-----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, JyL9V8RHNk+xBsBQRt1VFl5MDzQYKOklyhwuvMkqiFerKOMgYp+cr5SZIGXYFQwE eAwKmVpAEwgtEI1rUuPo7g== 0000354396-95-000027.txt : 19951119 0000354396-95-000027.hdr.sgml : 19951119 ACCESSION NUMBER: 0000354396-95-000027 CONFORMED SUBMISSION TYPE: 10-K/A PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19941231 FILED AS OF DATE: 19951114 SROS: NYSE SROS: PSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: USF&G CORP CENTRAL INDEX KEY: 0000354396 STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331] IRS NUMBER: 521220567 STATE OF INCORPORATION: MD FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K/A SEC ACT: 1934 Act SEC FILE NUMBER: 001-08233 FILM NUMBER: 95591415 BUSINESS ADDRESS: STREET 1: 100 LIGHT ST CITY: BALTIMORE STATE: MD ZIP: 21202 BUSINESS PHONE: 4105473000 MAIL ADDRESS: STREET 1: P O BOX 1138 CITY: BALTIMORE STATE: MD ZIP: 21203 10-K/A 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 Form 10-K/A Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Fiscal Year Ended Commission File Number December 31, 1994 1-8233 USF&G CORPORATION (Exact name of registrant as specified in its charter) Maryland 52-1220567 (State of Incorporation) (IRS Employer Identification No.) 100 Light Street, Baltimore, Maryland 21202 (Address of principal executive offices) (zip code) Telephone: 410-547-3000 Securities registered pursuant to Section 12(b) of the Act: $4.10 Series A Convertible Exchangeable Preferred Stock, Par Value $50 Registered-New York Stock Exchange Registered-Pacific Stock Exchange $5.00 Series C Cumulative Convertible Preferred Stock, Par Value $50 Registered-New York Stock Exchange Registered-Pacific Stock Exchange Preferred Share Purchase Rights Registered-New York Stock Exchange Registered-Pacific Stock Exchange Common Stock, Par Value $2.50 Registered-New York Stock Exchange Registered-Pacific Stock Exchange 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 twelve (12) months 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 voting stock held by non-affiliates of the registrant as of March 28, 1995, was $1,416,793,672. Voting stock held by any persons who may be deemed to be affiliates under Rule 405 would be immaterial. The number of shares outstanding of the issuer's common stock as of March 28, 1995: Common Stock, Par Value $2.50; 101,199,548 shares outstanding. Documents Incorporated by Reference: Portions of the 1994 Annual Report to Shareholders (Restated) are incorporated by reference into Parts I and II. Portions of the definitive proxy statement for the Annual Meeting held on May 17, 1995, are incorporated by reference into Part III. Exhibit Index is on page 15. USF&G Corporation Index Part I Item 1. Description of Business 1.1. General 1 1.2. Business Segments 1 1.3. Distribution Systems 5 1.4. Competition 6 1.5. Investments 6 1.6. Property/Casualty Loss Reserves 7 1.7. Life Benefit Reserves 10 1.8. Geographical Distribution 11 1.9. Executive Officers of the Registrant 11 Item 2. Business Properties 12 Item 3. Legal Proceedings 12 Item 4. Submission of Matters to a Vote of Security Holders 12 Part II Item 5. Market for Registrant's Common Equity and Related Shareholder Matters 13 Item 6. Selected Financial Data 13 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 13 Item 8. Financial Statements and Supplementary Data 13 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 13 Part III Item 10. Executive Officers and Directors of the Registrant 14 Item 11. Executive Compensation 14 Item 12. Security Ownership of Certain Beneficial Owners and Management 14 Item 13. Certain Relationships and Related Transactions 14 Part IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 15 USF&G Corporation Part I Item 1. Description of Business 1.1. General USF&G Corporation (the "Corporation") is a holding corporation organized in 1981 as a Maryland corporation. United States Fidelity and Guaranty Company ("USF&G Company"), organized in 1896 under Maryland law, is the predecessor registrant of the Corporation. The term "Corporation" as used in the Form 10-K/A refers to the Corporation and all of its subsidiaries. As of December 31, 1994, the Corporation had approximately 6,300 employees. USF&G Corporation's Form 10-K for the year ended December 31, 1994 is hereby amended to reflect mergers with Discover Re Managers, Inc. ("Discover Re"), and Victoria Financial Corporation ("Victoria"), which were completed during the second quarter of 1995. Restatement of prior periods is provided due to the application of the pooling-of-interests method of accounting. The Corporation, through its subsidiaries, is primarily engaged in the business of insurance. Property/casualty insurance is its primary business. USF&G Company, the Corporation's largest subsidiary, is the 24th largest property/casualty insurer among over 2,400 insurers in the United States based on 1993 statutory net premiums written. Life insurance and annuity products are sold by Fidelity and Guaranty Life Insurance Company ("F&G Life"). Noninsurance operations are composed of the parent company, asset management, and management consulting services. 1.2. Business segments Financial information about the Corporation's business segments is set forth in Note 14 of the Notes to Consolidated Financial Statements in the Corporation's 1994 Annual Report to Shareholders (Restated) and incorporated herein by reference. A description of the Corporation's principal business segments begins with the Property/Casualty Insurance Segment on page 1, and continues with the Life Insurance Segment on page 4, and Parent and Noninsurance Operations on page 5 of this Form 10-K/A. 1.2a. Property/casualty insurance segment Selected financial data for the property/casualty insurance segment are as follows: (dollars in millions) 1994 1993 1992 1991 1990 1989 1988 1987 1986 1985 Operating Results: Premiums earned $2,356 $2,392 $2,579 $3,044 $3,349 $3,548 $3,623 $3,754 $3,542 $2,964 Losses and loss expenses 1,744 1,805 2,120 2,562 2,776 2,743 2,654 2,738 2,767 2,623 Underwriting expenses 814 816 887 1,001 1,096 1,142 1,134 1,112 1,051 921 Underwriting loss $ (202) $ (229) $ (428) $ (519) $ (523) $ (337) $ (165) $ (96) $ (276) $ (580) Net investment income $ 429 $ 437 $ 478 $ 501 $ 577 $ 624 $ 622 $ 607 $ 565 $ 348 Net income (loss) 498 285 194 (41) (192) 200 318 331 309 (116) Financial Position: Investments $6,440 $7,012 $7,019 $7,648 $7,021 $7,496 $7,428 $6,658 $6,033 $5,001 Assets 9,487 9,710 8,362 9,422 9,008 9,468 9,310 8,496 7,781 6,779 Unpaid losses and loss expenses* 6,158 6,370 5,565 5,716 5,636 5,467 5,260 4,777 4,113 3,521 Operating Ratios-GAAP: Loss ratio 74.0 75.4 82.2 84.2 82.9 77.3 73.2 72.9 78.1 88.5 Expense ratio 34.9 34.2 34.5 32.9 32.7 32.2 31.3 29.6 29.7 31.1 Combined ratio 108.9 109.6 116.7 117.1 115.6 109.5 104.5 102.5 107.8 119.6 Statutory Data:** Premiums written $2,389 $2,502 $2,475 $3,064 $3,651 $3,717 $3,903 $3,854 $3,701 $3,152 Policyholders' surplus (USF&G Company) 1,621 1,577 1,498 1,432 1,359 1,423 1,400 1,246 1,241 913 Operating Ratios-Statutory: Loss ratio 73.1 75.3 81.8 84.0 81.8 76.4 73.0 73.2 79.1 90.7 Expense ratio 34.8 33.5 34.8 33.1 32.9 32.8 31.2 30.1 29.1 30.0 Combined ratio 107.9 108.8 116.6 117.1 114.7 109.2 104.2 103.3 108.2 120.7 Policyholders' dividend ratio .3 .3 .3 .5 .5 .6 .6 .9 .8 1.0 *USF&G adopted SFAS No. 113 in 1993 which requires the effects of reinsurance activity to be reported on a gross basis. Prior to 1993 information presented for the property/casualty insurance segment is net of applicable reinsurance amounts. **For comparability, statutory amounts are restated for Discover Re and Victoria; however, restatement of prior periods for business combinations is not prescribed by statutory accounting. USF&G Company currently underwrites most forms of property/casualty insurance. USF&G Company's property/casualty business is grouped into four business categories: commercial, personal, reinsurance, and fidelity/surety. In 1994, the property/casualty segment accounted for 84 percent of the Corporation's total revenues and 68 percent of its total assets. USF&G Company reinsures portions of its policy risks with other insurance companies or underwriters and remains contingently liable under these contracts (ceded reinsurance). In addition, it assumes policy risks from other insurance companies and through participation in pools and associations (assumed reinsurance). (Refer to the Assumed Reinsurance Category discussion on page 3 of this Form 10-K/A.) Ceded reinsurance allows USF&G Company to obtain indemnification against losses associated with insurance contracts it has written by entering into a reinsurance contract with another insurance enterprise (the reinsurer). USF&G Company pays (cedes) an amount to the reinsurer who agrees to reimburse USF&G Company for a specified portion of any claims paid on business under the reinsured contracts. Reinsurance gives USF&G Company the ability to write certain individually large risks or groups of risks, and control its exposure to losses by ceding a portion of such large risks. USF&G Company's ceding reinsurance agreements are generally structured on a treaty basis whereby all risks meeting a certain criteria are automatically reinsured. USF&G Company may also use supplemental facultative reinsurance based on an underwriter's evaluation of characteristics of a specific insured risk. The following table summarizes the approximate extent of the Company's reinsurance coverages. Coverage Risk Type Percentage Retention Coverage Property Cat Program (a) 95% $75 million $140 million Property Per Risk (b) 100 Variable 50 million Fidelity 100 2 million 13 million Surety (c) 100 5 million 30 million Workers' Compensation (d) 100 1 million 525 million Commercial Umbrella 100 15 million 5 million (a) Second Event Coverage purchased lowers retention to $50 million for second catastrophe. (b) Retention of individual property losses are $1 million, but can be increased to $4 million subject to underwriting criteria. (c) Represents limits at December 31, 1994. Fourth layer canceled for 1995, reducing limit to $25 million. (d) Represents limits at December 31, 1994. Accident and Health Workers' Compensation Catastrophe Coverage canceled for 1995, reducing limit to $425 million. Commercial Category: Commercial coverages provide protection related to property loss, liability claims and workers' compensation benefits to businesses and other institutions. This type of insurance protects against loss from damage to the insured's covered properties and protects against legal liability for injuries to other persons or damage to their property arising from the insured's business operations. Workers' compensation provides benefits to employees, as mandated by state laws, for employment-related accidents, injuries or illnesses. Selected data for the commercial category are as follows: (dollars in millions) 1994 1993 1992 Automobile: Premiums written $ 376 $ 391 $ 413 Statutory combined ratio 86.6 86.9 96.5 General Liability: Premiums written $ 352 $ 365 $ 366 Statutory combined ratio 133.3 118.9 137.6 Property: Premiums written $ 329 $ 326 $ 315 Statutory combined ratio 111.8 100.0 115.6 Workers' Compensation: Premiums written $ 142 $ 165 $ 261 Statutory combined ratio 151.6 232.2 150.0 Total Commercial: Premiums written $1,199 $1,247 $1,355 Underwriting loss* (186) (223) (343) Percent of total premiums written 50% 50% 54% GAAP Underwriting Ratios: Loss ratio 78.1 83.0 87.8 Expense ratio 37.5 35.3 35.4 Combined ratio 115.6 118.3 123.2 Statutory Underwriting Ratios: Loss ratio 78.1 83.0 86.9 Expense ratio 36.2 34.4 36.3 Combined ratio 114.3 117.4 123.2 *Reported in accordance with Generally Accepted Accounting Principles ("GAAP") Personal Category: Personal coverages for automobile and homeowners insurance include aspects of property loss and liability risks. Automobile policies cover liability to third-parties for bodily injury and property damage, and cover physical damage to the insured's own vehicle resulting from collision and various other perils. Homeowners policies protect against loss of dwellings and contents arising from a variety of perils, as well as liability arising from ownership or occupancy. Selected data for the personal category are as follows: (dollars in millions) 1994 1993 1992 Automobile: Premiums written $402 $493 $512 Statutory combined ratio 99.6 99.9 103.5 Homeowners: Premiums written $124 $139 $169 Statutory combined ratio 150.2 115.4 143.0 Other Property: Premiums written $ 38 $ 26 $ 45 Statutory combined ratio 105.2 131.4 110.0 Total Personal: Premiums written $564 $658 $726 Underwriting loss* (60) (28) (110) Percent of total premiums written 24% 26% 29% GAAP Underwriting Ratios: Loss ratio 74.2 70.6 80.9 Expense ratio 36.3 33.5 33.1 Combined ratio 110.5 104.1 114.0 Statutory Underwriting Ratios: Loss ratio 74.2 70.7 80.0 Expense ratio 36.8 33.7 33.2 Combined ratio 111.0 104.4 113.2 *Reported in accordance with GAAP Assumed Reinsurance Category: USF&G Company operates a separate reinsurance division which underwrites treaty reinsurance and is composed of various wholly- owned subsidiaries. The lead company in this group, F&G Re, Inc., acts as the reinsurance underwriting manager and solicits and services assumed reinsurance for USF&G Company. F&G Re, Inc., writes reinsurance in North America and in specific foreign countries (mainly in Western Europe and Japan). Reinsurance prices and conditions are not normally subject to the same state regulation applicable to the primary insurance market because reinsurers contract solely with other insurance companies. Selected data for the reinsurance category are as follows: (dollars in millions) 1994 1993 1992 Premiums written $415 $403 $243 Underwriting gain* 40 32 20 Percent of total premiums written 17% 16% 10% GAAP Underwriting Ratios: Loss ratio 73.2 66.7 75.0 Expense ratio 16.5 22.6 12.1 Combined ratio 89.9 89.3 87.1 Statutory Underwriting Ratios: Loss ratio 67.9 67.3 76.9 Expense ratio 22.7 24.6 17.0 Combined ratio 90.6 91.9 93.9 *Reported in accordance with GAAP Fidelity/Surety Category: Fidelity bonds indemnify employers against the dishonesty or default of employees in their employment. These types of bonds are written for mercantile businesses, financial institutions, and public officials. Surety bonds guarantee the performance of a principal who undertakes contractual or statutory obligations, and indemnify third-party obligees for damages caused by the principal's failure to perform. Selected data for the fidelity/surety category are as follows: (dollars in millions) 1994 1993 1992 Fidelity: Premiums written $ 21 $ 19 $ 18 Statutory combined ratio 74.5 108.8 75.8 Surety: Premiums written $113 $102 $ 91 Statutory combined ratio 93.8 105.8 100.1 Total Fidelity/Surety: Premiums written $134 $121 $109 Underwriting gain (loss)* 6 (8) 6 Percent of total premiums written 6% 5% 4% GAAP Underwriting Ratios: Loss ratio 36.7 50.2 32.3 Expense ratio 57.9 56.6 62.6 Combined ratio 94.6 106.8 94.9 Statutory Underwriting Ratios: Loss ratio 36.7 50.2 32.0 Expense ratio 54.2 56.0 64.0 Combined ratio 90.9 106.2 96.0 *Reported in accordance with GAAP Discover Re: Discover Re provides insurance, reinsurance and related services to the alternative risk transfer ("ART") market, primarily in the municipalities, transportation, education and retail sectors. The ART market represents approximately 30 percent of the commercial insurance market. This merger facilitates USF&G's access to the ART market and, management believes, provides increased growth potential by augmenting certain of the existing core commercial lines operations. Selected data for Discover Re are as follows: (dollars in millions) 1994 1993 1992 Premiums written $ 27 $ 20 $ 12 Underwriting loss* - (1) - Percent of total premiums written 1% 1% 1% GAAP Underwriting Ratios: Loss ratio 76.2 76.2 80.0 Expense ratio 23.8 26.7 30.3 Combined ratio 100.0 102.9 110.3 Statutory Underwriting Ratios: Loss ratio 76.2 76.2 80.0 Expense ratio 22.6 23.9 28.4 Combined ratio 98.8 100.1 108.4 *Reported in accordance with GAAP Victoria: Victoria is an insurance holding company which specializes in nonstandard personal lines auto coverage. Management believes that this merger will allow USF&G to enhance premium retention and grow the personal lines business through an expanded product portfolio. Selected data for Victoria are as follows: (dollars in millions) 1994 1993 1992 Premiums written $ 50 $ 53 $ 43 Underwriting loss* (2) (1) (1) Percent of total premiums written 2% 2% 2% GAAP Underwriting Ratios: Loss ratio 69.1 70.1 69.1 Expense ratio 31.2 28.5 30.1 Combined ratio 100.3 98.6 99.2 Statutory Underwriting Ratios: Loss ratio 69.1 70.1 69.1 Expense ratio 32.2 28.2 30.3 Combined ratio 101.3 98.3 99.4 *Reported in accordance with GAAP 1.2b. Life insurance segment The life insurance segment ("F&G Life") sells many forms of annuity and life insurance products. In 1994, F&G Life segment accounted for 14 percent of the Corporation's total revenues and 33 percent of its total assets. Selected financial data for the life insurance segment are as follows:
(dollars in millions) 1994 1993 1992 1991 1990 1989 1988 1987 1986 1985 Operating Results: Premium income $ 152 $ 129 $ 104 $ 169 $ 186 $ 165 $ 178 $ 133 $ 79 $ 67 Net investment income 317 321 349 370 348 273 159 88 67 50 Net income (loss) 12 10 (5) 31 (16) 31 14 37 20 27 Life Insurance Sales: Annuities $ 274 $ 199 $ 144 $ 266 $ 1,032 $ 934 $ 962 $ 221 $ 67 $ 104 Permanent 9 4 9 12 17 20 106 51 10 9 Term and group 3 2 2 2 5 6 9 6 6 6 Total $ 286 $ 205 $ 155 $ 280 $ 1,054 $ 960 $ 1,077 $ 278 $ 83 $ 119 Financial Position: Investments $ 4,202 $ 4,540 $ 4,512 $ 4,672 $ 4,308 $ 3,372 $ 2,240 $ 1,086 $ 707 $ 535 Assets 4,575 4,848 4,856 5,012 4,721 3,645 2,471 1,194 784 607 Policy benefit reserves 3,804 3,973 3,896 3,773 3,924 2,838 1,875 795 501 402 Statutory surplus 326 316 310 283 254 245 169 107 82 56 Life Insurance in Force: Permanent $ 6,348 $ 6,733 $ 6,769 $ 6,937 $ 7,014 $ 6,038 $ 4,930 $ 3,979 $ 3,035 $ 2,228 Term 5,467 5,347 5,549 5,854 6,463 6,438 6,603 6,579 6,648 6,338 Group 27 30 42 586 4,373 4,605 4,058 2,834 2,687 2,737 Total $11,842 $12,110 $12,360 $13,377 $17,850 $17,081 $15,591 $13,392 $12,370 $11,303
F&G Life Products: Life insurance and annuity sales (premiums and deposits) by product type are as follows: (in millions) 1994 1993 1992 Structured settlement annuities $ 88 $ 66 $ 37 Single premium deferred annuities 82 44 33 Tax-sheltered annuities 63 35 - Other annuities 41 54 74 Life insurance 12 6 11 Total $286 $205 $155 Single premium deferred annuities ("SPDAs") offer the owner the option of receiving a lump sum distribution at a future date or a series of fixed payments over a specified period. Tax-sheltered annuity ("TSA") products, which provide retirement income, are a type of deferred annuity. Other annuities consist of single premium immediate annuities ("SPIAs"), which provide for payments that begin within one year after the sale and continue over a fixed period or an individual's lifetime. Structured settlements are immediate annuities principally sold through the property/casualty company in settlement of insurance claims. Other insurance products include recurring and single premium universal life and term insurance that generally provide a fixed benefit upon the death of the insured. These products were sold on an individual and group basis. However, F&G Life sold its group life business in 1991. Universal life insurance provides a death benefit for the life of the insured and accumulates cash values to which interest is credited. Term life insurance provides a fixed death benefit if the insured dies during the contractual period. Universal life products, which represent all the permanent life insurance sales in 1992 through 1994, and have been the majority of permanent life insurance sales since 1988, also include a cash value component that is credited with interest at competitive rates. The interest rates are applied to premiums for one year from receipt; new rates are declared quarterly on recurring premium policies and semi-monthly on single premium policies. Universal life cash values are charged for the cost of life insurance coverage and for administrative expenses. Additional information on F&G Life's products is discussed on page 22 of Management's Discussion and Analysis of Financial Condition and Results of Operations. 1.2c. Parent and noninsurance operations Selected financial data for the parent company and noninsurance operations are as follows: (in millions) 1994 1993 1992 Revenues before realized gains: Management consulting $ 32 $ 32 $ 30 Oil and gas - - 19 Other noninsurance investments 24 10 4 Parent 20 8 14 Total revenues before realized gains $ 76 $ 50 $ 67 Parent company expenses: Interest expense $ (34) $ (37) $ (35) Unallocated expense, net (48) (35) (34) Noninsurance gains (losses): Management consulting 1 (2) (4) Oil and gas - - (18) Other noninsurance investments 2 (9) (13) Facilities exit costs (211) - - Realized gains (losses) on investments 14 (45) (50) Restructuring charges - - (2) Loss from discontinued operations - - (7) Other 3 2 3 Total parent/noninsurance net loss $(273) $(126) $(160) The parent company performs corporate functions including managing the capital requirements of the Corporation and its subsidiaries. The noninsurance operations include management consulting services, asset management services, and discontinued operations. As a result of restructuring, there were no oil and gas operating losses in 1994 and 1993. During 1992, the investment in oil and gas properties was merged with another oil and gas exploration and production company. Discontinued operations included certain investment management, leasing, marketing, and travel services, and other noninsurance operations. During 1994, the Corporation committed to a plan to consolidate its home office operations in Baltimore, Maryland at its Mount Washington facility. The parent company recognized facilities exit costs of $211 million representing the present value of the rent and other operating expenses to be incurred under the lease on the Corporation's principal office building from the time USF&G vacates the building through the expiration of the lease in 2009. (Refer to Note 6 of the Notes to Consolidated Financial Statements in the Corporation's 1994 Annual Report to Shareholders (Restated).) 1.3. Distribution systems The Corporation's subsidiaries market a full range of property/casualty insurance and life insurance products. Property/Casualty Insurance: USF&G Company's products have been sold exclusively by independent agents since its founding in 1896. Independent agents generally represent multiple insurance companies. USF&G Company's products are sold through approximately 3,800 independent agencies in the United States on a commission basis. As of December 31, 1994, USF&G Company maintained 5 regional offices and 30 branch offices to service its independent agents and policyholders. The regional offices are located in the Northeast, Southeast, Midwest, and Western areas, and in Mississippi. The branch offices are located throughout the United States. These offices support the administration of underwriting standards, the delivery of policies, and the supervision of the Company's claim offices. In the first quarter of 1995, the Company eliminated the Midwest regional office and consolidated its business into the other regional offices. This measure was taken to save expenses as well as increase efficiency of operations. Life Insurance: F&G Life's sales by distribution system are as follows: (in millions) 1994 1993 1992 Direct-structured settlements $ 88 $ 66 $ 37 Property/casualty brokerage 48 49 67 National brokerage 46 14 - National wholesaler 71 39 - Other 33 37 51 Total $286 $205 $155 Structured settlements are annuities sold predominantly through the property/casualty company in settlement of certain of its insurance claims. Tax- sheltered annuities are sold through a national wholesale distribution network primarily to teachers. SPDAs are sold primarily through independent agents and insurance brokers. Prior to 1992, most SPDAs were sold through securities brokerage firms (New York Stock Exchange member firms and other financial institutions). 1.4. Competition Property/Casualty Insurance: The property/casualty insurance industry is highly competitive with about 2,400 companies nationwide. These insurers are not only stock companies, but also mutual companies and other underwriting organizations. USF&G Company ranked 24th in the industry, based on 1993 statutory net premiums written and 23rd based on 1993 statutory policyholders' surplus. USF&G Company competes with other property/casualty insurance companies whose products are distributed through national, regional and local independent agencies, direct sales and brokers. Consumers may also use self-insurance, which includes captive insurance subsidiaries. Pricing is a primary means of competition in the property/casualty industry. The industry is currently in a period of significant price competition, which adversely affects USF&G Company's profitability. Availability and quality of products, quality and speed of service (including claims service), financial strength, distribution systems and technical expertise are also important elements of competition. In personal and other lines offered by USF&G Company, significant price competition is experienced from direct-writing companies that do not use independent agents and generally have lower policy acquisition costs. Life Insurance: The Corporation's life insurance subsidiaries operate in a competitive environment, with approximately 1,300 companies in the industry including stock and mutual companies. F&G Life ranked 86th in the United States based on 1993 statutory assets and 97th based on 1993 statutory capital and surplus. In the life insurance industry, interest crediting rates, policy features, financial stability and service quality are important competitive factors. F&G Life's products compete not only with those offered by other life insurance companies, but also with other income accumulation-oriented products offered by other financial institutions. F&G Life has experienced considerable competitive pressure in recent periods as a result of its relatively lower credit ratings. Competitive pressures for agency business also have intensified in recent years because of an increase in the variety of products available in the market and efforts of competitors to expand their market shares. Premium Rates: Most states have laws requiring that rate schedules and other information be filed with a regulatory authority for substantially all property, casualty, and surety lines. Some states permit insurers to use rates without prior regulatory approval whereas other states prohibit implementation of new rates without such approval. The authority may disapprove a filing if it finds that the rates are inadequate, excessive, or unfairly discriminatory. Rates are not necessarily uniform for all insurers. In states that require prior approval of rates, regulators usually require the submission of historical data to justify rate increases and, accordingly, there is often a time lag between identifying the need for rate increases and securing such increases. The effect of this lag is particularly severe in times of rising claims and inflation. Rates for life insurance are generally not regulated. 1.5. Investments Investing the net cash flows from operations is a major aspect of the property/casualty and life insurance businesses. The components of the Corporation's investment portfolio and investment performance are discussed on pages 24 through 29, 46 through 48, 51 and 52 of the 1994 Annual Report to Shareholders (Restated), which pages are incorporated herein by reference. 1.6. Property/casualty loss reserves 1.6a. General The reserve liabilities for property/casualty losses and loss expenses represent estimates of the ultimate net cost of all unpaid losses and loss adjustment expenses incurred through December 31 of each year. The reserves are determined using adjusters' individual case estimates and actuarially based statistical projections. USF&G Company's estimates of losses for reported claims are established judgmentally on an individual case basis. Such estimates are based on a claim adjuster's particular expertise with the type of risk involved and knowledge of circumstances surrounding the individual claims. These estimates are reviewed on a regular basis and updated as additional facts become known. The reserves derived from statistical projections are subject to the effects of trends in claim severity and frequency. Statistical projections are employed in three specific areas: 1) to calculate bulk reserves for incurred but not reported ("IBNR") losses and provide for development of case basis loss reserves; 2) to calculate allocated loss expense reserves; and 3) to calculate unallocated loss expense reserves. IBNR and Case Development Reserves: USF&G Company's estimates of IBNR and case development reserves are derived from analyses of historical patterns of development of paid and reported losses by accident year for each line of business. The loss projection procedures used in this analysis contain explicit provisions for quantifying the effect of inflation on loss payments expected to be made in the future. This process relies on the basic assumption that past experience adjusted for the effect of current developments and likely trends is an appropriate basis for predicting future events. Loss Expense: USF&G Company's estimates of unpaid loss expenses are based on analyses of the long-term relationship of projected ultimate loss expense to projected ultimate losses for each line of business. By using incurred losses as a base, inflation assumptions applicable to loss reserves apply equally to allocated expense reserves. Unallocated Loss Expense: Unallocated loss expense reserves are based on historical relationships of paid unallocated expenses to paid losses. As with allocated loss expenses, the inflation assumptions applicable to loss reserves are presumed to apply equally to unallocated expense reserves. The process of estimating the liability for unpaid losses and loss expenses is inherently judgmental. The process is influenced by factors which are subject to significant variation. Possible sources of variation include changing rates of inflation (particularly medical cost inflation) as well as changes in other economic conditions, the legal system and internal claims settlement practices, among other variables. In many cases, significant periods of time may lapse between the occurrence of an insured event, the reporting of a claim to USF&G Company and USF&G Company's final settlement of the claim. More than 46 percent of USF&G Company's loss and loss expense reserves are provided for claims which have been incurred but not reported and for future development on reported claims. While USF&G Company reports a single amount as the estimate for unpaid loss and loss expenses as of each valuation date, the reported reserves should be considered the best estimate from a range of possible outcomes. It is unlikely that future losses and loss expenses will develop exactly as projected and may in fact vary significantly from projections. These estimates are continually reviewed and updated as experience develops and new information becomes known. Any resulting adjustments are reflected in current operating results. 1.6b. Discounted loss reserves The reserves for permanent-total disability benefits and long-term medical care benefits under workers' compensation insurance are discounted at rates of interest generally ranging from 3 percent to 5 percent. The carrying amount of such workers' compensation reserves, net of reinsurance and net of discount, was $1.60 billion, $1.75 billion, and $1.80 billion at December 31, 1994, 1993, and 1992, respectively. The discount is amortized over the expected lifetimes of the claimants. Discounted reserves come from three sources: reserves assumed from the Workers' Compensation Reinsurance Bureau ("WCRB"), reserves assumed from residual market pools, and reserves for USF&G Company's net retained business. (in millions) 1994 1993 1992 Estimated discount, January 1 $508 $680 $683 Estimated (reduction) additional discount accrued (32) (138) 29 Estimated discount amortized (35) (34) (32) Estimated discount, December 31 $441 $508 $680 The source of the negative discount accrual of $32 million in 1994 results from an acceleration in the underlying payment pattern of workers' compensation claims. An increase in the use of structured settlements to resolve claims is the primary factor affecting the change in the payment stream. The source of the negative discount accrual of $34 million in 1993 results from the WCRB commutation and the concurrent reduction in discount rates. Additionally, the discount was reduced by a redistribution of reserves to states and re- apportionment on reserves assumed from residual market pools. 1.6c. Roll-forward of liability for loss and loss expenses The following table reconciles the changes in loss and loss expense reserves for the years presented: (in millions) 1994 1993 1992 Net balance at January 1 $5,316 $5,564 $5,716 Related To: Current year 1,752 1,744 2,042 Prior years (8) 61 78 Total incurred 1,744 1,805 2,120 Paid Related To: Current year 634 582 698 Prior years 1,284 1,471 1,574 Total paid 1,918 2,053 2,272 Net balance at December 31 5,142 5,316 5,564 Plus reinsurance recoverables 1,016 1,054 1 Total reserve at end of year, gross $6,158 $6,370 $5,565 1.6d. Analysis of loss and loss expense reserve development The following table shows property/casualty loss reserves net of ceded reinsurance as recorded in the indicated years, subsequent payments made with respect to such reserves and re-estimates of such reserves. The top line shows the estimated liability that was recorded at the end of each of the indicated years for all current and prior year unpaid losses and loss expenses. The upper portion of the table shows the cumulative amount subsequently paid in succeeding years. The lower portion of the table shows re-estimates of the original recorded reserve as of the end of each successive year. Such re-estimations result from development of additional facts and circumstances pertaining to unsettled claims. The bottom line shows the dollar amount of the cumulative change through 1994 that is attributable to the original recorded reserve for each prior year. Such change has been reflected in income of subsequent years. A new table, added in 1994, provides data gross of ceded reinsurance for the carried reserve at year ends 1993 and 1994 and the development of the year end 1993 reserve. This information immediately follows the Analysis of Net Loss and Net Loss Expense Reserve Development table. Analysis of Net Loss and Net Loss Expense Reserve Development* At December 31 (in millions) 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 Liability for unpaid losses and loss expenses $2,817 $3,510 $4,090 $4,744 $5,208 $5,467 $5,636 $5,716 $5,564 $5,316 $5,142 Cumulative paid as of: One year later 1,027 1,251 1,348 1,374 1,539 1,723 1,654 1,574 1,471 1,284 Two years later 1,659 2,040 2,164 2,258 2,614 2,794 2,746 2,534 2,393 - Three years later 2,131 2,557 2,778 3,032 3,350 3,593 3,418 3,225 - - Four years later 2,451 2,971 3,314 3,550 3,939 4,055 3,929 - - - Five years later 2,708 3,362 3,640 3,992 4,265 4,435 - - - - Six years later 2,947 3,595 3,864 4,239 4,542 - - - - - Seven years later 3,112 3,759 4,056 4,456 - - - - - - Eight years later 3,243 3,918 4,234 - - - - - - - Nine years later 3,368 4,068 - - - - - - - - Ten years later 3,497 - - - - - - - - - Liability re-estimated: One year later 3,131 3,696 4,209 4,883 5,237 5,679 5,766 5,794 5,625 5,308 Two years later 3,249 3,914 4,444 4,943 5,485 5,800 5,906 5,922 5,644 - Three years later 3,384 4,168 4,586 5,109 5,566 5,960 6,150 5,974 - - Four years later 3,563 4,341 4,722 5,287 5,761 6,245 6,216 - - - Five years later 3,696 4,457 4,917 5,442 6,029 6,331 - - - - Six years later 3,778 4,631 5,049 5,700 6,125 - - - - - Seven years later 3,932 4,743 5,279 5,788 - - - - - - Eight years later 4,039 4,954 5,365 - - - - - - - Nine years later 4,220 5,032 - - - - - - - - Ten years later 4,288 - - - - - - - - - Cumulative (deficiency) excess (1,471) (1,522) (1,275) (1,044) (917) (864) (580) (258) (80) 8 Analysis of Gross Loss and Gross Loss Expense Reserve Development* At December 31 (in millions) 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 Net reserve $ - $ - $ - $ - $ - $ - $ - $ - $ - $5,316 $5,142 Reinsurance recoverables - - - - - - - - - 1,054 1,016 Gross reserve - - - - - - - - - 6,370 6,158 Net re-estimated reserve - - - - - - - - - 5,308 Re-estimated reinsurance recoverables - - - - - - - - - 1,044 Gross re-estimated reserve - - - - - - - - - 6,352 Gross cumulative excess $ - $ - $ - $ - $ - $ - $ - $ - $ - $ 18
