirements principally with clearing organizations. Smith Barney also trades certain fixed income securities on a "when-issued" basis, primarily to facilitate customer transactions and to hedge proprietary inventory positions. At December 31, 1996, Smith Barney had commitments to purchase $281 million and to sell $20 million of such securities when-issued. At December 31, 1995 Smith Barney had commitments to purchase $369 million and to sell $324 million of such securities when-issued. Smith Barney has entered into purchase agreements with various municipal issuers, whereby Smith Barney has purchased securities for forward delivery. These securities have been sold to the public for the same forward delivery dates. The total value of these commitments at December 31, 1996 and 1995 is $438 million and $475 million, respectively. Smith Barney had outstanding commitments to underwrite variable rate municipal securities totaling $346 million and $800 million at December 31, 1996 and 1995, respectively; conditions of the offerings include bond insurance and liquidity support facilities. At December 31, 1996 and 1995, Smith Barney had outstanding forward repurchase agreements totaling $725 million and $1.2 billion, respectively, and forward reverse repurchase agreements totaling $500 million and $625 million, respectively. These commitments represent forward financing transactions with agreed upon interest rates, principal amounts and delivery dates. Smith Barney and its principal broker-dealer subsidiary have each provided a portion of a residual value guarantee in connection with the lease of the buildings occupied by Smith Barney's executive offices and New York operations. The amount of the guarantee is dependent upon the final build-out costs with a maximum of $586 million. The Company makes commitments to fund partnership investments and transfers receivables to third parties with recourse from time to time. The off-balance sheet risks of these financial instruments were not significant at December 31, 1996 or 1995. 22. Contingencies ------------- A subsidiary of the Company is in arbitration with underwriters at Lloyd's of London (Lloyd's) in New York State to enforce reinsurance contracts with respect to recoveries for certain asbestos claims. The dispute involves the ability of old Travelers to aggregate asbestos claims under a market agreement between Lloyd's and old Travelers 71 Notes to Consolidated Financial Statements (continued) or under the applicable reinsurance treaties. The Company believes that the outcome of the arbitration is not likely to have a material adverse effect on its results of operations, financial condition or liquidity. With respect to environmental and asbestos claims, see Note 11. In the ordinary course of business, the Company and/or its subsidiaries are defendants or co-defendants in various litigation matters, other than environmental and asbestos claims. Although there can be no assurances, the Company believes, based on information currently available, that the ultimate resolution of these legal proceedings would not be likely to have a material adverse effect on its results of operations, financial condition or liquidity. 72 Notes to Consolidated Financial Statements (continued) 23. Selected Quarterly Financial Data (unaudited)
1996 ------------------------------------------------------------------- (In millions, except per share amounts) First Second Third Fourth Total ---------- ---------- ---------- ---------- ---------- Total revenues $ 4,515 $ 5,426 $ 5,622 $ 5,782 $ 21,345 Total expenses 3,715 5,210 4,694 4,725 18,344 Gain (loss) on sales of stock of subsidiaries and affiliates -- 397 -- -- 397 Income before incomes taxes and minority interest 800 613 928 1,057 3,398 Provision for income taxes 280 81 323 367 1,051 Minority interest, net of income taxes -- (44) 44 47 47 ---------- ---------- ---------- ---------- ---------- Income from continuing operations 520 576 561 643 2,300 Discontinued operations, net of income taxes -- -- 31 -- 31 ---------- ---------- ---------- ---------- ---------- Net income $ 520 $ 576 $ 592 $ 643 $ 2,331 ========== ========== ========== ========== ========== Earnings per share of common stock: Continuing operations $ 0.77 $ 0.88 $ 0.84 $ 0.97 $ 3.45 Discontinued operations -- -- 0.04 -- 0.05 ---------- ---------- ---------- ---------- ---------- Net income $ 0.77 $ 0.88 $ 0.88 $ 0.97 $ 3.50 ========== ========== ========== ========== ========== Common stock price per share: High $ 35.2500 $ 34.3125 $ 37.4063 $ 47.5000 $ 47.5000 Low $ 28.5000 $ 28.2500 $ 29.0625 $ 36.8438 $ 29.0625 Close $ 33.0000 $ 34.2188 $ 36.8438 $ 45.3750 $ 45.3750 Dividends per share of common stock $ 0.1125 $ 0.1125 $ 0.1125 $ 0.1125 $ 0.4500 1995 ------------------------------------------------------------------- (In millions, except per share amounts) First Second Third Fourth Total ---------- ---------- ---------- ---------- ---------- Total revenues $ 3,960 $ 4,172 $ 4,290 $ 4,161 $ 16,583 Total expenses 3,490 3,590 3,583 3,379 14,042 Gain (loss) on sales of stock of subsidiaries and affiliates -- -- -- (20) (20) Income before incomes taxes and minority interest 470 582 707 762 2,521 Provision for income taxes 165 205 251 272 893 Minority interest, net of income taxes -- -- -- -- -- ---------- ---------- ---------- ---------- ---------- Income from continuing operations 305 377 456 490 1,628 Discontinued operations, net of income taxes 35 29 25 117 206 ---------- ---------- ---------- ---------- ---------- Net income $ 340 $ 406 $ 481 $ 607 $ 1,834 ========== ========== ========== ========== ========== Earnings per share of common stock: Continuing operations $ 0.45 $ 0.56 $ 0.68 $ 0.74 $ 2.43 Discontinued operations 0.06 0.05 0.04 0.18 0.33 ---------- ---------- ---------- ---------- ---------- Net income $ 0.51 $ 0.61 $ 0.72 $ 0.92 $ 2.76 ========== ========== ========== ========== ========== Common stock price per share: High $ 19.9375 $ 22.5000 $ 26.6875 $ 31.9375 $ 31.9375 Low $ 16.1875 $ 18.9375 $ 22.0000 $ 24.4375 $ 16.1875 Close $ 19.3125 $ 21.8750 $ 26.5625 $ 31.3125 $ 31.3125 Dividends per share of common stock $ 0.1000 $ 0.1000 $ 0.1000 $ 0.1000 $ 0.4000
Due to changes in the number of average shares outstanding, quarterly earnings per share of common stock do not add to the totals for the years. The above information has been restated to reflect the stock splits as discussed in Note 1. 73 Independent Auditors' Report KPMG Peat Marwick LLP - LOGO The Board of Directors and Stockholders Travelers Group Inc.: We have audited the accompanying consolidated statement of financial position of Travelers Group Inc. and subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of income, changes in stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 1996. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Travelers Group Inc. and subsidiaries as of December 31, 1996 and 1995, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1996 in conformity with generally accepted accounting principles. /S/ KPMG Peat Marwick LLP New York, New York January 17, 1997 74 Exhibit 21.01 SUBSIDIARIES OF TRAVELERS GROUP INC. as of March 7, 1997 The following list omits certain subsidiaries which, considered in the aggregate as a single subsidiary, would not constitute a significant subsidiary. The jurisdiction of incorporation of each subsidiary is also indicated. Name of Subsidiary Company Jurisdiction of Incorporation - -------------------------- ----------------------------- .... AC Health Ventures, Inc. Delaware .... AMCO Biotech, Inc. Delaware .... Associated Madison Companies, Inc. Delaware .... .... American National Life Insurance (T & C), Ltd. Turks and Caicos Islands .... .... ERISA Corporation New York .... .... Mid-America Insurance Services, Inc. Georgia (also D/B/A M-A Insurance Services, Inc.) .... .... National Marketing Corporation Pennsylvania (also D/B/A American Service Associates) .... .... PFS Services, Inc. Georgia .... .... .... The Travelers Insurance Group Inc. Connecticut .... .... .... .... Constitution Plaza, Inc. Connecticut .... .... .... .... KP Properties Corporation Massachusetts .... .... .... .... KPI 85, Inc. Massachusetts .... .... .... .... KRA Advisers Corporation Massachusetts .... .... .... .... KRP Corporation Massachusetts .... .... .... .... La Metropole S.A. Belgium .... .... .... .... The Prospect Company Delaware .... .... .... .... .... 89th & York Avenue Corporation New York .... .... .... .... .... 979 Third Avenue Corporation Delaware .... .... .... .... .... Meadow Lane, Inc. Georgia .... .... .... .... .... Panther Valley, Inc. New Jersey .... .... .... .... .... Prospect Management Services Company Delaware .... .... .... .... .... The Travelers Asset Funding Corporation Connecticut .... .... .... .... .... .... Travelers Capital Funding Corporation Connecticut .... .... .... .... The Travelers Insurance Company Connecticut .... .... .... .... .... Applied Expert Systems Inc. Massachusetts .... .... .... .... .... The Plaza Corporation Connecticut .... .... .... .... .... .... The Copeland Companies (Holding Company) New Jersey .... .... .... .... .... .... .... American Odyssey Funds Management, Inc. New Jersey .... .... .... .... .... .... .... .... American Odyssey Funds, Inc. Maryland .... .... .... .... .... .... .... Copeland Administrative Services, Inc. New Jersey .... .... .... .... .... .... .... Copeland Associates, Inc. Delaware .... .... .... .... .... .... .... .... Copeland Associates Agency of Ohio, Inc. Ohio .... .... .... .... .... .... .... .... Copeland Associates of Alabama, Inc. Alabama .... .... .... .... .... .... .... .... Copeland Associates of Montana, Inc. Montana .... .... .... .... .... .... .... .... Copeland Benefits Management Company New Jersey .... .... .... .... .... .... .... .... Copeland Equities, Inc. New Jersey .... .... .... .... .... .... .... .... H.C. Copeland Associates, Inc. of Massachusetts Massachusetts .... .... .... .... .... .... .... Copeland Financial Services, Inc. New Jersey .... .... .... .... .... .... .... Copeland Healthcare Services, Inc. New Jersey .... .... .... .... .... .... .... H.C. Copeland and Associates, Inc. of Texas Texas .... .... .... .... .... .... Three Parkway Inc. - I Pennsylvania .... .... .... .... .... .... Three Parkway Inc. - II Pennsylvania .... .... .... .... .... .... Three Parkway Inc. - III Pennsylvania
Name of Subsidiary Company Jurisdiction of Incorporation - -------------------------- ----------------------------- .... .... .... .... .... .... Tower Square Securities, Inc. Connecticut .... .... .... .... .... .... Travelers Asset Management International Corporation New York .... .... .... .... .... .... Travelers Distribution Company Delaware .... .... .... .... .... .... Travelers Investment Adviser, Inc. Delaware .... .... .... .... .... .... Travelers/Net Plus Agency of Ohio, Inc. Ohio .... .... .... .... .... .... Travelers/Net Plus Insurance Agency, Inc. Massachusetts .... .... .... .... .... .... Travelers/Net Plus, Inc. Connecticut .... .... .... .... .... The Travelers Life and Annuity Company Connecticut .... .... .... .... .... Travelers Group Investment Management, LLC Delaware .... .... .... .... .... Travelers Insurance Holdings Inc. Georgia .... .... .... .... .... .... AC RE, Ltd. Bermuda .... .... .... .... .... .... American Financial Life Insurance Company Texas .... .... .... .... .... .... Primerica Life Insurance Company Massachusetts .... .... .... .... .... .... .... National Benefit Life Insurance Company New York .... .... .... .... .... .... .... Primerica Financial Services (Canada) Ltd. Canada .... .... .... .... .... .... .... .... PFSL Investments Canada Ltd. Canada .... .... .... .... .... .... .... .... Primerica Financial Services Ltd. Canada .... .... .... .... .... .... .... .... Primerica Life Insurance Company of Canada Canada .... .... .... .... The Travelers Insurance Corporation Proprietary Limited Australia .... .... .... .... Travelers Canada Corporation Canada .... .... .... .... Travelers Mortgage Securities Corporation Delaware .... .... .... .... Travelers of Ireland Limited Ireland .... .... .... .... Travelers Property Casualty Corp.(1) Delaware .... .... .... .... .... The Aetna Casualty and Surety Company Connecticut .... .... .... .... .... .... AE Development Group, Inc. Connecticut .... .... .... .... .... .... Aetna Casualty & Surety Company of Canada Canada .... .... .... .... .... .... Aetna Casualty and Surety Company of America Connecticut .... .... .... .... .... .... Aetna Casualty and Surety Company of Illinois Illinois .... .... .... .... .... .... Aetna Casualty Company of Connecticut Connecticut .... .... .... .... .... .... Aetna Commercial Insurance Company Connecticut .... .... .... .... .... .... Aetna Excess and Surplus Lines Company Connecticut .... .... .... .... .... .... Aetna Information Services Inc. Connecticut .... .... .... .... .... .... Aetna Lloyds of Texas Insurance Company Texas .... .... .... .... .... .... Aetna National Accounts U.K. Limited United Kingdom .... .... .... .... .... .... Axia Services, Inc. New York .... .... .... .... .... .... Farmington Casualty Company Connecticut .... .... .... .... .... .... Farmington Management, Inc. Connecticut .... .... .... .... .... .... Urban Diversified Properties, Inc. Connecticut .... .... .... .... .... The Standard Fire Insurance Company Connecticut .... .... .... .... .... .... AE Properties, Inc. California .... .... .... .... .... .... Aetna Insurance Company Connecticut .... .... .... .... .... .... Aetna Insurance Company of Illinois Illinois .... .... .... .... .... .... Aetna Personal Security Insurance Company Connecticut .... .... .... .... .... .... Community Rehabilitation Investment Corporation Connecticut .... .... .... .... .... .... The Automobile Insurance Company of Hartford, Connecticut Connecticut .... .... .... .... .... The Travelers Indemnity Company Connecticut .... .... .... .... .... .... Commercial Insurance Resources, Inc. Delaware .... .... .... .... .... .... .... Gulf Insurance Company Missouri .... .... .... .... .... .... .... .... Atlantic Insurance Company Texas .... .... .... .... .... .... .... .... Gulf Group Lloyds Texas .... .... .... .... .... .... .... .... Gulf Risk Services, Inc. Delaware .... .... .... .... .... .... .... .... Gulf Underwriters Insurance Company North Carolina
- -------- (1) Travelers Group Inc. owns approximately 82% of the outstanding common stock of Travelers Property Casualty Corp. 2 Name of Subsidiary Company Jurisdiction of Incorporation - -------------------------- ----------------------------- .... .... .... .... .... .... .... .... Select Insurance Company Texas .... .... .... .... .... .... Countersignature Agency, Inc. Florida .... .... .... .... .... .... First Floridian Auto and Home Insurance Company Florida .... .... .... .... .... .... First Trenton Indemnity Company New Jersey .... .... .... .... .... .... Laramia Insurance Agency, Inc. North Carolina .... .... .... .... .... .... Secure Affinity Agency, Inc. Delaware .... .... .... .... .... .... The Charter Oak Fire Insurance Company Connecticut .... .... .... .... .... .... The Parker Realty and Insurance Agency, Inc. Vermont .... .... .... .... .... .... The Phoenix Insurance Company Connecticut .... .... .... .... .... .... .... Constitution State Service Company Montana .... .... .... .... .... .... .... The Travelers Indemnity Company of America Georgia .... .... .... .... .... .... .... The Travelers Indemnity Company of Connecticut Connecticut .... .... .... .... .... .... .... The Travelers Indemnity Company of Illinois Illinois .... .... .... .... .... .... The Premier Insurance Company of Massachusetts Massachusetts .... .... .... .... .... .... The Travelers Home and Marine Insurance Company Indiana .... .... .... .... .... .... The Travelers Indemnity Company of Missouri Missouri .... .... .... .... .... .... The Travelers Lloyds Insurance Company Texas .... .... .... .... .... .... The Travelers Marine Corporation California .... .... .... .... .... .... TI Home Mortgage Brokerage, Inc. Delaware .... .... .... .... .... .... TravCo Insurance Company Indiana .... .... .... .... .... .... Travelers Bond Investments, Inc. Connecticut .... .... .... .... .... .... Travelers General Agency of Hawaii, Inc. Hawaii .... .... .... .... .... .... Travelers Medical Management Services Inc. Delaware .... .... .... .... .... .... Travelers Specialty Property Casualty Company, Inc. Connecticut .... .... Primerica Convention Services, Inc. Georgia .... .... Primerica Finance Corporation Delaware .... .... .... PFS Distributors, Inc. Georgia .... .... .... PFS Investments Inc. Georgia .... .... .... PFS T.A., Inc. Delaware .... .... Primerica Financial Services Home Mortgages, Inc. Georgia .... .... Primerica Financial Services, Inc. Nevada .... .... .... Primerica Financial Services Agency of New York, Inc. New York .... .... .... Primerica Financial Services Insurance Marketing of Connecticut, Inc. Connecticut .... .... .... Primerica Financial Services Insurance Marketing of Idaho, Inc. Idaho .... .... .... Primerica Financial Services Insurance Marketing of Nevada, Inc. Nevada .... .... .... Primerica Financial Services Insurance Marketing of Pennsylvania, Inc. Pennsylvania (also D/B/A Primerica Financial Services) .... .... .... Primerica Financial Services Insurance Marketing of the Virgin Islands, Inc. United States Virgin Islands .... .... .... Primerica Financial Services Insurance Marketing of Wyoming, Inc. Wyoming .... .... .... Primerica Financial Services Insurance Marketing, Inc. Delaware .... .... .... Primerica Financial Services of Alabama, Inc. Alabama .... .... .... Primerica Financial Services of Arizona, Inc. Arizona .... .... .... Primerica Financial Services of Kentucky Inc. Kentucky .... .... .... Primerica Financial Services of New Mexico, Inc. New Mexico .... .... .... Primerica Insurance Agency of Massachusetts, Inc. Massachusetts .... .... .... Primerica Insurance Marketing Services of Puerto Rico, Inc. Puerto Rico .... .... .... Primerica Insurance Services of Louisiana, Inc. Louisiana (also D/B/A A.L. Williams) .... .... .... Primerica Insurance Services of Maryland, Inc. Maryland .... .... Primerica Services, Inc. Georgia .... .... RCM Acquisition Inc. Delaware .... .... SCN Acquisitions Company Delaware .... .... SL&H Reinsurance, Ltd. Nevis .... .... .... Southwest Service Agreements, Inc. North Carolina
3 Name of Subsidiary Company Jurisdiction of Incorporation - -------------------------- ----------------------------- .... .... Southwest Warranty Corporation Florida .... Berg Associates New Jersey .... CCC Holdings, Inc. Delaware .... .... Commercial Credit Company Delaware .... .... .... American Health and Life Insurance Company Maryland .... .... .... Brookstone Insurance Company Vermont (also D/B/A Alexander Insurance Managers) .... .... .... CC Finance Company, Inc. New York .... .... .... CC Financial Services, Inc. Hawaii .... .... .... CCC Fairways, Inc. Delaware .... .... .... Chesapeake Appraisal and Settlement Services Inc. Maryland .... .... .... .... Chesapeake Appraisal and Settlement Services Agency of Ohio Inc. Ohio .... .... .... City Loan Financial Services, Inc. Ohio .... .... .... City Loan Financial, Inc. Ohio .... .... .... Commercial Credit Banking Corporation Oregon .... .... .... Commercial Credit Consumer Services, Inc. Minnesota .... .... .... Commercial Credit Corporation Alabama .... .... .... Commercial Credit Corporation California .... .... .... Commercial Credit Corporation (Hawaii) Hawaii .... .... .... Commercial Credit Corporation Iowa (also D/B/A Commercial Credit Corporation (IA)) .... .... .... .... Commercial Credit of Alabama, Inc. Delaware .... .... .... .... Commercial Credit of Mississippi, Inc. Delaware .... .... .... Commercial Credit Corporation Kentucky .... .... .... .... Certified Insurance Agency, Inc. Kentucky .... .... .... .... Commercial Credit Investment, Inc. Kentucky .... .... .... .... National Life Insurance Agency of Kentucky, Inc. Kentucky .... .... .... .... Union Casualty Insurance Agency, Inc. Kentucky .... .... .... Commercial Credit Corporation Maryland (also D/B/A Commercial Credit Corporation (MD)) .... .... .... .... Action Data Services, Inc. Missouri .... .... .... .... Commercial Credit Plan, Incorporated Oklahoma (also D/B/A Commercial Credit Consumer Services, Inc.) .... .... .... Commercial Credit Corporation New York .... .... .... Commercial Credit Corporation South Carolina .... .... .... Commercial Credit Corporation West Virginia .... .... .... Commercial Credit Corporation NC North Carolina .... .... .... Commercial Credit Europe, Inc. Delaware .... .... .... Commercial Credit Far East Inc. Delaware .... .... .... Commercial Credit Insurance Services, Inc. Maryland (also D/B/A Commercial Credit Insurance Agency) .... .... .... .... Commercial Credit Insurance Agency (P&C) of Mississippi, Inc. Mississippi .... .... .... .... Commercial Credit Insurance Agency of Alabama, Inc. Alabama .... .... .... .... Commercial Credit Insurance Agency of Hawaii, Inc. Hawaii .... .... .... .... Commercial Credit Insurance Agency of Kentucky, Inc. Kentucky .... .... .... .... Commercial Credit Insurance Agency of Massachusetts, Inc. Massachusetts .... .... .... .... Commercial Credit Insurance Agency of Nevada, Inc. Nevada .... .... .... .... Commercial Credit Insurance Agency of New Mexico, Inc. New Mexico .... .... .... .... Commercial Credit Insurance Agency of Ohio, Inc. Ohio .... .... .... Commercial Credit International, Inc. Delaware .... .... .... .... Commercial Credit International Banking Corporation Oregon .... .... .... .... .... Commercial Credit Corporation CCC Limited Canada .... .... .... .... .... Commercial Credit Services do Brazil Ltda. Brazil .... .... .... .... Commercial Credit Services Belgium S.A. Belgium
4 Name of Subsidiary Company Jurisdiction of Incorporation - -------------------------- ----------------------------- .... .... .... Commercial Credit Limited Delaware .... .... .... Commercial Credit Loan, Inc. New York .... .... .... Commercial Credit Loans, Inc. Delaware .... .... .... Commercial Credit Loans, Inc. Ohio .... .... .... Commercial Credit Loans, Inc. Virginia .... .... .... Commercial Credit Management Corporation Maryland .... .... .... Commercial Credit Plan Incorporated Tennessee (also D/B/A Commercial Credit Plan Incorporated (TN)) .... .... .... Commercial Credit Plan Incorporated Utah .... .... .... Commercial Credit Plan Incorporated of Georgetown Delaware .... .... .... Commercial Credit Plan Industrial Loan Company Virginia .... .... .... Commercial Credit Plan, Incorporated Colorado .... .... .... Commercial Credit Plan, Incorporated Delaware .... .... .... Commercial Credit Plan, Incorporated Georgia .... .... .... Commercial Credit Plan, Incorporated Missouri .... .... .... Commercial Credit Securities, Inc. Delaware .... .... .... DeAlessandro & Associates, Inc. Delaware .... .... .... Park Tower Holdings, Inc. Delaware .... .... .... .... CC Retail Services, Inc. Delaware .... .... .... .... .... Troy Textiles, Inc. Delaware .... .... .... .... Commercial Credit Development Corporation Delaware .... .... .... .... .... Myers Park Properties, Inc. Delaware .... .... .... .... Travelers Home Mortgage Services of Alabama, Inc. Delaware .... .... .... Penn Re, Inc. North Carolina .... .... .... Plympton Concrete Products, Inc. Delaware .... .... .... Resource Deployment, Inc. Texas .... .... .... The Travelers Bank Delaware .... .... .... The Travelers Bank USA Delaware .... .... .... Travelers Home Equity, Inc. North Carolina .... .... .... .... CC Consumer Services of Alabama, Inc. Alabama .... .... .... .... CC Home Lenders Financial, Inc. Georgia .... .... .... .... CC Home Lenders, Inc. Ohio .... .... .... .... Commercial Credit Corporation Texas .... .... .... .... Commercial Credit Financial of Kentucky, Inc. Kentucky .... .... .... .... Commercial Credit Financial of West Virginia, Inc. West Virginia .... .... .... .... Commercial Credit Plan Consumer Discount Company Pennsylvania (also D/B/A Commercial Credit Corporation) .... .... .... .... Commercial Credit Services of Kentucky, Inc. Kentucky .... .... .... .... Travelers Home Mortgage Services, Inc. North Carolina .... .... .... Triton Insurance Company Missouri (also D/B/A Voyager Guaranty Insurance Company) .... .... .... Verochris Corporation Delaware (also D/B/A Air Operations Associates) .... .... .... .... AMC Aircraft Corp. Delaware .... .... .... World Service Life Insurance Company Colorado .... Greenwich Street Capital Partners, Inc. Delaware .... Greenwich Street Investments, Inc. Delaware .... .... Greenwich Street Capital Partners Offshore Holdings, Inc. Delaware .... Mirasure Insurance Company, Ltd. Bermuda .... Pacific Basin Investments Ltd. Delaware .... Primerica Corporation Wyoming .... Primerica, Inc. Delaware .... Smith Barney Corporate Trust Company Delaware .... Smith Barney Holdings Inc. Delaware
5 Name of Subsidiary Company Jurisdiction of Incorporation - -------------------------- ----------------------------- .... .... Nextco Inc. Delaware .... .... R-H Capital, Inc. Delaware .... .... R-H Sports Enterprises Inc Georgia .... .... SB Cayman Holdings I Inc. Delaware .... .... .... Smith Barney Private Trust Company (Cayman) Limited Cayman Islands .... .... .... .... Greenwich (Cayman) I Limited Cayman Islands .... .... .... .... Greenwich (Cayman) II Limited Cayman Islands .... .... .... .... Greenwich (Cayman) III Limited Cayman Islands .... .... SB Cayman Holdings II Inc. Delaware .... .... .... Smith Barney Private Trust Company (Cayman) Limited Cayman Islands .... .... .... .... Greenwich (Cayman) I Limited Cayman Islands .... .... .... .... Greenwich (Cayman) II Limited Cayman Islands .... .... .... .... Greenwich (Cayman) III Limited Cayman Islands .... .... SB Cayman Holdings III Inc. Delaware .... .... .... Smith Barney Credit Services (Cayman) Ltd. Cayman Islands .... .... SB Cayman Holdings IV Inc. Delaware .... .... .... Smith Barney Credit Services (Cayman) Ltd. Cayman Islands .... .... Smith Barney (Delaware) Inc. Delaware .... .... .... 1345 Media Corp. Delaware .... .... .... Corporate Realty Advisors, Inc. Delaware .... .... .... IPO Holdings Inc. Delaware .... .... .... .... Institutional Property Owners, Inc. V Delaware .... .... .... .... Institutional Property Owners, Inc. VI Delaware .... .... .... MLA 50 Corporation Delaware .... .... .... MLA GP Corporation Delaware .... .... .... Smith Barney Acquisition Corporation Delaware .... .... .... Smith Barney Acquisition Fund, Inc. Cayman Islands .... .... .... Smith Barney Global Capital Management, Inc. Delaware .... .... .... Smith Barney Realty, Inc. Delaware .... .... .... Smith Barney Risk Investors, Inc. Delaware .... .... .... Smith Barney Venture Corp. Delaware .... .... Smith Barney (Ireland) Limited Ireland .... .... Smith Barney Asia Inc. Delaware .... .... Smith Barney Asset Management Group (Asia) Pte. Ltd. Singapore .... .... Smith Barney Canada Inc. Canada .... .... Smith Barney Capital Services Inc. Delaware .... .... Smith Barney Cayman Islands, Ltd. Cayman Islands .... .... Smith Barney Commercial Corp. Delaware .... .... Smith Barney Commercial Corporation Asia Limited Hong Kong .... .... Smith Barney Europe Holdings, Ltd. United Kingdom .... .... .... Smith Barney Europe, Ltd. United Kingdom .... .... .... Smith Barney Shearson Futures, Ltd. United Kingdom .... .... Smith Barney Futures Management Inc. Delaware .... .... .... Smith Barney Offshore Fund Ltd. Delaware .... .... .... Smith Barney Overview Fund PLC Dublin .... .... Smith Barney Inc. Delaware .... .... .... KEB Smith Barney Securities Co., Ltd. Korea .... .... .... SBHU Life Agency, Inc. Delaware .... .... .... .... Robinson-Humphrey Insurance Services Inc. Georgia .... .... .... .... .... Robinson-Humphrey Insurance Services of Alabama, Inc. Alabama .... .... .... .... SBHU Life Agency of Arizona, Inc. Arizona .... .... .... .... SBHU Life Agency of Indiana, Inc. Indiana .... .... .... .... SBHU Life Agency of Utah, Inc. Utah .... .... .... .... SBHU Life Insurance Agency of Massachusetts, Inc. Massachusetts
6 Name of Subsidiary Company Jurisdiction of Incorporation - -------------------------- ----------------------------- .... .... .... .... SBS Insurance Agency of Hawaii, Inc. Hawaii .... .... .... .... SBS Insurance Agency of Idaho, Inc. Idaho .... .... .... .... SBS Insurance Agency of Maine, Inc. Maine .... .... .... .... SBS Insurance Agency of Montana, Inc. Montana .... .... .... .... SBS Insurance Agency of Nevada, Inc. Nevada .... .... .... .... SBS Insurance Agency of Ohio, Inc. Ohio .... .... .... .... SBS Insurance Agency of South Dakota, Inc. South Dakota .... .... .... .... SBS Insurance Agency of Wyoming, Inc. Wyoming .... .... .... .... SBS Insurance Brokerage Agency of Arkansas, Inc. Arkansas .... .... .... .... SBS Insurance Brokers of Kentucky, Inc. Kentucky .... .... .... .... SBS Insurance Brokers of New Hampshire, Inc. New Hampshire .... .... .... .... SBS Insurance Brokers of North Dakota, Inc. North Dakota .... .... .... .... SBS Life Insurance Agency of Puerto Rico, Inc. Puerto Rico .... .... .... .... SLB Insurance Agency of Maryland, Inc. Maryland .... .... .... .... Smith Barney Life Agency Inc. Louisiana .... .... .... Smith Barney (Hong Kong) Limited Hong Kong .... .... .... Smith Barney (Netherlands) Inc. Delaware .... .... .... Smith Barney International Incorporated Oregon .... .... .... .... Smith Barney (Singapore) Pte Ltd Singapore .... .... .... .... Smith Barney Pacific Holdings, Inc. British Virgin Islands .... .... .... .... .... Smith Barney (Asia) Limited Hong Kong .... .... .... .... .... Smith Barney (Pacific) Limited Hong Kong .... .... .... .... Smith Barney Securities Pte Ltd Singapore .... .... .... Smith Barney Puerto Rico Inc. Puerto Rico .... .... .... The Robinson-Humphrey Company, Inc. Delaware .... .... Smith Barney Mortgage Brokers Inc. Delaware .... .... Smith Barney Mortgage Capital Corp. Delaware .... .... Smith Barney Mortgage Capital Group, Inc. Delaware .... .... Smith Barney Mutual Funds Management Inc. Delaware .... .... .... Smith Barney Strategy Advisers Inc. Delaware .... .... .... .... E.C. Tactical Management S.A. Luxembourg .... .... Smith Barney Offshore, Inc. Delaware .... .... .... Decathlon Offshore Limited Cayman Islands .... .... Smith Barney S.A. France .... .... .... Smith Barney Asset Management France S.A. France .... .... Smith Barney Securities Investment Consulting Co. Ltd. Taiwan .... .... Smith Barney Shearson (Chile) Corredora de Seguro Limitada Chile (also D/B/A SBS (Chile) Corredora de Seguros Ltda.) .... .... Structured Mortgage Securities Corporation Delaware .... .... The Travelers Investment Management Company Connecticut .... Smith Barney Private Trust Company New York .... Smith Barney Private Trust Company of Florida Florida .... Tinmet Corporation Delaware .... Travelers Group Diversified Distribution Services, Inc. Delaware .... .... Travelers Group Exchange, Inc. Delaware (also D/B/A VIPortfolio Agency) .... Travelers Services Inc. Delaware (also D/B/A Travelers Coronado Services Inc.) .... Tribeca Management Inc. Delaware .... TRV Employees Investments, Inc. Delaware .... TRV/RCM Corp. Delaware .... TRV/RCM LP Corp. Delaware
7 Exhibit 99.01 COMPANY'S FORM 10-Q September 30, 1993 Page 26 In October 1993, several purported class action lawsuits were filed in the Federal District Court for the Southern District of New York naming Smith Barney, Harris Upham & Co. Incorporated ("SBS") as defendant. The cases arise from SBS's participation as lead and co-underwriter in the initial public offerings of three separate funds managed by Hyperion Capital Management Inc. The plaintiffs have also named as defendants the funds' directors and the co-underwriters and their representatives. Plaintiffs allege that the registration statements and prospectuses by which the offerings were made between June 1992 and October 1992 were materially false and misleading, and are seeking unspecified damages in claims brought under the Federal securities laws. The Company believes it has meritorious defenses to these actions and intends to defend against them vigorously. COMPANY'S FORM 10-K December 31, 1995 Page 65 For information concerning several purported class action lawsuits filed against SBI in connection with three funds managed by Hyperion Capital Management Inc., see the description that appears in the fourth paragraph of page 26 of the Company's filing on Form 10-Q for the quarter ended September 30, 1993, which description is incorporated by reference herein. A copy of the pertinent paragraph of such filing is included as an exhibit to this Form 10-K. The actions were consolidated under the title In re: Hyperion Securities Litigation. SBI's motion to dismiss the claims was granted in July 1995. In August 1995, an appeal was filed in the U.S. Court of Appeals for the Second Circuit. The Company is awaiting a decision on the appeal. COMPANY'S FORM 10-Q September 30, 1996 Page 34 Item 1. Legal Proceedings. For information concerning the several class action lawsuits filed against Smith Barney Inc. in connection with three funds managed by Hyperion Capital Management Inc., see the descriptions that appear in the fourth paragraph on page 26 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993, and the first paragraph under the heading "Smith Barney" on page 65 of the Company's Annual Report on Form 10-K for the year ended December 31, 1995, which descriptions are incorporated by reference herein. A copy of the pertinent paragraphs of such filings is included as an exhibit to this Form 10-Q. In October 1996, the U.S. Court of Appeals for the Second Circuit affirmed the district court's dismissal of the claims. Plaintiffs have applied for a rehearing en banc. Exhibit 99.02 SMITH BARNEY HOLDINGS INC. Form 10-Q September 30, 1994 Page 16 In June, 1994, several actions relating to trading practices on the National Association of Securities Dealers Automated Quotation system were filed against a number of broker/dealers, including SBI, in various federal courts. In October 1994, the actions were consolidated in the Federal District Court for the Southern District of New York. The plaintiffs purport to represent a class of purchasers of stock trading in that system over the last four years. The claims generally allege price-fixing violations under the federal antitrust laws and violations of the federal securities laws relating to the use of even-eighth price quotes instead of odd-eighth bid and asked quotes. A consolidated amended complaint is expected to be filed in mid-December 1994. The Company is reviewing these allegations, believes that it has meritorious defenses and intends to vigorously defend against these claims. COMPANY'S FORM 10-K December 31, 1995 Page 65 For information concerning actions filed against a number of broker-dealers, including SBI, relating to trading practices on the National Association of Securities Dealers Automated Quotation system, see the description that appears in the third paragraph of page 16 of the Quarterly Report on Form 10-Q of Smith Barney Holdings Inc. for the quarter ended September 30, 1994, which description is incorporated by reference herein. A copy of the pertinent paragraph is included as an exhibit to this Form 10-K. A consolidated amended complaint was filed in December 1994. In August 1995, the defendants' motion to dismiss was granted with leave to replead, and a consolidated amended complaint was filed. Exhibit 99.03 COMPANY'S FORM 10-Q June 30, 1996 Page 35 Item 1. Legal Proceedings. In July 1996, a complaint seeking equitable relief was filed in the U.S. District Court for the Southern District of New York by the U.S. Department of Justice, naming twenty-four major brokerage firms, including the Company's subsidiary, Smith Barney Inc., as defendants. A proposed settlement has been agreed to by the parties, subject to approval of the court. Pursuant to this settlement, the defendants, without admitting any liability, would agree not to engage in certain practices relating to the quoting of Nasdaq securities and would further agree to implement a program to ensure compliance with federal antitrust laws and with the terms of the settlement. No monetary fines or penalties are imposed as part of the settlement. Exhibit 99.04 COMPANY'S FORM 8-K March 1, 1994 Pages 2 and 3 In a case entitled The Travelers Insurance Company et al. v. Richard John Ratcliffe Keeling et al., filed in New York Supreme Court in June 1991, old Travelers seeks to enforce reinsurance contracts with certain underwriters at Lloyd's of London with respect to recoveries for certain asbestos claims. In January 1994, the Court stayed litigation of this matter in favor of arbitration. The issues before the arbitration panel include the underwriters' breach of contract and anticipated breach of their agreement with the Company on asbestos-related reinsurance claims. Exhibit 99.05 PROSPECTUS OF TRAVELERS/AETNA PROPERTY CASUALTY CORP. April 22, 1996 Pages 90 and 91 A number of cases have been filed against several insurance companies and industry organizations relating to service fee charges and premium calculations on certain workers' compensation insurance. Certain subsidiaries of the Company are defendants in South Carolina ex rel. Medlock v. National Council on Compensation Insurance ("NCCI"), an action filed by the Attorney General of South Carolina in August 1994 in the Court of Common Pleas, County of Greenville, South Carolina; Four Way Plant Farm v. NCCI, a purported class action filed in September 1994 in the Circuit Court for Bullock County, Alabama, and NC Steel, Inc. v. NCCI, a purported class action filed in November 1993 in the Superior Court Division of the General Court of Justice, Wake County, North Carolina. In these cases, the plaintiffs generally allege that the administration of each state's workers' compensation assigned risk pool conspired with servicing carriers for the pool to collect excessive fees in violation of state antitrust and/or unfair trade practice laws. The plaintiffs seek unspecified compensatory, treble and/or punitive damages and injunctive relief. The Company believes it has meritorious defenses and intends to contest the allegations. In NC Steel, Inc. v. NCCI, the defendants' motion to dismiss was granted in February 1995, and the plaintiffs have appealed to the North Carolina Court of Appeals. In April 1994, certain subsidiaries of [the Company] were named as additional defendants in a purported class action pending in the 116th District of Dallas County, Texas, entitled Weatherford Roofing Company v. Employers National Insurance Company. The plaintiffs in this case allege that the workers' compensation carriers in Texas have conspired to collect excessive or improper premiums in violation of state insurance laws, antitrust laws and/or state unfair trade practices laws. The plaintiffs seek compensatory, treble and/or punitive damages as well as declaratory and injunctive relief. In a statutory demand letter, plaintiffs' counsel allege classwide compensatory damages, including interest through October 1994, of approximately $572 million. Since that time, court-approved settlements with certain other insurers have been based on single damage, or alleged overcharge, calculations which, if applied to Company-issued policies of class members, would yield single damages of $50 million or less. The Company believes it has meritorious defenses and intends to contest the allegations unless an attractive settlement opportunity arises. COMPANY'S FORM 10-Q June 30, 1996 Page 35 For information concerning actions filed against several insurance companies and industry organizations relating to service fee charges and premium calculations on certain workers' compensation insurance, see the description that appears in the paragraph beginning on page 90 and continuing on page 91 of the Prospectus dated April 22, 1996 of Travelers/Aetna Property Casualty Corp., a majority-owned subsidiary of the Company, which description is incorporated by reference herein. A copy of the pertinent paragraph of such filing is included as an exhibit to this Form 10-Q. Two of such actions, Four Way Plant Farm v. NCCI and Weatherford Roofing Company v. Employees National Insurance Company, have been settled, subject to approval of the court. In NC Steel, Inc. v. NCCI, the North Carolina Court of Appeals affirmed the trial court's dismissal in part, reversed in part and remanded for further proceedings. COMPANY'S FORM 10-Q September 30, 1996 Page 34 For information concerning actions filed against several insurance companies and industry organizations relating to service fee charges and premium calculations on certain workers' compensation insurance, see the descriptions that appear in the paragraph that begins on page 90 and ends on page 91 of the Prospectus dated April 22, 1996 of Travelers/Aetna Property Casualty Corp., a majority-owned subsidiary of the Company, and in the second paragraph on page 35 of the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1996, which descriptions are incorporated by reference herein. A copy of the pertinent paragraphs of such filings is included as an exhibit to this Form 10-Q. In October 1996, certain subsidiaries of the Company were named as defendants in a purported class action filed in the District Court of Wyandotte County, Kansas, Civil Court Department under the name Amundson & Associates Art Studio Ltd. v. NCCI, et al. The plaintiffs make allegations and seek damages that are similar to those in the cases referred to above. Exhibit 99.06 COMPANY'S FORM 10-Q September 30, 1995 Page 30 In July 1995, a purported class action was filed under the name Elvidio Vennettilli et. al. v. Primerica Inc. et. al. in the United States District Court for the Eastern District of Michigan on behalf of individuals who purchased interests in oil and gas rights owned by Basic Energy and Affiliated Resources Inc. ("BEAR"). Notwithstanding that the alleged violations were in contravention of agreements between the agents and Primerica Financial Services ("PFS") and did not involve securities of the Company or any subsidiary thereof, the complaint, which seeks unspecified monetary damages, alleges that defendants, including PFS, committed violations of the federal securities laws and common law fraud. The Company believes it has meritorious defenses and intends to contest the allegations. COMPANY'S FORM 10-Q March 31, 1996 Page 25 For information concerning a purported class action against Primerica Inc. and others in connection with the purchase of oil and gas rights owned by Basic Energy and Affiliated Resources Inc. ("BEAR"), see the description that appears in the second paragraph of page 30 of the Company's filing on Form 10-Q for the quarter ended September 30, 1995, which description is incorporated by reference herein. A copy of the pertinent paragraph of such filing is included as an exhibit to this Form 10-Q. Two additional alleged class actions making similar allegations and seeking similar relief, Fournier v. PFS Inc. and McNeely v. BEAR, have purported to name certain subsidiaries of the Company as defendants. These cases are pending in the U.S. District Court for the Eastern District of Michigan. The Company has filed a motion to dismiss each of these actions. COMPANY'S FORM 10-Q September 30, 1996 Page 34 For information concerning a purported class action filed against Primerica Financial Services Inc. ("PFSI"), a subsidiary of the Company, in connection with the purchase by individuals of interests in oil and gas rights owned by Basic Energy and Affiliated Resources Inc. ("BEAR"), see the description that appears in the second paragraph on page 30 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1995 and the fourth paragraph on page 25 of the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1996, which descriptions are incorporated by reference herein. A copy of the pertinent paragraphs of such filings is included as an exhibit to this Form 10-Q. In October 1996, the court dismissed several claims against PFSI. Also in October 1996, the National Association of Securities Dealers, Inc. ("NASD") filed a complaint against PFSI alleging a failure to supervise certain registered representatives and associated persons and to establish and maintain proper written procedures for compliance with NASD rules regarding private securities transactions relating to BEAR. EX-99.02 5 QUARTERLY REPORT ON FORM 10-Q EXHIBIT 99.02 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C. 20549 ------------------------ FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 1997 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _________ to _________ ------------------------ Commission file number 1-9924 ------------------------ TRAVELERS GROUP INC. (Exact name of registrant as specified in its charter) Delaware 52-1568099 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 388 Greenwich Street, New York, New York 10013 (Address of principal executive offices) (Zip Code) (212) 816-8000 (Registrant's telephone number, including area code) ------------------------ Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes /x/ No / / Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date: Common stock outstanding as of July 31, 1997: 641,114,987 Travelers Group Inc. TABLE OF CONTENTS ----------------- Part I Financial Information Item 1. Financial Statements: Page No. Condensed Consolidated Statement of Income (Unaudited)-- Three and Six Months Ended June 30, 1997 and 1996.................................... 3 Condensed Consolidated Statement of Financial Position-- June 30, 1997 (Unaudited) and December 31, 1996.................................... 4 Condensed Consolidated Statement of Changes in Stockholders' Equity (Unaudited)--Six Months Ended June 30, 1997................................ 5 Condensed Consolidated Statement of Cash Flows (Unaudited)-- Six Months Ended June 30, 1997 and 1996.................. 6 Notes to Condensed Consolidated Financial Statements--(Unaudited)....... 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 14 Part II--Other Information Item 1. Legal Proceedings.......................... 35 Item 2. Changes in Securities...................... 36 Item 6. Exhibits and Reports on Form 8-K........... 36 Exhibit Index......................................... 37 Signatures............................................ 38 Travelers Group Inc. and Subsidiaries Condensed Consolidated Statement of Income (Unaudited) (In millions of dollars, except per share amounts) THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, -------------------- -------------------- 1997 1996 1997 1996 --------- --------- --------- --------- Revenues Insurance premiums.................$ 2,220 $ 2,060 $ 4,444 $ 3,316 Commissions and fees............... 841 878 1,718 1,766 Interest and dividends............. 1,638 1,417 3,206 2,543 Finance related interest and other charges.......................... 321 287 627 571 Principal transactions............. 250 265 514 543 Asset management and administration fees............................. 386 331 762 648 Other income....................... 317 188 630 554 ------ --------- --------- --------- Total revenues................... 5,973 5,426 11,901 9,941 --------- --------- --------- --------- Expenses Policyholder benefits and claims... 1,906 2,319 3,811 3,590 Non-insurance compensation and benefits......................... 966 958 1,950 1,930 Insurance underwriting, acquisition and operating.................... 799 861 1,604 1,367 Interest........................... 696 563 1,349 1,060 Provision for consumer finance credit losses.................... 73 60 145 128 Other operating.................... 435 449 876 850 --------- --------- --------- --------- Total expenses................... 4,875 5,210 9,735 8,925 --------- --------- --------- --------- Gain (loss) on sale of subsidiaries and affiliates................... -- 397 -- 397 --------- --------- --------- --------- Income before income taxes and minority interest................ 1,098 613 2,166 1,413 Provision for income taxes......... (386) (81) (763) (361) Minority interest, net of income taxes............................ (49) 44 (98) 44 --------- --------- --------- --------- Net income.........................$ 663 $ 576 $ 1,305 $ 1,096 --------- --------- --------- --------- --------- --------- --------- --------- Net income per share of common stock and common stock equivalents......................$ 1.00 $ 0.88 $ 1.96 $ 1.65 --------- --------- --------- --------- --------- --------- --------- --------- Weighted average number of common shares outstanding and common stock equivalents (millions)..... 