-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, GYQlRTxJwT+pOfxxEjyAUe1BA6vRVhNrfFPBVFMmOKJC333mjI9NgaMIKvwjx1T2 KBDOUUMX6y2HD2LPhjyLxA== 0000354396-96-000010.txt : 19960816 0000354396-96-000010.hdr.sgml : 19960816 ACCESSION NUMBER: 0000354396-96-000010 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19960630 FILED AS OF DATE: 19960814 SROS: NYSE SROS: PSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: USF&G CORP CENTRAL INDEX KEY: 0000354396 STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331] IRS NUMBER: 521220567 STATE OF INCORPORATION: MD FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-08233 FILM NUMBER: 96614514 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 FORM 10-Q - JUNE 30, 1996 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q Quarterly Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Quarter Ended Commission File Number June 30, 1996 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; 117,844,371 shares outstanding as of August 9, 1996. Page 1 of 26 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 Report of Independent Auditors 11 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 12 PART II. Other Information Item 6. Exhibits and Reports on Form 8-K 22 Exhibit 11- Computation of Earnings Per Share 23 Exhibit 12- Computation of Ratio of Consolidated Earnings to Fixed Charges and Preferred Stock Dividends 24 Exhibit 15- Letter Regarding Unaudited Interim Financial Information 25 Signature 26
USF&G CORPORATION Condensed Consolidated Statement of Financial Position (Unaudited) At June 30 At December 31 (dollars in millions except per share data) 1996 1995 ----------------------------------------------- Assets Investments: Fixed maturities available for sale, at market (cost, 1996, $8,924; 1995, $9,118) $ 8,881 $ 9,458 Common and preferred stocks, at market (cost, 1996, $42; 1995, $70) 40 65 Short-term investments 390 288 Mortgage loans 325 254 Real estate 634 653 Other invested assets 485 389 ----------------------------------------------- Total investments 10,755 11,107 ----------------------------------------------- Cash 41 119 Accounts, notes, and other receivables 785 795 Reinsurance receivables 759 604 Servicing carrier receivables 679 699 Deferred policy acquisition costs 501 434 Other assets 905 893 ----------------------------------------------- Total assets $14,425 $14,651 ----------------------------------------------- Liabilities Unpaid losses, loss expenses, and policy benefits $ 9,607 $ 9,816 Unearned premiums 1,154 1,055 Corporate debt 583 591 Real estate and other debt 16 16 Other liabilities 1,298 1,189 ----------------------------------------------- Total liabilities 12,658 12,667 ----------------------------------------------- Shareholders' Equity Preferred stock, par value $50.00 (12,000,000 shares authorized; shares issued, 1996 and 1995, 4,277,460) 213 213 Common stock, par value $2.50 (240,000,000 shares authorized; shares issued, 1996, 117,954,715; 1995, 119,606,095) 295 299 Paid-in capital 1,169 1,188 Net unrealized gains (losses) on investments and foreign currency (25) 271 Minimum pension liability (100) (100) Retained earnings 215 113 ----------------------------------------------- Total shareholders' equity 1,767 1,984 ----------------------------------------------- Total liabilities and shareholders' equity $14,425 $14,651 ----------------------------------------------- See Notes to Condensed Consolidated Financial Statements.
USF&G CORPORATION Condensed Consolidated Statement of Operations (Unaudited) Three Months Ended June 30 (dollars in millions except per share data) 1996 1995 ---------------------------------------- Revenues Premiums earned $674 $659 Net investment income 181 182 Other 2 14 ---------------------------------------- Revenues before net realized gains 857 855 Net realized gains on investments 1 1 ---------------------------------------- Total revenues 858 856 ---------------------------------------- Expenses Losses, loss expenses, and policy benefits 536 551 Underwriting, acquisition, and operating expenses 257 247 Interest expense 10 12 Facilities exit costs/(sublease income) (12) - ---------------------------------------- Total expenses 791 810 ---------------------------------------- Income from operations before income taxes 67 46 Provision for income taxes - - ---------------------------------------- Net income $ 67 $ 46 ---------------------------------------- Preferred stock dividend requirements 5 7 ---------------------------------------- Net income available to common stock $ 62 $ 39 ---------------------------------------- Primary Earnings Per Common Share $.52 $.35 ---------------------------------------- Fully Diluted Earnings Per Common Share $.50 $.33 ---------------------------------------- Weighted average common shares outstanding (000s): Primary 119,190 110,565 Fully diluted 128,978 130,022 ---------------------------------------- Dividends declared per common share $.05 $.05 ---------------------------------------- See Notes to Condensed Consolidated Financial Statements.
USF&G CORPORATION Condensed Consolidated Statement of Operations (Unaudited) Six Months Ended June 30 (dollars in millions except per share data) 1996 1995 ---------------------------------------- Revenues Premiums earned $1,341 $1,276 Net investment income 361 367 Other 11 26 ---------------------------------------- Revenues before net realized gains 1,713 1,669 Net realized gains on investments 12 5 ---------------------------------------- Total revenues 1,725 1,674 ---------------------------------------- Expenses Losses, loss expenses, and policy benefits 1,079 1,069 Underwriting, acquisition, and operating expenses 516 494 Interest expense 20 22 Facilities exit costs/(sublease income) (14) (6) ---------------------------------------- Total expenses 1,601 1,579 ---------------------------------------- Income from operations before income taxes 124 95 Provision for income taxes - - ---------------------------------------- Net income $ 124 $ 95 ---------------------------------------- Preferred stock dividend requirements 10 15 ---------------------------------------- Net income available to common stock $ 114 $ 80 ---------------------------------------- Primary Earnings Per Common Share $ .95 $ .73 ---------------------------------------- Fully Diluted Earnings Per Common Share $ .91 $ .69 ---------------------------------------- Weighted average common shares outstanding (000s): Primary 119,411 108,870 Fully diluted 129,709 129,996 ---------------------------------------- Dividends declared per common share $ .10 $ .10 ---------------------------------------- See Notes to Condensed Consolidated Financial Statements.
USF&G CORPORATION Condensed Consolidated Statement of Cash Flows (Unaudited) Three Months Ended June 30 (in millions) 1996 1995 ---------------------------------- Operating Activities Direct premiums collected $ 533 $ 486 Net investment income collected 190 209 Direct losses, loss expenses and policy benefits paid (438) (433) Net reinsurance activity (34) 1 Underwriting and operating expenses paid (142) (171) Interest paid (16) (10) Income taxes paid (3) (2) Other items, net 5 21 ---------------------------------- Net cash provided from operating activities 95 101 ---------------------------------- Investing Activities Net (purchases) sales and maturities of short-term investments (26) 60 Sales of fixed maturities held to maturity - 6 Maturities/repayments of fixed maturities held to maturity - 27 Purchases of fixed maturities available for sale (200) (276) Sales of fixed maturities available for sale 93 105 Maturities/repayments of fixed maturities available for sale 192 91 Purchases of equities and other investments (100) (42) Sales, maturities, and repayments of equities and other investments 61 76 Purchases of property and equipment (17) (7) Disposals of property and equipment - - ---------------------------------- Net cash provided from investing activities 3 40 ---------------------------------- Financing Activities Deposits for universal life and investment contracts 89 90 Withdrawals of universal life and investment contracts (245) (195) Net borrowings of short-term debt 24 (227) Long-term borrowings - 228 Repayments of long-term borrowings (11) (15) Issuances of common stock 3 4 Repurchases of common stock (26) - Cash dividends paid to shareholders (11) (12) ---------------------------------- Net cash used in financing activities (177) (127) ---------------------------------- (Decrease) increase in cash (79) 14 Cash at beginning of period 120 83 ---------------------------------- Cash at end of period $ 41 $ 97 ---------------------------------- See Notes to Condensed Consolidated Financial Statements.