*Certain reserves are recorded on a discounted basis to reflect the value of timing differences between the recording of reserves and subsequent payment. The amortization of that discount is included in the reserve deficiencies shown above. Conditions and trends that have affected reserve development in the past have changed and may not necessarily occur in the future. Therefore, care should be exercised in extrapolating future reserve redundancies or deficiencies from such development. The net development table shows a $8 million decrease in the current year on prior year incurred loss and loss expenses net of ceded reinsurance. Although the overall development is flat, there are a number of offsetting occurrences. Adverse development resulted from discount amortization in workers' compensation and reserve strengthening in general liability for environmental and asbestos liabilities. The adverse development was offset by favorable development in both personal and commercial auto liability. A decrease of $18 million in the current year on prior year incurred loss and loss expenses gross of ceded reinsurance is shown on the gross development table. The gross development table shows more favorable development than the net development table due to favorable development on losses ceded to reinsurers. Effect of Reserve Re-estimations on Calendar Year Operations (increase) decrease in reserves Accident (in millions) 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 Year Accident Years: 1984 & Prior $(314) $(118) $(135) $(179) $(133) $ (82) $(154) $(107) $(181) $ (68) $(1,471) 1985 - (68) (83) (75) (40) (34) (20) (5) (30) (10) (365) 1986 - - 99 19 31 (20) (21) (20) (19) (8) 61 1987 - - - 96 82 (30) 17 (23) (28) (2) 112 1988 - - - - 31 (82) 97 (40) (10) (8) (12) 1989 - - - - - 36 (40) 35 (17) 10 24 1990 - - - - - - (9) 20 41 20 72 1991 - - - - - - - 62 116 14 192 1992 - - - - - - - - 67 33 100 1993 - - - - - - - - - 27 27 Total by calendar year $(314) $(186) $(119) $(139) $ (29) $(212) $(130) $ (78) $ (61) $ 8 $(1,260)
In the table above all entries are shown net of ceded reinsurance. Each column total shows reserve re-estimates made in the indicated calendar year for each accident year. Adverse development on accident years prior to 1986 is primarily attributable to workers' compensation discount amortization and environmental and asbestos reserve strengthening. Ongoing review of automobile liability reserves indicates more favorable projections of ultimate incurred loss than previously recognized on accident years 1991 and subsequent. 1.6e. Loss portfolio transfers Also included in the table "Analysis of Net Loss and Net Loss Expense Reserve Development" are various loss portfolio transfer transactions. These transactions are reinsurance contracts that do not involve the same type of risk as traditional reinsurance. In a loss portfolio reinsurance contract, USF&G Company assumes another insurer's outstanding loss reserves for a price equal to their discounted value plus a fee. These contracts generally provide for fixed loss payments at specified future dates. The financial risk involved is whether the investment income earned on the cash received will cover the discount associated with the losses assumed. This financial risk is controlled by the Corporation's asset/liability management techniques, which involve matching the maturities of the investment portfolio to expected patterns of future claim and benefit payments. Loss portfolio transfers have had no impact on reported reserve deficiencies and no future loss development, either adverse or favorable, is anticipated. Loss portfolio transfers included in outstanding reserves were as follows: (in millions) 1994 $ 86 1993 110 1992 123 1991 279 1990 324 1989 397 1988 394 1987 355 1.6f. Structured settlements Structured settlements represent the settlement of claims through the purchase of annuities. While they result in accelerated claim payments, structured settlements generally reduce the ultimate amount of losses paid. Structured settlements are used primarily in the third-party liability and workers' compensation lines of business. These types of settlements were not used extensively on liability lines until 1985. Their use was extended to workers' compensation claims in 1987. The number of such settlements has grown steadily and they appear to be having an impact on claim payment patterns. USF&G Company has developed procedures to ensure that the impact of structured settlements is given appropriate recognition in estimating ultimate reserve liabilities. 1.6g. Reconciliation of liability for loss and loss expenses from SAP to GAAP The following table presents the differences between property/casualty insurance claim reserves reported in accordance with GAAP in the consolidated financial statements in the 1994 Annual Report to Shareholders (Restated), and the consolidated annual statement filed with state insurance departments in accordance with statutory accounting practices ("SAP"): At December 31 (in millions) 1994 1993 1992 SAP basis property/casualty reserves $4,875 $ 5,001 $5,385 Reserves of foreign subsidiaries (consolidated for GAAP but not SAP) 267 315 240 Estimated salvage and subrogation recoveries (primarily on property and surety lines, cash basis for SAP but accrual basis for GAAP until 1993), plus other material items - - (61) GAAP basis property/casualty reserves, net 5,142 5,316 5,564 Reinsurance receivable 1,016 1,054 N/A GAAP basis property/casualty reserves, gross 6,158 6,370 5,564 Reserves of life insurance subsidiaries, net 3,798 3,969 3,896 Reinsurance receivable 6 4 N/A Reserves of life insurance subsidiaries, gross 3,804 3,973 3,896 Total liability on GAAP basis $9,962 $10,343 $9,460 1.7. Life benefit reserves Ordinary life insurance future policy benefit reserves are computed under the net level premium method using assumptions for future investment yields, mortality, and withdrawal rates. These assumptions reflect F&G Life's experience, modified to reflect anticipated trends, and provide for possible adverse deviation. Reserve interest rate assumptions are graded and range from 4.25 percent to 8.25 percent. Universal life and annuity reserves are computed on the retrospective deposit method, which produces reserves equal to the cash value of the contracts. Such reserves are not reduced for charges that would be deducted from the cash value of policies surrendered. Reserves on single premium annuities with guaranteed payments are computed on the prospective deposit method, which produces reserves equal to the present value of future benefit payments. The table below shows F&G Life's benefit reserves by policy type. At December 31 (in millions) 1994 1993 1992 Single Premium Annuities: Deferred $1,860 $2,138 $2,077 Immediate 867 815 788 Other annuities 492 462 508 Universal life/term/group life 579 554 523 Total, net 3,798 3,969 3,896 Reinsurance receivable 6 4 N/A Total, gross $3,804 $3,973 $3,896 1.8. Geographical distribution The risks insured by the Corporation's insurance subsidiaries are geographically diversified primarily throughout the United States. The Corporation has established a subsidiary to market fidelity/surety insurance in Canada. Reinsurance risks are incurred throughout North America and specific foreign countries (mainly in Western Europe and Japan). The products marketed by the Corporation's management consulting subsidiary, a part of noninsurance operations, are distributed throughout the world. Total assets and revenues of foreign operations are not material. The tables below show the composition of statutory voluntary direct premiums written for the Corporation's property/casualty operations and statutory premium income of its life insurance operations by region for the year ended 1994. Property/Casualty Voluntary Direct Premiums Written Northeast 29% Southeast 24 Midwest 21 West 18 Mississippi 8 Total 100% Life Statutory Premium Income Northeast 41% Northwest 21 South 14 Southwest 13 Midwest 11 Total 100% 1.9. Executive officers of the Registrant Positions and Office with Registrant or Name Age Significant Subsidiaries Norman P. Blake, Jr. 53 Chairman of the Board, President, Chief Executive Officer, and Director Glenn W. Anderson 42 Executive Vice President-Commercial Lines Gary C. Dunton 39 Executive Vice President-Field Operations Dan L. Hale 50 Executive Vice President-Chief Financial Officer Kenneth E. Cihiy 48 Senior Vice President-Claim Paul B. Ingrey 55 President-F&G Re, Inc. Robert J. Lamendola 50 Senior Vice President-Fidelity/Surety James R. Lewis 46 Senior Vice President-Personal Lines Thomas K. Lewis, Jr. 42 Senior Vice President-Chief Information Officer John A. MacColl 46 Senior Vice President-General Counsel and Senior Vice President-Human Resources Andrew A. Stern 37 Senior Vice President-Strategic Planning, Corporate Marketing Harry N. Stout 42 President-F&G Life John C. Sweeney 50 Chairman-Falcon Asset Management, Inc., and Senior Vice President-Chief Investment Officer All persons in the preceding table are officers of the Registrant except Glenn W. Anderson, Gary C. Dunton, Kenneth E. Cihiy, Robert J. Lamendola and James R. Lewis, who are executive officers of United States Fidelity and Guaranty Company (a wholly owned subsidiary of the Registrant); Paul B. Ingrey who is an executive officer of F&G Re, Inc.; and Harry N. Stout who is an executive officer of Fidelity and Guaranty Life Insurance Company. Mr. Blake was Chairman and Chief Executive Officer of Heller International Corporation, a world-wide commercial financial services organization, and joined the Corporation in November 1990. Mr. Anderson was Vice President of Strategic Target Marketing with Fireman's Fund Insurance Company, a domestic insurance company, and joined the Corporation in December 1992. Mr. Dunton was Vice President and Division Manager of Standard Lines with Aetna Life and Casualty Company and joined the Corporation in December 1992. Mr. Hale was President and Chief Executive Officer of Chase Manhattan Leasing Company, an international leasing company, and joined the Corporation in February 1991. Mr. Cihiy was Resident Vice President of Sacramento Field Operations with Aetna Life and Casualty Company, an insurance and financial services company, and joined the Corporation in May 1993. Mr. Ingrey was Resident Vice President and Director of Prudential Reinsurance Company and joined the Corporation in October 1983. Mr. Lamendola was Managing Director of Marsh & McLennan, Inc. and joined the Corporation in June 1992. Mr. James R. Lewis was Senior Vice President and General Manager of CIGNA and joined the Corporation in October 1992. Mr. Thomas K. Lewis, Jr. was Vice President and General Manager for Europe, Middle East, and Africa for Seer Technologies, a joint venture of CS First Boston and IBM, and joined the Corporation in November 1993. Mr. MacColl was previously a partner in the Baltimore office of the law firm of Piper & Marbury, and joined the Corporation in January 1989. Mr. Stern was Partner and Vice President of Booz Allen & Hamilton, a national business consulting firm, and joined the Corporation in May 1993. Mr. Stout was Senior Vice President of United Pacific Life Insurance Company and joined the Corporation in May 1993. Mr. Sweeney was a Principal and Practice Director with Tillinghast/Towers Perrin, an asset management and consulting company, and joined the Corporation in November 1992. Item 2. Business Properties Real estate owned and used in the regular conduct of business consists of 12 business properties located in various cities throughout the United States. The Corporation's Mount Washington Center, located in Baltimore, Maryland, is the principal owned property. This is the headquarters for the life insurance operations, and the location of the information systems, and training and development complexes. In addition, the Corporation leases approximately 120 offices in various cities in the regular course of business. See Note 6 of Notes to the Consolidated Financial Statements. The principal leased property is a 40-story home office building in Baltimore, Maryland, sold in 1984 and leased back by the Corporation. During 1994, the Corporation committed to a plan to consolidate its home office operations in Baltimore, Maryland at its Mount Washington facility. The facilities exit costs of $183 million represent the present value of the rent and other operating expenses to be incurred under the lease on the Corporation's principal office building from the time USF&G vacates the building through the expiration of the lease in 2009. (Refer to Note 6 of the Notes to Consolidated Financial Statements in the Corporation's 1994 Annual Report to Shareholders (Restated).) Item 3. Legal Proceedings The Corporation's insurance subsidiaries are routinely engaged in litigation in the normal course of their business, including defending claims for punitive damages. As a liability insurer, they defend third-party claims brought against their insureds. As an insurer, they defend themselves against coverage claims. In the opinion of management, such litigation and the litigation described in Section 8.1 and 8.2 of Management's Discussion and Analysis of Financial Condition and Results of Operations and Note 13 of the Notes to Consolidated Financial Statements of the 1994 Annual Report to Shareholders (Restated), which section and Note are herein incorporated by reference, is not expected to have a material adverse effect on USF&G Corporation's consolidated financial position, although it is possible that the results of operations in a particular quarter or annual period would be materially affected by an unfavorable outcome. Item 4. Submission of Matters to a Vote of Security Holders There were no matters submitted to a vote of security holders, through the solicitation of proxies or otherwise, during the fourth quarter of 1994. USF&G Corporation Part II Item 5. Market for Registrant's Common Equity and Related Shareholder Matters Market and dividend information for the Corporation's common stock on page 69 of the 1994 Annual Report to Shareholders (Restated) is incorporated herein by reference. Item 6. Selected Financial Data Selected financial data of the Corporation on pages 36 and 37 of the 1994 Annual Report to Shareholders (Restated) is incorporated herein by reference. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Management's Discussion and Analysis on pages 12 through 35 of the 1994 Annual Report to Shareholders (Restated) is incorporated herein by reference. Item 8. Financial Statements and Supplementary Data The consolidated financial statements of the Corporation and notes to such financial statements on pages 38 through 62 of the 1994 Annual Report to Shareholders (Restated) are incorporated herein by reference. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure Not applicable. USF&G Corporation Part III Item 10. Directors and Executive Officers of the Registrant Information regarding the Corporation's executive officers can be found on pages 11 and 12 of this Form 10-K/A. Information regarding the Corporation's directors is incorporated herein by reference to the Election of Directors section of the Corporation's definitive proxy statement for its annual meeting of shareholders which was held May 17, 1995. Item 11. Executive Compensation See the Compensation of Executive Officers and Directors section of the Corporation's definitive proxy statement for its Annual Meeting of Shareholders which was held May 17, 1995, which section is incorporated herein by reference. To the best of the Corporation's knowledge, there were no late filings under Section 16(a) of the Securities Exchange Act of 1934. Item 12. Security Ownership of Certain Beneficial Owners and Management See the Stock Ownership of Certain Beneficial Owners, Directors and Management section of the Corporation's definitive proxy statement for its Annual Meeting of Shareholders which was held May 17, 1995, which section is incorporated herein by reference. Item 13. Certain Relationships and Related Transactions See the Other Information-Certain Business Relationships section of the Corporation's definitive proxy statement for its Annual Meeting of Shareholders which was held May 17, 1995, which section is incorporated herein by reference. USF&G Corporation Part IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (a) (1) Financial Statements The following consolidated financial statements of USF&G Corporation and its subsidiaries, included in the Registrant's 1994 Annual Report to Shareholders (Restated), are incorporated by reference in Item 8: Consolidated Statement of Operations Consolidated Statement of Financial Position Consolidated Statement of Cash Flows Consolidated Statement of Shareholders' Equity Notes to Consolidated Financial Statements Report of Independent Auditors (2) Schedules The following consolidated financial statement schedules of USF&G Corporation and its subsidiaries are included in Item 14(d): Page 20 Schedule I. Summary of Investments-Other than Investments in Related Parties 21-23 Schedule II. Condensed Financial Information of Registrant 24 Schedule III. Supplementary Insurance Information 25 Schedule IV. Reinsurance 26 Schedule VI. Supplemental Information Concerning Consolidated Property/Casualty Insurance Operations All other schedules specified by Article 7 of Regulation S-X are not required pursuant to the related instructions or are inapplicable and, therefore, have been omitted. (3) Exhibits The following exhibits are included in Item 14: Page 27 Exhibit 11 Computation of Earnings Per Share 28 Exhibit 12 Computation of Ratio of Consolidated Earnings to Fixed Charges and Preferred Stock Dividends A copy of all other exhibits not included with this Form 10-K/A may be obtained without charge upon written request to the Secretary at the address shown on page 29 of this Form 10-K/A. Exhibit 3A Charter of USF&G Corporation. Incorporated by reference to Exhibit 3A to the Registrant's Form 10-K for the year ended December 31, 1993, File No. 1-8233. Exhibit 3B Amended By-laws of USF&G Corporation. Exhibit 4A Rights agreement dated as of September 18, 1987, between USF&G Corporation and First Chicago Trust Company of New York (successor to Morgan Shareholder's Service Trust Company) including Form of Rights Certificate. Incorporated by reference to Exhibits 1 and 2 to the Registrant's Form 8-A filed September 30, 1987, File No. 1-8233. Exhibit 4B Bond issuance and payment agreement dated November 16, 1987, for Swiss Franc Public Issue of 5 1/2% Bonds 1988-1996 of Swiss Francs 120,000,000. Incorporated by reference to Exhibit 4M to the Registrant's Form 10-K for the year ended December 31, 1987, File No. 1-8233. Exhibit 4C Indenture dated January 28, 1994, between USF&G Corporation and Chemical Bank. Incorporated by reference to Exhibit 4E to the Registrant's Form 10-K for the year ended December 31, 1993, File No. 1-8233. Exhibit 4D Indenture dated January 28, 1994, between USF&G Corporation and Signet Bank. Exhibit 4E Form of Note dated March 3, 1994, for Zero Coupon Convertible Subordinated Notes due 2009. Incorporated by reference to Exhibit 4 to the Registrant's Form 8-K dated March 3, 1994, File No. 1-8233. Exhibit 4F Form of Note dated June 30, 1994, for 8 3/8% Senior Notes due 2001. Incorporated by reference to Exhibit 4 to the Registrant's Form 8-K dated June 30, 1994, File No. 1-8233. Exhibit 4G Credit Agreement dated as of September 30, 1994, among USF&G Corporation and Morgan Guaranty Trust Company of New York as agent. Incorporated by reference to Exhibit 10 to the Registrant's Form 10-Q for the quarter ended September 30, 1994, File No. 1-8233. Exhibit 4H Credit Agreement dated as of December 1, 1994, among USF&G Corporation and Deutsche Bank AG, as agent. Exhibit 4I Letter of Credit Agreement dated as of October 25, 1994, among USF&G Corporation and The Bank of New York, as agent. Exhibit 10A 1994 Stock Plan For Employees of USF&G. Exhibit 10B Stock Option Plan of 1987. Incorporated by reference to Exhibit 4.1 to the Registrant's Form S-8 dated July 28, 1987, File No. 33-16111. Exhibit 10C Employment Agreement dated November 20, 1990, between the Registrant and Norman P. Blake, Jr. Incorporated by reference to Exhibit 10A to the Registrant's Form 10-K for the year ended December 31, 1990, File No. 1-8233. Exhibit 10D USF&G Supplemental Executive Retirement Agreement between the Registrant and Norman P. Blake, Jr., dated November 20, 1990. Incorporated by reference to Exhibit 10B to the Registrant's Form 10-K for the year ended December 31, 1990, File No. 1-8233. Exhibit 10E Stock Option Plan of 1990. Incorporated by reference to Exhibit 4 to the Registrant's Form S-8 Registration Statement as filed December 7, 1990, File No. 33-38113. Certified Copy of the Board Resolution adopted on December 6, 1990, amending the Stock Option Plan of 1990. Incorporated by reference to Exhibit 10G to the Registrant's Form 10-K for the year ended December 31, 1990, File No. 1-8233. Exhibit 10F Description of Management Incentive Plan. Incorporated by reference to Exhibit 10J to the Registrant's Form 10-K for the year ended December 31, 1990, File No. 1-8233. Exhibit 10G Description of Long-Term Cash Incentive Compensation Plan. Incorporated by reference to Exhibit 10K to the Registrant's Form 10-K for the year ended December 31, 1990, File No. 1-8233. Exhibit 10H Stock Incentive Plan of 1991. Incorporated by reference to Exhibit 4(a) to the Registrant's Form S-8 Registration Statement as filed February 11, 1992, File No. 33-45664. Exhibit 10I Form of Stock Option Agreement used in connection with the Stock Option Plan of 1987, Stock Option Plan of 1990, and Stock Incentive Plan of 1991. Incorporated by reference to Exhibit 10I to the Registrant's Form 10-K for the year ended December 31, 1993, File No. 1-8233. Exhibit 10J 1993 Stock Plan for Non-Employee Directors. Incorporated by reference to Exhibit 10N to the Registrant's Form 10-K for the year ended December 31, 1992, File No. 1-8233. Exhibit 10K Employment Agreement dated November 10, 1993, between the Registrant and Norman P. Blake, Jr. Incorporated by reference to Exhibit 10K to the Registrant's Form 10-K for the year ended December 31, 1993, File No. 1-8233. Exhibit 10L Stock Option Agreement dated November 10, 1993, between the Registrant and Norman P. Blake, Jr. Incorporated by reference to Exhibit 10L to the Registrant's Form 10-K for the year ended December 31, 1993, File No. 1-8233. Exhibit 10M Stock Option Agreement dated November 10, 1993, between the Registrant and Norman P. Blake, Jr. Incorporated by reference to Exhibit 10M to the Registrant's Form 10-K for the year ended December 31, 1993, File No. 1-8233. Exhibit 10N Waiver dated November 10, 1993, between the Registrant and Norman P. Blake, Jr. Incorporated by reference to Exhibit 10N to the Registrant's Form 10-K for the year ended December 31, 1993, File No. 1-8233. Exhibit 10O First Amendment to USF&G Supplemental Executive Retirement Agreement between the Registrant and Norman P. Blake, Jr. dated November 10, 1993. Incorporated by reference to Exhibit 10O to the Registrant's Form 10-K for the year ended December 31, 1993, File No. 1-8233. Exhibit 10P Letter dated November 19, 1992, describing Employment Arrangement between the Registrant and Gary C. Dunton. Incorporated by reference to Exhibit 10K to the Registrant's Form 10-K for the year ended December 31, 1993, File No. 1-8233. Exhibit 10Q USF&G Supplemental Retirement Plan. Incorporated by reference to Exhibit 10Q to the Registrant's Form 10-K for the year ended December 31, 1993, File No. 1- 8233. Exhibit 10R Amended and Restated Stock Incentive Plan of 1991. Exhibit 10S Long-Term Incentive Plan. Exhibit 11 Computation of earnings per share. Exhibit 12 Computation of ratio of consolidated earnings to fixed charges and preferred stock dividends. Exhibit 13 1994 Annual Report to Shareholders (Restated). Exhibit 21 Subsidiaries of the Registrant. Exhibit 23 Consent of Independent Auditors. Exhibit 28 Information from reports furnished to state insurance regulatory authorities. All other exhibits specified by Item 601 of Regulation S-K are not required pursuant to the related instructions or are inapplicable and, therefore, have been omitted. (b) Reports on Form 8-K The Registrant filed a Form 8-K on October 28, 1994, reporting under Item 5, Other Events, a press release announcing call of shares of Series C Cumulative Convertible Preferred Stock. The Registrant filed a Form 8-K on December 21, 1994, reporting under Item 5, Other Events, a press release announcing the signing of a definitive agreement by which USF&G will acquire all of the outstanding Victoria Financial Corporation ("Victoria") stock for approximately $55.3 million of USF&G common stock. The Registrant filed a Form 8-K on January 12, 1995, reporting under Item 5, Other Events, a press release announcing the signing of a definitive agreement by which USF&G will acquire all of the outstanding Discover Re equity for approximately $78.5 million of USF&G common stock and options. The Registrant filed a Form 8-K on January 20, 1995, reporting under Item 5, Other Events, a press release announcing information as to fourth quarter earnings expectations in addition to an announcement relating to plans to consolidate its Baltimore facilities. The Registrant filed a Form 8- K on January 25, 1995, reporting under Item 5, Other Events, a press release announcing its call for redemption of all outstanding shares of Series C Cumulative Convertible Preferred Stock. USF&G Corporation Signatures Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized. USF&G CORPORATION NORMAN P. BLAKE, JR. Norman P. Blake, Jr. Chairman of the Board, President, and Chief Executive Officer Dated at Baltimore, Maryland October 6, 1995 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. Principal Executive Officer: NORMAN P. BLAKE, JR. Norman P. Blake, Jr. Chairman of the Board, President, Chief Executive Officer, and Director Principal Financial and Accounting Officer: DAN L. HALE Dan L. Hale Executive Vice President and Chief Financial Officer Dated at Baltimore, Maryland October 6, 1995 Directors H. FURLONG BALDWIN H. Furlong Baldwin MICHAEL J. BIRCK Michael J. Birck GEORGE L. BUNTING, JR. George L. Bunting, Jr. ROBERT E. DAVIS Robert E. Davis DALE F. FREY Dale F. Frey ROBERT E. GREGORY, JR. Robert E. Gregory, Jr. ROBERT J. HURST Robert J. Hurst WILBUR G. LEWELLEN Wilbur G. Lewellen HENRY A. ROSENBERG, JR. Henry A. Rosenberg, Jr. LARRY P. SCRIGGINS Larry P. Scriggins ANNE MARIE WHITTEMORE Anne Marie Whittemore R. JAMES WOOLSEY R. James Woolsey USF&G Corporation Schedule I. Summary of Investments-Other Than Investments in Related Parties At December 31, 1994* Amount at which shown Market in the Statement of (in millions) Cost Value Financial Position Fixed Maturities Bonds: Held to maturity: United States Government and government agencies and authorities $ 1,291 $ 1,211 $ 1,291 States, municipalities, and political subdivisions 107 102 107 Foreign governments 15 14 15 Public utilities 265 240 265 All other corporate bonds 2,981 2,717 2,981 Total fixed maturities held to maturity 4,659 4,284 4,659 Available for sale: United States Government agencies and authorities 784 752 752 States, municipalities, and political subdivisions 258 253 253 Foreign governments 108 92 92 Public utilities 143 136 136 All other corporate bonds 2,972 2,848 2,848 Total fixed maturities available for sale 4,265 4,081 4,081 Total fixed maturities $ 8,924 $ 8,365 $ 8,740 Equity Securities Common stocks: Banks, trust, and insurance companies $ 2 $ 1 $ 1 Industrial, miscellaneous, and all other 51 45 45 Total common stocks 53 46 46 Nonredeemable preferred stocks 26 26 26 Total equity securities $ 79 $ 72 $ 72 Short-term investments 450 450 450 Mortgage loans 349 331 349 Real estate 662 662 Other invested assets 288 288 Total investments $10,752 $10,561 *Amounts have been restated to reflect mergers with Discover Re Managers, Inc., and Victoria Financial Corporation. USF&G Corporation Schedule II. Condensed Financial Information of Registrant- Statement of Financial Position (Parent Company) At December 31 (in millions) 1994 1993 1992 Assets Cash $ 1 $ 2 $ 10 Investment in subsidiaries, at equity 2,503 2,399 2,127 Due from subsidiaries 131 127 135 Other assets 24 23 34 Total assets $2,659 $2,551 $2,306 Liabilities Debt (short-term, 1994, $215; 1993, $395; 1992, $375) $ 586 $ 574 $ 574 Dividends payable to shareholders 14 16 16 Due to subsidiaries 310 322 335 Other liabilities 308 83 81 Total liabilities 1,218 995 1,006 Shareholders' Equity Preferred stock 331 455 455 Common stock 262 228 225 Paid-in capital 1,104 986 971 Net unrealized gains (losses) on investments (147) 191 (29) Minimum pension liability (63) (85) - Retained earnings (deficit) (46) (219) (322) Total shareholders' equity 1,441 1,556 1,300 Total liabilities and shareholders' equity $2,659 $2,551 $2,306 See Note to Condensed Financial Statements. Statement of Operations (Parent Company) Years Ended December 31 (in millions) 1994 1993 1992 Revenues Net investment income: Dividends from subsidiaries $125 $125 $125 Interest expense on loans from subsidiaries (8) (6) (7) Other (1) - - Other revenues: From subsidiaries 7 7 9 From others 5 5 22 Total revenues 128 131 149 Expenses Facilities exit costs 211 - - Interest expense 34 37 43 Lease expense 30 21 21 Other operating expense 24 19 20 299 77 84 Foreign currency losses - - 1 Total expenses 299 77 85 Income (loss) from continuing operations before income taxes and equity in earnings of subsidiaries and cumulative effect of adopting new accounting standards (171) 54 64 Provision for income taxes - - - Income (loss) from continuing operations before equity in earnings of subsidiaries and cumulative effect of adopting new accounting standards (171) 54 64 Equity in undistributed earnings of subsidiaries: Continuing operations 408 76 (28) Discontinued operations - - (7) Income from cumulative effect of adopting new accounting standards - 38 - Net income $237 $168 $ 29 See Note to Condensed Financial Statements. Statement of Cash Flows (Parent Company) Years Ended December 31 (in millions) 1994 1993 1992 Net Cash Provided From Operating Activities $ 129 $ 58 $ 71 Investing Activities Purchases of short-term investments - - (23) Sales or maturities of short-term investments - - 23 Other, net (4) (4) (12) Net cash used in investing activities (4) (4) (12) Financing Activities Repayments of short-term borrowings (160) - - Intercompany advances, net (51) (2) 49 Long-term borrowings 270 - - Repayments of long-term borrowings (120) - (36) Issuances of common stock 14 6 3 Redemption of preferred stock (13) - - Cash dividends paid to shareholders (66) (66) (66) Net cash provided from (used in) financing activities (126) (62) (50) Increase (decrease) in cash (1) (8) 9 Cash at beginning of year 2 10 1 Cash at end of year $ 1 $ 2 $ 10 See Note to Condensed Financial Statements. Note to Condensed Financial Statements The accompanying condensed financial statements should be read in conjunction with the consolidated financial statements and notes thereto of the 1994 Annual Report to Shareholders (Restated) incorporated herein by reference. Amounts have been restated to reflect mergers with Discover Re Managers, Inc., and Victoria Financial Corporation, which were completed during the second quarter of 1995. Restatement of prior periods is provided due to the application of the pooling- of-interests method of accounting. Certain amounts have been reclassified to conform to the 1994 presentation. The parent company's provision for income taxes is based on the Corporation's consolidated federal income tax allocation policy. USF&G Corporation Schedule III. Supplementary Insurance Information At December 31* Years Ended December 31* Deferred Unpaid Other Amortization policy losses, loss policy- Net Losses, loss of deferred Other acquisi- expenses, Unearned holders' investment expenses, policy operating tion & policy premiums funds Premium income & policy acquisition expenses Premiums (in millions) costs benefits (B) (B) (A) revenue (A) benefits costs (A) written 1994 Property/casualty insurance: Commercial $161 $ 3,891 $455 $1,189 $ 929 $354 $ 97 $1,200 Personal 71 471 253 575 427 151 45 565 Reinsurance 9 668 41 395 289 67 27 415 Fidelity/surety 30 54 65 124 46 60 17 134 Discover Re and Victoria 9 58 37 73 53 15 15 77 Reinsurance receivable - 1,016 117 - - - - - Other - - - - - - - (2) Property/ casualty 280 6,158 968 $ 7 2,356 $432 1,744 647 201 2,389 Life insurance 224 3,804 - 79 152 317 388 21 45 N/A Total $504 $ 9,962 $968 $86 $2,508 $749 $2,132 $668 $246 $2,389 1993 Property/casualty insurance: Commercial $168 $ 4,108 $444 $1,223 $1,014 $359 $ 71 $1,239 Personal 69 553 264 681 481 175 46 653 Reinsurance 6 559 29 305 204 71 28 403 Fidelity/surety 28 56 56 118 59 59 9 120 Discover Re and Victoria 9 40 33 65 47 12 11 73 Reinsurance receivable - 1,054 124 - - - - - Other - - - - - - - 14 Property/ casualty 280 6,370 950 $ 7 2,392 $432 1,805 676 165 2,502 Life insurance 164 3,973 - 67 129 321 395 9 50 N/A Total $444 $10,343 $950 $74 $2,521 $753 $2,200 $685 $215 $2,502 1992 Property/casualty insurance: Commercial $170 $ 4,348 $420 $1,480 $1,299 $426 $ 86 $1,356 Personal 76 626 286 785 635 210 42 727 Reinsurance 3 511 11 157 118 22 25 243 Fidelity/surety 28 55 53 111 36 55 19 109 Discover Re and Victoria 6 24 27 46 32 9 9 55 Other - - - - - - - (15) Property/ casualty 283 5,564 797 $ 9 2,579 $471 2,120 722 181 2,475 Life insurance 189 3,896 - 56 104 349 377 25 51 N/A Total $472 $ 9,460 $797 $65 $2,683 $820 $2,497 $747 $232 $2,475 *Amounts have been restated to reflect mergers with Discover Re Managers, Inc., and Victoria Financial Corporation. N/A - Not applicable to life insurance pursuant to Rule 12-16 of Regulation S-X. (A) Other policyholders' funds, net investment income, and other operating expenses are not allocated to property/casualty categories. (B) Unpaid losses and loss expenses reflect the implementation of SFAS No. 113, "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts," which increased liabilities by $1.2 billion with a corresponding increase in assets at December 31, 1993. This standard requires reinsurance receivables and prepaid reinsurance premiums to be reported separately as assets instead of the previous practice of netting such receivables against the related loss and unearned premium liabilities. USF&G Corporation Schedule IV. Reinsurance Years Ended December 31* Ceded to Assumed Percentage of Gross other from other Net amount (in millions) amount companies companies amount assumed to net 1994 Life insurance in force $11,683 $1,350 $160 $10,493 1.5% Premiums earned: Life insurance $ 155 $ 4 $ - $ 151 -% Accident/health insurance - - 1 1 98.5 Property/casualty insurance 2,284 516 588 2,356 25.0 Total $ 2,439 $ 520 $589 $ 2,508 23.5% 1993 Life insurance in force $11,955 $1,404 $155 $10,706 1.4% Premiums earned: Life insurance $ 133 $ 5 $ - $ 128 -% Accident/health insurance - - 1 1 99.1 Property/casualty insurance 2,390 521 523 2,392 21.9 Total $ 2,523 $ 526 $524 $ 2,521 20.8% 1992 Life insurance in force $12,228 $1,444 $132 $10,916 1.2% Premiums earned: Life insurance $ 107 $ 5 $ 1 $ 103 .3% Accident/health insurance - - 1 1 94.0 Property/casualty insurance 2,734 539 384 2,579 14.9 Total $ 2,841 $ 544 $386 $ 2,683 14.4% *Amounts have been restated to reflect mergers with Discover Re Managers, Inc., and Victoria Financial Corporation. USF&G Corporation Schedule VI. Supplemental Information Concerning Consolidated Property/Casualty Insurance Operations At December 31 (in millions) 1994* 1993* 1992* Deferred policy acquisition costs $ 280 $ 280 $ 283 Reserves for unpaid losses and loss expenses (A) 6,158 6,370 5,564 Discount deducted from reserves (B) 441 508 680 Unearned premiums (A) 968 950 797 (A) Reserves for unpaid claims and claim adjustments reflect the implementation of SFAS No. 113, "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts," which increased liabilities by $1.2 billion with a corresponding increase in assets at December 31, 1993. This standard requires reinsurance receivables and prepaid reinsurance premiums to be reported separately as assets instead of the previous practice of netting such receivables against the related loss and unearned premium liabilities. (B) Certain long-term disability payments for workers' compensation are discounted at rates ranging from 3% to 5%. Years Ended December 31 (in millions) 1994* 1993* 1992* Earned premiums $2,356 $2,392 $2,579 Net investment income 432 432 471 Losses and loss expenses incurred related to: Current year 1,752 1,744 2,042 Prior years (8) 61 78 Amortization of deferred policy acquisition costs 647 676 722 Paid losses and loss expenses 1,918 2,053 2,272 Premiums written 2,389 2,502 2,475 *Amounts have been restated to reflect mergers with Discover Re Managers, Inc., and Victoria Financial Corporation. USF&G Corporation Exhibit 11 - Computation of Earnings per Share Years Ended December 31 (dollars in millions except per share data) 1994* 1993* 1992* Net Income Available to Common Stock Primary: Income from continuing operations before cumulative effect of adopting new accounting standards $ 237 $ 130 $ 36 Less preferred stock dividend requirements (46) (48) (48) Income (loss) from continuing operations before cumulative effect of adopting new accounting standards available to common stock 191 82 (12) Loss from discontinued operations - - (7) Income from cumulative effect of adopting new accounting standards - 38 - Net income (loss) available to common stock $ 191 $ 120 $ (19) Fully diluted: Income from continuing operations before cumulative effect of adopting new accounting standards $ 237 $ 130 $ 36 Less preferred stock dividend requirements (16) (16) (48) Add interest expense on zero coupon bonds 5 - - Income (loss) from continuing operations before cumulative effect of adopting new accounting standards available to common stock 226 114 (12) Loss from discontinued operations - - (7) Income from cumulative effect of adopting new accounting standards - 38 - Net income (loss) available to common stock $ 226 $ 152 $(19) Weighted Average Shares Outstanding Primary common shares (A) 95,796,671 90,566,398 89,235,158 Fully diluted (B): Common shares 95,796,671 90,566,398 89,235,158 Assumed conversion of preferred stock 24,950,202 26,611,211 - Assumed exercise of stock options 1,038,214 1,672,482 - Assumed conversion of zero coupon bonds 6,022,712 - - Total fully diluted 127,807,799 118,850,091 89,235,158 Earnings Per Common Share Primary (A): Income (loss) from continuing operations before cumulative effect of adopting new accounting standards $2.00 $ .90 $(.14) Loss from discontinued operations - - (.08) Income from cumulative effect of adopting new accounting standards - .42 - Net income (loss) $2.00 $1.32 $(.22) Fully diluted (B): Income (loss) from continuing operations before cumulative effect of adopting new accounting standards $1.77 $ .96 $(.14) Loss from discontinued operations - - (.08) Income from cumulative effect of adopting new accounting standards - .32 - Net income (loss) $1.77 $1.28 $(.22) *Amounts have been restated to reflect mergers with Discover Re Managers, Inc., and Victoria Financial Corporation. (A) Shares issuable under stock options (1,021,230 shares in 1994, 1,672,482 shares in 1993, 876,839 shares in 1992) have not been used as common stock equivalents in the computation of primary earnings per common share presented on the face of the Consolidated Statement of Operations because the dilutive effect is not material. (B) Fully diluted earnings per common share amounts are calculated assuming the conversion of all securities whose contingent issuance would have a dilutive effect on earnings. The effect of assuming conversion of the preferred stock (30,959,211 shares in 1992) is antidilutive and, therefore, the amounts presented in the Consolidated Statement of Operations for primary and fully diluted earnings per share are the same. Shares issuable under stock options (1,151,647 in 1992) have not been used as common stock equivalents because the dilutive effect is not material. USF&G Corporation Exhibit 12 - Computation of Ratio of Consolidated Earnings to Fixed Charges and Preferred Stock Dividends Years Ended December 31 (dollars in millions) 1994* 1993* 1992* Fixed Charges Interest expense $ 37 $ 41 $ 41 Interest capitalized - - 8 Portion of rents representative of interest (A) 159 27 28 Total fixed charges 196 68 77 Preferred stock dividend requirements (B) 46 48 48 Combined Fixed Charges and Preferred Stock Dividends $242 $116 $125 Consolidated Earnings Available for Fixed Charges and Preferred Stock Dividends Income (loss) from continuing operations before income taxes and cumulative effect of adopting new accounting standards $(43) $103 $ 36 Adjustments: Fixed charges 196 68 77 Less interest capitalized during the period - - (8) Consolidated earnings available for fixed charges and preferred stock dividends $153 $171 $105 Ratio of Consolidated Earnings to Fixed Charges (C) (D) 0.8 2.5 1.4 Ratio of Consolidated Earnings to Combined Fixed Charges and Preferred Stock Dividends (C) (D) 0.6 1.5 0.8 * Amounts have been restated to reflect mergers with Discover Re Managers, Inc., and Victoria Financial Corporation. (A) Includes approximately $130 million net present value of rents representative of interest included in facilities exit costs in 1994. (B) Preferred stock dividend requirements of $46 million in 1994 and $48 million in both 1993 and 1992 divided by 100% less the effective income tax rate of 0% in 1994, 1993, and 1992. (C) In 1994, the ratio of consolidated earnings before facilities exit costs to fixed charges was 3.1, and the ratio of consolidated earnings before facilities exit costs to combined fixed charges and preferred stock dividends was 1.8. (D) In 1994, earnings were inadequate to cover fixed charges by $43 million and combined fixed charges and preferred stock dividends by $89 million. UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 EXHIBITS TO ANNUAL REPORT ON FORM 10-K/A USF&G CORPORATION For the Fiscal Year Ended Commission File Number December 31, 1994 1-8233 A copy of all other of the Corporation's Exhibits to the 1994 Form 10-K/A report not included herein may be obtained without charge upon written request to John F. Hoffen, Jr., Corporate Secretary at the corporate headquarters: 100 Light Street Baltimore, Maryland 21202
EX-13 2 USF&G Corporation Management's Discussion and Analysis of Financial Condition and Results of Operations This section provides management's assessment of financial results and material changes in financial position for USF&G Corporation and its two primary subsidiaries, United States Fidelity and Guaranty Company ("USF&G Company") and Fidelity and Guaranty Life Insurance Company ("F&G Life"), (collectively, "USF&G" or "the Corporation") and discusses the results of operations for the year ended December 31, 1994. The analysis focuses on the performance of USF&G's business segments and its investment portfolio. Amounts have not been restated for the mergers with Discover Re Managers, Inc. ("Discover Re"), and Victoria Financial Corporation ("Victoria"). The mergers are accounted for as poolings-of-interests; therefore, the consolidated financial statements and notes thereto have been restated. A reconciliation of the previously separate enterprises to the restated financial statements is included as Note 1.11 to the consolidated financial statements. Separate discussions regarding Discover Re and Victoria are included at Section 2a and Section 2b of this Analysis, respectively. (Note: A glossary of certain terms used in this discussion can be found at the end of this section. The terms are italicized the first time they appear in the text.) Index 1. Consolidated Results 12 2. Property/Casualty Insurance Operations 13 2a. Discover Re 21 2b. Victoria 22 3. Life Insurance Operations 22 4. Parent and Noninsurance Operations 24 5. Investments 24 6. Financial Condition 29 7. Liquidity 30 8. Regulation 31 9. Income Taxes 33 10. Glossary of Terms 35 1. Consolidated Results 1.1. Summary of net income The table below shows the major components of net income. (in millions) 1994 1993 1992 Income (loss) from continuing operations before realized gains, facilities exit costs, income taxes and cumulative effect of adopting new accounting standards $ 129 $ 3 $(113) Net realized gains on investments 5 6 148 Facilities exit costs (183) - - Loss from discontinued operations - - (7) Income tax benefit 281 28 - Income (loss) from cumulative effect of adopting new accounting standards: Income taxes - 90 - Postretirement benefits - (52) - Net income $ 232 $ 165 $ 28 The table below shows the components by major business segment of income (loss) from continuing operations before realized gains, facilities exit costs, income taxes and cumulative effect of adopting new accounting standards. (in millions) 1994 1993 1992 Property/casualty insurance $194 $182 $ (3) Life insurance 14 (6) (4) Parent and noninsurance (79) (83) (106) Income (loss) from continuing operations before realized gains, facilities exit costs, income taxes and cumulative effect of adopting new accounting standards $129 $ 93 $(113) Property/casualty insurance segment income (loss) from continuing operations before realized gains, facilities exit costs, income taxes and cumulative effect of adopting new accounting standards increased $12 million from 1993 to 1994 due to improved underwriting results. The life insurance segment's $20 million improvement from 1993 to 1994 was due to the combined effects of higher product sales and improved spreads on annuity products. The major factors influencing the improvement in the parent and noninsurance segment for 1994 are the improved results from noninsurance subsidiaries and reduced interest expense partially offset by a loss on long-term subleases. Other items affecting net income include a $183 million charge related to the planned consolidation of the Corporation's Baltimore headquarters facilities (refer to Section 1.2 of this Analysis). Also included in net income is a $281 million income tax benefit primarily related to the recognition of deferred tax assets (refer to Section 9 of this Analysis). The $137 million improvement in net income from 1992 to 1993 was driven by a $200 million improvement in property/casualty underwriting results. The 1992 net income included $51 million in restructuring charges related to branch office consolidation which has been completed. 1.2. Facilities exit costs As a result of USF&G's restructuring activities in the early 1990s and ongoing efforts to improve the overall cost effectiveness of the Corporation, USF&G's available headquarters office space significantly exceeds it needs, particularly at the 40-story office building ("the Tower") in downtown Baltimore. USF&G sold the Tower in 1984 and subsequently leased it back. Since 1991, the total headquarters staff has decreased by approximately 28 percent, including a 48 percent decrease in the number of employees who are located at the Tower. During 1994, USF&G developed and committed to a plan to consolidate its Baltimore headquarters facilities. The plan encompasses relocating all USF&G personnel currently residing at the Tower to the Mount Washington facilities in Baltimore which USF&G owns. Implementation of the plan began in January 1995. The relocation of Tower personnel will begin in mid-1995 and is expected to be completed by the end of 1996. The lease on the Tower, which expires in September 2009, will not be terminated. Approximately 30 percent of the Tower is currently sublet and USF&G intends to sublet the remaining space as it is vacated. The facilities exit costs of $183 million recorded in the fourth quarter of 1994 represent the present value of the rent and other operating expenses incurred under the Tower lease from the time USF&G vacates the Tower through the expiration of the lease in 2009. Approximately $28 million of unamortized deferred gain arising from the 1984 sale-leaseback was also recognized upon adoption of the facilities exit plan. Potential future sublease income was not considered in calculating the facilities exit costs. To the extent that additional or extended subleases are signed in the future, the present value of income to be received over the term of such a sublease will be recognized in the period the sublease is signed. 2. Property/Casualty Insurance Operations Property/casualty insurance operations, the principal business segment, accounted for 84 percent of USF&G's revenues in 1994, compared with 85 percent and 88 percent in 1993 and 1992, respectively, and 67 percent of its assets at December 31, 1994 and 1993, compared with 63 percent at December 31, 1992. Financial results for this segment are as follows: (in millions) 1994 1993 1992 Premiums earned* $ 2,283 $ 2,327 $ 2,533 Losses and loss expenses (1,691) (1,758) (2,088) Underwriting expenses (792) (796) (872) Net underwriting losses (200) (227) (427) Net investment income 423 433 475 Restructuring charges - - (46) Other revenues and (expenses), net (29) (24) (5) Income (loss) from continuing operations before realized gains, facilities exit costs, income taxes and cumulative effect of adopting new accounting standards $ 194 $ 182 $ (3) *See Glossary of Terms Improved underwriting results were the primary reason for the increase in property/casualty income in 1994 when compared with 1993 and 1992 (refer to Section 2.2 of this Analysis). The decrease in net investment income is attributable to an investment base which declined in order to meet cash flow needs (refer to Section 5.1 of this Analysis). The 1993 fluctuation in other revenues and expenses primarily reflects the decision to eliminate certain policyholders' dividends in 1992 and the reversal in that year of previously accrued but unpaid dividends. Restructuring charges relating to branch office consolidations also affected results in 1992. 2.1. Premiums earned Premiums earned totaled $2.3 billion in 1994 and 1993, compared with $2.5 billion in 1992. The table below shows the major components of premiums earned and premiums written. 1994 1993 1992 Premiums Premiums Premiums (in millions) Earned Written Earned Written Earned Written Branch Office Voluntary Production: Direct $1,919 $1,968 $1,949 $1,929 $2,272 $2,128 Ceded reinsurance (150) (162) (124) (124) (85) (85) Net branch office voluntary 1,769 1,806 1,825 1,805 2,187 2,043 Voluntary pools and associations 41 37 45 46 41 44 Involuntary pools and associations 83 70 152 133 163 147 Other premium adjustments (5) (16) - 42 (15) (57) Total primary 1,888 1,897 2,022 2,026 2,376 2,177 Assumed Reinsurance: Finite risk 172 180 169 249 74 171 Traditional risk 223 235 136 154 83 72 Total assumed 395 415 305 403 157 243 Total $2,283 $2,312 $2,327 $2,429 $2,533 $2,420 Direct voluntary premiums written increased two percent in 1994 in response to management's strategies to grow business in targeted market segments. These growth strategies follow planned actions to exit unprofitable markets and product lines in 1993 which had reduced premium production by nine percent in that year. The increase in ceded reinsurance is primarily the result of risk management as part of USF&G's strategy to enter the excess property market in commercial lines. Additionally, USF&G ceded $5 million of catastrophe reinsurance premiums under an assessment by the Florida Hurricane Catastrophe Fund which was established in response to 1992's Hurricane Andrew. Premiums from involuntary pools and associations decreased 47 percent in 1994, after a 10 percent decrease in 1993, as USF&G continued to reduce exposure in these unprofitable markets. Other premium adjustments relate primarily to changes in earned but not reported premiums and unbilled installment premiums. Traditional risk assumed reinsurance premiums increased substantially in 1994 as USF&G expanded into international reinsurance markets, while the demand for finite risk reinsurance has decreased as a result of the new accounting requirements of Statement of Financial Accounting Standards ("SFAS") No. 113 and Emerging Issues Task Force ("EITF") 93-6 which were issued in 1993. The table below shows net premiums earned and the statutory loss ratios by lines of property/casualty insurance including results from voluntary and involuntary pools and associations. The table illustrates the changes in premium mix from 1992 to 1994. Management's focus on reducing exposure to less profitable lines of insurance has been a key factor in the improved underwriting results. The most dramatic examples are the workers' compensation line and assumed reinsurance. Workers' compensation has a cumulative three-year statutory loss ratio of 143.8 and represented 13 percent of total property/casualty premiums earned in 1992 but only 5 percent in 1994. Assumed reinsurance premiums increased from 6 percent of total premiums earned in 1992 to 17 percent in 1994, with a cumulative three-year statutory loss ratio of 69.9 as of December 31, 1994. In 1995, management will continue to develop strategies to achieve a more profitable mix of business by further penetrating target markets, implementing new products and services, and enhancing underwriting and customer service structures through improved technology and performance. 1994 1993 1992 Premiums Statutory Premiums Statutory Premiums Statutory Earned % Loss Ratio Earned % Loss Ratio Earned % Loss Ratio (dollars in millions) Commercial Lines: Auto $ 380 17% 58.8 $ 399 17% 54.8 $ 442 18% 64.5 General liability 357 16 89.4 351 15 80.5 388 15 99.2 Property 326 14 71.8 321 14 60.4 332 13 69.5 Workers' compensation 126 5 121.0 152 7 210.8 318 13 121.0 Total commercial lines 1,189 52 78.1 1,223 53 83.0 1,480 59 86.9 Fidelity/Surety: Fidelity 17 1 29.6 18 1 55.7 19 1 24.6 Surety 107 5 37.8 100 4 49.2 92 3 33.5 Total fidelity/ surety 124 6 36.7 118 5 50.2 111 4 32.0 Personal Lines: Auto 410 18 66.5 504 22 70.3 551 22 73.6 Homeowners 126 5 107.3 149 6 73.3 184 7 102.2 Other personal 39 2 49.1 28 1 65.6 50 2 67.9 Total personal lines 575 25 74.2 681 29 70.7 785 31 80.0 Assumed Reinsurance: Finite risk 172 7 71.9 169 7 70.1 74 3 78.9 Traditional risk 223 10 64.8 136 6 62.1 83 3 72.8 Total assumed reinsurance 395 17 67.9 305 13 67.3 157 6 76.9 Total $2,283 100% 73.1 $2,327 100% 75.4 $2,533 100% 82.0
2.2. Underwriting results Underwriting results represent premiums earned less incurred losses, loss expenses and underwriting expenses. It is not unusual for property/casualty insurance companies to have underwriting losses that are offset by investment income. Underwriting gains (losses) by major business category are as follows: (in millions) 1994 1993 1992 Commercial $(186) $(223) $(343) Fidelity/surety 6 (8) 6 Personal (60) (28) (110) Total primary (240) (259) (447) Assumed reinsurance 40 32 20 Net underwriting losses $(200) $(227) $(427) Voluntary $(179) $(176) $(390) Involuntary (21) (51) (37) Net underwriting losses $(200) $(227) $(427) Consolidated property/casualty underwriting ratios, calculated based on generally accepted accounting principles ("GAAP") and statutory accounting practices, are as follows: 1994 1993 1992 GAAP Underwriting Ratios: Loss ratio 74.0 75.6 82.4 Expense ratio* 34.7 34.2 34.4 Combined ratio 108.7 109.8 116.8 Statutory Underwriting Ratios: Loss ratio 73.1 75.4 82.0 Expense ratio 35.0 33.7 34.9 Combined ratio 108.1 109.1 116.9 *See Glossary of Terms Statutory underwriting ratios exclude the effects of policyholder dividends which, if included, would increase the ratios by 0.3 each year. Underwriting results improved $27 million from 1993 to 1994 and $200 million from 1992 to 1993. The improvements generally resulted from management's actions to improve product/market mix, apply stricter underwriting standards, and improve claims practices, as well as from lower incurred catastrophe losses in 1994 and 1993 when compared to 1992 (refer to Section 2.4 of this Analysis). The rate of improvement in 1994 was not as dramatic as that seen in 1993 since net catastrophe losses were relatively consistent from 1993 to 1994 after decreasing $72 million from 1992 to 1993. Additionally, significant weather related losses not designated as catastrophe losses had an adverse effect on 1994 results, particularly in personal lines. The statutory loss ratio has improved 8.9 points overall since 1992, and 6.7 points in that same period when catastrophe losses are excluded. The overall improvement of $16 million in involuntary underwriting results since 1992 reflects management's actions to reduce exposure to involuntary business in states with substantial involuntary market burdens. The major impact of these actions was felt in 1992 when involuntary underwriting results improved more than $100 million when compared to previous years. While management will remain focused on controlling involuntary underwriting losses, the degree of improvement is expected to be less than that realized in previous years. The increase in involuntary underwriting losses in 1993 over 1992 was primarily due to an assessment of loss reserves from involuntary workers' compensation insurance pools. Improved premium mix and reduced costs have been the main reason for the improved underwriting results since 1990, despite continuing competitive pressures. Management intends to monitor the premium mix and costs and implement other strategies with the goal of continuing the improvement in underwriting results, although such improvements cannot be assured. These strategies include the introduction of specialty products, continued penetration of targeted industries and market segments, further development of underwriting expertise, reduced catastrophe exposure and investments in technological advancements. Management will also continue to focus on improving product pricing, although intense competitive pressures in the property/casualty insurance industry, especially in the pricing of commercial lines products, is expected to continue to restrict underwriting results. Commercial Lines Commercial lines products include property, auto, inland marine, workers' compensation, and general and umbrella liability coverage for businesses. The commercial lines business has two distinct market segments-middle market and small business. USF&G has further defined the middle market into three strategic business units in an effort to better service customers and improve profitability: service businesses, contractors, and manufacturers. The following table shows the components of underwriting results for commercial lines: (in millions) 1994 1993 1992 Premiums Written: Branch office voluntary direct $ 1,210 $ 1,165 $ 1,303 Other, net of ceded reinsurance (11) 82 52 Total premiums written $ 1,199 $ 1,247 $ 1,355 Premiums earned $ 1,189 $ 1,223 $ 1,480 Losses (929) (1,014) (1,299) Expenses (446) (432) (524) Net underwriting losses $ (186) $ (223) $ (343) Voluntary $ (181) $ (187) $ (316) Involuntary (5) (36) (27) Net underwriting losses $ (186) $ (223) $ (343) GAAP and statutory underwriting ratios are as follows: 1994 1993 1992 GAAP Underwriting Ratios: Loss ratio 78.1 83.0 87.8 Expense ratio 37.5 35.3 35.4 Combined ratio 115.6 118.3 123.2 Statutory Underwriting Ratios: Loss ratio 78.1 83.0 86.9 Expense ratio 36.2 34.4 36.3 Combined ratio 114.3 117.4 123.2 Commercial lines branch office voluntary direct premiums written increased 4 percent in 1994, compared with decreases of 11 percent and 20 percent in 1993 and 1992, respectively. The increase is primarily the result of new business growth in targeted market segments. Although net premiums written in the commercial lines business have declined, the largest components of the decline have been the reduced participation in voluntary pools and the decrease in involuntary premium, both of which have benefited net underwriting results. The involuntary business losses were $31 million less in 1994 than in 1993, after increasing $9 million from 1992 to 1993. The improved involuntary results arose primarily from management actions to reduce workers' compensation premiums which led to reduced participation in the involuntary workers' compensation pools. Underwriting results in the commercial lines category improved $37 million over 1993 and $120 million from 1992 to 1993. This improvement is primarily the result of the change in the mix of business and the application of stricter underwriting standards, as well as lower catastrophe losses in 1994 and 1993. In commercial lines, the mix of the least profitable line of business, workers' compensation, with a 1994 statutory loss ratio of 121.0, has decreased from 21 percent of commercial lines premiums earned in 1992 to 11 percent in 1994, while the mix of the two most profitable lines of business, auto and core property, has increased. Commercial auto, with a statutory loss ratio of 58.8 in 1994, increased from 30 percent of commercial lines premiums earned in 1992 to 32 percent in 1994. USF&G's core commercial property business consists of fire/allied and inland marine products, which had a statutory loss ratio of 62.1 in 1994. Premiums from these product lines increased from 15 percent of commercial lines premiums earned in 1992 to 19 percent in 1994. The statutory loss ratio for commercial lines improved 4.9 points in 1994 from 1993 and 8.8 points in 1994 from 1992. Management believes the improved loss ratio trend is evidence of the positive effects of the strategies implemented to improve underwriting results. Also contributing to the improvement over 1992 is the reduction in catastrophe losses (refer to Section 2.4 of this Analysis). Losses incurred from Hurricane Andrew represented approximately 1.6 points of the 1992 commercial lines statutory loss ratio. In January 1995, USF&G entered into a definitive agreement to purchase all of the outstanding equity of Discover Re Managers, Inc. The transaction closed in the second quarter of 1995. See Section 2a of this Analysis. Fidelity/Surety The fidelity/surety segment provides contract and non-contract surety bonds to construction companies, commercial businesses and individuals; financial institution bonds to banks, stockbrokers and credit unions; and fidelity bonds to commercial businesses and governmental entities. The following table shows the components of underwriting results for fidelity/surety: (in millions) 1994 1993 1992 Premiums Written: Branch office voluntary direct $169 $148 $137 Other, net of ceded reinsurance (35) (27) (28) Total premiums written $134 $121 $109 Premiums earned $124 $118 $111 Losses (46) (59) (36) Expenses (72) (67) (69) Net underwriting gains (losses) $ 6 $ (8) $ 6 Voluntary $ 6 $ (8) $ 6 Involuntary - - - Net underwriting gains (losses) $ 6 $ (8) $ 6 GAAP and statutory underwriting ratios are as follows: 1994 1993 1992 GAAP Underwriting Ratios: Loss ratio 36.7 50.2 32.3 Expense ratio 57.9 56.6 62.6 Combined ratio 94.6 106.8 94.9 Statutory Underwriting Ratios: Loss ratio 36.7 50.2 32.0 Expense ratio 54.2 56.0 64.0 Combined ratio 90.9 106.2 96.0 Fidelity/surety experienced an improvement in underwriting results in 1994 due to increased premiums and decreased losses. The regionalization of USF&G's surety business in 1993 led to further penetration of existing contract surety markets in 1994, while new products and further expansion into financial institutions markets resulted in premium growth in the fidelity lines. Losses decreased in 1994 after a $23 million increase in 1993 which was primarily a result of unfavorable loss developments on a limited number of prior years' claims. Personal Lines Personal lines products include auto, homeowners, watercraft and personal excess insurance for individuals and families. The following table shows the components of underwriting results for personal lines: (in millions) 1994 1993 1992 Premiums Written: Branch office voluntary direct $ 589 $ 616 $ 688 Other, net of ceded reinsurance (25) 42 38 Total premiums written $ 564 $ 658 $ 726 Premiums earned $ 575 $ 681 $ 785 Losses (427) (481) (635) Expenses (208) (228) (260) Net underwriting losses $ (60) $ (28) $(110) Voluntary $ (44) $ (13) $(100) Involuntary (16) (15) (10) Net underwriting losses $ (60) $ (28) $(110) GAAP and statutory underwriting ratios are as follows: 1994 1993 1992 GAAP Underwriting Ratios: Loss ratio 74.2 70.6 80.9 Expense ratio 36.3 33.5 33.1 Combined ratio 110.5 104.1 114.0 Statutory Underwriting Ratios: Loss ratio 74.2 70.7 80.0 Expense ratio 36.8 33.7 33.2 Combined ratio 111.0 104.4 113.2 Branch office voluntary premium has declined only 4 percent in 1994, after declining 10 percent in 1993. In 1994, the net premium decrease resulted from management's plans to improve the agency force and exit certain involuntary markets, and from increased ceded reinsurance. The net premium decreases in 1993 were a result of planned management actions to exit certain unprofitable markets and to reduce writings in high risk catastrophe areas. The increased underwriting loss in 1994 is primarily due to increased losses from the homeowners line of business which was adversely affected in 1994 by significantly higher than normal first quarter weather related losses not designated as catastrophe losses. Winter storms and the Northridge earthquake in the first quarter of 1994 produced most of the $32 million in catastrophe losses for the personal lines business, primarily in homeowners. Exclusive of these catastrophe losses, the homeowners statutory loss ratio was 84.2 in 1994, compared with 107.3 when catastrophe losses are included. Although the personal lines statutory loss ratio increased 3.5 points in 1994, almost half of that increase is the result of catastrophe losses. The personal lines statutory loss ratio improved 9.3 points from 1992 to 1993 (a 3.5 point improvement excluding Hurricane Andrew in 1992). Management's strategies to reduce exposure in unprofitable markets and lines of business, including reunderwriting the auto book of business, applying stricter underwriting standards, reducing exposure in certain high risk catastrophe areas and introducing new products, have improved the underwriting results and statutory loss ratios of the auto and other personal lines of business since 1992. These strategies are currently being applied to the homeowners line, and are anticipated to result in improvements in 1995 in selected target markets. Underwriting losses from involuntary markets were relatively consistent from 1993 to 1994, and increased $5 million from 1992 to 1993. The increase in 1993 losses was due to unfavorable development on prior years' claims and costs associated with third party administrators managing the assigned risk involuntary business. In December 1994, USF&G entered into a definitive agreement to purchase all of the outstanding stock of Victoria Financial Corporation. The transaction closed in the second quarter of 1995. See Section 2b of this Analysis. Assumed Reinsurance Reinsurance products are managed by F&G Re and marketed through national and international reinsurance brokers. The reinsurance segment has historically produced underwriting gains. The following table shows the components of underwriting results for assumed reinsurance lines: (in millions) 1994 1993 1992 Premiums written $ 415 $ 403 $ 243 Premiums earned $ 395 $ 305 $ 157 Losses (290) (204) (118) Expenses (65) (69) (19) Net underwriting gains $ 40 $ 32 $ 20 Finite risk $ 12 $ 9 $ 14 Traditional risk 28 23 6 Net underwriting gains $ 40 $ 32 $ 20 GAAP and statutory underwriting ratios are as follows: 1994 1993 1992 GAAP Underwriting Ratios: Loss ratio 73.2 66.7 75.0 Expense ratio 16.5 22.6 12.1 Combined ratio 89.7 89.3 87.1 Statutory Underwriting Ratios: Loss ratio 67.9 67.3 76.9 Expense ratio 22.7 24.6 17.0 Combined ratio 90.6 91.9 93.9 Underwriting results in this category continue to be favorably affected by increased premiums due to the strong demand for reinsurance. Recent large catastrophe losses, such as Hurricane Andrew in 1992 and the Northridge earthquake in 1994, have increased the demand for traditional risk reinsurance in both the international and domestic property catastrophe markets. Net premiums written in the international market for traditional risk assumed reinsurance increased to $120 million in 1994 from $49 million in 1993. This growth in international writings accounts for over 87 percent of the increase in traditional risk premiums written. This increase is offset by the reduced demand for finite risk assumed reinsurance as a result of the accounting requirements of SFAS No. 113 and EITF 93-6 which were issued in 1993. 