-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: keymaster@town.hall.org Originator-Key-Asymmetric: MFkwCgYEVQgBAQICAgADSwAwSAJBALeWW4xDV4i7+b6+UyPn5RtObb1cJ7VkACDq pKb9/DClgTKIm08lCfoilvi9Wl4SODbR1+1waHhiGmeZO8OdgLUCAwEAAQ== MIC-Info: RSA-MD5,RSA, fNWBSo56e3ylvMYWZfFZvvHQeRqO0Kn8kJp52NOSDlmgAjJbgP2HbTXFVMgIG6Af 4v51UZz+Tmn9n92jlJ/pmA== 0000354396-94-000032.txt : 19940819 0000354396-94-000032.hdr.sgml : 19940819 ACCESSION NUMBER: 0000354396-94-000032 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19940630 FILED AS OF DATE: 19940815 FILER: COMPANY DATA: COMPANY CONFORMED NAME: USF&G CORP CENTRAL INDEX KEY: 0000354396 STANDARD INDUSTRIAL CLASSIFICATION: 6331 IRS NUMBER: 521220567 STATE OF INCORPORATION: MD FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-08233 FILM NUMBER: 94544359 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-Q 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q Quarterly Report Under Section 13 or 15(d) of the Securities and Exchange Act of 1934 For the Quarter Ended Commission File Number June 30, 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 and zip code) (410) 547-3000 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve (12) months, and (2) has been subject to such filing requirements for the past 90 days. Yes X No Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: Common Stock, Par Value $2.50; 85,404,975 shares outstanding as of July 29, 1994. USF&G Corporation Contents PART I. FINANCIAL INFORMATION Item 1. Financial Statements: Condensed Consolidated Statement of Financial Position 3 Condensed Consolidated Statements of Operations 4 Condensed Consolidated Statements of Cash Flows 6 Notes to Condensed Consolidated Financial Statements 8 Independent Auditor's Review Report 10 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 11 PART II. OTHER INFORMATION Item 1. Legal Proceedings 25 Item 4. Submission of Matters to a Vote of Shareholders 25 Item 6. Exhibits and Reports on Form 8-K 25 Exhibit 4 - Instruments Defining the Rights of Security Holders Including Indentures 25 Exhibit 11 - Computation of Earnings Per Share 26 Exhibit 12 - Computation of Ratio of Consolidated Earnings to Fixed Charges and Preferred Stock Dividends 27 Exhibit 15 - Letter Regarding Unaudited Interim Financial Information 28 SIGNATURE 29 2 USF&G Corporation Condensed Consolidated Statement of Financial Position At June 30 At December 31 (dollars in millions except share data) 1994 1993 Assets Unaudited Investments: Fixed maturities: Held to maturity, at amortized cost (market, 1994, $4,470;1993, $4,796) $ 4,714 $ 4,661 Available for sale, at market (cost, 1994, $4,329; 1993,$4,681) 4,254 4,903 Common stocks, at market (cost, 1994, $85; 1993, $98) 75 87 Preferred stocks, at market (cost, 1994, $65; 1993, $48) 65 48 Short-term investments 325 322 Mortgage loans 329 302 Real estate 722 685 Other invested assets 374 369 Total investments 10,858 11,377 Cash 83 17 Accounts, notes, and other receivables 695 656 Reinsurance receivables 625 573 Servicing carrier receivables 684 719 Deferred policy acquisition costs 478 435 Other assets 579 558 Total assets $14,002 $14,335 Liabilities Unpaid losses, loss expenses, and policy benefits $10,177 $10,302 Unearned premiums 942 917 Corporate debt 581 574 Real estate and other debt 53 44 Other liabilities 937 987 Total liabilities 12,690 12,824 Shareholders' Equity Preferred stock, par value $50.00 (12,000,000 shares authorized; shares issued, 1994 and 1993, 9,099,910) 455 455 Common stock, par value $2.50 (240,000,000 shares authorized; shares issued, 1994, 85,375,814; 1993, 85,009,482) 213 212 Paid-in capital 965 963 Net unrealized gains (losses) on investments (75) 192 Net unrealized losses on foreign currency - (2) Minimum pension liability (85) (85) Retained earnings (deficit) (161) (224) Total shareholders' equity 1,312 1,511 Total liabilities and shareholders' equity $14,002 $14,335 See Notes to Condensed Consolidated Financial Statements. 3 USF&G Corporation Condensed Consolidated Statement of Operations (Unaudited) Three Months Ended June 30 (dollars in millions except per share data) 1994 1993 Revenues Premiums earned (net of premiums ceded, 1994, $117; 1993, $112) $ 589 $ 620 Net investment income 191 189 Other 10 11 Revenues before realized gains 790 820 Realized gains on investments 1 - Total revenues 791 820 Expenses Losses, loss expenses, and policy benefits (net of losses ceded, 1994, $68; 1993, $10) 523 537 Underwriting, acquisition, and operating expenses 223 247 Interest expense 7 11 Total expenses 753 795 Pretax income before cumulative effect of adopting new accounting standards 38 25 Provision for income taxes (benefit) (35) - Income before cumulative effect of adopting new accounting standards 73 25 Income (loss) from cumulative effect of adopting new accounting standards: Income taxes - - Postretirement benefits - - Net income $ 73 $ 25 Preferred stock dividend requirements 12 12 Net income available to common stock $ 61 $ 13 Primary Earnings Per Common Share Income before cumulative effect of adopting new accounting standards $ .72 $ .15 Income (loss) from cumulative effect of adopting new accounting standards: Income taxes - - Postretirement benefits - - Net income $ .72 $ .15 Full Diluted Earnings Per Common Share Income before cumulative effect of adopting new accounting standards $ .59 $ .15 Income (loss) from cumulative effect of adopting new accounting standards: Income taxes - - Postretirement benefits - - Net income $ .59 $ .15 Weighted average common shares outstanding (000s): Primary 85,320 84,695 Fully diluted 119,879 84,695 Dividends declared per common share $ .05 $ .05 See Notes to Condensed Consolidated Financial Statements. 4 USF&G Corporation Condensed Consolidated Statement of Operations (Unaudited) Six Months Ended June 30 (dollars in millions except per share data) 1994 1993 Revenues Premiums earned (net of premiums ceded, 1994, $244; 1993, $246) $ 1,159 $ 1,294 Net investment income 374 381 Other 18 19 Revenues before realized gains 1,551 1,694 Realized gains on investments 6 1 Total revenues 1,557 1,695 Expenses Losses, loss expenses, and policy benefits (net of losses ceded, 1994, $131; 1993, $74) 1,032 1,127 Underwriting, acquisition, and operating expenses 447 499 Interest expense 16 21 Total expenses 1,495 1,647 Pretax income before cumulative effect of adopting new accounting standards 62 48 Provision for income taxes (benefit) (34) - Income before cumulative effect of adopting new accounting standards 96 48 Income (loss) from cumulative effect of adopting new accounting standards: Income taxes - 90 Postretirement benefits - (52) Net income $ 96 $ 86 Preferred stock dividend requirements 24 24 Net income available to common stock $ 72 $ 62 Primary Earnings Per Common Share Income before cumulative effect of adopting new accounting standards $ .85 $ .28 Income (loss) from cumulative effect of adopting new accounting standards: Income taxes - 1.06 Postretirement benefits - (.61) Net income $ .85 $ .73 Full Diluted Earnings Per Common Share Income before cumulative effect of adopting new accounting standards $ .77 $ .35 Income (loss) from cumulative effect of adopting new accounting standards: Income taxes - .80 Postretirement benefits - (.46) Net income $ .77 $ .69 Weighted average common shares outstanding (000s): Primary 85,226 84,619 Fully diluted 117,406 113,036 Dividends declared per common share $ .10 $ .10 See Notes to Condensed Consolidated Financial Statements. 5 USF&G Corporation Condensed Consolidated Statement of Cash Flows (Unaudited) Three Months Ended June 30 (dollars in millions) 1994 1993 Operating Activities Net income $ 73 $ 25 Adjustments to reconcile net income to net cash provided from (used in) operating activities: Cumulative effect of adopting new accounting standards - - Realized gains on investments (1) - Change in insurance liabilities 22 4 Change in deferred policy acquisition costs (23) 6 Change in receivables (6) (22) Change in other liabilities (53) (35) Change in other assets (46) (20) Other items, net 11 3 Net cash provided from (used in) operating activities (23) (39) Investing Activities Net (purchases) sales and maturities of short-term investments 15 (15) Purchases of fixed maturities held to maturity (154) (320) Sales of fixed maturities held to maturity 37 78 Maturities/repayments of fixed maturities held to maturity 92 229 Purchases of fixed maturities available for sale (68) (165) Sales of fixed maturities available for sale 167 203 Repayments of fixed maturities available for sale 105 94 Purchases of equities and other investments (140) (31) Sales, maturities, or repayments of equities and other investments 95 34 Purchases of property and equipment (7) (4) Disposals of property and equipment 1 1 Net cash provided from investing activities 143 104 Financing Activities Deposits for universal life and investment contracts 56 35 Withdrawals of universal life and investment contracts (113) (71) Net short-term borrowings (repayments) (160) - Long-term borrowings 148 - Repayments of long-term borrowings - - Issuances of common stock 2 2 Cash dividends paid to shareholders (17) (17) Net cash used in financing activities (84) (51) Increase in cash 36 14 Cash at beginning of period 47 13 Cash at end of period $ 83 $ 27 See Notes to Condensed Consolidated Financial Statements. 