USF&G CORPORATION Condensed Consolidated Statement of Cash Flows (Unaudited) Six Months Ended June 30 (in millions) 1996 1995 ---------------------------------- Operating Activities Direct premiums collected $1,052 $1,005 Net investment income collected 364 376 Direct losses, loss expenses and policy benefits paid (858) (878) Net reinsurance activity (23) 73 Underwriting and operating expenses paid (358) (411) Interest paid (21) (21) Income taxes paid (3) (2) Other items, net (4) 14 ---------------------------------- Net cash provided from operating activities 149 156 ---------------------------------- Investing Activities Net (purchases) sales and maturities of short-term investments (102) 150 Sales of fixed maturities held to maturity - 6 Maturities/repayments of fixed maturities held to maturity - 53 Purchases of fixed maturities available for sale (419) (448) Sales of fixed maturities available for sale 145 132 Maturities/repayments of fixed maturities available for sale 452 166 Purchases of equities and other investments (147) (53) Sales, maturities, and repayments of equities and other investments 150 143 Purchases of property and equipment (26) (13) Disposals of property and equipment 2 - ---------------------------------- Net cash provided from investing activities 55 136 ---------------------------------- Financing Activities Deposits for universal life and investment contracts 167 168 Withdrawals of universal life and investment contracts (401) (397) Net borrowings of short-term debt 29 (227) Long-term borrowings - 229 Repayments of long-term borrowings (32) (15) Issuances of common stock 3 4 Repurchases of common stock (26) - Cash dividends paid to shareholders (22) (26) ---------------------------------- Net cash used in financing activities (282) (264) ---------------------------------- (Decrease) increase in cash (78) 28 Cash at beginning of period 119 69 ---------------------------------- Cash at end of period $ 41 $ 97 ---------------------------------- See Notes to Condensed Consolidated Financial Statements.
USF&G CORPORATION Notes to Condensed Consolidated Financial Statements Note 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 (collectively, "USF&G"). Intercompany transactions are eliminated in consolidation. Certain 1995 amounts have been reclassified to conform to the 1996 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 1995 Annual Report to Shareholders. 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. Effective January 1, 1996, USF&G adopted Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of". The standard includes a requirement that impairments in the value of real estate investments be recorded as direct reductions in the carrying value of those investments. USF&G's prior practice was to establish valuation allowances for impairment to specific investments where impairment is deemed other than temporary. The adoption of this standard did not have a material effect on USF&G's financial statements since existing valuation allowances were applied against the related impaired investments reducing the cost basis of those investments. Note 2 Review of Independent Auditors USF&G'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, 1996 and 1995. 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. Note 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. Note 4 Ratio of Consolidated Earnings to Fixed Charges and Preferred Stock Dividends For purposes of computing the ratio of consolidated earnings to fixed charges and preferred stock dividends, earnings consist of income before considering income taxes and fixed charges. Fixed charges consist of interest and that portion of rentals that is deemed to be an appropriate interest factor. Refer to the computation in Exhibit 12. Note 5 Supplemental Cash Flow Information The Condensed Consolidated Statement of Cash Flows is presented using the "direct method," which reports major classes of cash receipts and cash payments. A reconciliation of net income to net cash provided from operating activities is as follows: Three Months Ended Six Months Ended June 30 June 30 (in millions) 1996 1995 1996 1995 - ---------------------------------------------------------------- Net income $ 67 $ 46 $124 $ 95 Adjustments to reconcile net income to net cash provided from operating activities: Realized gains on investments (1) (1) (12) (5) Facilities exit costs/(sublease income) (12) - (14) (6) Change in insurance liabilities 100 100 131 127 Change in deferred policy acquisition costs (17) 9 1 28 Change in receivables (75) (41) (127) (63) Change in other liabilities (31) 6 33 (3) Change in other assets 56 (6) 2 (12) Other items, net 8 (12) 11 (5) --------------------------- Net cash provided from operating activities $ 95 $101 $149 $156 --------------------------- Note 6 Unrealized Gains (Losses) on Investments At June 30, 1996, gross unrealized gains and gross unrealized losses pertaining to investments in common and preferred stocks totaled $1 million and $3 million, respectively. In addition, gross unrealized gains and gross unrealized losses on limited partnerships, foreign currency and other investments totaled $27 million and $2 million, respectively. At June 30, 1996, there were gross unrealized gains of $108 million and gross unrealized losses of $151 million pertaining to fixed maturities available for sale. There were also $5 million of gross unrealized losses relating to a deferred policy acquisition costs ("DPAC") adjustment. This DPAC adjustment was made to reflect assumptions about the effect of potential asset sales of fixed maturities available for sale on future DPAC amortization. The change in net unrealized gains (losses) on investments and foreign currency amounted to a loss of $296 million during the six months ended June 30, 1996, compared with a gain of $203 million during the six months ended June 30, 1995. Note 7 Proceeds From Sales of Fixed Maturity Investments In December 1995, USF&G reclassified all of its fixed maturities previously classified as "held to maturity" to "available for sale". During the six-month period ended June 30, 1995, proceeds from sales of fixed maturities held to maturity were $6 million. The 1995 sales were based on evidence of significant deterioration of the issuers' creditworthiness. Gross losses of less than $1 million were realized on those sales. Proceeds from sales of fixed maturities available for sale were $145 million for the six months ended June 30, 1996, compared with $132 million for the same period in 1995. Gross gains and gross losses of $5 million and $8 million, respectively, were realized on 1996 sales. Gross gains and gross losses of $2 million were realized on 1995 sales. Note 8 Facilities Exit Costs During 1994, USF&G committed to a plan to consolidate its home office operations in Baltimore, Maryland at its Mount Washington facility. Facilities exit costs of $183 million were recorded in the fourth quarter of 1994, representing the present value of the rent and other operating expenses to be incurred under the lease on USF&G's office building (the "Tower") from the time USF&G vacates the building through the expiration of the lease in 2009. Facilities exit costs recorded in 1994 did not consider any potential future sublease income, as such income was neither probable nor reasonably estimable at that time. To the extent that additional or extended subleases are subsequently negotiated, the present value of income to be received over the term of those subleases is recognizable in the period such income becomes probable and reasonably estimable. Net income for the six months ended June 30, 1996 and 1995 includes sublease income of $2 million and $6 million, respectively, recognized as a result of entering into new or renegotiated sublease agreements. There were no subleases negotiated in the second quarter of 1996. In the second quarter of 1996, USF&G recognized a $12 million benefit as a separate item captioned "facilities exit costs/(sublease income)" in the Condensed Consolidated Statement of Operations. The benefit relates primarily to reduced property tax assessments on the Tower resulting from a settlement reached with the State of Maryland and the City of Baltimore. This adjustment to the facilities exit cost reserve represents the difference between the present value of the new property tax assessments estimated to be paid through the end of the Tower lease, and the present value of the originally estimated property taxes which were included in the facilities exit costs recognized in 1994. Note 9 Legal Contingencies USF&G's insurance subsidiaries are routinely engaged in litigation in the normal course of their businesses, including defending claims for punitive damages. As insurers, they defend third-party claims brought against their insureds, as well as defend themselves against first-party and 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, as well as in USF&G's 1995 Annual Report to Shareholders. In the opinion of management, such contingencies and the contingencies described below are 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. 