-----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, VDDVzCEIBFll1PYx2d6qMzwpFoQDxR0l8208MR+rFL4v0050+ySpr3/xXugcz9yA uVol4DxhsDKaDL4ZLGYBUg== 0000867579-04-000154.txt : 20040507 0000867579-04-000154.hdr.sgml : 20040507 20040507145135 ACCESSION NUMBER: 0000867579-04-000154 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 20040331 FILED AS OF DATE: 20040507 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SAFECO CORP CENTRAL INDEX KEY: 0000086104 STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331] IRS NUMBER: 910742146 STATE OF INCORPORATION: WA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-06563 FILM NUMBER: 04788692 BUSINESS ADDRESS: STREET 1: 4333 BROOKLYN AVE NE STREET 2: SAFECO PLAZA CITY: SEATTLE STATE: WA ZIP: 98185 BUSINESS PHONE: 2065455000 MAIL ADDRESS: STREET 1: 4333 BROOKLYN AVE NE CITY: SEATTLE STATE: WA ZIP: 98185 FORMER COMPANY: FORMER CONFORMED NAME: GENERAL AMERICA CORP DATE OF NAME CHANGE: 19680529 10-Q 1 en0706_10q.txt 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 - ------------------------------------------------------------------------------ FORM 10-Q - ------------------------------------------------------------------------------ [ X ] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the Quarterly Period Ended March 31, 2004 [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the Transition Period from _____ to _____. Commission File Number: 1-6563 Safeco Corporation State of Incorporation: Washington I.R.S. Employer I.D. No.: 91-0742146 Address of Principal Executive Offices: Safeco Plaza, Seattle, Washington 98185 Telephone: 206-545-5000 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X]. NO [ ]. Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). YES [X]. NO [ ]. 139,309,813 shares of common stock of Safeco Corporation, no par value, were outstanding at April 30, 2004. Safeco Corporation and Subsidiaries - ------------------------------------------------------------------------------- CONTENTS - ------------------------------------------------------------------------------- Item Description Page - -------------------------------------------------------------------------------------------------------------- Part I Financial Information 1 Financial Statements Consolidated Statements of Income for the three months ended March 31, 2004 and 2003 3 Consolidated Balance Sheets March 31, 2004 and December 31, 2003 4 Consolidated Statements of Cash Flows for the three months ended March 31, 2004 and 2003 6 Consolidated Statements of Shareholders' Equity for the three months ended March 31, 2004 and 2003 8 Consolidated Statements of Comprehensive Income for the three months ended March 31, 2004 and 2003 8 Condensed Notes to Consolidated Financial Statements 9 2 Management's Discussion and Analysis of Financial Condition and 23 Results of Operations 4 Controls and Procedures 47 Part II Other Information 1 Legal Proceedings 48 6 Exhibits and Reports on Form 8-K 48 Signatures 50
Safeco Corporation and Subsidiaries - -------------------------------------------------------------------------------- Consolidated Statements of Income - -------------------------------------------------------------------------------- THREE MONTHS ENDED MARCH 31 2004 2003 - ----------------------------------------------------------------------------------------------------------- (In Millions, Except Per Share Amounts) (Unaudited) REVENUES Property & Casualty Earned Premiums $ 1,340.5 $ 1,163.1 Net Investment Income 115.0 119.6 Net Realized Investment Gains 42.8 8.2 Other -- 2.6 ----------------------------- Total 1,498.3 1,293.5 ----------------------------- EXPENSES Losses and Loss Adjustment Expenses 826.0 789.1 Other Underwriting and Operating Expenses 154.1 158.4 Amortization of Deferred Policy Acquisition Costs 226.9 204.6 Interest Expense 30.5 34.8 Restructuring Charges 1.3 -- ----------------------------- Total 1,238.8 1,186.9 ----------------------------- Income from Continuing Operations before Income Taxes 259.5 106.6 Provision for Income Taxes 73.9 27.1 ----------------------------- Income from Continuing Operations 185.6 79.5 Income from Discontinued Operations (Net of Taxes of $26.9 and $6.3) 50.6 10.5 ----------------------------- Net Income $ 236.2 $ 90.0 - ----------------------------------------------------------------------------------------------------------- INCOME PER SHARE OF COMMON STOCK - DILUTED Income from Continuing Operations $ 1.33 $ 0.57 Income from Discontinued Operations 0.36 0.08 ----------------------------- Net Income 1.69 0.65 INCOME PER SHARE OF COMMON STOCK - BASIC Income from Continuing Operations 1.34 0.57 Income from Discontinued Operations 0.36 0.08 ----------------------------- Net Income 1.70 0.65 Dividends Declared $ 0.185 $ 0.185 - ----------------------------------------------------------------------------------------------------------- Average Number of Shares Outstanding During the Period: Diluted 140.0 138.7 Basic 138.9 138.3 - ----------------------------------------------------------------------------------------------------------- See Condensed Notes to Consolidated Financial Statements. Safeco Corporation and Subsidiaries - ------------------------------------------------------------------------------- Consolidated Balance Sheets - ------------------------------------------------------------------------------- MARCH 31 DECEMBER 31 2004 2003 - ------------------------------------------------------------------------------------------------------------- (In Millions) (Unaudited) ASSETS Investments Available-for-Sale Securities: Fixed Maturities, at Fair Value (Cost or amortized cost: $7,797.0; $7,717.2) $ 8,311.7 $ 8,159.2 Marketable Equity Securities, at Fair Value (Cost: $653.9; $684.8) 1,134.8 1,166.2 Other Invested Assets 26.1 18.8 Short-Term Investments 68.5 77.6 ---------------------------------- Total Investments 9,541.1 9,421.8 Cash and Cash Equivalents 317.5 241.4 Accrued Investment Income 110.9 120.9 Premiums and Service Fees Receivable 1,079.9 1,043.9 Other Notes and Accounts Receivable 151.6 104.8 Current Income Taxes Recoverable -- 20.5 Deferred Income Taxes Recoverable 204.4 274.3 Reinsurance Recoverables 358.6 372.0 Deferred Policy Acquisition Costs 361.4 356.8 Land, Buildings and Equipment for Company Use (At cost less accumulated depreciation: $323.8; $311.8) 420.7 433.7 Other Assets 238.3 256.5 Securities Lending Collateral 1,023.0 951.9 Assets of Discontinued Operations 23,108.3 22,548.9 ---------------------------------- Total Assets $ 36,915.7 $ 36,147.4 - ------------------------------------------------------------------------------------------------------------- See Condensed Notes to Consolidated Financial Statements. Safeco Corporation and Subsidiaries - -------------------------------------------------------------------------------- Consolidated Balance Sheets - -------------------------------------------------------------------------------- MARCH 31 DECEMBER 31 2004 2003 - ------------------------------------------------------------------------------------------------------------- (In Millions) (Unaudited) LIABILITIES AND SHAREHOLDERS' EQUITY Loss and Loss Adjustment Expense Reserves $ 5,068.9 $ 5,044.6 Unearned Premiums 2,085.2 2,053.6 Debt 1,951.3 1,951.3 Current Income Taxes Payable 31.1 -- Other Liabilities 998.8 1,180.0 Securities Lending Payable 1,023.0 951.9 Liabilities of Discontinued Operations 20,222.7 19,942.7 -------------------------------------- Total Liabilities 31,381.0 31,124.1 -------------------------------------- Commitments and Contingencies -- -- Preferred Stock, No Par value Shares Authorized: 10 Shares Issued and Outstanding: None -- -- Common Stock, No Par Value Shares Authorized: 300 Shares Reserved for Options: 11.0; 11.6 Shares Issued and Outstanding: 139.2; 138.6 1,216.9 1,197.3 Retained Earnings 2,519.2 2,308.7 Accumulated Other Comprehensive Income, Net of Taxes Unrealized Gains and Losses on Available-for-Sale Securities and Derivative Financial Instruments 1,892.4 1,589.0 Unrealized Foreign Currency Translation Adjustment (9.8) (8.8) Deferred Policy Acquisition Costs Valuation Allowance (78.3) (57.2) Minimum Pension Liability Adjustment (5.7) (5.7) -------------------------------------- Total Accumulated Other Comprehensive Income 1,798.6 1,517.3 -------------------------------------- Total Shareholders' Equity 5,534.7 5,023.3 -------------------------------------- Total Liabilities and Shareholders' Equity $ 36,915.7 $ 36,147.4 - ------------------------------------------------------------------------------------------------------------- See Condensed Notes to Consolidated Financial Statements. Safeco Corporation and Subsidiaries - -------------------------------------------------------------------------------- Consolidated Statements of Cash Flows - -------------------------------------------------------------------------------- THREE MONTHS ENDED MARCH 31 2004 2003 - ------------------------------------------------------------------------------------------------------------ (In Millions) (Unaudited) OPERATING ACTIVITIES Insurance Premiums Received $ 1,336.0 $ 1,191.9 Dividends and Interest Received 138.7 116.1 Insurance Claims Paid (807.0) (845.1) Underwriting, Acquisition, Insurance and Other Operating Costs Paid (552.6) (398.4) Interest Paid (63.4) (47.9) Income Taxes Received (Paid) 19.8 (23.6) Discontinued Operations, Net 260.4 224.6 ----------------------------- Net Cash Provided by Operating Activities 331.9 217.6 ----------------------------- INVESTING ACTIVITIES Purchases of Fixed Maturities Available-for-Sale (405.8) (550.7) Equity Securities Available-for-Sale (110.3) (33.5) Maturities and Calls of Fixed Maturities Available-for-Sale 195.8 307.8 Sales of: Fixed Maturities Available-for-Sale 180.0 389.5 Equity Securities Available-for-Sale 135.4 30.0 Net (Increase) Decrease in Short-Term Investments 9.1 (253.0) Other, Net 11.0 6.0 Discontinued Operations, Net (25.5) (296.3) ----------------------------- Net Cash Used in Investing Activities (10.3) (400.2) ----------------------------- FINANCING ACTIVITIES Proceeds from Notes -- 495.9 Repayment of Notes -- (307.1) Dividends Paid to Shareholders (25.7) (25.6) Other, Net 15.1 2.2 Discontinued Operations, Net (196.2) 44.0 ----------------------------- Net Cash Provided by (Used in) Financing Activities (206.8) 209.4 ----------------------------- Cash (Provided By) Used In Discontinued Operations (38.7) 27.7 ----------------------------- Net Increase in Cash and Cash Equivalents in Continuing Operations 76.1 54.5 Cash and Cash Equivalents at Beginning of Period 241.4 121.1 ----------------------------- Cash and Cash Equivalents at End of Period $ 317.5 $ 175.6 - ------------------------------------------------------------------------------------------------------------ See Condensed Notes to Consolidated Financial Statements. Safeco Corporation and Subsidiaries - -------------------------------------------------------------------------------------------------------------- Consolidated Statements of Cash Flows - Reconciliation of Net Income to Net Cash Provided by Operating Activities - -------------------------------------------------------------------------------------------------------------- THREE MONTHS ENDED MARCH 31 2004 2003 - ----------------------------------------------------------------------------------------------------------- (In Millions) (Unaudited) Net Income $ 236.2 $ 90.0 ---------------------------- ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH PROVIDED BY OPERATiNG ACTIVITIES Income from Discontinued Operations, Net of Taxes (50.6) (10.5) Net Realized Investment Gains (42.8) (8.2) Amortization of Fixed Maturities 9.5 (3.7) Amortization and Depreciation 14.8 14.4 Deferred Income Tax Provision 38.3 30.2 Other 2.8 -- Changes in Accrued Investment Income 10.0 10.8 Deferred Policy Acquisition Costs (4.6) 0.4 Property & Casualty Loss and Loss Adjustment Expense Reserves 24.3 (84.3) Unearned Premiums 31.6 44.6 Current Income Taxes Recoverable 51.6 (25.8) Other Assets and Liabilities (249.6) (64.9) Discontinued Operations, Net 260.4 224.6 ---------------------------- Total Adjustments 95.7 127.6 ---------------------------- Net Cash Provided by Operating Activities $ 331.9 $ 217.6 - ----------------------------------------------------------------------------------------------------------- There were no significant non-cash financing or investing activities for the three months ended March 31, 2004 and 2003. See Condensed Notes to Consolidated Financial Statements. Safeco Corporation and Subsidiaries - -------------------------------------------------------------------------------- Consolidated Statements of Shareholders' Equity - -------------------------------------------------------------------------------- THREE MONTHS ENDED MARCH 31 2004 2003 - ----------------------------------------------------------------------------------------------------------- (In Millions) (Unaudited) COMMON STOCK Balance at Beginning of Period $ 1,197.3 $ 1,178.1 Stock Issued for Options and Rights 16.8 2.4 Stock Option Expense 2.8 -- ---------------------------- Balance at End of Period 1,216.9 1,180.5 ---------------------------- RETAINED EARNINGS Balance at Beginning of Period 2,308.7 2,072.2 Net Income 236.2 90.0 Dividends Declared (25.7) (25.6) Other -- (0.1) ---------------------------- Balance at End of Period 2,519.2 2,136.5 ---------------------------- ACCUMULATED OTHER COMPREHENSIVE INCOME, NET OF TAXES Balance at Beginning of Period 1,517.3 1,181.3 Other Comprehensive Income 281.3 63.7 ---------------------------- Balance at End of Period 1,798.6 1,245.0 ---------------------------- Shareholders' Equity $ 5,534.7 $ 4,562.0 - ----------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Consolidated Statements of Comprehensive Income - -------------------------------------------------------------------------------- THREE MONTHS ENDED MARCH 31 2004 2003 - ----------------------------------------------------------------------------------------------------------- (In Millions) (Unaudited) Net Income $ 236.2 $ 90.0 ---------------------------- Other Comprehensive Income, Net of Taxes: Change in Unrealized Gains (Losses) on Available-for-Sale Securities 257.7 21.8 Reclassification Adjustment for Net Realized Investment (Gains) Losses Included in Net Income 38.4 32.4 Derivatives Qualifying as Cash Flow Hedges - Net Change in Fair Value 7.3 2.1 Adjustment for Deferred Policy Acquisition Costs Valuation Allowance (21.1) 1.6 Foreign Currency Translation Adjustments (1.0) 5.8 ---------------------------- Other Comprehensive Income 281.3 63.7 ---------------------------- Comprehensive Income $ 517.5 $ 153.7 - ----------------------------------------------------------------------------------------------------------- See Condensed Notes to Consolidated Financial Statements.