6 USF&G Corporation Condensed Consolidated Statement of Cash Flows (Unaudited) Six Months Ended June 30 (dollars in millions) 1994 1993 Operating Activities Net income $ 96 $ 86 Adjustments to reconcile net income to net cash provided from (used in) operating activities: Cumulative effect of adopting new accounting standards - (38) Realized gains on investments (6) (1) Change in insurance liabilities 61 41 Change in deferred policy acquisition costs (43) 6 Change in receivables (68) (6) Change in other liabilities (77) 15 Change in other assets (6) (35) Other items, net 27 12 Net cash provided from (used in) operating activities (16) 80 Investing Activities Net (purchases) sales and maturities of short-term investments (4) 255 Purchases of fixed maturities held to maturity (351) (1,561) Sales of fixed maturities held to maturity 50 124 Maturities/repayments of fixed maturities held to maturity 251 437 Purchases of fixed maturities available for sale (117) (165) Sales of fixed maturities available for sale 184 843 Repayments of fixed maturities available for sale 287 122 Purchases of equities and other investments (253) (72) Sales, maturities, or repayments of equities and other investments 245 108 Purchases of property and equipment (14) (8) Disposals of property and equipment 4 1 Net cash provided from investing activities 282 84 Financing Activities Deposits for universal life and investment contracts 106 70 Withdrawals of universal life and investment contracts (266) (202) Net short-term borrowings (repayments) (160) - Long-term borrowings 270 - Repayments of long-term borrowings (121) - Issuances of common stock 4 3 Cash dividends paid to shareholders (33) (33) Net cash used in financing activities (200) (162) Increase in cash 66 2 Cash at beginning of period 17 25 Cash at end of period $ 83 $ 27 See Notes to Condensed Consolidated Financial Statements. 7 USF&G Corporation Notes to Condensed Consolidated Financial Statements 1. Basis of Accounting The condensed 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"). Intercompany transactions are eliminated in consolidation. Certain 1993 amounts have been reclassified to conform to the 1994 presentation. The interim financial statements in this report should be read in conjunction with the consolidated financial statements and notes thereto in USF&G's Annual Report to Shareholders for the year ended December 31, 1993. In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain the necessary adjustments, all of which are of a normal recurring nature for interim period reporting purposes, for a fair presentation of results for the interim periods. 2. Review by Independent Auditors USFG's independent auditors, Ernst & Young LLP, have performed a review of the condensed consolidated financial statements in this Form 10-Q as to the three and six month periods ended June 30, 1994, and 1993. Their limited review in accordance with standards established by the American Institute of Certified Public Accountants did not constitute an audit. Accordingly, they do not express an opinion on this information. 3. Earnings Per Common Share Primary earnings per common share are based on income, after deduction of preferred stock dividends, and the weighted average number of common shares outstanding during the periods. Common stock equivalents were not included as they were insignificant. Fully diluted earnings per common share assume the conversion of all securities whose contingent issuance would have a dilutive effect on earnings. Refer to the computation in Exhibit 11. 4. Ratio of Consolidated Earnings to Fixed Charges For purposes of computing the ratio of consolidated earnings to fixed charges and preferred stock dividends, earnings consist of income before considering income taxes, the cumulative effect of adopting new accounting standards, and fixed charges. Fixed charges consist of interest, that portion of rentals that is deemed to be an appropriate interest factor, and preferred stock dividend requirements. Refer to the computation in Exhibit 12. 5. Unrealized Gains (Losses) on Investments At June 30, 1994, gross unrealized gains and gross unrealized losses pertaining to equity securities totaled $2 million and $12 million, respectively. In addition, gross unrealized gains and gross unrealized losses on limited partnerships included in other investments totaled $7 million and $1 million, respectively. At June 30, 1994, there were gross unrealized gains of $2 million and gross unrealized losses of $77 million pertaining to fixed maturities available for sale. There were also $4 million of gross unrealized gains relating to a deferred policy acquisition cost adjustment. The change in net unrealized gains (losses) on investments amounted to a loss of $267 million during the six months ended June 30, 1994, compared with a gain of $28 million during the six months ended June 30, 1993. 6. Proceeds From Sales of Fixed Maturity Investments Proceeds on sales of fixed maturities held to maturity were $50 million for the six months ended June 30, 1994. Gross gains and gross losses of less than $1 million were realized on those sales. During the six month period ended June 30, 1993, proceeds from sales of fixed maturities held to maturity were $124 million. Gross gains of $5 million and gross losses of $5 million were realized on sales in 1993. Proceeds from sales of fixed maturities available for sale were $184 million for the six months ended June 30, 1994, compared with $843 million for the same period in 1993. Gross gains and gross losses of $1 million were realized on 1994 sales. Gross gains of $39 million and gross losses of $2 million were realized on sales in 1993. 7. Legal Contingencies 7.1.General USF&G'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. 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. 7.2.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 encouraged agents to place employers in the assigned risk pool, and improperly promoted 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 construction fraud, and treble damages under the North Carolina antitrust laws. USF&G believes that it has meritorious defenses and has determined to defend the action vigorously. 7.3.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 their claims under various legal theories, including breach of contract, fraud, civil conspiracy, 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. 7.4.South Carolina Workers Compensation Litigation The Attorney General of the State of South Carolina has, pursuant to a statutory provision requiring formal notice prior to filing of a suit, given notice that he intends to file 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, 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. 9 USF&G Corporation Report of Independent Auditors Board of Directors USF&G Corporation We have reviewed the accompanying condensed consolidated statement of financial position of USF&G Corporation as of June 30, 1994, and the related condensed consolidated statements of operations and cash flows for the three-month and six-month periods ended June 30, 1994 and 1993. These financial statements are the responsibility of the Company's management. We conducted our reviews in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical review procedures to financial data, and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with generally accepted auditing standards, which will be performed for the full year with the objective of expressing an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion. Based on our reviews, we are not aware of any material modifications that should be made to the accompanying condensed consolidated financial statements referred to above for them to be in conformity with generally accepted accounting principles. We have previously audited, in accordance with generally accepted auditing standards, the consolidated statement of financial position of USF&G Corporation as of December 31, 1993, and the related consolidated statements of operations, stockholders' equity, and cash flows for the year then ended (not presented herein) and, in our report dated February 11, 1994, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated statement of financial position as of December 31, 1993, is fairly stated, in all material respects, in relation to the consolidated statement of financial position from which it has been derived. Baltimore, Maryland August 12, 1994 10 USF&G Corporation Management's Discussion and Analysis of Financial Condition and Results of Operations This section provides an assessment of financial results and material changes in financial position for USF&G Corporation and its subsidiaries ("USF&G") and