2.3. Losses incurred and loss reserves Losses and loss expenses incurred totaled $1.7 billion in 1994, compared with $1.8 billion and $2.1 billion in 1993 and 1992, respectively. The reduction is due primarily to lower premium volume and actions taken to better manage claims and claim costs and reduce exposures in undesirable markets. The reduction from 1992 to 1993 is also due to lower catastrophe losses. Reserves for unpaid losses and loss expenses totaled $6.1 billion at December 31, 1994, a decrease of $229 million from December 31, 1993. The impact of adopting SFAS No. 113 increased reserves by $1.2 billion at December 31, 1993 when compared with December 31, 1992. This new accounting standard eliminated the previous practice of reporting assets and liabilities net of the effect of reinsurance. Excluding the effects of SFAS No. 113, reserves in 1993 declined $264 million from 1992. Selected claims information for the property/casualty segment is as follows: (dollars in millions) 1994 1993 1992 At December 31: Net reserves $5,084 $5,276 $5,540 Number of outstanding claims 81,024 91,285 103,952 For the year ended December 31: Losses paid $1,883 $2,022 $2,252 Number of new claims 342,292 352,194 395,697 Although reserve levels have been reduced, the 8 percent decrease in net reserves since 1992 is significantly less than the decreases in earned premiums, losses paid and claim activity over the same period. Earned premiums decreased $250 million, or 10 percent, since 1992, while losses paid decreased 16 percent over the same period. The number of outstanding claims at December 31, 1994 declined by 22 percent compared with December 31, 1992, and the number of new claims reported (excluding catastrophe claims) declined 13 percent from 1992 to 1994. USF&G categorizes environmental, asbestos and other long-term exposures where multiple claims relate to a similar cause of loss (excluding catastrophes) as "common circumstance claims." Reserves for losses that have been reported and certain legal expenses are established on the "case basis." Common circumstance claims which have emerged, while substantial, are a relatively small portion of total claim payments and reserves. Case reserves for these claims are approximately three percent of the total reserves for unpaid losses and loss expenses at December 31, 1994 and 1993. The most significant common circumstance claim exposures include negligent construction, environmental, and asbestos claims. Case reserves for these exposures represent 82 percent of total common circumstance case reserves at December 31, 1994. Other common circumstance claim categories stem from a variety of situations such as lead paint, toxic fumes, breast implants, sexual molestation and other disparate causes, provisions for which are included in the total common circumstance case reserves. The following tables set forth selected information for each of the three primary categories of common circumstance claims, net of ceded reinsurance. Negligent (in millions) Construction Environmental Asbestos Total reserves at December 31, 1991 $ 48 $184 $106 Losses incurred 25 30 33 Claims paid (3) (27) (13) Total reserves at December 31, 1992 70 187 126 Losses incurred 14 99 22 Claims paid (10) (37) (23) Total reserves at December 31, 1993 74 249 125 Losses incurred (6) 106 5 Claims paid (13) (26) (5) Total reserves at December 31, 1994 $ 55 $329 $125 Total Reserves at December 31 (in millions) 1994 1993 1992 Negligent Construction: Case reserves $ 18 $ 14 $ 14 Bulk reserves 37 60 56 Total $ 55 $ 74 $ 70 Environmental: Case reserves $ 65 $ 61 $ 43 Bulk reserves 264 188 144 Total $329 $249 $187 Asbestos: Case reserves $ 25 $ 45 $ 46 Bulk reserves 100 80 80 Total $125 $125 $126 The increase in environmental incurred losses is primarily due to an increased allocation of bulk reserves from other lines of business based on enhancements in the actuarial database with respect to such claims. This reallocation did not effect management's assessment of the overall adequacy of the reserve position. Management believes that USF&G's reserve position is adequate relative to its exposure to environmental and asbestos matters, and compares favorably to other large property/casualty insurers. USF&G's customer base generally does not include large manufacturing companies, which tend to incur most of the known environmental and asbestos exposures. Many of USF&G's environmental claims relate to small industrial or transportation accidents which individually are unlikely to involve material exposures. In addition, USF&G has traditionally been a primary coverage carrier, having written relatively little high-level excess coverage; therefore, liability exposures are generally restricted to primary coverage limits. USF&G's net paid losses and loss expenses for environmental and asbestos claims have averaged approximately $35 million per year over the last five years, or less than two percent of the estimated industry level as of December 31, 1994, while USF&G's related reserves at the end of 1994 are three percent of the estimated industry total. In a study published in 1994, A.M. Best Company, Inc., an insurance industry rating agency, measured the environmental and asbestos reserves held by property/casualty insurers in terms of the number of years the reserves could fund the average rate of payments, described as the "survival ratio." USF&G's survival ratio of approximately 13 years for environmental and asbestos losses is almost double A.M. Best's estimated 1994 industry average. In 1994, approximately 28 percent of paid environmental claims related to matters under which a USF&G insured was a potentially responsible party ("PRP") under the Comprehensive Environmental Response, Compensation and Liability Act, commonly referred to as "Superfund", but many of these PRPs were only peripherally involved. In 1993, 35 percent of the environmental claims paid related to Superfund. The level of loss reserves for both current and prior years' claims is continually monitored and adjusted for changing economic, social, judicial and legislative conditions, as well as for changes in historical trends as information regarding such conditions and actual claims develops. Management believes that loss reserves are adequate, but establishing appropriate reserves, particularly with respect to environmental, asbestos and other long- term exposure claims, is highly judgmental and an inherently uncertain process. It is possible that, as conditions change and claims experience develops, additional reserves may be required in the future. There can be no assurance that such adjustments will not have a material adverse effect on USF&G's results of operations or financial condition. 2.4. Catastrophe losses Gross catastrophe losses totaled $73 million in 1994, compared with $81 million in 1993 and $292 million in 1992. These losses, net of losses ceded to reinsurers, were $67 million in 1994, $68 million in 1993 and $140 million in 1992. Catastrophe losses, net of reinsurance, represented three percent of premiums earned for the years ended December 31, 1994 and 1993, compared with six percent for 1992. Net catastrophe losses in 1994 included $23 million from the Northridge earthquake in February, as well as approximately $26 million from winter storms in the first quarter of the year, while 1993's net catastrophe losses included $27 million from the East Coast blizzard in March 1993. The 1992 losses, the highest in USF&G's history, were primarily from Hurricane Andrew in Florida and hailstorms and tornadoes in Kansas and Oklahoma. 2.5. Ceded reinsurance USF&G reinsures portions of its policy risks with other insurance companies or underwriters. Reinsurance allows USF&G to obtain indemnification against losses associated with insurance contracts it has written by entering into a reinsurance contract with another insurance enterprise (the reinsurer). USF&G pays (cedes) an amount to the reinsurer which in turn agrees to reimburse USF&G for a specified portion of any claims paid under the reinsured contracts. Reinsurance gives USF&G the ability to write certain individually large risks or groups of risks, and helps to control its exposure to losses by ceding a portion of such large risks. USF&G's ceding reinsurance agreements are generally structured on a treaty basis whereby all risks meeting a certain criteria are automatically reinsured. Shrinking capacity in the reinsurance market and the high catastrophe losses in recent years have increased prices and reduced the availability of catastrophe reinsurance. Property catastrophe reinsurance costs were $34 million in 1994 (including a $5 million assessment from the Florida Hurricane Catastrophe Fund), compared with $30 million and $26 million in 1993 and 1992, respectively. The current catastrophe structure shows improvement from prior years by increasing USF&G's total reinsurance protection from $205 million in 1993 to $215 million in 1994, and by providing greater protection in all treaty layers through increased reinsurance placement. USF&G's property catastrophe loss retention level at December 31, 1994 is $75 million, which in the event of a second loss, is lowered to $50 million. Loss retention levels for 1993 and 1992 were $50 million and $23 million, respectively, and did not include any "second event" protection. 2.6. Capacity A key measure of both strength and growth capacity for property/casualty insurers is the ratio of premiums written to statutory policyholders' surplus. At the end of 1994 and 1993, USF&G's premium-to-surplus ratio was 1.4:1, compared with 1.5:1 at the end of 1992. The industry average is approximately 1.3:1. Insurance regulators generally accept a ceiling for this ratio of 3.0:1; therefore, at its current ratio, USF&G has the capacity to grow by writing new business. 2a. Discover Re On April 13, 1995, USF&G consummated its merger with Discover Re. In the transaction, which is accounted for as a pooling-of-interests, USF&G exchanged 5.4 million shares of common stock, worth approximately $78.5 million, for all of the outstanding equity of Discover Re. Discover Re provides insurance, reinsurance and related services to the alternative risk transfer ("ART") market, primarily in the municipalities, transportation, education and retail sectors. Through the ART market, a company can self-insure the predictable, frequency portion of its own losses. The insurance premiums which were previously paid to traditional insurance companies in order to transfer risk are instead used to self-insure those relatively predictable losses and to purchase insurance for the less frequent, high severity losses that could have a major financial impact on a company. Although ART mechanisms reduce the amount of premium to the traditional market, they do not reduce the need for comprehensive risk management services, including policy and claims management and processing, underwriting, actuarial, investment and other administrative management. Also, in some cases, ART clients still require third party insurance policies. The ART market represents approximately 30 percent of the commercial insurance market. This merger facilitates USF&G's access to the ART market and, management believes, provides increased growth potential by augmenting certain of the existing core commercial lines insurance operations. The following table shows the components of underwriting results for Discover Re: (in millions) 1994 1993 1992 Premiums written $ 27 $ 20 $ 12 Premiums earned $ 22 $ 16 $ 8 Losses (17) (13) (6) Expenses (5) (4) (2) Net underwriting losses $ - $ (1) $ - GAAP and statutory underwriting ratios are as follows: 1994 1993 1992 GAAP Underwriting Ratios: Loss ratio 76.2 76.2 80.0 Expense ratio 23.8 26.7 30.3 Combined ratio 100.0 102.9 110.3 Statutory Underwriting Ratios: Loss ratio 76.2 76.2 80.0 Expense ratio 22.6 23.9 28.4 Combined ratio 98.8 100.1 108.4 2b. Victoria On May 22, 1995, USF&G consummated its merger with Victoria. In the transaction, which is accounted for as a pooling-of-interests, USF&G exchanged 3.8 million shares of common stock, worth approximately $59.1 million, for all of the outstanding equity of Victoria. Victoria is an insurance holding company which specializes in nonstandard personal lines auto coverage. Nonstandard automobile insurance companies provide automobile insurance to individuals who are unable to obtain preferred or standard insurance coverage due to their inability to meet certain standard underwriting criteria, based on factors such as age, type of automobile, residence location and driving record. Management believes that this merger will allow USF&G to enhance premium retention and grow the personal lines business through an expanded product portfolio. The following table shows the components of underwriting results for Victoria: (in millions) 1994 1993 1992 Premiums written $ 50 $ 53 $ 43 Premiums earned $ 51 $ 49 $ 38 Losses (36) (34) (26) Expenses (17) (16) (13) Net underwriting losses $ (2) $ (1) $ (1) GAAP and statutory underwriting ratios are as follows: 1994 1993 1992 GAAP Underwriting Ratios: Loss ratio 69.1 70.1 69.1 Expense ratio 31.2 28.5 30.1 Combined ratio 100.3 98.6 99.2 Statutory Underwriting Ratios: Loss ratio 69.1 70.1 69.1 Expense ratio 32.2 28.2 30.3 Combined ratio 101.3 98.3 99.4 3. Life Insurance Operations Life insurance operations (F&G Life) represent 15 percent of USF&G's total revenues in 1994, compared with 14 percent and 13 percent in 1993 and 1992, respectively. F&G Life also represents 33 percent of the assets at December 31, 1994, compared with 34 percent and 37 percent at December 31, 1993 and 1992, respectively. Financial results for F&G Life are as follows: Years Ended December 31 (in millions) 1994 1993 1992 Premiums $ 152 $ 129 $ 104 Net investment income 317 321 349 Policy benefits (388) (395) (377) Underwriting and operating expenses (67) (61) (77) Restructuring charges - - (3) Income (loss) from continuing operations before realized gains, facilities exit costs, income taxes and cumulative effect of adopting new accounting standards $ 14 $ (6) $ (4) Income for the year ended December 31, 1994 improved when compared with 1993 and 1992 as a result of continued positive sales trends and improved profit margins, partially offset by higher sales related expenses. The increase in sales is attributed to the new product initiatives and refocused distribution channels (refer to Section 3.2 of this Analysis). Profit margins improved during the year as current and projected spreads between investment income and interest credited to policyholders improved compared with 1993 levels. This resulted from lower rates being credited to annuities where the guaranteed rate period has expired and improved spread management on new and renewal business. The higher profit margins are also attributable to the favorable retention of the single premium deferred annuity ("SPDA") block, originally sold in 1988 through 1990 by investment brokers (refer to Section 3.3 of this Analysis). The declining trend in net investment income is primarily due to SPDA surrenders which are reducing the level of invested assets. This trend is likely to continue in 1995. This trend was partially offset in 1994 by the recognition of $8 million from the sale of a timber investment. 3.1. Products F&G Life issues annuity and life insurance products. F&G Life's principal products are structured settlements, deferred annuities (including tax sheltered annuities), immediate annuities and life insurance products. Structured settlements are immediate annuities principally sold to the property/casualty company in settlement of insurance claims. Deferred annuity products accumulate cash values to which interest is credited. In 1994, deferred annuities were credited with interest rates that ranged between 4.0 and 9.5 percent, depending upon the year of issue and interest guarantee duration. The majority of deferred annuities in force were issued with initial interest guarantees from one to six years, with most of these written between 1988 and 1990 with a six year interest guarantee. The deferred annuities also include provisions for charges if the annuitant chooses to surrender the policy (see Section 3.3 of this Analysis). After the interest guarantee expires, the interest crediting rates can be adjusted annually on a policy's anniversary date. Deferred annuity products are sold through independent agents, insurance brokers and national wholesale distributors. F&G Life's tax sheltered annuity products ("TSAs") are deferred annuities that provide retirement income. TSAs are sold through a national wholesale distribution network primarily to teachers. Other annuities sold by F&G Life primarily consist of single premium immediate annuities ("SPIAs"). SPIAs provide a fixed stream of payments over a fixed period of time or over an individual's lifetime. F&G Life markets universal life ("UL") and term life insurance products, primarily through independent agents. UL insurance provides a death benefit for the life of the insured and accumulates cash values to which interest is credited. Term life insurance provides a fixed death benefit if the insured dies during the contractual period. 3.2. Sales The following table shows life insurance and annuity sales (premiums and deposits) by distribution system and product type: (in millions) 1994 1993 1992 Distribution System: Direct-structured settlements $ 88 $ 66 $ 37 Property/casualty brokerage 48 49 67 National brokerage 46 14 - National wholesaler 71 39 - Other 33 37 51 Total $286 $205 $155 Product Type: Structured settlement annuities $ 88 $ 66 $ 37 Single premium deferred annuities 82 44 33 Tax sheltered annuities 63 35 - Other annuities 41 54 74 Life insurance 12 6 11 Total $286 $205 $155 Sales in 1994, led by structured settlement annuities, single premium deferred annuities, and tax sheltered annuities, have increased 40 percent over 1993 sales and 85 percent over 1992 sales. In its effort to continue the improvement in sales and profitability, F&G Life intends to continue to concentrate on the expansion of its existing distribution channels while also developing other marketing networks. F&G Life is also continuing the development of selected products, and modifying current product offerings to meet customer needs. Despite F&G Life's attention to expanding its distribution channels and to product development, demand for its products is affected by fluctuating interest rates and the relative attractiveness of alternative investment, annuity or insurance products, as well as its credit ratings. As a result, there is no assurance that the improved sales trend will continue at the same level. Total life insurance in force was $11.8 billion at December 31, 1994, compared with $12.1 billion and $12.4 billion at December 31, 1993 and 1992, respectively. 3.3. Policy surrenders Deferred annuities and universal life products are subject to surrender. Nearly all of F&G Life's surrenderable annuity policies allow a refund of the cash value balance less a surrender charge. The surrender charge varies by product. Single premium deferred annuities, which represent 67 percent of surrenderable business, have surrender charges that decline from six percent in the first policy year to zero percent in the seventh and later policy years. Newer products that have been issued during 1994 have surrender charges that decline from nine percent in the first policy year to zero percent in the tenth and later policy years. Such built-in surrender charges provide protection against premature policy surrender. Policy surrenders totaled $576 million for the year ended December 31, 1994. This compares with $211 million and $192 million for 1993 and 1992, respectively. Surrender activity has increased as a result of expiring surrender charges, primarily on the investment broker block of SPDA, as policyholders seek other investment alternatives. During 1994, management had in place a policy conservation program that provided policyholders with a competitive renewal option within F&G Life once their surrender charge period had expired. Through December 31, 1994, policyholders representing approximately 27 percent of the expiring block elected this option. An additional 23 percent of the expiring block was retained under the terms of the original contract, free of surrender charges and at short-term interest rates which are adjusted annually. The total account value of F&G Life's deferred annuities is $2.3 billion, 15 percent of which is surrenderable at current account value (i.e., without surrender charges). The surrender charge period on an additional $1.3 billion of F&G Life's single premium deferred annuity products expires through the end of 1997, of which $515 million expires during 1995. The experience thus far for $693 million of SPDAs where the surrender charge period expired in the fourth quarter of 1993 through the fourth quarter of 1994 indicates that on average, 50 percent of the expiring block may surrender; however, in the future, a larger percentage may surrender should interest rates continue their upward trend. While this will put pressure on F&G Life's ability to increase assets, given the relatively high interest rates credited when these annuities were issued, overall profit margins would continue to improve as they surrender or rollover to new products with lower rates. Management believes that F&G Life, with liquid assets equal to 124 percent of the surrender value of surrenderable business at December 31, 1994, continues to maintain a high degree of liquidity and has the ability to meet surrender obligations for the foreseeable future. 3.4. Deferred policy acquisition costs ("DPAC") Costs to acquire and issue annuities and life insurance policies are generally deferred and amortized in future periods in relationship to expected gross profits. The recoverability of these amounts is regularly reviewed by management through monitoring of surrender experience, projected investment spreads and other criteria. Policy acquisition costs unfavorably affected results as $4 million, $8 million and $10 million of normally deferrable costs were expensed in 1994, 1993 and 1992, respectively, because surrender experience and sales levels did not support the continued deferral of such costs. During the year ended December 31, 1994, $26 million of current year expense has been deferred compared with $12 million and $11 million for the years ended December 31, 1993 and 1992, respectively. The increase in the deferral is due to the higher level of sales and improved future spread income during 1994 compared with 1993 and 1992. Amortization of the beginning DPAC balance was $21 million, $10 million and $25 million for the years ended 1994, 1993 and 1992, respectively. The rate of amortization in future periods would be accelerated if surrender activity increases and/or product margins permanently narrow. 4. Parent and Noninsurance Operations Parent company interest and other unallocated expenses and net losses from noninsurance operations were as follows: Years Ended December 31 (in millions) 1994 1993 1992 Parent Company Expenses: Interest expense $ (34) $ (37) $ (35) Unallocated expense, net (48) (35) (34) Noninsurance Operations: Management consulting 1 (2) (4) Oil and gas - - (18) Other noninsurance investments 2 (9) (13) Restructuring charges - - (2) Income (loss) from continuing operations before realized gains, facilities exit costs, income taxes and cumulative effect of adopting new accounting standards $ (79) $ (83) $(106) The results for the parent company and noninsurance operations improved slightly when compared to 1993. This improvement was primarily a result of recognizing $6 million of dividend income from an investment in an asset management company, as well as improvements in management consulting operations and certain real estate investments. Unallocated expenses increased over 1993 due primarily to a $9 million non-recurring loss on long-term subleases. Interest expense was slightly lower in 1994 than 1993; however, interest expense is expected to increase in 1995 due to higher short-term interest rates (refer to Section 6 of this Analysis). The $18 million loss in 1992 related to an oil and gas subsidiary which was merged with another oil and gas company converting USF&G's interest into an equity investment of the successor company. 5. Investments USF&G's investment mix continues to reflect a concentration in high quality fixed-income securities. Long-term fixed maturities comprised 83 percent of total investments at December 31, 1994, compared with 84 percent and 81 percent at December 31, 1993 and 1992, respectively. Total investments have decreased due to unrealized losses in the available for sale portfolio, as well as the use of proceeds from sales and repayments of fixed maturities to meet cash flow needs, primarily from SPDA surrenders. The following table shows the distribution of USF&G's investment portfolio. At December 31 (dollars in millions) 1994 1993 1992 Total investments $10,421 $11,377 $11,346 Fixed Maturities: Held to maturity 45% 41% 64% Available for sale 38 43 17 Total fixed maturities 83 84 81 Common and preferred stocks 1 1 1 Short-term investments 4 3 5 Mortgage loans and real estate 10 9 9 Other invested assets 2 3 4 Total 100% 100% 100% 5.1. Net investment income The following table shows the components of net investment income. Years Ended December 31 (dollars in millions) 1994 1993 1992 Net Investment Income From: Fixed maturities $669 $721 $739 Equity securities 7 9 12 Options - - 37 Short-term investments 13 9 27 Mortgage loans and real estate 58 41 50 Other, less expenses (4) (31) (48) Total $743 $749 $817 Average Yields: Total investments 6.9% 6.7% 7.3% Fixed maturities 7.4% 7.7% 8.6% Investment income for the period ended December 31, 1994 decreased $6 million or one percent, and $74 million or nine percent when compared to the same periods of 1993 and 1992, respectively. The decrease in investment income from fixed maturities is primarily due to an investment base which declined in order to meet SPDA surrenders and other cash flow needs. In addition, given the relatively low long-term interest rate environment, proceeds from sales, maturities or repayments of fixed maturities during 1993 and 1994 were reinvested in fixed maturities with lower yields. Overall, investment income in fixed maturities decreased by seven percent and ten percent when compared to 1993 and 1992, respectively. Although interest rates have increased in 1994, new purchases of fixed maturities totaling $693 million were not significant enough to affect the average yield. The increase in net investment income from short-term investments since 1993 primarily reflects the higher short-term interest rate environment. Real estate and mortgage loan investment income has increased as a result of the sale of timberland investments, prepayment of a mortgage loan, and a new loan program whereby USF&G is investing a greater percentage of capital in commercial mortgage loans versus equity real estate. Other income less expenses improved primarily due to USF&G's share of earnings from an equity interest in Renaissance Reinsurance Ltd. ("Renaissance Re"), an offshore reinsurance company. USF&G recorded $17 million of net investment income from Renaissance Re during 1994 and $5 million during 1993. Future income from the investment in Renaissance Re is subject to volatility and exposure to catastrophe losses and other risks inherent in the property/casualty reinsurance industry. Reduced interest expense accrued on ceded premiums held by USF&G accounts for the remainder of the improvement in other net investment income. 5.2. Net realized gains on investments The components of net realized gains include the following: Years Ended December 31 (in millions) 1994 1993 1992 Net Gains From Sales: Fixed maturities $ 3 $ 79 $179 Equities and options - 5 44 Real estate and other 12 6 16 Total net gains 15 90 239 Impairments: Fixed maturities (1) (10) (20) Equities - (8) - Real estate and other (9) (66) (71) Total impairments (10) (84) (91) Net realized gains $ 5 $ 6 $148 Realized gains from real estate and other investments for 1994 resulted from the sale of timberland investments and USF&G's portion of realized gains from investments in limited partnerships. The $79 million in realized gains on fixed maturities in 1993 is primarily due to USF&G's repositioning a portion of its fixed maturity investments to more effectively match the duration of its life insurance liabilities. The $179 million in realized gains in 1992 is the result of investment sales to offset declines in capital and statutory surplus caused by catastrophe losses in 1992. In 1992, USF&G realized $52 million of gains on equities and reallocated the proceeds to relatively less volatile fixed maturities. To reflect the impairments in the value of certain investments, USF&G made provisions for impairment of $10 million in 1994 compared with $84 million in 1993 and $91 million in 1992. Real estate impairments in 1994 primarily related to specific properties whose recent appraisal values reflected other than temporary impairments. Real estate impairments were taken in 1993 to write down to net realizable value properties that were sold or expected to be sold in the near term. Real estate impairments in 1992 reflect both changes in circumstances related to specific properties and general real estate market deterioration. The impairment of fixed maturities relates to specific investments whose impairment is considered other than temporary. The 1993 impairments on equities related to specific equity holdings which were sold shortly thereafter. 5.3. Unrealized gains (losses) The components of the changes in unrealized gains (losses) were as follows: Years Ended December 31 (in millions) 1994 1993 1992 Fixed maturities available for sale $(401) $222 $ - Deferred policy acquisition costs adjustment 63 (30) - Equity securities 3 23 (39) Options, foreign currency and other 1 4 21 Total $(334) $219 $(18) USF&G adopted SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities," in the fourth quarter of 1993. SFAS 115 requires that the portion of fixed maturity investments classified as "available for sale" be recorded at market value with the unrealized gains/losses reported as a component of shareholders' equity. Prior to the adoption of SFAS No. 115, fixed maturities available for sale were recorded at lower of cost or market with no effect on shareholders' equity. Unrealized gains on fixed maturities at December 31, 1993 reflects the low interest rate environment of 1993. However, rising interest rates during 1994 resulted in a decrease in the unrealized gain on fixed maturities available for sale from $222 million at December 31, 1993 to an unrealized loss of $179 million at December 31, 1994. This was partially offset by a related change in the DPAC adjustment from the prior year's unrealized loss of $30 million to an unrealized gain of $33 million at December 31, 1994. This adjustment is made to reflect assumptions about the effect of potential asset sales of fixed maturities available for sale on future DPAC amortization. 5.4. Fixed maturity investments The tables below detail the composition of the fixed maturity portfolio. At December 31 1994 Net Amortized Market Unrealized (in millions) Cost Value (Loss) Fixed Maturities: Held to maturity $4,650 $4,275 $(375) Available for sale 4,160 3,981 (179) Total $8,810 $8,256 $(554) At December 31 1993 Net Amortized Market Unrealized (in millions) Cost Value Gain Fixed Maturities: Held to maturity $4,661 $4,796 $135 Available for sale 4,681 4,903 222 Total $9,342 $9,699 $357 At December 31 1992 Net Amortized Market Unrealized (in millions) Cost Value Gain Fixed Maturities: Held to maturity $7,218 $7,290 $72 Available for sale 1,987 2,029 42 Total $9,205 $9,319 $114 At December 31 (dollars in millions) 1994 % 1993 % 1992 % Corporate investment-grade bonds $5,017 57 $4,866 52 $3,103 34 Mortgage-backed securities 1,915 22 2,403 26 3,824 42 Asset-backed securities 931 10 1,149 12 995 11 U.S. Government bonds 277 3 308 3 554 6 High-yield bonds* 616 7 562 6 522 5 Tax-exempt bonds 47 1 48 1 71 1 Other 7 - 6 - 136 1 Total fixed maturities at amortized cost 8,810 100 9,342 100 9,205 100 Total market value of fixed maturities 8,256 9,699 9,319 Net unrealized gains (losses) $ (554) $ 357 $ 114 Percent market-to-amortized cost 94 104 101 *See Glossary of Terms Increasing interest rates, which resulted in declining bond prices, were responsible for the 10 percent decrease in the fixed maturity portfolio's overall market-to-amortized cost ratio from December 31, 1993. Interest rates rose an average 270 basis points during 1994. Investments in mortgage-backed securities declined 20 percent and 50 percent when compared with holdings at December 31, 1993 and 1992, respectively, due primarily to prepayments of the underlying mortgages. While subject to prepayment risk, credit risk related to USF&G's mortgage-backed securities portfolio at December 31, 1994 is believed to be minimal since 99 percent of such securities have AAA ratings or are collateralized by obligations of the U.S. Government or its agencies. Asset-backed securities declined 19 percent and six percent when compared with holdings at December 31, 1993 and 1992, respectively, as a result of sales and maturities. The net proceeds from sales, maturities and prepayments in 1994 were generally reinvested into corporate investment-grade bonds. Investment-grade bonds, including debt obligations of the U.S. Government and its agencies, comprised 93 percent of the portfolio at December 31, 1994, compared with 94 percent and 93 percent at December 31, 1993 and 1992, respectively. The table below shows the credit quality of the long-term fixed maturity portfolio as of December 31, 1994. Percent Market- Amortized Market to-Amortized (dollars in millions) Cost Percent Value Cost U.S. Government and U.S. Government Agencies $2,075 23% $1,952 94% AAA 1,368 16 1,324 97 AA 1,317 15 1,191 90 A 2,395 27 2,244 94 BBB 1,039 12 973 94 Below BBB 616 7 572 93 Total $8,810 100% $8,256 94% USF&G's holdings in high-yield bonds comprised seven percent of the total fixed maturity portfolio at December 31, 1994, compared with six percent at both December 31, 1993 and 1992. Of the total high-yield bond portfolio, 72 percent is held by the life insurance segment, representing 10 percent of its total investments. The table below illustrates the credit quality of USF&G's high- yield bond portfolio at December 31, 1994. Percent Market- Amortized Market to-Amortized (dollars in millions) Cost Percent Value Cost BB $366 60% $337 92% B 248 40 233 94 CCC and lower 2 - 2 100 Total $616 100% $572 93% The information on credit quality in the preceding two tables is based upon the higher of the rating assigned to each issue by either Standard & Poor's or Moody's. Where neither Standard & Poor's nor Moody's has assigned a rating to a particular fixed maturity issue, classification is based on 1) ratings available from other recognized rating services; 2) ratings assigned by the NAIC; or 3) an internal assessment of the characteristics of the individual security, if no other rating is available. At December 31, 1994, USF&G's five largest investments in high-yield bonds totaled $88 million in amortized cost and had a market value of $72 million. None of these investments individually exceeded $30 million. USF&G's largest single high-yield bond exposure represented five percent of the high-yield portfolio and 0.3 percent of the total fixed maturity portfolio. 