Safeco Corporation and Subsidiaries - -------------------------------------------------------------------------------- Condensed Notes to Consolidated Financial Statements (unaudited) - -------------------------------------------------------------------------------- (Dollar amounts in millions except per share data, unless noted otherwise) NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Nature of Operations Safeco Corporation is a Washington State corporation operating across the United States, with insignificant non-U.S. activities. Our subsidiaries sell property and casualty insurance including surety. Our discontinued businesses sell life insurance, group stop-loss medical insurance and asset management products to individuals and corporations. We generated virtually all of our revenues for the periods presented in this report from these activities. Throughout our unaudited Consolidated Financial Statements, Safeco Corporation and its subsidiaries are referred to as "Safeco" "we" and "our." The property and casualty businesses including surety are referred to as "Property & Casualty" and "P&C". All other continuing activities, primarily the financing of our business activities, are collectively referred to as "Corporate." The discontinued life insurance, group stop-loss medical insurance and asset management businesses are referred to as "Discontinued Operations", "Life & Investments" and "L&I". On March 15, 2004, we entered into definitive agreements to sell substantially all our L&I operations. On April 8, 2004, we entered into an agreement for the sale of the remaining part of our L&I operations and accordingly we have presented L&I as a Discontinued Operation in these Consolidated Financial Statements in accordance with Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards (SFAS) 144, "Accounting for the Impairment or Disposal of Long-Lived Assets". Prior-year amounts have been restated to reflect the presentation of Discontinued Operations. Basis of Consolidation and Reporting and Use of Estimates We prepared the unaudited Consolidated Financial Statements in conformity with accounting principles generally accepted in the United States (GAAP) for interim financial information and with the instructions to Form 10-Q. Certain financial information, which is required in the annual financial statements prepared in conformity with GAAP, may not be required for interim financial reporting purposes and has been condensed or omitted. In the opinion of management, all adjustments (consisting of normal and recurring adjustments) considered necessary for a fair presentation of results for the interim periods have been included. Results for the three-month period ended March 31, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004. These unaudited Consolidated Financial Statements and condensed notes should be read in conjunction with the Consolidated Financial Statements and notes included in our 2003 Annual Report on Form 10-K that was previously filed with the Securities and Exchange Commission. The preparation of these interim Consolidated Financial Statements in conformity with GAAP requires us to make estimates and assumptions that may affect amounts reported in these Consolidated Financial Statements and accompanying notes. Actual results could differ from those estimates. The unaudited Consolidated Financial Statements include Safeco Corporation and its subsidiaries. All significant intercompany transactions and balances have been eliminated in the Consolidated Financial Statements. We have made certain reclassifications to the prior-year amounts to conform to the current-year presentation. Earnings per Share We calculate basic earnings per share by dividing net income by the weighted-average number of common shares outstanding during the quarter. Diluted earnings per share reflect the potential dilution that could occur if options or other dilutive instruments granted under our stock-based compensation plans were exercised. We present the computation of net income per share below, based upon weighted-average common and dilutive shares outstanding: THREE MONTHS ENDED MARCH 31 2004 2003 - ------------------------------------------------------------------------------------------------------------- Net Income $ 236.2 $ 90.0 Average Number of Common Shares Outstanding 138.9 138.3 ------------------------------- Basic Net Income Per Share $ 1.70 $ 0.65 - ------------------------------------------------------------------------------------------------------------- Net Income $ 236.2 $ 90.0 Average Number of Common Shares Outstanding 138.9 138.3 Additional Common Shares Assumed Issued Under Treasury Stock Method 1.1 0.4 ------------------------------- Average Number of Common Shares Outstanding - Diluted 140.0 138.7 ------------------------------- Diluted Net Income Per Share $ 1.69 $ 0.65 - -------------------------------------------------------------------------------------------------------------
Stock Compensation Expense Prior to 2003, we applied Accounting Principles Board (APB) Opinion 25 in accounting for our stock options, as allowed under SFAS 123, "Accounting for Stock-Based Compensation," as amended. Under APB 25, we recognized no compensation expense related to options because the exercise price of our employee stock options equaled the fair market value of the underlying stock on the date of grant. In December 2002, the FASB issued SFAS 148, "Accounting for Stock-Based Compensation - Transition and Disclosure," amending SFAS 123, to provide alternative methods of transition to the fair value method of accounting for stock-based employee compensation under SFAS 123. Effective January 1, 2003, we adopted the fair value method for accounting for stock options as defined in SFAS 123, using the prospective basis transition method. Under this method, we have recognized stock-based compensation expense for options granted, modified or settled after January 1, 2003. No stock options were granted in the first quarter of 2003. Stock-based compensation expense was $2.8 ($1.5 after tax) for the three months ended March 31, 2004. The following table illustrates the pro forma effect on net income and net income per share as if the fair value method had been applied to all outstanding and unvested awards in each period: THREE MONTHS ENDED MARCH 31 2004 2003 - -------------------------------------------------------------------------------------------------------------- Net Income, as reported $ 236.2 $ 90.0 Add: Stock-based Compensation Expense Included in Reported Net Income, After Tax 1.5 -- Deduct: Pro Forma Stock-based Compensation Expense* (2.6) (1.9) ----------------------------- Pro Forma Net Income $ 235.1 $ 88.1 ----------------------------- Net Income Per Share Basic - as Reported $ 1.70 $ 0.65 Diluted - as Reported $ 1.69 $ 0.65 Basic - Pro Forma $ 1.69 $ 0.64 Diluted - Pro Forma $ 1.68 $ 0.64 - -------------------------------------------------------------------------------------------------------------- * Determined under fair value based method for all awards, net of related tax effects.
Cash Balance Plan The Safeco Cash Balance Plan (CBP) is a noncontributory defined benefit plan that provides benefits for each year of service after 1988, based on each eligible participant's compensation plus a stipulated rate of return on their benefit balance. We make contributions to the CBP based on funding requirements set by the Employee Retirement Income Security Act (ERISA). Our annual contribution for 2004 was made in the first quarter and totaled $12.9. Other Postretirement Benefits We also provide certain healthcare and life insurance benefits, Other Postretirement Benefits (OPRB), for certain retired employees, their beneficiaries and eligible dependents. We contributed $1.3 in the first quarter and expect to contribute a total of $5.2 to the OPRB program in 2004. We amended our OPRB program in the third quarter of 2003. The amendments created negative prior service cost which will be amortized over the average remaining service period all active participants. The related amortization resulted in a credit to OPRB expense of $2.6 pretax for the three months ended March 31, 2004. The following table summarizes CBP and OPRB costs charged (credited) to income: CBP OPRB ---------------------------------------------------------------- THREE MONTHS ENDED MARCH 31 2004 2003 2004 2003 - ------------------------------------------ --------------- -------------- -------------- --------------- Service Cost $ 3.4 $ 2.4 $ 0.1 $ 1.3 Interest Cost 2.4 2.1 0.9 2.3 Expected Return on Plan Assets (2.8) (1.9) -- -- Amortization of Prior Service Cost and Unrecognized Net Actuarial (Gain) Loss 0.1 0.4 (2.6) 0.4 - ------------------------------------------ --------------- -------------- -------------- --------------- Total $ 3.1 $ 3.0 $ (1.6) $ 4.0 - ------------------------------------------ --------------- -------------- -------------- ---------------
New Accounting Standards American Institute of Certified Public Accountants (AICPA) Statement of Position (SOP) 03-1, "Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts" The provisions of SOP 03-1 are effective for fiscal years beginning after December 15, 2003. SOP 03-1 provides guidance in three areas: separate account presentation and valuation; the accounting recognition given sales inducements; and the classification and valuation of long-duration contract liabilities. Our Discontinued Operations adopted SOP 03-1 effective January 1, 2004, with no material impact on our Consolidated Financial Statements. FASB Exposure Draft, "Share-Based Payment" On March 31, 2004, the FASB issued its Exposure Draft, "Share-Based Payment", which is a proposed amendment to SFAS 123. The proposed statement would require all share-based compensation awards granted, modified or settled after December 15, 1994 to be accounted for using the fair value method of accounting on a prospective basis. As discussed above, we adopted the fair value method of accounting for share-based awards effective January 1, 2003. Based on the current amount of remaining unvested, and previously unaccounted for, share-based awards issued since December 15, 1994, we do not believe that adoption of the statement in its current form would have a material impact on our financial condition or results of operations. The FASB expects to issue a final statement late in 2004 that would be effective for public companies for fiscal years beginning after December 15, 2004. NOTE 2 - INVESTMENTS FIXED MATURITIES AND MARKETABLE EQUITY SECURITIES The following tables summarize our fixed maturities and marketable equity securities: COST OR GROSS GROSS NET AMORTIZED UNREALIZED UNREALIZED UNREALIZED MARCH 31, 2004 COST GAINS LOSSES GAINS FAIR VALUE - ------------------------------- ----------------------------------------------------------------------------- Fixed Maturities: U.S. Government and Agencies $ 936.5 $ 66.3 $ (0.1) $ 66.2 $ 1,002.7 State and Political Subdivisions 2,215.2 172.8 (1.9) 170.9 2,386.1 Foreign Governments 78.3 4.0 -- 4.0 82.3 Corporate Securities 3,466.0 226.7 (5.4) 221.3 3,687.3 Mortgage-Backed Securities 1,101.0 52.9 (0.6) 52.3 1,153.3 - ------------------------------- ----------------------------------------------------------------------------- Total Fixed Maturities 7,797.0 522.7 (8.0) 514.7 8,311.7 Marketable Equity Securities 653.9 483.9 (3.0) 480.9 1,134.8 - ------------------------------- ----------------------------------------------------------------------------- Total - Continuing Operations $ 8,450.9 $ 1,006.6 $ (11.0) $ 995.6 $ 9,446.5 - ------------------------------- ----------------------------------------------------------------------------- Fixed Maturities - Discontinued Operations $ 16,671.8 $ 1,856.5 $ -- $ 1,856.5 $ 18,528.3 Marketable Equity Securities Discontinued Operations 96.3 16.5 -- 16.5 112.8 - ------------------------------- --------------- -------------- -------------- --------------- -------------- Total - Discontinued $ 16,768.1 $ 1,873.0 $ -- $ 1,873.0 $ 18,641.1 Operations - ------------------------------- ----------------------------------------------------------------------------- COST OR GROSS GROSS NET AMORTIZED UNREALIZED UNREALIZED UNREALIZED DECEMBER 31, 2004 COST GAINS LOSSES GAINS FAIR VALUE - ------------------------------- ----------------------------------------------------------------------------- U.S. Government and Agencies $ 964.6 $ 53.3 $ (0.5) $ 52.8 $ 1,017.4 Fixed Maturities: State and Political Subdivisions 2,219.6 164.9 (3.4) 161.5 2,381.1 Foreign Governments 41.8 3.7 -- 3.7 45.5 Corporate Securities 3,403.3 193.5 (9.8) 183.7 3,587.0 Mortgage-Backed Securities 1,087.9 43.6 (3.3) 40.3 1,128.2 - ------------------------------------------------------------------------------------------------------------------ Total Fixed Maturities 7,717.2 459.0 (17.0) 442.0 8,159.2 Marketable Equity Securities 684.8 484.1 (2.7) 481.4 1,166.2 - ------------------------------------------------------------------------------------------------------------------ Total - Continuing Operations $ 8,402.0 $ 943.1 $ (19.7) $ 923.4 $ 9,325.4 - ------------------------------------------------------------------------------------------------------------------ Fixed Maturities - Discontinued Operations $ 16,573.0 $ 1,474.3 $ -- $ 1,474.3 $ 18,047.3 Marketable Equity Securities- Discontinued Operations 96.9 15.9 -- 15.9 112.8 - ------------------------------------------------------------------------------------------------------------------ Total - Discontinued Operations $ 16,669.9 $ 1,490.2 $ -- $ 1,490.2 $ 18,160.1 - ------------------------------------------------------------------------------------------------------------------
We have recorded an impairment charge for all securities held by L&I with unrealized losses at March 31, 2004 and December 31, 2003 because we do not expect them to recover in value before the sale of the L&I businesses is completed. The following table shows our investment gross unrealized losses and fair values, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at March 31, 2004: LESS THAN 12 MONTHS 12 MONTHS OR MORE TOTAL ------------------------- ------------------------- ------------------------ DESCRIPTION OF SECURITIES FAIR UNREALIZED FAIR UNREALIZED FAIR UNREALIZED VALUE LOSSES VALUE LOSSES VALUE LOSSES - --------------------------- ---------- -------------- -- ---------- -------------- -- ----------- ------------ Fixed Maturities: U.S. Government and Agencies $ 40.0 $ (0.1) $ -- $ -- $ 40.0 $ (0.1) State and Political Subdivisions 67.9 (0.9) 9.5 (1.0) 77.4 (1.9) Corporate Securities 100.3 (1.3) 36.7 (4.1) 137.0 (5.4) Mortgaged-Backed Securities 45.7 (0.3) 4.2 (0.3) 49.9 (0.6) - --------------------------- ---------- -------------- -- ---------- -------------- -- ----------- ------------ Total Fixed Maturities 253.9 (2.6) 50.4 (5.4) 304.3 (8.0) Marketable Equity Securities 39.8 (3.0) -- -- 39.8 (3.0) - --------------------------- ---------- -------------- -- ---------- -------------- -- ----------- ------------ Total - Continuing Operations $ 293.7 $ (5.6) $ 50.4 $ (5.4) $ 344.1 $ (11.0) - --------------------------- ---------- -------------- -- ---------- -------------- -- ----------- ------------
We reviewed all our investments with unrealized losses at March 31, 2004 in accordance with our impairment policy. Our evaluation concluded that these declines in fair value were temporary after considering: o For securities in an unrealized loss position for less than 12 months, the volatility of each security's market price and the length of time the security has been in an unrealized loss position o For securities in an unrealized loss position for 12 months or more, the number of securities that were in an unrealized loss position and the extent to which each security was in an unrealized loss position FIXED MATURITIES BY MATURITY DATE The following table summarizes the cost or amortized cost and fair value of our Continuing Operations fixed maturities at March 31, 2004, by contractual years-to-maturity. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without prepayment penalties: COST OR MATURITY AMORTIZED COST FAIR VALUE - -------------------------------------------------------------- ---------------------------- --------------------- One Year or Less $ 652.8 $ 666.5 Over One Year through Five Years 3,280.8 3,478.7 Over Five Years through Ten Years 872.1 938.2 Over Ten Years 1,890.3 2,075.0 Mortgage-Backed Securities 1,101.0 1,153.3 - -------------------------------------------------------------- ---------------------------- --------------------- Total Fixed Maturities - Continuing Operations $ 7,797.0 $ 8,311.7 - -------------------------------------------------------------- ---------------------------- ---------------------
The carrying value of securities on deposit with state regulatory authorities was $339.5 at March 31, 2004 and $399.9 at December 31, 2003 for our Continuing Operations. The carrying value of securities on deposit with state regulatory authorities for our Discontinued Operations was $11.0 at March 31, 2004 and $11.0 at December 31, 2003. NOTE 3 - DERIVATIVE FINANCIAL INSTRUMENTS Derivatives are instruments whose values are derived from underlying instruments, indices or rates, have notional amounts and can be net settled. This may include derivatives that are "embedded" in other derivative instruments or in certain existing assets or liabilities. We use derivative financial instruments, including interest rate swaps, options and financial futures, as a means of hedging exposure to equity price changes and/or interest rate risk on anticipated transactions or on existing assets and liabilities. Interest rate risk is the risk of economic losses due to changes in the level of interest rates. We manage interest rate risk through active portfolio management and selective use of interest rate swaps as hedges to change the characteristics of certain assets and liabilities. With interest rate swap agreements, we exchange with a counterparty, at specified intervals, interest rate payments of differing character (for example, fixed-rate payments exchanged for variable-rate payments), based on an underlying principal balance (notional amount). No cash is exchanged at the outset of the contract and no principal payments are made by either party. The net interest accrued and the net interest payments made at each interest payment due date are recorded to interest income or expense, depending on the hedged item. Continuing Operations FAIR VALUE HEDGES We use interest rate swaps to hedge the change in fair value of certain fixed-rate debt. At March 31, 2004 we had $575.0 of notional amounts outstanding relating to such hedges. These derivatives have been designated as fair value hedges and, because they have been determined to be highly effective, changes in their fair value and the related portions of the debt that they hedge are recognized on a net basis in Net Realized Investment Gains in the Consolidated Statements of Income. In January 2003, we discontinued $300.0 notional of interest rate swaps as the underlying medium-term notes were repaid. There were no significant fair value hedges discontinued during the first quarter of 2004. Differences between the changes in fair value of these derivatives and the hedged items represent hedge ineffectiveness. In the three months ended March 31, 2004 and 2003, no amounts were recognized in earnings due to hedge ineffectiveness. OTHER DERIVATIVES Safeco Financial Products (SFP), our wholly owned subsidiary, engaged in limited derivatives activity by selling single-name credit default swaps, writing and hedging S&P 500 index options and investing in and hedging convertible bonds. All these derivative positions were terminated prior to December 31, 2003. These SFP activities were not designated for hedge accounting treatment under SFAS 133. Changes in the fair values of these instruments were recognized in Net Realized Investment Gains in the Consolidated Statements of Income. The fee income on the credit default swaps and the earnings and fair value adjustments for the S&P 500 index options and the convertible bonds were included in Net Investment Income in the Consolidated Statements of Income. Pretax income (loss) before net realized investment gains for SFP was $(0.4), and $2.1 for the three months ended March 31, 2004 and 2003. Net realized investment gains before tax for SFP were $9.0 for the three months ended March 31, 2003 and there were no gains or losses in the three months ended March 31, 2004. Discontinued Operations FAIR VALUE HEDGES Our Discontinued Operations use interest rate swaps to offset the change in fair value of certain fixed rate assets. At March 31, 2004 we had $317.1 of notional amounts outstanding relating to such hedges. There was no hedge ineffectiveness recognized related to these fair value hedges in the three months ended March 31, 2004 and 2003. CASH FLOW HEDGES We also