-----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, TYZcnXCEngkNE9lZnNQO3pPtIIUJNOAZQwO6YnGvZ6cgVnbqEAOP6C0cmGmdqBjh e9PYKEBg/AuEmunfmKjoqQ== 0001047469-99-012029.txt : 19990406 0001047469-99-012029.hdr.sgml : 19990406 ACCESSION NUMBER: 0001047469-99-012029 CONFORMED SUBMISSION TYPE: 10-Q/A PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19990329 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ST PAUL COMPANIES INC /MN/ CENTRAL INDEX KEY: 0000086312 STANDARD INDUSTRIAL CLASSIFICATION: 6331 IRS NUMBER: 410518860 STATE OF INCORPORATION: MN FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q/A SEC ACT: SEC FILE NUMBER: 001-10898 FILM NUMBER: 99576333 BUSINESS ADDRESS: STREET 1: 385 WASHINGTON ST CITY: SAINT PAUL STATE: MN ZIP: 55102 BUSINESS PHONE: 6123107911 FORMER COMPANY: FORMER CONFORMED NAME: ST PAUL COMPANIES INC /MN/ DATE OF NAME CHANGE: 19920703 FORMER COMPANY: FORMER CONFORMED NAME: SAINT PAUL COMPANIES INC DATE OF NAME CHANGE: 19900730 10-Q/A 1 10-Q/A SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q/A (Mark One) X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) - - -- OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1998 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 0-3021 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 incorporation or organization) Identification No.) 385 Washington St., Saint Paul, MN 55102 (Address of principal executive offices) (Zip Code) 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 on November 12, 1998, was 235,733,012. THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES TABLE OF CONTENTS
Page No. -------- PART I. FINANCIAL INFORMATION Consolidated Statements of Operations (Unaudited), Three Months and Nine Months Ended September 30, 1998 and 1997 3 Consolidated Balance Sheets, September 30, 1998 (Unaudited) and December 31, 1997 4 Consolidated Statements of Shareholders' Equity, Nine Months Ended September 30, 1998 (Unaudited) and Twelve Months Ended December 31, 1997 6 Consolidated Statements of Comprehensive Income (Unaudited),Three Months and Nine Months Ended September 30, 1998 and 1997 7 Consolidated Statements of Cash Flows (Unaudited), Nine Months Ended September 30, 1998 and 1997 8 Notes to Consolidated Financial Statements (Unaudited) 9 Management's Discussion and Analysis of Financial Condition and Results of Operations 21 PART II. OTHER INFORMATION Item 1 through Item 6 40 Signatures 41 EXHIBIT INDEX 42
PART I FINANCIAL INFORMATION THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Consolidated Statements of Operations Unaudited (In thousands)
Three Months Ended Nine Months Ended September 30 September 30 ------------------------- ------------------------- 1998 1997 1998 1997 ---- ---- ---- ---- Revenues: Premiums earned $1,698,787 1,810,402 5,232,511 5,507,374 Net investment income 390,601 392,082 1,185,148 1,172,493 Realized investment gains 24,835 47,478 210,208 314,951 Asset management- investment banking 76,470 61,939 222,791 180,299 Other 20,564 12,389 64,472 44,526 ------------ ------------ ------------ ------------ Total revenues 2,211,257 2,324,290 6,915,130 7,219,643 ------------ ------------ ------------ ------------ Expenses: Insurance losses and loss adjustment expenses 1,386,905 1,261,322 4,320,777 3,908,363 Life policy benefits 66,080 57,873 187,711 179,509 Policy acquisition expenses 393,812 427,362 1,243,928 1,297,232 Operating and administrative 326,462 303,182 1,284,916 859,825 ------------ ------------ ------------ ------------ Total expenses 2,173,259 2,049,739 7,037,332 6,244,929 ------------ ------------ ------------ ------------ Income (loss) from continuing operations before income taxes 37,998 274,551 (122,202) 974,714 Income tax expense (benefit) (29,695) 59,379 (110,770) 233,432 ------------ ------------ ------------ ------------ Income (loss) from continuing operations 67,693 215,172 (11,432) 741,282 Loss on disposal of discontinued operations, net of taxes - - - (67,750) ------------ ------------ ------------ ------------ Net income (loss) $67,693 215,172 (11,432) 673,532 ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ Basic earnings (loss) per common share: Income (loss) from continuing operations $0.27 0.92 (0.09) 3.18 Loss from discontinued operations - - - (0.30) ------------ ------------ ------------ ------------ Net income (loss) $0.27 0.92 (0.09) 2.88 ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ Diluted earnings (loss) per common share: Income (loss) from continuing operations $0.27 0.85 (0.09) 2.95 Loss from discontinued operations - - - (0.27) ------------ ------------ ------------ ------------ Net income (loss) $0.27 0.85 (0.09) 2.68 ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ Dividends declared on common stock $0.25 0.235 0.75 0.71 ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
See notes to consolidated financial statements. THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Consolidated Balance Sheets (In thousands)
September 30, December 31, ASSETS 1998 1997 - - ----------- ---------- ---------- (Unaudited) Investments: Fixed maturities, at estimated market value $21,149,340 20,945,219 Equities, at estimated market value 1,064,029 1,052,370 Real estate, at cost less accumulated depreciation of $105,196 (1997; $93,015) 936,332 985,317 Mortgage loans, at cost 674,125 640,734 Venture capital, at estimated market value 506,968 461,892 Other investments 1,033,193 923,933 Short-term investments, at cost 863,961 970,568 ----------- ----------- Total investments 26,227,948 25,980,033 Cash 129,391 113,175 Investment banking inventory securities 52,009 130,203 Reinsurance recoverables: Unpaid losses 4,000,161 3,839,051 Paid losses 127,804 128,422 Ceded unearned premiums 318,423 376,343 Receivables: Underwriting premiums 2,250,015 2,213,926 Interest and dividends 376,874 355,970 Other 94,127 104,727 Deferred policy acquisition expenses 876,151 872,460 Deferred income taxes 1,148,038 1,213,790 Office properties and equipment, at cost less accumulated depreciation of $408,403 (1997; $369,414) 518,084 602,381 Goodwill 602,075 618,528 Other assets 791,259 809,819 ----------- ----------- Total assets $37,512,359 37,358,828 ----------- ----------- ----------- -----------
See notes to consolidated financial statements. THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Consolidated Balance Sheets (continued) (In thousands)
September 30, December 31, LIABILITIES AND SHAREHOLDERS' EQUITY 1998 1997 - - ------------------------------------------------------------ --------------- ----------- (Unaudited) Liabilities: Insurance reserves: Losses and loss adjustment expenses $18,653,723 18,153,080 Future policy benefits 3,959,164 3,816,050 Unearned premiums 3,411,620 3,528,234 -------------- -------------- Total insurance reserves 26,024,507 25,497,364 Debt 1,097,742 1,304,008 Payables: Income taxes 176,299 303,549 Reinsurance premiums 314,837 258,495 Accrued expenses and other 1,231,881 1,327,549 Other liabilities 1,527,909 1,556,995 -------------- -------------- Total liabilities 30,373,175 30,247,960 -------------- -------------- Company-obligated mandatorily redeemable preferred capital securities of subsidiaries or trusts holding solely convertible subordinated debentures of the Company 502,700 502,700 -------------- -------------- Shareholders' equity: Preferred: Series B convertible preferred stock; 1,450 shares authorized; 937 shares outstanding (956 shares in 1997) 135,522 137,892 Guaranteed obligation - PSOP (118,605) (121,167) -------------- -------------- Total preferred shareholders' equity 16,917 16,725 -------------- -------------- Common: Common stock, 480,000 shares authorized; 236,872 shares outstanding (233,130 shares in 1997) 2,142,667 2,057,108 Retained earnings 3,540,005 3,720,140 Guaranteed obligation - ESOP - (8,453) Accumulated other comprehensive income: Unrealized appreciation 969,904 845,811 Unrealized loss on foreign currency translation (33,009) (23,163) -------------- -------------- Total accumulated other comprehensive income 936,895 822,648 -------------- -------------- Total common shareholders' equity 6,619,567 6,591,443 -------------- -------------- Total shareholders' equity 6,636,484 6,608,168 -------------- -------------- Total liabilities, redeemable preferred securities and shareholders' equity $37,512,359 37,358,828 -------------- -------------- -------------- --------------
See notes to consolidated financial statements. THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Consolidated Statements of Shareholders' Equity (In thousands)
Nine Twelve Months Ended Months Ended September 30, December 31, 1998 1997 ------------ ------------ (Unaudited) Preferred shareholders' equity: Series B convertible preferred stock: Beginning of period $ 137,892 142,131 Redemptions during period (2,370) (4,239) ------------- ------------- End of period 135,522 137,892 ------------- ------------- Guaranteed obligation - PSOP: Beginning of period (121,167) (126,068) Principal payments 2,562 4,901 ------------- ------------- End of period (118,605) (121,167) ------------- ------------- Total preferred shareholders' equity 16,917 16,725 ------------- ------------- Common shareholders' equity: Common stock: Beginning of period 2,057,108 1,895,608 Stock issued under stock incentive plans 66,889 32,421 Stock issued for preferred shares redeemed 5,394 8,708 Stock issued for acquisitions - 113,264 Reacquired common shares - (13,892) Other 13,276 20,999 ------------- ------------- End of period 2,142,667 2,057,108 ------------- ------------- Retained earnings: Beginning of period 3,720,140 3,097,261 Net income (loss) (11,432) 929,292 Dividends declared on common stock (167,793) (186,036) Dividends declared on preferred stock, net of taxes (6,395) (10,304) Reacquired common shares (153) (114,232) Premium on preferred shares converted or redeemed (3,025) (4,052) Other changes during period 8,663 8,211 ------------- ------------- End of period 3,540,005 3,720,140 ------------- ------------- Guaranteed obligation - ESOP: Beginning of period (8,453) (20,353) Principal payments 8,453 11,900 ------------- ------------- End of period - (8,453) ------------- ------------- Unrealized appreciation, net of taxes: Beginning of period 845,811 679,381 Change during the period 124,093 166,430 ------------- ------------- End of period 969,904 845,811 ------------- ------------- Unrealized loss on foreign currency translation, net of taxes: Beginning of period (23,163) (20,500) Currency translation adjustments (9,846) (2,663) ------------- ------------- End of period (33,009) (23,163) ------------- ------------- Total common shareholders' equity 6,619,567 6,591,443 ------------- ------------- Total shareholders' equity $6,636,484 6,608,168 ------------- ------------- ------------- -------------
See notes to consolidated financial statements. THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Consolidated Statements of Comprehensive Income Unaudited (In thousands)
Three Months Ended Nine Months Ended September 30 September 30 -------------------------- ---------------------- 1998 1997 1998 1997 ------ ------- ------ ------ Net income (loss), as reported $67,693 215,172 (11,432) 673,532 ------- ------- -------- ------- Other comprehensive income, net of taxes: Change in unrealized appreciation 103,569 212,046 124,093 98,626 Change in unrealized loss on foreign currency translation (10,501) 533 (9,846) 5,832 ------- ------- -------- ------- Other comprehensive income 93,068 212,579 114,247 104,458 ------- ------- -------- ------- Comprehensive income $160,761 427,751 102,815 777,990 ------- ------- -------- ------- ------- ------- -------- -------
See notes to consolidated financial statements. THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows Unaudited (In thousands)