645.3 634.7 645.7 636.1 --------- --------- --------- --------- --------- --------- --------- --------- See Notes to Condensed Consolidated Financial Statements. Travelers Group Inc. and Subsidiaries Condensed Consolidated Statement of Financial Position (In millions of dollars) JUNE 30, DECEMBER 31, 1997 1996 ----------- ------------- ASSETS (UNAUDITED) Cash and cash equivalents (including $1,306 and $1,256 segregated under federal and other regulations)..................... $ 1,739 $ 1,868 Investments and real estate held for sale: Fixed maturities, primarily available for sale at market value (amortized cost--$45,292 and $43,277). 45,981 43,998 Equity securities, at market (cost--$1,324 and $1,113)............. 1,377 1,157 Mortgage loans.......................... 3,748 3,812 Real estate held for sale............... 502 459 Policy loans............................ 1,873 1,910 Short-term and other.................... 5,135 5,173 ----------- ------------- Total investments and real estate held for sale......................... 58,616 56,509 ----------- ------------- Securities borrowed or purchased under agreements to resell................... 27,950 25,280 Brokerage receivables.................... 8,507 7,305 Trading securities owned, at market value.................................. 14,014 12,465 Net consumer finance receivables......... 8,834 7,885 Reinsurance recoverables................. 9,876 10,234 Value of insurance in force and deferred policy acquisition costs...... 2,698 2,563 Cost of acquired businesses in excess of net assets................... 2,991 2,933 Separate and variable accounts........... 9,830 9,023 Other receivables........................ 5,108 4,869 Other assets............................. 9,443 10,133 ----------- ------------- Total assets............................. $ 159,606 $ 151,067 ----------- ------------- ----------- ------------- Liabilities Investment banking and brokerage borrowings............................. $ 4,268 $ 3,217 Short-term borrowings.................... 2,812 1,557 Long-term debt........................... 11,122 11,327 Securities loaned or sold under agreements to repurchase............... 26,889 24,449 Brokerage payables....................... 5,042 5,809 Trading securities sold not yet purchased, at market value............. 9,640 8,378 Contractholder funds..................... 14,601 13,621 Insurance policy and claims reserves..... 43,940 43,944 Separate and variable accounts........... 9,818 8,949 Accounts payable and other liabilities... 15,196 14,702 ----------- ------------- Total liabilities...................... 143,328 135,953 ----------- ------------- ESOP Preferred stock--Series C (net of note guarantee of $17 and $35).. 140 129 ----------- ------------- TRV-obligated mandatorily redeemable preferred securities of subsidiary trusts holding solely junior subordinated debt securities of TRV..... 1,000 1,000 ----------- ------------- TAP-obligated mandatorily redeemable preferred securities of subsidiary trusts holding solely junior subordinated debt securities of TAP..... 900 900 ----------- ------------- Stockholders' equity Preferred stock, at aggregate liquidation value....................... 1,075 675 Common stock ($.01 par value; authorized shares: 1.5 billion; issued shares: 1997--743,415,984 shares and 1996--743,082,134 shares)........... 7 7 Additional paid-in capital................ 7,561 7,217 Retained earnings......................... 8,524 7,452 Treasury stock, at cost (1997--103,807,529 shares and 1996--105,503,401 shares)............... (2,958) (2,446) Unrealized gain (loss) on investment securities.............................. 436 469 Other, principally unearned compensation.. (407) (289) ---------- ------------- Total stockholders' equity.............. 14,238 13,085 ----------- ------------- Total liabilities and stockholders' equity.................................. $ 159,606 $ 151,067 ----------- ------------- ----------- ------------- See Notes to Condensed Consolidated Financial Statements. Travelers Group Inc. and Subsidiaries Condensed Consolidated Statement of Changes in Stockholders' Equity (Unaudited) (In millions of dollars) Six months ended June 30, 1997 Amount Shares ----------- ----------- (in thousands) Preferred stock, at aggregate liquidation value Balance, beginning of year......................... $ 675 8,700 Issuance of preferred stock........................ 400 1,600 --------- ---------- Balance, end of period............................. $ 1,075 10,300 --------- ---------- --------- ---------- Common stock and additional paid-in capital Balance, beginning of year......................... $ 7,224 743,082 Issuance of shares pursuant to employee benefit plans............................................ 347 Exercise of common stock warrants.................. 6 334 Cost of issuance of preferred stock................ (9) ---------- ---------- Balance, end of period............................. 7,568 743,416 ---------- ---------- Retained earnings Balance, beginning of year......................... 7,452 Net income......................................... 1,305 Common dividends................................... (193) Preferred dividends................................ (40) ---------- Balance, end of period............................. 8,524 ---------- Treasury stock, at cost Balance, beginning of year......................... (2,446) (105,503) Issuance of shares pursuant to employee benefit plans, net of shares tendered for payment of option exercise price and withholding taxes...... (12) 11,054 Treasury stock acquired............................ (500) (9,359) ---------- ---------- Balance, end of period............................. (2,958) (103,808) ---------- ---------- Unrealized gain (loss) on investment securities Balance, beginning of year......................... 469 Net change in unrealized gains and losses on investment securities, net of tax................ (33) ---------- Balance, end of period............................. 436 ---------- Other, principally unearned compensation Balance, beginning of year......................... (289) Issuance of restricted stock, net of amortization.. (118) ---------- Balance, end of period............................. (407) ---------- Total common stockholders' equity and common shares outstanding............................... $ 13,163 639,608 ---------- ----------- ---------- ---------- Total stockholders' equity......................... $ 14,238 ---------- ---------- See Notes to Condensed Consolidated Financial Statements. Travelers Group Inc. and Subsidiaries Condensed Consolidated Statement of Cash Flows (Unaudited) (In millions of dollars) SIX MONTHS ENDED JUNE 30, 1997 1996 Cash flows from operating activities Income before income taxes and minority interest........................... $ 2,166 $ 1,413 Adjustments to reconcile income before income taxes and minority interest to net cash provided by (used in) operating activities: Amortization of deferred policy acquisition costs and value of insurance in force...... 709 499 Additions to deferred policy acquisition costs...................................... (854) (587) Depreciation and amortization................ 186 167 Provision for consumer finance credit losses. 145 128 Changes in: Trading securities, net.................... (287) (148) Securities borrowed, loaned and repurchase agreements, net............... (230) 164 Brokerage receivables net of brokerage payables................................. (1,969) (1,568) Insurance policy and claims reserves....... 226 511 Other, net................................. 1,068 1,174 --------- --------- Net cash provided by (used in) operations...... 1,160 1,753 Income taxes paid.............................. (586) (475) --------- --------- Net cash provided by (used in) operating activities................................. 574 1,278 --------- --------- Cash flows from investing activities Consumer loans originated or purchased......... (2,236) (1,468) Consumer loans repaid or sold.................. 1,391 1,266 Purchases of fixed maturities and equity securities................................... (12,819) (15,216) Proceeds from sales of investments and real estate: Fixed maturities available for sale and equity securities.......................... 9,895 12,584 Mortgage loans............................... 105 133 Real estate and real estate joint ventures... 25 86 Proceeds from maturities of investments: Fixed maturities............................. 1,571 1,748 Mortgage loans............................... 316 417 Other investments, primarily short-term, net... (632) (537) Business acquisition........................... -- (4,160) Other, net..................................... (389) (15) --------- --------- Net cash provided by (used in) investing activities....................... (2,773) (5,162) --------- --------- Cash flows from financing activities Dividends paid................................. (233) (191) Issuance of preferred stock.................... 391 -- Subsidiary issuance of preferred stock......... -- 900 Subsidiary's sale of Class A common stock...... -- 1,453 Treasury stock acquired........................ (500) (317) Stock tendered for payment of withholding taxes (156) (106) Issuance of long-term debt..................... 541 1,350 Payments and redemptions of long-term debt..... (742) (360) Net change in short-term borrowings (including investment banking and brokerage borrowings)........................ 2,306 1,428 Contractholder fund deposits................... 1,772 899 Contractholder fund withdrawals................ (1,310) (1,469) Other, net..................................... 1 66 --------- --------- Net cash provided by (used in) financing activities......................... 2,070 3,653 --------- --------- Change in cash and cash equivalents............ (129) (231) Cash and cash equivalents at beginning of period.................................... 1,868 1,866 --------- --------- Cash and cash equivalents at end of period..... $ 1,739 $ 1,635 --------- --------- Supplemental disclosure of cash flow information: Cash paid during the period for interest....... $ 1,335 $ 1,033 ========== ========= Supplemental schedule of noncash investing and financing activities Assets and liabilities of business acquired: Invested assets............................... -- $13,969 Reinsurance recoverables and other assets..... -- 10,386 Insurance policy and claim reserves........... -- (18,302) Other liabilities............................. -- (1,893) ---------- --------- Cash payment related to business acquisition............................... -- $ 4,160 ========== ========= See Notes to Condensed Consolidated Financial Statements. Travelers Group Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) 1. BASIS OF PRESENTATION The accompanying condensed consolidated financial statements as of June 30, 1997 and for the three-month and six-month periods ended June 30, 1997 and 1996 are unaudited and include the accounts of Travelers Group Inc. (TRV) and its subsidiaries (collectively, the Company). In the opinion of management all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation have been reflected. The accompanying condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in the Company's Annual Report to Stockholders for the year ended December 31, 1996. Certain financial information that is normally included in annual financial statements prepared in accordance with generally accepted accounting principles, but is not required for interim reporting purposes, has been condensed or omitted. Certain reclassifications have been made to the prior year's financial statements to conform to the current year's presentation. On April 2, 1996, Travelers Property Casualty Corp. (TAP), an indirect majority-owned subsidiary of the Company, purchased from Aetna Services, Inc. all of the outstanding capital stock of Travelers Casualty and Surety Company (formerly The Aetna Casualty and Surety Company) and The Standard Fire Insurance Company (collectively, Aetna P&C) for approximately $4.2 billion in cash. This acquisition was financed in part by the issuance by TAP of common stock resulting in a minority interest in TAP of approximately 18%. The acquisition was accounted for under the purchase method of accounting and, accordingly, the condensed consolidated financial statements include the results of Aetna P&C's operations only from the date of acquisition. On June 23, 1997, TAP repurchased an aggregate of approximately 6.6 million shares of Class A Common Stock held by four private investors for approximately $240.8 million. This repurchase increased TRV's ownership of TAP to approximately 83.4%. 2. AETNA P&C ACQUISITION--PRO FORMA RESULTS OF OPERATIONS The following unaudited pro forma information presents the results of operations of the Company and Aetna P&C for the six months ended June 30, 1996, with pro forma adjustments as if the acquisition and transactions related to the funding of the acquisition had been consummated as of the beginning of the period presented. This pro forma information is not indicative of what would have occurred had the acquisition and related transactions occurred on the date indicated, or of future results of the Company. SIX MONTHS ENDED JUNE 30, 1996* ----------------- (in millions, except per share data) Revenues................................................... $11,541 Net income................................................. $ 858 Net income per common share................................ $ 1.27 - ------------------------ * Historical results of Aetna P&C for the first quarter of 1996 include $307 million ($200 million after tax) of realized investment gains. In the second quarter of 1996 TAP recorded charges related to the acquisition and integration of Aetna P&C. These charges resulted primarily from anticipated costs of the acquisition and the application of Travelers strategies, policies and practices to Aetna P&C reserves and include: $221 million after tax and minority interest ($414 million before tax and minority interest) in reserve increases, net of reinsurance, related primarily to cumulative injury claims other than asbestos (CIOTA); $81 million after tax and minority interest ($152 million before tax and minority interest) in provisions for reinsurance recoverables and other receivables; and a $19 million after tax and minority interest ($35 million before tax and minority interest) provision for lease and severance costs of The Travelers Indemnity Company related to the restructuring plan for the acquisition. Excluding the charges discussed above associated with the acquisition of Aetna P&C, which total $321 million after tax and minority interest, pro forma net income would have been $1.18 billion or $1.77 per share for the six months ended June 30, 1996. In addition, in the second quarter of 1996 the Company recognized a gain of $363 million (before and after tax) from the issuance of shares of Class A Common Stock by TAP and such gain is not reflected in the pro forma financial information above. 3. CHANGES IN ACCOUNTING PRINCIPLES AND ACCOUNTING STANDARDS NOT YET ADOPTED Effective January 1, 1997, the Company adopted Statement of Financial Accounting Standards No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" (FAS No. 125). This Statement establishes accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities. These standards are based on an approach that focuses on control. Under this approach, after a transfer of financial assets, an entity recognizes the financial and servicing assets it controls and the liabilities it has incurred, derecognizes financial assets when control has been surrendered and derecognizes liabilities when extinguished. FAS No. 125 provides standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings. The requirements of FAS No. 125 are effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after December 31, 1996, and are to be applied prospectively. However, in December 1996 the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 127, "Deferral of the Effective Date of Certain Provisions of FASB Statement No. 125," which delays until January 1, 1998 the effective date for certain provisions. Earlier or retroactive application is not permitted. The adoption of the provisions of this Statement effective January 1, 1997 did not have a material impact on results of operations, financial condition or liquidity, and the Company is currently evaluating the impact of the provisions whose effective date has been delayed until January 1, 1998. In February 1997, the FASB issued Statement of Financial Accounting Standards No. 128, "Earnings per Share" (FAS No. 128). This Statement establishes standards for computing and presenting earnings per share (EPS) and applies to entities with publicly held common stock. This Statement simplifies the standards for computing earnings per share previously found in Accounting Principles Board Opinion No. 15, "Earnings per Share" (Opinion 15), and makes them comparable to international EPS standards. It replaces the presentation of primary EPS with a presentation of basic EPS. It also requires dual presentation of basic and diluted EPS on the face of the income statement for all entities with complex capital structures and requires a reconciliation of the numerator and denominator of the basic EPS computation to the numerator and denominator of the diluted EPS computation. Basic EPS excludes dilution and is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised. FAS No. 128 supersedes Opinion 15 and related accounting interpretations and is effective for financial statements issued for periods ending after December 15, 1997, including interim periods; earlier application is not permitted. However, an entity is permitted to disclose pro forma amounts computed using this Statement in the notes to the financial statements in periods prior to required adoption. On a pro forma basis, for the three months ended June 30, 1997 and 1996, basic EPS is $1.05 and $0.91, respectively, and diluted EPS is $0.99 and $0.87, respectively. On a pro forma basis, for the six months ended June 30, 1997 and 1996, basic EPS is $2.06 and $1.72, respectively, and diluted EPS is $1.95 and $1.64, respectively. In June 1997, the FASB issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" (FAS No. 130). FAS No. 130 establishes standards for the reporting and display of comprehensive income and its components in a full set of general-purpose financial statements. All items that are required to be recognized under accounting standards as components of comprehensive income are to be reported in a financial statement that is displayed with the same prominence as other financial statements. This Statement stipulates that comprehensive income reflect the change in equity of an enterprise during a period from transactions and other events and circumstances from nonowner sources. Comprehensive income will thus represent the sum of net income and other comprehensive income, although FAS No. 130 does not require the use of the terms comprehensive income or other comprehensive income. The accumulated balance of other comprehensive income is required to be displayed separately from retained earnings and additional paid-in capital in the statement of financial position. This Statement is effective for fiscal years beginning after December 15, 1997. The Company anticipates that the adoption of FAS No. 130 will result primarily in reporting unrealized gains and losses on investments in debt and equity securities in comprehensive income. In June 1997, the FASB also issued Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information" (FAS No. 131). FAS No. 131 establishes standards for the way that public enterprises report information about operating segments in annual financial statements and requires that selected information about those operating segments be reported in interim financial statements. This Statement supersedes Statement of Financial Accounting Standards No. 14, "Financial Reporting for Segments of a Business Enterprise". FAS No. 131 requires that all public enterprises report financial and descriptive information about their reportable operating segments. Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. This Statement is effective for fiscal years beginning after December 15, 1997. The Company's reportable operating segments are not expected to change as a result of the adoption of FAS No. 131. 4. DEBT Investment banking and brokerage borrowings consisted of the following: (MILLIONS) JUNE 30, 1997 DECEMBER 31, 1996 --------------- ------------------- Commercial paper...................... $ 4,116 $ 3,028 Bank loans and other borrowings....... 152 189 --------- --------- $ 4,268 $ 3,217 ========= ========= Investment banking and brokerage borrowings are short term and include commercial paper and bank loans and other borrowings used to finance Smith Barney Holdings Inc.'s (Smith Barney) operations, including the securities settlement process. The bank loans and other borrowings bear interest at variable rates based primarily on the Federal Funds interest rate. Smith Barney and its subsidiary Smith Barney Inc. have commercial paper programs that consist of both discounted and interest-bearing paper. Smith Barney also has substantial borrowing arrangements consisting of facilities that it has been advised are available, but where no contractual lending obligation exists. Short-term borrowings consisted of commercial paper outstanding as follows: (MILLIONS) JUNE 30, 1997 DECEMBER 31, 1996 --------------- ------------------- Commercial Credit Company............. $ 2,812 $ 1,482 Travelers Property Casualty Corp...... -- 25 The Travelers Insurance Company....... -- 50 --------- --------- $ 2,812 $ 1,557 ========= ========= TRV, Commercial Credit Company (CCC), TAP and The Travelers Insurance Company (TIC) issue commercial paper directly to investors. Each maintains unused credit availability under its respective bank lines of credit at least equal to the amount of its outstanding commercial paper. Each may borrow under its revolving credit facilities at various interest rate options and compensates the banks for the facilities through commitment fees. TRV, CCC and TIC have a five-year revolving credit facility with a syndicate of banks to provide $1.0 billion of revolving credit, to be allocated to any of TRV, CCC or TIC. The participation of TIC in this agreement is limited to $250 million. This facility expires in June 2001. Currently, $100 million is allocated to TRV, $850 million to CCC and $50 million to TIC. Under this facility TRV is required to maintain a certain level of consolidated stockholders' equity (as defined in the agreement). At June 30, 1997, this requirement was exceeded by approximately $5.2 billion. At June 30, 1997, there were no borrowings outstanding under this facility. CCC also has committed and available revolving credit facilities on a stand-alone basis of $4.4 billion of which $3.4 billion expires in 2002 and $1.0 billion expires in 1998. CCC is limited by covenants in its revolving credit agreements as to the amount of dividends and advances that may be made to its parent or its affiliated companies. At June 30, 1997, CCC would have been able to remit $313 million to its parent under its most restrictive covenants. TAP has a five-year revolving credit facility in the amount of $500 million with a syndicate of banks that expires in December 2001. Under this facility TAP is required to maintain a certain level of consolidated stockholders' equity (as defined in the agreement). At June 30, 1997, this requirement was exceeded by approximately $3.0 billion. At June 30, 1997, there were no borrowings outstanding under this facility. Long-term debt, including its current portion, consisted of the following: (MILLIONS) JUNE 30, 1997 DECEMBER 31, 1996 --------------- ------------------- Travelers Group Inc................... $ 1,699 $ 1,903 Commercial Credit Company............. 5,400 5,750 Smith Barney Holdings Inc............. 2,725 2,369 Travelers Property Casualty Corp...... 1,249 1,249 The Travelers Insurance Group Inc..... 49 56 --------- --------- $ 11,122 $ 11,327 ========= ========= During the first six months of 1997, Smith Barney issued $516 million of notes with varying interest rates and maturities. Smith Barney has a $1.250 billion revolving credit agreement with a bank syndicate that extends through May 2000, and has a $750 million, 364-day revolving credit agreement that extends through May 1998. At June 30, 1997, there were no borrowings outstanding under either facility. Smith Barney is limited as to the amount of dividends that may be paid to TRV. The amount of dividends varies based upon, among other things, levels of net income of Smith Barney. At June 30, 1997, Smith Barney would have been able to remit approximately $779 million to TRV under its most restrictive covenants. TIC is subject to various regulatory restrictions that limit the maximum amount of dividends available to its parent without prior approval of the Connecticut Insurance Department. A maximum of $507 million of statutory surplus is available in 1997 for such dividends without Department approval, of which $200 million has been paid during the first six months of 1997. TAP's insurance subsidiaries are subject to various regulatory restrictions that limit the maximum amount of dividends available to be paid to their parent without prior approval of insurance regulatory authorities. Dividend payments to TAP from its insurance subsidiaries are limited to $647 million in 1997 without prior approval of the Connecticut Insurance Department. TAP received $145 million of dividends from its insurance subsidiaries during the first six months of 1997 and received an additional $100 million of dividends on July 1, 1997. 5. STOCKHOLDERS' EQUITY In June 1997, the Company sold in a public offering 8.0 million depositary shares, each representing one-fifth of a share of 6.365% Cumulative Preferred Stock, Series F (Series F Preferred Stock) at an offering price of $50 per depositary share for an aggregate principal amount of $400 million. The Series F Preferred Stock has cumulative dividends payable quarterly commencing September 1, 1997 and a liquidation preference equivalent to $50 per depositary share plus accrued and accumulated unpaid dividends. On or after June 16, 2007, the Company may redeem the Series F Preferred Stock, in whole or in part, at any time at a redemption price of $50 per depositary share plus dividends accrued and unpaid to the redemption date. In July 1997, the Company sold in a public offering 4.0 million depositary shares, each representing one-fifth of a share of 6.213% Cumulative Preferred Stock, Series G (Series G Preferred Stock) at an offering price of $50 per depositary share for an aggregate principal amount of $200 million. The Series G Preferred Stock has cumulative dividends payable quarterly commencing September 1, 1997 and a liquidation preference equivalent to $50 per depositary share plus accrued and accumulated unpaid dividends. On or after July 11, 2007, the Company may redeem the Series G Preferred Stock, in whole or in part, at any time at a redemption price of $50 per depositary share plus dividends accrued and unpaid to the redemption date. On July 1, 1997 the Company redeemed all of the 7.5 million outstanding shares (15 million depositary shares) of its 9.25% Preferred Stock, Series D (Series D Preferred Stock). The aggregate principal amount of Series D Preferred Stock outstanding on June 30, 1997 was $375 million. All of the outstanding shares of the Series D Preferred Stock were redeemed at $50 per share ($25 per depositary share). On July 28, 1997 the Company redeemed all of the 1.2 million outstanding shares (12 million depositary shares) of its 8.125% Cumulative Preferred Stock, Series A (Series A Preferred Stock). The aggregate principal amount of Series A Preferred Stock outstanding as of June 30, 1997 was $300 million. All of the outstanding shares of the Series A Preferred Stock were redeemed at $250 per share ($25 per depositary share), plus accrued and unpaid dividends through July 28, 1997. 6. CONTINGENCIES Certain subsidiaries of the Company are in arbitration with underwriters at Lloyd's of London (Lloyd's) in New York State to enforce reinsurance contracts with respect to recoveries for certain asbestos claims. The dispute involves the ability to aggregate asbestos claims under a market agreement between Lloyd's and those subsidiaries or under the applicable reinsurance treaties. The Company believes that the outcome of the arbitration is not likely to have a material adverse effect on its results of operations, financial condition or liquidity. It is difficult to estimate the reserves for environmental and asbestos-related claims due to the vagaries of court coverage decisions, plaintiffs' expanded theories of liability, the risks inherent in major litigation and other uncertainties. Conventional actuarial techniques are not used to estimate such reserves. The reserves carried for environmental and asbestos claims at June 30, 1997 are the Company's best estimate of ultimate claims and claim adjustment expenses based upon known facts and current law. However, the conditions surrounding the final resolution of these claims continues to change. Currently, it is not possible to predict changes in the legal and legislative environment and their impact on the future development of asbestos and environmental claims. Such development will be affected by future court decisions and interpretations and changes in legislation. Because of these future unknowns, additional liabilities may arise for amounts in excess of the current reserves. These additional amounts, or a range of these additional amounts, cannot now be reasonably estimated, and could result in a liability exceeding reserves by an amount that would be material to the Company's operating results in a future period. However, the Company believes that it is not likely that these claims will have a material adverse effect on the Company's financial condition or liquidity. In the ordinary course of business TRV and/or its subsidiaries are also defendants or co-defendants in various litigation matters, other than those described above. Although there can be no assurances, the Company believes, based on information currently available, that the ultimate resolution of these legal proceedings would not be likely to have a material adverse effect on the Company's results of operations, financial condition or liquidity. 7. SUBSEQUENT EVENT On July 31, 1997, CCC acquired Security Pacific Financial Services from BankAmerica Corporation for a purchase price of approximately $1.6 billion. The purchase included approximately $1.2 billion of net consumer finance receivables and approximately $70 million of other net assets. Financing for the transaction was accomplished by CCC and included an equity contribution by TRV of $520 million to CCC. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CONSOLIDATED RESULTS OF OPERATIONS THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30 JUNE 30 -------------------- -------------------- (In millions, except per share amounts) 1997 1996 1997 1996 --------- -------- --------- --------- Revenues...................... $ 5,973 $ 5,426 $11,901 $ 9,941 --------- --------- --------- --------- --------- --------- --------- --------- Net income....................$ 663 $ 576 $ 1,305 $ 1,096 --------- --------- --------- --------- --------- --------- --------- --------- Earnings per share: Net income..................$ 1.00 $ 0.88 $ 1.96 $ 1.65 --------- --------- --------- --------- --------- --------- --------- --------- Weighted average number of common shares outstanding and common stock equivalents. 645.3 634.7 645.7 636.1 --------- --------- --------- --------- --------- --------- --------- --------- ACQUISITION As discussed in Note 1 of Notes to the Condensed Consolidated Financial Statements, on April 2, 1996, Travelers Property Casualty Corp. (TAP), an indirect majority-owned subsidiary of Travelers Group Inc. (TRV), completed the acquisition of the domestic property and casualty insurance subsidiaries of Aetna Services, Inc. (Aetna P&C) for approximately $4.2 billion in cash. This acquisition was financed in part by the issuance by TAP of common stock resulting in a minority interest in TAP of approximately 18%. The acquisition was accounted for under the purchase method of accounting and, accordingly, the condensed consolidated financial statements include the results of Aetna P&C's operations only from the date of acquisition. TAP also owns The Travelers Indemnity Company (Travelers Indemnity). Travelers Indemnity along with Aetna P&C are the primary vehicles through which the Company engages in the property and casualty insurance business. On June 23, 1997, TAP repurchased an aggregate of approximately 6.6 million shares of Class A Common Stock held by four private investors for approximately $240.8 million. This repurchase increased TRV's ownership of TAP to approximately 83.4%. RESULTS OF OPERATIONS Consolidated net income for the quarter ended June 30, 1997 was $663 million, and includes reported investment portfolio gains of $6 million after tax and minority interest. This compares with net income of $576 million in the 1996 period, which included portfolio losses of $59 million, as well as gains of $389 million from sales of stock of subsidiaries and affiliates, and charges related to the acquisition of Aetna P&C in April 1996, amounting to $321 million. Excluding these items, net income for the second quarter of 1997 was 16% above the comparable period in 1996, primarily reflecting increased earnings in the insurance operations and improved performance at Smith Barney Holdings Inc. (Smith Barney). Net income for the six months ended June 30, 1997 was $1.305 billion, compared to $1.096 billion in the 1996 period. Included in the 1997 six-month period are portfolio gains of $15 million compared to $19 million in portfolio losses in the 1996 six-month period and the other special items discussed above. Excluding these items, net income for the first six months of 1997 was 23% above the comparable period in 1996. The effective income tax rate for the three months and six months ended June 30, 1996 is below the statutory rate of 35% due primarily to the nontaxability of the $363 million gain recognized from the sale of shares of Class A Common Stock by TAP. The following discussion presents in more detail each segment's performance. Segment Results for the Three Months Ended June 30, 1997 and 1996 ----------------------------------------------------------------- INVESTMENT SERVICES THREE MONTHS ENDED JUNE 30, ------------------------------- 1997 1996 ------------------------------- (MILLIONS) REVENUES NET INCOME REVENUES NET INCOME ----------- --------------- --------- ---------- Smith Barney.............. $ 2,099 $ 232 $1,970 $ 230 ---------- -------------- --------- --------- ---------- -------------- --------- --------- SMITH BARNEY Despite a difficult trading and underwriting environment in April, Smith Barney reported net income of $232 million for the three months ended June 30, 1997, slightly higher than the $230 million reported in the 1996 second quarter. Smith Barney's return on equity of 31.5% for the second quarter of 1997 continues to be among the highest of its industry peer group. Pre-tax profit margins increased to 24.2% in the second quarter of 1997, up from 23.4% in the comparable prior year period. SMITH BARNEY REVENUES THREE MONTHS ENDED JUNE 30, ------------------------------- (millions) 1997 1996 ------------------------------- Commissions............... $ 576 $ 577 Asset management and administration fees..... 386 331 Investment banking........ 254 299 Principal transactions.... 250 265 Interest income, net*..... 117 100 Other income.............. 34 36 --------- --------- Net revenues*............. $ 1,617 $1,608 --------- --------- --------- --------- - ------------------------ * Net of interest expense of $482 million and $362 million in 1997 and 1996, respectively. Revenues included in the condensed consolidated statement of income are before deductions for interest expense. Revenues, net of interest expense of $1.617 billion for the 1997 second quarter were slightly ahead of the $1.608 billion in the 1996 second quarter. Commission revenues were $576 million in the 1997 second quarter, just about even with the $577 million in the 1996 comparable period, as declines in mutual funds and over-the-counter securities commissions were offset by an increase in listed securities commissions. Annualized retail gross production per Financial Consultant declined to $358,000 in the second quarter of 1997 from $369,000 in the comparable 1996 period. Smith Barney currently has a sales force of approximately 10,400 registered Financial Consultants working out of 438 domestic retail offices. Asset management and administration fees rose 16% to a record $386 million, reflecting broad growth in all recurring fee-based products--led by a 25% increase in managed accounts revenues, a 19% increase in Consulting Group revenues, and a 10% increase in money market and mutual fund revenues. At June 30, 1997 total fee-based assets under management were a record $177.4 billion, which includes a record $124.3 billion in internally managed assets, up 24% and 20%, respectively from the comparable 1996 period. Investment banking revenues totaled $254 million, a 15% decline from the comparable 1996 period, primarily reflecting a decrease in equity underwriting revenues. Principal transaction revenues were $250 million in the second quarter of 1997, a 5% decline from the comparable 1996 period, primarily because of a decline in equity and municipal trading partially offset by an increase in taxable fixed income trading. Net interest income reached $117 million, up 17% over the comparable 1996 period. The increase is primarily due to increased margin lending to clients and higher levels of interest earning net assets. Total expenses, excluding interest, were $1.226 billion in the 1997 second quarter compared to $1.231 billion in the comparable 1996 period. Smith Barney's ratio of non-compensation expenses to net revenues was 20.4% for the second quarter of 1997 compared to 20.7% in the comparable 1996 period. Smith Barney's ratio of compensation and benefit expense to net revenues declined to 55.5% from 55.8% in the prior year period. Smith Barney's business is significantly affected by the levels of activity in the securities markets, which in turn are affected by the level and trend of interest rates, the general state of the economy and the national and worldwide political environments, among other factors. An increasing interest rate environment could have an adverse impact on Smith Barney's businesses, including commissions (which are linked in part to the economic attractiveness of securities relative to time deposits) and investment banking (which is affected by the relative benefit to corporations and public entities of issuing public debt and/or equity versus other avenues for raising capital). Such effects, however, could be at least partially offset by a strengthening U.S. economy that would include growth in the business sector--accompanied by an increase in the demand for capital--and an increase in the capacity of individuals to invest. A declining interest rate environment could favorably impact Smith Barney's businesses. Smith Barney's asset management business provides a more predictable and steady income stream than its other businesses. Smith Barney continues to maintain tight expense controls which management believes will help the firm weather periodic downturns in market conditions. Smith Barney's principal business activities are, by their nature, highly competitive and subject to various risks, particularly volatile trading markets and fluctuations in the volume of market activity. While higher volatility can increase risk, it can also increase order flow, which drives many of Smith Barney's businesses. Other market and economic conditions, and the size, number and timing of transactions may also impact net income. As a result, revenues and profitability can vary significantly from year to year, and from quarter to quarter. Note 19 of Notes to Consolidated Financial Statements included in the Company's 1996 Annual Report describes Smith Barney's activities in derivative financial instruments, which are used primarily to facilitate customer transactions. ASSETS UNDER MANAGEMENT AT JUNE 30, -------------------- 1997 1996 --------- --------- Smith Barney........................... $ 124.3 $ 103.8 Travelers Life and Annuity (1)......... 22.2 21.1 --------- --------- Total Assets Under Management.......... $ 146.5 $ 124.9 --------- --------- --------- --------- - ------------------------ (1) Part of the Life Insurance Services segment. CONSUMER FINANCE SERVICES THREE MONTHS ENDED JUNE 30, --------------------------------------- (millions) 1997 1996 -------------- -------------- REVENUES NET INCOME REVENUES NET INCOME ------------ ----------- --------- ---------- Consumer Finance Services (1)....$ 380 $ 54 $ 348 $ 61 --------- --------- --------- --------- --------- --------- --------- --------- - ------------------------ (1) Net income in 1996 includes a portion of the gain ($1 million) from the disposition of RCM Capital Management, a California Limited Partnership (RCM). Earnings in the second quarter of 1997 were lower than the comparable period in 1996, as expected--reflecting a higher provision for loan losses in the 1997 period. Consumer finance receivables, net of unearned finance charges, grew $595 million during the second quarter of 1997, which represents an annualized growth rate of 28%. This growth was driven primarily by real estate loans generated through the Company's 855 branch office network and through the sales efforts of Primerica Financial Services (PFS). Total net receivables were a record $9.041 billion at June 30, 1997, a 21% increase from the prior year. The average yield, at 14.42%, was lower than the 1996 quarter's yield of 15.40%, mainly because of a shift in the portfolio mix toward lower risk/lower margin real estate loans. Sales of real estate-secured ($.M.A.R.T.-SM-) loans sold exclusively through PFS continued at record levels during the quarter. Travelers Bank credit card outstandings were $1.166 billion, up from $972 million at March 31, 1997, as a result of strong credit card originations. Delinquencies in excess of 60 days were 2.14% as of June 30, 1997--lower than the 2.25% at March 31, 1997 and the 2.18% at the end of the second quarter of 1996. The charge-off rate was 2.82% during the second quarter of 1997, lower than the 1997 first quarter of 2.95% and the comparable 1996 period's rate of 2.92%. Reserves as a percentage of net receivables were 2.91% at June 30, 1997, down from 2.97% at the end of the 1997 first quarter and 2.92% at the end of the 1996 second quarter. AS OF, OR FOR, THE THREE MONTHS ENDED JUNE 30, --------------------------------- 1997 1996 ------------- --------------- Allowance for credit losses as a % of net outstandings......... 2.91% 2.92% Charge-off rate for the period....... 2.82% 2.92% 60 + days past due on a contractual basis as a % of gross consumer finance receivables at quarter end.. 2.14% 2.18% On July 31, 1997, Commercial Credit Company (CCC) acquired Security Pacific Financial Services from BankAmerica Corporation for a purchase price of approximately $1.6 billion. The purchase included approximately $1.2 billion of net consumer finance receivables and approximately $70 million of other net assets. LIFE INSURANCE SERVICES THREE MONTHS ENDED JUNE 30, --------------------------------------- 1997 1996 --------------------- --------------- (MILLIONS) REVENUES NET INCOME REVENUES NET INCOME -------- ---------- --------- ---------- Travelers Life and Annuity (1) $ 666 $ 115 $ 549 $ 78 Primerica Financial Services (2) 375 81 354 70 -------- --------- --------- --------- Total Life Insurance Services $ 1,041 $ 196 $ 903 $ 148 -------- --------- --------- --------- -------- --------- --------- --------- - ------------------------ (1) Net income includes $10 million of reported investment portfolio gains in 1997 and $12 million of reported investment portfolio losses in 1996. (2) Net income in 1997 includes $1 million of reported investment portfolio losses. Net income in 1996 includes a portion of the gain ($4 million) from the disposition of RCM. TRAVELERS LIFE AND ANNUITY Travelers Life and Annuity consists of annuity, life and long-term care products marketed by The Travelers Insurance Company (TIC) under the Travelers name. Among the range of products offered are fixed and variable deferred annuities, payout annuities and term, universal and variable life and long-term care insurance to individuals and small businesses. Travelers Life and Annuity also provides group pension products, including guaranteed investment contracts, and group annuities to employer-sponsored retirement and savings plans. These products are primarily marketed through The Copeland Companies (Copeland), an indirect wholly owned subsidiary of TIC, Smith Barney Financial Consultants and a nationwide network of independent agents. The majority of the annuity business and a substantial portion of the life business written by Travelers Life and Annuity is accounted for as investment contracts, with the result that the premium deposits collected are not included in revenues. Earnings before portfolio gains increased 17% to $105 million in the second quarter of 1997, from $90 million in the comparable 1996 period. Improved earnings were largely driven by strong investment income, reflecting an improvement in fixed income yields over the past year, as well as very attractive yields on equity partnerships. Earnings growth attributable to strong sales of recently introduced products--including less capital-intensive variable life insurance and annuities--was partially offset by the gradual decline in the amount of higher margin business written several years ago. Deferred annuity policyholder account balances and benefit reserves at June 30, 1997 were $14.7 billion compared to $12.2 billion at June 30, 1996. Net written premiums and deposits were $627.7 million in the second quarter of 1997, up 23% from $509.5 million in the 1996 second quarter. Strong sales through Copeland, Smith Barney and a nationwide network of independent agents reflect the Company's ongoing effort to build market share by strengthening relationships in key distribution channels. Future sales may also benefit from A.M. Best Company's recently announced upgrade of The Travelers Insurance Company's rating to A+ (Superior), which rating may be revised or withdrawn at anytime. Payout and group annuity net premiums and deposits (excluding those of affiliates) totaled $632.0 million in the second quarter of 1997, up more than 200% from $210.0 million in the second quarter of 1996, primarily as a result of the $355 million growth in sales of one year variable rate guaranteed investment contracts. Policyholder account balances and reserves totaled $11.5 billion at June 30, 1997, marginally ahead of the June 30, 1996 balances but up $700 million from year-end 1996, reflecting the strong sales of new variable rate guaranteed investment contracts. Direct written premiums and deposits (excluding single premium policies) for individual life insurance were $68.5 million in the second quarter of 1997, a slight decrease from $69.8 million in the second quarter of 1996. Face amount of individual life insurance issued during the second quarter of 1997 was $1.5 billion, compared with $1.7 billion in the second quarter of 1996, bringing total life insurance in force to $50.7 billion at June 30, 1997. Net written premiums for the growing long-term care insurance line were $43.3 million in the second quarter of 1997, compared to $30.8 million in the second quarter of 1996, largely as a result of strong sales during the quarter, which improved 29% over the 1996 period. PRIMERICA FINANCIAL SERVICES Earnings (before portfolio gains and the 1996 disposition of RCM) for the second quarter of 1997 increased 24% to $82 million from $66 million in the second quarter of 1996, reflecting favorable mortality experience as well as continued strength in life insurance in force and sales of mutual funds and consumer loans. Face amount of new term life insurance sales was $14.1 billion in the second quarter of 1997, compared to $14.0 billion in the comparable 1996 quarter. Life insurance in force reached $365.4 billion at June 30, 1997, up from $354.8 billion at June 30, 1996, and continued to reflect good policy persistency. Sales of mutual funds (at net asset value) were $669.4 million for the second quarter of 1997, a 5% increase over second quarter 1996 sales of $636.7 million, reflecting strong customer demand in the U.S. and Canada. More than 33% of U.S. sales were from the Smith Barney products, predominantly The Concert Series-SM-, which PFS first introduced to its market in March 1996. Net receivables from $.M.A.R.T.