9.1. North Carolina workers' compensation litigation - -------------------------------------------------------------------------------- On November 24, 1993, N.C. Steel, Inc., and six other North Carolina employers filed a class action in the General Court of Justice, Superior Court Division, Wake County, North Carolina against the National Council on Compensation Insurance ("NCCI"), North Carolina Rate Bureau, USF&G and eleven other insurance companies which served as servicing carriers for the North Carolina involuntary workers' compensation market. On January 20, 1994, the plaintiffs filed an amended complaint seeking to certify a class of all employers who purchased workers' compensation insurance in the State of North Carolina after November 24, 1989. The amended complaint, which is captioned N.C. Steel, Inc., et al., v. National Council on Compensation Insurance, et al., alleges that the defendants conspired to suppress competition with respect to the North Carolina voluntary and involuntary workers' compensation business, thereby artificially inflating the rates in such markets and the fees payable to the insurers. The complaint also alleges that the carriers agreed to improperly deny qualified companies from acting as servicing carriers, improperly encourage agents to place employers in the assigned risk pool, and improperly promote inefficient claims handling. USF&G acted as a servicing carrier in North Carolina between 1990 and 1995. The plaintiffs are pursuing their claims under various legal theories, including violations of the North Carolina antitrust laws, unlawful conspiracy, breach of fiduciary duty, breach of implied covenant of good faith and fair dealing, unfair competition, constructive fraud, and unfair and deceptive trade practices. The plaintiffs seek unspecified compensatory damages, punitive damages for the alleged constructive fraud and treble damages under the North Carolina antitrust laws. On February 14, 1995, the trial court granted the defendants' motion to dismiss the complaint. The plaintiffs appealed the trial court's dismissal of the case and on July 16, 1996 the North Carolina Court of Appeals affirmed the dismissal of the plaintiffs' first claim for relief, which is premised on alleged excessive rates, but reversed the trial court's decision to dismiss the plaintiffs' second claim for relief, which is premised on employers allegedly being improperly shifted from the voluntary market to the assigned risk market as a result of stricter underwriting caused by high residual market burdens. The plaintiffs are seeking review of the decision by the North Carolina Supreme Court with respect to the appellate court's decision to affirm the dismissal of their first claim for relief, and the defendants may also seek review of the appellate court's decision not to affirm the dismissal of the plaintiffs' second claim for relief. USF&G believes that it has meritorious defenses and has determined to defend the action vigorously. 9.2. South Carolina workers' compensation litigation - -------------------------------------------------------------------------------- On August 22, 1994, the Attorney General of the State of South Carolina filed suit in the County of Greenville, South Carolina on behalf of South Carolina employers that have allegedly been damaged as a result of alleged unfair and deceptive trade practices. Specifically, the Attorney General alleges that the NCCI, the National Workers' Compensation Reinsurance Pool, USF&G and seven other insurance companies which served as servicing carriers for the South Carolina involuntary workers' compensation market, conspired to fix servicing carrier fees at unreasonably high and noncompetitive levels in violation of the South Carolina Uniform Trade Practices Act, allegedly causing inflated deficits in the involuntary market and an excessive expansion of the residual market. The Attorney General alleges that the conspiracy occurred for an unspecified period of time prior to January 1994. The Attorney General has indicated that he intends to pursue recovery on behalf of all South Carolina employers who have suffered an ascertainable loss as a result of such alleged conduct, civil penalties of $5,000 for each willful violation, and temporary and permanent injunctive relief. USF&G believes that it has meritorious defenses and has determined to defend the action vigorously. 9.3. Alabama workers' compensation litigation - -------------------------------------------------------------------------------- On September 14, 1994, three Alabama employers filed a class action captioned Four Way Plant Farm, Inc., et al., v. National Council on Compensation Insurance, et al., in the Circuit Court of Bullock County, Alabama on behalf of all Alabama employers that have allegedly been damaged as a result of an alleged conspiracy by the NCCI, the National Workers' Compensation Reinsurance Pool, USF&G and numerous other insurance companies which served as servicing carriers for the Alabama involuntary workers' compensation market, to fix servicing carrier fees at unreasonably high and noncompetitive levels in violation of Alabama law. The plaintiffs allege that the conspiracy occurred during the period January 1, 1985 to January 1, 1994, and caused inflated deficits in the involuntary market and an alleged excessive expansion of the workers' compensation residual market. The plaintiffs seek unspecified damages on behalf of each member of the proposed class action. The parties to the litigation have reached a settlement agreement subject to court approval. The settlement agreement requires the defendants to seek approval from the Alabama Insurance Department for changes in the Alabama's workers' compensation system designed to facilitate the depopulation of the Alabama workers' compensation assigned risk market. In addition, the settlement calls for the establishment and funding of a special committee to study ways to improve the management and operation of the Alabama workers' compensation assigned risk plan, and payment of attorneys fees. A hearing to review the settlement is scheduled for November 12, 1996. If the settlement is approved, the impact on USF&G is expected to be immaterial. Note 10 Subsequent Events On July 24, 1996, USF&G entered into a definitive agreement to sell its interest in Chancellor Capital Management, Inc. ("Chancellor"). United States Fidelity and Guaranty Company, a wholly-owned subsidiary of USF&G Corporation, holds an approximate 44.5% ownership interest in Chancellor. If the transaction closes in accordance with the agreement, then USF&G expects to report a realized gain of approximately $75 million. Effective August 1, 1996, Fidelity and Guaranty Life Insurance Company ("F&G Life"), a wholly-owned subsidiary of USF&G Corporation, entered into a coinsurance contract with an unaffiliated life insurance company to cede a significant portion of F&G Life's remaining block of single premium deferred annuities. The block has a current account value of approximately $950 million. The transaction is not expected to have a material effect on USF&G's earnings. 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, 1996 and the related condensed consolidated statements of operations and cash flows for the three- and six-month periods ended June 30, 1996 and 1995. 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, 1995, 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 23, 1996, 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, 1995, is fairly stated in all material respects in relation to the consolidated statement of financial position from which it has been derived. ERNST & YOUNG LLP Baltimore, Maryland August 12, 1996 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 (collectively, "USF&G") and explains the results of operations for the quarter and six months ended June 30, 1996. 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 of Financial Condition and Results of Operations" in the 1995 Annual Report to Shareholders and should be read in conjunction therewith. The results of operations for the quarter and six months ended June 30, 1996 are compared with those for the same periods of 1995 unless otherwise noted. Financial position at June 30, 1996 is compared with December 31, 1995. In connection with, and because it desires to take advantage of, the new "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995, USF&G cautions readers regarding certain forward-looking statements in the following discussion and elsewhere in this Form 10-Q and in any other statement made by, or on the behalf of, USF&G, whether or not in future filings with the Securities and Exchange Commission. Forward-looking statements are statements not based on historical information and which relate to future operations, strategies, financial results, or other developments. Forward-looking statements are necessarily based upon estimates and assumptions that are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond USF&G's control and many of which, with respect to future business decisions, are subject to change. These uncertainties and contingencies can affect actual results and could cause actual results to differ materially from those expressed in any forward-looking statements made by, or on behalf of, USF&G. USF&G disclaims any obligation to update forward-looking information. (Note: A glossary of certain terms used in the discussion can be found at the end of this section. The terms are italicized the first time they appear in text.) Index 1. Consolidated Results 12 2. Property/Casualty Insurance Operations 13 3. Life Insurance Operations 16 4. Parent and Noninsurance Operations 17 5. Investments 17 6. Financial Condition 19 7. Liquidity 19 8. Regulation 20 9. Glossary of Terms 21 1. Consolidated Results The table below shows the major components of net income. Three Months Six Months Ended Ended June 30 June 30 (in millions) 1996 1995 1996 1995 - --------------------------------------------------------------- Income from operations before realized gains, facilities exit (costs)/sublease