Nine Months Ended September 30 --------------------------------------- 1998 1997 ---- ---- OPERATING ACTIVITIES Net income (loss) $ (11,432) 673,532 Adjustments: Change in net property-liability insurance reserves 256,881 (59,818) Change in insurance premiums receivable (36,371) (69,231) Change in asset management balances (19,834) 148,549 Realized investment gains (210,208) (314,951) Provision for loss on disposal of discontinued operations - 67,750 Other 143,510 225,903 ----------- --------- Net cash provided by operating activities 122,546 671,734 ----------- --------- INVESTING ACTIVITIES Purchase of investments (4,002,198) (4,288,064) Proceeds from sales and maturities of investments 3,982,566 3,897,736 Change in short-term investments 151,298 (99,363) Change in open security transactions (7,598) 60,249 Net purchases of office properties and equipment (61,275) (106,680) Discontinued operations (20,218) (44,776) Other (5,209) (149,757) ----------- --------- Net cash provided by (used in) investing activities 37,366 (730,655) ----------- --------- FINANCING ACTIVITIES Deposits on universal life and investment contracts 311,365 380,662 Withdrawals on universal life and investment contracts (157,651) (166,076) Dividends paid on common and preferred stock (164,504) (148,637) Proceeds from issuance of debt 61,022 196,682 Repayment of debt (205,444) (100,000) Redemption of preferred shares - (199,484) Repurchase of common shares (153) (128,030) Proceeds from issuance of company-obligated mandatorily redeemable preferred securities of subsidiaries - 197,845 Stock options exercised and other 11,669 20,400 ----------- --------- Net cash provided by (used in) financing activities (143,696) 53,362 ----------- --------- Effect of exchange rate changes on cash - (23) ----------- --------- Increase (decrease) in cash 16,216 (5,582) Cash at beginning of period 113,175 109,855 ----------- --------- Cash at end of period $129,391 104,273 ----------- --------- ----------- ---------
See notes to consolidated financial statements. THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Unaudited September 30, 1998 NOTE 1 BASIS OF PRESENTATION The financial statements include The St. Paul Companies, Inc. and subsidiaries (The St. Paul), and have been prepared in conformity with generally accepted accounting principles. On April 24, 1998, The St. Paul completed its merger with USF&G Corporation (USF&G) in a tax-free exchange of stock accounted for as a pooling-of-interests. The consolidated financial statements for all current year and prior year periods in this report reflect the combined accounts and results of operations of The St. Paul and USF&G. See Note 8 on page 16 of this report for further information about the merger. 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. Some amounts in the 1997 consolidated financial statements have been reclassified to conform with the 1998 presentation. These reclassifications had no effect on net income or shareholders' equity, as previously reported. All references in the consolidated financial statements and related footnotes to per share amounts and to the number of common shares for both 1998 and 1997 reflect the effect of the 2-for-1 stock split which occurred on May 6, 1998 (See Note 9). THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued NOTE 2 EARNINGS (LOSS) PER SHARE Earnings (loss) per common share (EPS) amounts were calculated by dividing net income (loss), as adjusted, by the adjusted average common shares outstanding.
Three Months Ended Nine Months Ended September 30 September 30 -------------------------- ---------------------- 1998 1997 1998 1997 ------ ------ ------ ------ (In thousands) EARNINGS (LOSS) Basic: Net income (loss), as reported $67,693 215,172 (11,432) 673,532 Dividends on preferred stock, net of taxes (2,126) (2,163) (6,395) (8,175) Premium on preferred shares redeemed (820) (1,523) (3,025) (2,434) ---------- ---------- ---------- ---------- Net income (loss) available to common shareholders $64,747 211,486 (20,852) 662,923 ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- Diluted: Net income (loss) available to common shareholders $64,747 211,486 (20,852) 662,923 Effect of diluted securities: Convertible preferred stock 1,562 1,504 - 4,521 Zero coupon convertible notes 826 796 - 2,338 Convertible monthly income preferred securities 2,018 2,018 - 6,055 ---------- ---------- ---------- ---------- Net income (loss), as adjusted $69,153 215,804 (20,852) 675,837 ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- COMMON SHARES Basic: Weighted average common shares outstanding 236,244 229,885 235,214 230,101 ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- Diluted: Weighed average common shares outstanding 236,244 229,885 235,214 230,101 Effect of dilutive securities: Stock options 2,822 4,838 - 4,627 Convertible preferred stock 7,530 7,760 - 7,818 Zero coupon convertible notes 2,914 2,923 - 2,923 Convertible monthly income preferred securities 7,017 7,017 - 7,017 ---------- ---------- ---------- ---------- Total 256,527 252,423 235,214 252,486 ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- EARNINGS (LOSS) PER SHARE Basic $0.27 0.92 (0.09) 2.88 Diluted $0.27 0.85 (0.09) 2.68 ---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued The assumed exercise of stock options, and the assumed conversion of preferred stock, zero coupon notes and monthly income preferred securities are each anti-dilutive to The St. Paul's net income for the nine months ended Sept. 30, 1998. As a result, the potentially dilutive effect of those securities is not considered in the calculation of EPS amounts for that period. NOTE 3 INVESTMENTS Investment Activity. A summary of investment transactions is presented below.
Nine Months Ended September 30 ---------------------------------------- 1998 1997 ------ ------ (In thousands) Purchases: Fixed maturities $2,536,629 2,717,288 Equities 1,071,175 1,082,038 Real estate 63,152 117,138 Mortgage loans 112,598 197,572 Venture capital 118,727 98,360 Other investments 99,917 75,668 ------------ ------------ Total purchases 4,002,198 4,288,064 ------------ ------------ Proceeds from sales and maturities: Fixed maturities: Sales 1,013,762 1,337,993 Maturities and redemptions 1,471,002 956,025 Equities 1,169,491 1,058,804 Real estate 112,275 228,263 Mortgage loans 83,275 21,550 Venture capital 51,812 241,854 Other investments 80,949 53,247 ------------ ------------ Total sales and maturities 3,982,566 3,897,736 ------------ ------------ Net purchases $ 19,632 390,328 ------------ ------------ ------------ ------------
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Change in Unrealized Appreciation. The increase (decrease) in unrealized appreciation recorded in common shareholders' equity was as follows:
Nine Months Ended Twelve Months Ended September 30, 1998 December 31, 1997 -------------------------- ------------------------ (In thousands) Fixed maturities $328,176 399,696 Equities (113,318) 61,969 Venture capital 4,798 (154,826) Life deferred policy acquisition costs and policy benefits (5,903) (21,171) Single premium immediate annuity reserves (9,880) (27,411) Other (14,143) (1,974) ----------- ----------- Total change in pretax unrealized appreciation 189,730 256,283 Change in deferred taxes (65,637) (89,853) ----------- ----------- Total change in unrealized appreciation, net of taxes $124,093 166,430 ----------- ----------- ----------- -----------
NOTE 4 INCOME TAXES The components of income tax expense (benefit) on continuing operations are as follows:
Three Months Ended Nine Months Ended September 30 September 30 -------------------------- -------------------------- 1998 1997 1998 1997 ------ ------ ------ ------ (In thousands) Federal current tax expense (benefit) $(94,590) 63,289 (50,122) 249,574 Federal deferred tax expense (benefit) 60,758 (11,795) (79,187) (36,373) --------- --------- --------- --------- Total federal income tax expense (benefit) (33,832) 51,494 (129,309) 213,201 Foreign income taxes 2,820 6,383 13,202 15,712 State income taxes 1,317 1,502 5,337 4,519 --------- --------- --------- --------- Total income tax expense (benefit) on continuing operations $(29,695) 59,379 (110,770) 233,432 --------- --------- --------- --------- --------- --------- --------- ---------
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued NOTE 5 CONTINGENT LIABILITIES In the ordinary course of conducting business, the company and some of its subsidiaries have been named as defendants in various lawsuits. Some of these lawsuits attempt to establish liability under insurance contracts issued by those companies. Plaintiffs in these lawsuits are asking for money damages or to have the court direct the activities of The St. Paul's operations in certain ways. Although it is possible that the settlement of a contingency may be material to the company's results of operations and liquidity in the period in which the settlement occurs, the company believes that the total amounts that it or its subsidiaries will ultimately have to pay in all of these lawsuits will have no material effect on its 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. NOTE 6 DEBT Debt consists of the following:
September 30, December 31, 1998 1997 ----------------------- ------------------------- Book Fair Book Fair Value Value Value Value ------ ------ ------ ------ (In thousands) Medium-term notes $501,915 566,600 511,920 529,000 Commercial paper 229,373 229,373 168,429 168,429 8 3/8% senior notes 149,679 162,100 149,592 159,060 Zero coupon convertible notes 110,091 113,200 106,838 122,307 7 1/8% senior notes 79,842 87,500 79,824 82,680 Real estate mortgages 19,842 20,500 19,900 20,491 Nuveen debt 7,000 7,000 84,500 84,600 7% senior notes - - 145,225 145,744 Credit facility - - 35,000 35,000 Guaranteed ESOP debt - - 2,780 2,800 ---------- ---------- ---------- ---------- Total debt $1,097,742 1,186,273 1,304,008 1,350,111 ---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued NOTE 7 SEGMENT INFORMATION In connection with the merger with USF&G, The St. Paul performed a reassessment of its reportable segments in accordance with SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." Based on the merged organizational structure and related operating segment manager responsibilities, The St. Paul has redefined its reportable segments as follows:
Three Months Ended Nine Months Ended September 30 September 30 ----------------------- ------------------------- 1998 1997 1998 1997 ------ ------ ------ ------ REVENUES FROM CONTINUING OPERATIONS (In thousands) Property-liability insurance: Primary insurance operations $1,445,090 1,491,355 4,364,916 4,478,446 Reinsurance operations 222,937 293,934 786,594 950,508 ------------- ------------ ------------- ------------ Total premiums earned 1,668,027 1,785,289 5,151,510 5,428,954 Net investment income 322,094 328,360 984,987 985,694 Realized investment gains 6,573 39,163 186,549 302,106 Other 17,042 8,565 51,494 33,806 ------------- ------------- ------------- ------------ Total property-liability insurance 2,013,736 2,161,377 6,374,540 6,750,560 ------------- ------------- ------------- ------------ Life insurance 99,763 91,916 283,722 262,781 ------------- ------------- ------------- ------------ Asset management-investment banking 76,739 66,062 225,552 187,463 ------------- ------------- ------------- ------------ Total reportable segments 2,190,238 2,319,355 6,883,814 7,200,804 Parent company and eliminations 21,019 4,935 31,316 18,839 ------------- ------------- ------------- ------------ Total revenues $2,211,257 2,324,290 6,915,130 7,219,643 ------------- ------------- ------------- ------------ ------------- ------------- ------------- ------------
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued
Three Months Ended Nine Months Ended September 30 September 30 ----------------------- ------------------------- 1998 1997 1998 1997 ------ ------ ------ ------ INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES (In thousands) Property-liability insurance: Primary insurance operations $(265,940) (52,540) (877,835) (202,003) Reinsurance operations (21,199) 5,183 (5,120) 7,127 ------------- ------------ ------------ ------------ Total GAAP underwriting result (287,139) (47,357) (882,955) (194,876) Net investment income 322,094 328,360 984,987 985,694 Realized investment gains 6,573 39,163 186,549 302,106 Other (10,842) (35,661) (234,967) (80,424) ------------- ------------- ------------- ------------- Total property-liability insurance 30,686 284,505 53,614 1,012,500 ------------- ------------- ------------ ------------- Life insurance 22,368 20,041 8,631 45,329 ------------- ------------- ------------ ------------- Asset management-investment banking: Pretax income before minority interest 33,889 30,605 98,416 88,665 Minority interest (8,017) (7,456) (23,834) (21,382) ------------- ------------- ------------- ------------- Total asset management- investment banking 25,872 23,149 74,582 67,283 ------------- ------------- ------------- ------------- Total reportable segments 78,926 327,695 136,827 1,125,112 Parent company and eliminations (40,928) (53,144) (259,029) (150,398) ------------- ------------- ------------- ------------- Total income (loss) from continuing operations before income taxes $ 37,998 274,551 (122,202) 974,714 ------------- ------------- ------------- ------------- ------------- ------------- ------------- -------------