-SM- and $.A.F.E.-SM- consumer loans continued to advance, reaching $1.901 billion at the end of the second quarter of 1997, up 12% from $1.696 billion at the end of the 1997 first quarter and up 43% from $1.326 billion at the end of the 1996 second quarter. Earnings and assets relating to these consumer loans are included in the Consumer Finance segment. The TRAVELERS SECURE-R- home and auto insurance products issued through TAP continue to experience growth in applications and policies, and as of June 30, 1997, had been introduced in 37 states and were sold through nearly 8,000 agents licensed to sell the product. PROPERTY & CASUALTY INSURANCE SERVICES (MILLIONS) Three Months Ended June 30, -------------------------------------- 1997 1996 ---------------- ---------------- NET NET INCOME INCOME REVENUES (LOSS) REVENUES (LOSS) -------- ------- -------- ------- Commercial Lines(1) (2) $ 1,612 $ 209 $ 1,445 $ (237) Personal Lines(1) (3) 815 97 750 51 Financing costs and other (1) 4 (30) 7 (30) Minority interest -- (49) -- 44 -------- --------- -------- --------- Total Property & Casualty Insurance Services......... $ 2,431 $ 227 $ 2,202 $ (172) -------- -------- -------- --------- -------- -------- -------- --------- - ------------------------ (1) Before minority interest. (2) Net income includes $32 million of reported investment portfolio losses in 1996 and $383 million of charges in 1996 related to the acquisition and integration of Aetna P&C. (3) Net income includes $4 million and $6 million of reported investment portfolio losses in 1997 and 1996, respectively, and $8 million of charges in 1996 related to the acquisition and integration of Aetna P&C. As previously indicated, in the second quarter of 1996 TAP recorded charges related to the acquisition and integration of Aetna P&C. These charges resulted primarily from anticipated costs of the acquisition and the application of Travelers strategies, policies and practices to Aetna P&C reserves and include: $221 million after tax and minority interest ($414 million before tax and minority interest) in reserve increases, net of reinsurance, related primarily to cumulative injury claims other than asbestos (CIOTA); $81 million after tax and minority interest ($152 million before tax and minority interest) in provisions for reinsurance recoverables and other receivables; and a $19 million after tax and minority interest ($35 million before tax and minority interest) provision for lease and severance costs of Travelers Indemnity related to the restructuring plan for the acquisition. For purposes of computing GAAP combined ratios, fee income is now allocated as a reduction of losses and loss adjustment expenses and other underwriting expenses. Previously fee income was included with premiums for purposes of computing GAAP combined ratios. The 1996 GAAP combined ratios have been restated to conform to the current year's presentation. COMMERCIAL LINES Earnings before portfolio gains/losses and acquisition-related charges increased 17% to $209 million in the second quarter of 1997 from $178 million in the second quarter of 1996, primarily reflecting strong net investment income and expense savings. Catastrophe losses were insignificant in both periods. Commercial Lines net written premiums for the second quarter of 1997 totaled $1.141 billion, up 4% from $1.100 billion in the second quarter of 1996 (excluding an adjustment associated with a reinsurance transaction in 1996). This increase reflects continued growth in programs designed to leverage underwriting experience in specific industries, and was offset in part by the highly competitive conditions in the marketplace and the Company's continuing focus on writing profitable business. Fee income for the second quarter of 1997 was $91.4 million compared to $100.6 million in the second quarter of 1996. This decrease was due to the depopulation of involuntary pools as the loss experience of workers' compensation improved and insureds moved to voluntary markets, the Company's selective renewal activity to address the competitive pricing environment and its continued success in lowering workers' compensation losses of service customers, slightly offset by National Accounts writing more service fee-based product versus premium-based product. A significant component of Commercial Lines is National Accounts, which works with national brokers and regional agents providing insurance coverages and services, primarily workers' compensation, mainly to large corporations. National Accounts also includes the alternative market business which covers primarily workers' compensation products and services to voluntary and involuntary pools. National Accounts net written premiums of $149.7 million for the second quarter of 1997 decreased $29.9 million from the second quarter of 1996 (excluding an adjustment associated with a reinsurance transaction). This decrease was due to National Accounts writing less premium-based product versus service fee-based product and the competitive marketplace. For the second quarter of 1997, National Accounts new business was significantly lower than the second quarter of 1996. This decrease primarily reflects the addition of one large account in the second quarter of 1996 and the competitive marketplace. National Accounts business retention ratio was virtually the same in the second quarter of 1997 and 1996. Commercial Accounts serves mid-sized businesses through a network of independent agents and brokers. Commercial Accounts net written premiums were $453.0 million in the second quarter of 1997 compared to $380.5 million in the second quarter of 1996. For the second quarter of 1997, new premium business in Commercial Accounts was significantly higher compared to the second quarter of 1996, reflecting continued growth through programs designed to leverage underwriting experience in specific industries. The Commercial Accounts business retention ratio was significantly higher in the second quarter of 1997 compared to the 1996 second quarter. Commercial Accounts continues to focus on the retention of existing business while maintaining its product pricing standards and its selective underwriting policy. Select Accounts serves small businesses through a network of independent agents. Select Accounts net written premiums were $369.6 million in the second quarter of 1997 compared to $368.6 million in the second quarter of 1996. New premium business in Select Accounts was moderately higher in the second quarter of 1997 compared to the second quarter of 1996. The Select Accounts business retention ratio was moderately higher in the second quarter of 1997 compared to the second quarter of 1996. These increases reflect the broader industry and product line expertise of the combined company. Specialty Accounts markets products to national, midsize and small customers and distributes them through both wholesale brokers and retail agents and brokers throughout the United States. Specialty Accounts net written premiums were $168.4 million in the second quarter of 1997 compared to $171.7 million in the second quarter of 1996. The statutory combined ratio (before policyholder dividends) for Commercial Lines in the second quarter of 1997 was 109.7% compared to 171.1% in the second quarter of 1996. The GAAP combined ratio (before policyholder dividends) for Commercial Lines in the second quarter of 1997 was 110.0% compared to 171.1% in the second quarter of 1996. The decreases in the second quarter of 1997 statutory and GAAP combined ratios for Commercial Lines were primarily attributable to the 1996 charges related to the acquisition and integration of Aetna P&C. Excluding these amounts the statutory and GAAP combined ratios for the second quarter of 1996 would have been 111.5% and 114.3%, respectively. The decrease in the second quarter of 1996 statutory and GAAP combined ratios compared to the second quarter of 1996 statutory and GAAP combined ratios excluding acquisition-related charges was due to slightly lower losses and loss adjustment expenses in the second quarter of 1997 compared to the second quarter of 1996 as well as expense reductions in 1997. The GAAP combined ratio for Commercial Lines differs from the statutory combined ratio primarily due to the deferral and amortization of certain expenses for GAAP reporting purposes only. In addition, the purchase accounting adjustments recorded for GAAP in connection with the Aetna P&C acquisition resulted in a statutory charge in 1996. PERSONAL LINES Earnings before portfolio gains/losses increased 57% to $101 million in the second quarter of 1997 from $65 million in the second quarter of 1996. Results for the second quarter of 1997 reflect the impact of catastrophe losses, after taxes and reinsurance, of $4.5 million compared to $14.0 million in the 1996 period. The strong operating earnings reflect a low level of catastrophe losses during the quarter, lower expenses and the continued favorable prior year reserve development in personal automobile lines. Net written premiums in the second quarter of 1997 were $744.9 million, compared to $675.8 million in the second quarter of 1996. This increase reflects lower ceded premiums due to a change in a reinsurance arrangement in January 1997, growth in target markets served by independent agents and growth in the affinity marketing and TRAVELERS SECURE-R- programs. Business retention continued to be strong. The statutory combined ratio for Personal Lines in the second quarter of 1997 was 92.8% compared to 100.1% in the second quarter of 1996. The GAAP combined ratio for Personal Lines in the second quarter of 1997 was 92.1% compared to 102.1% in the second quarter of 1996. The decrease in the combined ratios in 1997 was due to the favorable prior year reserve development in personal automobile lines, lower catastrophe losses and expense reductions. FINANCING COSTS AND OTHER The primary component of net income (loss) in the second quarter of 1997 was interest expense of $26 million after tax, compared to $25 million after tax in the second quarter of 1996, reflecting financing costs associated with the acquisition of Aetna P&C. CORPORATE AND OTHER THREE MONTHS ENDED JUNE 30, ---------------------------------------------------- (millions) 1997 1996 ------------------------ ----------------------- NET INCOME NET INCOME REVENUES (EXPENSE) REVENUES (EXPENSE) --------- ----------- ---------- ------------ Net expenses (1) -- $ (46) -- $ (75) Net gain (loss) on sale of subsidiaries and affiliates -- -- -- 384 --------- --------- --------- --------- Total Corporate and Other $ 22 $ (46) $ 3 $ 309 --------- --------- --------- --------- --------- --------- --------- --------- - ------------------------ (1) Net income (expense) includes $15 million of reported investment portfolio losses in 1996. Net corporate expenses (before reported portfolio losses) were down in the second quarter of 1997 compared to the second quarter of 1996, reflecting higher income from corporate investments and lower borrowing costs. Segment Results for the Six Months Ended June 30, 1997 and 1996 --------------------------------------------------------------- The overall operating trends for the six months ended June 30, 1997 and 1996 were substantially the same as those of the second quarter periods except as noted below. INVESTMENT SERVICES SIX MONTHS ENDED JUNE 30, --------------------------------------------- 1997 1996 ------------------------ ------------------ (MILLIONS) REVENUES NET INCOME REVENUES NET INCOME ----------- ------------ ---------- ---------- Smith Barney...............$ 4,204 $ 471 $ 3,927 $ 454 ----------- ------------ ---------- --------- ----------- ------------ ---------- --------- SMITH BARNEY REVENUES SIX MONTHS ENDED JUNE 30, -------------------- (millions) 1997 1996 --------- --------- Commissions................... $ 1,183 $ 1,182 Asset management and administration fees......... 762 648 Investment banking............ 518 576 Principal transactions........ 514 543 Interest income, net*......... 234 195 Other income.................. 67 71 --------- --------- Net revenues*................. $ 3,278 $ 3,215 --------- --------- --------- --------- - ------------------------ * Net of interest expense of $926 million and $712 million in 1997 and 1996, respectively. Revenues included in the condensed consolidated statement of income are before deductions for interest expense. Revenues, net of interest expense, increased 2% to $3.278 billion for the first six months of 1997 from $3.215 billion in the first six months of 1996. Commission revenues were $1.183 billion in the first six months of 1997, slightly ahead of the $1.182 billion in the 1996 comparable period. Asset management and administration fees rose 18% to a record $762 million in the first six months of 1997. Investment banking revenues in the first six months of 1997 totaled $518 million, a 10% decline from the comparable 1996 period. Contributing to the decline in investment banking revenues during the first six months of 1997 was a decrease in merger and acquisition advisory activity. Principal transaction revenues were $514 million in the first six months of 1997, a 5% decline from the comparable 1996 period. Net interest income reached $234 million in the first six months of 1997, up 20% over the comparable 1996 period. Total expenses, excluding interest, increased to $2.486 billion in the first six months of 1997 from $2.471 billion in the comparable 1996 period. Smith Barney's ratio of non-compensation expenses to net revenues was 20.5% for the first six months of 1997 and 1996. Smith Barney's ratio of compensation and benefit expense to net revenues declined to 55.3% for the first six months of 1997 from 56.3% in the comparable prior year period. CONSUMER FINANCE SERVICES SIX MONTHS ENDED JUNE 30, --------------------------------------------- 1997 1996 ------------------------ ------------------ (MILLIONS) REVENUES NET INCOME REVENUES NET INCOME ----------- ------------ ---------- ---------- Consumer Finance Services(1)............. $ 757 $ 101 $ 696 $ 117 ----------- ------------ ---------- ---------- ----------- ------------ ---------- ---------- - ------------------------ (1) Net income in 1996 includes a portion of the gain ($1 million) from the disposition of RCM. During the first six months of 1997 the average yield, at 14.53%, was lower than the 15.41% in the first six months of 1996, mainly because of a shift in the portfolio mix toward lower risk/lower margin real estate loans. The charge-off rate remained relatively flat at 2.88% for the first six months of 1997, compared to the comparable 1996 period's rate of 2.89%. LIFE INSURANCE SERVICES SIX MONTHS ENDED JUNE 30, --------------------------------------------- 1997 1996 ------------------------ ------------------ (MILLIONS) REVENUES NET INCOME REVENUES NET INCOME ----------- ------------ ---------- ---------- ----------- ------------ ---------- ---------- Travelers Life and Annuity(1)............. $ 1,284 $ 220 $ 1,126 $ 163 Primerica Financial Services(2)............ 750 160 709 141 ---------- --------- ---------- --------- Total Life Insurance Services............... $ 2,034 $ 380 $ 1,835 $ 304 ---------- --------- ---------- --------- ---------- --------- ---------- --------- - ------------------------ (1) Net income includes $14 million of reported investment portfolio gains in 1997 and $9 million of reported investment portfolio losses in 1996. (2) Net income in 1996 includes $6 million of reported investment portfolio gains and a portion of the gain ($4 million) from the disposition of RCM. TRAVELERS LIFE AND ANNUITY Deferred annuity net written premiums and deposits were $1.201 billion in the first six months of 1997, up 20% from $997.2 million in the first six months of 1996. Payout and group annuity net premiums and deposits (excluding those of affiliates) totaled $1.279 billion in the first six months of 1997, up 86% from $688.9 million in the first six months of 1996. Face amount of individual life insurance issued during the first six months of 1997 was $3.0 billion, compared to $3.2 billion in the first six months of 1996. Direct written premiums and deposits (excluding single premium policies) for individual life insurance were $139.7 million in the first six months of 1997, even with the first six months of 1996. Net written premiums for the growing long-term care insurance line were $85.8 million in the first six months of 1997, compared to $58.5 million in the first six months of 1996. PRIMERICA FINANCIAL SERVICES Face amount of new term life insurance sales was $26.1 billion in the first six months of 1997, compared to $26.3 billion in the comparable 1996 period. Sales of mutual funds (at net asset value) were $1.391 billion for the first six months of 1997, a 16% increase over the comparable 1996 period sales of $1.204 billion. PROPERTY & CASUALTY INSURANCE SERVICES SIX MONTHS ENDED JUNE 30, ----------------------------------------- 1997 1996 -------------------- ------------------ (MILLIONS) REVENUES NET REVENUES NET INCOME INCOME (LOSS) (LOSS) --------- --------- ---------- ------- Commercial Lines(1) (2) $ 3,236 $ 410 $ 2,250 $ (143) Personal Lines(1) (3) 1,620 202 1,123 73 Financing costs and other (1) 6 (63) 7 (30) Minority interest -- (98) -- 44 --------- --------- ---------- ------- Total Property & Casualty Insurance Services $ 4,862 $ 451 $ 3,380 $ (56) --------- --------- ---------- ------- --------- --------- ---------- ------- - ------------------------ (1) Before minority interest. (2) Net income in 1997 includes $8 million of reported investment portfolio gains. Net income in 1996 includes $11 million of reported investment portfolio losses and $383 million of charges related to the acquisition and integration of Aetna P&C. (3) Net income includes $7 million and $6 million of reported investment portfolio losses in 1997 and 1996, respectively, and $8 million of charges in 1996 related to the acquisition and integration of Aetna P&C. Segment earnings exclude the property and casualty operations of Aetna P&C prior to its acquisition on April 2, 1996. Certain production statistics related to Aetna P&C operations are provided for comparative purposes for periods prior to April 2, 1996 and are not reflected in such prior period revenues or operating results. COMMERCIAL LINES Commercial Lines net written premiums for the first six months of 1997 totaled $2.479 billion, up $739 million from $1.740 billion for the first six months of 1996 (excluding an adjustment associated with a reinsurance transaction in 1996). This premium increase reflects the inclusion in 1997 of Aetna P&C for the entire six months compared to only the second quarter of 1996 and a $142 million increase due to a change to conform the Aetna P&C method with Travelers Indemnity and its subsidiaries' (Travelers P&C) method of recording certain net written premiums within Commercial Lines. Offsetting these increases in part were the highly competitive conditions in the marketplace and the Company's continuing focus on writing profitable business. On a combined total basis including Aetna P&C (for periods prior to April 2, 1996 for comparative purposes only), Commercial Lines net written premiums for the first six months of 1997 totaled $2.479 billion, compared to $2.345 billion for the first six months of 1996. This increase was primarily attributable to the change to conform the Aetna P&C method with the Travelers P&C method of recording net written premiums. Fee income for the first six months of 1997 was $188.4 million compared to $193.7 million in the first six months of 1996. National Accounts net written premiums of $371.3 million for the first six months of 1997 decreased $4.2 million from the first six months of 1996 (excluding an adjustment associated with a reinsurance transaction in 1996). On a combined total basis including Aetna P&C (for periods prior to April 2, 1996 for comparative purposes only), National Accounts net written premiums were $371.3 million for the first six months of 1997 compared to $446.3 million for the first six months of 1996. National Accounts new business in the first six months of 1997 was virtually the same as in the first six months of 1996. National Accounts business retention ratio was significantly higher in the first six months of 1997 compared to the first six months of 1996, reflecting an unusually low retention ratio in the first quarter of 1996. Commercial Accounts net written premiums were $1.014 billion in the first six months of 1997 compared to $582.1 million in the first six months of 1996. On a combined total basis including Aetna P&C (for periods prior to April 2, 1996 for comparative purposes only), Commercial Accounts net written premiums were $1.014 billion in the first six months of 1997 compared to $821.4 million in the first six months of 1996. This increase reflected $127 million due to the change to conform the Aetna P&C method with the Travelers P&C method of recording certain net written premiums and the continued growth through programs designed to leverage underwriting experience in specific industries, partially offset by the competitive marketplace. For the first six months of 1997, new premium business in Commercial Accounts has significantly improved compared to the first six months of 1996, reflecting continued growth in programs designed to leverage underwriting experience in specific industries. The Commercial Accounts business retention ratio in the first six months of 1997 has significantly improved compared to the first six months of 1996. Select Accounts net written premiums were $733.3 million in the first six months of 1997 compared to $509.5 million in the first six months of 1996. On a combined total basis including Aetna P&C (for periods prior to April 2, 1996 for comparative purposes only), Select Accounts net written premiums of $733.3 million for the first six months of 1997 were $2.7 million above the first six months of 1996 premium levels. This increase reflected $15 million due to the change to conform the Aetna P&C method with Travelers P&C method of recording certain net written premiums, mostly offset by a decrease due to the competitive marketplace. New premium business in Select Accounts was moderately higher in the first six months of 1997 compared to the first six months of 1996, reflecting an increase due to the acquisition of Aetna P&C, partially offset by a decrease due to the competitive marketplace. The Select Accounts business retention ratio was moderately higher in the first six months of 1997 compared to the first six months of 1996, reflecting the broader industry and product line expertise of the combined company. Specialty Accounts net written premiums were $361.0 million in the first six months of 1997 compared to $273.3 million in the first six months of 1996. On a combined total basis including Aetna P&C (for periods prior to April 2, 1996 for comparative purposes only), Specialty Accounts net written premiums were $361.0 million in the first six months of 1997 compared to $347.2 million in the first six months of 1996. The growth is primarily attributable to increased writings of its excess and surplus lines business. Catastrophe losses, net of taxes and reinsurance, were $5.1 million and $6.4 million in the first six months of 1997 and 1996, respectively. The 1997 catastrophe losses were primarily due to tornadoes in the Midwest in the first quarter. The 1996 catastrophe losses were primarily due to winter storms in the first quarter. The statutory combined ratio (before policyholder dividends) for Commercial Lines in the first six months of 1997 was 109.3% compared to 149.2% in the first six months of 1996. The GAAP combined ratio (before policyholder dividends) for Commercial Lines in the first six months of 1997 was 108.5% compared to 148.6% in the first six months of 1996. The decreases in the first six months of 1997 statutory and GAAP combined ratios for Commercial Lines compared to the first six months of 1996 were primarily attributable to the 1996 charges related to the acquisition and integration of Aetna P&C. Excluding these amounts, the statutory and GAAP combined ratios for the six months ended June 30, 1996 would have been 110.5% and 111.8%, respectively. The decrease in the first six months of 1997 statutory and GAAP combined ratios compared to the first six months of 1996 statutory and GAAP combined ratios excluding acquisition-related charges was generally due to the inclusion in 1997 of Aetna P&C's results for the entire six months compared to only the second quarter in 1996. Aetna P&C has historically had a higher underwriting expense ratio, partially offset by a lower loss ratio, which reflects the mix of business including the favorable effect of the lower loss ratio of the Bond business. PERSONAL LINES Net written premiums in the first six months of 1997 were $1.520 billion, compared to $1.017 billion in the first six months of 1996. This increase primarily reflects the acquisition of Aetna P&C. On a combined total basis including Aetna P&C (for periods prior to April 2, 1996 for comparative purposes only), Personal Lines net written premiums for the first six months of 1997 totaled $1.520 billion compared to $1.333 billion for the first six months of 1996. The statutory combined ratio for Personal Lines in the first six months of 1997 was 91.5% compared to 101.9% in the first six months of 1996. The GAAP combined ratio for Personal Lines in the first six months of 1997 was 90.4% compared to 102.6% in the first six months of 1996. The decrease in the combined ratios in 1997 was due to the favorable prior year reserve development in personal automobile lines, lower catastrophe losses and expense reductions. FINANCING COSTS AND OTHER The primary component of net income (loss) for the first six months of 1997 was interest expense of $52 million after tax, compared to $25 million after tax in the first six months of 1996, reflecting financing costs associated with the acquisition of Aetna P&C in the second quarter of 1996. ENVIRONMENTAL CLAIMS The Company's reserves for environmental claims are not established on a claim-by-claim basis. An aggregate bulk reserve is carried for all of the Company's environmental claims that are in the dispute process, until the dispute is resolved. This bulk reserve is established and adjusted based upon the volume of in-process environmental claims and the Company's experience in resolving such claims. At June 30, 1997, approximately 15% of the net environmental reserves (i.e., approximately $182 million) are case reserves for resolved claims. The balance, approximately 85% of the net environmental reserves (i.e., approximately $1.041 billion), is carried in a bulk reserve and includes incurred but not yet reported environmental claims for which the Company has not received any specific claims. The following table displays activity for environmental losses and loss expenses and reserves for the six months ended June 30, 1997 and 1996. ENVIRONMENTAL LOSSES SIX MONTHS ENDED SIX MONTHS ENDED (MILLIONS) JUNE 30, 1997 JUNE 30, 1996 ------------------- ---------------- Beginning reserves: Direct.................... $ 1,369 $ 454 Ceded..................... (127) (50) --------- --------- Net....................... 1,242 404 Acquisition of Aetna P&C: Direct.................... -- 938 Ceded..................... -- (24) Incurred losses and loss expenses: Direct.................... 38 38 Ceded..................... (2) (2) Losses paid: Direct.................... 100 63 Ceded..................... (45) (20) Ending reserves: Direct.................... 1,307 1,367 Ceded..................... (84) (56) --------- --------- Net....................... $ 1,223 $ 1,311 --------- --------- --------- --------- ASBESTOS CLAIMS At June 30, 1997, approximately 24% of the net asbestos reserves (i.e., approximately $257 million) are for pending asbestos claims. The balance, approximately 76% (i.e., approximately $808 million) of the net asbestos reserves, represents incurred but not yet reported losses. The following table displays activity for asbestos losses and loss expenses and reserves for the six months ended June 30, 1997 and 1996. In general, the Company posts case reserves for pending asbestos claims within approximately 30 business days of receipt of such claims. ASBESTOS LOSSES SIX MONTHS ENDED SIX MONTHS ENDED (MILLIONS) JUNE 30, 1997 JUNE 30, 1996 ------------------ ------------------ Beginning reserves: Direct.................... $ 1,443 $ 695 Ceded..................... (370) (293) --------- --------- Net....................... 1,073 402 Acquisition of Aetna P&C: Direct.................... -- 776 Ceded..................... -- (116) Incurred losses and loss expenses: Direct.................... 37 49 Ceded..................... (14) 16 Losses paid: Direct.................... 89 65 Ceded..................... (58) (36) Ending reserves: Direct.................... 1,391 1,455 Ceded..................... (326) (357) --------- --------- Net....................... $ 1,065 $1,098 --------- --------- --------- --------- UNCERTAINTY REGARDING ADEQUACY OF ENVIRONMENTAL AND ASBESTOS RESERVES It is difficult to estimate the reserves for environmental and asbestos-related claims due to the vagaries of court coverage decisions, plaintiffs' expanded theories of liability, the risks inherent in major litigation and other uncertainties. Conventional actuarial techniques are not used to estimate such reserves. The reserves carried for environmental and asbestos claims at June 30, 1997 are the Company's best estimate of ultimate claims and claim adjustment expenses based upon known facts and current law. However, the conditions surrounding the final resolution of these claims continue to change. Currently, it is not possible to predict changes in the legal and legislative environment and their impact on the future development of asbestos and environmental claims. Such development will be affected by future court decisions and interpretations and changes in legislation. Because of these future unknowns, additional liabilities may arise for amounts in excess of the current reserves. These additional amounts, or a range of these additional amounts, cannot now be reasonably estimated, and could result in a liability exceeding reserves by an amount that would be material to the Company's operating results in a future period. However, the Company believes that it is not likely that these claims will have a material adverse effect on the Company's financial condition or liquidity. CUMULATIVE INJURY OTHER THAN ASBESTOS (CIOTA) CLAIMS Cumulative injury other than asbestos (CIOTA) claims are generally submitted to the Company under general liability policies and often involve an allegation by a claimant against an insured that the claimant has suffered injuries as a result of long-term or continuous exposure to potentially harmful products or substances. Such potentially harmful products or substances include, but are not limited to, lead paint, pesticides, pharmaceutical products, silicone-based personal products, solvents and other deleterious substances. At June 30, 1997, approximately 18% of the net CIOTA reserves (i.e., approximately $204 million) are for pending CIOTA claims. The balance, approximately 82% (i.e., approximately $901 million) of the net CIOTA reserves, represents incurred but not yet reported losses for which the Company has not received any specific claims. The following table displays activity for CIOTA losses and loss expenses and reserves for the six months ended June 30, 1997 and 1996. In general, the Company posts case reserves for pending CIOTA claims within approximately 30 business days of receipt of such claims. CIOTA LOSSES SIX MONTHS ENDED SIX MONTHS ENDED (MILLIONS) JUNE 30, 1997 JUNE 30, 1996 ---------------- ---------------- Beginning reserves: Direct.................... $ 1,560 $ 374 Ceded..................... (446) -- --------- -------- Net....................... 1,114 374 Acquisition of Aetna P&C: Direct.................... -- 709 Ceded..................... -- (293) Incurred losses and loss expenses: Direct.................... 12 544 Ceded..................... -- (160) Losses paid: Direct.................... 36 36 Ceded..................... (15) (4) Ending reserves: Direct.................... 1,536 1,591 Ceded..................... (431) (449) --------- --------- Net....................... $ 1,105 $1,142 --------- --------- --------- --------- CORPORATE AND OTHER SIX MONTHS ENDED JUNE 30, ------------------------------------------ (millions) 1997 1996 ------------------- --------------------- NET INCOME NET INCOME REVENUES (EXPENSE) REVENUES (EXPENSE) --------- ---------- ---------- ---------- Net expenses (1).......... -- $ (98) -- $ (107) Net gain (loss) on sale of subsidiaries and affiliates.............. -- -- -- 384 -------- ---------- ---------- ---------- Total Corporate and Other................. $ 44 $ (98) $ 103 $ 277 -------- ---------- ---------- ---------- -------- ---------- ---------- ---------- - ----------------------- (1) Net income (expense) includes $5 million of reported investment portfolio losses in 1996. Net corporate expenses (before reported portfolio losses) were down in the first six months of 1997 compared to the first six months of 1996 reflecting higher income from corporate investments and lower borrowing costs. LIQUIDITY AND CAPITAL RESOURCES TRV services its obligations primarily with dividends and other advances that it receives from subsidiaries. The subsidiaries' dividend-paying abilities are limited by certain covenant restrictions in credit agreements and/or by regulatory requirements. TRV believes it will have sufficient funds to meet current and future commitments. Each of TRV's major operating subsidiaries finances its operations on a stand-alone basis consistent with its capitalization and ratings. TRAVELERS GROUP INC. (TRV) TRV issues commercial paper directly to investors and maintains unused credit availability under committed revolving credit agreements at least equal to the amount of commercial paper outstanding. TRV, Commercial Credit Company (CCC) and The Travelers Insurance Company (TIC) have a five-year revolving credit facility with a syndicate of banks to provide $1.0 billion of revolving credit, to be allocated to any of TRV, CCC or TIC. The participation of TIC in this agreement is limited to $250 million. This facility expires in June 2001. Currently $100 million is allocated to TRV, $850 million to CCC and $50 million to TIC. Under this facility TRV is required to maintain a certain level of consolidated stockholders' equity (as defined in the agreement). At June 30, 1997 this requirement was exceeded by approximately $5.2 billion. At June 30, 1997, there were no borrowings outstanding under this facility. Currently, TRV has unused credit availability of $100 million under the five-year revolving credit facility. TRV may borrow under this revolving credit facility at various interest rate options and compensates the banks for the facility through commitment fees. In June 1997, the Company sold in a public offering 8.0 million depositary shares, each representing one-fifth of a share of 6.365% Cumulative Preferred Stock, Series F (Series F Preferred Stock) at an offering price of $50 per depositary share for an aggregate principal amount of $400 million. The Series F Preferred Stock has cumulative dividends payable quarterly commencing September 1, 1997 and a liquidation preference equivalent to $50 per depositary share plus accrued and accumulated unpaid dividends. On or after June 16, 2007, the Company may redeem the Series F Preferred Stock, in whole or in part, at any time at a redemption price of $50 per depositary share plus dividends accrued and unpaid to the redemption date. In July 1997, the Company sold in a public offering 4.0 million depositary shares, each representing one-fifth of a share of 6.213% Cumulative Preferred Stock, Series G (Series G Preferred Stock) at an offering price of $50 per depositary share for an aggregate principal amount of $200 million. The Series G Preferred Stock has cumulative dividends payable quarterly commencing September 1, 1997 and a liquidation preference equivalent to $50 per depositary share plus accrued and accumulated unpaid dividends. On or after July 11, 2007, the Company may redeem the Series G Preferred Stock, in whole or in part, at any time at a redemption price of $50 per depositary share plus dividends accrued and unpaid to the redemption date. On July 1, 1997 the Company redeemed all of the 7.5 million outstanding shares (15 million depositary shares) of its 9.25% Preferred Stock, Series D (Series D Preferred Stock). The aggregate principal amount of Series D Preferred Stock outstanding on June 30, 1997 was $375 million. All of the outstanding shares of the Series D Preferred Stock were redeemed at $50 per share ($25 per depositary share). On July 28, 1997 the Company redeemed all of the 1.2 million outstanding shares (12 million depositary shares) of its 8.125% Cumulative Preferred Stock, Series A (Series A Preferred Stock). The aggregate principal amount of Series A Preferred Stock outstanding as of June 30, 1997 was $300 million. All of the outstanding shares of the Series A Preferred Stock were redeemed at $250 per share ($25 per depositary share), plus accrued and unpaid dividends through July 28, 1997. TRV as of August 7, 1997, had $1.0 billion available for debt offerings and $400 million available for preferred security offerings under its shelf registration statements. TRAVELERS PROPERTY CASUALTY CORP. (TAP) TAP also issues commercial paper directly to investors and maintains unused credit availability under a committed revolving credit agreement at least equal to the amount of commercial paper outstanding. TAP has a five-year revolving credit facility in the amount of $500 million with a syndicate of banks that expires in December 2001. Under this facility TAP is required to maintain a certain level of consolidated stockholders' equity (as defined in the agreement). At June 30, 1997, this requirement was exceeded by approximately $3.0 billion. At June 30, 1997, there were no borrowings outstanding under this facility. TAP's insurance subsidiaries are subject to various regulatory restrictions that limit the maximum amount of dividends available to be paid to their parent without prior approval of insurance regulatory authorities. Dividend payments to TAP from its insurance subsidiaries are limited to $647 million in 1997 without prior approval of the Connecticut Insurance Department. TAP received $145 million of dividends from its insurance subsidiaries during the first six months of 1997 and received an additional $100 million of dividends on July 1, 1997. TAP as of August 7, 1997, had $750 million available for debt offerings under its shelf registration statement. COMMERCIAL CREDIT COMPANY (CCC) CCC also issues commercial paper directly to investors and maintains unused credit availability under committed revolving credit agreements at least equal to the amount of commercial paper outstanding. CCC has unused credit availability of $4.250 billion under five-year revolving credit facilities, (including the $850 million referred to above) and $1.0 billion under a 364-day facility. CCC may borrow under its revolving credit facilities at various interest rate options and compensates the banks for the facilities through commitment fees. CCC is limited by covenants in its revolving credit agreements as to the amount of dividends and advances that may be made to its parent or its affiliated companies. At June 30, 1997, CCC would have been able to remit $313 million to its parent under its most restrictive covenants. CCC completed the following long-term debt offerings in 1997 and, as of August 7, 1997 had $650 million available for debt offerings and $400 million available for trust preferred security offerings under its shelf registration statements: - - 6.45% Notes due July 1, 2002....................... $300 million - - 6.75% Notes due July 1, 2007....................... $300 million - - 6 1/2% Notes due August 1, 2004.................... $250 million SMITH BARNEY HOLDINGS INC. (SMITH BARNEY) Smith Barney funds its day-to-day operations through the use of commercial paper, collateralized and uncollateralized borrowings (both committed and uncommitted), internally generated funds, repurchase transactions, and securities lending arrangements. The volume of Smith Barney's borrowings generally fluctuates in response to changes in the amount of reverse repurchase transactions outstanding, the level of securities inventories, customer balances and securities borrowing transactions. Smith Barney has a $1.250 billion revolving credit agreement with a bank syndicate that extends through May 2000, and has a $750 million 364-day revolving credit agreement with a bank syndicate that extends through May 1998. At June 30, 1997, there were no borrowings outstanding under either facility. Smith Barney also has substantial borrowing arrangements consisting of facilities that it has been advised are available, but where no contractual lending obligation exists. Smith Barney and its subsidiary Smith Barney Inc. issue commercial paper directly to investors. As a policy, Smith Barney attempts to maintain sufficient capital and funding sources in order to have the capacity to finance itself on a fully collateralized basis at all times, including periods of financial stress. In addition, Smith Barney monitors its leverage and capital ratios on a daily basis. Smith Barney is limited as to the amount of dividends that may be paid to TRV. At June 30, 1997, Smith Barney would have been able to remit approximately $779 million to TRV under its most restrictive covenants. Smith Barney completed the following long-term debt offerings in 1997 and, as of August 7, 1997, had $750 million available for debt offerings under its shelf registration statement: - - S&P 500 Equity Linked Notes due March 11, 2002....... $66 million - - 7% Notes due March 15, 2004.......................... $250 million - - 7 3/8% Notes due May 15, 2007........................ $200 million - - 6 5/8% Notes due July 1, 2002........................ $250 million In addition to the long-term debt offerings above, in May 1997 Smith Barney, through a private placement, issued $25 million of 6.98% Notes due December 30, 1999. SECURITIES BORROWED, LOANED AND SUBJECT TO REPURCHASE AGREEMENTS Smith Barney engages in "matched book" transactions in government and mortgage-backed securities as well as "conduit" transactions in corporate equity and debt securities. These transactions are similar in nature. A "matched book" transaction involves a security purchased under an agreement to resell (i.e., reverse repurchase transaction) and simultaneously sold under an agreement to repurchase (i.e., repurchase transaction). A "conduit" transaction involves the borrowing of a security from a counterparty and the simultaneous lending of the security to another counterparty. These transactions are reported gross in the Condensed Consolidated Statement of Financial Position and typically yield interest spreads, generally ranging from 10 to 30 basis points. The interest spread results from the net of interest received on the reverse repurchase or security borrowed transaction and the interest paid on the corresponding repurchase or security loaned transaction. Interest rates charged or credited in these activities are usually based on current Federal Funds rates but can fluctuate based on security availability and other market conditions. The size of balance sheet positions resulting from these activities can vary significantly depending primarily on levels of activity in the bond markets, but the impact on net income would be relatively smaller. THE TRAVELERS INSURANCE COMPANY (TIC) At June 30, 1997, TIC had $23.3 billion of life and annuity product deposit funds and reserves. Of that total, $12.4 billion is not subject to discretionary withdrawal based on contract terms. The remaining $10.9 billion is for life and annuity products that are subject to discretionary withdrawal by the contractholder. Included in the amount that is subject to discretionary withdrawal is $1.7 billion of liabilities that are surrenderable with market value adjustments. Also included are an additional $5.3 billion of the life insurance and individual annuity liabilities, which are subject to discretionary withdrawal and have an average surrender charge of 4.8%. In the payout phase, these funds are credited at significantly reduced interest rates. The remaining $3.9 billion of liabilities is surrenderable without charge. More than 17% of these relate to individual life products. These risks would have to be underwritten again if transferred to another carrier, which is considered a significant deterrent against withdrawal by long-term policyholders. Insurance liabilities that are surrendered or withdrawn are reduced by outstanding policy loans and related accrued interest prior to payout. TIC issues commercial paper to investors and maintains unused committed revolving credit facilities at least equal to the amount of commercial paper outstanding. Currently, TIC has unused credit availability of $50 million under the five-year revolving credit facility referred to above. TIC is subject to various regulatory restrictions that limit the maximum amount of dividends available to its parent without prior approval of the Connecticut Insurance Department. A maximum of $507 million of statutory surplus is available in 1997 for such dividends without Department approval, of which $200 million has been paid during the first six months of 1997. FUTURE APPLICATION OF ACCOUNTING STANDARDS See Note 3 of Notes to Condensed Consolidated Financial Statements for a discussion of recently issued accounting pronouncements. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS. For information concerning several purported class action lawsuits filed against Smith Barney Inc. in connection with three funds managed by Hyperion Capital Management Inc., see the descriptions that appear in the fourth paragraph on page 26 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993, the first paragraph under the heading "Smith Barney" on page 65 of the Company's Annual Report on Form 10-K for the year ended December 31, 1995, the first paragraph on page 34 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996, the third full paragraph on page 83 of the Company's Annual Report on Form 10-K for the year ended December 31, 1996 and the first paragraph on page 28 of the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1997, which descriptions are incorporated by reference herein. A copy of the pertinent paragraphs of such filings is included as an exhibit to this Form 10-Q. In June 1997, the U.S. Supreme Court denied plaintiffs' petition for certiorari. For information concerning a complaint seeking equitable relief that was filed by the U.S. Department of Justice, naming 24 major brokerage firms, including SBI, see the description that appears in the first paragraph on page 35 of the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1996, which description is incorporated by reference herein. A copy of the pertinent paragraph of such filing is included as an exhibit to this Form 10-Q. In April 1997, the U.S. District Court for the Southern District of New York approved the settlement previously agreed to by the parties. In May 1997, plaintiffs in the related civil class action challenged certain provisions of the settlement. For information concerning actions filed against several insurance companies and industry organizations relating to service fee charges and premium calculations on certain workers' compensation insurance, see the descriptions that appear in the paragraph that begins on page 90 and ends on page 91 of the Prospectus dated April 22, 1996 of Travelers Property Casualty Corp., the second paragraph on page 84 of the Company's Annual Report on Form 10-K for the year ended December 31, 1996 and the third paragraph on page 28 of the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1997, which descriptions are incorporated by reference herein. A copy of the pertinent paragraphs of such filings is included as an exhibit to this Form 10-Q. In July 1997, the Texas Department of Insurance issued a rule addressing the same premium calculation issues raised by the proposed intervenor class in Travelers Indemnity Company of Connecticut v. Texas Workers Compensation Insurance Facility. The Company believes that this rule, which requires that rebates be paid to certain 1991 to 1994 Texas workers compensation policyholders, exceeds the Department's authority. Accordingly, the Company has joined with several other insurers in an appeal proceeding, entitled Highlands Insurance Company v. Texas Department of Insurance, which was filed in July 1997 in the District Court of Travis County, Texas. In July 1997, a purported class action, entitled El Chico Restaurants, Inc. v. The Aetna Casualty and Surety Company, et al., was filed in the U.S. District Court for the Southern District of Florida, with allegations similar to those in the two El Chico purported class actions filed earlier this year in Tennessee and Georgia. ITEM 2. CHANGES IN SECURITIES. On June 2, 1997, Smith Barney Inc. ("SBI") acquired the business of Perkins Shareholder Services, Inc. ("PSS"), a California corporation that provides stock option plan administration services, for approximately $85,000 in cash and certain other non-cash consideration. In connection with the transaction, on June 4, 1997, the Company issued 25,877 shares (the "Shares") of common stock, $.01 par value per share, of the Company, to Marilyn J. Perkins Claassen, PSS's president and sole stockholder, which Shares vest periodically over three and one-half years and which may be forfeited under certain circumstances. The Company received approximately $1,420,000 from SBI (based on the June 2, 1997 closing price of $54.875) to pay for the Shares. The issuance of the Shares was exempt from registration pursuant to Section 4(2) of the Securities Act of 1933, as amended. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits: See Exhibit Index. (b) Reports on Form 8-K: On June 13, 1997, the Company filed a Current Report on Form 8-K, dated June 11, 1997, filing certain exhibits under Item 7 thereof relating to the offer and sale of the Company's 6.365% Cumulative Preferred Stock, Series F, $1.00 par value per share. No other reports on Form 8-K were filed during the quarter ended June 30, 1997; however, on July 10, 1997, the Company filed a Current Report on Form 8-K, dated July 8, 1997, filing certain exhibits under Item 7 thereof relating to the offer and sale of the Company's 6.213% Cumulative Preferred Stock, Series G, $1.00 par value per share. EXHIBIT INDEX EXHIBIT FILING NUMBER DESCRIPTION OF EXHIBIT METHOD - --------- ------------------------ ---------- 3.01 Restated Certificate of Incorporation of Electronic Travelers Group Inc. (the "Company"), Certificate of Designation of Cumulative Adjustable Rate Preferred Stock, Series Y, Certificate of Amendment to the Restated Certificate of Incorporation, filed April 24, 1996, Certificate of Amendment to the Restated Certificate of Incorporation, filed April 23, 1997, Certificate of Designation of 6.365% Cumulative Preferred Stock, Series F, and Certificate of Designation of 6.213% Cumulative Preferred Stock, Series G. 3.02 By-Laws of the Company as amended and restated through April 23, 1997, incorporated by reference to Exhibit 3.02 to the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 1997 (File No. 1-9924) (the "Company's 3/31/97 10-Q"). 11.01 Computation of Earnings Per Share. Electronic 12.01 Computation of Ratio of Earnings to Fixed Electronic Charges. 27.01 Financial Data Schedule. Electronic 99.01 The fourth paragraph on page 26 of the Electronic Company's Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 1993, the first paragraph under the heading "Smith Barney" on page 65 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1995, the first paragraph on page 34 of the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 1996, the third full paragraph on page 83 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1996 (the "Company's 1996 10-K") and the first paragraph on page 28 of the Company's 3/31/97 10-Q. 99.02 The first paragraph on page 35 of the Electronic Company's Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 1996. 99.03 The paragraph that begins on page 90 and ends Electronic on page 91 of the Prospectus dated April 22, 1996 of Travelers Property Casualty Corp., the second paragraph on page 84 of the Company's 1996 10-K and the third paragraph on page 28 of the Company's 3/31/97 10-Q. The total amount of securities authorized pursuant to any instrument defining rights of holders of long-term debt of the Company does not exceed 10% of the total assets of the Company and its consolidated subsidiaries. The Company will furnish copies of any such instrument to the Securities and Exchange Commission upon request. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Travelers Group Inc. Date: August 12, 1997 By /s/ Heidi Miller ------------------------------ Heidi Miller Senior Vice President and Chief Financial Officer (Principal Financial Officer) Date: August 12, 1997 By /s/ Irwin Ettinger ------------------------------ Irwin Ettinger Executive Vice President and Chief Accounting Officer (Principal Accounting Officer) EXHIBIT INDEX EXHIBIT FILING NUMBER DESCRIPTION OF EXHIBIT METHOD - --------- ---------------------- ---------- 3.01 Restated Certificate of Incorporation of Electronic Travelers Group Inc. (the "Company"), Certificate Electronic of Designation of Cumulative Adjustable Rate Preferred Stock, Series Y, Certificate of Amendment to the Restated Certificate of Incorporation, filed April 24, 1996, Certificate of Amendment to the Restated Certificate of Incorporation, filed April 23, 1997, Certificate of Designation of 6.365% Cumulative Preferred Stock, Series F, and Certificate of Designation of 6.213% Cumulative Preferred Stock, Series G. 3.02 By-Laws of the Company as amended and restated through April 23, 1997, incorporated by reference to Exhibit 3.02 to the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 1997 (File No. 1-9924) (the "Company's 3/31/97 10-Q"). 11.01 Computation of Earnings Per Share. Electronic 12.01 Computation of Ratio of Earnings to Fixed Charges. Electronic 27.01 Financial Data Schedule. Electronic 99.01 The fourth paragraph on page 26 of the Electronic Company's Quarterly Report on Form 10-Q for the Electronic fiscal quarter ended September 30, 1993, the first paragraph under the heading "Smith Barney" on page 65 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1995, the first paragraph on page 34 of the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 1996, the third full paragraph on page 83 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1996 (the "Company's 1996 10-K") and the first paragraph on page 28 of the Company's 3/31/97 10-Q. 99.02 The first paragraph on page 35 of the Electronic Company's Quarterly Report on Form 10-Q for the Electronic fiscal quarter ended June 30, 1996. 99.03 The paragraph that begins on page 90 and ends Electronic on page 91 of the Prospectus dated April 22, Electronic 1996 of Travelers Property Casualty Corp., the second paragraph on page 84 of the Company's 1996 10-K and the third paragraph on page 28 of the Company's 3/31/97 10-Q. The total amount of securities authorized pursuant to any instrument defining rights of holders of long-term debt of the Company does not exceed 10% of the total assets of the Company and its consolidated subsidiaries. The Company will furnish copies of any such instrument to the Securities and Exchange Commission upon request. EXHIBIT 11.01 TRAVELERS GROUP INC. AND SUBSIDIARIES COMPUTATION OF EARNINGS PER SHARE (IN MILLIONS, EXCEPT FOR PER SHARE AMOUNTS) SIX MONTHS ENDED THREE MONTHS ENDED JUNE 30, JUNE 30, ------------------------ --------------------- 1997 1996 1997 1996 ----------- ----------- ----------- -------- Earnings: Net income..................... $ 663 $ 576 $ 1,305 $ 1,096 Preferred dividends: 8.125% Cumulative Preferred Stock--Series A.............. (6) (6) (12) (12) 5.5% Convertible Preferred Stock--Series B.............. -- (2) -- (4) $4.53 Convertible Preferred Stock--Series C.............. (5) (4) (11) (14) 9 1/4% Preferred Stock-- Series D..................... (9) (8) (18) (17) 6.365% Cumulative Preferred Stock--Series F.............. (1) -- (1) -- ------- ------- --------- -------- (21) (20) (42) (47) ------- ------- --------- -------- Income applicable to common stock........................ $ 642 $ 556 $ 1,263 $ 1,049 ------- ------- --------- -------- Average shares: Common......................... 612.1 609.6 612.3 610.2 Warrants....................... 4.6 2.8 4.6 2.9 Assumed exercise of dilutive stock options.................. 12.0 9.6 13.0 10.7 Incremental shares--Stock based incentive plans................ 16.6 12.7 15.8 12.3 --------- -------- ------- -------- 645.3 634.7 645.3 636.1 --------- -------- ------- -------- Earnings per share: Net Income.................... $ 1.00 0.88 1.96 $ 1.65 -------- -------- ------- -------- Earnings per common share is computed after recognition of preferred stock dividend requirements and is based on the weighted average number of common shares outstanding during the period after consideration of the dilutive effect of common stock warrants and stock options and the incremental shares assumed issued under the Capital Accumulation Plan and other restricted stock plans. Fully diluted earnings per common share, assuming conversion of all outstanding dilutive convertible preferred stock and the maximum dilutive effect of common stock equivalents, fhave not been presented because the effects are not material. The fully diluted earnings per common share calculation for the three and six months ended June 30, 1997 would entail adding the number of shares issuable on conversion of the dilutive convertible preferred stock (4.8 and 4.8 million, respectively) and the incremental dilutive effect of common stock equivalents (2.8 million and 3.5 million, respectively) to the number of shares included in the earnings per common share calculation (resulting in 652.9 and 654.0 million shares, respectively) and eliminating the dividend requirements of the dilutive convertible preferred stock ($2.3 and $4.7 million, respectively). The fully diluted earnings per common share calculation for the three and six months ended June 30, 1996 would entail adding the number of shares issuable on conversion of the dilutive convertible preferred stock (11.3 and 11.3 million, respectively) and the incremental dilutive effect of common stock equivalents (2.6 million and 3.2 million, respectively) to the number of shares included in the earnings per common share calculation (resulting in 648.6 and 650.6 million shares, respectively) and eliminating the dividend requirements of the dilutive convertible preferred stock ($4.7 and $9.5 million, respectively). Exhibit 12.01 Travelers Group Inc. and Subsidiaries Computation of Ratio of Earnings to Fixed Charges (In millions of dollars, except for ratio) SIX MONTHS ENDED JUNE 30, ----------------- 1997 1996 -------- ------- Income from continuing operations before income taxes and minority interest.. $ 2,166 $ 1,413 Interest..................................... 1,349 1,060 Portion of rentals deemed to be interest..... 55 53 -------- ------- Earnings available for fixed charges....... $ 3,570 $ 2,526 -------- ------- -------- ------- Fixed charges Interest..................................... $ 1,349 $ 1,060 Portion of rentals deemed to be interest..... 55 53 -------- ------- Fixed charges.............................. $ 1,404 $ 1,113 -------- ------- -------- ------- Ratio of earnings to fixed charges........... 2.54x 2.27x -------- ------- -------- ------- Exhibit 99.01 COMPANY'S FORM 10-Q September 30, 1993 Page 26 In October 1993, several purported class action lawsuits were filed in the Federal District Court for the Southern District of New York naming Smith Barney, Harris Upham & Co. Incorporated ("SBS") as defendant. The cases arise from SBS's participation as lead and co-underwriter in the initial public offerings of three separate funds managed by Hyperion Capital Management Inc. The plaintiffs have also named as defendants the funds' directors and the co-underwriters and their representatives. Plaintiffs allege that the registration statements and prospectuses by which the offerings were made between June 1992 and October 1992 were materially false and misleading, and are seeking unspecified damages in claims brought under the Federal securities laws. The Company believes it has meritorious defenses to these actions and intends to defend against them vigorously. COMPANY'S FORM 10-K December 31, 1995 Page 65 For information concerning several purported class action lawsuits filed against SBI in connection with three funds managed by Hyperion Capital Management Inc., see the description that appears in the fourth paragraph of page 26 of the Company's filing on Form 10-Q for the quarter ended September 30, 1993, which description is incorporated by reference herein. A copy of the pertinent paragraph of such filing is included as an exhibit to this Form 10-K. The actions were consolidated under the title In re: Hyperion Securities Litigation. SBI's motion to dismiss the claims was granted in July 1995. In August 1995, an appeal was filed in the U.S. Court of Appeals for the Second Circuit. The Company is awaiting a decision on the appeal. COMPANY'S FORM 10-Q September 30, 1996 Page 34 Item 1. Legal Proceedings. For information concerning the several class action lawsuits filed against Smith Barney Inc. in connection with three funds managed by Hyperion Capital Management Inc., see the descriptions that appear in the fourth paragraph on page 26 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993, and the first paragraph under the heading "Smith Barney" on page 65 of the Company's Annual Report on Form 10-K for the year ended December 31, 1995, which descriptions are incorporated by reference herein. A copy of the pertinent paragraphs of such filings is included as an exhibit to this Form 10-Q. In October 1996, the U.S. Court of Appeals for the Second Circuit affirmed the district court's dismissal of the claims. Plaintiffs have applied for a rehearing en banc. COMPANY'S FORM 10-K December 31, 1996 Page 83 For information concerning several purported class action lawsuits filed against SBI in connection with three funds managed by Hyperion Capital Management Inc., see the descriptions that appear in the fourth paragraph on page 26 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993, the first paragraph under the heading "Smith Barney" on page 65 of the Company's Annual Report on Form 10-K for the year ended December 31, 1995 and the first paragraph on page 34 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996, which descriptions are incorporated by reference herein. A copy of the pertinent paragraphs of such filings is included as an exhibit to this Form 10-K. Plaintiffs' petition for a rehearing en banc was denied in January 1997. COMPANY'S FORM 10-Q March 31, 1997 Page 28 ITEM 1. LEGAL PROCEEDINGS. For information concerning several purported class action lawsuits filed against Smith Barney Inc. in connection with three funds managed by Hyperion Capital Management Inc., see the descriptions that appear in the fourth paragraph on page 26 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993, the first paragraph under the heading "Smith Barney" on page 65 of the Company's Annual Report on Form 10-K for the year ended December 31, 1995, the first paragraph on page 34 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996 and the third full paragraph on page 83 of the Company's Annual Report on Form 10-K for the year ended December 31, 1996, which descriptions are incorporated by reference herein. A copy of the pertinent paragraphs of such filings is included as an exhibit to this Form 10-Q. In March 1997, plaintiffs filed a petition for certiorari with the U.S. Supreme Court. Exhibit 99.02 COMPANY'S FORM 10-Q June 30, 1996 Page 35 Item 1. Legal Proceedings. In July 1996, a complaint seeking equitable relief was filed in the U.S. District Court for the Southern District of New York by the U.S. Department of Justice, naming twenty-four major brokerage firms, including the Company's subsidiary, Smith Barney, Inc., as defendants. A proposed settlement has been agreed to by the parties, subject to approval of the court. Pursuant to this settlement, the defendants, without admitting any liability, would agree not to engage in certain practices relating to the quoting of Nasdaq securities and would further agree to implement a program to ensure compliance with federal antitrust laws and with the terms of the settlement. No monetary fines or penalties are imposed as part of the settlement. Exhibit 99.03 PROSPECTUS OF TRAVELERS PROPERTY CASUALTY CORP. April 22, 1996 Pages 90 and 91 A number of cases have been filed against several insurance companies and industry organizations relating to service fee charges and premium calculations on certain workers' compensation insurance. Certain subsidiaries of the Company are defendants in South Carolina ex rel. Medlock v. National Council on Compensation Insurance ("NCCI"), an action filed by the Attorney General of South Carolina in August 1994 in the Court of Common Pleas, County of Greenville, South Carolina; Four Way Plant Farm v. NCCI, a purported class action filed in September 1994 in the Circuit Court for Bullock County, Alabama, and NC Steel, Inc. v. NCCI, a purported class action filed in November 1993 in the Superior Court Division of the General Court of Justice, Wake County, North Carolina. In these cases, the plaintiffs generally allege that the administration of each state's workers' compensation assigned risk pool conspired with servicing carriers for the pool to collect excessive fees in violation of state antitrust and/or unfair trade practice laws. The plaintiffs seek unspecified compensatory, treble and/or punitive damages and injunctive relief. The Company believes it has meritorious defenses and intends to contest the allegations. In NC Steel, Inc. v. NCCI, the defendants' motion to dismiss was granted in February 1995, and the plaintiffs have appealed to the North Carolina Court of Appeals. In April 1994, certain subsidiaries of [the Company]were named as additional defendants in a purported class action pending in the 116th District of Dallas County, Texas, entitled Weatherford Roofing Company v. Employers National Insurance Company. The plaintiffs in this case allege that the workers' compensation carriers in Texas have conspired to collect excessive or improper premiums in violation of state insurance laws, antitrust laws and/or state unfair trade practices laws. The plaintiffs seek compensatory, treble and/or punitive damages as well as declaratory and injunctive relief. In a statutory demand letter, plaintiffs' counsel allege classwide compensatory damages, including interest through October 1994, of approximately $572 million. Since that time, court-approved settlements with certain other insurers have been based on single damage, or alleged overcharge, calculations which, if applied to Company-issued policies of class members, would yield single damages of $50 million or less. The Company believes it has meritorious defenses and intends to contest the allegations unless an attractive settlement opportunity arises. COMPANY'S FORM 10-Q December 31, 1996 Page 84 For information concerning actions filed against several insurance companies and industry organizations relating to service fee charges and premium calculations on certain workers' compensation insurance, see the descriptions that appear in the paragraph that begins on page 90 and ends on page 91 of the Prospectus dated April 22, 1996 of TAP, the second paragraph on page 35 of the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1996 and the second paragraph on page 34 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996, which descriptions are incorporated by reference herein. A copy of the pertinent paragraphs of such filings is included as an exhibit to this Form 10-K. In NC Steel, Inc. v. NCCI, plaintiffs and defendants have appealed to the North Carolina State Supreme Court. In November 1996, Amundson & Associates Art Studio v. NCCI, et al. was removed to the U.S. District Court for the District of Kansas. In December 1996, a purported class action entitled Forman, Inc. v. NCCI, et al. was filed in Chancery Court, Marion County, Tennessee, with allegations similar to those in NC Steel and seeking unspecified monetary damages. In January 1997, two additional purported class actions, each entitled El Chico Restaurants, Inc. v. The Aetna Casualty and Surety Company, et al., were filed in Chancery Court, Davidson County, Tennessee, and Superior Court, Richmond County, Georgia, respectively, with allegations similar to those in Weatherford Roofing Company v. Employers National Insurance Company, which was settled in mid-1996. Plaintiffs seek unspecified monetary damages. In February 1997, one action was removed to the U.S. District Court for the Middle District of Tennessee and the other action was removed to the U.S. District Court for the Southern District of Georgia. Also in January 1997, a purported class of Texas workers' compensation insureds filed a petition to intervene in a lawsuit pending since 1995 in District Court, Travis County, Texas, entitled Travelers Indemnity Company of Connecticut v. Texas Workers Compensation Insurance Facility. The pending lawsuit arose out of a fee dispute between certain subsidiaries of the Company and the administration of the Texas assigned risk pool. The proposed class challenges both the fees paid to servicing carriers for the pool from 1991 to 1993 and certain premium calculations on certain workers' compensation policies from 1991 forward. The Company believes it has meritorious defenses to these actions and intends to contest the allegations. COMPANY'S FORM 10-Q March 31, 1997 Page 28 For information concerning actions filed against several insurance companies and industry organizations relating to service fee charges and premium calculations on certain workers' compensation insurance, see the descriptions that appear in the paragraph that begins on page 90 and ends on page 91 of the Prospectus dated April 22, 1996 of Travelers Property Casualty Corp., the second paragraph on page 35 of the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1996, the second paragraph on page 34 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996 and the second paragraph on page 84 of the Company's Annual Report on Form 10-K for the year ended December 31, 1996, which descriptions are incorporated by reference herein. A copy of the pertinent paragraphs of such filings is included as an exhibit to this Form 10-Q. In April 1997, the purported class of Texas workers' compensation insureds that filed a petition to intervene in Travelers Indemnity Company of Connecticut v. Texas Workers Compensation Insurance Facility withdrew its claims against the Company's subsidiaries. However, in May 1997, such purported class filed a second amended petition in intervention alleging substantially the same claims as the original petition but covering the periods from 1992 through 1994. EX-99.03 6 ANNUAL REPORT ON FORM 10-K EXHIBIT 99.03 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ----------------- FORM 10-K |X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1996 OR |_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ______ to ______ ---------------- Commission file number 1-12484 ---------------- SMITH BARNEY HOLDINGS INC. (Exact name of registrant as specified in its charter) Delaware 06-1274088 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification No.) 388 Greenwich Street, New York, New York 10013 (Address of principal executive offices) (Zip Code) (212) 816-6000 (Registrant's telephone number, including area code) ---------------- Securities registered pursuant to Section 12(b) of the Act: Name of each exchange Title of each class on which registered ------------------- --------------------- 6 5/8% Notes due June 1, 2000 New York Stock Exchange Smith Barney S&P 500 Equity Chicago Board Options Exchange Linked Notes due August 13, 2001 and New York Stock Exchange Smith Barney S&P 500 Equity Chicago Board Options Exchange Linked Notes due March 11, 2002 Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $.10 per share. REDUCED DISCLOSURE FORMAT The registrant meets the conditions set forth in General Instruction I (1)(a) and (b) of Form 10-K and is therefore filing this Form 10-K with the reduced disclosure format. Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes |X| No |_| Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. |X| Because the registrant is a wholly owned subsidiary of Travelers Group Inc., none of the registrant's outstanding voting stock is held by nonaffiliates of the registrant. As of the date hereof, 100 shares of the registrant's Common Stock, $.10 par value, were issued and outstanding. Documents Incorporated by Reference: None SMITH BARNEY HOLDINGS INC. ANNUAL REPORT ON FORM 10-K FOR FISCAL YEAR ENDED DECEMBER 31, 1996 ------------------------------ TABLE OF CONTENTS FORM 10-K ITEM NUMBER PAGE - ----------- ---- PART I ------ 1. Business............................................................ 1 2. Properties.......................................................... 9 3. Legal Proceedings................................................... 10 4. Omitted Pursuant to General Instruction I PART II ------- 5. Market for Registrant's Common Equity and Related Stockholder Matters....................................... 11 6. Omitted Pursuant to General Instruction I 7. Management's Discussion and Analysis of Financial Condition and Results of Operations............................... 12 8. Financial Statements and Supplementary Data......................... 17 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure............................... 17 PART III -------- 10-13 Omitted Pursuant to General Instruction I PART IV ------- 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K....................................................... 17 Exhibit Index....................................................... 19 Signatures.......................................................... 21 Index to Consolidated Financial Statements and Schedules............ F-1 PART I ------ ITEM 1. BUSINESS. THE COMPANY Smith Barney Holdings Inc. ("SB Holdings") provides investment banking, asset management, brokerage and other financial services through its wholly owned subsidiaries. Its principal operating subsidiary is Smith Barney Inc. ("SBI"), an investment banking, securities trading and brokerage firm that traces its origins back to 1873. As used in this Form 10-K, unless the context otherwise requires, the "Company" refers to SB Holdings and its consolidated subsidiaries. The Company operates through approximately 450 offices throughout the United States, and 17 offices in 15 foreign countries. With approximately 10,400 Financial Consultants, the Company believes that it is currently the second largest domestic brokerage firm in the United States. The Company is a wholly owned subsidiary of Travelers Group Inc. ("Travelers Group"), a financial services holding company engaged, through its subsidiaries, principally in four business segments: (i) Investment Services (primarily through the Company); (ii) Consumer Finance Services; (iii) Property & Casualty Insurance Services; and (iv) Life Insurance Services. The periodic reports of Travelers Group provide additional business and financial information concerning that company and its consolidated subsidiaries. The principal offices of the Company are located at 388 Greenwich Street, New York, New York 10013, telephone number (212) 816-6000. The Company was incorporated in Delaware in 1989. INVESTMENT BANKING AND SECURITIES BROKERAGE The Company is an investment banking and securities trading and brokerage firm serving United States and foreign corporations, governments and institutional and individual investors. Its business includes securities, options and commodities brokerage for domestic and international institutional and individual clients; underwriting and distribution of securities; arranging for the private placement of securities; assisting in mergers and acquisitions and providing other financial advisory services; market making and trading in corporate debt and equity, United States government and agency, mortgage-related and municipal securities and foreign exchange, futures and forward contracts; customer financing activities; securities lending activities; investment management and advisory services; securities research; and other related activities. 1 The Company's investment banking services include the underwriting of debt and equity issues for United States and foreign corporations and for state, local and other governmental and government sponsored authorities. The Company frequently acts as managing underwriter in corporate and public securities offerings. The Company also acts as a private placement agent for various clients, and as such helps to place securities for clients with large institutions and other qualified investors. The Company also provides financial advice to investment banking clients on a wide variety of transactions including mergers and acquisitions, exchanges of securities and corporate restructurings. The Company executes securities brokerage transactions on all major United States securities exchanges and distributes a wide variety of financial products. It makes inter-dealer markets and trades as principal in corporate debt and equity securities, primarily of United States corporate issuers, United States and foreign government, and agency securities, mortgage-related securities, whole loans, municipal and other tax-exempt securities, commercial paper and other money market instruments as well as emerging market debt securities. The firm carries inventories of securities to facilitate sales to customers and other dealers and with a view to realizing trading gains. SBI is one of the leading dealers in municipal securities and is a "Primary Dealer" in United States government securities, as designated by the Federal Reserve Bank of New York. Its daily trading inventory positions in United States government and agency securities are financed largely through the use of repurchase agreements pursuant to which the Company sells the securities and simultaneously agrees to repurchase them at a future date. The Company also acts as an intermediary between borrowers and lenders of short-term funds utilizing repurchase and reverse repurchase agreements. The Company uses derivative financial instruments to facilitate customer transactions and to manage exposure to interest rate, currency and market risk. In addition, for its own account the Company engages in a limited manner in certain arbitrage activities, which primarily seek to benefit from temporary price discrepancies that occur with respect to related securities or to the same security on different markets. The Company also engages in the borrowing and lending of securities. The Company's network of Financial Consultants also sells variable annuities and other individual products of Travelers Life and Annuity, a unit of The Travelers Insurance Group Inc., an indirect wholly owned subsidiary of Travelers Group. The Company executes transactions in large blocks of exchange-listed stocks, usually with institutional investors, and often acts as principal to facilitate these transactions. It makes markets, buying and selling as principal, in common stocks, convertible preferred stocks, warrants and other securities traded on the NASDAQ system or otherwise in the over-the-counter market. The Company also maintains trading positions in equity options, convertible securities, debt options, foreign exchange and commodities instruments. It executes significant client transactions in both listed and unlisted options and in foreign exchange, and often acts as principal to facilitate these transactions. The Company also sells various types of structured securities on both a principal and an agency basis. The Company's securities trading and investment activities involve significant risk in that the values of positions carried in its trading 2 and investment accounts are subject to market fluctuations. The Company engages in a variety of financial techniques designed to manage this risk. CUSTOMER FINANCING Customers' securities transactions are executed on either a cash or margin basis. Federal regulations prescribe the minimum original margin that must be deposited by securities purchasers, and exchange regulations prescribe the minimum margins that must be maintained by customers. The Company imposes margin maintenance requirements that are equal to or exceed those required by exchange regulations. Such requirements are intended to reduce the risk assumed by the Company that a market decline will reduce the value of a customer's collateral below the amount of the customer's indebtedness before the collateral can be sold. Substantially all transactions in commodities futures contracts are on margin subject to individual exchange regulations. Margin, in the case of commodities futures contracts, is primarily funded in the form of cash or United States Treasury securities. Commodities transactions involve substantial risk, principally because of low margin requirements permitted by the exchanges. Income earned on financing customers' securities transactions provides the Company with an additional source of income. Credit losses may arise as a result of this financing activity; however, such losses have not been material. ASSET MANAGEMENT The Company provides discretionary and non-discretionary asset management and consulting services to a wide array of mutual funds and institutional and individual investors, with respect to domestic and foreign equity and debt securities, municipal bonds, money market instruments, and related options and futures contracts. The Company typically receives ongoing fees from its asset management and consulting clients, generally stated as a percentage of the client's assets with respect to which the Company's services are rendered. At December 31, 1996, such client assets in the aggregate exceeded $111.8 billion, as compared to approximately $96.2 billion at December 31, 1995 and approximately $78.0 billion at December 31, 1994. At December 31, 1996, the Company sponsored 59 mutual funds (open-end investment companies) with aggregate assets of approximately $69.7 billion distributed through its sales force of Financial Consultants. Of these, ten are taxable and tax-exempt money market funds, with assets of approximately $41.2 billion. At December 31, 1995, aggregate assets in Company-sponsored mutual funds were approximately $61.6 billion, of which approximately $35.6 billion related to money market funds, compared to aggregate assets in such funds at December 31, 1994 of approximately $50.6 billion, $28.6 billion of which related to money market funds. A wholly owned subsidiary of SB Holdings serves as investment manager to these mutual funds, as well as to twelve closed-end investment companies, the shares of which are listed for trading on one or more securities exchanges. At December 31, 1996 and December 31, 1995, assets of these closed-end funds aggregated approximately $2.8 billion, as compared to 3 approximately $2.5 billion at December 31, 1994. The open-end and closed-end funds sponsored and managed by the Company have various investment objectives, including growth, growth and income, taxable income and tax-exempt income. In addition, at December 31, 1996, the Company managed 25 mutual fund portfolios serving as funding vehicles for variable annuity contracts, with aggregate assets of approximately $2.3 billion. At December 31, 1995 and December 31, 1994, aggregate assets in the mutual fund portfolios managed by the Company were approximately $1.8 billion and $1.4 billion, respectively. This includes six mutual fund portfolios that are investment options for the Travelers Universal variable annuity contracts. The Company also sponsors and manages nine mutual funds domiciled outside the U.S. which are offered to the Company's non-resident alien client base. At December 31, 1996, these off-shore funds had aggregate assets of approximately $1.2 billion, as compared to approximately $980 million at December 31, 1995 and $780 million at December 31, 1994. In 1996, the Company launched The Concert Series-SM-, a group of mutual funds that invests in various of the Company's mutual funds instead of directly in stocks, bonds or other securities. The Concert Series-SM- simplifies the process of investing and enables investors to achieve a broad diversification of their investments. The Concert Series-SM- is sold through the Company's Financial Consultants and the sales force of the Primerica Financial Services group of companies, which are subsidiaries of Travelers Group. In addition to these proprietary funds, the Company also sells through its Financial Consultants a large number of mutual funds sponsored and managed by unaffiliated entities. The Company receives commissions and other sales and service revenues from this activity. The Company also sponsors and oversees the portfolios of a large number of unit investment trusts, which are unmanaged investment companies, the portfolios of which are generally static. Such unit investment trusts may hold domestic and foreign equity and debt securities, including municipal bonds. Certain trusts are sponsored and overseen solely by the Company; other trusts are jointly sponsored through a syndicate of major broker-dealers of which the Company is a member. At December 31, 1996, outstanding unit trust assets held by the Company's clients exceeded $8.6 billion, as compared to approximately $7.2 billion at December 31, 1995 and approximately $6.4 billion at December 31, 1994. The Company's asset management units provide separate account discretionary investment management services to a wide variety of individual and institutional clients, including private and public retirement plans, endowments, municipalities and other institutions. Client relationships may be introduced through the Company's network of Financial Consultants or independent from such network (e.g., through traditional pension plan consultants unaffiliated with the Company). Assets under the Company's management exceeded $24.0 billion at December 31, 1996, as compared to approximately $20.4 billion at December 31, 1995 and approximately $15.7 billion at December 31, 1994. 4 The Company's Consulting Group ("CG") provides a variety of investment management and consulting services to institutional and individual clients. CG sponsors a number of different "wrap fee" programs, in which CG and the Company typically provide: an analysis of the client's financial situation, investment needs and risk tolerance; a recommendation that the client retain one or more investment management firms (which may be affiliated or unaffiliated with the Company); ongoing monitoring of the performance and suitability of the investment manager(s) retained; securities execution and custody; and client reporting and recordkeeping. In such programs, the client generally pays a single bundled fee for the services provided. CG also provides traditional investment management consulting services to institutions, including assisting clients in formulating investment objectives and policies and in selecting investment management firms for the day-to-day management of client portfolios. CG's programs and services generally are delivered through the Company's Financial Consultants, many of whom specialize in such programs and services. As of December 31, 1996, the Company provided consulting services with respect to client assets aggregating approximately $49.1 billion, excluding the TRAK-R- program described below, as compared to approximately $39.1 billion at December 31, 1995 and approximately $29.7 billion at December 31, 1994. The Company's TRAK-R- program provides clients with non-discretionary asset allocation advice based on the client's identification of investment objectives and risk tolerances. TRAK-R- clients include both individuals and institutions, including participant-directed 401(k) plans. Clients can choose to allocate assets among the CG Capital Markets funds, a series of 13 mutual funds each corresponding to a particular asset class and investment style, or from among the selected fund offerings of 28 no-load or load-waived mutual fund families (including Smith Barney's family of funds) corresponding to the same asset class and investment style criteria. At December 31, 1996, TRAK-R- assets exceeded $6.6 billion, as compared to approximately $4.8 billion at December 31, 1995 and approximately $3.3 billion at December 31, 1994. The Company also offers a separate offshore TRAK-R- program to non-resident alien clients, which includes client investment in a series of asset class/investment style funds domiciled outside the United States. MISCELLANEOUS ACTIVITIES Certain subsidiaries of Travelers Group are chartered as trust companies and provide a full range of fiduciary services with a particular emphasis on personal trust services. Another subsidiary of Travelers Group offers a broad range of trustee services for qualified retirement plans, with particular emphasis on the 401(k) plan market. Each of these trust companies is subject to the supervision of the state banking authority where it was chartered and uses the distribution network of SBI to market its services. The Company provides certain advisory and support services to the trust companies and receives fees for such services. In 1996, the Company formed a joint venture with the Korea Exchange Bank. The venture, a brokerage and underwriting company based in Seoul, South Korea, that is owned 49% by the Company, is engaged in the securities brokerage and underwriting business in the Korean 5 markets. The venture is licensed with the Korea Ministry of Finance and Economy to conduct securities activities in Korea. COMPETITION The businesses in which the Company is engaged are highly competitive. The principal factors affecting competition in the investment banking and securities brokerage industry are the quality and ability of professional personnel and the relative prices of services and products offered. In addition to competition from other investment banking firms, both domestic and international, and securities brokerage companies and discount securities brokerage operations, including regional firms in the United States, there has been increasing competition from other sources, such as commercial banks, insurance companies and other major companies that have entered the investment banking and securities brokerage industry, in many cases through acquisitions. Certain of those competitors may have greater capital and other resources than the Company. The Federal Reserve Board has substantially removed the barrier originally erected by the Glass-Steagall Act restricting investment banking activities of commercial banks and their affiliates, by permitting certain commercial banks to engage, through affiliates, in the underwriting of and dealing in certain types of securities, subject to certain limitations. Proposed legislation has been introduced in Congress from time to time that would modify certain other provisions of the Glass-Steagall Act and other laws and regulations affecting the financial services industry. The potential impact of such legislation on the Company's businesses cannot be predicted at this time. Competitors of the Company's mutual funds and asset management groups include a large number of mutual fund management and sales companies and asset management firms. Competition in mutual fund sales and investment management is based on investment performance, service to clients and product design. REGULATION Certain of the Company's subsidiaries are registered as broker-dealers and as investment advisers with the Securities and Exchange Commission (the "Commission") and as futures commission merchants and as commodity pool operators with the Commodity Futures Trading Commission ("CFTC"). SBI and The Robinson-Humphrey Company, Inc., an investment banking and financial services subsidiary of SBI ("R-H"), are members of the New York Stock Exchange, Inc. (the "NYSE") and other principal United States securities exchanges, as well as the National Association of Securities Dealers, Inc. ("NASD") and the National Futures Association ("NFA"), a not-for-profit membership corporation which has been designated as a registered futures association by the CFTC. SBI and R-H are registered as broker-dealers in all 50 states, the District of Columbia and Puerto Rico, and in addition are registered as investment advisers in certain states that require such registration. SBI is also a reporting dealer to the Federal Reserve Bank of New York, a member of the principal United States futures exchanges and a registered broker-dealer in Guam. Both SBI and R-H are subject 6 to extensive regulation, primarily for the benefit of their customers, including minimum capital requirements, which are promulgated and enforced by, among others, the Commission, the CFTC, the NFA, the NYSE, various self-regulatory organizations of which SBI and R-H are members and the securities administrators of the 50 states, the District of Columbia and Puerto Rico and, in SBI's case, Guam. The Commission and the CFTC also require certain registered broker-dealers (including SBI) to maintain records concerning certain financial and securities activities of affiliated companies that may be material to the broker-dealer, and to file certain financial and other information regarding such affiliated companies. The Company's operations abroad, described in this paragraph, are conducted through various subsidiaries. Its activities in the United Kingdom, which include investment banking, trading, brokerage and asset management services, are subject to the Financial Services Act 1986, which regulates organizations that conduct investment businesses in the United Kingdom (including imposing capital and liquidity requirements), and to the rules of the Securities and Futures Authority and the Investment Management Regulatory Organisation. The Company is a member of the International Petroleum Exchange, the London Metals Exchange and the London International Financial Futures and Options Exchange and, as such, is subject to the rules and regulations of those Exchanges. In Ireland, a subsidiary of the Company that sponsors commodities-related pooled investment funds is subject to the supervision of the Central Bank of Ireland. In France, the Company operates as a regulated securities house and an authorized mutual fund manager. The Company is a licensed securities company in Japan and, as such, its activities in Japan are subject to Japanese law applicable to securities firms. The Company is also a member of the Tokyo Stock Exchange and the Osaka Stock Exchange, and its activities in Japan are therefore subject to the rules and regulations of those Exchanges. The Company conducts securities and commodities businesses in Singapore and Hong Kong that are regulated by the Monetary Authority of Singapore and the Hong Kong Securities and Futures Commission, respectively. The Company also is a "B license holder" with the Zurich Stock Exchange. Additionally, certain subsidiaries of the Company are licensed as an "international dealer," an "international adviser" and an "investment dealer" with the Ontario Securities Commission, and as broker-dealers with the Securities Board of The Netherlands. The Company's representative offices in Mexico City, Mexico, Paris, France, Beijing, People's Republic of China, Manama, Bahrain and Taipei, Taiwan are also subject to the jurisdiction of local financial services regulatory authorities. The Company also operates a private trust services business that is licensed as a bank and trust company in the Cayman Islands, and is subject to the regulation of the Director of Financial Services, Banks & Trust Companies Supervision Department of the Cayman Islands. In connection with the mutual funds business, the Company and its subsidiaries must comply with regulations of a number of regulatory agencies and organizations, including the Commission and the NASD. The Company is the direct or indirect parent of investment advisers registered and regulated under the Investment Advisers Act of 1940, and of companies that distribute shares of mutual funds pursuant to distribution agreements subject to regulation under the Investment Company Act of 1940. Under those Acts, the advisory contracts between the 7 Company's investment adviser subsidiaries and the mutual funds they serve ("Affiliated Funds"), as well as the mutual fund distribution agreements, would automatically terminate upon an assignment of such contracts by the investment adviser or the fund distribution company, as the case may be. Such an assignment would be presumed to have occurred if any party were to acquire more than 25% of Travelers Group's voting securities. Continuation of advisory and distribution relationships under these circumstances could be achieved only by obtaining consent to the assignment from the shareholders of the Affiliated Funds involved. In addition, SBI and the Affiliated Funds are subject to certain restrictions in their dealings with each other. For example, SBI may act as broker to an Affiliated Fund in a transaction involving an exchange-traded security only when that fund maintains procedures that govern, among other things, the execution price of the transaction and the commissions paid; SBI may not, however, conduct principal transactions with an Affiliated Fund. Further, an Affiliated Fund may acquire securities during the existence of an underwriting where SBI is a principal underwriter only in certain limited situations. SBI and R-H are members of the Securities Investor Protection Corporation ("SIPC"), which, in the event of liquidation of a broker-dealer, provides protection for customers' securities accounts held by the firm of up to $500,000 for each eligible customer, subject to a limitation of $100,000 for claims for cash balances. In addition, the Company has purchased additional coverage of up to $150 million for eligible customers, approximately $50 million of which is from a subsidiary of Travelers Group. As registered broker-dealers, SBI and R-H are subject to the Commission's net capital rule, Rule 15c3-1 (the "Net Capital Rule"), promulgated under the Securities Exchange Act of 1934, as amended (the "Exchange Act"). SBI and R-H compute net capital under the alternative method of the Net Capital Rule which requires the maintenance of minimum net capital, as defined. A member of the NYSE may be required to reduce its business if its net capital is less than 4% of aggregate debit balances (as defined) and may also be prohibited from expanding its business or paying cash dividends if resulting net capital would be less than 5% of aggregate debit balances. Furthermore, the Net Capital Rule does not permit withdrawal of equity or subordinated capital if the resulting net capital would be less than 5% of such debit balances. The Net Capital Rule also limits the ability of broker-dealers to transfer large amounts of capital to parent companies and other affiliates. Under the Net Capital Rule, equity capital cannot be withdrawn from a broker-dealer without the prior approval of the Commission in certain circumstances, including when net capital after the withdrawal would be less than (i) 120% of the minimum net capital required by the Net Capital Rule, or (ii) 25% of the broker-dealer's securities position "haircuts," i.e., deductions from capital of certain specified percentages of the market value of securities to reflect the possibility of a market decline prior to disposition. In addition, the Net Capital Rule requires broker-dealers to notify the Commission and the appropriate self-regulatory organization two business days before a withdrawal of excess net capital if the withdrawal would exceed the greater of $500,000 or 30% of the broker-dealer's excess net capital, and two business days after a withdrawal that exceeds the greater of $500,000 or 20% of 8 excess net capital. Finally, the Net Capital Rule authorizes the Commission to order a freeze on the transfer of capital if a broker-dealer plans a withdrawal of more than 30% of its excess net capital and the Commission believes that such a withdrawal would be detrimental to the financial integrity of the firm or would jeopardize the broker-dealer's ability to pay its customers. Compliance with the Net Capital Rule could limit those operations of the Company that require the intensive use of capital, such as underwriting and trading activities and the financing of customer account balances, and also could restrict the Company's ability to withdraw capital from SBI and R-H which in turn could limit the Company's ability to pay dividends and make payments on its debt. See Note 12 of Notes to Consolidated Financial Statements. At December 31, 1996, SBI had net capital, computed in accordance with the Net Capital Rule, of $1.216 billion, which exceeded its minimum net capital requirement by $1.060 billion. OTHER INFORMATION GENERAL BUSINESS FACTORS In the judgment of the Company, no material part of the business of the Company and its subsidiaries is dependent upon a single customer or group of customers, the loss of any one of which would have a materially adverse effect on the Company, and no one customer or group of affiliated customers accounts for as much as 10% of the Company's consolidated revenues. At December 31, 1996, the Company had approximately 26,600 full-time and 1,450 part-time employees. SOURCE OF FUNDS For a discussion of the Company's sources of funds and maturities of the long-term debt of the Company's subsidiaries, see Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources," and Notes 3 and 4 of Notes to Consolidated Financial Statements. TAXATION For a discussion of tax matters affecting the Company and its operations, see Note 11 of Notes to Consolidated Financial Statements. ITEM 2. PROPERTIES. The Company's principal executive offices are located in New York City. In addition, SBI owns two office buildings in New York City, which total approximately 627,000 square feet. Most of SBI's other offices are located in leased premises, the leases for which expire at various times. 