-----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, UkfU9hi0IO7VHEJAIQc+vPOfqyWpkHAuz04kEhEQvCvDUzHYNV2fMfOrNPLZw8YV 8RO+O+xYGKRLPzxbM3rXXw== 0001047469-99-012875.txt : 19990406 0001047469-99-012875.hdr.sgml : 19990406 ACCESSION NUMBER: 0001047469-99-012875 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 17 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990331 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-K SEC ACT: SEC FILE NUMBER: 001-10898 FILM NUMBER: 99582154 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-K 1 10-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 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 Street, Saint Paul, MN 55102 -------------------------------------- ----- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code 651-310-7911 ------------ Securities registered pursuant to Section 12(b) of the Act: Common Stock (without par value) New York Stock Exchange London Stock Exchange Stock Purchase Rights New York Stock Exchange --------------------- ----------------------- (Title of class) (Name of each exchange on which registered) Securities registered pursuant to Section 12(g) of the Act: None. Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No____ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ( ) The aggregate market value of the outstanding Common Stock held by nonaffiliates of the Registrant on March 11, 1999, was $7,435,808,686. The number of shares of the Registrant's Common Stock, without par value, outstanding at March 11, 1999, was 228,924,899. An Exhibit Index is set forth at page 38 of this report. DOCUMENTS INCORPORATED BY REFERENCE ----------------------------------- Portions of the Registrant's 1998 Annual Report to Shareholders are incorporated by reference into Parts I, II and IV of this report. Portions of the Registrant's Proxy Statement relating to the Annual Meeting of Shareholders to be held May 4, 1999 are incorporated by reference into Parts III and IV of this report. PART I ITEM 1. BUSINESS. GENERAL DESCRIPTION The St. Paul Companies, Inc. (The St. Paul) is incorporated as a general business corporation under the laws of the State of Minnesota. The St. Paul and its subsidiaries constitute one of the oldest insurance organizations in the United States, dating back to 1853. The St. Paul is a management company principally engaged, through its subsidiaries, in providing property-liability and life insurance, and reinsurance products and services worldwide. The St. Paul also has a presence in the asset management industry through its majority ownership of The John Nuveen Company (Nuveen). As a management company, The St. Paul oversees the operations of its subsidiaries and provides them with capital, management and administrative services. At March 1, 1999, The St. Paul and its subsidiaries employed approximately 14,000 persons. USF&G MERGER On April 24, 1998, The St. Paul completed its merger with USF&G Corporation (USF&G), a Baltimore, Maryland-based holding company for property-liability and life insurance and reinsurance operations. The St. Paul issued 66.5 million of its common shares in exchange for all of the outstanding common stock of USF&G in a business combination accounted for as a pooling of interests. Accordingly, the consolidated financial statements for all periods prior to the combination were restated to include the accounts and results of operations of USF&G. The merged organization operates under The St. Paul name with headquarters in St. Paul, Minnesota. The merger was valued at approximately $3.7 billion, which included the assumption of USF&G's debt and capital security obligations. The St. Paul recorded a pretax merger-related charge to earnings of $292 million in 1998, primarily for severance and facilities exit costs. The integration of the two companies is expected to result in annualized pretax 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 are expected to result primarily from the reduction in employee salaries and benefits after the elimination of redundant employee positions from the merged organization. Note 2 to the consolidated financial statements included in The St. Paul's 1998 Annual Report to Shareholders, which includes additional information regarding the merger, including the components of and cash payments relating to the merger-related charges, is incorporated herein by reference. The St. Paul also recorded a $250 million pretax provision to increase USF&G's loss and loss adjustment expense reserves subsequent to the merger. Note 7 to the consolidated financial statements included in The St. Paul's 1998 Annual Report to Shareholders, which includes additional information about the $250 million provision, is incorporated herein by reference. Before the merger, The St. Paul was ranked as the 263rd-largest U.S.-based corporation in "Fortune" magazine's rankings of total 1997 revenues. On a pro forma revenue basis, the combined operations of The St. Paul and USF&G would have ranked No. 160 on the 1997 Fortune list. BUSINESS SEGMENTS The St. Paul's property-liability insurance operations, composed of five distinct underwriting business segments and an investment operations segment, accounted for at least 92% of consolidated revenues from continuing operations in each of the years 1998, 1997 and 1996. The St. Paul's life insurance segment, Fidelity and Guaranty Life Insurance Company and subsidiaries (F&G Life), accounted for 4% of revenues in each of those years, and Nuveen accounted for virtually all of the remaining revenues in each year. Financial information about The St. Paul's business segments is set forth in Note 17 to the consolidated financial statements included in The St. Paul's 1998 Annual Report to Shareholders, and is incorporated herein by reference. 2 The following table summarizes the sources of The St. Paul's consolidated revenues from continuing operations for each of the last three years. Following the table is a narrative description of each of The St. Paul's business segments.
Percentage of Consolidated Revenues 1998 1997 1996 ---- ---- ---- PROPERTY-LIABILITY INSURANCE: PRIMARY INSURANCE OPERATIONS U.S. UNDERWRITING: Commercial lines 28.7% 30.3% 30.2% Specialty commercial 15.9 15.0 15.3 Personal insurance 15.3 13.5 14.4 ---- ---- ------ TOTAL U.S. UNDERWRITING 59.9 58.8 59.9 International 3.6 2.9 2.9 ----- ----- ----- TOTAL PRIMARY INSURANCE OPERATIONS 63.5 61.7 62.8 Reinsurance 11.4 12.7 13.4 ---- ---- ---- TOTAL UNDERWRITING 74.9 74.4 76.2 INVESTMENT OPERATIONS Net investment income 14.3 13.8 13.4 Realized investment gains 2.1 4.2 2.9 ----- ----- ----- Total investment operations 16.4 18.0 16.3 Other 0.7 0.6 0.6 ----- ----- ----- TOTAL PROPERTY-LIABILITY INSURANCE 92.0 93.0 93.1 LIFE INSURANCE 4.3 4.2 3.9 ASSET MANAGEMENT 3.4 2.7 2.5 PARENT COMPANY, OTHER OPERATIONS AND ELIMINATIONS 0.3 0.1 0.5 ----- ------ ----- TOTAL 100.0% 100.0% 100.0% ----- ------ ----- ----- ------ -----
NARRATIVE DESCRIPTION OF BUSINESS PROPERTY-LIABILITY INSURANCE The St. Paul's property-liability insurance underwriting operations consist of three U.S.-based primary underwriting segments collectively referred to as U.S. UNDERWRITING, an international underwriting segment (INTERNATIONAL) and a reinsurance segment (ST. PAUL RE). The St. Paul's U.S. Underwriting operations underwrite property and liability insurance and provide insurance-related products and services to commercial, professional and individual customers throughout the United States. International underwrites primary property and liability insurance coverages outside the United States. International also includes insurance written for foreign exposures of U.S.-based corporations and U.S. exposures of foreign-based companies and The St. Paul's operations at Lloyd's of London. St. Paul Re underwrites reinsurance for leading property- liability insurance companies worldwide. The St. Paul's property-liability operations also include an investment segment responsible for overseeing the property-liability investment portfolio. The primary sources of property-liability revenues are premiums earned from insurance policies and reinsurance contracts, income earned from the investment portfolio and gains from sales of investments. According to the most recent industry statistics published in "Best's Review" with respect to property-liability insurers doing business in the United States, as a result from the merger, The St. Paul's underwriting operations would rank 8th on the basis of 1997 written premiums. PRINCIPAL DEPARTMENTS AND PRODUCTS. The "Property-Liability Underwriting Results by Segment" table included in "Management's Discussion and Analysis" in The St. Paul's 1998 Annual Report to Shareholders, which summarizes written premiums, underwriting results and statutory combined ratios for each of its underwriting segments for the last three years, is incorporated herein by reference. The following discussion summarizes the business structure of The St. Paul's property-liability insurance underwriting operations. 3 U.S. UNDERWRITING U.S. Underwriting operates through the following business segments: COMMERCIAL LINES. The Commercial Lines segment includes the SMALL COMMERCIAL and MIDDLE MARKET COMMERCIAL business centers, which offer general liability, umbrella and excess liability, commercial auto and fire, inland marine, workers' compensation and package coverages to a broad range of small to midsized commercial enterprises. Tailored coverages and products are marketed to specific customer groups such as golf courses, museums, colleges and schools, multipurpose recreational facilities, manufacturers, wholesalers and processors. Coverages marketed specifically to small commercial customers include the Package Accounts for Commercial Enterprises (PACE) policy and the Business Insurance Policy (BIP) for individuals, groups or franchise operations, including retailers, offices and family restaurants. The Commercial Lines segment includes the SURETY business center, which underwrites surety bonds, primarily for construction contractors, which guarantee that third parties will be indemnified against the nonperformance of contractual obligations. Based on 1997 written premiums of $319 million, the Surety underwriting operations of The St. Paul ranked as the largest underwriter of surety bonds in the United States. The Commercial Lines segment also includes several business centers that provide specialized products and services for targeted industry groups. CONSTRUCTION provides insurance to a broad range of general contractors, highway contractors and specialty contractors. MANUFACTURING provides liability insurance and risk management products and services for large manufacturing operations. SERVICE INDUSTRIES provides large service-related businesses with insurance and risk management programs. Businesses served include retailers, wholesalers, insurance companies, and hospitality and entertainment firms. SPECIAL PROPERTY underwrites large property accounts, layered and excess property programs, large deductible accounts, stop-loss and loss limit programs and other customized property business. NATIONAL PROGRAMS underwrites coverages for nationwide, multiple-policyholder programs through a single agency source. TRANSPORTATION provides large motor carriers with customized insurance programs. The CATASTROPHE RISK business center provides personal property coverages, such as monoline earthquake coverage in California, through GeoVera Insurance Company, and homeowners coverage in selected coastal states through USF&G Specialty Insurance Company. The St. Paul's participation in insurance pools and associations, which provide specialized underwriting skills and risk management services for the classes of business that they write, is also included in Commercial Lines results. These pools and associations serve to increase the underwriting capacity of participating companies for insurance policies where the concentration of risk is so high or the amount so large that a single company could not prudently accept the entire risk. The St. Paul's participation in these pools and associations is limited. SPECIALTY COMMERCIAL. The Specialty Commercial segment includes the MEDICAL SERVICES, CUSTOM MARKETS and PROFESSIONAL MARKETS business centers. This segment, in general, provides coverage for damage to the customer's property (fire, inland marine and auto), liability for bodily injury or damage to the property of others (general liability, auto liability and excess), workers' compensation insurance, and various professional liability coverages. Medical Services underwrites professional liability, property and general liability insurance for the health care delivery system. Products include coverages for health care professionals (physicians and surgeons, dental professionals and nurses); individual health care facilities (including hospitals, long-term care facilities and other facilities such as laboratories); and entire systems, such as hospital networks and managed care systems. Specialized claim and loss control services are vital components of Medical Services' insurance products and services. The Medical Services business center is the second-largest medical liability insurer in the United States, with premium volume accounting for approximately 7% of the U.S. market based on 1997 premium data published in "Best's Review." 4 Custom Markets includes the following business units serving specific commercial customer groups. OCEAN MARINE provides a variety of property-liability insurance related to ocean and inland waterways traffic, including cargo and hull property protection. Effective Jan. 1, 1999, the Ocean Marine business center was transferred to The St. Paul's International segment to form a new Global Marine underwriting unit. SURPLUS LINES underwrites products liability insurance, umbrella and excess liability coverages, property insurance for high-risk classes of business, and coverages for unique, sometimes one-of-a-kind risks. TECHNOLOGY underwrites a range of specialized coverages for information technology firms, including manufacturers of electronics, industrial machinery and medical equipment. OIL AND GAS provides standard and specialty insurance coverages for customers involved in the exploration and production of oil and gas, including operators, drillers and oil servicing contractors. SPECIALTY LINES provides unsupported umbrellas, policies and SIR products in the specialty admitted market. ST. PAUL ATHENA is a specialty underwriting facility dedicated to business generated through Swett & Crawford, a wholesale insurance brokerage subsidiary of Aon Corporation (Aon). Professional Markets is composed of FINANCIAL AND PROFESSIONAL SERVICES, which provides fidelity and property-liability coverages for depository institutions, and markets errors and omissions coverages for lawyers, insurance agents and other nonmedical professionals, including directors and officers; and PUBLIC SECTOR SERVICES, which markets insurance products and services, including professional liability insurance, to all levels of government entities. PERSONAL INSURANCE. This segment provides a broad portfolio of property-liability insurance products and services for individuals. Through a variety of single-line policies and multi-line package policies, individuals can acquire coverages to protect personal property such as homes, automobiles and boats, as well as to provide coverage for personal liability. The Personal Insurance segment also provides nonstandard auto coverages, which are marketed to individuals who are unable to obtain standard coverage due to their inability to meet certain underwriting criteria. INTERNATIONAL The St. Paul's International business segment is responsible for most of The St. Paul's primary insurance written outside the United States. International has a presence through insurance companies licensed in Canada and 11 countries in Europe, Africa and Latin America. It also includes business generated from The St. Paul's participation in Lloyd's of London as a provider of capital to selected underwriting syndicates and as the owner of three managing agencies. International also includes insurance written for foreign operations of multinational corporations based in the United States and insurance written to cover exposures in the United States for foreign-based companies. This segment predominantly markets specialty commercial insurance in the international arena, offering a broad range of products and services tailored to meet the unique needs of both its multinational customers as well as its customers in each of the domestic markets which it serves. The St. Paul sold its personal insurance business in the United Kingdom in early 1998 to Norwich Union Insurance Ltd. ST. PAUL RE St. Paul Re underwrites reinsurance worldwide, with clients in North America, Latin America, the Caribbean, Europe, Australia and the Asia-Pacific region. Reinsurance is an agreement by which an insurance company will transfer, or "cede," a portion of the risk it has underwritten to a reinsurer, paying a premium to do so. A large portion of reinsurance is effected automatically under general reinsurance contracts known as treaties. In some instances, reinsurance is effected by negotiation on individual risks, which is referred to as facultative reinsurance. St. Paul Re underwrites both treaty and facultative reinsurance for property, liability, ocean marine, surety and several specialty coverages. The merger added USF&G's reinsurance operation, F&G Re, to The St. Paul's reinsurance segment. F&G Re brought a diverse mix of reinsurance products and enhanced St. Paul Re's capabilities in several areas, including "non-traditional" reinsurance, an area of increasing demand that combines elements of traditional underwriting risk with financial risk protections. 5 The merger also added Discover Re Managers, Inc. (Discover Re) to The St. Paul's reinsurance segment. Discover Re provides primary insurance, reinsurance and related services to the alternative risk transfer market, primarily in the municipalities, transportation, education and retail markets. Through alternative risk transfer, a company self-insures, or insures through a captive insurer, the portion of its own losses which are predictable and purchases insurance for the less predictable, high-severity losses that could have a major financial impact on the company. According to data published by the Reinsurance Association of America, St. Paul Re's written premium volume of $833 million through the first nine months of 1998 ranked it as the sixth-largest reinsurer in the United States. According to data published in "Best's Review," The St. Paul would rank as the 14th- largest property-liability reinsurer in the world, based on 1997 written premiums. PRINCIPAL MARKETS AND METHODS OF DISTRIBUTION The St. Paul's U.S. Underwriting operations are licensed to transact business in all 50 states, the District of Columbia, Puerto Rico, Guam and the Virgin Islands. At least five percent of U.S. Underwriting's 1998 property-liability written premiums were produced in each of Illinois, California, Florida and New York. U.S. Underwriting's business is produced primarily through approximately 8,400 independent insurance agencies and insurance brokers. The needs of agents, brokers and policyholders are addressed through 40 service offices in major cities throughout the United States and 85 additional offices in the United States. St. Paul Re produces reinsurance business from its New York headquarters, as well as from offices in London, Miami, Chicago, Atlanta, Philadelphia, Brussels, Morristown NJ, Munich, Singapore, Hong Kong, Tokyo, Sydney and San Francisco. It underwrites business through brokers and, for certain types of reinsurance and in certain markets, on a direct basis. Discover Re underwrites alternative risk transfer business from its Farmington, CT headquarters, from regional U.S. offices in Atlanta, Pittsburgh, Dallas, Minneapolis and San Francisco, and from a correspondent office in London. Our International operations are headquartered in London and underwrite insurance through domestic operations in 11 markets outside the United States (Argentina, Botswana, Canada, France, Germany, Ireland, Mexico, South Africa, Spain, The Netherlands and the United Kingdom). These operations distribute their products principally through independent brokers. Through its presence at Lloyd's of London, International has access to business markets in virtually every country of the world for its specialty products including aviation, kidnap and ransom, malicious product tampering, creditor/payment protection and personal accident. International's group of three Lloyd's of London managing agencies underwrites business for eight syndicates, collectively representing approximately 4% of Lloyd's total capacity. RESERVES FOR LOSSES AND LOSS ADJUSTMENT EXPENSES GENERAL INFORMATION. When claims are made by or against policyholders, any amounts that The St. Paul's underwriting operations pay or expect to pay to the claimant are referred to as losses. The costs of investigating, resolving and processing these claims are referred to as loss adjustment expenses (LAE). The St. Paul establishes reserves that reflect the estimated unpaid total cost of these two items. The reserves for unpaid losses and LAE at Dec. 31, 1998 cover claims that were incurred not only in 1998 but also in prior years. They include estimates of the total cost of claims that have already been reported but not yet settled ("case" reserves), and those that have been incurred but not yet reported ("IBNR" reserves). Loss reserves are reduced for estimates of salvage and subrogation. Loss reserves for certain workers' compensation business and certain assumed reinsurance contracts are discounted to present value. Additional information about these discounted liabilities is set forth in Note 1 to the consolidated financial statements included in The St. Paul's 1998 Annual Report to Shareholders, and is incorporated herein by reference. During 1998, $3.8 million of discount was amortized and $5.0 million of discount was accrued. 6 Management continually reviews loss reserves, using a variety of statistical and actuarial techniques to analyze current claim costs, frequency and severity data, and prevailing economic, social and legal factors. Management believes that the reserves currently established for losses and LAE are adequate to cover their eventual costs. However, final claim payments may differ from these reserves, particularly when these payments may not take place for several years. Reserves established in prior years are adjusted as loss experience develops and new information becomes available. Adjustments to previously estimated reserves are reflected in results in the year in which they are made. For certain reinsurance contracts entered into prior to the issuance of Statement of Financial Accounting Standards (SFAS) No. 113, "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts," (for GAAP accounting purposes) and Chapter 22 - Reinsurance (for statutory accounting purposes), The St. Paul follows deposit accounting for GAAP purposes and reinsurance accounting for statutory purposes. Since the statutory accounting was implemented on a prospective basis, however, a difference between GAAP and statutory reserves exists for contracts entered into prior to Chapter 22 implementation. Such difference amounted to $124 million at Dec. 31, 1998. TEN-YEAR DEVELOPMENT. The table on page 9 presents a development of net loss and LAE reserve liabilities and payments for the years 1988 through 1998. The top line on the table shows the estimated liability for unpaid losses and LAE, net of reinsurance recoverables, recorded at the balance sheet date for each of the years indicated. In 1997, The St. Paul changed the method by which it assigns loss activity to a particular year for assumed reinsurance written by its U.K.-based reinsurance operation. Prior to 1997, that loss activity was assigned to the year in which the underlying reinsurance contract was written. In 1997, The St. Paul's analysis indicated that an excess amount of loss activity was being assigned to prior years because of this practice. As a result, The St. Paul implemented an improved procedure in 1997 that more accurately assigns loss activity for this business to the year in which it occurred. This change had the impact of increasing favorable development on previously established reserves by approximately $110 million in 1997. There was no net impact on total incurred losses, however, because there was a corresponding increase in the provision for current year loss activity in 1997. Development data for individual years prior to 1997 in this table were not restated to reflect this new procedure because reliable data to do so was not available. The upper portion of the table, which shows the re-estimated amounts relating to the previously recorded liabilities, is based upon experience as of the end of each succeeding year. These estimates are either increased or decreased as further information becomes known about individual claims and as changes in the trend of claim frequency and severity become apparent. The "Cumulative redundancy (deficiency)" line on the table for any given year represents the aggregate change in the estimates for all years subsequent to the year the reserves were initially established. For example, the 1991 reserve of $12,848 million developed to $12,479 million, or a $369 million redundancy, by the end of 1993. By the end of 1998, the 1991 reserve had developed a redundancy of $949 million. The changes in the estimate of 1991 loss reserves were reflected in operations during the past seven years. In 1993, The St. Paul adopted the provisions of SFAS No. 113, "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts." This statement required, among other things, that reinsurance recoverables on unpaid losses and LAE be shown as an asset, instead of the prior practice of netting this amount against insurance reserves for balance sheet reporting purposes. The middle portion of the table, which includes data for only those periods impacted since the adoption of SFAS No. 113 (the years 1992 through 1998), represents a reconciliation between the net reserve liability as shown on the top line of the table and the gross reserve liability as shown on The St. Paul's balance sheet. This portion of the table also presents the gross re-estimated reserve liability as of the end of the latest re-estimation period (Dec. 31, 1998) and the related re-estimated reinsurance recoverable. The St. Paul did not restate data for years prior to 1992 in this table for presentation on a gross basis due to the impracticality of determining such gross data on a reliable basis for its foreign underwriting operations. 7 The lower portion of the table presents the cumulative amounts paid with respect to the previously recorded liability as of the end of each succeeding year. For example, as of Dec. 31, 1998, $8,812 million of the currently estimated $11,899 million of losses and LAE that have been incurred for the years up to and including 1991 have been paid. Thus, as of Dec. 31, 1998, it is estimated that $3,087 million of incurred losses and LAE have yet to be paid for the years up to and including 1991. Caution should be exercised in evaluating the information shown on this table. It should be noted that each amount includes the effects of all changes in amounts for prior periods. For example, the portion of the development shown for year-end 1995 reserves that relates to 1988 losses is included in the cumulative redundancy (deficiency) for the years 1988 through 1995. In addition, the table presents calendar year data. It does not present accident or policy year development data, which some readers may be more accustomed to analyzing. The social, economic and legal conditions and other trends which have had an impact on the changes in the estimated liability in the past are not necessarily indicative of the future. Accordingly, readers are cautioned against extrapolating any conclusions about future results from the information presented in this table. Note 7 to the consolidated financial statements, which is included in The St. Paul's 1998 Annual Report to Shareholders, includes a reconciliation of beginning and ending loss reserve liabilities for each of the last three years and is incorporated herein by reference. Additional information about The St. Paul's reserves is contained in the "Loss and Loss Adjustment Expense Reserves" and "Environmental and Asbestos Claims" sections of "Management's Discussion and Analysis" of The St. Paul's 1998 Annual Report to Shareholders, which are incorporated herein by reference. 8 ANALYSIS OF LOSS AND LOSS ADJUSTMENT EXPENSE (LAE) DEVELOPMENT (in millions)
Year ended December 31 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 - - ---------------------- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- Net liability for unpaid losses and LAE $10,679 11,343 11,881 12,848 13,211 13,258 13,290 13,732 15,021 15,100 15,194 ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ Liability re-estimated as of: One year later 10,519 11,305 12,228 12,684 12,911 12,874 12,954 13,286 14,350 14,822 Two years later 10,370 11,517 12,130 12,479 12,589 12,501 12,518 12,690 13,953 Three years later 10,670 11,480 12,058 12,280 12,384 12,200 12,035 12,371 Four years later 10,822 11,518 11,930 12,222 12,144 11,815 11,861 Five years later 10,943 11,503 11,918 12,065 11,915 11,677 Six years later 10,970 11,544 11,850 11,944 11,818 Seven years later 11,060 11,538 11,869 11,899 Eight years later 11,098 11,646 11,844 Nine years later 11,306 11,642 Ten years later 11,325 Cumulative redundancy (deficiency) $(646) (299) 37 949 1,393 1,581 1,429 1,361 1,068 278 ------ ------ ----- ----- ----- ----- ----- ----- ----- ----- ------ ------ ----- ----- ----- ----- ----- ----- ----- ----- Cumulative redundancy (deficiency) excluding foreign exchange (1) $(644) (326) 28 949 1,382 1,571 1,425 1,355 1,077 324 ------ ------ ----- ----- ----- ----- ----- ----- ----- ----- ------ ------ ----- ----- ----- ----- ----- ----- ----- ----- Net liability for unpaid losses and LAE 13,211 13,258 13,290 13,732 15,021 15,100 15,194 Reinsurance recoverable on unpaid losses 3,903 2,585 2,537 2,827 2,868 3,053 3,264 ------ ------ ------ ------ ------ ------ ------- Gross liability 17,114 15,843 15,827 16,559 17,889 18,153 18,458 ------ ------ ------ ------ ------ ------ ------- ------ ------ ------ ------ ------ ------ ------- Gross re-estimated liability: One year later 16,467 15,435 15,912 16,140 17,325 18,022 Two years later 16,143 15,459 15,554 15,387 17,077 Three years later 15,998 15,245 14,954 15,260 Four years later 15,825 14,771 14,959 Five years later 15,536 14,798 Six years later 15,565 Gross cumulative redundancy 1,549 1,045 868 1,299 812 131 ------ ------ ----- ----- ----- ----- ------ ------ ----- ----- ----- ----- Gross cumulative redundancy excluding foreign exchange (1) 1,519 1,030 843 1,301 838 191 ------ ------ ----- ----- ----- ----- ------ ------ ----- ----- ----- ----- Cumulative amount of net liability paid through: One year later $2,735 3,041 3,105 3,027 3,017 2,850 2,787 3,029 3,453 3,632 Two years later 4,658 5,004 5,107 5,027 4,970 4,699 4,698 5,003 5,816 Three years later 5,996 6,390 6,433 6,380 6,263 6,003 6,037 6,493 Four years later 6,982 7,271 7,371 7,276 7,173 6,915 7,065 Five years later 7,613 7,931 8,006 7,917 7,838 7,632 Six years later 8,096 8,388 8,470 8,424 8,329 Seven years later 8,464 8,745 8,875 8,812 Eight years later 8,743 9,077 9,196 Nine years later 9,052 9,337 Ten years later 9,276 Cumulative amount of gross liability paid through: One year later 4,072 3,443 3,389 3,547 3,837 4,079 Two years later 6,585 5,683 5,700 5,582 6,508 Three years later 8,178 7,282 7,082 7,301 Four years later 9,304 8,233 8,291 Five years later 10,009 9,083 Six years later 10,597
(1) The results of The St. Paul's U.K.-based operations translated from original currencies into U.S. dollars are included with The St. Paul's U.S. underwriting operations in this table for all years presented. The foreign currency translation impact on the cumulative redundancy arises from the difference between reserve developments translated at the exchange rates at the end of the year in which the liabilities were originally estimated, and the exchange rates at the end of the year in which the liabilities were re- estimated. 9 CEDED REINSURANCE. Through ceded reinsurance, other insurers and reinsurers agree to share certain risks that The St. Paul's subsidiaries have underwritten. The purpose of reinsurance is to limit a ceding insurer's maximum net loss arising from large risks or catastrophes. Reinsurance also serves to increase the direct writing capacity of the ceding insurer. Amounts recoverable on ceded losses are recorded as an asset. With respect to ceded reinsurance, The St. Paul strives to protect its assets from large individual risk and occurrence losses, and provide its respective underwriting operations with the capacity necessary to write large limits on accounts. The collectibility of reinsurance is subject to the solvency of reinsurers. The St. Paul's Reinsurance Security Committee, which has established financial standards to determine qualified, financially secure reinsurers, guides the placement of ceded reinsurance. Uncollectible reinsurance recoverables have not had a material adverse impact on The St. Paul's results of operations, liquidity or financial position. Note 15 to the consolidated financial statements, which is included in The St. Paul's 1998 Annual Report to Shareholders, provides a schedule of ceded reinsurance information and is incorporated herein by reference. PROPERTY - LIABILITY INVESTMENT OPERATIONS OBJECTIVES. The St. Paul's board of directors approves the overall aggregate investment plan for the companies within The St. Paul group. Each subsidiary adopts its own specific investment policy tailored to comply with domestic laws and regulations and the overall corporate investment plan. The primary objectives of those plans are as follows: 1) to maintain a widely diversified fixed maturities portfolio structured to maximize investment income while minimizing credit risk through investments in high-quality instruments; 2) to provide for long-term growth in the market value of the investment portfolio and enhance shareholder value through investments in certain other investment classes, such as equity securities, venture capital and real estate. The St. Paul has had limited involvement with derivative financial instruments for purposes of hedging against fluctuations in foreign currency and interest rates. The St. Paul has not participated in the derivatives market for trading or speculative purposes. FIXED MATURITIES. Fixed maturities constituted 77% of The St. Paul's property- liability insurance operations' investment portfolio at Dec. 31, 1998. The portfolio is primarily composed of high-quality, intermediate-term taxable U.S. government agency and corporate bonds and tax-exempt U.S. municipal bonds. The following table presents information about the fixed maturities portfolio for the last three years (dollars in millions).
Pretax Net Amortized Cost at Estimated Fair Investment Weighted Average Weighted Average Year Year-end Value at Year-end Income Pre-tax Yield After-tax Yield ----- ----------------- ----------------- ----------- ---------------- ----------------- 1998 $16,761.6 $17,777.7 $1,217.6 6.8% 5.1% 1997 17,215.1 18,067.9 1,241.3 7.1% 5.2% 1996 16,927.3 17,455.5 1,160.1 7.0% 5.1%
The St. Paul determines the mix of its investments in taxable and tax-exempt securities based on its current and projected tax position and the relationship between taxable and tax-exempt investment yields. Fixed maturity purchases in 1998 consisted of intermediate-term, investment-grade taxable and tax-exempt securities. The fixed maturities portfolio is carried on The St. Paul's balance sheet at estimated fair value, with unrealized appreciation and depreciation (net of taxes) recorded in common shareholders' equity. At December 31, 1998, pretax unrealized appreciation totaled $1.02 billion. 10 The fixed maturities portfolio is managed conservatively to provide reasonable returns while limiting exposure to risks. Approximately 95% of the fixed maturities portfolio is rated at investment grade levels (BBB or better). Nonrated and non-investment grade (high-yield) securities comprise the remainder of the portfolio. The high-yield investments, acquired in the merger with USF&G, represent a minimal percentage of the portfolio. EQUITIES. Equity securities comprised 4% of the property-liability operations' investments (at cost) at December 31, 1998, and consist of a diversified portfolio of common stocks, which are held with the primary objective of achieving capital appreciation. Sales of equities generated $158 million of pretax realized investment gains in 1998, and dividend income totaled $15 million. The portfolio's carrying value at year-end included $300 million of pretax unrealized appreciation. REAL ESTATE AND MORTGAGE LOANS. The St. Paul's property-liability operations' real estate holdings consist of a diversified portfolio of commercial office and warehouse properties that The St. Paul owns directly or has partial interest in through joint ventures. The properties are geographically distributed throughout the United States. The St. Paul also has a portfolio of real estate mortgage investments acquired in the merger with USF&G. The real estate and mortgage loan portfolio produced $82 million of pretax investment income in 1998, and sales of these investments in 1998 generated $8 million of pretax realized gains. VENTURE CAPITAL. Securities of small- to medium-sized companies spanning a variety of industries comprise The St. Paul's venture capital holdings, which accounted for 2% of property-liability investments (at cost) at December 31, 1998. These investments are in the form of limited partnership interests or direct equity investments. Venture capital investments generated pretax realized investment gains of $25 million in 1998. The carrying value of venture capital investments at December 31, 1998 included $182 million of pretax unrealized appreciation. SECURITIES LENDING COLLATERAL. This investment class consists of collateral held on certain fixed-maturity securities loaned to other institutions through a lending agent for short periods of time. The collateral is maintained at 102%, marked to market daily, of the fair value of the loaned securities. The St. Paul retains full ownership of the loaned securities and is indemnified by the lending agent in the event a borrower becomes insolvent or fails to return the securities. OTHER INVESTMENTS. The St. Paul's portfolio also includes short-term securities and other miscellaneous investments, which in the aggregate comprised 5% of property-liability investments at December 31, 1998. Notes 1, 4, 5 and 6 to the consolidated financial statements, which are included in The St. Paul's 1998 Annual Report to Shareholders, provide additional information about The St. Paul's investment portfolio and are incorporated herein by reference. The "Investment Operations" and "Exposures to Market Risk" sections of "Management's Discussion and Analysis" in said Annual Report are also incorporated herein by reference. LIFE INSURANCE Fidelity and Guaranty Life Insurance Company (F&G Life) and its subsidiaries market many forms of annuity and life insurance products, including equity-indexed annuities, single premium deferred annuities, tax sheltered annuities, single premium immediate annuities and universal life and term life insurance. Single premium deferred annuities and equity indexed annuities are sold primarily through independent agents and insurance brokers. Tax sheltered annuities are sold through a national wholesaler. Structured settlements are annuities sold predominantly to property-liability companies (including The St. Paul's U.S. Underwriting operations) in settlement of certain of their insurance claims. Note 7 to the consolidated financial statements, which is included in The St. Paul's 1998 Annual Report to Shareholders, provides a table of F&G Life's future policy benefit reserves by type of product and is incorporated herein by reference. 11 LIFE INSURANCE INVESTMENT OPERATIONS. F&G Life's investment portfolio totaled $3.8 billion at December 31, 1998, consisting of investment grade government and corporate securities (59% of the total); asset-backed and mortgage-backed securities (19%); high-yield investments (9%); real estate mortgage loans and other investments (13%). F&G Life uses derivative instruments in the form of over-the-counter indexed call options for the purpose of hedging interest credited on its equity-indexed annuity products. The cost of derivatives amounts to less than 1% of invested assets. ASSET MANAGEMENT The John Nuveen Company (Nuveen) is The St. Paul's asset management subsidiary. The St. Paul and its largest property-liability insurance subsidiary, St. Paul Fire and Marine Insurance Company (Fire and Marine) hold a combined 78% interest in Nuveen. Nuveen's principal businesses are asset management and related research; the development, marketing and distribution of investment products and services; and municipal and corporate investment banking services. Nuveen distributes its investment products, including mutual funds, exchange-traded funds (closed-end funds), defined portfolio products (formerly referred to as unit trusts), and individually managed accounts through registered representatives associated with unaffiliated firms including broker/dealers, commercial banks, affiliates of insurance providers, financial planners, accountants, consultants, and investment advisers. Nuveen's primary business activities generate three principal sources of revenue: (1) ongoing advisory fees earned on assets under management, including mutual funds, exchange-traded funds, and individually managed accounts; (2) transaction-based revenue earned upon the distribution of mutual fund and defined portfolio products; and (3) investment banking revenues, consisting of underwriting and advisory fees. Nuveen's operations are organized around five subsidiaries: John Nuveen & Co. Incorporated (Nuveen & Co.), a registered broker and dealer in securities under the Securities Exchange Act of 1934 and four investment advisory subsidiaries registered under the Investment Advisers Act of 1940. The four investment advisory subsidiaries are Nuveen Advisory Corp. (NAC), Nuveen Institutional Advisory Corp. (NIAC), Nuveen Asset Management Inc. (NAM) and Rittenhouse Financial Services, Inc. (Rittenhouse). Nuveen & Co. provides investment product distribution and related services for Nuveen's managed funds and defined portfolios, and houses Nuveen's investment banking activities. NAC and NIAC provide investment management services for and administer the business affairs of the Nuveen managed funds. Rittenhouse and NAM provide investment management services to individually managed accounts and Rittenhouse also acts as sub-adviser and portfolio manager to a mutual fund managed by NIAC. At December 31, 1998, Nuveen's assets under management totaled $55.3 billion, consisting of $26.2 billion of exchange-traded funds, $16.4 billion of managed accounts, and $12.7 billion of mutual funds. Municipal securities accounted for 71% of the underlying managed assets. In 1998, Nuveen repurchased 732,700 of its outstanding common shares (solely from minority shareholders) for a total cost of $27 million. In 1997, Nuveen repurchased 1.8 million of its outstanding common shares for a total cost of $55 million. The repurchases in 1997 were proportioned between The St. Paul and minority shareholders to maintain the combined 77% ownership interest in Nuveen then held by The St. Paul and Fire and Marine. The St. Paul received proceeds of $41 million from Nuveen's share repurchases in 1997. 12 COMPETITION AND REGULATION PROPERTY-LIABILITY INSURANCE. The St. Paul's domestic and international underwriting subsidiaries compete with a large number of other insurers and reinsurers. In addition, many large commercial customers self-insure their risks or utilize large deductibles on purchased insurance. The St. Paul's subsidiaries compete principally by attempting to offer a combination of superior products, underwriting expertise and services at a competitive price. The combination of products, services, pricing and other methods of competition varies by line of insurance and by coverage within each line of insurance. The St. Paul and its underwriting subsidiaries are subject to regulation by certain states as an insurance holding company system. Such regulation generally provides that transactions between companies within the holding company system must be fair and equitable. Transfers of assets among such affiliated companies, certain dividend payments from underwriting subsidiaries and certain material transactions between companies within the system may be subject to prior notice to, or prior approval by state regulatory authorities. During 1998, The St. Paul received from its U.S. Underwriting operations $200 million of cash dividends. In 1999, up to $295 million in cash dividends can be paid by the U.S. Underwriting operations to The St. Paul without regulatory approval. In addition, any change of control (generally presumed by the holding company laws to occur with the acquisition of 10% or more of an insurance holding company's voting securities) of The St. Paul and its underwriting subsidiaries is subject to prior approval. The underwriting subsidiaries are subject to licensing and supervision by government regulatory agencies in the jurisdictions in which they do business. The nature and extent of such regulation vary but generally have their source in statutes which delegate regulatory, supervisory and administrative powers to insurance regulators, which in the U.S. are state authorities. Such regulation, supervision and administration of the underwriting subsidiaries may relate, among other things, to the standards of solvency which must be met and maintained; the licensing of insurers and their agents; the nature of and limitations on investments; restrictions on the size of risk which may be insured under a single policy; deposits of securities for the benefit of policyholders; regulation of policy forms and premium rates; periodic examination of the affairs of insurance companies; annual and other reports required to be filed on the financial condition of insurers or for other purposes; requirements regarding reserves for unearned premiums, losses and other matters; the nature of and limitations on dividends to policyholders and shareholders; the nature and extent of required participation in insurance guaranty funds; and the involuntary assumption of hard-to-place or high-risk insurance business, primarily in the personal auto and workers' compensation insurance lines. Loss ratio trends in property-liability insurance underwriting experience may be improved by, among other things, changing the kinds of coverages provided by policies, providing loss prevention and risk management services, increasing premium rates or by a combination of these. The freedom of The St. Paul's insurance underwriting subsidiaries to meet emerging adverse underwriting trends may be slowed, from time to time, by the effects of laws which require prior approval by insurance regulatory authorities of changes in policy forms and premium rates. The St. Paul's U.S. Underwriting operations do business in all 50 states and the District of Columbia, Puerto Rico, Guam and the U.S. Virgin Islands. Many of these jurisdictions require prior approval of most or all premium rates. The St. Paul's insurance underwriting business in the United Kingdom is regulated by the Financial Services Authority (FSA). The FSA's principal objectives are to ensure that insurance companies are responsibly managed, that they have adequate funds to meet liabilities to policyholders and that they maintain required levels of solvency. In Canada, the conduct of insurance business is regulated under provisions of the Insurance Companies Act of 1992, which requires insurance companies to maintain certain levels of capital depending on the type and amount of insurance policies in force. The Lloyd's of London operation is currently regulated by the Council of Lloyd's, a self-regulatory organization, but will in due course be regulated by the FSA. The St. Paul is also subject to regulations in the other countries and jurisdictions in which it writes insurance business. LIFE INSURANCE. The St. Paul's life insurance subsidiaries operate in a competitive environment, with approximately 1,200 companies nationwide in the industry including stock and mutual companies. F&G Life ranked 173rd based on 1997 statutory net premiums written, 144th based on 1997 statutory assets, and 173rd based on 1997 statutory capital and surplus. In the life insurance industry, interest crediting rates, underwriting philosophy, policy features, 13 financial stability and service quality are important competitive factors. F&G Life's products compete not only with those offered by other life insurance companies, but also with other income accumulation-oriented products offered by other financial services companies. The life insurance industry has experienced considerable competitive pressure in recent periods as a result of fluctuating interest rates. F&G Life is subject to licensing and supervision by government regulatory agencies in the jurisdictions in which it does business. The nature and extent of regulation vary but generally have their source in statutes which delegate regulatory, supervisory and administrative powers to state insurance commissioners. Such regulation and supervision of F&G Life may relate, among other things, to the standards of solvency which must be met and maintained; the licensing of insurers and agents, the nature of and limitations on investments, deposits of securities for the benefit of policyholders; regulation of policy forms; periodic examination of the affairs of the company; annual and other reports required to be filed; requirements regarding reserves for policyholder benefits; fixing maximum interest rates on life insurance policy loans and minimum rates for accumulation of surrender values; the nature of and limitations on dividends to policyholders and shareholder; and the nature and extent of required participation in insurance guaranty funds. ASSET MANAGEMENT. Nuveen is subject to substantial competition in all aspects of its business. Investment products are sold to the public by broker-dealers, banks, insurance companies and others. Nuveen competes with these other providers of products primarily on the basis of the range of products offered, the investment performance of such products, quality of service, fees charged, the level and type of broker compensation, the manner in which such products are marketed and distributed, and the services provided to investors. Nuveen is a publicly-traded company registered under the Securities Exchange Act of 1934 and listed on the New York Stock Exchange. One of its subsidiaries, Nuveen & Co., is a broker and dealer registered under the Securities Exchange Act of 1934, and is subject to regulation by the Securities and Exchange Commission, the National Association of Securities Dealers, Inc. and other federal and state agencies and self-regulatory organizations. It is also subject to net capital requirements that restrict its ability to pay dividends. Nuveen's other four subsidiaries are investment advisers registered under the Investment Advisers Act of 1940. As such, they are subject to regulation by the Securities and Exchange Commission. YEAR 2000 READINESS DISCLOSURE The "Year 2000 Readiness Disclosure" section of "Management's Discussion and Analysis" included in The St. Paul's 1998 Annual Report to Shareholders is incorporated herein by reference. 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 and other factors on premiums and revenues, costs and income, anticipated cost savings as a result of the USF&G merger, and expectations regarding Year 2000 issues and The St. Paul'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 the 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. 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 14 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. ITEM 2. PROPERTIES. Fire and Marine owns The St. Paul's corporate headquarters buildings, located at 385 Washington Street and 130 West Sixth Street, St. Paul, MN. These buildings are adjacent to one another and connected by skyway, and consist of approximately 1.1 million square feet of gross floor space. Fire and Marine also owns a building in Freeport, Illinois that houses a portion of its personal insurance operations, and property in Woodbury, MN where its Administrative Services Building and off-site computer processing operations are located. The St. Paul also owns the former USF&G headquarters campus known as Mount Washington Center, located in Baltimore, MD. The campus currently houses offices for certain executives of The St. Paul, as well as offices for certain underwriting, legal and claim personnel. A training and development center also resides on the Mount Washington campus. The St. Paul has entered into an agreement to lease a substantial portion of one of the buildings on the campus to an outside party. St. Paul International Insurance Company Ltd. owns a building in London, England, which houses a portion of its operations. One of the two Minet buildings in London that The St. Paul retained ownership of after the sale of Minet to Aon in 1997 was sold at the end of 1998. In March 1999, The St. Paul reached an agreement to lease the other Minet building to an outside party. Fire and Marine and its subsidiary, St. Paul Properties, Inc., own a portfolio of income-producing properties in various locations across the United States that they have purchased for investment. A portion of the real estate investment portfolio of the former USF&G is being integrated into The St. Paul's portfolio, with the remainder being held for sale to third parties. The St. Paul's operating subsidiaries rent or lease office space in most cities in which they operate. Management considers the currently owned and leased office facilities of The St. Paul and its subsidiaries adequate for the current and anticipated future level of operations. ITEM 3. LEGAL PROCEEDINGS. The information set forth in the "Legal Matters" section of Note 12 to the consolidated financial statements, and the "Environmental and Asbestos Claims" section of "Management's Discussion and Analysis," which are included in The St. Paul's 1998 Annual Report to Shareholders, are incorporated herein by reference. In 1990, at the direction of the UK Department of Trade and Industry (DTI), five insurance underwriting subsidiaries of London United Investments PLC (LUI) suspended underwriting new insurance business. At the same time, four of those subsidiaries, being insolvent, suspended payment of claims and have since been placed in provisional liquidation. The fifth subsidiary, Walbrook Insurance Company, continued paying claims until May of 1992 but has now also been placed in provisional insolvent liquidation. Weavers Underwriting Agency (Weavers), an LUI subsidiary, managed these insurers. Minet, a former insurance brokerage subsidiary of The St. Paul, had brokered business to and from Weavers for many years. From 1973 through 1980, The St. Paul's UK-based underwriting operations, now called St. Paul International Insurance Company Ltd. (SPI), had accepted business from Weavers. A portion of that business was ceded by SPI to reinsurers. Certain of those reinsurers have challenged the validity of certain reinsurance contracts relating to the Weavers pool, of which SPI was a member, in an attempt to avoid liability under those contracts. SPI and other members of the Weavers pool are seeking enforcement of the reinsurance contracts. Minet may also become the subject of legal proceedings arising from its role as one of the major brokers for Weavers. When The St. Paul sold Minet in May 1997, it agreed to indemnify the purchaser for most of Minet's preclosing liabilities, including liabilities relating to the Weavers matter. Any proceedings relating to the Weavers matter will be vigorously contested by The St. Paul and it recognizes that the final outcome of these proceedings, if adverse to The St. Paul, may materially impact the results of operations in the period in which that outcome occurs, but believes it will not have a materially adverse effect on its liquidity or overall financial position. 15 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. No matter was submitted to a vote of security holders during the quarter ended December 31, 1998. EXECUTIVE OFFICERS OF THE REGISTRANT All of the following persons are regarded as executive officers of The St. Paul Companies, Inc. because of their responsibilities and duties as elected officers of The St. Paul, Fire and Marine, St. Paul International Underwriting or St. Paul Re. There are no family relationships between any of The St. Paul's executive officers and directors, and there are no arrangements or understandings between any of these officers and any other person pursuant to which the officer was selected as an officer. The officers listed in the chart below, except Thomas A. Bradley, Michael J. Conroy, James E. Gustafson, James Hom, Stephen W. Lilienthal, Paul J. Liska, John A. MacColl and David R. Nachbar, have held positions with The St. Paul or one or more of its subsidiaries for more than five years, and have been employees of The St. Paul or a subsidiary for more than five years. Messrs. Thomas A. Bradley, Stephen W. Lilienthal and John A. MacColl held positions and were employees of USF&G Corporation or one of its subsidiaries for five or more years prior to its merger with The St. Paul. in April of 1998. James E. Gustafson joined the company on Jan. 30, 1999. He had been an employee of General Re Corporation since 1969 where he held various executive positions until being named President and Chief Operating Officer of General Re Corporation in 1995. Paul J. Liska joined The St. Paul in January of 1997. For three years prior to that date, Mr. Liska held various management positions with Specialty Foods Corporation, including the position of president and chief executive officer from January 1996 to January 1997. Michael J. Conroy joined The St. Paul in August of 1994. For five years prior to that date, Mr. Conroy held various manager positions with The Home Insurance Company, including executive vice president and chief administrative officer. James Hom joined The St. Paul in October of 1994. Prior to that, Mr. Hom served as vice president-corporate claims and project management for The Home Insurance Company. David R. Nachbar joined The St. Paul in August 1998. For two years prior to that date, Mr. Nachbar was employed as vice president, human resources and chief of staff-Asia for Citibank. From 1995 - 1996 he was the area human resources director for Frito-Lay, a PepsiCo unit. From 1989 through 1995, Mr. Nachbar was employed in various capacities in the human resources area by the Pizza Hut division of PepsiCo.
TERM OF OFFICE AND PERIOD OF NAME AGE POSITIONS PRESENTLY HELD SERVICE ---- --- ------------------------ ---------------------------- Douglas W. Leatherdale 62 Chairman and Chief Executive Serving at the pleasure of the Officer Board from 5-90 (The St. Paul Companies, Inc.) James E. Gustafson 52 President and Chief Operating Serving at the pleasure of the Officer Board from 1-99 (The St. Paul Companies, Inc.) Paul J. Liska 43 Executive Vice President and Serving at the pleasure of the Chief Financial Officer Board from 1-97 (The St. Paul Companies, Inc.) James F. Duffy 55 Chairman, President and Chief Serving at the pleasure of the Executive Officer (St. Paul Re) Board from 9-93
16
TERM OF OFFICE AND PERIOD OF NAME AGE POSITIONS PRESENTLY HELD SERVICE ---- --- ------------------------ ---------------------------- John A. MacColl 50 Executive Vice President - Serving at the pleasure of the Baltimore Operations Board from 5-98 (The St. Paul Companies, Inc.) Mark L. Pabst 52 President and Chief Operating Serving at the pleasure of the Officer (St. Paul International) Board from 2-95 Michael J. Conroy 57 Executive Vice President and Serving at the pleasure of the Chief Administrative Officer Board from 8-95 (Fire and Marine ) Stephen W. Lilienthal 49 Executive Vice President (Fire Serving at the pleasure of the and Marine) Board from 4-98 Joseph B. Nardi 54 Executive Vice President & Serving at the pleasure of the President - Specialty Commercial Board from 2-98 (Fire and Marine) Bruce A. Backberg 50 Senior Vice President and Chief Serving at the pleasure of the Legal Counsel Board from 11-97 (The St. Paul Companies, Inc.) James L. Boudreau 63 Senior Vice President - Corporate Serving at the pleasure of the Finance Board from 3-98 (The St. Paul Companies, Inc.) Thomas A. Bradley 41 Senior Vice President and Serving at the pleasure of the Corporate Controller Board from 5-98 (The St. Paul Companies, Inc.) Karen L. Himle 43 Senior Vice President - Corporate Serving at the pleasure of the Affairs Board from 11-97 (The St. Paul Companies, Inc.) James Hom 43 Senior Vice President - Strategic Serving at the pleasure of the Planning and Development Board from 10-94 (The St. Paul Companies, Inc.) David R. Nachbar 36 Senior Vice President - Human Serving at the pleasure of the Resources Board from 8-98 (The St. Paul Companies, Inc.) Sandra Ulsaker Wiese 39 Senior Corporate Counsel and Serving at the pleasure of the Corporate Secretary Board from 2-98 (The St. Paul Companies, Inc.)