use interest rate swaps to hedge the variability of future cash flows arising from changes in interest rates associated with certain variable rate assets and forecasted transactions. At March 31, 2004, we had $404.4 of notional amounts outstanding relating to such hedges. These derivatives have been designated as cash flow hedges and, because they have been determined to be highly effective, we recognize the changes in fair value of the derivatives as a component of Other Comprehensive Income (OCI), net of deferred income taxes, until the hedged transaction affects current earnings. At the time current earnings are affected by the variability of cash flows due to interest rate changes, the related portion of deferred gains or losses on cash flow hedge derivatives are reclassified from OCI and recorded in the Consolidated Statements of Income. Amounts recorded in OCI related to derivatives qualifying as cash flow hedges resulted in an increase of $7.3 after tax for the three months ended March 31, 2004 and an increase of $2.1 after tax for the same period in 2003. The interest rate swaps related to forecasted transactions that are considered probable of occurring are considered to be highly effective and qualify for hedge treatment under SFAS 133. SFAS 133 requires that amounts deferred in OCI be reclassified into earnings either when the forecasted transaction occurs, or when it is considered not probable of occurring - whichever happens sooner. In the three months ended March 31, 2004, $3.6 after tax was reclassified from OCI to Income from Discontinued Operations relating to forecasted transactions that were considered no longer probable of occurring. No such amounts were reclassified from OCI in the three months ended March 31, 2003. At March 31, 2004, the maximum length of time over which we were hedging our exposure to future cash flows for forecasted transactions was approximately 27 months. Differences between the changes in fair value of cash flow hedges and the hedged items represent hedge ineffectiveness and are recognized in interest expense. In 2003, no amounts were recognized in earnings due to hedge ineffectiveness. OTHER DERIVATIVES In 1997, L&I introduced its Equity Indexed Annuity (EIA) product that credits the policyholder based on a percentage of the gain in the S&P 500 Index. Sales of the EIA product were suspended in the fourth quarter of 1998. In connection with this product, Safeco has a hedging program with the objective to hedge the exposure to changes in the S&P 500 Index by purchasing S&P 500 index options. As permitted under a grandfathering clause in SFAS 133, we elected not to apply the fair value adjustment requirement of this statement to the embedded derivatives contained in the liability related to EIA products sold prior to January 1, 1999. The change in fair value of the options, as well as any gains or losses when they expire or terminate, are recognized as an adjustment to results of Discontinued Operations in the Consolidated Statements of Income. We did not recognize any adjustments for the three months ended March 31, 2004 and 2003. NOTE 4 - INCOME TAXES We use the liability method of accounting for income taxes in accordance with SFAS 109, "Accounting for Income Taxes," under which deferred income tax assets and liabilities are determined based on the differences between their financial reporting and their tax bases and are measured using the enacted tax rates. Differences between income taxes computed by applying the U.S. federal income tax rate of 35% to Income from Continuing Operations and Discontinued Operations before Income Taxes and the consolidated provision (benefit) for income taxes were as follows: THREE MONTHS ENDED MARCH 31 2004 2003 - ----------------------------------------------------------------------------------------------------------- CONTINUING DISCONTINUED CONTINUING DISCONTINUED OPERATIONS OPERATIONS OPERATIONS OPERATIONS - ----------------------------------------------------------------------------------------------------------- Income before Income Taxes $ 259.5 $ 77.5 $ 106.6 $ 16.8 - ----------------------------------------------------------------------------------------------------------- Computed "Expected" Tax Expense 90.8 27.1 37.3 5.9 Tax-Exempt Municipal Bond Income (9.1) -- (9.2) -- Dividends Received Deduction (2.4) (0.8) (1.4) (0.8) Other (5.4) 0.6 0.4 1.2 - ----------------------------------------------------------------------------------------------------------- Consolidated Provision for Income Taxes 73.9 26.9 27.1 6.3 - ----------------------------------------------------------------------------------------------------------- Current Provision (Benefit) for Income 25.4 Taxes 35.6 3.7 (3.1) Deferred Provision for Income Taxes 38.3 23.2 30.2 (19.1) - ----------------------------------------------------------------------------------------------------------- Consolidated Provision for Income Taxes $ 73.9 $ 26.9 $ 27.1 $ 6.3 - ----------------------------------------------------------------------------------------------------------- The tax effects of temporary differences that give rise to the deferred income tax assets and deferred income tax liabilities at March 31, 2004 and December 31, 2003 were as follows: MARCH 31, 2004 DECEMBER 31, 2003 - ------------------------------------------------------------------------------------------------------------ CONTINUING DISCONTINUED CONTINUING DISCONTINUED OPERATIONS OPERATIONS OPERATIONS OPERATIONS - ------------------------------------------------------------------------------------------------------------ Deferred Income Tax Assets Goodwill $ 180.8 $ 14.5 $ 185.9 $ 14.9 Discounting of Loss and LAE Reserves for Tax Purposes 207.7 -- 211.4 -- Unearned Premium Liability 160.5 -- 159.0 -- Investment Impairments 20.9 92.8 26.2 99.4 Postretirement Benefits 40.9 3.8 42.1 4.0 Alternative Minimum Tax Carryforwards 57.6 -- 62.4 -- Net Operating Loss Carryforwards -- -- 23.5 -- Adjustment to Life Policy Liabilities -- 80.1 -- 96.7 Capitalization of Life Policy Acquisition Costs -- 73.8 -- 76.1 Other 65.3 24.1 63.8 25.6 - ------------------------------------------------------------------------------------------------------------ Total Deferred Income Tax Assets 733.7 289.1 774.3 316.7 - ------------------------------------------------------------------------------------------------------------ Unrealized Appreciation of Investment Securities, Derivative Financial Instruments, Deferred Policy Acquisition Cost Valuation Allowance, Minimum Pension Liability and Foreign Currency Adjustment 345.1 618.0 314.2 497.2 Deferred Policy Acquisition Costs 126.5 128.3 124.9 129.6 Other 57.7 53.2 60.9 56.6 - ------------------------------------------------------------------------------------------------------------ Total Deferred Income Tax Liabilities 529.3 799.5 500.0 683.4 - ------------------------------------------------------------------------------------------------------------ Net Deferred Income Tax Asset $ 204.4 $ (510.4) $ 274.3 $ (366.7) (Liability) - ------------------------------------------------------------------------------------------------------------ NOTE 5 - LONG-TERM DEBT The following table shows the total principal amount of our long-term debt, interest rates and maturities of debt. No debt is classified as current at March 31, 2004 and December 31, 2003. MARCH 31, 2004 DECEMBER 31, 2003 - ------------------------------------------------------------------------------------------------------------- 6.875% Notes Due 2007 $ 200.0 $ 200.0 4.200% Notes Due 2008 200.0 200.0 4.875% Notes Due 2010 300.0 300.0 7.250% Notes Due 2012 375.0 375.0 8.072% Debentures Due 2037 876.3 876.3 - ------------------------------------------------------------------------------------------------------------- Total Debt $ 1,951.3 $ 1,951.3 - -------------------------------------------------------------------------------------------------------------
We maintain a bank credit facility with $500.0 available through September 2005. After the sale of L&I is completed, we may lower the bank credit facility and we expect to reset the amount of the requirement to maintain a minimum level of shareholders' equity. NOTE 6 - RESTRUCTURING CHARGES We have identified expense reductions across the company that will enable us to better compete in property and casualty insurance markets. In September 2003, we announced that we would eliminate approximately 500 jobs and as of March 31, 2004, all such jobs had been eliminated. Positions impacted are primarily in our corporate departments. We expect this initiative to reduce our 2004 operating expenses by approximately $75.0. For the three months ended March 31, 2004, period costs associated with the restructuring totaled $1.3. These period costs represented one-time termination benefits. Charges have been recognized and accrued as a restructuring charge and allocated to our reportable segments in accordance with SFAS 146, "Accounting for Costs Associated with Exit or Disposal Activities". Other charges that do not meet the criteria for accrual will be expensed as restructuring charges when incurred. Estimated and actual costs associated with the restructuring are as follows: THREE MONTHS TOTAL ENDED EXPECTED COSTS 2003 MARCH 31, 2004 - ---------------------------------------------------------------------------------------------------- One-Time Termination Benefits $ 9.7 $ 8.2 $ 1.3 Lease Termination Costs and Other Costs 3.2 1.0 -- - ---------------------------------------------------------------------------------------------------- Total $ 12.9 $ 9.2 $ 1.3 - ----------------------------------------------------------------------------------------------------
Estimated costs associated with the restructuring to reduce our expenses are allocated to our reportable segments in our Continuing Operations as follows: THREE MONTHS TOTAL ENDED EXPECTED COSTS 2003 MARCH 31, 2004 - ---------------------------------------------------------------------------------------------------- Safeco Personal Insurance (SPI) Auto $ 5.5 $ 3.8 $ 0.6 Property 2.2 1.6 0.2 Specialty 0.2 0.1 -- - ---------------------------------------------------------------------------------------------------- Total SPI 7.9 5.5 0.8 - ---------------------------------------------------------------------------------------------------- Safeco Business Insurance (SBI) SBI Regular 2.7 1.9 0.3 SBI Special Accounts Facility 0.9 0.6 0.1 - ---------------------------------------------------------------------------------------------------- Total SBI 3.6 2.5 0.4 - ---------------------------------------------------------------------------------------------------- Surety 0.4 0.3 0.1 P&C Other 0.1 0.0 -- - ---------------------------------------------------------------------------------------------------- Total P&C 12.0 8.3 1.3 Corporate 0.9 0.9 -- - ---------------------------------------------------------------------------------------------------- Total $ 12.9 $ 9.2 $ 1.3 - ---------------------------------------------------------------------------------------------------- The activity related to previously accrued restructuring charges as of March 31, 2004 was as follows: BALANCE AT BALANCE AT DECEMBER 31 COSTS AMOUNTS MARCH 31 2003 ACCRUED PAID 2004 - ----------------------------- ------------------- ---------------- --------------- ------------------- Severance Costs $ 0.2 $ -- $ 0.2 $ -- Lease Terminations and Other Costs 0.7 -- 0.7 -- - ----------------------------- ------------------- ---------------- --------------- ------------------- Total $ 0.9 $ -- $ 0.9 $ -- - ----------------------------- ------------------- ---------------- --------------- -------------------
NOTE 7 - COMPREHENSIVE INCOME Comprehensive income is defined as all changes in shareholders' equity, except those arising from transactions with shareholders. Comprehensive income includes net income and other comprehensive income, which for us consists of changes in unrealized gains or losses on investments carried at fair market value, changes in foreign currency translation gains or losses, deferred policy acquisition costs valuation allowance, derivatives and minimum pension liability. The components of accumulated other comprehensive income or losses were as follows: THREE MONTHS ENDED 2004 2003 MARCH 31 - ---------------------------------------------------------------------------------------------------------- PRETAX TAXES AFTER TAX PRETAX TAXES AFTER TAX ----------------------------------------------------------------------------- Change in Unrealized Gains and Losses of Available-for-Sale Securities $ 396.3 $ (138.6) $ 257.7 $ 33.6 $ (11.8) $ 21.8 Reclassification adjustment for Net Realized Investment (Gains)Losses included in Net Income 59.1 (20.7) 38.4 49.9 (17.5) 32.4 Derivatives Qualifying as Cash Flow Hedges - Net Changes in Fair Value 11.3 (4.0) 7.3 3.2 (1.1) 2.1 Deferred Policy Acquisition Costs Valuation Allowance (32.4) 11.3 (21.1) 2.5 (0.9) 1.6 Foreign Currency Translation Adjustments (1.6) 0.6 (1.0) 8.9 (3.1) 5.8 ----------------------------------------------------------------------------- Other Comprehensive Income $ 432.7 $ (151.4) $ 281.3 $ 98.1 $ (34.4) $ 63.7 - ----------------------------------------------------------------------------------------------------------
NOTE 8 - SEGMENT INFORMATION Continuing Operations On January 1, 2004, we made minor revisions to our P&C segments that better reflect how these segments are managed. Our non-voluntary auto and property results, previously in P&C Other, are now included in SPI Auto and SPI Property. Certain products, previously reported in SPI Specialty, primarily earthquake, inland marine and dwelling fire, are now included in SPI Property. Our commercial specialty programs and large commercial accounts in runoff, previously in SBI Runoff, are now included in P&C Other. Prior-period amounts have been restated to reflect the revised presentation of P&C segments. P&C Our P&C Insurance operations are organized around our four business segments: Safeco Personal Insurance (SPI), Safeco Business Insurance (SBI), Surety and P&C Other. These operations contain our reportable segments, which are managed separately as described below. SAFECO PERSONAL INSURANCE SPI offers auto, homeowners and other specialty insurance products for individuals, and the SPI operations are organized around three reportable segments - Auto, Property and Specialty - which are managed separately by these product groupings. The Auto segment provides coverage for liability of our customers to others for both bodily injury and property damage, for injuries sustained by our customers and for physical damage to our customers' vehicles from collision and other hazards. The Property segment provides homeowners, earthquake, dwelling fire and inland marine coverage for individuals. Our Property coverages protect homes, condominiums and rental property contents against losses from a wide variety of hazards. We also protect individuals from liability for accidents that occur on their property. The Specialty segment provides umbrella, recreational vehicle, motorcycle and boat insurance coverage for individuals. SAFECO BUSINESS INSURANCE SBI offers business owner policies, multi-peril packages, property, general liability, commercial auto and workers compensation. SBI's operations are organized around two segments: SBI Regular and SBI Special Accounts Facility, which are managed separately based on the nature of the underlying insured. SBI Regular is our core commercial segment writing a variety of commercial insurance products for small- to medium-sized businesses (customers who pay annual written premiums of $100,000 or less). Our principal business insurance products include business owner policies, commercial auto, commercial multi-peril, workers compensation, property and general liability. SBI Special Accounts Facility writes larger commercial accounts for our key agents who sell our core P&C products as well as our four specialty commercial programs, which are lender-placed property insurance, agents' errors and omissions insurance, mini-storage and warehouse properties and non-profit social services organizations. SURETY We offer surety bonds primarily for construction, performance and legal matters that include appeals, probate and bankruptcies. P&C OTHER P&C Other includes large commercial business accounts, commercial specialty programs and London operations that are in runoff and certain product lines that we have exited. P&C RESULTS Our management measures segment profit or loss for P&C based upon underwriting results. Underwriting results (profit or loss) represents the net amount of earned premium less underwriting losses and expenses on a pretax basis. Management views underwriting profit or loss as a critical measure to assess underwriting effectiveness and to evaluate the results of the P&C operations. Underwriting results are not a substitute for net income determined in accordance with GAAP. CORPORATE In addition to these operating segments, certain activities are reported in the Corporate segment and not allocated to individual segments. The Corporate segment includes operating results for the parent company, which includes interest expense for our debt; SFP, which was engaged in limited derivative activity until its operations were wound down in December 2003; intercompany eliminations and other corporate activities. Discontinued Operations L&I The Discontinued Operations include results of our L&I businesses. See Note 9 for more information. In reporting L&I as a discontinued operation, general corporate overhead expenses are no longer allocated to L&I. Previously allocated expenses of $3.0 in the first quarter of 2003 have been eliminated from the L&I operations. Prior-period amounts have been restated to reflect the presentation of L&I as a Discontinued Operation. The following tables present selected financial information by segment for our Continuing Operations and reconcile segment revenues and underwriting results to amounts reported in the Consolidated Statements of Income. REVENUES THREE MONTHS ENDED MARCH 31 2004 2003 - --------------------------------------------------------------------------------------------------------- PROPERTY & CASUALTY Safeco Personal Insurance (SPI) Auto $ 620.1 $ 522.1 Property 228.2 227.5 Specialty 21.2 19.7 ---------------------------------- Total SPI 869.5 769.3 ---------------------------------- Safeco Business Insurance (SBI) SBI Regular 302.4 266.0 SBI Special Accounts Facility 116.7 87.9 ---------------------------------- Total SBI 419.1 353.9 ---------------------------------- Surety 45.4 32.1 P&C Other 6.5 7.8 ---------------------------------- Total Property & Casualty Earned Premiums 1,340.5 1,163.1 P&C Net Investment Income 111.7 112.8 ---------------------------------- Total Property & Casualty Revenues (excluding Net Realized Investment Gains) 1,452.2 1,275.9 ---------------------------------- CORPORATE 3.3 9.4 Net Realized Investment Gains 42.8 8.2 ---------------------------------- TOTAL REVENUES $ 1,498.3 $ 1,293.5 - --------------------------------------------------------------------------------------------------------- PRETAX UNDERWRITING PROFITS (LOSSES) AND NET INCOME THREE MONTHS ENDED MARCH 31 2004 2003 - --------------------------------------------------------------------------------------------------------- PROPERTY & CASUALTY Underwriting Profits (Losses) Safeco Personal Insurance (SPI) Auto $ 23.1 $ (6.6) Property 61.4 28.0 Specialty 6.4 5.3 ---------------------------------- Total SPI 90.9 26.7 ---------------------------------- Safeco Business Insurance (SBI) SBI Regular 23.8 (5.3) SBI Special Accounts Facility 18.5 6.4 ---------------------------------- Total SBI 42.3 1.1 ---------------------------------- Surety 9.3 3.7 P&C Other (7.1) (10.5) ---------------------------------- Total Pretax Underwriting Profit 135.4 21.0 P&C Net Investment Income 111.7 112.8 Restructuring Charges (1.3) -- ---------------------------------- Total Property & Casualty 245.8 133.8 ---------------------------------- CORPORATE (29.1) (35.4) Net Realized Investment Gains before Taxes 42.8 8.2 ---------------------------------- Income from Continuing Operations before Income Taxes 259.5 106.6 Provision for Income Taxes 73.9 27.1 ---------------------------------- Income from Continuing Operations 185.6 79.5 Income from Discontinued Operations, Net of Tax 50.6 10.5 ---------------------------------- NET INCOME $ 236.2 $ 90.0 - --------------------------------------------------------------------------------------------------------- ASSETS MARCH 31 DECEMBER 31 2004 2003 - --------------------------------------------------------------------------------------------------------- PROPERTY & CASUALTY Safeco Personal Insurance (SPI) Auto $ 3,923.5 $ 3,683.0 Property 2,212.9 2,199.8 Specialty 199.5 189.0 ---------------------------------- Total SPI 6,335.9 6,071.8 ---------------------------------- Safeco Business Insurance (SBI) SBI Regular 3,342.8 3,235.6 SBI Special Accounts Facility 779.8 722.1 ---------------------------------- Total SBI 4,122.6 3,957.7 ---------------------------------- Surety 432.2 385.6 P&C Other 2,368.2 2,490.3 ---------------------------------- TOTAL PROPERTY & CASUALTY 13,258.9 12,905.4 ---------------------------------- CORPORATE 548.5 693.1 DISCONTINUED OPERATIONS 23,108.3 22,548.9 ---------------------------------- TOTAL ASSETS $ 36,915.7 $ 36,147.4 - ---------------------------------------------------------------------------------------------------------