9 The Company leases two buildings, located at 388 and 390 Greenwich Street and totaling approximately 2,300,000 square feet, through 1999. The Company has a purchase option with respect to these properties. The Company believes that these facilities are adequate for the purposes for which they are used and are well maintained. For further information concerning leases, see Note 5 of Notes to Consolidated Financial Statements. ITEM 3. LEGAL PROCEEDINGS. This section describes the major pending legal proceedings, other than ordinary routine litigation incidental to the business, to which the Company or any of its subsidiaries is a party or to which any of their property is subject. For information concerning several purported class action lawsuits filed against SBI in connection with three funds managed by Hyperion Capital Management Inc., see the description that appears in the third paragraph on page 2 of the Company's Current Report on Form 8-K dated November 9, 1993, the second paragraph on page 10 of the Company's Annual Report on Form 10-K for the year ended December 31, 1995 and the first paragraph on page 19 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996, which descriptions are incorporated by reference herein. A copy of the pertinent paragraphs of such filings is included as an exhibit to this Form 10-K. Plaintiffs' petition for a rehearing en banc was denied in January 1997. For information concerning two purported class actions filed in October 1994 and one purported class action filed in October 1996 in connection with certain public offering documents of Greyhound Bus Lines, Inc., see the descriptions that appear in the second paragraph on page 16 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1994, the fourth paragraph on page 10 of the Company's Annual Report on Form 10-K for the year ended December 31, 1995 and the second paragraph on page 19 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996, which descriptions are incorporated by reference herein. A copy of the pertinent paragraphs of such filings is included as an exhibit to this Form 10-K. In December 1996, the Company filed a plea and abatement in Clarkson v. Greyhound Lines, Inc., et al. For information concerning actions filed against a number of broker-dealers, including SBI, relating to trading practices on the National Association of Securities Dealers Automated Quotation system, see the descriptions that appear in the third paragraph on page 16 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1994 and the last paragraph on page 10 of the Company's Annual Report on Form 10-K for the year ended December 31, 1995, which descriptions are incorporated by reference herein. A copy of the pertinent paragraphs of such filings is included as an exhibit to this Form 10-K. In March 1996, plaintiffs filed a motion for class certification. 10 For information concerning a complaint seeking equitable relief that was filed by the U.S. Department of Justice, naming 24 major brokerage firms, including SBI, see the description that appears in the second paragraph on page 2 of the Company's Current Report on Form 8-K dated August 7, 1996 (filed August 7, 1996), which description is incorporated by reference herein. A copy of the pertinent paragraph of such filing is included as an exhibit to this Form 10-K. For information concerning a complaint seeking unspecified monetary damages that was filed by Orange County, California against numerous brokerage firms, including SBI, see the description that appears in the Company's Current Report on Form 8-K dated March 6, 1997 (filed March 7, 1997), which description in incorporated by reference herein. A copy of the pertinent paragraph of such filing is included as an exhibit to this Form 10-K. Various subsidiaries of the Company have been named as defendants in numerous civil actions, arbitration proceedings and other matters incident to and typical of the businesses in which they are engaged, including actions arising in the normal course of business out of activities as a broker and dealer in securities, as an underwriter, as an investment banker or otherwise. In the opinion of the Company's management, none of these actions is expected to have a material adverse effect on the consolidated financial condition, liquidity or results of operations of the Company and its subsidiaries. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. Pursuant to General Instruction I of Form 10-K, the information required by Item 4 is omitted. PART II ------- ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. All of the outstanding common stock of the Company is owned by Travelers Group. ITEM 6. SELECTED FINANCIAL DATA. Pursuant to General Instruction I of Form 10-K, the information required by Item 6 is omitted. 11 Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis reflects the financial condition and results of operations of the Company and its consolidated subsidiaries for the periods presented. RESULTS OF OPERATIONS For the years ended December 31, 1996 and 1995 The Company reported record net income of $883 million for the year ended December 31, 1996, an increase of 48% from the $595 million reported for the year ended December 31, 1995. This increase is primarily attributable to continued strength in the financial markets as the Dow Jones Industrial Average reached record levels throughout the year, as well as to improved performance in most of the Company's product categories. Return on equity reached a record 34.5% for 1996, compared to 24.6% for 1995. Pre-tax profit margin increased to 23.2% for 1996 compared to 18.9% for 1995. Revenue, net of interest expense increased 16% to $6,267 million in 1996 from $5,408 million in 1995. Commission revenues increased 12% to $2.2 billion, compared to $2.0 billion in 1995. This is attributable to increases in listed and over-the-counter securities, as well as increased insurance and annuity sales. Principal trading revenues declined 3% to $990 million compared to $1.02 billion in 1995. This decline is the result of lower activity in taxable fixed income and municipal trading, offset to an extent by gains in equity trading. Investment banking revenues increased 36% to $1.1 billion in 1996 compared to $847 million in 1995. The increase reflects continued strength in equity, high yield, public finance, high grade debt and unit trust underwritings. Asset management fees rose to a record $1.3 billion in 1996, up 28% from the $1.1 billion reported in 1995. This increase is to a great extent directly related to the increase in assets under management, as well as bringing in-house all of the administrative functions for proprietary mutual funds and money funds in the third quarter of 1995. Internally managed assets reached a record $111.8 billion at December 31, 1996 compared to $96.2 billion at December 31, 1995. Internally managed assets are comprised of money market funds, mutual funds, managed accounts, and accounts managed by financial consultants. Net interest and dividends increased 11% to a record $419 million in 1996 compared to $377 million in 1995. The increase is primarily due to increased margin lending to clients and increased taxable fixed income inventories. Total expenses, excluding interest increased 10% to $4.8 billion in 1996 compared to $4.4 billion in 1995. This increase is primarily the result of higher production-related employee compensation 12 and benefits expense, and other operating expenses. These increases were partially offset by a decline in communications occupancy and equipment expense. Expenses other than interest and employee compensation and benefits expense were $1.3 billion compared to $1.2 billion in 1995. Employee compensation and benefits expense as a percentage of net revenues in 1996 declined to 56.2% from 59.0% in 1995 and the ratio of non-compensation expense as a percentage of net revenues was 20.6% in 1996 compared to 22.1% in 1995. The Company continues to maintain its focus on controlling fixed expenses. At December 31, 1996 the number of non-production employees has decreased 3% since the fourth quarter of 1995. The Company's business is significantly affected by the levels of activity in the securities markets. Many factors have an impact on securities markets including the level and trend of interest rates, the general state of the economy and the national and worldwide political environments. An increasing interest rate environment could have an adverse impact on the Company's businesses, including commissions (which are linked in part to the economic attractiveness of securities relative to time deposits) and investment banking (which is affected by the relative benefit to corporations and other entities of issuing debt and/or equity versus other avenues for raising capital). Such effects, however, could be at least partially offset by a strengthening U.S. economy that would include growth in the business sector -- accompanied by an increase in the demand for capital -- and an increase in the capacity of individuals to invest. A decline in interest rates could favorably impact the Company's business. The Company's asset management business provides a more predictable and steady income stream than its other businesses. The Company continues to maintain tight expense controls that management believes will help the firm weather periodic downturns in market conditions. The Company's principal business activities are, by their nature, highly competitive and subject to various risks, particularly volatile trading markets and fluctuations in the volume of market activity. While higher volatility can increase risk, it can also increase order flow, which drives many of the Company's businesses. Other market and economic conditions and the size, number and timing of transactions may also affect net income. As a result, revenues and profitability can vary significantly from year to year, and from quarter to quarter. For the years ended December 31, 1995 and 1994 The Company reported net income of $595 million for the year ended December 31, 1995, an increase of 53% from the $388 million reported for the year ended December 31, 1994. Net income in 1994 includes a $21 million after-tax gain from the sale of the Company's interest in HG Asia. This increase is primarily attributable to strong financial markets throughout 1995 compared to 1994. Commission revenues increased by 12% to $2.0 billion in 1995 compared to $1.8 billion in 1994. The increase is a result of gains in listed, over-the-counter, and options activity, offset by declines in futures, mutual fund and insurance activity. Principal trading revenues increased 13% to $1.02 billion in 1995 compared to $900 million in 1994. The increase resulted primarily from improved performance in equities and taxable fixed income, offset by a decline in municipal trading. 13 Investment banking revenues increased 25% to $847 million in 1995 compared to $680 million in 1994. The increase reflects strong volume in equity, high yield, unit trust and high grade corporate debt underwritings, as well as merger and acquisition fees. The Company's market share in a number of categories, particularly equity IPOs, continued to advance during 1995. Asset management fees rose to $1.1 billion in 1995, an increase of 12% from the $941 million reported in 1994. This increase reflects growth in assets under management which increased to a record $96.2 billion in 1995 compared to $78.0 billion in 1994. This increase also reflects fees associated with bringing in-house all the administrative functions for proprietary mutual funds and money funds in the third quarter of 1995. Net interest and dividends revenue increased 15% to $377 million in 1995 compared to $329 million in 1994. This increase is primarily attributable to an increase in net interest-earning assets. Total expenses, excluding interest, increased 7% to $4.4 billion in 1995 compared to $4.1 billion in 1994. This increase is primarily attributable to higher production related compensation and benefit expense reflecting increased revenues of the Company, as well as an increase in depreciation expense driven by the upgrade in systems and infrastructure to support the Company's expanded business activities. These increases were offset, in part, by a decline in communications, occupancy and equipment expense as a result of further consolidation of the Company's executive operations and certain other New York City operations. At December 31, 1995 the number of non-production employees has decreased 6% since the fourth quarter of 1994. Employee compensation and benefit expense as a percentage of net revenues for 1995 declined to 59.0% compared to 62.2% in 1994. LIQUIDITY AND CAPITAL RESOURCES The Company maintains a highly liquid balance sheet, with substantially all of its assets consisting of marketable securities and short-term collateralized receivables arising from securities transactions. The highly liquid nature of these assets provides the Company with flexibility in financing and managing its business. The Company monitors and evaluates the adequacy of its capital and borrowing base on a daily basis in order to allow for flexibility in its funding, to maintain liquidity, and to ensure that its capital base supports the regulatory capital requirements of its subsidiaries. The Company funds its operations through the use of its equity, long-term borrowings, commercial paper, collateralized and uncollateralized borrowings, repurchase transactions and securities lending arrangements. The maturities of borrowings generally correspond to the anticipated holding periods of the assets being financed. At December 31, 1996, there was $1,500 million in committed uncollateralized revolving lines of credit available, none of which was utilized. In addition, the Company has substantial borrowing arrangements consisting of facilities that the Company has been advised are available, but where no contractual lending obligation exists. These arrangements are reviewed on an ongoing basis to ensure flexibility in meeting the Company's short-term requirements. During 1996, the Company increased its long-term funding by issuing on January 30, 1996, $250 million aggregate principal amount of 5 7/8% Notes due 2001. On August 12, 1996, the Company 14 issued $40 million aggregate principal amount of S&P 500 Equity Linked Notes due 2001. On October 10, 1996, the Company issued $200 million aggregate principal amount of 7 1/8 Notes due 2006. On November 18, 1996, the Company issued $200 million aggregate principal amount of 6 5/8 Notes due 2003. As of December 31, 1996, total long-term public debt was $2,369 million, of which $200 million will mature on March 15, 1997. On March 11, 1997, the Company issued $66 million aggregate principal amount of S&P 500 Equity Linked Notes due 2002. On March 13, 1997, the Company issued $250 million aggregate principal amount of 7% Notes due 2004. As of March 21, 1997, the Company had $684 million of debt securities available for issuance under a shelf registration statement filed with the Securities and Exchange Commission. The Company's borrowing relationships are with a broad range of banks, financial institutions and other firms from which it draws funds. The volume of the Company's borrowings generally fluctuates in response to changes in the level of the Company's securities inventories, customer balances, the amount of reverse repurchase transactions outstanding (i.e., purchases of securities under agreements to resell the same security) and securities borrowed transactions. As the Company's activities increase, borrowings generally increase to fund the additional activities. Availability of financing to the Company can vary depending upon market conditions, credit ratings, and the overall availability of credit to the securities industry. The Company seeks to expand and diversify its funding mix as well as its creditor sources. Concentration levels for these sources, particularly for short-term lenders, are closely monitored both in terms of single investor limits and daily maturities. The Company monitors liquidity by tracking asset levels, collateral and funding availability to maintain flexibility to meet its financial commitments. As a policy, the Company attempts to maintain sufficient capital and funding sources in order to have the capacity to finance itself on a fully collateralized basis at all times, including periods of financial stress. In addition, the Company monitors its leverage and capital ratios on a daily basis. The Company's leverage ratio (total assets to equity) at December 31, 1996 and 1995 was 18.6x and 16.6x, respectively. For significant transactions, the Company's credit review process includes an initial evaluation of the counterparty's creditworthiness, with periodic reviews of credit standing, and collateral and various other credit enhancements obtained in certain circumstances. The Company establishes general counterparty credit limits by product type, taking into account the perceived risk associated with the product. Increases to these credit limits are determined individually based on the underlying financial strength and management of the counterparty. The usage and resultant exposure from these credit limits are monitored daily by the Company's Credit Analysis Group. EFFECTS OF INFLATION Because the Company's assets are, to a large extent, liquid in nature, they are not significantly affected by inflation. However, the rate of inflation affects the Company's expenses, such as employee compensation, office space leasing costs and communications charges, which may not be 15 readily recoverable in the price of services transacted by the Company. To the extent inflation results in rising interest rates and has other adverse effects upon the securities markets, it may adversely affect the Company's financial position and results of operations in certain businesses. ASSETS AND LIABILITIES Asset and liability levels are primarily determined by order flow and can fluctuate depending upon economic and market conditions, customer demand and transactional volume. The Company's total assets increased to $51.2 billion at December 31, 1996 from $41.0 billion at December 31, 1995. Securities owned at market value increased due to trading activities, primarily in U.S. Government and agencies obligations. The increase in securities sold not yet purchased, at market value relates to the hedging of market risk and increased financing requirements associated with this increased trading activity. Securities purchased under agreements to resell and securities sold under agreements to repurchase were impacted by higher levels of "matched book" activity. Deposits paid for securities borrowed and deposits received for securities loaned were impacted by higher levels of "conduit" transactions. The Company engages in "matched book" transactions in government and mortgage-backed securities as well as "conduit" transactions in corporate equity and debt securities. These transactions are similar in nature. A "matched book" transaction involves a security purchased under an agreement to resell (i.e., reverse repurchase transaction) and simultaneously sold under an agreement to repurchase (i.e., repurchase transaction). A "conduit" transaction involves the borrowing of a security from a counterparty and the simultaneous lending of the security to another counterparty. These transactions are reported gross in the Consolidated Statement of Financial Condition and typically yield interest spreads ranging from 10 to 30 basis points. The interest spread results from the net of interest received on the reverse repurchase or security borrowed transaction and the interest paid on the corresponding repurchase or security loaned transaction. Interest rates charged or credited in these activities are usually based on current Federal Funds rates but can fluctuate based on security availability and other market conditions. The size of balance sheet positions resulting from these activities can vary significantly, depending primarily on levels of activity in the bond markets, but would not materially impact net income. 16 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. See Index to Consolidated Financial Statements and Schedules on page F-1 hereof. There is also incorporated by reference herein in response to this Item the Company's Consolidated Financial Statements and the notes thereto and the material under the caption "Quarterly Financial Data (Unaudited)" set forth in the Consolidated Financial Statements. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. PART III -------- ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. Pursuant to General Instruction I of Form 10-K, the information required by Item 10 is omitted. ITEM 11. EXECUTIVE COMPENSATION. Pursuant to General Instruction I of Form 10-K, the information required by Item 11 is omitted. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. Pursuant to General Instruction I of Form 10-K, the information required by Item 12 is omitted. Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. Pursuant to General Instruction I of Form 10-K, the information required by Item 13 is omitted. PART IV ------- ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. (a) Documents filed as a part of the report: (1) Financial Statements. See Index to Consolidated Financial Statements 17 and Schedules on page F-1 hereof. (2) Financial Statement Schedules. See Index to Consolidated Financial Statements and Schedules on page F-1 hereof. (3) Exhibits: See Exhibit Index. (b) Reports on Form 8-K: On October 9, 1996, the Company filed a Current Report on Form 8-K dated October 7, 1996, filing certain exhibits under Item 7 thereof relating to the offer and sale of the Company's 7 1/8% Notes due October 1, 2006. On October 15, 1996, the Company filed a Current Report on Form 8-K dated October 14, 1996, reporting under Item 5 thereof the results of its operations for the three and nine months ended September 30, 1996, and certain additional financial information. On November 15, 1996, the Company filed a Current Report on Form 8-K dated November 13, 1996, filing certain exhibits under Item 7 thereof relating to the offer and sale of the Company's 6 5/8% Notes due November 15, 2003. No other reports on Form 8-K have been filed by the Company during the last quarter of the period covered by this report; however, on January 21, 1997, the Company filed a Current Report on Form 8-K, dated January 21, 1997, reporting under Item 5 thereof the results of its operations for the three months and twelve months ended December 31, 1996, and certain additional financial information; on March 7, 1997, the Company filed a Current Report on Form 8-K, dated March 6, 1997, reporting under Item 5 thereof certain additional information regarding legal proceedings involving the Company; on March 7, 1997, the Company filed a Current Report on Form 8-K, dated March 6, 1997, filing certain exhibits under Item 7 thereof relating to the offer and sale of the Company's Smith Barney S&P 500 Equity Linked Notes due March 11, 2002; and on March 12, 1997, the Company filed a Current Report on Form 8-K, dated March 10, 1997, filing certain exhibits under Item 7 thereof relating to the offer and sale of the Company's 7% Notes due March 15, 2004. 18 EXHIBIT INDEX ------------- EXHIBIT FILING NUMBER DESCRIPTION OF EXHIBIT METHOD - ------ ---------------------- ------ 3.01 Restated Certificate of Incorporation of Smith Barney Holdings Inc. (the "Company") and the Certificate of Amendment thereto, effective June 1, 1994, incorporated by reference to Exhibit 3.01 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (File No. 1-12484) (the "Company's 1994 10-K"). 3.02 Restated By-laws of the Company, as amended September 26, 1994, incorporated by reference to Exhibit 3.2 to the Company's 1994 10-K. 10.01.1 Three-Year Competitive Advance and Revolving Credit Facility Agreement (the "Three-Year Competitive Advance and Revolving Credit Facility Agreement") dated as of July 23, 1993, as amended and restated as of May 31, 1994, among the Company, the Lenders named therein, Chemical Bank, Citibank, N.A. and Credit Lyonnais New York Branch as Managing Agents, the banks named therein as Co-Agents and Chemical Bank as Administrative Agent, incorporated by reference to Exhibit 10.02 to the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 1994 (File No. 1-12484) (the "Company's September 30, 1994 10-Q"). 10.01.2 Cumulative Amendment dated as of May 28, 1996 to the Three-Year Competitive Advance and Revolving Credit Facility Agreement, incorporated by reference to Exhibit 10.01 to the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 1996 (File No. 1-12484) (the "Company's September 30, 1996 10-Q"). 10.02 Amended and Restated Lease dated as of December 30, 1994 between State Street Bank and Trust Company of Connecticut, National Association, as Trustee (Lessor), and Smith Barney Inc., Mutual Management Corp., Smith Barney Mutual Funds Management Inc. and The Travelers Inc., as tenants in common (Lessee), incorporated by reference to Exhibit 10.03 to the Company's 1994 10-K. 12.01 Computation of ratio of earnings to fixed charges. Electronic 21.01 Pursuant to General Instruction I of Form 10-K, the list of subsidiaries of the Company is omitted. 19 EXHIBIT FILING NUMBER DESCRIPTION OF EXHIBIT METHOD - ------ ---------------------- ------ 23.01 Consent of Coopers & Lybrand L.L.P. Electronic 24.01 Powers of Attorney of certain directors of the Company. Electronic 27.01 Financial Data Schedule. Electronic 99.01 The third paragraph on page 2 of the Company's Current Electronic Report on Form 8-K dated November 9, 1993, the second paragraph on page 10 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1995 (the "Company's 1995 10-K") and the first paragraph on page 19 of the Company's September 30, 1996 10-Q. 99.02 The second paragraph on page 16 of the Company's Electronic September 30, 1994 10-Q, the fourth paragraph on page 10 of the Company's 1995 10-K and the second paragraph on page 19 of the Company September 30, 1996 10-Q. 99.03 The third paragraph on page 16 of the Company's Electronic September 30, 1994 10-Q and the last paragraph on page 10 of the Company's 1995 10-K. 99.04 The second paragraph on page 2 of the Company's Current Electronic Report on Form 8-K dated August 7, 1996 (filed August 7, 1996). 99.05 The second paragraph on page 2 of the Company's Current Electronic Report on Form 8-K dated March 6, 1997 (filed March 7, 1997). The total amount of securities authorized pursuant to any instrument defining rights of holders of long-term debt of the Company does not exceed 10% of the total assets of the Company and its consolidated subsidiaries. The Company will furnish copies of any such instrument to the Commission upon request. Copies of any of the exhibits referred to above will be furnished at a cost of $.25 per page to security holders who make written request therefor to Smith Barney Holdings Inc., 388 Greenwich Street, New York, New York 10013, Attention: Corporate Secretary. 20 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 26th day of March, 1997. SMITH BARNEY HOLDINGS INC. (Registrant) By: /s/ James Dimon -------------------------------------- James Dimon, Chairman of the Board and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities indicated on the 26th day of March, 1997. SIGNATURE TITLE --------- ----- /s/ James Dimon Chairman of the Board, Chief Executive - ------------------------------ Officer (Principal Executive Officer) and James Dimon Director /s/ Charles w. Scharf Vice President and Chief Financial Officer - ------------------------------ (Principal Financial Officer) Charles W. Scharf /s/ Michael J. Day Vice President and Controller - ------------------------------ (Principal Accounting Officer) Michael J. Day * Director - ------------------------------ Steven D. Black * Director - ------------------------------ James S. Boshart, III 21 SIGNATURE TITLE --------- ----- * Director - ------------------------------ Robert A. Case * Director - ------------------------------ Robert Druskin * Director - ------------------------------ Robert H. Lessin * Director - ------------------------------ William J. Mills, II * Director - ------------------------------ Michael B. Panitch * Director - ------------------------------ Paul Underwood *By: /s/ James Dimon - ------------------------------ James Dimon Attorney-in-fact 22 SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES Report of Independent Accountants F-2 - --------------------------------- Consolidated Financial Statements - --------------------------------- Consolidated Statements of Financial Condition for the years ended December 31, 1996 and 1995 F-3 Consolidated Statements of Operations for the years ended December 31, 1996, 1995 and 1994 F-4 Consolidated Statements of Changes in Stockholder's Equity for the years ended December 31, 1996, 1995 and 1994 F-5 Consolidated Statements of Cash Flows for the years ended December 31, 1996, 1995 and 1994 F-6 - F-7 Notes to Consolidated Financial Statements F-8 - F-24 Schedules - --------- Schedule I - Condensed Financial Information F-25 - F-29 Schedules other than the one listed above are omitted since they are not required or are not applicable or the information is furnished elsewhere in the consolidated financial statements or the notes thereto. F-1 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Stockholder of Smith Barney Holdings Inc. and Subsidiaries: We have audited the consolidated financial statements and the financial statement schedule of Smith Barney Holdings Inc. (a wholly owned subsidiary of Travelers Group Inc.) and Subsidiaries (the Company) listed on the index on Page F-1 of this Form 10-K. These financial statements and the financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and the financial statement schedule 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 financial statements referred to above present fairly, in all material respects, the consolidated financial position of Smith Barney Holdings Inc. and Subsidiaries as of December 31, 1996 and 1995, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1996 in conformity with generally accepted accounting principles. In addition, in our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information required to be included therein. /s/ COOPERS & LYBRAND L.L.P. New York, New York January 15, 1997. F-2 SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (In millions, except share data) December 31, ---------------- ASSETS 1996 1995 ------ ------- ------- Cash and cash equivalents $ 405 $ 612 Cash segregated and on deposit for Federal and other regulations 1,256 1,072 Securities purchased under agreements to resell 16,345 12,087 Deposits paid for securities borrowed 8,935 7,514 Receivable from brokers and dealers 323 510 Receivable from customers 6,981 6,048 Securities owned, at market value 12,465 8,984 Property, equipment and leasehold improvements, at cost, net of accumulated depreciation and amortization of $242 and $168, respectively 438 448 Excess of purchase price over fair value of net assets acquired, net of accumulated amortization of $70 and $61, respectively 278 287 Other assets 3,807 3,397 ------- ------- $51,233 $40,959 ======= ======= LIABILITIES AND STOCKHOLDER'S EQUITY ------------------------------------ Commercial paper and other short-term borrowings $ 3,217 $ 2,955 Securities sold under agreements to repurchase 19,637 17,167 Deposits received for securities loaned 4,034 2,899 Payable to brokers and dealers 221 227 Payable to customers 5,588 4,176 Securities sold not yet purchased, at market value 8,378 4,563 Notes payable 2,379 1,885 Accounts payable and accrued liabilities 4,795 4,389 Subordinated indebtedness 226 224 ------- ------- 48,475 38,485 ------- ------- Stockholder's equity: Common stock ($.10 par value, 1,000 shares authorized; 100 shares issued and outstanding) Additional paid-in capital 1,803 1,803 Retained earnings 951 666 Cumulative translation adjustment 4 5 ------- ------- 2,758 2,474 ------- ------- $51,233 $40,959 ======= ======= The accompanying notes are an integral part of these consolidated financial statements. F-3 SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (In millions) Year ended December 31, ----------------------- 1996 1995 1994 ------ ------ ------ Revenues: Commissions $2,250 $2,008 $1,800 Principal trading 990 1,016 900 Investment banking 1,148 847 680 Asset management fees 1,349 1,052 941 Other 111 108 98 ------ ------ ------ Total non-interest revenues 5,848 5,031 4,419 Interest and dividends 1,926 1,752 1,099 Interest expense 1,507 1,375 770 ------ ------ ------ Net interest and dividends 419 377 329 ------ ------ ------ Net revenues 6,267 5,408 4,748 ------ ------ ------ Expenses, excluding interest: Employee compensation and benefits 3,522 3,193 2,953 Communications, occupancy and equipment 565 572 574 Floor brokerage and other production 147 137 138 Other operating and administrative expenses 579 485 441 ------ ------ ------ Total expenses, excluding interest 4,813 4,387 4,106 ------ ------ ------ Gain on sale of equity investment 34 ------ Income before provision for income taxes 1,454 1,021 676 Provision for income taxes 571 426 288 ------ ------ ------ Net income $ 883 $ 595 $ 388 ====== ====== ====== The accompanying notes are an integral part of these consolidated financial statements. F-4 SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDER'S EQUITY (In millions, except share data)
Additional Cumulative Total Common Paid-in Retained Translation Stockholder's Stock* Capital Earnings Adjustment Equity ------ ---------- -------- ----------- -------------- Balance, December 31, 1993 $1,803 $ 315 $ 2 $ 2,120 Net income 388 388 Dividends (194) (194) Translation adjustment 2 2 ------ ------ ----- --- ------- Balance, December 31, 1994 1,803 509 4 2,316 Net income 595 595 Dividends (438) (438) Translation adjustment 1 1 ------ ------ ----- --- ------- Balance, December 31, 1995 1,803 666 5 2,474 Net income 883 883 Dividends (598) (598) Translation adjustment (1) (1) ------ ------ ----- --- ------- Balance, December 31, 1996 $1,803 $ 951 $ 4 $ 2,758 ====== ====== ===== === =======
* $.10 par value, 1,000 shares authorized; 100 shares issued and outstanding. The accompanying notes are an integral part of these consolidated financial statements. F-5 SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In millions)
Year ended December 31, ----------------------------- 1996 1995 1994 ------- ------- ------- Cash flows from operating activities: Net income $ 883 $ 595 $ 388 Adjustments to reconcile net income to cash provided by (used in) operating activities: Gain on sale of equity investment (34) Depreciation and amortization 188 160 123 Deferred tax (benefit) provision (47) (37) 26 (Increase) decrease in operating assets: Cash segregated and on deposit for Federal and other regulations (184) (256) 98 Securities purchased under agreements to resell (4,258) (3,781) (3,894) Deposits paid for securities borrowed (1,421) 9,835 (6,602) Receivable from brokers and dealers 187 225 328 Receivable from customers (933) 1,454 (398) Securities owned, at market value (3,481) (2,039) (1,082) Other assets (278) (108) (882) Increase (decrease) in operating liabilities: Securities sold under agreements to repurchase 2,470 2,545 9,540 Deposits received for securities loaned 1,135 (4,099) 454 Payable to brokers and dealers (6) (932) (682) Payable to customers 1,412 (2,472) 1,477 Securities sold not yet purchased, at market value 3,815 218 510 Accounts payable and accrued liabilities 497 691 (196) ------- ------- ------- Cash provided by (used in) operating activities (21) 1,999 (826) ------- ------- ------- Cash flows from investing activities: Purchase of property, equipment and leasehold improvements (96) (152) (250) Proceeds from sale of equity investment 55 Other (159) (84) (69) ------- ------- ------- Cash used in investing activities (255) (236) (264) ------- ------- -------
(continued on next page) F-6 SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In millions) (continued)
Year ended December 31, ----------------------------- 1996 1995 1994 ------- ------- ------- Cash flows from financing activities: Proceeds from (repayments of) commercial paper and other short-term borrowings, net $ 262 $(1,419) $ 922 Proceeds from notes payable 690 825 600 Repayments of notes payable (200) (408) (426) Proceeds from subordinated indebtedness 71 109 112 Repayments of subordinated indebtedness (69) (176) (176) Dividends paid to Travelers Group (684) (299) (217) ------- ------- ----- Cash provided by (used in) financing activities 70 (1,368) 815 ------- ------- ----- Effect of exchange rate changes on cash (1) 4 ------- ------- ----- Net change in cash and cash equivalents (207) 395 (271) Cash and cash equivalents, beginning of year 612 217 488 ------- ------- ----- Cash and cash equivalents, end of year $ 405 $ 612 $ 217 ======= ======= ===== Supplemental disclosures of cash flow information: Cash paid during the year for: Interest $ 1,483 $ 1,376 $ 722 ======= ======= ===== Income taxes $ 596 $ 350 $ 278 ======= ======= ===== Dividends declared but not paid $ 100 $ 186 $ 47 ======= ======= =====