income, and income taxes $54 $45 $ 98 $84 Net realized gains on investments 1 1 12 5 Facilities exit (costs)/sublease income 12 - 14 6 Provision for income taxes - - - - ------------------------- Net income $67 $46 $124 $95 ------------------------- The table below shows the components by major business segment of income from operations before realized gains, facilities exit (costs)/sublease income, and income taxes. Three Months Six Months Ended Ended June 30 June 30 (in millions) 1996 1995 1996 1995 - --------------------------------------------------------------- Property/casualty insurance $ 59 $ 59 $111 $115 Life insurance 12 6 23 12 Parent and noninsurance (17) (20) (36) (43) ------------------------- Income from operations before realized gains, facilities exit (costs)/sublease income, and income taxes $ 54 $ 45 $ 98 $ 84 ------------------------- Property/casualty segment income from operations before realized gains, facilities exit (costs)/sublease income, and income taxes for the six months ended June 30, 1996 declined $4 million when compared with the same period of the previous year. The decline is primarily related to increased catastrophe losses and other significant weather related losses incurred during the first quarter of 1996. The continued improvement in the life insurance segment is principally due to improving profit margins on annuity products. Parent and noninsurance operations improved primarily due to lower interest expense on corporate debt and reduced parent company operating expenses. During 1994, USF&G developed and committed to a plan to consolidate its Baltimore headquarters facilities. The plan encompasses relocating all USF&G personnel currently residing at the 40-story office building (the "Tower") in downtown Baltimore to the Mount Washington facilities in Baltimore which USF&G owns. Implementation of the plan began in January 1995 and is generally proceeding as originally planned. The relocation of the majority of Tower personnel is expected to be completed by the end of the year. A $12 million reduction of the facilities exit cost reserve was included in net income for the quarter ended June 30, 1996. This adjustment relates primarily to reduced property tax assessments on the Tower resulting from a settlement reached with the State of Maryland and the City of Baltimore. Additionally, USF&G recognized $2 million and $6 million of sublease income related to the Tower in the first quarters of 1996 and 1995, respectively. 2. Property/Casualty Insurance Operations Property/casualty insurance operations, the principal business segment, accounted for 87 percent of USF&G's revenues in the second quarter of 1996 compared with 85 percent in the same period of 1995. Financial results for this segment are as follows: Three Months Six Months Ended Ended June 30 June 30 (in millions) 1996 1995 1996 1995 - ------------------------------------------------------------------- Premiums earned* $ 632 $ 614 $1,268 $1,193 Losses and loss expenses incurred (450) (449) (913) (874) Underwriting expenses (217) (207) (431) (409) ------------------------------- Net underwriting loss (35) (42) (76) (90) Net investment income 109 108 218 219 Other revenues and expenses, net (15) (7) (31) (14) ------------------------------- Income from operations before realized gains, facilities exit (costs)/sublease income, and income taxes $ 59 $ 59 $ 111 $ 115 ------------------------------- *See Glossary of Terms Improved underwriting results in the second quarter of 1996 were offset by an increase in other expenses, related to a swing in foreign currency gains/losses, resulting in no change in income from operations before realized gains, facilities exit (costs)/sublease income, and income taxes for the period when compared with the second quarter of 1995. The underwriting improvement for the first half of 1996, is attributable to premium growth, and a refinement of workers' compensation reserves, offset somewhat by significant catastrophe losses and other severe weather related losses incurred in the first quarter of 1996. Increased policyholders' dividends and foreign currency translation losses were the primary reasons for the increase in other expenses for the first half of 1996. 2.1. Premiums - -------------------------------------------------------------------------------- The following tables show the major components of premiums earned and premiums written. Three Months Ended June 30 1996 1995 ------------------ ----------------- Premiums Premiums (in millions) Earned Written Earned Written - ------------------------------------------------------------------ Voluntary direct: Commercial lines $332 $380 $313 $357 Personal lines 159 161 159 157 Surety 41 46 39 45 ------------------------------------- Total voluntary direct 532 587 511 559 Ceded reinsurance* (35) (38) (39) (43) ------------------------------------- Net voluntary 497 549 472 516 Alternative risk transfer* 6 6 6 9 Pools and associations 12 12 20 15 Other premium adjustments (1) (3) - (4) ------------------------------------- Total primary 514 564 498 536 ------------------------------------- Assumed reinsurance: Finite risk* 43 53 55 50 Traditional risk 75 67 61 57 ------------------------------------- Total assumed 118 120 116 107 ------------------------------------- Total segment $632 $684 $614 $643 ------------------------------------- *See Glossary of Terms Six Months Ended June 30 1996 1995 ------------------ ------------------- Premiums Premiums (in millions) Earned Written Earned Written - ------------------------------------------------------------------ Voluntary direct: Commercial lines $ 667 $ 725 $ 616 $ 675 Personal lines 316 313 316 306 Surety 78 87 75 85 ------------------------------------- Total voluntary direct 1,061 1,125 1,007 1,066 Ceded reinsurance (69) (67) (76) (84) ------------------------------------- Net voluntary 992 1,058 931 982 Alternative risk transfer 12 9 12 12 Pools and associations 29 22 36 18 Other premium adjustments - (3) 1 (8) ------------------------------------- Total primary 1,033 1,086 980 1,004 ------------------------------------- Assumed reinsurance: Finite risk 79 96 80 98 Traditional risk 156 153 133 138 ------------------------------------- Total assumed 235 249 213 236 ------------------------------------- Total segment $1,268 $1,335 $1,193 $1,240 ------------------------------------- Premiums earned for the quarter ended June 30, 1996 increased $18 million, or approximately three percent, compared with the same period in 1995. Direct voluntary premiums written in the second quarter and the first half of 1996 are $28 million and $59 million higher, respectively, over the same periods of 1995. The Commercial Insurance Group ("CIG") (refer to Section 2.2 of this Analysis) has experienced the greatest growth during these periods. The results reflect the implementation of management's strategy to grow the excess and surplus lines business and specialty segments such as real estate, technology and transportation, with the expectations of higher profit margins. 2.2. Underwriting results - -------------------------------------------------------------------------------- Underwriting results generally represent premiums earned less incurred losses, loss adjustment expenses and underwriting expenses. It is not unusual for property/casualty insurance companies to have underwriting losses that are offset by investment income. The following tables show underwriting gains (losses) and the statutory loss ratios by lines of property/casualty insurance. Three Months Ended June 30 1996 1995 ----------------------- ---------------------- Statutory Statutory (dollars in Underwriting Loss Underwriting Loss millions) Results Ratio Results Ratio - ------------------------------------------------------------------- Commercial lines $(28) 74.4% $(32) 77.2% Personal lines (21) 77.6 (22) 76.5 Surety (1) 47.8 - 33.4 Alternative risk transfer 1 78.4 - 78.5 ---------------------------------------------- Total primary (49) 73.7 (54) 74.3 Assumed reinsurance 14 60.4 12 67.2 ---------------------------------------------- Total segment $(35) 71.2% $(42) 73.0% ---------------------------------------------- Voluntary $(38) 71.7% $(40) 72.6% Involuntary 3 44.0 (2) 86.3 ---------------------------------------------- Total segment $(35) 71.2% $(42) 73.0% ---------------------------------------------- Six Months Ended June 30 1996 1995 ----------------------- -------------------- Statutory Statutory (dollars in Underwriting Loss Underwriting Loss millions) Results Ratio Results Ratio - ----------------------------------------------------------------- Commercial lines $ (43) 71.6% $ (56) 75.0% Personal lines (60) 85.0 (48) 77.7 Surety (3) 51.7 1 34.7 Alternative risk transfer 1 78.5 - 78.0 -------------------------------------------- Total primary (105) 74.5 (103) 73.5 Assumed reinsurance 29 59.8 13 71.2 -------------------------------------------- Total segment $ (76) 71.8% $ (90) 73.1% -------------------------------------------- Voluntary $ (80) 72.0% $ (79) 72.2% Involuntary 4 60.0 (11) 107.2 -------------------------------------------- Total segment $ (76) 71.8% $ (90) 73.1% -------------------------------------------- Consolidated property/casualty underwriting ratios, calculated based on generally accepted accounting principles ("GAAP") and statutory accounting practices, are as follows: Three Months Six Months Ended Ended June 30 June 30 (in millions) 1996 1995 1996 1995 - -------------------------------------------------------------- GAAP underwriting ratios: Loss ratio 71.2% 73.1% 