-----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, F57drK9+8CJWGt20i9GCgL+No147t9VP/DIRgEFntymdsnnyZjc4aXh19kBsBS81 Or2jT7l9YoxfiXmWAHq7IQ== 0000086312-01-500012.txt : 20010815 0000086312-01-500012.hdr.sgml : 20010815 ACCESSION NUMBER: 0000086312-01-500012 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 20010630 FILED AS OF DATE: 20010814 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ST PAUL COMPANIES INC /MN/ CENTRAL INDEX KEY: 0000086312 STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331] IRS NUMBER: 410518860 STATE OF INCORPORATION: MN FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-10898 FILM NUMBER: 1711480 BUSINESS ADDRESS: STREET 1: 385 WASHINGTON ST CITY: SAINT PAUL STATE: MN ZIP: 55102 BUSINESS PHONE: 6123107911 FORMER COMPANY: FORMER CONFORMED NAME: SAINT PAUL COMPANIES INC DATE OF NAME CHANGE: 19900730 FORMER COMPANY: FORMER CONFORMED NAME: ST PAUL COMPANIES INC/MN/ DATE OF NAME CHANGE: 19990219 FORMER COMPANY: FORMER CONFORMED NAME: ST PAUL FIRE & MARINE INSURANCE CO/MD DATE OF NAME CHANGE: 19990219 10-Q 1 tenq601.txt JUNE 30, 2001 FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF ----- THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2001 ------------- or TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) ----- OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to ---------- ---------- Commission File Number 001-10898 --------- THE ST. PAUL COMPANIES, INC. ---------------------------------------------------- (Exact name of Registrant as specified in its charter) Minnesota 41-0518860 ------------------------------ --------------------------------- (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 385 Washington St., Saint Paul, MN 55102 ---------------------------------- -------- (Address of principal executive (Zip Code) offices) Registrant's telephone number, including area code: (651) 310-7911 ------------- Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes X No ----- ----- The number of shares of the Registrant's Common Stock, without par value, outstanding at August 10, 2001, was 208,947,154. THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES TABLE OF CONTENTS Page No. PART I. FINANCIAL INFORMATION -------- Consolidated Statements of Operations (Unaudited), Three Months and Six Months Ended June 30, 2001 and 2000 3 Consolidated Balance Sheets, June 30, 2001 (Unaudited) and December 31, 2000 4 Consolidated Statements of Shareholders' Equity, Six Months Ended June 30, 2001 (Unaudited) and Twelve Months Ended December 31, 2000 6 Consolidated Statements of Comprehensive Income (Unaudited), Six Months Ended June 30, 2001 and 2000 7 Consolidated Statements of Cash Flows (Unaudited), Six Months Ended June 30, 2001 and 2000 8 Notes to Consolidated Financial Statements (Unaudited) 9 Management's Discussion and Analysis of Financial Condition and Results of Operations 23 PART II. OTHER INFORMATION Item 1 through Item 6 38 Signatures 38 EXHIBIT INDEX 39 PART I FINANCIAL INFORMATION THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Consolidated Statements of Operations (Unaudited) Three Months Ended Six Months Ended (In millions, except June 30 June 30 per share data) ------------------ ---------------- 2001 2000 2001 2000 ------ ------ ------ ------ Revenues: Premiums earned $1,743 1,421 3,371 2,777 Net investment income 300 317 635 636 Asset management 85 84 170 177 Realized investment gains 7 110 83 445 Other 31 39 71 82 ------ ------ ------ ------ Total revenues 2,166 1,971 4,330 4,117 ------ ------ ------ ------ Expenses: Insurance losses and loss adjustment expenses 1,346 1,026 2,529 2,054 Policy acquisition expenses 356 321 736 658 Operating and administrative 331 323 634 584 ------ ------ ------ ------ Total expenses 2,033 1,670 3,899 3,296 ------ ------ ------ ------ Income from continuing operations before income taxes 133 301 431 821 Income tax expense 37 84 126 255 ------ ------ ------ ------ Income from continuing operations 96 217 305 566 Discontinued operations: Operating gain (loss), net of taxes - 2 (1) 15 Gain (loss) on disposal, net of taxes 8 (7) 2 (12) ------ ------ ------ ------ Income (loss) from discontinued operations, net of taxes 8 (5) 1 3 ------ ------ ------ ------ Net income $ 104 212 306 569 ====== ====== ====== ====== Basic earnings per common share: Income from continuing operations $0.43 1.00 1.37 2.57 Discontinued operations, net of taxes 0.04 (0.02) 0.01 0.02 ------ ------ ------ ------ Net income $0.47 0.98 1.38 2.59 ====== ====== ====== ====== Diluted earnings per common share: Income from continuing operations $0.41 0.94 1.32 2.42 Discontinued operations, net of taxes 0.04 (0.02) 0.01 0.01 ------ ------ ------ ------ Net income $0.45 0.92 1.33 2.43 ====== ====== ====== ====== Dividends declared on common stock $0.28 0.27 0.56 0.54 ====== ====== ====== ====== See notes to consolidated financial statements. THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Consolidated Balance Sheets (In millions) Restated June 30, December 31, ASSETS 2001 2000 - ---------- ----------- ------------ (Unaudited) Investments: Fixed maturities, at estimated fair value $15,823 $15,937 Equities, at estimated fair value 1,269 1,466 Real estate and mortgage loans 999 1,025 Venture capital, at estimated fair value 973 1,064 Securities lending collateral 1,003 1,207 Other investments 108 229 Short-term investments, at cost 850 1,124 ------- -------- Total investments 21,025 22,052 Cash 94 52 Reinsurance recoverables: Unpaid losses 5,121 4,651 Paid losses 382 324 Ceded unearned premiums 767 814 Receivables: Underwriting premiums 2,983 2,937 Interest and dividends 269 277 Other 304 181 Deferred policy acquisition expenses 639 576 Deferred income taxes 986 930 Office properties and equipment, at cost less accumulated depreciation of $464 (2000; $452) 486 492 Goodwill 519 510 Asset management securities held for sale 31 29 Other assets 1,871 1,677 ------- ------- Total assets $35,477 $35,502 ======= ======= See notes to consolidated financial statements. THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Consolidated Balance Sheets (continued) (In millions) Restated June 30, December 31, LIABILITIES AND SHAREHOLDERS' EQUITY 2001 2000 - ------------------------------------ -------- ------------ (Unaudited) Liabilities: Insurance reserves: Losses and loss adjustment expenses $18,411 $18,196 Unearned premiums 3,908 3,648 ------- ------- Total insurance reserves 22,319 21,844 Debt 1,796 1,647 Payables: Reinsurance premiums 933 1,060 Income taxes 127 170 Accrued expenses and other 946 1,031 Securities lending 1,023 1,231 Other liabilities 1,127 955 ------- ------- Total liabilities 28,271 27,938 ------- ------- Company-obligated mandatorily redeemable preferred capital securities of trusts holding solely subordinated debentures of the Company 337 337 ------- ------- Shareholders' equity: Preferred: SOP convertible preferred stock; 1.45 shares authorized; 0.8 shares outstanding (0.8 shares in 2000) 114 117 Guaranteed obligation - SOP (58) (68) ------- ------- Total preferred shareholders' equity 56 49 ------- ------- Common: Common stock, 480 shares authorized; 211 shares outstanding (218 shares in 2000) 2,211 2,238 Retained earnings 4,143 4,243 Accumulated other comprehensive income: Unrealized appreciation 522 765 Unrealized loss on foreign currency translation (62) (68) Unrealized loss on derivatives (1) - ------- ------- Total accumulated other comprehensive income 459 697 ------- ------- Total common shareholders' equity 6,813 7,178 ------- ------- Total shareholders' equity 6,869 7,227 ------- ------- Total liabilities, redeemable preferred securities and shareholders' equity $35,477 $35,502 ======= ======= See notes to consolidated financial statements. THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Consolidated Statements of Shareholders' Equity (In millions) Six Twelve Months Ended Months Ended June 30 December 31 -------------- ------------ 2001 2000 -------- -------- (Unaudited) Preferred shareholders' equity: Series B SOP convertible preferred stock: Beginning of period $117 $129 Redemptions during period (3) (12) -------- -------- End of period 114 117 -------- -------- Guaranteed obligation - SOP: Beginning of period (68) (105) Principal payments 10 37 -------- -------- End of period (58) (68) -------- -------- Total preferred shareholders' equity 56 49 -------- -------- Common shareholders' equity: Common stock: Beginning of period 2,238 2,079 Stock issued under stock incentive plans 43 95 Stock issued for preferred shares redeemed 8 23 Conversion of company-obligated preferred securities - 207 Reacquired common shares (86) (170) Other 8 4 -------- -------- End of period 2,211 2,238 -------- -------- Retained earnings: Beginning of period 4,243 3,827 Net income 306 993 Dividends declared on common stock (119) (232) Dividends declared on preferred stock, net of taxes (5) (8) Reacquired common shares (303) (366) Tax benefit on employee stock options, and other changes 26 40 Premium on preferred shares redeemed (5) (11) -------- -------- End of period 4,143 4,243 -------- -------- Unrealized appreciation, net of taxes: Beginning of period 765 568 Change during the period (243) 197 -------- -------- End of period 522 765 -------- -------- Unrealized gain (loss)loss on foreign currency translation, net of taxes: Beginning of period (68) (26) Change during the period 6 (42) -------- -------- End of period (62) (68) -------- -------- Unrealized loss on derivatives, net of taxes: Beginning of period - - Change during the period (1) - -------- -------- End of period (1) - -------- -------- Total common shareholders' equity 6,813 7,178 -------- -------- Total shareholders' equity $6,869 $7,227 ======== ======== See notes to consolidated financial statements. THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Consolidated Statements of Comprehensive Income Unaudited (In millions) Three Months Ended Six Months Ended June 30 June 30 ------------------ ---------------- 2001 2000 2001 2000 ------ ------ ------ ------ Net income $104 $212 $306 $569 ------ ------ ------ ------ Other comprehensive income (loss), net of taxes: Change in unrealized appreciation (130) (45) (243) 97 Change in unrealized loss on foreign currency translation (13) (7) 6 (21) Change in unrealized loss on derivatives 1 - (1) - ------ ------ ------ ------ Other comprehensive income (loss) (142) (52) (238) 76 ------ ------ ------ ------ Comprehensive income (loss) $ (38) $160 $ 68 $645 ====== ====== ====== ====== See notes to consolidated financial statements. THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows Unaudited (In millions) Six Months Ended June 30 ---------------------- 2001 2000 ------ ------ OPERATING ACTIVITIES Net income $306 $569 Adjustments: Gain from discontinued operations (1) (3) Change in insurance reserves 601 232 Change in reinsurance balances (661) (615) Realized investment gains (83) (445) Change in deferred acquisition costs (65) (46) Change in accounts payable and accrued expenses (81) (196) Change in insurance premiums receivable (71) (210) Change in income taxes payable/refundable (31) 177 Provision for federal deferred tax expenses 147 117 Depreciation and amortization 49 49 Change in other assets and liabilities (155) (128) ------ ------ Net Cash Used by Continuing Operations (45) (499) Net Cash Provided by Discontinued Operations 101 75 ------ ------ Net Cash Provided (Used) by Operating Activities 56 (424) ------ ------ INVESTING ACTIVITIES Purchase of investments (2,968) (2,957) Proceeds from sales and maturities of investments 3,198 3,515 Net sales of short-term investments 267 165 Change in open security transactions 44 7 Purchases of office properties and equipment (34) (52) Sales of office properties and equipment 3 7 Acquisitions, net of cash acquired - (206) Proceeds from sale of subsidiaries - 201 Other (13) 86 ------ ------ Net Cash Provided by Continuing Operations 497 766 Net Cash Used by Discontinued Operations (365) (246) ------ ------ Net Cash Provided by Investing Activities 132 520 ------ ------ FINANCING ACTIVITIES Dividends paid on common and preferred stock (124) (120) Proceeds from issuance of debt 292 498 Repayment of debt (161) (415) Repurchase of common shares (389) (333) Stock options exercised and other (1) 34 ------ ------ Net Cash Used by Continuing Operations (383) (336) Net Cash Provided by Discontinued Operations 238 187 ------ ------ Net Cash Used by Financing Activities (145) (149) ------ ------ Effect of exchange rate changes on cash (1) - ------ ------ Increase (decrease) in cash 42 (53) Cash at beginning of period 52 105 ------ ------ Cash at end of period $ 94 $ 52 ====== ====== See notes to consolidated financial statements. THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Unaudited June 30, 2001 Note 1 - Basis of Presentation - ------------------------------ The financial statements include The St. Paul Companies, Inc. and subsidiaries ("The St. Paul" or "the company"), and have been prepared in conformity with generally accepted accounting principles ("GAAP"). These consolidated financial