The accompanying notes are an integral part of these consolidated financial statements. F-7 SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In millions) 1. Summary of Significant Accounting Policies ------------------------------------------ Basis of Presentation The accompanying consolidated financial statements include the accounts of Smith Barney Holdings Inc., a wholly owned subsidiary of Travelers Group Inc. ("Travelers Group"), and its subsidiaries (the "Company"). The Company's principal operating subsidiary, Smith Barney Inc. ("Smith Barney"), is primarily engaged in the securities industry in the United States and has operations in various foreign countries whose currencies are freely convertible into U.S. dollars. Financial statements pertaining to foreign operations are generally translated at current exchange rates. All material intercompany balances and transactions have been eliminated. Certain reclassifications have been made to prior year amounts to conform to current year presentations. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Accounting Policies Proprietary transactions are recorded in the consolidated statement of financial condition on a trade date basis. Customer transactions are recorded on a settlement date basis. Commissions, underwriting and principal trading revenues and related expenses are recognized in income on trade date, as are unrealized gains and losses on proprietary futures and forward contracts. Securities owned and securities sold not yet purchased are valued at market and the resulting unrealized gains and losses are included in income. Cash equivalents consist of highly liquid investments with a maturity of three months or less when purchased, other than those held for sale in the ordinary course of business. Securities purchased under agreements to resell ("reverse repurchase agreements") and securities sold under agreements to repurchase ("repurchase agreements") are treated as collateralized financing transactions and are recorded at the amount at which the securities will be subsequently resold or reacquired, including accrued interest, as specified in the respective agreements. It is the Company's policy to take possession of securities purchased under agreements to resell. The Company monitors the market value of securities to be repurchased and resold daily, and additional collateral is obtained as necessary to protect against credit exposure. Deposits paid for securities borrowed ("securities borrowed") and deposits received for securities loaned ("securities loaned") are recorded at the amount of cash advanced or received. Securities borrowed transactions require the Company to deposit cash or other collateral with the lender. F-8 SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In millions) 1. Summary of Significant Accounting Policies (Cont'd) --------------------------------------------------- With respect to securities loaned, the Company receives cash collateral in an amount generally in excess of the market value of securities loaned. The Company monitors the market value of securities borrowed and securities loaned daily, and additional collateral is obtained as necessary. The Company has receivables and payables for financial instruments sold to and purchased from broker-dealers. The Company is exposed to risk of loss from the inability of broker-dealers to pay for purchases or to deliver the financial instruments sold, in which case the Company would have to sell or purchase the financial instruments at prevailing market prices. The Company seeks to protect itself from the risks associated with customer activities by requiring customers to maintain margin collateral in compliance with regulatory requirements and its own internal guidelines, which are generally more stringent than regulatory margin requirements. Margin levels are monitored daily and additional collateral must be deposited as required. Where customers cannot meet collateral requirements, the Company will liquidate sufficient underlying financial instruments to bring the account in compliance with the required margin level. Exposure to credit risk is impacted by the markets for financial instruments, which can be volatile and may impair both the ability of clients to satisfy their obligations to the Company, as well as the Company's ability to liquidate any underlying collateral in the event of default. Credit limits are established and closely monitored for customers and broker-dealers engaged in futures, forwards and other transactions deemed to be credit-sensitive. Property, equipment and leasehold improvements are reported at cost, net of accumulated depreciation and amortization. Property includes buildings and related capital improvements which are depreciated on a straight-line basis over estimated useful lives of ten to forty years. Depreciation of furniture and equipment is provided on either a straight-line or accelerated method, over estimated useful lives of three to ten years. Leasehold improvements are amortized over the lesser of the estimated useful life of the asset or the remaining terms of the leases. The excess of the allocated purchase price over the fair value of the Company's net assets, which resulted from the 1988 acquisition by Travelers Group, is being amortized over forty years on a straight-line basis. The Company amortizes other intangible assets on a straight-line basis over their estimated useful lives ranging from four to twenty years. F-9 SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In millions) 1. Summary of Significant Accounting Policies (Cont'd) --------------------------------------------------- Accounting Pronouncements In June 1996, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities ("SFAS 125"). SFAS 125 provides accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities. These standards are based on consistent application of a financial-components approach that focuses on control. Under that approach, after a transfer of financial assets, an entity recognizes the financial and servicing assets it controls and the liabilities it has incurred, derecognizes financial assets when control has been surrendered, and derecognizes liabilities when extinguished. SFAS 125 provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings. This Statement is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after December 31, 1996, and is to be applied prospectively; however, the FASB has issued Statement of Financial Accounting Standards No. 127 which delays until January 1, 1998 the effective date of certain provisions. Earlier or retroactive application is not permitted. The adoption of the provisions of this statement effective January 1, 1997, will not have a material impact on the results of operations, financial condition or liquidity of the Company. The Company is currently evaluating the impact of the provisions whose effective date has been delayed until January 1, 1998. 2. Securities, at Market Value --------------------------- Securities consisted of the following: December 31, ---------------------- 1996 1995 ------- ------ Securities owned - ---------------- U.S. Government and agencies obligations $ 6,564 $4,224 Corporate debt 2,841 2,019 Commercial paper and other short-term debt 958 815 State and municipal obligations 818 698 Corporate convertibles, equities and other securities 1,284 1,228 ------- ------ $12,465 $8,984 ======= ====== Securities sold not yet purchased - --------------------------------- U.S. Government and agencies obligations $ 7,388 $3,493 Corporate debt 348 385 Corporate convertibles, equities and other securities 642 685 ------- ------ $ 8,378 $4,563 ======= ====== F-10 SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In millions) 2. Securities, at Market Value (Cont'd) ------------------------------------ Securities owned and securities sold not yet purchased are recorded at their current market values. Securities sold not yet purchased must be ultimately acquired in the marketplace at the then prevailing prices, which may differ from the values reflected on the consolidated statement of financial condition. 3. Commercial Paper and Other Short-term Borrowings ------------------------------------------------ Commercial paper and other short-term borrowings include commercial paper, and collateralized and uncollateralized borrowings used to finance operations, including the securities settlement process. The collateralized and uncollateralized borrowings bear interest at variable rates based primarily on the Federal Funds interest rate. Smith Barney's commercial paper program consists of both discounted and interest-bearing paper. Commercial paper and other short-term borrowings consisted of the following: December 31, -------------------- 1996 1995 ------ ------ Commercial paper $3,028 $2,401 Uncollateralized borrowings 189 399 Collateralized borrowings 155 ------ ------ $3,217 $2,955 ====== ====== At December 31, 1995 the market value of securities pledged as collateral for borrowings was $171. The weighted average interest rate on the Company's commercial paper and other short-term borrowings was 5.7% at December 31, 1996, and 5.9% at December 31, 1995. In addition to the revolving credit agreements referenced in Note 4, the Company also has substantial borrowing arrangements consisting of facilities that the Company has been advised are available, but where no contractual lending obligation exists. F-11 SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In millions) 4. Notes Payable and Subordinated Indebtedness ------------------------------------------- Notes payable consisted of the following: December 31, 1996 1995 ---- ---- 5 3/8% Notes due 1996 $ 150 7.4% Medium-term Note due 1996 50 6% Notes due 1997 $ 200 200 5 5/8% Notes due 1998 150 150 5 1/2% Notes due 1999 200 200 7 7/8% Notes due 1999 150 150 6 5/8% Notes due 2000 150 150 7.98% Notes due 2000 200 200 7% Notes due 2000 150 150 5 7/8% Notes due 2001 250 S&P 500 Equity Linked Notes due 2001 44 6 1/2% Notes due 2002 150 150 7.50% Notes due 2002 150 150 6 5/8% Notes due 2003 200 6 7/8% Notes due 2005 175 175 7 1/8% Notes due 2006 200 Other 10 10 ------ ------ $2,379 $1,885 ====== ====== The Company has a $1,000 revolving credit agreement with a bank syndicate that extends through May 1999. In addition, the Company has a $500 364-day revolving credit agreement that extends through May 1997. Any amounts outstanding on the 364-day revolving credit agreement's termination date in May 1997 are due in May 1998. The total of these revolving credit agreements of $1,500 was available and undrawn at December 31, 1996. The Company is limited by covenants in these revolving credit facilities as to the amount of dividends that may be paid to Travelers Group. The amount of dividends varies based upon, among other things, levels of net income of the Company. At December 31, 1996, the Company would have been able to remit approximately $659 to Travelers Group under its most restrictive covenants. At December 31, 1996 and 1995, the fair value of notes payable was approximately $2,384 and $1,939, respectively. Fair value of long-term debt was estimated using quoted market prices. Subordinated indebtedness consists of employee deferred compensation plans of $226 and $224 at December 31, 1996 and 1995, respectively. These plans have various maturities, primarily ranging from 1997 to 2001 with interest accrued based on the 30-day Treasury Bill rate. F-12 SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In millions) 4. Notes Payable and Subordinated Indebtedness (Cont'd) ---------------------------------------------------- Notes payable and subordinated indebtedness at December 31, 1996 mature as follows: Principal Year Amount ---- --------- 1997 $ 273 1998 209 1999 375 2000 510 2001 297 Thereafter 941 ------ $2,605 ====== 5. Lease Commitments ----------------- The Company leases certain office facilities and operating equipment under noncancelable and cancelable agreements. At December 31, 1996, future minimum rental commitments under long-term noncancelable lease agreements, expiring in various years to 2012, net of cumulative sublease income of $26, are as follows: Annual Lease Commitments ------------------------ 1997 $146 1998 137 1999 111 2000 51 2001 38 Thereafter 88 ---- $571 ==== Rent expense was $174, $184 and $200 for the years ended December 31, 1996, 1995 and 1994, respectively. The Company, together with certain of its affiliates, leases, with an option to purchase, two buildings in New York City with a remaining lease term of three years. 6. Fair Value of Financial Instruments ----------------------------------- At December 31, 1996, substantially all of the Company's financial instruments are carried at fair value or amounts approximating fair value, except for notes payable for which the fair value was $2,384 and $1,939 at December 31, 1996 and 1995, respectively (book value was $2,379 and $1,885, respectively, see note 4) and the Company's end user interest rate swaps, for which the fair value was $5 and $2 at December 31, 1996 and 1995, respectively (see Note 8). Financial instruments recorded at quoted market value in the Company's consolidated statement of financial condition include securities owned and securities sold not yet purchased. F-13 SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In millions) 6. Fair Value of Financial Instruments (Cont'd) ------------------------------------------- The Company's financial instruments are short-term and carried at amounts which approximate fair value. These instruments include cash and cash equivalents, cash segregated and on deposit for federal and other regulations, reverse repurchase and repurchase agreements, securities borrowed and loaned, receivable from and payable to brokers and dealers and customers, commercial paper and other short-term borrowings, and accounts payable and accrued liabilities. At December 31, 1996 and 1995, the carrying value of subordinated indebtedness also approximates fair value. 7. Trading Activities ------------------ The Company trades both cash and derivative financial instruments. While trading activities are primarily generated by client order flow, the Company also takes proprietary positions in interest rate, foreign exchange, debt, equity and commodity instruments based on expectations of future market movements and conditions. The Company's trading strategies rely on the joint management of its client-driven and proprietary transactions, along with the hedging and financing of these positions. This strategy helps reduce market risk and volatility in principal trading revenues. Detailed information on principal trading revenues by product category follows: 1996 1995 1994 ---- ------ ---- Equities $493 $ 459 $392 Taxable fixed-income 257 305 239 Municipals 189 216 248 Foreign exchange, and other derivative financial instruments 51 36 21 ---- ------ ---- Total principal trading revenues $990 $1,016 $900 ==== ====== ==== The revenue amounts presented include gains and losses from cash instruments and related derivatives, including swaps, forwards, futures and options. Equity revenues include realized and unrealized gains and losses on market-making and trading, primarily in over-the-counter, listed and convertible securities and options. Taxable fixed-income revenues include realized and unrealized gains and losses on market-making and trading, primarily in U.S. Government and agencies obligations, mortgage and asset-backed securities and corporate debt and preferred securities, net of hedges in financial futures, options on financial futures and forward contracts. Municipal revenues include realized and unrealized gains and losses in market-making and trading municipal and tax-exempt securities. Foreign exchange revenues include realized and unrealized gains and losses in currency forward and options contracts. F-14 SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In millions) 7. Trading Activities (Cont'd) --------------------------- Other derivative financial instrument revenues include realized and unrealized gains and losses on swaps, caps, floors, and swaptions, net of related hedges, including financial futures and options, and non-derivative (or cash) financial instruments. 8. Derivative Financial Instruments -------------------------------- Derivative financial instruments traded by the Company include forwards, futures, swaps and options, whose value is based upon an underlying asset, index or reference rate, and generally represent future commitments to exchange currencies or cash flows, or to purchase or sell other financial instruments at specific terms on specified future dates. A derivative contract may be traded on an exchange or over-the-counter ("OTC"). Exchange-traded derivatives are standardized and include futures and certain option contracts. OTC derivative contracts are negotiated between contracting parties and include forwards, swaps and certain options, including interest rate caps, floors and swaptions. Derivative and non-derivative (or cash) financial instruments are subject to similar market and credit risks. The Company uses cash and derivative financial instruments in the normal course of its business primarily to facilitate customer transactions, and to manage exposure from loss due to interest rate, currency and market risk and in its proprietary activities. The risks of derivatives should not be viewed in isolation but rather should be considered on an aggregate basis along with risks related to the Company's non-derivative trading and other activities. Market risk is the potential change in value caused by fluctuations in interest rates, foreign exchange rates, or market prices of an underlying financial instrument or index. Market risk is directly impacted by the volatility and liquidity in the markets in which financial instruments are traded. The Company seeks to control market risk related to trading financial instruments by measuring and monitoring risk limits across trading activities. In many cases, derivative financial instruments are used to hedge other on- and off-balance sheet transactions. Credit risk is the possibility that a loss may occur due to the failure of a counterparty to perform according to the terms of a contract. The Company's exposure to the credit risk associated with counterparty non-performance is limited to the net replacement cost of OTC contracts (including options held) in a gain position. Options written do not give rise to counterparty credit risk since they obligate the Company (not its counterparty) to perform. Exchange-traded financial instruments such as futures and certain options generally do not give rise to significant counterparty exposure due to the margin requirements of the individual exchanges. F-15 SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In millions) 8. Derivative Financial Instruments (Cont'd) ----------------------------------------- For significant transactions, the Company's credit review process includes an initial evaluation of the counterparty's creditworthiness, with periodic reviews of credit standing, and collateral and various other credit enhancements obtained in certain circumstances. The Company establishes general counterparty credit limits by product type, taking into account the perceived risk associated with the product. Increases to these credit limits are determined individually based on the underlying financial strength and management of the counterparty. The usage and resultant exposure from these credit limits are monitored daily by the Company's Credit Analysis Group. The Company's derivative contracts are generally short-term, with a weighted average maturity of approximately 7 1/2 months at December 31, 1996, and 7 months at December 31, 1995. The gross notional or contractual amounts of these derivative financial instruments set forth below do not represent the amounts subject to market risk, but are an indication of the volume of these transactions. In many cases, these financial instruments limit the Company's exposure to losses from market risk by hedging other on- and off-balance sheet transactions. Notional/Contract Amount December 31, 1996 December 31, 1995 ----------------- ----------------- Purchase Sale Purchase Sale -------- ---- -------- ---- Mortgage-backed contracts (TBA) $10,997 $11,490 $6,907 $7,479 Forward contracts: Foreign currency $13,081 $14,174 $6,127 $7,568 Precious metals 359 359 465 465 Interest rate and other 150 297 Futures contracts: Foreign currency $ 1,469 $ 520 $1,458 $ 11 Financial 467 3,110 2,889 493 Commodities 3 11 9 8 Held Written Held Written ---- ------- ---- ------- Options: OTC foreign currency $ 5,849 $ 5,511 $3,266 $3,502 Exchange-traded 1,295 1,128 2,201 62 Interest rate caps, floors and swaptions 2,035 2,571 550 1,197 OTC debt and equity 756 682 210 207 Open Contracts Open Contracts -------------- -------------- Interest rate and other swaps $5,393 $2,305 F-16 SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In millions) 8. Derivative Financial Instruments (Cont'd) ----------------------------------------- Written foreign currency options consist of $2,373 and $3,138 of put and call contracts, respectively, at December 31, 1996 and $1,799 and $1,703 of put and call contracts, respectively, at December 31, 1995. The fair values of these instruments at December 31, 1996 and 1995, which are recorded in the statements of financial condition, and the average fair values for the years, based on month-end balances, were as follows: Average Fair Value Fair Value Year Ended December 31, 1996 December 31, 1996 ----------------- ----------------- Asset Liability Asset Liability ----- --------- ----- --------- Mortgage-backed contracts (TBA) $ 46 $ 25 $ 47 $ 45 Forward contracts: Foreign currency 296 261 321 272 Precious metals 5 4 5 5 Interest rate and other 1 Options: OTC foreign currency 73 75 60 65 Exchange-traded 5 7 10 9 Interest rate caps, floors and swaptions 41 33 26 20 OTC debt and equity 35 29 29 15 Interest rate and other swaps 16 47 19 46 ---- ---- ---- ---- Total $517 $481 $518 $477 ==== ==== ==== ==== Average Fair Value Fair Value Year Ended December 31, 1995 December 31, 1995 ----------------- ----------------- Asset Liability Asset Liability ----- --------- ----- --------- Mortgage-backed contracts (TBA) $ 45 $ 38 $ 40 $ 39 Forward contracts: Foreign currency 156 101 273 242 Precious metals 5 5 12 12 Interest rate and other 7 3 1 Options: OTC foreign currency 39 48 73 74 Exchange-traded 9 6 11 10 Interest rate caps, floors and swaptions 62 39 40 27 OTC debt and equity 66 13 34 13 Interest rate and other swaps 37 90 34 59 ---- ---- ---- ---- Total $426 $340 $520 $477 ==== ==== ==== ==== F-17 SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In millions) 8. Derivative Financial Instruments (Cont'd) ----------------------------------------- The fair values do not include receivables or payables related to exchange-traded futures contracts. Fair values for certain exchange-traded derivatives, principally futures and certain options, are based on quoted market prices. Futures contracts are settled in cash daily and therefore the receivable or payable is limited to one day's price move. The fair value of a derivative contract represents the amount the Company would have to pay a third party to assume its obligations under the contract or the amount a third party would pay to receive the Company's benefits under the contract. The Company's OTC derivative financial instruments, principally forwards, options, and swaps, are generally marked-to-market by pricing models based on the present value of future cash flows, with adjustments, as required, for credit, liquidity and other costs. These adjustments are integral components of the mark to market process. Realized and unrealized gains and losses from derivatives are recognized on a trade date basis in the consolidated statement of operations in principal trading revenues. Following is a discussion of the Company's principal derivatives activities. Mortgage-Backed Securities Contracts -- The Company trades mortgage-backed "to be announced" securities ("TBA") to facilitate customer transactions and to hedge proprietary inventory positions. At December 31, 1996 and 1995, over $9,005 and $5,674, respectively, of purchase and sale contracts represent offsetting purchases and sales of the same security, and substantially all of the total contract values were for settlement within 60 days. Foreign Currency Contracts -- In its role as a market intermediary, the Company acts as a principal in currency forward and options contracts, primarily to facilitate customer transactions. These transactions expose the firm to foreign exchange rate risk, which is generally hedged by entering into foreign currency forward, futures and options contracts with inverse market risk profiles. At December 31, 1996 and 1995, approximately 81% and 83%, respectively, of foreign currency derivative instruments were for settlement within 90 days, and related primarily to major currencies such as the Japanese yen, German mark and British pound. Financial Futures and Options on Futures Contracts -- The Company trades financial futures contracts and options on financial futures, primarily to hedge proprietary inventory positions. Precious Metals Contracts -- Forward precious metals contracts are entered into to facilitate customer transactions. These contracts call for settlement in the London Bullion Market, which is used globally for hedging and trading purposes. The Company may use precious metals futures as hedges of its forward inventory to reduce market risk. F-18 SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In millions) 8. Derivative Financial Instruments (Cont'd) ----------------------------------------- Interest Rate Products -- The Company structures interest rate swaps and writes interest rate caps, floors and swaptions as part of its proprietary trading strategy. These instruments are hedged with derivative financial instruments, including financial futures and options, and non-derivative (or cash) financial instruments. In addition, the Company has entered into an interest rate swap contract as an end user to manage interest rate risk related to certain variable rate obligations. Under this swap, the Company has fixed $475 of its variable rate obligations at an average rate of 5.2%. This swap is accounted for as a hedge of the related liabilities; therefore an unrealized gain on this swap of $5 and $2 at December 31, 1996 and 1995 resepectively, is not recorded in the consolidated financial statements. The difference to be received or paid on the swap is recorded as an adjustment to expense as incurred and any related receivable from or payable to the counterparty is recorded as an asset or liability, accordingly. Option Contracts -- As a writer of option contracts, the Company receives a fee to become obligated to buy or sell financial instruments for a period of time at the holder's option. During this period, the Company bears the risk of an unfavorable change in the market value of the financial instrument underlying the option, but has no credit risk, as the counterparty has no performance obligation to the Company once it has paid its cash premium. 9. Commitments and Contingencies ----------------------------- The Company trades "when-issued" fixed income securities, primarily to facilitate customer transactions and to hedge proprietary inventory positions. At December 31, 1996, the Company had commitments to purchase and sell $281 and $20, respectively, of when-issued fixed income securities. At December 31, 1995, the Company had commitments to purchase and sell $369 and $324, of when-issued fixed income securities. The Company had outstanding commitments to underwrite variable rate municipal securities totaling $346 and $800 at December 31, 1996 and 1995, respectively; conditions of the offerings include bond insurance and liquidity support facilities. The Company had obtained letters of credit aggregating $147 and $119 at December 31, 1996 and 1995, respectively, of which $147 and $112, respectively, were used to satisfy various collateral and deposit requirements principally with clearing organizations. The Company has entered into purchase agreements with various municipal issuers, whereby the Company has purchased securities for forward delivery. These securities have been sold to the public for the same forward delivery dates. The total value of these commitments at December 31, 1996 and 1995, is $438 and $475, respectively. F-19 SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In millions) 9. Commitments and Contingencies (Cont'd) -------------------------------------- At December 31, 1996 and 1995, the Company borrowed securities having a market value of $2,085 and $451, respectively, against which it pledged securities having a market value of $2,132 and $459, respectively. At December 31, 1996 and 1995, the Company had outstanding forward repurchase agreements totaling $725 and $1,200, respectively, and forward reverse repurchase agreements totaling $500 and $625, respectively. These commitments represent forward financing trades with agreed upon interest rates, principal amounts and delivery dates. The Company has provided a residual value guarantee of $586 in connection with the lease of the buildings occupied by the Company's executive offices and New York operations. On July 31, 1993, Smith Barney (then known as Smith Barney, Harris Upham & Co. Incorporated), along with certain of its affiliates and Travelers Group (then known as Primerica Corporation), acquired the domestic retail brokerage and asset management businesses (the "Shearson Acquisition") of Lehman Brothers Holdings Inc. (then known as Shearson Lehman Brothers Holdings Inc.) and its subsidiaries. In conjunction with the Shearson Acquisition, the Company has agreed to pay American Express Company additional amounts contingent upon the Company's future performance, consisting of up to $50 per year for three years based upon the Company's revenues and 10% of the Company's after-tax profits in excess of $250 per year over a five-year period. Amounts paid under this agreement amounted to $110 and $76 in 1996 and 1995, respectively. The contingent consideration will be accounted for prospectively, as additional purchase price, which will result in amortization over periods of up to 20 years. In management's opinion, commitments outstanding will settle without a material adverse effect on the financial position, liquidity or the results of operations of the Company. The Company has been named as a defendant in legal actions relating to its operations, some of which seek damages of material or indeterminate amounts. In addition, from time to time the Company is a party to examinations and inquiries by various regulatory and self-regulatory bodies. In the opinion of management, based on consultation with legal counsel, these matters would not be likely to have a material adverse effect on the results of operations, the financial position or liquidity of the Company. 10. Concentrations of Credit Risk ----------------------------- As a major securities firm, the Company is actively involved in securities underwriting, brokerage, distribution and trading. These and other related services are provided on a worldwide basis to a large and diversified group of clients and customers, including multinational corporations, governments, emerging growth companies, financial institutions and individual investors. F-20 SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In millions) 10. Concentrations of Credit Risk (Cont'd) -------------------------------------- A substantial portion of the Company's securities and commodities transactions are collateralized and executed with and on behalf of commercial banks and other institutional investors, including other brokers and dealers. The Company's exposure to credit risk associated with the non-performance of these customers and counterparties in fulfilling their contractual obligations can be directly impacted by volatile or illiquid trading markets, which may impair the ability of customers and counterparties to satisfy their obligations to the Company. Substantially all of the collateral bonds held by the Company for reverse repurchase agreements and bonds borrowed (included in securities borrowed), which together represented 39% of total assets at December 31, 1996, consisted of securities issued by the U.S. government or federal agencies. The Company's most significant counterparty concentrations are other brokers and dealers, commercial banks, institutional clients and other financial institutions. This concentration arises in the normal course of the Company's business. 11. Income Taxes ------------ Under an income tax allocation agreement with Travelers Group, the Company's federal, state and local income taxes are provided on a separate return basis and are subject to the utilization of tax attributes in Travelers Group's consolidated income tax provision. The following summarizes the provision for income taxes: Year ended December 31, ----------------------- 1996 1995 1994 ----- ----- ---- Current tax provision: Federal $ 507 $ 354 $196 State and local 103 105 65 Foreign 8 4 1 Deferred tax (benefit)/provision: Federal (35) (29) 18 State and local (12) (8) 8 ----- ----- ---- $ 571 $ 426 $288 ===== ===== ==== The net asset for deferred income taxes relates to the following: December 31, -------------- Deferred tax assets: 1996 1995 ----- ----- Compensation and related benefits $ 334 $ 277 Other deferred tax assets 109 105 ----- ----- 443 382 ----- ----- Deferred tax liabilities: Intangible assets (293) (339) Depreciation and related costs (59) (24) Other deferred tax liabilities (36) (11) ----- ----- (388) (374) ----- ----- Net deferred tax asset $ 55 $ 8 ===== ===== F-21 SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In millions) 11. Income Taxes (Cont'd) --------------------- The following is a reconciliation of the income tax provision to the amount computed by applying the federal statutory rate to income before taxes: Year ended December 31, -------------------------------- 1996 1995 1994 ------ ------ ------ Income tax provision computed at federal statutory rate $ 509 $ 357 $ 237 Changes resulting from the tax effect of: Foreign, state and local taxes, net of federal benefit 61 63 47 Other, net 1 6 4 ------ ------ ----- $ 571 $ 426 $ 288 ====== ====== ===== 12. Net Capital Requirements ------------------------ Smith Barney, as a broker-dealer, is subject to the Uniform Net Capital Rule of the Securities and Exchange Commission ("SEC") (Rule 15c3-1). Under the alternative method permitted by this rule, net capital, as defined, shall not be less than 2% of aggregate debit items arising from customer transactions, as defined. At December 31, 1996, net capital of $1,216 exceeded the requirement by $1,060. At December 31, 1995, net capital of $1,139 exceeded the requirement by $1,007. The Robinson-Humphrey Company, Inc. ("RH Co."), a broker-dealer and a wholly owned subsidiary of Smith Barney, is also subject to Rule 15c3-1. Under the basic method permitted by this rule, RH Co., as a block positioner pursuant to Rule 97.30 of the New York Stock Exchange, Inc., is required to maintain net capital of $1. At December 31, 1996, RH Co.'s net capital, as defined, of $79 exceeded the minimum requirement by $78. At December 31, 1995 net capital of $65 exceeded the minimum requirement by $64. Smith Barney Europe, Ltd., a United Kingdom registered broker-dealer and a wholly owned subsidiary of the Company, is subject to capital requirements of the Securities and Futures Authority ("SFA"). Financial resources must exceed the financial resources requirement as defined by the SFA. At December 31, 1996, financial resources of $150 exceeded the minimum requirement by $104. At December 31, 1995, financial resources of $111 exceeded the minimum requirement by $63. Advances, dividend payments and other equity withdrawals from Smith Barney and other regulated subsidiaries are restricted by the regulations of the SEC, New York Stock Exchange and other regulatory agencies. These regulatory restrictions may limit the amounts that these subsidiaries pay as dividends or advances to the Company. F-22 SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In millions) 13. Employee Benefit Plans ---------------------- The Company participates in a noncontributory defined benefit pension plan with Travelers Group that covers substantially all U.S. employees. Separate plans are maintained to cover foreign employees. These plans resulted in expenses of $21, $45 and $41 for the years ended December 31, 1996, 1995 and 1994, respectively. In addition, the Company provides other postretirement and postemployment benefits, primarily related to disability and severance related costs. During 1996, 1995 and 1994, expenses for these benefits totaled $7, $6, and $11, respectively. The Company, through Travelers Group, has a defined contribution employee savings plan covering substantially all U.S. employees. In addition, the Company has various incentive plans under which stock of Travelers Group is purchased for subsequent distribution to employees, subject to vesting requirements. These plans resulted in expenses of $186, $163 and $126 for the years ended December 31, 1996, 1995 and 1994, respectively. The Company participates in a stock option plan sponsored by Travelers Group that provides for the granting of stock options in Travelers Group common stock to officers and key employees. The Company applies Accounting Principles Board Opinion No. 25 ("APB 25") and related interpretations in accounting for stock options. Since stock options are issued at fair market value on the date of award, no compensation cost has been recognized for these awards. In October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation ("SFAS 123"). This statement provides an alternative to APB 25 whereby fair values may be ascribed to options using a valuation model and amortized to compensation cost over the vesting period of the options. Had the Company applied SFAS 123 in accounting for stock options, net income would have been reduced by $14 and $5 in 1996 and 1995, respectively. 14. Related Party Transactions -------------------------- The Company has entered into various related party transactions with Travelers Group. Other than the transactions disclosed in the Financial Statements and elsewhere in the Notes, these amounts are immaterial at December 31, 1996. The Company believes that amounts arising through related party transactions are reasonable and approximate the amounts that would have been incurred if the Company operated as an unaffiliated entity. 15. Other Events ------------ In November 1994, the Company sold a 20% equity investment in HG Asia Holdings Ltd., which was acquired in 1992, for $55, recording an after-tax gain of $21 ($34 pre-tax). F-23 SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In millions) 16. Quarterly Financial Data (unaudited) ------------------------------------ Quarterly results for the year ended December 31, 1996 were as follows: Quarter ended ------------------------------------------------- March 31 June 30 September 30 December 31 -------- ------- ------------ ----------- Non-interest revenues $1,505 $1,501 $1,394 $1,448 Net interest and dividends 95 100 106 118 ------ ------ ------ ------ Net revenues 1,600 1,601 1,500 1,566 Expenses, excluding interest 1,234 1,227 1,159 1,193 ------ ------ ------ ------ Income before provision for income taxes 366 374 341 373 Provision for income taxes 143 145 134 149 ------ ------ ------ ------ Net income $ 223 $ 229 $ 207 $ 224 ====== ====== ====== ====== Quarterly results for the year ended December 31, 1995 were as follows: Quarter ended ------------------------------------------------- March 31 June 30 September 30 December 31 -------- ------- ------------ ----------- Non-interest revenues $1,111 $1,216 $1,330 $1,374 Net interest and dividends 92 97 93 95 ------ ------ ------ ------ Net revenues 1,203 1,313 1,423 1,469 Expenses, excluding interest 1,028 1,083 1,123 1,153 ------ ------ ------ ------ Income before provision for income taxes 175 230 300 316 Provision for income taxes 76 97 123 130 ------ ------ ------ ------ Net income $ 99 $ 133 $ 177 $ 186 ====== ====== ====== ====== F-24 Schedule I SMITH BARNEY HOLDINGS INC. CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONDENSED STATEMENTS OF FINANCIAL CONDITION (Parent Company Only) (In millions, except share data) ASSETS December 31, ------ ---------------- 1996 1995 ------ ------ Investment in subsidiaries, at equity $2,744 $2,539 Receivable from subsidiaries 1,754 1,148 Notes receivable 709 715 Subordinated notes receivable 800 766 Other assets 410 277 ------ ------ $6,417 $5,445 ====== ====== LIABILITIES AND STOCKHOLDER'S EQUITY ------------------------------------ Short-term borrowings $ 97 $ 140 Drafts payable 895 598 Notes payable 2,382 1,891 Accounts payable and accrued liabilities 285 342 ------ ------ 3,659 2,971 ------ ------ Stockholder's equity: Common stock ($.10 par, 1,000 shares authorized; 100 shares issued and outstanding) Additional paid-in capital 1,803 1,803 Retained earnings 951 666 Cumulative translation adjustment 4 5 ------ ------ 2,758 2,474 ------ ------ $6,417 $5,445 ====== ====== The accompanying notes are an integral part of these condensed financial statements. F-25 Schedule I SMITH BARNEY HOLDINGS INC. CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONDENSED STATEMENTS OF OPERATIONS (Parent Company Only) (In millions) Year ended December 31, ----------------------- 1996 1995 1994 ---- ---- ---- Revenues: Interest and dividends $163 $142 $121 Other 5 7 14 ---- ---- ---- Total revenues 168 149 135 Interest expense 143 126 103 ---- ---- ---- Revenues, net of interest expense 25 23 32 ---- ---- ---- Total expenses, excluding interest 4 6 1 ---- ---- ---- Gain on sale of equity investment 34 ---- Income before provision for income taxes and equity in earnings of subsidiaries 21 17 65 Provision for income taxes 8 7 25 ---- ---- ---- Income before equity in earnings of subsidiaries 13 10 40 Equity in earnings of subsidiaries 870 585 348 ---- ---- ---- Net income $883 $595 $388 ==== ==== ==== The accompanying notes are an integral part of these condensed financial statements. F-26 Schedule I SMITH BARNEY HOLDINGS INC. CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONDENSED STATEMENTS OF CASH FLOWS (Parent Company Only) (In millions) Year ended December 31, ----------------------- 1996 1995 1994 ----- ----- ----- Cash flows from operating activities: Net income $ 883 $ 595 $ 388 Adjustments to reconcile net income to cash (used in) provided by operating activities: Equity in earnings of subsidiaries (870) (585) (348) Gain on sale of equity investment (34) Net change in operating assets and liabilities: Receivable from subsidiaries (656) (511) 93 Dividends received from subsidiaries 730 358 218 Other assets (133) (87) (59) Accounts payable and accrued liabilities 36 70 26 ----- ----- ----- Cash (used in) provided by operating activities (10) (160) 284 ----- ----- ----- Cash flows from investing activities: Capital contributions to subsidiaries (20) (66) (35) Payments of notes receivable 15 Issuance of notes receivable (9) (26) (134) Issuance of subordinated notes receivable (34) (84) (200) Proceeds from sale of equity investment 55 ----- ----- ----- Cash used in investing activities (48) (176) (314) ----- ----- ----- Cash flows from financing activities: (Repayments of) proceeds from short-term borrowings, net (43) (257) 212 Proceeds from drafts payable, net 297 476 3 Proceeds from notes payable 690 825 608 Repayments of notes payable (202) (409) (426) Repayments of subordinated indebtedness (150) Dividends paid to Travelers Group (684) (299) (217) ----- ----- ----- Cash provided by financing activities 58 336 30 ----- ----- ----- Change in cash during the year 0 0 0 Cash at beginning of year 0 0 0 ----- ----- ----- Cash at end of year $ 0 $ 0 $ 0 ===== ===== ===== Supplemental disclosure of cash flow information: Dividends declared but not paid $ 100 $ 186 $ 47 ===== ===== ===== The accompanying notes are an integral part of these condensed financial statements. F-27 Schedule I SMITH BARNEY HOLDINGS INC. NOTES TO CONDENSED FINANCIAL INFORMATION OF REGISTRANT (Parent Company Only) (In millions) 1. Basis of presentation --------------------- The condensed financial statements of Smith Barney Holdings Inc. ("SBH"), a wholly owned subsidiary of Travelers Group Inc., should be read in conjunction with the consolidated financial statements of SBH and its subsidiaries. Certain reclassifications have been made to prior year amounts to conform to current year presentations. 2. Notes Payable ------------- Notes payable consisted of the following: December 31, ----------------- 1996 1995 ------ ------ 5 3/8% Notes due 1996 $ 150 7.4% Medium-term Note due 1996 50 6% Notes due 1997 $ 200 200 5 5/8% Notes due 1998 150 150 5 1/2% Notes due 1999 200 200 7 7/8% Notes due 1999 150 150 6 5/8% Notes due 2000 150 150 7.98% Notes due 2000 200 200 7% Notes due 2000 150 150 5 7/8% Notes due 2001 250 S&P 500 Equity Linked Notes due 2001 44 6 1/2% Notes due 2002 150 150 7.50% Notes due 2002 150 150 6 5/8% Notes due 2003 200 6 7/8% Notes due 2005 175 175 7 1/8% Notes due 2006 200 Other 13 16 ------ ------ $2,382 $1,891 ====== ====== SBH has a $1,000 revolving credit agreement with a bank syndicate that extends through May 1999. In addition, SBH has a $500 364-day revolving credit agreement that extends through May 1997. Any amounts outstanding on the 364-day revolving credit agreement's termination date in May 1997 are due in May 1998. The total of these revolving credit agreements of $1,500 was available and undrawn at December 31, 1996. F-28 Schedule I SMITH BARNEY HOLDINGS INC. NOTES TO CONDENSED FINANCIAL INFORMATION OF REGISTRANT (Parent Company Only) (In millions) 2. Notes Payable (Cont'd) ---------------------- Notes payable at December 31, 1996 mature as follows: Principal Year Amount ---- --------- 1997 $ 213 1998 150 1999 350 2000 500 2001 294 Thereafter 875 ------ $2,382 ====== 3. Related Party Transactions -------------------------- SBH engages in various transactions with its subsidiaries that are characteristic of a consolidated group under common control. As a public debt issuer, SBH has access to long-term sources of funds which are loaned from SBH to certain of its subsidiaries. Such intercompany advances are payable on demand and bear interest at varying rates. Dividends and capital distributions declared to SBH by its subsidiaries for the three years ended December 31, 1996, 1995 and 1994 were $681, $486 and $191, respectively. F-29 EXHIBIT INDEX ------------- EXHIBIT FILING NUMBER DESCRIPTION OF EXHIBIT METHOD - ------ ---------------------- ------ 3.01 Restated Certificate of Incorporation of Smith Barney Holdings Inc. (the "Company") and the Certificate of Amendment thereto, effective June 1, 1994, incorporated by reference to Exhibit 3.01 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (File No. 1-12484) (the "Company's 1994 10-K"). 3.02 Restated By-laws of the Company, as amended September 26, 1994, incorporated by reference to Exhibit 3.2 to the Company's 1994 10-K. 10.01.1 Three-Year Competitive Advance and Revolving Credit Facility Agreement (the "Three-Year Competitive Advance and Revolving Credit Facility Agreement") dated as of July 23, 1993, as amended and restated as of May 31, 1994, among the Company, the Lenders named therein, Chemical Bank, Citibank, N.A. and Credit Lyonnais New York Branch as Managing Agents, the banks named therein as Co-Agents and Chemical Bank as Administrative Agent, incorporated by reference to Exhibit 10.02 to the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 1994 (File No. 1-12484) (the "Company's September 30, 1994 10-Q"). 10.01.2 Cumulative Amendment dated as of May 28, 1996 to the Three-Year Competitive Advance and Revolving Credit Facility Agreement, incorporated by reference to Exhibit 10.01 to the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 1996 (File No. 1-12484) (the "Company's September 30, 1996 10-Q"). 10.02 Amended and Restated Lease dated as of December 30, 1994 between State Street Bank and Trust Company of Connecticut, National Association, as Trustee (Lessor), and Smith Barney Inc., Mutual Management Corp., Smith Barney Mutual Funds Management Inc. and The Travelers Inc., as tenants in common (Lessee), incorporated by reference to Exhibit 10.03 to the Company's 1994 10-K. 12.01 Computation of ratio of earnings to fixed charges. Electronic 21.01 Pursuant to General Instruction I of Form 10-K, the list of subsidiaries of the Company is omitted. 23.01 Consent of Coopers & Lybrand L.L.P. Electronic EXHIBIT FILING NUMBER DESCRIPTION OF EXHIBIT METHOD - ------ ---------------------- ------ 24.01 Powers of Attorney of certain directors of the Company. Electronic 27.01 Financial Data Schedule. Electronic 99.01 The third paragraph on page 2 of the Company's Current Electronic Report on Form 8-K dated November 9, 1993, the second paragraph on page 10 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1995 (the "Company's 1995 10-K") and the first paragraph on page 19 of the Company's September 30, 1996 10-Q. 99.02 The second paragraph on page 16 of the Company's Electronic September 30, 1994 10-Q, the fourth paragraph on page 10 of the Company's 1995 10-K and the second paragraph on page 19 of the Company September 30, 1996 10-Q. 99.03 The third paragraph on page 16 of the Company's Electronic September 30, 1994 10-Q and the last paragraph on page 10 of the Company's 1995 10-K. 99.04 The second paragraph on page 2 of the Company's Current Electronic Report on Form 8-K dated August 7, 1996 (filed August 7, 1996). 99.05 The second paragraph on page 2 of the Company's Current Electronic Report on Form 8-K dated March 6, 1997 (filed March 7, 1997). The total amount of securities authorized pursuant to any instrument defining rights of holders of long-term debt of the Company does not exceed 10% of the total assets of the Company and its consolidated subsidiaries. The Company will furnish copies of any such instrument to the Commission upon request. Copies of any of the exhibits referred to above will be furnished at a cost of $.25 per page to security holders who make written request therefor to Smith Barney Holdings Inc., 388 Greenwich Street, New York, New York 10013, Attention: Corporate Secretary. Exhibit 12.01 SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES COMPUTATION IN SUPPORT OF RATIO OF EARNINGS TO FIXED CHARGES (IN MILLIONS, EXCEPT RATIO)
Year Ended December 31, ---------------------------------------------- 1996 1995 1994 1993 1992 ---- ---- ---- ---- ---- Earnings before income taxes and cumulative effect of changes in accounting principles $1,454 $1,021 $ 676 $536 $266 ------ ------ ------ ---- ---- Interest expense 1,507 1,375 770 277 228 Portion of rentals deemed to be interest 58 61 67 42 23 ------ ------ ------ ---- ---- Total fixed charges 1,565 1,436 837 319 251 ------ ------ ------ ---- ---- Earnings before income taxes, cumulative effect of changes in accounting principles and fixed charges $3,019 $2,457 $1,513 $855 $517 ====== ====== ====== ==== ==== Ratio of earnings to fixed charges 1.93 1.71 1.81 2.68 2.06 ====== ====== ====== ==== ====