NOTE 9 - DISCONTINUED OPERATIONS On March 15, 2004, we entered into a definitive agreement to sell our life insurance, group stop-loss medical insurance and asset management operations to a group of investors led by White Mountains Insurance Group, Ltd., and Berkshire Hathaway Inc. The purchase price is $1,350.0 and could include a minor adjustment to proceeds based on June 30, 2004 statutory book value. In a separate transaction, we entered into a definitive agreement to sell Talbot Financial Corporation (Talbot), our insurance brokerage operation for $90.0 to an investor group led by senior management of Talbot, with financial support from Hub International Limited. We expect both transactions to close by September 30, 2004. The life insurance, group stop-loss medical insurance and asset management operations transaction is subject to regulatory approvals and other customary closing conditions. We anticipate a net loss on these sale transactions of approximately $200.0 after tax. On April 8, 2004, we entered into a definitive agreement to sell Safeco Trust Company to Mellon Trust of Washington, and on April 19, 2004, this transaction was completed. The enterprises included in these transactions represent all of the business and earnings generated by the L&I segments. We have presented L&I as a Discontinued Operation, as we have met all of the "held-for-sale" criteria under SFAS 144. In reporting L&I as a discontinued operation, general corporate overhead expenses are no longer allocated to L&I. Previously allocated expenses of $3.0 in the first quarter of 2003 have been eliminated from the L&I Other segment and included in our Corporate segment. Results of Operations for our Discontinued Operations were as follows: THREE MONTHS ENDED MARCH 31 2004 2003 - ----------------------------------------------------------------------------------------------------------- REVENUES Premiums and Other Revenues $ 216.5 $ 223.9 Net Investment Income 303.2 303.5 Net Realized Investment Gains (Losses) 16.2 (58.1) -------------------------------- Total Revenues 535.9 469.3 EXPENSES Policy Benefits 338.2 343.0 Other Operating Expenses 120.2 109.5 -------------------------------- Total Expenses 458.4 452.5 -------------------------------- Income from Discontinued Operations before Income Taxes 77.5 16.8 Provision for Income Taxes on Discontinued Operations 26.9 6.3 -------------------------------- Income from Discontinued Operations, Net of Taxes $ 50.6 $ 10.5 - ----------------------------------------------------------------------------------------------------------- Assets and liabilities of our Discontinued Operations were as follows: MARCH 31 DECEMBER 31 2004 2003 - ----------------------------------------------------------------------------------------------------------- ASSETS Total Investments $ 19,746.2 $ 19,301.4 Other Assets 1,002.4 1,055.6 Separate Account Assets 1,164.7 1,137.4 Securities Lending Collateral 1,195.0 1,054.5 -------------------------------- Total Assets of Discontinued Operations 23,108.3 22,548.9 LIABILITIES Funds Held Under Deposit Contracts 16,577.4 16,582.4 Life Policy Liabilities 332.0 331.8 Accident and Health Reserves 134.4 139.1 Deferred Income Taxes Payable 510.4 366.7 Other Liabilities 308.8 330.8 Separate Account Liabilities 1,164.7 1,137.4 Securities Lending Collateral 1,195.0 1,054.5 -------------------------------- Total Liabilities of Discontinued Operations 20,222.7 19,942.7 -------------------------------- Net Assets of Discontinued Operations $ 2,885.6 $ 2,606.2 - -----------------------------------------------------------------------------------------------------------
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Dollar amounts in millions unless noted otherwise) This discussion should be read with the consolidated financial statements and related footnotes included elsewhere in this report. Forward-Looking Information Forward-looking information contained in this report is subject to risk and uncertainty. Information contained in this report that relates to anticipated financial performance, business prospects and plans, regulatory developments and similar matters are "forward-looking statements" as defined in the Private Securities Litigation Reform Act of 1995. Statements in this report that are not historical information are forward-looking. Our business is subject to certain risks and uncertainties that may cause actual results to differ materially from those suggested by the forward-looking statements in this report. The risks and uncertainties include, but are not limited to: o Risks related to the pricing and underwriting of our products, and the subsequent establishment of reserves, such as: - Successful implementation of a new-business entry model for personal and commercial lines - Our ability to appropriately price and reserve for changes in the mix of our book of business - Our ability to establish pricing for any changes in driving patterns - Inflationary pressures on medical care costs, auto parts and repair, construction costs and other economic sectors that increase the severity of claims - Our availability and pricing of our reinsurance, including coverage for loss from terrorism and our ability to collect from our reinsurers - Our ability to price for or exclude the risk of loss from terrorism on our policies o Risks related to our P&C insurance strategy such as: - Our ability to achieve premium targets and profitability, including realization of growth and business retention estimates - Our ability to achieve overall expense goals - Our ability to run off our London business and other businesses that we have exited or intend to exit in the future without incurring material unexpected charges o Regulatory, judicial and legislative risks such as: - Our ability to freely enter and exit lines of business - Our ability to successfully obtain regulatory approval of rates and underwriting guidelines, including price-tiered products and the use of insurance scores that include credit information as a component - Interpretation of insurance policy provisions by courts or tax authorities, court decisions regarding coverage and theories of liability, trends in litigation and changes in claims settlement practices - The outcome of any litigation against us - Legislative and regulatory developments affecting the actions of insurers, including requirements regarding rates, taxes and availability of coverage o The competitive pricing environment, initiatives by competitors and other changes in the competition o Unusual loss activity, such as: - Weather conditions, including the severity and frequency of storms, hurricanes, hail, snowfall and winter conditions - The occurrence of significant natural disasters, including earthquakes - The occurrence of significant man-made disasters, such as the attack on September 11, 2001, or war - The occurrence of bankruptcies that result in losses under surety bonds, investment losses or lower investment income o Our ability to successfully divest the L&I businesses o Financial and economic conditions such as: - Performance of financial markets - Availability of bank credit facilities - Fluctuations in interest rates - General economic conditions o Operational risks such as: - Damage to our infrastructure in a disruption of our operations - Internal or external fraud perpetrated against us Summary We are an insurance company with headquarters in Seattle, Washington. We sell insurance products through a national network of independent agents, brokers and financial advisors. Our business helps people protect what they value and deal with the unexpected. We earn revenue from insurance policy premiums and income on our invested assets. Our Property & Casualty (P&C) subsidiaries provide insurance for autos, homes and other personal property; insurance for small- and mid-sized businesses; and surety bonds. On March 15, 2004, we entered into two definitive agreements to sell substantially all our L&I operations to separate investor groups, and on April 8, 2004, we entered into a definitive agreement to sell the remaining operation. We have presented L&I as a Discontinued Operation in our Consolidated Financial Statements in accordance with Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards (SFAS) 144, "Accounting for the Impairment or Disposal of Long-Lived Assets". Prior-year amounts have been restated to reflect the presentation of Discontinued Operations. Reviewing Our Results of Operations HOW WE REPORT OUR RESULTS On January 1, 2004, we made minor revisions to our P&C segments. Our non-voluntary auto and property results, previously in P&C Other, are now included in SPI Auto and SPI Property. Certain products, previously reported in SPI Specialty, primarily earthquake, inland marine and dwelling fire, are now included in SPI Property. Our commercial specialty programs and large commercial accounts in runoff, previously SBI Runoff, are now included in P&C Other. Prior-period amounts have been restated to reflect the revised presentation of our P&C segments. We manage our P&C businesses in four business and seven reportable segments: o Safeco Personal Insurance (SPI) -- Auto -- Property -- Specialty o Safeco Business Insurance (SBI) -- SBI Regular -- SBI Special Accounts Facility o Surety o P&C Other As previously discussed, our L&I businesses are now reported as Discontinued Operations. We managed them in six reportable segments: o Group o Income Annuities o Retirement Services o Individual o Asset Management o L&I Other In addition to these segments, certain activities such as interest expense and intercompany eliminations are reported in Corporate and not allocated to individual segments. HOW WE MEASURE PROFITABILITY P&C -- We use three measures of our underwriting results to assess the profitability of our P&C businesses. These measures are net earned premiums, underwriting profit or loss and combined ratio. We include property and casualty insurance premiums in revenue as earned over the terms of the respective policies. We report the unearned premium as a liability on the Consolidated Balance Sheets before the effect of reinsurance. Underwriting profit or loss is our net earned premiums less our losses from claims, loss adjustment expenses (LAE) and underwriting expenses. Combined ratio is our losses, LAE and underwriting expenses divided by our net earned premiums. We report combined ratio as a percentage. For example, a combined ratio of 95% means that our losses, LAE and underwriting expenses equal 95% of our net earned premiums, or a 5% underwriting profit. A lower combined ratio reflects better results than a higher combined ratio. We don't include our investment portfolio results when measuring the profitability of our P&C businesses. That's because we manage the investment portfolio separately from our underwriting activities. Discontinued Operations - L&I -- We measure our Discontinued Operations' results using revenues and pretax operating earnings. Pretax operating earnings excludes net realized investment gains and losses and is a non-GAAP measure. We believe that looking at pretax operating earnings enhances the understanding of our L&I results of operations. Net realized investment gains and losses can fluctuate significantly and distort the comparison of our results. INVESTMENT RESULTS Investment activities are an important part of our business. We invest insurance premiums received in a diversified portfolio until needed to pay claims. Income from our investments is a significant part of our total revenues and net income. Our investment philosophy is to: o Emphasize investment yield, balanced with investment quality and risk o Provide for liquidity when needed o Diversify our portfolio We measure our investment results in two parts - the net investment income that we earn on our invested assets and the net realized investment gains and losses we recognize when we sell or impair investments. Application of Critical Accounting Estimates We have identified P&C Loss and LAE Reserves, P&C Reinsurance and Valuation of Investments as accounting estimates critical to understanding our results of operations and financial condition. As such, they require management to use judgments involving assumptions and estimates concerning future results, trends, or other developments that could significantly influence our results should actual experience differ from those assumptions and estimates. Please see additional discussion of critical accounting estimates in the MD&A section of our 2003 Annual Report on Form 10-K. Consolidated Results of Operations The following table presents summary consolidated financial information for the periods indicated. THREE MONTHS ENDED MARCH 31 2004 2003 - ---------------------------------------------------------------------------------------------------------- REVENUES P&C Earned Premiums $ 1,340.5 $ 1,163.1 Net Investment Income 115.0 119.6 Net Realized Investment Gains 42.8 8.2 Other Revenues -- 2.6 ----------------------------- Total Revenues 1,498.3 1,293.5 ----------------------------- EXPENSES Losses and Loss Adjustment Expenses 826.0 789.1 Other Underwriting and Operating Expenses 154.1 158.4 Amortization of Deferred Acquisition Costs 226.9 204.6 Interest Expense 30.5 34.8 Restructuring Charges 1.3 -- ----------------------------- Total Expenses 1,238.8 1,186.9 ----------------------------- Income from Continuing Operations before Income Taxes 259.5 106.6 Provision for Income Taxes 73.9 27.1 ----------------------------- Income from Continuing Operations 185.6 79.5 Income from Discontinued Operations (Net of Taxes of $26.9 and $6.3) 50.6 10.5 ----------------------------- Net Income $ 236.2 $ 90.0 - ----------------------------------------------------------------------------------------------------------
Net Income - Consolidated net income increased in first quarter 2004 over the same period in 2003 driven primarily by growth and improved underwriting results within our Continuing Operations. Revenues - The increase in revenues in the first quarter of 2004 reflected growth in P&C earned premiums that resulted from: o Growth in policies-in-force in our Auto segment o Premium rate increases across all our lines of business o Improved renewal retention in our SBI Regular segment An increase in net realized investment gains due to lower impairments also contributed to the increase in revenues. Losses and Loss Adjustment Expenses - The increase in losses and LAE for the first three months of 2004 reflect our growth. However, losses and loss adjustment expenses did not grow at the same rate due to improvement in our loss ratios. Our loss ratios in SPI Auto were 61.7% for the three months ended March 31, 2004 compared with 62.3% for the same period in 2003, our loss ratios in SPI Property were 36.3% for the three months ended March 31, 2004 compared with 48.0% for the same period in 2003, and our SBI Regular loss ratios were 46.2% for the three months ended March 31, 2004 compared with 49.5% for the same period in 2003. The improving ratios resulted from price increases, segmented underwriting techniques that better matched rate and risk, and favorable loss experience particularly from lower claim frequency in Property. Underwriting and Operating Expenses, Amortization of Deferred Acquisition Costs - - The increases in underwriting, acquisition and operating expenses primarily resulted from growth in our businesses during first quarter 2004 but the rate of increase was at a lower pace due to our expense reduction efforts initiated in September 2003. Interest Expense - The decrease in interest expense in 2004 was primarily due to the additional interest expense of $3.4 in 2003 on $500.0 of debt issued in January 2003 that was subsequently used to pay down $300.0 of debt on March 15, 2003 and $200.0 on April 1, 2003. Restructuring Charges - The charges in 2004 represent one-time termination benefits related to the $75.0 corporate expense reduction effort announced in September 2003. Discontinued Operations - Results from Discontinued Operations increased in first quarter 2004 over the same period a year ago, primarily due to an increase in net realized investment gains as a result of fewer impairments in 2004. Continuing Operations Reconciling Segment Results The following table assists in reconciling our GAAP results, specifically the "Income from Continuing Operations before Income Taxes" line from our Consolidated Statements of Income to our segment performance measures. THREE MONTHS ENDED MARCH 31 2004 2003 - ---------------------------------------------------------------------------------------------------------- P&C $ 284.7 $ 132.3 Corporate (25.2) (25.7) ------------------------------- Income from Continuing Operations before Income Taxes $ 259.5 $ 106.6 - ----------------------------------------------------------------------------------------------------------
The P&C GAAP results are further detailed into segment underwriting results. Underwriting results provide a helpful picture of how our company is doing. However, using them to measure profitability - while fairly common in our industry - does not follow GAAP. Our P&C Operating Results The primary measures of our operating results include our underwriting profit or loss, net earned premiums, and combined ratios. The next three tables report those key items - by our reportable segments - for the first three months of 2004 and 2003. More information about the results - also by segment - follows the tables. First, net earned premiums are the primary driver of our revenues: NET EARNED PREMIUMS ------------------------------- THREE MONTHS ENDED MARCH 31 2004 2003 - ---------------------------------------------------------------------------------------------------------- SPI Auto $ 620.1 $ 522.1 Property 228.2 227.5 Specialty 21.2 19.7 ------------------------------- Total SPI 869.5 769.3 ------------------------------- SBI Regular 302.4 266.0 SBI Special Accounts Facility 116.7 87.9 ------------------------------- Total SBI 419.1 353.9 ------------------------------- Surety 45.4 32.1 P&C Other 6.5 7.8 ------------------------------- Total P&C Earned Premiums $ 1,340.5 $ 1,163.1 - ----------------------------------------------------------------------------------------------------------
Next, underwriting profit (loss) is our measure of each P&C segment's performance: UNDERWRITING PROFITS (LOSSES) -------------------------------- THREE MONTHS ENDED MARCH 31 2004 2003 - ----------------------------------------------------------------------------------------------------------- SPI Auto $ 23.1 $ (6.6) Property 61.4 28.0 Specialty 6.4 5.3 -------------------------------- Total SPI 90.9 26.7 -------------------------------- SBI Regular 23.8 (5.3) SBI Special Accounts Facility 18.5 6.4 -------------------------------- Total SBI 42.3 1.1 -------------------------------- Surety 9.3 3.7 P&C Other (7.1) (10.5) -------------------------------- Total Underwriting Profit 135.4 21.0 P&C Net Investment Income 111.7 112.8 Restructuring Charges (1.3) -- P&C Net Realized Investment Gains (Losses) 38.9 (1.5) -------------------------------- P&C Income from Continuing Operations before Income Taxes $ 284.7 $ 132.3 - -----------------------------------------------------------------------------------------------------------
Finally, combined ratios show the relationship between net earned premiums and underwriting profit (loss). Using ratios help us see our operating trends without the effect of changes in net earned premiums: COMBINED RATIOS+ -------------------------------- THREE MONTHS ENDED MARCH 31 2004 2003 - ----------------------------------------------------------------------------------------------------------- SPI Auto 96.3% 101.3% Property 73.1 87.7 Specialty 70.0 73.4 -------------------------------- Total SPI 89.5 96.5 -------------------------------- SBI Regular 92.1 102.0 SBI Special Accounts Facility 84.2 92.7 -------------------------------- Total SBI 89.9 99.6 -------------------------------- Surety 79.6 88.6 P&C Other * * -------------------------------- Total P&C Operations 89.9% 98.2% - ----------------------------------------------------------------------------------------------------------- + Combined ratios are GAAP basis. Expressed as a percentage, they are equal to losses and expenses divided by net earned premiums. * Not meaningful because this is in runoff with minimal premium.