explains the results of operations for the second quarter and six month periods ended June 30, 1994. The analysis focuses on the performance of USF&G's business segments and its investment portfolio. This discussion updates the -Management's Discussion and Analysis' in the 1993 Annual Report to Shareholders and should be read in conjunction therewith. The results of operations for the second quarter and six months ended June 30, 1994, are compared with those for the same period of 1993, unless otherwise noted. Financial position at June 30, 1994, will be compared with December 31, 1993. (Note: A glossary of certain terms used in this discussion can be found at the end of this section. The terms are CAPITALIZED the first time they appear in the text.) Index to Financial Information 1. Consolidated Results 11 2. Property/Casualty Insurance Operations 12 3. Life Insurance Operations 15 4. Parent and Noninsurance Operations 16 5. Investments 16 6. Financial Condition 19 7. Liquidity 20 8. Regulation 21 9. Glossary of Terms 24 1. Consolidated Results The table below shows the major components of net income. Three Months Ended Six Months Ended June 30 June 30 (in millions) 1994 1993 1994 1993 Pretax income before realized gains and cumulative effect of adopting new accounting standards $ 37 $ 25 $ 56 $ 47 Realized gains on investments, net 1 - 6 1 Income tax (benefit) expense (35) - (34) - Income (loss) from cumulative effect of adopting new accounting standards: Income taxes - - - 90 Postretirement benefits - - - (52) Net income $ 73 $ 25 $ 96 $ 86 The table below shows the components of pretax income before realized gains and cumulative effect of adopting new accounting standards by major business segment. Three Months Ended Six Months Ended June 30 June 30 (in millions) 1994 1993 1994 1993 Property/casualty insurance $ 53 $ 43 $ 86 $ 83 Life insurance 4 - 8 - Parent and noninsurance (20) (18) (38) (36) Pretax income before realized gains and cumulative effect of adopting new accounting standards $ 37 $ 25 $ 56 $ 47 Net income for the second quarter and six months ended June 30, 1994, was favorably affected by continued improvement in property/casualty UNDERWRITING RESULTS and a $35 million income tax benefit. The income tax benefit was recognized as a result of reducing the valuation allowance on net deferred tax assets related to SFAS No.109. Management reviews the valuation allowance on a quarterly basis. Based on the recent history of quarterly profits, management believes it is more likely than not that the company will generate sufficient future taxable income to utilize a larger portion of the deferred tax asset. As of June 30, 1994, USF&G's tax-effected net deferred tax asset (net of deferred tax liabilities) was $584 million. The net deferred tax asset is reduced by a valuation allowance of $426 million. The valuation allowance will be released as a component of income when management's ongoing review of current evidence indicates that it is more likely than not that the deferred tax asset will be utilized. Net income for the first half of 1993 included the impact of the adoption of two new Statements of Financial Accounting Standards ("SFAS"). Pretax income before these accounting changes and realized gains and losses for the property/casualty insurance segment increased $10 million and $3 million for the quarter and six months ended June 30, 1994, respectively, due primarily to improved underwriting results. The life insurance segment's $4 million and $8 million improvement for the quarter and six month period resulted mainly from the combined effects of higher product sales and improved profit margins. 11 2. Property/Casualty Insurance Operations Property/casualty insurance operations, the principal business segment, accounted for 84 percent of USF&G's revenues in the first half of 1994 compared with 86 percent in the first half of 1993. Financial results for this segment were as follows: Three Months Ended Six Months Ended June 30 June 30 (in millions) 1994 1993 1994 1993 Premiums earned* $ 558 $ 594 $1,091 $1,242 Losses and loss expenses incurred (431) (448) (839) (948) Underwriting expenses (178) (203) (365) (419) Net underwriting loss (51) (57) (113) (125) Net investment income 111 108 211 218 Other revenues and expenses, net (7) (8) (12) (10) Pretax income before realized gains and the cumulative effect of adopting new accounting standards $ 53 $ 43 $ 86 $ 83 *See Glossary of Terms Improved underwriting results were the primary reason for the increase in pretax income before realized gains and the cumulative effect of adopting new accounting standards in the second quarter and first six months of 1994 when compared with the same periods of 1993. Underwriting results improved despite lower premiums earned. This improvement is attributed to management's efforts over the last several years to improve the overall quality of the book of business and to control expenses. 2.1. PREMIUMS EARNED Premiums earned totaled $558 million and $1.1 billion for the second quarter and first half of 1994, respectively, compared with $594 and $1.2 billion for the same period 1993. The tables below show the major components of premiums earned and PREMIUMS WRITTEN. Premiums Earned Premiums Written Three Months Ended Three Months Ended June 30 June 30 (in millions) 1994 1993 1994 1993 Branch office voluntary production: Direct $475 $483 $511 $480 Ceded reinsurance (37) (21) (52) (21) Net branch office voluntary 438 462 459 459 Voluntary pools and associations 11 10 8 10 Involuntary pools and associations* 9 46 10 38 Other premium adjustments - (4) - (4) Total primary* 458 514 477 503 Assumed reinsurance: Finite risk 51 37 46 49 Traditional risk 49 43 46 39 Total assumed 100 80 92 88 Total $558 $594 $569 $591 Premiums Earned Premiums Written Six Months Ended Six Months Ended June 30 June 30 (in millions) 1994 1993 1994 1993 Branch office voluntary production: Direct $ 942 $ 971 $ 983 $ 976 Ceded reinsurance (73) (40) (88) (40) Net branch office voluntary 869 931 895 936 Voluntary pools and associations 24 21 21 22 Involuntary pools and associations* 36 94 36 80 Other premium adjustments (1) (7) (10) (8) Total primary* 928 1,039 942 1,030 Assumed reinsurance: Finite risk 74 141 84 182 Traditional risk 89 62 93 66 Total assumed 163 203 177 248 Total $1,091 $1,242 $1,119 $1,278 * See Glossary of Terms Premiums earned for the quarter ended June 30, 1994, decreased $36 million compared with the same period in 1993. Premiums earned for the six months ended June 30, 1994, decreased $151 million. The reduction in earned premium is related in part to increased ceded reinsurance costs on contracts entered into after Hurricane Andrew. In addition, a decrease in premiums from involuntary pools and associations is due to reduced participation in such pools as a result of management actions to reduce premium production in unprofitable markets and product lines. The first half of 1994 was also affected by reduced premiums from assumed finite risk reinsurance. The market demand for finite risk reinsurance was diminished by the effects of accounting changes under SFAS No. 113 and EITF 93-6 which were first required in 1993. Branch office direct voluntary premiums written increased $32 million and $8 million for the quarter and six months ended June 30, 1994, when compared with the same periods of 1993. Premiums from new business increased 29 percent in the second quarter 1994 and retention ratios for both Commercial and Personal Lines improved. The tables below show premiums earned and the statutory LOSS RATIOS by lines of property/casualty insurance. Three Months Ended Three Months Ended June 30, 1994 June 30, 1993 Premiums Statutory Premiums Statutory (dollars in millions) Earned Loss Ratio Earned Loss Ratio Commercial lines $285 80.7 $293 79.2 Fidelity/Surety 30 32.9 29 71.8 Personal lines 143 74.8 192 73.8 Total primary 458 75.8 514 76.7 Assumed reinsurance 100 62.4 80 71.8 Total $558 73.5 $594 76.0 12 Six Months Ended Six Months Ended June 30, 1994 June 30, 1993 Premiums Statutory Premiums Statutory (dollars in millions) Earned Loss Ratio Earned Loss Ratio Commercial lines $ 585 77.7 $ 611 83.4 Fidelity/Surety 58 30.7 55 50.6 Personal lines 285 86.5 373 75.9 Total primary 928 77.4 1,039 78.9 Assumed reinsurance 163 60.9 203 65.3 Total $1,091 75.0 $1,242 76.3 The significant increase in the Personal Lines statutory loss ratio for the first six months is primarily due to the high level of first quarter catastrophes and other weather related losses not classified as catastrophes. The year-to-date Commercial Lines loss ratio was also negatively affected by weather related losses, however, this was offset by improved core underwriting performance and favorable results from reinsurance pools. 