Exhibit 99.01 Company's Form 8-K November 9, 1993 Page 2 In October 1993, several purported class action lawsuits were filed in the Federal District Court for the Southern District of New York naming Smith Barney, Harris Upham & Co. Incorporated ("SBS") as defendant. The cases arise from SBS's participation as lead or co-underwriter in the initial public offerings of three separate funds managed by Hyperion Capital Management Inc. The plaintiffs have also named as defendants the funds' directors and the co-underwriters and their representatives. Plaintiffs allege that the registration statements and prospectuses by which the offerings were made between June 1992 and October 1992 were materially false and misleading, and are seeking unspecified damages in claims brought under the Federal securities laws. The Company believes it has meritorious defenses to these actions and intends to defend against them vigorously. Company's Form 10-K December 31, 1995 Page 10 For information concerning several purported class action lawsuits filed against SBI in connection with three funds managed by Hyperion Capital Management Inc., see the description that appears in the third paragraph on page 2 of the Company's Current Report on Form 8-K dated November 9, 1993, which description is incorporated by reference herein. A copy of the pertinent paragraph of such filing is included as an exhibit to this Form 10-K. The actions were consolidated under the title In re: Hyperion Securities Litigation. SBI's motion to dismiss the claims was granted in July 1995. In August 1995, an appeal was filed in the U.S. Court of Appeals for the Second Circuit. Company's Form 10-Q September 30, 1996 Page 19 Item 1. Legal Proceedings. For information concerning several class action lawsuits filed against Smith Barney in connection with three funds managed by Hyperion Capital Management Inc., see the descriptions that appear in the third paragraph on page 2 of the Company's Current Report on Form 8-K, dated November 9, 1993, and the second paragraph on page 10 of the Company's Annual Report on Form 10-K for the year ended December 31, 1995, which descriptions are incorporated by reference herein. A copy of the pertinent paragraphs of such filings is included as an exhibit to this Form 10-Q. In October 1996, the U.S. Court of Appeals for the Second Circuit affirmed the district court's dismissal of the claims. Plaintiffs have applied for a rehearing en banc. Exhibit 99.02 Company's Form 10-Q September 30, 1994 Page 16 Item 1. Legal Proceedings. Two purported class actions were filed in October 1994 against Greyhound Bus Lines, Inc. ("Greyhound"), various of its officers and directors and SBI and one of its managing directors, in the United States District Court for the Northern District of Texas. The plaintiffs purport to represent purchasers of senior notes, subordinated covertible debentures and common stock of Greyhound. SBI was lead manager or co-lead manager on the underwritng of certain of these securities. The actions allege, among other things, that the prospectuses and other public statements contained inaccurate statements relating to Greyhound's financial prospects. The plaintiffs are seeking money damages in an unspecified amount. The Company is reviewing the allegations, believes that it has meritorious defenses and intends to vigorously defend against these actions. Company's Form 10-K December 31, 1995 Page 10 For information concerning two purported class actions filed in October 1994 in connection with certain public offering documents of Greyhound Bus Lines, Inc., see the description that appears in the second paragraph of page 16 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1994, which description is incorporated by reference herein. A copy of the pertinent paragraph is included as an exhibit to this Form 10-K. An amended complaint was filed in July 1995, and the defendants filed a motion to dismiss in September 1995. A motion to certify this matter as a class action was filed in January 1996. Company's Form 10-Q September 30, 1996 Page 19 For information concerning two purported class actions filed in October 1994 in connection with certain public offering documents of Greyhound Bus Lines, Inc., see the descriptions that appear in the second paragraph on page 16 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1994 and the fourth paragraph on page 10 of the Company's Annual Report on Form 10-K for the year ended December 31, 1995, which descriptions are incorporated by reference herein. A copy of the pertinent paragraphs of such filings is included as an exhibit to this Form 10-Q. Although the defendants' motion to dismiss was granted in October 1996, plaintiffs subsequently filed a second amended complaint. In addition, in late October 1996, a purported class action was filed against Smith Barney, among others, in the District Court, Dallas County, Texas, entitled Clarkson v. Greyhound Lines, Inc., et al., with allegations similar to those in the federal case referred to above. The Company believes it has meritorious defenses to this action and intends to contest the allegations. Exhibit 99.03 Company's Form 10-Q September 30, 1994 Page 16 In June 1994, several actions relating to trading practices on the National Association of Securities Dealers Automated Quotation system were filed against a number of major broker/dealers, including SBI, in various federal courts. In October 1994, the actions were consolidated in the Federal District Court for the Southern District of New York. The plaintiffs purport to represent a class of purchasers of stock trading in that system over the last four years. The claims generally allege price-fixing violations under the federal antitrust laws and violations of the federal securities laws relating to the use of even-eighth price quotes instead of odd-eighth bid and asked quotes. A consolidated amended complaint is expected to be filed in mid-December 1994. The Company is reviewing these allegations, believes that it has meritorious defenses and intends to vigorously defend against these claims. Company's Form 10-K December 31, 1995 Page 10 For information concerning actions filed against a number of broker-dealers, including SBI, relating to trading practices on the National Association of Securities Dealers Automated Quotation system, see the description that appears in the third paragraph of page 16 of the Company's Quarterly Report on Form l0-Q for the quarter ended September 30, 1994, which description is incorporated by reference herein. A copy of the pertinent paragraph is included as an exhibit to this Form 10-K. A consolidated amended complaint was filed in December 1994. In August l995, the defendants' motion to dismiss was granted with leave to replead, and a consolidated amended complaint was filed. Exhibit 99.04 Company's Form 8-K August 7, 1996 Page 2 In July 1996, a complaint seeking equitable relief was filed in the U.S. District Court for the Southern District of New York by the U.S. Department of Justice, naming twenty-four major brokerage firms, including the Company's subsidiary Smith Barney Inc., as defendants. A proposed settlement has been agreed to by the parties, subject to approval of the court. Pursuant to this settlement, the defendants, without admitting any liability, would agree not to engage in certain practices relating to the quoting of Nasdaq securities and would further agree to implement a program to ensure compliance with federal antitrust laws and with the terms of the settlement. No monetary fines or penalties are imposed as part of the settlement. Exhibit 99.05 Company's Form 8-K March 6, 1997 Page 2 In December 1996, a complaint seeking unspecified monetary damages was filed by Orange County, California against numerous brokerage firms, including Smith Barney Inc., in the U.S. Bankruptcy Court for the Central District of California. Plaintiff alleges, among other things, that defendants recommended and sold to plaintiff unsuitable securities. The Company believes it has meritorious defenses to this action and intends to contest the allegations. The case, entitled County of Orange et al. v. Bear, Stearns & Co. Inc. et al., has been stayed by agreement of the parties. EX-99.04 7 QUARTERLY REPORT ON FORM 10-Q EXHIBIT 99.04 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1997 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO ---- ---- COMMISSION FILE NUMBER 1-12484 SMITH BARNEY HOLDINGS INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 06-1274088 - ------------------------------- ------------------- (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 388 GREENWICH STREET NEW YORK, NEW YORK 10013 - -------------------- ---------- (ADDRESS OF PRINCIPAL (ZIP CODE) EXECUTIVE OFFICES) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (212) 816-6000 INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING REQUIREMENTS FOR THE PAST 90 DAYS. YES X NO --- --- THE REGISTRANT IS A WHOLLY OWNED SUBSIDIARY OF TRAVELERS GROUP INC. AS OF THE DATE HEREOF, 100 SHARES OF THE REGISTRANT'S COMMON STOCK, PAR VALUE $.10 PER SHARE, WERE ISSUED AND OUTSTANDING. REDUCED DISCLOSURE FORMAT THE REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTIONS H 1 (a) AND (b) OF FORM 10-Q AND THEREFORE IS FILING THIS FORM WITH THE REDUCED DISCLOSURE FORMAT CONTEMPLATED THEREBY. SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 1997 TABLE OF CONTENTS
Part I. FINANCIAL INFORMATION Page Number --------------------- ----------- Item 1. Financial Statements: Condensed Consolidated Statements of Operations (Unaudited) - Three and Six Months Ended June 30, 1997 and 1996 1 Condensed Consolidated Statements of Financial Condition - June 30, 1997 (Unaudited) and December 31, 1996 2 Condensed Consolidated Statements of Cash Flows (Unaudited) - Six Months Ended June 30, 1997 and 1996 3 - 4 Notes to Condensed Consolidated Financial Statements (Unaudited) 5 - 10 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 11 - 15 Part II. OTHER INFORMATION ----------------- Item 1. Legal Proceedings 16 Item 6. Exhibits and Reports on Form 8-K 16 - 17 Exhibit Index 18 Signatures 19
SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (IN MILLIONS)
Three months ended Six months ended June 30, June 30, ------------------ ------------------ 1997 1996 1997 1996 ---- ---- ---- ---- Revenues: Commissions $ 576 $ 577 $1,183 $1,182 Principal transactions 250 265 514 543 Investment banking 254 299 518 576 Asset management and administration fees 386 331 762 648 Other 26 29 52 57 ------ ------ ------ ------ Total non-interest revenues 1,492 1,501 3,029 3,006 ------ ------ ------ ------ Interest and dividends 599 463 1,160 908 Interest expense 482 363 926 713 ------ ------ ------ ------ Net interest and dividends 117 100 234 195 ------ ------ ------ ------ Net revenues 1,609 1,601 3,263 3,201 ------ ------ ------ ------ Expenses, excluding interest: Employee compensation and benefits 897 898 1,812 1,811 Communications 72 74 145 148 Occupancy and equipment 66 65 129 130 Floor brokerage and other production 41 35 84 74 Other operating and administrative expenses 145 155 306 298 ------ ------ ------ ------ Total expenses, excluding interest 1,221 1,227 2,476 2,461 ------ ------ ------ ------ Income before provision for income taxes 388 374 787 740 Provision for income taxes 157 145 318 288 ------ ------ ------ ------ Net income $ 231 $ 229 $ 469 $ 452 ====== ====== ====== ======
The accompanying notes are an integral part of these condensed consolidated financial statements. 1 SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (IN MILLIONS, EXCEPT SHARE DATA)
June 30, December 31, ASSETS 1997 1996 ------ ----------- ------------ (Unaudited) Cash and cash equivalents $ 232 $ 405 Cash segregated and on deposit for Federal and other regulations and deposits with clearing organizations 1,421 1,384 Securities purchased under agreements to resell 14,610 16,345 Deposits paid for securities borrowed 13,340 8,935 Receivables: Customers 7,561 6,981 Brokers and dealers 946 323 Other 762 1,698 Securities owned, at market value 14,014 12,465 Property, equipment and leasehold improvements, at cost, net of accumulated depreciation and amortization of $262 and $242, respectively 450 438 Excess of purchase price over fair value of net assets acquired, net of accumulated amortization of $74 and $70, respectively 274 278 Other assets 2,127 1,981 ------- ------- $55,737 $51,233 ======= ======= LIABILITIES AND STOCKHOLDER'S EQUITY ------------------------------------ Commercial paper and other short-term borrowings $ 4,268 $ 3,217 Securities sold under agreements to repurchase 19,479 19,637 Deposits received for securities loaned 6,431 4,034 Payables: Customers 4,784 5,588 Brokers and dealers 258 221 Other 2,779 2,500 Securities sold not yet purchased, at market value 9,640 8,378 Notes payable 2,735 2,379 Accounts payable and accrued liabilities 2,148 2,295 Subordinated indebtedness 224 226 ------- ------- 52,746 48,475 ------- ------- Stockholder's equity: Common stock ($.10 par value, 1,000 shares authorized; 100 shares issued and outstanding) Additional paid-in capital 1,803 1,803 Retained earnings 1,183 951 Cumulative translation adjustment 5 4 ------- ------- 2,991 2,758 ------- ------- $55,737 $51,233 ======= =======
The accompanying notes are an integral part of these condensed consolidated financial statements. 2 SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (IN MILLIONS)
Six months ended June 30, -------------------- 1997 1996 ---- ---- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 469 $ 452 Adjustments to reconcile net income to cash used in operating activities: Depreciation and amortization 102 91 Deferred tax provision 7 2 (Increase) decrease in operating assets: Cash segregated and on deposit for Federal and other regulations and deposits with clearing organizations (37) 22 Securities purchased under agreements to resell 1,735 (374) Deposits paid for securities borrowed (4,405) (1,271) Receivable from customers (580) (721) Receivable from brokers and dealers (623) 64 Securities owned, at market value (1,549) (1,867) Other assets 766 807 Increase (decrease) in operating liabilities: Securities sold under agreements to repurchase (158) 1,254 Deposits received for securities loaned 2,397 273 Payable to customers (804) (830) Payable to brokers and dealers 37 (80) Securities sold not yet purchased, at market value 1,262 1,719 Accounts payable and accrued liabilities 131 (37) ------- ------- Cash used in operating activities (1,250) (496) ------- ------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of property, equipment and leasehold improvements (71) (43) Other (20) (55) ------- ------- Cash used in investing activities (91) (98) ------- -------
(continued on next page) 3 SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (IN MILLIONS) (CONTINUED)
Six months ended June 30, ------------------ 1997 1996 ---- ---- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from commercial paper and other short-term borrowings, net $ 1,051 $ 528 Proceeds from notes payable 541 250 Repayments of notes payable (200) (150) Proceeds from subordinated indebtedness 26 Repayments of subordinated indebtedness (2) (4) Dividends paid (222) (409) ------- ----- Cash provided by financing activities 1,168 241 ------- ----- Net change in cash and cash equivalents (173) (353) Cash and cash equivalents, beginning of period 405 612 ------- ----- Cash and cash equivalents, end of period $ 232 $ 259 ======= ===== SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the period for: Interest $ 896 $ 706 ======= ===== Income taxes $ 276 $ 243 ======= ===== Dividends declared but not paid $ 114 $ 175 ======= =====
The accompanying notes are an integral part of these condensed consolidated financial statements. 4 SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (IN MILLIONS) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ------------------------------------------ BASIS OF PRESENTATION The accompanying condensed consolidated financial statements include the accounts of Smith Barney Holdings Inc. ("SBH") and its subsidiaries (collectively the "Company"). SBH is a wholly owned subsidiary of Travelers Group Inc. The Company's principal operating subsidiary is Smith Barney Inc. ("Smith Barney"). All material intercompany balances and transactions have been eliminated. The interim condensed consolidated financial statements are unaudited; however, in the opinion of management, all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation have been reflected. These interim condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 1996. Certain financial information that is normally included in financial statements prepared in accordance with generally accepted accounting principles but is not required for interim reporting purposes has been condensed or omitted. Certain reclassifications have been made to prior period amounts to conform to current period presentations. ACCOUNTING PRONOUNCEMENTS In June 1996, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities ("FAS 125"). FAS 125 provides accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities. These standards are based on an approach that focuses on control. Under that approach, after a transfer of financial assets, an entity recognizes the financial and servicing assets it controls and the liabilities it has incurred, derecognizes financial assets when control has been surrendered, and derecognizes liabilities when extinguished. FAS 125 provides standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings. This Statement is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after December 31, 1996, and is to be applied prospectively; however, the FASB has issued Statement of Financial Accounting Standards No. 127 which delays until January 1, 1998 the effective date of certain provisions. Earlier or retroactive application is not permitted. The adoption of the provisions of this Statement effective January 1, 1997 did not have a material impact on the results of operations, financial condition or liquidity of the Company. The Company is currently evaluating the impact of the provisions whose effective date has been delayed until January 1, 1998. In June 1997, the FASB issued Statement of Financial Accounting Standards No. 130, Reporting Comprehensive Income and Statement of Financial Accounting Standards No. 131, Disclosure about Segments of an Enterprise and Related Information. The impact of adopting these pronouncements will not be material to the Company. 5 SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (IN MILLIONS) 2. SECURITIES, AT MARKET VALUE --------------------------- Securities consisted of the following:
June 30, December 31, Securities owned 1997 1996 - ---------------- -------- ------------ U.S. Government and agencies obligations $ 7,641 $ 6,564 Corporate debt 2,688 2,841 Commercial paper and other short-term debt 1,164 958 State and municipal obligations 903 818 Corporate convertibles, equities and other securities 1,618 1,284 ------- ------- $14,014 $12,465 ======= =======
June 30, December 31, Securities sold not yet purchased 1997 1996 - --------------------------------- -------- ------------ U.S. Government and agencies obligations $ 8,219 $ 7,388 Corporate convertibles and equities 451 379 Corporate debt and other securities 970 611 ------- ------- $ 9,640 $ 8,378 ======= =======
3. COMMERCIAL PAPER AND OTHER SHORT-TERM BORROWINGS ------------------------------------------------ Commercial paper and other short-term borrowings include commercial paper and bank loans and other borrowings used to finance operations, including the securities settlement process. The bank loans and other borrowings bear interest at variable rates based primarily on the Federal Funds interest rate. SBH and Smith Barney have commercial paper programs that consist of both discounted and interest-bearing paper. Commercial paper and other short-term borrowings consisted of the following:
June 30, December 31, 1997 1996 -------- ------------ Commercial paper $ 4,116 $ 3,028 Bank loans and other borrowings 152 189 ------- ------- $ 4,268 $ 3,217 ======= =======
In addition to the revolving credit agreements referenced in Note 4, the Company has substantial borrowing arrangements consisting of facilities that the Company has been advised are available, but where no contractual lending obligation exists. 6 SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (IN MILLIONS) 4. NOTES PAYABLE AND SUBORDINATED INDEBTEDNESS ------------------------------------------- Notes payable consisted of the following:
June 30, December 31, 1997 1996 -------- ------------ 6% Notes due 1997 $ 200 5 5/8% Notes due 1998 $ 150 150 5 1/2% Notes due 1999 200 200 6.98% Notes due 1999 25 7 7/8% Notes due 1999 150 150 6 5/8% Notes due 2000 150 150 7.98% Notes due 2000 200 200 7% Notes due 2000 150 150 5 7/8% Notes due 2001 250 250 S&P 500 Equity Linked Notes due 2001 53 44 S&P 500 Equity Linked Notes due 2002 72 6 1/2% Notes due 2002 150 150 7.50% Notes due 2002 150 150 6 5/8% Notes due 2003 200 200 7% Notes due 2004 250 6 7/8% Notes due 2005 175 175 7 1/8% Notes due 2006 200 200 7 3/8% Notes due 2007 200 Other 10 10 ------ ------ $2,735 $2,379 ====== ======
The Company has a $1,250 revolving credit agreement with a bank syndicate that extends through May 2000. The Company also has a $750 364-day revolving credit agreement that extends through May 1998. As of June 30, 1997, there were no borrowings outstanding under either of these agreements. Subordinated indebtedness consists of deferred compensation of $224 and $226 at June 30, 1997 and December 31, 1996, respectively. These deferred compensation plans have various maturities, primarily ranging from 1997 to 2000, with interest accrued based on the 30-day Treasury Bill rate. The Company is limited as to the amount of dividends that may be paid to Travelers Group Inc. The amount of dividends varies based upon, among other things, levels of net income of the Company. At June 30, 1997, the Company would have been able to remit approximately $779 to Travelers Group Inc. under its most restrictive covenants. 5. DERIVATIVE FINANCIAL INSTRUMENTS -------------------------------- Derivative financial instruments traded by the Company include forwards, futures, swaps and options, whose value is based upon an underlying asset, index or reference rate, and generally represent future commitments to exchange currencies or cash flows, or to purchase or sell other financial instruments at specific terms on specified future dates. A derivative contract may be traded on an exchange or over-the-counter ("OTC"). Exchange-traded derivatives are standardized and include futures and interest rate, equity and currency option contracts. OTC derivative contracts are negotiated between contracting parties and include forwards, swaps and certain options, including interest rate caps, floors and swaptions. 7 SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (IN MILLIONS) 5. DERIVATIVE FINANCIAL INSTRUMENTS (CONT'D) ----------------------------------------- Derivative and non-derivative (or cash) financial instruments are subject to similar market and credit risks. The Company uses cash and derivative financial instruments in the normal course of its business primarily to facilitate customer transactions, and to manage exposure from loss due to interest rate, currency and market risk and in its proprietary activities. The risks of derivatives should not be viewed in isolation but rather should be considered on an aggregate basis along with risks related to the Company's non-derivative trading and other activities. The Company's derivative contracts are generally short-term, with a weighted average maturity of approximately 9 months at June 30, 1997, and 7 1/2 months at December 31, 1996. The gross notional or contractual amounts of these derivative financial instruments set forth below do not represent the amounts subject to market risk, but are an indication of the volume of these transactions. In many cases, these financial instruments limit the Company's exposure to losses from market risk by hedging other on and off-balance sheet transactions.
Notional/Contract Amount June 30, 1997 December 31, 1996 ------------- ----------------- Purchase Sale Purchase Sale -------- ---- -------- ---- Mortgage-backed contracts (TBA) $11,271 $12,058 $10,997 $11,490 Forward contracts: Foreign currency $18,114 $17,561 $13,081 $14,174 Precious metals 456 457 359 359 Interest rate and other 805 150 Futures contracts: Foreign currency $ 421 $ 1,291 $ 1,469 $ 520 Financial 841 2,701 467 3,110 Commodities 3 3 11
Held Written Held Written ---- ------- ---- ------- Options: OTC foreign currency $15,784 $15,685 $ 5,849 $ 5,511 Exchange-traded, interest rate 2,966 856 1,230 1,058 Exchange-traded, other 663 622 65 70 Interest rate caps, floors and swaptions 3,601 5,570 2,035 2,571 OTC debt and equity 1,090 1,409 756 682
Open Contracts Open Contracts -------------- -------------- Interest rate swaps $ 8,942 $ 5,393
8 SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (IN MILLIONS) 5. DERIVATIVE FINANCIAL INSTRUMENTS (CONT'D) ----------------------------------------- At June 30, 1997 and December 31, 1996, approximately $9,484 and $9,005, respectively, of TBA purchase and sale contracts represented offsetting purchases and sales of the same security, and substantially all of the total contract values were for settlement within 60 days. In its role as a market intermediary, the Company acts as a principal in foreign currency forward and options contracts. These transactions expose the firm to foreign exchange rate risk, which is generally hedged by entering into foreign currency forward, futures and options contracts with inverse market risk profiles. Written OTC foreign currency options consist of $7,041 and $8,644 of put and call contracts, respectively, at June 30, 1997 and $2,373 and $3,138 of put and call contracts, respectively, at December 31, 1996. The Company's foreign currency forward, futures and options contracts are generally short-term, with a weighted average maturity of approximately 80 days at June 30, 1997 and December 31, 1996. The Company's exposure to credit risk associated with counterparty non-performance is limited to the net replacement cost of over-the-counter contracts (including options held) in a gain position. Options written do not give rise to counterparty credit risk since they obligate the Company (not its counterparty) to perform. Exchange-traded financial instruments such as futures and options on futures generally do not give rise to significant counterparty exposure due to the margin requirements of the individual exchanges. 6. COMMITMENTS AND CONTINGENCIES ----------------------------- At June 30, 1997 and December 31, 1996, respectively, the Company borrowed securities having a market value of $773 and $2,085, against which it pledged securities having a market value of $792 and $2,132. The Company has entered into purchase agreements with various municipal issuers, whereby the Company has purchased securities for forward delivery. These securities have been sold to the public for the same forward delivery dates. The total value of these commitments at June 30, 1997 and December 31, 1996 was $564 and $438, respectively. At June 30, 1997 and December 31, 1996, the Company had outstanding forward repurchase agreements totaling $500 and $725, respectively, and forward reverse repurchase agreements totaling $275 and $500, respectively. These commitments represent forward financing transactions with agreed upon interest rates, principal amounts and delivery dates. In the opinion of management, commitments outstanding will settle without a material adverse effect on the financial position, liquidity or the results of operations of the Company. The Company has been named as a defendant in legal actions relating to its operations, some of which seek damages of material or indeterminate amounts. In addition, from time to time the Company is a party to examinations and inquiries by various regulatory and self-regulatory bodies. In the opinion of management, based on consultation with legal counsel, these matters would not be likely to have a material adverse effect on the results of operations, financial position or liquidity of the Company. 9 SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (IN MILLIONS) 7. CONCENTRATIONS OF CREDIT RISK ----------------------------- A substantial portion of the Company's securities and commodities transactions is collateralized and executed with and on behalf of commercial banks and other institutional investors, including other brokers and dealers. The Company's exposure to credit risk associated with the non-performance of these customers and counterparties in fulfilling their contractual obligations can be directly impacted by volatile or illiquid trading markets, which may impair the ability of customers and counterparties to satisfy their obligations to the Company. Substantially all of the collateral held by the Company for reverse repurchase agreements and bonds borrowed (included in securities borrowed), which together represented 35% of total assets at June 30, 1997, consisted of securities issued by the U.S. Government or federal agencies. The Company's most significant counterparty concentrations are other brokers and dealers, commercial banks and institutional clients and other financial institutions. This concentration arises in the normal course of the Company's business. 8. NET CAPITAL REQUIREMENTS ------------------------ Smith Barney, as a broker-dealer, is subject to the Uniform Net Capital Rule of the Securities and Exchange Commission (Rule 15c3-1). Under the alternative method permitted by this rule, net capital, as defined, shall not be less than 2% of aggregate debit items arising from customer transactions, as defined. At June 27, 1997, Smith Barney's net capital of $1,300 was 15% of aggregate debit items and exceeded the minimum requirement by $1,122. The Robinson-Humphrey Company, Inc. ("RH Co."), a broker-dealer and a wholly owned subsidiary of Smith Barney, is also subject to Rule 15c3-1. Under the basic method permitted by this rule, RH Co., as a block positioner pursuant to Rule 97.30 of the New York Stock Exchange, Inc., is required to maintain net capital of $1. At June 27, 1997, RH Co.'s net capital, as defined, of $77 exceeded the minimum requirement by $76. Smith Barney Europe, Ltd. ("Smith Barney Europe"), a United Kingdom registered broker-dealer and a wholly owned subsidiary of SBH, is subject to capital requirements of the Securities and Futures Authority ("SFA "). Financial resources must exceed the financial resources requirement as defined by the SFA. At June 27, 1997, Smith Barney Europe's financial resources of $127 exceeded the minimum requirement by $91. 10 SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 1997 AND 1996 Despite a difficult trading and underwriting environment in April, the Company reported earnings of $231 million for the three months ended June 30, 1997 (the "1997 Quarter") up slightly from the $229 million reported for the three months ended June 30, 1996 (the "1996 Quarter") and less than 3% below the record 1997 first quarter. Return on equity was 31.5% in the 1997 Quarter, compared to 36.6% in the 1996 Quarter. Pre-tax profit margin increased to 24.1% in the 1997 Quarter from 23.4% in the 1996 Quarter. Revenues, net of interest expense, increased to $1,609 million in the 1997 Quarter from $1,601 million in the 1996 Quarter. Annualized retail gross production per Financial Consultant declined 3% to $358,000 in the 1997 Quarter, from $369,000 in the 1996 Quarter. The Company reported net income of $469 million for the six months ended June 30, 1997 (the "1997 Period"), an increase of 4% from the $452 million reported for the six months ended June 30, 1996 (the "1996 Period"). Return on equity was 32.6% in the 1997 Period compared to 36.3% in the 1996 Period. Pre-tax profit margin increased to 24.1% in the 1997 Period compared to 23.1% in the 1996 Period. Revenues, net of interest expense, increased 2% to $3,263 million in the 1997 Period compared to $3,201 million in the 1996 Period. Annualized retail gross production per Financial Consultant increased 2% to $375,000 in the 1997 Period, from $366,000 in the 1996 Period. Commission revenues were $576 million in the 1997 Quarter, compared to $577 million in the 1996 Quarter, as declines in mutual funds and over-the-counter securities commissions were offset by an increase in listed securities commissions. Commission revenues were $1,183 million in the 1997 Period compared to $1,182 in the 1996 Period. Commission revenues were composed of the following:
Three Six Months Ended Months Ended June 30, June 30, ---------------- ------------------ (in millions) 1997 1996 1997 1996 - ------------- ---- ---- ---- ---- Listed & over-the-counter $402 $400 $ 830 $ 818 Mutual funds 92 99 193 206 Other 82 78 160 158 ---- ---- ------ ------ Total commission revenues $576 $577 $1,183 $1,182 ==== ==== ====== ======
11 SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Principal transactions revenues were $250 million in the 1997 Quarter, down 6% from the $265 million reported in the 1996 Quarter. This decrease is a result of a decline in equity and municipal trading, offset to an extent by an increase in taxable fixed income trading. Overall, principal transactions revenues decreased 5% to $514 million in the 1997 Period compared to $543 million in the 1996 Period. This decrease is a result of a decline in equity and taxable fixed income trading. Principal transactions revenues were composed of the following:
Three Six Months Ended Months Ended June 30, June 30, ---------------- ---------------- (in millions) 1997 1996 1997 1996 - ------------- ---- ---- ---- ---- Equities $107 $135 $228 $268 Taxable fixed income 73 64 149 157 Municipals 50 54 96 95 Foreign exchange, derivative and other financial instruments 20 12 41 23 ---- ---- ---- ---- Total principal transactions revenues $250 $265 $514 $543 ==== ==== ==== ====
Investment banking revenues were $254 million in the 1997 Quarter, down 15% from $299 million in the 1996 Quarter, primarily due to a decline in equity underwriting revenues. Investment banking revenues declined 10% to $518 million in the 1997 Period compared to $576 million in the 1996 Period. Also contributing to the decline in the 1997 Period was a decrease in merger and acquistion advisory activity. Asset management and administration fees rose to a record $386 million in the 1997 Quarter, an increase of 17% from the $331 million reported in the 1996 Quarter. This increase reflects broad growth in all recurring fee-based products, led by a 25% increase in managed accounts, a 19% increase in Consulting Group revenues and a 10% increase in money market and mutual fund revenues. At June 30, 1997, internally managed assets reached a record $124.3 billion, and total fee-based assets under management were a record $177.4 billion compared to $103.8 billion and $143.5 billion, respectively, at June 30, 1996. Asset management fees increased 18% to $762 million in the 1997 Period compared to $648 million in the 1996 Period. Asset management and administration fees were composed of the following:
Three Six Months Ended Months Ended June 30, June 30, ---------------- ---------------- (in millions) 1997 1996 1997 1996 - ------------- ---- ---- ---- ---- Money market and mutual funds $155 $142 $309 $282 Managed accounts 97 78 189 149 Consulting Group externally managed assets 134 111 264 217 ---- ---- ---- ---- Total asset management and administration fees $386 $331 $762 $648 ==== ==== ==== ====
12 SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Total assets under fee-based management were composed of the following:
As of June 30, --------------------- (in billions) 1997 1996 - ------------- ------ ------ Money market funds $ 43.8 $ 38.5 Mutual funds 37.7 33.1 Managed accounts 33.0 25.5 Financial Consultant managed accounts 9.8 6.7 ------- ------- Total internally managed assets 124.3 103.8 ------- ------- Consulting Group externally managed assets 53.1 39.7 ------- ------- Total fee-based assets under management $ 177.4 $ 143.5 ======= =======
Net interest and dividends increased 17% to $117 million in the 1997 Quarter from $100 million in the 1996 Quarter, primarily due to increased margin lending to clients and higher levels of interest-earning net assets. Net interest and dividends increased 20% to $234 million in the 1997 Period compared to $195 million in the 1996 Period. Total expenses, excluding interest, decreased slightly to $1,221 million in the 1997 Quarter from $1,227 million in the 1996 Quarter. Employee compensation and benefits expense, as a percentage of net revenues, in the 1997 Quarter declined to 55.7% from 56.1% in the 1996 Quarter and the ratio of non-compensation expenses to net revenues was 20.1% in the 1997 Quarter compared to 20.6% in the 1996 Quarter. The Company continues to maintain its focus on controlling fixed expenses. Total expenses, excluding interest, were $2,476 million in the 1997 Period compared to $2,461 million in the 1996 Period. Employee compensation and benefits expense as a percentage of net revenues in the 1997 Period declined to 55.5% compared to 56.6% in the 1996 Period and the ratio of non-compensation expenses to net revenues stood at 20.3% in each of the 1997 and 1996 Periods. The Company's business is significantly affected by the levels of activity in the securities markets. Many factors have an impact on securities markets, including the level and trend of interest rates, the general state of the economy and the national and worldwide political environments. An increasing interest rate environment could have an adverse impact on the Company's businesses, including commissions (which are linked in part to the economic attractiveness of securities relative to time deposits) and investment banking (which is affected by the relative benefit to corporations and other entities of issuing debt and/or equity versus other avenues for raising capital). Such effects, however, could be at least partially offset by a strengthening U.S. economy that would include growth in the business sector -- accompanied by an increase in the demand for capital -- and an increase in the capacity of individuals to invest. A decline in interest rates could favorably impact the Company's businesses. The Company's asset management business provides a more predictable and steady income stream than its other businesses. The Company continues to maintain tight expense controls that management believes will help the firm weather periodic downturns in market conditions. 13 SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The Company's principal business activities are, by their nature, highly competitive and subject to various risks, particularly volatile trading markets and fluctuations in the volume of market activity. While higher volatility can increase risk, it can also increase order flow, which drives many of the Company's businesses. Other market and economic conditions and the size, number and timing of transactions, may also affect net income. As a result, revenues and profitability can vary significantly from year to year, and from quarter to quarter. LIQUIDITY AND CAPITAL RESOURCES The Company maintains a highly liquid balance sheet, with substantially all of its assets consisting of marketable securities and short-term collateralized receivables arising from securities transactions. The highly liquid nature of these assets provides the Company with flexibility in financing and managing its business. The Company monitors and evaluates the adequacy of its capital and borrowing base on a daily basis in order to allow for flexibility in its funding, to maintain liquidity and to ensure that its capital base supports the regulatory capital requirements of its subsidiaries. The Company funds its operations through the use of its equity, medium and long-term borrowings, commercial paper, collateralized and uncollateralized borrowings (through both committed and uncommitted facilities), internally generated funds, repurchase transactions and securities lending arrangements. The maturities of borrowings generally correspond to the anticipated holding periods of the assets being financed. At June 30, 1997, there was $2 billion in committed uncollateralized revolving lines of credit available, none of which was utilized. In addition, the Company has substantial borrowing arrangements consisting of facilities that the Company has been advised are available, but where no contractual lending obligation exists. These arrangements are reviewed on an ongoing basis to ensure flexibility in meeting the Company's short-term requirements. As of June 30, 1997, total long-term public debt was $2,700 million, compared to total long-term public debt of $2,369 million at December 31, 1996. On July 9, 1997, the Company issued $250 million aggregate principal amount of 6 5/8% Notes due July 1, 2002. As of August 11, 1997, the Company had $750 million available for issuance under a shelf registration statement filed with the Securities and Exchange Commission. The Company's borrowing relationships are with a broad range of banks, financial institutions and other firms from which it draws funds. The volume of the Company's borrowings generally fluctuates in response to changes in the level of the Company's securities inventories, customer balances, the amount of reverse repurchase transactions outstanding (i.e., purchases of securities under agreements to resell the same security) and securities borrowed transactions. As the Company's activities increase, borrowings generally increase to fund the additional activities. Availability of financing to the Company can vary depending upon market conditions, credit ratings, and the overall availability of credit to the securities industry. The Company seeks to expand and diversify its funding mix as well as its creditor sources. Concentration levels for these sources, particularly for short-term lenders, are closely monitored in terms of both single investor limits and daily maturities. 14 SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The Company monitors liquidity by tracking asset levels, collateral and funding availability to maintain flexibility to meet its financial commitments. As a policy, the Company attempts to maintain sufficient capital and funding sources in order to have the capacity to finance itself on a fully collateralized basis at all times, including periods of financial stress. In addition, the Company monitors its leverage and capital ratios on a daily basis. The Company's leverage ratio (total assets to equity) at June 30, 1997 and December 31, 1996 was 18.6x. For significant transactions, the Company's credit review process includes an initial evaluation of the counterparty's creditworthiness, with periodic reviews of credit standing, and collateral and various other credit enhancements obtained in certain circumstances. The Company establishes general counterparty credit limits by product type, taking into account the perceived risk associated with the product. Increases to these credit limits are determined individually based on the underlying financial strength and management of the counterparty. The usage and resultant exposure from these credit limits are monitored daily by the Company's Credit Analysis Group. ASSETS AND LIABILITIES Asset and liability levels are primarily determined by order flow and can fluctuate depending upon economic and market conditions, customer demand and transactional volume. The Company's total assets increased to $55.7 billion at June 30, 1997 from $51.2 billion at December 31, 1996. Securities owned at market value increased due to trading activities, primarily in U.S. Government and agency obligations. The increase in securities sold not yet purchased, at market value relates to the hedging of market risk and increased financing requirements associated with this increased trading activity. Deposits paid for securities borrowed and deposits received for securities loaned were impacted by higher levels of "conduit" transactions, as well as increased business volume related to the revision of the securities borrowing provisions of Federal Reserve Board Regulation T. The Company engages in "matched book" transactions in government and mortgage-backed securities as well as "conduit" transactions in corporate equity and debt securities. These transactions are similar in nature. A "matched book" transaction involves a security purchased under an agreement to resell (i.e., reverse repurchase transaction) and simultaneously sold under an agreement to repurchase (i.e., repurchase transaction). A "conduit" transaction involves the borrowing of a security from a counterparty and the simultaneous lending of the security to another counterparty. These transactions are reported gross in the Condensed Consolidated Statement of Financial Position and typically yield interest spreads ranging from 10 to 30 basis points. The interest spread results from the net of interest received on the reverse repurchase or security borrowed transaction and the interest paid on the corresponding repurchase or security loaned transaction. Interest rates charged or credited in these activities are usually based on current Federal Funds rates but can fluctuate based on security availability and other market conditions. The size of balance sheet positions resulting from these activities can vary significantly, depending primarily on levels of activity in the bond markets, but would not materially impact net income. 15 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS. For information concerning several purported class action lawsuits filed against Smith Barney Inc. in connection with three funds managed by Hyperion Capital Management Inc., see the descriptions that appear in the third paragraph on page 2 of the Company's Current Report on Form 8-K dated November 9, 1993, the second paragraph on page 10 of the Company's Annual Report on Form 10-K for the year ended December 31, 1995, the first paragraph on page 19 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996, the fourth full paragraph on page 10 of the Company's Annual Report on Form 10-K for the year ended December 31, 1996 and the first paragraph on page 18 of the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1997, which descriptions are incorporated by reference herein. A copy of the pertinent paragraphs of such filings is included as an exhibit to this Form 10-Q. In June 1997, the U.S. Supreme Court denied plaintiffs' petition for certiorari. For information concerning two purported class actions filed in October 1994 and one purported class action filed in October 1996 in connection with certain public offering documents of Greyhound Bus Lines, Inc., see the descriptions that appear in the second paragraph on page 16 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1994, the fourth paragraph on page 10 of the Company's Annual Report on Form 10-K for the year ended December 31, 1995, the second paragraph on page 19 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996 and the fifth full paragraph on page 10 of the Company's Annual Report on Form 10-K for the year ended December 31, 1996, which descriptions are incorporated by reference herein. A copy of the pertinent paragraphs of such filings is included as an exhibit to this Form 10-Q. In April 1997, the Company's plea and abatement in Clarkson v. Greyhound Lines, Inc., et al. was denied. For information concerning a complaint seeking equitable relief that was filed by the U.S. Department of Justice, naming 24 major brokerage firms, including Smith Barney Inc., see the description that appears in the second paragraph on page 2 of the Company's Current Report on Form 8-K, dated August 7, 1996 (filed August 7, 1996), which description is incorporated by reference herein. A copy of the pertinent paragraph of such filing is included as an exhibit to this Form 10-Q. In April 1997, the U.S. District Court for the Southern District of New York approved the settlement previously agreed to by the parties. In May 1997, plaintiffs in the related civil action challenged certain provisions of the settlement. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits: See Exhibit Index. (b) Reports on Form 8-K: On May 16, 1997, the Company filed a Current Report on Form 8-K, dated May 14, 1997, filing certain exhibits under Item 7 thereof relating to the offer and sale of the Company's 7 3/8% Notes due May 15, 2007. 16 No other reports on Form 8-K have been filed by the Company during the quarter ended June 30, 1997; however the following reports on Form 8-K have been filed by the Company subsequent to the quarter ended June 30, 1997: On July 11, 1997, the Company filed a Current Report on Form 8-K, dated July 9, 1997, filing certain exhibits under Item 7 thereof relating to the offer and sale of the Company's 6 5/8% Notes due July 1, 2002. On July 15, 1997, the Company filed a Current Report on Form 8-K, dated July 15, 1997, reporting under Item 5 thereof the results of its operations for the three months and six months ended June 30, 1997, and certain additional financial information. On July 25, 1997, the Company filed a Current Report on Form 8-K, dated July 24, 1997, filing certain exhibits under Item 7 thereof relating to commencement of the program for the Company's Medium-Term Notes, Third Series, Due Nine Months or More from Date of Issue. 17 EXHIBIT INDEX EXHIBIT FILING NUMBER DESCRIPTION OF EXHIBIT METHOD - ------- ---------------------- ------ 3.01 Restated Certificate of Incorporation of Smith Barney Holdings Inc. (the "Company") and the Certificate of Amendment thereto, effective June 1, 1994, incorporated by reference to Exhibit 3.01 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (File No. 1-12484) (the "Company's 1994 10-K"). 3.02 Restated By-Laws of the Company, as amended September 26, 1994, incorporated by reference to Exhibit 3.02 to the Company's 1994 10-K. 12.01 Computation of Ratio of Earnings to Fixed Charges. Electronic 27.01 Financial Data Schedule. Electronic 99.01 The third paragraph on page 2 of the Company's Current Electronic Report on Form 8-K dated November 9, 1993, the second paragraph on page 10 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1995 (the "Company's 1995 10-K"), the first paragraph on page 19 of the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 1996, the fourth full paragraph on page 10 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1996 (the "Company's 1996 10-K") and the first paragraph on page 18 of the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended March 31,1997. 99.02 The second paragraph on page 16 of the Company's Electronic Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 1994, the fourth paragraph on page 10 of the Company's 1995 10-K the second paragraph on page 19 of the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 1996 and the fifth full paragraph on page 10 of the Company's 1996 10-K. 99.03 The second paragraph on page 2 of the Company's Current Electronic Report on Form 8-K, dated August 7, 1996 (filed August 7, 1996). The total amount of securities authorized pursuant to any instrument defining rights of holders of long-term debt of the Company does not exceed 10% of the total assets of the Company and its consolidated subsidiaries. The Company will furnish copies of any such instrument to the Commission upon request. 18 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. SMITH BARNEY HOLDINGS INC. -------------------------- (Registrant) Date: August 12, 1997 By: /s/ Charles W. Scharf ------------------------------------------ Charles W. Scharf Vice President and Chief Financial Officer By: /s/ Michael J. Day ------------------------------------------ Michael J. Day Vice President and Controller 19 EXHIBIT INDEX EXHIBIT FILING NUMBER DESCRIPTION OF EXHIBIT METHOD - ------- ---------------------- ------ 3.01 Restated Certificate of Incorporation of Smith Barney Holdings Inc. (the "Company") and the Certificate of Amendment thereto, effective June 1, 1994, incorporated by reference to Exhibit 3.01 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (File No. 1-12484) (the "Company's 1994 10-K"). 3.02 Restated By-Laws of the Company, as amended September 26, 1994, incorporated by reference to Exhibit 3.02 to the Company's 1994 10-K. 12.01 Computation of Ratio of Earnings to Fixed Charges. Electronic 27.01 Financial Data Schedule. Electronic 99.01 The third paragraph on page 2 of the Company's Current Electronic Report on Form 8-K dated November 9, 1993, the second paragraph on page 10 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1995 (the "Company's 1995 10-K"), the first paragraph on page 19 of the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 1996, the fourth full paragraph on page 10 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1996 (the "Company's 1996 10-K") and the first paragraph on page 18 of the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended March 31,1997. 99.02 The second paragraph on page 16 of the Company's Electronic Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 1994, the fourth paragraph on page 10 of the Company's 1995 10-K the second paragraph on page 19 of the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 1996 and the fifth full paragraph on page 10 of the Company's 1996 10-K. 99.03 The second paragraph on page 2 of the Company's Current Electronic Report on Form 8-K, dated August 7, 1996 (filed August 7, 1996). The total amount of securities authorized pursuant to any instrument defining rights of holders of long-term debt of the Company does not exceed 10% of the total assets of the Company and its consolidated subsidiaries. The Company will furnish copies of any such instrument to the Commission upon request. EXHIBIT 12.01 SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES (IN MILLIONS, EXCEPT RATIO)