statements rely, in part, on estimates. In the opinion of management, all necessary adjustments, consisting of normal recurring adjustments, have been reflected for a fair presentation of the results of operations, financial position and cash flows in the accompanying unaudited consolidated financial statements. The results for the period are not necessarily indicative of the results to be expected for the entire year. On April 26, 2001, we announced that our subsidiary, St. Paul Fire and Marine Insurance Company, had reached a definitive agreement to sell its subsidiary, Fidelity and Guaranty Life Insurance Company ("F&G Life") to Old Mutual plc, a London-based international financial services company. F&G Life's results of operations have been reclassified to discontinued operations for all periods presented in this report. On our consolidated balance sheets as of June 30, 2001 and Dec. 31, 2000, F&G Life's net assets were included in "Other Assets," classified as net assets of discontinued operations. See Footnote 12. Reference should be made to the "Notes to Consolidated Financial Statements" in The St. Paul's annual report to shareholders for the year ended December 31, 2000. The amounts in those notes have not changed materially except as a result of transactions in the ordinary course of business or as otherwise disclosed in these notes. Some amounts in the 2000 consolidated financial statements have been reclassified to conform with the 2001 presentation. These reclassifications had no effect on net income, comprehensive income or shareholders' equity, as previously reported. In June, 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," which establishes accounting and reporting standards for derivative instruments and hedging activities. This statement requires all derivatives to be recorded at fair value on the balance sheet and establishes new accounting rules for hedging. In June 1999, the FASB issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FAS No. 133," which amended SFAS No. 133 to make it effective for all quarters of fiscal years beginning after June 15, 2000. In June 2000, the FASB issued FASB No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities," as an additional amendment to SFAS No. 133, to address a limited number of issues causing implementation difficulties. Effective Jan. 1, 2001, we adopted the provisions of SFAS No. 133, as amended. See Footnote 11 on page 20 and Footnote 6 on page 14 of this report for further information regarding the impact of the adoption on our financial statements. THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Note 2 - Earnings Per Share - --------------------------- The following table provides the calculation of our earnings per common share for the three months and six months ended June 30, 2001 and 2000. Three Months Ended Six Months Ended June 30 June 30 ------------------ ---------------- 2001 2000 2001 2000 ------ ------ ------ ------ (In millions, except per share data) EARNINGS Basic: Net income, as reported $104 $212 $306 $569 Dividends on preferred stock, net of taxes (2) (2) (4) (4) Premium on preferred shares redeemed (3) (2) (5) (6) ------ ------ ------ ------ Net income available to common shareholders $ 99 $208 $297 $559 ====== ====== ====== ====== Diluted: Net income available to common shareholders $ 99 $208 $297 $559 Effect of dilutive securities: Convertible preferred stock 2 2 3 3 Zero coupon convertible notes 1 1 2 1 Convertible monthly income preferred securities - 2 - 4 ------ ------ ------ ------ Net income available to common shareholders, as adjusted $102 $213 $302 $567 ====== ====== ====== ====== COMMON SHARES Basic: Weighted average common shares outstanding 214 212 215 216 ====== ====== ====== ====== Diluted: Weighted average common shares outstanding 214 212 215 216 Effect of dilutive securities: Stock options 4 2 4 1 Convertible preferred stock 7 7 7 7 Zero coupon convertible notes 2 2 2 3 Convertible monthly income preferred securities - 7 - 7 ------ ------ ------ ------ Total 227 230 228 234 ====== ====== ====== ====== EARNINGS PER SHARE Basic $0.47 $0.98 $1.38 $2.59 ====== ====== ====== ====== Diluted $0.45 $0.92 $1.33 $2.43 ====== ====== ====== ====== THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Note 3 - Investments - -------------------- Investment Activity. The following is a summary of our investment purchases, sales and maturities for continuing operations. Six Months Ended June 30 ------------------------ 2001 2000 ------- ------- (In millions) Purchases: Fixed maturities $1,896 $1,459 Equities 868 1,189 Real estate and mortgage loans 48 - Venture capital 147 299 Other investments 9 10 ------- ------- Total purchases 2,968 2,957 ------- ------- Proceeds from sales and maturities: Fixed maturities 2,061 1,720 Equities 866 1,170 Real estate and mortgage loans 99 80 Venture capital 22 532 Other investments 150 13 ------- ------- Total sales and maturities 3,198 3,515 ------- ------- Net sales $(230) $(558) ======= ======= THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Note 3 - Investments (continued) - ------------------------------- Change in Unrealized Appreciation. The increase (decrease) in unrealized appreciation of investments recorded in common shareholders' equity was as follows: Restated Six Months Ended Twelve Months Ended June 30, 2001 December 31, 2000 ---------------- ------------------- (In millions) Fixed maturities $ 70 $467 Equities (228) (198) Venture capital (216) (61) Other (50) 47 ------ ------ Total change in pretax unrealized appreciation on continuing operations (424) 255 Change in deferred taxes 167 (92) ------ ------ Total change in unrealized appreciation on continuing operations, net of taxes $ (257) $163 Change in pretax unrealized appreciation on discontinued operations 21 52 Change in deferred taxes (7) (18) ------ ------ Total change in pretax appreciation on discontinued operations, net of taxes 14 34 ------ ------ Total change in pretax appreciation, net of taxes $(243) $197 ====== ====== THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Note 4 - Income Taxes - --------------------- The components of income tax expense (benefit) on income from continuing operations were as follows : Three Months Ended Six Months Ended June 30 June 30 ------------------ ---------------- 2001 2000 2001 2000 ------ ------ ------ ------ (In millions) Federal current tax expense (benefit) $ (13) $ (4) $ (25) $ 130 Federal deferred tax expense 51 88 147 117 ------ ------ ------ ------ Total federal income tax expense 38 84 122 247 Foreign income tax expense (benefit) (2) (5) (1) 1 State income tax expense 1 5 5 7 ------ ------ ------ ------ Total income tax expense $ 37 $ 84 $ 126 $ 255 ====== ====== ====== ====== Note 5 - Contingent Liabilities - ------------------------------- In the ordinary course of conducting business, we and some of our subsidiaries have been named as defendants in various lawsuits. Some of these lawsuits attempt to establish liability under insurance contracts issued by our underwriting operations. Plaintiffs in these lawsuits are asking for money damages or to have the court direct the activities of our operations in certain ways. Although it is possible that the settlement of a contingency may be material to our results of operations and liquidity in the period in which the settlement occurs, we believe that the total amounts that we and our subsidiaries will ultimately have to pay in all of these lawsuits will have no material effect on our overall financial position. In some cases, plaintiffs seek to establish coverage for their liability under environmental protection laws. See "Environmental and Asbestos Claims" in Management's Discussion and Analysis for information on these claims. THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Note 6 - Debt - ------------- Debt consists of the following: June 30, December 31, 2001 2000 -------------- ---------------- Book Fair Book Fair Value Value Value Value ----- ----- ----- ------ (In millions) Medium-term notes $ 606 $ 612 $ 617 $ 619 Commercial paper 403 403 138 138 7-7/8% senior notes 249 264 249 261 8-1/8% senior notes 249 271 249 267 Zero coupon convertible notes 101 103 98 95 7-1/8% senior notes 80 82 80 82 Variable rate borrowings 64 64 64 64 Real estate debt 29 30 2 2 8-3/8% senior notes - - 150 151 ----- ----- ----- ----- Total obligations 1,781 1,829 $1,647 $1,679 Fair value of interest ===== ===== rate swap agreements 15 15 ----- ----- Total debt reported on balance sheet $1,796 $1,844 ===== ===== In June 2001, our $150 million, 8-3/8% senior notes matured. The repayment of these notes was funded through a combination of internally-generated funds and the issuance of commercial paper. At June 30, 2001, we were party to a number of interest rate swap agreements related to several of our debt securities outstanding. The notional amount of these swaps totaled $380 million, and their aggregate fair value at June 30, 2001 was an asset of $15 million. Prior to our adoption of SFAS No. 133, as amended, on Jan. 1, 2001, the fair value of these swap agreements was not recorded on our balance sheet. Upon adoption, we reflected the fair value of these swap agreements as an increase to other assets and a corresponding increase to debt on our balance sheet. Note 7 - Segment Information - ---------------------------- We have seven reportable business segments in our property- liability insurance operation, consisting of the Commercial Lines Group, Global Surety, Global Health Care, Other Specialty, International, Reinsurance and Investment Operations. We also have an asset management segment (The John Nuveen Company). We evaluate the performance of our property-liability underwriting segments based on GAAP underwriting results. The property- liability investment operation is disclosed as a separate reportable segment because that operation is managed at the corporate level and the invested assets, net investment income and realized gains are not allocated to individual underwriting segments. The asset management segment is evaluated based on its pretax income, which includes investment income. As discussed in Note 12 on page 21 of this report, on April 26, 2001, we announced a definitive agreement to sell F&G Life, which comprises our life insurance segment. As a result, F&G Life's results of operations were included in discontinued operations on our statements of income included in this report for the six months ended June 30, 2001 and 2000. THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Note 7 - Segment Information (continued) - --------------------------------------- The reportable underwriting business segments in our property- liability operation are reported separately because they offer insurance products to unique customer classes and utilize different underwriting criteria and marketing strategies. For example, the Commercial Lines Group provides "commodity-type" insurance products to the small and medium-sized commercial markets. By contrast, each of our Specialty segments (Global Surety, Global Health Care and Other Specialty) market specialized insurance products and services tailored to meet the individual needs of specific customer groups, such as doctors, lawyers, officers and directors, as well as technology firms and government entities. Customers in the Specialty segments generally require specialized underwriting expertise and claim settlement services. The tabular information that follows provides revenue and income data from continuing operations for each of our business segments for the three months and six months ended June 30, 2001 and 2000. In the first quarter of 2001, we reclassified certain business that had previously been included in the Other Specialty segment to the International segment to more accurately reflect the manner in which this business is managed. Data for 2000 in the tables have been reclassified to be consistent with the 2001 presentation. Three Months Ended Six Months Ended June 30 June 30 ----------------- ------------------ 2001 2000 2001 2000 ------ ------ ------ ------ (In millions) Revenues Property-liability insurance: Commercial Lines Group $436 $392 $858 $780 Global Surety 109 107 213 220 Global Health Care 182 178 364 312 Other Specialty 437 333 861 661 International 257 169 427 246 ------ ------ ------ ------ Total primary insurance operations 1,421 1,179 2,723 2,219 Reinsurance 322 242 648 558 ------ ------ ------ ------ Total property-liability premiums earned 1,743 1,421 3,371 2,777 ------ ------ ------ ------ Investment operations: Net investment income 295 312 625 631 Realized investment gains 6 107 58 438 ------ ------ ------ ------ Total investment operations 301 419 683 1,069 Other 24 32 59 61 ------ ------ ------ ------ Total property- liability insurance 2,068 1,872 4,113 3,907 ------ ------ ------ ------ Asset management 87 88 174 188 ------ ------ ------ ------ Total reportable segments 2,155 1,960 4,287 4,095 Parent company, other operations and consolidating eliminations 11 11 43 22 ------ ------ ------ ------ Total revenues $2,166 $1,971 $4,330 $4,117 ====== ====== ====== ====== THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Note 7 - Segment Information (continued) - --------------------------------------- Three Months Ended Six Months Ended June 30 June 30 ------------------ ---------------- 2001 2000 2001 2000 ----- ----- ----- ----- (In millions) Income (Loss) Before Income Taxes Property-liability insurance: Commercial Lines Group $36 $54 $109 $ 32 Global Surety 15 12 32 31 Global Health Care (123) (45) (254) (64) Other Specialty 41 4 51 (17) International (51) (59) (89) (71) ----- ----- ----- ----- Total primary insurance (82) (34) (151) (89) Reinsurance (31) (33) (49) (78) ----- ----- ----- ----- Total GAAP underwriting result (113) (67) (200) (167) ----- ----- ----- ----- Investment operations: Net investment income 295 312 625 631 Realized investment gains 6 107 58 438 ----- ----- ----- ----- Total investment operations 301 419 683 1,069 Other (41) (33) (45) (64) ----- ----- ----- ----- Total property- liability insurance 147 319 438 838 ----- ----- ----- ----- Asset management: Pretax income before minority interest 45 43 90 86 Minority interest (11) (10) (21) (20) ----- ----- ----- ----- Total asset management 34 33 69 66 ----- ----- ----- ----- Total reportable segments 181 352 507 904 Parent company, other operations and consolidating eliminations (48) (51) (76) (83) ----- ----- ----- ----- Total income before income taxes $133 $301 $431 $821 ===== ===== ===== ===== THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Note 8 - Reinsurance - -------------------- Our consolidated financial statements reflect the effects of assumed and ceded reinsurance transactions. Assumed reinsurance refers to our acceptance of certain insurance risks that other insurance companies have underwritten. Ceded reinsurance involves transferring certain insurance risks (along with the related written and earned premiums) we have underwritten to other insurance companies who agree to share these risks. The primary purpose of ceded reinsurance is to protect us against earnings volatility and from potential losses in excess of the amount we are prepared to accept. We expect those with whom we have ceded reinsurance to honor their obligations. In the event these companies are unable to honor their obligations, we will pay these amounts. We have established allowances for possible nonpayment of amounts due to us. In both 2001 and 2000, we entered into separate aggregate excess- of-loss reinsurance treaties effective Jan. 1 of each year (the "corporate program"). Coverage under the corporate program is triggered when our insurance losses and loss adjustment expenses spanning all segments of our business reach a certain level. In addition, our Reinsurance segment was party to separate aggregate excess-of-loss reinsurance treaties unrelated to the corporate program in both years. All of these treaties are collectively referred to hereafter as the "reinsurance treaties." Under terms of the reinsurance treaties, we transfer, or "cede," insurance losses and loss adjustment expenses to our reinsurers, along with the related written and earned premiums. In the six months ended June 30, 2001 coverage under the corporate program was not triggered; but we ceded $9 million and $5 million of written and earned premiums, respectively, representing the initial premium paid to our reinsurer. Under the separate Reinsurance segment treaty, we ceded $45 and $43 million of written and earned premiums, respectively, and $102 million of insurance losses and loss adjustment expenses, for a net benefit of $59 million, in the first six months of 2001. In the six months ended June 30, 2000 our income from continuing operations benefited from cessions made under the corporate program, and cessions made under the separate treaty exclusive to our Reinsurance segment. Under the corporate program, we ceded written premiums of $80 million, earned premiums of $70 million, and insurance losses and loss adjustment expenses of $111 million, resulting in a net benefit of $41 million to our pretax income from continuing operations. The losses and loss adjustment expenses ceded and $61 million of the earned premiums ceded under the corporate program in the first quarter of 2000 were the result of adverse development on losses originally incurred during the 1999 accident year. Under the separate Reinsurance segment treaty, we ceded written and earned premiums of $56 million, and insurance losses and loss adjustment expenses of $120 million, resulting in a net pretax benefit of $64 million in the six months ended June 30, 2000. THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Note 8 - Reinsurance (continued) - ------------------------------- The effect of assumed and ceded reinsurance on premiums written, premiums earned and insurance losses and loss adjustment expenses are as follows: Three Months Six Months Ended June 30 Ended June 30 ------------- ------------- (In millions) 2001 2000 2001 2000 ---- ---- ---- ---- Written premiums: Direct $1,606 $1,288 $3,219 $2,410 Assumed 778 521 1,348 1,116 Ceded (531) (318) (868) (636) ----- ----- ----- ----- Net premiums written 1,853 1,491 3,699 2,890 ===== ===== ===== ===== Earned premiums: Direct 1,546 1,286 3,028 2,447 Assumed 715 420 1,237 918 Ceded (518) (285) (894) (588) ----- ----- ----- ----- Total premiums earned 1,743 1,421 3,371 2,777 ===== ===== ===== ===== Insurance losses and loss adjustment expenses: Direct 1,206 995 2,426 1,834 Assumed 650 463 1,061 1,036 Ceded (510) (432) (958) (816) ----- ----- ----- ----- Total net insurance losses and loss adjustment expenses $1,346 $1,026 $2,529 $2,054 ===== ===== ===== ===== Note 9 - Restructuring Charges - ------------------------------ Since 1998, we have recorded three restructuring charges related to actions taken to improve our operations. Note 15 in our 2000 Annual Report to Shareholders provides more detailed information regarding these charges. In August 1999, we announced a cost reduction program designed to enhance our efficiency and effectiveness in a highly competitive environment. In the third quarter of 1999, we recorded a pretax charge of $60 million related to this program, including $25 million in employee-related charges, $33 million in occupancy- related charges and $2 million in equipment charges. Late in the fourth quarter of 1998, we recorded a pretax restructuring charge of $34 million. The majority of the charge, $26 million, related to the anticipated termination of approximately 520 employees, primarily in our commercial insurance operations. The remaining charge of $8 million related to costs to be incurred to exit lease obligations. THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Note 9 - Restructuring Charges (continued) - ----------------------------------------- In connection with our merger with USF&G, in the second quarter of 1998 we recorded a pretax charge to earnings of $292 million, primarily consisting of severance and other employee-related costs related to the anticipated termination of approximately 2,000 positions, facilities exit costs, asset impairments and transaction costs. All actions have been taken and all obligations have been met regarding these three charges, with the exception of certain remaining lease commitments. During the first quarter of 2001, we reduced the reserve by $1 million related to sublease and buyout activity which reduced our estimated remaining lease commitments. We expect to be obligated under certain lease commitments for at least 7 years. The following presents a rollforward of activity related to these commitments: Original Reserve Reserve (In millions) Pre-tax at Dec. 31, at June 30, ----------- Charge 2000 Payments Adjustment 2001 ------- ---------- -------- ---------- ---------- Lease commitments charged to earnings: $75 $43 $(6) $(1) $36 === === ==== ==== === Note 10 - Acquisitions - ----------------------- In February 2000, we closed on our purchase of Pacific Select Insurance Holdings, Inc., and its wholly-owned subsidiary Pacific Select Property Insurance Co. (together, Pacific Select), a California insurer that sells earthquake coverage to California homeowners. The transaction was accounted for as a purchase, at a cost of approximately $37 million. Pacific Select's results of operations from the date of purchase are included in our consolidated results. In April 2000, we closed on our acquisition of MMI Companies, Inc. ("MMI"), a Deerfield, Illinois-based provider of medical services-related insurance products and consulting services. The transaction was accounted for as a purchase, with a total purchase price of approximately $206 million, in addition to the assumption of $165 million in capital securities and debt. The final purchase price adjustments resulted in an excess of purchase price over net tangible assets acquired of approximately $85 million, which we expect to amortize over 15 years. MMI's results of operations from the date of purchase are included in our consolidated results. In connection with the MMI purchase, we established a reserve of $28 million, including $4 million in employee-related costs and $24 million in occupancy-related costs. The employee-related costs represent severance and related benefits such as outplacement counseling to be paid to, or incurred on behalf of, terminated employees. We estimated that approximately 130 employee positions would be eliminated, at all levels throughout MMI. Through June 30, 2001, 118 employees had been terminated, with payments totaling $4 million. Our remaining obligations for employee-related costs at MMI are expected to be less than $1 million. The occupancy-related cost represents excess space created by the terminations, calculated by determining the percentage of anticipated excess space, by location, and the current lease costs over the remaining lease period. The amounts payable under the existing leases were not discounted, and sublease income was included in the calculation only for those locations where sublease agreements were in place. THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Note 10 - Acquisitions (continued) - --------------------------------- The following presents a rollforward of activity related to these accruals: (In millions) ----------- Original Reserve Reserve Charges to Pre-tax at Dec. 31, at June 30, earnings: Charge 2000 Payments Adjustment 2001 --------- -------- ---------- -------- ---------- ---------- Employee- related $ 4 $ 1 $(1) $ - $ - Occupancy- related 24 23 (7) (8) 8 ----- ----- ----- ----- ----- Total $28 $24 $(8) $(8) $8 ===== ===== ===== ===== ===== During the first quarter of 2001, we entered into a lease buyout related to a portion of the space, resulting in a cash payment of $5 million. We also reduced the reserve by $8 million, primarily representing additional lease payments we were no longer obligated to make related to the buyout. During 2000, we experienced severe prior year loss development on the reserves acquired from MMI, primarily related to its major accounts business. This was consistent with the adverse prior year development experienced on the remainder of our Global Health Care major accounts business. The major accounts business serves large health care entities, which have recently suffered from increasingly significant amounts awarded in jury verdicts. As a result of this overall deterioration, we have performed a comprehensive review of our entire Global Health Care segment. Based on the results of this review and specific actions identified to restore this segment to future profitability, as well as our evaluation of the ongoing strategic value of the Unionamerica entity, MMI's United Kingdom - based subsidiary, we have determined that the excess of purchase price over net tangible assets acquired we recorded as part of the MMI purchase has not been impaired. Note 11 - Adoption of Accounting Pronouncement - ----------------------------------------------- Effective Jan. 1, 2001, we adopted the provisions of SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended. According to the statement, hedging instruments may be specifically designated into one of three categories based on their intended use. The applicable category dictates the accounting for each derivative. The following categories and the related impacts and disclosures required by SFAS No. 133 are applicable to The St. Paul: Fair Value Hedges: We have several interest rate swaps that are designated as fair value hedges of selected portions of our fixed rate debt. The terms of the swaps match those of the debt instruments, and the swaps are therefore considered 100% effective. The transitional impact of adopting SFAS No. 133 for the fair value of the hedges was $15 million, which is recorded in "Other Assets" on the balance sheet with an equivalent offset recorded in debt. The related income statement impacts are offsetting; as a result, there was no transitional income statement impact of adopting SFAS No. 133 for fair value hedges. The impact related to the six months ended June 30, 2001 movement in interest rates was a $500,000 increase in