17 PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. The St. Paul's common stock is traded on the New York Stock Exchange, where it is assigned the symbol SPC. The stock is also listed on the London Stock Exchange under the symbol SPA. The number of holders of record, including individual owners, of The St. Paul's common stock was 24,179 as of March 1, 1999. The "Stock Trading" and "Stock Price and Dividend Rate" portions of the "Shareholder Information" section of The St. Paul's 1998 Annual Report to Shareholders are incorporated herein by reference. ITEM 6. SELECTED FINANCIAL DATA. The "Six-Year Summary of Selected Financial Data" included in The St. Paul's 1998 Annual Report to Shareholders is incorporated herein by reference. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The "Management's Discussion and Analysis" included in The St. Paul's 1998 Annual Report to Shareholders is incorporated herein by reference. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. The "Exposures to Market Risk" section in The St. Paul's 1998 Annual Report to Shareholders is incorporated herein by reference. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. The "Management's Responsibility for Financial Statements," "Independent Auditors' Report," Consolidated Balance Sheets, Consolidated Statements of Income, Comprehensive Income, Shareholders' Equity and Cash Flows, and Notes to Consolidated Financial Statements included in The St. Paul's 1998 Annual Report to Shareholders are incorporated herein by reference. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. 18 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. The "Election of Directors - Nominees for Directors" section, which provides information regarding The St. Paul's directors, on pages 4 to 6 of The St. Paul's Proxy Statement relating to the Annual Meeting of Shareholders to be held May 4, 1999, is incorporated herein by reference. James E. Gustafson, 52, elected President and Chief Operating Officer of The St. Paul Companies, Inc. by the board of directors in January of 1999, is standing for election by shareholders for the first time at the 1999 Annual Meeting of Shareholders. Norman P. Blake, Jr., 57, is currently a director of The St. Paul, but is not standing for re-election at the 1999 Annual Meeting of Shareholders. Information regarding The St. Paul's executive officers is included in Part I of this report. The "Section 16(a) Beneficial Ownership Reporting Compliance" section on page 40 of The St. Paul's Proxy Statement relating to the Annual Meeting of Shareholders to be held May 4, 1999, is incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION. The "Executive Compensation" section on pages 22 to 35 and the "Election of Directors - Board of Directors Compensation" section on pages 7 to 10 of the Proxy Statement relating to the Annual Meeting of Shareholders to be held May 4, 1999, are incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The "Security Ownership of Certain Beneficial Owners and Management" section on pages 37 to 39 of the Proxy Statement relating to the Annual Meeting of Shareholders to be held May 4, 1999, is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The "Indebtedness of Management" section on page 36 of the Proxy Statement relating to the Annual Meeting of Shareholders to be held May 4, 1999, is incorporated herein by reference. 19 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K. (a) Filed documents. The following documents are filed as part of this report: 1. Financial Statements. Incorporated by reference into Part II of this report: The St. Paul Companies, Inc. and Subsidiaries: Consolidated Statements of Income - Years Ended December 31, 1998, 1997 and 1996 Consolidated Statements of Comprehensive Income - Years Ended December 31, 1998, 1997 and 1996 Consolidated Balance Sheets - December 31, 1998 and 1997 Consolidated Statements of Shareholders' Equity - Years Ended December 31, 1998, 1997 and 1996 Consolidated Statements of Cash Flows - Years Ended December 31, 1998, 1997 and 1996 Notes to Consolidated Financial Statements Independent Auditors' Report The foregoing documents are incorporated by reference to The St. Paul's 1998 Annual Report to Shareholders. 2. Financial Statement Schedules. The St. Paul Companies, Inc. and Subsidiaries: Independent Auditors' Report on Financial Statement Schedules I. Summary of Investments - Other than Investments in Related Parties II. Condensed Financial Information of Registrant III. Supplementary Insurance Information IV. Reinsurance V. Valuation and Qualifying Accounts VII. Predecessor Auditors' Reports on Consolidated Financial Statements and Financial Statement Schedules All other schedules are omitted because they are not applicable, not required, or the information is included elsewhere in the Consolidated Financial Statements or Notes thereto. 3. Exhibits. An Exhibit Index is set forth at page 38 of this report. (2) The definitive Agreement and Plan of Merger among The St. Paul, USF&G Corporation and SP Merger Corporation is incorporated herein by reference to the Form 8-K Current Report dated January 19, 1998. (3) (a) The current articles of incorporation of The St. Paul are filed herewith. (b) The current bylaws of The St. Paul are incorporated herein by reference to Form 10-Q for the quarter ended March 31, 1994. 20 (4) (a) A specimen certificate of The St. Paul's common stock is filed herewith. (b) The Amended and Restated Shareholder Protection Rights Agreement is incorporated herein by reference to Form 10-Q for the quarter ended June 30, 1995. There are no long-term debt instruments in which the total amount of securities authorized exceeds 10% of the total assets of The St. Paul and its subsidiaries on a consolidated basis. The St. Paul agrees to furnish a copy of any of its long-term debt instruments to the Securities and Exchange Commission upon request. (10)(a) The Employment Agreement between The St. Paul and Mr. James E. Gustafson dated as of January 6, 1999 is filed herewith. (b) The Restricted Stock Award Plan, as amended, is filed herewith. (c) The 1988 Stock Option Plan as in effect for options granted prior to June 1994, as amended, is filed herewith. (d) The Non-Employee Director Stock Retainer Plan is filed herewith. (e) The Amended and Restated Special Severance Policy is filed herewith. (f) The Confidential Separation Agreement between The St. Paul and Mr. Patrick A. Thiele dated as of September 1, 1998 is filed herewith. (g) The Annual Incentive Plan is incorporated by reference to the Proxy Statement relating to the Annual Meeting of Shareholders to be held May 4, 1999. (h) The Amended and Restated 1994 Stock Incentive Plan is incorporated by reference to the Proxy Statement relating to the Annual Meeting of Shareholders to be held May 4, 1999. (i) The Deferred Management Incentive Awards Plan is incorporated by reference to Form 10-K for the year ended December 31, 1997. (j) The Directors' Deferred Compensation Plan is incorporated by reference to Form 10-K for the year ended December 31, 1997. (k) The Relocation Loan Payback Agreement with Mr. James F. Duffy is incorporated by reference to Form 10-K for the year ended December 31, 1997. (l) The Benefit Equalization Plan - 1995 Revision is incorporated by reference to Form 10-K for the year ended December 31, 1997. (m) First Amendment to Benefit Equalization Plan - 1995 Revision is incorporated by reference to Form 10-K for the year ended December 31, 1997. (n) Executive Post-Retirement Life Insurance Plan - Summary Plan Description is incorporated by reference to Form 10-K for the year ended December 31, 1997. (o) Executive Long-Term Disability Plan - Summary Plan Description is incorporated by reference to Form 10-K for the year ended December 31, 1997. 21 (p) Letter Agreement dated Jan. 18, 1998 among The St. Paul, USF&G Corporation, SP Merger Corporation and Mr. Norman P. Blake, Jr. pertaining to Mr. Blake's duties with The St. Paul subsequent to the consummation of the proposed merger of The St. Paul and USF&G Corporation is incorporated by reference to Form 10-K for the year ended December 31, 1997. (q) The St. Paul Re Long-Term Incentive Plan is incorporated by reference to the Form S-8 Registration Statement filed March 17, 1998 (Commission File No. 333-48121). (r) Letter Agreement between The St. Paul and Mr. Paul J. Liska relating to the terms of his employment is incorporated by reference to Form 10-Q for the quarter ended March 31, 1997. (s) Letter Agreement between The St. Paul and Mr. Paul J. Liska relating to severance benefits is incorporated by reference to Form 10-Q for the quarter ended March 31, 1997. (t) The Special Leveraged Stock Purchase Plan is incorporated by reference to Form 10-Q for the quarter ended March 31, 1997. (u) Amendment to Deferred Stock Agreement with Mr. Mark L. Pabst is incorporated by reference to Form 10-Q for the quarter ended March 31, 1997. (v) The Deferred Stock Grant Agreement with Mr. Mark L. Pabst is incorporated by reference to the Form 10-K for the year ended December 31, 1995. (w) The Directors' Charitable Award Program is incorporated by reference to the Form 10-K for the year ended December 31, 1994. (x) The Long-Term Incentive Plan is incorporated by reference to Form 10-Q for the quarter ended March 31, 1994. (y) The summary description of the Outside Directors' Retirement Plan is incorporated by reference to the Proxy Statement relating to the Annual Meeting of Shareholders to be held May 4, 1999. (11) A statement regarding the computation of per share earnings is filed herewith. (12) A statement regarding the computation of the ratio of earnings to fixed charges and the ratio of earnings to combined fixed charges and preferred stock dividends is filed herewith. (13) The St. Paul's 1998 Annual Report to Shareholders is furnished to the Commission in paper format pursuant to Rule 14a-3(c). The following portions of such annual report, representing those portions expressly incorporated by reference in this report on Form 10-K, are filed as an exhibit to this report: 22
Location of Information Portions of Annual Report for the Year Ended Incorporated by December 31, 1998 Reference ---------------------------------------------------- ------------------ Consolidated Financial Statements Item 8 Notes to Consolidated Financial Statements Item 1, 8 Independent Auditors' Report Item 8 Management's Discussion and Analysis Item 1, 3, 7 Six-Year Summary of Selected Financial Data Item 6 Shareholder Information Item 5
(21) List of subsidiaries of The St. Paul Companies, Inc. is filed herewith. (23) Consents of independent auditors to incorporation by reference of certain reports into Registration Statements on Form S-8 (SEC File No. 33-15392, No. 33-23446, No. 33-23948, No. 33-24220, No. 33-24575, No. 33-26923, No. 33-49273, No. 33-56987, No. 333-01065, No. 333-22329, No. 333-25203, No. 333-28915, No. 333-48121, No. 333-50935, No. 333-50937, No. 333-50941, No. 333-50943 and No. 333-67983) and Form S-3 (SEC File No. 33-33931, No. 33-50115, No. 33-58491, No. 333- 06465 and No. 333-67139) are filed herewith. (24) Power of attorney is filed herewith. (27) Financial data schedule is filed herewith. (b) Reports on Form 8-K. A Form 8-K Current Report dated October 12, 1998 was filed relating to the announcement of the anticipated impact of catastrophe losses on The St. Paul's third quarter 1998 financial results, and the anticipated impact of adverse market conditions in the general commercial property/casualty marketplace on The St. Paul's third and fourth quarter 1998 financial results. A Form 8-K Current Report dated November 3, 1998 was filed relating to the announcement of The St. Paul's financial results for the quarter ended Sept. 30, 1998. A Form 8-K Current Report dated January 6, 1999 was filed relating to the election of James E. Gustafson as president and chief operating officer of The St. Paul. A Form 8-K Current Report dated January 29, 1999 was filed relating to the announcement of The St. Paul's financial results for the year ended Dec. 31, 1998. A Form 8-K Current Report dated March 4, 1999 was filed relating to the announcement of The St. Paul's revised financial results for the year ended Dec. 31, 1998. 23 Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, The St. Paul Companies, Inc. 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 31, 1999 By /s/ Sandra Ulsaker Wiese -------------- ------------------------ Sandra Ulsaker Wiese Senior Corporate Counsel and Corporate Secretary Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of The St. Paul Companies, Inc. and in the capacities and on the dates indicated. Date: March 31, 1999 By /s/ Douglas W. Leatherdale -------------- -------------------------- Douglas W. Leatherdale, Director, Chairman of the Board and Chief Executive Officer Date: March 31, 1999 By /s/ James E. Gustafson -------------- ---------------------- James E. Gustafson, Director, President and Chief Operating Officer Date: March 31, 1999 By /s/ Paul J. Liska -------------- ----------------- Paul J. Liska, Executive Vice President and Chief Financial Officer Date: March 31, 1999 By /s/ Thomas A. Bradley -------------- --------------------- Thomas A. Bradley, Senior Vice President and Chief Accounting Officer Date: March 31, 1999 By /s/ H. Furlong Baldwin -------------- ---------------------- H. Furlong Baldwin*, Director Date: March 31, 1999 By /s/ Norman P. Blake, Jr. -------------- ------------------------ Norman P. Blake, Jr.*, Director Date: March 31, 1999 By /s/ Michael R. Bonsignore -------------- ------------------------- Michael R. Bonsignore*, Director Date: March 31, 1999 By /s/ John H. Dasburg -------------- ------------------- John H. Dasburg*, Director Date: March 31, 1999 By /s/ W. John Driscoll -------------- -------------------- W. John Driscoll*, Director Date: March 31, 1999 By /s/ Kenneth M. Duberstein -------------- ------------------------- Kenneth M. Duberstein*, Director Date: March 31, 1999 By /s/ Pierson M. Grieve -------------- --------------------- Pierson M. Grieve*, Director Date: March 31, 1999 By /s/ Thomas R. Hodgson -------------- --------------------- Thomas R. Hodgson*, Director 24 Date: March 31, 1999 By /s/ David G. John -------------- ----------------- David G. John*, Director Date: March 31, 1999 By /s/ William H. Kling -------------- -------------------- William H. Kling*, Director Date: March 31, 1999 By /s/ Bruce K. MacLaury -------------- --------------------- Bruce K. MacLaury*, Director Date: March 31, 1999 By /s/ Glen D. Nelson, M.D. -------------- ------------------------ Glen D. Nelson, M.D.*, Director Date: March 31, 1999 By /s/ Anita M. Pampusch -------------- --------------------- Anita M. Pampusch*, Director Date: March 31, 1999 By /s/ Gordon M. Sprenger -------------- ---------------------- Gordon M. Sprenger*, Director Date: March 31, 1999 *By /s/ Sandra Ulsaker Wiese -------------- ------------------------ Sandra Ulsaker Wiese, Attorney-in-fact 25 INDEPENDENT AUDITORS' REPORT ON FINANCIAL STATEMENT SCHEDULES The Board of Directors and Shareholders The St. Paul Companies, Inc.: Under date of March 2, 1999, we reported on the consolidated balance sheets of The St. Paul Companies, Inc. and subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of income, shareholders' equity, comprehensive income and cash flows for each of the years in the three-year period ended December 31, 1998, as contained in the 1998 annual report to shareholders. These consolidated financial statements and our report thereon are incorporated by reference in the annual report on Form 10-K for the year 1998. In connection with our audits of the aforementioned consolidated financial statements we also have audited the related financial statement schedules I through V, as listed in the index in Item 14(a)2. of said Form 10-K. These financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statement schedules based on our audits. The consolidated financial statements and financial statement schedules as of December 31, 1997 and for each of the years in the two-year period then ended have been restated to reflect the pooling of interests with USF&G Corporation. We did not audit the consolidated financial statements or financial statement schedules of USF&G Corporation as of December 31, 1997 or for either of the years in the two-year period ended December 31, 1997, which statements reflect total assets constituting 43 percent as of December 31, 1997 and total revenues constituting 35 percent and 38 percent for the years ended December 31, 1997 and 1996, respectively, of the related consolidated totals. Those statements and financial statement schedules were audited by other auditors whose reports have been furnished to us, and our opinion, insofar as it relates to the amounts included for USF&G Corporation, as of December 31, 1997 and for each of the years in the two-year period then ended, is based solely on the reports of the other auditors. In our opinion, based on our audits and the reports of the other auditors, such financial statement schedules I through V, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein. Minneapolis, Minnesota /s/ KPMG Peat Marwick LLP March 2, 1999 ------------------------- KPMG Peat Marwick LLP 26 THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES SCHEDULE I - SUMMARY OF INVESTMENTS OTHER THAN INVESTMENTS IN RELATED PARTIES December 31, 1998 (In thousands)
1998 --------------------------------------------------------- Amount at which shown in the Cost* Value* balance sheet ------------ ---------- ------------- Type of investment: FIXED MATURITIES: United States Government and government agencies and authorities $ 2,672,630 $2,881,094 $ 2,881,094 States, municipalities and political subdivisions 6,113,669 6,558,821 6,558,821 Foreign governments 909,353 978,216 978,216 Corporate securities 6,747,847 7,096,370 7,096,370 Asset-backed securities 661,259 684,440 684,440 Mortgage-backed securities 2,791,677 2,857,318 2,857,318 ---------- ---------- ---------- Total fixed maturities 19,896,435 21,056,259 21,056,259 ---------- ---------- ---------- EQUITY SECURITIES: Common stocks: Public utilities 57,341 86,100 86,100 Banks, trusts and insurance companies 104,951 122,705 122,705 Industrial, miscellaneous and all other 779,431 1,049,704 1,049,704 ---------- ---------- ---------- Total equity securities 941,723 1,258,509 1,258,509 ---------- ---------- ---------- Venture capital 389,225 571,340 571,340 ------- ----------- ------- Real estate and mortgage loans 1,519,227** 1,507,448 Securities lending collateral 1,368,322 1,368,322 Other investments 371,526 371,526 Short-term investments 982,488 982,488 ---------- ---------- Total investments $25,468,946 $27,115,892 ----------- ----------- ----------- -----------
* See Notes 1, 4, 5 and 6 to the consolidated financial statements included in The St. Paul's 1998 Annual Report to Shareholders. ** The cost of real estate represents the cost of properties before valuation provisions. (See Schedule V on page 35). 27 THE ST. PAUL COMPANIES, INC. (Parent Only) SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONDENSED BALANCE SHEET INFORMATION December 31, 1998 and 1997 (In thousands)
Assets: 1998 1997 ---------- ---------- Investment in subsidiaries $7,207,450 $7,078,111 Investments: Fixed maturities 124,640 159,957 Equity securities 70,332 52,834 Short-term investments 11,832 11,472 Cash 8,796 - Deferred income taxes 359,463 455,445 Other assets 599,445 257,925 ---------- --------- Total assets $8,381,958 $8,015,744 ---------- ---------- ---------- ---------- Liabilities: Debt $1,406,339 $1,091,995 Dividends payable to shareholders 58,320 39,305 Other liabilities 280,912 276,276 ---------- ---------- Total liabilities 1,745,571 1,407,576 ---------- ---------- Shareholders' Equity: Preferred: Convertible preferred stock 134,181 137,892 Guaranteed obligation - PSOP (118,605) (121,167) ---------- ---------- Total preferred shareholders' equity 15,576 16,725 ---------- ---------- Common: Common stock, authorized 480,000 shares; issued 233,750 shares (233,130 in 1997) 2,127,671 2,057,108 Retained earnings 3,480,057 3,720,140 Guaranteed obligation - ESOP - (8,453) Accumulated other comprehensive income: Unrealized appreciation of investments 1,027,390 845,811 Unrealized loss on foreign currency translation (14,307) (23,163) ---------- ---------- Total accumulated other comprehensive income 1,013,083 822,648 ---------- ---------- Total common shareholders' equity 6,620,811 6,591,443 ---------- ---------- Total shareholders' equity 6,636,387 6,608,168 ---------- ---------- Total liabilities and shareholders' equity $8,381,958 $8,015,744 ---------- ---------- ---------- ----------
See accompanying notes to condensed financial information. 28 THE ST. PAUL COMPANIES, INC. (Parent Only) SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONDENSED STATEMENT OF INCOME INFORMATION Years Ended December 31, 1998, 1997 and 1996 (In thousands)
1998 1997 1996 -------- -------- -------- Revenues: Net investment income $ 17,693 $ 17,472 $ 12,695 Realized investment gains 6,478 7,211 8,810 -------- -------- -------- Total revenues 24,171 24,683 21,505 -------- -------- -------- Expenses: Interest expense 66,784 66,726 64,731 Administrative and other 66,479 52,160 39,906 -------- -------- -------- Total expenses 133,263 118,886 104,637 -------- -------- -------- Loss before income tax benefit (109,092) (94,203) (83,132) Income tax benefit (79,799) (113,366) (46,462) -------- -------- -------- Net income (loss) from continuing operations- parent only (29,293) 19,163 (36,670) Provision for loss on disposal of discontinued operations - (67,750) (88,543) -------- -------- -------- Net loss - parent only (29,293) (48,587) (125,213) Equity in net income of subsidiaries 118,641 977,879 857,915 -------- -------- -------- Consolidated net income $ 89,348 $929,292 $732,702 --------- -------- -------- --------- -------- --------
See accompanying notes to condensed financial information. 29 THE ST. PAUL COMPANIES, INC. (Parent Only) SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONDENSED STATEMENT OF CASH FLOWS INFORMATION Years Ended December 31, 1998, 1997 and 1996 (In thousands)
1998 1997 1996 --------- --------- --------- Operating Activities: Net loss $ (29,293) $ (48,587) $(125,213) Cash dividends from subsidiaries 223,228 216,301 200,648 Tax payments from subsidiaries 71,445 166,423 93,928 Federal tax refund from carryback claim 81,403 - - Federal income tax payments (27,437) (61,000) (70,000) Adjustments to reconcile net (loss) to net cash provided by operating activities: Deferred tax benefit -operations (78,062) (59,779) (21,891) Realized investment gains (6,478) (7,211) (8,810) Provision for loss on discontinued operations - 67,750 88,543 Other (3,901) (19,458) (3,951) --------- --------- --------- Cash provided by operating activities 230,905 254,439 153,254 --------- --------- --------- Investing Activities: Purchases of investments (46,617) (55,756) (104,322) Proceeds from sales and maturities of investments 80,714 75,674 109,958 Capital contributions and loans to subsidiaries (178,112) (107,120) (55,922) Discontinued operations (20,218) (54,018) - Other 10,417 (3,221) (268) --------- --------- --------- Cash used in investing activities (153,816) (144,441) (50,554) --------- --------- --------- Financing Activities: Dividends paid to shareholders (210,318) (165,809) (155,268) Proceeds from issuance of debt 239,041 117,572 53,000 Repayment of debt (25,000) (100,000) (17,711) Repurchase of common shares (135,088) (26,503) (74,217) Proceeds from Nuveen stock repurchase - 41,069 73,966 Stock options exercised and other 63,072 23,673 17,530 --------- --------- --------- Cash used in financing activities (68,293) (109,998) (102,700) --------- --------- --------- Change in cash 8,796 - - Cash at beginning of year - - - --------- --------- --------- Cash at end of year $ 8,796 $ - $ - --------- --------- --------- --------- --------- ---------
See accompanying notes to condensed financial information. 30 THE ST. PAUL COMPANIES, INC. (Parent Only) SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT NOTES TO CONDENSED FINANCIAL INFORMATION 1. The accompanying condensed financial information should be read in conjunction with the consolidated financial statements and notes included in The St. Paul's 1998 Annual Report to Shareholders. The Annual Report includes The St. Paul's Consolidated Statements of Shareholders' Equity and Comprehensive Income. Some data in the accompanying condensed financial information for the years 1997 and 1996 were reclassified to conform with the 1998 presentation. 2. Debt consists of the following (in thousands):
December 31, ------------------------------- 1998 1997 --------- --------- Medium-term notes $ 636,913 $ 511,920 Convertible subordinated debentures (1) 262,026 262,026 Commercial paper 257,461 168,429 Guaranteed PSOP debt (1) 118,606 121,167 Zero coupon convertible notes 111,333 - Intercompany loan (1) 20,000 20,000 Guaranteed ESOP debt (1) - 5,673 Guaranteed ESOP debt - 2,780 ---------- ------------ Total debt $1,406,339 $1,091,995 ---------- ---------- ---------- ----------
(1) Eliminated in consolidation. See Note 9 to the consolidated financial statements included in the 1998 Annual Report to Shareholders for further information on debt outstanding at Dec. 31, 1998. The amount of debt, other than debt eliminated in consolidation, that becomes due during each of the next five years (including the debt discussed in Note 3 below) is as follows: 1999, $277.5 million; 2000, none; 2001, $195.2; 2002, $48.7 million; and 2003, $67.3 million. 3. Subsequent Event: The St. Paul Companies, Inc. merged with USF&G Corporation on April 24, 1998 in a business combination accounted for as a pooling of interests. (See Note 2, "Merger with USF&G Corporation," to the consolidated financial statements included in The St. Paul's 1998 Annual Report to Shareholders). Effective Jan. 1, 1999, the former holding company for USF&G Corporation was merged into St. Paul Fire and Marine Insurance Company, and the holding company was dissolved. Prior to that merger, the debt obligations of USF&G's holding company were assumed by The St. Paul Companies, Inc. As a result, The St. Paul Companies, Inc. parent-only financial statements in 1999 will include $150 million of 8-3/8% Senior Notes and $80 million of 7-1/8% Senior Notes assumed from the former USF&G holding company. 31 THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES SCHEDULE III - SUPPLEMENTARY INSURANCE INFORMATION (In thousands)
At December 31, --------------------------------------------------------------------------- Gross loss, Deferred loss Other policy policy adjustment Gross claims and acquisition expense reserves and unearned benefits expenses policy benefits* premiums* payable ---------- -------------------- -------- ------------ 1998 - - ---- Property-Liability Insurance: Commercial Lines $338,644 $ 8,964,612 $ 1,169,361 - Specialty Commercial 122,802 3,659,826 886,353 - Personal Insurance 111,553 1,077,105 596,699 - ---------- ----------- ----------- --------- Total U. S. Underwriting 572,999 13,701,543 2,652,413 - International 19,630 1,280,316 162,850 - ---------- ----------- ----------- --------- Total Primary Underwriting 592,629 14,981,859 2,815,263 - Reinsurance 84,436 3,476,062 450,499 - ---------- ----------- ----------- --------- Property-Liability 677,065 18,457,921 3,265,762 - Life Insurance 201,107 4,142,277 - $76,242 ---------- ----------- ----------- --------- Total $878,172 $22,600,198 $3,265,762 $76,242 ---------- ----------- ----------- --------- ---------- ----------- ----------- --------- 1997 - - ---- Property-Liability Insurance: Commercial Lines $343,862 $ 8,040,145 $ 1,377,740 - Specialty Commercial 119,714 3,537,850 910,383 - Personal Insurance 117,643 944,176 550,166 - ---------- ----------- ----------- --------- Total U. S. Underwriting 581,219 12,522,171 2,838,289 - International 20,715 1,227,370 154,181 - ---------- ----------- ----------- --------- Total Primary Underwriting 601,934 13,749,541 2,992,470 - Reinsurance 83,123 3,231,588 418,673 - Reinsurance Recoverables - 1,171,951 117,091 - ---------- ----------- ----------- --------- Property-Liability 685,057 18,153,080 3,528,234 - Life Insurance 187,403 3,816,050 - $61,370 ---------- ----------- ----------- --------- Total $872,460 $21,969,130 $3,528,234 $61,370 ---------- ----------- ----------- --------- ---------- ----------- ----------- ---------
* 1997 segment data included for the former USF&G Corporation in these columns is presented net of reinsurance, because such data on a gross basis by segment is unavailable. As a result, reinsurance recoverables relating to the former USF&G Corporation are included, separately, to present The St. Paul's consolidated loss and loss adjustment reserves and unearned premium reserve in total on a gross basis. 32 THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES SCHEDULE III - SUPPLEMENTARY INSURANCE INFORMATION (In thousands)
Insurance losses, Amortization Net loss of policy Other Premiums investment adjustment expenses acquisition operating Premiums 1998 earned income and policy benefits expenses expenses written - - ------- ------------ --------- ------------------- ------------- --------- ---------- Property-Liability Insurance: Commercial Lines $2,614,645 - $ 2,312,273 $755,194 $ 249,262 2,492,483 Specialty Commercial 1,446,937 - 1,176,182 288,983 104,158 1,348,278 Personal Insurance 1,392,325 - 1,153,352 299,641 123,023 1,418,230 ---------- ---------- ----------- -------- --------- ---------- Total U. S. Underwriting 5,453,907 - 4,641,807 1,343,818 476,443 5,258,991 International 333,186 - 277,304 68,627 56,698 377,948 ---------- ---------- ----------- -------- --------- ---------- Total Primary Underwriting 5,787,093 - 4,919,111 1,412,445 533,141 5,636,939 Reinsurance 1,038,687 - 684,450 225,692 121,809 1,056,229 Net investment income - $1,306,828 - - - - Other - - - - 352,035 - ---------- ---------- ----------- -------- --------- ---------- Property-Liability 6,825,780 1,306,828 5,603,561 1,638,137 1,006,985 6,693,168 Life Insurance 118,795 275,741 272,756 15,476 84,105 - ---------- ---------- ----------- -------- --------- ---------- Total $6,944,575 $1,582,569 $5,876,317 $1,653,613 $1,091,090 $6,693,168 ---------- ---------- ----------- -------- --------- ---------- ---------- ---------- ----------- -------- --------- ---------- 1997 - - ------- Property-Liability Insurance: Commercial Lines $2,912,393 - $ 1,987,597 $798,116 $ 304,182 $2,788,018 Specialty Commercial 1,441,835 - 1,012,387 256,402 103,791 1,400,565 Personal Insurance 1,302,110 - 1,022,212 273,355 117,136 1,250,068 ---------- ---------- ----------- -------- --------- ---------- Total U. S. Underwriting 5,656,338 - 4,022,196 1,327,873 525,109 5,438,651 International 277,778 - 231,912 49,989 46,357 293,641 ---------- ---------- ----------- -------- --------- ---------- Total Primary Underwriting 5,934,116 - 4,254,108 1,377,862 571,466 5,732,292 Reinsurance 1,226,913 - 839,413 318,715 76,742 1,200,245 Net investment income - $1,323,967 - - - - Other - - - - 116,170 - ---------- ---------- ----------- -------- --------- ---------- Property-Liability 7,161,029 1,323,967 5,093,521 1,696,577 764,378 6,932,537 Life Insurance 137,071 252,572 276,848 12,462 36,515 - ---------- ---------- ----------- -------- --------- ---------- Total $7,298,100 $1,576,539 $5,370,369 $1,709,039 $800,893 $6,932,537 ---------- ---------- ----------- -------- --------- ---------- ---------- ---------- ----------- -------- --------- ---------- 1996 - - ---- Property-Liability Insurance: Commercial Lines $2,775,349 - $ 1,910,057 $730,695 $ 342,239 $2,709,758 Specialty Commercial 1,416,577 - 944,705 296,857 43,507 1,418,350 Personal Insurance 1,335,451 - 1,225,196 313,435 132,324 1,351,289 ---------- ---------- ----------- -------- --------- ---------- Total U. S. Underwriting 5,527,377 - 4,079,958 1,340,987 518,070 5,479,397 International 269,266 - 197,249 47,308 46,360 268,762 ---------- ---------- ----------- -------- --------- ---------- Total Primary Underwriting 5,796,643 - 4,277,207 1,388,295 564,430 5,748,159 Reinsurance 1,237,467 - 876,358 286,023 59,398 1,286,324 Net investment income - $1,236,013 - - - - Other - - - - 131,761 - ---------- ---------- ----------- -------- --------- ---------- Property-Liability 7,034,110 1,236,013 5,153,565 1,674,318 755,589 7,034,483 Life Insurance 144,572 269,243 312,737 8,470 43,257 - ---------- ---------- ----------- -------- --------- ---------- Total $7,178,682 $1,505,256 $5,466,302 $1,682,788 $798,846 $7,034,483 ---------- ---------- ----------- -------- --------- ---------- ---------- ---------- ----------- -------- --------- ----------
33 THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES SCHEDULE IV - REINSURANCE Years Ended December 31, 1998, 1997 and 1996 (In thousands)
Percentage Ceded to Assumed of amount Gross other from other Net assumed to amount companies companies amount net ------ --------- --------- ------ ---------- 1998 - - ---- Life insurance in force $ 10,637,329 $2,304,635 $ 136,426 $8,469,120 1.6% ------------ ---------- --------- ---------- ------ ------------ ---------- --------- ---------- ------ Premiums earned: Life insurance 130,869 13,492 1,418 118,795 1.2% Property-liability 6,311,124 874,610 1,389,266 6,825,780 20.4% ------------ ---------- --------- ---------- Total premiums $6,441,993 $888,102 $1,390,684 $6,944,575 20.0% ------------ ---------- --------- ---------- ------ ------------ ---------- --------- ---------- ------ 1997 - - ---- Life insurance in force $10,613,288 $1,784,965 $134,410 $8,962,733 1.5% ------------ ---------- --------- ---------- ------ ------------ ---------- --------- ---------- ------ Premiums earned: Life insurance 143,153 7,607 1,525 137,071 1.1% Property-liability 6,528,712 898,652 1,530,969 7,161,029 21.4% ------------ ---------- --------- ---------- Total premiums $6,671,865 $906,259 $1,532,494 $7,298,100 21.0% ------------ ---------- --------- ---------- ------ ------------ ---------- --------- ---------- ------ 1996 - - ---- Life insurance in force $10,579,505 $1,219,897 $149,339 $9,508,947 1.6% ------------ ---------- --------- ---------- ------ ------------ ---------- --------- ---------- ------ Premiums earned: Life insurance 152,042 9,329 1,859 144,572 1.3% Property-liability 6,347,572 897,737 1,584,275 7,034,110 22.5% ------------ ---------- --------- ---------- Total premiums $6,499,614 $907,066 $1,586,134 $7,178,682 22.1% ------------ ---------- --------- ---------- ------ ------------ ---------- --------- ---------- ------
34 THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES SCHEDULE V - VALUATION AND QUALIFYING ACCOUNTS Years Ended December 31, 1998, 1997 and 1996 (In thousands)
Additions ------------------------------- Balance at Charged to Charged to Balance beginning costs and other at end Description of year expenses accounts Deductions(1) of year - - ----------------- ----------- ------------ ------------ ------------- --------- 1998 - - ---- Real estate valuation adjustment $11,779 - - - 11,779 ------- ----- ----- ----- ------ Allowance for uncollectible: Agency loans $ 2,321 859 - - 3,180 ------- ----- ----- ----- ------ Premiums receivable from underwriting activities $28,593 5,241 - 7,180 26,654 ------- ----- ----- ----- ------ Reinsurance $29,753 - - 2,043 27,710 ------- ----- ----- ----- ------ Uncollectible deductibles $18,951 7,557 - 3,571 22,937 ------- ----- ----- ----- ------ 1997 - - ---- Real estate valuation adjustment $19,000 1,779 - 9,000 11,779 ------- ----- ----- ----- ------ Allowance for uncollectible: Agency loans $ 2,153 168 - - 2,321 ------- ----- ----- ----- ------ Premiums receivable from underwriting activities $25,579 10,227 - 7,213 28,593 ------- ----- ----- ----- ------ Reinsurance $25,681 5,784 - 1,712 29,753 ------- ----- ----- ----- ------ Uncollectible deductibles $15,694 3,257 - - 18,951 ------- ----- ----- ----- ------ 1996 - - ---- Real estate valuation adjustment $39,000 - - 20,000 19,000 ------- ----- ----- ----- ------ Allowance for uncollectible: Agency loans $ 2,173 - - 20 2,153 ------- ----- ----- ----- ------ Premiums receivable from underwriting activities $22,680 5,731 - 2,832 25,579 ------- ----- ----- ----- ------ Reinsurance $25,081 1,150 - 550 25,681 ------- ----- ----- ----- ------ Uncollectible deductibles $16,000 - - 306 15,694 ------- ----- ----- ----- ------
(1) Deductions include write-offs of amounts determined to be uncollectible, unrealized foreign exchange gains and losses and, for real estate, a reduction in the valuation allowance for properties sold during the year. 35 THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES SCHEDULE VII - PREDECESSOR AUDITORS' REPORT ON CONSOLIDATED FINANCIAL STATEMENTS Report of Independent Auditors Board of Directors USF&G Corporation We have audited the consolidated statement of financial position of USF&G Corporation as of December 31, 1997, and the related consolidated statements of operations, cash flows and shareholders' equity for each of the years in the two-year period then ended (not presented separately herein). These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of USF&G Corporation at December 31, 1997, and the consolidated results of its operations and its cash flows for each of the years in the two-year period then ended, in conformity with generally accepted accounting principles. /s/ Ernst & Young LLP --------------------- Ernst & Young LLP Baltimore, Maryland February 20, 1998 36 THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES SCHEDULE VII - PREDECESSOR AUDITORS' REPORT ON FINANCIAL STATEMENT SCHEDULES CONSENT OF INDEPENDENT AUDITORS We consent to the use of our report dated February 20, 1998, with respect to the consolidated financial statements of USF&G Corporation for the year ended December 31, 1997 (not included separately herein) included as Schedule VII in The St. Paul Companies, Inc.'s Annual Report (Form 10-K) for the year ended December 31, 1998, filed with the Securities and Exchange Commission. Our audits also included the financial statement schedules of USF&G Corporation listed in Item 14(a) of USF&G Corporation's Annual Report (Form 10-K) for the year ended December 31, 1997 (not included separately herein). These schedules are the responsibility of management. Our responsibility is to express an opinion based on our audits. In our opinion, the financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein. We also consent to the incorporation by reference in the Registration Statements on Form S-8 (SEC File No. 33-15392, No. 33-23446, No. 33-23948, No. 33-24220, No. 33-24575, No. 33-26923, No. 33-49273, No. 33-56987, No. 333-01065, No. 333-22329, No. 333-25203, No. 333-28915, No. 333-48121, No. 333-50935, No. 333-50937, No. 333-50941, No. 333-50943 and No. 333-67983), and Form S-3 (SEC File No. 33-33931, No. 33-50115, No. 33-58491, No. 333-06465 and No. 333-67139), of The St. Paul Companies, Inc., of our report dated February 20, 1998, with respect to the consolidated financial statements and schedules of USF&G Corporation (these financial statements and schedules are not presented herein) included as Schedule VII in The St. Paul Companies, Inc. Annual Report on Form 10-K filed with the Securities and Exchange Commission. /s/ Ernst & Young LLP --------------------- Ernst & Young LLP Baltimore, Maryland March 31, 1999 37 EXHIBIT INDEX*
Exhibit (2) Plan of acquisition, reorganization, arrangement, liquidation, or succession..... (a) Definitive Agreement and Plan of Merger among The St. Paul, USF&G Corporation and SP Merger Corporation***.............................. (3) Articles of incorporation and by-laws (a) Articles of Incorporation................................................... (1) (b) By-laws***.................................................................. (4) Instruments defining the rights of security holders, including indentures (a) Specimen Common Stock Certificate............................................ (1) (b) Amended and Restated Shareholder Protection Rights Agreement***.............. (9) Voting trust agreements**........................................................ (10) Material contracts (a) Employment Agreement between The St. Paul and Mr. James E. Gustafson dated as of Jan. 6, 1999........................................... (1) (b) Restricted Stock Award Plan, as amended...................................... (1) (c) The 1988 Stock Option Plan................................................... (1) (d) Non-Employee Director Stock Retainer Plan.................................... (1) (e) The Amended and Restated Special Severance Policy............................ (1) (f) The Confidential Separation Agreement between The St. Paul and Mr. Patrick A. Thiele dated as of Sept. 1, 1998.......................................... (1) (g) The Annual Incentive Plan.................................................... (h) The Amended and Restated 1994 Stock Incentive Plan........................... (i) The Deferred Management Incentive Awards Plan***............................. (j) The Directors' Deferred Compensation Plan***................................. (k) Relocation Loan Payback Agreement with Mr. James F. Duffy***................. (l) Benefit Equalization Plan - 1995 Revision***................................. (m) First Amendment to Benefit Equalization Plan - 1995 Revision***.............. (n) Executive Post-Retirement Life Insurance Plan - Summary Plan Description***.. (o) Executive Long-Term Disability Plan - Summary Plan Description***............ (p) Letter Agreement dated Jan. 18, 1998 among The St. Paul, USF&G Corporation, SP Merger Corporation and Mr. Norman P. Blake, Jr. pertaining to Mr. Blake's duties with The St. Paul subsequent to the consummation of the proposed merger of The St. Paul and USF&G Corporation***.............................. (q) The St. Paul Re Long-Term Incentive Plan***.................................. (r) Letter Agreement dated May 8, 1997 between The St. Paul and Mr. Paul J. Liska related to the terms of his employment***.............. (s) Letter Agreement, agreed to January 20, 1997 between The St. Paul and Mr. Paul J. Liska related to severance benefits***.............. (t) The Special Leveraged Stock Purchase Plan***................................. (u) Amendment to Deferred Stock Agreement with Mr. Mark L. Pabst***.............. (v) The Deferred Stock Grant Agreement with Mr. Mark L. Pabst***................. (w) The Directors' Charitable Award Program***................................... (x) Long-Term Incentive Plan***.................................................. (y) Outside Directors' Retirement Plan -Summary Description***................... (11) Statements re computation of per share earnings................................. (1) (12) Statements re computation of ratios............................................. (1) (13) Annual report to security holders............................................... (1) (16) Letter re change in certifying accountant**..................................... (18) Letter re change in accounting principles**..................................... (21) Subsidiaries of The St. Paul.................................................... (1) (22) Published report regarding matters submitted to vote of security holders**........................................................... (23) Consents of experts and counsel................................................. (a) Consent of KPMG Peat Marwick LLP............................................ (1) (b) Consent of Ernst & Young LLP................................................ (1) (24) Power of attorney............................................................... (1) (27) Financial data schedule......................................................... (1) (99) Additional exhibits**...........................................................
* The exhibits are included only with the copies of this report that are filed with the Securities and Exchange Commission. However, copies of the exhibits may be obtained from The St. Paul for a reasonable fee by writing to the Corporate Secretary, The St. Paul Companies, Inc., 385 Washington Street, St. Paul, Minnesota 55102. ** These items are not applicable. *** These items are incorporated by reference as described in Item 14(a)(3) of this report. (1) Filed herewith. 38 EX-3 2 EXHIBIT 3 EXHIBIT 3 RESTATED ARTICLES OF INCORPORATION OF THE ST. PAUL COMPANIES, INC. ARTICLE I The name of the corporation is THE ST. PAUL COMPANIES, INC. ARTICLE II The address of the registered office of the corporation is 385 Washington Street, St. Paul, Minnesota 55102. ARTICLE III The aggregate number of shares that the corporation has authority to issue is four hundred eight-five million shares which shall consist of five million undesignated shares and four hundred eighty million shares of voting common stock. All shares of voting common stock shall have equal rights and preferences. The board of directors of the corporation is authorized to establish, from the undesignated shares, one or more classes and series of shares, to designate each such class and series and to fix the relative rights and preferences of each such class and series, provided that in no event shall the board of directors fix a preference with respect to a distribution in liquidation in excess of $100 per share plus accrued and unpaid dividends, if any. No shares shall confer on the holder any right to cumulate votes in the election of directors. All shareholders are denied preemptive rights, unless, with respect to some or all of the undesignated shares, the board of directors shall grant preemptive rights. The corporation may, without any new or additional consideration, issue shares of voting common stock or any other class or series pro rata to the holders of the same or one or more other classes or series of shares. Each share of common stock with a par value of One Dollar Fifty Cents which is issued and outstanding (and has not been reacquired by the corporation) as of the effective date of these Restated Articles of Incorporation is hereby reclassified into one share of voting common stock and each certificate representing a share or shares of common stock with a par value of One Dollar Fifty Cents shall represent the same number of shares of voting common stock. [AMENDED ON 5/5/98.] ARTICLE IV An action required or permitted to be taken at a board meeting may be taken by written action signed by the number of directors that would be required to act in taking the same action at a meeting of the board at which all directors were present. ARTICLE V Where shareholder approval, authorization or adoption is required by Chapter 302A, Minnesota Statutes, for any of the following transactions, the vote required for such approval, authorization or adoption shall be the affirmative vote of the holders of at least two-thirds of the voting power of all voting shares: (a) Any plan of merger; (b) Any plan of exchange; (c) Any sale, lease, transfer or other disposition of all or substantially all of the corporation's property and assets, including its good will, not in the usual and regular course of its business; or (d) Any dissolution of the corporation. The shareholder vote required for approval, authorization or adoption of an amendment to these Restated Articles of Incorporation (other than an amendment to this article) shall be the affirmative vote of the holders of at least one-half of the voting power of all voting shares. The shareholder vote required for approval, authorization or adoption of an amendment to this article shall be the affirmative vote of the holders of at least two-thirds of the voting power of all voting shares. The provisions of this article are not intended either to require that the holders of the shares of any class or series of shares vote separately as a class or series or to affect or increase any class or series vote requirement of Chapter 302A, Minnesota Statutes. ARTICLE VI A director of the Corporation shall have no personal liability to the Corporation or its shareholders for monetary damages for breach of fiduciary duty as a director, to the full extent such immunity is permitted from time to time under the Minnesota Business Corporation Act. Any repeal or modification of the foregoing paragraph by the shareholders of the Corporation shall not adversely affect any right or protection of a Director of the Corporation existing at the time of such repeal or modification. STATEMENT OF THE ST. PAUL COMPANIES, INC. WITH RESPECT TO SERIES B CONVERTIBLE PREFERRED STOCK Pursuant to Section 302A.401, Subd. 3(b) of Minnesota Statutes The undersigned officers of The St. Paul Companies, Inc. (the "Corporation"), being duly authorized by the Board of Directors of the Corporation, do hereby certify that the following resolution was duly adopted by the Board of Directors of the Corporation on January 24, 1990 pursuant to Minnesota Statutes, Section 302A.401, Subd. 3(a): RESOLVED, That there is hereby established, out of the presently available undesignated shares of the Corporation, a series of Preferred Stock of the Corporation designated as stated below and having the relative rights and preferences that are set forth below (the "Series"): 1. Designation and Amount. The Series shall be designated as "Series B Convertible Preferred Stock" (the "Series B Preferred"). The number of shares constituting the Series shall be one million four hundred fifty thousand (1,450,000), which number may from time to time be decreased (but not below the number of shares then outstanding) by action of the Board of Directors of the Corporation (the "Board of Directors"). Shares of Series B Preferred shall have a preference upon liquidation, dissolution or winding up of the Corporation of One Hundred Dollars ($100.00) per share, which preference amount does not represent a determination by the Board of Directors for the purpose of the Corporation's capital accounts. 2. Rank. The Series B Preferred shall, with respect to dividend rights and rights on liquidation, winding up or dissolution of the Corporation, rank prior to the Corporation's Series A Junior Participating Preferred Stock and to the Corporation's voting common stock (the "Common Stock") (together, the "Junior Stock") and shall, with respect to dividend rights and rights on liquidation, winding up or dissolution of the Corporation, rank junior to all other classes and series of equity securities of the Corporation, now or hereafter authorized, issued or outstanding, other than any classes or series of equity securities of the Corporation ranking on a parity with the Series B Preferred as to dividend rights and rights upon liquidation, winding up or dissolution of the Corporation (the "Parity Stock"). 3. Dividends. (a) Holders of outstanding shares of Series B Preferred shall be entitled to receive, when, as and if declared by the Board of Directors, to the extent permitted by applicable law, cumulative quarterly cash dividends at the annual rate of Eleven and 724/1000 Dollars ($11.724) per share, in preference to and in priority over any dividends with respect to Junior Stock. (b) Dividends on the outstanding shares of Series B Preferred shall begin to accrue and be cumulative (regardless of whether such dividends shall have been declared by the Board of Directors) from and including the date of original issuance of each share of the Series B Preferred, and shall be payable in arrears on January 17, April 17, July 17 and October 17 of each year (each of such dates a "Dividend Payment Date"), commencing April 17, 1990. Each such dividend shall be payable to the holder or holders of record as they appear on the stock books of the Corporation at the close of business on such record dates, not more than thirty (30) calendar days and not less than ten (10) calendar days preceding the Dividend Payment Dates therefor, as are determined by the Board of Directors (each of such dates a "Record Date"). In any case where the date fixed for any dividend payment with respect to the Series B Preferred shall not be a Business Day, then such payment need not be made on such date but may be made on the next preceding Business Day with the same force and effect as if made on the date fixed therefor, without interest. (c) The amount of any dividends "accumulated" on any share of Series B Preferred at any Dividend Payment Date shall be deemed to be the amount of any unpaid dividends accrued thereon to and excluding such Dividend Payment Date regardless of whether declared, and the amount of dividends "accumulated" on any share of Series B Preferred at any date other than a Dividend Payment Date shall be calculated as the amount of any unpaid dividends accrued thereon to and excluding the last preceding Dividend Payment Date regardless of whether declared, plus an amount calculated on the basis of the annual dividend rate for the period from and including such last preceding Dividend Payment Date to and excluding the date as of which the calculation is made (regardless of whether declared). The amount of dividends payable with respect to a full dividend period on outstanding shares of Series B Preferred shall be computed by dividing the annual dividend rate by four and the amount of dividends payable for any period shorter than a full quarterly dividend period (including the initial dividend period) shall be computed on the basis of thirty (30)-day months, a three hundred sixty (360)-day year and the actual number of days elapsed in the period. (d) So long as the shares of Series B Preferred shall be outstanding, if (i) the Corporation shall be in default or in arrears with respect to the payment of dividends (regardless of whether declared) on any outstanding shares of Series B Preferred or any other classes or series of equity securities of the Corporation other than Junior Stock or (ii) the Corporation shall be in default or in arrears with respect to the mandatory or optional redemption, purchase or other acquisition, retirement or other requirement of, or with respect to, any sinking or other similar fund or agreement for the redemption, purchase or other acquisition, retirement or other requirement of, or with respect to, any shares of the Series B Preferred or any other classes or series of equity securities of the Corporation other than Junior Stock, then the Corporation may not (A) declare, pay or set apart for payment any dividends on any shares of Junior Stock, or (B) make any payment on account of, or set apart payment for, the purchase or other acquisition, redemption, retirement or other requirement of, or with respect to, any sinking or other similar fund or agreement for the purchase or other acquisition, redemption, retirement or other requirement of, or with respect to, any shares of Junior Stock or any warrants, rights, calls or options exercisable or exchangeable for or convertible into Junior Stock, other than with respect to any rights that are now or in the future may be issued and outstanding under or pursuant to the Shareholder Protection Rights Agreement dated as of December 4, 1989 between the Corporation and First Chicago Trust Company of New York as Rights Agent, as it may be amended in any respect or extended from time to time or replaced by a new shareholders' rights plan of any scope or nature (provided that in any amended or extended plan or in any replacement plan any redemption of rights feature permits only nominal redemption payments) (the "Rights Agreement"), or (C) make any distribution in respect of any shares of Junior Stock or any warrants, rights, calls or options exercisable or exchangeable for or convertible into Junior Stock, whether directly or indirectly, and whether in cash, obligations, or securities of the Corporation or other property, other than dividends or distributions of Junior Stock which is neither convertible into nor exchangeable or exercisable for any securities of the Corporation other than Junior Stock or rights, warrants, options or calls exercisable or exchangeable for or convertible into Junior Stock or (D) permit any corporation or other entity controlled directly or indirectly by the Corporation to purchase or otherwise acquire or redeem any shares of Junior Stock or any warrants, rights, calls or options exercisable or exchangeable for or convertible into shares of Junior Stock. (e) Dividends in arrears with respect to the outstanding shares of Series B Preferred may be declared and paid or set apart for payment at any time and from time to time, without reference to any regular Dividend Payment Date, to the holder or holders of record as they appear on the stock books of the Corporation at the close of business on the Record Date established with respect to such payment in arrears. If there shall be outstanding shares of Parity Stock, and if the payment of dividends on any shares of the Series B Preferred or the Parity Stock is in arrears, the Corporation, in making any dividend payment on account of any shares of the Series B Preferred or Parity Stock, shall make such payment ratably upon all outstanding shares of the Series B Preferred and Parity Stock in proportion to the respective amounts of accumulated dividends in arrears upon such shares of the Series B Preferred and Parity Stock to the date of such dividend payment. The Holder or holders of Series B Preferred shall not be entitled to any dividends, whether payable in cash, obligations or securities of the Corporation or other property, in excess of the accumulated dividends on shares of Series B Preferred. No interest, or sum of money in lieu of interest, shall be payable in respect of any dividend or other payment or payments which may be in arrears with respect to the Series B Preferred. All dividends paid with respect to the Series B Preferred shall be paid pro rata to the holders entitled thereto. (f) Subject to the foregoing provisions hereof and applicable law, the Board of Directors (i) may declare and the Corporation may pay or set apart for payment dividends on any Junior Stock or Parity Stock, (ii) may make any payment on account of or set apart payment for a sinking fund or other similar fund or agreement for the purchase or other acquisition, redemption, retirement or other requirement of, or with respect to, any Junior Stock or Parity Stock or any warrants, rights, calls or options exercisable or exchangeable for or convertible into any Junior Stock or Parity Stock, (iii) may make any distribution in respect to any Junior Stock or Parity Stock or any warrants, rights, calls or options exercisable or exchangeable for or convertible into any Junior Stock or Parity Stock, whether directly or indirectly, and whether in cash, obligations or securities of the Corporation or other property and (iv) may purchase or otherwise acquire, redeem or retire any Junior Stock or Parity Stock or any warrants, rights, calls or options exercisable or exchangeable for or convertible into any Junior Stock or Parity Stock, and the holder or holders of the Series B Preferred shall not be entitled to share therein. 4. Voting Rights. The holder or holders of Series B Preferred shall have no right to vote for any purpose, except as required by applicable law and except as provided in this Section 4. (a) So long as any shares of Series B Preferred remain outstanding, the affirmative vote of the holder or holders of at least a majority (or such greater number as required by applicable law) of the votes entitled to be cast with respect to the then outstanding Series B Preferred, voting separately as one class, at a meeting duly held for that purpose, shall be necessary to repeal, amend or otherwise change any of the provisions of the articles of incorporation of the Corporation in any manner which materially and adversely affects the rights or preferences of the Series B Preferred. For purposes of the preceding sentence, the increase (including the creation or authorization) or decrease in the amount of authorized capital stock of any class or series (excluding the Series B Preferred) shall not be deemed to be an amendment which materially and adversely affects the rights or preferences of the Series B Preferred. (b) The holder or holders of Series B Preferred shall be entitled to vote on all matters submitted to a vote of the holders of Common Stock, voting together with the holders of Common Stock as if one class. Each share of Series B Preferred in such case shall be entitled to a number of votes equal to the number of shares of Common Stock into which such share of Series B Preferred could have been converted on the record date for determining the holders of Common Stock entitled to vote on a particular matter. 5. Optional Redemption. (a) The Series B Preferred shall be redeemable, in whole or in part at any time and from time to time, to the extent permitted by applicable law, at the option of the Corporation, (i) on or before December 31, 1994, if (A) there is a change in any statute, rule or regulation of the United States of America which has the effect of limiting or making unavailable to the Corporation all or any of the tax deductions for amounts paid (including dividends) on the Series B Preferred when such amounts are used as provided under Section 404(k)(2) of the Internal Revenue Code of 1986, as amended and in effect on the date shares of Series B Preferred are initially issued, or (B) the Plan is not initially determined by the Internal Revenue Service to be qualified within the meaning of ss. 401(a) and ss. 4975(e)(7) of the Internal Revenue Code of 1986, as amended, or (C) the Plan is terminated by the Board of Directors or otherwise, at the greater of (1) $144.30 per share plus accumulated and unpaid dividends, without interest, to and excluding the date fixed for redemption, or (2) the Fair Market Value of the Series B Preferred redeemed, or (ii) after December 31, 1994, at the following redemption prices per share if redeemed during the twelve (12)-month period ending on and including December 31 in each of the following years:
REDEMPTION PRICE YEAR PER SHARE ---- ---------------- 1995 $149.52 1996 148.22 1997 146.92 1998 145.62 1999 and thereafter 144.30