72.0% 73.2% Expense ratio* 34.4 33.8 34.0 34.3 Combined ratio 105.6 106.9 106.0 107.5 Statutory underwriting ratios: Loss ratio 71.2 73.0 71.8 73.1 Expense ratio 33.3 33.6 33.4 34.1 Combined ratio 104.5 106.6 105.2 107.2 *See Glossary of Terms Underwriting results improved by $7 million and $14 million for the quarter and six months ended June 30, 1996, respectively, when compared to the corresponding periods of 1995. These favorable results are primarily driven by premium growth, continued overall improvement in the quality and mix of business, and continued expense management. The primary business' expense ratio decreased 1.7 points in the second quarter of 1996 compared with the second quarter of 1995. These improvements were offset by higher catastrophe losses and significant weather related losses not designated as catastrophes. In addition, 1996 results benefited from a $30 million reduction in workers' compensation reserves in the first quarter of 1996. These reductions were made as a result of the significant use of structured settlements to close medical claims in 1995. Inclusion of structured settlement payment patterns in the previously existing actuarial models for workers' compensation reserves tended to overestimate the indicated reserves. Based upon the results of revised modeling techniques, a refined estimate of required reserves was developed in the first quarter of 1996. The favorable results for assumed reinsurance for the first half of 1996 are due to lower catastrophe losses when compared to the same period of 1995. Underwriting results in the second quarter and the first half of 1996 included $19 million and $54 million of net catastrophe losses, respectively, compared with $15 million and $37 million in the same periods of 1995. The primary businesses incurred $51 million of catastrophe losses in the first half of 1996, primarily from severe winter storms and floods. The assumed reinsurance business incurred most of the first half of 1995's net catastrophe losses, recognizing estimated losses of $12 million for the January 1995 Kobe, Japan earthquake and further development of $4 million in losses on the February 1994 Los Angeles earthquake. The $3 million of catastrophe losses incurred by the assumed reinsurance business in 1996 are due to development on prior year occurrences such as Hurricane Marilyn. Underwriting results showed improvement despite continuing competitive pressures and the inflationary claims environment. Competitive pressures continue to affect underwriting results, especially in the pricing of Commercial Lines products. During 1995, with the goal of continuing the improvement in underwriting results, USF&G realigned its product segments based on the basic drivers of its different businesses, resulting in the formation of the product-driven Commercial Insurance Group ("CIG") (formerly, Commercial Lines Middle Market Group) and the distribution-driven Family and Business Insurance Group ("FBIG"). CIG includes the mid- and large-size account standard commercial business, the specialty commercial segments, and excess and surplus lines. FBIG includes the personal lines and small-size account commercial business. USF&G's field operations are being rationalized to fit the distribution strategy of each group. FBIG will consolidate its premium processing and underwriting operations into three Centers for Agency Services, while USF&G's branch offices will primarily support CIG. The following tables show selected financial information by business group (1995 amounts are estimates, based on actual Commercial and Personal Lines results). Three Months Ended June 30 1996 1995* ----------------------------------------- Direct Statutory Direct Statutory (dollars in Premiums Loss Premiums Loss millions) Written Ratio** Written Ratio** - -------------------------------------------------------------- CIG $281 74.9% $257 76.0% FBIG 260 76.0 257 74.6 Surety 46 47.8 45 33.4 ------------------------------------------ Total $587 73.6% $559 74.3% ------------------------------------------ Six Months Ended June 30 1996 1995* ----------------------------------------- Direct Statutory Direct Statutory (dollars in Premiums Loss Premiums Loss millions) Written Ratio** Written Ratio** - -------------------------------------------------------------- CIG $ 536 69.7% $ 485 76.0% FBIG 502 82.1 496 74.6 Surety 87 51.7 85 34.7 ------------------------------------------ Total $1,125 74.5% $1,066 73.5% ------------------------------------------ * Statutory loss ratios for CIG and FBIG are estimates for the full year 1995. ** Reflects estimates of certain components such as ceded reinsurance premiums and losses, loss development for years 1995 and prior, and certain underwriting expenses. 2.3. Loss reserves - -------------------------------------------------------------------------------- Reserves for unpaid losses and loss expenses totaled $6.1 billion at June 30, 1996, and approximate the December 31, 1995 position. USF&G categorizes long-term exposures where multiple claims relate to a similar cause of loss (excluding catastrophes) as "common circumstance claims". Common circumstance claim exposures include negligent construction, environmental and asbestos claims. Reserves for losses that have been reported and certain legal expenses are established on the "case basis". Bulk reserves are established in addition to the case reserves to reflect unreported claims and future development on reported claims. Total case and bulk reserves for these common circumstance claims, net of ceded reinsurance, comprise approximately eight percent of total net property/casualty reserves for unpaid losses and loss expenses at June 30, 1996 and December 31, 1995. The following table sets forth selected information for each of the three primary categories, net of ceded reinsurance. Negligent (in millions) Construction Environmental Asbestos - --------------------------------------------------------------- Total case and bulk reserves at December 31, 1995 $40 $312 $136 Losses incurred 7 12 2 Claims paid (5) (14) (2) ---------------------------------------- Total case and bulk reserves at June 30, 1996 $42 $310 $136 ---------------------------------------- Management believes that USF&G's reserve position is adequate relative to its exposure to environmental and asbestos matters. USF&G's customer base generally does not include large manufacturing companies, which tend to incur most of the known environmental and asbestos exposures. Many of USF&G's environmental claims relate to small industrial or transportation accidents which individually are unlikely to involve material exposures. In addition, USF&G has traditionally been a primary coverage carrier, having written relatively little high-level excess coverage; therefore, liability exposures are generally restricted to primary coverage limits. The level of loss reserves for both current and prior years' claims is continually monitored and adjusted for changing economic, social, judicial and legislative conditions, as well as for changes in historical trends as information regarding such conditions and actual claims develops. Management believes that loss reserves are adequate, but establishing appropriate reserves, particularly with respect to environmental, asbestos and other long-term exposure claims, is highly judgmental and an inherently uncertain process. It is possible that, as conditions change and claims experience develops, additional reserves may be required in the future. There can be no assurance that such adjustments will not have a material adverse effect on USF&G's results of operations or financial condition. 3. Life Insurance Operations Life insurance operations ("F&G Life") represent 13 percent of USF&G's total revenues for the first six months of 1996 compared with 14 percent for the same period of 1995. F&G Life also represents 30 percent of the assets at June 30, 1996 compared with 31 percent at December 31, 1995. F&G Life's financial results are as follows: Three Months Six Months Ended Ended June 30 June 30 (in millions) 1996 1995 1996 1995 - --------------------------------------------------------------- Premiums $ 42 $ 45 $ 73 $ 83 Net investment income 73 77 147 154 Policy benefits (86) (102) (166) (195) Underwriting and operating expenses (17) (14) (31) (30) ------------------------- Income from operations before realized gains, facilities exit (costs)/sublease income, and income taxes $ 12 $ 6 $ 23 $ 12 ------------------------- Income from operations before realized gains, facilities exit (costs)/sublease income, and income taxes for the life insurance segment improved $6 million and $11 million for the quarter and six months ended June 30, 1996 when compared with the corresponding periods of the previous year. The improvement is primarily due to improved interest rate spreads which yielded higher profit margins on the segment's book of business. The spreads between interest credited on annuity and other products and the income on invested assets are improving as the older block of low-margin single premium deferred annuities ("SPDAs") surrenders and is replaced by newer products with higher margins. Premiums declined mainly due to a reduced level of structured settlement sales in the quarter and six months ended June 30, 1996, while net investment income declined due to a reduced asset base created by the surrender of annuities. The decrease in policy benefits is due primarily to lower interest credited on a smaller annuity block of business, as well as the resetting of interest rates on new and renewal annuities. 