Auto The Auto segment provides voluntary and non-voluntary coverage for liability of our customers to others for both bodily injury and property damage, for injuries sustained by our customers and for physical damage to our customers' vehicles from collision and other hazards. THREE MONTHS ENDED MARCH 31 2004 2003 - ----------------------------------------------------------------------------------------------------------- Net Earned Premiums $ 620.1 $ 522.1 Underwriting Profit (Loss) 23.1 (6.6) Combined Ratio 96.3% 101.3% - -----------------------------------------------------------------------------------------------------------
NET EARNED PREMIUMS Net earned premiums increased by 18.8% in the three months ended March 31, 2004 compared with the same period in 2003. The increase in net earned premiums was driven by: o Growth of policies-in-force (PIF): PIF grew by 10.0% in first quarter 2004 compared with a year ago. The growth in PIF was driven by a 33.9% increase in new business coupled with stable retention. Our point-of-sale (POS) technology is making it easier for our distributors to sell our products. o Increases in filed rates: We file rate changes on a state-by-state basis. On average, we implemented mid-single digit rate increases in 2003 and into the first quarter of 2004. UNDERWRITING RESULTS AND COMBINED RATIO The improved underwriting results reflected higher earned premiums as discussed above and improved loss and expense ratios. Our loss ratio improved to 61.7% in the first quarter of 2004 compared with 62.3% in the first quarter of 2003. The expense ratio improved to 22.9% in 2004 from 23.7% in 2003. Lower expense ratios were primarily driven by efficiency improvements and corporate staff reductions. These underwriting results were primarily driven by: o Improved rate adequacy: Rate increases exceeded loss cost increases in the first quarter. Decreases in claims frequency - the number of claims filed that are not catastrophe-related - moderated in first quarter 2004, but claims severity - the average cost per claim - increased. o Claims handling: We've invested in training for our claims representatives. We now have more efficient processes. o Our segmented auto product: Our 15-tier segmented model continues to provide more accurate matching of prices for a wide range of risks. In April 2004, we started launching our auto product on Safeco Now, an internet-based sales platform where our distributors can quote and issue personal auto, homeowners and most of our small-business insurance products in minutes. We expect to complete the launch of our auto product on Safeco Now in all states where we write business by June 30, 2004. Property Our Property segment provides homeowners, earthquake, dwelling fire and inland marine coverage for individuals. Our Property coverages protect homes, condominiums and rental property contents against losses from a wide variety of hazards. We also protect individuals from liability for accidents that occur on their property. THREE MONTHS ENDED MARCH 31 2004 2003 - ----------------------------------------------------------------------------------------------------------- Net Earned Premiums $ 228.2 $ 227.5 Underwriting Profit 61.4 28.0 Combined Ratio 73.1% 87.7% - -----------------------------------------------------------------------------------------------------------
NET EARNED PREMIUMS Net earned premiums were flat in first quarter 2004 compared with first quarter 2003. This reflects a decline in PIF offset by rate increases: o Decline in PIF: The number of policies that did not renew in 2004 exceeded the number of new policies that we wrote, leading to a net reduction in PIF of 8.7% at March 31, 2004 compared with a year ago. However, our new business increased during the first quarter of 2004 over a year ago as our nine-tier new homeowners product is now rolled out in 43 of the 44 states where we write business. In addition, we lifted new business moratoriums throughout 2003 and into the first quarter of 2004. Currently we have a moratorium in only one state, Texas. o Rate increases: We file rate changes on a state-by-state basis. Overall we received approval for average rate changes in the low single-digits in the first quarter of 2004 and in the low to mid teens in 2003. These rate increases are earned in our revenues over the policy term. Additionally, premiums reflect automatic increases in the amount of insurance coverage to adjust for inflation. UNDERWRITING RESULTS AND COMBINED RATIO The improved underwriting results were driven by our homeowners line. The loss ratio in homeowners was 35.8% during first quarter 2004 compared with 50.0% in the same period in 2003. This was due to: o Our segmented homeowners product: Our nine-tier segmented underwriting model is performing as expected. It is now in place in every state except California. o Lower Losses: Property loss costs have declined in recent periods driven by a moderation of increases in claims severity and double-digit decreases in claims frequency. Many of our customers have increased their homeowners' policy deductibles from $250 to $500 or higher - this has significantly reduced the number of small maintenance-type claims. Severity increases reflect inflationary trends in repair material and labor costs. Catastrophe losses -- Our pretax catastrophe losses were $7.4 for the three months ended March 31, 2004 compared with $9.3 for the same period in 2003. Catastrophes in 2004 included snow and ice storms in Washington and Oregon. The second quarter is traditionally our most active quarter in terms of severe weather and catastrophe losses. We generally earn less in the second quarter than in any other period of the year due to this historical seasonality. In April 2004, we started launching our homeowners product on Safeco Now. We expect to complete the launch of our homeowners product in all states where we write business by June 30, 2004. We expect this to contribute to property premium growth in late 2004. Specialty THREE MONTHS ENDED MARCH 31 2004 2003 - ----------------------------------------------------------------------------------------------------------- Net Earned Premiums $ 21.2 $ 19.7 Underwriting Profit 6.4 5.3 Combined Ratio 70.0% 73.4% - -----------------------------------------------------------------------------------------------------------
Our Specialty operation provides individuals with umbrella, recreational vehicle, motorcycle and boat insurance. These products serve to round out our personal lines insurance product offerings. NET EARNED PREMIUMS Earned premiums increased 7.6% for first quarter 2004, driven by an increase in PIF due to a 38.3% increase in new business in umbrella and a 38.8% increase in new business in boatowners. UNDERWRITING RESULTS AND COMBINED RATIO The improvement in underwriting profit and combined ratio reflect lower loss experience. SBI Regular THREE MONTHS ENDED MARCH 31 2004 2003 - ----------------------------------------------------------------------------------------------------------- Net Earned Premiums $ 302.4 $ 266.0 Underwriting Profit (Loss) 23.8 (5.3) Combined Ratio 92.1% 102.0% - -----------------------------------------------------------------------------------------------------------
Our SBI Regular segment provides insurance for small-to-medium-sized businesses (customers who pay annual written premiums of $100,000 or less). This is our core commercial lines business. Our main products include: o Business owner policies (BOP) o Commercial auto o Commercial property o Commercial multi-peril o General liability o Workers compensation NET EARNED PREMIUMS Net earned premiums increased 13.7% in the first quarter of 2004 compared with the first quarter of 2003. This reflects rate increases averaging 10% in 2003 and mid-single digits in 2004, along with our efforts to make it easy for our distributors to sell our products. These efforts included: o Continued focus on our redesigned business model o Emphasis on retaining customers o Growth in our business service center Continued focus on our redesigned business model - In first quarter 2004, new sales utilizing Safeco Now, our web-based sales and underwriting platform, continued at a strong pace. The number of BOP new business policies sold increased by 45.0% over the same period of 2003 and, during the first quarter of 2004, we expanded our commercial auto and underwriting model to include fleets (up to nine vehicles), which helped to produce a 41.0% increase over last year's first quarter. Workers compensation new business policies sold increased 20.3% in the first quarter of 2004 over the same period in 2003. BOP was launched on Safeco Now in February 2003, commercial auto in July 2003, and workers compensation in December 2003. Emphasis on retaining customers - Renewal retention of SBI Regular customers improved to 80.2% in the first quarter of 2004 from 76.1% in first quarter 2003. This strong improvement is attributed to competitively pricing our business utilizing our automated underwriting platform. The model has allowed us to improve our accuracy in pricing risks and has led to strong retention within our most favorable pricing tiers. Growth in our business service center - We provide agents with an option to have us service the policies of their customers for a fee. This allows the agents to focus on growing their business and shifts the policy servicing activities to us. This service increases the retention of policyholders, benefiting both us and the agent. Since its inception in 2002, we have seen consistent growth in the business entering our Business Service Center. In first quarter 2004, we achieved a significant increase in premium volume, compared with the same period in 2003. Though we are still in the early stages of placing business in the Business Service Center, strong percentage growth is expected and this positive momentum is continuing. Underwriting Results and Combined Ratio Underwriting results during the first quarter of 2004 improved $29.1 over the same period in 2003 reflecting our efforts to restore profitability in this segment. The improvement in results reflects: o Improved rate adequacy o Completion of our reunderwriting of business o The continued impact of implementing our automated underwriting platform, which provides a better matching of price to risk Our pretax catastrophe losses were $2.4 in the first quarter of 2004 and $4.4 in the same period of 2003. SBI Regular is experiencing increased competition in middle market business (customers who pay annual written premiums from $25,000 to $100,000). Historically, this business is more price-competitive when rates are more adequate in relation to loss costs. Many regional carriers are lowering rates to be more price-competitive, particularly in the commercial property line where rates appear to be adequate. However, the inflation and building materials costs are increasing significantly and will impact loss costs. We remain committed to pricing our business based on loss cost trends. SBI Special Accounts Facility THREE MONTHS ENDED MARCH 31 2004 2003 - ----------------------------------------------------------------------------------------------------------- Net Earned Premiums $ 116.7 $ 87.9 Underwriting Profit 18.5 6.4 Combined Ratio 84.2% 92.7% - -----------------------------------------------------------------------------------------------------------
Our SBI Special Accounts Facility (SAF) segment includes insurance for large commercial accounts (customers who pay annual written premiums of more than $100,000) and four commercial programs. While our main focus is the small- to medium-sized market, we continue to serve some large commercial accounts on behalf of key agents and brokers who sell our core property and casualty products. Fifty-five percent of our new small-commercial business comes from distributors who also sell to large commercial accounts. SAF also provides insurance for the following commercial programs: o Lender-placed property o Agents' errors and omissions (predominantly for Safeco agents) o Mini-storage and warehouse properties o Non-profit social services organizations NET EARNED PREMIUMS The increase in net earned premiums during first quarter 2004 was driven by continued price increases in large account and program business. UNDERWRITING RESULTS AND COMBINED RATIO The SAF segment continues to produce solid underwriting results with both large accounts and program business posting improved combined ratios reflecting rate increases and stable loss costs. Surety THREE MONTHS ENDED MARCH 31 2004 2003 - ----------------------------------------------------------------------------------------------------------- Net Earned Premiums $ 45.4 $ 32.1 Underwriting Profit 9.3 3.7 Combined Ratio 79.6% 88.6% - -----------------------------------------------------------------------------------------------------------
Our Surety segment provides surety bonds for construction and commercial businesses. NET EARNED PREMIUMS Our net earned premiums increased 41.4% for the three months ended March 31, 2004 compared with the same period in 2003 due to rate increases in 2003 and new business. New business increased largely as a result of the 2003 opening of new offices in Glendale, California and Syracuse, New York. UNDERWRITING RESULTS AND COMBINED RATIO Our underwriting profit and our combined ratio improved in the first quarter of 2004 compared with the same period of 2003. These results reflect disciplined underwriting and lower loss experience. Surety implemented Safeco Now in April 2004 for the automated underwriting of small transactional bonds. While this is currently less than 5% of our surety premiums, it also allows our distributors to cross-sell with small-business insurance and to write these transactional bonds quickly and easily. P&C Other THREE MONTHS ENDED MARCH 31 2004 2003 - ----------------------------------------------------------------------------------------------------------- Net Earned Premiums $ 6.5 $ 7.8 Underwriting Loss (7.1) (10.5) - -----------------------------------------------------------------------------------------------------------
Our P&C Other segment includes our: o Runoff of assumed reinsurance business acquired as part of the American States acquisition o London operations that have been in runoff since the third quarter of 2002 o Large commercial business accounts in runoff and specialty programs that we exited Our Corporate Results THREE MONTHS ENDED MARCH 31 2004 2003 - ----------------------------------------------------------------------------------------------------------- Corporate Segment Loss $ (29.1) $ (35.4) Net Realized Investment Gains before Income Taxes 3.9 9.7 -------------------------------- Corporate Loss from Continuing Operations before Income Taxes $ (25.2) $ (25.7) - -----------------------------------------------------------------------------------------------------------
In our Corporate segment, we include: o Interest expense we pay on our debt o Our intercompany eliminations o Miscellaneous corporate activities Interest Expense - Our interest expense on borrowings totaled $30.5 in the first quarter of 2004 and $34.8 in the first quarter of 2003. The decrease in interest expense in 2004 was primarily due to a decline in the average amount of debt outstanding from 2003. Discontinued Operations Our L&I Operating Results The following discussion reflects the operating results of our Discontinued Operations. In reporting L&I as a Discontinued Operation, general corporate overhead expenses are no longer allocated to L&I. Previously allocated expenses of $3.0 in the first quarter of 2003 have been eliminated from the L&I Other segment and included in the Corporate segment above. The primary measures of our L&I operating results include revenues and pretax operating earnings. The next two tables summarize revenues and pretax operating earnings by our Discontinued Operations reportable segments for the three months ended March 31, 2004 and 2003. More information about the results - also by segment - follows the tables. First, revenues include premiums, net investment income and other fees. Revenues do not include our net realized investment gains and losses. REVENUES -------------------------------- THREE MONTHS ENDED MARCH 31 2004 2003 - ----------------------------------------------------------------------------------------------------------- Group $ 129.3 $ 142.3 Income Annuities 125.4 131.4 Retirement Services 97.0 96.1 Individual 95.6 95.9 Asset Management 7.1 6.2 L&I Other 65.3 55.5 -------------------------------- Total L&I Revenues $ 519.7 $ 527.4 - -----------------------------------------------------------------------------------------------------------
Next, pretax operating earnings is our measure of each segment's profitability: PRETAX OPERATING EARNINGS -------------------------------- THREE MONTHS ENDED MARCH 31 2004 2003 - ----------------------------------------------------------------------------------------------------------- Group $ 12.2 $ 29.0 Income Annuities 3.7 10.1 Retirement Services 9.5 5.0 Individual 7.4 1.9 Asset Management 1.6 0.1 L&I Other 26.9 28.8 -------------------------------- Pretax Operating Earnings 61.3 74.9 Net Realized Investment Gains (Losses) 16.2 (58.1) Provision for Income Taxes 26.9 6.3 -------------------------------- Income from Discontinued Operations, Net of Taxes $ 50.6 $ 10.5 - -----------------------------------------------------------------------------------------------------------