plus accumulated and unpaid dividends, without interest, to and excluding the date fixed for redemption. (b) Payment of the redemption price shall be made by the Corporation in cash or shares of Common Stock, or a combination thereof, as permitted by paragraph (d) of this Section S. On and after the date fixed for redemption, dividends on shares of Series B Preferred called for redemption shall cease to accrue, such shares shall no longer be deemed to be outstanding and all rights in respect of such shares shall cease, except the right to receive the redemption price. (c) Unless otherwise required by law, notice of redemption shall be sent to the holder or holders of Series B Preferred at the address shown on the books of the Corporation by first class mail, postage prepaid, mailed not less than twenty (20) days nor more than sixty (60) days prior to the redemption date. Each such notice shall state: (i) the redemption date; (ii) the total number of shares of the Series B Preferred to be redeemed and, if fewer than all the shares are to be redeemed, the number of such shares to be redeemed; (iii) the redemption price; (iv) the place or places where certificates for such shares are to be surrendered for payment of the redemption price; (v) that dividends on the shares to be redeemed will cease to accrue from and after such redemption date; and (vi) the conversion rights of the shares to be redeemed, the period within which conversion rights may be exercised, and the then current Conversion Price and number of shares of Common Stock issuable upon conversion of a share of Series B Preferred at the time. Upon surrender of the certificates for any shares so called for redemption and not previously converted (properly endorsed or assigned for transfer, if the Board of Directors shall so require and the notice shall so state), such shares shall be redeemed by the Corporation at the date fixed for redemption and at the redemption price. (d) The Corporation, at its option, may make payment of the redemption price required upon redemption of shares of Series B Preferred in cash or in shares of Common Stock, or in a combination of such shares and cash, any such shares to be valued for such purpose at the average Current Market Price for the five (5) consecutive trading days ending on the trading day next preceding the date of redemption. 6. Other Redemption Rights. Shares of Series B Preferred shall be redeemed by the Corporation at the option of the holder at any time and from time to time, to the extent permitted by applicable law, upon notice to the Corporation accompanied by the properly endorsed certificate or certificates given not less than five (5) Business Days prior to the date fixed by the holder in such notice for such redemption, when and to the extent necessary (a) for such holder to provide for distributions required to be made under The St. Paul Companies, Inc. Savings Plus Preferred Stock Ownership Plan and Trust, an employee stock ownership plan and trust within the meaning of ss. 4975(e)(7) of the Internal Revenue Code of 1986, as amended (the "Plan and Trust"), as the same may be amended, or any successor plans, or (b) for such holder to make payment of principal or interest due and payable (whether as scheduled or upon acceleration) on the 9.40% Note dated January 24, 1990, due January 31, 2005 made by Norwest Bank Minnesota, National Association, not individually but solely as Trustee for the Plan and Trust, payable to the order of St. Paul Fire and Marine Insurance Company or registered assigns, in the principal amount of One Hundred Fifty Million Dollars ($150,000,000) or other indebtedness of the Plan and Trust or if funds otherwise available are not adequate to make a required payment pursuant to such Note or other indebtedness, in each case at a redemption price of the greater of (1) $144.30 per share plus accumulated and unpaid dividends, without interest, to and excluding the date fixed for redemption, or (2) the Fair Market Value of the Series B Preferred redeemed. Upon surrender of the shares to be redeemed, such shares shall be redeemed by the Corporation on the date fixed for redemption and at the applicable redemption price and such price shall be paid within five (5) Business Days after such date of redemption, without interest. The terms and provisions of Sections 5(b) and 5(d) are applicable to any redemption under this Section 6. 7. Liquidation Preference. In the event of any voluntary or involuntary liquidation, dissolution or winding up of the Corporation, the holder or holders of outstanding shares of Series B Preferred shall be entitled to receive out of the assets of the Corporation available for distribution to shareholders, before any distribution of assets shall be made to the holders of shares of Junior Stock, an amount equal to One Hundred Dollars ($100.00) per share. If, upon any voluntary or involuntary liquidation, dissolution or winding up of the Corporation, the amounts payable with respect to the Series B Preferred and any Parity Stock are not paid in full, the holder or holders of the Series B Preferred and of such Parity Stock shall share ratably in any such distribution of assets of the Corporation in proportion to the full respective preferential amounts to which they are entitled. After payment to the holder or holders of the Series B Preferred of the full preferential amount provided for in this Section 7 and after the payment of any other preferential amounts to the holder or holders of other equity securities of the Corporation, the holder or holders of the Series B Preferred shall be entitled to share in distributions of any remaining assets with the holders of Common Stock, pro-rata on an as-if-converted basis, to the extent of $44.30 per share plus accumulated and unpaid dividends, without interest, to and excluding the date fixed for such distribution of assets. Written notice of any liquidation, dissolution or winding up of the Corporation shall be given to the holder or holders of Series B Preferred not less than twenty (20) days prior to the payment date. Neither the voluntary sale, conveyance exchange or transfer (for cash, securities or other consideration) of all or any part of the property or assets of the Corporation, nor the consolidation or merger or other business combination of the Corporation with or into any other corporation or corporations, shall be deemed to be a voluntary or involuntary liquidation, dissolution or winding up of the Corporation, unless such voluntary sale, conveyance, exchange or transfer shall be in connection with a plan of liquidation, dissolution or winding up of the Corporation. 8. Conversion Rights. (a) The holder of any Series B Preferred shall have the right, at the holder's option, at any time and from time to time, to convert any or all of such shares into the number of shares of Common Stock of the Corporation determined by dividing One Hundred Forty-four and 30/100 Dollars ($144.30) for each share of Series B Preferred to be converted by the then effective Conversion Price per share of Common Stock, except that if any shares of Series B Preferred are called for redemption by the Corporation or submitted for redemption by the holder thereof, according to the terms and provisions of this Resolution, the conversion rights pertaining to such shares shall terminate at the close of business on the date fixed for redemption (unless the Corporation defaults in the payment of the applicable redemption price). No fractional shares of Common Stock shall be issued upon conversion of Series B Preferred, but if such conversion results in a fraction, an amount shall be paid in cash by the Corporation to the converting holder equal to same fraction of the Current Market Price of the Common Stock on the effective date of the conversion. (b) The initial conversion price, which is Seventy-two and 15/100 Dollars ($72.15) per share of Common Stock, shall be subject to appropriate adjustment from time to time as follows and such initial conversion price or the latest adjusted conversion price is referred to in this Resolution as the "Conversion Price": (i) In case the Corporation shall, at any time or from time to time while any of the shares of the Series B Preferred is outstanding (A) pay a dividend in shares of Common Stock, (B) subdivide outstanding shares of Common Stock into a larger number of shares or (C) combine outstanding shares of Common Stock into a smaller number of shares, the Conversion Price in effect immediately prior to such action shall be adjusted so that the holder of any shares of the Series B Preferred thereafter surrendered for conversion shall be entitled to receive the number of shares of Common Stock of the Corporation which such holder would have owned or have been entitled to receive immediately following such action had such shares of the Series B Preferred been converted immediately prior thereto. An adjustment made pursuant to this Section 8(b)(i) shall become effective retroactively to immediately after the record date for determination of the shareholders entitled to receive the dividend in the case of a dividend and shall become effective immediately after the effective date in the case of a subdivision or combination. (ii) In case the Corporation shall, at any time or from time to time while any of the shares of the Series B Preferred is outstanding, distribute or issue rights, warrants, options or calls to all holders of shares of Common Stock entitling them to subscribe for or purchase shares of Common Stock (or securities convertible into or exercisable or exchangeable for Common Stock), at a per share price less than the Current Market Price on the record date referred to below, the Conversion Price shall be adjusted so that it shall equal the Conversion Price determined by multiplying the Conversion Price in effect immediately prior to the record date of the distribution or issuance of such rights, warrants, options or calls by a fraction, the numerator of which shall be the number of shares of Common Stock outstanding on such record date plus the number of shares which the aggregate offering price of the total number of shares of Common Stock so offered would purchase at such Current Market Price, and the denominator of which shall be the number of shares of Common Stock outstanding on such record date plus the number of additional shares of Common Stock offered for subscription or purchase. For the purpose of this Section 8(b)(ii), the distribution or issuance of rights, warrants, options or calls to subscribe for or purchase securities convertible into Common Stock shall be deemed to be the issuance of rights, warrants, options or calls to purchase the shares of Common Stock into which such securities are convertible at an aggregate offering price equal to the aggregate offering price of such securities plus the minimum aggregate amount (if any) payable upon conversion of such securities into shares of Common Stock; provided, however, that if all of the shares of Common Stock subject to such rights, warrants, options or calls have not been issued when such rights, warrants, options or calls expire, then the Conversion Price shall promptly be readjusted to the Conversion Price which would then be in effect had the adjustment upon the distribution or issuance of such rights, warrants, options or calls been made on the basis of the actual number of shares of Common Stock issued upon the exercise of such rights, warrants, options or calls. An adjustment made pursuant to this Section 8(b)(ii) shall become effective retroactively immediately after the record date for the determination of shareholders entitled to receive such rights, warrants, options or calls. This Section 8(b)(ii) shall be inapplicable with respect to any rights issued or to be issued pursuant to or governed by the Rights Agreement. (iii) In the event the Corporation shall, at any time or from time to time while any of the shares of Series B Preferred are outstanding, issue, sell or exchange shares of Common Stock (other than pursuant to (a) any right or warrant now or hereafter outstanding to purchase or acquire shares of Common Stock (including as such a right or warrant any security convertible into or exchangeable for shares of Common Stock), (b) any rights issued or to be issued pursuant to or governed by the Rights Agreement and (c) any employee, officer or director incentive or benefit plan or arrangement (including any employment, severance or consulting agreement) of the Corporation or any subsidiary of the Corporation heretofore or hereafter adopted) for a consideration having a Fair Market Value, on the date of such issuance, sale or exchange, less than the Fair Market Value of such shares on the date of issuance, sale or exchange, then, subject to the provisions of Sections 8(b)(v) and (vii), the Conversion Price shall be adjusted by multiplying such Conversion Price by the fraction the numerator of which shall be the sum of (x) the Fair Market Value of all the shares of Common Stock outstanding on the day immediately preceding the first public announcement of such issuance, sale or exchange plus (y) the Fair Market value of the consideration received by the Corporation in respect of such issuance, sale or exchange of shares of Common Stock, and the denominator of which shall be the product of (a) the Fair Market Value of a share of Common Stock on the day immediately preceding the first public announcement of such issuance, sale or exchange multiplied by (b) the sum of the number of shares of Common Stock outstanding on such day plus the number of shares of Common Stock so issued, sold or exchanged by the Corporation. In the event the Corporation shall, at any time or from time to time while any shares of Series B Preferred are outstanding, issue, sell or exchange any right or warrant to purchase or acquire shares of Common Stock (including as such a right or warrant any security convertible into or exchangeable for shares of Common Stock), other than any such issuance (a) to holders of shares of Common Stock as a dividend or distribution (including by way of a reclassification of shares or a recapitalization of the Corporation), (b) pursuant to any employee, officer or director incentive or benefit plan or arrangement (including any employment, severance or consulting agreement) of the Corporation or any subsidiary of the Corporation heretofore or hereafter adopted, (c) of rights issued or to be issued pursuant to or governed by the Rights Agreement and (d) which is covered by the terms and provisions of Section 8(b)(ii) hereof, for a consideration having a Fair Market Value, on the date of such issuance, sale or exchange, less than the Non-Dilutive Amount, then, subject to the provisions of Sections 8(b)(v) and (vii) hereof, the Conversion Price shall be adjusted by multiplying such Conversion Price by a fraction the numerator of which shall be the sum of (I) the Fair Market Value of all the shares of Common Stock outstanding on the day immediately preceding the first public announcement of such issuance, sale or exchange plus (II) the Fair Market Value of the consideration received by the Corporation in respect of such issuance, sale or exchange of such right or warrant plus (III) the Fair Market Value at the time of such issuance of the consideration which the Corporation would receive upon exercise in full of all such rights or warrants, and the denominator of which shall be the product of (x) the Fair Market Value of a share of Common Stock on the day immediately preceding the first public announcement of such issuance, sale or exchange multiplied by (y) the sum of the number of shares of Common Stock outstanding on such day plus the maximum number of shares of Common Stock which could be acquired pursuant to such right or warrant at the time of the issuance, sale or exchange of such right or warrant (assuming shares of Common Stock could be acquired pursuant to such right or warrant at such time). (iv) In the event the Corporation shall, at any time or from time to time while any of the shares of Series B Preferred are outstanding, make an Extraordinary Distribution in respect of the Common Stock, whether by dividend, distribution, reclassification of shares or recapitalization of the Corporation (including a recapitalization or reclassification effected by a merger or consolidation to which Section 8(c) hereof does not apply) or effect a Pro Rata Repurchase of Common Stock, the Conversion Price in effect immediately prior to such Extraordinary Distribution or Pro Rata Repurchase shall, subject to Sections 8(b)(v) and (vii) hereof, be adjusted by multiplying such Conversion Price by the fraction the numerator of which is the difference between (a) the product of (x) the number of shares of Common Stock outstanding immediately before such Extraordinary Distribution or Pro Rata Repurchase multiplied by (y) the Fair Market Value of a share of Common Stock on the day before the ex-dividend date with respect to an Extraordinary Distribution which is paid in cash and on the distribution date with respect to an Extraordinary Distribution which is paid other than in cash, or on the applicable expiration date (including all extensions thereof) of any tender offer which is a Pro Rata Repurchase, or on the date of purchase with respect to any Pro Rata Repurchase which is not a tender offer, as the case may be, and (b) the Fair Market Value of the Extraordinary Distribution or the aggregate purchase price of the Pro Rata Repurchase, as the case may be, and the denominator of which shall be the product of (x) the number of shares of Common Stock outstanding immediately before such Extraordinary Dividend or Pro Rata Repurchase minus, in the case of a Pro Rata Repurchase, the number of shares of Common Stock repurchased by the Corporation multiplied by (y) the Fair Market Value of a share of Common Stock on the day before the ex-dividend date with respect to an Extraordinary Distribution which is paid in cash and on the distribution date with respect to an Extraordinary Distribution which is paid other than in cash, or on the applicable expiration date (including all extensions thereof) of any tender offer which is a Pro Rata Repurchase or on the date of purchase with respect to any Pro Rata Repurchase which is not a tender offer, as the case may be. The Corporation shall send each holder of Series B Preferred (i) notice of its intent to make any dividend or distribution and (ii) notice of any offer by the Corporation to make a Pro Rata Repurchase, in each case at the same time as, or as soon as practicable after, such offer is first communicated (including by announcement of a record date in accordance with the rules of any stock exchange on which the Common Stock is listed or admitted to trading) to holders of Common Stock. Such notice shall indicate the intended record date and the amount and nature of such dividend or distribution, or the number of shares subject to such offer for a Pro Rata Repurchase and the purchase price payable by the Corporation pursuant to such offer, as well as the Conversion Price and the number of shares of Common Stock into which a share of Series B Preferred may be converted at such time. (v) If the Corporation shall make any dividend or distribution on the Common Stock or issue any Common Stock, other capital stock or other security of the Corporation or any rights or warrants to purchase or acquire any such security, which transaction does not result in an adjustment to the Conversion Price pursuant to this Section 8, the Board of Directors shall consider whether such action is of such a nature that an adjustment to the Conversion Price should equitably be made in respect of such transaction. If in such case the Board of Directors determines that an adjustment to the Conversion Price should be made, an adjustment shall be made effective as of such date, as determined by the Board of Directors (which adjustment shall in no event adversely affect the rights or preferences of the Series B Preferred as set forth herein). The determination of the Board of Directors as to whether an adjustment to the Conversion Price should be made pursuant to the foregoing provisions of this Section 8(b)(v), and, if so, as to what adjustment should be made and when, shall be final and binding on the Corporation and all shareholders of the Corporation. (vi) In addition to the foregoing adjustments, the Corporation may, but shall not be required to, make such adjustments in the Conversion Price as it considers to be advisable in order that any event treated for federal income tax purposes as a dividend of stock or stock rights shall either not be taxable to the recipients or shall be taxable to the recipients to the minimum extent reasonable under the circumstances, as determined by the Board of Directors in its sole discretion. (vii) In no event shall an adjustment in the Conversion Price be required unless such adjustment would result in an increase or decrease of at least one percent (1%) in the Conversion Price then in effect; provided, however, that any such adjustments that are not made shall be carried forward and taken into account in determining whether any subsequent adjustment is required. In no event shall the Conversion Price be adjusted to an amount less than any minimum required by law. Except as set forth in this Section 8, the Conversion Price shall not be adjusted for the issuance of Common Stock or any securities convertible into or exercisable or exchangeable for Common Stock, or carrying the right or option to purchase or otherwise acquire the foregoing, in exchange for cash, other property or services. (viii) Whenever an adjustment in the Conversion Price is required, the Corporation shall forthwith place on file with its transfer agent (or if the Corporation performs the functions of a transfer agent, with the corporate secretary) a statement signed by its chief executive officer or a vice president and by its secretary, assistant secretary or treasurer, stating the adjusted Conversion Price determined as provided herein. Such statements shall set forth in reasonable detail such facts as shall be necessary to show the reason and the manner of computing such adjustment. As soon as practicable after the adjustment of the Conversion Price, the Corporation shall mail a notice thereof to each holder of shares of the Series B Preferred of such adjustment. (ix) In the event that at any time, as a result of an adjustment made pursuant to this Section 8, the holder of any shares of Series B Preferred hereafter surrendered for conversion shall be entitled to receive any securities other than shares of Common Stock, thereafter the amount of such other securities so receivable upon conversion of any shares of Series B Preferred shall be subject to adjustment from time to time in a manner and on terms as nearly as equivalent as practicable to the provisions with respect to the Common Stock contained in this Section 8, and the provisions of this Section 8 with respect to the Common Stock shall apply on like terms to any such other securities. (c) In case of any consolidation or merger of the Corporation with or into any other corporation (other than a merger in which the Corporation is the surviving corporation), or in case of any sale or transfer of substantially all the assets of the Corporation, or in case of reclassification, capital reorganization or change of outstanding shares of Common Stock (other than combinations or subdivisions described in Section 8(b)(i) and other than Extraordinary Distributions described in Section 8(b)(iv)), there shall be no adjustment to the Conversion Price then in effect, but appropriate provisions shall be made so that any holder of Series B Preferred shall be entitled, after the occurrence (or, if applicable, the record date) of any such event ("Transaction"), to receive on conversion the consideration which the holder would have received had the holder converted such holder's Series B Preferred to Common Stock immediately prior to the occurrence of the Transaction and had such holder, if applicable, elected to receive the consideration in the form and manner elected by the plurality of the electing holders of Common Stock. In any such Transaction, effective provisions shall be made to ensure that the holder or holders of the Series B Preferred shall receive the consideration that they are entitled to receive pursuant to the provisions hereof, and in particular, as a condition to any consolidation or merger in which the holders of securities into which the Series B Preferred is then convertible are entitled to receive equity securities of another corporation, such other corporation shall expressly assume the obligation to deliver, upon conversion of the Series B Preferred, such equity securities as the holder or holders of the Series B Preferred shall be entitled to receive pursuant to the provisions hereof. Notwithstanding the foregoing provisions of this Section 8(c), in the event the consideration to be received pursuant to the provisions hereof is not to be constituted solely of employer securities within the meaning of Section 409(l) of the Internal Revenue Code of 1986, as amended, or any successor provisions of law, and of a cash payment in lieu of any fractional securities, then the outstanding shares of Series B Preferred shall be deemed converted by virtue of the Transaction immediately prior to the consummation thereof into the number and kind of securities into which such shares of Series B Preferred could have been voluntarily converted at such time and such securities shall be entitled to participate fully in the Transaction as if such securities had been outstanding on the appropriate record, exchange or distribution date. In the event the Corporation shall enter into any agreement providing for any Transaction, then the Corporation shall as soon as practicable thereafter (and in any event at least ten (10) Business Days before consummation of the Transaction) give notice of such agreement and the material terms thereof to each holder of Series B Preferred and each such holder shall have the right, to the extent permitted by applicable law, to elect, by written notice to the Corporation, to receive, upon consummation of the Transaction (if and when the Transaction is consummated), from the Corporation or the successor of the Corporation, in redemption of such Series B Preferred, a cash payment per share equal to the amount determined according to the following table, with the redemption date to be deemed to be the same date that the Transaction giving rise to the redemption election is consummated:
TRANSACTION CONSUMMATED IN YEAR REDEMPTION PRICE ENDING DECEMBER 31 PER SHARE - - ------------------- ---------------- 1990 $156.02 1991 154.72 1992 153.42 1993 152.12 1994 150.82 1995 149.52 1996 148.22 1997 146.92 1998 145.62 1999 and thereafter 144.30
plus accumulated and unpaid dividends, without interest, to and excluding such deemed redemption date. No such notice of redemption by the holder of Series B Preferred shall be effective unless given to the Corporation prior to the close of business at least two (2) Business Days prior to consummation of the Transaction. (d) The holder or holders of Series B Preferred as they appear on the stock books of the Corporation at the close of business on a dividend payment Record Date shall be entitled to receive the dividend payable on such shares on the corresponding Dividend Payment Date notwithstanding the subsequent conversion thereof or the Corporation's default on payment of the dividend due on such Dividend Payment Date; provided, however, that the holder or holders of Series B Preferred subject to redemption on a redemption date after such Record Date and before such Dividend Payment Date shall not be entitled under this provision to receive such dividend on such Dividend Payment Date. However, shares of Series B Preferred surrendered for conversion during the period after any dividend payment Record Date and before the corresponding Dividend Payment Date (except shares subject to redemption on a redemption date during such period) must be accompanied by payment of an amount equal to the dividend payable on such shares on such Dividend Payment Date. The holder or holders of Series B Preferred as they appear on the stock books of the Corporation at the close of business on a dividend payment Record Date who convert shares of Series B Preferred on a Dividend Payment Date shall be entitled to receive the dividend payable on such Series B Preferred by the Corporation on such Dividend Payment Date, and the converting holders need not include payment in the amount of such dividend upon surrender of shares of Series B Preferred for conversion. Except as provided above, the Corporation shall make no payment or allowance for unpaid dividends (whether or not accumulated and in arrears) on converted shares or for dividends on the shares of Common Stock issuable upon such conversion. (e) Each conversion of shares of Series B Preferred into shares of Common Stock shall be effected by the surrender of the certificate or certificates representing the shares to be converted, accompanied by instruments of transfer satisfactory to the Corporation and sufficient to transfer such shares to the Corporation free of any adverse claims (the "Converting Shares"), at the principal executive office of the Corporation (or such other office or agency of the Corporation as the Corporation may designate by written notice to the holder or holders of Series B Preferred) at any time during its respective usual business hours, together with written notice by the holder of such Converting Shares, stating that such holder desires to convert the Converting Shares, or a stated number of the shares represented by such certificate or certificates, into such number of shares of Common Stock into which such shares may be converted (the "Converted Shares"). Such notice shall also state the name or names (with addresses and federal taxpayer identification numbers) and denominations in which the certificate or certificates for the Converted Shares are to be issued, shall include instructions for the delivery thereof and shall include such other information as the Corporation or its agents may reasonably request. Promptly after such surrender and the receipt of such written notice and the receipt of any required transfer documents and payments representing dividends as described above, the Corporation shall issue and deliver in accordance with the surrendering holder's instructions the certificate or certificates evidencing the Converted Shares issuable upon such conversion, and the Corporation will deliver to the converting holder (without cost to the holder) a certificate (which shall contain such legends as were set forth on the surrendered certificate or certificates) representing any shares of Series B Preferred which were represented by the certificate or certificates that were delivered to the Corporation in connection with such conversion, but which were not converted. (f) Such conversion, to the extent permitted by applicable law, shall be deemed to have been effected at the close of business on the date on which such certificate or certificates shall have been surrendered and such notice and any required transfer documents and payments representing dividends shall have been received by the Corporation, and at such time the rights of the holder of the Converting Shares as such holder shall cease, and the person or persons in whose name or names the certificate or certificates for the Converted Shares are to be issued upon such conversion shall be deemed to have become the holder or holders of record of the Converted Shares. Upon issuance of shares in accordance herewith, such Converted Shares shall be deemed to be fully paid and nonassessable. From and after the effectiveness of any such conversion, shares of the Series B Preferred so converted shall, upon compliance with applicable law, be restored to the status of authorized but unissued undesignated shares, until such shares are once more designated as part of a particular series by the Board of Directors. (g) Notwithstanding any provision herein to the contrary, the Corporation shall not be required to record the conversion of, and no holder of shares shall be entitled to convert, shares of Series B Preferred into shares of Common Stock unless such conversion is permitted under applicable law; provided, however, that the Corporation shall be entitled to rely without independent verification upon the representation of any holder that the conversion of shares by such holder is permitted under applicable law, and in no event shall the Corporation be liable to any such holder or any third party arising from any such conversion whether or not permitted by applicable law. (h) The Corporation will pay any and all stamp, transfer or other similar taxes that may be payable in respect of the issuance or delivery of Common Stock received upon conversion of the shares of Series B Preferred, but shall not, however, be required to pay any tax which may be payable in respect of any transfer involved in the issuance or delivery of Common Stock in a name other than that in which such shares of Series B Preferred were registered and no such issuance or delivery shall be made unless and until the person requesting such conversion shall have paid to the Corporation the amount of any and all such taxes or shall have established to the satisfaction of the Corporation that such taxes have been paid in full. (i) The Corporation shall at all times reserve and keep available, free from preemptive rights, out of its authorized but unissued stock, for the purpose of effecting the conversion of the shares of the Series B Preferred, such number of its duly authorized shares of Common Stock or other securities as shall from time to time be sufficient to effect the conversion of all outstanding shares of the Series B Preferred. (j) Whenever the Corporation shall issue shares of Common Stock upon conversion of shares of Series B Preferred as contemplated by this Section 8, the Corporation shall issue together with each such share of Common Stock one Right (as defined in the Rights Agreement) pursuant to the terms and provisions of the Rights Agreement. 9. Transfer Restriction. Shares of Series B Preferred shall be issued only to the Plan and Trust and the certificate or certificates representing such shares so issued may be registered in the name of the Plan and Trust or in the name of one or more Trustees acting on behalf of the Plan and Trust (or the nominee name of any such trustee). In the event the Plan and Trust, acting through any such trustee or otherwise, should transfer beneficial or record ownership of one or more shares of Series B Preferred to any person or entity, the shares of Series B Preferred so transferred, upon such transfer and without any further action by the Corporation or the Plan and Trust or anyone else, shall be automatically converted, as of the time of such transfer, into shares of Common Stock on the terms otherwise provided for the voluntary conversion of shares of Series B Preferred into shares of Common Stock pursuant to Section 8 hereof and no transferee of such share or shares shall thereafter have or receive any of the rights and preferences of the shares of Series B Preferred so converted. Certificates representing shares of Series B Preferred shall be legended to reflect the aforesaid restriction on transfer. Shares of Series B Preferred may also be subject to restrictions on transfer which relate to the securities laws of the United States of America or any state or other jurisdiction thereof. 10. No other Rights. The shares of Series B Preferred shall not have any rights or preferences, except as set forth herein or as otherwise required by applicable law. 11. Rules and Regulations. The Board of Directors shall have the right and authority from time to time to prescribe rules and regulations as it may determine to be necessary or advisable in its sole discretion for the administration of the Series B Preferred in accordance with the foregoing provisions and applicable law. 12. Definitions. For purposes of this Resolution, the following definitions shall apply: "Adjustment Period" shall mean the period of five (5) consecutive trading days preceding the date as of which the Fair Market Value of a security is to be determined. "Business Day" shall mean each day that is not a Saturday, Sunday or a day on which state or federally chartered banking institutions in New York, New York are not required to be open. "Current Market Price" of publicly traded shares of Common Stock or any other class of capital stock or other security of the Corporation or any other issuer for any day shall mean the last reported sales price, regular way, or, in the event that no sale takes place on such day, the average of the reported closing bid and asked prices, regular way, in either case as reported on the New York Stock Exchange Composite Tape or, if such security is not listed or admitted to trading on the New York Stock Exchange, on the principal national securities exchange on which such security is listed or admitted to trading or, if not listed or admitted to trading on any national securities exchange, on the National Market System of the National Association of Securities Dealers, Inc. Automated Quotation System ("NASDAQ") or, if such security is not quoted on such National Market System, the average of the closing bid and asked prices on each such day in the over-the-counter market as reported by NASDAQ or, if bid and asked prices for such security on each such day shall not have been reported through NASDAQ, the average of the bid and asked prices for such day as furnished by any New York Stock Exchange member firm regularly making a market in such security selected for such purpose by the Board of Directors or a committee thereof. "Extraordinary Distribution" shall mean any dividend or other distribution to holders of Common Stock (effected while any of the shares of Series B Preferred are outstanding) (i) of cash (other than a regularly scheduled quarterly dividend not exceeding 135% of the average quarterly dividend for the four quarters immediately preceding such dividend), where the aggregate amount of such cash dividend or distribution together with the amount of all cash dividends and distributions made during the preceding period of twelve (12) months, when combined with the aggregate amount of all Pro Rata Repurchases (for this purpose, including only that portion of the aggregate purchase price of such Pro Rata Repurchase which is in excess of the Fair Market Value of the Common Stock repurchased as determined on the applicable expiration date (including all extensions thereof) of any tender offer or exchange offer which is a Pro Rata Repurchase, or the date of purchase with respect to any other Pro Rata Repurchase which is not a tender offer or exchange offer made during such period), exceeds ten percent (10%) of the aggregate Fair Market Value of all shares of Common Stock outstanding on the day before the ex-dividend date with respect to such Extraordinary Distribution which is paid in cash and on the distribution date with respect to an Extraordinary Distribution which is paid other than in cash, and/or (ii) of any shares of capital stock of the Corporation (other than shares of Common Stock), other securities of the Corporation (other than securities of the type referred to in Section 8(b)(ii) or (iii) hereof), evidences of indebtedness of the Corporation or any other person or any other property (including shares of any subsidiary of the Corporation) or any combination thereof. The Fair Market Value of an Extraordinary Distribution for purposes of Section 8(b)(iv) hereof shall be equal to the sum of the Fair Market Value of such Extraordinary Distribution plus the amount of any cash dividends (other than regularly scheduled dividends not exceeding 135% of the aggregate quarterly dividends for the preceding period of twelve (12) months) which are not Extraordinary Distributions made during such 12-month period and not previously included in the calculation of an adjustment pursuant to Section 8(b)(iv) hereof. "Fair Market Value" shall mean, as to shares of Common Stock or any other class of capital stock or securities of the Corporation or any other issue which are publicly traded, the average of the Current Market Prices of such shares or securities for each day of the Adjustment Period. The "Fair Market Value" of any security which is not publicly traded or of any other property shall mean the fair value thereof as determined by an independent investment banking or appraisal firm experienced in the valuation of such securities or property selected in good faith by the Board of Directors or a committee thereof, or, if no such investment banking or appraisal firm is in the good faith judgment of the Board of Directors or such committee available to make such determination, as determined in good faith by the Board of Directors or such committee. The Fair Market Value of the Series B Preferred for purposes of Section 5(a) hereof and for purposes of Section 6 hereof shall be as determined by an independent appraiser, appointed by the Corporation in accordance with the provisions of the Plan and Trust, as of the most recent Valuation Date, as defined in the Plan and Trust. "Non-Dilutive Amount" in respect of an issuance, sale or exchange by the Corporation of any right or warrant to purchase or acquire shares of Common Stock (including any security convertible into or exchangeable for shares of Common Stock) shall mean the difference between (i) the product of the Fair Market Value of a share of Common Stock on the day preceding the first public announcement of such issuance, sale or exchange multiplied by the maximum number of shares of Common Stock which could be acquired on such date upon the exercise in full of such rights and warrants (including upon the conversion or exchange of all such convertible or exchangeable securities), whether or not exercisable (or convertible or exchangeable) at such date, and (ii) the aggregate amount payable pursuant to such right or warrant to purchase or acquire such maximum number of shares of Common Stock; provided, however, that in no event shall the Non-Dilutive Amount be less than zero. For purposes of the foregoing sentence, in the case of a security convertible into or exchangeable for shares of Common Stock, the amount payable pursuant to a right or warrant to purchase or acquire shares of Common Stock shall be the Fair Market Value of such security on the date of the issuance, sale or exchange of such security by the Corporation. "Pro Rata Repurchase" shall mean any purchase of shares of Common Stock by the Corporation or any subsidiary thereof, whether for cash, shares of capital stock of the Corporation, other securities of the Corporation, evidences of indebtedness of the Corporation or any other person or any other property (including shares of a subsidiary of the Corporation), or any combination thereof, effected while any of the shares of Series B Preferred are outstanding, pursuant to any tender offer or exchange offer subject to Section 13(e) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), or any successor provision of law, or pursuant to any other offer available to substantially all holders of Common Stock; provided, however, that no purchase of shares by the Corporation or any subsidiary thereof made in open market transactions shall be deemed a Pro Rata Repurchase. For purposes of this definition, shares shall be deemed to have been purchased by the Corporation or any subsidiary thereof "in open market transactions" if they have been purchased substantially in accordance with the requirements of Rule 10b-18, as in effect under the Exchange Act, on the date shares of Series B Preferred are initially issued by the Corporation or on such other terms and conditions as the Board of Directors or a committee thereof shall have determined are reasonably designed to prevent such purchases from having a material effect on the trading market for the Common Stock. CERTIFICATE OF DESIGNATION OF THE ST. PAUL COMPANIES, INC. Series C Cumulative Convertible Preferred Stock THE UNDERSIGNED, Bruce A. Backberg, the Vice President and Corporate Secretary of The St. Paul Companies, Inc. (the "Corporation"), does hereby certify that pursuant to Minnesota Statutes Section 302A.401, Subd.3(a), resolutions as hereinafter set forth were adopted by written consent executed by a majority of the Directors as of May 9, 1995. RESOLVED, that there is hereby established, out of the presently available undesignated shares of the Corporation, a series of Preferred Stock of the Corporation designated and having such terms and relative rights, preferences and privileges as set forth in Exhibit A attached hereto (the "Series C Preferred Stock"). RESOLVED FURTHER, that the Vice President and Corporate Secretary or any Assistant Secretary of the Corporation shall prepare a Certificate of Designation describing the Series C Preferred Stock and cause the same to be filed with the Secretary of State of the State of Minnesota. IN WITNESS WHEREOF, the undersigned has signed this Certificate of Designation this 16th day of May, 1995. /s/ BRUCE A. BACKBERG --------------------- Bruce A. Backberg Vice President and Corporate Secretary EXHIBIT A SECTION 1. Designation and Amount; Special Purpose; Restriction on Senior Series. (A) The shares of this series of Preferred Stock shall be designated as "Series C Cumulative Convertible Preferred Stock" ("Series C Preferred Stock") and the number of shares constituting such series shall be 41,400, without par value. (B) Shares of Series C Preferred Stock shall be issued by the conversion and exchange agent (the "Conversion Agent") for the Series C Preferred Stock only upon the exchange of 6% Convertible Subordinated Debentures due 2025 of the Corporation (the "Subordinated Debentures"), and accrued interest thereon following a valid exchange election (an "Exchange Election") by the holders of a majority of the aggregate liquidation preference of the outstanding 6% Convertible Monthly Income Preferred Securities, liquidation preference $50 per security (the "St. Paul Capital Preferred Securities"), of St. Paul Capital L.L.C., a Delaware limited liability company ("St. Paul Capital"), to cause the St. Paul Capital Preferred Securities then outstanding to be exchanged for depositary shares, each representing a one hundredth (1/100th) interest in a share of Series C Preferred Stock (the "Depositary Shares"), issued pursuant to the Deposit Agreement, dated as of May 16, 1995, among the Corporation, The Chase Manhattan Bank (National Association), as Depositary, and the holders from time to time of the receipts described therein (the "Deposit Agreement"), in the manner prescribed in the Amended and Restated Limited Liability Company Agreement of St. Paul Capital, dated as of May 16, 1995 (the "L.L.C. Agreement"). (C) So long as any St. Paul Capital Preferred Securities are outstanding, the Corporation shall not authorize or issue any other class or series of capital stock ranking senior as to the payment of dividends or amounts upon liquidation, dissolution or winding-up to the Series C Preferred Stock without the approval of the holders of not less than 66% of the aggregate liquidation preference of the St. Paul Capital Preferred Securities then outstanding. SECTION 2. Dividends and Distributions. (A)(1) The holders of shares of Series C Preferred Stock shall be entitled to receive, when, as and if declared by the Board of Directors of the Corporation out of funds legally available therefor, cumulative cash dividends in an amount per share per annum equal to $300 (equivalent to a rate per annum of 6% of the stated liquidation preference of $5,000 per share of Series C Preferred Stock), calculated on the basis of a 360-day year consisting of 12 months of 30 days each, and for any period shorter than a full monthly dividend period, dividends will be computed on the basis of the actual number of days elapsed in such period, and payable in United States dollars monthly in arrears on the last day of each calendar month of each year. (2) Dividends, when, as and if declared by the Board of Directors of the Corporation out of funds legally available therefor, shall be paid on the last day of each month. Such dividends will accrue and be cumulative whether or not they have been earned or declared and whether or not there are funds of the Corporation legally available for the payment of dividends. Dividends on the Series C Preferred Stock shall be cumulative from the date of the Exchange Election. Accumulated but unpaid dividends, if any (including arrearages at the rate of 6% per annum compounded monthly), on the St. Paul Capital Preferred Securities on the date of the Exchange Election shall constitute, and be treated as, accumulated and unpaid dividends on the Series C Preferred Stock as of the date of the issuance thereof. The record date for each dividend payment date shall be the day immediately preceding such dividend payment date, provided that such day is a day on which banking institutions in The City of New York are not authorized or obligated by law or executive order to be closed (a "Business Day"). In the event that any date on which dividends are payable on the Series C Preferred Stock is not a Business Day, then payment of the dividend payable on such date will be made on the next succeeding day that is a Business Day (and without any interest or other payment in respect of any such delay) except that, if such Business Day is in the next succeeding calendar year, such payment shall be made on the immediately preceding Business Day, in each case with the same force and effect as if made on such date. (B) In the event that full cumulative dividends on the Series C Preferred Stock have not been declared and paid or set apart for payment when due, then the Corporation shall not, and shall not permit any direct or indirect majority-owned subsidiary of the Corporation (except any of The John Nuveen Company, a Delaware corporation, and its consolidated subsidiaries) to, declare or pay any dividend on, or redeem, purchase, acquire for value or make a liquidation payment with respect to, any Pari Passu Stock or Junior Stock (each as defined herein) (other than as a result of a reclassification of Pari Passu Stock or Junior Stock or the exchange or conversion of one class or series of Pari Passu Stock or Junior Stock for another class or series of Pari Passu Stock or Junior Stock, respectively), or make any guarantee payments with respect to the foregoing (other than payments under the Guarantee Agreement dated as of May 16, 1995 of the Corporation in favor of the holders of St. Paul Capital Preferred Securities with respect to such securities or dividends or guarantee payments to the Corporation). When dividends are not paid in full, all dividends declared upon the Series C Preferred Stock and all dividends declared upon any Pari Passu Stock shall be paid ratably in proportion to the respective amounts of dividends accumulated and unpaid on the Series C Preferred Stock and accumulated and unpaid on such Pari Passu Stock. "Pari Passu Stock" means the Series B Convertible Preferred Stock, liquidation preference $100 per share (the "Senior B Preferred Stock") of the Corporation, together with any preference stock or preferred stock of the Corporation, or any guarantee now or hereafter entered into by the Corporation in respect of any preferred or preference stock of any affiliate of the Corporation, ranking, in such case, as to the payment of dividends and amounts upon liquidation, dissolution and winding-up on a parity with the Series C Preferred Stock. "Junior Stock" means Common Stock, the Series A Junior Participating Preferred Stock, without par value, of the Corporation, and any other class or series of capital stock of the Corporation or any of its affiliates which by its express terms ranks junior in the payment of dividends or amounts upon liquidation, dissolution or winding-up to the Series C Preferred Stock. SECTION 3. Voting Rights. (A) In the event that full cumulative dividends on the Series C Preferred Stock have not been paid for 18 monthly dividend periods (including for this purpose any arrearage with respect to St. Paul Capital Preferred Securities), the number of directors of the Corporation constituting the entire Board of Directors shall be increased by two (2) persons and the holders of the Series C Preferred Stock shall have the right to elect two persons to fill such positions at any regular meeting of shareholders or special meeting held in place thereof, or at a special meeting of the holders of the Series C Preferred Stock called as hereinafter provided. Whenever all arrearages of dividends on the Series C Preferred Stock then outstanding shall have been paid and dividends thereon for the current monthly period shall have been paid or declared and set apart for payment, then the right of the holders of the Series C Preferred Stock to elect such additional two (2) directors shall cease (but subject always to the same provisions for the vesting of such voting rights in the case of any similar future arrearages in dividends), and the terms of office of all persons elected as directors by the holders of the Series C Preferred Stock shall forthwith terminate and the number of directors of the Corporation shall be reduced accordingly. At any time after such voting power shall have been so vested in the holders of shares of the Series C Preferred Stock, the Secretary of the Corporation may, and upon the written request for a special meeting signed by the holders of at least 10% of all outstanding Series C Preferred Stock (addressed to the Secretary at the principal office of the Corporation) shall, call a special meeting of the holders of the Series C Preferred Stock for the election of the two (2) directors to be elected by them as herein provided; such call to be made by notice similar to that provided for in the by-laws for a special meeting of the shareholders or as required by law. If any such special meeting required to be called as above provided shall not be called by the Secretary within 20 days after receipt of any such request, then any holder of Series C Preferred Stock may call such meeting, upon the notice above provided, and for that purpose shall have access to the stock books and records of the Corporation. The directors elected at any such special meeting shall hold office until the next regular meeting of the shareholders or special meeting held in place thereof if such office shall not have previously terminated as above provided. In case any vacancy shall occur among the directors elected by the holders of the Series C Preferred Stock, a successor shall be elected by the Board of Directors to serve until the next regular meeting of the shareholders or special meeting held in place thereof upon the nomination of the then remaining director elected by the holders of the Series C Preferred Stock or the successor of such remaining director. (B) Except as otherwise required by law or set forth herein, holders of Series C Preferred Stock shall have no voting rights and their consent shall not be required for the taking of any corporate action. So long as any shares of Series C Preferred Stock are outstanding, the consent of the holders of not less than 66% of the outstanding shares of Series C Preferred Stock, given in person or by proxy either at a regular meeting or at a special meeting called for that purpose, at which the holders of Series C Preferred Stock shall vote separately as a series, shall be necessary for effecting, validating or authorizing any one or more of the following: (1) The amendment, alteration or repeal of any of the provisions of the Restated Articles of Incorporation, as amended, of the Corporation, or any amendment thereto or any other certificate filed pursuant to law (including any such amendment, alteration or repeal effected by any merger or consolidation to which the Corporation is a party) that would adversely affect any of the rights, powers or preferences of outstanding shares of Series C Preferred Stock; PROVIDED, HOWEVER, that any amendment or amendments to the provisions of the Restated Articles of Incorporation, as amended, so as to authorize or create, or to increase the authorized amount of, any Pari Passu Stock or any Junior Stock shall not be deemed to adversely affect the voting powers, rights or preferences of the holders of the Series C Preferred Stock; (2) The creation of any shares of any class or series or any security convertible into shares of any class or series of capital stock ranking prior to the Series C Preferred Stock in the distribution of assets on any liquidation, dissolution or winding-up of the Corporation or in the payment of dividends; or (3) Any merger or consolidation with or into, or any sale, transfer, exchange or lease of all or substantially all of the assets of the Corporation to, any other corporation, in either case that would adversely affect any of the rights, powers or preferences of outstanding shares of Series C Preferred Stock; provided, that so long as the convertible subordinated debentures of the Corporation issued pursuant to the Indenture, dated as of May 16, 1995, among the Corporation, St. Paul Capital L.L.C. ("St. Paul Capital") and The Chase Manhattan Bank (National Association), as Trustee, are exchangeable for shares of Series C Preferred Stock, that the consent of the holders of not less than 66_% of the aggregate liquidation preference of the 6% Convertible Monthly Income Preferred Securities of St. Paul Capital, given in person or by proxy at a meeting called for that purpose, shall be necessary for effecting validity or authorizing any one or more of the foregoing actions. (C) For purposes of this Section 3, while St. Paul Capital Preferred Securities are outstanding and owned by any entity other than the Corporation, St. Paul Capital, or their subsidiaries or affiliates, any St. Paul Capital Preferred Securities owned by the Corporation, St. Paul Capital or their subsidiaries or affiliates shall not have the voting rights referred to in this Section. SECTION 4. Redemption. (A) If at any time following the Conversion Expiration Date (as defined below), less than five percent (5%) of the shares of Series C Preferred Stock remain outstanding, such shares of Series C Preferred Stock are redeemable, at the option of the Corporation, in whole but not in part, from time to time, at a redemption price equal to the liquidation preference, plus accumulated and unpaid dividends, whether or not earned or declared, to the date of redemption (the "Redemption Price"). (B) Unless otherwise required by law, notice of redemption will be sent to the holders of Series C Preferred Stock by first-class mail, postage prepaid, mailed not less than thirty (30), nor more than sixty (60) days prior to the redemption date. Each such notice shall state: (i) the redemption date; (ii) the Redemption Price; (iii) the place or places where receipts for Depositary Shares representing such shares are to be surrendered for payment of the Redemption Price; and (iv) that dividends on the shares to be redeemed will cease to accrue on such redemption date. Upon surrender of the receipts for Depositary Shares representing the shares so called for redemption (properly endorsed or assigned for transfer, if the Board of Directors of the Corporation shall so require and the notice shall so state), such shares shall be redeemed by the Corporation on the date fixed for redemption at the Redemption Price. SECTION 5. Liquidation, Dissolution or Winding-Up. (A) Upon any voluntary or involuntary liquidation, dissolution, winding-up or termination of the Corporation, the holders of Series C Preferred Stock at the time outstanding will be entitled to receive out of the net assets of the Corporation available for payment to shareholders and subject to the rights of the holders of any stock of the Corporation ranking senior to or on a parity with the Series C Preferred Stock in respect of distributions upon liquidation, dissolution, winding-up or termination of the Corporation, before any amount shall be paid or distributed with respect to any Junior Stock, liquidating distributions in the amount of $50 per share plus an amount equal to all accrued and unpaid dividends thereon (whether or not earned or declared) to the date fixed for distribution. If, upon any liquidation, dissolution, winding-up or termination of the Corporation, the amounts payable with respect to the Series C Preferred Stock and the Pari Passu Stock are not paid in full, the holders of the Series C Preferred Stock and the Pari Passu Stock shall share ratably in any distribution of assets based on the proportion of their full respective liquidation preference to the entire amount of the unpaid aggregate liquidation preference of the Series C Preferred Stock and the Pari Passu Stock. After payment of the full amount to which they are entitled as provided by the foregoing provisions of this Section 5(A), the holders of shares of Series C Preferred Stock shall not be entitled to any further right or claim to any of the remaining assets of the Corporation. (B) Neither the merger or consolidation of the Corporation with or into any other corporation, nor the merger or consolidation of any other corporation with or into the Corporation, nor the sale, transfer, exchange or lease of all or any portion of the assets of the Corporation, shall be deemed to be a dissolution, liquidation or winding-up of the affairs of the Corporation for purposes of this Section 5. (C) Written notice of any voluntary or involuntary liquidation, dissolution or winding-up of the Corporation, stating the payment date or dates when, and the place or places where, the amounts distributable to holders of Series C Preferred Stock in such circumstances shall be payable, shall be given by first-class mail, postage prepaid, mailed not less than twenty (20) days prior to any payment date stated therein, to the holders of Series C Preferred Stock, at the address shown on the books of the Corporation or the transfer agent for the Series C Preferred Stock; PROVIDED, HOWEVER, that a failure to give notice as provided above or any defect therein shall not affect the Corporation's ability to consummate a voluntary or involuntary liquidation, dissolution or winding-up of the Corporation. SECTION 6. Conversion Rights of Series C Preferred Stock. The shares of Series C Preferred Stock are convertible at any time before the close of business on the Conversion Expiration Date (as defined in the L.L.C. Agreement), at the option of the holder thereof, into shares of Common Stock at the initial conversion price of $59 per share of Common Stock, subject to adjustment, as provided in Section 7 (as so adjusted, the "Conversion Price"). For this purpose, each share of Series C Preferred Stock shall be taken at $5,000. Holders of record of Series C Preferred Stock at the close of business on a dividend payment record date will be entitled to receive the dividend payable on such shares of Series C Preferred Stock on the corresponding dividend payment date notwithstanding the conversion thereof following such dividend payment record date but on or prior to such dividend payment date. Except as provided in the immediately preceding sentence, the Corporation will make no payment or allowance for accumulated and unpaid dividends, whether or not in arrears, on converted shares of Series C Preferred Stock. No fractional shares of Common Stock will be issued as a result of conversion, but in lieu thereof, the Corporation shall pay a cash adjustment in an amount equal to the same fraction of the Closing Price (as hereinafter defined) on the date on which the certificate or certificates for such shares were duly surrendered for conversion, or, if such date is not a Trading Day (as hereinafter defined), on the next Trading Day. Any holder of shares of Series C Preferred Stock desiring to convert such shares into shares of Common Stock shall surrender the certificate or certificates representing the shares of Series C Preferred Stock being converted, duly assigned or endorsed for transfer to the Corporation (or accompanied by duly executed stock powers relating thereto), at the principal executive office of the Corporation or the offices of the transfer agent for the Series C Preferred Stock or such office or offices in the continental United States of an agent for conversion as may from time to time be designated by notice to the holders of the Series C Preferred Stock by the Corporation or the transfer agent for the Series C Preferred Stock, accompanied by written notice of conversion, on any day prior to the Conversion Expiration Date that is a Business Day. Such notice of conversion shall specify (i) the number of shares of Series C Preferred Stock to be converted and the name or names in which such holder desires the certificate or certificates for Common Stock and for any shares of Series C Preferred Stock not to be so converted to be issued (subject to compliance with applicable legal requirements if any of such certificates are to be issued in a name other than the name of the holder), and (ii) the address to which such holder wishes delivery to be made of such new certificates to be issued upon such conversion. Upon surrender of a certificate representing a share or shares of Series C Preferred Stock for conversion, the Corporation shall issue and send by hand delivery (with receipt to be acknowledged) or by first-class mail, postage prepaid, to the holder thereof, at the address designated by such holder, a certificate or certificates representing the number of shares of Common Stock to which such holder shall be entitled upon conversion. In the event that there shall have been surrendered a certificate or certificates representing shares of Series C Preferred Stock, only part of which are to be converted, the Corporation shall issue and deliver to such holder or such holder's designee in the manner provided in the immediately preceding sentence a new certificate or certificates representing the number of shares of Series C Preferred Stock that shall not have been converted. The issuance by the Corporation of shares of Common Stock upon a conversion of shares of Series C Preferred Stock into shares of Common Stock made at the option of the holder thereof shall be effective upon the surrender by such holder or such holder's designee of the certificate or certificates for the shares of Series C Preferred Stock to be converted, duly assigned or endorsed for transfer to the Corporation (or accompanied by duly executed stock powers relating thereto). The person or persons entitled to receive the Common Stock issuable upon such conversion shall be treated for all purposes as the record holder or holders of such shares of Common Stock as of the close of business on the effective date of the conversion. No allowance or adjustment shall be made in respect of dividends payable to holders of Common Stock of record as of any date prior to such effective date. Whenever the Corporation shall issue shares of Common Stock upon conversion of shares of Series C Preferred Stock as contemplated by this Section 6, the Corporation shall issue, together with each such share of Common Stock, one right to purchase Series A Junior Participating Preferred Stock of the Corporation (or other securities in lieu thereof) pursuant to the Shareholder Protection Rights Agreement, dated as of December 4, 1989 (the "Rights Agreement"), between the Corporation and First Chicago Trust Company of New York, as Rights Agent, as such Rights Agreement may from time to time be amended, or any similar rights issued to holders of Common Stock of the Corporation in addition thereto or in replacement therefor (such rights, together with any additional or replacement rights, being collectively referred to as the "Rights"), whether or not such Rights shall be exercisable at such time, but only if such Rights are issued and outstanding and held by other holders of Common Stock of the Corporation (or are evidenced by outstanding share certificates representing Common Stock) at such time and have not expired or been redeemed. (i) On and after May 31, 1999, the Corporation shall have the right, at its option, to cause the conversion rights set forth in this Section to expire, provided that the Current Market Price (as defined below) of the Common Stock of the Corporation on each of 20 Trading Days within any period of 30 consecutive Trading Days, including the last Trading Day of such period, exceeds 120% of the Conversion Price in effect on such Trading Day; (ii) In order to exercise its option to cause the conversion rights of holders of shares of Series C Preferred Stock to expire, the Corporation must issue a press release for publication on the Dow Jones News Service and such other print and electronic media as the Corporation shall select announcing the Conversion Expiration Date (the "Press Release") prior to the opening of business on the second Trading Day after a period in which the condition in the preceding paragraph has been met (but in no event prior to May 31, 1999). The Press Release shall state that the Corporation has elected to exercise its right to extinguish the conversion rights of holders of shares of Series C Preferred Stock, specify the Conversion Expiration Date and provide the Conversion Price of the Series C Preferred Stock and the Current Market Price of the Common Stock, in each case as of the close of business on the Trading Day next preceding the date of the Press Release. If the Corporation exercises the option described in this paragraph, the "Conversion Expiration Date" shall be a date selected by the Corporation which date shall be not less than 30 or more than 60 days after the date on which the Corporation issues the Press Release; and (iii) In addition to issuing the Press Release, the Company shall send notice of the expiration of conversion rights (a "Notice of Conversion Expiration") by first-class mail to each record holder of shares of Series C Preferred Stock not more than four (4) Business Days after the Corporation issues the Press Release. Such Notice of Conversion Expiration shall state: (1) the Conversion Expiration Date; (2) the Conversion Price of the Series C Preferred Stock and the Current Market Price of the Common Stock, in each case as of the close of business on the Trading Day next preceding the date of the Notice of Conversion Expiration; (3) the place or places at which receipts for Depositary Shares representing shares of Series C Preferred Stock are to be surrendered prior to the Conversion Expiration Date for certificates representing shares of Common Stock; and (4) such other information or instructions as the Corporation deems necessary or advisable to enable a holder of shares of Series C Preferred Stock to exercise its conversion right hereunder. No defect in the Notice of Conversion Expiration or in the mailing thereof with respect to any shares of Series C Preferred Stock shall affect the validity of such notice with respect to any other share of Series C Preferred Stock. As of the close of business on the Conversion Expiration Date, the Series C Preferred Stock shall no longer be convertible into Common Stock. As used in this Section, "Current Market Price" of publicly traded shares of Common Stock for any day means the last reported sales price, regular way on such day, or, if no sale takes place on such day, the average of the reported closing bid and asked prices on such day, regular way, in either case as reported on the New York Stock Exchange Consolidated Transaction Tape, or, if the Common Stock is not listed or admitted to trading on the New York Stock Exchange, on the principal national securities exchange on which the Common Stock is listed or admitted to trading if the Common Stock is listed on a national securities exchange, or the National Market System of the National Association of Securities Dealers, Inc., or, if the Common Stock is not quoted or admitted to trading on such quotation system, on the principal quotation system on which the Common Stock may be listed or admitted to trading or quoted, or, if not listed or admitted to trading or quoted on any national securities exchange or quotation system, the average of the closing bid and asked prices of the Common Stock in the over-the-counter market on the day in question as reported by the National Quotation Bureau Incorporated, or a similar generally accepted reporting service, or, if not so available in such manner, as furnished by any New York Stock Exchange member firm selected from time to time by the Board of Directors of the Corporation for that purpose or, if not so available in such manner, as otherwise determined in good faith by the Board of Directors. The Corporation shall at all times reserve and keep available out of its authorized and unissued Common Stock, solely for issuance upon the conversion of shares of Series C Preferred Stock as herein provided, free from any preemptive or other similar rights, such number of shares of Common Stock as shall from time to time be issuable upon the conversion of all the shares of Series C Preferred Stock then outstanding. All shares of Common Stock delivered upon conversion of the Series C Preferred Stock shall be duly authorized, validly issued, fully paid and non-assessable, free and clear of all liens, claims, interests and other encumbrances. The Corporation shall prepare and shall use its best efforts to obtain and keep in force such governmental or regulatory permits or other authorizations as may be required by law, and shall comply with all applicable requirements as to registration or qualification of the Common Stock (and all requirements to list the Common Stock issuable upon conversion of Series C Preferred Stock that are at the time applicable), in order to enable the Corporation lawfully to issue and deliver to each holder of record of Series C Preferred Stock such number of shares of its Common Stock as shall from time to time be sufficient to effect the conversion of all shares of Series C Preferred Stock then outstanding and convertible into shares of Common Stock. SECTION 7. Adjustment of Conversion Price. (A) Adjustment of Conversion Price. The Conversion Price at which a share of Series C Preferred Stock is convertible into Common Stock shall be subject to adjustment from time to time as follows: (i) In case the Corporation shall pay or make a dividend or other distribution on any class or series of capital stock of the Corporation exclusively in Common Stock, the Conversion Price in effect at the opening of business on the day following the date fixed for the determination of shareholders entitled to receive such dividend or other distribution shall