the fair value of the swaps and the related debt on the balance sheet, with the income statement impacts again offsetting. THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Note 11 - Adoption of Accounting Pronouncement (continued) - ---------------------------------------------------------- Cash Flow Hedges: We have purchased foreign currency forward contracts that are designated as cash flow hedges. They are utilized to minimize our exposure to fluctuations in foreign currency values that result from forecasted foreign currency payments, as well as from foreign currency payables and receivables. The transitional impact of adopting SFAS No. 133 for cash flow hedges was a gain of less than $200,000, which was included in "Other Comprehensive Income." In the six months ended June 30, 2001, we recognized a $1.5 million loss on the cash flow hedges, which is also included in "Other Comprehensive Income." The amounts included in other comprehensive income will be reclassified into earnings concurrent with the timing of the hedged cash flows, which is not expected to occur within the next twelve months. In the six months ended June 30, 2001 we recognized a loss in the income statement of less than $1 million representing the portions of the forward contracts deemed ineffective. Non-Hedge Derivatives: We have entered into a variety of other financial instruments considered to be derivatives, but which are not designated as hedges, that we utilize to minimize the potential impact of market movements in certain investment portfolios. There was no transition adjustment related to the adoption of SFAS No. 133, and we recorded less than $600,000 of operating and administrative expense in the six months ended June 30, 2001 relating to the change in the market value of these derivatives during the period. Note 12 - Discontinued Operations - ---------------------------------- Life Insurance Segment - ---------------------- On April 26, 2001, we announced an agreement by our subsidiary, St. Paul Fire and Marine Insurance Company ("Fire and Marine"), to sell its life insurance company, Fidelity and Guaranty Life Insurance Company, and its subsidiary, Thomas Jefferson Life, (together, "F&G Life") to Old Mutual plc ("Old Mutual") for $335 million in cash and $300 million in shares of Old Mutual stock. The consideration is subject to possible adjustment related to F&G Life's investment portfolio. If the market value of specified securities within that portfolio changes between March 31, 2001 and the closing date, or if any securities within that portfolio experience specified credit rating downgrades prior to closing, the consideration is subject to adjustment. Pursuant to the purchase agreement, The St. Paul, or any direct or indirect wholly owned subsidiary of The St. Paul, must hold the Old Mutual stock received for one year after the closing of the transaction. The consideration is also subject to possible additional adjustment based on the market price of Old Mutual's stock at the end of that one-year period, as described in greater detail in the purchase agreement. The sale is subject to regulatory approvals and other conditions, and is expected to close in the third quarter of 2001. We expect to realize a modest gain on the sale of F&G Life, the exact amount of which will be determined at closing. Our consolidated statements of operations presented herein reflect F&G Life's results of operations in discontinued operations. In the first six months of 2001, F&G Life recorded net income of $14 million, compared with net income of $15 million in the same period of 2000. In addition, on our consolidated balance sheet as of June 30, 2001, F&G Life's net assets of $614 million were included in "Other Assets," classified as net assets of discontinued operations. THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Note 12 - Discontinued Operations (continued) - --------------------------------------------- Standard Personal Insurance Business - ------------------------------------ On Sept. 30, 1999, we completed the sale of our standard personal insurance operations to Metropolitan Property and Casualty Insurance Company ("Metropolitan"). As a result, the standard personal insurance operations were accounted for as discontinued operations for all periods presented herein. We recorded a $32 million pretax charge for various costs incurred in the disposition of the operations. All of the obligations of this charge have been met, with the exception of $5 million in occupancy-related charges. These obligations will exist until lease commitments in place at the time of the sale expire, or until we buy them out before expiration. Metropolitan purchased Economy Fire & Casualty Company and its subsidiaries ("Economy"), as well as the rights and interests in those non-Economy policies constituting our remaining standard personal insurance operations. Those rights and interests were transferred to Metropolitan by way of a reinsurance and facility agreement ("Reinsurance Agreement"). The Reinsurance Agreement relates solely to the non-Economy standard personal insurance policies, and was entered into solely as a means of accommodating Metropolitan through a transition period. The Reinsurance Agreement allows Metropolitan to write non-Economy business on our policy forms while Metropolitan obtains the regulatory license, form and rate approvals necessary to write non-Economy business through their own insurance subsidiaries. Any business written on our policy forms during this transition period is then fully ceded to Metropolitan under the Reinsurance Agreement. We recognized no gain or loss on the inception of the Reinsurance Agreement and will not incur any net revenues or expenses related to the Reinsurance Agreement. All economic risk of post-sale activities related to the Reinsurance Agreement has been transferred to Metropolitan. We anticipate that Metropolitan will pay all claims incurred related to this Reinsurance Agreement. In the event Metropolitan is unable to honor their obligations to us, we will pay these amounts. As part of the sale to Metropolitan, we guaranteed the adequacy of Economy's loss and loss expense reserves. Under that guarantee, we will pay for any deficiencies in those reserves and will share in any redundancies that develop by Sept. 30, 2002. We remain liable for claims on non-Economy policies that result from losses occurring prior to closing. By agreement, Metropolitan will adjust those claims and share in redundancies in related reserves that may develop. As of June 30, 2001, we had determined that we could not reasonably estimate to any probable certainty whether any deficiency or redundancy existed in the pre- sale reserves, and we have not recorded a liability or receivable related to those reserves. Any losses incurred by us under these agreements will be reflected in discontinued operations in the period they are incurred. For the first six months of 2001, we recorded a pretax loss of $19 million in discontinued operations, related to pre-sale non-Economy claims. We have no other contingent liabilities related to the sale. Nonstandard Auto Business - ------------------------- On Jan. 4, 2000, we announced an agreement to sell our nonstandard auto business to The Prudential Insurance Company of America ("Prudential") for $200 million in cash. As a result, the nonstandard auto business results of operations were accounted for as discontinued operations for all periods presented. On May 1, 2000, we closed on the sale of our nonstandard auto business to Prudential, receiving total cash consideration of approximately $175 million (net of a $25 million dividend paid to our property-liability operations prior to closing). Note 13 - Statutory Accounting Practices - ---------------------------------------- The National Association of Insurance Commissioners has published revised statutory accounting practices in connection with its codification project which became effective, and which we adopted, as of Jan. 1, 2001. The cumulative effect to our property-liability insurance operations of the adoption of these practices was to increase statutory surplus by $328 million. THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations June 30, 2001 On April 26, 2001, The St. Paul Companies, Inc. announced that its subsidiary, St. Paul Fire and Marine Insurance Company ("Fire and Marine"), had reached a definitive agreement to sell Fidelity and Guaranty Life Insurance Company ("F&G Life") to Old Mutual plc ("Old Mutual"), a London-based international financial services company. The transaction is expected to be finalized in the third quarter of 2001. F&G Life's results of operations have been reclassified to discontinued operations for all periods presented in the following discussion. Consolidated Results -------------------- The following table summarizes The St. Paul's results for the second quarter and first six months of 2001 and 2000. Three Months Six Months Ended June 30 Ended June 30 ------------- ------------- (In millions, except per share data) 2001 2000 2001 2000 ---------------------------------- ----- ----- ----- ----- Pretax income (loss): Property-liability insurance: GAAP underwriting result $(113) $ (67) $(200) $(167) Net investment income 295 312 625 631 Realized investment 6 107 58 438 Other (41) (33) (45) (64) ----- ----- ----- ----- Total property-liability insurance 147 319 438 838 Asset management 34 33 69 66 Parent and other (48) (51) (76) (83) ----- ----- ----- ----- Pretax income from continuing operations 133 301 431 821 Income tax expense 37 84 126 255 ----- ----- ----- ----- Income from continuing operations 96 217 305 566 Discontinued operations, net of taxes 8 (5) 1 3 ----- ----- ----- ----- Net income $104 $212 $306 $569 ===== ===== ===== ===== Diluted net income per share $0.45 $0.92 $1.33 $2.43 ===== ===== ===== ===== Consolidated Results - -------------------- Our pretax income from continuing operations of $133 million in the second quarter of 2001 was 56% below comparable pretax income of $301 million in the same 2000 period. Through the first half of 2001, pretax income from continuing operations was nearly $400 million below the comparable period of 2000. The decline in both second quarter and year-to-date earnings was primarily due to a significant decrease in realized investment gains in our property- liability operations. Realized gains in 2000 were unusually high due to the sale of several venture capital investments. In addition, underwriting results in our property-liability operations for the second quarter and first six months of 2001 deteriorated from comparable 2000 levels, primarily due to adverse prior-year loss development in our Health Care segment. Agreement to Sell F&G Life Insurance Company - -------------------------------------------- In April 2001 Fire and Marine signed a definitive agreement to sell F&G Life to Old Mutual. Under terms of the agreement, Fire and Marine will receive $335 million in cash, and shares of Old Mutual common stock valued at $300 million on the closing date. The consideration is subject to possible adjustment related to F&G Life's investment portfolio. If the market value of specified securities within that portfolio changes between March 31, 2001 and the closing date, or if any securities within that portfolio experience specified credit rating downgrades prior to closing, the consideration is subject to adjustment. Pursuant to the purchase agreement, Fire and Marine THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion, Continued Consolidated Highlights (continued) ---------------------------------- must hold the Old Mutual stock received for one year after the closing of the transaction. The consideration is also subject to possible adjustment based on the market price of Old Mutual's stock at the end of that one-year period, as described in greater detail in the purchase agreement. The sale is subject to regulatory approvals and other conditions, and is expected to close in the third quarter of 2001. We expect to realize a modest gain on the sale of F&G Life, the exact amount of which will be determined at closing. F&G Life's results of operations for the three months and six months ended June 30, 2001 and 2000 are included in discontinued operations on our consolidated statements of income. In the first half of 2001, F&G Life recorded net income of $14 million, compared with net income of $15 million in the same period of 2000. F&G Life's product sales totaled $701 million in the first half of 2001, compared with sales of $487 million in the same 2000 period. Discontinued Operations - Personal Insurance - -------------------------------------------- In 1999, we sold our standard personal insurance operations to Metropolitan Property and Casualty Insurance Company (Metropolitan). Metropolitan purchased Economy Fire & Casualty Company and subsidiaries ("Economy"), and the rights and interests in those non-Economy policies constituting the remainder of our standard personal insurance operations. Those rights and interests were transferred to Metropolitan by