3.1. Sales - -------------------------------------------------------------------------------- The following table shows life insurance and annuity sales (premiums and deposits) by distribution system and product type. Three Months Six Months Ended Ended June 30 June 30 (in millions) 1996 1995 1996 1995 - --------------------------------------------------------------- Distribution System: Direct-structured settlements $21 $30 $ 42 $ 53 Brokerage 44 37 73 68 National wholesaler 19 24 38 47 Other 4 8 11 15 ------------------------- Total $88 $99 $164 $183 ------------------------- Product Type: Structured settlement annuities $21 $30 $ 42 $ 53 Single premium deferred annuities 39 33 62 62 Tax sheltered annuities 18 22 38 43 Other annuities 6 9 15 19 Life insurance 4 5 7 6 ------------------------- Total $88 $99 $164 $183 ------------------------- Sales decreased eleven percent in the second quarter of 1996 when compared with the same period in 1995. This decrease was spread across various product types, with the largest decrease occurring in structured settlement annuities. F&G Life intends to continue to concentrate on the expansion of its existing distribution channels while also developing other marketing networks. F&G Life is also continuing the development of selected products, and modifying current product offerings to meet customer needs. Despite F&G Life's attention to expanding its distribution channels and to product development, demand for its products is affected by fluctuating interest rates and the relative attractiveness of alternative investment, annuity or insurance products, as well as its credit ratings. Total life insurance in force was $11.1 billion at June 30, 1996 compared with $11.4 billion at December 31, 1995. 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. F&G Life's current product offerings have surrender charges that decline from nine percent in the first policy year to zero percent by the tenth policy year. Such built-in surrender charges provide protection against premature policy surrender. Policy surrenders totaled $224 million and $365 million for the quarter and six months ended June 30, 1996. This compares with $166 million and $352 million for the same periods in 1995. Surrender activity on a large block of SPDAs that were originally sold through major stock brokerage firms represents, on average, 71 percent of total surrenders. Relatively low interest rates and increased competition from other investment vehicles resulted in the increased surrenders as more of these stock broker-sold policies reached the expiration of their surrender charge period in the first six months of 1996 than during the same period of 1995. Effective August 1, 1996, F&G Life entered into a coinsurance contract with an unaffiliated life insurance company to cede 100 percent of the remaining block of stock broker-sold SPDAs. The block ceded has a current account value of approximately $950 million. The transaction, which is not expected to have a material effect on earnings, removes an underperforming block of business that had significant exposure to changes in current interest rates from F&G Life's direct obligations. Additionally, the agreement will result in a significant improvement in cash flow related to reduced surrender activity and will enable redeployment of capital to other marketing and/or investment opportunities. 4. Parent and Noninsurance Operations Parent company interest and other unallocated expenses and noninsurance operations are as follows: Three Months Six Months Ended Ended June 30 June 30 (in millions) 1996 1995 1996 1995 - --------------------------------------------------------------- Parent Company Expenses: Interest expense $ (9) $(11) $(19) $(21) Unallocated expense, net (9) (12) (18) (24) Noninsurance operations 1 3 1 2 ------------------------- Loss from operations before realized gains, facilities exit (costs)/sublease income, and income taxes $(17) $(20) $(36) $(43) ------------------------- Parent and noninsurance operations show a decrease in loss from operations before realized gains, facilities exit (costs)/sublease income, and income taxes of $3 million and $7 million for the quarter and six months ended June 30, 1996. The decreases are primarily attributable to reduced interest expense due to the refinancing of corporate debt, and reduced parent company operating expenses. In the second quarter of 1996, these decreases were partially offset by the absence of net income from Kepner-Tregoe, Inc., a management consulting subsidiary, which was sold in March 1996. 5. Investments At June 30, 1996, USF&G's investment mix is comparable with year-end 1995. Fixed maturities and total investments have decreased slightly due to a decline in unrealized gains in the fixed maturities portfolio. The table below shows the distribution of USF&G's investment portfolio. (dollars in millions) At June 30, 1996 At December 31, 1995 - --------------------------------------------------------------- Total investments $10,755 $11,107 -------------------------------------- Fixed maturities 83% 85% Common and preferred stocks - 1 Short-term investments 4 3 Mortgage loans and real estate 9 8 Other invested assets 4 3 -------------------------------------- Total 100% 100% -------------------------------------- 5.1. Net investment income - -------------------------------------------------------------------------------- The following table shows the components of net investment income. Three Months Six Months Ended Ended June 30 June 30 (dollars in millions) 1996 1995 1996 1995 - --------------------------------------------------------------- Net investment income from: Fixed maturities $164 $167 $329 $332 Common and preferred stocks 1 1 2 2 Short-term investments 4 5 8 11 Mortgage loans and real estate 10 12 20 24 Other investment income, net of interest expense on funds held 5 2 9 7 ------------------------- Total investment income 184 187 368 376 Investment expenses (3) (5) (7) (9) ------------------------- Net investment income $181 $182 $361 $367 ------------------------- Average annualized yields: Total investments 6.9% 6.8% 6.8% 6.9% Fixed maturities 7.3 7.4 7.3 7.4 ------------------------- Investment income for the six months ended June 30, 1996 has decreased $6 million, or two percent, when compared with the same period in 1995. Interest on short-term investments has decreased due to lower short-term interest rates and a lower average short-term investment base. Investment income on mortgage loans and real estate for the first half of 1996 declined primarily due to a lower investment base, resulting from the sales of certain mortgage loans in 1995. Other investment income includes $5 million and $7 million for the second quarter 1996 and 1995, respectively, and $9 million and $15 million for the six months ended June 30, 1996 and 1995, respectively, of income related to USF&G's share of earnings from an equity interest in RenaissanceRe Holdings, Ltd. ("RenaissanceRe"), a property reinsurance company in Bermuda. Income from the investment in RenaissanceRe is subject to volatility and exposure to catastrophe losses and other risks inherent to the property/casualty reinsurance industry. Also netted against other investment income is interest credited to funds held on assumed reinsurance contracts of $5 million and $9 million for the second quarter 1996 and 1995, respectively, and $11 million and $15 million for the six months ended June 30, 1996 and 1995, respectively. 5.2. Realized gains (losses) - -------------------------------------------------------------------------------- The components of net realized gains (losses) include the following: Three Months Six Months Ended Ended June 30 June 30 (in millions) 1996 1995 1996 1995 - --------------------------------------------------------------- Net gains (losses): Fixed maturities $(2) $ - $(1) $ - Common and preferred stocks - - - 2 Mortgage loans and real estate - - 4 1 Other 4 7 10 11 ------------------------- Total net gains (losses) 2 7 13 14 Impairments (1) (6) (1) (9) ------------------------- Net realized gains $ 1 $ 1 $12 $ 5 ------------------------- Other realized gains primarily relate to USF&G's share of gains from its equity in certain venture capital-type limited partnerships. Impairments relate to specific investments and are realized when the decline in fair value is deemed other than temporary, or when the fair value is significantly less than book value and it is probable that the investment will be sold before any recovery in value can occur. Realized gains on mortgage loans and real estate for the six months ended June 30, 1996 resulted from the sale of properties in the first quarter of 1996. 5.3. Unrealized gains (losses) - -------------------------------------------------------------------------------- The components of the changes in unrealized gains (losses) were as follows: Six Months Ended June 30 (in millions) 1996 - ----------------------------------------------------------- Fixed maturities available for sale $(383) Deferred policy acquisition costs and policy benefits adjustment 68 Common and preferred stocks 3 Foreign currency and other 16 --------- Total $(296) --------- Fixed maturity investments classified as "available for sale" are recorded at market value with the unrealized gains (losses) reported as a component of shareholders' equity. Yields on U.S. Treasuries with 2- to 30-year maturities increased an average of 104 basis points during the first half of 1996, which reduced the unrealized gain on fixed maturities available for sale from $340 million at December 31, 1995 to an unrealized loss of $43 million at June 30, 1996. This was partially offset by a related change in F&G Life's deferred policy acquisition costs ("DPAC") and policy benefits adjustment from an unrealized loss of $73 million at December 31, 1995 to an unrealized loss of $5 million at June 30, 1996. 