The St. Paul recorded a $291.6 million pretax charge in the second quarter of 1998 related to its merger with USF&G (see Note 8). The charge was recorded in the following captions of the "Income (Loss) from Continuing Operations Before Income Taxes" section of the foregoing segment table: $142.4 million in property-liability insurance - other; $14.1 million in property-liability insurance - realized gains; $9.4 million in life insurance; and $125.7 million in parent company and eliminations. The St. Paul also recorded a $250.0 million pretax charge to increase its loss reserves in the second quarter of 1998 to reflect the application of The St. Paul's loss reserving policies to USF&G's loss and loss adjustment expense reserves subsequent to the merger. The charge is included in the primary insurance operations GAAP underwriting result caption of the foregoing table. In addition, The St. Paul recorded a $41.0 million pretax charge to write down the carrying value of its life insurance operation's deferred policy acquisition costs, which is reflected in the life insurance caption in the table. See Note 9 for further discussion of these charges. THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued NOTE 8 MERGER WITH USF&G CORPORATION On April 24, 1998, The St. Paul issued 66,468,572 of its common shares (as adjusted for the May 6, 1998 two-for-one stock split) in exchange for all of the outstanding common stock of USF&G Corporation, a holding company for property-liability and life insurance operations. The transaction was valued at approximately $3.7 billion, which included the assumption of USF&G's debt and capital securities. This business combination has been accounted for as a pooling of interests; accordingly, the consolidated unaudited financial statements for periods prior to the combination have been restated to include the accounts and results of operations of USF&G Corporation. Prior to the merger, USF&G discounted all of its workers' compensation reserves to present value, whereas The St. Paul did not discount any of its loss reserves. Subsequent to the merger, The St. Paul and USF&G, on a combined basis, discount only tabular workers' compensation reserves using an interest rate of up to 3.5%. Since these reserves have an ultimate cost and payment pattern that is fixed and determinable in accordance with Staff Accounting Bulletin No. 62, "Discounting by Property-Casualty Insurance Companies," The St. Paul has determined that the discounting of such reserves is the preferable accounting treatment. The St. Paul recorded a pretax charge to earnings of $291.6 million ($221.0 million after-tax) in the second quarter of 1998 related to the merger, primarily consisting of severance and other employee-related costs, facilities exit costs, asset impairments and transaction costs. The St. Paul estimates that approximately 2,000 positions will be eliminated due to the combination of the two organizations, resulting from efficiencies to be realized by the larger organization and the elimination of redundant functions. All levels of employees, from technical staff to senior management, will be affected by the reductions. The number of positions expected to be reduced by function include approximately 950 in The St. Paul's property-liability underwriting operation, 350 in claims and 700 in finance and other administrative positions. The reductions will occur throughout the United States. Through Sept. 30, 1998, approximately 1,100 positions had been eliminated, and the cost of termination benefits paid was $58.7 million. The St. Paul expects to realize annualized pretax expense savings of approximately $200 million as a result of its plan to merge the two organizations, primarily due to a reduction in employee salaries and benefits. The merger-related charge was determined in accordance with Emerging Issues Task Force (EITF) Issue No 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity," Statement of Financial Accounting Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," SFAS No. 5, "Accounting for Contingencies," and Accounting Principles Board Opinion No. 16, "Business Combinations." The following table provides information about the components of the charge taken in the second quarter, payments made and the balance of accrued amounts remaining at Sept. 30, 1998. THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued
(in thousands) Pre-tax CHARGES TO EARNINGS: Charge ------------ USF&G corporate headquarters $36,400 Long-lived assets 22,835 Software depreciation acceleration 9,678 Computer leases and equipment 9,600 Other equipment and furniture 7,700 ----------- Subtotal 86,213 ----------- Accrued charges subject to rollforward: Reserve at Pre-tax Sept. 30, Charge Payments 1998 ------------ ------------- ------------- Executive severance 89,352 $(47,787) $ 41,565 Other severance 52,200 (10,913) 41,287 Branch lease exit costs 34,150 (52) 34,098 Transaction costs 29,676 (29,331) 345 ------------ ------------- ------------ Accruals subject to rollforward 205,378 (88,083) 117,295 ------------ ------------- ------------ Total $291,591 $117,295 ------------ ------------
On The St. Paul's Consolidated Statement of Operations, $268.8 million of the merger-related charge was recorded in the "Operating and administrative" expense caption and $22.8 million was recorded in the "Realized investment gains" revenue caption. The following discussion provides more information regarding the rationale for and calculation of each component of the second-quarter merger-related charge: USF&G CORPORATE HEADQUARTERS The Founders Building had been one of USF&G's headquarters buildings in Baltimore, MD. Upon consummation of the merger, it was determined that the headquarters for the combined entity would reside in St. Paul, MN, and that a significant number of personnel working in Baltimore would be terminated, thus vacating a significant portion of the Founders Building. The St. Paul developed a plan to lease that space to outside parties and thus categorized it as an "asset to be held or used" as defined in SFAS No. 121 for purposes of evaluating the potential impairment of its $64 million carrying value. That evaluation, based on the anticipated undiscounted future cash flows from potential lessees, indicated that an impairment in the carrying value had occurred, and the building was written down by $36 million to its fair value of $28 million. The writedown is reflected in "parent company and eliminations" results. The building continues to be depreciated over its estimated remaining useful life. THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued LONG-LIVED ASSETS Upon consummation of the merger, The St. Paul determined that several of USF&G's real estate investments were not consistent with The St. Paul's real estate investment strategy. A plan was developed to sell a number of apartment buildings and various other miscellaneous holdings, with an expected disposal date in 1999. In applying the provisions of SFAS No. 121, it was determined that four of these miscellaneous investments should be written down to fair value, based on The St. Paul's plan to sell them. Fair value was determined based on a discounted cash flow analysis, or based on market prices for similar assets. The impairment writedown is reflected in the Consolidated Statement of Operations in the "Realized investment gains" revenue caption. The four investments are as follows: 1) Description of investment: Percentage rents retained after sale of a portfolio of stores to a third party Carrying amount: $21.6 million prior to writedown of $16.6 million, for current amount of $5.0 million 2) Description of investment: 138-acre land parcel in New Jersey, with farm buildings being rented out Carrying amount: $4.9 million prior to writedown of $2.1 million, for current amount of $2.8 million 3) Description of investment: Receivable representing cash flow guarantee payments related to real estate partnerships. Carrying amount: $4.8 million prior to writedown of $1.7 million, for a balance of $3.1 million. 4) Description of investment: Limited partnership interests in three citrus groves Carrying amount : $7.4 million prior to writedown of $2.4 million, for current amount of $5.0 million
These writedowns are reflected in the following operations: $14.1 million in property-liability investment operations; $6.2 million in parent company and eliminations; and $2.5 million in life insurance. ACCELERATION OF SOFTWARE DEPRECIATION The St. Paul conducted an extensive technology study upon consummation of the merger as part of the business plan to merge the two companies. The resulting strategy to standardize technology throughout the combined entity and maintain one data center in St. Paul, MN, resulted in the identification of duplicate software applications. As a result, the estimated useful life for that software was shortened, resulting in an additional charge to earnings. THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued COMPUTER LEASES AND EQUIPMENT The technology study also identified redundant computer hardware, resulted in lease buy-out transactions and disposals of computer equipment. OTHER EQUIPMENT AND FURNITURE The decision to combine all corporate headquarters in St. Paul, MN created excess equipment and furniture in Baltimore, MD. The charge was calculated based on the book value of assets at that location. EXECUTIVE SEVERANCE Represents the obligations The St. Paul will be required to pay in accordance with the USF&G Senior Executive Severance Plan in place at the time of the merger. The plan provides for payments to participants in the event the participant is terminated without cause by the company or for good reason by the participant within two years of the effective date of a transaction covered by the plan. OTHER SEVERANCE Represents severance and related benefits such as out-placement counseling, vacation buy-out and medical coverage to be paid to terminated employees not covered under the USF&G Senior Executive Severance Plan. BRANCH LEASE EXIT COSTS As a result of the merger, excess space will be created in several locations due to the anticipated staff reduction in the combined organization. The charge for branch lease exit costs was calculated by determining the percentage of anticipated excess space at each site and the current lease costs over the remaining lease period. In certain locations, the lease is expected to be terminated. For leases not expected to be terminated, the amount of expense included in the charge was calculated as the percentage of excess space (20% to 100%) times the net of: remaining rental payments plus capitalized leasehold improvements less actual sub-lease income. No amounts were discounted to present value in the calculation. TRANSACTION COSTS This amount consists of registration fees, costs of furnishing information to stockholders, consultant fees, investment banker fees, and legal and accounting fees. NOTE 9 CHARGES TO INCREASE LOSS RESERVES AND REDUCE THE CARRYING VALUE OF LIFE INSURANCE DEFERRED ACQUISITION COSTS In the second quarter of 1998, The St. Paul recorded pretax loss and loss adjustment expenses of $250.0 million to reflect the application of The St. Paul's loss reserving policies to USF&G's loss and loss adjustment expense reserves subsequent to the merger. Prior to the merger, both companies, in accordance with generally accepted accounting principles, recorded their best estimate of reserves within a range of estimates bounded by a high point and a low point. Subsequent to the consummation of the merger in April 1998, The St. Paul obtained the raw data underlying, and documentation supporting, USF&G's December 31, 1997 reserve analysis. The St. Paul's actuaries reviewed such information and concurred with the reasonableness of USF&G's range of estimates for their reserves. However, applying their THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued judgment and interpretation to the range, The St. Paul's actuaries, who would be responsible for setting reserve amounts for the combined entity, concluded that strengthening the reserves would be appropriate, resulting in the $250 million adjustment. The adjustment was allocated