way of a reinsurance and facility agreement. We guaranteed the adequacy of Economy's loss and loss expense reserves, and we remain liable for claims on non-Economy policies that result from losses occurring prior to the Sept. 30, 1999 closing date. Under the reserve guarantee, we will pay for any deficiencies in those reserves and will share in any redundancies that develop by Sept. 30, 2002. As of June 30, 2001, we had determined that we could not reasonably estimate to any probable certainty whether any deficiency or redundancy existed in the pre-sale reserves and we have not recorded a liability or receivable related to those reserves. Any losses incurred by us under these agreements are reflected in discontinued operations in the period during which they are incurred. In the first half of 2001 and 2000, we recorded pretax losses of $19 million and $8 million, respectively, in discontinued operations related to these agreements. Common Share Repurchases - ------------------------ In the second quarter of 2001, we repurchased and retired 4.1 million of our common shares for a total cost of $202 million, bringing our six month repurchase total to 8.3 million shares at a total cost of $389 million, or $46.68 per share. These repurchases were funded through a combination of internally- generated funds and the issuance of commercial paper. The shares repurchased in the first six months of 2001 represented approximately 4% of our total shares outstanding at the beginning of the year. Adoption of SFAS No. 133 - ------------------------ On January 1, 2001, we adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended by SFAS Nos. 137 and 138. Provisions of SFAS No. 133 require the recognition of derivatives as either assets or liabilities on the balance sheet and the measurement of those instruments at fair value. We have limited involvement with derivative instruments, primarily for purposes of hedging against fluctuations in market indices, foreign currency exchange rates and interest rates. We also have entered into a variety of other financial instruments considered to be derivatives, but which are not designated as hedges, that we utilize to minimize the potential impact of market movements in certain investment portfolios. Our adoption of SFAS No 133, as amended, did not have a material impact on our financial position or results of operations. Subsequent Event- Agreement to Purchase London Guarantee Insurance Company - -------------------------------------------------------------------------- On August 3, 2001 we announced a definitive agreement to purchase London Guarantee Insurance Company for US$80 million/C$125 million. London Guarantee, headquartered in Toronto, is a specialty property-liability insurance company focused on providing surety products, and management liability, bond, and professional indemnity products. The company generated approximately C$65 million in net written premiums in 2000. The transaction is expected to close within three to five months, after regulatory approval has been received and the appropriate closing conditions are met. THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion, Continued Property-Liability Insurance ---------------------------- Overview - -------- Our consolidated written premiums totaled $1.85 billion in the second quarter of 2001, 24% higher than premium volume of $1.49 billion in the same period of 2000. Through the first half of 2001, our reported premium volume of $3.70 billion grew $808 million, or 28%, over comparable 2000 written premiums of $2.89 billion. Several factors impacted the comparability of our 2001 and 2000 year-to-date premium volume. First, we acquired MMI Companies, Inc. ("MMI"), an international health care risk services company, in April 2000. MMI accounted for $97 million of incremental written premiums in the first half of 2001. Second, last year's six-month premium total included $31 million of incremental premiums resulting from the elimination of the one- quarter reporting lag for our reinsurance operations based in the United Kingdom ("St. Paul Re - UK"). Third, our reported premium volume for the first six months of 2001 and 2000 was reduced by $54 million and $136 million, respectively, by cessions made under certain reinsurance treaties (described below). Excluding all of these factors in both years, six-month consolidated premiums of $3.66 billion in 2001 were 22% higher than comparable 2000 premium volume of $3.0 billion. The growth in premiums in 2001 was due to price increases and strong renewal retention rates throughout nearly all of our business segments, as well as new business in several of those segments. In both 2001 and 2000, we entered into separate aggregate excess- of-loss reinsurance treaties effective Jan. 1 of each year (the "corporate reinsurance program"). Coverage under the corporate reinsurance program is triggered when our insurance losses and loss adjustment expenses spanning all segments of our business reach a certain level. In addition, our Reinsurance segment was party to separate aggregate excess-of-loss reinsurance treaties unrelated to the corporate reinsurance program in both years. All of these treaties are collectively referred to hereafter as the "reinsurance treaties." Under terms of the reinsurance treaties, we transfer, or "cede," insurance losses and loss adjustment expenses to our reinsurers, along with the related written and earned premiums. The following table describes the combined impact of these cessions on our property-liability underwriting segments in 2001 and 2000. In the three months ended June 30, 2001 and 2000, and in the six months ended June 30, 2001, coverage under the corporate reinsurance program was not triggered; the written and earned premiums ceded in those periods represent the initial premium paid to our reinsurer. Three Months Six Months Ended June 30 Ended June 30 ------------- ------------- (In millions) 2001 2000 2001 2000 ----------- ---- ---- ---- ---- Corporate program: Ceded written premiums $ - $ - $ 9 $ 80 Ceded earned premiums 2 5 5 70 Ceded losses and loss adjustment expenses - - - 111 --- --- --- --- Net pretax benefit (detriment) (2) (5) (5) 41 --- --- --- --- Reinsurance segment treaty: Ceded written premiums 42 39 45 56 Ceded earned premiums 40 39 43 56 Ceded losses and loss adjustment expenses 76 88 102 120 --- --- --- --- Net pretax benefit 36 49 59 64 --- --- --- --- Combined total: Ceded written premiums 42 39 54 136 Ceded earned premiums 42 44 48 126 Ceded losses and loss adjustment expenses 76 88 102 231 --- --- --- --- Net pretax benefit $ 34 $ 44 $ 54 $ 105 === === === === THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion, Continued Property-Liability Insurance (continued) --------------------------------------- The pretax benefit (detriment) of the reinsurance treaties was allocated to our business segments as follows: Three Months Six Months Ended June 30 Ended June 30 ------------- ------------- (In millions) 2001 2000 2001 2000 ----------- ---- ---- ---- ---- Commercial Lines Group $ - $ - $ (1) $ - Global Health Care (1) - (1) - Other Specialty - - (1) - International - (1) (1) 12 ---- ---- ---- ---- Total Primary Insurance (1) (1) (4) 12 Reinsurance 35 45 58 93 ---- ---- ---- ---- Total Property Liability Insurance $ 34 $ 44 $ 54 $105 ==== ==== ==== ==== Our reported consolidated loss ratio, which measures insurance losses and loss adjustment expenses as a percentage of earned premiums, was 77.2 in the second quarter of 2001, five points worse than the second-quarter 2000 loss ratio of 72.2. The 2001 ratio included a 6.1 point detriment from a $107 million provision to strengthen prior-year loss reserves in our Global Health Care segment. The second-quarter 2000 ratio included a 7.2 point benefit resulting from a $102 million reduction in reserves related to favorable prior year development on workers' compensation coverages. Excluding those factors, the adjusted 2001 second-quarter ratio of 71.1 was significantly better than the adjusted second-quarter 2000 loss ratio of 79.4. The improvement was centered in our Commercial Lines Group and Other Specialty business segments. Catastrophe losses in the second quarter totaled $69 million, the majority of which were the result of Tropical Storm Allison, which struck the southeastern United States in May. In last year's second quarter, catastrophe losses of $67 million were largely the result of additional loss development from European storms at the end of 1999. Through the first six months of 2001, the pricing environment throughout virtually all of the commercial and reinsurance markets in which we operate continued to be favorable. Price increases throughout our United States primary insurance operations averaged 14% in the first half of the year. We expect to achieve continued price increases in the second half of 2001. In the majority of our business segments, current underwriting year results continued to improve, reflecting the success of our efforts to improve the quality of our business through disciplined risk selection, and the impact of sustained price increases over the last 18 months. Our reported consolidated expense ratio, measuring underwriting expenses as a percentage of premiums written, was 29.3 for the second quarter and 30.2 for the first half of 2001, compared to expense ratios of 32.9 and 32.3 for the respective periods of 2000. Excluding the reinsurance treaties in both years, the year- to-date 2001 expense ratio of 29.8 was over a point better than the comparable 2000 ratio of 30.9. The improvement over 2000 reflects the combined effect of significant premium growth and the efficiencies realized as a result of our expense reduction initiatives over the last two years. The table on the following page summarizes key financial results (from continuing operations) by property-liability underwriting business segment (underwriting results are presented on a GAAP basis; combined ratios are presented on a statutory accounting basis). THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion, Continued Property-Liability Insurance (continued) --------------------------------------- % of Three Months Six Months 2001 Ended June 30 Ended June 30 (Dollars in millions) Written ------------- ------------- ------------------- Premiums 2001 2000 2001 2000 -------- ----- ----- ----- ----- Commercial Lines Group: Written Premiums 25% $444 403 935 795 Underwriting Result $36 54 109 32 Combined Ratio 91.7 86.5 85.9 96.4 Global Health Care: Written Premiums 9% $147 127 324 240 Underwriting Result $(123) (45) (254) (64) Combined Ratio 175.3 133.2 172.9 125.1 Global Surety: Written Premiums 6% $108 117 213 240 Underwriting Result $15 12 32 31 Combined Ratio 85.5 87.7 85.0 83.8 Other Specialty: Written Premiums 25% $477 361 939 679 Underwriting Result $41 4 51 (17) Combined Ratio 89.7 97.9 93.8 102.0 International: Written Premiums 14% $369 249 522 312 Underwriting Result $(51) (59) (89) (71) Combined Ratio 119.0 129.8 120.1 125.7 --- ----- ----- ----- ----- Total Primary Insurance: Written Premiums 79% $1,545 1,257 2,933 2,266 Underwriting Result $(82) (34) (151) (89) Combined Ratio 105.6 102.7 105.2 104.2 Reinsurance: Written Premiums 21% $308 234 766 624 Underwriting Result $(31) (33) (49) (78) Combined Ratio 111.1 116.8 105.1 115.1 --- ----- ----- ----- ----- Total Property-Liability Insurance: Written Premiums 100% $1,853 1,491 3,699 2,890 GAAP Underwriting Result $(113) (67) (200) (167) Statutory Combined Ratio: Loss and Loss Expense Ratio 77.2 72.2 75.0 74.0 Underwriting Expense Ratio 29.3 32.9 30.2 32.3 ----- ----- ----- ----- Combined Ratio 106.5 105.1 105.2 106.3 ===== ===== ===== ===== THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion, Continued Property-Liability Insurance (continued) --------------------------------------- Underwriting Results by Segment - ------------------------------- Commercial Lines Group - ---------------------- The Commercial Lines Group ("CLG") segment includes our standard commercial, nonstandard commercial and catastrophe risk business centers, as well as the results of our limited involvement in insurance pools. The following table summarizes key financial data for this segment excluding the impact of the corporate reinsurance program, which had a minimal impact on year-to-date results in 2001. Three Months Ended Six Months Ended June 30 June 30 ------------------ ---------------- (Dollars in millions) 2001 2000 2001 2000 ------ ------ ------ ------ Net written premiums $444 $403 $938 795 Percentage change from 2000 10% 18% GAAP underwriting profit $36 $54 $110 $32 Statutory combined ratio: Loss and loss adjustment expense ratio 62.5 53.2 55.9 62.7 Underwriting expense ratio 29.2 33.3 29.8 33.7 ----- ----- ----- ----- Combined ratio 91.7 86.5 85.7 96.4 ===== ===== ===== ===== Premium growth in the second quarter and first six months of 2001 was driven by price increases, strong renewal retention rates and new business. In the first half of the year, price increases averaged 12.0% in our standard and nonstandard commercial operations. Despite these increases, our