5.5. Real estate The table below shows the components of USF&G's real estate portfolio. At December 31 (in millions) 1994 1993 1992 Mortgage loans $ 349 $ 302 $ 186 Equity real estate 760 793 926 Reserves (98) (108) (108) Total $1,011 $ 987 $1,004 The increase in mortgage loans reflects USF&G's strategy of maintaining a generally consistent level of real estate assets while changing the mix to more traditional mortgage loans and less equity real estate investments. This strategy is designed to reduce risk and increase yields in the real estate portfolio. USF&G's real estate investment strategy emphasizes diversification by geographic region, property type and stage of development. The diversification of USF&G's mortgage loan and real estate portfolio is as follows: At December 31 1994 1993 1992 Geographic Region: Pacific/Mountain 34% 33% 33% Midwest 20 18 19 Mid-Atlantic 17 19 17 Southeast 16 22 22 Southwest 8 5 6 Northeast 5 3 3 Type of Property: Office 37% 37% 33% Land 26 27 28 Apartments 24 19 16 Retail/other 7 6 10 Industrial 6 9 11 Timberland/agriculture - 2 2 Development Stage: Operating property 75% 73% 72% Land development 15 16 17 Land packaging 10 11 11 Real estate investments are generally appraised at least once every three years. Appraisals are obtained more frequently under certain circumstances such as when there have been significant changes in property performance or market conditions. All of these appraisals are performed by professionally certified appraisers. At December 31, 1994, USF&G's five largest real estate investments had a book value of $325 million. The largest single investment was a land development project located in San Diego, California with a book value of $93 million, or nine percent of the total real estate portfolio. Mortgage loans and real estate investments not performing in accordance with contractual terms, or performing significantly below expectation, are categorized as nonperforming. Nonperforming real estate investments at December 31, 1994 declined 16 percent and 40 percent when compared with December 31, 1993 and 1992, respectively. This decline in nonperforming real estate was a result of the combination of the sale of a nonperforming real estate property, write-downs on other specific properties, and reclassifications. The book value of the components of nonperforming real estate are as follows: At December 31 (dollars in millions) 1994 1993 1992 Restructured loans and investments* $ - $ 4 $ 4 Real estate held as in-substance foreclosure* - 14 15 Real estate acquired through foreclosure or deed-in-lieu of foreclosure* 117 121 190 Land investments* 56 57 71 Nonperforming equity investments* 35 53 66 Total nonperforming real estate $ 208 $ 249 $ 346 Real estate reserves $ (98) $(108) $(108) Reserves/nonperforming real estate 47% 43% 31% *See Glossary of Terms Valuation allowances are established for impairments of mortgage loans and equity real estate values based on periodic evaluations of the operating performance of the properties and their exposure to declines in value. The allowance totaled $98 million, or nine percent of the entire real estate portfolio, at December 31, 1994, compared with $108 million, or 10 percent of the total real estate portfolio, at both December 31, 1993 and 1992. The decrease in the reserves on real estate investments is a result of applying the reserve to specific properties where permanent impairment has occurred. In light of USF&G's current plans with respect to the portfolio, management believes the allowance at December 31, 1994 continues to adequately reflect the current condition of the portfolio. Should deterioration occur in the general real estate market or with respect to individual properties in the future, additional reserves may be required. Although USF&G anticipates that any sales of real estate will be in an orderly fashion as and when market conditions permit, if USF&G was required to dispose of a significant portion of its real estate in the near term, it is likely that it would recover amounts substantially less than the related carrying values. Prospectively, efforts will continue to reduce risk and increase yields in the real estate portfolio by selling equity real estate when it is advantageous to do so and reinvesting the proceeds in medium-term mortgage loans. 6. Financial Condition 6.1. Assets USF&G's assets totaled $13.8 billion at December 31, 1994, compared with $14.3 billion and $13.1 billion at the end of 1993 and 1992, respectively. The $561 million reduction in 1994 is primarily due to a $401 million reduction in the market value of the fixed maturity investments classified as available for sale. In addition, proceeds from the sale of investments were used to meet cash flow needs. 6.2. Debt USF&G's corporate debt totaled $586 million at December 31, 1994, compared with $574 million at December 31, 1993 and 1992. The increase in corporate debt is mainly attributable to foreign currency translation adjustments of $13 million from non-U.S. dollar denominated debt. As a result of entering into forward contracts, there was no effect on net income from the translation of non-U.S. dollar denominated debt. Proceeds from two debt offerings in 1994 were used to retire other portions of USF&G Corporation's debt. During the first quarter of 1994, proceeds of $126 million from the issuance of Zero Coupon Convertible Notes were used to redeem higher interest bearing medium and long-term notes. USF&G also issued $150 million 8 3/8% Senior Notes due 2001 in the second quarter of 1994, the proceeds from which were used to repay a portion of the short-term bank credit facility (see Section 7 of this Analysis). USF&G's real estate and other debt totaled $30 million at December 31, 1994, compared with $44 million and $42 million at December 31, 1993 and 1992, respectively. Real estate debt increased as a result of the restructuring of a real estate partnership where USF&G became a controlling general partner. Shortly thereafter, USF&G defeased all but $9 million of such debt. Real estate debt was reduced by $11 million as a result of a deed-in-lieu of foreclosure, whereby property in which USF&G has a partnership interest was conveyed back to the lender, and further reduced by the early payoff of a $11 million real estate loan. 6.3. Shareholders' equity USF&G's shareholders' equity totaled $1.4 billion at December 31, 1994, $1.5 billion at December 31, 1993 and $1.3 billion at December 31, 1992. The decrease was primarily the result of the $401 million decline in unrealized gains on fixed maturity investments available for sale reduced by a $63 million change in the related life insurance segment's DPAC adjustment. Net income of $232 million less common and preferred dividends of $64 million partially offset the reduction in equity. 6.4. Regulatory risk-based capital The National Association of Insurance Commissioners ("NAIC") has adopted model regulations which establish minimum capitalization requirements based on a "risk-based capital" formula. These regulations, which were first effective for property/casualty companies for the year ended December 31, 1994 and for life insurance companies for the year ended December 31, 1993, establish four levels at which corrective action must be taken. These levels are: (1) the "company action level," at which the company must submit a comprehensive financial plan with specific proposals to address certain financial problems; (2) the "regulatory action level," at which the appropriate regulatory authorities will perform a financial analysis and order certain corrective actions; (3) the "authorized control level," at which the regulatory authorities may place the company under regulatory control; and (4) the "mandatory control level," at which the regulatory authorities must place the company under regulatory control. Application of these levels depends upon the insurer's "adjusted risk-based capital" as a percentage of the "minimum risk-based capital." Risk-based capital is calculated after adjusting capital for certain asset, credit, market, underwriting, off balance sheet and other risks inherent in the assets, liabilities and business of the insurer. Various levels of corrective actions are required if the adjusted risk-based capital is less than 200% of the authorized control level risk-based capital. USF&G Company had adjusted risk-based capital of $1.62 billion as of December 31, 1994, which represented 382% of the authorized control level risk-based capital. F&G Life had adjusted risk-based capital of $427 million and $441 million as of December 31, 1994 and 1993, respectively, which represented 422% and 396% of the authorized control level risk-based capital as of those dates. Accordingly, as of the dates indicated, both USF&G Company and F&G Life had adjusted risk-based capital above the levels which would require corrective action. 6.5. Capital strategy In January 1994, USF&G filed a shelf registration statement with the Securities and Exchange Commission. As of the time this registration statement went into effect, USF&G had available $647 million of unissued debt, preferred stock, common stock and warrants to purchase debt and stock. This registration statement was reduced by $126 million after the issuance of the Zero Coupon Convertible Notes and by $149 million after the issuance of the 8 3/8% Senior Notes. Subject to capital market conditions, USF&G plans to refinance up to $300 million of debt over the next several years. During 1994, USF&G called for redemption 2.4 million shares of its Series C Preferred Stock. The remaining shares were called for redemption effective February 24, 1995. As a result of these calls, over 93 percent of the Series C Preferred Stock converted into 14.7 million shares of common stock in accordance with the terms of the Series C Preferred Stock. Pursuant to arrangements the Corporation previously entered into with an unaffiliated financial institution, USF&G sold 716,600 shares of common stock to this institution to fund a portion of the cash redemptions resulting from these calls. In December 1994, USF&G entered into a definitive agreement to purchase all of the outstanding stock of Victoria Financial Corporation for approximately 4.1 million shares or $55.3 million of USF&G's common stock, depending on the average market price of USF&G common stock over a specified period preceding the closing of the transaction. Victoria is an insurance holding company which specializes in nonstandard auto coverage. Additionally, in January 1995, USF&G entered into a definitive agreement to purchase all of the outstanding equity of Discover Re Managers, Inc., for approximately 5.4 million shares or $78.5 million of USF&G's common stock. Discover Re provides insurance, reinsurance and related services to the alternative risk transfer market. Both transactions are expected to close in the second quarter of 1995. As further explained in Section 7.2 of this Analysis, USF&G negotiated a $400 million credit facility in 1994 to replace the $700 million facility that was due to expire in March 1995. 7. Liquidity Liquidity is a measure of an entity's ability to secure enough cash to meet its contractual obligations and operating needs. USF&G requires cash primarily to pay policyholders' claims and benefits, debt and dividend obligations, and operating expenses. USF&G's sources of cash include cash flow from operations, credit facilities, marketable securities and sales of other assets. Management believes that internal and external sources of cash will continue to exceed USF&G's short-term and long-term needs. 7.1. Cash flow USF&G had cash flow from operating activities of $115 million for the year ended December 31, 1994 and $87 million and $97 million for the years ended December 31, 1993 and 1992, respectively. The growth of cash flows from operating activities for 1994 as compared to 1993 is due primarily to large repayments made to reinsurers in 1993 because of new accounting pronouncements that initiated the termination of several reinsurance contracts. In addition, deposits and withdrawals of universal life and investment contracts, which for GAAP reporting purposes are considered financing activities, had a net cash outflow of $418 million in 1994 as compared to $196 million and $125 million for 1993 and 1992, respectively. 7.2. Credit facilities At December 31, 1994, USF&G maintained a $400 million committed credit facility with a group of foreign and domestic banks. This represents the renegotiation of a prior credit facility of $700 million at December 31, 1993. Management elected to reduce the size of the facility due to the reduction in borrowings against it and the Corporation's reestablished access to capital markets. Borrowings outstanding under the credit facility totaled $215 million at December 31, 1994 and $375 million at both December 31, 1993 and 1992. The credit agreement contains restrictive covenants pertaining to indebtedness, tangible net worth, liens and other matters. USF&G was in compliance with these covenants at December 31, 1994, 1993 and 1992. In addition, at December 31, 1994, USF&G maintained a $100 million foreign currency credit facility and a $100 million letter of credit facility. There were no borrowings on the foreign currency credit facility or the letter of credit facility at December 31, 1994. 7.3. Marketable securities USF&G's fixed-income, equity security and short-term investment portfolios are liquid and represent substantial sources of cash. The market value of its fixed-income securities was $8.3 billion at December 31, 1994 which represents 94 percent of its amortized cost. At December 31, 1994, equity securities, which are reported at market value on the balance sheet, totaled $70 million. Short-term investments totaled $421 million. 7.4. Liquidity restrictions There are certain restrictions on payments of dividends by insurance subsidiaries that may limit USF&G's ability to receive funds from its subsidiaries. The Maryland Insurance Code requires the Maryland Insurance Commissioner's prior approval for any dividend payments during a 12 month period from a Maryland insurance subsidiary, such as USF&G Company, to its holding company which exceeds 10 percent of policyholders' surplus as of the prior calendar year end. In addition, notice of any other dividend must be given to the Maryland Insurance Commissioner prior to payment, and the Commissioner has the right to prevent payment of such dividend if it is determined that such payment could impair the insurer's surplus or financial condition. Dividends of approximately $157 million are currently available for payment to USF&G Corporation from USF&G Company during 1995 without prior regulatory approval. Dividends paid to USF&G Corporation from USF&G Company totaled $125 million in 1994, 1993 and 1992. USF&G's insurance subsidiaries' admitted assets for statutory purposes included a total of approximately $244 million in receivables from the parent and affiliated companies. 7.5. Technology upgrades USF&G has initiated a plan to upgrade its information technology and convert its mainframe based systems to a client server based system. During 1995, USF&G plans to invest over $20 million in this project. Total expenditures over the next three years on this project are estimated to be approximately $50 million. USF&G's plan is to recover this investment through future cost savings and competitive advantages. 8. Regulation USF&G's insurance subsidiaries are subject to extensive regulatory oversight in the jurisdictions where they do business. This regulatory structure, which generally operates through state insurance departments, involves the licensing of insurance companies and agents, limitations on the nature and amount of certain investments, restrictions on the amount of single insured risks, approval of policy forms and rates, setting of capital requirements, limitations on dividends, limitations on the ability to withdraw from certain lines of business such as personal lines and workers' compensation, and other matters. From time to time, the insurance regulatory framework has been the subject of increased scrutiny. At any one time there may be numerous initiatives within state legislatures or state insurance departments to alter and, in many cases, increase state authority to regulate insurance companies and their businesses. Proposals to adopt a federal regulatory framework have also been discussed. It is not possible to predict the future impact of increasing state or potential federal regulation on USF&G's operations. Additional information regarding legal and regulatory contingencies may be found in Note 13, "Legal Contingencies," to the consolidated financial statements. 8.1. Proposition 103 In November 1988, voters in the State of California passed Proposition 103, which required insurers doing business in California to rollback most property/casualty premium prices in effect between November 1988 and November 1989 to November 1987 levels, less an additional 20 percent discount, unless an insurer could establish that such rate levels threatened its solvency. In May 1989, the California Supreme Court ruled that an insurer does not have to face insolvency in order to qualify for an exemption from the rollback requirements and is entitled to a "fair and reasonable return." The California Insurance Department's authority to establish regulations setting forth a basis for determining what constitutes a "fair and reasonable return" has been the subject of significant controversy. In August 1994, the California Supreme Court issued its opinion in 20th Century Insurance Company v. Garamendi, affirming the California Insurance Department's authority to establish a broad industry-wide formula for implementing Proposition 103. The 20th Century Insurance Company subsequently settled the matter with the California Insurance Department, and on February 22, 1995, the United States Supreme Court denied the writ of certiorari filed by the other litigants in the proceedings. It is not clear how the current regulations adopted by the California Insurance Department will apply to USF&G, and there are many issues which remain unsettled. The range of liability to USF&G could be from less than $10 million up to approximately $31 million, including interest. The ultimate outcome of this issue is not expected to have a material adverse effect on USF&G's results of operations or financial position since any such liability is not expected to materially exceed amounts already reserved. 8.2. Maine "Fresh Start" litigation In 1987, the State of Maine adopted workers' compensation reform legislation which was intended to rectify historic rate inadequacies and encourage insurance companies to reenter the Maine voluntary workers' compensation market. This legislation, which was popularly known as "Fresh Start," required the Maine Superintendent of Insurance to annually determine whether the premiums collected for policies written in the involuntary market and related investment income were adequate on a policy-year basis. The Superintendent was required to assess a surcharge on policies written in later policy years if it was determined that rates were inadequate. Assessments were to be borne by workers' compensation policyholders, except that for policy years beginning in 1989 the Superintendent could require insurance carriers to absorb up to 50 percent of any deficits if the Superintendent found that insurance carriers failed to make good faith efforts to expand the voluntary market and depopulate the residual market. Insurance carriers which served as servicing carriers for the involuntary market would be obligated to pay 90 percent of the insurance industry's share. The Maine Fresh Start statute requires the Superintendent to annually estimate each year's deficit for seven years before making a final determination with respect to that year. In March 1993, the Superintendent affirmed a prior Decision and Order (known as the "1992 Fresh Start Order") in which he found, among other things, that there were deficits for the 1988, 1989 and 1990 policy years, and that insurance carriers had not made a good faith effort to expand the voluntary market and consequently were required to bear 50 percent of any deficits relating to the 1989 and 1990 policy years. The Superintendent further found that a portion of these deficits were attributable to servicing carrier inefficiencies and poor investment practices and ordered that these costs be absorbed by insurance carriers. Also, in May 1993, the Superintendent found that insurance carriers would be liable for 50 percent of any deficits relating to the 1991 policy year (the "1993 Fresh Start Order"), but indicated that he would make no further determinations regarding the portions of any deficits attributable to alleged servicing carrier inefficiencies and poor investment practices until his authority to make such determinations was clarified in the various suits involving prior Fresh Start orders. USF&G was a servicing carrier for the Maine residual market in 1988 through 1991. USF&G withdrew from the Maine voluntary market and as a servicing carrier effective December 31, 1991. USF&G joined in an appeal of the 1992 Fresh Start Order which was filed April 5, 1993 in the Maine Superior Court. In addition to The Hartford Accident and Indemnity Company and USF&G, the National Council of Compensation Insurance ("NCCI") and several other insurance companies which were servicing carriers during this time frame have instituted similar appeals. Similar appeals of the Superintendent's 1993 Fresh Start Order have been filed by USF&G, the NCCI and several other servicing carriers in the same court. The appeals of the 1993 Fresh Start Order will be heard on a consolidated basis. On October 17, 1994, the Superior Court of Maine upheld the Superintendent's finding in the 1992 Fresh Start Order that the insurance carriers failed to exercise their good faith best efforts to expand the voluntary market and consequently were required to bear 50 percent of the deficit relating to the 1989 and 1990 policy years. The Superior Court also held that the Superintendent improperly held that $40 million of the deficit should be attributed to the carriers due to servicing carrier inefficiencies and poor investment practices. USF&G and the other parties challenging the Superintendent's order have appealed to the Maine Law Court, the highest court in Maine, the Superior Court's ruling on the carriers' lack of good faith, and the Superintendent may likewise appeal the Superior Court ruling that it was improper to shift $40 million of the deficit to carriers due to alleged inefficiencies and poor investment practices. Estimates of the potential deficits vary widely and are continuously revised as loss and claims data matures. If the Superintendent were to prevail on all issues, then the range of ultimate liability for USF&G, based on the most recent estimates provided by the Superintendent and the NCCI, respectively, could range from approximately $12 million to approximately $21 million. 8.3. Involuntary market plans Most states require insurers to provide coverage for less desirable risks through participation in mandatory programs. USF&G's participation in assigned risk pools and similar plans, mandated now or in the future, creates and is expected to create downward pressure on earnings. 8.4. Withdrawal from business lines Some states have adopted legislation or regulations restricting or otherwise limiting an insurer's ability to withdraw from certain lines of business. Such restrictions are most often found in personal lines and workers' compensation insurance. They include prohibitions on mid-term cancellations and limiting reasons based upon which an insurer may non-renew policies, requirements for amendments to underwriting standards, rates and policy forms to be approved by state regulators, specifications of a maximum percentage of a book of business which may be non-renewed within the state within any 12 month period, and prohibitions on exiting a single line of business within a state (thus requiring an insurer to either continue an unprofitable line or give up all lines of business and withdraw from a state entirely). Such restrictions limit USF&G's ability to manage its exposure to unprofitable lines and adversely affects earnings to the extent USF&G is required to continue writing unprofitable business. 8.5. Guaranty funds Insurance guaranty fund laws have been adopted in most states to protect policyholders in case of an insurer's insolvency. Insurers doing business in those states can be assessed for certain obligations of insolvent companies to policyholders and claimants. These assessments, under certain circumstances can be credited against future premium taxes. Net of such tax credits, USF&G incurred $9 million of guaranty fund expense in 1994 and $15 million and $13 million in 1993 and 1992, respectively. Financial difficulties of certain insurance companies over the past several years are expected to result in additional assessments that could have a negative impact on future earnings. State laws limit the amount of annual assessments which are based on percentages (generally two percent) of assessable annual premiums in the year of insolvency. The ultimate amount of these assessments cannot be reasonably estimated, but are not expected to have a material adverse effect on USF&G's financial position. 8.6. NAIC proposals The National Association of Insurance Commissioners ("NAIC") has proposed several model laws and regulations which are in varying stages of discussion. The NAIC has adopted model regulations which establish minimum capitalization requirements based on a "risk-based capital" formula (refer to Section 6.4 of this Analysis). The NAIC has also proposed a Model Investment Law and amendments to the Model Holding Company System Regulatory Act. These model acts address investments which are permissible for property/casualty and life insurers to hold, and investments in subsidiaries and affiliates, respectively. Adoption of these model laws is targeted for 1995. It is not expected that the final adoption of these regulations by the NAIC will result in any material adverse effect on USF&G's liquidity or financial position. 8.7. National health care President Clinton and Congress have considered various proposals to enact a comprehensive national health care system. Enactment of certain of these proposals would result in the coordination of the medical payment system for workers' compensation and the medical payments component of automobile insurance within a reformed national health care system or a merger of workers' compensation and automobile medical coverage into a reformed health care system. Although some form of national health care may be enacted, it is unclear whether or to what extent such legislation will address workers' compensation or personal automobile insurance. No reliable prediction can be made at this time as to the ultimate outcome of the legislative deliberations regarding national health care reform or the effect such legislation may have on USF&G. 8.8. Superfund The Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA"), more commonly known as "Superfund," is scheduled to be reauthorized in 1995. Insurance companies, other businesses, environmental groups and municipalities are advocating a variety of reform proposals to revise the cleanup and liability provisions of CERCLA. No reliable prediction can be made as to the ultimate outcome of the legislative deliberations regarding the reauthorization of CERCLA or the effect such revisions may have on USF&G. 8.9. Insurance regulatory information system The NAIC's Insurance Regulatory Information System ("IRIS") ratios are intended to assist state insurance departments in their review of the financial condition of insurance companies operating within their respective states. IRIS specifies eleven industry ratios and establishes a "usual range" for each ratio. Significant departure from a number of ratios may lead to inquiries from state insurance regulators. As of December 31, 1994, USF&G was within the "usual range" for all IRIS ratios. 8.10. Taxation of deferred annuities From time to time, various proposals have been considered by Congress, the Office of Management and Budget and the Department of the Treasury to include within current taxable income all or a portion of the interest payments which accrue on certain deferred annuity products, including some deferred annuity products sold by F&G Life. Currently, such interest is not taxed until the time of distribution. All such proposals have focused exclusively on deferred annuities and have not included annuities issued in connection with structured settlements of claims or on tax sheltered annuities. No reliable prediction can be made at this time as to the outcome of any such proposals or the effect such proposals may have on F&G Life. 8.11. Federal antitrust legislation Congress has considered various proposals to revise the McCarran-Ferguson Act of 1945. This act has historically provided the insurance industry with broad antitrust exemptions. Various proposals have been made which would repeal many of those exemptions, although "safe harbors" may be preserved for data collection, loss development, common policy forms, residual market pooling arrangements and other areas essential to the property/casualty insurance industry. No reliable prediction can be made at this time as to the outcome of any of these proposals or the effect they may have on USF&G. 9. Income Taxes Effective January 1, 1993, USF&G changed its method of accounting for income taxes as required by SFAS No. 109, "Accounting for Income Taxes." This standard requires recognition of future tax benefits attributable to net operating loss carry-forwards ("NOLs") and to deductible temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. A valuation allowance is required if it is more likely than not that some or all of the deferred tax asset may not be realized. The valuation allowance is established based on an evaluation of positive and negative evidence as to the likelihood of realizing some or all of the deferred tax assets. At December 31, 1993, USF&G had recorded a $119 million net deferred tax asset, as it was the opinion of management it was more likely than not that there would be sufficient future taxable income to result in the realization of this benefit. The primary negative evidence that existed at December 31, 1993 was the cumulative pretax net losses for the years 1991 through 1993. The primary positive evidence at that time was forecasted taxable income sufficient to recover a portion of the tax benefit within three to five years and a tax planning strategy to generate future taxable income to utilize such NOLs, if necessary. At December 31, 1994, the net deferred tax asset increased to $416 million, primarily based on the increasing weight of positive evidence which resulted in a $203 million net decrease in the valuation allowance. Management reviews the valuation allowance on a quarterly basis. Throughout 1994, the weight of evidence became increasingly more positive as the core earnings trend improved each quarter. As 1994 progressed, the negative evidence of cumulative losses which were caused by 1991 results became increasingly less of a factor. By the end of 1994, cumulative pretax net income was positive from 1992 through 1994. Given the substantially reduced degree of negative evidence and management's increased confidence in the sustainability of the improved earnings of the core insurance segments and, therefore, its enhanced ability to forecast future taxable income, it became appropriate to reduce the valuation allowance beginning in the second quarter of 1994. The largest adjustment to the valuation allowance occurred in the fourth quarter of 1994 as the Corporation continued to achieve its forecasted results. This coincided with the elimination of the negative evidence of three-year cumulative net losses and with the completion of the Corporation's budgeting and mid-range forecasting process, allowing for more reliable projections of future taxable income. USF&G has NOLs of $750 million which expire as follows: $147 million in 2005 and $603 million in 2006. The NOLs available for future utilization were generated primarily by the noninsurance businesses of USF&G and nonrecurring charges related to the business restructuring program. A majority of these noninsurance businesses that caused a significant drain on prior earnings have been sold, divested or liquidated by USF&G. Future levels of net income and taxable income from the core insurance operations are dependent on several factors, including general economic and specific insurance industry conditions, competitive pressures, catastrophe losses, adverse involuntary loss experience, etc. Because of these risk factors, as well as other factors beyond the control of management, no assurance can be given that sufficient taxable income will be generated to utilize the NOLs or otherwise realize the deferred tax assets. However, management has considered these factors in reaching its conclusion that it is more likely than not that there will be sufficient future taxable income to result in the realization of the recorded $416 million deferred tax asset. This realization is dependent, in whole or in part, on USF&G's ability to generate future taxable income from ordinary and recurring operations. Based on USF&G's evaluations, approximately $1.2 billion of future taxable income would need to be generated to realize the $416 million deferred tax asset. If 1994 pretax net income before realized gains and facilities exit costs of $129 million is assumed to be an average taxable income for future years, then USF&G will be able to realize enough income within nine years to fully recognize the net deferred tax asset. This is well within the tax carry-forward period. Further, management's three to five year forecast, which reflects management's expectations as to earnings growth, indicates sufficient future taxable income to, more likely than not, realize the recorded asset. USF&G's tax returns have not been reviewed by the Internal Revenue Service ("IRS") since 1989 and the availability of the NOLs could be challenged by the IRS upon review of returns through 1993. Management believes, however, that IRS challenges that would limit the recoverability of $416 million in tax benefits are unlikely, and adjustments to the tax liability, if any, for years through 1994 will not have a material adverse effect on USF&G's financial position. 