be reduced by multiplying such Conversion Price by a fraction of which the numerator shall be the number of shares of Common Stock outstanding at the close of business on the date fixed for such determination and the denominator shall be the sum of such number of shares and the total number of shares constituting such dividend or other distribution or exchange, such reduction to become effective immediately after the opening of business on the day following the date fixed for such determination. For the purposes of this subparagraph (i), the number of shares of Common Stock at any time outstanding shall not include shares held in the treasury of the Corporation. The Corporation shall not pay any dividend or make any distribution on shares of any class or series of capital stock of the Corporation exclusively in Common Stock held in the treasury of the Corporation. (ii) In case the Corporation shall pay or make a dividend or other distribution on its Common Stock consisting exclusively of, or shall otherwise issue to all holders of its Common Stock, rights or warrants entitling the holders thereof to subscribe for or purchase shares of Common Stock at a price per share less than the current market price per share (determined as provided in subparagraph (vii) of this Section 7(a)) of the Common Stock on the date fixed for the determination of shareholders entitled to receive such rights or warrants, the Conversion Price in effect at the opening of business on the day following the date fixed for such determination shall be reduced by multiplying such Conversion Price by a fraction of which the numerator shall be the number of shares of Common Stock outstanding at the close of business on the date fixed for such determination plus the number of shares of Common Stock which the aggregate of the offering price of the total number of shares of Common Stock so offered for subscription or purchase would purchase at such current market price and the denominator shall be the number of shares of Common Stock outstanding at the close of business on the date fixed for such determination plus the number of shares of Common Stock so offered for subscription or purchase, such reduction to become effective immediately after the opening of business on the day following the date fixed for such determination. In case any rights or warrants referred to in this subparagraph (ii) in respect of which an adjustment shall have been made shall expire unexercised within 45 days after the same shall have been distributed or issued by the Corporation, the Conversion Price shall be readjusted at the time of such expiration to the Conversion Price that would have been in effect if no adjustment had been made on account of the distribution or issuance of such expired rights or warrants. (iii) In case outstanding shares of Common Stock shall be subdivided into a greater number of shares of Common Stock, the Conversion Price in effect at the opening of business on the day following the day upon which such subdivision becomes effective shall be proportionately reduced, and conversely, in case outstanding shares of Common Stock shall each be combined into a smaller number of shares of Common Stock, the Conversion Price in effect at the opening of business on the day following the day upon which such combination becomes effective shall be proportionately increased, such reduction or increase, as the case may be, to become effective immediately after the opening of business on the day following the day upon which such subdivision or combination becomes effective. (iv) Subject to the last sentence of this subparagraph (iv), in case the Corporation shall, by dividend or otherwise, distribute to all holders of its Common Stock evidences of its indebtedness, shares of any class or series of capital stock, cash or assets (including securities, but excluding any rights or warrants referred to in subparagraph (ii) of this Section 7(A), any dividend or distribution paid exclusively in cash and any dividend or distribution referred to in subparagraph (i) of this Section 7(A)), the Conversion Price shall be reduced so that the same shall equal the price determined by multiplying the Conversion Price in effect immediately prior to the effectiveness of the Conversion Price reduction contemplated by this subparagraph (iv) by a fraction of which the numerator shall be the current market price per share (determined as provided in subparagraph (vii) of this Section 7(A)) of the Common Stock on the date fixed for the payment of such distribution (the "Reference Date") less the fair market value (as determined in good faith by the Board of Directors, whose determination shall be conclusive and described in a resolution of the Board of Directors), on the Reference Date, of the portion of the evidences of indebtedness, shares of capital stock, cash and assets so distributed applicable to one share of Common Stock and the denominator shall be such current market price per share of the Common Stock, such reduction to become effective immediately prior to the opening of business on the day following the Reference Date. If the Board of Directors determines the fair market value of any distribution for purposes of this subparagraph (iv) by reference to the actual or when issued trading market for any securities comprising such distribution, it must in doing so consider the prices in such market over the same period used in computing the current market price per share of Common Stock pursuant to subparagraph (vii) of this Section 7(A). For purposes of this subparagraph (iv), any dividend or distribution that includes shares of Common Stock or rights or warrants to subscribe for or purchase shares of Common Stock shall be deemed instead to be (1) a dividend or distribution of the evidences of indebtedness, shares of capital stock, cash or assets other than such shares of Common Stock or such rights or warrants (making any Conversion Price reduction required by this subparagraph (iv)) immediately followed by (2) a dividend or distribution of such shares of Common Stock or such rights or warrants (making any further Conversion Price reduction required by subparagraph (i) or (ii) of this Section 7(A)), except (A) the Reference Date of such dividend or distribution as defined in this subparagraph (iv) shall be substituted as "the date fixed for the determination of shareholders entitled to receive such dividend or other distribution," "the date fixed for the determination of shareholders entitled to receive such rights or warrants" and "the date fixed for such determination" within the meaning of subparagraphs (i) and (ii) of this Section 7(A) and (B) any shares of Common Stock included in such dividend or distribution shall not be deemed "outstanding at the close of business on the date fixed for such determination" within the meaning of subparagraph (i) of this Section 7(A). (v) In case the Corporation shall pay or make a dividend or other distribution on its Common Stock exclusively in cash (excluding, in the case of any regular cash dividend on the Common Stock, the portion thereof that does not exceed the per share amount of the next preceding regular cash dividend on the Common Stock (as adjusted to appropriately reflect any of the events referred to in subparagraphs (i), (ii), (iii), (iv), (v) and (vi) of this Section 7(A)), or excluding all of such regular cash dividend if the annualized amount thereof per share of Common Stock does not exceed 15% of the current market price per share (determined as provided in subparagraph (vii) of this Section 7(A)) of the Common Stock on the Trading Day (as defined in Section 7(E)) next preceding the date of declaration of such dividend), the Conversion Price shall be reduced so that the same shall equal the price determined by multiplying the Conversion Price in effect immediately prior to the effectiveness of the Conversion Price reduction contemplated by this subparagraph (v) by a fraction of which the numerator shall be the current market price per share (determined as provided in subparagraph (vii) of this Section 7(A)) of the Common Stock on the date fixed for the payment of such distribution less the amount of cash so distributed and not excluded as provided above applicable to one share of Common Stock and the denominator shall be such current market price per share of the Common Stock, such reduction to become effective immediately prior to the opening of business on the day following the date fixed for the payment of such distribution. (vi) In case a tender or exchange offer made by the Corporation or any subsidiary of the Corporation for all or any portion of the Corporation's Common Stock shall expire and such tender or exchange offer shall involve the payment by the Corporation or such subsidiary of consideration per share of Common Stock having a fair market value (as determined in good faith by the Board of Directors, whose determination shall be conclusive and described in a resolution of the Board of Directors) at the last time (the "Expiration Time") tenders or exchanges may be made pursuant to such tender or exchange offer (as it shall have been amended) that exceeds 10% of the current market price per share (determined as provided in subparagraph (vii) of this Section 7(A)) of the Common Stock on the Trading Day (as defined in Section 7(E)) next succeeding the Expiration Time, the Conversion Price shall be reduced so that the same shall equal the price determined by multiplying the Conversion Price in effect immediately prior to the effectiveness of the Conversion Price reduction contemplated by this subparagraph (vi) by a fraction of which the numerator shall be the number of shares of Common Stock outstanding (including any tendered or exchanged shares) at the Expiration Time multiplied by the current market price per share (determined as provided in subparagraph (vii) of this Section 7(A)) of the Common Stock on the Trading Day next succeeding the Expiration Time and the denominator shall be the sum of (x) the fair market value (determined as aforesaid) of the aggregate consideration payable to holders of Common Stock based on the acceptance (up to any maximum specified in the terms of the tender or exchange offer) of all shares validly tendered or exchanged and not withdrawn as of the Expiration Time (the shares deemed so accepted, up to any such maximum, being referred to as the "Purchased Shares") and (y) the product of the number of shares of Common Stock outstanding (less any Purchased Shares) at the Expiration Time and the current market price per share (determined as provided in subparagraph (vii) of this Section 7(A)) of the Common Stock on the Trading Day next succeeding the Expiration Time, such reduction to become effective immediately prior to the opening of business on the day following the Expiration Time. (vii) For the purpose of any computation under subparagraphs (ii), (iv), (v) and (vi) of this Section 7(A), the current market price per share of Common Stock on any date in question shall be deemed to be the average of the daily Closing Prices (as defined in Section 7(E)) for the five consecutive Trading Days selected by the Company commencing not more than 20 Trading Days before, and ending not later than, the earlier of the day in question and, if applicable, the day before the "ex" date with respect to the issuance or distribution requiring such computation; PROVIDED, however, that if another event occurs that would require an adjustment pursuant to subparagraphs (i) through (vi), inclusive, the Board of Directors may make such adjustments to the Closing Prices during such five Trading Day period as it deems appropriate to effectuate the intent of the adjustments in this Section 7(A), in which case any such determination by the Board of Directors shall be set forth in a resolution of the Board of Directors and shall be conclusive. For purposes of this paragraph, the term "ex" date, (1) when used with respect to any issuance or distribution, means the first date on which the Common Stock trades regular way on the New York Stock Exchange or on such successor securities exchange as the Common Stock may be listed or in the relevant market from which the Closing Price was obtained without the right to receive such issuance or distribution, and (2) when used with respect to any tender or exchange offer means the first date on which the Common Stock trades regular way on such securities exchange or in such market after the Expiration Time of such offer. (viii) The Corporation may make such reductions in the Conversion Price, in addition to those required by subparagraphs (i), (ii), (iii), (iv), (v) and (vi) of this Section 7(A), as it considers to be advisable to avoid or diminish any income tax to holders of Common Stock or rights to purchase Common Stock resulting from any dividend or distribution of stock (or rights to acquire stock) or from any event treated as such for income tax purposes. The Corporation from time to time may reduce the Conversion Price by any amount for any period of time if the period is at least twenty (20) days, the reduction is irrevocable during the period, and the Board of Directors of the Corporation shall have made a determination that such reduction would be in the best interest of the Corporation, which determination shall be conclusive. Whenever the Conversion Price is reduced pursuant to the preceding sentence, the Corporation shall mail to holders of record of the Series C Preferred Stock a notice of the reduction at least fifteen (15) days prior to the date the reduced Conversion Price takes effect, and such notice shall state the reduced Conversion Price and the period it will be in effect. (ix) Notwithstanding anything herein to the contrary, no adjustment in the Conversion Price shall be required unless such adjustment would require an increase or decrease of at least 1% in the Conversion Price; PROVIDED, HOWEVER, that any adjustments which by reason of this subparagraph (ix) are not required to be made shall be carried forward and taken into account in any subsequent adjustment. (x) Whenever the Conversion Price is adjusted as herein provided: (1) the Corporation shall compute the adjusted Conversion Price and shall prepare a certificate signed by the Chief Financial Officer or the Treasurer of the Corporation setting forth the adjusted Conversion Price and showing in reasonable detail the facts upon which such adjustment is based, and such certificate shall forthwith be filed with the transfer agent for the Series C Preferred Stock; and (2) a notice stating that the Conversion Price has been adjusted and setting forth the adjusted Conversion Price shall as soon as practicable be mailed by the Corporation to all record holders of shares of Series C Preferred Stock at their last addresses as they shall appear upon the stock transfer books of the Corporation. (B) Reclassification, Consolidation, Merger or Sale of Assets. In the event that the Corporation shall be a party to any transaction (including without limitation any recapitalization or reclassification of the Common Stock (other than a change in par value, or from par value to no par value, or from no par value to par value, or as a result of a subdivision or combination of the Common Stock), any consolidation of the Corporation with, or merger of the Corporation into, any other person, any merger of another person into the Corporation (other than a merger which does not result in a reclassification, conversion, exchange or cancellation of outstanding shares of Common Stock of the Corporation), any sale or transfer of all or substantially all of the assets of the Corporation or any compulsory share exchange) pursuant to which the Common Stock is converted into the right to receive other securities, cash or other property), then lawful provision shall be made as part of the terms of such transaction whereby the holder of each share of Series C Preferred Stock then outstanding shall have the right thereafter, to convert such share only into (i) in the case of any such transaction other than a Common Stock Fundamental Change (as defined in Section 7(E)), the kind and amount of securities, cash and other property receivable upon such transaction by a holder of the number of shares of Common Stock of the Corporation into which such share of Series C Preferred Stock could have been converted immediately prior to such transaction, after giving effect, in the case of any Non-Stock Fundamental Change (as defined in Section 7(E)), to any adjustment in the Conversion Price required by the provisions of Section 7(D), and (ii) in the case of a Common Stock Fundamental Change, common stock of the kind received by holders of Common Stock as a result of such Common Stock Fundamental Change in an amount determined pursuant to the provisions of Section 7(D). The Corporation or the person formed by such consolidation or resulting from such merger or which acquires such assets or which acquires the Corporation's shares, as the case may be, shall make provision in its certificate or articles of incorporation or other constituent document to establish such right. Such certificate or articles of incorporation or other constituent document shall provide for adjustments which, for events subsequent to the effective date of such certificate or articles of incorporation or other constituent document, shall be as nearly equivalent as may be practicable to the adjustments provided for in this Section 7. The above provisions shall similarly apply to successive transactions of the foregoing type. (C) Prior Notice of Certain Events. In case: (i) the Corporation shall (1) declare any dividend (or any other distribution) on its Common Stock, other than (A) a dividend payable in shares of Common Stock or (B) a dividend payable in cash out of its retained earnings that would not require an adjustment pursuant to 7(A)(iv) or (v) or (2) authorize a tender or exchange offer that would require an adjustment pursuant to 7(A)(vi); (ii) the Corporation shall authorize the granting to all holders of Common Stock of rights or warrants to subscribe for or purchase any shares of stock of any class or series or of any other rights or warrants; (iii) of any reclassification of Common Stock (other than a subdivision or combination of the outstanding Common Stock, or a change in par value, or from par value to no par value, or from no par value to par value), or of any consolidation or merger to which the Corporation is a party and for which approval of any shareholders of the Corporation shall be required, or of the sale or transfer of all or substantially all of the assets of the Corporation or of any compulsory share exchange whereby the Common Stock is converted into other securities, cash or other property; or (iv) of the voluntary or involuntary dissolution, liquidation or winding-up of the Corporation; then the Corporation shall cause to be filed with the transfer agent for the Series C Preferred Stock, and shall cause to be mailed to the holders of record of the Series C Preferred Stock, at their last addresses as they shall appear upon the stock transfer books of the Corporation, at least fifteen (15) days prior to the applicable record or effective date hereinafter specified, a notice stating (x) the date on which a record (if any) is to be taken for the purpose of such dividend, distribution, redemption, repurchase, rights or warrants or, if a record is not to be taken, the date as of which the holders of Common Stock of record to be entitled to such dividend, distribution, redemption, repurchase, rights or warrants are to be determined or (y) the date on which such reclassification, consolidation, merger, sale, transfer, share exchange, dissolution, liquidation or winding-up is expected to become effective, and the date as of which it is expected that holders of Common Stock of record shall be entitled to exchange their shares of Common Stock for securities, cash or other property deliverable upon such reclassification, consolidation, merger, sale, transfer, share exchange, dissolution, liquidation or winding-up (but no failure to mail such notice or any defect therein or in the mailing thereof shall affect the validity of the corporate action required to be specified in such notice). (D) Adjustments in Case of Fundamental Changes. Notwithstanding any other provision in this Section 7 to the contrary, if any Fundamental Change (as defined in Section 7(E)) occurs, then the Conversion Price in effect will be adjusted immediately after such Fundamental Change as described below. In addition, in the event of a Common Stock Fundamental Change, each share of Series C Preferred Stock shall be convertible solely into common stock of the kind and amount received by holders of Common Stock as the result of such Common Stock Fundamental Change as more specifically provided in the following clauses (D)(i) and (D)(ii). For purposes of calculating any adjustment to be made pursuant to this Section 7(D) in the event of a Fundamental Change, immediately after such Fundamental Change: (i) in the case of a Non-Stock Fundamental Change, the Conversion Price of the Series C Preferred Stock shall thereupon become the lower of (A) the Conversion Price in effect immediately prior to such Non-Stock Fundamental Change, but after giving effect to any other prior adjustments effected pursuant to this Section 7, and (B) the result obtained by multiplying the greater of the Applicable Price (as defined in Section 7(E)) or the then applicable Reference Market Price (as defined in Section 7(E)) by a fraction of which the numerator shall be $50 and the denominator shall be an amount per share of Series C Preferred Stock determined by the Corporation in its sole discretion, after consultation with a nationally recognized investment banking firm, to be the equivalent of the hypothetical redemption price that would have been applicable if the Series C Preferred Stock had been redeemable during such period; and (ii) in the case of a Common Stock Fundamental Change, the Conversion Price of the Series C Preferred Stock in effect immediately prior to such Common Stock Fundamental Change, but after giving effect to any other prior adjustments effected pursuant to this Section 7, shall thereupon be adjusted by multiplying such Conversion Price by a fraction of which the numerator shall be the Purchaser Stock Price (as defined in Section 7(E)) and the denominator shall be the Applicable Price; PROVIDED, HOWEVER, that in the event of a Common Stock Fundamental Change in which (A) 100% by value of the consideration received by a holder of Common Stock is common stock of the successor, acquiror or other third party (and cash, if any, is paid with respect to any fractional interests in such common stock resulting from such Common Stock Fundamental Change) and (B) all of the Common Stock shall have been exchanged for, converted into or acquired for common stock (and cash with respect to fractional interests) of the successor, acquiror or other third party, the Conversion Price of the Series C Preferred Stock in effect immediately prior to such Common Stock Fundamental Change shall thereupon be adjusted by multiplying such Conversion Price by a fraction of which the numerator shall be one (1) and the denominator shall be the number of shares of common stock of the successor, acquiror, or other third party received by a shareholder for one share of Common Stock as a result of such Common Stock Fundamental Change. (E) Definitions. The following definitions shall apply to terms used in this Section 7: (1) "Applicable Price" shall mean (i) in the event of a Non-Stock Fundamental Change in which the holders of the Common Stock receive only cash, the amount of cash received by a shareholder for one share of Common Stock and (ii) in the event of any other Non-Stock Fundamental Change or any Common Stock Fundamental Change, the average of the daily Closing Prices of the Common Stock for the ten (10) consecutive Trading Days prior to and including the record date for the determination of the holders of Common Stock entitled to receive securities, cash or other property in connection with such Non-Stock Fundamental Change or Common Stock Fundamental Change, or, if there is no such record date, the date upon which the holders of the Common Stock shall have the right to receive such securities, cash or other property, in each case, as adjusted in good faith by the Board of Directors of the Corporation to appropriately reflect any of the events referred to in subparagraphs (i), (ii), (iii), (iv), (v) and (vi) of Section 7(A). (2) "Closing Price" of any common stock on any day shall mean the last reported sale price regular way on such day or, in case no such sale takes place on such day, the average of the reported closing bid and asked prices regular way of such common stock, in each case on the principal national securities exchange on which such common stock is listed, if the common stock is listed on a national securities exchange, or the NASDAQ National Market System of the National Association of Securities Dealers, Inc., or, if the common stock is not quoted or admitted to trading on such quotation system, on the principal national securities exchange or quotation system on which the common stock is listed or admitted to trading or quoted, or, if not listed or admitted to trading or quoted on any national securities exchange or quotation system, the average of the closing bid and asked prices of the common stock in the over-the-counter market on the day in question as reported by the National Quotation Bureau Incorporated, or a similarly generally accepted reporting service, or, if not so available in such manner, as furnished by any New York Stock Exchange member firm selected from time to time by the Board of Directors of the Corporation for that purpose or, if not so available in such manner, as otherwise determined in good faith by the Board of Directors. (3) "Common Stock Fundamental Change" shall mean any Fundamental Change in which more than 50% by value (as determined in good faith by the Board of Directors of the Corporation) of the consideration received by holders of Common Stock consists of common stock that for each of the ten (10) consecutive Trading Days referred to with respect to such Fundamental Change in Section 7(E)(1) above has been admitted for listing or admitted for listing subject to notice of issuance on a national securities exchange or quoted on the NASDAQ National Market System of the National Association of Securities Dealers, Inc.; PROVIDED, HOWEVER, that a Fundamental Change shall not be a Common Stock Fundamental Change unless either (i) the Corporation continues to exist after the occurrence of such Fundamental Change and the outstanding shares of Series C Preferred Stock continue to exist as outstanding shares of Series C Preferred Stock, or (ii) not later than the occurrence of such Fundamental Change, the outstanding shares of Series C Preferred Stock are converted into or exchanged for shares of convertible preferred stock of a corporation succeeding to the business of the Corporation, which convertible preferred stock has powers, preferences and relative, participating, optional or other rights, and qualifications, limitations and restrictions, substantially similar to those of the Series C Preferred Stock. (4) "Fundamental Change" shall mean the occurrence of any transaction or event in connection with a plan pursuant to which all or substantially all of the Common Stock shall be exchanged for, converted into, acquired for or constitute solely the right to receive securities, cash or other property (whether by means of an exchange offer, liquidation, tender offer, consolidation, merger, combination, reclassification, recapitalization or otherwise); PROVIDED, HOWEVER, in the case of a plan involving more than one such transaction or event, for purposes of adjustment of the Conversion Price, such Fundamental Change shall be deemed to have occurred when substantially all of the Common Stock of the Corporation shall be exchanged for, converted into, or acquired for or constitute solely the right to receive securities, cash or other property, but the adjustment shall be based upon the highest weighted average of consideration per share which a holder of Common Stock could have received in such transactions or events as a result of which more than 50% of the Common Stock of the Corporation shall have been exchanged for, converted into, or acquired for or constitute solely the right to receive securities, cash or other property. (5) "Non-Stock Fundamental Change" shall mean any Fundamental Change other than a Common Stock Fundamental Change. (6) "Purchaser Stock Price" shall mean, with respect to any Common Stock Fundamental Change, the average of the daily Closing Prices of the common stock received in such Common Stock Fundamental Change for the ten (10) consecutive Trading Days prior to and including the record date for the determination of the holders of Common Stock entitled to receive such common stock, or, if there is no such record date, the date upon which the holders of the Common Stock shall have the right to receive such common stock, in each case, as adjusted in good faith by the Board of Directors of the Corporation to appropriately reflect any of the events referred to in subparagraphs (i), (ii), (iii), (iv), (v) and (vi) of Section 7(A). (7) "Reference Market Price" shall initially mean $32.25 and in the event of any adjustment to the Conversion Price other than as a result of a Non-Stock Fundamental Change, the Reference Market Price shall also be adjusted so that the ratio of the Reference Market Price to the Conversion Price after giving effect to any such adjustment shall always be the same as the ratio of $32.25 to the initial Conversion Price per share. (8) "Trading Day" shall mean a day on which securities are traded on the national securities exchange or quotation system or in the over-the-counter market used to determine the Closing Price. (F) Dividend or Interest Reinvestment Plans. Notwithstanding the foregoing provisions, the issuance of any shares of Common Stock pursuant to any plan providing for the reinvestment of dividends or interest payable on securities of the Corporation and the investment of additional optional amounts in shares of Common Stock under any such plan, and the issuance of any shares of Common Stock or options or rights to purchase such shares pursuant to any employee benefit plan or program of the Corporation or pursuant to any option, warrant, right or exercisable, exchangeable or convertible security outstanding as of the date the Series C Preferred Stock is first issued, shall not be deemed to constitute an issuance of Common Stock or exercisable, exchangeable or convertible securities by the Corporation to which any of the adjustment provisions described above applies. (G) Certain Additional Rights. In case the Corporation shall, by dividend or otherwise, declare or make a distribution on its Common Stock referred to in Section 7(A)(iv) or 7(A)(v) (including, without limitation, dividends or distributions referred to in the last sentence of Section 7(A)(iv)), the holder of each share of Series C Preferred Stock, upon the conversion thereof subsequent to the close of business on the date fixed for the determination of shareholders entitled to receive such distribution and prior to the effectiveness of the Conversion Price adjustment in respect of such distribution, shall also be entitled to receive for each share of Common Stock into which such share of Series C Preferred Stock is converted, the portion of the shares of Common Stock, rights, warrants, evidences of indebtedness, shares of capital stock, cash and assets so distributed applicable to one share of Common Stock; PROVIDED, HOWEVER, that, at the election of the Corporation (whose election shall be evidenced by a resolution of the Board of Directors) with respect to all holders so converting, the Corporation may, in lieu of distributing to such holder any portion of such distribution not consisting of cash or securities of the Corporation, pay such holder an amount in cash equal to the fair market value thereof (as determined in good faith by the Board of Directors, whose determination shall be conclusive and described in a resolution of the Board of Directors). If any conversion of a share of Series C Preferred Stock described in the immediately preceding sentence occurs prior to the payment date for a distribution to holders of Common Stock which the holder of the share of Series C Preferred Stock so converted is entitled to receive in accordance with the immediately preceding sentence, the Corporation may elect (such election to be evidenced by a resolution of the Board of Directors) to distribute to such holder a due bill for the shares of Common Stock, rights, warrants, evidences of indebtedness, shares of capital stock, cash or assets to which such holder is so entitled, provided that such due bill (i) meets any applicable requirements of the principal national securities exchange or other market on which the Common Stock is then traded and (ii) requires payment or delivery of such shares of Common Stock, rights, warrants, evidences of indebtedness, shares of capital stock, cash or assets no later than the date of payment or delivery thereof to holders of shares of Common Stock receiving such distribution. (H) Stock Issuances; Multiple Adjustments. There shall be no adjustment of the Conversion Price in case of the issuance of any stock (or securities convertible into or exchangeable for stock) of the Corporation except as specifically described in this Section 7. If any action would require adjustment of the Conversion Price pursuant to more than one of the provisions described above, only one adjustment shall be made and such adjustment shall be the amount of adjustment which has the highest absolute value to holders of Series C Preferred Stock. SECTION 8. Ranking; Attributable Capital and Adequacy of Surplus; Retirement of Shares. (A) The Series C Preferred Stock shall rank senior to all shares of Junior Stock and PARI PASSU (i.e., on a parity) with Pari Passu Stock of the Corporation as to the payment of dividends and amounts upon the liquidation, dissolution or winding-up of the Corporation. The ranking of any subsequent series of Preferred Stock issued by the Corporation as compared to the Series C Preferred Stock as to the payment of dividends and amounts upon the liquidation, dissolution or winding-up of the Corporation shall be as specified in the Restated Articles of Incorporation, as amended, of the Corporation, the Certificate of Designation pertaining thereto and, if appropriate, shall also be subject to the provisions of paragraph (C) of Section 1 and paragraph (B) of Section 3 hereof. (B) The capital of the Corporation allocable to the Series C Preferred Stock for purposes of the Minnesota Business Corporation Act shall be $5,000 per share. (C) Any shares of Series C Preferred Stock acquired by the Corporation by reason of the conversion or redemption of such shares, or otherwise so acquired, shall be retired as shares of Series C Preferred Stock and restored to the status of authorized but unissued undesignated shares of the Corporation and may thereafter be reissued as part of a new series of Preferred Stock as permitted by law. SECTION 9. Miscellaneous. (A) All notices referred to herein shall be in writing, and all notices hereunder shall be deemed to have been given upon the earlier of receipt thereof or three business days after the mailing thereof if sent by registered or certified mail (unless first-class mail shall be specifically permitted for such notice) with postage prepaid addressed: (i) if to the Corporation, to its office at 385 Washington Street, St. Paul, Minnesota 55102 (Attention: Secretary) or to the transfer agent for the Series C Preferred Stock, or such other agent of the Corporation designated as permitted by this paragraph, or (ii) if to any holder of the Series C Preferred Stock or Common Stock, as the case may be, to such holder at the address of such holder as listed in the stock record books of the Corporation (which may include the records of any transfer agent for the Series C Preferred Stock or Common Stock, as the case may be) or (iii) to such other address as the Corporation or any such holder, as the case may be, shall have designated by notice similarly given. (B) The term "Common Stock" as used herein means the Corporation's Common Stock, without par value, as the same exists at the date of filing of the Certificate of Designation relating to the Series C Preferred Stock (the "Certificate of Designation") with the Secretary of State of the state of Minnesota, or any other class of stock resulting from successive changes or reclassifications of such Common Stock consisting solely of changes in par value, or from par value to no par value, or from no par value to par value. However, subject to the provisions of Section 7(B), shares of Common Stock issuable on conversion of shares of Series C Preferred Stock shall include only shares of the class designated as Common Stock of the Corporation at the date of the filing of the Certificate of Designation with the Secretary of State of the state of Minnesota or shares of any class or classes resulting from any reclassification or reclassifications thereof and which have no preference in respect of dividends or of amounts payable in the event of any voluntary or involuntary liquidation, dissolution or winding-up of the Corporation and which are not subject to redemption by the Corporation; PROVIDED that if at any time there shall be more than one such resulting class, the shares of each such class then so issuable shall be substantially in the proportion which the total number of shares of such class resulting from all such reclassifications bears to the total number of shares of such classes resulting from all such reclassifications. (C) The Corporation shall pay any and all stock transfer and documentary stamp taxes that may be payable in respect of any issuance or delivery of shares of Series C Preferred Stock or shares of Common Stock or other securities issued on account of Series C Preferred Stock pursuant hereto or certificates representing such shares or securities. The Corporation shall not, however, be required to pay any such tax that may be payable in respect of any transfer involving the issuance or delivery of shares of Series C Preferred Stock or Common Stock or other securities in a name other than that in which the shares of Series C Preferred Stock with respect to which such shares or other securities are issued or delivered were registered, or in respect of any payment to any person with respect to any such shares or securities other than a payment to the registered holder thereof, and shall not be required to make any such issuance, delivery or payment unless and until the person otherwise entitled to such issuance, delivery or payment has paid to the Corporation the amount of any such tax or has established, to the satisfaction of the Corporation, that such tax has been paid or is not payable. (D) In the event that a holder of shares of Series C Preferred Stock shall not by written notice designate the name in which shares of Common Stock to be issued upon conversion of such shares should be registered or to whom payment upon redemption of shares of Series C Preferred Stock should be made or the address to which the certificate or certificates representing such shares, or such payment, should be sent, the Corporation shall be entitled to register such shares, and make such payment, in the name of the holder of such Series C Preferred Stock as shown on the records of the Corporation and to send the certificate or certificates representing such shares, or such payment, to the address of such holder shown on the records of the Corporation. (E) The Corporation may appoint, and from time to time discharge and change, a transfer agent for the Series C Preferred Stock. Upon any such appointment or discharge of a transfer agent, the Corporation shall send notice thereof by first-class mail, postage prepaid, to each holder of record of Series C Preferred Stock. EX-4 3 EXHIBIT 4 COMMON STOCK COMMON STOCK NUMBER SHARES M-364270 [LOGO] THIS CERTIFICATE IS CUSIP 792860 10 TRANSFERABLE IN NEW YORK, NY OR MINNEAPOLIS, MN SEE REVERSE SIDE FOR CERTAIN DEFINITIONS AND FOR STATEMENT REGARDING RIGHTS AND RESTRICTION THE ST. PAUL COMPANIES, INC. THIS CERTIFIES THAT SPECIMEN IS THE OWNER OF FULLY PAID AND NON-ASSESSABLE SHARES OF THE VOTING COMMON STOCK OF THE ST. PAUL COMPANIES, INC. EACH TRANSFERABLE ON THE BOOKS OF THE CORPORATION BY THE HOLDER HEREOF IN PERSON OR BY DULY AUTHORIZED ATTORNEY ON SURRENDER OF THIS CERTIFICATE PROPERLY ENDORSED. THIS CERTIFICATE IS NOT VALID UNLESS COUNTERSIGNED BY THE TRANSFER AGENT AND REGISTRAR. WITNESS THE FACSIMILE SEAL OF THE CORPORATION AND THE FACSIMILE SIGNATURES OF ITS DULY AUTHORIZED OFFICERS. DATED:
COUNTERSIGNED AND REGISTERED: NORWEST BANK MINNESOTA, N.A. TRANSFER AGENT AND REGISTRAR [SEAL] /s/ Sandra Ulsaker Wiese BY /s/ L.M. Kaufman -------------------- ------------ CORPORATE SECRETARY AUTHORIZED SIGNATURE /s/ D.W. Leatherdale -------------------- CHAIRMAN AND CHIEF EXECUTIVE OFFICER
The following abbreviations, when used in the inscription on the face of this certificate, shall be construed as though they were written out in full according to applicable laws or regulations:
TEN COM as tenants in common UNIF GIFT MIN ACT ............... Custodian ............... TEN ENT -- as tenants by the entireties (Cust) (Minor) under Uniform Gifts to Minors JT TEN -- as joint tenants with right of survivorship and not as tenants Act............................ in common (State) Additional abbreviations may also be used though not in the above list.
PLEASE INSERT SOCIAL SECURITY OR OTHER IDENTIFYING NUMBER OF ASSIGNEE - - ------------------------------------------- - - ------------------------------------------- FOR VALUE RECEIVED,_____________________________________hereby sell, assign and transfer unto ____________________________________________________________ Please print or typewrite name and address of assignee ______________________________________________________________________________ _______________________________________________________________________ Share of the Voting Common Stock represented by the within Certificate, and do hereby irrevocably constitute and appoint_____________________________________ Attorney, to transfer said stock on the books of the within-named Corporation, with full power of substitution in the premises. Dated________________________________ ___________________________________________ SIGNATURE GUARANTEED NOTICE: The signature to this assignment must correspond with the name as written upon the face of the Certificate, in every particular, without alteration or enlargement, or any change whatever. Until the close of business on the Separation Date (as defined in the Rights Agreement referred to below), this certificate also evidences and entitles the holder hereof to certain Rights as set forth in a Rights Agreement, dated as of December 4, 1989 (as such may be amended from time to time, the "Rights Agreement"), between The St. Paul Companies, Inc. and First Chicago Trust Company of New York, as Rights Agent, the terms of which are hereby incorporated herein by reference and a copy of which is on file at the principal executive offices of The St. Paul Companies, Inc. Under certain circumstances, as set forth in the Rights Agreement, such Rights may be redeemed, may be exchanged for shares of Common Stock or other securities or assets of the Company or a Subsidiary of the Company, may expire, may become void (if they are "Beneficially Owned" by an "Acquiring Person" or "Adverse Person" or an Affiliate thereof, as such terms are defined in the Rights Agreement, or by any transferee of any of the foregoing) or may be evidenced by separate certificates and may no longer be evidenced by this certificate. The St. Paul Companies, Inc. will mail or arrange for the mailing of a copy of the Rights Agreement to the holder of this certificate without charge within five days after the receipt of a written request therefor. ON DECEMBER 11, 1998 NORWEST BANK MINNESOTA, N.A. WAS NAMED SUCCESSOR RIGHTS AGENT REPLACING FIRST CHICAGO TRUST COMPANY OF NEW YORK. - - ------------------------------------------------------------------------------- The Corporation will furnish to any shareholder, without charge and upon request addressed to the Corporation at its principal office at 385 Washington Street, St. Paul, Minnesota 55102, a full statement of the designations, preferences, limitations, and relative rights of the shares of each class or series authorized to be issued, so far as they have been determined, and the authority of the Corporation's Board of Directors to determine the relative rights and preferences of subsequent classes or series of shares. - - ------------------------------------------------------------------------------- EX-10.(A) 4 EXHIBIT 10(A) EXHIBIT 10(a) EMPLOYMENT AGREEMENT THIS AGREEMENT, dated as of January 6, 1999, by and between THE ST. PAUL COMPANIES, INC., a Minnesota corporation (the "Company"), and James E. Gustafson (hereinafter called the "Executive"). WHEREAS, the Company desires to employ the Executive and the Executive is willing to serve as an employee of the Company, subject to the terms and conditions of this Agreement; NOW, THEREFORE, in consideration of the mutual covenants contained herein, and other good and valuable consideration, the parties hereto agree as follows: Section 1. EMPLOYMENT During the Term of Employment, as defined in Section 2 hereof, the Company shall employ the Executive, and the Executive shall perform services for the Company, on the terms and conditions set forth in this Agreement. Section 2. TERM OF EMPLOYMENT The Term of Employment of this Agreement shall be the period commencing January 30, 1999 (the "Commencement Date") and ending on December 31, 2002; PROVIDED, that commencing on January 1, 2001 and on each subsequent January 1, the Term of Employment shall automatically be extended for an additional year, unless, no later than 90 days before each such anniversary, either party provides notice to the other party of an intention not to extend, and PROVIDED FURTHER, that the Term of Employment and this Agreement may be sooner terminated if the Executive's employment is terminated pursuant to Section 7 hereof. Section 3. DUTIES During the Term of Employment, the Executive shall serve as the President and Chief Operating Officer of the Company and shall have such duties and responsibilities as are assigned to him by the Chairman and Chief Executive Officer of the Company and/or the Board of Directors of the Company (the "Board"). The Executive shall report directly to the Chairman and Chief Executive Officer of the Company. The Executive shall be elected as a member of the Board as of the Commencement Date and shall serve on the Board during the Term of Employment. Section 4. CASH AND CERTAIN STOCK BASED COMPENSATION (a) BASE SALARY. The Executive shall receive, as compensation for his duties and obligations to the Company, a salary at the annual rate of $850,000. Executive's annual salary shall be payable in substantially equal installments in accordance with the Company's payroll practice. The Board shall review the annual salary annually and in light of such review may, in its discretion, increase such base annual salary taking into account any change in Executive's then responsibilities, performance by the Executive, and other pertinent factors. (Such base annual salary, as it may be increased from time to time, is referred to hereinafter as the "Base Salary".) (b) ANNUAL BONUS. The Executive shall be eligible for an annual cash bonus pursuant to the terms of the Company's incentive plans for each fiscal year of the Company during the Term of Employment with a target level of 85% of Base Salary, as determined by the Compensation Committee of the Board (the "Compensation Committee"). (c) INCENTIVE AWARDS. The Company shall grant the Executive on the Commencement Date options to purchase 375,000 shares of the Company's common stock (the "Performance Stock Options") pursuant to the terms of the Company's 1994 Stock Incentive Plan (the "1994 Plan"). Except as otherwise provided herein, if the Executive remains an employee of the Company until at least December 2, 2000, (i) 50% of the -2- Performance Stock Options shall vest on the later of such date or the date the daily closing price of the Company's common stock on the New York Stock Exchange during any 20 consecutive trading days exceeds $50 per share and (ii) an additional 50% of the Performance Stock Options shall vest on the later of December 2, 2000 or the date the daily closing price of the Company's common stock on the New York Stock Exchange during any 20 consecutive trading days exceeds $55 per share. To the extent that the Performance Stock Options either have not become exercisable or have not been exercised by the Executive on or prior to December 1, 2001, such Performance Stock Options shall expire. In addition, on the Commencement Date, the Company shall make an award of 30,000 shares of restricted stock pursuant to the terms of the 1994 Plan (the "Restricted Stock"). The Restricted Stock shall vest in three equal installments commencing on the first anniversary of the Commencement Date (and all restrictions on such portion of the Restricted Stock shall then lapse, other than as required by applicable law) if the Executive is employed by the Company on such anniversary; provided, however, that all such Restricted Stock may vest at an earlier date as specified in this Agreement. Section 5. OTHER BENEFIT AND COMPENSATION PROGRAMS AND PLANS (a) EMPLOYEE BENEFIT PROGRAMS. During the Term of Employment, the Executive shall be entitled to participate in all employee benefit programs of the Company in effect from time to time for employees and senior executive officers of the Company. (b) EXECUTIVE COMPENSATION PLANS. In addition to the compensation, the Performance Stock Options and the Restricted Stock provided for in Section 4 hereof and the employee benefit programs provided for in paragraph (a) of this Section, the Executive shall be entitled to participate in the Company's executive compensation plans, as presently in effect or as they may be modified or added to by the Company from time to time. It is expected that the annual target grant of stock options would cover 130,000 shares of the Company's common stock and that the first grant thereof would be made in February or March of 1999 when grants are generally made to other senior executives of the Company. -3- (c) VACATIONS AND SICK LEAVE. The Executive shall be entitled to vacation and sick leave each year, in accordance with the Company's policies in effect from time to time, provided, however, that the Executive shall be entitled to a minimum of five weeks vacation per year. (d) EXPENSES. The Company shall reimburse the Executive for reasonable expenses and disbursements in carrying out his duties and responsibilities under this Agreement, in accordance with the Company's established policies. (e) PENSION CREDIT. For purposes of the calculations of pension benefits under the Company's Benefit Equalization Plan, the Company shall credit the Executive with five years of service as of the Commencement Date. The Executive shall be fully vested in the benefits accrued under the Company's Benefit Equalization Plan during the Term of Employment. (f) LEVERAGED STOCK PURCHASE PROGRAM. As soon as practicable following the Commencement Date, the Company shall provide the Executive with an opportunity to participate in the Company's Special Leveraged Stock Purchase Program for the purpose of purchasing shares of the common stock of the Company, subject to a maximum loan amount of $2,500,000. Section 6. PAYMENTS RELATING TO CHANGE OF EMPLOYMENT (a) CASH BONUS. In consideration of the Executive's entering into this Agreement and serving as an employee of the Company, within five days from the Commencement Date, the Company will pay the Executive the sum of $1,000,000 to replace the estimated 1998 incentive award to which the Executive would have been entitled had he continued in employment with his prior employer. (b) EQUITY AWARDS. In addition, in consideration of the Executive's entering into this Agreement and serving as an employee of the Company, on the Commencement Date the Company shall grant the Executive (i) options to purchase 125,000 shares of the Company's common stock (the "Replacement Stock Options") -4- pursuant to the terms of the 1994 Plan which shall vest in full as of the first anniversary of the Commencement Date and (ii) 85,000 shares of restricted stock pursuant to the terms of the 1994 Plan (the "Replacement Restricted Stock") which shall vest in full on the third anniversary of the Commencement Date (and all restrictions on such Replacement Restricted Stock shall then lapse, other than as required by applicable law) in each case if the Executive is then employed by the Company; provided, however, that all such Replacement Stock Options and Replacement Restricted Stock may vest at an earlier date as specified in this Agreement. (c) SUPPLEMENTAL RETIREMENT BENEFITS. The Executive represents that he may be entitled to certain benefits under the Supplemental Benefit Equalization Plan of his prior employer. In the event that the prior employer refuses to pay all or a portion of such benefits to the Executive or contests the Executive's entitlement to such benefits, the Company shall reimburse Executive on a current basis for all reasonable legal fees and expenses, if any, incurred by the Executive in seeking to enforce his rights to payments of such benefits. Section 7. TERMINATION (a) TERMINATION FOR CAUSE. In order to terminate the employment of Executive for Cause, the Company must deliver to Executive a Notice of Termination given within ninety (90) days after the Board both (i) has actual knowledge of conduct or an event allegedly constituting Cause, and (ii) has reason to believe that such conduct or event could be grounds for Cause. For purposes of this Agreement a "Notice of Termination" shall mean a copy of a resolution duly adopted by the affirmative vote of not less than a majority of the membership of the Board, excluding Executive, at a meeting called for the purpose of determining that Executive has engaged in conduct which constitutes Cause (and at which Executive had a reasonable opportunity, in consultation with his counsel, to be heard before the Board prior to such vote). -5- For purposes of this Agreement "Cause" shall mean (A) the Executive is convicted of, or has plead guilty or NOLO CONTENDERE to, a felony involving intentional conduct; (B) the Executive is convicted of, or has plead guilty or NOLO CONTENDERE to any lesser crime or offense involving the illegal use or conversion of property of the Company or its subsidiaries; (C) the willful and continued failure by the Executive to perform substantially his duties with the Company (other than any such failure resulting from incapacity due to physical or mental illness or Disability) after a demand for substantial performance is delivered to the Executive by the Company which specifically identifies the manner in which the Company believes the Executive has not substantially performed his duties and which provides the Executive with an opportunity to cure by substantially performing his duties; (D) the Executive engages in willful misconduct in carrying out his duties with the Company (which shall not be deemed to include any action taken by the Executive in good faith in the best interest of the Company); or (E) the Executive engages in actions in his business or personal life which demonstrably harm the reputation or damage the good name of the Company. In the event of termination of the Executive's employment by the Company for Cause, the Executive shall only be entitled to: (w) any accrued but unpaid Base Salary through his date of termination; (x) any earned but unpaid bonus from a prior fiscal year; (y) reimbursement of reasonable business expenses incurred prior to the date of termination; and (z) other or additional benefits, if any, in accordance with (i) the applicable employee benefit programs of the Company referred to in Section 5(a) and (ii) Section 6(c). (b) DEATH OR DISABILITY. In the event of the death or Disability of the Executive, the Executive's employment shall be terminated as of the date of such death or Disability and the Executive, or the Executive's estate or legal representative, as appropriate, shall be entitled to the amounts referred to in paragraph (a) of this Section, -6- together with (x) any applicable amounts under the Company's executive compensation plans referred to in Section 5(b) and (y) full vesting in the Replacement Stock Options and Replacement Restricted Stock referred to in Section 6(b). In addition, in the event of the Executive's Disability, the Executive shall receive service credit under the Company's Benefit Equalization Plan from the date of his termination of employment pursuant to this Section 7(b) through the end of the Term of Employment (determined as if no extensions thereof occurred after such termination of employment). For purposes of this Agreement, "Disability" shall mean "total and permanent disability", as defined in the Company's long-term disability plan for senior executives (or such other Company-provided long-term disability benefit plan sponsored by the Company in which Executive participates at the time the determination of Disability is made). (c) TERMINATION WITHOUT CAUSE OR FOR GOOD REASON. If the Company should terminate the Executive's employment other than for Cause, or in the event the Executive terminates employment for Good Reason, the Company shall pay the Executive, in a lump sum within ten (10) days following his termination of employment, an amount equal to three times the sum of (i) the Executive's highest Base Salary during the 12-month period prior to his termination of employment and (ii) the average of the annual bonus payable to the Executive for each of the two fiscal years of the Company (or the bonus for the 1999 fiscal year if the Executive's employment is terminated prior to December 31, 2000) during the Term of Employment preceding the fiscal year in which his termination of employment occurs; provided, however, that in the event that the Executive's employment is terminated pursuant to this Section 7(c) prior to December 31, 1999, the Executive's target bonus in the year of termination shall be substituted for purposes of this clause (ii). The Executive shall also be entitled to: (A) the amounts referred to in paragraph (a) of this Section; (B) any applicable amounts to which he is entitled under the Company's executive compensation plans referred to in Section 5(b) including the full vesting of -7- annual stock options granted to the Executive after the date hereof; (C) continued participation in the medical, dental, hospitalization and group life insurance coverage plans of the Company ("Welfare Plans") in which he was participating on the date of the termination of his employment until the earlier of: (x) the end of the 36-month period following his termination of employment; and (y) the date, or dates, he receives coverage and benefits under the plans and programs of a subsequent employer; PROVIDED, HOWEVER, if the Executive cannot continue to participate in the Company's Welfare Plans, the Company shall otherwise provide such benefits on the same after-tax basis as if continued participation has been permitted; and PROVIDED FURTHER, HOWEVER, nothing herein shall be deemed to limit any amounts or benefits to which the Executive is otherwise entitled under the terms of any benefit plans of the Company as in effect from time to time; (D) Full vesting in the Replacement Stock Options and the Replacement Restricted Stock referred to in Section 6(b); (E) Full vesting of the Restricted Stock referred to in Section 4(c); (F) The Performance Stock Options referred to in Section 4(c) shall become exercisable by the Executive on December 2, 2000 (but not prior thereto) (i) with respect to 50% of such Performance Stock Options if the $50 target price referred to in Section 4(c) has been achieved prior to the Executive's termination of employment and (ii) with respect to the remaining 50% of such Performance Stock Options if the $55 target price referred to in Section 4(c) has been achieved prior to the Executive's termination of employment; provided, however, that all other terms and conditions applicable to the grant of the Performance Stock Options shall continue to apply; and (G) The Executive shall receive outplacement services at the Company's expense for a period of up to one year following the date of termination of employment in accordance with the policies of the Company as in effect from time to time. -8- Executive must, within ninety (90) days after the Executive has actual knowledge of the occurrence of an event or circumstances which would give him reason to believe constitutes Good Reason, give thirty (30) days prior written notice of his intent to terminate employment for Good Reason which notice sets forth the event or circumstances believed to constitute Good Reason. Upon receipt of such notice, the Company shall have ten (10) days to cure its conduct, to the extent such cure is possible. For purposes of this Agreement, "Good Reason" shall mean any of the following (without Executive's express written consent): (i) a reduction in the amount of the Executive's then current Base Salary; (ii) (A) the removal of or failure to elect or reelect the Executive as President or Chief Operating Officer of the Company prior to May 7, 2002 (other than for Cause or as a result of the election of the Executive as Chairman or Chief Executive Officer of the Company), or (B) the failure by the Company to elect the Executive as Chairman or Chief Executive Officer of the Company on May 7, 2002 or on an earlier date in the event that the current Chairman and Chief Executive Officer of the Company is no longer serving in such capacities, it being understood that if the current Chairman and Chief Executive Officer continues to serve as Chairman in the Board's discretion, the Executive shall have Good Reason hereunder if he is elected to serve as Chief Executive Officer. (iii) the assignment to the Executive of duties or responsibilities which are materially inconsistent with his then current position; and (iv) any requirement by the Company that the Executive relocate to Company headquarters which are more than 50 miles from where such headquarters are located on the Commencement Date. (d) TERMINATION WITHOUT GOOD REASON. In the event of a termination of employment by the Executive without Good Reason (other than a termination due to death -9- or Disability), the Executive shall have the same entitlements as provided in paragraph (a) of this Section for termination for Cause. (e) CHANGE IN CONTROL. In the event of a Change in Control of the Company (as such term is defined in the Company's Special Severance Policy (the "Policy"), the Executive shall be entitled to the benefits provided under the Policy if his employment terminates under the circumstances provided under the Policy or the severance compensation and benefits provided in Section (c) of this Section, whichever is greater. Notwithstanding anything contained in the Policy to the contrary, if the Executive is required, pursuant to Section 4999 of the Internal Revenue Code of 1986, as amended (the "Code"), to pay (through withholding or otherwise) an excise tax on "excess parachute payments" (as defined in Section 280G of the Code) by reason of the Change in Control of the Company, the Company shall pay the Executive the minimum amount necessary to place the Executive in the same after-tax financial position that he would have been in if he had not incurred any excise tax liability under Section 4999 of the Code. Section 8. NO MITIGATION The Executive shall not be required to mitigate the amount of any payments or benefits provided for in Section 7(c) or 7(e) hereof by seeking other employment or otherwise and no amounts earned by the Executive shall be used to reduce or offset the amounts payable hereunder, except as otherwise provided in Section 7(c). Section 9. NONCOMPETITION AND NONSOLICITATION (a) The Executive hereby covenants and agrees that at no time during the period of his employment nor for a period of two years following the termination thereof for any reason will he, without the prior written consent of the Board, for himself or on behalf of any other person, partnership, company or corporation, directly or indirectly, acquire any financial or beneficial interest in (except as provided in the next sentence), provide consulting services to, be employed by, or own, manage, operate or control any -10- business which is in competition with a business engaged in by the Company or any of its subsidiaries or affiliates in any state of the United States or in any foreign country in which any of them are engaged in business at the time of such termination of employment for as long as they carry on a business therein. Notwithstanding the preceding sentence, the Executive shall not be prohibited from owning less than five (5%) percent of any publicly traded corporation, whether or not such corporation is in competition with the Company. (b) The Executive hereby covenants and agrees that, at all times during the period of his employment and for a period of two years immediately following termination for any reason, the Executive shall not, without the prior written consent of the Board, solicit or take any action to cause the solicitation of any person who as of that date was a client, customer, policyholder, vendor, consultant or agent of the Company to discontinue business, in whole or in part with the Company. (c) The Executive hereby covenants and agrees that, at all times during the period of his employment and for a period of one year immediately following the termination thereof for any reason, the Executive shall not, without the prior written consent of the Board, employ or seek to employ any person employed at that time by the Company or any of its subsidiaries, or otherwise encourage or entice such person or entity to leave such employment. (d) Notwithstanding the foregoing, paragraphs (a), (b) and (c) of this Section 9 shall not apply to the Executive in the event that the Executive's employment is terminated for any reason within the two-year period following a Change in Control of the Company, within the meaning of the Policy referred to in Section 7(e). (e) It is the intention of the parties hereto that the restrictions contained in this Section be enforceable to the fullest extent permitted by applicable law. Therefore, to the extent any court of competent jurisdiction shall determine that any portion of the foregoing restrictions is excessive, such provision shall not be entirely void, but rather shall be limited or revised only to the extent necessary to make it enforceable. Specifically, if any court of competent jurisdiction should hold that any portion of the foregoing -11- description is overly broad as to one or more states of the United States or one or more foreign jurisdictions, then that state or states or foreign jurisdiction or jurisdictions shall be eliminated from the territory to which the restrictions of paragraph (a) of this Section applies and the restrictions shall remain applicable in all other states of the United States and foreign jurisdictions. Section 10. CONFIDENTIAL INFORMATION The Executive agrees to keep secret and retain in the strictest confidence all confidential matters which relate to the Company, its subsidiaries and affiliates, including, without limitation, customer lists, client lists, trade secrets, pricing policies and other business affairs of the Company, its subsidiaries and affiliates learned by him from the Company or any such subsidiary or affiliate or otherwise before or after the date of this Agreement, and not to disclose any such confidential matter to anyone outside the Company or any of its subsidiaries or affiliates, whether during or after his period of service with the Company, except (i) as such disclosure may be required or appropriate in connection with his work as an employee of the Company or (ii) when required to do so by a court of law, by any governmental agency having supervisory authority over the business of the Company or by any administrative or legislative body (including a committee thereof) with apparent jurisdiction to order him to divulge, disclose or make accessible such information. The Executive agrees to give the Company advance written notice of any disclosure pursuant to clause (ii) of the preceding sentence and to cooperate with any efforts by the Company to limit the extent of such disclosure. Upon request by the Company, the Executive agrees to deliver promptly to the Company upon termination of his services for the Company, or at any time thereafter as the Company may request, all Company, subsidiary or affiliate memoranda, notes, records, reports, manuals, drawings, designs, computer files in any media and other documents (and all copies thereof) relating to the Company's or any subsidiary's or affiliate's business and all property of the Company -12- or any subsidiary or affiliate associated therewith, which he may then possess or have under his direct control, other than personal notes, diaries, rolodexes and correspondence. Section 11. REMEDY Should the Executive engage in or perform, either directly or indirectly, any of the acts prohibited by Sections 9 or 10 hereof, it is agreed that the Company shall be entitled to full injunctive relief, to be issued by any competent court of equity, enjoining and restraining the Executive and each and every other person, firm, organization, association, or corporation concerned therein, from the continuance of such violative acts. The foregoing remedy available to the Company shall not be deemed to limit or prevent the exercise by the Company of any or all further rights and remedies which may be available to the Company hereunder or at law or in equity. Section 12. ARBITRATION. Any dispute among the parties hereto, except as provided by Section 11 of this Agreement, shall be settled by final and binding arbitration in Minneapolis/St. Paul, Minnesota, in accordance with the then effective rules of the American Arbitration Association, and judgment upon the award rendered may be entered in any court having jurisdiction thereover. Section 13. SUCCESSORS AND ASSIGNS This Agreement shall be binding upon and inure to the benefit of the heirs and representatives of the Executive and the assigns and successors of the Company, but neither this Agreement nor any rights hereunder shall be assignable or otherwise subject to hypothecation by the Executive (except by will or by operation of the laws of intestate succession) or by the Company except that the Company shall be required to assign this Agreement to any successor (whether by purchase or otherwise) to all or substantially all of the assets or businesses of the Company, unless otherwise requested by the Executive. -13- Section 14. REPRESENTATIONS The Company represents and warrants that it is fully authorized and empowered to enter into this Agreement and that the performance of its obligations under this Agreement will not violate any material agreement to which it is a party or by which it is bound. The Executive represents that he is not a party or bound by any agreement that would be violated by the performance of his obligations under this Agreement. Section 15. GOVERNING LAW This Agreement shall be governed by and construed and enforced in accordance with the laws of the State of Minnesota, without reference to rules relating to conflicts of law. Section 16. ENTIRE AGREEMENT This Agreement constitutes the full and complete understanding and agreement of the parties with respect to the subject matter hereof and supersedes all prior understandings and agreements as to employment of the Executive by the Company. This Agreement cannot be amended, changed, modified or terminated without the written consent of the parties hereto. Section 17. WAIVER OF BREACH. The waiver by either party of a breach of any term of this Agreement shall not operate nor be construed as a waiver of any subsequent breach thereof. Any waiver must be in writing and signed by the Executive or an authorized officer of the Company, as the case may be. -14- Section 18. SURVIVORSHIP The respective rights and obligations of the parties hereunder shall survive any termination of the Executive's employment to the extent necessary to the intended preservation of such rights and obligations. Section 19. NOTICES Any notice, report, request or other communication given under this Agreement shall be written and shall be effective upon delivery personally or when sent by certified or registered mail, postage prepaid, return receipt requested. Unless otherwise notified by any of the parties, notices shall be sent to the parties as follows: To the Company: The St. Paul Companies, Inc. 385 Washington Street St. Paul, Minnesota 55102 Attention: General Counsel With a copy to: The St. Paul Companies, Inc. 385 Washington Street St. Paul, Minnesota 55102 Attention: Senior Vice President, Human Resources To the Executive: James E. Gustafson 4292 North Pine Valley Lecanto, Florida 32661 -15- Section 20. SEVERABILITY If any one or more of the provisions contained in this Agreement shall be invalid, illegal or unenforceable in any respect under any applicable law, the validity, legality and enforceability of the remaining provisions contained herein shall not in any way be affected or impaired thereby. Section 21. HEADINGS The headings of the sections contained in this Agreement are for convenience only and shall not be deemed to control or affect the meaning or construction of any provision of this Agreement. Section 22. COUNTERPARTS This Agreement may be executed in one or more counterparts, each of which shall be deemed to be an original but all of which together will constitute one and the same instrument. IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the day and year first above written. THE ST. PAUL COMPANIES, INC. By: /s/ Douglas W. Leatherdale --------------------------------- Douglas W. Leatherdale /s/ James E. Gustafson ------------------------------------ James E. Gustafson -16- EX-10.