renewal retention rates continued to grow in the second quarter. We expect price increases on renewal business to continue in the second half of 2001. The reported second-quarter 2001 loss ratio included a 7.2 point impact of catastrophe losses totaling $31 million, the majority of which resulted from Tropical Storm Allison. Catastrophe losses in the second quarter of 2000 were $5 million. The reported year-to-date loss ratio in 2001 benefited from a $100 million reduction in previously established reserves in the first quarter, which resulted from an actuarial analysis of reserves for certain business written prior to 1989. In 2000, the year-to- date loss ratio included the benefit of a $69 million reduction in previously established workers' compensation reserves. Excluding those reserve reductions in both years, the adjusted six-month 2001 loss ratio of 67.5 was four points better than the adjusted 2000 ratio of 71.5, despite the $26 million increase in catastrophe losses in 2001. The significant improvement in the second-quarter and year-to-date expense ratios in 2001 reflected the combined impact of our aggressive expense reduction initiatives over the last several years and the significant growth in written premium volume. Global Health Care - ------------------ Our Global Health Care segment provides property-liability insurance throughout the entire health care delivery system. The following table summarizes key financial data for Global Health Care excluding the impact of the corporate reinsurance program, which had a minimal impact on second-quarter and six-month results in 2001. THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion, Continued Property-Liability Insurance (continued) --------------------------------------- Three Months Ended Six Months Ended June 30 June 30 ------------------ ----------------- (Dollars in millions) 2001 2000 2001 2000 ------------------- ------ ------ ------ ------ Net written premiums $147 $127 $325 $240 Percentage change from 2000 16% 35% GAAP underwriting loss $(122) $(45) $(253) $(64) Statutory combined ratio: Loss and loss adjustment expense ratio 148.9 97.3 147.6 94.4 Underwriting expense ratio 26.4 35.9 25.1 30.7 ----- ----- ----- ----- Combined ratio 175.3 133.2 172.7 125.1 ===== ===== ===== ===== Premium growth in the second quarter and first six months of 2001 was predominantly due to price increases, which averaged 21.9% across this segment in the first half of the year. In addition, approximately $48 million of the increase in year-to-date premium volume resulted from our acquisition of MMI in April 2000. We have severely curtailed the amount of new business in the Global Health Care segment in 2001 due to an unfavorable pricing environment in many of the lines of business and geographical locations in which we offer our products. The severe deterioration in the second-quarter 2001 loss ratio in comparison to the same 2000 period was due to a $107 million provision to strengthen loss reserves for the accident years 1997 through 1999. Our actuarial analysis indicated that the severity of losses incurred throughout our domestic operations, including, but not limited to, business acquired in the MMI transaction, had increased to a degree that warranted the recording of additional reserves for those accident years. Amounts awarded in jury verdicts in professional liability lawsuits have continued to increase sharply, resulting in an increase in our estimate of ultimate losses incurred and causing a severe impact on our second-quarter and year-to-date results in 2001. We have undertaken an initiative in 2001 to accelerate the resolution of high-severity claims in order to minimize the impact of the increase in the cost of jury verdicts. This initiative accelerated paid losses into the current period that would have otherwise been included in future periods, and has contributed to the increase in severity which prompted the reserve strengthening in the second quarter. Severity trends for business written in accident years 2000 and 2001 have not exhibited the same deterioration experienced in the earlier accident years, indicating that the actions we have implemented in the last two years to significantly raise prices, exit unfavorable geographic locations and restrict the terms and conditions of coverage offered have favorably impacted loss experience for those years. In the second quarter of 2001, we completed a comprehensive review of our entire Health Care segment. Based on the results of that review and specific actions identified to restore this segment to future profitability , as well as our evaluation of the strategic value of the Unionamerica entity, MMI's United Kingdom-based subsidiary, we have determined that the excess purchase price over net tangible assets acquired we recorded as part of the MMI acquisition has not been impaired. In the second half of 2001, we will continue to pursue price increases in the Health Care segment. Of the 28 states in which we filed for approval for rate increases on July 2001 renewals for physicians and surgeons coverage, we received approval in 23 states, with price increases averaging 20%. Global Surety - ------------- Our Global Surety segment underwrites surety bonds, which guarantee that third parties will be indemnified against the nonperformance of contractual obligations. The table on the following page summarizes key financial data for this segment for the second quarter and first six months of 2001 and 2000. The Surety segment was not impacted by the reinsurance treaties in either year. THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion, Continued Property-Liability Insurance (continued) --------------------------------------- Three Months Ended Six Months Ended June 30 June 30 ------------------ ----------------- (Dollars in millions) 2001 2000 2001 2000 ------------------- ------ ------ ------ ------ Net written premiums $108 $117 $214 $240 Percentage change from 2000 (8)% (11)% GAAP underwriting profit $15 $12 $32 $31 Statutory combined ratio: Loss and loss adjustment expense ratio 35.5 35.3 33.4 35.6 Underwriting expense ratio 50.0 52.4 51.3 48.2 ----- ----- ----- ----- Combined ratio 85.5 87.7 84.7 83.8 ===== ===== ===== ===== The decline in written premium volume compared with 2000 reflects the impact of tightened underwriting standards implemented in anticipation of an economic slowdown in both the United States and Mexico. Such a slowdown could have a negative impact on the construction industry, and, in turn, on our contract surety operations. The improvement in Global Surety's year-to-date 2001 loss ratio over the same 2000 period was primarily due to favorable current-year loss experience. The increase in the expense ratio over 2000 was driven by higher reinsurance costs in the first half of 2001. Other Specialty - --------------- The Other Specialty segment includes the following business centers: Construction, Technology, Global Marine, Financial & Professional Services, Public Sector Services, Excess & Surplus Lines and Oil & Gas. The following table summarizes results for this segment excluding the impact of the corporate reinsurance program, which had a minimal impact on year-to-date results in 2001. Three Months Ended Six Months Ended June 30 June 30 ------------------- ---------------- (Dollars in millions) 2001 2000 2001 2000 ------------------- ------ ------ ------ ------ Net written premiums $477 $361 $941 $679 Percentage change from 2000 32% 39% GAAP underwriting profit (loss) $41 $4 $52 $(17) Statutory combined ratio: Loss and loss adjustment expense ratio 61.7 67.4 65.8 71.7 Underwriting expense ratio 28.0 30.5 27.8 30.3 ----- ----- ----- ----- Combined ratio 89.7 97.9 93.6 102.0 ===== ===== ===== ===== Significant price increases, strong renewal retention rates and new business throughout the business centers comprising this segment accounted for the growth in second-quarter and year-to- date premium volume over the equivalent periods of 2000. In our Construction operation, premium volume of $149 million in the second quarter was 37% ahead of the same period last year, and year-to-date premiums of $308 million grew 44% over 2000. Price increases in this operation averaged 17.0% for the first half of 2001. Our Technology business center THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion, Continued Property-Liability Insurance (continued) --------------------------------------- recorded premiums of $107 million and $201 million for the second quarter and first six months of 2001, respectively, representing growth rates of 37% and 43% over the respective periods of 2000. Technology price increases averaged 12.4% for the first six months of the year. Year-to-date written premiums of $190 million in Financial & Professional Services were 26% ahead of 2000, driven by new business in international markets and price increases averaging 9.8%. The 5.7 point improvement in the second-quarter loss ratio over the same 2000 period was centered in Financial & Professional Services and, to a lesser extent, in Excess & Surplus Lines, and was primarily the result of favorable development on prior-year losses in both business centers. Second-quarter and six-month results in 2000 included a $33 million benefit from a reduction in previously established workers' compensation reserves. Excluding that benefit from year-to-date 2000 results, the loss ratio of 65.8 for the first half of 2001 was nearly 11 points better than the adjusted 2000 ratio of 76.7. Financial & Professional Services, Technology, Construction and Global Marine were all major contributors to the significant improvement in year-to-date results in 2001, reflecting the favorable impact of significant price increases over the last 12 months and the underlying improvement in the quality of our business in these market sectors. International - ------------- Our International segment consists of our operations at Lloyd's, specialty business underwritten outside of the United States that is not managed on a global basis, and MMI's London-based insurance operation, Unionamerica. The following table summarizes this segment's results for the second quarter and first six months of 2001 and 2000 excluding the impact of the corporate reinsurance program, which is detailed on page 26 of this report. Three Months Ended Six Months Ended June 30 June 30 ------------------ ----------------- (Dollars in millions) 2001 2000 2001 2000 ------------------- ------ ------ ------ ------ Net written premiums $369 $249 $522 $335 Percentage change from 2000 48% 56% GAAP underwriting loss $(51) $(58) $(88) $(83) Statutory combined ratio: Loss and loss adjustment expense ratio 98.6 102.7 95.0 99.7 Underwriting expense ratio 20.4 27.1 24.9 28.9 ----- ----- ----- ----- Combined ratio 119.0 129.8 119.9 128.6 ===== ===== ===== ===== The 48% increase in second-quarter 2001 premium volume over the same 2000 period was primarily the result of our increased involvement at Lloyd's, which accounted for $272 million of the International segment's premium volume for the quarter. Significant price increases at Lloyd's and in primary insurance markets throughout the world were also a major contributor to premium growth in the second quarter. In addition to these factors, the increase in year-to-date premium volume over 2000 was partially due to incremental premiums from Unionamerica, which was acquired in the MMI transaction in April 2000. Although we ceased writing new business through Unionamerica Insurance Company in 2001, we are contractually obligated to underwrite business in certain of Unionamerica's syndicates at Lloyd's. International's loss ratios for the second quarter and first six months of 2001 showed slight improvement over the comparable periods of 2000, primarily due to price increases over the last several quarters and improved loss experience in several Lloyd's syndicates. We are in the process of reorganizing our operations at Lloyd's, focusing on increasing our capacity in selected syndicates that offer potential for profitable growth. We continue to implement corrective underwriting, pricing and efficiency initiatives throughout the entire International segment, and we expect further improvement in results during the second half of 2001. THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion, Continued Property-Liability Insurance (continued) --------------------------------------- Reinsurance - ----------- Our Reinsurance segment ("St. Paul Re") underwrites treaty and facultative reinsurance for property, liability, ocean marine, surety and certain specialty classes of business, and also underwrites "nontraditional" reinsurance, which combines traditional underwriting risk with financial risk protection. The following table summarizes key financial data for the Reinsurance segment excluding the impact of the reinsurance treaties, which is detailed on page 26 of this report. Three Months Ended Six Months Ended June 30 June 30 ------------------ ----------------- (Dollars in millions) 2001 2000 2001 2000 ------------------- ------- ------- ------ ------- Net written