Six months ended June 30, ------------------ 1997 1996 ---- ---- Earnings before income taxes $ 787 $ 740 ------ ------ Interest expense 926 713 Portion of rentals deemed to be interest 28 29 ------ ------ Total fixed charges 954 742 ------ ------ Earnings before income taxes and fixed charges $1,741 $1,482 ====== ====== Ratio of earnings to fixed charges 1.82x 2.00x ====== ======
Exhibit 99.01 Company's Form 8-K November 9, 1993 Page 2 In October 1993, several purported class action lawsuits were filed in the Federal District Court for the Southern District of New York naming Smith Barney, Harris Upham & Co. Incorporated ("SBS") as defendant. The cases arise from SBS's participation as lead or co-underwriter in the initial public offerings of three separate funds managed by Hyperion Capital Management Inc. The plaintiffs have also named as defendants the funds' directors and the co-underwriters and their representatives. Plaintiffs allege that the registration statements and prospectuses by which the offerings were made between June 1992 and October 1992 were materially false and misleading, and are seeking unspecified damages in claims brought under the Federal securities laws. The Company believes it has meritorious defenses to these actions and intends to defend against them vigorously. Company's Form 10-K December 31, 1995 Page 10 For information concerning several purported class action lawsuits filed against SBI in connection with three funds managed by Hyperion Capital Management Inc., see the description that appears in the third paragraph on page 2 of the Company's Current Report on Form 8-K dated November 9, 1993, which description is incorporated by reference herein. A copy of the pertinent paragraph of such filing is included as an exhibit to this Form 10-K. The actions were consolidated under the title In re: Hyperion Securities Litigation. SBI's motion to dismiss the claims was granted in July 1995. In August 1995, an appeal was filed in the U.S. Court of Appeals for the Second Circuit. Company's Form 10-Q September 30, 1996 Page 19 For information concerning several class action lawsuits filed against Smith Barney in connection with three funds managed by Hyperion Capital Management Inc., see the descriptions that appear in the third paragraph on page 2 of the Company's Current Report on Form 8-K, dated November 9, 1993, and the second paragraph on page 10 of the Company's Annual Report on Form 10-K for the year ended December 31, 1995, which descriptions are incorporated by reference herein. A copy of the pertinent paragraphs of such filings is included as an exhibit to this Form 10-Q. In October 1996, the U.S. Court of Appeals for the Second Circuit affirmed the district court's dismissal of the claims. Plaintiffs have applied for a rehearing en banc. Company's Form 10-K December 31, 1996 Page 10 For information concerning several purported class action lawsuits filed against SBI in connection with three funds managed by Hyperion Capital Management Inc., see the description that appears in the third paragraph on page 2 of the Company's Current Report on Form 8-K dated November 9, 1993, the second paragraph on page 10 of the Company's Annual Report on Form 10-K for the year ended December 31, 1995 and the first paragraph on page 19 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996, which descriptions are incorporated by reference herein. A copy of the pertinent paragraphs of such filings is included as an exhibit to this Form 10-K. Plaintiffs' petition for a rehearing en banc was denied in January 1997. Company's Form 10-Q March 31, 1997 Page 18 ITEM 1. LEGAL PROCEEDINGS. For information concerning several purported class action lawsuits filed against Smith Barney Inc. in connection with three funds managed by Hyperion Capital Management Inc., see the descriptions that appear in the third paragraph on page 2 of the Company's Current Report on Form 8-K dated November 9, 1993, the second paragraph on page 10 of the Company's Annual Report on Form 10-K for the year ended December 31, 1995, the first paragraph on page 19 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996 and the fourth full paragraph on page 10 of the Company's Annual Report on Form 10-K for the year ended December 31, 1996, which descriptions are incorporated by reference herein. A copy of the pertinent paragraphs of such filings is included as an exhibit to this Form 10-Q. In March 1997, plaintiffs filed a petition for certiorari with the U.S. Supreme Court. Exhibit 99.02 Company's Form 10-Q September 30, 1994 Page 16 Item 1. Legal Proceedings. Two purported class actions were filed in October 1994 against Greyhound Bus Lines, Inc. ("Greyhound"), various of its officers and directors and SBI and one of its managing directors, in the United States District Court for the Northern District of Texas. The plaintiffs purport to represent purchasers of senior notes, subordinated convertible debentures and common stock of Greyhound. SBI was lead manager or co-lead manager on the underwriting of certain of these securities. The actions allege, among other things, that the prospectuses and other public statements contained inaccurate statements relating to Greyhound's financial prospects. The plaintiffs are seeking money damages in an unspecified amount. The Company is reviewing the allegations, believes that it has meritorious defenses and intends to vigorously defend against these actions. Company's Form 10-K December 31, 1995 Page 10 For information concerning two purported class actions filed in October 1994 in connection with certain public offering documents of Greyhound Bus Lines, Inc., see the description that appears in the second paragraph of page 16 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1994, which description is incorporated by reference herein. A copy of the pertinent paragraph is included as an exhibit to this Form 10-K. An amended complaint was filed in July 1995, and the defendants filed a motion to dismiss in September 1995. A motion to certify this matter as a class action was filed in January 1996. Company's Form 10-Q September 30, 1996 Page 19 For information concerning two purported class actions filed in October 1994 in connection with certain public offering documents of Greyhound Bus Lines, Inc., see the descriptions that appear in the second paragraph on page 16 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1994 and the fourth paragraph on page 10 of the Company's Annual Report on Form 10-K for the year ended December 31, 1995, which descriptions are incorporated by reference herein. A copy of the pertinent paragraphs of such filings is included as an exhibit to this Form 10-Q. Although the defendants' motion to dismiss was granted in October 1996, plaintiffs subsequently filed a second amended complaint. In addition, in late October 1996, a purported class action was filed against Smith Barney, among others, in the District Court, Dallas County, Texas, entitled Clarkson v. Greyhound Lines, Inc., et al., with allegations similar to those in the federal case referred to above. The Company believes it has meritorious defenses to this action and intends to contest the allegations. Company's Form 10-K December 31, 1996 Page 10 For information concerning two purported class actions filed in October 1994 and one purported class action filed in October 1996 in connection with certain public offering documents of Greyhound Bus Lines, Inc., see the descriptions that appear in the second paragraph on page 16 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1994, the fourth paragraph on page 10 of the Company's Annual Report on Form 10-K for the year ended December 31, 1995 and the second paragraph on page 19 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996, which descriptions are incorporated by reference herein. A copy of the pertinent paragraphs of such filings is included as an exhibit to this Form 10-K. In December 1996, the Company filed a plea and abatement in Clarkson v. Greyhound Lines, Inc., et al. Exhibit 99.03 Company's Form 8-K August 7, 1996 Page 2 In July 1996, a complaint seeking equitable relief was filed in the U.S. District Court for the Southern District of New York by the U.S. Department of Justice, naming twenty-four major brokerage firms, including the Company's subsidiary Smith Barney Inc., as defendants. A proposed settlement has been agreed to by the parties, subject to approval of the court. Pursuant to this settlement, the defendants, without admitting any liability, would agree not to engage in certain practices relating to the quoting of Nasdaq securities and would further agree to implement a program to ensure compliance with federal antitrust laws and with the terms of the settlement. No monetary fines or penalties are imposed as part of the settlement. EX-99.05 8 TRAVELERS PRO FORMA FINANCIALS EXHIBIT 99.05 UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS The following unaudited pro forma condensed combined statement of financial condition combines the historical consolidated statement of financial condition of Travelers and the historical consolidated statement of financial condition of Salomon giving effect to the Merger as though it had been consummated on June 30, 1997. The following unaudited pro forma condensed combined statements of income combine the historical statements of income of Travelers and Salomon giving effect to the Merger. This information should be read in conjunction with the accompanying notes hereto; the separate historical financial statements of Travelers as of June 30, 1997 and for the six months ended June 30, 1997 and 1996, and for each of the three years ended December 31, 1996 which are contained in Travelers' Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1997 and its Annual Report on Form 10-K for the fiscal year ended December 31, 1996, respectively; and the separate historical financial statements of Salomon as of June 30, 1997 and for the six months ended June 30, 1997 and 1996, and for each of the three years ended December 31, 1996 which are contained in Salomon's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1997 and its Annual Report on Form 10-K for the fiscal year ended December 31, 1996, respectively. The pro forma financial data is not necessarily indicative of the results of operations that would have occurred had the Merger been consummated or of future operations of the combined company. TRAVELERS GROUP INC. AND SUBSIDIARIES UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF FINANCIAL POSITION AS OF JUNE 30, 1997 (in millions of dollars)
TRAVELERS SALOMON PRO FORMA PRO FORMA HISTORICAL HISTORICAL ADJUSTMENTS COMBINED ------------ ------------ ------------- ----------- ASSETS Cash and cash equivalents ........................................ $ 1,739 $ 2,081 $ $ 3,820 Investments and real estate held for sale: Fixed maturities, primarily available for sale at market value . 45,981 45,981 Equity securities, at market value............................... 1,377 1,377 Mortgage loans................................................... 3,748 3,748 Real estate held for sale........................................ 502 502 Policy loans..................................................... 1,873 1,873 Short-term and other............................................. 5,135 5,135 ------------ ------------ ------------- ----------- Total investments and real estate held for sale................. 58,616 -- -- 58,616 ------------ ------------ ------------- ----------- Securities borrowed or purchased under agreements to resell ...... 27,950 91,320 119,270 Brokerage receivables............................................. 8,507 6,014 14,521 Trading securities owned, at market value......................... 14,014 132,848 146,862 Commodities and related products and instruments.................. 1,533 1,533 Net consumer finance receivables.................................. 8,834 8,834 Reinsurance recoverables.......................................... 9,876 9,876 Value of insurance in force and deferred policy acquisition costs 2,698 2,698 Cost of acquired businesses in excess of net assets............... 2,991 2,991 Separate and variable accounts.................................... 9,830 9,830 Other receivables................................................. 5,108 624 5,732 Other assets...................................................... 9,443 1,533 10,976 ------------ ------------ ------------- ----------- Total assets...................................................... $159,606 $235,953 $ -- $395,559 ============ ============ ============= =========== LIABILITIES Investment banking and brokerage borrowings....................... $ 4,268 $ 8,036 $ $ 12,304 Short-term borrowings............................................. 2,812 2,812 Long-term debt.................................................... 11,122 16,080 27,202 Securities loaned or sold under agreements to repurchase ......... 26,889 108,814 135,703 Brokerage payables................................................ 5,042 7,269 12,311 Trading securities sold not yet purchased, at market value ....... 9,640 87,058 96,698 Contractholder funds.............................................. 14,601 14,601 Insurance policy and claims reserves.............................. 43,940 43,940 Separate and variable accounts.................................... 9,818 9,818 Accounts payable and other liabilities............................ 15,196 2,843 18,039 ------------ ------------ ------------- ----------- Total liabilities............................................... 143,328 230,100 -- 373,428 ------------ ------------ ------------- ----------- ESOP Preferred stock--Series C.................................... 140 140 Redeemable preferred stock........................................ 420 420 Mandatorily redeemable preferred securities of subsidiary trusts 1,900 345 2,245 STOCKHOLDERS' EQUITY Preferred stock................................................... 1,075 450 1,525 Common stock...................................................... 7 159 (158) 8 Additional paid-in capital........................................ 7,561 438 (1,089) 6,910 Retained earnings................................................. 8,524 5,811 (2,807) 11,528 Treasury stock, at cost........................................... (2,958) (1,769) 4,054 (673) Unrealized gain on investment securities.......................... 436 436 Other............................................................. (407) (1) (408) ------------ ------------ ------------- ----------- Total stockholders' equity...................................... 14,238 5,088 -- 19,326 ------------ ------------ ------------- ----------- Total liabilities and stockholders' equity........................ $159,606 $235,953 $ -- $395,559 ============ ============ ============= ===========
See accompanying Notes to Unaudited Pro Forma Condensed Combined Financial Statements TRAVELERS GROUP INC. AND SUBSIDIARIES UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF INCOME FOR THE SIX MONTHS ENDED JUNE 30, 1997 (in millions of dollars, except per share amounts)
TRAVELERS SALOMON PRO FORMA HISTORICAL HISTORICAL COMBINED ------------ ------------ ----------- REVENUES: Insurance premiums............................................ $ 4,444 $ $ 4,444 Commissions and fees.......................................... 1,718 640 2,358 Interest and dividends........................................ 3,206 3,045 6,251 Finance related interest and other charges.................... 627 627 Principal transactions........................................ 514 927 1,441 Asset management and administration fees...................... 762 29 791 Other income.................................................. 630 630 ------------ ------------ ----------- Total revenues.............................................. 11,901 4,641 16,542 ------------ ------------ ----------- EXPENSES: Policyholder benefits and claims.............................. 3,811 3,811 Non-insurance compensation and benefits....................... 1,950 1,111 3,061 Insurance underwriting, acquisition and operating ............ 1,604 1,604 Interest...................................................... 1,349 2,527 3,876 Provision for consumer finance credit losses.................. 145 145 Other operating............................................... 876 374 1,250 ------------ ------------ ----------- Total expenses.............................................. 9,735 4,012 13,747 ------------ ------------ ----------- Income before income taxes and minority interest.............. 2,166 629 2,795 Provision for income taxes.................................... 763 236 999 Minority interest, net of income taxes........................ 98 98 ------------ ------------ ----------- Income from continuing operations............................. $ 1,305 $ 393 $ 1,698 ============ ============ =========== INCOME PER SHARE OF COMMON STOCK AND COMMON STOCK EQUIVALENTS: Continuing operations......................................... $ 1.96 $ 3.34 $ 2.12 ============ ============ =========== Weighted average common shares outstanding and common stock equivalents (millions)....................................... 645.7 108.8 768.6 ============ ============ ===========
See accompanying Notes to Unaudited Pro Forma Condensed Combined Financial Statements TRAVELERS GROUP INC. AND SUBSIDIARIES UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF INCOME FOR THE SIX MONTHS ENDED JUNE 30, 1996 (in millions of dollars, except per share amounts)
TRAVELERS SALOMON PRO FORMA HISTORICAL HISTORICAL COMBINED ------------ ------------ ----------- REVENUES: Insurance premiums............................................ $3,316 $ $ 3,316 Commissions and fees.......................................... 1,766 597 2,363 Interest and dividends........................................ 2,543 3,008 5,551 Finance related interest and other charges.................... 571 571 Principal transactions........................................ 543 1,235 1,778 Asset management and administration fees...................... 648 22 670 Other income.................................................. 554 554 ------------ ------------ ----------- Total revenues.............................................. 9,941 4,862 14,803 ------------ ------------ ----------- EXPENSES: Policyholder benefits and claims.............................. 3,590 3,590 Non-insurance compensation and benefits....................... 1,930 1,096 3,026 Insurance underwriting, acquisition and operating ............ 1,367 1,367 Interest...................................................... 1,060 2,401 3,461 Provision for consumer finance credit losses.................. 128 128 Other operating............................................... 850 352 1,202 ------------ ------------ ----------- Total expenses.............................................. 8,925 3,849 12,774 ------------ ------------ ----------- Gain on sale of subsidiaries and affiliates................... 397 397 ------------ ------------ ----------- Income before income taxes and minority interest.............. 1,413 1,013 2,426 Provision for income taxes.................................... 361 405 766 Minority interest, net of income taxes........................ (44) (44) ------------ ------------ ----------- Income from continuing operations............................. $1,096 $ 608 $ 1,704 ============ ============ =========== INCOME PER SHARE OF COMMON STOCK AND COMMON STOCK EQUIVALENTS: Continuing operations......................................... $ 1.65 $ 5.41 $ 2.15 ============ ============ =========== Weighted average common shares outstanding and common stock equivalents (millions)....................................... 636.1 106.0 755.9 ============ ============ ===========
See accompanying Notes to Unaudited Pro Forma Condensed Combined Financial Statements TRAVELERS GROUP INC. AND SUBSIDIARIES UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF INCOME FOR THE YEAR ENDED DECEMBER 31, 1996 (in millions of dollars, except per share amounts)
TRAVELERS SALOMON PRO FORMA HISTORICAL HISTORICAL COMBINED ------------ ------------ ----------- REVENUES: Insurance premiums............................................ $ 7,633 $ $ 7,633 Commissions and fees.......................................... 3,422 1,179 4,601 Interest and dividends........................................ 5,549 5,748 11,297 Finance related interest and other charges.................... 1,163 1,163 Principal transactions........................................ 990 1,990 2,980 Asset management and administration fees...................... 1,349 48 1,397 Other income.................................................. 1,239 81 1,320 ------------ ------------ ----------- Total revenues................................................ 21,345 9,046 30,391 ------------ ------------ ----------- EXPENSES: Policyholder benefits and claims.............................. 7,366 7,366 Non-insurance compensation and benefits....................... 3,768 2,039 5,807 Insurance underwriting, acquisition and operating ............ 3,013 3,013 Interest...................................................... 2,259 4,679 6,938 Provision for consumer finance credit losses.................. 260 260 Other operating............................................... 1,678 718 2,396 ------------ ------------ ----------- Total expenses................................................ 18,344 7,436 25,780 ------------ ------------ ----------- Gain on sale of subsidiaries and affiliates................... 397 397 ------------ ------------ ----------- Income before income taxes and minority interest.............. 3,398 1,610 5,008 Provision for income taxes.................................... 1,051 628 1,679 Minority interest, net of income taxes........................ 47 47 ------------ ------------ ----------- Income from continuing operations............................. $ 2,300 $ 982 $ 3,282 ============ ============ =========== INCOME PER SHARE OF COMMON STOCK AND COMMON STOCK EQUIVALENTS: Continuing operations......................................... $ 3.45 $ 8.59 $ 4.11 ============ ============ =========== Weighted average common shares outstanding and common stock equivalents (millions)....................................... 638.8 106.4 759.0 ============ ============ ===========
See accompanying Notes to Unaudited Pro Forma Condensed Combined Financial Statements TRAVELERS GROUP INC. AND SUBSIDIARIES UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF INCOME FOR THE YEAR ENDED DECEMBER 31, 1995 (in millions of dollars, except per share amounts)
TRAVELERS SALOMON PRO FORMA HISTORICAL HISTORICAL COMBINED ------------ ------------ ----------- REVENUES: Insurance premiums............................................ $ 4,977 $ $ 4,977 Commissions and fees.......................................... 2,874 804 3,678 Interest and dividends........................................ 4,355 7,021 11,376 Finance related interest and other charges ................... 1,119 1,119 Principal transactions........................................ 1,016 1,077 2,093 Asset management and administration fees ..................... 1,052 39 1,091 Other income.................................................. 1,190 12 1,202 ------------ ------------ ----------- Total revenues.............................................. 16,583 8,953 25,536 ------------ ------------ ----------- EXPENSES: Policyholder benefits and claims ............................. 5,017 5,017 Non-insurance compensation and benefits....................... 3,442 1,710 5,152 Insurance underwriting, acquisition and operating ............ 1,912 1,912 Interest...................................................... 1,956 5,754 7,710 Provision for consumer finance credit losses.................. 171 171 Other operating............................................... 1,544 690 2,234 ------------ ------------ ----------- Total expenses.............................................. 14,042 8,154 22,196 ------------ ------------ ----------- Loss on sale of subsidiaries and affiliates................... (20) (20) ------------ ------------ ----------- Income before income taxes.................................... 2,521 799 3,320 Provision for income taxes.................................... 893 286 1,179 ------------ ------------ ----------- Income from continuing operations............................. $ 1,628 $ 513 $ 2,141 ============ ============ =========== INCOME PER SHARE OF COMMON STOCK AND COMMON STOCK EQUIVALENTS: Continuing operations......................................... $ 2.43 $ 4.17 $ 2.63 ============ ============ =========== Weighted average common shares outstanding and common stock equivalents (millions)....................................... 634.8 106.5 755.1 ============ ============ ===========
See accompanying Notes to Unaudited Pro Forma Condensed Combined Financial Statements TRAVELERS GROUP INC. AND SUBSIDIARIES UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF INCOME FOR THE YEAR ENDED DECEMBER 31, 1994 (in millions of dollars, except per share amounts)
TRAVELERS SALOMON PRO FORMA HISTORICAL HISTORICAL COMBINED ------------ ------------ ----------- REVENUES: Insurance premiums......................................... $ 5,144 $ $ 5,144 Commissions and fees....................................... 2,526 822 3,348 Interest and dividends..................................... 3,401 5,902 9,303 Finance related interest and other charges................. 1,030 1,030 Principal transactions..................................... 900 (560) 340 Asset management and administration fees................... 1,010 23 1,033 Other income............................................... 932 7 939 ------------ ------------ ----------- Total revenues........................................... 14,943 6,194 21,137 ------------ ------------ ----------- EXPENSES: Policyholder benefits and claims........................... 5,227 5,227 Non-insurance compensation and benefits.................... 3,241 1,455 4,696 Insurance underwriting, acquisition and operating ......... 1,867 1,867 Interest................................................... 1,284 4,873 6,157 Provision for consumer finance credit losses............... 152 152 Other operating............................................ 1,524 715 2,239 ------------ ------------ ----------- Total expenses........................................... 13,295 7,043 20,338 ------------ ------------ ----------- Gain on sale of subsidiaries and affiliates................ 226 226 ------------ ------------ ----------- Income (loss) before income taxes.......................... 1,874 (849) 1,025 Provision for income taxes................................. 717 (439) 278 ------------ ------------ ----------- Income (loss) from continuing operations................... $ 1,157 $ (410) $ 747 ============ ============ =========== INCOME (LOSS) PER SHARE OF COMMON STOCK AND COMMON STOCK EQUIVALENTS: Continuing operations...................................... $ 1.67 $(4.41) $ 0.79 ============ ============ =========== Weighted average common shares outstanding and common stock equivalents (millions).............................. 644.0 106.8 764.7 ============ ============ ===========
See accompanying Notes to Unaudited Pro Forma Condensed Combined Financial Statements NOTES TO UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS 1. DESCRIPTION OF TRANSACTION AND BASIS OF PRESENTATION The Merger Agreement provides that each share of Salomon Common Stock will be exchanged for 1.13 shares of Travelers Common Stock. The Merger, which is expected to be completed in the fourth quarter of 1997, is expected to be accounted for under the pooling of interests method and, accordingly, Travelers historical consolidated financial statements presented in future reports will be restated to include the accounts and results of Salomon. The Merger is subject to customary closing conditions, including regulatory and Salomon stockholder approval. 2. ACCOUNTING POLICIES Travelers and Salomon are in the process of reviewing their accounting policies and, as a result of this review, it may be necessary to restate either Travelers' or Salomon's financial statements to conform to those accounting policies that are determined to be most appropriate. No such restatements have been made to the pro forma combined financial statements. 3. INTERCOMPANY TRANSACTIONS Transactions between Travelers and Salomon are not material in relation to the pro forma combined financial statements and therefore intercompany balances have not been eliminated from the pro forma combined amounts. 4. PRO FORMA ADJUSTMENTS The pro forma adjustments to common stock, paid-in capital, retained earnings and treasury stock at June 30, 1997 reflect (1) the retirement of shares of Salomon Common Stock held in treasury pursuant to the Merger Agreement, (2) adjustments to account for 70 million shares of Travelers Common Stock held in treasury to be issued in the transaction as though retired, in accordance with APB No. 16, and (3) the issuance of 121.4 million shares of Travelers Common Stock to effect the Merger. The number of shares to be issued at consummation of the Merger will be based on the actual number of shares of Salomon Common Stock outstanding at that time. 5. PRO FORMA EARNINGS PER SHARE The pro forma combined primary earnings per share for the respective periods presented is based on the combined weighted average number of common shares and share equivalents of Travelers and Salomon. The number of common shares and common share equivalents of Salomon is based on an exchange ratio of 1.13 shares of Travelers Common Stock for each issued and outstanding share and share equivalent of Salomon. 6. RESTRUCTURING CHARGE The pro forma financial data do not reflect a planned Merger-related restructuring charge of between $400 million and $500 million (after-tax) primarily for severance and costs related to excess or unused office space and other facilities since such restructuring charge is non-recurring. Although there can be no assurance that the restructuring charge will fall within the range provided, this range represents management's best estimate based on the currently available information. 7. FUTURE COST SAVINGS As Salomon's operations are integrated with the existing operations of Travelers, management expects to achieve, by the end of a three year period, annual cost savings in excess of $200 million (after-tax) from the reduction of overhead expenses, changes in corporate infrastructure and the elimination of redundant expenses. There can be no assurance that these projected cost savings will be achieved. These expected future cost savings are not reflected in the pro forma financial data. The statements contained in notes 6 and 7 above may be deemed to be forward-looking statements within the meaning of Section 27A of the Securities Act. Forward-looking statements are typically identified by the words "believe," "expect," "anticipate," "intend," "estimate" and similar expressions. These forward-looking statements are based largely on management's expectations and are subject to a number of uncertainties. Actual results could differ materially from these forward-looking statements as a result of a number of factors, including (1) determination of the number, job classification and location of employee positions to be eliminated, (2) compatibility of the operating systems of the combining companies, (3) the degree to which existing administrative and back-office functions and costs are complementary or redundant, and (4) the timing of implementation of changes in operations to effect cost savings. Travelers undertakes no obligation to update publicly or revise any forward-looking statements. EX-99.06 9 SMITH BARNEY PRO FORMA FINANCIALS EXHIBIT 99.06 UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS The following unaudited pro forma condensed combined statement of financial condition combines the historical consolidated statement of financial condition of Smith Barney and the historical consolidated statement of financial condition of Salomon giving effect to the merger of Salomon Inc and Smith Barney Holdings Inc. as though the transaction had been consummated on June 30, 1997. The following unaudited pro forma condensed combined statements of operations combine the historical statements of operations of Smith Barney and Salomon giving effect to this merger. This information should be read in conjunction with the accompanying notes hereto; the separate historical financial statements of Smith Barney as of June 30, 1997 and for the six months ended June 30, 1997 and 1996, and for each of the three years ended December 31, 1996 which are contained in Smith Barney's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1997 and its Annual Report on Form 10-K for the fiscal year ended December 31, 1996, respectively; and the separate historical financial statements of Salomon as of June 30, 1997 and for the six months ended June 30, 1997 and 1996, and for each of the three years ended December 31, 1996 which are contained in Salomon's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1997 and its Annual Report on Form 10-K for the fiscal year ended December 31, 1996, respectively. The pro forma financial data is not necessarily indicative of the results of operations that would have occurred had the merger been consummated or of future operations of the combined company. SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF FINANCIAL CONDITION AS OF JUNE 30, 1997 (In millions)
Smith Barney Salomon Pro Forma Pro Forma Historical Historical Adjustments Combined ---------- ---------- ----------- -------- ASSETS Cash and cash equivalents $ 232 $ 2,081 $ 2,313 Cash segregated and on deposit for Federal and other regulations and deposits with clearing organizations 1,421 -- 1,421 Securities purchased under agreements to resell 14,610 62,547 77,157 Deposits paid for securities borrowed 13,340 28,773 42,113 Receivables: Customers 7,561 4,877 12,438 Brokers and dealers 946 1,137 2,083 Other 762 624 1,386 Securities owned, at market value 14,014 132,848 146,862 Commodities and related products and instruments -- 1,533 1,533 Property, equipment and leasehold improvements, at cost, net of accumulated depreciation and amortization 450 505 955 Excess of purchase price over fair value of net assets acquired, net of accumulated amortization 274 -- 274 Other assets 2,127 1,028 -- 3,155 ------------------------------------------------ Total assets $55,737 $ 235,953 $ -- $291,690 ================================================ LIABILITIES AND STOCKHOLDER'S EQUITY Commercial paper and other short-term borrowings $ 4,268 $ 8,036 12,304 Securities sold under agreements to repurchase 19,479 105,999 125,478 Deposits received for securities loaned 6,431 2,815 9,246 Payables to Customers 4,784 3,290 8,074 Payables to Brokers and dealers 258 3,979 4,237 Securities sold not yet purchased, at market value 9,640 87,058 96,698 Notes payable 2,735 16,050 18,785 Other payables and accrued liabilities 4,927 2,843 7,770 Subordinated indebtedness 224 30 254 ------------------------------------------------ Total liabilities 52,746 230,100 -- 282,846 ------------------------------------------------ Redeemable preferred stock -- 420 (420) 0 Guaranteed preferred beneficial interests in subordinated debt securities -- 345 345 Stockholder's equity: Preferred stock -- 450 (450) 0 Common stock -- 159 (53) 106 Additional paid-in capital 1,803 438 750 2,991 Retained earnings 1,183 5,811 (1,596) 5,398 Treasury stock, at cost -- (1,769) 1,769 0 Cumulative translation adjustment 5 (1) 4 ------------------------------------------------ Total stockholder's equity 2,991 5,088 420 8,499 ------------------------------------------------ Total liabilities and stockholder's equity $55,737 $ 235,953 $ -- $291,690 ================================================
See Notes to Unaudited Pro Forma Condensed Combined Financial Statements SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 1997 (In millions)
Smith Barney Salomon Pro Forma Historical Historical Combined ---------- ---------- -------- Revenues: Commissions $1,183 $ 199 $1,382 Principal transactions 514 927 1,441 Investment banking 518 441 959 Asset management and administration fees 762 29 791 Other 52 -- 52 ------------------------------- Total non-interest revenues 3,029 1,596 4,625 Interest and dividends 1,160 3,045 4,205 Interest expense 926 2,527 3,453 ------------------------------- Net interest and dividends 234 518 752 ------------------------------- Net revenues 3,263 2,114 5,377 Expenses, excluding interest: Employee compensation and benefits 1,812 1,111 2,923 Communications, occupancy and equipment 274 197 471 Floor brokerage and other production 84 40 124 Other operating and administrative expenses 306 137 443 ------------------------------- Total expenses, excluding interest 2,476 1,485 3,961 ------------------------------- Income before income taxes 787 629 1,416 Income tax expense 318 236 554 ------------------------------- Income from continuing operations $ 469 $ 393 $ 862 ===============================
See Notes to Unaudited Pro Forma Condensed Combined Financial Statements SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 1996 (In millions)
Smith Barney Salomon Pro Forma Historical Historical Combined ---------- ---------- -------- Revenues: Commissions $1,182 $ 165 $1,347 Principal transactions 543 1,235 1,778 Investment banking 576 432 1,008 Asset management and administration fees 648 22 670 Other 57 -- 57 ------------------------------- Total non-interest revenues 3,006 1,854 4,860 Interest and dividends 908 3,008 3,916 Interest expense 713 2,401 3,114 ------------------------------- Net interest and dividends 195 607 802 ------------------------------- Net revenues 3,201 2,461 5,662 Expenses, excluding interest: Employee compensation and benefits 1,811 1,096 2,907 Communications, occupancy and equipment 278 181 459 Floor brokerage and other production 74 34 108 Other operating and administrative expenses 298 137 435 ------------------------------- Total expenses, excluding interest 2,461 1,448 3,909 ------------------------------- Income before income taxes 740 1,013 1,753 Income tax expense 288 405 693 ------------------------------- Income from continuing operations $ 452 $ 608 $1,060 ===============================
See Notes to Unaudited Pro Forma Condensed Combined Financial Statements SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1996 (In millions)
Smith Barney Salomon Pro Forma Historical Historical Combined ---------- ---------- -------- Revenues: Commissions $2,250 $ 326 $ 2,576 Principal transactions 990 1,990 2,980 Investment banking 1,148 853 2,001 Asset management and administration fees 1,349 48 1,397 Other 111 81 192 ------------------------------- Total non-interest revenues 5,848 3,298 9,146 Interest and dividends 1,926 5,748 7,674 Interest expense 1,507 4,679 6,186 ------------------------------- Net interest and dividends 419 1,069 1,488 ------------------------------- Net revenues 6,267 4,367 10,634 Expenses, excluding interest: Employee compensation and benefits 3,522 2,039 5,561 Communications, occupancy and equipment 565 374 939 Floor brokerage and other production 147 74 221 Other operating and administrative expenses 579 270 849 ------------------------------- Total expenses, excluding interest 4,813 2,757 7,570 ------------------------------- Income before income taxes 1,454 1,610 3,064 Income tax expense 571 628 1,199 ------------------------------- Income from continuing operations $ 883 $ 982 $ 1,865 ===============================
See Notes to Unaudited Pro Forma Condensed Combined Financial Statements SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1995 (In millions)
Smith Barney Salomon Pro Forma Historical Historical Combined ---------- ---------- -------- Revenues: Commissions $2,008 $ 332 $2,340 Principal transactions 1,016 1,077 2,093 Investment banking 847 472 1,319 Asset management and administration fees 1,052 39 1,091 Other 108 12 120 ------------------------------- Total non-interest revenues 5,031 1,932 6,963 Interest and dividends 1,752 7,021 8,773 Interest expense 1,375 5,754 7,129 ------------------------------- Net interest and dividends 377 1,267 1,644 ------------------------------- Net revenues 5,408 3,199 8,607 Expenses, excluding interest: Employee compensation and benefits 3,193 1,710 4,903 Communications, occupancy and equipment 572 385 957 Floor brokerage and other production 137 63 200 Other operating and administrative expenses 485 242 727 ------------------------------- Total expenses, excluding interest 4,387 2,400 6,787 ------------------------------- Income before income taxes 1,021 799 1,820 Income tax expense 426 286 712 ------------------------------- Income from continuing operations $ 595 $ 513 $1,108 ===============================
See Notes to Unaudited Pro Forma Condensed Combined Financial Statements SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1994 (In millions)
Smith Barney Salomon Pro Forma Historical Historical Combined ---------- ---------- -------- Revenues: Commissions $1,800 $ 336 $ 2,136 Principal transactions 900 (560) 340 Investment banking 680 486 1,166 Asset management and administration fees 941 23 964 Other 98 7 105 ------------------------------ Total non-interest revenues 4,419 292 4,711 Interest and dividends 1,099 5,902 7,001 Interest expense 770 4,873 5,643 ------------------------------ Net interest and dividends 329 1,029 1,358 ------------------------------ Net revenues 4,748 1,321 6,069 Expenses, excluding interest: Employee compensation and benefits 2,953 1,455 4,408 Communications, occupancy and equipment 574 383 957 Floor brokerage and other production 138 70 208 Other operating and administrative expenses 441 262 703 ------------------------------ Total expenses, excluding interest 4,106 2,170 6,276 ------------------------------ Gain on sale of equity investment 34 -- 34 ------------------------------ Income (loss) before income taxes 676 (849) (173) Income tax expense (benefit) 288 (439) (151) ------------------------------ Income (loss) from continuing operations $ 388 $ (410) $ (22) ==============================
See Notes to Unaudited Pro Forma Condensed Combined Financial Statements Notes to Unaudited Pro Forma Condensed Combined Financial Statements 1. Description of Transaction and Basis of Presentation The Merger Agreement provides that each share of Salomon Inc ("Salomon") common stock will be exchanged for 1.13 shares of Travelers Group Inc. ("Travelers Group") common stock. The Merger, which is expected to be completed in the fourth quarter of 1997, is expected to be accounted for under the pooling of interests method. After the Merger, Salomon will be merged with Smith Barney Holdings Inc. ("Smith Barney"), a wholly owned subsidiary of Travelers Group. The assets and liabilities of both companies will be combined at historical cost. Historical consolidated financial statements presented in future reports will be restated to include the accounts and results of Salomon. The Merger is subject to customary closing conditions, including regulatory and Salomon stockholder approval. 2. Accounting Policies Smith Barney and Salomon are in the process of reviewing their accounting policies and, as a result of this review, it may be necessary to restate either Smith Barney's or Salomon's financial statements to conform to those accounting policies that are determined to be most appropriate. No such restatements have been made to the pro forma combined financial statements. 3. Intercompany Transactions Transactions between Smith Barney and Salomon are not material in relation to the pro forma combined financial statements and therefore intercompany balances have not been eliminated from the pro forma combined amounts. 4. Pro Forma Adjustments The pro forma adjustments at June 30, 1997 reflect, pursuant to the Merger Agreement, the cancellation and retirement of all Salomon common stock held in treasury and the conversion of Salomon redeemable preferred stock and preferred stock into redeemable preferred stock and preferred stock of Travelers Group with substantially identical terms. 5. Restructuring Charge The pro forma financial data do not reflect a planned merger-related restructuring charge of between $400 million and $500 million (after-tax) primarily for severance and costs related to excess or unused office space and other facilities since such restructuring charge is non-recurring. Although there can be no assurance that the restructuring charge will fall within the range provided, this range represents management's best estimate based on the currently available information. 6. Future Cost Savings As Salomon's operations are integrated with the existing operations of Smith Barney, management expects to achieve, by the end of a three year period, annual cost savings in excess of $200 million (after-tax) from the reduction of overhead expenses, changes in corporate infrastructure and the elimination of redundant expenses. There can be no assurance that these projected cost savings will be achieved. These expected future cost savings are not reflected in the pro forma financial data. The statements contained in notes 5 and 6 above may be deemed to be forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended. Forward-looking statements are typically identified by the words "believe," "expect," "anticipate," "intend," "estimate" and similar expressions. These forward-looking statements are based largely on management's expectations and are subject to a number of uncertainties. Actual results could differ materially from these forward-looking statements as a result of a number of factors, including (1) determination of the number, job classification and location of employee positions to be eliminated, (2) compatibility of the operating systems of the combining companies, (3) the degree to which existing administrative and back-office functions and costs are complementary or redundant, and (4) the timing of implementation of changes in operations to effect cost savings. Smith Barney undertakes no obligation to update publicly or revise any forward-looking statements. -----END PRIVACY-ENHANCED MESSAGE-----