2.2. UNDERWRITING RESULTS Underwriting results generally represent premiums earned less incurred losses, loss adjustment expenses ("LAE"), and underwriting expenses. Property/casualty insurance companies often have underwriting losses that are offset by investment income. Underwriting gains (losses) by major business category are as follows: Three Months Ended Six Months Ended June 30 June 30 (in millions) 1994 1993 1994 1993 Commercial $(51) $ (45) $ (82) $(111) Fidelity/Surety 5 (9) 9 (6) Personal (14) (11) (59) (27) Total primary (60) (65) (132) (144) Assumed reinsurance 9 8 19 19 Net underwriting losses $(51) $ (57) $(113) $(125) Voluntary $(53) $ (50) $(112) $ (98) Involuntary 2 (7) (1) (27) Net underwriting losses $(51) $ (57) $(113) $(125) Consolidated property/casualty GAAP and statutory underwriting ratios are as follows: Three Months Ended Six Months Ended June 30 June 30 1994 1993 1994 1993 GAAP underwriting ratios: Loss ratio* 77.2 75.2 76.8 76.3 Expense ratio* 32.0 34.5 33.5 33.8 Combined ratio 109.2 109.7 110.3 110.1 Statutory underwriting ratios: Loss ratio 73.5 76.0 75.0 76.3 Expense ratio 35.6 34.1 35.0 33.9 Combined ratio 109.1 110.1 110.0 110.2 *See Glossary of Terms Underwriting results improved by $6 million in the second quarter 1994 when compared with the same period of 1993 primarily due to improved Fidelity/Surety results. Personal and Commercial Lines underwriting results declined for the second quarter 1994 due to the combined effects of higher reinsurance costs, lower servicing carrier revenues, and several large losses which were only partially offset by lower CATASTROPHE LOSSES. For the first six months of 1994 over the same period 1993, Personal Lines results were affected by higher reinsurance costs and higher than normal first quarter weather related losses not designated as catastrophes. The improved underwriting results from Commercial Lines for the first six months of 1994 are a result of the overall improvement in the quality and mix of business and reduction of exposures to involuntary pools and associations. Underwriting results in the second quarter and first half of 1994 included $10 million and $50 million, respectively, of net catastrophe losses compared with $25 million and $54 million in the same periods of 1993. Gross catastrophe losses were $10 million and $49 million in the second quarter and first half of 1994, respectfully, compared with $27 million and $62 million in the same periods of 1993. The catastrophe losses in the first half of 1994 were primarily related to severe winter snow and ice storms and the Los Angeles earthquake. Approximately half of the catastrophes in the first six months of 1993 were from the March east coast blizzard. Excluding catastrophe losses, the statutory loss ratio for the first half of 1994 improved 1.7 points when compared with first half 1993. Underwriting results showed improvement despite continuing competitive pressures, the inflationary claims environment, and the adverse impact of involuntary markets. Competitive pressures continue to effect underwriting results, especially in the pricing of commercial lines products. Competitive pressures include the historic cyclicality of the property/casualty insurance industry pricing environment. These cycles have been evidenced by extended periods of overcapacity that adversely affect premium rates, followed by periods of undercapacity resulting in rising rates. The industry has experienced an intense period of price competition since 1987, during which the industry generally has been unable to charge rates sufficient to offset rising claim costs. Some industry analysts are beginning to point to factors such as high catastrophe losses, low interest rates, and reduced reinsurance capacity as indications that the underwriting cycle has started to improve. Other analysts believe, as the result of capital infusions and other factors, that excess surplus capacity still exists in the industry and that pricing pressure will continue. USF&G is unable to predict whether or when the property/casualty insurance cycle will improve, but is continuing to pursue long term objectives that include continued underwriting improvements without reliance on a significant cycle turn. 2.3. LOSSES INCURRED AND LOSS RESERVES Losses and loss adjustment expenses incurred totaled $431 million and $839 for the three months and six months ended June 30, 1994, respectively. This compares favorably with $448 million and $948 million for the same periods in 1993. These reductions are attributed to lower premium volume and lower catastrophe losses as well as actions taken by management to better manage claims and claim costs and reduce exposures in undesirable markets. Reserves for unpaid losses and loss expense totaled $6.2 billion at June 30, 1994, a decrease of $91 million from December 31, 1993, or only 2 percent, despite the 12 percent reduction in earned premiums for the first six months of 1994. Pending claims have been reduced by 6 percent and new claims have decreased 9 percent in the first half of 1994. USF&G categorizes environmental, product liability, other long term exposures such as asbestos, and other types of exposures where multiple claims relate to a similar cause of loss (excluding catastrophes) as "common circumstance claims." USF&G does not believe it has material exposure to such claims because its customer base generally consists of small and medium sized businesses and does not include large manufacturing companies, which tend to incur most of the known environmental and product liability exposure. Reserves for losses that have been reported and certain legal expenses are established on the "case basis." Common circumstance claims incurred but not reported ("IBNR") and related adjustment expenses are included in the calculation of USF&G's bulk reserves. Case reserves (exclusive of bulk reserves) outstanding for common circumstance claims were $210 million at June 30, 1994, compared with $214 million at December 31, 1993. The primary reason for the decrease in the case reserves relates to reinsurance recoverables and payments made during the first six months of 1994. Case reserves for these claims are approximately three percent of the total reserves for unpaid losses and loss expense at both June 30, 1994 and December 31, 1993. The most significant common circumstance claim exposures include negligent construction, environmental, and asbestos claims. The table below sets forth selected information for each of these three categories: Total Claims Paid from 1985- 1994* Case Reserves at (in millions) (includes LAE) June 30, 1994 Negligent construction $ 83 $68 Environmental 142 76 Asbestos 86 35 * amount is through the second quarter of 1994. USF&G continuously evaluates its exposure to environmental and other long term claims. Significant legal issues, primarily pertaining to issues of coverage, exist with regard to the alleged liability of these types of claims. USF&G disputes some coverage of common circumstance claims of the policyholders and also assists in defending the insured in underlying litigation. Management believes reserves established for common circumstance claims are adequate; however, as the legal cases of such claims evolve, the related losses and expenses may require adjustment. The above discussion regarding common circumstance claims relates solely to USF&G's direct business and does not include exposures assumed through F&G Re, USF&G+s reinsurance management subsidiary, or otherwise. Management does not believe that assumed business, which includes common circumstance claims, involves exposures materially in excess of established reserves since F&G Re was not a major writer of reinsurance prior to 1985, the year the industry adopted policy language intended to exclude pollution coverage except in specific circumstances. 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. Management believes that loss reserves are adequate, but establishing appropriate reserves, particularly with respect to environmental or other long term exposure claims which are the subject of evolving legislative and judicial theories of liability, is highly judgmental and an inherently uncertain process. 14 3. Life Insurance Operations Life insurance operations ("F&G Life") represent 15 percent of USF&G's total revenues for the first six months of 1994 compared with 13 percent for the same period of 1993. F&G Life's financial results were as follows: Three Months Ended Six Months Ended June 30 June 30 (in millions) 1994 1993 1994 1993 Premiums $ 31 $ 26 $ 68 $ 52 Net investment income 81 80 164 162 Other income - 1 - 1 Policy benefits (92) (89) (193) (179) Underwriting and operating expenses (16) (18) (31) (36) Pretax income before realized gains and the cumulative effect of adopting new accounting standards $ 4 $ - $ 8 $ - Income for the second quarter and six months ended June 30, 1994, improved when compared with the same periods of 1993 due primarily to positive sales growth and improved profit margins. The increase in sales is attributable to the new product initiatives and refocused distribution channels. 