(B) 5 EXHIBIT 10(B) THE ST. PAUL COMPANIES, INC. RESTRICTED STOCK AWARD PLAN as Amended (1) as of December 1, 1987 (2) as of March 25, 1988 (3) as of March 5, 1990 June 20, 1986 SECTION 1 - PURPOSE The St. Paul Companies, Inc. Restricted Stock Award Plan is designed to enable Selected Employees of The St. Paul Companies, Inc. and its Subsidiaries to acquire a proprietary interest or an increased proprietary interest in the Company and thus to share in the future success of the Company's business. Accordingly, the Plan is intended as a further means, not only of attracting, retaining and motivating outstanding management personnel, but also of promoting a closer identity of interests between the Selected Employees and the Company's stockholders. -2- SECTION 2 - DEFINITIONS For the purpose of this Plan, unless the context clearly indicates otherwise, the following terms shall have the following meanings: a) "Beneficiary" means the person or persons designated in writing by the Selected Employee as his or her beneficiary under the Company's, or its Subsidiaries' group life insurance program, unless otherwise designated in writing and provided to the Company. Any such designation may be revoked and a new designation substituted therefore at any time before the Selected Employee's death. b) "Board" means the Board of Directors of the Company. c) "CEO" means the Chief Executive Officer of The St. Paul Companies, Inc. d) "Committee" means the Executive Compensation Committee of the Board of any successor committee designated by Board action. e) "Common Stock" means the Company's common stock, without par value. f) "Company" means The St. Paul Companies, Inc. g) "Disability" means a disability as defined in the Company's, or its Subsidiaries' long term disability plan. h) "Division" means a non-incorporated business operating or staff group of the Company or any Subsidiary. i) "Fair Market Value" on a specified day means the last sale price on that day of the Company's Common Stock as reported on the National Association of Securities Dealers Automated Quotation (NASDAQ) National Market System, or, if no sale of the Company's Common Stock shall have occurred on that day, on the next preceding day on which there was such a sale. j) "Plan" means The St. Paul Companies, Inc. Restricted Stock Award Plan. k) "Plan Year" means the calendar year. l) "RESTRICTED PERIOD" MEANS THE PERIOD OF NO MORE THAN TEN YEARS FROM THE DATE OF THE AWARD, AS DESIGNATED BY THE CEO, OR AS DESIGNATED BY THE COMMITTEE IF THE SELECTED EMPLOYEE IS THE CEO, PURSUANT TO SECTION 3.2(c). m) "Restricted Shares" or "Restricted Stock" (used interchangeably) means Common Stock which has been awarded to a Selected Employee subject to the restrictions referred to in Section 7, so long as such restrictions are in effect. -3- n) "Restricted Stock Award and Custody Agreement" means the agreement between the Company and a Selected Employee, pursuant to the terms of which an award of Restricted Stock is made. o) "RETIREMENT" MEANS A SELECTED EMPLOYEE'S TERMINATION OF EMPLOYMENT WITH THE COMPANY OR A SUBSIDIARY AT SUCH TIME AS THE SELECTED EMPLOYEE IS ENTITLED TO AN IMMEDIATE REGULAR BENEFIT UNDER THE TERMS OF A RETIREMENT/PENSION PLAN OF THE COMPANY OR A SUBSIDIARY, AS AMENDED FROM TIME TO TIME. p) "SELECTED EMPLOYEES" MEANS EMPLOYEES, INCLUDING, AMONG OTHERS, OFFICERS OF THE COMPANY OR OF ANY SUBSIDIARY OR DIVISION, WHO ARE RESPONSIBLE FOR THE MANAGEMENT AND GROWTH OF THE BUSINESS OF THE COMPANY, OR SUCH SUBSIDIARY OR DIVISION, AND/OR WHO ARE EXPECTED TO CONTINUE MAKING SUBSTANTIAL CONTRIBUTIONS TO SUCH GROWTH, AS DESIGNATED BY THE CEO (OR BY THE COMMITTEE IF THE SELECTED EMPLOYEE IS THE CEO) AND APPROVED BY THE COMMITTEE. q) "Stock" or "Shares" (used interchangeably) means shares of the Company's Common Stock. r) "Subsidiary" means any corporation or other legal entity, domestic or foreign, more than fifty percent of the equity securities of which are owned or controlled, directly or indirectly, by the Company. s) "Unrestricted Shares" means Shares awarded under the provisions of this Plan as to which all restrictions against disposition have lapsed. -4- SECTION 3 - ADMINISTRATION OF THE PLAN 3.1 The plan shall be administered by the Executive Compensation Committee, who shall, at their discretion delegate certain administrative responsibilities to certain officers of the Company or any Subsidiary. 3.2 Subject to the provisions of the Plan, and Committee review and approval, the CEO, or his delegate, shall have authority to: a) Interpret the provisions of the Plan and decide all questions of fact arising in its application; b) Prescribe, amend and rescind rules and regulations relating to the Plan; c) DETERMINE THE SELECTED EMPLOYEES TO PARTICIPATE HEREUNDER; THE TIME WHEN SUCH INDIVIDUALS SHALL BE GRANTED A RESTRICTED STOCK AWARD; THE NUMBER OF RESTRICTED SHARES TO BE AWARDED TO SUCH INDIVIDUALS; THE RESTRICTED PERIOD WHICH SHALL APPLY TO SUCH AWARDS AND WHETHER OR NOT THE RESTRICTIONS IN SECTION 7.2 SHALL LAPSE UNDER SECTION 7.4 UPON THE SELECTED EMPLOYEE'S RETIREMENT. IF THE CEO IS A SELECTED EMPLOYEE, THE DETERMINATIONS REQUIRED UNDER THIS SECTION 3.2 c) SHALL BE MADE BY THE COMMITTEE. -5- SECTION 4 - EFFECTIVE DATE OF PLAN The Plan shall become effective when adopted by the Board, and, unless sooner terminated in accordance with Section 11 hereof, the Plan shall remain in effect for a period of ten years following adoption by the Board. No Plan Year shall begin after December 31, 1995. -6- SECTION 5 - NUMBER AND SOURCE OF SHARES SUBJECT TO THE PLAN 5.1 Shares to be awarded to Selected Employees under this Plan shall be made available at the Committee's discretion either from authorized but unissued Shares or from Shares reacquired by the Company, including Shares purchased in the open market. 5.2 Subject to adjustment as provided in Section 8 an aggregate of 500,000 Shares will be available and reserved for issuance to Selected Employees under the Plan. 5.3 Any Restricted Shares that are forfeited to the Company pursuant to the terms of Section 7.3 shall thereafter be available for further Restricted Stock awards. -7- SECTION 6 - AWARDS TO SELECTED EMPLOYEES 6.1 SUBJECT TO COMMITTEE REVIEW AND APPROVAL, AND IN ACCORDANCE WITH SECTION 3.2(c), THE CEO (OR IF THE CEO IS THE SELECTED EMPLOYEE, THEN THE COMMITTEE) WILL SELECT THE EMPLOYEES TO RECEIVE A RESTRICTED STOCK AWARD, AND DETERMINE THE NUMBER OF RESTRICTED SHARES TO BE AWARDED TO EACH SELECTED EMPLOYEE. THE PRIME CONSIDERATION FOR SELECTING EMPLOYEES FOR SUCH AN AWARD IS THE ACQUISITION AND RETENTION OF KEY INDIVIDUALS WHOSE POTENTIAL OR CONTINUED CONTRIBUTION TO THE COMPANY, OR ANY SUBSIDIARY OR DIVISION, IS IMPORTANT TO ITS FUTURE SUCCESS, WITH MAJOR EMPHASIS ON THE ATTRACTION OF NEW EXECUTIVE PERSONNEL. AN EMPLOYEE MAY ALSO BE SELECTED FOR AN AWARD BECAUSE OF HIS OR HER PAST CONTRIBUTIONS TO THE SUCCESS OF THE COMPANY, OR ANY SUBSIDIARY OR DIVISION. -8- SECTION 7 - RESTRICTIONS 7.1 AN AWARD OF RESTRICTED STOCK SHALL ENTITLE A SELECTED EMPLOYEE TO THE NUMBER OF RESTRICTED SHARES DESIGNATED BY VIRTUE OF THE PROVISIONS OF SECTION 6.1, AS OF THE DATE OR DATES DESIGNATED. THE COMPANY SHALL RETAIN CUSTODY OF SUCH SHARES UNTIL ALL RESTRICTIONS LAPSE. RESTRICTED STOCK AWARDS SHALL BE EXPRESSLY SUBJECT TO THE TERMS AND CONDITIONS DESCRIBED IN THIS SECTION. 7.2 DURING THE RESTRICTED PERIOD, SHARES OF RESTRICTED STOCK AWARDED TO THE SELECTED EMPLOYEE MAY NOT BE SOLD, ASSIGNED, TRANSFERRED, PLEDGED OR OTHERWISE ENCUMBERED, EXCEPT AS HEREINAFTER PROVIDED. EXCEPT FOR SUCH RESTRICTIONS, THE SELECTED EMPLOYEE, AS OWNER OF SUCH SHARES, SHALL HAVE ALL THE RIGHTS OF A STOCKHOLDER, INCLUDING (BUT NOT LIMITED TO) THE RIGHT TO RECEIVE ALL DIVIDENDS PAID ON SUCH SHARES (SUBJECT TO THE PROVISIONS OF SECTION 8 AND 9) AND THE RIGHT TO VOTE SUCH SHARES. 7.3 If a Selected Employee ceases to be an employee of the Company or any of its Subsidiaries during the Restricted Period for any reason other than death, Disability or Retirement, all Restricted Shares theretofore awarded to him or her which are still subject to the restrictions imposed by Section 7.2 shall, upon such termination of employment, be forfeited to and retained by the Company. 7.4 EXCEPT IN THE CASE OF A RESTRICTED STOCK AWARD IN WHICH THE RESTRICTIONS IN SECTION 7.2 DO NOT LAPSE UPON RETIREMENT AS DETERMINED UNDER SECTION 3.2 c), IF A SELECTED EMPLOYEE CEASES TO BE AN EMPLOYEE OF THE COMPANY OR ANY OF ITS SUBSIDIARIES DURING THE RESTRICTED PERIOD BY REASON OF DEATH, DISABILITY OR RETIREMENT, SHARES OF RESTRICTED STOCK SHALL BECOME UNRESTRICTED SHARES, FREE OF THE RESTRICTIONS IN SECTION 7.2, AND THE COMPANY WILL DELIVER TO HIM/HER OR HIS/HER BENEFICIARY, AS THE CASE MAY BE, WITHIN 60 DAYS OF THE DATE OF SUCH OCCURRENCE, SUCH SHARES PURSUANT TO SECTION 7.9. 7.5 When the termination of employment of a Selected Employee would otherwise result in forfeiture as described in Section 7.3, the CEO, in his sole discretion, may elect to waive all or any portion of any restrictions remaining. 7.6 Each Selected Employee awarded Shares of Restricted Stock shall enter into a Restricted Stock Award and Custody Agreement with the Company substantially in the form attached hereto. 7.7 Each certificate issued in respect of Shares of Restricted Stock awarded under the Plan shall be registered in the name of the Selected Employee, shall be deposited by him or her with the Company together with a stock power endorsed in blank and shall bear the following (or similar) legend: -9- "The Shares of Company Common Stock evidenced by this certificate are subject to the terms and restrictions of The St. Paul Companies, Inc. Restricted Stock Award Plan; such Shares shall not be sold, transferred, assigned, pledged, encumbered or otherwise alienated or hypothecated except pursuant to the provisions of said Plan, a copy of which Plan is available from the Company upon request." 7.8 The Restricted Stock Award and Custody Agreement shall specify, among other terms, the Restricted Period as defined in Section 2.1. 7.9 When all restrictions imposed under Section 7 or other similar restrictions expire or have otherwise been satisfied with respect to any Restricted Shares, the Company shall deliver to the Selected Employee (or his or her legal representative, Beneficiary or heir) a certificate representing such Shares, without the legend referred to in Section 7.7. At that time, the Restricted Stock Award and Custody Agreement referred to in Section 7.6, as it relates to such Shares shall be terminated. 7.10 At the end of the Restricted Period, or after occurrence of any of the events described in Section 7.4, no restrictions shall lapse and the Company shall not deliver a certificate representing the Shares with respect to which the Restricted Period has just ended, until the Company receives full payment of any F.I.C.A. Federal, State and/or local income tax withholding which may become due as a result of the lifting of the restrictions. 7.11 (a) NOTWITHHOLDING ANY PROVISIONS OF THIS PLAN TO THE CONTRARY, UPON THE OCCURRENCE OF A CHANGE IN CONTROL (AS DEFINED BELOW) ALL RESTRICTED SHARES THERETOFORE AWARDED TO A SELECTED EMPLOYEE WHICH ARE STILL SUBJECT TO THE RESTRICTIONS IMPOSED BY SECTION 7.2 SHALL BECOME UNRESTRICTED SHARES, FREE OF THE RESTRICTIONS IMPOSED BY SECTION 7.2; PROVIDED, HOWEVER, THAT IF THE ACCELERATION OF THE LAPSING OF THE RESTRICTIONS ON ANY SHARES PURSUANT TO THE PROVISIONS OF THIS SECTION 7.11, WHEN TAKEN TOGETHER WITH ANY OTHER PAYMENTS WHICH THE SELECTED EMPLOYEES HAS THE RIGHT TO RECEIVE FROM THE COMPANY OR ANY CORPORATION WHICH IS A MEMBER OF AN "AFFILIATED GROUP" (AS DEFINED IN SECTION 1504(a) OF THE INTERNAL REVENUE CODE OF 1986, AS AMENDED (THE "CODE"), WITHOUT REGARD TO SECTION 1504(b) OF THE CODE) OF WHICH THE COMPANY IS A MEMBER, WOULD CONSTITUTE A "PARACHUTE PAYMENT" (AS DEFINED IN SECTION 280G(b)(2) OF THE CODE), THEN THE ACCELERATION OF THE LAPSING OF THE RESTRICTIONS PURSUANT TO THE PROVISIONS OF THIS SECTION 7.11 SHALL BE LIMITED TO THE LARGEST WHOLE NUMBER OF SHARES AS WILL RESULT IN NO PORTION OF SUCH SHARES AND SUCH OTHER PAYMENTS BEING SUBJECT TO THE EXCISE TAX IMPOSED BY SECTION 4999 OF THE CODE. (b) FOR PURPOSES OF THIS SECTION 7.11, THE DETERMINATION AS TO WHETHER ANY LIMITATION IN THE ACCELERATION OF THE LAPSING OF RESTRICTIONS ON ANY SHARES PURSUANT TO SECTION 7.11(a) IS NECESSARY: (i) SHALL NOT TAKE INTO ACCOUNT ANY -10- SUCH OTHER PAYMENTS TO THE EXTENT THAT SUCH OTHER PAYMENTS ARE OR WOULD BE MADE PURSUANT TO A "SEVERANCE AGREEMENT" WHICH CONTAINS A "PARACHUTE PAYMENT" LIMITATION (SUBSTANTIALLY SIMILAR TO THE PARACHUTE PAYMENT LIMITATION SET FORTH IN THIS SECTION 7.11) THAT WOULD TAKE INTO ACCOUNT THE EFFECTS OF THE ACCELERATION PROVISIONS SET FORTH IN THIS SECTION 7.11; (ii) SHALL BE MADE BY THE AFFECTED SELECTED EMPLOYEE IN GOOD FAITH; AND (iii) SHALL BE CONCLUSIVE AND BINDING ON THE COMPANY WITH RESPECT TO ITS TREATMENT OF THE PAYMENT FOR TAX REPORTING PURPOSES. (c) FOR PURPOSES OF THIS SECTION 7.11, A "CHANGE IN CONTROL" OF THE COMPANY SHALL MEAN A CHANGE IN CONTROL OF A NATURE THAT WOULD BE REQUIRED TO BE REPORTED (ASSUMING SUCH EVENT HAS NOT BEEN "PREVIOUSLY REPORTED") IN RESPONSE TO ITEM 1(a) OF THE CURRENT REPORT ON FORM 8-K, AS IN EFFECT ON FEBRUARY 2, 1988 PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934; PROVIDED THAT, WITHOUT LIMITATION, SUCH A CHANGE IN CONTROL SHALL BE DEEMED TO HAVE OCCURRED AT SUCH TIME AS (i) ANY "PERSON" (WITHIN THE MEANING OF SECTION 14(d) OF THE SECURITIES EXCHANGE ACT OF 1934, OTHER THAN THE COMPANY, A SUBSIDIARY OF THE COMPANY OR ANY EMPLOYEE BENEFIT PLAN(S) SPONSORED BY THE COMPANY OR A SUBSIDIARY OF THE COMPANY) IS OR BECOMES THE "BENEFICIAL OWNER" (AS DEFINED IN RULE 13(d)-3 UNDER THE SECURITIES EXCHANGE ACT OF 1934), DIRECTLY OR INDIRECTLY, OF 50% OR MORE OF THE COMBINED VOTING POWER OF THE COMPANY'S OUTSTANDING SECURITIES ORDINARILY HAVING THE RIGHT TO VOTE AT ELECTIONS OF DIRECTORS; OR (ii) INDIVIDUALS WHO CONSTITUTE THE BOARD OF DIRECTORS OF THE COMPANY ON FEBRUARY 2, 1988, CEASE FOR ANY REASON TO CONSTITUTE AT LEAST A MAJORITY THEREOF, PROVIDED THAT ANY PERSON BECOMING A DIRECTOR SUBSEQUENT TO FEBRUARY 2, 1988 WHOSE ELECTION, OR NOMINATION FOR ELECTION BY THE COMPANY'S SHAREHOLDERS, WAS APPROVED BY A VOTE OF AT LEAST THREE QUARTERS OF THE DIRECTORS COMPRISING THE BOARD OF DIRECTORS OF THE COMPANY ON FEBRUARY 2, 1988 (EITHER BY A SPECIFIC VOTE OR BY APPROVAL OF THE PROXY STATEMENT OF THE COMPANY IN WHICH SUCH PERSON IS NAMED AS A NOMINEE FOR DIRECTOR, WITHOUT OBJECTION TO SUCH NOMINATION) SHALL BE, FOR PURPOSES OF THIS CLAUSE (ii), CONSIDERED AS THOUGH SUCH PERSON WERE A MEMBER OF THE BOARD OF DIRECTORS OF THE COMPANY ON FEBRUARY 2, 1988. (d) IN THE EVENT THAT APPLICATION OF THE LIMITATION IMPOSED BY SECTION 7.11(a) RESULTS IN THE ACCELERATION OF LAPSING OF RESTRICTIONS ON LESS THAN ALL OF A SELECTED EMPLOYEE'S RESTRICTED SHARES, ACCELERATION SHALL FIRST OCCUR FOR THOSE RESTRICTIONS EXTENDING FURTHEST INTO THE FUTURE AND THEN PROCEED IN REVERSE CHRONOLOGICAL ORDER. TO THE EXTENT THAT THE ACCELERATION OF LAPSING OF RESTRICTIONS ON RESTRICTED SHARES BECAUSE OF THE OCCURRENCE OF A CHANGE IN CONTROL DOES NOT OCCUR BECAUSE OF THE LIMITATION IMPOSED BY SECTION 7.11(a), SUCH RESTRICTED SHARES SHALL REMAIN VALID AND SUBJECT TO THE LAPSE OF RESTRICTIONS IN ACCORDANCE WITH THE TERMS OF THIS PLAN. (e) NOTWITHSTANDING ANY PROVISIONS OF SECTION 11 OF THIS PLAN TO THE CONTRARY, THE PROVISIONS OF THIS SECTION 7.11 MAY NOT BE TERMINATED, -11- SUSPENDED OR MODIFIED, IN WHOLE OR IN PART, WITH RESPECT TO ANY PRIOR GRANTED RESTRICTED STOCK AWARDS FOLLOWING A CHANGE IN CONTROL WITHOUT THE PRIOR WRITTEN CONSENT OF THE SELECTED EMPLOYEES WHOSE RESTRICTED STOCK AWARDS WOULD BE AFFECTED THEREBY; PROVIDED, FIRST, THAT, NOTHING CONTAINED IN THIS SECTION 7.11(e) OR IN SECTION 11 SHALL PREVENT THE COMPANY FROM TERMINATING, SUSPENDING OR MODIFYING THIS SECTION 7.11, IN WHOLE OR IN PART, PRIOR TO THE OCCURRENCE OF A CHANGE IN CONTROL; AND, SECOND, THAT, NOTWITHSTANDING THE OCCURRENCE OF A CHANGE IN CONTROL, FOR SO LONG AS THE INDIVIDUALS WHO CONSTITUTE THE BOARD OF DIRECTORS OF THE COMPANY ON DECEMBER 1, 1987 CONSTITUTE AT LEAST A MAJORITY OF THE BOARD OF DIRECTORS, THE COMPANY MAY TERMINATE, SUSPEND OR MODIFY SECTION 7.11 OF THIS PLAN, IN WHOLE OR IN PART. -12- SECTION 8 - ADJUSTMENT FOR CHANGES IN CAPITALIZATION In the event of any change in the outstanding Shares of Common Stock by reason of any stock dividend or split, recapitalization, merger, consolidation, combination or exchange of Shares or other similar corporate change, the maximum aggregate number and class of Shares in which awards may be granted under the Plan, and the number of Restricted Shares outstanding shall be appropriately adjusted by the Committee, whose determination shall be conclusive. Any Shares of stock or other securities received by a Selected Employee with respect to shares of Restricted Stock will be subject to the same restrictions and shall be deposited with the Company under the terms of the related Restricted Stock Award and Custody Agreement. -13- SECTION 9 - EFFECT OF MERGER OR OTHER REORGANIZATION If the Company shall be consolidated or merged with another corporation, each Selected Employee who has received Shares of Restricted Stock that are still subject to the restrictions imposed by Section 7.2 may be required to deposit with the successor corporation the stock, securities or other property that he or she is entitled to receive by reason of his or her ownership of the Shares of Restricted Stock, and such stock, securities or other property shall become subject to the restrictions imposed by Section 7.2 and shall bear an appropriate legend similar in form and substance to the legend set forth in Section 7.7. -14- SECTION 10 - EXCLUSION FROM BENEFITS COMPUTATION NO AWARD UNDER THE PLAN SHALL BE TAKEN INTO ACCOUNT IN DETERMINING A SELECTED EMPLOYEE'S COMPENSATION FOR THE PURPOSES OF ANY GROUP LIFE INSURANCE OR OTHER EMPLOYEE BENEFIT OR PENSION, RETIREMENT, THRIFT, PROFIT SHARING, 401(k), OR SIMILAR PLAN OF THE COMPANY OR ANY SUBSIDIARY; PROVIDED, HOWEVER, THAT SUCH AWARDS MAY BE TAKEN INTO ACCOUNT UNDER ANY SUCH PLANS TO THE EXTENT THAT SUCH AWARDS ARE RELEVANT TO THE DETERMINATION OF ANY LIMITATIONS ON "PARACHUTE PAYMENTS" WITHIN THE MEANING OF CODE SECTION 280G OR CODE SECTION 4999. -15- SECTION 11 - TERMINATION, SUSPENSION OR MODIFICATION OF THE PLAN The Board may, by a majority vote of the members present and voting at any time terminate, suspend or modify the Plan. No termination, suspension or modification of the Plan shall adversely affect any prior granted Restricted Stock awards to Selected Employees. -16- SECTION 12 - LIABILITY OF THE COMPANY The liability of the Company and its Subsidiaries under this Plan and any Restricted Shares or Unrestricted Shares transferred hereunder is limited to the obligations set forth with respect to those Restricted Shares or Unrestricted Shares, and nothing herein contained shall be construed to impose any liability on the Company in favor of the recipient of any Restricted Stock award with respect to any loss, cost or expense which the recipient may incur in connection with the award. -17- SECTION 13 - MISCELLANEOUS 13.1 The Plan shall not be deemed an exclusive method of providing incentive compensation for the Selected Employees of the Company and its Subsidiaries, nor shall it preclude the Board from authorizing or approving other forms of incentive compensation. 13.2 All expenses and costs in connection with the operation of the Plan shall be borne by the Company (or its Subsidiaries, where appropriate). 13.3 The CEO may in any Plan Year refrain from designating Selected Employees and refrain from granting any Restricted Stock awards, but such action shall not be deemed a termination of the Plan. No Selected Employee or any officer or employee shall have any claim or right to be granted awards under the Plan. 13.4 Nothing in this Plan shall be construed to constitute or be evidence of an agreement or understanding, express or implied, on the part of the Company to employ any Selected Employee for any specific period of time. The granting of a Restricted Stock award to a Selected Employee in any year shall not give that individual any right to any similar award in future years. 13.5 The Plan shall be construed and its provision enforced and administered in accordance with the laws of Minnesota except to the extent that such laws may be superceded by any Federal law. -18- EX-10.(C) 6 EXHIBIT 10(C) THE ST. PAUL COMPANIES, INC. 1988 STOCK OPTION PLAN 1. PURPOSE This Plan is intended to strengthen the ability of the Company and its Subsidiaries to attract and retain Key Executives (and Non-Employee Directors) of outstanding competence by providing them with added incentive to render high levels of performance and effective service in connection with their employment in management positions (or service as Non-Employee Directors), and, in certain cases to reward Key Executives (and Non-Employee Directors) for having done so, through the opportunity for Common Stock ownership and benefits of Common Stock appreciation. 2. DEFINITION For the purpose of the Plan, except where the context otherwise indicates the following definitions shall apply. "Board" means the Board of Directors of the Company. "Change in Control" means a change in control of the Company of a nature that would be required to be reported (assuming such event has not been "previously reported") in response to Item 1(a) of the Current Report on Form 8-K, as in effect on May 4, 1988, pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934; provided that, without limitation, such a change in control shall be deemed to have occurred at such time as (a) any "person" within the meaning of Section 14(d) of the Securities Exchange Act of 1934, other than the Company, a Subsidiary or any employee benefit plan(s) sponsored by the Company or any Subsidiary is or becomes the "beneficial owner" (as defined in Rule 13d-3 under the Securities Exchange Act of 1934), directly or indirectly, of 50% or more of the Common Stock; or (b) individuals who constitute the Board on May 4, 1988, cease for any reason to constitute at least a majority thereof, provided that any person becoming a director subsequent to May 4, 1988, whose election, or nomination for election by the Company's shareholders, was approved by a vote of at least three quarters of the directors comprising the Board on May 4, 1988 (either by a specific vote or by approval of the proxy statement of the Company in which such person is named as a nominee for director, without objection to such nomination) shall be, for purposes of this clause (b), considered as though such person were a member of the Board on May 4, 1988. "Code" means the Internal Revenue code of 1986, as amended from time to time. "Committee" means the Executive Compensation Committee or any other committee designated by the Board to have administrative responsibility with respect to the Plan. "Common Stock" means the Company's common stock, without par value. "Company" means The St. Paul Companies, Inc. "Date of Grant" means the date an Option or any related SAR becomes effective under the terms of the governing Option Agreement. "Disinterested Person" means "disinterested person" as defined in Rule 16b-3 of the Securities and Exchange Commission, as amended from time to time, and, generally, means any member of the Board who is not at the time of acting on a matter, and within the previous year has not been, a Key Executive of the Company or a Subsidiary. 1 "Exercise Notice" means a written notice from an Optionee to the Company, made on a form and in a manner as the Committee may from time to time determine, pursuant to which the Optionee irrevocably elects to exercise all or any portion of an Option and irrevocably directs the Company to deliver the Optionee's Common Stock certificates to be issued to such Optionee upon such Option exercise directly to a "broker" or "dealer" (within the meaning of Section 3(a) of the Securities Exchange Act of 1934, as amended from time to time). An Exercise Notice must be accompanied by or contain irrevocable instructions to the broker or dealer (i) to promptly sell a sufficient number of shares of such Common Stock, or to loan the Optionee a sufficient amount of money, to pay the exercise price for the Options and to fund any related employment or withholding tax obligations to which the Exercise Notice relates, and (ii) to promptly remit such sums to the Company upon the broker's or dealer's receipt of the certificates. "Fair Market Value" means the fair market value of Common Stock determined by the Committee. "Incentive Stock Option" means an Option granted as an incentive stock option as defined in Section 422A of the Code. "Key Executive" means any person designated by the Committee who is employed by the company or a Subsidiary on a salaried basis (including an officer who may also be a director but excluding any director who is not such an employee of the Company or a Subsidiary) and whose performance, in the judgment of the Committee, could have or did have a significant effect on either (or both) the current or long-term success of the Company or a Subsidiary (or both). "Non-Employee Director" means any member of the Board who is not a current or former employee of the Company or any Subsidiary. "Nonqualified Stock Option" means an Option that does not qualify as an Incentive Stock Option. The terms of the Option Agreement for a Nonqualified Stock Option shall expressly state that the Option is a Nonqualified Stock Option. "Option" means the rights granted to a Key Executive (or a Non-Employee Director in accordance with Section 15 of the Plan) to purchase Common Stock pursuant to the terms and conditions of an Option Agreement, including both Incentive Stock Options and Nonqualified Stock Options. "Option Agreement" means a written agreement (and any amendment or supplement thereto) between the Company and a Key Executive (or Non-Employee Director) designating the terms and conditions of an Option, including any related SAR. "Optionee" means a Key Executive (or Non-Employee Director) to whom an Option and any related SAR are granted. "Plan" means The St. Paul Companies, Inc. 1988 Stock Option Plan. "Stock Appreciation Right" or "SAR" means a right (which shall not exist separately from a related unexercised Option) granted pursuant to the terms and conditions of an Option Agreement to surrender an unexercised Option, or some portion of an unexercised Option, and to receive from the Company either shares of Common Stock (valued at Fair Market Value on the Date of Exercise of the SAR), cash, or a combination thereof, equal in amount to the excess of the aggregate Fair Market Value (on the Date of Exercise of the SAR) of the shares as to which the Option is surrendered, over the aggregate Option price of such shares, subject to any limitations in Section 7. Notwithstanding any other provision of this Plan or of an Option Agreement to the contrary, in no event shall the amount payable to the Optionee upon exercise of an SAR related to an Incentive Stock Option exceed 100% of 2 the difference between the exercise price of the related Incentive Stock Option and the Fair Market Value of the Common Stock at the Date of Exercise of the SAR. "Subsidiary" means any entity of which, at the time such Subsidiary status is to be determined, at least 50% of the combined voting power of such entity is directly or indirectly owned or controlled by the Company. 3. ADMINISTRATION OF THE PLAN The Plan shall be administered by the Committee (whose members shall be appointed by the Board) consisting solely of four or more members of the Board who are Disinterested Persons. A majority of the Committee shall constitute a quorum, and all acts of the Committee must be approved by a majority (at least three) of its members. Subject to the provisions of the Plan and except where inconsistent with the provisions of Section 15 of the Plan with respect to Options granted to Non-Employee Directors, the Committee shall have authority in its sole discretion: (a) To interpret the provisions of the Plan and decide all questions of fact arising in its application; (b) To prescribe, amend and rescind rules and regulations relating to the Plan; (c) To determine the Key Executives to who, the time or times at which, the price at which, and the extent to which Options and any SARs shall be granted based upon the nature of the services rendered to be rendered by the persons it deems eligible, their past, present and potential contributions to the success of the Company and/or any of its Subsidiaries, their other compensation from the Company or any Subsidiary, and such other factors as the Committee in its discretion shall deem relevant; (d) To determine the time or times when Options and any SARs become exercisable and the duration of the exercise period; (e) To determine whether any shares of Common Stock under any Option must be purchased before any related SAR becomes exercisable; (f) To prescribe and amend the form or forms of the Option Agreements; (g) To determine the form or forms of consideration which will be accepted by the Company from an Optionee in payment of the purchase price upon the exercise of any Option; and (h) To determine which Options shall be Incentive Stock Options and which Options shall be Nonqualified Options. The Committee's determinations of the foregoing matters shall be final and conclusive. 4. ELIGIBILITY Options and any SARs may be granted under the Plan only to Key Executives (or Non-Employee Directors in accordance with Section 15 of the Plan). Any Key Executive (or Non-Employee Director) may be granted and may hold more than one Option and, with respect to Key Executives, more than one SAR. In no event shall an Incentive Stock Option be granted to a Key Executive if the grant of such Incentive Stock Option would cause the aggregate Fair Market Value (on the Date of Grant) of the Common Stock with respect to which Incentive Stock Options are exercisable for the first time by 3 such Key Executive during any calendar year (under all plans of the Company and any parent or subsidiary corporations of the Company within the meaning of Code Section 425) to exceed $100,000. 5. SHARES AVAILABLE Subject to adjustments as provided in Section 9 hereof, an aggregate of 1,000,000 shares of Common Stock will be available and reserved for issue or transfer with respect to options or SARs granted under the Plan. When the right to purchase shares or a combination thereof, the aggregate number of shares covered by the related Option shall be reduced by the number of shares with respect to which the SAR was exercised, and such shares shall not be available for granting further Options and SARs. If an Option shall terminate for any reason without having been exercised in full or surrendered on exercise of a SAR, the unpurchased and nonsurrendered shares subject thereto shall become available for further Options and SARs. 6. OPTIONS Each Option granted shall be subject to the following conditions: (a) The Option price per share of Common Stock shall be set by the Option agreement but shall in no instance be less than 100% of the Fair Market Value on the Date of Grant with respect to any Incentive Stock Option. (b) Each Option will become exercisable in part or in full on the date or dates specified in the Option Agreement. (c) Upon the occurrence of a Change in Control of the Company, subject to any limitation set forth in the Option agreement, all outstanding Options shall become immediately exercisable in full. (d) Each Option and any related SARs shall terminate: (1) If the Optionee is then living, at the earliest of the following times: (i) ten years after the Date of Grant of the Option; (ii) five years after termination of employment because of retirement; (iii) one month after termination of employment other than termination because of retirement or through discharge for cause provided, however, that if any Option is not fully exercisable at the time of such termination of employment, such Option shall expire on the date of such termination of employment to the extent not then exercisable; (iv) immediately upon termination of employment through discharge for cause; or (v) any earlier time set forth in the Option Agreement. (2) If the Optionee dies while employed by the Company or any Subsidiary, or if no longer so employed, prior to termination of the entire Option under Section 6(d)(1)(ii) or (iii) hereof, one year after the date of death, but subject to earlier termination pursuant to Sections 6(d)(1)(i) or (v). However, notwithstanding the provisions of Sections 6(d)(1)(v), to the extent an Option is exercisable on the date of the Optionee's death, it shall remain exercisable until the sixtieth (60th) day following 4 the date of death. To the extent an Option is exercisable afrter the death of the Optionee, it may be exercised by the person or persons to whom the Optionee's rights under the Option Agreement have passed by will or by the applicable laws of descent and distribution. (e) Other conditions set forth in the Plan. If the Optionee exercises any Option or SAR with respect to some, but not all, of the shares of Common Stock subject to such Option or SAR, the right to exercise such Option or SAR with respect to the remaining shares shall continue until it lapses or terminates. No Option shall be exercisable except in respect of whole shares. The exercise of an Option or SAR may be made with respect to no fewer than ten shares at one time unless fewer than ten shares remain subject to the Option or SAR. Any exercise of an Option shall be effective on the Date of Exercise, provided the full purchase price of such shares or an effective Exercise Notice has been tendered with the notice of exercise. Payment of the purchase price upon the exercise of any Option shall be made in cash (including check, bank draft or money order), provided, however, that the Committee may, at its discretion, allow such payments to be made, in whole or in part, in shares of Common Stock delivered by the Optionee valued at Fair Market Value or by promissory note (containing such terms and conditions as the Committee may in its discretion determine) or by any combination thereof. Nothing in the Plan or in any Option Agreement shall in any way diminish the right of the company or any Subsidiary to reduce the compensation or to terminate the employment of any Optionee or Key Executive. 7. STOCK APPRECIATION RIGHTS The Committee may in its discretion grant SARs either concurrently with or subsequent to the Date of Grant of the related Option. A SAR shall be evidenced by provisions in the Option Agreement or an amendment or supplement thereto. SARs shall be subject to the following terms and conditions. (a) GRANT. The number of shares of Common Stock covered by a SAR shall not exceed the number of shares of Common Stock covered by the related Option. (b) EXERCISE. A SAR shall be exercisable, in whole or in part, at such time or times, on the conditions and to the extent set forth in the Option Agreement, but in no event will such SAR be exercisable; (i) At any time that the related Option is not exercisable; or (ii) At any time that the Fair Market Value of a share of Common Stock does not exceed the Option price of the related Option share. A SAR will terminate on the same date as the related Option. An Optionee shall be entitled upon exercise of a SAR to receive payment in the amount described in the definition of "Stock Appreciate Right". In connection with the exercise of a SAR, the Optionee thereof may, subject to the provisions of the following paragraph, request by application to the Committee to receive payment in the form of cash, shares of Common Stock, or a combination thereof. However, the Committee, in its sole discretion, shall determine the form of payment. 5 If a person who, in the opinion of the Committee, is or may be subject to Section 16 of the Securities Exchange Act of 1934, as amended from time to time, wishes to exercise a SAR and make application to receive payment in cash or partly in cash, such person shall do so only during the period beginning on the third business day following the date of release for publication of the Company's regular quarterly or annual summary statement of revenues and income (assuming such financial data appears on a wire service, in a financial news service, or in a newspaper of general circulation, or is otherwise made publicly available) and ending on the twelfth business day following such date and during the period described in the next sentence. A SAR may also be exercised and application to receive payment in cash or partly in cash made by such a person, subject to any limitations set forth in the Option Agreement, during the 30 day period that commences on the later of (a) the date of a Change in Control or (b) the date that is 6 months after the Date of Grant of the SAR provided that a Change in Control has occurred since the Date of Grant. The Committee may impose such additional conditions or limitations on exercise of a SAR as it may deem necessary or desirable to secure the Optionees the benefit of Rule 16b-3 of the Securities and Exchange Commission, as amended from time to time. 8. RESTRICTED SHARES Any shares of Common Stock issued or transferred pursuant to the Plan shall not be sold, transferred or otherwise disposed of by Optionees except in compliance with applicable registration requirements of state and federal securities laws unless in the opinion of counsel for the Company, such sale, transfer or disposition is exempt from registration. 9. ADJUSTMENT OF SHARES If any change is made in the Common Stock subject to the Plan, or subject to any Option or SAR, through merger, consolidation, reorganization, recapitalization, stock dividend, stock split, combination of shares, rights offerings, change in corporate structure of the Company, or otherwise, the Board in its discretion may make appropriate adjustment as to the number and type of securities subject to and reserved for issue or transfer under the Plan and, in order to prevent dilution or enlargement of the rights of Optionees, the number, type and Option price of securities subject to outstanding Options and SARs. 10. NONTRANSFERABILITY No Option or SAR is transferable by the Optionee other than by will or the laws of descent and distribution, and no Option or SAR is exercisable during the Optionee's lifetime by anyone other than the Optionee. 11. SHAREHOLDER'S RIGHTS Neither the Optionee nor the Optionee's legal representative, legatees or distributees, as the case may be, shall have any of the rights or privileges of a shareholder of the Company by virtue of the grant of an Option or SAR except with respect to any shares of Common Stock actually issues or transferred of record and delivered to one of the aforementioned persons. 12. TERMINATION, SUSPENSION OR MODIFICATION OF PLAN The Board may at any time terminate, suspend or modify the Plan. No termination, suspension or modification of the Plan shall adversely affect any right acquired by any Optionee under the terms of an Option or SAR granted before the date of such termination, suspension or modification, unless such Optionee shall consent. 6 13. GOVERNING LAWS The Plan and all rights and obligations thereunder shall be construed in accordance with and governed by the laws of the State of Minnesota. 14. TERM Unless previously terminated by the Board, the Plan shall terminate at the close of business on May 1, 1998. No Options or SARs shall be granted after Plan termination, but such termination shall not affect any Option or SAR previously granted. 15. AUTOMATIC GRANT TO NON-EMPLOYEE DIRECTORS Commencing with the first meeting of the Board in November 1990, each year on the date of the first meeting of the Board in November of each such year, each Non-Employee Director who is a director of the Company as of such date shall, without any Committee action, automatically be granted a Nonqualified Stock Option to purchase 500 shares of Common Stock (subject to adjustment upon changes in capitalization of the Company as provided in Section 9 of the Plan) at an exercise price per share equal to 100% of the Fair Market Value of one share of Common Stock on the date the Option is granted. Payment of the exercise price of the shares to be purchased under such Options must be made in cash only (including check, bank draft or money order) at the time of exercise of such Option. No SARs shall be granted in connection with such Options either concurrently with or subsequent to the Date of Grant of such Options. Each Option shall be evidenced by an appropriate form of agreement setting forth the terms described in this Section 15 and such additional terms of the Plan as are not inconsistent with the terms of this Section 15. Options granted pursuant to this Section 15 shall be immediately exercisable in full and shall remain exercisable until terminated in accordance with Section 6(d) of the Plan, provided that references in Section 6(d) to "employment" and "termination of employment" shall, for purposes of this Section 15, refer to "service as a director" and "termination of service as a director." The provisions of this Section 15 shall control with respect to such Options over any other inconsistent provisions of the Plan. It is intended that the provisions of this Section 15 shall not cause the Non-Employee Directors to cease to be considered Disinterested Persons and, as a result, the provisions of this Section 15 shall be interpreted to be consistent with the foregoing intent. 7 EX-10.(D) 7 EXHIBIT 10(D) THE ST. PAUL COMPANIES, INC. NON-EMPLOYEE DIRECTOR STOCK RETAINER PLAN 1. PURPOSE. The purpose of the Non-Employee Director Stock Retainer Plan (the "Plan") is to advance the interests of The St. Paul Companies, Inc. (the "Company") and its shareholders by providing non-employee directors with the ability to increase their proprietary interest in the Company's long-term success and progress and more closely identify themselves with the interests of the Company's shareholders through the payment of all or a portion of their annual retainer in the form of common stock of the Company that is subject to certain service-related restrictions. 2. ADMINISTRATION. The Plan shall be administered by a committee (the "Committee") consisting solely of three or more members of the Board of Directors of the Company (the "Board"). All questions of interpretation of the Plan or of any stock issued under it shall be determined by the Committee, and such determination shall be final and binding upon all persons having an interest in the Plan. The Committee, however, shall have no power to (a) determine the eligibility for participation in the Plan or the timing, pricing, amount or other terms and conditions of stock issued to any participant, or (b) take any action specifically delegated to the Board under the Plan. Members of the Committee shall be appointed from time-to-time by the Board, shall serve at the pleasure of the Board and may resign at any time upon written notice to the Board. A majority of the members of the Committee shall constitute a quorum. The Committee shall act by majority approval of the members present at a meeting and shall keep minutes of its meetings. Action of the Committee may be taken without a meeting if the written consent of all the members is given. 3. PARTICIPATION IN THE PLAN. Directors of the Company who are not employees of the Company or any subsidiary of the Company ("Eligible Directors") shall be eligible to participate in the Plan. 4. STOCK SUBJECT TO THE PLAN. (a) NUMBER OF SHARES. The maximum number of shares of Common Stock that shall be reserved for issuance under the Plan shall be 50,000 shares of the Company's common stock without par value (the "Common Stock"), subject to adjustment upon changes in capitalization of the Company as provided in Section 4(b) below. The maximum number of shares authorized may be increased from time-to-time by approval of the Board and, if required pursuant to Rule 16b-3 of the Securities and Exchange Commission or the applicable rules of any stock exchange, the shareholders of the Company. Shares of Common Stock that are issued under the Plan shall be applied to reduce the maximum number of shares of Common Stock remaining available for use under the Plan. 1 (b) CHANGES IN STOCK. If any change is made in the terms or provisions of the Common Stock subject to the Plan (whether by reason of reorganization, merger, consolidation, recapitalization, stock dividend, stock split, combination of shares, exchange of shares, change in corporate structure or otherwise), then appropriate adjustments shall be made to the maximum number of shares subject to and reserved under the Plan. 5. ANNUAL RETAINER ELECTION. (a) ELECTION TO RECEIVE STOCK. Each Eligible Director shall be given an opportunity by the Company, on an annual basis, to elect to receive all or a portion of his or her Annual Retainer (as defined below) for the succeeding calendar year in the form of shares of Common Stock that are subject to the service-related restrictions described in Section 5(b) below (the "Restricted Stock"). An election pursuant to this Section 5(a) must be in writing, must be effective before January 1 of the calendar year to which the election relates and must be irrevocable. Such an election will entitle the Eligible Director to be issued a number of shares of Restricted Stock determined by dividing 110% of the Annual Retainer for which the election is being made by the average of the Fair Market Value (as defined in Section 5(e) below) of one share of Common Stock as of the last trading day of each calendar quarter of the calendar year to which the election relates. In the event any person becomes an Eligible Director other than on January 1 of a year, such person shall not be entitled to participate in the Plan until the following year. An Eligible Director whose service on the Board terminates prior to the last trading day of a year shall not receive payment in the form of Common Stock regardless of whether he or she has made an election as described in this Section 5(a) but, rather, shall receive the portion of the Annual Retainer earned as of the date of service termination in cash. For purposes of the Plan, "Annual Retainer" for any given year shall mean the cash retainer to be paid to such Eligible Director in respect of service as a director but shall not include any per diem amounts paid with respect to Board or committee meeting attendance. (b) FORFEITURE RESTRICTIONS. If, within five years from the date Restricted Stock is issued to an Eligible Director, the Eligible Director's service on the Board is terminated for any reason other than death, Disability or Retirement (as these terms are defined below), such Restricted Stock shall be forfeited on the date the Eligible Director's service on the Board is terminated (the "Forfeiture Restrictions"). For purposes of the Plan, "Disability" shall mean the disability of the Eligible Director as defined in the long-term disability plan of the Company then covering the Eligible Director or, if no such plan exists or is not applicable to Eligible Directors, the permanent and total disability of the Eligible Director within the meaning of Section 22(e)(3) of the Internal Revenue Code of 1986, as amended, and "Retirement" shall mean the termination of service of an Eligible Director as a director of the 2 Company pursuant to and in accordance with the Board's tenure policy or other regular or, if approved by the Board for the purposes of the plan, early retirement/pension plan or other practice or policy then covering the Eligible Director. If an Eligible Director's service on the Board is terminated due to death, Disability or Retirement, the Forfeiture Restrictions with respect to all Restricted Stock then held by an Eligible Director shall lapse as of the date of such termination. (SECTION 5(b), AS AMENDED 11/2/93.) (c) DIVIDENDS AND DISTRIBUTIONS. Any dividends or distributions (including dividends or distributions paid in cash) paid with respect to shares of Common Stock subject to the Forfeiture Restrictions shall be paid to such Eligible Directors. (d) ENFORCEMENT OF RESTRICTIONS. For purposes of enforcing the Forfeiture Restrictions, a legend shall be placed on the stock certificates referring to such restrictions, and such stock certificates shall be kept, duly endorsed, in the custody of the Company. As a condition to the receipt of Restricted Stock, each Eligible Director shall grant to the Company a possessory lien on the Restricted Stock related thereto in order to secure retransfer of such shares into the name of the Company. (e) FAIR MARKET VALUE. For purposes of the Plan, "Fair Market Value" shall mean, as of any date, (i) if the Common Stock is listed or admitted to unlisted trading privileges on any national securities exchange or is not so listed or admitted but transactions in the Common Stock are reported by the NASDAQ National Market System, the closing sale price of the Common Stock on such exchange or by the NASDAQ National Market System as of such date (or, if no such shares were traded on such date, as of the next preceding day on which there was such a trade); or (ii) if the Common Stock is not so listed or admitted to unlisted trading privileges or reported on the NASDAQ National Market System, and bid and asked prices therefor in the over-the-counter market are reported by the NASDAQ System or the National Quotation Bureau, Inc. (or any comparable reporting service), the mean of the closing bid and ask prices of the Common Stock as of such date, as so reported. (f) FRACTIONS OF SHARES. Whenever under the terms of the Plan a fractional share would be required to be issued, the fractional share shall be rounded up to the next full share. 6. ISSUANCE OF CERTIFICATES AND WITHHOLDING. (a) As promptly as practicable following December 31 of each year, the Company shall issue stock certificates registered in the name of each Eligible Director entitled to receive Restricted Stock representing the number of shares of Restricted Stock issued to such Eligible Director pursuant to Section 3 5 above, and the last trading day of each year shall be deemed to be the date of issuance. (b) Anything to the contrary herein notwithstanding, the Company shall not be required to issue any shares of Common Stock under the Plan if, in the sole opinion of the Committee, the issuance and delivery of such shares would constitute a violation by the Eligible Director or the Company of any applicable law or regulation of any governmental authority, including without limitation federal and state securities laws, or the regulations of any stock exchange on which the Common Stock may then be listed. The certificates for the shares of Common Stock issued under the Plan shall be restricted by the Company as to transfer unless the Company receives an opinion of counsel satisfactory to the Company to the effect that registration under state or federal securities laws is not required with respect to such transfer. (c) The Company may make such provisions as it may deem appropriate for the withholding of any taxes which the Company determines it is required to withhold in connection with any stock issuance under this Plan. 7. RIGHTS AS A SHAREHOLDER. Subject to the restrictions described in Section 5 above, upon issuance and registration of the stock certificates the Eligible Director in whose name the certificates are registered shall have all of the rights of a shareholder with respect to such shares, including the right to vote the stock and to receive dividends and distributions with regard to the stock. Shares of Common Stock issued under the Plan shall be fully paid and non-assessable. 8. NO RIGHT TO CONTINUE AS A DIRECTOR. Neither the Plan, nor the issuing of Common Stock nor any other action taken pursuant to the Plan, shall constitute or be evidence of any agreement or understanding, express or implied, that the Company will retain an Eligible Director for any period of time, or at any particular rate of compensation. Nothing in this Plan shall in any way limit or affect the right of the Board or the shareholders of the Company to remove any Eligible Director or otherwise terminate his or her service as a director of the Company. 9. AMENDMENT OF THE PLAN. The Board may suspend or terminate the Plan or any portion thereof at any time and may amend the Plan from time-to-time in any respect the Board may deem to be in the best interests of the Company; provided, however, that (a) no such amendment shall be effective without approval of the shareholders of the Company, if shareholder approval of the amendment is then required pursuant to Rule 16b-3 under the Securities Exchange Act of 1934, or the applicable rules of any securities exchange, and (b) to the extent prohibited by Rule 16b-3(c)(2)(ii)(B) under the Securities Exchange Act of 1934, the Plan may not be amended more than once every six months. 4 10. EFFECTIVE DATE AND DURATION OF THE PLAN. The Plan shall, subject to approval at the 1992 Annual Meeting of Shareholders, be deemed effective January 1, 1992. Issuances of Common Stock under the Plan shall be subject to such shareholder approval. The Plan shall operate through December 31, 2006 and shall terminate after the December 31, 2006 issuances of Restricted Stock, but may be terminated prior thereto by action of the Board. No issuances shall be made after termination of the Plan. 11. GOVERNING LAWS. The Plan and all rights and obligations under the Plan shall be construed in accordance with and governed by the laws of the State of Minnesota. 5 EX-10.(E) 8 EXHIBIT 10(E) THE ST. PAUL COMPANIES, INC. AMENDED AND RESTATED SPECIAL SEVERANCE POLICY The Board of Directors of The St. Paul Companies, Inc. (the "Company") has determined that it is in the best interests of the Company and its stockholders to adopt The St. Paul Companies, Inc. Amended and Restated Special Severance Policy (the "Policy") to provide severance benefits to all Employees of the Company and its Subsidiaries, excluding John Nuveen & Co. Incorporated and its Subsidiaries, in the event their employment terminates following a Change in Control. The purpose of the Policy is to secure the continued services, dedication and objectivity of the employees of the Company and its Subsidiaries in the event of any threat or occurrence of a Change in Control without concern as to whether such employees might be hindered or distracted by personal uncertainties and risks created by any such actual or threatened Change in Control. 