10. Glossary of Terms Account value: Deferred annuity cash value available to policyholders before the assessment of surrender charges. Catastrophe losses: Property/casualty insurance claim losses resulting from a sudden calamitous event, such as a severe storm, are categorized as "catastrophes" when they meet certain severity and other criteria determined by a national organization. Expense ratio: The ratio of underwriting expenses to net premiums written, if determined in accordance with statutory accounting practices ("SAP"), or the ratio of underwriting expenses (adjusted by deferred policy acquisition costs) to earned premiums, if determined in accordance with GAAP. High-yield bonds: Fixed maturity investments with a credit rating below the equivalent of Standard & Poor's "BBB." In addition, nonrated fixed maturities that, in the judgment of USF&G, have credit characteristics similar to those of a fixed maturity rated below BBB are considered high-yield bonds. Involuntary pools and associations: Property/casualty insurance companies are required by state laws to participate in a number of assigned risk pools, automobile reinsurance facilities, and similar mandatory plans ("involuntary market plans"). These plans generally require coverage of less desirable risks, principally for workers' compensation and automobile liability, that do not meet the companies' normal underwriting standards. As mandated by legislative authorities, insurers generally participate in such plans based upon their shares of the total writings of certain classes of insurance. Liquid assets to surrender value: Liquid assets (publicly traded bonds, stocks, cash and short-term investments) divided by surrenderable policy liabilities, net of surrender charges. A measure of an insurance company's ability to meet liquidity needs in case of annuity surrenders. Loss ratio: The ratio of incurred losses and loss expenses to earned premiums, determined in accordance with SAP or GAAP, as applicable. The difference between SAP and GAAP relates to deposit accounting for GAAP related to certain financial reinsurance assumed. Nonperforming real estate: Mortgage loans and real estate investments that are not performing in accordance with their contractual terms or that are performing at an economic level significantly below expectations. Included in the table of nonperforming real estate are the following terms: Deed-in-lieu of foreclosure: Real estate to which title has been obtained in satisfaction of a mortgage loan receivable in order to prevent foreclosure proceedings. In-substance foreclosure: Collateral for a mortgage loan is in-substance foreclosed when the borrower has little or no equity in the collateral, does not have the ability to repay the loan, and has effectively abandoned control of the collateral to USF&G. Land investments: Land investments that are held for future development where, based on current market conditions, returns are projected to be significantly below original expectations. Nonperforming equity investments: Equity investments with cash and GAAP return on book value less than five percent, but excluding land investments. Restructured loans and investments: Loans and investments whose terms have been restructured as to interest rates, participation, and/or maturity date such that returns are projected to be significantly below original expectations. Policyholders' surplus: The net assets of an insurer as reported to regulatory agencies based on accounting practices prescribed or permitted by the National Association of Insurance Commissioners and the state of domicile. Premiums earned: The portion of premiums written applicable to the expired period of policies. Premiums written: Premiums retained by an insurer, after the assumption and cession of reinsurance. Underwriting results: Property/casualty pretax operating results excluding investment results, policyholders' dividends, and noninsurance activities; generally, premiums earned less losses and loss expenses incurred and "underwriting" expenses incurred. EX-13 3 USF&G Corporation Eleven-Year Summary of Selected Financial Data Years Ended December 31 (dollars in millions except per share data) 1994* 1993* 1992* 1991* Consolidated Results Premiums earned $ 2,508 $ 2,521 $ 2,683 $ 3,213 Revenues 3,310 3,323 3,712 4,202 Income (loss) from continuing operations before cumulative effect of adopting new accounting standards 237 130 36 (145) Income (loss) from discontinued operations - - (7) (32) Cumulative effect of adopting new accounting standards - 38 - - Net income (loss) 237 168 29 (177) Per Share Results Income (loss) from continuing operations before cumulative effect of adopting new accounting standards $ 2.00 $ .90 $ (.14) $ (2.06) Income (loss) from discontinued operations - - (.08) (.36) Cumulative effect of adopting new accounting standards - .42 - - Net income (loss) 2.00 1.32 (.22) (2.42) Book value 9.96 11.33 8.66 9.30 Investment Results Net investment income $ 749 $ 753 $ 820 $ 880 Realized gains (losses) 5 6 148 38 Change in unrealized gains (losses) (338) 220 (18) 37 Financial Position Assets $ 13,980 $14,481 $13,242 $14,555 Investments 10,561 11,474 11,417 12,216 Corporate debt 586 574 574 617 Real estate and other debt 42 53 54 73 Shareholders' equity 1,441 1,556 1,300 1,346 Common Stock Market high $ 16 1/8 $19 5/8 $ 15 $12 1/2 Market low 11 11/16 11 1/8 7 1/8 5 5/8 Market close 13 5/8 14 3/4 12 3/8 7 1/4 Cash dividends declared .20 .20 .20 .20 Common shares outstanding 104,810,794 91,418,372 89,985,083 88,566,897 Property/Casualty Insurance Premiums earned $ 2,356 $ 2,392 $ 2,579 $ 3,044 Net income (loss) 498 285 194 (41) Statutory premiums written 2,389 2,502 2,475 3,064 Statutory loss ratio 73.1 75.3 81.8 84.0 Statutory expense ratio 34.8 33.5 34.8 33.1 Statutory combined ratio 107.9 108.8 116.6 117.1 Life Insurance Sales $ 286 $ 205 $ 155 $ 280 Premium income 152 129 104 169 Net income (loss) 12 10 (5) 31 Noninsurance Operations Revenues $ 90 $ 5 $ 17 $ 38 Net loss (273) (126) (160) (167) * Amounts have been restated to reflect mergers with Discover Re Managers, Inc., and Victoria Financial Corporation. 1990* 1989* 1988* 1987* 1986* 1985* 1984* $ 3,535 $ 3,713 $ 3,801 $ 3,888 $ 3,622 $ 3,031 $ 2,275 4,191 4,653 4,559 4,500 4,314 3,589 2,630 (433) 148 251 263 276 (109) (64) (136) (31) (20) 2 (2) 1 - - - - - - - - (569) 119 247 279 295 (108) (64) $ (5.10) $ 1.52 $ 2.87 $ 3.36 $ 4.04 $ (1.79) $ (1.16) (1.55) (.35) (.24) .03 (.03) .02 - - - - - - - - (6.65) 1.18 2.82 3.57 4.32 (1.77) (1.16) 11.65 20.61 22.29 19.29 19.90 18.62 18.74 $ 930 $ 912 $ 796 $ 699 $ 619 $ 392 $ 369 (354) (36) (92) (133) 53 150 (23) (30) 32 185 (282) (105) 118 (10) $13,951 $13,576 $12,342 $10,171 $ 8,943 $ 7,676 $ 6,105 11,259 10,911 9,787 7,901 6,831 5,692 4,146 659 543 448 407 348 197 146 129 92 44 24 5 3 4 1,227 2,011 2,058 1,727 1,579 1,217 1,048 $30 3/8 $ 34 $34 3/8 $48 3/4 $46 3/4 $41 1/2 $30 7/8 7 28 1/4 28 1/2 26 1/4 36 1/4 25 5/8 17 5/8 7 1/2 29 28 1/2 28 3/8 39 3/4 39 27 1/2 2.44 2.80 2.64 2.48 2.32 2.20 2.08 88,157,862 87,864,146 83,320,477 79,193,184 69,319,067 65,371,755 55,923,452 $ 3,349 $ 3,548 $ 3,623 $ 3,754 $ 3,542 $ 2,964 $ 2,217 (192) 200 318 331 309 (116) (69) 3,651 3,717 3,903 3,854 3,701 3,152 2,320 81.8 76.4 73.0 73.2 79.1 90.7 90.5 32.9 32.8 31.2 30.1 29.1 30.0 31.4 114.7 109.2 104.2 103.3 108.2 120.7 121.9 $ 1,054 $ 960 $ 1,077 $ 278 $ 83 $ 119 $ 80 186 165 178 133 79 67 58 (16) 31 14 37 20 27 18 $ 22 $ 84 $ 114 $ 112 $ 8 $ 41 $ 33 (361) (112) (85) (88) (86) (23) (13)
USF&G Corporation Consolidated Statement of Operations Years Ended December 31 (dollars in millions except per share data) 1994* 1993* 1992* Revenues Premiums earned $2,508 $2,521 $2,683 Net investment income 749 753 820 Other 48 43 61 Revenues before net realized gains 3,305 3,317 3,564 Net realized gains on investments 5 6 148 Total revenues 3,310 3,323 3,712 Expenses Losses, loss expenses and policy benefits 2,132 2,200 2,497 Underwriting, acquisition and operating expenses 1,001 979 1,087 Interest expense 37 41 41 Restructuring charges - - 51 Facilities exit costs 183 - - Total expenses 3,353 3,220 3,676 Income (loss) from continuing operations before income taxes and cumulative effect of adopting new accounting standards (43) 103 36 Provision for income taxes (benefit) (280) (27) - Income from continuing operations before cumulative effect of adopting new accounting standards 237 130 36 Loss from discontinued operations - - (7) Income (loss) from cumulative effect of adopting new accounting standards: Income taxes - 90 - Postretirement benefits - (52) - Net income $ 237 $ 168 $ 29 Preferred stock dividend requirements 46 48 48 Net income (loss) available to common stock $ 191 $ 120 $ (19) Primary Earnings Per Common Share Income (loss) from continuing operations before cumulative effect of adopting new accounting standards $ 2.00 $ .90 $ (.14) Loss from discontinued operations - - (.08) Income from cumulative effect of adopting new accounting standards - .42 - Net income (loss) $ 2.00 $ 1.32 $ (.22) Fully Diluted Earnings Per Common Share Income (loss) from continuing operations before cumulative effect of adopting new accounting standards $ 1.77 $ .96 $ (.14) Loss from discontinued operations - - (.08) Income from cumulative effect of adopting new accounting standards - .32 - Net income (loss) $ 1.77 $ 1.28 $ (.22) Weighted average common shares outstanding: Primary 95,796,671 90,566,398 89,235,158 Fully diluted 127,807,799 118,850,091 89,235,158 * Amounts have been restated to reflect mergers with Discover Re Managers, Inc., and Victoria Financial Corporation (See Note 1.11). See Notes to Consolidated Financial Statements.
USF&G Corporation Consolidated Statement of Financial Position At December 31 (dollars in millions except per share data) 1994* 1993* 1992* Assets Investments: Fixed maturities: Held to maturity, at amortized cost (market, 1994, $4,284; 1993, $4,807; 1992, $7,300) $ 4,659 $ 4,672 $ 7,228 Available for sale, at market** (cost, 1994, $4,265; 1993, $4,753; market, 1992, $2,076) 4,081 4,976 2,033 Common stocks, at market (cost, 1994, $53; 1993, $80; 1992, $163) 46 66 125 Preferred stocks, at market (cost, 1994, $26; 1993, $23; 1992, $24) 26 23 29 Short-term investments 450 335 532 Mortgage loans 349 302 186 Real estate 662 685 818 Other invested assets 288 415 466 Total investments 10,561 11,474 11,417 Cash 69 18 26 Accounts, notes and other receivables 741 691 748 Reinsurance receivables 554 573 - Servicing carrier receivables 706 719 - Deferred policy acquisition costs 504 444 472 Other assets 845 562 579 Total assets $13,980 $14,481 $13,242 Liabilities Unpaid losses, loss expenses and policy benefits $ 9,962 $10,343 $ 9,460 Unearned premiums 968 950 797 Corporate debt 586 574 574 Real estate and other debt 42 53 54 Other liabilities 981 1,005 1,057 Total liabilities 12,539 12,925 11,942 Shareholders' Equity Preferred stock, par value $50.00 (12,000,000 shares authorized; shares issued, 1994, 6,627,896; 1993, 9,099,910; 1992, 9,100,000) 331 455 455 Common stock, par value $2.50 (240,000,000 shares authorized; shares issued, 1994, 104,810,794; 1993, 91,418,372; 1992, 89,985,083) 262 228 225 Paid-in capital 1,104 986 971 Net unrealized gains (losses) on investments and foreign currency (147) 191 (29) Minimum pension liability (63) (85) - Retained earnings (deficit) (46) (219) (322) Total shareholders' equity 1,441 1,556 1,300 Total liabilities and shareholders' equity $13,980 $14,481 $13,242 * Amounts have been restated to reflect mergers with Discover Re Managers, Inc., and Victoria Financial Corporation (See Note 1.11). ** 1992 amounts are at amortized cost (See Note 1.3). See Notes to Consolidated Financial Statements.
USF&G Corporation Consolidated Statement of Cash Flows Years Ended December 31 (in millions) 1994* 1993* 1992* Operating Activities Direct premiums collected $ 2,029 $ 2,117 $ 2,367 Net investment income collected 750 774 844 Direct losses, loss expenses and policy benefits paid (1,884) (1,922) (2,134) Net reinsurance activity 22 (113) (112) Underwriting and operating expenses paid (789) (774) (842) Interest paid 31 41 42 Income taxes paid (12) (5) (10) Other items, net (7) (14) (39) Net cash provided from continuing operations 140 104 116 Net cash used in discontinued operations - - (2) Net cash provided from operating activities 140 104 114 Investing Activities Net sales and maturities of short-term investments (115) 200 58 Purchases of fixed maturities held to maturity (400) (1,912) (6,945) Sales of fixed maturities held to maturity 65 462 1,116 Maturities/repayments of fixed maturities held to maturity 348 942 327 Purchases of fixed maturities available for sale (351) (1,257) (499) Sales of fixed maturities available for sale 345 1,270 4,812 Repayments of fixed maturities available for sale 480 316 778 Purchases of equities and other investments (434) (256) (439) Sales, maturities and repayments of equities and other investments 482 399 842 Sales of subsidiaries - - 17 Purchases of property and equipment (33) (29) (12) Disposals of property and equipment 4 4 7 Net investing activities of discontinued operations - - 2 Net cash provided from investing activities 391 139 64 Financing Activities Deposits for universal life and investment contracts 246 168 164 Withdrawals of universal life and investment contracts (664) (364) (289) Net short-term borrowings (repayments) (167) (3) 2 Long-term borrowings 270 - - Repayments of long-term borrowings (124) (3) (53) Issuances of common stock 38 17 3 Redemptions of preferred stock (13) - - Cash dividends paid to shareholders (66) (66) (66) Net cash used in financing activities (480) (251) (239) Increase (decrease) in cash 51 (8) (61) Cash at beginning of year 18 26 87 Cash at end of year $ 69 $ 18 $ 26 * Amounts have been restated to reflect mergers with Discover Re Managers, Inc., and Victoria Financial Corporation (See Note 1.11). See supplemental cash flow information at Note 1.12. See Notes to Consolidated Financial Statements.
USF&G Corporation Consolidated Statement of Shareholders' Equity Years Ended December 31 (dollars in millions except per share data) 1994* 1993* 1992* Preferred Stock Balance at beginning of year $ 455 $ 455 $ 455 Par value of shares issued: Series C shares converted to common shares (111) - - Series C shares redeemed (13) - - Balance at end of year 331 455 455 Common Stock Balance at beginning of year 228 225 221 Par value of shares issued 11 3 4 Par value of shares issued for conversion of Series C shares 23 - - Balance at end of year 262 228 225 Paid-In Capital Balance at beginning of year 986 971 967 Excess of proceeds over par value of shares issued 32 15 4 Excess of proceeds over par value of Series C shares converted 86 - - Balance at end of year 1,104 986 971 Net Unrealized Gains (Losses) on Investments and Foreign Currency Balance at beginning of year 191 (29) (11) Net change in unrealized gains (losses) (338) 220 (18) Balance at end of year (147) 191 (29) Minimum Pension Liability Balance at beginning of year (85) - - Change in unfunded accumulated benefits 22 (85) - Balance at end of year (63) (85) - Retained Earnings (Deficit) Balance at beginning of year (219) (322) (286) Net income 237 168 29 Common stock dividends declared (per share, 1994, 1993, and 1992, $.20) (18) (17) (17) Preferred stock dividends declared (per share, 1994, 1993, and 1992, Series A, $4.10, Series B, $10.25, Series C, $5.00) (46) (48) (48) Balance at end of year (46) (219) (322) Total shareholders' equity $1,441 $1,556 $1,300 * Amounts have been restated to reflect mergers with Discover Re Managers, Inc., and Victoria Financial Corporation (See Note 1.11). See Notes to Consolidated Financial Statements.
USF&G Corporation Notes to Consolidated Financial Statements Note 1 Summary of Significant Accounting Policies 1.1. Basis of presentation The consolidated financial statements are prepared in accordance with generally accepted accounting principles ("GAAP"). These statements include the accounts of USF&G Corporation and its subsidiaries ("USF&G," or "the Corporation"). Intercompany transactions are eliminated in consolidation. Certain prior year amounts have been reclassified to conform to the 1994 presentation. See also Note 1.11 regarding restatements for mergers consummated in the second quarter of 1995. 1.2. Permitted statutory accounting practices Reporting practices for insurance subsidiaries prescribed or permitted by state regulatory authorities (statutory accounting) differ from GAAP. Statutory amounts for USF&G's insurance operations follow. (Note: For comparability, amounts are restated to include Discover Re and Victoria (See Note 1.11). However, restatement of prior periods for business combinations is not prescribed by statutory accounting.) Years Ended December 31 (in millions) 1994 1993 1992 Statutory Net Income: Property/casualty insurance $ 170 $ 202 $ 216 Reinsurance subsidiaries and affiliates 3 1 1 Life insurance 30 5 23 At December 31 (in millions) 1994 1993 1992 Statutory Surplus: Property/casualty insurance* $1,621 $1,577 $1,498 Reinsurance subsidiaries and affiliates 211 147 152 Life insurance 326 316 310 *This amount includes the surplus of the life insurance subsidiary and certain reinsurance subsidiaries and affiliates. USF&G's primary insurance subsidiaries, United States Fidelity and Guaranty Company ("USF&G Company") and Fidelity and Guaranty Life Insurance Company ("F&G Life"), are domiciled in the State of Maryland and prepare their statutory financial statements in accordance with accounting practices prescribed or permitted by the Maryland Insurance Administration. Prescribed statutory accounting practices include state laws, regulations and general administrative rules issued by the State of Maryland as well as a variety of publications and manuals of the National Association of Insurance Commissioners ("NAIC"). Permitted statutory accounting practices encompass all accounting practices not so prescribed. Property/Casualty Insurance: USF&G Company received written approval from the Maryland Insurance Administration to extend the required disposal period for real property acquired as security for loans or other obligations. Under the current Maryland Insurance Code, these assets are required to be disposed of within five years from the date of acquisition. The Maryland Insurance Administration extended this time period for certain properties up to no later than December 31, 1997. As of December 31, 1994, this permitted transaction increased statutory surplus by $19 million over what it would have been had prescribed accounting practices been followed. Life Insurance: F&G Life has received permission from the Maryland Insurance Administration to reduce non-admitted assets by the associated asset valuation reserve subcomponent ending balance. As of December 31, 1994, this permitted accounting practice had the effect of increasing statutory surplus by $15 million over what it would have been had prescribed accounting practices been followed. Since Maryland does not specifically prescribe by law or regulation reserves for universal life policies or group annuities, F&G Life follows reserving practices which are permitted by the State of Maryland. These practices are as follows: Universal Life: For older generation universal life ("UL") policies, the full account value is held as a reserve. For newer generation universal life policies, reserves are held based on a calculation according to the NAIC UL Model Regulation, which has been adopted by many states. The reserves calculated according to the NAIC UL Model Regulation equal the account value at the end of the surrender charge period which varies from 8 to 15 years. Group Annuities: Many of the group annuities are used to fund qualified pension and/or profit sharing plans. For these annuities, the funds are not allocated to individual participants. The full account value is held as the reserve for these annuities. For the group annuities where the funds and/or benefits are allocated to the individual certificate holder, reserves are calculated according to the laws prescribed for individual annuities. 1.3. Investments Fixed Maturities: USF&G classifies fixed maturities as "held to maturity" if it has both the positive intent and ability to hold the securities until maturity or near enough to maturity such that interest rate risk is substantially eliminated as a pricing factor. Fixed maturities held to maturity are carried at amortized cost. Changes in the market values of these investments are generally not recognized in the financial statements. Specific write-downs are taken when an impairment is deemed other than temporary. Fixed maturities that are bought and held principally for the purpose of selling them in the near term are classified as "trading securities." USF&G has no securities classified as trading securities. Fixed maturities not classified as either "held to maturity" or "trading securities" are classified as "available for sale." These securities are held for an indefinite period of time and may be sold in response to changes in interest rates and the yield curve, prepayment risk, liquidity needs, or other factors. Effective December 31, 1993, upon the adoption of Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities," available for sale fixed maturities are carried at market value, with unrealized gains and losses recorded as a separate component of shareholders' equity. Unrealized gains or losses on fixed maturities available for sale are offset by an adjustment to life insurance deferred policy acquisition costs which is made on a proforma basis as if the unrealized gains or losses on those assets which match certain life insurance liabilities were realized. At December 31, 1992, before adoption of SFAS No. 115, fixed maturities available for sale were carried at the lower of aggregate amortized cost or market value. Market value exceeded amortized cost at December 31, 1992; therefore, there were no unrealized losses reported in shareholders' equity. Equity Securities and Options: Investments in common and preferred stocks are carried at market value with the resulting unrealized gains or losses reported directly in shareholders' equity. In 1992 premiums received on options written were recorded as liabilities. The premiums paid on options purchased were recorded as assets. Outstanding option positions were carried at market value, and the resulting unrealized gains or losses were reported directly in shareholders' equity. There were no outstanding options at December 31, 1994 and 1993. Securities Lending: USF&G participates in a securities lending program where certain securities from its portfolio are loaned to other institutions for short periods of time. A fee is paid to USF&G by the borrower. Collateral that exceeds the market value of the loaned securities is invested by the lending agent to represent USF&G's interest. USF&G's interest in securities lending is reported in other invested assets. USF&G's invested assets and other liabilities include $6 million, $141 million and $206 million at December 31, 1994, 1993 and 1992, respectively, related to its interest in the securities lending program. Mortgage Loans and Real Estate: Mortgage loans are carried at unpaid principal balances. Real estate investments are reported at cost adjusted for equity participation. Real estate acquired through foreclosure or deed-in-lieu of foreclosure is initially recorded at estimated market value. Valuation allowances are provided for probable impairments in estimated net realizable value based on periodic evaluations. Specific write-downs are taken when an impairment is deemed other than temporary. Interest and Dividend Income: Interest on fixed maturity investments is recorded as income when earned and is adjusted for any amortization of purchase premium or discount. Dividends on equity securities are recorded as income on ex-dividend dates. Realized Gains and Losses: Realized gains and losses on the sale of investments are determined based on specific cost. Realized losses are also recorded when an investment's net realizable value is below cost and the decline is considered other than temporary. 1.4. Recognition of premium revenues Property/Casualty Insurance: Property/casualty insurance premiums are earned principally on a pro rata basis over the lives of the policies and include accruals for ultimate premium revenue anticipated under auditable and retrospectively rated policies. Unearned premiums represent the portion of premiums written applicable to the unexpired terms of policies in force. Unearned premiums also include estimated and unbilled premium adjustments. Life Insurance: Premiums on life insurance policies with fixed and guaranteed premiums and benefits, and premiums on annuities with significant life contingencies are recognized when due. Universal life policies and annuity contracts are issued on both a single premium and recurring premium basis. Revenues for these contracts consist of policy charges assessed against benefit account balances during the period for the cost of insurance, policy administration and surrenders. 1.5. Unpaid losses, loss expenses and policy benefits Property/Casualty Insurance: The liability for unpaid property/casualty insurance losses and loss expenses is based on an evaluation of reported losses and on estimates of incurred but unreported losses. The reserve liabilities are determined using adjusters' individual case estimates and statistical projections. The liability was reported net of estimated salvage and subrogation recoverables of $116 million, $139 million and $138 million at December 31, 1994, 1993 and 1992, respectively. Adjustments to the liability based on subsequent developments or other changes in the estimate are reflected in results of operations in the period in which such adjustments become known. Certain liabilities for unpaid losses and loss expenses related to workers' compensation coverage are discounted to present value. The carrying amount of such workers' compensation liabilities, net of reinsurance and net of discount, was $1,598 million, $1,752 million and $1,798 million at December 31, 1994, 1993 and 1992, respectively. Interest rates used to discount these liabilities generally ranged from 3 percent to 5 percent. Life Insurance: Ordinary life insurance reserves are computed under the net level premium method using assumptions for future investment yields, mortality and withdrawal rates. These assumptions reflect USF&G's experience, modified to reflect anticipated trends, and provide for possible adverse deviation. Reserve interest rate assumptions are graded and range from 4.25 percent to 8.25 percent. Universal life and deferred annuity reserves are computed on the retrospective deposit method, which produces reserves equal to the cash value of the contracts. Such reserves are not reduced for charges that would be deducted from the cash value of policies surrendered. Reserves on immediate annuities with guaranteed payments are computed on the prospective deposit method, which produces reserves equal to the present value of future benefit payments. 1.6. Deferred policy acquisition costs Acquisition costs, consisting of commissions, brokerage, and other expenses incurred at policy issuance, are generally deferred. Anticipated losses, loss expenses, policy benefits and remaining costs of servicing the policies are considered in determining the amount of costs to be deferred. Anticipated investment income is considered in determining whether a premium deficiency exists related to short-duration contracts. Amortization of deferred policy acquisition costs totaled $668 million, $685 million and $747 million for the years ended December 31, 1994, 1993 and 1992, respectively, and are included in underwriting, acquisition and operating expenses in the Consolidated Statement of Operations. Property/Casualty Insurance: Property/casualty insurance acquisition costs are amortized over the period that related premiums are earned. Life Insurance: Life insurance acquisition costs are amortized based on assumptions consistent with those used for computing policy benefit reserves. Acquisition costs on ordinary life business are amortized over their assumed premium paying periods. Universal life and investment annuity acquisition costs are amortized in proportion to the present value of their estimated gross profits over the products' assumed durations, which are regularly evaluated and adjusted as appropriate. 1.7. Property and equipment Property and equipment is carried at cost less accumulated depreciation. At December 31, 1994, 1993 and 1992, $189 million, $196 million and $201 million, respectively, of property and equipment was included in other assets. Depreciation is computed on the straight-line basis over the estimated useful lives of the assets. For the years ended December 31, 1994, 1993 and 1992, depreciation expense of $24 million, $21 million and $25 million, respectively, is included in underwriting, acquisition and operating expenses. 1.8. Foreign currency translation The functional currency for USF&G's foreign operations is the applicable local currency. Foreign currency balance sheet accounts are translated to U.S. dollars using exchange rates in effect at the balance sheet date. Revenue and expense accounts are translated using the average exchange rates prevailing during the year. The unrealized gains or losses, net of applicable deferred income taxes, resulting from translation are included in shareholders' equity. Foreign currency gains and losses on transactions denominated in a currency other than the entity's functional currency are generally recorded in operations. Such gains and losses may be reduced or effectively eliminated by certain financial instruments used by USF&G to reduce its foreign exchange exposure. 1.9. Earnings per common share Primary earnings per common share are computed by subtracting dividends on preferred stock from net income and then dividing by the weighted average common shares outstanding during the period. The effect of common stock equivalents is excluded from the calculations because their effect is not material. Fully diluted earnings per common share assume the conversion of all securities whose contingent issuance would have a dilutive effect on earnings. 1.10. Facilities exit costs During 1994, USF&G committed to a plan to consolidate its home office operations in Baltimore, Maryland at its Mount Washington facility. The facilities exit costs of $183 million represent the present value of the rent and other operating expenses to be incurred under the lease on the Corporation's principal office building from the time USF&G vacates the building through the expiration of the lease in 2009. (See Note 6.) 1.11. Business Combinations On April 13, and May 22, 1995, USF&G consummated mergers with Discover Re Managers, Inc. ("Discover Re"), and Victoria Financial Corporation ("Victoria"), respectively. In the transactions, USF&G exchanged 5.4 million shares of common stock, worth approximately $78.5 million, for all of the outstanding equity of Discover Re, and 3.8 million shares, worth approximately $59.1 million, for all of the outstanding equity of Victoria. Discover Re provides insurance, reinsurance and related services to the alternative risk transfer market. Victoria is an insurance holding company which specializes in nonstandard personal lines auto coverage. Both of these business combinations are accounted for as poolings-of-interests. Accordingly, the financial statements have been restated to reflect the mergers with Discover Re and Victoria. A reconciliation of the previously separate enterprises to the restated consolidated results of operations for periods prior to the mergers is as follows: USF&G Corporation USF&G Corporation (in millions) as Previously Reported Discover Re Victoria as Restated Year Ended December 31, 1994 Revenues Premiums earned $ 2,435 $ 22 $51 $ 2,508 Net investment income 743 3 3 749 Other 38 5 5 48 Revenues before net realized gains 3,216 30 59 3,305 Realized gains on investments 5 - - 5 Total revenues 3,221 30 59 3,310 Expenses Losses, loss expenses and policy benefits 2,079 17 36 2,132 Underwriting, acquisition and operating expenses 971 9 21 1,001 Interest expense 37 - - 37 Facilities exit costs 183 - - 183 Total expenses 3,270 26 57 3,353 Income (loss) from continuing operations before income taxes (49) 4 2 (43) Provision for income taxes (benefit) (281) 1 - (280) Net income 232 3 2 237 Preferred stock dividend requirements 46 - - 46 Net income available to common stock $ 186 $ 3 $ 2 $ 191 Total assets $13,774 $111 $95 $13,980
Year Ended December 31, 1993 Premiums earned $ 2,456 $ 16 $49 $ 2,521 Net investment income 749 2 2 753 Total revenues 3,249 21 53 3,323 Net income 165 1 2 168 Total assets 14,335 63 83 14,481 Year Ended December 31, 1992 Premiums earned $ 2,637 $ 8 $38 $ 2,683 Net investment income 817 1 2 820 Total revenues 3,660 11 41 3,712 Net income 28 - 1 29 Total assets 13,134 40 68 13,242