3.1. Sales The following table shows life insurance and annuity sales (new annualized premiums and deposits) by distribution system and product type. Three Months Ended Six Months Ended June 30 June 30 1994 1993 1994 1993 Distribution System Direct structured settlements $15 $15 $ 35 $25 Independent agencies/insurance brokers 19 12 40 22 National wholesaler 14 5 29 9 Other 10 10 19 22 Total $58 $42 $123 $78 Product Type Structured settlement annuities $15 $15 $ 35 $25 Single premium deferred annuities 15 5 32 10 Tax sheltered annuities 13 5 25 9 Other annuities 13 15 27 30 Life insurance 2 2 4 4 Total $58 $42 $123 $78 Sales in the second quarter and first six months of 1994 continue to be favorably affected by F&G Life's refocus on its marketing and customer service operations. Variable cost distribution channels have replaced high fixed cost marketing programs. New products recently introduced were designed to meet the needs of the distributors and increase sales. As a result, year-to-date sales, led by single premium deferred annuities ("SPDAs"), tax sheltered annuities ("TSAs"), and structured settlement annuities have increased 38 percent and 58 percent over the second quarter and first six months of 1993, respectfully. 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 market products and modifying current product offerings to meet customer needs. There is no assurance, however, that the improved sales trend will continue. During the first six months of 1994, 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. Total life insurance in force was $12.0 billion at June 30, 1994, compared with $12.1 billion at December 31, 1993. 3.2. 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 78 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. Such built-in surrender charges provide protection against premature policy surrender. Policy surrenders totaled $86 million and $217 million for the quarter and six months ended June 30, 1994, respectively. This compares with $45 million and $95 million for the same periods of 1993. Surrender activity has increased as a result of expiring surrender charges, especially on SPDAs, as policyholders seek other investment alternatives. Management has in place a conservation program that provides policyholders with a competitive renewal option within F&G Life once their surrender charge period has expired. Through June 30, 1994, approximately 30 percent of these eligible policyholders have elected this renewal option. The total ACCOUNT VALUE of F&G Life's deferred annuities is $2.5 billion, with only seven percent surrenderable at current account value (i.e., without surrender charges). The surrender charge period on $2.1 billion of F&G Life's single-premium deferred annuity products expires through the end of 1997. The surrender charge period on $383 million expires through the 15 remainder of 1994. The experience thus far for $313 million of SPDAs where the surrender charge period expired in the fourth quarter of 1993 through the second quarter of 1994 indicates that up to 50 percent of the expiring block may surrender; however, in the future, a larger percentage may surrender should interest rates rise throughout the year. This is likely to result in decreasing life insurance assets, although, given the relatively high interest rates credited when these annuities were issued, overall profit margins may continue to improve as they surrender or rollover to new products. A potential improvement in profit margin could be partially offset by acceleration of the amortization of deferred policy acquisition costs (see Deferred Policy Acquisition Cost section). F&G Life, with a LIQUID ASSETS TO SURRENDER VALUE of surrenderable business of 122 percent at June 30, 1994, continues to maintain a high degree of liquidity and has the ability to meet surrender obligations for the foreseeable future. 3.3. Deferred policy acquisition costs ("DPAC") Costs to acquire and issue 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 by the monitoring of surrender experience, projected investment spreads and other criteria. In the first half of 1994, $12 million of current year expense has been deferred compared with $4 million in the first half of 1993. The increase in the deferral is due to the higher level of sales during the first half of 1994 compared with the same period of 1993. Amortization of the beginning DPAC balance was $9 million in the first half of 1994 and $11 million in the first half of 1993. 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: Three Months Ended Six Months Ended June 30 June 30 (in millions) 1994 1993 1994 1993 Parent Company Expenses: Interest expense $ (7) $(10) $(15) $(19) Unallocated expense, net (12) (6) (21) (13) Noninsurance losses: Management consulting - - - (1) Other noninsurance investments (1) (2) (2) (3) Pretax loss from operations before realized gains $(20) $(18) $(38) $(36) The results for parent and noninsurance operations for the second quarter and first half of 1994 remained essentially unchanged from the same periods of 1993. Unallocated expenses increased in the second quarter of 1994 primarily due to an increase in corporate advertising and promotion expenses. This was offset by lower corporate interest expense for the three month period ending June 30, 1994. During the second half of 1994, interest expense may increase as the result of higher short-term interest rates and the refinancing of a portion of USF&G's short-term credit facility with longer term debt (see Financial Condition section). 5. Investments At June 30, 1994, USF&G's investment mix is comparable with year-end 1993. Long-term fixed maturities comprise 82 percent of total investments at June 30, 1994, compared with 84 percent at December 31, 1993. The table below shows the distribution of USF&G's investment portfolio. At June 30, 1994 At December 31, 1993 Total Investments (in millions) $10,858 $11,377 Fixed maturities: Held to maturity 43% 41% Available for sale 39 43 Total fixed maturities 82 84 Common and preferred stock 2 1 Short-term investments 3 3 Mortgage loans and real estate 10 9 Other invested assets 3 3 Total 100% 100% 5.1. Net Investment Income The following table shows the components of net investment income. Three Months Ended Six Months Ended June 30 June 30 (dollars in millions) 1994 1993 1994 1993 Net investment income from: Fixed maturities $168 $182 $338 $367 Equity securities 7 1 7 2 Short-term investments 4 2 7 5 Real estate and mortgage loans 17 11 34 23 Other, less expenses (5) (7) (12) (16) Total $191 $189 $374 $381 Average yields (annualized): Total investments 7.1% 6.7% 6.9% 6.8% Fixed maturities 7.3 7.7 7.3 7.8 16 Investment income from fixed maturities has continued to be less than the respective 1993 periods. This decline is a result of investing cash flows in a declining interest rate environment during 1993. The increase in investment income from equity securities for the second quarter is due primarily to USF&G's share of earnings from an investment in a reinsurance company. Real estate and mortgage loan investment income increased as a result of the prepayment of a mortgage loan in the second quarter and a new loan program whereby USF&G is investing a greater percentage of capital into mortgage loans versus equity real estate. 5.2. Realized Gains (Losses) The components of net realized gains (losses) include the following: Three Months Ended Six Months Ended June 30 June 30 (in millions) 1994 1993 1994 1993 Net gains (losses) from sales: Fixed maturities $ 1 $ 18 $ 3 $ 36 Equities 1 (3) - (3) Real estate and mortgage loans (3) 2 6 2 Other 3 (2) 6 (2) Total net gains 2 15 15 33 Provisions for impairment: Fixed maturities (1) (2) (1) (5) Equities - (7) - (8) Real estate - - (5) (11) Other - (6) (3) (8) Total provisions (1) (15) (9) (32) Net realized gains $ 1 $ - $ 6 $ 1 The majority of the realized gains from real estate for the first six months of 1994 is the result of the first quarter sale of timberland properties. USF&G's portion of realized gains from investments in limited partnerships accounted for the $6 million gains in other invested assets for the first half of 1994. The $33 million of realized gains in the first half of 1993 primarily relates to USF&G's repositioning of a portion of its fixed maturity investments to more effectively match the duration of its investments with its life insurance liabilities. To reflect impairments in the value of certain real estate investments, USF&G made provisions for impairment of $5 million in 1994 compared with $11 million in 1993. Real estate provisions in 1994 primarily related to specific properties whose recent appraisal values reflected other than temporary impairments of the investments. Real estate provisions were taken in 1993 relating to other specific properties. The 1993 provision for impairment on equities related to provisions on specific equity holdings that were expected to be sold in the near term and $8 million in reserves or direct write downs were established related to other than temporary impairments of other invested assets. 