to the following underwriting business centers: General Commercial ($120 million); Specialized Commercial ($95 million); and Personal Insurance ($35 million). Also in the second quarter, The St. Paul recorded a $41.0 million pretax charge to reflect a writedown in the carrying value of deferred policy acquisition costs (DPAC) in its life insurance segment. The writedown related to universal life-type and investment-type contracts which are subject to the guidance in SFAS No. 97, "Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments." According to SFAS No. 97, amortization of DPAC is based on the present value of estimated gross profits expected to be realized over the life of the contract. Estimates of expected gross profits used as a basis for amortization are evaluated regularly and the total amortization to date should be adjusted if actual experience or other evidence suggests that earlier estimates should be revised. The $41.0 million DPAC charge had three components. First, the persistency of certain in-force business, particularly universal life and flexible premium annuities, sold through some USF&G distribution channels, had begun to deteriorate after the USF&G merger announcement. To mitigate this, management decided, in the second quarter, to increase credited rates on certain universal life business. This change lowered the estimated future profits on this business, which, as required under SFAS No. 97, triggered $19.1 million in accelerated DPAC amortization. Second, the low interest rate environment during the first half of 1998 led to assumption changes as to the future "spread" on certain interest sensitive products, lowering gross profit expectations and triggering a $15.6 million DPAC charge. The remaining $6.3 million charge resulted from a change in annuitization assumptions for certain tax-sheltered annuity products. NOTE 10 2-FOR-1 COMMON STOCK SPLIT The St. Paul's Restated Articles of Incorporation were amended after the vote of shareholders at the 1998 Annual Meeting of Shareholders on May 5, 1998, to increase the authorized common shares of the company from 240 million to 480 million. Subsequent to this action, The St. Paul's board of directors approved a 2-for-1 common stock split. One additional share of common stock for each outstanding share was issued on May 11, 1998, to shareholders of record on May 6, 1998. NOTE 11 DISCONTINUED OPERATIONS In May 1997, The St. Paul completed the sale of its brokerage operation, Minet, to Aon Corporation. The St. Paul's gross proceeds from the sale were approximately equal to its remaining carrying value of Minet. In connection with the transaction, The St. Paul agreed to indemnify Aon against most preclosing liabilities of the Minet businesses. The company recorded a net after-tax loss on disposal of $67.8 million in the first quarter of 1997, which resulted primarily from The St. Paul's agreement to be responsible for certain severance, employee benefits, future lease commitments and other costs relating to Minet. THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations September 30, 1998 CONSOLIDATED RESULTS ON APRIL 24, 1998, THE ST. PAUL COMPANIES, INC. (THE ST. PAUL) COMPLETED ITS MERGER WITH USF&G CORPORATION (USF&G) IN A TAX-FREE EXCHANGE OF STOCK ACCOUNTED FOR AS A POOLING-OF-INTERESTS. THE COMBINED ORGANIZATION OPERATES UNDER THE ST. PAUL NAME AND IS HEADQUARTERED IN ST. PAUL, MN. THE FOLLOWING DISCUSSION IS BASED ON THE COMBINED RESULTS OF THE ST. PAUL AND USF&G FOR ALL PERIODS PRESENTED. The St. Paul's pretax income from continuing operations of $38 million in the third quarter of 1998 fell significantly below income of $275 million in the corresponding 1997 period. The St. Paul's pretax loss from continuing operations of $122 million in the first nine months of 1998 included a pretax charge of $292 million recorded in the second quarter related to the merger with USF&G, and other charges, totaling $291 million, relating to property-liability loss reserve strengthening to reflect the application of The St. Paul's loss reserving policies to USF&G's loss and loss adjustment expense reserves subsequent to the merger, and the writedown of deferred policy acquisition costs in the life insurance segment. Excluding these charges, nine-month pretax earnings of $461 million were over $500 million behind comparable 1997 earnings of $975 million. Results for the third quarter and nine months of 1998 were negatively impacted by severe catastrophe losses and deterioration in other loss experience in several property-liability underwriting business centers. The following table summarizes The St. Paul's results for the third quarter and year-to-date.
Three Months Nine Months Ended September 30 Ended September 30 ------------------ ------------------ (in millions) 1998 1997 1998 1997 ---- ---- ---- ---- Pretax income (loss): Property-liability insurance: GAAP underwriting result $(287) (47) (883) (195) Net investment income 322 328 985 986 Realized investment gains 7 39 187 302 Other (11) (35) (235) (80) --- --- ----- ----- Total property-liability insurance 31 285 54 1,013 Life insurance 22 20 9 45 Asset management-investment banking 26 23 75 67 Parent and other (41) (53) (260) (150) -- --- ---- ---- Income (loss) from continuing operations before income taxes 38 275 (122) 975 Income tax expense (benefit) (30) 60 (111) 234 --- --- ----- --- Income (loss) from continuing operations 68 215 (11) 741 Loss from discontinued operations, net of taxes - - - (67) ----- ----- ----- ----- Net income (loss) $68 215 (11) 674 ----- ----- ----- ----- ----- ----- ----- ----- Diluted net income (loss) per common share $0.27 0.85 (0.09) 2.68 ----- ----- ----- ----- ----- ----- ----- -----
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion, Continued
REVENUES Three Months Nine Months Ended September 30 Ended September 30 -------------------- -------------------- (in millions) 1998 1997 1998 1997 ---- ---- ---- ---- Earned premiums $1,699 1,810 5,233 5,507 Net investment income 391 392 1,185 1,172 Realized investment gains 25 47 210 315 Asset management-investment banking 76 62 223 181 Other 20 13 64 45 ------- ------- ------- ------- Total revenues $2,211 2,324 6,915 7,220 ------- ------- ------- ------- ------- ------- ------- -------
Premiums earned in The St. Paul's insurance operations for the third quarter and first nine months of 1998 declined 6% and 5%, respectively, compared with the same periods of 1997. The St. Paul's General Commercial and Reinsurance business centers, where intensely competitive market conditions have negatively impacted business volume and pricing, accounted for virtually all of the third quarter and nine-month declines from 1997. Life insurance premiums earned were $6 million ahead of the third quarter of 1997 and $3 million higher for the first nine months of the year. Realized investment gains for the first nine months of 1998 declined from 1997; however, the 1997 total was unusually large due to the sale of one venture capital investment which generated a $129 million pretax gain. The increase in asset management-investment banking revenues in 1998 reflects the impact of an acquisition in September 1997. MERGER-RELATED CHARGE As part of the integration plan to merge The St. Paul and USF&G operations, management performed a comprehensive review of the operations of the separate companies. The review identified redundant job functions, staffing levels, geographical locations, leased space and technology platforms. To address these redundancies and implement its plan of integration, The St. Paul recorded a $292 million pretax merger-related charge in the second quarter, composed of the following components: - $141 million of severance and other employee-related costs, representing $89 million to be paid under the USF&G Senior Executive Severance Plan in effect at the time of the merger, and $52 million of other severance and related benefits, such as out-placement counseling, vacation buy-out and medical coverage, for terminated employees not covered under the Senior Executive Severance Plan. The St. Paul estimates that approximately 2,000 positions will be eliminated (the majority by the end of 1999) due to the combination of the two organizations, resulting from efficiencies to be realized by the larger organization and the elimination of redundant functions. All levels of employees, from technical staff to senior management, will be affected by the reductions. The total number of positions expected to be reduced by function include approximately 950 in the property-liability underwriting operations, 350 in claim and 700 in finance and other administrative positions. Through Sept. 30, 1998, approximately 1,100 positions had been eliminated, and $59 million in severance and other employee-related costs had been paid. THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion, Continued CONSOLIDATED RESULTS - $70 million of facilities exit costs, consisting of a $36 million writedown in the carrying value of a former USF&G headquarters building in Baltimore, MD and $34 million of expenses related to the consolidation of redundant branch office locations. The St. Paul determined that the merger would result in excess space at the Baltimore headquarters location, and developed a plan to lease that space to outside parties. Based on an analysis of potential future undiscounted cash flows, The St. Paul determined that an impairment in the carrying value had occurred and recorded the $36 million writedown to its estimated fair value. For certain redundant branch office locations, the lease is expected to be terminated. For leases not expected to be terminated, the amount of expense recorded in the second quarter charge was calculated as the percent of excess space (20% to 100%) times the net of: remaining rental payments plus capitalized leasehold improvements less actual sub-lease income. No amounts were discounted to present value in the calculation. - $30 million of transaction costs, consisting of registration fees, costs of furnishing information to stockholders, consultant fees, investment banker fees, and legal and accounting fees. - $23 million writedown of certain long-lived assets. The St. Paul determined several of USF&G's real estate investments were not consistent with The St. Paul's real estate investment strategy, and developed a plan to sell them, with an expected disposal date in 1999. The St. Paul determined that four of these investments should be written down to estimated fair value. The fair value was calculated based on a discounted cash flow analysis, or market prices for similar assets. - $10 million of depreciation expense resulting from shortening the estimated useful life of redundant software. - $10 million of expense for writedowns and lease buy-outs of redundant computer equipment. - $8 million writedown in the carrying value of excess furniture and equipment in Baltimore, MD created by the merger. The charge was calculated based on the book value of assets at that location. On The St. Paul's Consolidated Statement of Operations, $269 million of the merger-related charge was recorded in the "Operating and administrative" expense caption and $23 million was recorded in the "Realized investment gains" revenue caption. THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion, Continued CONSOLIDATED RESULTS The integration of the two companies is expected to result in annual expense savings of approximately $200 million, as measured against the combined 1997 pre-merger expenses of The St. Paul and USF&G. The expense savings will primarily result from the reduction in employee salaries and benefits after the elimination of redundant positions from the merged organization. No material increases in other expenses are expected to offset these expense reductions. However, the merger may result in the loss of business in the property-liability underwriting business. The amount of business that may be lost is not reasonably estimable, but it is not expected to materially affect the results of operations in future periods. As merger-related costs are paid, it is expected to have a short-term negative impact on operational cash flows. THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion, Continued PROPERTY-LIABILITY INSURANCE The following summarizes key financial results by property-liability underwriting operation. (Underwriting results are presented on a GAAP basis; combined ratios are presented on a statutory basis).