1.12. Supplemental cash flow information The Consolidated Statement of Cash Flows is presented using the "direct method," which reports major classes of cash receipts and cash payments. A reconciliation of net income to net cash provided from operating activities is as follows: Years Ended December 31 (in millions) 1994 1993 1992 Net income $ 237 $168 $ 29 Adjustments to reconcile net income to net cash provided from operating activities: Loss from discontinued operations - - 7 Cumulative effect of adopting new accounting standards - (38) - Facilities exit costs 183 - - Provision for income taxes (benefit) (280) (27) - Net realized gains on investments (5) (6) (148) Change in insurance liabilities 72 60 68 Change in deferred policy acquisition costs (60) 28 66 Change in receivables (24) 48 137 Change in other liabilities (29) (55) (71) Change in other assets 39 (96) (21) Change in other items, net 7 22 49 Net cash provided from continuing operations 140 104 116 Net cash used in discontinued operations - - (2) Net cash provided from operating activities $ 140 $104 $ 114 Note 2 Investments 2.1. Components of net investment income Years Ended December 31 (in millions) 1994 1993 1992 Interest on fixed maturities $674 $725 $742 Equity security dividends 7 9 12 Option income - - 37 Short-term interest 14 9 27 Real estate and mortgage loans 58 41 50 Other investment income and (expenses) (4) (31) (48) Net investment income $749 $753 $820 2.2. Net realized gains on investments Years Ended December 31 (in millions) 1994 1993 1992 Gains (Losses) on Sales: Fixed maturities $ 3 $ 79 $179 Equity securities and options - 5 44 Real estate and other 12 6 16 Net gains on sales 15 90 239 Impairments: Fixed maturities (1) (10) (20) Equity securities and options - (8) - Real estate and other (9) (66) (71) Total impairments (10) (84) (91) Net realized gains on investments $ 5 $ 6 $148 2.3. Gross unrealized gains (losses) At December 31 (in millions) 1994 1993 1992 Unrealized Gains: Fixed maturities available for sale $ 9 $225 $ - Deferred policy acquisition costs adjustment 33 - - Equity securities 2 14 16 Options, foreign currency and other 16 10 5 Gross unrealized gains 60 249 21 Unrealized Losses: Fixed maturities available for sale (193) (2) - Deferred policy acquisition costs adjustment - (30) - Equity securities (8) (23) (48) Options, foreign currency and other (6) (3) (2) Gross unrealized losses (207) (58) (50) Net unrealized gains (losses) $(147) $191 $(29) 2.4. Change in net unrealized gains (losses) Years Ended December 31 (in millions) 1994 1993 1992 Fixed maturities available for sale $(407) $223 $ - Deferred policy acquisition costs adjustment 63 (30) - Equity securities 3 23 (39) Options, foreign currency and other 3 4 21 Net change $(338) $220 $(18) 2.5. Estimated market values of fixed maturity investments The increase (decrease) in the difference between cost and market value of fixed maturity investments for the years ended December 31, 1994, 1993 and 1992, was $(917) million, $243 million and $(259) million, respectively. The cost and market value of total fixed maturities are as follows: At December 31, 1994 Gross Unrecognized/ Unrealized Market (in millions) Cost Gains Losses Value Fixed maturities held to maturity $4,659 $32 $(407) $4,284 Fixed maturities available for sale 4,265 9 (193) 4,081 Total $8,924 $41 $(600) $8,365 At December 31, 1993 Gross Unrecognized/ Unrealized Market (in millions) Cost Gains Losses Value Fixed maturities held to maturity $4,672 $191 $(56) $4,807 Fixed maturities available for sale 4,753 225 (2) 4,976 Total $9,425 $416 $(58) $9,783 At December 31, 1992 Gross Unrecognized Market (in millions) Cost Gains Losses Value Fixed maturities held to maturity $7,228 $171 $ (99) $7,300 Fixed maturities available for sale 2,033 50 (7) 2,076 Total $9,261 $221 $(106) $9,376 The cost and market value of fixed maturities held to maturity are as follows: At December 31, 1994 Gross Unrecognized Market (in millions) Cost Gains Losses Value U.S. Government bonds $ 13 $ - $ (2) $ 11 Mortgage/asset-backed securities 1,496 19 (105) 1,410 Corporate bonds 2,637 6 (268) 2,375 High-yield bonds 483 6 (31) 458 Tax-exempt bonds 23 1 (1) 23 Other 7 - - 7 Total $4,659 $32 $(407) $4,284 At December 31, 1993 Gross Unrecognized Market (in millions) Cost Gains Losses Value U.S. Government bonds $ 4 $ - $ (1) $ 3 Mortgage/asset-backed securities 1,669 70 (19) 1,720 Corporate bonds 2,464 79 (30) 2,513 High-yield bonds 505 37 (6) 536 Tax-exempt bonds 24 3 - 27 Other 6 2 - 8 Total $4,672 $191 $(56) $4,807 At December 31, 1992 Gross Unrecognized Market (in millions) Cost Gains Losses Value U.S. Government bonds $ 349 $ 3 $ - $ 352 Mortgage/asset-backed securities 3,536 88 (47) 3,577 Corporate bonds 2,661 48 (40) 2,669 High-yield bonds 511 24 (12) 523 Tax-exempt bonds 62 4 - 66 Other 109 4 - 113 Total $7,228 $171 $(99) $7,300 The cost and market value of fixed maturities available for sale are as follows: At December 31, 1994 Gross Unrealized Market (in millions) Cost Gains Losses Value U.S. Government bonds $ 273 $- $ (12) $ 261 Mortgage/asset-backed securities 1,367 3 (57) 1,313 Corporate bonds 2,394 5 (104) 2,295 High-yield bonds 133 - (19) 114 Tax-exempt bonds 98 1 (1) 98 Other - - - - Total $4,265 $9 $(193) $4,081 At December 31, 1993 Gross Unrealized Market (in millions) Cost Gains Losses Value U.S. Government bonds $ 308 $ 20 $ - $ 328 Mortgage/asset-backed securities 1,898 73 - 1,971 Corporate bonds 2,418 126 - 2,544 High-yield bonds 57 2 (2) 57 Tax-exempt bonds 72 4 - 76 Other - - - - Total $4,753 $225 $(2) $4,976 At December 31, 1992 Gross Unrecognized Market (in millions) Cost Gains Losses Value U.S. Government bonds $ 209 $ 3 $ - $ 212 Mortgage/asset-backed securities 1,293 40 (4) 1,329 Corporate bonds 461 7 (1) 467 High-yield bonds 11 - (1) 10 Tax-exempt bonds 32 - (1) 31 Other 27 - - 27 Total $2,033 $50 $(7) $2,076 2.6. Stated due dates of fixed maturities The table below shows the stated due dates of fixed maturities held to maturity. At December 31, 1994 Market (in millions) Cost Value In 1995 $ 18 $ 18 1996 through 1999 341 324 2000 through 2004 1,820 1,684 After 2004 984 848 Subtotal 3,163 2,874 Mortgage/asset-backed securities 1,496 1,410 Fixed maturities held to maturity $4,659 $4,284 The table below shows the stated due dates of fixed maturities available for sale. At December 31, 1994 Market (millions) Cost Value In 1995 $ 153 $ 153 1996 through 1999 1,467 1,418 2000 through 2004 735 702 After 2004 543 495 Subtotal 2,898 2,768 Mortgage/asset-backed securities 1,367 1,313 Fixed maturities available for sale $4,265 $4,081 Expected maturities may differ from stated due dates as borrowers may have the right to call or prepay obligations. During 1994, USF&G received proceeds from sales or repayments of fixed maturities of $1.2 billion. The table below illustrates the source of 1994 proceeds. Gross Gross (in millions) Cost Proceeds Gains Losses Proceeds From Sales of Fixed Maturities: Held to maturity $ 65 $ 65 $1 $(1) Available for sale 347 345 2 (4) Subtotal 412 410 3 (5) Proceeds from Maturities/Repayments: Held to maturity 344 348 5 (1) Available for sale 479 480 1 - Subtotal 823 828 6 (1) Total proceeds $1,235 $1,238 $9 $(6) Sales in 1994 of fixed maturities classified as held to maturity involved 21 different issuers and were based on evidence of significant deterioration of the issuers' creditworthiness. The determination of significant credit deterioration was based upon current developments related specifically to the issuers. USF&G performed a detailed analysis of the issuers' operating trends, cash flows and its ability to meet debt service. USF&G's analysts continually monitor news events, published financial results, rating agency reports and other related financial information. Sales of fixed maturities under such circumstances are not inconsistent with their original classifications as held to maturity. Prior to the adoption of SFAS No. 115 in 1993, proceeds from sales of fixed maturities held to maturity totaled $462 million with gross gains of $20 million and gross losses of $12 million and occurred primarily due to repositioning a portion of the portfolio to more effectively match the duration of life insurance liabilities. Proceeds from sales of fixed maturities available for sale were $1.3 billion in 1993 with gross gains of $73 million and gross losses of $2 million. In 1992, proceeds from sales of fixed maturities held to maturity totaled $1.1 billion with gross gains of $68 million and gross losses of $9 million. Proceeds from sales of fixed maturities available for sale were $4.8 billion in 1992 with gross gains of $293 million and gross losses of $193 million. 2.7. Investment commitments USF&G has outstanding commitments to provide permanent financing for various real estate development projects. The funded amounts of these commitments are collateralized by the real estate projects. At December 31, 1994, unfunded commitments totaled approximately $7 million, with approximately $3 million of this expected to be funded in 1995. USF&G has a potential commitment to fund $12 million under the terms of a participatory note investment if certain collateralization tests are not met. 2.8. Nonincome-producing investments Fixed maturities held at December 31, 1994, for which no income was recorded during 1994, totaled $2 million. In addition, nonperforming real estate, defined as mortgage loans and real estate investments that are not performing in accordance with their contractual terms or are performing significantly below expectations, totaled $208 million at December 31, 1994. Note 3 Insurance Liabilities 3.1. Property/casualty insurance reserves - unpaid losses and loss expenses Activity in the unpaid losses and loss expenses for the property/casualty segment is summarized as follows: (in millions) 1994 1993 1992 Total reserve at beginning of year, gross $6,370 $5,565 $5,716 Less reinsurance recoverables 1,054 1 N/A Net balance at January 1 5,316 5,564 5,716 Incurred Related To: Current year 1,752 1,744 2,042 Prior years (8) 61 78 Total incurred 1,744 1,805 2,120 Paid Related To: Current year 634 582 698 Prior years 1,284 1,471 1,574 Total paid 1,918 2,053 2,272 Net balance at December 31 5,142 5,316 5,564 Plus reinsurance recoverables 1,016 1,054 1 Total reserve at end of year, gross $6,158 $6,370 $5,565 Loss and loss expenses recorded in the current period financial statements are affected by changes in estimates of insured events occurring in prior periods. Losses incurred in 1994 but related to prior years were a reduction of $8 million, or less than 1 percent of 1994 incurred losses. Losses incurred but related to prior years were $61 million in 1993, primarily as a result of the strengthening of the unallocated loss expense reserve for voluntary and servicing carrier business, and increased by $78 million in 1992 primarily because of adverse development on reinsurance assumed from underwriting pools and associations. Reserves for asbestos-related illnesses and environmental claims cannot be estimated with traditional loss reserving techniques. Liabilities are established for known claims (including the cost of litigation) when sufficient information has been developed to indicate the involvement of a specific insurance policy, and management can reasonably estimate its liability. In addition, liabilities have been established to cover additional exposures on both known and unasserted claims. Estimates of the liabilities are reviewed and updated continually. Developed case law and adequate claim history do not exist for such claims, especially because significant uncertainty exists about the outcome of coverage litigation and whether past claim experience will be representative of future loss experience. 3.2. Life benefit reserves The table below shows F&G Life's benefit reserves by policy type. At December 31 (in millions) 1994 1993 1992 Single Premium Annuities: Deferred $1,860 $2,138 $2,077 Immediate 867 815 788 Other annuities 492 462 508 Universal life/term/group life 579 554 523 Net balance 3,798 3,969 3,896 Reinsurance receivable 6 4 - Total reserve at end of year, gross $3,804 $3,973 $3,896 Note 4 Debt and Credit Arrangements 4.1. Debt outstanding At December 31 (in millions) 1994 1993 1992 Corporate: Short-term $215 $395 $375 Long-term: 9.98% and 10.1% Universal Medium-Term Notes due 1994 - - 20 8 7/8% Notes due 1996 - 99 99 5 1/2% Swiss Franc Bonds due 1996 92 80 80 Zero Coupon Convertible Notes due 2009 130 - - 8 3/8% Senior Notes due 2001 149 - - Total corporate debt 586 574 574 Real Estate and Other: Short-term 12 18 12 Long-term: 8% Secured Note due 1995 - 11 11 9 3/8% Secured Note due 1994 - - 11 9.96% Secured Notes due through 1999 14 14 15 Other 16 10 5 Total real estate and other debt 42 53 54 Total debt outstanding $628 $627 $628
4.2. Short-term debt For general corporate purposes, USF&G maintained a committed, standby credit facility with a group of foreign and domestic banks totaling $400 million at December 31, 1994. This new facility, which expires in 1997, represents the renegotiation of a prior credit facility of $700 million which was available at December 31, 1993. USF&G pays facility fees on the total amount of the commitments which are based on its long-term debt credit ratings. In order to minimize facility fees, and due to the reduced borrowings against it, the Corporation elected to reduce the size of the facility to its current level. Borrowings against the facilities totaled $215 million at December 31, 1994 and $375 million at December 31, 1993 and 1992. Interest rates are based on current market rates. USF&G was in compliance with the covenants contained in these agreements at December 31, 1994, 1993 and 1992. The most restrictive covenants require USF&G to maintain a tangible net worth of at least $1.1 billion plus 50 percent of the net income earned during the commitment period and an indebtedness-to-capital ratio below 55 percent. In 1994, USF&G also entered into agreements under which a $100 million foreign currency credit facility and a $100 million letter of credit facility are available. USF&G pays facility fees on the total amount of each commitment. There were no borrowings against these facilities at December 31, 1994. 4.3. Debt extinguishments With proceeds from the issuance of the Zero Coupon Convertible Notes issued in March 1994, USF&G extinguished $99 million principal of the Corporation's 8 7/8% Notes due 1996 and $20 million principal of Medium-Term Notes due 1994. Proceeds from the issuance of the 8 3/8% Senior Notes in June 1994 were used to reduce the short-term credit facility borrowings by $147 million. Real estate debt was reduced by $11 million as the result of prepaying notes due in 1995 and further reduced $11 million as a result of a deed-in-lieu of foreclosure whereby property in which USF&G had a partnership interest was conveyed back to the lender. Real estate debt increased by $63 million as a result of the restructuring of a real estate partnership whereby USF&G became a controlling general partner. Shortly thereafter, $54 million of this partnership debt was defeased, reducing the amount that would otherwise have been consolidated as a result of this restructuring to $9 million. 4.4. Shelf registrations In January 1994, USF&G filed a shelf registration statement with the Securities and Exchange Commission. As of the time this registration statement went into effect, USF&G had available $647 million of unissued debt, preferred stock, common stock and warrants to purchase debt and stock. This registration statement was reduced by $126 million by the issuance of the Zero Coupon Convertible Notes and $149 million by the issuance of the 8 3/8% Senior Notes. 4.5. Redeemable debt In 1994 and thereafter, the 5 1/2% Swiss Franc Bonds are redeemable at par plus accrued interest. The Zero Coupon Convertible Notes are redeemable beginning in 1999 for an amount equal to the original issue price plus amortized original issue discount. 4.6. Currency swaps USF&G entered into currency swap agreements in 1989 to hedge its foreign currency exposure on the SwF120 million 5 1/2% Swiss Franc Bonds. This hedge was canceled in September 1994 and USF&G received a payment of approximately $19 million. USF&G then rehedged the repayment of the SwF120 million Swiss Franc debt and interest payments with forward contracts. 4.7. Interest rate swaps As of December 31, 1993, USF&G had outstanding an interest rate swap for the notional amount of $25 million to exchange variable rate debt into a fixed rate of 9.405%. During 1994, USF&G entered into a new floating-for-fixed-rate swap to reduce the floating rate exposure created by the prior swap. In conjunction with the issuance of the 8 3/8% Senior Notes, USF&G entered into two interest rate swaps with a total notional amount of $150 million which convert the fixed interest payments from the debt issuance to floating rate debt for the first three years of the seven year term of the debt. These agreements involve, to varying degrees, interest rate and credit risk. The notional amount represents the amount of the underlying debt to which the swap applies, not future cash requirements. The maximum credit risk related to the swap agreements is the amount related to periodic settlements, which is not material at December 31, 1994. USF&G seeks to manage the credit risk through monitoring procedures and investigation of counterparties to the transactions. 4.8. Interest Interest expense incurred in the years ended December 31, 1994, 1993 and 1992 was $37 million, $41 million and $41 million, respectively. Interest incurred and capitalized in 1992 was $8 million. There was no interest capitalized in 1993 or 1994. 4.9. Maturities of long-term debt Real Estate (in millions) Corporate and Other 1995 $ - $ 12 1996 92 - 1997 - - 1998 - - 1999 - 24 Note 5 Financial Instruments and Derivatives Fair value information is based on quoted market prices where available. In cases where quoted market prices are not available, fair values are based on internal estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, such as applicable discount rate and estimated future cash flows. Therefore, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. Fair value disclosure requirements exclude certain financial instruments and all nonfinancial instruments. The fair value of many insurance related liabilities do not require disclosure. However, in its strategy of asset/liability matching, USF&G takes into consideration the future cash requirements of its insurance related liabilities. Had a presentation of these liabilities been made, due to their long-term nature, the fair value of insurance related liabilities would have been significantly less than their carrying value. 5.1. Financial instruments Cash and Short-Term Investments: The carrying amounts reported in the Consolidated Statement of Financial Position for these instruments approximate their fair values. Fixed Maturity Investments: Fair values for publicly traded fixed maturity investments are based on quoted market prices. For privately placed fixed maturities, estimated fair values are derived by discounting expected future cash flows using a current market rate applicable to the yield, credit quality and maturity of the investment. At December 31, 1994, the amortized cost, carrying amounts and fair values of fixed maturity investments were as follows: Amortized Carrying Fair (in millions) Cost Amount Value Publicly traded $8,694 $8,513 $8,147 Private placements 230 227 218 Total fixed maturity investments $8,924 $8,740 $8,365 The preceding table includes fixed maturities available for sale with a market and carrying value of $4.1 billion and amortized cost of $4.3 billion. Such investments are reported in the Consolidated Statement of Financial Position at market value. Equity Investments: The carrying values of equity securities as reported in the Consolidated Statement of Financial Position are based on quoted market prices and reflect their fair values. Mortgage Loans and Policy Loans: The fair values for mortgage loans and policy loans are estimated based on discounted cash flow analyses, using interest rates currently being offered for similar loans to borrowers with similar credit ratings. Loans with similar characteristics are aggregated for purposes of the calculations. At December 31, 1994, the carrying amounts and fair values of investments in mortgage loans and policy loans were as follows: Carrying Fair (in millions) Amount Value Mortgage loans $349 $331 Policy loans 61 55 Other Assets and Other Liabilities: Other invested assets considered financial instruments include equity interests in minority ownership investments, interests in limited partnerships and related notes receivable. It is not practicable to estimate their fair value due to the closely-held nature of these investments. Other assets and liabilities considered financial instruments include agents' balances receivable, prepaid and accrued expenses and other receivables generally of a short-term nature. It is assumed the carrying value of these financial instruments approximates their fair value. Short and Long-Term Debt: The carrying amount of USF&G's short-term borrowings approximates its fair value. The fair value of long-term debt is based on market quotes or estimated discounted cash flow analyses, based on USF&G's current incremental borrowing rates for similar types of borrowing arrangements. The carrying amounts and estimated fair value of debt instruments at December 31, 1994 were as follows: Carrying Fair (in millions) Amount Value Corporate: Short-term $215 $215 Long-term 371 349 Real estate and other 42 44 Total $628 $608 Investment Contracts: Fair values for F&G Life's single premium deferred annuities, other deferred annuities, single premium immediate annuities and supplementary contracts are primarily derived by estimating the cost to extinguish its liabilities under an assumption reinsurance transaction. The estimated statutory profits the assuming company would realize from the transaction are discounted at a typical internal rate of return objective. If such a transaction were to occur, GAAP would require the unamortized balance of deferred acquisition costs associated with these liabilities be immediately expensed. The amount of the related unamortized deferred acquisition costs was approximately $98 million at December 31, 1994. The fair values of the remaining liabilities under investment contracts are estimated using discounted cash flow calculations, based on interest rates currently being offered for like contracts with similar maturities. The carrying amounts and estimated fair values of F&G Life's liabilities for investment contracts at December 31, 1994 are as follows: Carrying Fair (in millions) Amount Value Single premium deferred annuities $1,870 $1,818 Other deferred annuities 349 319 Single premium immediate annuities and supplementary contracts 121 116 Funding agreements 1 1 Group annuities 130 124 Total $2,471 $2,378 Off-Balance Sheet Financial Instruments: The fair values of USF&G's unfunded real estate commitments and its financial commitment on investments are estimated using discounted cash flow analyses, based on USF&G's current incremental borrowing rate for similar types of borrowing arrangements. The estimates of the fair value of USF&G's interest rate swaps were obtained from the counterparties to the agreement or were derived by discounting the expected future cash flows. The estimated fair values of USF&G's off-balance sheet financial instruments at December 31, 1994, are as follows: Fair (in millions) Value Liabilities: Unfunded real estate commitments $ 6 Commitment on investments 13 Debt-related Derivatives: Interest rate swaps 7 Currency forwards 2 5.2. Derivatives USF&G uses derivative instruments to manage foreign exchange and interest rate risk, reduce borrowing costs and minimize the impact of rate fluctuations on the settlement of debt and other financial instruments. USF&G is subject to the risk that the counterparties will fail to perform. However, these risks are mitigated by the credit quality of the counterparties and the gains and losses of the underlying instruments. USF&G does not use derivative instruments for trading purposes. Foreign Exchange Rate Instruments: The Corporation relies predominantly on natural hedges to manage foreign exchange rate risk by maintaining offsetting foreign asset and foreign liability positions wherever possible, without sacrificing other financing objectives. Foreign exchange derivative instruments in use as of December 31, 1994 were two currency forward contracts to purchase Swiss Francs for the principal and interest payment associated with USF&G's SwF120 million 5 1/2% Swiss Franc Bonds due 1996. The difference between the spot rate at the initiation of the forward contract and the forward rate is amortized over the life of the forward contract as foreign currency expense. Interest Rate Instruments: The Corporation uses interest rate derivatives selectively to enable it to maintain a certain fixed/floating rate exposure given the current and projected interest rate environment. The interest rate environment in 1994 was one in which short-term floating rate obligations initially provided lower cost financing, but entailed greater interest rate risk and provided only short duration liquidity. At the outset of 1994, USF&G had approximately 61 percent floating rate debt ($375 million) and 39 percent fixed rate debt ($243 million). In June 1994, USF&G issued $150 million of 8 3/8% Senior Notes due 2001, proceeds of which were used to repay a portion of the floating rate debt. USF&G subsequently entered into two interest rate swaps with a total notional amount of $150 million in which it pays floating interest rates and receives a fixed interest rate to maintain an appropriate fixed/floating rate exposure. At December 31, 1994, USF&G had approximately 59 percent floating rate debt ($364 million) and 41 percent fixed rate debt ($252 million). Additionally, in 1994, USF&G entered into a $25 million floating-for-fixed-rate swap to reduce the exposure created by a 1990 fixed-for-floating-rate swap. The new floating-for-fixed-rate swap has terms similar to the remaining terms of the 1990 transaction. Other Instruments: USF&G has issued financial instruments with a maximum contingent liability of $2 million depending on the market price of USF&G's common stock at the maturity of the instruments. Note 6 Leases USF&G occupies office facilities under lease agreements that expire at various dates through 2009. In addition, data processing, office and transportation equipment is leased under agreements that expire at various dates through 1999. Most leases contain renewal options that may provide for rent increases based on prevailing market conditions. Some leases also may contain purchase options based on fair market values or contractual values, if greater. All leases are accounted for as operating leases. Rent expense for the years ended December 31, 1994, 1993 and 1992 was $63 million, $55 million and $59 million, respectively. Rent expense in 1994 included a $9 million loss on long-term subleases. The table below shows the future minimum payments to be made under noncancelable leases at December 31, 1994. Home Other Office Office Equip- (in millions) Building Space ment Total 1995 $ 16 $18 $11 $ 45 1996 16 13 6 35 1997 16 11 3 30 1998 16 9 2 27 1999 19 7 - 26 After 1999 250 6 - 256 Total $333 $64 $22 $419 USF&G is also the lessor under various subleases on its office facilities. The minimum rentals to be received in the future under noncancelable subleases is $33 million at December 31, 1994. USF&G's principal office lease involves a 40-story office building ("the Tower") which the Corporation sold in 1984 and subsequently leased back. During 1994, USF&G developed and committed to a plan to consolidate its Baltimore headquarters facilities. The plans encompass relocating all USF&G personnel currently residing at the Tower to the Mount Washington facilities in Baltimore which USF&G owns. Implementation of the plan began in January 1995. The relocation of Tower personnel will begin in mid-1995 and is expected to be completed by the end of 1996. The facilities exit costs of $183 million recorded in the fourth quarter of 1994 represent the present value of the acceleration of net expenses, including rent and operating expenses, to be incurred under the Tower lease from the time USF&G vacates the Tower through the expiration of the lease in 2009. The lease on the Tower, which provides for rent increases every five years through its expiration in September 2009, will not be terminated. USF&G will continue to make rental payments under the lease. The deferred gain arising from the sale-leaseback was being amortized over the noncancelable lease term prior to the recognition of the facilities exit costs. For each of the years ended December 31, 1994, 1993 and 1992, amortization of approximately $2 million is netted with underwriting, acquisition and operating expenses. The unamortized amount of the deferred gain of $30 million and $31 million at December 31, 1993 and 1992, respectively, is included in other liabilities. The unamortized deferred gain of $28 million at December 31, 1994 was recognized upon adoption of the facilities exit plan and is netted against the lease expenses included in the facilities exit costs. Note 7 Shareholders' Equity 7.1. Classes of stock USF&G is authorized to issue 12 million shares of $50 par value preferred stock and 240 million shares of $2.50 par value common stock. 7.2. Preferred stock USF&G has 4 million shares of $4.10 Series A Convertible Exchangeable Preferred Stock ("Series A Preferred Stock"), 1.3 million shares of $10.25 Series B Cumulative Convertible Preferred Stock ("Series B Preferred Stock"), and 1.3 million shares of $5.00 Series C Cumulative Convertible Preferred Stock ("Series C Preferred Stock") issued and outstanding at December 31, 1994. USF&G had 4 million shares of Series A Preferred Stock, 1.3 million shares of Series B Preferred Stock, and 3.8 million shares of Series C Preferred Stock issued and outstanding at December 31, 1993 and 1992. During 1994, USF&G called for redemption 2.4 million shares of its Series C Preferred Stock. The remaining shares were called for redemption effective February 24, 1995. As a result of these calls, over 93 percent of the Series C Preferred Stock converted into 14.7 million shares of common stock in accordance with the terms of the Series C Preferred Stock. Pursuant to arrangements the Corporation previously entered into with an unaffiliated financial institution, USF&G sold 716,600 shares of common stock to this institution to fund a portion of the cash redemptions resulting from these calls. Each share of the Series A Preferred Stock entitles the holder to an annual cumulative dividend of $4.10 and a liquidation preference of $50 plus accrued and unpaid dividends. Each share of Series B Preferred Stock entitles the holder to an annual cumulative dividend of $10.25 and a liquidation preference of $100 plus accrued and unpaid dividends. At December 31, 1994, at the option of the holder, subject to adjustment under certain conditions, each share of Series A and Series B Preferred Stock is convertible to 1.192 and 8.316 shares, respectively, of USF&G's common stock. The Series A Preferred Stock is exchangeable in whole at USF&G's option on any dividend payment date for 8.2% Convertible Subordinated Debentures due in 2011 at a rate of $50 principal amount per share. Series B Preferred Stock is not exchangeable. Shares of the Series A Preferred Stock are redeemable for cash, in whole or in part, at USF&G's option at $50.82 per share plus accrued and unpaid dividends to the redemption date. The redemption price declines to $50 per share in 1996. One half of the outstanding shares of Series B Preferred Stock are redeemable for cash, in part, at USF&G's option commencing in 1994 at $100 per share plus accrued and unpaid dividends and a premium that declines ratably to zero per share in 2001. The remainder is redeemable beginning in 1995 and 1996. No redemption may be made prior to 1997 unless the closing price of the common stock exceeds 150 percent of the Series B Preferred Stock conversion price and subject to certain other conditions. In addition, if a change in control event should occur, then at the election of each holder of Series B Preferred Stock, USF&G will issue and sell additional nonredeemable equity securities and apply the net proceeds thereof to redeem these shares, but only if and to the extent any such proceeds are raised. Holders of the preferred stock are not entitled to vote, except that they may vote separately with respect to certain matters including the authorizations of any additional classes of capital stock that would rank senior to the preferred stock. In the event that six quarterly dividends for Series A Preferred Stock or two quarterly dividends for Series B Preferred Stock are unpaid, USF&G's Board of Directors will be increased by two members, and holders of preferred stock may elect two directors until all such dividends in arrears have been paid. 7.3. Dividend restrictions Payment of dividends to USF&G Corporation by its insurance subsidiary is subject to certain restrictions. The Maryland Insurance Code requires the Maryland Insurance Commissioner's prior approval for any dividend payments during a twelve month period from a Maryland insurance subsidiary, such as USF&G Company, to its holding company which exceeds 10 percent of policyholders' surplus. In addition, notice of any other dividend must be given to the Maryland Insurance Commissioner prior to payment, and the Commissioner has the right to prevent payment of such dividend if it is determined that such payment could impair the insurer's surplus of financial condition. At December 31, 1994, $157 million of dividends is currently available for payment to USF&G Corporation from its insurance subsidiary during 1995 without prior regulatory approval. At December 31, 1993, $154 million in dividends was available for payment to USF&G Corporation from its insurance subsidiary without restriction, of which $125 million of dividends was paid during 1994. 7.4. Changes in common stock shares Years Ended December 31 1994 1993 1992 Common Stock: Outstanding, January 1 91,418,372 89,985,083 88,566,897 Shares issued 13,392,422 1,433,289 1,418,186 Outstanding, December 31 104,810,794 91,418,372 89,985,083 USF&G issued 9.9 million shares of common stock during 1994 related to the conversion of Series C Preferred Stock. Another 5.5 million common stock shares were issued in February 1995 for the conversion of the remaining Series C Preferred Stock. 