5.3. Unrealized Gains (Losses) The components of the changes in unrealized gains (losses) were as follows: Three Months Ended Six Months Ended June 30 June 30 (in millions) 1994 1993 1994 1993 Fixed maturities available for sale $(115) $ - $(297) $ - Deferred policy acquisition cost adjustment 17 - 34 - Equity securities - 11 (3) 20 Other (4) 3 (1) 8 Total $(102) $ 14 $(267) $ 28 USF&G adopted SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities," in the fourth quarter of 1993. Prior to the adoption of SFAS No. 115, unrealized gains (losses) on fixed maturities were not included as a component of shareholders' equity. Under SFAS No. 115, unrealized gains (losses) on fixed maturities are included as a component of shareholders' equity to the extent such securities are classified as "available for sale." An environment of rising interest rates during the first half of 1994 has 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 $75 million at June 30, 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 $4 million at June 30, 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. The favorable change in unrealized gains in 1993 resulted from appreciation in equities and the sale of a portion of foreign equities that had an unrealized loss at year-end 1992. 5.4. Fixed Maturity Investments The tables below detail the composition of the fixed maturity portfolio. (dollars in millions) At June 30, 1994 At December 31, 1993 Corporate investment-grade bonds $5,029 55% $4,866 52% Mortgage-backed securities 2,013 22 2,403 26 Asset-backed securities 1,050 12 1,149 12 U. S. Government bonds 278 3 308 3 High-yield bonds* 619 7 562 6 Tax-exempt bonds 47 1 48 1 Other 7 - 6 - Total fixed maturities at amortized cost $9,043 100% $9,342 100% Total market value of fixed maturities $8,724 $9,699 Net unrealized gains (losses) $ (319) $ 357 Percent market-to-amortized cost 96% 104% * See Glossary of Terms At June 30, 1994 At December 31, 1993 Net Net Amortized Market Unrealized Amortized Market Unrealized (in millions) Cost Value (Loss) Cost Value Gain Fixed maturities: Held to maturity $4,714 $4,470 $(244) $4,661 $4,796 $135 Available for sale 4,329 4,254 (75) 4,681 4,903 222 Total $9,043 $8,724 $(319) $9,342 $9,699 $357 Increasing interest rates, which resulted in declining bond prices, were responsible for the eight percentage point decrease in the fixed maturity portfolio's overall market-to-amortized cost ratio from December 31, 1993. Investments in mortgage-backed securities declined 16 percent when compared with holdings at December 31, 1993, due primarily to prepayments. While subject to prepayment risk, credit risk related to USF&G's mortgage-backed securities portfolio at June 30, 1994, is believed to be minimal as 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 nine percent since year-end 1993 as a result of sales and maturities. The proceeds from sales, maturities, and prepayments are primarily being reinvested into corporate investment-grade bonds. Debt obligations of the U.S. Government and its agencies and other investment-grade bonds comprised 93 percent of the portfolio at June 30, 1994 and 94 percent at December 31, 1993. The table below shows the credit quality of the long-term fixed maturity portfolio as of June 30, 1994. Percent Market- Amortized Market to-Amortized (dollars in millions) Cost Percent Value Cost U.S. Government and U.S. Government Agencies $2,150 24% $2,089 97% AAA 1,496 16 1,476 99 AA 1,289 14 1,203 93 A 2,421 27 2,328 96 BBB 1,068 12 1,022 96 Below BBB 619 7 606 98 Total $9,043 100% $8,724 96% USF&G's holdings in high-yield bonds comprised seven percent of the total fixed maturity portfolio at June 30, 1994, compared with six percent at December 31, 1993. Of the total high-yield bond portfolio, 71 percent is held by the life insurance segment, representing 10 percent of the F&G Life's total investments. The table below illustrates the credit quality of USF&G's high-yield bond portfolio at June 30, 1994. Percent Market- Amortized Market to-Amortized (dollars in millions) Cost Percent Value Cost BB $396 64% $382 96% B 225 36 219 97 CCC and lower 8 1 5 60 Valuation allowance (10) (1) - - Total $619 100% $606 98% The information on credit quality in the preceding two tables is based upon the higher of the rating assigned to each issue of fixed-income maturities 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 June 30, 1994, USF&G's five largest investments in high-yield bonds totaled $91 million in amortized cost and had a market value of $82 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. (dollars in millions) At June 30, 1994 At December 31, 1993 Mortgage loans $ 329 $ 302 Equity real estate 830 793 Reserves (108) (108) Total $1,051 $ 987 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 real estate equity-type investments. This strategy is designed to reduce risk and increase yields in the real estate portfolio. While not part of USF&G's continuing strategy, equity real estate increased in the second quarter as a result of the restructuring of a real estate partnership where USF&G has become the controlling general partner. 18 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 at June 30, 1994, is as follows: Geographic Region Type of Property Development Stage Pacific/Mountain 33% Office 34% Operating property 75% Midwest 21 Land 25 Land development 15 Southeast 18 Apartments 22 Land packaging 10 Mid-Atlantic 17 Retail/other 12 Southwest 8 Industrial 7 Northeast 3 Real estate investments are generally appraised at least once every three years. Appraisals are obtained more frequently under certain circumstances such as significant changes in property performance or market conditions. All of these appraisals are performed by professionally certified appraisers. At June 30, 1994, USF&G's five largest real estate investments had a book value of $329 million. The largest single investment was a land development located in San Diego, California with a book value of $91 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. NONPREFORMING REAL ESTATE investments declined six percent at June 30, 1994, when compared with December 31, 1993. 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 the reclassifications to and from the nonperforming real estate portfolio. The book value of the components of nonperforming real estate are as follows: (book value in millions) At June 30, 1994 At December 31, 1993 Restructured loans and investments* $ - $ 4 Real estate held as in-substance foreclosure* - 14 Real estate acquired through foreclosure or deed-in-lieu of foreclosure* 115 121 Land investments* 62 57 Nonperforming equity investments* 58 53 Total nonperforming real estate $235 $249 Real estate reserves $108 $108 Reserves/nonperforming real estate 46% 43% *See Glossary of Terms Valuation allowances are established for impairments of mortgage loans and real estate equity values based on periodic evaluations of the operating performance of the properties and their exposure to declines in value. The allowance totaled $108 million, or 9 percent and 10 percent of the entire real estate portfolio at June 30, 1994 and December 31, 1993, respectively. In light of USF&G's current plans with respect to the portfolio, management believes the allowance at June 30, 1994, adequately reflects 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. 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 $14.0 billion at June 30,1994, compared with $14.3 billion at December 31, 1993. The $333 million reduction is primarily due to a $297 million reduction in the market value of the fixed maturity investments classified as available for sale. 6.2. Debt USF&G's debt totaled $634 million at June 30, 1994, compared with $618 million at December 31, 1993. The increase is mainly attributable to foreign currency translation adjustments of $9 million from non-U.S. dollar denominated debt. As a result of entering into offsetting currency swap agreements, there was no effect on net income from translation of non-U.S. dollar denominated debt. Also increasing real estate debt is debt assumed as a result of the restructuring of a real estate partnership where 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 the result of this restructuring. Also affecting the composition of USF&G's debt was $126 million of zero coupon convertible subordinated notes issued during the first quarter with the proceeds used to redeem $119 million of higher interest bearing medium and long-term notes. USF&G also issued $149 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 Liquidity section). 19 6.3. Equity USF&G's shareholders' equity totaled $1.3 billion at June 30, 1994, compared with $1.5 billion at December 31, 1993. The decrease is primarily the result of the $297 million decline in unrealized gains on fixed maturity investments available for sale reduced by a $34 million change in the related life insurance segment's DPAC adjustment. This was partially offset by net income of $96 million less $33 million in common and preferred stock dividends. 