% of Three Months Nine Months 1998 Ended Sept. 30 Ended Sept. 30 Written ------------------ ------------------ ($ in millions) Premiums 1998 1997 1998 1997 - - -------------- -------- ---- ---- ---- ---- Specialized Commercial: Written Premiums 35% $660 682 1,817 1,829 Underwriting Result ($80) 40 (249) 66 Combined Ratio 112.0 93.0 115.5 97.4 General Commercial Written Premiums 22% $364 434 1,111 1,357 Underwriting Result ($109) (61) (384) (158) Combined Ratio 128.4 114.4 134.1 112.7 Personal Insurance: Written Premiums 21% $386 341 1,077 943 Underwriting Result ($55) (18) (193) (74) Combined Ratio ------- 116.1 104.8 118.7 106.8 ----- ----- ----- ----- Total U.S. Underwriting: Written Premiums 78% $1,410 1,457 4,005 4,129 Underwriting Result ($244) (39) (826) (166) Combined Ratio 117.5 102.4 121.5 104.7 International Underwriting: Written Premiums 6% $78 81 289 229 Underwriting Result ($22) (14) (52) (36) Combined Ratio ------- 127.0 114.1 117.6 115.3 ----- ----- ----- ----- Total Primary Insurance Operations: Written Premiums 84% $1,488 1,538 4,294 4,358 Underwriting Result ($266) (53) (878) (202) Combined Ratio 118.0 103.0 121.4 105.2 Reinsurance Operations: Written Premiums 16% $239 288 833 968 Underwriting Result ($21) 6 (5) 7 Combined Ratio ------- 108.1 97.8 99.4 97.6 ----- ---- ---- ----- Total Property-Liability Underwriting: Written Premiums 100% $1,727 1,826 5,127 5,326 Underwriting Result ($287) (47) (883) (195) Combined Ratio: Loss and Loss Expense Ratio 83.1 70.7 83.9 72.0 Underwriting Expense Ratio 33.6 31.5 34.1 31.8 ----- ----- ----- ----- Combined Ratio 116.7 102.2 118.0 103.8 ----- ----- ----- ----- ----- ----- ----- -----
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion, Continued PROPERTY-LIABILITY INSURANCE OVERVIEW The year-to-date data in the table on the preceding page reflects the impact of the $250 million pretax provision for losses and loss adjustment expenses recorded in the second quarter of 1998 to apply The St. Paul's reserving policies to USF&G's loss reserves subsequent to the consummation of the merger (the "USF&G loss reserve provision"). Prior to the merger, both companies, in accordance with generally accepted accounting principles, recorded their best estimate of reserves within a range of estimates bounded by a high point and a low point. Subsequent to the consummation of the merger in April 1998, The St. Paul obtained the raw data underlying, and documentation supporting, USF&G's December 31, 1997 reserve analysis. The St. Paul's actuaries reviewed such information and concurred with the reasonableness of USF&G's range of estimates for their reserves. However, applying their judgment and interpretation to the range, The St. Paul's actuaries, who would be responsible for setting reserve amounts for the combined entity, concluded that strengthening the reserves would be appropriate, resulting in the $250 million adjustment. The adjustment was allocated to the following business centers in the foregoing table: General Commercial - $120 million; Specialized Commercial - $95 million; and Personal Insurance - $35 million. The following table isolated the impact of catastrophe losses on The St. Paul's GAAP underwriting results.
Three Months Nine Months Ended Sept. 30 Ended Sept. 30 ------------------ ------------------- ($ in millions) 1998 1997 1998 1997 ---- ---- ---- ---- GAAP underwriting result ($287) (47) (883) (195) Statutory combined ratio 116.7 102.2 118.0 103.8 Pretax catastrophe losses $173 36 381 120 Impact on combined ratio 10.4 2.0 7.4 2.2 ----- ------ ------ ------ Excluding catastrophes: GAAP underwriting result ($114) (11) (502) (75) Statutory combined ratio 106.3 100.2 110.6 101.6 ------ ------ ------ ------ ------ ------ ------ ------
Hurricane Georges, which struck the Caribbean region and the Gulf Coast of the United States in September, accounted for $102 million of catastrophe losses in 1998's third quarter. The remainder of third quarter losses primarily resulted from several summer storms throughout the United States. Numerous storms in several of The St. Paul's largest markets in the first half of 1998 contributed to the nine-month catastrophe total of $381 million. The $250 million USF&G loss reserve provision accounted for 4.9 points of the combined ratio for the nine months ended Sept. 30, 1998. The deterioration in underwriting results excluding the USF&G loss reserve provision and catastrophes was largely due to intensely competitive conditions in several markets, particularly the midsized commercial sector, and accelerating loss costs in the Medical Services business center. THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion, Continued PROPERTY-LIABILITY INSURANCE The consolidated expense ratio of 33.6 for the third quarter reflects the impact of declining written premium volume and an increase in commission expenses resulting from efforts to retain USF&G business during the integration of The St. Paul and USF&G into one organization. UNDERWRITING RESULTS BY BUSINESS CENTER SPECIALIZED COMMERCIAL This category includes The St. Paul's business centers which serve specific commercial customer segments and provide specialized products and services for targeted industry groups. Written premiums totaled $660 million in the third quarter, down 3% from comparable 1997 premiums of $682 million. The St. Paul's Medical Services operation recorded premiums of $174 million for the quarter, down 10% from last year's third quarter total of $192 million. Competitive conditions in the medical liability insurance market have negatively impacted pricing levels and new business opportunities in 1998. Medical Services' third quarter and year-to-date underwriting losses of $38 million and $91 million, respectively, reflect the impact of accelerating loss costs and the poor pricing environment. However, The St. Paul began implementing price increases on selected physicians and surgeons' policy renewals in 1998, and intends to pursue additional pricing actions in 1999. For the remainder of Specialized Commercial, premium volume in the third quarter and first nine months of 1998 was virtually level with the same periods of 1997. Underwriting results for both periods, however, were significantly worse than 1997, primarily due to deteriorating loss experience in several operations, particularly the Construction business center. The second quarter USF&G loss reserve provision increased Specialized Commercial's nine-month underwriting loss by $95 million, adding 5.0 points to the combined ratio. Catastrophe losses were also a factor in Specialized Commercial's results for the third quarter and nine months of 1998. The St. Paul's Surety underwriting operation, now the largest in the United States as a result of the USF&G merger, recorded a 21% increase in net premium volume and a $53 million underwriting profit through the first nine months of 1998, representing a 23% increase over the same 1997 period. GENERAL COMMERCIAL The St. Paul's General Commercial business center provides insurance products and services for a broad range of small to midsized commercial enterprises. Premium volume declined 16% for the quarter and 18% for the first nine months of the year. Prices continue to decline in this operation, particularly in the commercial middle-market sector, reflecting the continuing intense competition for business. In response to these difficult conditions, The St. Paul intends to adhere to strict underwriting standards with regard to new and renewal business going forward, which may result in a reduction of up to $200 million in annual premium volume in this business center. The third quarter underwriting loss of $109 million, which included $31 million of catastrophe losses, primarily resulted from a general deterioration in noncatastrophe prior year loss development across the book of business. On a year-to-date basis, the underwriting loss of $384 million was $226 million worse than 1997, with $120 million of the second quarter USF&G loss reserve provision and catastrophe losses of $112 million playing a large role in the deterioration. Catastrophe losses in the first nine months of 1997 totaled $46 million. THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion, Continued PROPERTY-LIABILITY INSURANCE PERSONAL INSURANCE Personal Insurance provides property-liability insurance products and services to individuals. Third quarter and year-to-date written premium volume grew 13% and 14%, respectively, over the same periods of 1997, primarily due to The St. Paul's acquisition in December 1997 of Titan Holdings, Inc., a property-liability company which has a substantial book of nonstandard automobile business. Underwriting results in the Personal Insurance segment were severely impacted by catastrophe losses of $60 million in the third quarter and $147 million for the nine months. Numerous storms throughout the United States, including two May storms in Minnesota which generated over 11,000 claims and nearly $50 million of losses, were the primary contributors to this business center's catastrophe total through the first nine months of 1998. The year-to-date underwriting loss of $193 million also included $35 million of the second quarter USF&G loss reserve provision. The nonstandard auto business center provides automobile coverage for individuals who are unable to obtain standard coverage due to their inability to meet certain underwriting criteria. Premiums generated by this business center totaled $191 million in the first nine months of 1998, compared with $57 million in the same period of 1997. The increase was primarily the result of the acquisition of Titan Holdings, Inc. INTERNATIONAL This operation provides commercial and personal property-liability insurance products and services in selected international markets. Premium volume for the third quarter of 1998 declined 4% compared to the same period of 1998, but year-to-date premiums were 26% higher than the first nine months of 1997. New commercial business in Europe, and growth in business generated through The St. Paul's involvement with Lloyd's of London, were the primary factors contributing to the year-to-date premium increase in 1998. The Emerging Markets sector of the International business center also provided premium growth over 1997, due to new business in Botswana and South Africa. Underwriting results for the third quarter and first nine months of 1998 deteriorated from comparable 1997 results, primarily due to severe ice storms in Canada during the first quarter and adverse prior year development on Canadian loss reserves. REINSURANCE The St. Paul's Reinsurance business center consists of St. Paul Re, F&G Re and Discover Re. St. Paul Re and F&G Re underwrite both treaty and facultative reinsurance for property, liability, ocean marine, surety and certain specialty classes of business. Discover Re provides products and services to the alternative risk transfer market, and provides products for self-insured companies and insurance pools, as well as ceding to and reinsuring captive insurers. Written premiums of $239 million in the third quarter were down 17% from the same period of 1997. Premium volume of $833 million through the first nine months of 1998 declined 14% from the first nine months of 1997. The significant declines in 1998 reflect soft global market conditions for this segment, resulting from excess capacity in primary reinsurance markets. The Reinsurance business center recorded a $21 million underwriting loss in the third quarter, compared with a profit of $6 million in 1997's third quarter. Third quarter catastrophe losses totaled $53 million, virtually all of which resulted from Hurricane Georges. Catastrophe losses in last year's third quarter were negligible. The year-to-date underwriting loss of $5 million in 1998 includes a catastrophe impact of $58 million. THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion, Continued PROPERTY-LIABILITY INSURANCE INVESTMENT OPERATIONS Third quarter pretax investment income of $322 million in The St. Paul's property-liability operations declined 2% from the same period of 1997. Year-to-date income of $985 million was virtually level with 1997. A 4% decline in written premiums and 4% increase in insurance losses paid through the first nine months of 1998 have resulted in a significant decline in new funds available for investment. In addition, market yields on new investments have continued to decline in 1998. As a result, The St. Paul does not anticipate investment income growth for the remainder of 1998. The fixed maturities portfolio on Sept. 30, 1998 of $18.0 billion included $1.1 billion of pretax unrealized appreciation. Approximately 95% of those investments were rated at investment grade (BBB or above). The weighted average pretax yield on the fixed maturities portfolio was 6.8% at September 30, 1998. Pretax realized investment gains totaled $7 million in the third quarter, compared with gains of $39 million in last year's third quarter. Year-to-date pretax gains in 1998 of $187 million were down from last year's nine-month gains of $302 million. Sales of equity security investments accounted for the majority of 1998's gains. The sale of a single venture capital investment generated a pretax gain of $129 million in 1997. ENVIRONMENTAL AND ASBESTOS CLAIMS The St. Paul's property-liability underwriting operations continue to receive claims alleging injuries from environmental pollution or alleging covered property damages for the cost to clean up polluted sites. The St. Paul also receives 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. The St. Paul's alleged liability for both environmental and asbestos claims is complicated by significant legal issues, primarily pertaining to the scope of coverage. In the company's opinion, court decisions in certain jurisdictions have tended to broaden insurance coverage beyond the intent of the original policies. The St. Paul's ultimate liability for environmental claims is difficult to estimate because of these issues. Insured parties have submitted claims for losses not covered in the insurance policy, and the ultimate resolution of these claims may be subject to lengthy litigation, making it difficult to estimate The St. Paul's 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 the ultimate liability for asbestos claims is equally difficult. The primary factors influencing the estimate of the total cost of these claims are case law and a history of prior claims experience, both of which are still developing. THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion, Continued ENVIRONMENTAL AND ASBESTOS CLAIMS The following table represents a reconciliation of total gross and net environmental reserve development for the nine months ended September 30, 1998 (unaudited), and the years ended Dec. 31, 1997 and 1996. Amounts in the "net" column are reduced by reinsurance recoverables.