Group Group's principal product is stop-loss medical insurance sold to employers with self-insured medical plans. The revenue decrease during first quarter 2004 reflects the continued competitive rate environment, which has resulted in some of our policyholders renewing their coverage with other carriers. We continue to adhere to our disciplined underwriting standards in this environment and do not lower premiums to compete for business where it does not meet our profit targets. The decrease in our pretax operating earnings was due to lower revenues and a higher loss ratio due to higher claim activity. Our loss ratio was 65.8% in the first quarter of 2004, compared with 56.2% in the same period in 2003. The first quarter of 2003 included a $10.5 benefit from favorable loss reserve development related to policies obtained in the Swiss Re Life & Health America Holding Company (Swiss Re) acquisition and this contributed to our favorable loss ratio in 2003. Income Annuities Income Annuities' main product is structured settlement annuities, sold to fund third-party personal injury settlements and long-term claim settlements of our P&C affiliates. This product is extremely sensitive to financial strength ratings, and our ratings downgrades in 2001 decreased our ability to sell this product. Income Annuities also sells non-structured fixed annuities, which provide an immediate payment stream. The decrease in revenue during the first quarter of 2004 resulted mainly from the impact of unfavorable prepayment adjustments of $0.3 on our mortgage-backed securities investment portfolio. This compared with $3.7 favorable impact in the same period last year. Pretax operating earnings decreased $6.4 in the first quarter of 2004 compared with the same period last year. The decrease was primarily due to the unfavorable prepayment adjustments on mortgage-backed securities discussed above and lower market interest rates on reinvested assets. Retirement Services Retirement Services' principal products are fixed deferred and variable annuities. We earn revenues relative to the amount of assets under management. The minor increase in revenues during the first quarter of 2004 was primarily due to higher investment income driven by growth in our general account liabilities. Higher fee income on separate account liabilities, due to the improved performance of equity markets in the first three months 2004 also contributed to our increase in revenues. These increases were partially offset by the impact of lower average interest rates on new and reinvested assets. General account liabilities are amounts we owe to contract holders for products where we bear the investment risks and include fixed deferred annuities and guaranteed investment contracts. Our general account liabilities have grown significantly due to an increase in the amount of fixed deposits which exceeded surrenders. They were: o $6,609.4 at March 31, 2004 o $6,151.3 at March 31, 2003 The increases in pretax operating earnings in the first three months of 2004 compared to the same period of 2003 resulted from: o Growth in our general account liabilities, which contributed additional interest income o Higher fee income due to our growth in separate account liabilities Individual Individual's products include term, universal & variable universal life and bank-owned life insurance (BOLI). BOLI is universal life insurance sold to banks. Our ratings downgrades in 2001 significantly curtailed BOLI sales. The increase in pretax operating earnings in the first quarter of 2004 was primarily due to favorable mortality experience, lower operating expenses and higher margins on our BOLI products. Asset Management Asset Management serves as an investment advisor for Safeco Mutual Funds, variable insurance portfolios and institutional and trust accounts. The increase in revenue in the first quarter of 2004 was due to higher investment advisory fee revenue on higher average assets under management reflecting the overall increase in equity markets. Our average assets under management were: o $4,049.5 in the first quarter of 2004 o $3,804.3 in the first quarter of 2003 The slight increase in our pretax operating earnings for 2004 reflects the higher investment advisory fees from our higher assets under management and lower operating expenses. L&I Other L&I Other is comprised mainly of investment income on capital and accumulated earnings of other L&I segments, and Talbot Financial Corporation (Talbot), our insurance agency that distributes property and casualty, life insurance and investment products. The increase in revenue in the first quarter of 2004 was due to increases in net investment income reflecting higher retained capital, and increases in commission revenues from Talbot. Decreased earnings in the first quarter of 2004 reflected $9.3 for expenses associated with the planned sale of the L&I operations, offset by $4.9 of interest income on a tax settlement, higher investment income from an increase in retained capital, and increases in commission revenues from Talbot. Capital Resources and Liquidity OUR LIQUIDITY NEEDS Continuing Operations - P&C liabilities are somewhat unpredictable and generally short in duration. The payments we make to policyholders depend upon losses they suffer from accidents or other events. While we can estimate fairly well how much cash we'll need and when we'll need it, we cannot predict all future events, particularly catastrophes. So we use investments with greater liquidity to support our P&C businesses' need for funds. Discontinued Operations - Life insurance, retirement services and annuity-products have primarily longer-duration liabilities that are typically predictable in nature and are matched with investments that are generally longer duration and less liquid. SOURCES OF OUR FUNDS Our Continuing Operations get cash primarily from insurance premiums, dividends, interest and sales or maturity of investments. We have not engaged in the sale of investments or other assets by securitization. The cash flow from our Continuing Operations operating activities was: o $71.5 of cash flow generated in the first quarter of 2004 o $7.0 of cash flow used in the first quarter of 2003 We believe that cash flows from our operations, investment portfolio, and credit facilities are sufficient to meet our future liquidity needs. Our Discontinued Operations get cash from insurance premiums, funds received under deposit contracts, dividends, interest, asset management fees and sales or maturity of investments. The cash flow from our Discontinued Operations operating activities was: o $260.4 in the first quarter of 2004 o $224.6 in the first quarter of 2003 HOW WE USE OUR FUNDS We use funds to support operations, make interest and principal payments on debt, pay dividends to our shareholders, and grow our investment portfolio. We use cash from insurance operations primarily to pay claims and claim adjustment expenses. We require insurance premiums to be paid in advance. As a result, cash flows into our business before or at the time premium revenues are recognized. Cash flows out of our business in subsequent months or years as claims are paid. We previously announced that we will repurchase a limited amount of our common stock under an existing stock repurchase program. Under this program, the Board of Directors authorized the repurchase of up to 11 million shares of Safeco's common stock, of which 2.37 million shares remain available for repurchase. Purchases will be made from time to time on the open market or in negotiated transactions and any repurchases will be reported in our quarterly report for the quarter in which the purchases were made. Our Bank Credit Facility -- We maintain a bank credit facility with $500.0 available. The terms of the bank credit facility - which runs through September 2005 - require us to: o Pay a fee to have these funds available o Maintain a specified minimum level of shareholders' equity o Keep our debt-to-capitalization ratio below a specified maximum The bank credit facility does not require us to maintain any deposits as compensating balances. At March 31, 2004 and December 31, 2003, we had no borrowings under the bank credit facility. In addition, we were in compliance with all the terms of this credit facility. After we complete our planned sale of L&I, we may lower amount available under the bank credit facility and we expect to reset the amount of the requirement to maintain a minimum level of shareholders' equity. This will be necessary as we intend to return a portion of the sale proceeds to shareholders through a special dividend or stock repurchase or combination of the two, and that will lower our shareholders' equity. In addition, we will continue to keep our debt-to-capitalization ratio below the maximum requirement as we will use proceeds from the sale of L&I to reduce our debt-to-capitalization ratio to a level consistent with that prior to the sale. FINANCIAL STRENGTH RATINGS Financial strength (or claims paying) ratings provide a benchmark for comparing insurers. Higher ratings generally indicate greater financial strength and a greater ability to pay claims. These ratings are important for the marketing of insurance products, particularly structured settlement annuities and BOLI products in our L&I operations. Here are our current ratings for our Continuing Operations: A.M. STANDARD BEST & POOR'S MOODY'S FITCH - -------------------------------------------- ----------------- --------------- -------------- -------------- Safeco Corporation Senior Debt bbb+ BBB+ Baa1 A- P&C Insurance Subsidiaries A A+ A1 AA- - -------------------------------------------- ----------------- --------------- -------------- --------------
Each agency has a stable outlook on the ratings, and all ratings have been affirmed within the last six months. We believe our financial position is sound. As we have continued to execute our plans to improve P&C operating results, our financial position has strengthened. Our debt service coverage has improved over the last two years, and we expect that to continue. Here are our current ratings for our Discontinued Operations: A.M. STANDARD BEST & POOR'S MOODY'S FITCH - -------------------------------------------- ----------------- --------------- -------------- -------------- L&I Insurance Subsidiaries A BBB+ A2 A+ - -------------------------------------------- ----------------- --------------- -------------- --------------
On March 15, 2004, we entered into definitive agreements to sell our L&I operations. As a result, Standard & Poor's and Fitch downgraded the rating of our life insurance subsidiaries with a stable outlook. A.M. Best commented that the life insurance subsidiaries remain under review with developing implications, but that it is "likely to affirm" the current rating. IMPACT OF FINANCIAL STRENGTH RATINGS Lower financial strength ratings could materially and adversely affect our company and its performance and could: o Increase the number of customers who terminate their policies o Inhibit our distributors' willingness and ability to sell our products, particularly products within our Discontinued Operations o Decrease new sales o Increase our borrowing costs o Limit our access to capital o Restrict our ability to compete OUR INVESTMENT RESULTS Investment returns are an important part of our overall profitability. Fluctuations in the fixed income or equity markets could affect the timing and the amount of our net investment income. Defaults by third parties in the payment or performance of their obligations - primarily on our investments in corporate bonds - could reduce our investment income or result in realized investment losses. NET INVESTMENT INCOME Continuing Operations This table summarizes our pretax net investment income by portfolio: THREE MONTHS ENDED MARCH 31 2004 2003 - -------------------------------------------- ----------------- --------------------------------------------- Property & Casualty $ 111.7 $ 112.8 Corporate and Other 3.3 6.8 -------------------------------- Total $ 115.0 $ 119.6 - -----------------------------------------------------------------------------------------------------------
Our pretax investment income yield was 5.2% for the three months ended March 31, 2004 compared with 6.0% for the same period in 2003. The declines in our pretax investment yields in our portfolio reflected the low interest rate environment. Our after tax investment income yield was 3.9% for the three months ended March 31, 2004 compared with 4.4% for the same period in 2003. Discontinued Operations Our pretax net investment income for Discontinued Operations for the three months ended March 31, 2004 was $303.2 compared with $303.5 over the same period last year. Our pretax investment income yield was 6.8% for the three months ended March 31, 2004 compared with 7.0% for the same period in 2003. The declines in our pretax investment yields in our portfolio reflected the low interest rate environment. Our after tax investment income yield was 4.4% for the three months ended March 31, 2004 compared with 4.6% for the same period in 2003. NET REALIZED INVESTMENT GAINS AND LOSSES Continuing Operations Pretax net realized investment gains and losses for the three months ended March 31, 2004 and 2003 by portfolio were: THREE MONTHS ENDED MARCH 31 2004 2003 - ----------------------------------------------------------------------------------------------------------- Property & Casualty $ 38.9 $ (1.5) Corporate 3.9 9.7 -------------------------------- Total $ 42.8 $ 8.2 - -----------------------------------------------------------------------------------------------------------
Pretax net realized investment gains and losses for the three months ended March 31, 2004 and 2003 by component were: THREE MONTHS ENDED MARCH 31 2004 2003 - ----------------------------------------------------------------------------------------------------------- Net Gains on Securities Transactions $ 47.5 $ 18.1 Impairments on Fixed Maturities (4.5) (17.4) Impairment on Equity Securities (0.1) (4.1) Credit Default Swap Mark-to-Market -- 9.0 Other (0.1) 2.6 -------------------------------- Total $ 42.8 $ 8.2 - -----------------------------------------------------------------------------------------------------------
Investment Sales Activity - Net gains on securities transactions during the first quarter of 2004 and 2003 resulted primarily from calls and fixed maturity sales initiated to manage our call risk and improve the credit quality of the underlying portfolio. These calls - issuers redeeming bonds in which we have invested before the final maturity date - are an expected part of our investment activity, particularly when interest rates are low. Impairments - We closely monitor every investment that has declined in fair value to below our cost. If we determine that the decline is other than temporary, we write down the security to its fair value and record the charge as an impairment in the Consolidated Statements of Income in the period of other than the temporary decline. We continually monitor our investment portfolio and markets for opportunities to: o Improve credit quality o Reduce our exposure to companies and industries with credit problems o Manage call risk In our impairment determination process, we consider our intent and ability to hold investments long enough for them to recover in value. However, our intent to hold the investment can change due to: o Financial market fluctuations o Changes in the financial condition and near-term prospects of the issuer o Strategic decisions to sell businesses o Strategic decision to reposition our investment portfolio's duration or asset allocation Pretax investment impairments for the three months ended March 31, 2004 and 2003 by portfolio were: THREE MONTHS ENDED MARCH 31 2004 2003 - ----------------------------------------------------------------------------------------------------------- Property & Casualty $ 4.6 $ 20.6 Corporate -- 0.9 -------------------------------- Total $ 4.6 $ 21.5 - -----------------------------------------------------------------------------------------------------------
The impairments in the first quarter of 2003 primarily resulted from: o Credit deterioration in the airline and franchise sectors o Credit problems of some of the companies in which we've invested For the three months ended March 31, 2004, the fair value of fixed maturities and equity securities that we sold at a loss was $62.5 compared with $90.1 in the same period last year. Our total net realized investment loss on these sales for the quarter ended March 31, 2004 was $12.9 and for the quarter ended March 31, 2003 was $11.2. Discontinued Operations Pretax net realized investment gains for our Discontinued Operations were $16.2 for the three months ended March 31, 2004 compared with a net realized loss of $58.1 in the same period of 2003. Pretax net realized investment gains and losses for the three months ended March 31, 2004 and 2003 by component were: THREE MONTHS ENDED MARCH 31 2004 2003 - ----------------------------------------------------------------------------------------------------------- Net Gains on Securities Transactions $ 24.7 $ 10.1 Impairments on Fixed Maturities (8.5) (62.0) Impairments on Equity Securities -- (0.7) Other -- (5.5) -------------------------------- Total $ 16.2 $ (58.1) - -----------------------------------------------------------------------------------------------------------
We have impaired all securities held by L&I with unrealized losses at March 31, 2004 because we do not expect them to recover in value before the sale of the L&I businesses is completed. Investment Portfolio This table summarizes our Continuing Operations investment portfolio at March 31, 2004: COST OR CARRYING MARCH 31, 2004 AMORTIZED COST VALUE - ----------------------------------------------------------------------------------------------------------- P&C Fixed Maturities - Taxable $ 5,668.4 $ 6,020.8 Fixed Maturities - Non-taxable 1,983.4 2,144.9 Equity Securities 619.9 1,084.5 CORPORATE Fixed Maturities - Taxable 145.2 146.0 Equity Securities 34.0 50.3 ------------------------------------ Total Fixed Maturities and Equity Securities 8,450.9 9,446.5 Other Invested Assets 26.1 26.1 Short-Term Investments 68.5 68.5 ------------------------------------ Total Investment Portfolio $ 8,545.5 $ 9,541.1 - -----------------------------------------------------------------------------------------------------------
Our fixed maturities carried at $8,311.7 included: o Gross unrealized gains of $522.7 o Gross unrealized losses of $8.0 Our equity securities carried at $1,134.8 included: o Gross unrealized gains of $483.9 o Gross unrealized losses of $3.0 We reviewed all our investments with unrealized losses at the end of March 31, 2004. Our evaluation determined that their declines in fair value were temporary. This table summarizes our Discontinued Operations investment portfolio at March 31, 2004: COST OR CARRYING MARCH 31, 2004 AMORTIZED COST VALUE - --------------------------------------------------------------------- --------------------- ---------------- Fixed Maturities - Taxable $ 16,664.3 $ 18,520.2 Fixed Maturities - Non-taxable 7.5 8.1 Equity Securities 96.3 112.8 Mortgage Loans 927.0 927.0 Other Invested Assets 104.2 104.2 Short-Term Investments 73.9 73.9 - --------------------------------------------------------------------- --------------------- ---------------- Total Discontinued Operations $ 17,873.2 $ 19,746.2 - --------------------------------------------------------------------- --------------------- ----------------
DIVERSIFICATION Our investment portfolio is well-diversified by issuer and industry type with no single holding exceeding 1% of our consolidated investment portfolio. Here is a summary of our Continuing Operations investments showing investment types and industries that exceed 3% of our portfolio at March 31, 2004. CARRYING PERCENT MARCH 31, 2004 VALUE OF TOTAL - ----------------------------------------------------------------------------------------------------------- State and Political Subdivisions $ 2,386.1 25% Mortgage-Backed Securities 1,153.3 12 U.S Government and Agencies 1,017.5 11 Banks 850.6 9 Electric Utilities 474.9 5 Diversified Financial Services 287.1 3 Other 3,277.0 34 ---------------------------------- Total Fixed Maturities and Equity Securities 9,446.5 99 Other Invested Assets 26.1 -- Short-Term Investments 68.5 1 ---------------------------------- Total Investment Portfolio-Continuing Operations $ 9,541.1 100% - -----------------------------------------------------------------------------------------------------------
Here is a summary of our Discontinued Operations investments showing investment types and industries that exceed 3% of our portfolio at March 31, 2004. CARRYING PERCENT MARCH 31, 2004 VALUE OF TOTAL - ----------------------------------------------------------------------------------------------------------- Electric Utilities $ 1,611.5 8% Banks 1,547.3 8 U.S Government and Agencies 1,104.7 5 Gas Utilities 733.4 4 State and Political Subdivisions 698.7 4 Diversified Financial Services 604.1 3 Mortgage-Backed Securities 4,425.4 22 Other 7,916.0 40 ---------------------------------- Total Fixed Maturities and Equity Securities 18,641.1 94 Mortgage Loans 927.0 5 Other Invested Assets 104.2 1 Short-Term Investments 73.9 -- ---------------------------------- Total Investment Portfolio-Discontinued Operations $ 19,746.2 100% - ----------------------------------------------------------------------------------------------------------- INVESTMENT PORTFOLIO QUALITY The quality ratings of our Continuing Operations fixed maturities portfolio were: PERCENT AT RATING MARCH 31, 2004 - ----------------------------------------------------------------------------------------------------------- AAA 43% AA 11 A 24 BBB 19 BB and lower 2 Not Rated 1 ----------------- Total 100% - -----------------------------------------------------------------------------------------------------------
The quality ratings of our Discontinued Operations fixed maturities portfolio were: PERCENT AT RATING MARCH 31, 2004 - ----------------------------------------------------------------------------------------------------------- AAA 32% AA 4 A 24 BBB 32 BB and lower 6 Not Rated 2 ----------------- Total 100% - -----------------------------------------------------------------------------------------------------------