6.4. Capital Strategy. Subject to capital market conditions, USF&G plans to refinance up to approximately $300 million of debt over the next several years. In anticipation of the expiration in March 1995 of the short-term bank credit facility, it is expected that portions of the $215 million balance outstanding at June 30, 1994, will be refinanced and the short-term facility will be renegotiated. Where opportunities exist, other outstanding debt may be refinanced at lower interest rates. In addition, depending upon the market value of its common stock, USF&G is considering strategies and opportunities to replace all or a portion of the Series C Preferred Stock with common stock equity, through redemptions intended to result in shares of such preferred stock being converted to common stock or otherwise. 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. In January 1994, USF&G filed a shelf registration statement with the Securities and Exchange Commission. As of its effective date in February 1994, USF&G had $647 million in aggregate unissued debt, preferred stock and common stock (and warrants to purchase debt and equity securities) registered. These securities may be issued from time to time, depending on market conditions. This shelf amount was reduced by $126 million in proceeds received from the zero coupon convertible subordinated notes issued in March 1994 and by $149 million in proceeds from the 8 3/8% Senior Notes due 2001 issued in June 1994. 7.1. Cash flow from operations USF&G had negative cash flow from operations of $23 million and $16 million for the quarter and six month periods ended June 30, 1994, compared with negative cash flow of $39 million and positive cash flow of $80 for the same periods in 1993. Cash flow declined for the first half of 1994 primarily due to a decline in premiums collected in the property/casualty segment offset by a reduction in paid losses. 7.2. Credit facilities At June 30, 1994, USF&G maintained a $500 million committed credit facility with a group of foreign and domestic banks. Effective July 11, 1994, the credit facility was reduced to $375 million. Borrowings outstanding under the credit facility totaled $215 million at June 30, 1994 and $375 million at December 31, 1993. The credit agreement contains restrictive covenants, defined in the agreement, pertaining to indebtedness and tangible net worth levels. USF&G was in compliance with these covenants at June 30, 1994 and December 31, 1993. 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 $8.7 billion at June 30, 1994, which represents 96 percent of its amortized cost. At June 30, 1994, equity securities, which are reported at market value on the balance sheet, totaled $140 million. Short-term investments totaled $325 million. 7.4. Liquidity restrictions There are certain restrictions on payment 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 twelve 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. USF&G Company's policyholders' surplus at December 31, 1993, totaled $1.5 billion. Dividends of approximately $154 million are available for payment to USF&G from USF&G Company during 1994 without prior regulatory approval. Of these available dividends, $62 million was paid during the six months ended June 30, 1994. 20 8. Regulation 8.1. General 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, limitations on dividends, limitations on the ability to withdraw from certain lines of business such as personal lines and workers compensation, and other matters. Recently, there has been increased scrutiny of the insurance regulatory framework. A number of state legislatures have considered or enacted legislation that alters and, in many cases, increases state authority to regulate insurance companies. 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. 8.2. Proposition 103 In November 1988, California voters passed Proposition 103, which required insurers doing business in that state to rollback property/casualty premium prices in effect between November 1988 and November 1989 to 1987 levels, less an additional 20 percent discount, unless an insurer could establish that such rate levels threatened its solvency. As a result of a court challenge, the California Supreme Court ruled in May 1989 that an insurer does not have to face insolvency in order to qualify for exemption from the rollback requirements and is entitled to a "fair and reasonable return." Significant controversy has surrounded the numerous regulations proposed by the California Insurance Department, which would be used to determine whether rate rollbacks and premium refunds are required by insurers. Some of the Insurance Department's proposals were disapproved by the California Office of Administrative Law ("OAL"), which is responsible for the review and approval of such regulations. The most recent regulations proposed by the Insurance Department are the subject of a court challenge by various insurers to the Department's authority to issue such regulations. On February 25, 1993, the trial judge presiding over that court challenge voided substantial parts of the regulations proposed by the Insurance Department. The court held that the Insurance Department's regulations exceeded the Department's authority by setting rates based upon an across-the-board formula. The court indicated that rates and what constitutes a reasonable return would have to be determined individually for each insurer and that the Department's authority was to approve or disapprove rates proposed by insurers rather than setting rates which cannot vary from a prescribed formula. The trial court's opinion was appealed to the California Supreme Court and a decision is expected by September 30, 1994. During 1989, less than five percent of USF&G's total premiums were written in the State of California. USF&G believes that the returns it received, both during and since the one-year rollback period, have not exceeded the "fair and reasonable return" standard. Additionally, based on the long history of events and the significant uncertainty about the Insurance Department's regulations, management does not believe it is probable that the revenue recognized during the rollback period will be subject to a material refund. Management believes that no premium refund should be required for any period after November 8, 1988, but that any rate rollbacks and premium refunds, if ultimately required, would not have a material adverse effect on USF&G's financial position. 8.3. 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, among other things, found 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. 21 USF&G was a servicing carrier for the Maine residual market in 1988, 1989, 1990, and 1991. USF&G withdrew from the Maine voluntary market and as a servicing carrier effective December 31, 1991. USF&G has 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. These appeals will be heard on a consolidated basis. USF&G is seeking, among other things, to have the court set aside the Superintendent's findings that the industry did not make a good faith effort to expand the voluntary market and is responsible for deficiencies resulting from alleged poor servicing and investments. 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 August 3, 1994, arguments were held on the appeal and the parties are awaiting a ruling from the Superior Court. 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 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. However, USF&G believes that it has meritorious defenses and has determined to defend the actions vigorously. 8.4. 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. 8.5. 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. 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. 8.6. 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 $4 million of guaranty fund expense in the first six months of 1994 and $6 million in the same period of 1993. Financial difficulties of certain insurance companies over the past several years are expected to result in additional assessments that would 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 amount of these assessments cannot be reasonably estimated and is not expected to have a material adverse effect on USF&G's financial position. 8.7. 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. One version of this model regulation is applicable for life insurers with respect to their financial position as of December 31, 1993 and each calendar year thereafter. A second version was adopted by the NAIC in December 1993 for implementation by property/casualty insurers in 1995 with respect to their financial position as of December 31, 1994, and each calendar year thereafter. The statutory "risk adjusted" capital of USF&G Company and F&G Life as of December 31, 1993, were such that no regulatory action would be required (assuming that the NAIC model regulation applied to property/casualty insurers in 1993). The NAIC has also proposed a Model Investment Law which prescribes the investments that are permissible for property/casualty and life insurers to hold. Adoption of this model law is targeted for December 1994, at the earliest. 