1998 Environmental (nine months) 1997 1996 - - ------------- ----------- ---- ---- (in millions) Gross Net Gross Net Gross Net ----- --- ----- --- ----- --- Beginning reserves $867 677 889 676 840 631 Reserves acquired - - - - 18 7 Incurred losses 23 25 44 58 87 92 Paid losses (53) (45) (66) (57) (56) (54) --- --- --- --- --- --- Ending reserves $837 657 867 677 889 676 --- --- --- --- --- --- --- --- --- --- --- ---
Many significant environmental claims currently being brought against insurance companies arise out of contamination that occurred 25 to 35 years ago. Since 1970, The St. Paul's commercial general liability policy form has included a specific pollution exclusion, and, since 1986, an industry standard absolute pollution exclusion for policies underwritten in the United States. The following table represents a reconciliation of total gross and net reserve development for asbestos claims for the nine months ended September 30, 1998 (unaudited), and the years ended Dec. 31, 1997 and 1996:
1998 Asbestos (nine months) 1997 1996 - - -------- ----------- ---- ---- (in millions) Gross Net Gross Net Gross Net ----- --- ----- --- ----- --- Beginning reserves $397 279 413 304 421 294 Reserves acquired - - - - 6 6 Incurred losses 29 10 22 (5) 18 25 Paid losses (27) (8) (38) (20) (32) (21) --- --- --- --- --- --- Ending reserves $399 281 397 279 413 304 --- --- --- --- --- --- --- --- --- --- --- ---
Most of the asbestos claims the company has received pertain to policies written prior to 1986. Since 1986, for policies underwritten in the United States, The St. Paul's commercial general liability policy has included the industry standard absolute pollution exclusion, which the company believes applies to asbestos claims. The St. Paul's reserves for environmental and asbestos losses at September 30, 1998 represent its best estimate of its ultimate liability for such losses, based on all information currently available. Because of the difficulty inherent in estimating such losses, however, the company cannot give assurances that its ultimate liability for environmental and asbestos losses will, in fact, match current reserves. The St. Paul continues to evaluate new information and developing loss patterns, but it believes any future additional loss provisions for environmental and asbestos claims will not materially impact its results of operations, liquidity or financial position. Total gross environmental and asbestos reserves at September 30, 1998 of $1.24 billion represented approximately 7% of gross consolidated property-liability reserves of $18.65 billion. THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion, Continued LIFE INSURANCE The St. Paul's life insurance segment is comprised of Fidelity and Guaranty Life Insurance Company and subsidiaries ("F&G Life"), acquired in the USF&G merger. F&G Life underwrites traditional life insurance and annuities, which are sold throughout the United States through independent agents, managing general agents and specialty brokerage firms. F&G Life's pretax income of $9 million for the nine months ended Sept. 30, 1998 reflected a $41 million charge in the second quarter to reflect a writedown of the carrying value of deferred policy acquisition expenses (DPAC) relating to universal life-type and investment-type contracts. According to generally accepted accounting principles, DPAC amortization is based on the present value of estimated gross profits expected to be realized over the life of the contract. Estimates of expected gross profits used as a basis for amortization are evaluated regularly and the total amortization to date should be adjusted if actual experience or other evidences suggests that earlier estimates should be revised. The $41 million DPAC charge had three components. First, the persistency of certain in-force business, particularly universal life and flexible premium annuities, sold through some USF&G distribution channels, began to deteriorate after the USF&G merger announcement in April 1998. To mitigate this, management decided, in the second quarter, to increase credited rates on certain universal life business. This change lowered the estimated future profits on this business, which, as required under SFAS No. 97, triggered $19 million in accelerated DPAC amortization. Second, the low interest rate environment during the first half of 1998 led to assumption changes as to the future "spread" on certain interest sensitive products, lowering gross profit expectations and triggering a $16 million DPAC charge. The remaining $6 million charge resulted from a change in annuitization assumptions for certain tax-sheltered annuity products. F&G Life also recorded a $9 million pretax merger-related charge in the second quarter of 1998, primarily related to severance and facilities exit costs. Highlights of F&G Life's financial performance for the third quarter and nine months of 1998 and 1997 were as follows:
Three Months Nine Months Ended Sept. 30 Ended Sept. 30 -------------- -------------- (in millions) 1998 1997 1998 1997 ---- ---- ---- ---- Sales (annualized premiums) $131 109 282 344 Premiums earned $31 25 81 78 Policy surrenders $48 44 162 125 Net investment income $66 64 198 185 Pretax earnings (including realized gains) $22 20 9 45
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion, Continued LIFE INSURANCE The increase in sales for the third quarter was driven by sales of a new equity indexed annuity product introduced in June 1998. Credited interest rates on this product are tied to the performance of the S&P 500 index. The overall decline in sales through the first nine months of 1998 was primarily due to the significantly lower level of interest rates and its negative impact on fixed interest rate annuities. Fluctuating interest rates and the relative attractiveness of alternative investment, annuity or insurance products affect the demand for annuity products. The increase in premiums earned in the third quarter of 1998 was largely due to an increase in sales of structured settlement annuities, which are sold primarily to property-liability insurers to settle insurance claims. Expansion of the structured settlement program into The St. Paul's claim organization is expected to result in a continued increase in sales. Deferred annuities and universal life products are subject to surrender by policyholders. Nearly all of F&G Life's surrenderable annuity policies allow a refund of the cash value balance less a surrender charge. Surrender activity increased in 1998 due to an increase in the size and maturity of the annuity book of business and from competition from alternative investments, primarily equity-based products. Net investment income grew in 1998 as a result of an increasing asset base generated by positive cash flow. Pretax earnings for the first nine months of 1998 excluding the DPAC charge and the merger-related charge were higher than the same period of 1997 due to improved investment spread management on annuity and universal life products and strong expense controls. Total life insurance in force at September 30, 1998 was $10.69 billion, compared with $10.62 billion at September 30, 1997. ASSET MANAGEMENT-INVESTMENT BANKING The St. Paul's portion of The John Nuveen Company's third quarter 1998 pretax earnings was $26 million, $3 million higher than the same period of 1997. For the first nine months of 1998, the company's portion of such earnings was $75 million, compared with $67 million for the first nine months of 1997. At September 30, 1998, The St. Paul owned 78% of Nuveen. Nuveen's asset management fee revenue of $69 million for the third quarter was $13 million, or 22%, higher than in the same period of 1997. The increase was primarily due to Nuveen's acquisition of Rittenhouse Financial Services, Inc., which manages individual equity and balanced accounts for affluent investors, in September 1997. Year-to-date management fee revenues totaled $201 million in 1998, compared with $158 million through the first nine months of 1997. Nuveen's assets under management grew to $52.5 billion at Sept. 30, 1998, an increase of 6% since year-end 1997. THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion, Continued CAPITAL RESOURCES The St. Paul's capitalization (debt, redeemable preferred securities and equity) stood at $8.24 billion at Sept. 30, 1998, down 2% from the year-end 1997 total of $8.41 billion. Common shareholders' equity at the end of the third quarter was slightly higher than year-end 1997. Total debt outstanding at the end of September was $1.10 billion, a decline of $206 million, or 16%, from the Dec. 31, 1997 total of $1.30 billion. The reduction was driven by the maturity of $145 million of 7% senior notes in May 1998, which was funded with a combination of internal funds and the issuance of commercial paper. In addition, Nuveen's short-term debt outstanding declined by $78 million from year-end 1997. Medium-term notes with varying maturities accounted for 46% of The St. Paul's debt outstanding at Sept. 30, 1998. These notes bear a weighted-average interest rate of 7.0%. Commercial paper comprised 21% of The St. Paul's total debt at the end of the third quarter. Debt (excluding capital securities) as a percentage of total capitalization at Sept. 30, 1998, was 13%, down from 15% at year-end 1997. Including capital securities as a component of debt, the ratios were 19% at Sept. 30, 1998 and 21% at year-end 1997. The merger with USF&G Corporation consummated on April 24, 1998 was a tax-free exchange of stock accounted for as a pooling-of-interests. The St. Paul issued 66.5 million shares of its common stock in exchange for all of the outstanding common stock of USF&G. The transaction was valued at approximately $3.7 billion, which included the assumption of USF&G's debt and capital securities. On November 3, 1998, The St. Paul's board of directors authorized the company to repurchase up to $500 million of its common stock in the open market or through private transactions. The repurchases will be primarily financed through the issuance of debt securities. Through November 12, 1998, The St. Paul had repurchased 1.6 million shares for a total cost of $57 million under this program. The St. Paul's year-to-date pretax loss from continuing operations was inadequate to cover "fixed charges" by $122 million and "combined fixed charges and preferred stock dividends" by $163 million. For the first nine months of 1997, The St. Paul's ratio of earnings to fixed charges was 11.98, and the ratio of earnings to combined fixed charges and preferred stock dividends was 8.46. Fixed charges consist of interest expense before reduction for capitalized interest and one-third of rental expense, which is considered to be representative of an interest factor. LIQUIDITY Liquidity refers to The St. Paul's ability to generate sufficient funds to meet the cash requirements of its business operations. Net cash provided by operations was $123 million in the first nine months of 1998, compared with $672 million for the same period of 1997. The significant decline in operational cash flows compared with 1997 resulted from an increase in insurance loss payments due to deteriorating loss experience and severe catastrophes, a decline in property-liability written premiums, and expenses paid relating to the merger with USF&G. Despite the decline in operational cash flows in 1998, The St. Paul's ability to meet its short-term and long-term liquidity requirements remains intact due to the high level of readily marketable investment securities in its portfolio which generate strong levels of investment income, and the prospects for future profitable growth. THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion, Continued YEAR 2000 READINESS DISCLOSURE Many computer systems in the world have the potential of being disrupted at the turn of the century due to programming limitations that may cause the two-digit year code of "00" to be recognized as the year 1900, instead of 2000. The St. Paul is heavily dependent on its many computer systems, and those of its independent agents and brokers (The St. Paul "distribution network") and its vendors, for virtually every aspect of its operations, including underwriting, claims, investments and financial reporting. Thus, the "Year 2000" issue involves potential serious operational risks for the Company. For several years, The St. Paul has been evaluating its computer systems to determine the impact of the Year 2000 issue on their operation. With the completion of the merger with USF&G Corporation on April 24, 1998, The St. Paul has also been