1. DEFINITIONS. The following definitions shall apply for purposes of the Policy: (a) "Base Salary" means the highest annual rate of salary or wages (excluding all bonus, overtime and incentive compensation) payable by the Company and its Subsidiaries to the Participant during the 12-month period immediately prior to the Participant's Date of Termination. (b) "Board" means the Board of Directors of the Company. (c) "Cause" means: (i) for Tier 1 Employees (A) the willful and continued failure of Participant to perform substantially Participant's duties with the Company (other than any such failure resulting from Participant's incapacity due to physical or mental illness) after a written demand for substantial performance is delivered to Participant by the Board which specifically identifies the manner in which the Board believes that Participant has not substantially performed Participant's duties, or (B) the willful engaging by Participant in illegal conduct or gross misconduct which is demonstrably and materially injurious to the Company or its affiliates. For purposes of this paragraph, no act or failure to act by Participant shall be considered "willful" unless done or omitted to be done by Participant in bad faith and without reasonable belief that Participant's action or omission was in the best interests of the Company or its affiliates. Any act, or failure to act, based upon authority given pursuant to a resolution duly adopted by the Board, based upon the advice of counsel for the Company shall be conclusively presumed to be done, or omitted to be done, by Participant in good faith and in the best interests of the Company. Cause shall not exist unless and until the Company has delivered to -2- Participant a copy of a resolution duly adopted by three-quarters (3/4) of the entire Board (excluding Participant if Participant is a Board member) at a meeting of the Board called and held for such purpose (after reasonable notice to Participant and an opportunity for Participant, together with counsel, to be heard before the Board), finding that in the good faith opinion of the Board an event set forth in clauses (A) or (B) has occurred and specifying the particulars thereof in detail; (ii) for Tier 2 Employees (A) the willful and continued failure of Participant to perform substantially Participant's duties with the Company (other than any such failure resulting from Participant's incapacity due to physical or mental illness) after a written demand for substantial performance is delivered to Participant by the Board which specifically identifies the manner in which the Board believes that Participant has not substantially performed Participant's duties, or (B) the willful engaging by Participant in illegal conduct or gross misconduct which is demonstrably and materially injurious to the Company or its affiliates. For purposes of this paragraph, no act or failure to act by Participant shall be considered "wilful" unless done or omitted to be done by Participant in bad faith and without reasonable belief that Participant's action or -3- omission was in the best interests of the Company or its affiliates; and (iii) for Tier 3 Employees (A) the willful and continued failure of Participant to perform substantially Participant's duties with the Company (other than any such failure resulting from Participant's incapacity due to physical or mental illness) or (B) the engaging by Participant in illegal conduct or gross misconduct which is injurious to the Company or its affiliates. (d) "Change in Control" means the occurrence of any one of the following events: (i) individuals who, on February 1, 1999, constitute the Board (the "Incumbent Directors") cease for any reason to constitute at least a majority of the Board, provided that any person becoming a director subsequent to February 1, 1999, whose election or nomination for election was approved by a vote of at least two-thirds of the Incumbent Directors then on the Board (either by a specific vote or by approval of the proxy statement of the Company in which such person is named as a nominee for director, without written objection to such nomination) shall be an Incumbent Director; PROVIDED, HOWEVER, that no individual initially elected or nominated as a director of the Company as a result of an actual or threatened election contest (as described in Rule 14a-11 under the -4- Securities Exchange Act of 1934 (the "Act")) ("Election Contest") or any other actual or threatened solicitation of proxies or consents by or on behalf of any "person" (as such term is defined in Section 3(a)(9) of the Act) other than the Board ("Proxy Contest"), including by reason of any agreement intended to avoid or settle any Election Contest or Proxy Contest, shall be deemed to be an Incumbent Director; (ii) any person is or becomes a "beneficial owner" (as defined in Rule 13d-3 under the Act), directly or indirectly, of securities of the Company representing 30% or more of the combined voting power of the Company's then outstanding securities eligible to vote for the election of the Board (the "Company Voting Securities"); PROVIDED, HOWEVER, that the event described in this paragraph (ii) shall not be deemed to be a Change in Control of the Company by virtue of any of the following acquisitions: (A) by the Company or any Subsidiary, (B) by any employee benefit plan (or related trust) sponsored or maintained by the Company or any Subsidiary, (C) by any underwriter temporarily holding securities pursuant to an offering of such securities, or (D) pursuant to any acquisition by Participant or any group of persons including Participant (or any entity controlled by Participant or any group of persons including Participant); -5- (iii) the consummation of a merger, consolidation, statutory share exchange or similar form of corporate transaction involving the Company or any of its Subsidiaries that requires the approval of the Company's stockholders, whether for such transaction or the issuance of securities in the transaction (a "Reorganization"), or sale or other disposition of all or substantially all of the Company's assets to an entity that is not an affiliate of the Company (a "Sale"), unless immediately following such Reorganization or Sale: (A) more than 60% of the total voting power of (x) the corporation resulting from such Reorganization or Sale (the "Surviving Company"), or (y) if applicable, the ultimate parent corporation that directly or indirectly has beneficial ownership of 100% of the voting securities eligible to elect directors of the Surviving Company (the "Parent Company"), is represented by Company Voting Securities that were outstanding immediately prior to such Reorganization or Sale (or, if applicable, is represented by shares into which such Company Voting Securities were converted pursuant to such Reorganization or Sale), and such voting power among the holders thereof is in substantially the same proportion as the voting power of such Company Voting Securities among the holders thereof immediately prior to the Reorganization of Sale, (B) no person (other than any employee benefit plan (or related trust) sponsored or maintained by the -6- Surviving Company or the Parent Company), is or becomes the beneficial owner, directly or indirectly, of 30% or more of the total voting power of the outstanding voting securities eligible to elect directors of the Parent Company (or, if there is no Parent Company, the Surviving Company) and (C) at least a majority of the members of the board of directors of the Parent Company (or, if there is no Parent Company, the Surviving Company) following the consummation of the Reorganization or Sale were Incumbent Directors at the time of the Board's approval of the execution of the initial agreement providing for such Reorganization or Sale (any Reorganization or Sale which satisfies all of the criteria specified in (A), (B) and (C) above shall be deemed to be a "Non-Qualifying Transaction"); or (iv) the stockholders of the Company approve a plan of complete liquidation or dissolution of the Company. Notwithstanding the foregoing, a Change in Control of the Company shall not be deemed to occur solely because any person acquires beneficial ownership of more than 30% of the Company Voting Securities as a result of the acquisition of Company Voting Securities by the Company which reduces the number of Company Voting Securities outstanding; PROVIDED THAT if after such acquisition by the Company such person becomes the beneficial owner of additional Company Voting Securities that increases the percentage of outstanding -7- Company Voting Securities beneficially owned by such person, a Change in Control of the Company shall then occur. (e) "Committee" means the Personnel and Compensation Committee of the Board. (f) "Compensation Rate" means, with respect to a Tier 3 Employee, the result of dividing (i) the sum of (A) the Employee's highest annual base salary earned with the Employer within the one-year period prior to such Employee's Date of Termination (or if employed by the Employer for less than one year, such Employee's annualized base salary) and (B) the Employee's highest total annual bonus and overtime pay earned in any of the three calendar years prior to such Employee's Date of Termination, by (ii) 52. (g) "Date of Termination" means the date on which a Participant's employment with the Participant's Employer terminates. (h) "Effective Date" means the date set forth in Section 14(b) of this Policy as the effective date of this Policy. (i) "Employee" means any regular, full-time employee of an Employer. (j) "Employer" means the Company or any Subsidiary which is covered by this Policy pursuant to Section 8. -8- (k) "Good Reason" means: (i) for Tier 1 Employees and Tier 2 Employees, the occurrence of any of the following events within the two-year period following a Change in Control without such Participant's express written consent: (A) (1) any change in the duties or responsibilities (including reporting responsibilities) of Participant that is inconsistent in any material and adverse respect with Participant's position(s), duties, responsibilities or status with the Company immediately prior to such Change in Control (including any material and adverse diminution of such duties or responsibilities) or (2) a material and adverse change in Participant's titles or offices (including, if applicable, membership on the Board) with the Company as in effect immediately prior to such Change in Control; (B) any reduction in Participant's rate of annual base salary or annual target bonus opportunity (including any material and adverse change in the formula for such annual bonus target) as in effect immediately prior to such Change in Control or as the same may be increased from time to time thereafter; (C) any requirement of the Company that Participant (1) be based anywhere more than thirty (30) miles from the office where Participant is located at the time of the Change in Control or (2) travel on -9- Company business to an extent substantially greater than the travel obligations of Participant immediately prior to such Change in Control; or (D) the failure of the Company to (1) continue in effect any employee benefit plan, compensation plan, welfare benefit plan or fringe benefit plan in which Participant is participating immediately prior to such Change in Control, or the taking of any action by the Company which would materially adversely affect Participant's participation in or reduce Participant's benefits under any such plan, unless Participant is permitted to participate in plans providing Participant with substantially equivalent benefits (at substantially equivalent cost with respect to welfare benefit plans), or (2) provide Participant with paid vacation in accordance with the most favorable vacation policies of the Employer as in effect for Participant immediately prior to such Change in Control, including the crediting of all service for which Participant had been credited under such vacation policies prior to the Change in Control. An isolated, insubstantial and inadvertent action taken in good faith and which is remedied by the Company within thirty (30) days after receipt of written notice thereof given by Participant to the Company's Senior Vice President, Human Resources shall not constitute Good Reason. Participant's right to terminate employment for Good Reason shall not be -10- affected by Participant's incapacities due to mental or physical illness and Participant's continued employment shall not constitute consent to, or a waiver of rights with respect to, any event or condition constituting Good Reason; and (ii) for Tier 3 Employees, the occurrence of any of the following events within the two-year period following a Change in Control without such Participant's express written consent: (A) any reduction of such Participant's Base Salary; or (B) any requirement of the Company that Participant be based anywhere more than thirty (30) miles from the office where Participant is located at the time of the Change in Control. An isolated, insubstantial and inadvertent action taken in good faith and which is remedied by the Company within thirty (30) days after receipt of written notice thereof given by Participant to the Company's Senior Vice President, Human Resources shall not constitute Good Reason. Participant's right to terminate employment for Good Reason shall not be affected by Participant's incapacities due to mental or physical illness and Participant's continued employment shall not constitute consent to, or a waiver of rights with respect to, any event or condition constituting Good Reason. -11- (l) "Qualifying Termination" means (i) a termination of a Participant's employment by the Employer other than for Cause during the two-year period following a Change in Control, (ii) a termination of a Participant's employment by such Participant for Good Reason during the two-year period following a Change in Control or (iii) the termination of employment by a Participant who is a Tier 1 Employee for any reason (or no reason at all) during the 30-day period commencing one year after the date of a Change in Control. Termination of a Participant's employment on account of Participant's death or on account of Participant's disability, as defined under the Employer's long-term disability plan, shall not be treated as a Qualifying Termination. Notwithstanding the foregoing, a Tier 3 Employee who has an Offer of Continued Employment, as defined below, shall in no event be deemed to have a Qualifying Termination. For purposes of this paragraph, "Offer of Continued Employment" means a job offer to a Tier 3 Employee by an Employer or an affiliate of an Employer (or a purchaser or transferee in the case of a sale or transfer of all or any portion of a Subsidiary, division or business operation of the Company or any Employer) for a position (x) with base compensation equal to or greater than the Employee's then current Base Salary and (y) at the Employee's then current work site or a location less than thirty (30) miles from the -12- Employee's then current work site (or in the case of virtual office Employees, a location less than thirty (30) miles from the office to which the Employee is assigned. (m) "Participant" means, as applicable, a Tier 1 Employee, a Tier 2 Employee or a Tier 3 Employee. (n) "Policy" means The St. Paul Companies, Inc. Amended and Restated Special Severance Policy. (o) "Separation Benefit" means the benefit payable in accordance with Section 3(a)(2) of this Policy. (p) "Subsidiary" means any corporation or other entity in which the Company has a direct or indirect ownership interest of 50% or more of the total combined voting power of the then outstanding securities or interests of such corporation or other entity entitled to vote generally in the election of directors or in which the Company has the right to receive 50% or more of the distribution of profits or 50% of the assets or liquidation or dissolution. (q) "Tier 1 Employee" means the Chairman of the Company, an executive officer of the Company who reports directly to the Chairman of the Company and any other Employee designated by the Committee as a Tier 1 Employee based on a determination that such Employee is in a position to contribute in substantial measure to -13- the successful achievement of the Employer's objectives. (r) "Tier 2 Employee" means an Employee whose annual Base Salary is at least $100,000, other than a Tier 1 Employee, and any other Employee who has substantially equivalent responsibilities and is designated by the Chief Executive Officer of the Company as a Tier 2 Employee. (s) "Tier 3 Employee" means an Employee other than a Tier 1 Employee or a Tier 2 Employee. 2. ELIGIBILITY. Each Tier 1 Employee who is an Employee at the time of the Change in Control and each Tier 2 and Tier 3 Employee who (a) is an Employee at the time of the Change in Control and (b) has completed at least three months of service with an Employer at the time such Employee's employment terminates shall be eligible to participate in this Policy. Notwithstanding the foregoing, if a Participant ceases to be an Employee prior to a Change in Control, such Participant shall have no further rights under this Policy; PROVIDED, HOWEVER, if such Participant is a Tier 1 Employee or a Tier 2 Employee and (i) such Participant's employment is terminated prior to a Change in Control for reasons that would have constituted a Qualifying Termination if they had occurred following a Change in Control; (ii) such Participant reasonably demonstrates that such termination (or Good Reason event) was at the request of a third party who had indicated an intention or taken -14 steps reasonably calculated to effect a Change in Control; and (iii) a Change in Control involving such third party (or a party competing with such third party to effectuate a Change in Control) does occur, then for purposes of this Policy, the date immediately prior to the date of such termination of employment or event constituting Good Reason shall be treated as a Change in Control. With respect to a Participant described in the immediately preceding sentence, the timing of payments and benefits to Participant under Section 3 shall be determined by treating the date of the actual Change in Control as the Tier 1 Employee's or Tier 2 Employee's Date of Termination hereunder. 3. PAYMENTS UPON TERMINATION OF EMPLOYMENT. If during the two-year period following a Change in Control the employment of a Participant shall terminate, by reason of a Qualifying Termination, then the Company shall provide to such Participant the following benefits: (1) Within thirty (30) days following the Participant's Date of Termination, the Company shall pay to such Participant a lump-sum cash amount equal to the sum of (A) the Participant's Base Salary (without regard to any reduction constituting Good Reason) through the Date of Termination and any bonus awards that have been awarded, but are not yet payable, (B) any accrued vacation or sick pay, and (C) any other accrued -15- compensation in each case to the extent not theretofore paid. (2) (A) Within thirty (30) days following the Date of Termination of a Tier 1 or Tier 2 Employee, the Company shall pay to such Tier 1 or Tier 2 Employee a lump-sum Separation Benefit, based upon the Participant's position (without regard to any change in position following a Change in Control which would constitute Good Reason hereunder) as of the Participant's Date of Termination, equal to: (i) for a Tier 1 Employee, three (3) times the sum of such Participant's Base Salary and target bonus for the year in which the Date of Termination occurs. (ii) for a Tier 2 Employee, two (2) times the sum of such Participant's Base Salary and target bonus for the year in which the Date of Termination occurs. (B) For a Tier 3 Employee, severance pay at the Employee's Compensation Rate, payable biweekly, equal to four weeks for each year of "vesting service" (as defined in the Employer's retirement plan, as in effect immediately prior to the Change in Control) with the Employer; provided, however, that no Employee shall receive such severance pay for less than 8 weeks or more than 52 weeks and, provided, further, that, if any -16- such biweekly payment is not timely paid, all remaining biweekly payments shall immediately become due and payable in full. (3) For a period commencing on the Date of Termination and continuing for the number of years equal to (i) the multiple used to determine the Separation Benefit for a Tier 1 or Tier 2 Employee and (ii) one year for a Tier 3 Employee, the Company shall continue to keep in full force and effect (or otherwise provide) all policies of medical, dental, accident, disability (other than long-term disability) and life insurance with respect to the Participant and Participant's dependents with the same level of coverage, upon the same terms and otherwise to the same extent as such policies shall have been in effect for such Participant immediately prior to the Date of Termination (or, if more favorable to the Participant, immediately prior to the Change in Control), and the Company and the Participant shall share the costs of the continuation of such insurance coverage in the same proportion as such costs were shared immediately prior to the Date of Termination. If the Participant cannot continue to participate in the policies of the Company (or the Participant's Employer) providing such benefits, the Company shall otherwise provide such benefits outside of the policies on the same -17- after-tax basis as if participation had continued. Notwithstanding the foregoing, if such Participant becomes reemployed with another employer and is eligible to receive any of the welfare benefits described in this Section 3(a)(3) from such employer, the Participant shall cease receiving such benefit under this Policy. (4) Outplacement assistance no less favorable than under the terms of the relevant outplacement assistance plan in effect at the time of the Change in Control for Employees at the same level of compensation, seniority and position with the Employer as the Participant; provided, however, that the Participant may elect prior to the Date of Termination in accordance with procedures established by the Committee to receive in lieu of outplacement assistance a lump sum cash payment equal to the cost of such outplacement assistance. 4. ADDITIONAL PAYMENTS OR LIMITATIONS ON PAYMENTS. (a) Payments made to a Tier 1 Employee shall be subject to the additional provisions of Exhibit A hereto. (b) Payments made to a Tier 2 Employee shall be subject to the additional provisions of Exhibit B hereto. 5. WITHHOLDING TAXES. The Company may withhold from all payments due to a Participant (or Participant's -18- beneficiary or estate) hereunder all taxes which, by applicable federal, state, local or other law, the Company or any Employer is required to withhold therefrom. 6. FULL SETTLEMENT; RESOLUTION OF DISPUTES. The Company's obligation to make the payments provided for in this Agreement and otherwise to perform its obligations hereunder shall not be affected by any set-off, counterclaim, recoupment, defense or other claim, right or action which the Company may have against the Participant or others. In no event shall the Participant be obligated to seek other employment or take any other action by way of mitigation of the amounts payable to the Participant under any of the provisions of this Agreement, and, except as set forth in Section 3(a)(3), such amounts shall not be reduced whether or not the Participant obtains other employment. 7. REIMBURSEMENT OF EXPENSES; ARBITRATION. The Company agrees to pay as incurred all legal fees and expenses which the Participant may reasonably incur as a result of any contest pursued or defended against in good faith by the Participant regarding the Policy plus in each case interest on any delayed payment at the applicable Federal rate provided for in Section 7872(f)(2)(A) of the Internal Revenue Code of 1986, as amended (the "Code"). Any dispute or controversy arising under or in connection with this Policy shall be settled exclusively by arbitration in the city nearest to the place of residence of the Employee in which a United States District Court is situated by three arbitrators in accordance with the rules of the American -19- Arbitration Association then in effect. Judgment may be entered on the arbitrators' award in any court having jurisdiction; provided, however, that the Employee shall be entitled to seek specific performance of such Employee's right to be paid under this Policy during the pendency of any dispute or controversy arising under or in connection with this Policy. The Company shall bear all costs and expenses arising in connection with any arbitration proceeding pursuant to this Section. 8. PARTICIPATING EMPLOYERS. Each U.S. based Subsidiary of the Company, except for the Subsidiaries set forth on Exhibit C hereto, shall, automatically and without action on the part of such Subsidiary, be deemed to be an Employer and the provisions of this Policy shall be fully applicable to the Employees of such Subsidiary. Any Subsidiary based outside of the U.S. shall, if approved by the Chief Executive Officer of the Company, be an Employer and the Employees of any such approved Subsidiary shall be covered hereunder pursuant to such terms and conditions as are approved by the Chief Executive Officer of the Company and set forth on Exhibit D, which shall not provide greater benefits than those provided to Employees of Employers which are U.S. based Subsidiaries of the Company. 9. TERMINATION OR AMENDMENT OF POLICY. (a) Subject to paragraph (b) below, this Policy shall be in effect as of the Effective Date. This Policy supersedes in its entirety the Special Severance Policy of -20- The St. Paul Companies which was approved by the Board on February 2, 1988. (b) The Company shall have the right prior to a Change in Control, in its sole discretion pursuant to action by the Board, to approve the termination or amendment of this Policy; PROVIDED, HOWEVER, that no such action which would adversely affect the rights or potential rights of Participants shall be effective if taken or approved by the Board during the twelve (12) month period prior to a Change in Control; and PROVIDED, FURTHER, that notwithstanding anything in paragraph (a) of this Section 9 to the contrary, in no event shall this Policy be terminated or amended following a Change in Control in any manner which would adversely affect the rights or potential rights of Participants under this Policy with respect to such Change in Control. 10. SUCCESSORS. (a) This Policy shall not be terminated by any merger, consolidation, share exchange or similar event involving the Company whereby the Company is or is not the surviving or resulting entity. In the event of any merger, consolidation, share exchange or similar event, the provisions of this Policy shall be binding upon the surviving or resulting corporation or the person or entity to which such assets are transferred. (b) This Policy shall inure to the benefit of and be enforceable by each Participant's personal or legal -21- representatives, executors, administrators, successors, heirs, distributees, devisees and legatees. If a Participant shall die while any amounts are payable to the Participant hereunder (including any payments which may be owed under Section 4), all such amounts, unless otherwise provided herein, shall be paid in accordance with the terms of this Policy to such person or persons appointed in writing by the Participant to receive such amounts or, if no person is so appointed, to the Participant's estate. 11. NON-SOLICITATION; NON-DISCLOSURE. The following conditions apply to the receipt of the payments and benefits provided for under this Policy; (a) The Participant, at all times during Participant's employment and for a period of one year immediately following termination for any reason, shall not, without the prior written consent of the Committee (or its delegate), solicit or take any action to cause the solicitation of any person who as of that date was a client, customer, policyholder, vendor, consultant or agent of the Company to discontinue business, in whole or in part with the Company. (b) The Participant, at all times during Participant's employment and for a period of one year immediately following the termination thereof for any reason, shall not, without the prior written consent of the Committee (or its delegate), employ or seek to employ any person employed at that time by the Company or any of its -22- Subsidiaries, or otherwise encourage or entice such person or entity to leave such employment. (c) The Participant shall keep secret and retain in the strictest confidence all confidential matters which relate to the Company, its Subsidiaries and affiliates, including, without limitation, customer lists, client lists, trade secrets, pricing policies and other business affairs of the Company, its Subsidiaries and affiliates learned by him from the Company or any such Subsidiary or affiliate or otherwise, and not to disclose any such confidential matter to anyone outside the Company or any of its Subsidiaries or affiliates, whether during or after Participant's period of service with the Company, except (i) as such disclosure may be required or appropriate in connection with Participant's work as an employee of the Company or (ii) when required to do so by a court of law, by any governmental agency having supervisory authority over the business of the Company or by any administrative or legislative body (including a committee thereof) with apparent jurisdiction to order Participant to divulge, disclose or make accessible such information. The Participant must give the Company advance written notice of any disclosure pursuant to clause (ii) of the preceding sentence and to cooperate with any efforts by the Company to limit the extent of such disclosure. Upon request by the Company, the Participant will deliver promptly to the Company upon termination of Participant's services for the Company, or at any time thereafter as the Company may request, all Company, Subsidiary or affiliate -23- memoranda, notes, records, reports, manuals, drawings, designs, computer files in any media and other documents (and all copies thereof) relating to the Company's or any Subsidiary's or affiliate's business and all property of the Company or any subsidiary or affiliate associated therewith, which Participant may then possess or have under Participant's direct control, other than personal notes, diaries, rolodexes and correspondence. 12. GOVERNING LAW; VALIDITY. The interpretation, construction and performance of this Policy, unless preempted by the Employee Retirement Income Act of 1974, as amended, ("ERISA"), shall be governed by and construed and enforced in accordance with the laws of the State of Minnesota without regard to the principle of conflicts of laws. The invalidity or unenforceability of any provision of this Policy shall not affect the validity or enforceability of any other provision of this Policy, which other provisions shall remain in full force and effect. 13. ADMINISTRATION. The Policy shall be administered by the Committee. Consistent with the requirements of ERISA and the regulations thereunder of the Department of Labor, the Committee shall provide adequate written notice to any Participant whose claim for Separation Benefits has been denied, setting forth specific reasons for such denial, written in a manner calculated to be understood by such Participant, and affording such Participant a full and fair review of the decision denying the claim. -24- 14. MISCELLANEOUS. (a) Neither the Company nor any Employer shall be required to fund or otherwise segregate assets to be used for the payment of any benefits under the Policy. The Company shall make such payments only out of its general corporate funds, and therefore its obligation to make such payments shall be subject to any claims of its other creditors having priority as to its assets. (b) The "Effective Date" of the Policy is February 1, 1999. (c) This Policy does not constitute a contract of employment or impose on the Company or the Participant's Employer any obligation to retain the Participant as an Employee, to change the status of the Participant's employment, or to change the policies of the Company or its Subsidiaries regarding termination of employment. (d) Any amounts payable to any Participant pursuant to any other plan, policy of, or agreement with, the Company or other Employer on account of Participant's termination of employment shall be offset against any payments made to such Participant pursuant to this Policy to the extent necessary to avoid the duplication of benefits. -25- EXHIBIT A CERTAIN ADDITIONAL PAYMENTS BY THE COMPANY. (a) Anything in this Policy to the contrary notwithstanding, in the event it shall be determined that any payment, award, benefit or distribution (or any acceleration of any payment, award, benefit or distribution) by the Company (or any of its affiliated entities) or any entity which effectuates a Change in Control (or any of its affiliated entities) to or for the benefit of a Participant who is a Tier 1 Employee (whether pursuant to the terms of this Policy or otherwise, but determined without regard to any additional payments required under this Exhibit A) (the "Payments") would be subject to the excise tax imposed by Section 4999 of the Internal Revenue Code of 1986, as amended (the "Code"), or any interest or penalties are incurred by the Participant with respect to such excise tax (such excise tax, together with any such interest and penalties, are hereinafter collectively referred to as the "Excise Tax"), then the Company shall pay to the Participant an additional payment (a "Gross-Up Payment") in an amount such that after payment by the Participant of all taxes (including any Excise Tax) imposed upon the Gross-Up Payment, the Participant retains an amount of the Gross-Up Payment equal to the sum of (x) the Excise Tax imposed upon the Payments and (y) the product of any deductions disallowed because of the inclusion of the Gross-Up Payment in the Participant's adjusted gross income and the highest -26- applicable marginal rate of federal income taxation for the calendar year in which the Gross-Up Payment is to be made. For purposes of determining the amount of the Gross-up Payment, the Participant shall be deemed to (i) pay federal income taxes at the highest marginal rates of federal income taxation for the calendar year in which the Gross-up Payment is to be made, (ii) pay applicable state and local income taxes at the highest marginal rate of taxation for the calendar year in which the Gross-up Payment is to be made, net of the maximum reduction in federal income taxes which could be obtained from deduction of such state and local taxes and (iii) have otherwise allowable deductions for federal income tax purposes at least equal to those which could be disallowed because of the inclusion of the Gross-up Payment in the Participant's adjusted gross income. Notwithstanding the foregoing provisions of this Exhibit A, if it shall be determined that the Participant is entitled to a Gross-Up Payment, but that the Payments would not be subject to the Excise Tax if the Payments were reduced by an amount that is less than 10% of the portion of the Payments that would be treated as "parachute payments" under Section 280G of the Code, then the amounts payable to the Participant under this Policy shall be reduced (but not below zero) to the maximum amount that could be paid to Participant without giving rise to the Excise Tax (the "Safe Harbor Cap"), and no Gross-Up Payment shall be made to the Participant. The reduction of the amounts payable hereunder, if applicable, shall be made by reducing first -27- the payments under Section 3(a) (2), unless an alternative method of reduction is elected by the Participant. For purposes of reducing the Payments to the Safe Harbor Cap, only amounts payable under this Policy (and no other Payments) shall be reduced. If the reduction of the amounts payable hereunder would not result in a reduction of the Payments to the Safe Harbor Cap, no amounts payable under this Policy shall be reduced pursuant to this provision. (b) All determinations required to be made under this Exhibit A, including whether and when a Gross-Up Payment is required, the amount of such Gross-Up Payment, the reduction of the Payments to the Safe Harbor Cap and the assumptions to be utilized in arriving at such determinations, shall be made by the public accounting firm that is retained by the Company as of the date immediately prior to the Change in Control (the "Accounting Firm") which shall provide detailed supporting calculations both to the Company and the Participant within fifteen (15) business days of the receipt of notice from the Company or the Participant that there has been a Payment, or such earlier time as is requested by the Company (collectively, the "Determination"). In the event that the Accounting Firm is serving as accountant or auditor for the individual, entity or group affecting the Change in Control, the Participant may appoint another nationally recognized public accounting firm to make the determinations required hereunder (which accounting firm shall then be referred to as the Accounting Firm hereunder). All fees and expenses of the Accounting -28- Firm shall be borne solely by the Company and the Company shall enter into any Agreement requested by the Accounting Firm in connection with the performance of the services hereunder. The Gross-up Payment with respect to any Payments shall be made no later than thirty (30) days following such Payment. If the Accounting Firm determines that no Excise Tax is payable by the Participant, it shall furnish the Participant with a written opinion to such effect, and to the effect that failure to report the Excise Tax, if any, on the Participant's applicable federal income tax return will not result in the imposition of a negligence or similar penalty. In the event the Accounting Firm determines that the Payments shall be reduced to the Safe Harbor Cap, it shall furnish the Participant with a written opinion to such effect. The Determination by the Accounting Firm shall be binding upon the Company and the Participant. As a result of the uncertainty in the application of Section 4999 of the Code at the time of the Determination, it is possible that Gross-Up Payments which will not have been made by the Company should have been made ("Underpayment") or Gross-up Payments are made by the Company which should not have been made ("Overpayment"), consistent with the calculations required to be made hereunder. In the event that the Participant thereafter is required to make payment of any Excise Tax or additional Excise Tax, the Accounting Firm shall determine the amount of the Underpayment that has occurred and any such Underpayment (together with interest at the rate provided in Section 1274 (b) (2) (B) of the Code) -29- shall be promptly paid by the Company to or for the benefit of the Participant. In the event the amount of the Gross-up Payment exceeds the amount necessary to reimburse the Participant for Participant's Excise Tax, the Accounting Firm shall determine the amount of the Overpayment that has been made and any such Overpayment (together with interest at the rate provided in Section 1274 (b) (2) of the Code) shall be promptly paid by the Participant (to the extent he has received a refund if the applicable Excise Tax has been paid to the Internal Revenue Service) to or for the benefit of the Company. The Participant shall cooperate, to the extent Participant's expenses are reimbursed by the Company, with any reasonable requests by the Company in connection with any contests or disputes with the Internal Revenue Service in connection with the Excise Tax. -30- EXHIBIT B LIMITATION ON PAYMENTS BY THE COMPANY. (a) Notwithstanding anything in this Policy to the contrary, in the event it shall be determined that any payment, award, benefit or distribution (or any acceleration of any payment, award, benefit or distribution) by the Company (or any of its affiliated entities) or any entity which effectuates a Change in Control (or any of its affiliated entities) to or for the benefit of a Participant who is a Tier 2 Employee (whether pursuant to the terms of this Policy or otherwise) (the "Payments") would be subject to the excise tax (the "Excise Tax") under Section 4999 of the Internal Revenue Code of 1986, as amended (the "Code"), then the amounts payable to the Participant under this Policy shall be reduced (reducing first the payments under Section 3(a) (2), unless an alternative method of reduction is elected by Participant) to the maximum amount as will result in no portion of the Payments being subject to such excise tax (the "Safe Harbor Cap"). For purposes of reducing the Payments to the Safe Harbor Cap, only amounts payable to the Participant under this Policy (and no other Payments) shall be reduced, unless consented to by the Participant. (b) All determinations required to be made under this Exhibit B shall be made by the public accounting firm that is retained by the Company as of the date immediately prior to the Change in Control (the "Accounting Firm"). In the event that the Accounting Firm is serving as accountant or auditor for the individual, entity or group effecting the Change in Control, the Participant may select another -31- nationally recognized public accounting firm to make the determinations required hereunder (which accounting firm shall then be referred to as the Accounting Firm hereunder). All fees, costs and expenses (including, but not limited to, the costs of retaining experts) of the Accounting Firm shall be borne by the Company. The determination by the Accounting Firm shall be binding upon the Company and the Participant (except as provided in paragraph (c) below). (c) If it is established pursuant to a final determination of a court or an Internal Revenue Service (the "IRS") proceeding which has been finally and conclusively resolved, that Payments have been made to, or provided for the benefit of, the Participant by the Company, which are in excess of the limitations provided in this Exhibit B (hereinafter referred to as an "Excess Payment"), such Excess Payment shall be deemed for all purposes to be a loan to the Participant made on the date the Participant received the Excess Payment and the Participant shall repay the Excess Payment to the Company on demand, together with interest on the Excess Payment at the applicable federal rate (as defined in Section 1274(d) of the Code) from the date of the Participant's receipt of such Excess Payment until the date of such repayment. As a result of the uncertainty in the application of Section 4999 of the Code at the time of the determination, it is possible that Payments which will not have been made by the Company should have been made (an "Underpayment"), consistent with the calculations required to be made under this Exhibit B. In the event that it is determined (1) by the Accounting Firm, the Company (which shall include the position taken by the Company, or together with its consolidated group, on its -32- federal income tax return) or the IRS or (2) pursuant to a determination by a court, that an Underpayment has occurred, the Company shall pay an amount equal to such Underpayment to the Participant within ten (10) days of such determination together with interest on such amount at the applicable federal rate from the date such amount would have been paid to the Participant until the date of payment. -33- EXHIBIT C EXCLUDED SUBSIDIARIES This Policy shall not apply to John Nuveen & Co. Incorporated or any of its Subsidiaries. -34- EX-10.(F) 9 EXHIBIT 10(F) CONFIDENTIAL SEPARATION AGREEMENT This Confidential Separation Agreement ("Agreement") is made and entered into as of the date indicated below between THE ST. PAUL COMPANIES, INC., including all of its subsidiaries, affiliates and related entities (collectively "St. Paul"), and Patrick A. Thiele ("EXECUTIVE"). St. Paul and Executive wish to provide for the separation of their employment relationship and all agreements that may have existed between them, and fully and finally to settle any and all disputes arising out of Executive's employment by St. Paul or the separation of that employment, without any admission of any kind by either party. Therefore, in consideration of the mutual promises and agreements set forth in this Agreement, St. Paul and Executive agree as follows: I. EMPLOYMENT SEPARATION A. SEPARATION DATE. Effective as of September 4, 1998 (the "Separation Date"), Executive's employment relationship with St. Paul will cease. Executive hereby resigns, effective as of the Separation Date, from all active employment with St. Paul and, effective as of August 21, 1998, from all directorships, offices and positions with St. Paul, including, without limitation, as a director of The St. Paul Companies, Inc. and The John Nuveen Company. B. SEPARATION. Effective on the Separation Date, Executive shall have no duties and no authority to make any representations or commitments on behalf of St. Paul. Thereafter, Executive shall have no further rights deriving from Executive's employment by St. Paul, and shall not be entitled to any further compensation or non-vested benefits, except as provided in this Agreement. Executive agrees to vacate St. Paul premises on the Separation Date. II. CONSIDERATION Subject to Executive's compliance with, and in exchange for, the promises contained in Section III, and subject further to the effectiveness of the Waiver and Release of Claims and Covenant Not To Sue set forth in Section IV, and to the terms and conditions set forth in this Agreement, St. Paul agrees to provide Executive with the payments and benefits set forth in this Section II ("Consideration"). The payments and other benefits to be provided hereunder are in place of, and not in addition to, payments otherwise provided under The St. Paul Companies, Inc. Severance Plan or any other St. Paul severance plan or policy. No payments will be made hereunder until the Effective Date, as defined in Section IV. In no event shall Executive be obligated to seek other employment or take other action by way of mitigation of the amounts payable to Executive under any of the provisions of this Agreement. (1) A. SEPARATION PAYMENT. 1. SEPARATION PAYMENT; BASE SALARY CONTINUATION. St. Paul will pay Executive a separation payment of $900,000, on or promptly after the Separation Date. In addition, St. Paul will pay Executive a separation payment equal to One Million, Two Hundred Thousand Dollars ($1,200,000.00), payable in equal installments over a twenty-four (24) month period on the first of each month in advance, PROVIDED that the first installment hereunder will be paid as of the first day of the month following the month in which Effective Date occurs. 2. ADDITIONAL PAYMENT. Executive will be eligible to receive an annual incentive bonus for the calendar year containing Executive's Separation Date, (1998) and for the two calendar years following such year (1999 and 2000) payable on the date that incentive bonuses with respect to such calendar years are paid to active employees under the terms of The St. Paul Companies, Inc. Annual Incentive Plan. The bonus amount payable pursuant to this Subsection in respect of 1998 will equal the incentive bonus to which Executive would have been entitled to receive at Executive's opportunity level immediately prior to the Separation Date in accordance with the terms of said Annual Incentive Plan multiplied by the achievement percentage which applies to the Chief Executive Officer of The St. Paul Companies, Inc. for 1998, and the bonus amount payable pursuant to this Subsection in respect of each of 1999 and 2000 shall be $300,000 per year. B. STOCK OPTIONS. 1. 1998 GRANT. The option to purchase 98,982 shares of common stock of The St. Paul Companies, Inc. granted to Executive in 1998 pursuant to the 1994 Stock Incentive Plan shall expire as of the Separation Date. St. Paul will grant Executive a stock appreciation right in the form attached hereto as Appendix A (the "1998 SAR") in respect of 98,982 shares of common stock of The St. Paul Companies, Inc. 2. OTHER OPTIONS. All options held by Executive which are vested and exercisable as of the Separation Date will remain exercisable for a period of one month following the Separation Date (the "Expiration Date") in accordance with the terms of The St. Paul Companies, Inc. 1988 or 1994 Stock Incentive Plan, as the case may be. St. Paul will grant Executive a stock appreciation right (the "Vested SAR") in the form attached hereto as Appendix A with respect to options which are vested and remain unexercised as of the Expiration Date. All options, other than the 1998 Grant, which have not vested as of the Separation Date, including without limitation the "mega-grant," which will be canceled, will be treated in accordance with the terms of the applicable grant and shall expire as of the Separation Date. (2) 3. COMPENSATION COMMITTEE APPROVAL. St. Paul represents to Employee that the grant of the 1998 SAR and the Vested SAR to Executive have been approved, or will have been approved prior to September 4, 1998, by the Compensation Committee of The St. Paul Companies, Inc. Board of Directors, which is comprised solely of Non-Employee Directors (as defined in Rule 16b-3 under the Securities Exchange Act of 1934). C. RESTRICTED STOCK. St. Paul will allow the sale restrictions applicable to the 8,000 (post-stock split) shares of restricted stock granted to Executive on May 2, 1994 which remain subject to restrictions as of the Separation Date to lapse as of their regular vesting date of May 2, 1999. D. LTIP PAYMENT. Executive will receive a long-term incentive award under The St. Paul Companies, Inc. Long-Term Incentive Plan for the 1996-1998 performance period, payable in a single lump sum at the same time that active employees will receive payment of their long-term incentive awards for the 1996-1998 performance period. This payment will equal the amount that would have been payable to Executive had Executive remained employed with St. Paul through December 31, 1998. E. EXECUTIVE RETIREMENT PLAN BENEFITS. Executive will be entitled to receive a benefit under the Executive Retirement Plan component of The St. Paul Companies, Inc. Benefit Equalization Plan equal to the actuarial present value of Executive's Executive Retirement Plan benefits, if any, under the Executive Retirement Plan provisions of The St. Paul Companies, Inc. Benefit Equalization Plan as of the date Executive becomes eligible to receive benefits under the Plan (the "Benefit Commencement Date"). For purposes of the preceding sentence, the actuarial present value of Executive's Executive Retirement Plan benefits shall be computed in the same manner and using the same actuarial assumptions used by The St. Paul Companies, Inc. Employees' Retirement Plan to determine the actuarial present value of a person's retirement benefits thereunder as of the Benefit Commencement Date; PROVIDED, HOWEVER, that for this purpose Executive will be credited with an additional two years of service. The Executive Retirement Plan benefit (including any death benefit) payable pursuant to this Subsection E. shall be in full satisfaction of the Executive Retirement Plan benefits payable to Executive pursuant to the Executive Retirement Plan provisions of The St. Paul Companies, Inc. Benefit Equalization Plan. F. BENEFITS CONTINUATION. St. Paul will continue to provide, for a period of twenty-four (24) months following the Separation Date, or until the date that Executive becomes eligible to participate in the welfare plans of a new employer, if earlier, the Executive's family medical and dental coverage, life, long-term disability and AD&D insurance currently provided under The St. Paul Companies, Inc. Employee Benefit Plan under substantially the same terms and conditions (including contributions or premium payments required from Executive for such benefits) as (3) applicable from time to time to senior executives of The St. Paul Companies, Inc., PROVIDED, that if Executive cannot continue to participate in any such Employee Benefit Plan under its terms, St. Paul will otherwise provide comparable benefits on the same after-tax basis as if continued participation had been permitted. After the expiration of the continuation coverage period, Executive may elect to convert his employee/dependent life insurance coverage to an individual policy in accordance with the provisions of The St. Paul Companies, Inc. Employee Benefit Plan. G. MISCELLANEOUS PAYMENTS. St. Paul will pay Executive One Hundred Thirty-Six Thousand, Seven Hundred and Ninety-Eight Dollars ($136,798) as soon as practicable following the Separation Date. H. VACATION. Executive will receive payment for any unused, earned regular, banked or purchased vacation days, as well as any unused floating holidays, credited to Executive as of the Separation Date. Such payment will be made with Executive's final regular payroll check. I. OUTPLACEMENT SERVICES. Executive will receive outplacement services from Lee Hecht Harrison at St. Paul's expense, for a period of up to one-year following the Separation Date. Such outplacement services will include the provision of an office and secretarial, telephone and telecopier services for use by the Executive during such one-year period; PROVIDED THAT St. Paul may elect to provide Executive with office, secretarial, telephone and telecopier services on the Company's premises or in other office space provided for Executive. J. ACKNOWLEDGMENT. Executive acknowledges that the Consideration provided in this Agreement, which is in place of other payments and benefits, is good and valuable consideration in exchange for this Agreement, and includes payments and benefits to which Executive is not otherwise entitled. K. WITHHOLDING. St. Paul will withhold from the compensation and benefits payable to Executive under Section II of this Agreement all appropriate deductions for employee benefits, if applicable, and the amounts necessary for St. Paul to satisfy its withholding obligations under Federal, state and local income and employment tax laws. III. EXECUTIVE'S COVENANTS TO ST. PAUL The parties desire to provide for the protection of the business, good will, confidential information, relationship and other proprietary rights of St. Paul. Accordingly, Executive agrees to the following: (4) A. PROPERTY OF ST. PAUL. By the Separation Date, Executive will return to St. Paul all Company property, including, but not limited to all identification cards; files; computer hardware, software, equipment and disks; keys; Company owned or leased vehicles; credit cards; and records. B. FUTURE CONDUCT. Executive agrees that he shall refer any inquiries from the media, financial analysts or St. Paul shareholder communities concerning the reasons for his departure from St. Paul to the Senior Vice President-Human Resources or Senior Vice President-Chief Legal Counsel of St. Paul and shall not provide any such persons with any information concerning the reasons for his departure beyond that described in St. Paul's announcement of Executive's departure. Executive further agrees not to engage in any discussion with any former or present director of St. Paul concerning his reasons for departure without first informing the Senior Vice President-Human Resources of St. Paul or its Senior Vice President-Chief Legal Counsel. For purposes of this paragraph, St. Paul and Executive further agree, however, that, subject to the following sentence and the other provisions of this agreement, Executive may explain, solely in connection with his search for future employment, that the primary reason for his departure was the decision of the Board of Directors of The St. Paul Companies, Inc. that Executive would not be considered as a candidate to become President or CEO of The St. Paul Companies, Inc. and that, although Executive was offered another executive position within St. Paul, he would not continue as President of world wide insurance operations. Executive agrees not to engage in any form of conduct, or make any statements or representations, that disparage or otherwise harm the reputation, goodwill or commercial interests of St. Paul or its management. In addition, Executive agrees to cooperate fully with St. Paul, including its attorneys or accountants, in connection with any potential or actual litigation, or other real or potential disputes, which directly or indirectly involves St. Paul. Executive agrees to appear as a witness and be available to attend depositions, consultations or meetings regarding litigation or potential litigation as reasonably requested by St. Paul. St. Paul acknowledges that these efforts, if necessary, will impose on Executive's time and would likely interfere with other commitments Executive may have in the future. Consequently, St. Paul shall attempt to schedule such depositions, consultations or meetings in coordination with Executive's schedule, but Executive recognizes that scheduling of certain court proceedings, including depositions, may be beyond St. Paul's control. Likewise, St. Paul agrees to provide Executive with reasonable compensation for Executive's time spent traveling to and from and attending such depositions, consultations or meetings, not to include ancillary time spent at hotels and related locations during evenings between proceedings. St. Paul also agrees to reimburse Executive for the out-of-pocket expenditures actually and reasonably incurred by Executive in connection with the performance of the services contemplated by this Subsection, including hotel accommodations, air fare transportation and meals consistent with St. Paul's generally-applicable expense reimbursement policies. It is expressly understood by the parties that any compensation paid by St. Paul to Executive under this Subsection shall be in exchange for Executive's time and is not intended or (5) understood to be dependent upon the character of content of any information Executive discloses in good faith in any such proceedings, meetings or consultation. C. CONFIDENTIALITY OF THIS AGREEMENT. Executive and St. Paul agree that this Agreement and its terms will be regarded as privileged and confidential communications between the parties, and that neither they nor their counsel will reveal or disclose either the terms or the substance of this Agreement to any other person, except as required by law (including the securities laws), subpoena, court order or other legal process. This restriction applies to any members of the public, and to any current, future or former employees of St. Paul. If disclosure is compelled by law (including the securities laws), subpoena, court order or other legal process, or as otherwise required by law, the party so compelled agrees to notify the other party as soon as notice of such requirement or process is received and before disclosure takes place. Notwithstanding these provisions, Executive may disclose the terms of this Agreement to members of Executive's immediate family, Executive's accountant or financial advisor, and Executive's attorney upon their agreement to maintain this Agreement in strict confidence, as set forth in this Subsection. Further, nothing in this Subsection limits St. Paul's ability to disclose the information internally to those persons with a legitimate business reason to have access to the information. D. CONFIDENTIAL INFORMATION. Executive acknowledges that he has had access to confidential Company business information (including, but not limited to, future business plans, pricing strategies, marketing plans, customer lists, agent/broker lists, underwriting objectives, financial information and personnel information) concerning the business, plans, finances and assets of St. Paul ("Confidential Information") and which is not generally known outside St. Paul. For all time, Executive agrees that he shall not, without the proper written authorization of St. Paul, directly or indirectly use, divulge, furnish or make accessible to any person any Confidential Information, but instead shall keep all Confidential Information strictly and absolutely confidential. Executive will use reasonable and prudent care to safeguard and prevent the unauthorized use or disclosure of Confidential Information. Further, Executive expressly acknowledges that the terms of this Subsection are material to this Agreement, and if Executive breaches the terms of this Subsection, Executive shall be responsible for all damages and, at the election of St. Paul, the return of all consideration paid hereunder, without prejudice to any other rights and remedies that St. Paul may have. Executive acknowledges and agrees that the Confidential Information and special knowledge acquired during Executive's employment with St. Paul is valuable and unique, and that breach by Executive of the provisions of this Agreement as described in this Subsection will cause St. Paul irreparable injury and damage, which cannot be reasonably or adequately compensated by money damages. Executive, therefore, expressly agrees that St. Paul shall be entitled to injunctive or other equitable relief in order to prevent a breach of this Agreement or any part thereof, in (6) addition to such other remedies legally available to St. Paul. Executive expressly waives the claim that St. Paul has an adequate remedy at law. E. SOLICITATION OF EMPLOYEES. Executive shall not, at any time prior to the Separation Date or during twenty-four (24) month period following the Separation Date, solicit, participate in or promote the solicitation of any person who was employed by St. Paul on the Separation Date to leave the employ of St. Paul or, on behalf of himself or any other person, hire, employ or engage any such person. Executive further agrees that, during such time, if an employee of St. Paul contacts Executive about prospective employment, Executive will inform such employee that he or she cannot discuss the matter further without informing St. Paul. F. SOLICITATION OF CLIENTS, CUSTOMERS, ETC. Executive shall not, at any time prior to the Separation Date or during the twenty-four (24) month period following the Separation Date, solicit or take any action to cause the solicitation of any person who, as of the Separation Date was a client, customer, policyholder, vendor, consultant or agent of St. Paul to discontinue business, in whole or in part with St. Paul. This provision is not intended to apply to situations in which an independent agent, who has a pre-existing relationship with an insurer or other subsequent employer of Executive, decides of his or her own volition to do business with such insurer or other employer which has the effect of reducing the business of St. Paul with such independent agent; PROVIDED, that Executive has not personally instigated or caused such independent agent to discontinue business with St. Paul. Executive further agrees that, during such time, if a client, customer, policyholder, vendor, consultant or agent of St. Paul contacts Executive about discontinuing business with St. Paul and/or moving that business elsewhere, Executive will inform such person that he cannot discuss the matter further without informing St. Paul. IV. GENERAL WAIVER, RELEASE AND COVENANT NOT TO SUE BY EXECUTIVE A. GENERAL WAIVER AND RELEASE BY EXECUTIVE. 1. As a material inducement to St. Paul to enter into this Agreement, and in consideration of St. Paul's promise to make the payments and provide the benefits set forth in this Agreement, Executive hereby knowingly and voluntarily releases and forever discharges St. Paul, and all of its Affiliates, parents, subsidiaries and related entities, and all of their past, present and future respective agents, officers, directors, shareholders, employees, attorneys and assigns from any federal, state or local charges, claims, demands, actions, liabilities, suits, or causes of action, at law or equity or otherwise and any and all rights to or claims for continued employment after the Separation Date, attorneys fees or damages including contract, compensatory, punitive or liquidated damages) or equitable relief, which he may ever have had, has now or may ever have or which Executive's heirs, executors or assigns can or shall have, against any or all of them, (7) whether known or unknown, on account of or arising out of Executive's employment with St. Paul or the termination thereof. 2. This release includes, but is not limited to, rights and claims arising under the Age Discrimination in Employment Act of 1967, as amended by the Older Workers Benefit Protection Act of 1990, Title VII of the Civil Rights Act of 1964, as amended, the Americans with Disabilities Act, the Fair Labor Standards Act, any state or local human rights statute or ordinance, any claims or rights of action relating to breach of contract, public policy, personal or emotional injury, defamation, additional compensation, or fringe benefits. Executive specifically waives the benefit of any statute or rule of law which, if applied to this Agreement, would otherwise exclude from its binding effect any claims not now known by Executive to exist. This release does not purport to waive claims arising under these laws after the date of this Agreement. 3. Executive acknowledges that he has reviewed the information about the severance offer described above as part of this Agreement. Executive confirms that he has been given at least twenty-one (21) days within which to consider this Agreement and the General Waiver and Release contained herein. Executive further confirms that he has been advised in writing prior to his execution of this Agreement to consult with legal counsel. Executive acknowledges that if he executes this Agreement prior to the expiration of twenty-one (21) days, or chooses to forgo the advice of legal counsel, or any personal or financial advisor, he does so freely and knowingly, and waives any and all future claims that such action or actions would affect the validity of this Agreement. Executive acknowledges that any changes made to this Agreement after its first presentation to Executive, whether material or immaterial, do not restart the tolling of this twenty-one (21) day period. 4. Executive understands that he may revoke this Agreement at any time on or before the fifteenth (15th) day following the date on which he signs the Agreement. To be effective, the decision to revoke must be in writing and delivered to St. Paul, personally or by certified mail, to the attention of: Bruce A. Backberg, Esq. Senior Vice President The St. Paul Companies, Inc. 385 Washington Street St. Paul, Minnesota 55102-1396 on or before the fifteenth (15th) day after Executive signs the Agreement. In no case will this Agreement become effective or enforceable against the Executive or St. Paul until the expiration of the fifteen (15) day revocation period (the "Effective Date"). If Executive exercises this limited right to revoke, or if the release provisions of Section V are held invalid for any reason (8) whatsoever, Executive agrees to return any consideration received under the terms of this Agreement and that St. Paul is released from any obligations under this Agreement. B. COVENANT NOT TO SUE. Executive covenants and agrees not to sue or bring any action, whether federal, state, or local, judicial or administrative, now or at any future time, against St. Paul, its Affiliates, its or their respective agents, directors, officers or employees, with respect to any claim released hereby or arising out of Executive's employment with St. Paul or its Affiliates. Nevertheless, this Agreement does not purport to limit any right Executive may have to file a charge under the ADEA or other civil rights statute or to participate in an investigation or proceeding conducted by the Equal Employment Opportunity Commission or other investigatory agency. This Agreement does, however, waive and release any right to recover damages under the ADEA or other civil rights statute. V. MISCELLANEOUS PROVISIONS A. NON-ASSIGNMENT OF CLAIMS. Executive represents and warrants that Executive has not sold, assigned, transferred, conveyed or otherwise disposed of to any third-party, by operation of law or otherwise, any action, cause of action, suit, debt, obligation, account, contract, agreement, covenant, guarantee, controversy, judgment, damage, claim, counterclaim, liability or demand of any nature whatsoever relating to any matter covered by this Agreement. B. SUCCESSORS. This Agreement shall be binding upon, enforceable by and inure to the benefit of Executive's personal or legal representatives, executors, administrators, successors, heirs, distributees, devisees and legatees and St. Paul and any successor company, but neither this Agreement nor any rights or payments arising hereunder may be assigned, pledged, transferred or hypothecated by Executive. C. CONTROLLING LAW AND VENUE. THE VALIDITY OF THIS AGREEMENT AND ANY OF ITS PROVISIONS AND CONDITIONS, AS WELL AS THE RIGHTS AND DUTIES OF THE PARTIES, SHALL BE INTERPRETED AND CONSTRUED PURSUANT TO AND IN ACCORDANCE WITH THE INTERNAL LAWS, AND NOT THE LAW OF CONFLICTS, OF THE STATE OF MINNESOTA. THE PARTIES SELECT AND IRREVOCABLY SUBMIT TO THE EXCLUSIVE JURISDICTION OF ANY MINNESOTA OR UNITED STATES FEDERAL COURT SITTING IN THE STATE OF MINNESOTA FOR ANY ACTION TO ENFORCE, CONSTRUE OR INTERPRET THIS AGREEMENT. THE PARTIES FURTHER WAIVE ANY OBJECTION TO VENUE IN SUCH STATE ON THE BASIS OF FORUM NON CONVENIENS OR OF CONVENIENCE OF THE PARTY. D. AMENDMENT. Any amendment to this Agreement shall only be made in writing and signed by the parties. (9) E. WAIVER. No claim or right arising out of a breach or default under this Agreement can be discharged by a waiver of that claim or right unless the waiver is in writing signed by the party hereto to be bound by such waiver. A waiver by any party of a breach or default by the other party of any provision of this Agreement shall not be deemed a waiver of future compliance with such provision, and such provision shall remain in full force and effect. F. NOTICE. All notices, requests, demands and other communications under the Agreement shall be in writing and delivered in person or sent by certified mail, postage prepaid, and properly addressed as follows: To Executive: Patrick A. Thiele 3 Edgcumbe Place St. Paul, Minnesota 55116 To St. Paul: Bruce A. Backberg Senior Vice President The St. Paul Companies, Inc. 385 Washington Street, Mail Code: 102U St. Paul, Minnesota 55102-1396 The parties agree to notify each other promptly of any change in mailing address. G. HEADINGS. Headings used in this Agreement are for reference purposes only and shall not be deemed to be a part of this Agreement. H. ENTIRE AGREEMENT. St. Paul and Executive each represent and warrant that no promise or inducement has been offered or made except as set forth and that the consideration stated is the sole consideration for this Agreement. This Agreement and the Exhibit(s) hereto is a complete agreement and states fully all agreements, understandings, promises and commitments as between Executive and St. Paul as to the separation of Executive from employment by St. Paul. This Agreement supersedes any prior agreements, whether oral or written, between Executive and St. Paul. Except as expressly provided herein, Executive is not entitled to any other or further compensation or remuneration. I. STATUTORY INDEMNIFICATION. Pursuant to Minn. Stat. Section 181-970, Subd. 1, "An employer shall defend and indemnify its employee for civil damages, penalties or fines claimed or levied against the employee provided that the employee: (1) was acting in the performance of the duties of the employee's position; (2) was not guilty of intentional misconduct, willful neglect of the duties of the employee's position, or bad faith; and (3) has not been indemnified by another Person for the same damages, penalties or fines." St. Paul warrants to Executive that it will (10) comply with the requirements of this statute and with any other indemnity obligations owing to Executive arising out of Executive's service as a director or officer of St. Paul. J. UNEMPLOYMENT COMPENSATION. In the event that Executive files a claim for unemployment compensation or re-employment insurance benefits, St. Paul agrees that it will not contest Executive's claims on any grounds, including, without limitation, that Executive has voluntarily resigned from employment or committed acts of disqualifying misconduct. Nothing contained in this paragraph prohibits St. Paul from correcting misstatements made by Executive. K. REFERENCES. St. Paul warrants that those employees who were made aware of the circumstances of Executive's termination from St. Paul's employ shall not make statements or representations that disparage or otherwise harm the reputation of Executive. St. Paul agrees that if requested by Executive St. Paul will cause its officers and directors to provide favorable oral or written employment references. L. ASSISTANCE. St. Paul agrees to assist Executive in satisfying Executive's obligations to complete and file Forms 4 and/or 5 under the Securities Exchange Act of 1934. M. AMBIGUITY. Executive and St. Paul and counsel for both Executive and St. Paul have reviewed this Agreement. Therefore the normal rule of construction that any ambiguity or uncertainty in a writing shall be interpreted against the Party drafting the writing shall not apply to any action on this Agreement. IN WITNESS WHEREOF, the parties hereto have executed this Agreement on the day and year set forth below: PATRICK A. THIELE THE ST. PAUL COMPANIES, INC. /s/ Patrick A. Thiele By: /s/ Bruce A. Backberg - - ------------------------- ------------------------- Its: SVP Date: September 1, 1998 Date: September 1, 1998 (11) Appendix A [Letterhead of The St. Paul Companies, Inc.] September __, 1998 Patrick A. Thiele 3 Edgcumbe Place St. Paul, Minnesota 55116 Re: STOCK APPRECIATION RIGHTS Dear Mr. Thiele: In connection with your Separation Agreement with The St. Paul Companies, Inc. ("St. Paul") dated September 1, 1998, you have been awarded Stock Appreciation Rights (the "SARs") on the terms and conditions set forth below. I. 1998 SARS You are hereby granted 98,982 SARs, each entitling you to receive any increase in the fair market value of one share of common stock, without par value (the "Common Stock") of the St. Paul over $43.9375 per share (the "1998 SARs"). You may elect to receive payment as described below with respect to all or any part of the 1998 SARs remaining outstanding beginning on February 3, 1999 through and until September 4, 2000. After September 4, 2000, all 1998 SARs then outstanding will expire and you shall have no right to receive any corresponding payment. II. VESTED SARS You hold options that are presently exercisable and that were granted in February of each year from 1992 through 1997 (each an "Annual Option Grant"). These options will, by their terms, terminate on the date (the "Option Termination Date") one month after your termination of employment with St. Paul, and you and St. Paul wish to provide a contractual replacement for any options that are so terminated prior to exercise ("Unexercised Vested Options") on terms that will give you the potential to benefit in the appreciation through September 4, 2000 of the fair market value of Common Stock over the original exercise price of the option so terminated. You are hereby granted SARs (the "Vested SARs") in respect of the number of shares of Common Stock (if any) in each Annual Option Grant that after the Option Termination Date are Unexercised Vested Options. Each such SAR shall entitle you to receive any increase in the fair market value of one share of Common Stock over the Exercise Price set forth below in STOCK APPRECIATION RIGHTS September 4, 1998 Page 2 respect of such Annual Option Grant. You may elect to receive payment as described below with respect to all or any part of the Vested SARs remaining outstanding beginning on January 1, 1999 through and until September 4, 2000. After September 4, 2000, all Vested SARs then outstanding shall expire and you shall have no rights to receive any corresponding payment. You agree that you will not seek to exercise any outstanding option after the Option Termination Date.