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. 8.8. National Health Care President Clinton has presented a proposal to enact a comprehensive national health care system. One component of this proposal would coordinate the medical payment system for workers compensation and the medical payments component of automobile insurance within a reformed national health care system. The Administration's bill also provides for a national commission to study the possible merger of workers compensation and automobile medical coverage into the reformed health care system. Although some form of the Administration's national health care proposal 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. 22 8.9. Superfund The Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA"), more commonly known as Superfund, is currently scheduled to be reauthorized in 1994. 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. 8.10. 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 June 30, 1994, USF&G was within the "usual range" for all IRIS ratios calculated on an interim year basis. 8.11. 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. 8.12. Federal Antitrust legislation The House Judiciary Committee has approved a bill providing that the McCarran-Ferguson Act of 1945 be revised. This act has historically provided the insurance industry with broad antitrust exemptions. The current proposal would repeal many of those exemptions, although "safe harbors" would be preserved for data collection, loss development, common policy forms, residual market pooling arrangements and certain other areas essential to the property/casualty insurance industry. No reliable prediction can be made at this time as to the outcome of this proposal or the effect it may have on USF&G. 23 9. 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. EITF: Emerging Issues Task Force of the Financial Accounting Standards Board. 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. GAAP: Generally Accepted Accounting Principles. 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 business: 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: GAAP 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 policy surrenders. Loss ratio: The ratio of incurred losses and loss adjustment 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 financial reinsurance. 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, after the assumption and cession of reinsurance. Premiums written: Premiums retained by an insurer, after the assumption and cession of reinsurance. Primary insurance: Branch office voluntary and voluntary and involuntary pool experience, net of ceded 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. 24 USF&G Corporation Part II. Other Information Item 1. Legal Proceedings See Notes 7.3 and 7.4 of the Notes to Condensed Consolidated Financial Statements, respectively, regarding the filing of a class action regarding workers compensation insurance in Texas and a notice received from the Attorney General of South Carolina regarding alleged unfair and deceptive trade practices by servicing carriers and others for the South Carolina workers compensation involuntary markets. Item 4. Submission of Matters to a Vote of Shareholders The 1994 annual meeting of shareholders was held May 4, 1994. The information required in this item was included under Item 4 for the Form 10-Q filed by the registrant for the quarter ended March 30, 1994, File No. 1-8233, and such item is incorporated herein by reference. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits. Exhibit 4.A Form of 8 3/8% Senior Notes due 2001. (Incorporated by reference to the registrant+s Form 8-K filed on June 30, 1994, File No. 1-8233.) Exhibit 11. Computation of Earnings per Share. Exhibit 12. Computation of Ratio of Earnings to Fixed Charges and Preferred Stock Dividends. Exhibit 15. Letter Regarding Unaudited Interim Financial Information. (b) Reports on Form 8-K. The registrant filed a Form 8-K on June 30, 1994, reporting under Item 5, Other Events, certain information related to the sale of $150,000,000 face amount at maturity of 8 3/8% Senior Notes due 2001, including as an exhibit the form of the note. 25 USF&G Corporation Signature Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Quarterly Report to be signed on its behalf by the undersigned, thereunto duly authorized. USF&G Corporation BY DAN L. HALE Dan L. Hale Executive Vice President and Chief Financial Officer Dated at Baltimore, Maryland August 12, 1994 EX-11 2 EXHIBIT 11 6/30/94 USF&G Corporation Exhibit 11 - Computation of Earnings Per Share (Unaudited) Six Months Ended June 30 (dollars in millions except per share data) 1994 1993 Net Income Available to Common Stock Primary Income before cumulative effect of adopting new accounting standards $ 96 $ 48 Less preferred stock dividend requirements 24 24 Income (loss) before cumulative effect of adopting new accounting standards available to common stock 72 24 Income (loss) from cumulative effect of accounting standards: Income taxes - 90 Postretirement benefits - (52) Net income (loss) available to common stock $ 72 $ 62 Fully Diluted: Income before cumulative effect of adopting new accounting standards $ 96 $ 48 Less preferred stock dividend requirements 8 8 Add interest expense on convertible notes 2 - Income (loss) before cumulative effect of adopting new accounting standards available to common stock 90 40 Income (loss) from cumulative effect of adopting new accounting standards: Income taxes - 90 Postretirement benefits - (52) Net income (loss) available to common stock $ 90 $ 78 Weighted Average Shares Outstanding Primary Common Shares 85,226,142 84,618,567 Fully Diluted: Common shares 85,226,142 84,618,567 Assumed conversion of preferred stock 26,611,211 26,611,211 Assumed exercise of stock options 750,603 1,806,091 Assumed conversion of zero coupon convertible notes 4,818,170 - Total 117,406,126 113,035,869 Earnings Per Common Share Primary (A): Income (loss) before cumulative effect of adopting new accounting standards $ .85 $ .28 Income (loss) from cumulative effect of adopting new accounting standards: Income taxes - 1.06 Postretirement benefits - (.61) Net income (loss) $ .85 $ .73 Fully Diluted (B): Income (loss) before cumulative effect of adopting new accounting standards $ .77 $ .35 Income (loss) from cumulative effect of adopting new accounting standards: Income taxes - .80 Postretirement benefits - (.46) Net income (loss) $ .77 $ . 69 (A) Shares issuable under stock options (750,603 shares in 1994 and 1,430,454 in 1993) have not been used as common stock equivalents in the computation of primary earnings per common share presented on the face of the Condensed 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 1994 calculation assumes the conversion of preferred stock series B and C and the zero coupon convertible subordinated notes. The 1993 calculation assumes the conversion of preferred stock series B and C. 26 EX-12 3 EXHIBIT 12 6/30/94 USF&G Corporation Exhibit 12 - Computation of Ratio of Consolidated Earnings to Fixed Charges and Preferred Stock Dividends Six Months Ended June 30 (dollars in millions) 1994 1993 Fixed Charges Interest expense $16 $21 Interest capitalized - - Portion of rents representative of interest 14 14 Total fixed charges 30 35 Preferred stock dividend requirements (A) 24 24 Combined Fixed Charges and Preferred Stock Dividends $54 $59 Consolidated Earnings Available for Fixed Charges and Preferred Stock Dividends Pretax income before cumulative effect of adopting new accounting standards $62 $48 Adjustments: Fixed charges 30 35 Less interest capitalized during the period - - Consolidated earnings available for fixed charges and preferred stock dividends $92 $83 Ratio of Consolidated Earnings to Fixed Charges 3.1 2.4 Ratio of Consolidated Earnings to Combined Fixed Charges and Preferred Stock Dividends 1.7 1.4 (A) Preferred stock dividend requirements of $24 million in 1994 and 1993 divided by 100% less the effective income tax rate of 0% in 1994 and 0.3% in 1993. 27 EX-15 4 EXHIBIT 15 6/30/94 USF&G Corporation Exhibit 15 - Letter Regarding Unaudited Interim Financial Information USF&G Corporation We are aware of the incorporation by reference in the Registration Statement Numbers 33-20449, 33-9405, 33-33271, and 33-21132, 33-50825, and 33-51859 on Form S-3 and Numbers 2-61626, 2-72026, 2-98232, 33-16111, 33-35095, 33-38113, 33-43132, 33-45664, 33-45665, and 33-61965 on Form S-8, of our report on the unaudited condensed consolidated interim financial statements of USF&G Corporation which is included in its Form 10-Q for the quarter ended June 30, 1994. Pursuant to Rule 436(c) of the Securities Act of 1993 our reports are not a part of the registration statement prepared or certified by accountants within the meaning of Section 7 or 11 of the Securities Act of 1933. ERNST & YOUNG LLP Baltimore, Maryland August 12, 1994 28 -----END PRIVACY-ENHANCED MESSAGE-----