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 change in unrealized gains on other investments primarily relates to USF&G's share of unrealized gains from its equity interests in certain venture capital-type limited partnerships. 5.4. Investment portfolios - -------------------------------------------------------------------------------- The table below details the composition of the fixed maturity portfolio. At June 30, At December 31, (dollars in millions) 1996 1995 - ----------------------------------------------------------------- Corporate and other investment-grade bonds $5,370 60% $5,361 59% Mortgage-backed securities 1,632 18 1,739 19 Asset-backed securities 926 11 999 11 U.S. Government bonds 367 4 380 4 High-yield bonds* 596 7 599 7 Tax-exempt bonds 33 - 40 - --------------------------------- Total fixed maturities at amortized cost 8,924 100% 9,118 100% Total market value of fixed maturities 8,881 9,458 --------------------------------- Net unrealized gains (losses) $ (43) $ 340 --------------------------------- Percent market-to-amortized cost 100% 104% --------------------------------- *See Glossary of Terms Increasing interest rates, which resulted in declining bond prices, were responsible for the four percentage point decrease in the fixed maturity portfolio's overall market-to-amortized cost ratio from December 31, 1995. The table below shows the components of USF&G's mortgage loan and real estate investment portfolio. (in millions) At June 30, 1996 At December 31, 1995 - --------------------------------------------------------------- Mortgage loans $325 $254 Equity real estate, net 634 653 ------------------------------------------ Total $959 $907 ------------------------------------------ The increase in mortgage loans from December 31, 1995 is primarily due to new loan originations in the first half of 1996. This increase was partly offset by the sale of equity real estate, including three land parcels. Mortgage loan and real estate investments are evaluated on a quarterly basis as part of management's asset quality review process. This process ensures that the financial and operating aspects of a property's performance are closely monitored and analyzed. Although USF&G anticipates that any sales of real estate will be in an orderly fashion as and when market conditions permit, if USF&G was required to dispose of a significant portion of its real estate in the near term, it is likely that it would recover amounts substantially less than the related carrying values. Prospectively, efforts will continue to reduce risk and increase yields in the real estate portfolio by selling equity real estate when it is advantageous to do so and reinvesting the proceeds in medium-term mortgage loans. 6. Financial Condition 6.1. Assets - -------------------------------------------------------------------------------- USF&G's assets totaled $14.4 billion at June 30, 1996, compared with $14.7 billion at December 31, 1995. The decrease is primarily a result of the $296 million decrease in net unrealized gains (losses). 6.2. Debt - -------------------------------------------------------------------------------- USF&G's corporate debt totaled $583 million at June 30, 1996, compared with $591 million at December 31, 1995. The decrease in debt is a result of the repurchase of $32 million of Zero Coupon Convertible Subordinated Notes, offset by an increase in the balance due under the committed credit facility. In January 1996, $75 million was drawn against the committed credit facility to repay the balance due upon maturity of the previously outstanding 5 1/2% Swiss Franc Bonds. During the first half of 1996, another $27 million was drawn against the facility to fund the repurchase of Zero Coupon Convertible Subordinated Notes. Subject to market conditions, USF&G plans to refinance or repurchase other outstanding debt over the next several years. In April 1996, USF&G entered into a 5-year, $80 million notional principle, fixed-for-floating interest rate swap. This instrument effectively converts the 7 1/8% Senior Notes to floating rate debt with an effective rate of approximately 5.6% at June 30, 1996. 6.3. Shareholders' equity - -------------------------------------------------------------------------------- USF&G's shareholders' equity totaled $1.8 billion at June 30, 1996, compared with $2.0 billion at December 31, 1995. The decrease is the result of the $296 million decrease in net unrealized gains (losses), the repurchase of $26 million of the corporation's common stock, and $22 million in common and preferred stock dividends. Net income of $124 million partly offset these decreases. 6.4. Capital strategy - -------------------------------------------------------------------------------- In April 1996, USF&G announced a plan to repurchase up to five million shares of its common stock. The purchases are made from time to time via open market purchases, block trades, or as otherwise determined by management, and are funded primarily through excess parent company cash flow. The timing and amount of purchases depends on market conditions and corporate requirements. Through August 9, 1996, approximately 2.2 million shares have been repurchased. In conjunction with the stock repurchase program, USF&G also sold 300,000 put options on its common stock during the second quarter of 1996. These put options mature in the third quarter of this year. 7. Liquidity 7.1. Cash flow - -------------------------------------------------------------------------------- USF&G had cash flow from operations of $95 million and $149 million for the quarter and six months ended June 30, 1996, respectively. For the corresponding periods of 1995, cash flow from operations totaled $101 million and $156 million, respectively. USF&G has generated positive cash flow from operations for eight consecutive quarters generally as a result of premium growth and the overall improvement in basic underwriting and expense control. Deposits and withdrawals of universal life and investment contracts, such as annuities, had net cash outflows of $156 million and $234 million in the second quarter and first half of 1996, respectively, which is higher than the $105 million and $229 million in the corresponding periods of 1995 due to increased SPDA surrender activity. As a result of F&G Life ceding a significant portion of the remaining SPDA block, cash outflows for surrender activity are expected to decrease in the future (refer to Section 3.2 of this Analysis). 7.2. Credit facilities - -------------------------------------------------------------------------------- At June 30, 1996, USF&G maintained a $250 million committed credit facility with a group of foreign and domestic banks. Borrowings outstanding under the credit facility totaled $102 million at June 30, 1996. There were no borrowings against the facility at December 31, 1995. The increase in borrowings is a result of the use of the facility to repay the balance due upon maturity of the 5 1/2% Swiss Franc Bonds and to repurchase Zero Coupon Convertible Subordinated Notes. The credit agreement contains restrictive covenants pertaining to indebtedness, tangible net worth, liens and other matters. USF&G was in compliance with these covenants at June 30, 1996 and December 31, 1995. In addition, at June 30, 1996, USF&G maintained a $150 million foreign currency credit facility. There were no borrowings on this credit facility as of June 30, 1996. 7.3. Marketable securities - -------------------------------------------------------------------------------- USF&G's fixed maturity, common and preferred stocks, and short-term investment portfolios are liquid and represent substantial sources of cash. The market value of its fixed maturities investments was $8.9 billion at June 30, 1996, which represents 99.5 percent of its amortized cost. At June 30, 1996, investments in common and preferred stocks, which are reported at market value in the Condensed Consolidated Statement of Financial Position, totaled $40 million. Short-term investments totaled $390 million. 7.4. Liquidity restrictions - -------------------------------------------------------------------------------- There are certain restrictions on payments of dividends by insurance subsidiaries that may limit USF&G Corporation's ability to receive funds from its subsidiaries. Under the Maryland Insurance Code, Maryland insurance subsidiaries, such as United States Fidelity and Guaranty Company and Fidelity and Guaranty Life Insurance Company, must provide the Maryland Insurance Commissioner (the "Commissioner") with not less than thirty days' prior written notice before payment of an "extraordinary dividend" to its holding company. "Extraordinary dividends" are dividends which, together with any dividends paid during the immediately preceding twelve-month period, would be in excess of ten percent of the subsidiary's statutory policyholders' surplus as of the prior calendar year end. Extraordinary dividends may not be paid until either such thirty-day period has expired and the Commissioner has not disapproved the payment or the Commissioner has approved the payment within such period. In addition, ten days' prior notice of any other dividend must be given to the 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. Effective December 29, 1995, F&G Life, with the Commissioner's consent, paid extraordinary dividends to USF&G Corporation. Because any dividends paid during the immediately preceding twelve-month period are considered when determining whether future dividends constitute extraordinary dividends, any dividends which F&G Life would propose to pay in the twelve-month period beginning December 29, 1995, would be deemed extraordinary dividends and subject to the thirty-day notice period described above. The application of the thirty-day notice requirement to dividends of F&G Life is not expected to materially affect the liquidity of USF&G Corporation. 