BELOW INVESTMENT GRADE AND OTHER SECURITIES Continuing Operations A security is considered below investment grade if it has a rating below BBB. Our Continuing Operations investment portfolio includes below investment grade securities with a fair value of: o $222.1 at March 31, 2004 o $252.7 at December 31, 2003 At March 31, 2004, these securities represented 2.3% of our investments at fair value. The related amortized cost of the below investment grade securities at March 31, 2004 was $202.5 compared with $233.7 at December 31, 2003. Our below investment grade securities had a net unrealized investment gain of $19.6 at March 31, 2004. That gain comprised of: o Gross unrealized investment gains of $21.0 o Gross unrealized investment losses of $1.4 At March 31, 2004 our investment portfolio also included: o $94.3 of non-publicly traded fixed maturities and equity securities - representing 1.0% of our total portfolio o $91.6 of not-rated securities - representing 1.0% of our total portfolio Discontinued Operations Our Discontinued Operations investment portfolio includes below investment grade securities with a fair value of: o $1,031.4 at March 31, 2004 o $1,047.4 at December 31, 2003 During the first quarter of 2004, these securities represented 5.6% of our total fixed maturities at fair value. The related amortized cost of the below investment grade securities at March 31, 2004 was $913.9 compared with $939.0 at December 31, 2003. Our below investment grade securities had a net unrealized investment gain of $117.4 at March 31, 2004. That gain was fully comprised of gross unrealized investment gains as we have impaired all securities held by L&I with unrealized losses at March 31, 2004 because we do not expect them to recover in value before the sale of the L&I businesses is completed. At March 31, 2004 our Discontinued Operations investment portfolio also included: o $231.0 of non-publicly traded fixed maturities and equity securities - representing 1.2% of our L&I investment portfolio o $495.5 of not-rated securities - representing 2.5% of our L&I investment portfolio OUR MORTGAGE LOAN PORTFOLIO Our Discontinued Operations held $927.0 of mortgage loans at March 31, 2004. That represents 4.7% of our L&I investment portfolio. Our mortgage loans are on completed, income-producing commercial real estate, primarily in the retail, industrial and office building sectors. The majority of the properties on which we hold mortgages are in three states: o 29% in Washington o 24% in California o 11% in Oregon We hold mortgages in no other state that represents greater than 10% of the mortgage loan balance. Our mortgage loan policy includes these guidelines: o No loan when issued shall exceed 75% of the property's appraised value o Individual loans generally do not exceed $10.0 o First mortgage liens secure the loans Less than 1% of our mortgage loans were non-performing - those loans in default of principal or interest or both - at the end of the last two years and at March 31, 2004. As a result, our allowance for mortgage loan losses has remained unchanged at $10.2 at March 31, 2004 and December 31, 2003. MORTGAGE-BACKED SECURITIES This table summarizes our Continuing Operations holdings of mortgage-backed securities at March 31, 2004. CARRYING VALUE COST OR -------------------- MARCH 31, 2004 AMORTIZED COST AMOUNT PERCENT - ------------------------------------------------------------------------------------------------------------- RESIDENTIAL Planned and Targeted Amortization Class and Sequential Pay CMOs $ 176.6 $ 181.9 16% Accrual Coupon (Z-Tranche) CMOs 337.0 343.2 29 Floating Rate CMOs 22.8 23.4 2 Residential Mortgage-Backed Pass-Throughs (Non-CMOs) 7.3 7.9 1 --------------------------------------------- Total Residential 543.7 556.4 48 --------------------------------------------- SECURITIZED COMMERCIAL REAL ESTATE Government/Agency-Backed 44.3 47.6 4 CMOs and Pass-Throughs (Non-agency) 391.1 422.6 37 --------------------------------------------- Total Securitized Commercial Real Estate 435.4 470.2 41 --------------------------------------------- Other CMOs 121.9 126.7 11 - ------------------------------------------------------------------------------------------------------------- Total $ 1,101.0 $ 1,153.3 100% - -------------------------------------------------------------------------------------------------------------
Our Continuing Operations hold $1,153.3 in mortgage-backed securities as of March 31, 2004. 93% were either government/agency-backed or AAA rated. Here are the quality ratings of our Continuing Operations mortgage-backed securities portfolio. RATING MARCH 31, 2004 - ---------------------------------------------------------- ---------------------------------- Government/Agency Backed 45% AAA 48 AA 6 A -- BBB 1 BB or lower -- - ---------------------------------------------------------- ---------------------------------- Total 100% - ---------------------------------------------------------- ----------------------------------
This table summarizes our Discontinued Operations holdings of mortgage-backed securities at March 31, 2004. CARRYING VALUE COST OR -------------------- MARCH 31, 2004 AMORTIZED COST AMOUNT PERCENT - ------------------------------------------------------------------------------------------------------------- RESIDENTIAL Planned and Targeted Amortization Class and Sequential Pay CMOs $ 2,025.6 $ 2,099.0 47% Accrual Coupon (Z-Tranche) CMOs 456.1 495.2 11 Floating Rate CMOs 100.0 104.4 3 Companion/Support, Principal Only, Interest Only CMOs 8.8 9.3 -- Subordinates 19.0 19.6 -- Residential Mortgage-Backed Pass-Throughs (Non-CMOs) 380.6 391.3 9 ----------------------------------------------- Total Residential 2,990.1 3,118.8 70 ----------------------------------------------- Securitized Commercial Real Estate Government/Agency-Backed 429.1 456.3 10 CMOs and Pass-Throughs (Non-agency) 629.0 686.3 16 ----------------------------------------------- Total Securitized Commercial Real Estate 1,058.1 1,142.6 26 ----------------------------------------------- Other CMOs 157.2 164.0 4 - ------------------------------------------------------------------------------------------------------------- Total $ 4,205.4 $ 4,425.4 100% - -------------------------------------------------------------------------------------------------------------
Quality of Our Mortgage-Backed Securities - At March 31, 2004, 95% of our mortgage-backed securities were either government/agency-backed or AAA rated. We've limited our investment in riskier, more volatile CMOs and CMBSs to $28.9. That amount represents 0.7% of our total mortgage-backed securities. Here are the quality ratings of our Discontinued Operations mortgage-backed securities portfolio. RATING MARCH 31, 2004 - ---------------------------------------------------------------- -------------------------------- Government/Agency Backed 74% AAA 21 AA 3 A 1 BBB 1 BB or lower -- - ---------------------------------------------------------------- -------------------------------- Total 100% - ---------------------------------------------------------------- --------------------------------
ITEM 4 - CONTROLS AND PROCEDURES We have evaluated the effectiveness of the design and operation of our disclosure controls and procedures under the supervision and with the participation of management, including our Chief Executive Officer, Chief Financial Officer and our disclosure committee. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective as of March 31, 2004 to ensure that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms. There have been no changes in our internal controls over financial reporting during the first quarter that materially affected, or are reasonably likely to materially affect, our controls over financial reporting. Safeco Corporation and Subsidiaries - ------------------------------------------------------------------------------- PART II - OTHER INFORMATION - -------------------------------------------------------------------------------- Item 1 - LEGAL PROCEEDINGS Because of the nature of our businesses, we are subject to legal actions filed or threatened in the ordinary course of our operations. Generally, our involvement in legal action involves defending third-party claims brought against our insureds (in our role as liability insurer) and defending policy coverage claims brought against us. We do not believe that such litigation will materially and adversely affect our financial condition, future operating results or liquidity. Our property and casualty insurance subsidiaries are parties to a number of lawsuits for liability coverages related to environmental claims. Estimation of reserves for environmental claims is difficult. However, we do not expect these lawsuits to materially affect our financial condition. Our P&C companies are being sued in the U.S. District Court of Connecticut pursuant to a suit filed on January 14, 2003 and in California state court pursuant to a suit filed in August 10, 2001 by plaintiffs who seek back overtime pay for claims adjusters who they claim should have been considered non-exempt employees under the labor laws. In each of these suits, we have denied any suggestion of wrongdoing, and are actively defending against these allegations. Summary judgment in our favor was entered in the California case in January 2004. ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K (A)(3) - EXHIBITS 10.1 Separation Agreement between Safeco Corporation and Bruce Allenbaugh dated January 31, 2004. 31.1 Certification of Chief Executive Officer of Safeco Corporation, dated May 7, 2004, in accordance with Securities Exchange Act Rule 13a-14(a)/15d-14(a) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of Chief Financial Officer of Safeco Corporation, dated May 7, 2004, in accordance with Securities Exchange Act Rule 13a-14(a)/15d-14(a) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification of Chief Executive Officer of Safeco Corporation, dated May 7, 2004, in accordance with 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification of Chief Financial Officer of Safeco Corporation, dated May 7, 2004, in accordance with 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (B) - REPORTS ON FORM 8-K The registrant filed the following reports on Form 8-K during the quarter ended March 31, 2004 and for the period up to the filing date of this Form 10-Q. FILING DATED UNDER FILING RELATED TO: ------------------------------------------------------------------------------------------------- January 26, 2004 Item 12 (Results Earnings Release for Quarter ended December 31, 2003. of Operations and Financial Condition) March 15, 2004 Item 5 Agreement to sell Life & Investments operations to (Other Events) investor group led by White Mountains and Berkshire Hathaway. Agreement to sell Talbot Financial Corp. to Senior Management Group. April 20, 2004 Item 12 (Results of Earnings Release for Quarter ended March 31, 2004. Operations and Financial Condition) -------------------------------------------------------------------------------------------------
Safeco Corporation and Subsidiaries - ------------------------------------------------------------------------------- Signatures - ------------------------------------------------------------------------------- Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized on May 7, 2004. Safeco Corporation ------------------------- Registrant /s/ MAURICE S. HEBERT ------------------------- Maurice S. Hebert Vice President, Controller EX-10.1 2 en0706.txt EX-10.1 SEPARATION AND GENERAL RELEASE AGREEMENT This Separation and General Release Agreement (this "Agreement") is made and entered into by and between Bruce Allenbaugh ("Employee") and Safeco Corporation (the "Company"). RECITALS A. Employee has been employed by Company as its Senior Vice President of Marketing and Communications. Employee has tendered his notice of resignation from employment with the Company effective January 31, 2004, which resignation is accepted by the Company. B. To resolve any issues between Employee and the Company or any of its affiliates arising out of Employee's employment, Employee and the Company have voluntarily agreed to enter into this Agreement. This Agreement sets forth the complete understanding between Employee and the Company regarding Employee's resignation as an officer of any of the Safeco group of companies and his resignation as an employee of the Company, and the commitments and obligations arising out of the termination of the employment relationship between Employee and the Company. AGREEMENT 1. Employment Termination. 1.1 Resignation. In consideration of the Severance Payment and other compensation and benefits described herein, Employee tenders his resignation of employment, including resignation as an officer of the Company and its affiliates, effective January 31, 2004 (the "Termination Date"). 1.2 Compensation Through Termination Date. The Company shall pay Employee all base salary through the Termination Date. Until the Termination Date, Employee shall continue to be eligible for employee benefit plan coverages available to employees of the Company and for continued vesting under the Safeco Incentive Stock Option Plan of 1987 (the "1987 Plan") and/or the Safeco Long-Term Incentive Plan of 1997 (the "LTIP"). 1.3 Group Medical Benefits Coverage. The Company shall continue to provide coverage under any group medical benefits plan under which Employee and/or his dependents were covered on the date hereof, through and including the Termination Date. Employee shall be responsible to pay any amounts chargeable as "employee premium contribution" amounts with respect to any such coverage. From and after the Termination Date, the Company shall provide Employee and/or Employee's dependents with such benefits continuation or conversion coverage as may be available or required under the terms of the Company's benefits plans or policies (understanding that the Company retains the right to modify, amend or terminate any of the plans at any time without advance notice). Employee and/or Employee's covered spouse and dependents may be eligible to elect a temporary extension of group health plan coverage under the Consolidated Omnibus Budget Reconciliation Act of 1985, as subsequently amended ("COBRA"). 1.4 Payment for Accrued Vacation. On the Termination Date, the Company shall pay Employee for accrued but unused vacation that exists as of the Termination Date, which amount the parties agree equals Five Thousand Five Hundred, Fifty-Two Dollars ($5,552.00). 1.5 Reimbursement for Expenses Incurred. The Company shall reimburse Employee for reasonable and necessary business expenses incurred by Employee on or before the Termination Date to the extent such expenses are reimbursable under the Company's normal expense reimbursement policies and procedures, and provided that receipts or other acceptable documentation for such expenses are submitted to Human Resources by the Termination Date. 1.6 Acknowledgment of Full Compensation to Date. Employee acknowledges and agrees that, with the payment of his salary through the Termination Date, he will have received all compensation due and owing him (including base salary, bonus or other incentive payments) for services performed through the Termination Date. 1.7 No Authority To Act or Represent the Company. From and after the Termination Date, Employee shall have no further authority to bind the Company or any of its affiliates to any contract or agreement or to act on behalf of the Company or to represent the Company at any industry or business functions. 1.8 Return of Materials. On or before the Termination Date, Employee shall return to the Company all Company-owned equipment and materials, including, but not limited to, any computers, mobile phones, all documents (whether existing in paper or electronic/digital media), compilations of data, files, manuals, letters, notebooks, reports, diskettes and all other materials and records of any kind, and any copies or other reproductions thereof, owned by the Company or its affiliates and used by Employee in the course of Employee's employment. 1.9 Agreement to Cooperate. Employee agrees to respond promptly, and to cooperate with, reasonable requests for information that the Company may make relating to matters on which Employee worked while he was employed by the Company. 1.10 Continued Service on Alliance for Education Board. The Company agrees that Employee may continue to serve on the Board of Directors of the Alliance for Education through the end of his existing term. 2. Payments; Contributions. 2.1 Severance Payment. As compensation to Employee, and in consideration of the termination of Employee's role as an officer and Employee's resignation as an employee of the Company and its affiliates, Employee's release agreement in Section 4 and other agreements made herein, in addition to the benefits provided under Section 1 above and the further consideration provided under Section 3 below, the Company agrees to pay Employee a total sum of Four Hundred Fifty-One Thousand, Seventy-Five Dollars ($451,075) as a severance payment (the "Severance Payment"). The Severance Payment shall be subject to withholding and deduction for payroll taxes and other deductions as are required by federal and state law. The Severance Payment shall be paid in a lump sum within ten (10) business days of the Effective Date of the Agreement (see Paragraph 11.4). Employee and the Company agree that the Severance Payment represents sufficient consideration for the potential claims being released. 2.2 Payment in Lieu of Leadership Performance Plan Incentive. The Company agrees to pay Employee the sum of Three Hundred Fifty Thousand Dollars ($350,000) in lieu of any annual incentive payment Employee might have received in 2004 under the Leadership Performance Plan. Employee shall not be entitled to any other bonus, incentive payment or other variable pay for past services or the current calendar year. 2.3 Benefit Plan Contributions. Employee shall continue to be eligible as an "employee" of the Company through the Termination Date for employer contributions paid under the Company's employee benefit plans. Employee shall be eligible to participate in and shall receive pro rata contributions to the Safeco 401(k)/Profit Sharing Retirement Plan, as the same may be available to other employees of the Company. Employee acknowledges that any employer contributions to, or interest or other income credited to, any of the Safeco 401(k)/Profit Sharing Retirement Plan or Safeco Employees' Cash Balance Plan shall be additional compensation to Employee in excess of the total Severance Payment amount described above. 2.4 Stock Options and Accelerated Vesting of Unvested Options. The Compensation Committee of the Safeco Board of Directors has approved accelerated vesting of all of Employee's outstanding Non-Qualified Stock Options and Incentive Stock Options, such that each such Stock Option shall be fully vested, fully exercisable, and wholly non-forfeitable as of the Termination Date, contingent upon Employee's execution of this Agreement and the expiration of the revocation period. Pursuant to the provisions of the 1987 Plan and the LTIP relating to the termination of employment, each outstanding Stock Option shall, to the extent that it is or becomes exercisable as of the Termination Date, remain exercisable for three months thereafter, until April 30, 2004; provided, however, that no Stock Option shall remain exercisable beyond its maximum stated term. In the event that Employee accepts competitive employment that would result in forfeiture of gains from exercise of her Stock Options, the Company agrees that it will not seek or require forfeiture of Employee's gains so long as Employee is in full compliance with Employee's obligations under this Agreement. 