evaluating USF&G's activities to become "Year 2000" compliant. As compliance evaluation of the St. Paul and USF&G systems has progressed to an advanced stage, a shift of emphasis from evaluation to correction and compliance testing has taken place. The St. Paul has also been working with vendors and members of its distribution network in an effort to address Year 2000 issues that such relationships involve. Finally, The St. Paul has been reviewing and taking action to address non-systems related issues that may arise as a result of the Year 2000 problem, including insurance and reinsurance coverage issues, and has been seeking to reduce the Company's Year 2000 related exposures through the development of contingency plans. The following discussion describes The St. Paul's efforts to date and future plans to deal with the Year 2000 issue. These plans have been and continue to be updated and revised as additional information becomes available. STATE OF READINESS Since the late 1980's, The St. Paul has required that all of the internal computer systems supported by The St. Paul's Information Systems Division ("ISD") use a four-digit date field. Early implementation of this design standard has limited the number of systems requiring remediation. A Review Board was established by The St. Paul in the third quarter of 1997 to review and certify the remediation of the hundreds of internally developed and externally sourced systems used by the Company through rigorous testing. To coordinate the Year 2000 remediation efforts, The St. Paul has created the Year 2000 Project Office, which is responsible for the oversight, coordination and monitoring of the Company's Year 2000 efforts including, among other things, reviewing the compliance status of the Company's information systems in all operating units and subsidiaries, both foreign and domestic, directing the Year 2000 coordinators assigned to the Company's operating units, and formulating Company-wide contingency plans. Prior to the merger with USF&G, a separate "Y2K Action Committee" was maintained by USF&G, and a comprehensive program to address each of three identified aspects to the Year 2000 issue (readying USF&G's systems, coordinating with agents and other third parties with whom USF&G interacts, and managing the risk of claims from insured parties) had been established. The Year 2000 program developed by USF&G's Y2K Action Committee has now been integrated into The St. Paul's overall Year 2000 response. THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion, Continued YEAR 2000 READINESS DISCLOSURE INFORMATION TECHNOLOGY SYSTEMS All of The St. Paul's systems, whether internally developed or externally sourced, are subject to the Company-wide comprehensive testing and compliance standards promulgated by ISD, the oversight and monitoring of which is the responsibility of the Year 2000 Project Office. Insofar as internal systems are concerned, Year 2000 compliance is scheduled to be achieved by December 31, 1998. Compliance validation of all such systems is scheduled to be completed by March 31, 1999. The Year 2000 Project Office's plan for remediation and validation of externally sourced systems provides for the Company to work with the vendors of such systems to ensure that such systems become Year 2000 compliant at the earliest practicable date. Compliance testing in accordance with ISD standards takes place as and when compliant versions and/or affirmations of compliance from vendors are received. The St. Paul has identified what it believes to be all of its third-party supplied mission critical systems, and expects to receive Year 2000 compliant versions and/or affirmations of compliance for each of them, and to complete the validation process, before September 30, 1999. THIRD-PARTY SERVICE PROVIDERS AND DISTRIBUTION NETWORK The St. Paul relies indirectly on the information technology systems of its service providers and those of its distribution network. The Year 2000 Project Office is communicating with the Company's service providers, including financial institutions providing custody and other services, its independent agents and brokers, and other entities with which The St. Paul does business, to identify and resolve Year 2000 issues and to determine the potential impact, where relevant, of the possible failure of certain of such persons to achieve Year 2000 compliance on a timely basis. Results of this process are expected to be used in The St. Paul's contingency planning efforts discussed below. NUVEEN SYSTEMS Having started the development and implementation of internal four-digit date code software and system standards in the early 1980's, Nuveen's Year 2000 program consists primarily of Year 2000 compliance examination and testing of the software packages and hardware provided by third parties and of the systems and software of its service providers. Certification of Year 2000 compliance of third-party hardware and software systems used in processing at Nuveen is expected to be complete by the end of the first quarter of 1999. Nuveen is in the process of developing contingency plans based upon its examination of the Year 2000 readiness of its third-party supplied systems and its service providers. Nuveen believes that the costs associated with its Year 2000 efforts will not be material to its operations and financial position. EMBEDDED CHIP ISSUES Given the nature of its business, and that of its vendors and the members of its distribution network, the St. Paul believes that its exposure to embedded chip Year 2000 issues is minimal (other than its exposure to possible disruptions in electricity, telecommunications and other essential services provided by public utilities that are subject to embedded chip-related disruption). The St. Paul is, where appropriate, coordinating with vendors to obtain certificates of Year 2000 compliance for the embedded computer technology equipment that it uses. THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion, Continued YEAR 2000 READINESS DISCLOSURE YEAR 2000 COMPLIANCE PROGRAM COSTS The St. Paul has developed and implemented plans to address the system modifications required to prepare for the Year 2000, and does not expect the planning and implementation costs associated with Year 2000 efforts to be material to its results of operations, cash flows or consolidated financial position. Through December 31, 1997, the costs of Year 2000 remediation measures incurred by the Company, including USF&G prior to the merger, totaled approximately $6 million. The St. Paul expects such costs to be approximately $12 million in 1998, and approximately $5 million in 1999. CONTINGENCY PLANNING The Year 2000 Project Office's contingency planning team is currently developing a master contingency plan comprised of seven matrices, each matrix covering one of seven identified core sectors, setting potential risk exposure against three possible disruption duration scenarios. For each sector of activity and duration of disruption, the plan will provide an alternative work-around designed to permit continued operations and to minimize risk exposure. The overall plan is scheduled to be complete by March 31, 1999. The plan template and design model for each matrix will be distributed to all field office locations upon completion in order to permit the construction of plans specific to each office's operations. The St. Paul believes that its most significant Year 2000 exposure is the potential business disruptions that would be caused by widespread failure of public utility systems, particularly in the power generation/distribution and the telecommunication industries. While the contingency plans being developed by The St. Paul will provide work-arounds to lessen the impact of short duration disruptions, prolonged failure of power and telecommunications systems could have a material adverse effect on the Company's results of operations, cash flows and consolidated financial position. As noted above, The St. Paul indirectly relies on the information systems of the many components of its distribution network, which includes thousands of independent agents and brokers. The St. Paul is aware that some of its independent agents and brokers are currently Year 2000 non-compliant and expects that a much lesser number, unknown at this time and expected to consist primarily of smaller agents, will be non-compliant on January 1, 2000. The Company believes that Year 2000 related difficulties experienced by members of its distribution network have the potential to materially disrupt its business and that such potential disruptions constitute its second greatest area of potential exposure to the Year 2000 problem. As part of its contingency planning effort, The St. Paul has been providing information to members of its distribution network intended to sensitize them to the Year 2000 issue and to encourage them to take appropriate steps to become Year 2000 compliant. Although the Company's distribution network consists of thousands of agents and brokers, the number of different systems used by the constituent members is far less. For example, the Company believes that fewer than 20 different types of agency management systems are used by its property-liability insurance agents in the United States. Contingency arrangements are being discussed with distribution network members pursuant to which the Company may, among other provisional steps, provide data in alternative formats and offer temporary direct billing services in the event of a disruption in their individual systems. THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion, Continued YEAR 2000 READINESS DISCLOSURE The Company notes that the Year 2000 issue by its nature carries the risk of unforeseen and potentially very serious problems of internal or external origin. Some commentators believe that the Year 2000 issue has the potential of destabilizing the global economy or causing a global recession, either of which could adversely affect the Company. While The St. Paul believes it is taking appropriate action with respect to third parties on whose systems and services The St. Paul relies to a significant extent, there can be no assurance that the systems of such third parties will be Year 2000 compliant or that any third party's failure to have Year 2000 compliant systems would not have a material adverse effect on The St. Paul's earnings, cash flows or financial condition. INSURANCE COVERAGE The St. Paul also faces potential "Year 2000" claims under coverages provided by its reinsurance and insurance policies sold to insured parties who may incur losses as a result of the failure of such parties, or the customers or vendors of such parties, to be Year 2000 compliant. Because coverage determinations depend on unique factual situations, specific policy language and other variables, it is not possible to determine in advance whether and to what extent insured parties will incur losses, the amount of the losses or whether any such losses would be covered under The St. Paul's insurance policies. In some instances, coverage is not provided under the insurance policies or reinsurance contracts, while in other instances, coverage may be provided under certain circumstances. The St. Paul's standard property and inland marine policies require, among other things, direct physical loss or damage from a covered cause of loss as a condition of coverage. In addition, it is a fundamental principle of all insurance that a loss must be fortuitous to be considered potentially covered. Given the fact that Year 2000 related losses are not unforeseen, and that the Company expects that such losses will not, in most if not all cases, cause direct physical loss or damage, The St. Paul has concluded that its property and inland marine policies do not generally provide coverage for losses relating to Year 2000 issues. To reinforce its view on coverage afforded by such policies, The St. Paul has developed and is implementing a specific Year 2000 exclusion endorsement. The St. Paul continues to assess its exposure to insurance claims arising from its liability coverages, and it is taking a number of actions to address that exposure, including individual risk evaluation, communications with insured parties, the use of exclusions in certain types of policies, and classification of high hazard exposures that in the Company's view present unacceptable risk. The Company may also face claims from the beneficiaries of its surety bonds resulting from Year 2000 related performance failures by the purchasers of the bonds. The St. Paul is assessing its exposure to