premiums $350 $273 $812 $737 Percentage change from 2000 28% 10% GAAP underwriting loss $(66) $(77) $(106) $(170) Statutory combined ratio: Loss and loss adjustment expense ratio 87.6 105.5 82.1 103.1 Underwriting expense ratio 31.8 26.3 31.3 23.7 ----- ----- ----- ----- Combined ratio 119.4 131.8 113.4 126.8 ===== ===== ===== ===== Premium growth in 2001 was driven by significant price increases across virtually all lines of traditional reinsurance coverages and new business opportunities in the nontraditional insurance market. Year-to-date premium volume last year included $31 million of incremental premiums resulting from the elimination of the one-quarter reporting lag for St. Paul Re - UK. Excluding those premiums, St. Paul Re's 2001 year-to-date premium volume was $106 million, or 15%, higher than the adjusted 2000 total. The improvement in St. Paul Re's loss ratio for the second quarter and first six months of 2001 reflected the impact of price increases and corrective underwriting initiatives over the last several quarters, as well as a decline in catastrophe losses incurred. Catastrophe losses totaled $21 million and $16 million for the second quarter and first six months of 2001, respectively, compared with losses of $63 million and $110 million in the respective periods of 2000. Catastrophe losses for the first quarter of 2001 included $5 million of positive development on prior accident years, causing year-to-date totals to be less than quarter-only. Tropical Storm Allison and spring storms in the Midwest were the primary source of catastrophe losses in the second quarter of 2001, while additional loss development from 1999 European windstorms accounted for the majority of losses in the same period of 2000. The deterioration in expense ratios compared with 2000 was primarily the result of an increase in contingent commissions in St. Paul Re's nontraditional business, and an increase in ceded commissions on premium adjustments from 1999 and 2000 reinsurance treaties. The increase in both types of commissions was indicative of favorable loss experience on that business. Investment Operations - --------------------- The St. Paul's property-liability insurance operations produced pretax investment income of $295 million in the second quarter of 2001, down 5% from income of $312 million in the same period of 2000. Our year-to-date pretax investment income of $625 million, however, was only slightly below comparable 2000 income of $631 million, primarily due to strong returns generated by our real estate portfolio in the first quarter of the year. Negative underwriting cash flows have resulted in the net sale of fixed-maturity investments to fund a portion of our operational cash flow requirements, which has been the primary factor in the decline in investment income in the last several quarters. Underwriting cash flows have been negatively impacted by an increase in insurance loss and loss adjustment expense payments, particularly in our Health Care and International segments, which has more than offset the increase in premium collections from new business and significant price increases. Cumulative premium payments totaling $639 million since the fourth quarter of 1999 related to our corporate reinsurance program have also reduced funds available for investment. In addition, in January 2001 we undertook an initiative to hasten the THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion, Continued Property-Liability Insurance (continued) --------------------------------------- Investment Operations (continued) - -------------------------------- settlement of potentially high-severity pending claims throughout our property-liability operations, which has resulted in an acceleration of claim payments in the first half of the year. We expect our underwriting cash flows to improve in the last half of the year due to continued price increases and further improvement in loss experience throughout our property-liability business segments. Pretax realized investment gains in our property-liability insurance operations totaled $6 million in the second quarter, compared with $107 million in the same period of 2000. Through the first six months of 2001, realized gains of $58 million were much lower than the year-to-date 2000 total of $438 million. An uncertain economic outlook contributed to a decline in equity values and a lack of venture capital activity during the first half of 2001, resulting in a significant reduction in realized gains in comparison to 2000. In March 2001, we realized a pretax gain of $77 million on the sale of our investment in RenaissanceRe Holdings, Ltd., a Bermuda-based reinsurer. Last year's record six-month total was dominated by gains from our venture capital portfolio, including the single largest gain ($117 million) from the sale of our investment in Flycast Communications Corp., a leading provider of Internet direct response solutions. We also sold several other direct holdings, and our investments in various venture capital partnerships also contributed to the six-month 2000 realized gain total. Despite the decline in investment values, the quality of our portfolio remains high, and we have not recorded any significant permanent impairments in the carrying value of our investment holdings. The market value of our $15.1 billion fixed maturities portfolio was nearly $500 million higher than its cost on June 30, 2001. Approximately 95% of our portfolio is rated at investment grade (BBB or above), and its weighted average pretax yield at June 30, 2001 was 6.8%. The combined carrying value of our equity and venture capital investments at June 30, 2001 included pretax unrealized appreciation of $317 million. Environmental and Asbestos Claims --------------------------------- We continue to receive claims alleging injury or damage from environmental pollution or seeking payment for the cost to clean up polluted sites. We also receive asbestos injury claims arising out of product liability coverages under general liability policies. The vast majority of these claims arise from policies written many years ago. Our alleged liability for both environmental and asbestos claims is complicated by significant legal issues, primarily pertaining to the scope of coverage. In our opinion, court decisions in certain jurisdictions have tended to broaden insurance coverage beyond the intent of original insurance policies. Our ultimate liability for environmental claims is difficult to estimate because of these legal issues. Insured parties have submitted claims for losses not covered in their respective insurance policies, and the ultimate resolution of these claims may be subject to lengthy litigation, making it difficult to estimate our potential liability. In addition, variables, such as the length of time necessary to clean up a polluted site and controversies surrounding the identity of the responsible party and the degree of remediation deemed necessary, make it difficult to estimate the total cost of an environmental claim. Estimating our ultimate liability for asbestos claims is equally difficult. The primary factors influencing our estimate of the total cost of these claims are case law and a history of prior claim development, both of which continue to evolve. The following table represents a reconciliation of total gross and net environmental reserve development for the six months ended June 30, 2001, and the years ended Dec. 31, 2000 and 1999. Amounts in the "net" column are reduced by reinsurance recoverables. THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion, Continued Environmental and Asbestos Claims (continued) -------------------------------------------- 2001 Environmental (six months) 2000 1999 ------------- ----------- ----------- ----------- (In millions) Gross Net Gross Net Gross Net ----------- ----- ---- ----- ---- ----- ---- Beginning reserves $665 $563 $698 $599 $783 $645 Incurred losses 35 31 25 14 (33) 1 Paid losses (34) (31) (58) (50) (52) (47) ---- ---- ---- ---- ---- ---- Ending reserves $666 $563 $665 $563 $698 $599 ==== ==== ==== ==== ==== ==== The following table represents a reconciliation of total gross and net reserve development for asbestos claims for the six months ended June 30, 2001, and the years ended Dec. 31, 2000 and 1999. 2001 Asbestos (six months) 2000 1999 -------- ----------- ---------- ----------- (In millions) Gross Net Gross Net Gross Net ----------- ----- ---- ----- ---- ----- ---- Beginning reserves $397 $299 $398 $298 $402 $277 Incurred losses 27 36 41 33 28 51 Paid losses (25) (21) (42) (32) (32) (30) ---- ---- ---- ---- ---- ---- Ending reserves $399 $314 $397 $299 $398 $298 ==== ==== ==== ==== ==== ==== Our reserves for environmental and asbestos losses at June 30, 2001 represent our best estimate of our ultimate liability for such losses, based on all information currently available. Because of the inherent difficulty in estimating such losses, however, we cannot give assurances that our ultimate liability for environmental and asbestos losses will, in fact, match current reserves. We continue to evaluate new information and developing loss patterns, but we believe any future additional loss provisions for environmental and asbestos claims will not materially impact our results of operations, liquidity or financial position. Total gross environmental and asbestos reserves at June 30, 2001 of $1.07 billion represented approximately 6% of gross consolidated reserves of $18.40 billion. THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion, Continued Asset Management ---------------- Our asset management segment consists of our 77% majority ownership interest in The John Nuveen Company (Nuveen). Nuveen provides customized individual accounts, mutual funds, exchange- traded funds and defined portfolios to help financial advisors serve their affluent and high net worth clients. Highlights of Nuveen's performance for the second quarter and first six months of 2001 and 2000 were as follows: Three Months Six Months Ended June 30 Ended June 30 --------------- --------------- (In millions) 2001 2000 2001 2000 ----------- ----- ----- ----- ----- Revenues $87 $88 $174 $188 Expenses 42 45 84 102 ---- ---- ---- ---- Pretax earnings 45 43 90 86 Minority interest (11) (10) (21) (20) ---- ---- ---- ---- The St. Paul's share of pretax earnings $34 $33 $69 $66 ==== ==== ==== ==== Assets under management $62,990 $60,299 ====== ====== Nuveen's revenues for the second quarter and first six months of 2001 declined from comparable 2000 levels, due to a reduction in defined portfolio distribution revenue. Sales of equity and fixed-income retail managed accounts, however, totaled $2.0 billion in the second quarter, 38% higher than the same period of 2000. The strong increase in the sales of these accounts, which are customized investment portfolios marketed to the high-net- worth market, pushed year-to-date total gross product sales to $7.1 billion, a 19% increase over the first half of 2000. Equity products accounted for 60% of Nuveen's year-to-date gross sales total. The success of Nuveen's diverse selection of products for affluent investors continues to result in strong positive net asset flows (sales, plus reinvestments and exchanges, less redemptions) in a volatile and uncertain market environment. Net asset flows were $2.1 billion in the second quarter of 2001, 79% higher than net flows of $1.1 billion in the same 2000 period. Managed assets at the halfway point of 2001 consisted of $30.0 billion of exchange-traded funds, $21.1 billion of managed accounts, $11.5 billion of mutual funds and $428 million of money market funds. Total assets under management of $62.99 billion grew nearly $1 billion over the year-end 2000 managed asset total. In July 2001, Nuveen completed its acquisition of Symphony Asset Management, LLC, an institutional money manager specializing in alternative investment strategies. This acquisition will add over $4 billion to Nuveen's assets under management. Capital Resources ----------------- Common shareholders' equity totaled $6.81 billion at June 30, 2001, down $366 million from the year-end 2000 total of $7.18 billion. The decline reflected the impact of our significant share repurchases in the first half of the year and a reduction in the unrealized appreciation of our equity and venture capital investment portfolio. Through the first six months of 2001, we repurchased 8.3 million of our common shares for a total cost of $389 million, and an average cost of $46.68 per share. The repurchases were financed through a combination of internally- generated funds and commercial paper borrowings. From November 1998 through June 2001, we have repurchased and retired 41.2 million of our common shares for a total cost of $1.42 billion, or an average cost of $34.39 per share. Total debt obligations at June 30, 2001 of $1.78 billion was $133 million higher than the year-end 2000 total of $1.65 billion. In June 2001, our $150 million, 8.375% senior notes matured. That decline in our debt was more than offset by the issuance of $265 million of commercial paper, which financed