Annual Option Outstanding Unexercised Grant Date Options (8/21/98) Vested Options Exercise Price ------------- ----------------- -------------- -------------- 2/3/92 26,000 * $ 17.9375 2/2/93 30,000 * 19.7500 2/1/94 41,600 * 21.5938 2/7/95 60,000 * 23.9375 2/6/96 70,000 * 29.0000 2/3/97 89,628 * 31.5000 ----------
* Equals number of options granted at annual option grant date and not exercised on or prior to Option Termination Date. III. PAYMENT As soon as practicable after the exercise of any SARs granted hereunder, St. Paul shall pay to you in cash (after first withholding an amount sufficient to satisfy St. Paul's obligation to withhold federal, state and local taxes in connection with such exercise) any amounts owing hereunder. The SARs granted herein may be exercised by giving written notice to the Secretary of the Company, which notice shall specify the Annual Option Grant(s) to which the SAR exercise relates, the number of shares with respect to each such Annual Options Grant(s) as to which SARs are then being exercised and the exercise price of such exercised SAR under the Annual Option Grant(s). The Notice of Exercise shall be delivered personally to the Secretary of the Company or mailed certified mail return receipt requested, to her attention at the principal office of the Company, and exercise shall be deemed to have taken place when the notice is received by the Secretary or, if mailed, by her office. In the event of any transaction or event resulting in any adjustment to or modification of the securities issuable upon exercise or the exercise price or any other change or modification of any of the Annual Option Grants, then the SARs represented by this letter shall be adjusted equitably by St. Paul's Compensation Committee in a manner as similar as is practicable to the manner in which Annual Option Grants are adjusted. STOCK APPRECIATION RIGHTS September 4, 1998 Page 3 Neither the SARs nor any right to payment or other right in respect of this Agreement may be assigned, sold or otherwise transferred by you except by will or the laws of descent and distribution and any purported assignment, sale or other transfer shall render all SARs void. Very truly yours, THE ST. PAUL COMPANIES, INC. By: /s/ Bruce A. Backberg -------------------------------- Name: Bruce A. Backberg Title: Senior Vice President and Chief Legal Counsel EX-11 10 EXHIBIT 11 EXHIBIT 11 THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Computation of Earnings per Common Share (In thousands, except per share amounts)
Twelve Months Ended December 31, ---------------------------- 1998 1997 1996 ------- ------- ------- EARNINGS: Basic: Net income as reported $ 89,348 $929,292 $732,702 Preferred stock dividends, net of taxes (8,504) (10,304) (28,893) Premium on preferred shares redeemed (4,282) (4,441) (1,033) -------- -------- -------- Net income available to common shareholders 76,562 914,547 702,776 -------- -------- -------- -------- -------- -------- Diluted: Net income available to common shareholders 76,562 914,547 702,776 Effect of dilutive securities: Convertible preferred stock - 5,998 9,478 Zero coupon convertible notes - 3,143 5,133 Convertible monthly income preferred securities - 8,073 8,073 -------- -------- -------- Net income available to common shareholders $ 76,562 $931,761 $725,460 -------- -------- -------- -------- -------- -------- COMMON SHARES: Basic: Weighted average common shares outstanding 235,360 230,158 233,340 -------- -------- -------- -------- -------- -------- Diluted: Weighted average common shares outstanding 235,360 230,158 233,340 Effect of dilutive securities:: Stock options 3,322 4,399 3,089 Convertible preferred stock - 7,788 9,152 Zero coupon convertible notes - 2,923 3,263 Convertible monthly income preferred securities - 7,017 7,017 -------- -------- -------- Weighted average, as adjusted 238,682 252,285 255,861 -------- -------- -------- -------- -------- -------- EARNINGS PER COMMON SHARE: Basic $0.33 $3.97 $3.01 Diluted $0.32 $3.69 $2.84
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 year ended Dec. 31, 1998. As a result, the potentially dilutive effect of those securities is not considered in the calculation of EPS amounts. 38 EX-12 11 EXHIBIT 12 EXHIBIT 12 THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Computation of Ratios (In thousands, except ratios)
Twelve Months Ended December 31, -------------------------------------------------------------------------- 1998 1997 1996 1995 1994 EARNINGS: Income (loss) from continuing operations before income taxes ($46,287) $ 1,335,708 $ 991,098 $ 896,742 $577,272 Add: fixed charges 115,871 116,677 126,463 129,726 254,355 --------- ----------- --------- --------- -------- Income as adjusted $69,584 $1,452,385 $1,117,561 $1,026,468 $831,627 --------- ----------- --------- --------- -------- --------- ----------- --------- --------- -------- FIXED CHARGES AND PREFERRED DIVIDENDS: Fixed charges: Interest costs $75,391 $ 86,202 $ 87,419 $ 90,800 $76,659 Rental expense (1) 40,480 30,475 39,044 38,926 177,696 --------- ----------- --------- --------- -------- Total fixed charges 115,871 116,677 126,463 129,726 254,355 Preferred stock dividends 13,082 19,810 38,092 46,098 64,337 Dividend on preferred capital securities 37,726 33,312 12,585 7,763 - --------- ----------- --------- --------- -------- Total fixed charges and preferred dividends $166,679 $ 169,799 $177,140 $183,587 $318,692 --------- ----------- --------- --------- -------- --------- ----------- --------- --------- -------- Ratio of earnings to fixed charges (2) - 12.45 8.84 7.91 3.27 --------- ----------- --------- --------- -------- --------- ----------- --------- --------- -------- Ratio of earnings to combined fixed charges and preferred stock dividends (2) - 8.55 6.31 5.59 2.61 --------- ----------- --------- --------- -------- --------- ----------- --------- --------- --------
(1) Interest portion deemed implicit in total rent expense. Amounts 1998 and 1994 include $11 million and $130 million, respectively, of net present value of rents representative of interest included in facilities exit costs. (2) The 1998 loss is inadequate to cover "fixed charges" by $46.3 million and "combined fixed charges and preferred stock dividends" by $97.1 million. 39 EX-13 12 EXHIBIT 13 [LOGO] THE ST. PAUL COMPANIES, INC. ANNUAL REPORT TO SHAREHOLDERS 1998 [LOGO] March 29, 1999 To Our Shareholders: Enclosed is The St. Paul Companies, Inc. 1998 Annual Report to Shareholders, including the consolidated financial statements, notes to the financial statements, management's discussion and analysis, certain additional financial data, and other information. The full-color Annual Report to Shareholders will be sent to you prior to our annual shareholders' meeting, which will be held on Tuesday, May 4. Sincerely, /s/ Sandra Ulsaker Wiese - - ------------------------------ Sandra Ulsaker Wiese Corporate Secretary MANAGEMENT'S DISCUSSION AND ANALYSIS ON APRIL 24, 1998, THE ST. PAUL COMPANIES, INC. ("THE ST. PAUL") MERGED WITH USF&G CORPORATION ("USF&G"), A BALTIMORE, MD-BASED INSURANCE HOLDING COMPANY, IN A TAX-FREE EXCHANGE OF STOCK ACCOUNTED FOR AS A POOLING OF INTERESTS. THE FOLLOWING DISCUSSION AND ANALYSIS IS BASED ON THE COMBINED RESULTS OF THE MERGED ENTITY, WHICH OPERATES UNDER THE ST. PAUL NAME, FOR ALL PERIODS PRESENTED. EARNINGS DOWN SHARPLY IN LANDMARK YEAR; STRONG BALANCE SHEET AND CAPITAL BASE INTACT 1998 WAS ONE OF THE MOST NOTEWORTHY YEARS IN THE ST. PAUL'S 146-YEAR HISTORY, YET IT WAS ALSO A DIFFICULT YEAR FROM AN OPERATING AND PROFITABILITY STANDPOINT. OUR MERGER WITH USF&G COMBINED TWO ORGANIZATIONS THAT SHARED A SIMILAR SPECIALTY UNDERWRITING FOCUS, EXPANDED OUR PRESENCE IN MANY KEY MARKETS, AND MOST IMPORTANTLY, PROVIDED THE CRITICAL MASS NECESSARY TO EFFECTIVELY COMPETE IN THE EXTREMELY CHALLENGING AND RAPIDLY CONSOLIDATING PROPERTY-LIABILITY INSURANCE INDUSTRY. OPERATING RESULTS, HOWEVER, WERE SEVERELY IMPACTED IN 1998 BY CATASTROPHE LOSSES IN EXCESS OF $400 MILLION, SEVERAL SIGNIFICANT EARNINGS CHARGES AND DETERIORATING GLOBAL MARKET CONDITIONS FOR OUR INSURANCE PRODUCTS. The following table summarizes our results for each of the last three years:
YEAR ENDED DECEMBER 31 ------------------------------- 1998 1997 1996 --------- --------- --------- (IN MILLIONS, EXCEPT PER SHARE DATA) Pretax income (loss): Property-liability insurance..................................... $ 131 $ 1,391 $ 950 Life insurance................................................... 21 78 (8) Asset management................................................. 104 93 92 Parent company and other operations.............................. (302) (226) (43) --------- --------- --------- Pretax income (loss) from continuing operations................ (46) 1,336 991 Income tax expense (benefit)....................................... (135) 339 151 --------- --------- --------- Income from continuing operations.............................. 89 997 840 Loss from discontinued operations.................................. -- (68) (107) --------- --------- --------- Net income....................................................... $ 89 $ 929 $ 733 --------- --------- --------- --------- --------- --------- Per share........................................................ $ 0.32 $ 3.69 $ 2.84 --------- --------- --------- --------- --------- ---------
Our 1998 results included $617 million of pretax charges which we believe warrant separate discussion for a better understanding of our 1998 performance. The pretax charges consist of the following components: - $292 million of expenses related to the merger with USF&G (discussed below); - $250 million provision to strengthen loss reserves (discussed on pages 5 and 6 of this report); - $41 million writedown in the carrying value of deferred policy acquisition costs in our life insurance segment (discussed on page 19 of this report); - $34 million of expenses related to the restructuring of our commercial insurance operations (discussed on page 6 of this report). The sharp decline in property-liability insurance pretax income in 1998 reflects the impact of catastrophes and an increase in other insurance losses, and $441 million of earnings charges. Fidelity and Guaranty Life, new to The St. Paul from the merger, recorded a solid year of operating results, reduced by $50 million of earnings charges. The remaining $126 million of 2 earnings charges were recorded in "parent company and other operations," accounting for the deterioration in that category from 1997. Our asset management operation, The John Nuveen Company, posted a fourth consecutive year of record earnings. The tax benefit recorded in 1998 was disproportionately large compared with our pretax loss from continuing operations, due to the substantial amount of tax-exempt investment income we have. "Operating results," which exclude after-tax realized investment gains and losses, is a common measure of an insurance company's financial performance. Our consolidated after-tax operating loss was $40 million in 1998, compared with operating earnings of $743 million and $640 million in 1997 and 1996, respectively. Despite our low level of earnings in 1998, common shareholders' equity of $6.62 billion at the end of the year was slightly higher than year-end 1997 equity, primarily due to a $182 million net increase in unrealized appreciation on our investment portfolio. After issuing 66.5 million common shares to consummate the merger and executing a 2-for-1 stock split in 1998, 234 million common shares were outstanding at the end of the year, translating into a book value per share of $28.32. We repurchased 3.8 million of our common shares in 1998 for a total cost of $135 million. 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 our plan of integration, we recorded a $292 million pretax merger-related charge in 1998. The merger- related charge consisted 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. We estimated that approximately 2,000 positions would 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, were affected by the reductions. The total number of positions expected to be reduced by function include approximately 950 in our property-liability underwriting operations, 350 in claim and 700 in finance and other administrative positions. The reductions will occur throughout the United States. Through Dec. 31, 1998, approximately 1,400 positions had been eliminated, and $78 million in severance and other employee-related costs had been paid. The majority of the remaining positions are expected to be eliminated by the end of 1999. - $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. We 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, we 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 was calculated as the percent of excess space (20% to 100%) times the net of: remaining rental payments plus capitalized leasehold improvements less 3 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. We determined that several of USF&G's real estate investments were not consistent with our real estate investment strategy, and developed a plan to sell them, with an expected disposal date in 1999. We determined that four of these investments should be written down to estimated fair value. We calculated fair value 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. The charge was calculated based on the book value of assets at that location. On our Statement of Income, $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 integration of the two companies is expected to result in annualized expense savings of approximately $200 million, as measured against the combined 1997 pre-merger expenses of The St. Paul and USF&G. We began realizing expense savings in the second half of 1998. The expense savings 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 over the long-term. As merger-related costs were paid, there was a short-term negative impact on operational cash flows in 1998. Merger-related payments will negatively impact our operational cash flows to a lesser extent in 1999. REVENUES--The following table summarizes the source of our consolidated revenues for the last three years:
YEAR ENDED DECEMBER 31 -------------------------- 1998 1997 1996 ------ ------ ------ (IN MILLIONS) Revenues: Insurance premiums earned: Property-liability............... $6,826 $7,161 $7,034 Life............................. 119 137 145 Net investment income.............. 1,585 1,578 1,513 Realized investment gains.......... 202 423 262 Asset management................... 302 262 220 Other.............................. 74 62 58 ------ ------ ------ Total revenues................. $9,108 $9,623 $9,232 ------ ------ ------ ------ ------ ------ Change from prior year......... (5)% 4% 8%
The 5% reduction in revenues in 1998 was driven by a $335 million decline in property-liability premiums earned, primarily in our Commercial Lines segment, and a $221 million reduction in realized investment gains. Those gains were unusually high in 1997, largely due to the sale of one venture capital investment that generated a $129 million gain. The growth in earned premiums and investment income in 1997 over 1996 was primarily due to our 1996 acquisitions of Northbrook Holdings, Inc., a commercial lines insurance company, and Afianzadora Insurgentes, S.A. de C.V., a surety underwriting company in Mexico. 1997 VS. 1996--The 35% increase in consolidated 1997 pretax income from continuing operations compared with 1996 was centered in our property-liability insurance operations, where a decline in catastrophe losses, improvement in our core book of Personal Insurance business and significant growth in realized investment gains led to a $441 million increase in pretax earnings. F&G Life's pretax earnings also rebounded in 1997 after being heavily impacted by realized investment losses of $57 million in 1996, which largely consisted of asset writedowns. 4 The after-tax losses from discontinued operations of $68 million and $107 million in 1997 and 1996, respectively, were related to our sale of Minet, an insurance brokerage operation, to Aon Corporation in 1997. We recorded the initial loss in 1996 to reduce Minet's carrying value to its estimated net realizable value after our decision to exit the brokerage business. The loss recorded in 1997 reflects the costs associated with the actual Minet divestiture, primarily to recognize our commitment to Aon for certain severance, employee benefits, lease commitments and other costs. The following pages include a detailed discussion of results produced by the five distinct business segments which underwrite property-liability insurance and provide related services for particular market sectors. We also review the performance of our underwriting operations' investment segment. After the property-liability discussion, we discuss the results of our life insurance segment, F&G Life, and our asset management segment, The John Nuveen Company. PROPERTY-LIABILITY INSURANCE OVERVIEW CATASTROPHES AND DETERIORATING MARKET CONDITIONS PUSH UNDERWRITING LOSSES PAST $1 BILLION MARK IN 1998 OUR UNDERWRITING RESULTS CONTINUED TO SUFFER FROM THE EFFECTS OF INTENSE COMPETITION THROUGHOUT THE PROPERTY-LIABILITY INSURANCE INDUSTRY IN 1998. DESPITE ACCELERATING LOSS COSTS, PRICING LEVELS IN VIRTUALLY ALL COMMERCIAL INSURANCE MARKETS CONTINUED TO DECLINE DURING THE YEAR, REFLECTING AN OVERABUNDANCE OF CAPITAL IN THE MARKET. THE COMPETITIVE PRESSURES AND SOFT PRICING ENVIRONMENT, WHICH HAVE PERSISTED FOR SEVERAL YEARS, WERE MAJOR CONTRIBUTORS, ALONG WITH CATASTROPHES AND A RESERVE STRENGTHENING CHARGE, TO THE $1.26 BILLION DECLINE IN PROPERTY-LIABILITY PRETAX INCOME IN 1998. Consolidated net written premiums of $6.69 billion in 1998 were down 3% from 1997 premium volume of $6.93 billion. The decline in 1998 volume reflects the loss of business in certain markets following the merger with USF&G, as well as the soft pricing environment throughout global primary and reinsurance markets. Significant premium declines in our commercial insurance segments and the Reinsurance segment were partially offset by growth in our Personal Insurance segment, due to an acquisition in late 1997, and our International segment, due to new business expansion. Our consolidated GAAP underwriting loss, representing premiums earned less losses incurred and underwriting expenses, totaled $1.04 billion in 1998, more than $800 million worse than the 1997 loss of $233 million. Catastrophe losses of $419 million in 1998 were the second-highest total in our history, trailing only the $445 million of losses recorded in 1992 when Hurricane Andrew struck the southeastern U.S. coast. The nature of our catastrophe experience in 1998 differed from 1992, however, in that the majority of losses resulted from an unusually high number of relatively low-severity storms across the United States. Several of these storms struck our home state of Minnesota, where we have a heavy concentration of business, and the southeastern United States, where we also have a strong presence. Hurricane Georges, one of the most severe hurricanes since Andrew, accounted for $118 million, or 28%, of our catastrophe experience in 1998. By comparison, our total catastrophe losses in 1997 were $132 million. Our underwriting results in 1998 were also impacted by a $250 million provision to strengthen loss reserves, reflecting the application of our loss reserving policies to USF&G's loss and loss adjustment expense reserves subsequent to the merger. Prior to the merger, both The St. Paul and USF&G, 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, we 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 5 reasonableness of USF&G's range of estimates for their reserves. However, applying their judgment and interpretation to the range, our 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 segments: Commercial Lines ($197 million); Personal Insurance ($35 million); and Specialty Commercial ($18 million). Catastrophes and reserve strengthening notwithstanding, 1998 underwriting results were significantly worse than comparable 1997 results. The deterioration was centered in our Commercial Lines segment, and in the Medical Services business center of our Specialty Commercial segment. The factors driving 1998 results in these operations, and the corrective actions under way, are specifically addressed in the respective segment discussions in the following pages. A common measurement of a property-liability insurer's underwriting performance is its combined ratio, which is the sum of its loss ratio and expense ratio. The lower the ratio, the better the result. Our consolidated combined ratio was 116.2 in 1998, over 12 points worse than the 1997 ratio of 103.8. The loss ratio of 82.1, measuring losses and loss adjustment expenses incurred as a percentage of earned premiums, was 11 points worse than the comparable 1997 ratio of 71.1. The $250 million provision to strengthen loss reserves added 3.7 points to the 1998 ratio. Catastrophe losses accounted for 6.1 points of our loss ratio in 1998, compared with a 1.8 point impact in 1997. We expect catastrophes in a given year to account for approximately three points of our annual loss ratio based on historical average experience for our mix of business. The expense ratio, which measures underwriting expenses as a percentage of premiums written, deteriorated 1.4 points to 34.1 in 1998, reflecting the impact of a 3% decline in premium volume and a slight increase in underwriting expenses. Expenses incurred in the second half of 1998 declined when compared with earlier in the year, reflecting the initial impact of operational efficiencies realized from the merger. Late in the fourth quarter of 1998, we recorded a $34 million pretax charge to earnings in "Operating and administrative expenses" related to the restructuring of our Commercial Lines and Specialty Commercial segments. We implemented a plan to cut the number of our regional offices in half and streamline our underwriting structure. Approximately $26 million of the charge related to the anticipated termination of approximately 520 employees in the following operations: Claim, Commercial Lines, Information Systems, Medical Services and Professional Markets. The remaining charge of $8 million related to costs to be incurred to exit lease contracts. As of Dec. 31, 1998, no employees had been terminated under the restructuring plan. Actions to take place under the plan are expected to be completed by the end of 1999. We expect to realize annual expense savings of approximately $50 million in 1999 as a result of this plan, primarily due to a reduction in salaries and related costs. These savings are separate from the $200 million of expected savings related to the merger. 1997 VS. 1996--Premium volume in 1997 of $6.93 billion was down less than 2% from the equivalent 1996 total of $7.04 billion. Declines in Personal Insurance and Reinsurance volume were largely offset by premium gains in the Commercial Lines and International segments. The GAAP underwriting result improved by $117 million compared with 1996, primarily due to a decline in catastrophe losses and significant improvement in our Personal Insurance segment. OUTLOOK FOR 1999--We do not expect market conditions to improve in 1999. However, we believe the substantial economies of scale afforded by the merger with USF&G, coupled with the corrective underwriting initiatives and restructuring efforts already under way to improve our commercial insurance results, provide the opportunity for substantial earnings improvement in 1999. We will adhere to strict underwriting standards with respect to risk selection and pricing throughout our property-liability operations in 1999, and we are prepared to sacrifice premium volume and market share to restore profitability. 6 PROPERTY-LIABILITY INSURANCE RESULTS BY SEGMENT--The following table summarizes written premiums, underwriting results and statutory combined ratios for each of our property-liability insurance underwriting segments for the last three years. All data for 1997 and 1996 were reclassified to conform to the 1998 presentation. Following the table, we take a closer look at 1998 results for each segment and look ahead to 1999.
YEAR ENDED DECEMBER 31 % OF 1998 ------------------------------- WRITTEN PREMIUMS 1998 1997 1996 ------------------- --------- --------- --------- (DOLLARS IN MILLIONS) PRIMARY INSURANCE OPERATIONS: U.S. UNDERWRITING COMMERCIAL LINES Written premiums............................................... 37% $ 2,493 $ 2,788 $ 2,710 Underwriting result............................................ $ (659) $ (91) $ (95) Combined ratio................................................. 127.3 104.9 104.6 SPECIALTY COMMERCIAL Written premiums............................................... 20% $ 1,348 $ 1,401 $ 1,418 Underwriting result............................................ $ (147) $ 18 $ 71 Combined ratio................................................. 111.8 99.6 94.1 PERSONAL INSURANCE Written premiums............................................... 22% $ 1,418 $ 1,250 $ 1,351 Underwriting result............................................ $ (175) $ (111) $ (319) Combined ratio................................................. 113.1 107.3 123.3 ----- --------- --------- --------- TOTAL U.S. UNDERWRITING Written premiums............................................... 79% $ 5,259 $ 5,439 $ 5,479 Underwriting result............................................ $ (981) $ (184) $ (343) Combined ratio................................................. 119.5 104.1 106.4 INTERNATIONAL Written premiums............................................... 5% $ 378 $ 294 $ 269 Underwriting result............................................ $ (67) $ (53) $ (24) Combined ratio................................................. 116.7 118.1 108.7 ----- --------- --------- --------- TOTAL PRIMARY INSURANCE OPERATIONS Written premiums................................................. 84% $ 5,637 $ 5,733 $ 5,748 Underwriting result.............................................. $ (1,048) $ (237) $ (367) Combined ratio................................................... 119.4 104.8 106.4 REINSURANCE Written premiums............................................... 16% $ 1,056 $ 1,200 $ 1,286 Underwriting result............................................ $ 7 $ 4 $ 17 Combined ratio................................................. 98.7 99.0 99.0 ----- --------- --------- --------- TOTAL PROPERTY-LIABILITY INSURANCE Written premiums................................................. 100% $ 6,693 $ 6,933 $ 7,034 Underwriting result.............................................. $ (1,041) $ (233) $ (350) Combined ratio: Loss and loss expense ratio.................................... 82.1 71.1 73.2 Underwriting expense ratio..................................... 34.1 32.7 31.9 --------- --------- --------- Combined ratio................................................. 116.2 103.8 105.1 --------- --------- --------- --------- --------- ---------
7 PROPERTY-LIABILITY INSURANCE PRIMARY INSURANCE OPERATIONS OUR PRIMARY INSURANCE UNDERWRITING OPERATIONS CONSIST OF THREE U.S.-BASED BUSINESS SEGMENTS AND AN INTERNATIONAL SEGMENT, WHICH UNDERWRITE PROPERTY-LIABILITY INSURANCE AND PROVIDE INSURANCE-RELATED PRODUCTS AND SERVICES TO COMMERCIAL, PROFESSIONAL AND INDIVIDUAL CUSTOMERS. WE UTILIZE A NETWORK OF INDEPENDENT INSURANCE AGENTS AND BROKERS TO DISTRIBUTE OUR INSURANCE PRODUCTS. BASED ON 1997 PREMIUM VOLUME, THE ST. PAUL RANKED AS THE 8TH-LARGEST U.S. PROPERTY-LIABILITY UNDERWRITER. U.S. UNDERWRITING COMMERCIAL LINES The Commercial Lines segment includes our SMALL COMMERCIAL and MIDDLE MARKET COMMERCIAL operations, which serve small and mid-sized customers in the general commercial market, our SURETY business center, and several business centers which provide specialized products and services for targeted industry groups (CONSTRUCTION, MANUFACTURING, SERVICE INDUSTRIES, SPECIAL PROPERTY, NATIONAL PROGRAMS AND TRANSPORTATION). Our CATASTROPHE RISK operation and the results of our limited participation in insurance POOLS are also included in this segment. PREMIUMS--Written premiums of $2.49 billion in 1998 were nearly $300 million, or 11%, below 1997 volume of $2.79 billion. The premium decline was centered in our Middle Market and Construction operations, which together accounted for 57% of this segment's business volume in 1998. Pricing levels in these market sectors continued to erode in 1998 despite accelerating loss costs, reflecting the intense competition for market share among U.S. property-liability insurers. Our decision late in the year to selectively reduce exposures in these markets also contributed to the decline in premium volume. In addition, USF&G's exit from its unprofitable Trucking line of business in 1997 negatively impacted year-to-year premium comparisons. Small Commercial premiums of $429 million, accounting for 17% of Commercial Lines volume, were down 3% in 1998. Premiums generated by our Surety operation, now the largest in the U.S. as a result of the USF&G merger, grew to $376 million in 1998, an 18% increase over 1997. The increase primarily resulted from new business initiatives during the year. UNDERWRITING RESULT--Commercial Lines' 127.3 combined ratio for the year was over 22 points worse than the comparable 1997 ratio of 104.9. Approximately $197 million of the provision to increase USF&G's loss reserves was recorded in this segment, adding 7.5 points to the combined ratio. In addition, catastrophe losses of $138 million accounted for 5.3 points of the 1998 ratio. Catastrophe losses in 1997 totaled $62 million, adding 2.1 points to the combined ratio. Excluding the reserve strengthening provision in 1998 and catastrophes in both years, Commercial Lines' 1998 combined ratio of 114.5 was still significantly worse than 1997's comparable ratio of 102.8. Adverse development on reserves established in prior years, primarily for Middle Market and Construction business, was the chief factor in the deterioration from 1997. Deficiencies in prior risk selection, coupled with a sustained period of inadequate pricing levels, were the driving force behind our poor 1998 results in these operations. In addition, an increase in commission expenses resulting from efforts to retain certain business after the USF&G merger contributed to a 2.2 point increase in the 1998 expense ratio over 1997. Our large Surety operation, however, maintained its high level of profitability in 1998, posting a combined ratio of 79.0, virtually level with last year's ratio of 78.9. 1997 VS. 1996--Premium volume in 1997 of $2.79 billion was slightly ahead of 1996 written premiums of $2.71 billion. The increase resulted from the incremental impact on 1997 written premiums of two acquisitions made during 1996--Northbrook Holdings, Inc., a commercial insurance underwriting operation, and Afianzadora Insurgentes, S.A. de C.V., the largest surety bond underwriter in Mexico. Excluding these acquisitions, premiums in 1997 were down slightly from 1996, reflecting the competitive conditions prevailing throughout the commercial insurance marketplace. The 1997 combined ratio of 104.9 was virtually level with 8 the 1996 ratio of 104.6. Improvement in Middle Market Commercial results, largely due to a decline in catastrophe losses, was offset by deteriorating loss experience in the Construction and Transportation business centers. The 1997 expense ratio was almost a point worse than 1996, reflecting the impact of ongoing integration efforts from the two 1996 acquisitions. OUTLOOK FOR 1999--Market conditions will likely continue to deteriorate in 1999. In the second half of 1998, we began implementing comprehensive plans to address the profitability issues impacting Commercial Lines in general, and our Middle Market and Construction business centers in particular. We will focus on strict adherence to sound underwriting principles to ensure rate adequacy for individual risks, and work closely with our agents and brokers to take corrective actions on underpriced accounts and aggressive steps to retain profitable business. We expect our actions to result in a reduction of approximately $250 million in Commercial Lines' written premiums in 1999, which prompted our restructuring plan and the related charges to earnings in the fourth quarter of 1998. U.S. UNDERWRITING SPECIALTY COMMERCIAL The Specialty Commercial segment includes Medical Services, Custom Markets and Professional Markets. MEDICAL SERVICES provides a wide range of insurance products and services to the entire health care delivery system. CUSTOM MARKETS serves the following specific commercial customer groups: OCEAN MARINE, SURPLUS LINES, TECHNOLOGY, OIL AND GAS, and SPECIALTY LINES. PROFESSIONAL MARKETS is composed of FINANCIAL AND PROFESSIONAL SERVICES, which provides property and liability coverages for financial institutions and a variety of professionals, such as lawyers and real estate agents, and PUBLIC SECTOR SERVICES, which markets insurance products and services to all levels of government entities. PREMIUMS--Specialty Commercial written premiums totaled $1.35 billion in 1998, down 4% from comparable 1997 volume of $1.40 billion. In our Medical Services business center, 1998 premiums of $490 million fell 8% short of 1997's total of $530 million. The medical malpractice market, like most other commercial markets, was characterized by intense competition and product underpricing in 1998. We elected not to aggressively participate in that environment, resulting in fewer new business opportunities and downward pressure on renewal pricing. Custom Markets' 1998 written premiums of $437 million were down 6% from 1997 volume of $467 million, predominantly reflecting a reduction in Surplus Lines business resulting from excess capacity in primary insurance markets. Premiums generated by Professional Markets of $421 million in 1998 grew 4% over the 1997 total of $404 million, primarily due to the addition of a book of Public Sector Services business resulting from our acquisition of Titan Holdings, Inc. (Titan), a Texas-based property-liability insurer, at the end of 1997. Our Financial and Professional Services operation experienced a 4% decline in premiums from the 1997 total of $269 million. UNDERWRITING RESULT--Losses in our Medical Services operation were the primary factor in the 12.2 point deterioration in Specialty Commercial's 1998 combined ratio. We experienced a sharp increase in the severity, or average cost, per claim in Medical Services in 1998. In addition, unfavorable development on reported prior year claims, as well as a higher than expected level of newly reported claims from prior years, contributed to the $120 million deterioration in Medical Services' underwriting results compared with 1997. The magnitude of these losses overshadowed solid performances by several of our Specialty Commercial business units, including Technology, which posted a profitable 86.8 combined ratio, and Financial and Professional Services, where the combined ratio of 80.7 for the year was nearly five points better than the comparable 1997 ratio. The provision to strengthen USF&G's loss reserves had a minimal impact of $18 million on our Specialty Commercial segment in 1998. Catastrophe losses totaled $38 million in 1998, compared with losses of $21 million in 1997. 1997 VS. 1996--Premium volume of $1.40 billion in 1997 was down slightly from the 1996 total of $1.42 billion. Medical Services' written premiums of $530 million in 1997 were 9 9% lower than comparable 1996 premiums of $585 million, reflecting the challenging market environment which was particularly prevalent in the health care professionals sector throughout 1996. For the remainder of Specialty Commercial, premium growth generated by new business opportunities in the Technology and Public Sector Services lines of business in 1997 was partially offset by a decline in Surplus Lines production compared with 1996. Specialty Commercial's 1997 combined ratio, while still profitable at 99.6, was 5.5 points worse than 1996 primarily due to a $56 million decline in Medical Services' profitability. Improvement in the Financial and Professional Services and Technology lines in 1997 was offset by the deterioration in Surplus Lines results. OUTLOOK FOR 1999--We do not foresee dramatic changes in operating environments for the variety of markets served by this segment. Throughout the Specialty Commercial arena in 1999, we will intensify new product development, strengthen our agent and broker relationships and implement corrective underwriting actions in those lines where we have not achieved desired results. Aggressive expense management will also remain a priority. In Medical Services, we will continue to implement price increases for all underperforming lines of business in 1999, while at the same time taking steps to preserve our customer base and capitalize on opportunities for profitable growth in the future. In Custom Markets, we will pursue growth in our profitable Technology line, while continuing to build our new Oil and Gas and Specialty Lines operations. In Professional Markets, we will focus on maintaining and solidifying the leadership positions in the marketplace that were enhanced by the merger. U.S. UNDERWRITING PERSONAL INSURANCE Personal Insurance provides a broad portfolio of property-liability insurance products and services for individuals. Through a variety of single line and package policies, individuals can acquire coverages for personal property--such as homes, autos and boats--and for personal liability. PREMIUMS--Personal Insurance written premiums of $1.42 billion in 1998 grew 13% over comparable 1997 premiums of $1.25 billion. Virtually all of the increase resulted from our December 1997 acquisition of Titan, which added a substantial book of Nonstandard Auto business to our Personal Insurance segment. Nonstandard Auto coverages are marketed to individuals who are unable to obtain standard coverage due to their inability to meet certain underwriting criteria. The addition of Titan pushed Nonstandard Auto premiums to $245 million in 1998, substantially higher than the comparable total of $76 million in 1997. Premium volume in our standard personal lines operation, at $1.17 billion, was level with 1997, reflecting the competitive marketplace conditions for homeowners and auto coverages which have reduced opportunities for appreciable rate increases or new business growth. UNDERWRITING RESULT--Catastrophe losses of $152 million dominated our Personal Insurance segment results in 1998. These losses, which accounted for 10.9 points of this segment's 1998 loss ratio, were largely the result of numerous storms throughout the United States, including several major spring storms in our home state of Minnesota that generated over 22,000 claims and $95 million in losses. Catastrophe losses in this segment totaled $45 million in 1997. In addition, $35 million of the reserve strengthening provision was recorded in this segment, accounting for 2.5 points of the loss ratio. The expense ratio of 30.3 in 1998 was 1.5 points worse than 1997's 28.8, primarily due to a change in one of our property reinsurance treaties during the year which resulted in an increase in commission expenses retained. Our Nonstandard Auto business center posted a profitable 97.7 combined ratio in 1998, a slight improvement over the comparable 1997 ratio of 99.3. 1997 VS. 1996--Written premiums of $1.25 billion in 1997 were down $102 million, or 8%, from the 1996 total of $1.35 billion. The decline was primarily due to the ceding of $109 million of premiums under a new personal lines quota share reinsurance treaty we entered into in 1997 in connection with our efforts to realign a portion of our catastrophe reinsurance 10 coverage. The combined ratio in our Personal Insurance segment improved by 16 points in 1997 when compared to 1996, reflecting the impact of minimal catastrophe losses and corrective pricing and underwriting measures implemented in the wake of 1996's sizable losses. OUTLOOK FOR 1999--Capitalizing on the opportunities provided by the integration of The St. Paul's operations and systems with those of USF&G will be a key priority in 1999. We are in the process of applying the same corrective underwriting and pricing actions on USF&G's standard personal lines business that were successful in improving The St. Paul's book of this business after severe losses in 1996. The personal lines market is reaching maturity with limited potential for real growth. In that environment, our success will depend on maximizing operational efficiencies while adhering to rational underwriting standards in a marketplace characterized by an increase in price-cutting and an emphasis on brand identity. 11 PRIMARY INSURANCE OPERATIONS INTERNATIONAL THE INTERNATIONAL SEGMENT INCLUDES MOST PRIMARY INSURANCE WRITTEN OUTSIDE THE UNITED STATES. WE HAVE A PRESENCE AS A LICENSED INSURANCE COMPANY IN CANADA, AND 11 COUNTRIES IN EUROPE, AFRICA, AND LATIN AMERICA. THE INTERNATIONAL SEGMENT INCLUDES BUSINESS GENERATED FROM OUR PARTICIPATION IN LLOYD'S OF LONDON AS AN INVESTOR AND AS THE OWNER OF THREE MANAGING AGENCIES. THIS SEGMENT ALSO PROVIDES COVERAGE FOR THE NON-U.S. RISKS OF U.S. CORPORATE POLICYHOLDERS AND FOREIGN- BASED POLICYHOLDERS' EXPOSURES IN THE UNITED STATES. WE ARE PREDOMINANTLY A SPECIALTY COMMERCIAL INSURER IN THE INTERNATIONAL ARENA, MARKETING OUR SPECIALLY DESIGNED POLICIES AND RISK MANAGEMENT CAPABILITIES TO TARGETED CUSTOMER GROUPS. PREMIUMS--Written premiums in 1998 totaled $378 million, 29% higher than 1997 premium volume of $294 million. Virtually all of our International business centers recorded premium growth in 1998. Our Lloyd's of London operation generated premiums of $123 million in 1998, more than double the equivalent 1997 total of $61 million. Our agency group manages eight underwriting syndicates collectively representing approximately 4% of Lloyd's total capacity. Premiums generated in Africa and Latin America more than tripled to $34 million in 1998, primarily due to our acquisition of full ownership in an underwriting company in Botswana and the expansion of our South African operations. Our European operations' $166 million of written premiums in 1998 were 5% higher than 1997 despite the sale early in the year of our United Kingdom personal insurance business to Norwich Union Insurance Ltd. We exited this market, which had accounted for $57 million of written premiums in 1997, to concentrate on strengthening our position as a commercial insurance specialist in the United Kingdom. UNDERWRITING RESULT--The International segment's 1998 combined ratio of 116.7 was slightly better than the 1997 ratio of 118.1, primarily due to an improvement in the expense ratio. Improvement in loss experience across almost all of our International business centers compared with 1997 was offset by significant losses incurred in our Canadian operations, which posted a 148.8 combined ratio for the year. An unusually severe ice storm, which struck eastern Canada in early 1998, accounted for the majority of the deterioration in our underwriting results for Canada. Adverse development on prior years' business also contributed to the Canadian loss experience. Our European operations and the fast-growing operations in Africa and Latin America showed strong improvement over 1997, reflecting the benefit of corrective underwriting measures over the last several years. 1997 VS. 1996--Premium volume in 1997 grew 9% over 1996, largely due to the favorable impact of foreign currency translation in our European underwriting operations. Premiums generated through our Lloyd's of London operation were only slightly ahead of comparable 1996 volume, reflecting our strategic decision in 1997 to focus on a limited number of syndicates that offered profitable growth prospects. The 1997 combined ratio of 118.1 was almost ten points worse than the 1996 ratio, primarily due to reserve strengthening for medical liability and personal coverages in the United Kingdom and losses incurred in one of the Lloyd's syndicates in which we were an investor. Our commercial underwriting operations in the United Kingdom, as well as our operations in Ireland, posted strong results in 1997. OUTLOOK FOR 1999--We anticipate further growth in our International segment in 1999. We plan to build on our strategy of exporting our expertise in key specialty insurance lines to selected international markets which offer opportunities for profitable growth. An example is medical liability insurance, where our proven expertise has been a source of competitive differentiation for The St. Paul in several international markets. We have implemented corrective actions to swiftly address unprofitable results in our Canadian operations. We expect to continue to increase our capacity at Lloyd's of London, while at the same time pursuing efficiencies through the consolidation of our managing agency operations. In early 1999, we established a Global Ocean Marine business center in our International segment, designed to capitalize on our substantial market share in North America and our growing presence at Lloyd's. 12 REINSURANCE ST. PAUL RE OUR REINSURANCE SEGMENT UNDERWRITES REINSURANCE FOR LEADING PROPERTY-LIABILITY INSURANCE COMPANIES WORLDWIDE. ST. PAUL RE WRITES TRADITIONAL TREATY AND FACULTATIVE REINSURANCE FOR PROPERTY, LIABILITY, OCEAN MARINE, SURETY AND CERTAIN SPECIALTY CLASSES OF COVERAGE AND ALSO UNDERWRITES FINITE RISK REINSURANCE, WHICH PROVIDES COVERAGE AT LOWER MARGINS THAN TRADITIONAL REINSURANCE IN RETURN FOR A LOWER POSSIBILITY OF LOSS. OUR REINSURANCE SEGMENT, THROUGH DISCOVER RE MANAGERS, INC., ALSO UNDERWRITES PRIMARY INSURANCE AND REINSURANCE AND PROVIDES RELATED INSURANCE PRODUCTS AND SERVICES TO SELF-INSURED COMPANIES AND INSURANCE POOLS, IN ADDITION TO CEDING TO AND REINSURING CAPTIVE INSURERS. THE MERGER OF USF&G'S REINSURANCE OPERATIONS (F&G RE) WITH THOSE OF THE ST. PAUL IN 1998 CREATED THE 14TH-LARGEST PROPERTY-LIABILITY REINSURER IN THE WORLD, BASED ON COMBINED 1997 WRITTEN PREMIUMS. PREMIUMS--Written premiums of $1.06 billion for the year were down 12% from premium volume of $1.20 billion in 1997. The decline reflects a continuing worldwide erosion of rates for reinsurance products, and increasing capacity within the industry and from new product offerings in the capital markets. Our property reinsurance premiums declined sharply in 1998, reflecting a reduction in our exposures due to inadequate pricing on both new and renewal business. International and marine premiums were also down in 1998 as a result of soft pricing conditions and a decrease in demand for reinsurance coverages in those markets. Discover Re's written premiums of $39 million in 1998 were down $6 million from its 1997 total. UNDERWRITING RESULT--Despite the large decline in premium volume, our Reinsurance segment recorded a profitable combined ratio of 98.7 in 1998, slightly better than the 1997 ratio of 99.0. Catastrophe losses totaled $86 million in 1998, resulting largely from Hurricane Georges. Catastrophes in 1997 were just $3 million. The deterioration in catastrophe experience was offset in 1998 by favorable loss development on prior years' business. The underwriting divisions of St. Paul Re and F&G Re were substantially integrated in 1998. 1997 VS. 1996--In 1997, written premiums declined 7% from 1996, reflecting severe pricing competition in global markets. The magnitude of premium declines in 1997 was partially mitigated by growth in Discover Re's captive business and changes in its reinsurance program which resulted in an increase in net written premiums. We also capitalized on several new business opportunities which partially offset the impact of soft market conditions on 1997 premium volume. The 99.0 combined ratio in 1997 was level with 1996. Catastrophe losses were not a major factor in Reinsurance segment results in 1997 or 1996. OUTLOOK FOR 1999--We anticipate that current market conditions will persist in 1999, with continued deterioration in pricing levels. We are undertaking new initiatives designed to capture more business and become a preferred reinsurer in our traditional coverages, while continuing to exercise underwriting discipline in our risk selection. We will seek to take advantage of the opportunities created by the merger by developing new customized products to meet our customers' increasingly sophisticated reinsurance needs. We anticipate expanding our involvement with securitized reinsurance vehicles to provide us with additional reinsurance capacity. PROPERTY-LIABILITY INSURANCE INVESTMENT OPERATIONS Our primary investment objective is to maintain a high-quality portfolio designed to maximize investment returns and generate sufficient liquidity to fund our cash disbursements. To that end, we deploy the majority of funds available for investment in a widely diversified portfolio of predominantly investment-grade fixed maturities. We also invest lesser amounts in equity securities, venture capital, real estate and mortgage loans with the goal of producing long-term growth in the value of our invested asset base and ultimately enhancing shareholder value. The latter investment classes have the potential for higher returns, but also involve a greater degree of risk, 13 including less stable rates of return and less liquidity. Funds to be invested can be generated by underwriting cash flows, consisting of the excess of premiums collected over losses and expenses paid, and investment cash flows, which consist of income on existing investments and proceeds from sales and maturities of investments. Pretax investment income produced by our property-liability investment segment totaled $1.31 billion in 1998, down slightly from income of $1.32 billion in 1997. Our underwriting cash flows in 1998 were negatively affected by the combination of a 3% decline in written premiums and a 6% increase in loss and loss adjustment expense payments. Funds available for investment were reduced further in 1998 by cash outflows resulting from the USF&G merger, primarily severance and other employee-related expenses, and other integration-related expenses. In addition, investments maturing during 1998 were generally reinvested at lower current market yields, contributing to the overall decline in investment income in 1998. In 1997, pretax investment income of $1.32 billion was 7% higher than the 1996 total of $1.24 billion. The majority of the increase resulted from underlying growth in invested assets fueled by investment cash flows in 1997. The incremental impact of a full year's worth of income on Northbrook assets acquired in July 1996 also contributed to investment income growth in 1997. The following table summarizes the composition and carrying value of our property-liability investment segment's portfolio at the end of the last two years. More information on each of our investment classes follows the tables.
DECEMBER 31 -------------------- 1998 1997 --------- --------- (IN MILLIONS) CARRYING VALUE Fixed maturities................... $ 17,778 $ 18,068 Equities........................... 1,193 1,006 Real estate and mortgage loans..... 1,148 1,212 Venture capital.................... 571 462 Securities lending collateral...... 1,367 515 Short-term investments............. 859 849 Other investments.................. 286 319 --------- --------- Total investments................ $ 23,202 $ 22,431 --------- --------- --------- ---------
FIXED MATURITIES--Our fixed maturities portfolio is composed of high-quality, intermediate-term taxable U.S. government agency and corporate bonds and tax-exempt U.S. municipal bonds. We manage our bond portfolio conservatively, investing almost exclusively in investment-grade (BBB or better) securities. Approximately 95% of our portfolio at the end of 1998 was rated investment grade, with the remaining 5% consisting of high-yield and nonrated securities. The primary factors considered in determining the mix of taxable and tax-exempt security purchases are our consolidated tax position and the relationship between taxable and tax-exempt yields. Taxable securities accounted for 82% of our new bond purchases in 1998 and comprised 65% of our fixed maturities portfolio at the end of 1998. The bond portfolio in total carried a weighted average pretax yield of 6.8% at the end of the year and produced pretax investment income of $1.22 billion in 1998, compared with $1.24 billion and $1.16 billion in 1997 and 1996, respectively. We carry bonds on our balance sheet at estimated fair value, with the corresponding unrealized appreciation or depreciation recorded in shareholders' equity, net of taxes. The estimated fair values of our bonds fluctuate based on prevailing market yields at any given time. Movement in market interest rates and anticipated future trends in market yields can quickly and significantly impact bond market values. At the end of 1998, the pretax unrealized appreciation on our bond portfolio totaled $1.02 billion, compared with $853 million at the end of 1997. The increase in appreciation corresponds to the downward trend in market interest rates. The amortized cost of our bond portfolio at the end of 1998 was $16.76 billion, compared with $17.22 billion at the end of 1997. The decline from 1997 to 1998 is primarily due to the net sale of bonds in 1998 to fund our cash flow requirements. EQUITIES--Our equity holdings consist of a diversified portfolio of common stocks which accounted for 4% of total investments (at cost) at year-end 1998. The quality of our portfolio and favorable market conditions over the last 14 several years have resulted in substantial appreciation in our equity holdings. The pretax unrealized appreciation included in the carrying value of our equity portfolio totaled $300 million at the end of 1998, compared with $229 million at the end of 1997. REAL ESTATE AND MORTGAGE LOANS--Real estate and mortgage loans comprised 5% of our total investments at the end of 1998. Our real estate holdings consist primarily of commercial office and warehouse properties that we own directly or in which we have a partial interest through joint ventures. Our properties are geographically distributed throughout the United States. We acquired the portfolio of mortgage loans, which totaled $356 million at the end of 1998, in the USF&G merger. The loans are collateralized by income-producing real estate. VENTURE CAPITAL--Venture capital comprised 2% of our invested assets (at cost) at the end of 1998. These private investments span a variety of industries but are concentrated in information technology, health care and consumer products. The carrying value of the venture capital portfolio at year-end 1998 and 1997 included pretax unrealized appreciation of $182 million and $138 million, respectively. SECURITIES LENDING COLLATERAL--This investment class consists of collateral held on certain securities from our fixed maturities portfolio that we have loaned to other institutions through our lending agent for short periods of time. We receive a fee from the borrower in return. We require collateral from the borrower equal to 102% of the fair value of the loaned securities, and we maintain full ownership of the securities loaned. We are indemnified by the lending agent in the event a borrower becomes insolvent or fails to return securities. We record the collateral received as an asset, with a corresponding liability for the same amount. REALIZED GAINS (LOSSES)--The following table summarizes our realized gains and losses by investment class for each of the last three years.
YEAR ENDED DECEMBER 31 ------------------------------- 1998 1997 1996 --------- --------- --------- (IN MILLIONS) PRETAX REALIZED INVESTMENT GAINS (LOSSES) Fixed maturities................. $ 1 $ (18) $ (13) Equities......................... 158 155 201 Real estate and mortgage loans... 8 53 (10) Venture capital.................. 25 213 86 Other investments................ (4) 9 7 --------- --------- --------- Total.......................... $ 188 $ 412 $ 271 --------- --------- --------- --------- --------- ---------
Realized gains on sales of real estate and mortgage loans in 1998 were reduced by writedowns of $14 million. Venture capital gains in 1997 included a $129 million gain on the sale of the stock of Advanced Fibre Communications, Inc., one of our direct investments. Realized gains generated from equities in 1996 included a $78 million gain on the sale of our ownership interest in Chancellor Management, Inc. Realized losses on other investments in 1998 and 1997 primarily represent writedowns of miscellaneous investments. 1999 INVESTMENT OUTLOOK--We will continue to purchase investment-grade fixed maturities with the majority of funds available for investment in 1999, with a portion of funds allocated to our other asset classes as market conditions warrant. We expect cash flows available for investment to decline further in 1999, due to the anticipated reduction in written premium volume and ongoing cash disbursement requirements related to merger-related and restructuring costs. The current low interest rate environment also negatively affects prospects for investment income growth in 1999. As a result, we expect pretax investment income to fall below 1998 levels. We will retain the portfolio of real estate mortgage loans acquired in the USF&G merger, but we have ceased new mortgage loan originations. 15 PROPERTY-LIABILITY INSURANCE LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES We establish reserves that reflect our estimates of the total losses and loss adjustment expenses we will ultimately have to pay under insurance and reinsurance policies. These include losses that have been reported but not settled and losses that have been incurred but not reported to us (IBNR). Loss reserves for certain workers' compensation business and certain assumed reinsurance contracts are discounted to present value. We reduce our loss reserves for estimates of salvage and subrogation. For reported losses, we establish reserves on a "case" basis within the parameters of coverage provided in the insurance policy or reinsurance agreement. For IBNR losses, we estimate reserves using established actuarial methods. Both our case and IBNR reserve estimates reflect such variables as past loss experience, changes in legislative conditions, changes in judicial interpretation of legal liability and policy coverages, and inflation. We consider not only monetary increases in the cost of what we insure, but also changes in societal factors that influence jury verdicts and case law and, in turn, claim costs. Subjective judgments as to our ultimate exposure to losses are an integral and necessary component of our loss reserving process because many of the coverages we offer involve claims that may not ultimately be settled for many years after they are incurred. We record our reserves by considering a range of estimates bounded by a high and low point. Within that range, we record our best estimate. We continually review our reserves, using a variety of statistical and actuarial techniques to analyze current claim costs, frequency and severity data, and prevailing economic, social and legal factors. We adjust reserves established in prior years as loss experience develops and new information becomes available. Adjustments to previously estimated reserves are reflected in our financial results in the periods in which they are made. A reconciliation of our beginning and ending loss and loss adjustment expense reserves for each of the last three years is included in Note 7 on page 50 of this report. That reconciliation shows that we have recorded reductions in the loss provision for claims incurred in prior years totaling $271 million, $627 million and $414 million in 1998, 1997 and 1996, respectively. The reduction in prior year losses recorded in 1998 was significantly less than the reductions recorded in 1997 and 1996. The 1998 total was affected by the $250 million provision to strengthen loss reserves after the merger with USF&G, of which $189 million was classified as an increase in losses incurred in prior years. In addition, while the favorable prior year development on workers' compensation and medical professional liability coverages continued in 1998, the magnitude of that development was significantly less than that experienced in 1997 and 1996. We also experienced unfavorable prior year loss development in several commercial underwriting operations that have been affected by severe pricing pressures over the last several years, particularly our Middle Market and Construction business centers. The favorable prior year development on workers' compensation business in our commercial insurance segments over the last several years was largely attributable to the impact of legal and regulatory reforms throughout the country in the early 1990s which caused us to reduce our estimate of ultimate loss costs associated with those coverages. As the benefit of those reform efforts became apparent in the mid-1990s, we reduced our prior year loss provisions accordingly. During 1998, there were no significant additional improvements in our hindsight view of ultimate loss provisions for workers' compensation coverages. As a result, while we still generated a reduction in prior year losses, it was not of the same magnitude as in the preceding several years. With regard to medical professional liability coverages, the frequency and severity of claims can change suddenly. As a result, our reserving philosophy for this business, which has evolved over many years, requires that we wait for the 16 prior year experience to mature before recognizing any significant favorable adjustments to prior year loss provisions. In contrast, when loss activity indicates an unfavorable change in the frequency or severity of claims our reserving philosophy requires that we respond quickly and cautiously. Such was the case in 1998, when loss activity indicated an increase in the severity of claims incurred in the years 1995 through 1997. Accordingly, we adopted a more cautious view of ultimate loss provisions for those years, resulting in a much smaller reduction in prior year loss provisions than those recorded in recent years. Favorable development on assumed reinsurance also contributed to the reduction in prior year loss provisions in 1998, 1997 and 1996. The reduction in the prior year loss provision in 1997 was also significantly impacted by a change in the way we assigned loss activity to a particular year for assumed reinsurance written by our U.K.-based reinsurance operation. Our analysis indicated that an excess amount of loss activity was being assigned to the year that the underlying reinsurance contract was written. As a result, we implemented an improved procedure that more accurately assigned loss activity to the year in which it occurred. This change had the effect of increasing favorable prior year development by approximately $110 million in 1997, with a corresponding increase in the provision for current year loss activity. We did not reclassify the current year/ prior year split in 1996 because reliable data to do so was not available. PROPERTY-LIABILITY INSURANCE ENVIRONMENTAL AND ASBESTOS CLAIMS We continue to receive claims alleging injuries from environmental pollution or alleging covered property damages for the cost to clean up polluted sites. We also receive asbestos injury and property damage claims arising out of product liability coverages under general liability policies. The vast majority of these claims arise from policies written many years ago. Our alleged liability for both environmental and asbestos claims is complicated by significant legal issues, primarily pertaining to the scope of coverage. In our opinion, court decisions in certain jurisdictions have tended to broaden insurance coverage beyond the intent of original insurance policies. Our ultimate liability for environmental claims is difficult to estimate because of these legal issues. Insured parties have submitted claims for losses not covered in their respective insurance policies, and the ultimate resolution of these claims may be subject to lengthy litigation, making it difficult to estimate our potential liability. In addition, variables, such as the length of time necessary to clean up a polluted site and controversies surrounding the identity of the responsible party and the degree of remediation deemed necessary, make it difficult to estimate the total cost of an environmental claim. Estimating our ultimate liability for asbestos claims is equally difficult. The primary factors influencing our estimate of the total cost of these claims are case law and a history of prior claim development. The following table represents a reconciliation of total gross and net environmental reserve development for each of the years in the three-year period ended Dec. 31, 1998. Amounts in the "net" column are reduced by reinsurance recoverables.
1998 1997 1996 ------------ ------------ ------------ GROSS NET GROSS NET GROSS NET ----- ---- ----- ---- ----- ---- (IN MILLIONS) ENVIRONMENTAL Beginning reserves... $867 $677 $889 $676 $840 $631 Northbrook reserves acquired........... -- -- -- -- 18 7 Incurred losses...... (16) 26 44 58 87 92 Paid losses.......... (68) (58) (66) (57) (56) (54) ----- ---- ----- ---- ----- ---- Ending reserves...... $783 $645 $867 $677 $889 $676 ----- ---- ----- ---- ----- ---- ----- ---- ----- ---- ----- ----
The following table represents a reconciliation of total gross and net reserve development for asbestos claims for each of the 17 years in the three-year period ended Dec. 31, 1998.