2.5 Compensation for Restricted Stock Rights ("RSR"). Employee acknowledges and agrees that he shall have no rights in, or be entitled to any compensation for, any RSRs. 2.6 Performance Stock Rights ("PSR"). Employee acknowledges and agrees that he shall have no rights in, or be entitled to any compensation for, any PSRs. 3. Transition Services. As further consideration to Employee for the agreements hereunder, including the release granted under Section 5 of this Agreement, the Company agrees to provide Employee with transition services through David Nelson and Associates for a period of up to one year from January 31, 2004. Employee and the Company shall direct that invoices for services obtained by Employee from David Nelson and Associates be forwarded directly to the Company for payment. 4. Release and Settlement. 4.1 Release. In consideration of the Company's delivery of the Severance Payment and other consideration and benefits provided to Employee under this Agreement, Employee hereby releases the Company and its affiliated companies, insurers, employee benefit or stock option plans in which Employee participates, and the employees, agents, officers, directors and shareholders of any of them (including their respective spouses and marital communities), from all claims, demands, actions, causes of action, or damages, of any kind or nature whatsoever that Employee may now have or may ever have had against any of them, whether such claims are known or unknown, and including but not limited to the Claims as described below. However, nothing in this Agreement shall create or imply any waiver by Employee of any claims (a) with respect to Employee's entitlement to compensation for vested benefits arising under any Company pension, retirement or welfare benefit plan, program or agreement, in accordance with the terms and conditions of such plans, (b) arising under any insurance or investor account or similar client relationship, (c) with respect to any breach by the Company of its obligations under this Agreement, all of which rights shall be preserved and unaffected by this release, or (d) with respect to indemnification by the Company, to the extent that such indemnification rights may arise or be provided under the Company's Articles of Incorporation or Bylaws, in connection with Employee's official actions (or omissions) on behalf of the Company during the period Employee served as an officer of the Company. EMPLOYEE ACKNOWLEDGES AND AGREES THAT THROUGH THIS RELEASE EMPLOYEE IS GIVING UP ALL RIGHTS AND CLAIMS OF EVERY KIND AND NATURE WHATSOEVER, KNOWN OR UNKNOWN, CONTINGENT OR LIQUIDATED, THAT EMPLOYEE MAY HAVE AGAINST THE COMPANY, AND THE OTHER PERSONS REFERENCED ABOVE, EXCEPT FOR THE RIGHTS SPECIFICALLY EXCLUDED ABOVE. 4.2 The Claims. For the purposes of this Agreement, "Claims" shall mean and include, without limitation, Claims with respect to any of the following: (i) breach of contract; (ii) discrimination, retaliation, or constructive or wrongful discharge; (iii) lost wages, lost employee benefits, physical and personal injury, stress, mental distress, or impaired reputation; (iv) Claims arising under the Age Discrimination in Employment Act ("ADEA"), the Older Workers Benefit Protection Act, the Washington State Law Against Discrimination, Title VII of the Civil Rights Act, the Equal Pay Act, the Americans with Disabilities Act, the Family Medical Leave Act, or any other federal, state or local laws or regulations prohibiting employment discrimination; (v) attorneys' fees; and (vi) any other Claim arising from or relating to Employee's employment with the Company and/or Employee's separation from service. 4.3 Consideration for Release. The Company represents, and Employee acknowledges, that the Severance Payment and the other consideration and benefits provided hereunder exceed any amount the Company may arguably be required to pay under any agreement or arrangement to which Employee is a party or under which Employee claims some benefit, or under the standard policies and procedures of the Company, and represents valuable consideration to Employee for the release of the Claims described above. 5. No Admission. Employee understands and acknowledges that neither the Severance Payment nor the other benefits provided hereunder, nor the execution and delivery of this Agreement by the Company, constitutes an admission by the Company to (i) any breach of an agreement with Employee, (ii) any violation of a federal, state or local statute, regulation or ordinance, or (iii) any other wrongdoing. The Company understands and acknowledges that neither Employee's acceptance of the Severance Payment and other benefits provided hereunder, nor Employee's execution and delivery of this Agreement, constitutes an admission by Employee to (i) any breach of an agreement with the Company, (ii) any violation of a federal, state or local statute, regulation or ordinance, or (iii) any other wrongdoing. 6. Confidential Information. 6.1 Possession of Non-Public Information. Employee recognizes that by virtue of Employee's employment by the Company, Employee has acquired significant non-public information and trade secrets with respect to the Company and its affiliated companies, and their operations (the "Confidential Information"). Employee recognizes and acknowledges that the Confidential Information constitutes valuable, special and unique assets of the Company and its affiliates, access to and knowledge of which were essential to the performance of Employee's duties during Employee's employment. 6.2 Non-Disclosure. Employee agrees to hold the Confidential Information in trust and confidence. Employee agrees not to (i) directly or indirectly make use of the Confidential Information, (ii) reveal any Confidential Information to any other party, or (iii) divulge or use any Confidential Information for any purpose other than for the benefit of the Company, except to the extent that Employee may be required to disclose such Confidential Information by lawful order or process of a court (in which event Employee will provide reasonable advance notice of such disclosure to the Company and will cooperate with the Company's efforts to obtain protective treatment for such Confidential Information). 6.3 Materials. Employee shall not remove from the Company's premises or possession any documents, compilations of data or other files or records of any nature, or any copy or reproduction thereof, that contain Confidential Information or that belong to the Company. 7. Non-Disparagement/Non-Solicitation. Employee agrees not to make any disparaging or derogatory remarks about the Company, its affiliated companies or any of their officers, directors, employees or agents at any time. This Section 7 shall not be construed to prohibit Employee from responding truthfully and publicly to incorrect public statements or from making truthful statements when required by law or order of a court or other person or body having jurisdiction. Employee agrees that for six (6) months following the Termination Date, Employee will not directly or indirectly solicit or entice any person who is an employee, partner, affiliate, agent or prospective partner or agent of the Company to cease, terminate or reduce any relationship with the Company. 8. Legal Action. 8.1 No Claims. Employee represents that Employee has not filed a Claim or complaint against the Company or any of its affiliated companies, or any of their employees, agents, officers, directors or shareholders with any court or agency. The Company represents that it is not aware of any legal action pending or potentially pending against Employee for acts or omissions as an employee of the Company. 8.2 Indemnification. To the extent provided as of the Termination Date in the indemnification provisions of the Company's articles of incorporation and bylaws and to the maximum extent permitted under the laws of the state of Washington, Employee shall be entitled to indemnification, and advancement of expenses, in respect of matters that occurred during the time that he was an officer of the company. 8.3 No Action on Released Claims. Employee agrees not to sue or pursue any court or administrative action against the Company or any of its affiliates, or any of their employees, agents, officers, directors or shareholders, to the extent allowed by applicable law, regarding any Claims released herein or otherwise arising from Employee's employment with the Company or Employee's separation from service, except with respect to any breach by the Company of its obligations under this Agreement. If any government agency brings any claim or conducts any investigation against the Company, Employee waives and agrees to relinquish any damages or other individual relief that may be awarded as a result of any such proceedings. 8.4 Liability for Defense Costs. If, notwithstanding this Agreement, Employee should file any lawsuit or other proceeding based on legal claims that Employee has released herein, Employee agrees to pay or reimburse the Company for all reasonable costs, including attorneys' fees, that it, or its affiliates, or their employees, agents, officers or directors, incur in defending against Employee's claims. This paragraph shall not apply to any claimed breach by the Company of any of the terms or conditions of this Agreement. 9. Agreement Confidential. 9.1 Terms of Agreement. Employee and the Company agree that neither of them shall reveal or publicize the existence of this Agreement or its terms, including but not limited to the amount of the Severance Payment, except as required by law, including as required by annual financial and other corporate reporting requirements. Further, the parties agree that they shall not discuss with or make to the public at large or to any individual person or persons any statements with regard to this Agreement, or matters relating to its terms. Notwithstanding the foregoing, the parties may discuss the existence and terms of this Agreement with their respective attorneys, accountants, financial advisors to obtain counsel and advice, and, in Employee's case, with members of Employee's immediate family, and, in the Company's case, with members of the Company's Senior Leadership Team. Nothing in this confidentiality provision prohibits Employee from representing to third parties that Employee "resigned from the Company on mutually agreeable terms" or that the parties "parted amicably." 9.2 Employment References. Employee agrees to direct all requests for employment references from prospective employers to the attention of Allie Mysliwy, Senior Vice President and head of Human Resources for the Company. If a prospective employer contacts the Company for an employment reference with respect to Employee, the Company will provide, unless required otherwise by law, only the following information: Employee's dates of employment, and Employee's title and salary at the Termination Date. 10. Costs. No later than the Termination Date, the Company shall pay Employee a lump sum of One Thousand Five Hundred Dollars ($1,500) to defray any attorney and tax advisor fees incurred in connection with Employee's separation from employment with the Company. Except for this payment to Employee, each party shall separately bear their costs and expenses incurred in connection with the negotiation and preparation of this Agreement. 11. Acknowledgment. 11.1 Informed Agreement. Employee declares that Employee has read and fully understands the terms of this Agreement and its significance and consequence. Employee further declares that this Agreement is the product of good faith negotiations between Employee and the Company, and that Employee voluntarily accepts the same for the purpose of resolving arrangements with respect to Employee's resignation. 11.2 Attorney. Employee acknowledges that the Company has advised Employee to review the terms of this Agreement with an attorney of Employee's own choosing and that Employee has done so or knowingly waived Employee's right to do so. 11.3 Voluntary Act. Employee acknowledges that this Agreement is voluntary and has not been given as a result or any coercion. 11.4 Review and Revocation Periods, Effective Date. Employee acknowledges that the Company has given Employee at least twenty-one (21) days during which to consider this Agreement prior to signing. Negotiations about the terms or language of this Agreement shall not re-start the 21-day consideration period. Employee has seven (7) days after signing in which Employee may revoke this Agreement. This Agreement shall not become effective or enforceable until such seven-day period has expired (the "Effective Date of the Agreement"). Employee understands that she may revoke this Agreement by delivering a written notice to the attention of Allie Mysliwy at Safeco Plaza, T-17, Seattle, WA 98185, no later than the close of business on the seventh day after Employee signs this Agreement. Employee understands and acknowledges that if Employee revokes this Agreement it will not be effective or enforceable and Employee will not receive the payments or other benefits described herein. 12. Entire Agreement. This Agreement along with the Product Ownership Agreement, a copy of which is attached as Exhibit A, constitute the entire agreement between Employee and the Company, and they supersede and replaces all prior written and oral agreements and understandings between the parties with respect to their subject matter. Neither the Company nor any affiliate has made any promises to Employee other than those included within this Agreement. 13. Waiver. No waiver of any provision of this Agreement shall be deemed, or shall constitute, a waiver of any other provisions, whether or not similar, nor shall any waiver constitute a continuing waiver. No waiver shall be binding unless executed in writing by the party making the waiver. 14. Injunctive Relief. Employee recognizes that irreparable and continuing injury for which there is not adequate remedy at law will result to the Company and its business and property if Employee breaches Employee's obligations under this Agreement. In the event of any such breach or threatened breach, the Company shall be entitled to seek temporary injunctive relief upon a showing of such breach or threatened breach without proof of actual damage and without posting a bond therefore, and/or an order of temporary and permanent specific performance enforcing this Agreement, and any other remedies provided by applicable law. Employee agrees that in the event of any such proven breach, the Company shall be entitled to recover its costs associated with enforcing this Agreement, including reasonable attorney's fees. Employee further understands and agrees that the word "temporary" as used herein shall include both temporary and preliminary relief and/or remedies available. 15. Amendment. No supplement, modification, or amendment of this Agreement shall be valid, unless it is made in writing and signed by both parties hereto. 16. Severability. In the event any provision or portion of this Agreement is held to be unenforceable or invalid by any court of competent jurisdiction, the remainder of this Agreement shall remain in full force and effect and shall in no way be affected or invalidated thereby. 17. Governing Law; Jurisdiction and Venue. The parties acknowledge that this Agreement shall be governed, interpreted and enforced in accordance with the laws of the state of Washington, without regard to its conflict of law principles. Any suit or action arising out of or in connection with this Agreement, or any breach hereof, shall be brought and maintained in the federal or state courts located in Seattle, Washington. The parties irrevocably submit to the jurisdiction and venue of such courts for the purpose of such suit or action and hereby expressly and irrevocably waive, to the fullest extent permitted by law, any objection they may now or hereafter have to the venue of any such suit or action in any such court and any claim that any such suit or action has been brought in an inconvenient forum. (signature page follows) PLEASE READ CAREFULLY. THIS SEPARATION AND GENERAL RELEASE AGREEMENT INCLUDES A RELEASE OF ALL KNOWN AND UNKNOWN CLAIMS. /s/ Bruce Allenbaugh ------------------------------ BRUCE ALLENBAUGH Date: January 31, 2004 SAFECO CORPORATION By /s/ Michael S. McGavick ------------------------------ MICHAEL S. MCGAVICK Its President and Chief Executive Officer Date: January 31, 2004 EX-31.1 3 en0706_311.txt EX-31.1 Exhibit 31.1 Safeco Corporation and Subsidiaries - ------------------------------------------------------------------------------- Certification of Chief Executive Officer - ------------------------------------------------------------------------------- I, Michael S. McGavick, certify that: 1. I have reviewed this Quarterly Report on Form 10-Q of Safeco Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have; (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: May 7, 2004 /s/ MICHAEL S. MCGAVICK Michael S. McGavick Chairman, President and Chief Executive Officer EX-31.2 4 en0706_ex312.txt EX-31.2 Exhibit 31.2 Safeco Corporation and Subsidiaries - ------------------------------------------------------------------------------- Certification of Chief Financial Officer - ------------------------------------------------------------------------------- I, Christine B. Mead, certify that: 1. I have reviewed this Quarterly Report on Form 10-Q of Safeco Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have; (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: May 7, 2004 /s/ CHRISTINE B. MEAD Christine B. Mead Chief Financial Officer and Secretary EX-32.1 5 en0706_321.txt EX-32.1 Exhibit 32.1 Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 In connection with the Quarterly Report of Safeco Corporation (the "Company") on Form 10-Q for the quarter ended March 31, 2004 as filed with the Securities and Exchange Commission on the date hereof (the "Form 10-Q"), I, Michael S. McGavick, Chairman, President and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Form 10-Q fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)); and (2) The information contained in the Form 10-Q fairly presents, in all material respects, the financial condition and results of operations of the Company. Dated: May 7, 2004 /s/ MICHAEL S. MCGAVICK Michael S. McGavick Chairman, President and Chief Executive Officer A signed original of this written statement required by Section 906, or other document authenticating, acknowledging, or otherwise adopting the signature that appears in typed form within the electronic version of this written statement required by Section 906, has been provided to Safeco Corporation and will be retained by Safeco Corporation and furnished to the Securities and Exchange Commission or its staff upon request. EX-32.2 6 en0706_ex322.txt EX-32.2 Exhibit 32.2 Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 In connection with the Quarterly Report of Safeco Corporation (the "Company") on Form 10-Q for the quarter ended March 31, 2004 as filed with the Securities and Exchange Commission on the date hereof (the "Form 10-Q"), I, Christine B. Mead, Chief Financial Officer and Secretary of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Form 10-Q fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)); and (2) The information contained in the Form 10-Q fairly presents, in all material respects, the financial condition and results of operations of the Company. Dated: May 7, 2004 /s/ CHRISTINE B. MEAD Christine B. Mead Senior Vice President, Chief Financial Officer and Secretary A signed original of this written statement required by Section 906, or other document authenticating, acknowledging, or otherwise adopting the signature that appears in typed form within the electronic version of this written statement required by Section 906, has been provided to Safeco Corporation and will be retained by Safeco Corporation and furnished to the Securities and Exchange Commission or its staff upon request. -----END PRIVACY-ENHANCED MESSAGE-----