such potential claims. The St. Paul does not believe that Year 2000-related insurance or reinsurance coverage claims will have a material adverse effect on its earnings, cash flows or financial position. However, the uncertainties of litigation are such that unexpected policy interpretations could compel claim payments substantially beyond the Company's coverage intentions, possibly resulting in a material adverse effect on The St. Paul's results of operations and/or cash flows and a material adverse effect on its consolidated financial position. THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion, Continued IMPACT OF ACCOUNTING PRONOUNCEMENTS TO BE ADOPTED IN THE FUTURE In December 1997, the American Institute of Certified Public Accountants (AICPA) issued Statement of Position (SOP) No. 97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related Assessments." The SOP provides guidance for determining when a liability should be recognized for guaranty fund and other insurance-related assessments and on the measurement of that liability. It also provides guidance on when an asset should be recognized for a portion or all of the liability or paid assessment that can be recovered through premium tax offsets of policy surcharges. The SOP is effective for fiscal years beginning after December 31, 1998. The St. Paul currently intends to adopt the provisions of the SOP in the first quarter of 1999. The cumulative effect of adopting the SOP may be material to The St. Paul's results of operations in the period it is adopted; however, The St. Paul cannot at this time reasonably estimate the amount of that cumulative effect. In February 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits," which standardizes the disclosure requirements for pensions and other postretirement benefits to the extent practicable, requires additional information on changes in benefits obligations and fair values of plan assets, and eliminates certain disclosures currently required. SFAS No. 132 is effective for fiscal years beginning after December 15, 1997. The St. Paul will adopt the provisions of SFAS No. 132 for its 1998 annual financial statements. This adoption is not expected to materially change The St. Paul's current pension and postretirement disclosures, and will have no impact on net income in 1998 and succeeding years. In March 1998, the AICPA issued SOP No. 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use," which provides guidance for determining when computer software developed or obtained for internal use should be capitalized. It also provides guidance on the amortization of capitalized costs and the recognition of impairment. The SOP is effective for fiscal years beginning after December 31, 1998. The St. Paul intends to adopt the provisions of the SOP in the first quarter of 1999. The St. Paul believes the effect of adopting this SOP will not be material to its results of operations or financial position. In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," which establishes accounting and reporting standards for derivative instruments and hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the balance sheet, and measure those instruments at fair value. SFAS No. 133 is effective for all quarters of fiscal years beginning after June 15, 1999, and prohibits retroactive application to financial statements of prior periods. The St. Paul currently intends to implement the provisions of SFAS No. 133 in the first quarter of the year 2000. The St. Paul currently has limited involvement with derivative instruments, primarily for purposes of hedging against fluctuations in interest rates. The St. Paul cannot at this time reasonably estimate the potential impact of this adoption on its financial position or results of operations for future periods. 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 the effects of competition on premiums and revenues, expectations regarding Year 2000 issues and the company's efforts to address them. In light of the risks and uncertainties inherent in future projections, many of which are beyond The St. Paul's 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: 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 reinsurance or insurance; catastrophic events of unanticipated frequency or severity; loss of significant customers; judicial decisions and rulings; and various other matters, including the effects of the merger with USF&G Corporation. Actual results and experience relating to Year 2000 issues could differ materially from anticipated results or other expectations as a result of a variety of risks and uncertainties, including the impact of systems faults, the failure to successfully remediate material systems of The St. Paul, the time to remediate system failures once they occur, the failure of third parties (including public utilities, agents and brokers) to properly remediate material Year 2000 problems, and unanticipated judicial interpretations of the scope of its reinsurance or the insurance coverage provided by The St. Paul's policies. The St. Paul undertakes no obligation to release publicly the results of any future revisions it 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 July 8, 1998, relating to the anticipated total of approximately $155 million in pretax catastrophe losses for the second quarter of 1998. 2) The St. Paul filed a Form 8-K Current Report dated August 3, 1998, relating to the announcement of its financial results for the quarter ended June 30, 1998. 3) The St. Paul filed a Form 8-K Current Report dated August 20, 1998, relating to the announcement of several changes in its senior management. 4) The St. Paul filed a Form 8-K Current Report dated October 6, 1998, containing audited financial statements and related notes for The St. Paul and USF&G on a combined basis as of December 31, 1997 and 1996, and for the years ended December 31, 1997, 1996 and 1995. 5) The St. Paul filed a Form 8-K Current Report dated October 12, 1998, relating to the announcement of the anticipated total of approximately $175 million in pretax catastrophe losses for the third quarter of 1998, and the anticipated impact of difficult market conditions on its results for the third and fourth quarters of 1998. 6) The St. Paul filed a Form 8-K Current Report dated November 3, 1998, relating to the announcement of its financial results for the quarter ended September 30, 1998. 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: March 29, 1999 By /s/ Bruce A. Backberg --------------------- Bruce A. Backberg Senior Vice President and Chief Legal Counsel (Authorized Signatory) Date: March 29, 1999 By /s/ Thomas A. Bradley --------------------- Thomas A. Bradley Senior Vice President and Corporate Controller (Principal Accounting Officer) EXHIBIT INDEX ----------------------
Method of Exhibit Filing - - ------- ----------- (2) Plan of acquisition, reorganization, arrangement, liquidation or succession*.......................................................... (3) Articles of incorporation and 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**................................................................. (1) (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 Legal Services, The St. Paul Companies, 385 Washington Street, Saint Paul, MN 55102. (1) Filed electronically herewith. EX-11 2 EXHIBIT 11 Exhibit 11 THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Computation of Earnings Per Share (In thousands)
Three Months Ended Nine Months Ended September 30 September 30 ----------------------------- -------------------------- 1998 1997 1998 1997 ----- ----- ----- ----- EARNINGS (LOSS): Basic: Net income (loss), as reported $67,693 215,172 (11,432) 673,532 Dividends on preferred stock, net of taxes (2,126) (2,163) (6,395) (8,175) Premium on preferred shares redeemed (820) (1,523) (3,025) (2,434) -------------- -------------- -------------- -------------- Net income (loss) available to common shareholders $64,747 211,486 (20,852) 662,923 -------------- -------------- -------------- -------------- -------------- -------------- -------------- -------------- Diluted: Net income (loss) available to common shares $64,747 211,486 (20,852) 662,923 Effect of dilutive securities: - - Convertible preferred stock 1,562 1,504 - 4,521 Zero coupon convertible notes 826 796 2,338 Convertible monthly income preferred securities 2,018 2,018 - 6,055 -------------- -------------- -------------- -------------- Net income (loss) available to common shareholders $69,153 215,804 (20,852) 675,837 -------------- -------------- -------------- -------------- -------------- -------------- -------------- -------------- COMMON SHARES: Basic: Weighted average common shares outstanding 236,244 229,885 235,214 230,101 -------------- -------------- -------------- -------------- -------------- -------------- -------------- -------------- Diluted: Weighted average common shares outstanding 236,244 229,885 235,214 230,101 Effect of dilutive securities: Stock options 2,822 4,838 - 4,627 Convertible preferred stock 7,530 7,760 - 7,818 Zero coupon convertible notes 2,914 2,923 - 2,923 Convertible monthly income preferred securities 7,017 7,017 - 7,017 -------------- -------------- -------------- -------------- Weighted average, as adjusted 256,527 252,423 235,214 252,486 -------------- -------------- -------------- -------------- -------------- -------------- -------------- -------------- EARNINGS (LOSS) PER COMMON SHARE: Basic $0.27 0.92 (0.09) 2.88 Diluted $0.27 0.85 (0.09) 2.68
The assumed exercise of stock options, and the assumed conversion of preferred stock, zero coupon notes and monthly income preferred securities are each anti-dilutive to The St. Paul's net income for the nine months ended Sept. 30, 1998. As a result, the potentially dilutive effect of those securities is not considered in the calculation of EPS amounts for those periods. EX-12 3 EXHIBIT 12 THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Exhibit 12 Computation of Ratios (In thousands, except ratios)
Three Months Ended Nine Months Ended September 30 September 30 --------------------------- -------------------------- 1998 1997 1998 1997 ------ ------ ------ ------ EARNINGS: Income (loss) before income taxes $37,998 274,551 (122,202) 974,714 Add: fixed charges 25,061 29,743 92,028 88,783 ----------- ----------- ----------- ----------- Income (loss), as adjusted $63,059 304,294 (30,174) 1,063,497 ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- FIXED CHARGES: Interest costs $18,994 22,228 58,627 65,697 Rental expense (1) 6,067 7,515 33,401 23,086 ----------- ----------- ----------- ----------- Total fixed charges $25,061 29,743 92,028 88,783 ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- FIXED CHARGES AND PREFERRED STOCK DIVIDENDS: Fixed charges $25,061 29,743 92,028 88,783 PSOP preferred stock dividends 4,225 4,352 12,771 13,168 Dividends on redeemable preferred securities 9,356 9,332 28,207 23,818 ----------- ----------- ----------- ----------- Total fixed charges and preferred stock dividends $38,642 43,427 133,006 125,769 ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- Ratio of earnings to fixed charges (2) 2.52 10.23 - 11.98 ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- Ratio of earnings to combined fixed charges and preferred stock dividends (2) 1.63 7.01 - 8.46 ----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
(1) Interest portion deemed implicit in total rent expense. Total for nine months ended Sept. 30, 1998 includes an $11.4 million provision representative of interest included in charge for future lease buy-outs recorded in the second quarter of 1998 as a result of The St. Paul's merger with USS&G Corporation. (2) The year-to-date 1998 loss is inadequate to cover "fixed charges" by $122.2 million and "combined fixed charges and preferred stock dividends" by $163.2 million. EX-27 4 EXHIBIT 27
7 1,000 9-MOS 9-MOS DEC-31-1998 DEC-31-1997 SEP-30-1998 SEP-30-1997 21,149,340 20,773,959 0 0 0 0 1,064,029 1,061,405 674,125 581,980 936,332 1,135,320 26,227,948 25,220,389 129,391 104,273 127,804 53,473 876,151 867,594 37,512,359 36,240,470 22,612,887 21,795,267 3,411,620 3,613,921 0 0 0 0 1,097,742 1,267,421 502,700 502,700 16,917 18,408 2,142,667 1,913,238 4,476,900 4,268,354 37,512,359 36,240,470 5,232,511 5,507,374 1,185,148 1,172,493 210,208 314,951 287,263 224,825 4,508,488 4,087,872 1,243,928 1,297,232 1,284,916 859,825 (122,202) 974,714 (110,770) 233,432 (11,432) 741,282 0 (67,750) 0 0 0 0 (11,432) 673,532 (0.09) 2.88 (0.09) 2.68 0 0 0 0 0 0 0 0 0 0 0 0 0 0
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