the maturity of the senior notes and a portion of our share repurchases. The ratio of total debt to total capitalization was 20% at June 30, 2001, compared with 18% at the end of 2000. THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion, Continued Capital Resources (continued) ---------------------------- We have no current plans for major capital expenditures during the remainder of 2001, other than possible additional repurchases of our common stock. If any other expenditures were to occur, they would likely involve acquisitions of existing businesses consistent with our specialty commercial focus. From July 1, 2001 through August 10, 2001, we repurchased 2.6 million common shares for a total cost of $111 million. As of August 11, 2001, we had approximately $174 million of capacity to repurchase additional common shares under a repurchase program authorized by the company's board of directors in February 2001. We repurchase our shares in the open market and through private transactions when we deem such repurchases to be a prudent use of capital. For the first six months of 2001, our ratio of earnings to fixed charges was 6.03, compared with 10.51 for the same period of 2000. Our ratio of earnings to combined fixed charges and preferred stock dividend requirements was 5.57, compared with 9.67 for the same period of 2000. Fixed charges consist of interest expense, dividends on preferred capital securities and that portion of rental expense deemed to be representative of an interest factor. Liquidity --------- Liquidity is a measure of our ability to generate sufficient cash flows to meet the short- and long-term cash requirements of our business operations. Net cash flows used by continuing operations totaled $45 million in the first six months of 2001, compared with cash used by continuing operations of $499 million in the same period of 2000. The improvement over 2000 was centered in our property-liability underwriting operations and was primarily due to price increases. Our asset management segment also contributed to the improvement in operational cash flows in 2001. In our property-liability operations, underwriting cash flows remained negative, driven by significant loss payments in certain of our business segments and premium payments related to our corporate reinsurance program. We expect our operational cash flows to continue to improve during the second half of 2001 as the full impacts of continuing price increases and improvements in the quality of our book of business are realized. On a long-term basis, we believe our operational cash flows will benefit from the corrective pricing and underwriting actions under way in our property- liability operations. Our financial strength and conservative level of debt provide us with the flexibility and capacity to obtain funds externally through debt or equity financings on both a short-term and long-term basis should the need arise. Impact of Accounting Pronouncements to be Adopted in the Future --------------------------------------------------------------- In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 141, "Business Combinations" which establishes financial accounting and reporting standards for business combinations. The provisions of this statement reflect a fundamentally different approach to accounting for business combinations than previous requirements. It requires all business combinations to be accounted for under the purchase method of accounting and no longer allows for the pooling method to be used. In addition, this statement requires that intangible assets that can be identified and meet certain criteria be recognized as assets apart from goodwill. The provisions of this statement apply to all business combinations initiated after June 30, 2001. We intend to implement SFAS 141 in the periods during which its provisions become effective. Also in June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets" which establishes financial accounting and reporting for acquired goodwill and other intangible assets. It addresses how intangible assets that are acquired individually or with a group of other assets (but not those acquired in a business combination) should be accounted for in financial statements upon their acquisition. It also addresses how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements. The statement changes current accounting by requiring intangible items to be tested for impairment on an annual basis in lieu of the historical approach, which required goodwill to be amortized over the estimated useful life, not to exceed 40 years. The statement is effective for fiscal years beginning after December 15, 2001. We intend to implement SFAS No. 142 in the period during which its provisions become effective. We have not determined the impact of adopting this statement. THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion, Continued Forward-looking Statement Disclosure ------------------------------------ This report contains certain forward-looking statements within the meaning of the Private Litigation Reform Act of 1995. Forward-looking statements are statements other than historical information or statements of current condition. Words such as "expects," "anticipates," "intends," "plans," "believes," "seeks" or "estimates," or variations of such words, and similar expressions are also intended to identify forward-looking statements. Examples of these forward-looking statements include statements concerning: market and other conditions and their effect on future premiums, revenues, earnings, cash flow and investment income; price increases, improved loss experience, and expense savings resulting from the restructuring and other actions and initiatives announced in recent years. In light of the risks and uncertainties inherent in future projections, many of which are beyond our control, actual results could differ materially from those in forward-looking statements. These statements should not be regarded as a representation that anticipated events will occur or that expected objectives will be achieved. Risks and uncertainties include, but are not limited to, the following: competitive considerations, including the ability to implement price increases and possible actions by competitors; general economic conditions including changes in interest rates and the performance of financial markets; changes in domestic and foreign laws, regulations and taxes; changes in the demand for, pricing of, or supply of insurance or reinsurance; catastrophic events of unanticipated frequency or severity; loss of significant customers; worse than anticipated loss development from business written in prior years; judicial decisions and rulings; satisfaction of the conditions to closing of the sale of our life insurance business; and various other matters. We undertake no obligation to release publicly the results of any future revisions we may make to forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. PART II OTHER INFORMATION Item 1. Legal Proceedings. The information set forth in Note 5 to the consolidated financial statements is incorporated herein by reference. Item 2. Changes in Securities. Not applicable. Item 3. Defaults Upon Senior Securities. Not applicable. Item 4. Submission of Matters to a Vote of Security Holders. Not applicable. Item 5. Other Information. Not applicable. Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits. An Exhibit Index is set forth as the last page in this document. (b) Reports on Form 8-K. 1) The St. Paul filed a Form 8-K Current Report dated April 26, 2001, relating to the announcement of an agreement to sell Fidelity and Guaranty Life Insurance Company to Old Mutual plc, a London- based international financial services company. 2) The St. Paul filed a Form 8-K Current Report dated July 16, 2001, relating to the announcement of the expected impact of catastrophes and Health Care losses on The St. Paul's second- quarter 2001 operating results. 3) The St. Paul filed a Form 8-K Current Report dated July 19, 2001, relating to the announcement of several changes in executive management at the company, and the announcement of second-quarter 2001 operating results. 4) The St. Paul filed a Form 8-K Current Report dated August 3, 2001, related to the announcement of an agreement to purchase London Guarantee Insurance Company. 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. THE ST. PAUL COMPANIES, INC. (Registrant) Date: August 14, 2001 By /s/ Bruce A. Backberg --------------- --------------------- Bruce A. Backberg Senior Vice President (Authorized Signatory) Date: August 14, 2001 By /s/ John C. Treacy --------------- ------------------ John C. Treacy Vice President and Corporate Controller (Principal Accounting Officer) EXHIBIT INDEX ----------------------- Exhibit - --------- (2) Plan of acquisition, reorganization, arrangement, liquidation or succession*.................................. (3) (i) Articles of incorporation*................................. (ii) By-laws*.................................................. (4) Instruments defining the rights of security holders, including indentures*....................................... (10) Material contracts*............................................ (11) Statement re computation of per share earnings**...............(1) (12) Statement re computation of ratios**...........................(1) (15) Letter re unaudited interim financial information*............. (18) Letter re change in accounting principles*..................... (19) Report furnished to security holders*.......................... (22) Published report regarding matters submitted to vote of security holders*................................... (23) Consents of experts and counsel*............................... (24) Power of attorney*............................................. (27) Financial data schedule*....................................... (99) Additional exhibits*........................................... * These items are not applicable. ** This exhibit is included only with the copies of this report that are filed with the Securities and Exchange Commission. However, a copy of the exhibit may be obtained from the Registrant for a reasonable fee by writing to The St. Paul Companies, Inc., 385 Washington Street, Saint Paul, MN 55102, Attention: Corporate Secretary. (1) Filed herewith. EX-11 3 exh11601.txt EXHIBIT 11 Exhibit 11 THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Computation of Earnings Per Share Three Months Ended Six Months Ended June 30 June 30 ------------------ ----------------- 2001 2000 2001 2000 ------ ------ ------ ------ (In millions except per share data) EARNINGS Basic: Net income, as reported $104 $212 $306 $569 Dividends on preferred stock, net of taxes (2) (2) (4) (4) Premium on preferred shares redeemed (3) (2) (5) (6) ------ ------ ------ ------ Net income available to common shareholders $ 99 $208 $297 $559 ====== ====== ====== ====== Diluted: Net income available to common shareholders $ 99 $208 $297 $559 Effect of dilutive securities: Convertible preferred stock 2 2 3 3 Zero coupon convertible notes 1 1 2 1 Convertible monthly income preferred securities - 2 - 4 ------ ------ ------ ------ Net income available to common shareholders, as adjusted $102 $213 $302 $567 ====== ====== ====== ====== COMMON SHARES Basic: Weighted average common shares outstanding 214 212 215 216 ====== ====== ====== ====== Diluted: Weighted average common shares outstanding 214 212 215 216 Effect of dilutive securities: Stock options 4 2 4 1 Convertible preferred stock 7 7 7 7 Zero coupon convertible notes 2 2 2 3 Convertible monthly income preferred securities - 7 - 7 ------ ------ ------ ------ Total 227 230 228 234 ====== ====== ====== ====== EARNINGS PER SHARE Basic $0.47 $0.98 $1.38 $2.59 ====== ====== ====== ====== Diluted $0.45 $0.92 $1.33 $2.43 ====== ====== ====== ====== EX-12 4 exh12601.txt EXHIBIT 12 Exhibit 12 THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Computation of Ratios Three Months Ended Six Months Ended June 30 June 30 ------------------ ---------------- 2001 2000 2001 2000 ------ ------ ------ ------ (In millions, except ratios) EARNINGS: Income from continuing operations before income taxes $133 $301 $431 $821 Add: fixed charges 42 46 86 86 ------ ------ ------ ------ Income, as adjusted $175 $347 $517 $907 ====== ====== ====== ====== FIXED CHARGES AND PREFERRED DIVIDENDS: Interest expense and amortization $28 $29 $58 $55 Dividends on preferred capital securities 7 10 14 18 Rental expense (1) 7 7 14 13 ------ ------ ------ ------ Total fixed charges 42 46 86 86 Preferred stock dividend requirements 3 4 7 8 ------ ------ ------ ------ Total fixed charges and preferred stock dividend requirements $45 $50 $93 $94 ====== ====== ====== ====== Ratio of earnings to fixed charges 4.22 7.52 6.03 10.51 ====== ====== ====== ====== Ratio of earnings to combined fixed charges and preferred stock dividend requirements 3.89 6.95 5.57 9.67 ====== ====== ====== ====== (1) Interest portion deemed implicit in total rent expense. -----END PRIVACY-ENHANCED MESSAGE-----