8. Regulation USF&G's insurance subsidiaries are subject to extensive regulatory oversight in the jurisdictions where they do business. This regulatory structure, which generally operates through state insurance departments, involves the licensing of insurance companies and agents, limitations on the nature and amount of certain investments, restrictions on the amount of single insured risks, approval of policy forms and rates, setting of capital requirements, limitations on dividends, limitations on the ability to withdraw from certain lines of business such as personal lines and workers' compensation, and other matters. From time to time, the insurance regulatory framework has been the subject of increased scrutiny. At any one time there may be numerous initiatives within state legislatures or state insurance departments to alter and, in many cases, increase state authority to regulate insurance companies and their businesses. Proposals to adopt a federal regulatory framework have also been discussed. It is not possible to predict the future impact of increasing state or potential federal regulation on USF&G's operations. Additional information regarding legal and regulatory contingencies may be found in Note 9, "Legal Contingencies," to the condensed consolidated financial statements, as well as in USF&G's 1995 Annual Report to Shareholders. 9. Glossary of Terms Account value: Deferred annuity cash value available to policyholders before the assessment of surrender charges. Alternative risk transfer: A form of insurance through which a company self-insures the predictable frequency portion of its own losses and purchases insurance for the less frequent, high severity losses that could have a major financial impact on the company. Catastrophe losses: Property/casualty insurance claim losses resulting from a sudden calamitous event, such as a severe storm, are categorized as "catastrophes" when they meet certain severity and other criteria determined by a national organization. Expense ratio: The ratio of underwriting expenses to net premiums written, if determined in accordance with statutory accounting practices ("SAP"), or the ratio of underwriting expenses (adjusted by deferred policy acquisition costs) to earned premiums, if determined in accordance with GAAP. Finite risk reinsurance: Reinsurance arrangements providing coverage at lower margins than traditional risk reinsurance in return for a lower probability of loss to the reinsurer. 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. Loss ratio: The ratio of incurred losses and loss expenses to earned premiums, determined in accordance with SAP or GAAP, as applicable. The difference between SAP and GAAP relates to deposit accounting for GAAP related to certain financial reinsurance assumed. Policyholders' surplus: The net assets of an insurer as reported to regulatory agencies based on accounting practices prescribed or permitted by the National Association of Insurance Commissioners and the state of domicile. Premiums earned: The portion of premiums written applicable to the expired period of policies. Premiums written: Premiums retained by an insurer. Reinsurance: For a consideration, an assuming insurer agrees to indemnify a ceding insurer against all or part of the loss the latter may sustain under the policy or policies it has issued. The legal rights of the insured are not affected by the transaction and the ceding insurer remains liable to the insured for payment of policy benefits. 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. USF&G CORPORATION Part II. Other Information Item 4. Submission of Matters to a Vote of Shareholders (a) The 1996 Annual Meeting of Shareholders was held May 15, 1996. (b) and (c) The shareholders elected all proposed nominees for directors to a term of one year. The elections were uncontested and all nominees were currently directors of USF&G Corporation. The following table provides the voting tabulation for each nominee: For Withheld H. Furlong Baldwin 102,670,603 1,046,720 Michael J. Birck 102,727,768 989,555 Norman P. Blake, Jr. 102,545,940 1,171,383 George L. Bunting, Jr. 102,697,584 1,019,739 Robert E. Davis 102,598,119 1,119,204 Dale F. Frey 102,746,603 970,720 Robert E. Gregory, Jr. 102,788,493 928,830 Robert J. Hurst 101,172,737 2,544,586 Wilbur G. Lewellen 102,708,304 1,009,019 Henry A. Rosenberg, Jr. 102,643,822 1,073,501 Larry P. Scriggins 101,030,684 2,686,639 Anne Marie Whittemore 100,980,834 2,736,489 R. James Woolsey 100,946,019 2,771,304 Item 6. Exhibits and Reports on Form 8-K (a) Exhibits. Exhibit 11. Computation of Earnings Per Share. Exhibit 12. Computation of Ratio of Consolidated Earnings to Fixed Charges and Preferred Stock Dividends. Exhibit 15. Letter Regarding Unaudited Interim Financial Information. (b) Reports on Form 8-K. There were no reports on Form 8-K filed during the second quarter of 1996. The registrant filed a Form 8-K on July 24, 1996, reporting under Item 5, Other Events, certain information related to an agreement entered into under which United States Fidelity and Guaranty Company, a wholly-owned subsidiary of the registrant, will sell its approximate 44.5% interest in Chancellor Capital Management, Inc.
USF&G CORPORATION Exhibit 11 - Computation of Earnings Per Share (Unaudited) Six Months Ended June 30 (dollars in millions except per share data) 1996 1995 --------------------------------------- Net Income Available to Common Stock Primary: Net income $ 124 $ 95 Less preferred stock dividend requirements (10) (15) --------------------------------------- Net income available to common stock $ 114 $ 80 --------------------------------------- Fully Diluted: Net income $ 124 $ 95 Less preferred stock dividend requirements (8) (8) Add interest expense on convertible notes 2 3 --------------------------------------- Net income available to common stock $ 118 $ 90 --------------------------------------- Weighted Average Shares Outstanding Primary common shares (A) 119,411,427 108,869,519 --------------------------------------- Fully Diluted (B): Common shares 119,411,427 108,869,519 Assumed conversion of preferred stock 2,308,106 12,615,617 Assumed exercise of stock options 1,636,528 1,283,417 Assumed conversion of zero coupon convertible subordinated notes 6,352,827 7,227,255 --------------------------------------- Total 129,708,888 129,995,808 --------------------------------------- Earnings Per Common Share Primary (A) $ .95 $.73 Fully diluted (B) $ .91 $.69 --------------------------------------- (A) Shares issuable under stock options (1,550,319 shares in 1996 and 861,463 in 1995) 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 calculations assume the conversion of preferred stock series B and the Zero Coupon Convertible Subordinated Notes, as well as shares issuable under stock options. The 1995 calculation also assumes the conversion of preferred stock series C.
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) 1996 1995 -------------------------------------------- Fixed Charges Interest expense $ 20 $ 22 Portion of rents representative of interest 7 10 -------------------------------------------- Total fixed charges 27 32 Preferred stock dividend requirements (A) 10 15 -------------------------------------------- Combined Fixed Charges and Preferred Stock Dividends $ 37 $ 47 -------------------------------------------- Consolidated Earnings Available for Fixed Charges and Preferred Stock Dividends Income from operations before income taxes $124 $ 95 Adjustment: Fixed charges 27 32 -------------------------------------------- Consolidated earnings available for fixed charges and preferred stock dividends $151 $127 -------------------------------------------- Ratio of Consolidated Earnings to Fixed Charges 5.5 4.0 Ratio of Consolidated Earnings to Combined Fixed Charges and Preferred Stock Dividends 4.1 2.7 -------------------------------------------- (A) Preferred stock dividend requirements of $10 million in 1996 and $15 million in 1995 divided by 100% less the effective income tax rate of 0% in 1996 and 0.6% in 1995.
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, 33-21132, 33-51859, 33-63333, and 33-65471 on Form S-3; and Numbers 2-61626, 2-72026, 2-98232, 33-16111, 33-35095, 33-38113, 33-43132, 33-45664, 33-45665, 33-61965, 33-55667, 33-55669, 33-55671, 33-59535, 33-64839 and 333-04359 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, 1996. Pursuant to Rule 436(c) of the Securities Act of 1933, our report is not a part of the registration statements 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, 1996 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, 1996 EX-27 2 FINANCIAL DATA SCHEDULE
7 1000000 6-MOS DEC-31-1996 JUN-30-1996 8881 0 0 40 325 634 10755 41 759 501 14425 9598 1154 9 95 599 0 213 295 1259 14425 1341 361 12 11 1079 368 148 124 0 124 0 0 0 124 0.95 0.91 5113 994 (81) 279 656 5091 (81)
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