7.5. Shareholder rights plan USF&G has a shareholder rights plan ("the plan") to deter coercive or unfair takeover tactics and to prevent a potential purchaser from gaining control of USF&G without offering a fair price to all of the Corporation's shareholders. Under the plan, each outstanding share of USF&G's common stock has one preferred share purchase right (a "right") expiring in 1997. Each right entitles the registered holder to purchase 1/100 of a share of a new class of junior preferred stock for $140. The rights cannot be exercised unless certain events occur that might lead to a concentration in ownership of common shares. At that time, the rights may be exercised for common stock having a value of twice the exercise price. Under certain conditions, the rights also become exercisable into shares of common stock of a purchaser having a value of twice the exercise price. USF&G will generally be entitled to redeem the rights, at $.05 per right, any time before the tenth day after a 20 percent position is acquired. Note 8 Stock Ownership Plans 8.1. Stock options and stock purchase plans Stock Options: Stock options have been granted to full-time officers and key employees under four incentive plans: Long-Term Incentive Plan, Stock Option Plan of 1987, Stock Option Plan of 1990, and Stock Incentive Plan of 1991. In addition, the Employee Stock Option Plan of 1992 and the 1994 Stock Plan For Employees of USF&G granted eligible employees, other than officers and key employees participating in other stock incentive plans, options to purchase shares based on market quotations at the time of grant. Activity under the stock option plans is as follows: 1994 1993 1992 Outstanding, January 1 4,824,136 5,135,484 3,478,660 Granted 2,245,500 1,143,282 2,590,295 Exercised (483,590) (338,940) (26,868) Surrendered or cancelled (677,595) (1,115,690) (906,603) Outstanding, December 31 5,908,451 4,824,136 5,135,484 Expiration dates 1/95-12/2004 1/94-12/2003 1/93-12/2002 Exercise and surrender prices $6.25-30.82 $6.25-30.82 $6.25-30.82 Shares reserved and available for grant 8,106,029 2,324,047 2,364,267 Stock Purchase Plans: Shares had been offered to employees under the Employees' Stock Purchase Plans of 1985 and 1990. None were offered in 1992, 1993 or 1994. The purchase price was 85 percent of the market value of USF&G's common stock on the grant date or the end of the two-year purchase period, whichever was less. Activity under the stock purchase plans is as follows: 1994 1993 1992 Outstanding, January 1 - - 133,379 Granted - - - Shares purchased - - (98,882) Cancelled - - (34,497) Outstanding, December 31 - - - Expiration dates - - N/A Purchase prices - - $11.16 Shares reserved - - N/A Proceeds from the shares sold under the stock option and stock purchase plans are credited to common stock and paid-in capital. USF&G makes no charges to income for the plans. The number of shares under the plans are adjusted for any future stock dividends, stock splits or similar changes. 8.2. Directors stock plan The Corporation adopted the 1993 Stock Plan for Non-Employee Directors (the "Directors Stock Plan") on May 12, 1993. Only the Corporation's outside directors are eligible to participate, and participation is mandatory. The Directors Stock Plan has two components: (i) annual retainer awards, and (ii) retirement awards. The Directors Stock Plan authorizes the issuance of up to 300,000 shares of the Corporation's common stock, par value $2.50 per share. Activity under the Directors Stock Plan is as follows: 1994 1993 Outstanding, January 1 113,585 - Stock units awarded 17,115 135,885 Stock issued (34,198) (22,300) Outstanding, December 31 96,502 113,585 USF&G records compensation expense equal to the market value at grant date of the vested stock or stock units awarded under the Directors Stock Plan. In 1993, $2 million of compensation expense was recognized relating to this plan. The 1994 compensation expense related to these plans was minimal and is expected to continue to be so in future years. Note 9 Retirement Benefits 9.1. Retirement plans USF&G has noncontributory retirement plans covering most regular full-time employees of the Corporation and its affiliates. An employee's pension benefit is based on salary, years of service and Social Security benefits. USF&G makes contributions to the retirement plans based on amounts required to be funded under provisions of the Employee Retirement Income Security Act of 1974. The plans' funded status and amounts recognized in the consolidated financial statements are as follows: At December 31 (dollars in millions) 1994 1993 1992 Actuarial Present Value of: Accumulated benefit obligation $303 $338 $263 Vested benefits 291 322 249 Plan assets at fair value $289 $297 $265 Projected benefit obligation 313 351 278 Funded status (24) (54) (13) Unrecognized net loss 98 123 55 Unrecognized prior service cost (benefit) (22) (25) (28) Adjustment for minimum pension liability (63) (85) - Net prepaid (accrued) pension cost $(11) $(41) $ 14 Actuarial Assumptions: Weighted average discount rate 8.75% 7.50% 8.75% Average rate of increase in future compensation levels 5.0 5.0 6.0 Expected long-term rate of return on assets 8.5 8.5 9.5 As a result of the higher interest rate environment, USF&G increased the discount rate assumption as of December 31, 1994, which caused the accumulated benefit obligation to decrease. In accordance with SFAS No. 87, USF&G recorded a minimum pension liability for the underfunded amount, representing the accumulated benefit obligation in excess of the fair value of the plans' assets, plus the amount of prepaid pension costs. The minimum pension liability is reported as a separate reduction to shareholders' equity. The assets held by the plan consist primarily of fixed-income and equity securities. USF&G classifies prepaid pension cost with other assets and accrued pension cost with other liabilities in the Consolidated Statement of Financial Position. The components of net pension expense are as follows: Years Ended December 31 (in millions) 1994 1993 1992 Service cost $ 6 $ 4 $ 5 Interest cost 26 25 23 Actual return on plan assets 10 (19) (15) Net amortization and deferral (29) - (10) Net periodic pension expense $ 13 $ 10 $ 3 9.2. Postretirement benefits USF&G sponsors a defined dollar postretirement health care plan (medical and dental) and noncontributory life insurance plan covering most regular full-time employees of the Corporation and its affiliates. USF&G's contributions and costs are determined based on the annual salary and the type of coverage elected by covered employees. USF&G's contributions to the plan are a percentage of plan costs based on age and service of employees at retirement. Additionally, the plan costs are capped at projected 1995 cost levels, and retiree contributions are increased for the total medical costs over the projected levels. Effective January 1, 1993, USF&G adopted SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions." This statement requires USF&G to accrue a liability for the cost of health care, life insurance and other retiree benefits when the employees' services are rendered. As permitted under the new standard, the transition obligation of $52 million at January 1, 1993 was recognized as an immediate charge to net income by including the cumulative effect of adopting this accounting standard. USF&G continues to fund the health care and life insurance benefit costs principally on a pay-as-you-go basis. The pay-as-you-go expenditures for postretirement benefits were $5 million in 1994 and 1993, and $4 million in 1992. The plans' combined funded status and amounts recognized in the consolidated financial statements are as follows: At December 31 (in millions) 1994 1993 Accumulated Postretirement Benefit Obligation: Retirees $(45) $(46) Fully eligible active plan participants (1) (4) Other active plan participants (6) (8) (52) (58) Plan assets at fair value - - Funded status (52) (58) Unrecognized net loss (gain) (1) 6 Accrued postretirement benefit cost $(53) $(52) USF&G classifies accrued postretirement benefit cost with other liabilities in the Consolidated Statement of Financial Position. The components of the net periodic postretirement benefit cost are as follows: Years Ended December 31 (in millions) 1994 1993 Service cost $1 $1 Interest cost 4 4 Net periodic postretirement benefit cost $5 $5 The weighted average annual assumed rate of increase in per capita cost of covered benefits (i.e., medical trend rate) for the plans is 9.0 percent for 1995 (10.5 percent assumed for 1994) and is assumed to decrease to 5.5 percent in 2002 for participants age 65 or younger, and 7.75 percent for 1995 (8.0 percent for 1994), decreasing to 5.5 percent for participants over age 65, and remain at that level thereafter. Increasing the assumed medical trend rate by one percentage point in each year would increase the accumulated postretirement benefit obligation by approximately $4 million and the aggregate of the service and interest cost components of net periodic postretirement benefit cost for the year by approximately $0.4 million. The weighted average discount rate used in determining the accumulated postretirement benefit obligation was 8.75 percent at December 31, 1994 and 7.5 percent at December 31, 1993. Note 10 Federal Income Taxes USF&G Corporation and its subsidiaries file a consolidated federal income tax return. The provision for income taxes gives effect to permanent differences between income before income taxes and taxable income. Deferred federal income taxes are provided on temporary differences and net operating loss carry- forwards (for 1994 and 1993) and timing differences (for 1992) between financial and taxable income. Effective January 1, 1993, USF&G changed its method of accounting for income taxes as required by SFAS No. 109, "Accounting for Income Taxes." Under the standard, a deferred tax liability or asset is recognized for the estimated future tax effects attributable to net operating loss carry-forwards ("NOLs") and to temporary differences between the tax basis and GAAP basis of an asset or a liability. A valuation allowance is required if, based on the weight of available evidence, it is more likely than not that some or all of the deferred tax asset will not be realized. As permitted under SFAS No. 109, 1992 financial statements have not been restated. At December 31, 1994, the net deferred tax asset of $419 million recorded by USF&G is supported by a combination of forecasted taxable income and a tax strategy that USF&G would implement to prevent NOLs from expiring. A valuation allowance of $279 million has been recognized to offset the gross deferred tax assets. 10.1. Significant components of deferred tax assets and liabilities At December 31 (in millions) 1994 1993 Deferred Tax Liabilities: Deferred policy acquisition costs $165 $143 Other invested assets 7 44 Other 4 - Total deferred tax liabilities 176 187 Deferred Tax Assets: Facilities exit costs 74 - Unpaid losses and loss expenses 249 306 Unearned premiums 45 47 Foreign reinsurance 50 49 Real estate 25 30 Future policy benefits 54 50 Net unrealized losses 52 - Other 62 85 Net operating loss carry-forwards 263 222 Total deferred tax assets 874 789 Valuation allowance for deferred tax assets 279 482 Deferred tax assets, net of valuation allowance 595 307 Net deferred tax assets $419 $120 At December 31, 1994, the net deferred tax asset increased to $419 million, primarily based on the increasing weight of positive evidence which resulted in a $203 million net decrease in the valuation allowance. Throughout 1994, the weight of evidence became increasingly more positive as the core earnings trend improved each quarter. As 1994 progressed, the negative evidence of cumulative losses which were caused by 1991 results became increasingly less of a factor. Given the substantially reduced degree of negative evidence and management's increased confidence in the sustainability of the improved earnings of the core insurance segments and, therefore, its enhanced ability to forecast future taxable income, it became appropriate to reduce the valuation allowance. During 1993, the net decrease in the valuation allowance was $56 million reflecting the change in the realizability of the deferred tax asset. In addition, the valuation allowance was increased $15 million in 1993 due to the tax rate change enacted in that year. 10.2. Components of provision for income taxes (benefits) Years Ended December 31 Liability Liability Deferred Method Method Method (in millions) 1994 1993 1992 Current tax $ 32 $ 40 $ 23 NOL Utilization (22) (31) (16) Current tax, net of NOL utilization 10 9 7 Deferred tax (benefit) (23) 23 (7) Adjustment for enacted change in tax rates - (3) - Adjustment of the beginning of the year valuation allowance (267) (56) - Provision for income taxes (benefit) $(280) $(27) $ - Income taxes paid $ 12 $ 5 $ 10 10.3. Tax effects of timing differences between financial and taxable income Year Ended December 31 (in millions) 1992 Tax Effect (Benefit): Deferred policy acquisition costs $(15) Unbilled premium adjustments (4) Adjustment of life policy benefit reserves (1) Adjustment of property/casualty loss reserves 3 Adjustment of property/casualty unearned premium reserves (4) Deferred realized gains and losses (2) Unrecognized benefit of net losses 19 Other, net (2) Provision for income taxes (benefit) $ (6) 10.4. Tax effects of permanent differences Years Ended December 31 Liability Liability Deferred Method Method Method (in millions) 1994 1993 1992 Tax at federal rates $ (16) $ 36 $12 Tax Effect (Benefit): Adjustment of the beginning of the year valuation allowance (267) (56) - Effect of change in tax rates - (3) - Dividend received deduction - - (3) Tax-exempt interest income (3) (2) (3) Proration adjustment on non-taxable investment income - - 1 Adjustment of property/casualty salvage and subrogation accruals (fresh start) 6 - - Adjustment of property/casualty loss reserves (fresh start) - - (9) Other - (2) 2 Provision for income taxes (benefit) $(280) $(27) $ - 10.5. Net operating loss carry-forwards At December 31, 1994, USF&G had NOLs remaining for tax return purposes expiring in years 2005 and 2006. The amount and timing of recognizing the benefit of these NOLs depends on future taxable income and limitations imposed by tax laws. The approximate amounts of USF&G's NOLs on a regular tax basis and an alternative minimum tax ("AMT") basis at December 31, 1994 were as follows: (in millions) Tax Return Regular tax basis $750 AMT basis 553 Note 11 Reinsurance During 1993, USF&G adopted SFAS No. 113, "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts." This standard requires the effects of reinsurance activity to be reported on a gross basis. Reinsurance receivables and prepaid reinsurance premiums are reported separately as assets, instead of the previous practice of reporting such receivables net of the related loss and unearned premium liabilities. The standard also establishes the conditions required for a contract to be accounted for as reinsurance and prescribes income recognition and reporting standards for those contracts. The initial adoption of this standard had no effect on net income, but increased assets and liabilities by approximately $1.2 billion at December 31, 1993. USF&G reinsures portions of its policy risks with other insurance companies or underwriters, and assumes policy risks from other insurance companies and through participation in pools and associations. Reinsurance gives USF&G the ability to write larger risks and control its exposure to losses from catastrophes or other events that cause unfavorable underwriting results. USF&G's ceding reinsurance agreements are generally structured on a treaty basis whereby all risks meeting a certain criteria are automatically reinsured. Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policy. Reinsurance contracts do not relieve USF&G from its obligation to policyholders. Failure of reinsurers to honor their obligation could result in losses to USF&G. USF&G evaluates the financial condition of its reinsurers and monitors concentrations of credit risks arising from similar economic characteristics of the reinsurers to minimize its exposure to significant losses from reinsurer insolvencies. At December 31, 1994 and 1993, reinsurance receivables totaled $554 million and $573 million, respectively. Of these amounts, approximately $122 million and $150 million, respectively, were associated with the Workers' Compensation Reinsurance Bureau ("WCRB"), a single voluntary reinsurance association of primary workers' compensation insurers formed for the purpose of providing excess of loss reinsurance to its members. USF&G is a member of this pool. Each member is required to hold collateral, for the benefit of all member companies, in the form of investment-grade securities equaling 115 percent of the member's share of outstanding receivables of the WCRB. This collateral requirement mitigates the risk of WCRB becoming insolvent. Risk of loss is minimal for the remainder of receivables due to similar pool arrangements with collateral requirements, other contracts where funds are withheld, or letters of credit maintained. Credit risk is also diversified among numerous reinsurers. Additionally, USF&G is active in the involuntary market as a servicing carrier whereby USF&G processes business for a pool but takes no direct underwriting risk because it is directly reimbursed for the cost of processing policies and settling any related claims. Servicing carrier receivables of $706 million and $719 million associated with this business are separately disclosed in the Consolidated Statement of Financial Position at December 31, 1994 and 1993, respectively. 1994 Premiums Losses Unpaid Unearned (in millions) Written Earned Incurred Losses Premiums Property/Casualty: Direct $2,303 $2,284 $1,660 $4,826 $855 Assumed 594 588 407 1,332 113 Gross 2,897 2,872 2,067 6,158 968 Ceded (508) (516) (323) (1,016) (116) Net 2,389 2,356 1,744 5,142 852 Life N/A 152 388 3,804 N/A Total $2,389 $2,508 $2,132 $8,946 $852 1993 Premiums Losses Unpaid Unearned (in millions) Written Earned Incurred Losses Premiums Property/Casualty: Direct $2,400 $2,390 $1,508 $5,100 $836 Assumed 613 523 96 1,270 114 Gross 3,013 2,913 1,604 6,370 950 Ceded (511) (521) 201 (1,054) (124) Net 2,502 2,392 1,805 5,316 826 Life N/A 129 395 3,973 N/A Total $2,502 $2,521 $2,200 $9,289 $826 1992 Premiums Losses Unpaid Unearned (in millions) Written Earned Incurred Losses Premiums Property/Casualty: Direct $2,521 $2,734 $2,210 $5,610 $828 Assumed 271 384 391 1,563 104 Gross 2,792 3,118 2,601 7,173 932 Ceded (317) (539) (481) (1,609) (135) Net 2,475 2,579 2,120 5,564 797 Life N/A 104 377 3,896 N/A Total $2,475 $2,683 $2,497 $9,460 $797 Included in assumed unpaid losses in the above table are $86 million, $110 million and $123 million related to loss portfolio transfer agreements at December 31, 1994, 1993 and 1992, respectively. USF&G has not entered into any such agreements to cede its unpaid losses. The ceded unpaid losses and assumed unpaid losses for 1993 were reduced $464 million and $267 million, respectively, from 1992 due to a commutation involving the WCRB. At year end 1993, WCRB members commuted the lowest layer of reinsurance for accident years 1980 to 1992. As a result, USF&G was required to take back all reserves previously ceded into the layer and return reserves previously assumed. Note 12 Financial Guarantees 12.1. Insurance guarantees USF&G has underwritten and reinsured financial guarantee bonds for principal and interest payments or installment notes when due. The obligations guaranteed were issued by limited partnerships, municipalities and commercial enterprises. Assessment is made of the likelihood of loss in connection with these guarantees, and at December 31, 1994, 1993 and 1992, the reserve for such losses was not material. The risk of loss under these guarantees is diminished through reinsurance agreements and collateral. As of December 31, 1994, USF&G was contingently liable for par value amounts totaling less than $500 million on financial guarantee exposures ceded through reinsurance agreements with a monoline insurance company in which USF&G formerly had a minority ownership interest. In addition, USF&G has other financial guarantee obligations where the par value guaranteed totaled $27 million at December 31, 1994, maturing in 1995. 12.2. Corporate guarantees USF&G has also guaranteed the obligations of certain limited partnerships where it has an equity interest. The risk of loss under these guarantees is diminished by collateral in the underlying projects. The guarantees totaled $13 million at December 31, 1994, with maturities ranging from 1995 to 1999. In addition, USF&G has line of credit commitments outstanding totaling $55 million. Note 13 Legal Contingencies USF&G's insurance subsidiaries are routinely engaged in litigation in the normal course of their businesses, including defending claims for punitive damages. As a liability insurer, they defend third-party claims brought against their insureds. As an insurer, they defend themselves against coverage claims. Additional information regarding contingencies that may arise from insurance regulatory matters and regulatory litigation matters may be found in the Regulation section of Management's Discussion and Analysis of Financial Condition and Results of Operations. In the opinion of management, such litigation and the litigation described below is not expected to have a material adverse effect on USF&G's consolidated financial position, although it is possible that the results of operations in a particular quarter or annual period would be materially affected by an unfavorable outcome. 13.1. North Carolina workers' compensation litigation On November 24, 1993, N.C. Steel, Inc. and six other North Carolina employers filed a class action in the General Court of Justice, Superior Court Division, Wake County, North Carolina against the National Council on Compensation Insurance ("NCCI"), North Carolina Rate Bureau, USF&G and eleven other insurance companies which served as servicing carriers for the North Carolina involuntary workers' compensation market. On January 20, 1994, the plaintiffs filed an amended complaint seeking to certify a class of all employers who purchased workers' compensation insurance in the State of North Carolina after November 24, 1989. The amended complaint, which is captioned N.C. Steel, Inc., et al., v. National Council on Compensation Insurance, et al., alleges that the defendants conspired to suppress competition with respect to the North Carolina voluntary and involuntary workers' compensation business, thereby artificially inflating the rates in such markets and the fees payable to the insurers. The complaint also alleges that the carriers agreed to improperly deny qualified companies from acting as servicing carriers, improperly encourage agents to place employers in the assigned risk pool, and improperly promote inefficient claims handling. USF&G has acted as a servicing carrier in North Carolina since 1990. The plaintiffs are pursuing their claims under various legal theories, including violations of the North Carolina antitrust laws, unlawful conspiracy, breach of fiduciary duty, breach of implied covenant of good faith and fair dealing, unfair competition, constructive fraud, and unfair and deceptive trade practices. The plaintiffs seek unspecified compensatory damages, punitive damages for the alleged constructive fraud and treble damages under the North Carolina antitrust laws. On February 14, 1995, the trial court granted the defendant's motion to dismiss the complaint. The plaintiffs have appealed the trial court's dismissal of the case. USF&G believes that it has meritorious defenses and has determined to defend the action vigorously. 13.2. Texas workers' compensation litigation On April 18, 1994, Mi-De-Pizza, Inc. and ten other Texas insureds filed an amended class action in the District Court of Dallas County, Texas against the NCCI and all insurance companies and certain insurance brokers that wrote workers' compensation insurance in Texas during the period 1987 to 1991. The case, which was subsequently consolidated with another case to which USF&G was not a party and is now captioned Weatherford Roofing Company, et al., v. Employers National Insurance Company, et al., alleges that the defendants utilized rates and forms that had the effect of charging premium rates in excess of the rates approved by law. The plaintiffs are pursuing recovery of these alleged excess charges under various legal theories, including breach of contract, fraud, civil conspiracy and violation of the Texas Insurance Code and the Texas Business and Commerce Code. USF&G believes that it has meritorious defenses and has determined to defend the action vigorously. 13.3. South Carolina workers' compensation litigation On August 22, 1994, the Attorney General of the State of South Carolina filed suit in the County of Greenville, South Carolina on behalf of South Carolina employers that have allegedly been damaged as a result of alleged unfair and deceptive trade practices. Specifically, the Attorney General alleges that the NCCI, the National Workers' Compensation Reinsurance Pool, USF&G and seven other insurance companies which served as servicing carriers for the South Carolina involuntary workers' compensation market, conspired to fix servicing carrier fees at unreasonably high and noncompetitive levels in violation of the South Carolina Uniform Trade Practices Act, allegedly causing inflated deficits in the involuntary market and an excessive expansion of the residual market. The Attorney General alleges that the conspiracy occurred for an unspecified period of time prior to January 1994. The Attorney General has indicated that he intends to pursue recovery on behalf of all South Carolina employers who have suffered an ascertainable loss as a result of such alleged conduct, civil penalties of $5,000 for each willful violation, and temporary and permanent injunctive relief. USF&G believes that it has meritorious defenses and has determined to defend the action vigorously. 13.4. Alabama workers' compensation litigation On September 14, 1994, three Alabama employers filed a class action captioned Four Way Plant Farm, Inc., et al., v. National Council on Compensation Insurance, et al., in the Circuit Court of Bullock County, Alabama on behalf of all Alabama employers that have allegedly been damaged as a result of an alleged conspiracy by the NCCI, the National Workers' Compensation Reinsurance Pool, USF&G and numerous other insurance companies which served as servicing carriers for the Alabama involuntary workers' compensation market, to fix servicing carrier fees at unreasonably high and noncompetitive levels in violation of Alabama law. The plaintiffs allege that the conspiracy occurred during the period January 1, 1985 to January 1, 1994, and caused inflated deficits in the involuntary market and an alleged excessive expansion of the workers' compensation residual market. The plaintiffs seek unspecified damages on behalf of each member of the proposed class action. USF&G believes that it has meritorious defenses and has determined to defend the action vigorously. Note 14 Information on Business Segments USF&G's principal business segments are property/casualty insurance and life insurance. 14.1. Operations The insurance business is geographically diversified throughout the United States and Canada. Reinsurance and noninsurance operations are located in the United States, Europe and various foreign countries. Foreign operations, in total, are not material. Summarized financial information for the business segments is as follows: Years Ended December 31 Income (Loss) from Continuing Operations Revenues Before Income Taxes (in millions) 1994 1993 1992 1994** 1993 1992*** Property/Casualty Insurance: Commercial $1,189 $1,223 $1,480 $(186) $(223) $(343) Personal 575 681 785 (60) (28) (110) Reinsurance 395 305 157 40 32 20 Fidelity/surety 124 118 111 6 (8) 6 Discover Re and Victoria 73 65 46 (2) (2) (1) Property/casualty categories 2,356 2,392 2,579 (202) (229) (428) Net investment income* 429 437 478 429 437 478 Net realized gains (losses) on investments* (9) 31 199 (9) 31 199 Other 10 5 4 1 (22) (52) Total property/casualty insurance 2,786 2,865 3,260 219 217 197 Life Insurance: Premium income 152 129 104 Net investment income 317 321 349 Realized gains (losses) on investments - 20 (1) Other 1 1 2 Total life insurance 470 471 454 14 14 (5) Noninsurance operations and eliminations 54 (13) (2) (276) (128) (156) Consolidated total $3,310 $3,323 $3,712 $ (43) $ 103 $ 36
*Net investment income and net realized gains (losses) on investments are not allocated to property/casualty categories. **Income (loss) from continuing operations before income taxes for 1994 includes facilities exit costs by segment as follows: Property/casualty, $28 million; and Noninsurance operations, $(211) million. ***Income (loss) from continuing operations before income taxes for 1992 includes restructuring charges by segment as follows: Property/casualty, $46 million; Life, $3 million; and Noninsurance operations, $2 million. 14.2. Assets The assets of the insurance operations are primarily investments. Foreign assets are not material. Assets of the business segments are as follows: At December 31 (in millions) 1994 1993 1992 Property/casualty insurance $ 9,487 $ 9,711 $ 8,361 Life insurance 4,575 4,848 4,856 Noninsurance operations and eliminations (82) (78) 25 Consolidated total $13,980 $14,481 $13,242 EX-13 4 Note 15 Interim Financial Data (Unaudited) Quarter (in millions except per share data) First Second Third Fourth Summary Quarterly Results:* Revenues 1994 $786 $812 $ 835 $877 1993 891 837 775 820 1992 952 920 1,024 816 Income from continuing operations before cumulative effect of adopting new accounting standards 1994 23 74 76 64 1993 23 26 21 60 1992 4 7 12 13 Loss from discontinued operations 1994 - - - - 1993 - - - - 1992 - (1) (6) - Income from cumulative effect of adopting new accounting standards 1994 - - - - 1993 38 - - - 1992 - - - - Net income 1994 23 74 76 64 1993 61 26 21 60 1992 4 6 6 13 Primary Earnings per Common Share:* Income (loss) from continuing operations before cumulative effect of adopting new accounting standards 1994 $.11 $.66 $.67 $.54 1993 .12 .15 .10 .52 1992 (.09) (.06) - .01 Loss from discontinued operations 1994 - - - - 1993 - - - - 1992 - (.01) (.07) - Income from cumulative effect of adopting new accounting standards 1994 - - - - 1993 .42 - - - 1992 - - - - Net income (loss) 1994 .11 .66 .67 .54 1993 .54 .15 .10 .52 1992 (.09) (.07) (.07) .01 Fully Diluted Earnings per Common Share:* Income (loss) from continuing operations before cumulative effect of adopting new accounting standards 1994 $.11 $.56 $.58 $.47 1993 .16 .15 .10 .47 1992 (.09) (.06) - .01 Loss from discontinued operations 1994 - - - - 1993 - - - - 1992 - (.01) (.07) - Income from cumulative effect of adopting new accounting standards 1994 - - - - 1993 .32 - - - 1992 - - - - Net income (loss) 1994 .11 .56 .58 .47 1993 .48 .15 .10 .47 1992 (.09) (.07) (.07) .01
*The fourth quarter 1994 results reflect $183 million in facilities exit costs as discussed in Note 6, and a $210 million tax benefit as discussed in Note 10. The first quarter 1993 results include a $38 million net benefit of adopting two new accounting standards. The third quarter 1992 results reflect $142 million in realized gains on investments, $80 million of catastrophe losses as a result of Hurricane Andrew, and $51 million of restructuring charges. The sum of quarterly income (loss) per share amounts may not equal the full year's amount due to stock issuances during presented periods. USF&G Corporation Report of Independent Auditors Board of Directors USF&G Corporation We have audited the accompanying consolidated statement of financial position of USF&G Corporation as of December 31, 1994, 1993, and 1992, and the related consolidated statements of operations, shareholders' equity, and cash flows for the years then ended. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of USF&G Corporation at December 31, 1994, 1993, and 1992 and the consolidated results of its operations and its cash flows for the years then ended, in conformity with generally accepted accounting principles. In 1993, as a result of adopting new accounting standards and as discussed in Notes 1, 2, 9, and 10 to the consolidated financial statements, the Corporation changed its methods of accounting for certain investments in debt and equity securities, postretirement benefits other than pensions, and income taxes. ERNST & YOUNG LLP Baltimore, Maryland February 24, 1995, except for Note 1.11, as to which the date is May 22, 1995 USF&G Corporation Shareholders' Information Corporate Headquarters/Home Office 100 Light Street Baltimore, Maryland 21202 (410) 547-3000 Annual Meeting The Annual Meeting of Shareholders will be held Wednesday, May 17, 1995, at 9:00 a.m. at the Sheraton Inner Harbor Hotel, 300 South Charles Street, Baltimore, Maryland. Reports Filed with the Securities and Exchange Commission A copy of USF&G Corporation's Annual Report on Form 10-K or Quarterly Report on Form 10-Q, as filed with the Securities and Exchange Commission, may be obtained without charge upon request to John F. Hoffen, Jr., corporate secretary at the corporate headquarters. Stock Exchange Listing Common Stock: USF&G Corporation's common stock (ticker: FG) is listed on the New York Stock Exchange. The common stock appears in the NYSE Composite Listing as USFG. The common stock is also listed on the Pacific Stock Exchange, the London Stock Exchange, and the Stock Exchanges of Basle, Geneva, and Zurich, Switzerland. Preferred Stock: USF&G Corporation's $4.10 Series A Convertible Exchangeable Preferred Stock (ticker: FGpA) is listed on the New York Stock Exchange. The preferred stock appears in the NYSE Composite Listing as USFGpf, and is also listed on the Pacific Stock Exchange. Transfer Agent/Registrar First Chicago Trust Company of New York is transfer agent, registrar, and dividend disbursing agent for USF&G Corporation's common and preferred stock. Inquiries regarding stock transfer requirements, dividend payments, the Dividend Reinvestment and Stock Purchase Plan, or address changes should be addressed to: First Chicago Trust Company of New York P.O. Box 2500 Jersey City, NJ 07303-2500 Attention: Shareholders' Relations Department 1-800-446-2617 Stock and Dividend Information The following tabulation presents 1994 and 1993 data on the sale prices of USF&G Corporation's common stock on the New York Stock Exchange Composite Listing by quarter, and the dividends paid per share of common stock. At February 24, 1995, there were 33,689 shareholders of record and the closing price was $14 7/8. Sale Price High Low Dividends Paid 1994 First quarter $16 1/8 $ 13 $.05 Second quarter 14 11 11/16 .05 Third quarter 14 12 1/8 .05 Fourth quarter 14 5/8 12 5/8 .05 1993 First quarter $17 5/8 $ 11 1/8 $.05 Second quarter 19 5/8 15 3/4 .05 Third quarter 19 5/8 13 7/8 .05 Fourth quarter 15 1/4 12 3/8 .05 Dividend Reinvestment and Stock Purchase Plan The plan provides shareholders with a convenient way to invest cash dividends and to make optional cash investments in additional shares of USF&G Corporation's common stock without payment of any charges for brokerage commissions or fees. First Chicago Trust Company of New York administers the plan and additional information may be obtained from them by written request. For Additional Information Any investors and analysts requesting additional information regarding USF&G Corporation may dial our new toll-free number, 1-800-335-USFG (8734) or call directly: Jennifer Macke Investor Relations Department (410) 547-3939 Independent Auditors Ernst & Young LLP One North Charles Street Baltimore, Maryland 21201 EX-27 5
7 1000000 12-MOS DEC-31-1994 DEC-31-1994 4081 4659 4284 72 349 662 10561 69 554 504 13980 9951 968 11 85 628 262 0 331 848 13980 2508 749 5 48 2132 668 333 (43) (280) 237 0 0 0 237 2.00 1.77 5316 1752 (8) 634 1284 5142 (8)
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