1998 1997 1996 ------------ ------------ ------------ GROSS NET GROSS NET GROSS NET ----- ---- ----- ---- ----- ---- (IN MILLIONS) ASBESTOS Beginning reserves... $397 $279 $413 $304 $421 $294 Northbrook reserves acquired........... -- -- -- -- 6 6 Incurred losses...... 44 13 22 (5) 18 25 Paid losses.......... (39) (15) (38) (20) (32) (21) ----- ---- ----- ---- ----- ---- Ending reserves...... $402 $277 $397 $279 $413 $304 ----- ---- ----- ---- ----- ---- ----- ---- ----- ---- ----- ----
USF&G's net reserves for environmental and asbestos claims at the time of the merger totaled $304 million and $126 million, respectively. USF&G's reserve development for the three-year period ended Dec. 31, 1998, is included in the foregoing tables. USF&G's customer base generally did not include large manufacturing companies, which tend to incur the majority of known environmental and asbestos claims. In addition, USF&G had traditionally been a primary coverage carrier, having written relatively little high-level excess coverage; therefore, liability exposures were generally restricted to primary coverage limits. Our reserves for environmental and asbestos losses at Dec. 31, 1998 represent our best estimate of our ultimate liability for such losses, based on all information currently available to us. Because of the inherent difficulty in estimating such losses, however, we cannot give assurances that our ultimate liability for environmental and asbestos losses will, in fact, match our current reserves. We continue to evaluate new information and developing loss patterns, but we believe any future additional loss provisions for environmental and asbestos claims will not materially impact the results of our operations, liquidity or financial position. Total gross environmental and asbestos reserves at Dec. 31, 1998, of $1.19 billion represented approximately 6% of gross consolidated reserves of $18.46 billion. 18 NEW EQUITY-INDEXED PRODUCT FUELS SALES GROWTH IN 1998 LIFE INSURANCE F&G LIFE OUR LIFE INSURANCE SEGMENT CONSISTS OF FIDELITY AND GUARANTY LIFE INSURANCE COMPANY AND SUBSIDIARIES ("F&G LIFE"). F&G LIFE'S PRIMARY PRODUCTS ARE DEFERRED ANNUITIES (INCLUDING TAX SHELTERED ANNUITIES AND EQUITY-INDEXED ANNUITIES), STRUCTURED SETTLEMENT ANNUITIES, AND IMMEDIATE ANNUITIES. F&G LIFE ALSO UNDERWRITES TRADITIONAL LIFE INSURANCE PRODUCTS. F&G LIFE'S PRODUCTS ARE SOLD THROUGHOUT THE UNITED STATES THROUGH INDEPENDENT AGENTS, MANAGING GENERAL AGENTS AND SPECIALTY BROKERAGE FIRMS. OUR LIFE INSURANCE SEGMENT GENERATED 4% OF OUR TOTAL REVENUES IN 1998 AND ACCOUNTED FOR 13% OF OUR CONSOLIDATED ASSETS. Highlights of F&G Life's financial performance for the last three years are as follows:
YEAR ENDED DECEMBER 31 ------------------------------- 1998 1997 1996 --------- --------- --------- (IN MILLIONS) Sales..................... $ 501 $ 446 $ 427 Premiums and policy charges.................. 119 137 145 Policy surrenders......... 207 171 471 Net investment income..... 276 253 269 Pretax earnings (loss).... 21 78 (8) Life insurance in force... $ 10,774 $ 10,748 $ 10,729
F&G Life's pretax earnings in 1998 were reduced by a $41 million charge to reflect a writedown of the carrying value of deferred policy acquisition costs (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 evidence 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, 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, triggering $19 million of 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. We also recorded pretax merger-related charges of $9 million in this segment in 1998, primarily relating to severance and facilities exit costs. The following table shows life insurance and annuity sales (premiums and deposits) by distribution system and product type.
YEAR ENDED DECEMBER 31 ------------------------------- 1998 1997 1996 --------- --------- --------- (IN MILLIONS) Distribution system: Brokerage........................ $ 367 $ 268 $ 255 National wholesaler.............. 68 91 79 Direct structured settlements.... 55 74 79 Other............................ 11 13 14 --------- --------- --------- Total............................ $ 501 $ 446 $ 427 --------- --------- --------- --------- --------- --------- Product type: Equity-indexed annuities......... $ 209 -- -- Single premium deferred annuities....................... 134 $ 248 $ 231 Tax sheltered annuities.......... 64 84 78 Structured settlement annuities....................... 55 74 79 Other annuities.................. 24 23 27 Life insurance................... 15 17 12 --------- --------- --------- Total............................ $ 501 $ 446 $ 427 --------- --------- --------- --------- --------- ---------
The 12% increase in sales in 1998 when compared to 1997 was driven by the success of a new equity-indexed annuity product introduced in June 1998, which accounted for $209 million, or 42%, of total sales for the year. Credited interest rates on this product are tied to the performance of the S&P 500 equity index. Sales 19 of fixed interest rate annuities in 1998 declined from 1997 due to the significantly lower level of interest rates and its negative impact on our fixed interest rate products. The demand for our annuity products is affected by fluctuating interest rates and the relative attractiveness of alternative products. The 13% decline in premiums earned in 1998 was largely due to a reduction in sales of structured settlement annuities, which are sold primarily to property-liability insurers to settle insurance claims. Sales of structured settlement annuities and term life insurance are recognized as premiums earned under GAAP. Sales of investment-type contracts, such as our equity-indexed, deferred and tax sheltered annuities, and our universal life-type contracts are recorded directly to our balance sheet on a deposit accounting basis and are not recognized as premiums under GAAP. Sales of the structured settlement annuities in the middle of the year suffered from disruptions caused by the merger, but rebounded in the fourth quarter as the structured settlement program was expanded into our newly combined property-liability operations. Our deferred annuity and universal life products are subject to surrender by policyholders. Nearly all of our surrenderable annuity policies allow a refund of the cash value balance less a surrender charge. Surrender activity increased in 1998 due to growth in the size and maturity of our annuity book of business, as well as increased competition from alternative investments, particularly equity-based products. Net investment income grew 9% in 1998 as a result of an increasing asset base generated by positive cash flow. We incurred pretax realized investment losses of $2 million in 1998, down from gains of $14 million in 1997 primarily due to writedowns in the carrying value of fixed maturity investments, which offset gains of $13 million realized on real estate investments. Excluding realized investment gains and losses, and the $50 million of charges recorded in 1998, pretax earnings totaled $71 million, compared with $64 million in 1997. The increase resulted from improved investment spread management of annuity and universal life products, and strong expense controls. 1997 VS. 1996--Sales of $446 million in 1997 were 4% higher than 1996, primarily due to an increase in single premium deferred annuities (SPDA) sales. The $300 million decline in policy surrender activity from 1996 to 1997 primarily resulted from a 1996 transaction whereby we entered into a coinsurance contract with an unaffiliated life insurance company to cede all of our remaining SPDAs that had originally been sold through brokerage firms. This removed an underperforming block of business that had experienced high surrender rates. The $16 million decline in investment income in 1997 when compared with 1996 was due to a lower asset base created by the transfer of $918 million in fixed maturities under the 1996 coinsurance contract. The pretax loss of $8 million in 1996 was driven by writedowns in the carrying value of certain real estate and fixed maturity investments. OUTLOOK FOR 1999--We anticipate the sales momentum generated by our equity-indexed product in the second half of 1998 to carry into 1999. We will focus on repositioning our life products, increasing our marketing efforts and intensifying new product development in an increasingly competitive life insurance marketplace. We will also continue to expand F&G Life's structured settlement program into our property-liability claim operation in 1999. 20 NUVEEN POSTS DOUBLE-DIGIT GROWTH IN EARNINGS, MANAGED ASSETS ASSET MANAGEMENT THE JOHN NUVEEN COMPANY WE HOLD A 78% INTEREST IN THE JOHN NUVEEN COMPANY (NUVEEN), WHICH COMPRISES OUR ASSET MANAGEMENT SEGMENT. NUVEEN'S CORE BUSINESSES ARE ASSET MANAGEMENT; THE DEVELOPMENT, MARKETING AND DISTRIBUTION OF INVESTMENT PRODUCTS AND SERVICES; AND MUNICIPAL AND CORPORATE INVESTMENT BANKING SERVICES. NUVEEN SPONSORS AND MARKETS OPEN-END AND CLOSED-END (EXCHANGE-TRADED) MANAGED FUNDS, DEFINED PORTFOLIOS (UNIT INVESTMENT TRUSTS) AND MANAGES INDIVIDUAL ACCOUNTS. NUVEEN ALSO PROVIDES MUNICIPAL AND CORPORATE INVESTMENT BANKING SERVICES AND UNDERWRITES AND TRADES MUNICIPAL BONDS. The following table summarizes Nuveen's key financial data for the last three years:
YEAR ENDED DECEMBER 31 ------------------------------- 1998 1997 1996 --------- --------- --------- (IN MILLIONS) Revenues.................. $ 308 $ 269 $ 232 Expenses.................. 171 146 114 --------- --------- --------- Pretax income............. 137 123 118 Minority interest......... (33) (30) (26) --------- --------- --------- The St. Paul's share of pretax income........... $ 104 $ 93 $ 92 --------- --------- --------- --------- --------- --------- Assets under management... $ 55,267 $ 49,594 $ 33,191 --------- --------- --------- --------- --------- ---------
Nuveen's revenues in 1998 increased 14% over 1997, primarily due to growth in asset management fees. The increase in those fees resulted from a higher level of average assets under management during 1998 due to the acquisition of Rittenhouse Financial Services in August 1997, and new product sales during the year. Rittenhouse, an equity and balanced account management firm serving affluent investors, added $9 billion to Nuveen's managed assets at acquisition. The 16% increase in expenses over 1997 reflects goodwill amortization and the expected incremental operating expenses resulting from the Rittenhouse acquisition. Nuveen's gross product sales totaled $7.8 billion in 1998, compared with $3.0 billion in 1997. Additions to managed accounts provided the majority of the increase over 1997. Volatility in equity markets during 1998 contributed to a $600 million increase in Nuveen's mutual fund sales for the year, as investors sought to deploy their funds in more conservative investments. Nuveen's net flows (equal to the sum of sales, reinvestments and exchanges less redemptions) totaled $5.7 billion in 1998, compared with $1.8 billion in 1997. Assets under management at the end of 1998 consisted of $26.2 billion of exchange-traded funds, $16.4 billion of managed accounts, and $12.7 billion of mutual funds. The $5.7 billion increase in managed assets since the end of 1997 was primarily due to the increase in managed account and mutual fund sales during 1998 and growth in the market value of underlying investments. Municipal securities accounted for 71% of managed assets at the end of 1998, with the remaining 29% consisting of equity securities. Nuveen repurchased 732,700 common shares from minority shareholders in 1998 for a total cost of $27 million. Nuveen also made significant share repurchases in 1997 and 1996, which were proportioned between our holdings and minority shareholders to maintain our ownership percentage in Nuveen. Our proceeds from Nuveen's repurchases were $41 million and $74 million in 1997 and 1996, respectively. Nuveen's $147 million acquisition of Rittenhouse in 1997 was funded through cash on hand and borrowings under a committed credit line, which were subsequently paid down in the first quarter of 1998. Virtually all of the Rittenhouse purchase price consisted of goodwill, which is being amortized over 30 years. 1997 VS. 1996--In 1997, Nuveen's pretax earnings increased $5 million over 1996. The 16% growth in revenue in 1997 was driven by an increase in investment management fees resulting from managed assets acquired during the year. In January 1997, Nuveen acquired Flagship Resources, Inc. for approximately $72 million, which added over $4 billion to assets 21 under management. The addition of Rittenhouse in August 1997 added $9 billion to Nuveen's managed assets. Demand for Nuveen's traditional municipal investment products suffered in 1997 due to competition from strong equity markets and investor concerns about the global economy and interest rate trends. Expenses were 28% higher than in 1996, reflecting the impact of the two acquisitions, as well as increased advertising and promotional expenses associated with the launch of new equity and balanced mutual funds early in 1997. OUTLOOK FOR 1999--As a result of investments made over the last two years in new products and services, we expect Nuveen's current sales momentum to carry into 1999. Nuveen will continue to focus on meeting the needs of financial advisers working with affluent investors by leveraging its long heritage of investment expertise through a wide array of investment vehicles. STRONG CAPITAL BASE INTACT DESPITE DECLINE IN EARNINGS THE ST. PAUL COMPANIES CAPITAL RESOURCES Our capital resources consist of shareholders' equity, debt and capital securities, representing funds deployed or available to be deployed to support our business operations. The following table summarizes our capital resources at the end of the last three years:
DECEMBER 31 ------------------------------- 1998 1997 1996 --------- --------- --------- (IN MILLIONS) Shareholders' equity: Common equity: Common stock and retained earnings..................... $ 5,608 $ 5,777 $ 4,993 Unrealized appreciation of investments and other........ 1,013 814 638 --------- --------- --------- Total common shareholders' equity..................... 6,621 6,591 5,631 Preferred shareholders' equity... 15 17 216 --------- --------- --------- Total shareholders' equity... 6,636 6,608 5,847 Debt............................... 1,260 1,304 1,171 Capital securities................. 503 503 307 --------- --------- --------- Total capitalization......... $ 8,399 $ 8,415 $ 7,325 --------- --------- --------- --------- --------- --------- Ratio of debt to total capitalization 15% 15% 16% --------- --------- --------- --------- --------- ---------
EQUITY--Common shareholders' equity at the end of 1998 was slightly higher than year-end 1997, as a decline in our retained earnings resulting from common share repurchases and dividends was offset by an increase in the net unrealized appreciation of our investment portfolio. Common equity at the end of 1997 grew $960 million over a year earlier, primarily due to our record net income of $929 million in 1997. Our preferred shareholders' equity consists of the par value of Series B preferred shares we issued to our Preferred Stock Ownership Plan (PSOP) Trust, less the remaining principal balance of the PSOP Trust debt. Preferred equity at the end of 1996 also included $200 million of the former USF&G's Series A Preferred Stock, which were redeemed in 1997 through the issuance of capital securities. DEBT--Consolidated debt outstanding at the end of 1998 was down $44 million from year-end 1997, largely the result of a $75 million decline in Nuveen's debt. We issued $150 million of medium-term notes in the fourth quarter of 1998 under a shelf registration statement filed with the Securities and Exchange Commission in 1996. Proceeds were primarily used to fund our common share repurchases. The maturity of our $145 million, 7% senior notes in May 1998, as well as several medium-term note maturities throughout the year totaling $25 million, were funded through a combination of commercial paper issuances and internally generated funds. Commercial paper outstanding at the end of 1998 increased $89 million over year-end 1997. At Dec. 31, 1998, medium-term notes outstanding totaled $637 million, comprising just over one-half of our total debt. These notes bear a weighted average interest rate of 6.9%. The $133 million increase in debt outstanding at Dec. 31, 1997, compared to a year earlier was due in part to $85 million in new debt issued by Nuveen for general corporate purposes and to purchase securities for its investment products. We also issued $82 million of medium-term notes in 1997 under our shelf registration to partially fund the maturity of our 9 3/8% notes in June 1997. In addition, we borrowed $35 million under a standby credit 22 facility to refinance receivables outstanding related to an insurance premium finance company we acquired at the end of 1997. CAPITAL SECURITIES--Our $503 million of capital securities consist of company-obligated mandatorily redeemable preferred capital securities issued by four entities wholly-owned by The St. Paul. Each entity was formed for the purpose of issuing capital securities and the sole assets of each entity consist of securities issued by The St. Paul. We issued $196 million of capital securities in 1997 and $100 million in 1996, the proceeds of which were used to redeem an issue of $4.10 Series A Cumulative Convertible Preferred Stock, repay intercompany loans and retire borrowings outstanding against standby credit facilities. The remaining $207 million of capital securities were issued in 1995 for general corporate purposes and to repay commercial paper debt, and are convertible into shares of our common stock. CAPITAL TRANSACTIONS--Our merger with USF&G in 1998 was a tax-free exchange accounted for as a pooling-of-interests. The St. Paul issued 66.5 million of its common shares for all of the outstanding shares of USF&G. The transaction was valued at $3.7 billion, which included the assumption of USF&G's debt and capital securities. We repurchased 3.8 million common shares for a total cost of $135 million in late 1998, largely funded through the issuance of medium-term notes. We also repurchased 3.4 million shares in 1997 and 7.5 million shares in 1996 for a total cost of $128 million and $225 million, respectively. Our common and preferred dividend payments totaled $226 million in 1998, $198 million in 1997 and $200 million in 1996. In 1997, we purchased Titan Holdings, Inc., a property-liability company in San Antonio, Texas, for a total cost of $259 million, funded through the issuance of common stock and borrowings against standby credit facilities. In 1996, we purchased Northbrook Holdings, Inc. from Allstate Insurance Company for approximately $190 million in cash from internally generated sources. Also in 1996, 1.2 million common shares were issued to redeem all of the Series B Cumulative Convertible Preferred Stock. In February 1999, The St. Paul's board of directors increased our dividend rate to $1.04 per share, a 4% increase over the 1998 rate of $1.00 per share. Our dividend rate has grown at a compound annual rate of 7% over the last five years. We made no major capital improvements during 1998, 1997 or 1996. Through March 1, 1999, we had repurchased a total of 8.9 million common shares at a cost of $295 million under the $500 million repurchase program authorized by our board of directors in November 1998. We may make additional repurchases during the remainder of 1999 if we deem it a prudent use of capital. THE ST. PAUL COMPANIES LIQUIDITY Liquidity is a measure of our ability to generate sufficient cash flows to meet the short-and long-term cash requirements of our business operations. Our underwriting operations' short-term cash needs primarily consist of paying insurance loss and loss adjustment expenses and day-to-day operating expenses. Those needs are met through cash receipts from operations, which consist primarily of insurance premiums collected and investment income receipts. Our investment portfolio is also a source of liquidity, through the sale of readily marketable fixed maturities, equity securities and short-term investments, as well as longer-term investments which have appreciated in value. Cash flows from these underwriting and investment activities are used to build the investment portfolio and thereby increase future investment income. Cash flows from operations were $69 million in 1998, compared with $848 million in 1997 and $1.3 billion in 1996. Our cash flows have trended downward over the last three years due to deteriorating market conditions in our property-liability operations, where loss and loss expense payments have been increasing while net written premiums have gone down. Declining yields on new investment securities have also been a factor contributing to the reduction in cash flows 23 during that three-year period. Our cash flow in 1998 was also negatively impacted by payments of $108 million for liabilities incurred related to our merger with USF&G Corporation, primarily severance and other employee-related costs, and various transaction costs. Cash flow in 1997 was also adversely affected by the increase in loss payments resulting from the runoff of Northbrook loss reserves acquired in 1996. We do not expect an increase in operational cash flows in 1999, due to the anticipated decline in written premiums and investment income receipts. In addition, cash payments related to the merger and restructuring charges recorded in 1998 will negatively impact our 1999 cash flows, although to a lesser extent than in 1998. On a long-term basis, we believe our operational cash flows will benefit from the corrective underwriting and pricing actions under way in our property-liability operations, as well as the opportunities for profitable growth provided by our merger with USF&G in 1998. Our financial strength and conservative level of debt provide us with the flexibility and capacity to obtain funds externally through debt or equity financings on both a short-term and long-term basis should the need arise. We anticipate funding our 1999 common share repurchases primarily through the issuance of debt. We are not aware of any current recommendations by regulatory authorities that, if implemented, might have a material impact on our liquidity, capital resources or operations. THE ST. PAUL COMPANIES EXPOSURES TO MARKET RISK INTEREST RATE RISK--Our exposure to market risk for changes in interest rates is concentrated in our investment portfolio, and to a lesser extent, our debt obligations. However, changes in investment values attributable to interest rate changes are mitigated by corresponding and partially-offsetting changes in the economic value of our insurance reserves and debt obligations. We monitor this exposure through periodic reviews of our asset and liability positions. Our estimates of cash flows, as well as the impact of interest rate fluctuations relating to our investment portfolio and insurance reserves, are modeled and reviewed quarterly. The following table provides principal runoff estimates by year for our Dec. 31, 1998 inventory of interest-sensitive financial instrument assets. Also provided are the weighted-average interest rates associated with each year's runoff. Principal runoff projections for collateralized mortgage obligations were prepared using third-party prepayment analyses. Runoff estimates for mortgage passthroughs were prepared using average prepayment rates for the prior three months. Principal runoff estimates for callable bonds are either to maturity or to the next call date depending on whether the call was projected to be "in-the-money" assuming no change in interest rates. No projection of the impact of reinvesting the estimated cash flow runoff is included in the table, regardless of whether the runoff source is a short-term or long-term fixed income security. We have assumed that our "available-for-sale" securities are similar enough to aggregate those securities for purposes of this disclosure.
DECEMBER 31, 1998 -------------------------------- WEIGHTED AVERAGE INTEREST RATE PRINCIPAL ----------------- CASH FLOWS ------------- (IN MILLIONS) FIXED MATURITIES AND SHORT-TERM INVESTMENTS 1999...................... $ 3,612 6.2% 2000...................... 1,734 7.3 2001...................... 2,235 7.4 2002...................... 2,010 7.3 2003...................... 1,803 7.9 Thereafter................ 10,008 6.9 ------------- Total................... $ 21,402 ------------- ------------- Market Value at Dec. 31, 1998...................... $ 22,039 ------------- -------------
The estimated principal runoff on our mortgage loan investments is as follows: 1999, $42 million; 2000, $128 million; 2001, $58 million; 2002, $125 million; 2003, $117 million; thereafter, $164 million. The weighted average interest rate on those investments was 7.65% at Dec. 31, 1998. The estimated fair value of our mortgage loan investments at Dec. 31, 1998 was $629 million. 24 The following table provides principal runoff estimates by year for our Dec. 31, 1998 inventory of interest-sensitive debt obligations and related weighted average interest rates by stated maturity dates.
DECEMBER 31, 1998 -------------------------------- WEIGHTED AVERAGE INTEREST RATE PRINCIPAL ----------------- CASH FLOWS ------------- (IN MILLIONS) MEDIUM-TERM NOTES, ZERO COUPON NOTES AND SENIOR NOTES 1999...................... $ 20 7.6% 2000...................... -- -- 2001...................... 196 8.1 2002...................... 49 7.5 2003...................... 67 6.5 Thereafter................ 710 5.2 ------ Total................... $ 1,042 ------ ------ Fair Value at Dec. 31, 1998...................... $ 1,039 ------ ------
FOREIGN CURRENCY EXPOSURE--Our exposure to market risk for changes in foreign exchange rates is concentrated in our invested assets denominated in foreign currencies, which are predominantly British pounds sterling. Cash flows from our foreign operations are the primary source of funds for our purchase of these investments. We purchase these investments primarily to hedge insurance reserves and other liabilities denominated in the same currency, effectively reducing our foreign currency exchange rate exposure. The following table presents the U.S. dollar equivalent runoff estimates for our Dec. 31, 1998, inventory of sterling-denominated fixed-maturity and short-term investments. Also provided are the weighted-average interest rates associated with each year's runoff. Principal runoff estimates for callable bonds, if any, are either to maturity or to the next call date depending on whether the call was projected to be "in-the-money" assuming no change in interest rates. No projection of the impact of reinvesting the estimated cash flow runoff is included in the table, regardless of whether the runoff source is a short-term or long-term fixed income security. Additionally, the table presents the quoted forward foreign currency exchange rates on forward contracts available as of Dec. 31, 1998.
DECEMBER 31, 1998 ------------------------------------------- FORWARD FOREIGN WEIGHTED CURRENCY AVERAGE EXCHANGE INTEREST RATE RATE PRINCIPAL CASH ------------- ----------- FLOWS --------------- (IN MILLIONS) FIXED MATURITIES AND SHORT-TERM INVESTMENTS British pounds sterling: 1999................... $ 91 6.5% 1.653 2000................... 58 8.9% 1.656 2001................... 75 8.5% 1.651 2002................... 132 7.0% 1.653 2003................... 14 7.2% 1.654 Thereafter............. 339 7.7% VARIOUS ----- Total................ $ 709 ----- ----- Market Value at Dec. 31, 1998 $ 764 ----- -----
EQUITY PRICE RISK--Our portfolio of marketable equity securities, which we carry on our balance sheet at estimated fair value, has exposure to price risk. This risk is defined as the potential loss in estimated fair value resulting from an adverse change in prices. Our objective is to earn competitive relative returns by investing in a diverse portfolio of high-quality, liquid securities. Portfolio characteristics are analyzed regularly and market risk is actively managed through a variety of modeling techniques. Our holdings are diversified across industries, and concentrations in any one company or industry are limited by parameters established by senior management. Our portfolio of venture capital investments also has exposure to market risks, primarily relating to the viability of the various entities in which we have invested. These investments by their nature involve more risk than other investments, and we actively manage our market risk in a variety of ways. First, we allocate a comparatively small amount of funds to venture capital. At the end of 1998, the cost of these investments accounted for only 2% of total invested assets. Second, the investments are diversified to avoid concentration of risk in a particular industry. Third, we perform extensive research prior to investing in a new venture to 25 gauge prospects for success. Fourth, we regularly monitor the operational results of the entities in which we have invested. Finally, we generally sell our holdings in these firms soon after they become publicly traded, thereby reducing exposure to further market risk. At Dec. 31, 1998, our marketable equity securities and venture capital investments were recorded at their estimated fair value of $1.83 billion. A hypothetical 10% decline in each stock's price would have resulted in a $183 million impact on fair value. THE ST. PAUL COMPANIES 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. We are heavily dependent on our many computer systems, and those of our independent agents and brokers (our "distribution network") and our vendors, for virtually every aspect of our operations, including underwriting, claims, investments and financial reporting. Thus, the "Year 2000" issue involves potentially serious operational risks for the Company. For several years, we have been evaluating our 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, we have 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. We have also been working with vendors and members of our distribution network in an effort to address Year 2000 issues that such relationships involve. Finally, we have 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 have been seeking to reduce our Year 2000-related exposures through the development of contingency plans. The following discussion describes our 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 1980s, we have required that all of the internal computer systems supported by our Information Systems Division ("ISD") use a four-digit date field. Early implementation of this design standard has limited the number of systems requiring remediation. We established a Review Board in the third quarter of 1997 to review and certify the remediation of the hundreds of internally developed and externally sourced systems we use through rigorous testing. To coordinate the Year 2000 remediation efforts, we have created the Year 2000 Project Office, which is responsible for the oversight, coordination and monitoring of our Year 2000 efforts including, among other things, reviewing the compliance status of information systems in all operating units and subsidiaries, both foreign and domestic, directing the Year 2000 coordinators assigned to our 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 our overall Year 2000 response. INFORMATION TECHNOLOGY SYSTEMS--All of our 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 was achieved by Dec. 31, 1998. Initial compliance validation of all such systems is 26 scheduled to be completed by March 31, 1999. Additionally, all subsidiaries not headquartered in Saint Paul, MN or Baltimore, MD are scheduled to complete initial validation testing of their operating systems on or before June 30, 1999. The Year 2000 Project Office's plan for remediation and validation of externally sourced systems provides for us to work with the vendors of those systems to ensure that those 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. We have identified what we believe to be all of our third-party supplied mission critical systems, and expect to receive Year 2000 compliant versions and/or affirmations of compliance for each of them, and to complete the validation process, before Sept. 30, 1999. THIRD-PARTY SERVICE PROVIDERS AND DISTRIBUTION NETWORK--We rely indirectly on the information technology systems of our service providers and those of our distribution network. The Year 2000 Project Office is communicating with our service providers, including financial institutions providing custody and other services, our independent agents and brokers, and other entities with which we do 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 our 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 1980s, 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 and testing of critical 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, with the remaining certification and testing to follow in the second 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 our business, and that of our vendors and the members of our distribution network, we believe that our exposure to embedded chip Year 2000 issues is minimal (other than our exposure to possible disruptions in electricity, telecommunications and other essential services provided by public utilities that are subject to embedded chip-related disruption). We are, where deemed appropriate, coordinating with vendors to obtain certificates of Year 2000 compliance for the embedded computer technology equipment that we use. YEAR 2000 COMPLIANCE PROGRAM COSTS--We have developed and implemented plans to address the system modifications required to prepare for the Year 2000, and do not expect the planning and implementation costs associated with Year 2000 efforts to be material to our results of operations, cash flows or consolidated financial position. Through Dec. 31, 1997, the costs of Year 2000 remediation measures incurred, including costs incurred by USF&G prior to the merger, totaled approximately $6 million. We incurred costs of approximately $12 million in 1998, and we anticipate additional costs of approximately $5 million in 1999. CONTINGENCY PLANNING--The Year 2000 Project Office's contingency planning team created a contingency planning model and template that focuses on maintaining infrastructure and resuming critical business functions. Infrastructure teams, business and staff units, field offices and subsidiary location teams will create plans to address these areas. Infrastructure teams are focusing on creating plans to maintain critical operations at corporate headquarters. The corporate infrastructure team plans were completed during the first quarter of 1999. Each business or staff unit team is focusing 27 on creating plans to provide responsive actions for several potential disruption duration scenarios, and resuming critical business processes, products and services. For each disruption duration scenario, the business and staff unit plans will identify alternative procedures designed to permit continued operations and to minimize risk exposure. The business and staff unit contingency plans are scheduled to be completed on March 31, 1999. The contingency planning model and template will be distributed to all subsidiary and field office locations along with infrastructure plans and business and staff unit plans for leverage in creating their contingency plans. All plans will be analyzed and rolled up to an enterprise level following completion and will be modified as needed during 1999. We believe that our 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 we are developing will provide alternative procedures to lessen the impact of short duration disruptions, prolonged failure of power and telecommunications systems could have a material adverse effect on our results of operations, cash flows and consolidated financial position. As noted above, we indirectly rely on the information systems of the many components of our distribution network, which includes thousands of independent agents and brokers. We are aware that some of our independent agents and brokers are currently Year 2000 non-compliant and expect that a much lesser number, unknown at this time and expected to consist primarily of smaller agents, will be non-compliant on Jan. 1, 2000. We believe that Year 2000-related difficulties experienced by members of our distribution network have the potential to materially disrupt our business and that such potential disruptions constitute our second greatest area of potential exposure to the Year 2000 problem. As part of our contingency planning effort, we have been providing information to members of our 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 our distribution network consists of thousands of agents and brokers, the number of different systems used by the constituent members is far less. For example, we believe that fewer than 20 types of agency management systems are used by our property-liability insurance agents in the United States. Contingency arrangements are being discussed with distribution network members pursuant to which we 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. We note 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, both of which could adversely affect us. While we believe we are taking appropriate action with respect to third parties on whose systems and services we rely 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 our earnings, cash flows or financial condition. INSURANCE COVERAGE--We also face potential "Year 2000" claims under coverages provided by our insurance and reinsurance 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 our 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. 28 Our 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 we expect that such losses will not, in most if not all cases, cause direct physical loss or damage, we have concluded that our property and inland marine policies do not generally provide coverage for losses relating to Year 2000 issues. To reinforce our view on coverage afforded by such policies, we have developed and are implementing a specific Year 2000 exclusion endorsement. We continue to assess our exposure to insurance claims arising from our liability coverages, and we are 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 our view present unacceptable risk. We may also face claims from the beneficiaries of our surety bonds resulting from Year 2000-related performance failures by the purchasers of the bonds. We are assessing our exposure to such potential claims. We do not believe that Year 2000-related insurance or reinsurance coverage claims will have a material adverse effect on our earnings, cash flows or financial position. However, the uncertainties of litigation are such that unexpected policy interpretations could compel claim payments substantially beyond our coverage intentions, possibly resulting in a material adverse effect on our results of operations and/or cash flows and a material adverse effect on our consolidated financial position. THE ST. PAUL COMPANIES IMPACT OF ACCOUNTING PRONOUNCEMENTS TO BE ADOPTED IN THE FUTURE In December 1997, the 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 Dec. 31, 1998. We will adopt the provisions of this SOP in the first quarter of 1999. The pretax cumulative effect of such adoption is estimated to be an increase in our liabilities of approximately $32 million for the quarter ended March 31, 1999. The cumulative effect of adopting this accounting statement will be recorded separately on our statement of income, net of taxes. 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 Dec. 31, 1998. We will adopt the provisions of this SOP in the first quarter of 1999. We currently estimate that the effect of such adoption will be to record software having a value of approximately $19 million as an asset in 1999. 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 29 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. We intend to implement the provisions of SFAS No. 133 in the first quarter of the year 2000. We cannot at this time reasonably estimate the potential impact of this adoption on our financial position or results of operations for future periods. In October 1998, the AICPA issued SOP No. 98-7, "Deposit Accounting: Accounting for Insurance and Reinsurance Contracts That Do Not Transfer Insurance Risk," which provides guidance for accounting for such contracts. The SOP specifies that insurance and reinsurance contracts for which the deposit method of accounting is appropriate should be classified in one of four categories, and further specifies the accounting treatment for each of these categories. The SOP is effective for fiscal years beginning after June 15, 1999. We currently intend to implement the provisions of the SOP in the first quarter of the year 2000. We cannot at this time reasonably estimate the potential impact of this adoption on our financial position or results of operations for future periods. FORWARD-LOOKING STATEMENT DISCLOSURE This discussion 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 our control, actual results could differ materially from those in forward-looking statements. These statements should not be regarded as a representation that anticipated events will occur or that expected objectives will be achieved. Risks and uncertainties include, but are not limited to, the following: general economic conditions including changes in interest rates and the performance of financial markets; changes in domestic and foreign laws, regulations and taxes; changes in the demand for, pricing of, or supply of insurance or reinsurance; catastrophic events of unanticipated frequency or severity; loss of significant customers; 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, the time it may take 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 the insurance or reinsurance coverage provided by our policies. We undertake no obligation to release publicly the results of any future revisions we may make to forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. 30 SIX-YEAR SUMMARY OF SELECTED FINANCIAL DATA
1998 1997 1996 1995 1994 1993 --------- --------- --------- --------- --------- --------- (IN MILLIONS, EXCEPT PER SHARE DATA) CONSOLIDATED Revenues from continuing operations............. $ 9,108 $ 9,623 $ 9,232 $ 8,515 $ 7,678 $ 7,474 Income from continuing operations............... 89 997 840 768 728 667 INVESTMENT ACTIVITY Net investment income........................... 1,585 1,578 1,513 1,474 1,422 1,393 Pretax realized investment gains................ 202 423 262 92 47 64 OTHER SELECTED FINANCIAL DATA (as of December 31) Total assets.................................... 38,323 37,359 35,146 33,238 30,200 30,120 Debt............................................ 1,260 1,304 1,171 1,304 1,244 1,267 Capital securities.............................. 503 503 307 207 -- -- Common shareholders' equity..................... 6,621 6,591 5,631 5,342 3,675 3,910 Common shares outstanding....................... 233.8 233.1 230.9 235.4 227.5 221.0 PER COMMON SHARE DATA Income from continuing operations............... 0.32 3.96 3.26 2.96 2.85 2.66 Book value...................................... 28.32 28.27 24.39 22.69 16.15 17.69 Year-end market price........................... 34.81 41.03 29.31 27.81 22.38 22.47 Cash dividends declared......................... 1.00 0.94 0.88 0.80 0.75 0.70 PROPERTY-LIABILITY INSURANCE Written premiums................................ 6,693 6,933 7,034 6,806 6,012 5,681 Pretax operating earnings (loss)................ (56) 978 679 849 773 783 GAAP underwriting result........................ (1,041) (233) (350) (227) (267) (240) Statutory combined ratio: Loss and loss expense ratio................... 82.1 71.1 73.2 72.2 72.5 73.7 Underwriting expense ratio.................... 34.1 32.7 31.9 31.1 32.0 32.7 --------- --------- --------- --------- --------- --------- Combined ratio................................ 116.2 103.8 105.1 103.3 104.5 106.4 --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- LIFE INSURANCE Product sales................................... 501 446 427 348 286 205 Premium income.................................. 119 137 145 174 152 129 Net income (loss)............................... 13 51 (5) 19 12 10
31 INDEPENDENT AUDITORS' REPORT THE BOARD OF DIRECTORS AND SHAREHOLDERS THE ST. PAUL COMPANIES, INC.: We have audited the accompanying consolidated balance sheets of The St. Paul Companies, Inc. and subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of income, shareholders' equity, comprehensive income and cash flows for each of the years in the three-year period ended December 31, 1998. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. The consolidated financial statements as of December 31, 1997 and for each of the years in the two-year period then ended have been restated to reflect the pooling of interests with USF&G Corporation. We did not audit the consolidated financial statements of USF&G Corporation as of December 31, 1997 or for either of the years in the two-year period ended December 31, 1997, which statements reflect total assets constituting 43 percent as of December 31, 1997 and total revenues constituting 35 percent and 38 percent for the years ended December 31, 1997 and 1996, respectively, of the related consolidated totals. Those statements were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to the amounts included for USF&G Corporation as of December 31, 1997 and for each of the years in the two-year period then ended, is based solely on the report of the other auditors. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits and the report of other auditors provide a reasonable basis for our opinion. In our opinion, based on our audits and the report of the other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of The St. Paul Companies, Inc. and subsidiaries as of December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1998, in conformity with generally accepted accounting principles. /s/ KPMG PEAT MARWICK LLP - - ------------------------------ KPMG PEAT MARWICK LLP Minneapolis, Minnesota March 2, 1999 32 MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL STATEMENTS SCOPE OF RESPONSIBILITY--Management prepares the accompanying financial statements and related information and is responsible for their integrity and objectivity. The statements were prepared in conformity with generally accepted accounting principles. These financial statements include amounts that are based on management's estimates and judgments, particularly our reserves for losses and loss adjustment expenses. We believe that these statements present fairly the company's financial position and results of operations and that the other information contained in the annual report is consistent with the financial statements. INTERNAL CONTROLS--We maintain and rely on systems of internal accounting controls designed to provide reasonable assurance that assets are safeguarded and transactions are properly authorized and recorded. We continually monitor these internal accounting controls, modifying and improving them as business conditions and operations change. Our internal audit department also independently reviews and evaluates these controls. We recognize the inherent limitations in all internal control systems and believe that our systems provide an appropriate balance between the costs and benefits desired. We believe our systems of internal accounting controls provide reasonable assurance that errors or irregularities that would be material to the financial statements are prevented or detected in the normal course of business. INDEPENDENT AUDITORS--Our independent auditors, KPMG Peat Marwick LLP, have audited the consolidated financial statements. Their audit was conducted in accordance with generally accepted auditing standards, which includes the consideration of our internal controls to the extent necessary to form an independent opinion on the consolidated financial statements prepared by management. AUDIT COMMITTEE--The audit committee of the board of directors, composed solely of outside directors, oversees management's discharge of its financial reporting responsibilities. The committee meets periodically with management, our internal auditors and representatives of KPMG Peat Marwick LLP to discuss auditing, financial reporting and internal control matters. Both internal audit and KPMG Peat Marwick LLP have access to the audit committee without management's presence. CODE OF CONDUCT--We recognize our responsibility for maintaining a strong ethical climate. This responsibility is addressed in the company's written code of conduct. /s/ Douglas W. Leatherdale /s/ Paul J. Liska - - -------------------- -------------------- Douglas W. Leatherdale Paul J. Liska Chairman and Executive Vice President and Chief Chief Executive Officer Financial Officer 33 CONSOLIDATED STATEMENTS OF INCOME
YEAR ENDED DECEMBER 31 ---------------------------------------- THE ST. PAUL COMPANIES 1998 1997 1996 ------------ ------------ ------------ (IN THOUSANDS, EXCEPT PER SHARE DATA) REVENUES Premiums earned......................................................... $ 6,944,575 $ 7,298,100 $ 7,178,682 Net investment income................................................... 1,584,982 1,577,805 1,512,575 Realized investment gains............................................... 201,689 423,048 261,989 Asset management........................................................ 302,150 261,715 219,922 Other................................................................... 75,005 62,511 58,369 ------------ ------------ ------------ Total revenues...................................................... 9,108,401 9,623,179 9,231,537 ------------ ------------ ------------ EXPENSES Insurance losses and loss adjustment expenses........................... 5,603,561 5,093,521 5,153,565 Life policy benefits.................................................... 272,756 276,848 312,737 Policy acquisition expenses............................................. 1,653,613 1,709,039 1,682,788 Operating and administrative expenses................................... 1,624,758 1,208,063 1,091,349 ------------ ------------ ------------ Total expenses...................................................... 9,154,688 8,287,471 8,240,439 ------------ ------------ ------------ Income (loss) from continuing operations before income taxes............................................... (46,287) 1,335,708 991,098 Income tax expense (benefit)............................................ (135,635) 338,666 150,637 ------------ ------------ ------------ INCOME FROM CONTINUING OPERATIONS................................... 89,348 997,042 840,461 Discontinued operations: Operating loss, net of taxes.......................................... -- -- (19,216) Loss on disposal, net of taxes........................................ -- (67,750) (88,543) ------------ ------------ ------------ Loss from discontinued operations................................... -- (67,750) (107,759) ------------ ------------ ------------ NET INCOME.......................................................... $ 89,348 $ 929,292 $ 732,702 ------------ ------------ ------------ ------------ ------------ ------------ BASIC EARNINGS PER COMMON SHARE Income from continuing operations....................................... $ 0.33 $ 4.27 $ 3.47 Loss from discontinued operations....................................... -- (0.30) (0.46) ------------ ------------ ------------ NET INCOME.......................................................... $ 0.33 $ 3.97 $ 3.01 ------------ ------------ ------------ ------------ ------------ ------------ DILUTED EARNINGS PER COMMON SHARE Income from continuing operations....................................... $ 0.32 $ 3.96 $ 3.26 Loss from discontinued operations....................................... -- (0.27) (0.42) ------------ ------------ ------------ NET INCOME.......................................................... $ 0.32 $ 3.69 $ 2.84 ------------ ------------ ------------ ------------ ------------ ------------
See notes to consolidated financial statements. 34 CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
YEAR ENDED DECEMBER 31 ------------------------------------ THE ST. PAUL COMPANIES 1998 1997 1996 ---------- ------------ ---------- (IN THOUSANDS) Net income................................................................. $ 89,348 $ 929,292 $ 732,702 ---------- ------------ ---------- Other comprehensive income (loss), net of taxes: Change in unrealized appreciation........................................ 181,579 166,430 (219,738) Change in unrealized loss on foreign currency translation................ 8,856 (2,663) 20,467 Adjustment for minimum pension liability................................. -- -- 100,312 ---------- ------------ ---------- Other comprehensive income (loss)...................................... 190,435 163,767 (98,959) ---------- ------------ ---------- COMPREHENSIVE INCOME................................................... $ 279,783 $ 1,093,059 $ 633,743 ---------- ------------ ---------- ---------- ------------ ----------
See notes to consolidated financial statements. 35 CONSOLIDATED BALANCE SHEETS
DECEMBER 31 ------------------------ THE ST. PAUL COMPANIES 1998 1997 ----------- ----------- (IN THOUSANDS) ASSETS Investments: Fixed maturities...................................................................... $21,056,259 $20,945,219 Equities.............................................................................. 1,258,509 1,052,370 Real estate and mortgage loans........................................................ 1,507,448 1,626,051 Venture capital....................................................................... 571,340 461,892 Securities lending collateral......................................................... 1,368,322 515,043 Other investments..................................................................... 371,526 408,890 Short-term investments................................................................ 982,488 970,568 ----------- ----------- Total investments................................................................... 27,115,892 25,980,033 Cash.................................................................................... 119,841 113,175 Investment banking inventory securities................................................. 106,827 130,203 Reinsurance recoverables: Unpaid losses......................................................................... 3,977,789 3,839,051 Paid losses........................................................................... 157,484 128,422 Ceded unearned premiums................................................................. 288,107 376,343 Receivables: Underwriting premiums................................................................. 2,152,100 2,213,926 Interest and dividends................................................................ 361,133 355,970 Other................................................................................. 117,175 104,727 Deferred policy acquisition expenses.................................................... 878,172 872,460 Deferred income taxes................................................................... 1,193,292 1,213,790 Office properties and equipment......................................................... 518,497 602,381 Goodwill................................................................................ 592,057 618,528 Other assets............................................................................ 744,342 809,819 ----------- ----------- TOTAL ASSETS...................................................................... $38,322,708 $37,358,828 ----------- ----------- ----------- ----------- LIABILITIES Insurance reserves: Losses and loss adjustment expenses................................................... $18,457,921 $18,153,080 Future policy benefits................................................................ 4,142,277 3,816,050 Unearned premiums..................................................................... 3,265,762 3,528,234 ----------- ----------- Total insurance reserves............................................................ 25,865,960 25,497,364 Debt.................................................................................... 1,260,392 1,304,008 Payables: Reinsurance premiums.................................................................. 291,207 258,495 Income taxes.......................................................................... 221,270 303,549 Accrued expenses and other............................................................ 1,238,139 1,327,549 Securities lending.................................................................... 1,368,322 515,043 Other liabilities....................................................................... 938,331 1,041,952 ----------- ----------- TOTAL LIABILITIES................................................................. 31,183,621 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: PSOP convertible preferred stock...................................................... 134,181 137,892 Guaranteed obligation-PSOP............................................................ (118,605) (121,167) ----------- ----------- TOTAL PREFERRED SHAREHOLDERS' EQUITY.............................................. 15,576 16,725 ----------- ----------- Common: Common stock.......................................................................... 2,127,671 2,057,108 Retained earnings..................................................................... 3,480,057 3,720,140 Guaranteed obligation-ESOP............................................................ -- (8,453) Accumulated other comprehensive income: Unrealized appreciation............................................................. 1,027,390 845,811 Unrealized loss on foreign currency translation..................................... (14,307) (23,163) ----------- ----------- Total accumulated other comprehensive income...................................... 1,013,083 822,648 ----------- ----------- TOTAL COMMON SHAREHOLDERS' EQUITY................................................. 6,620,811 6,591,443 ----------- ----------- TOTAL SHAREHOLDERS' EQUITY........................................................ 6,636,387 6,608,168 ----------- ----------- TOTAL LIABILITIES, REDEEMABLE PREFERRED SECURITIES AND SHAREHOLDERS' EQUITY....... $38,322,708 $37,358,828 ----------- ----------- ----------- -----------
See notes to consolidated financial statements. 36 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
YEAR ENDED DECEMBER 31 ---------------------------------- THE ST. PAUL COMPANIES 1998 1997 1996 ---------- ---------- ---------- (IN THOUSANDS) PREFERRED SHAREHOLDERS' EQUITY PSOP convertible preferred stock: Beginning of year........................................................... $ 137,892 $ 142,131 $ 144,165 Redemptions during the year................................................. (3,711) (4,239) (2,034) ---------- ---------- ---------- End of year............................................................... 134,181 137,892 142,131 ---------- ---------- ---------- Guaranteed obligation--PSOP: Beginning of year........................................................... (121,167) (126,068) (133,293) Principal payments.......................................................... 2,562 4,901 7,225 ---------- ---------- ---------- End of year............................................................... (118,605) (121,167) (126,068) ---------- ---------- ---------- Convertible preferred stock: Beginning of year........................................................... -- 199,996 213,873 Conversions during the year................................................. -- (511) (12,677) Redemptions during the year................................................. -- (199,485) (1,200) ---------- ---------- ---------- End of year............................................................... -- -- 199,996 ---------- ---------- ---------- TOTAL PREFERRED SHAREHOLDERS' EQUITY...................................... 15,576 16,725 216,059 ---------- ---------- ---------- COMMON SHAREHOLDERS' EQUITY Common stock: Beginning of year........................................................... 2,057,108 1,895,608 1,869,241 Stock issued under stock incentive plans.................................... 69,578 32,421 32,956 Stock issued for preferred shares redeemed.................................. 7,993 8,708 8,338 Stock issued for acquisitions............................................... -- 113,264 1,664 Reacquired common shares.................................................... (34,732) (13,892) (28,808) Other....................................................................... 27,724 20,999 12,217 ---------- ---------- ---------- End of year............................................................... 2,127,671 2,057,108 1,895,608 ---------- ---------- ---------- Retained earnings: Beginning of year........................................................... 3,720,140 3,097,261 2,747,556 Net income.................................................................. 89,348 929,292 732,702 Dividends declared on common stock.......................................... (222,758) (186,036) (169,360) Dividends declared on preferred stock, net of taxes......................... (8,503) (10,304) (28,893) Reacquired common shares.................................................... (100,356) (114,232) (196,238) Tax benefit on employee stock options and awards............................ 6,468 8,211 5,623 Premium on preferred shares converted or redeemed........................... (4,282) (4,052) 5,871 ---------- ---------- ---------- End of year............................................................... 3,480,057 3,720,140 3,097,261 ---------- ---------- ---------- Guaranteed obligation--ESOP: Beginning of year........................................................... (8,453) (20,353) (32,294) Principal payments.......................................................... 8,453 11,900 11,941 ---------- ---------- ---------- End of year............................................................... -- (8,453) (20,353) ---------- ---------- ---------- Unrealized appreciation, net of taxes: Beginning of year........................................................... 845,811 679,381 899,119 Change for the year......................................................... 181,579 166,430 (219,738) ---------- ---------- ---------- End of year............................................................... 1,027,390 845,811 679,381 ---------- ---------- ---------- Unrealized loss on foreign currency translation, net of taxes: Beginning of year........................................................... (23,163) (20,500) (40,967) Currency translation adjustments............................................ 8,856 (2,663) (5,127) Realized loss relating to discontinued operations........................... -- -- 25,594 ---------- ---------- ---------- End of year............................................................... (14,307) (23,163) (20,500) ---------- ---------- ---------- Minimum pension liability, net of taxes: Beginning of year........................................................... -- -- (100,312) Change for the year......................................................... -- -- 100,312 ---------- ---------- ---------- End of year............................................................... -- -- -- ---------- ---------- ---------- TOTAL COMMON SHAREHOLDERS' EQUITY......................................... 6,620,811 6,591,443 5,631,397 ---------- ---------- ---------- TOTAL SHAREHOLDERS' EQUITY................................................ $6,636,387 $6,608,168 $5,847,456 ---------- ---------- ---------- ---------- ---------- ----------
See notes to consolidated financial statements. 37 CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31 ------------------------------------------- THE ST. PAUL COMPANIES 1998 1997 1996 ------------- ------------- ------------- (IN THOUSANDS) OPERATING ACTIVITIES Net income........................................................... $ 89,348 $ 929,292 $ 732,702 Adjustments: Change in property-liability insurance reserves.................... (24,969) (95,945) 162,242 Change in reinsurance balances..................................... 24,141 15,372 208,510 Change in premiums receivable...................................... 21,338 8,829 (105,395) Change in asset management balances................................ (32,300) 153,887 81,996 Depreciation and amortization...................................... 132,900 107,981 98,014 Realized investment gains.......................................... (201,689) (423,048) (261,989) Provision for loss on discontinued operations...................... -- 67,750 88,543 Other.............................................................. 59,869 83,387 295,033 ------------- ------------- ------------- NET CASH PROVIDED BY OPERATING ACTIVITIES........................ 68,638 847,505 1,299,656 ------------- ------------- ------------- INVESTING ACTIVITIES Purchases of investments............................................. (4,928,905) (5,447,411) (4,567,552) Proceeds from sales and maturities of investments.................... 4,958,699 5,228,222 4,188,916 Change in short-term investments..................................... (3,938) (207,245) (107,087) Change in open security transactions................................. (12,707) 28,418 (34,425) Venture capital distributions........................................ 49,592 29,565 28,446 Discontinued operations.............................................. (20,218) (54,018) -- Net purchases of office properties and equipment..................... (84,321) (139,942) (83,564) Acquisitions......................................................... (97,562) (235,876) (241,721) Other................................................................ 68,003 (26,662) 4,058 ------------- ------------- ------------- NET CASH USED IN INVESTING ACTIVITIES............................ (71,357) (824,949) (812,929) ------------- ------------- ------------- FINANCING ACTIVITIES Deposits for universal life and investment contracts................. 517,887 460,321 437,578 Withdrawals of universal life and investment contracts............... (186,405) (209,652) (534,762) Dividends paid on common and preferred stock......................... (226,355) (198,489) (199,879) Proceeds from issuance of debt....................................... 239,041 197,609 46,220 Repayment of debt.................................................... (224,938) (161,021) (142,532) Repurchase of common shares.......................................... (135,088) (128,224) (225,046) Proceeds from issuance of company-obligated mandatorily redeemable preferred capital securities of subsidiary trusts.................. -- 195,700 100,000 Redemption of preferred shares....................................... -- (199,485) (1,200) Stock options exercised and other.................................... 25,243 24,005 (1,509) ------------- ------------- ------------- NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES.............. 9,385 (19,236) (521,130) ------------- ------------- ------------- INCREASE (DECREASE) IN CASH...................................... 6,666 3,320 (34,403) ------------- ------------- ------------- Cash at beginning of year............................................ 113,175 109,855 144,258 ------------- ------------- ------------- CASH AT END OF YEAR.............................................. $ 119,841 $ 113,175 $ 109,855 ------------- ------------- ------------- ------------- ------------- -------------
See notes to consolidated financial statements. 38 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS THE ST. PAUL COMPANIES 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ACCOUNTING PRINCIPLES--We prepare our financial statements in accordance with generally accepted accounting principles (GAAP). We follow the accounting standards established by the Financial Accounting Standards Board (FASB) and the American Institute of Certified Public Accountants. CONSOLIDATION--We combine our financial statements with those of our subsidiaries and present them on a consolidated basis. The consolidated financial statements do not include the results of material transactions between us and our subsidiaries or among our subsidiaries. Our foreign underwriting operations' results are recorded on a one-month to one-quarter lag due to time constraints in obtaining and analyzing such results for inclusion in our consolidated financial statements on a current basis. In the event that significant events occur in the subsequent period, the impact is included in the current period results. DISCONTINUED OPERATIONS--In 1997, we sold our insurance brokerage operation, Minet. As a result, the financial statements for 1997 and 1996 reflect insurance brokerage results as discontinued operations. RECLASSIFICATIONS--We reclassified some amounts in our 1997 and 1996 financial statements and notes to conform with the 1998 presentation. These reclassifications had no effect on net income, or common or preferred shareholders' equity, as previously reported for those years. USE OF ESTIMATES--We make estimates and assumptions that have an effect on the amounts that we report in our financial statements. Our most significant estimates are those relating to our reserves for property-liability losses and loss adjustment expenses and life policy benefits. We continually review our estimates and make adjustments as necessary, but actual results could turn out significantly different than what we envisioned when we made these estimates. STOCK SPLIT--In May 1998, we declared a 2-for-1 stock split. All references in these financial statements and related notes to per-share amounts and to the number of shares of common stock reflect the effect of this stock split on all periods presented unless otherwise noted. ACCOUNTING FOR OUR PROPERTY-LIABILITY INSURANCE OPERATIONS PREMIUMS EARNED--Premiums on insurance policies are our largest source of revenue. We recognize the premiums as revenues evenly over the policy terms using the daily pro rata method. We record the premiums that we have not yet recognized as revenues as unearned premiums on our balance sheet. Assumed reinsurance premiums are recognized as revenues proportionately over the contract period. Premiums earned are recorded in our statement of income net of our cost to purchase reinsurance. INSURANCE LOSSES AND LOSS ADJUSTMENT EXPENSES--Losses represent the amounts we paid or expect to pay to claimants for events that have occurred. The costs of investigating, resolving and processing these claims are known as loss adjustment expenses ("LAE"). We record these items on our statement of income net of reinsurance, meaning that we reduce our gross losses and loss adjustment expenses incurred by the amounts we have recovered or will recover under reinsurance contracts. We establish reserves for the estimated total unpaid cost of losses and loss adjustment expenses, which cover events that occurred in 1998 and prior years. These reserves reflect our estimates of the total cost of claims that were reported to us, but not yet paid, and the cost of claims incurred but not yet reported to us (IBNR). Our estimates consider such variables as past loss experience, current claim trends and the prevailing social, economic and legal 39 environments. We reduce our loss reserves for estimated amounts of salvage and subrogation. Estimated amounts recoverable from reinsurers on unpaid losses and loss adjustment expenses are reflected as assets. We believe that the reserves we have established are adequate to cover the ultimate costs of losses and loss adjustment expenses. Final claim payments, how ever, may differ from the established reserves, particularly when these payments may not occur for several years. Any adjustments we make to reserves are reflected in the results for the year during which the adjustments are made. We participate in Lloyd's of London as an investor in underwriting syndicates and as the owner of three managing agencies. We record our pro rata share of syndicate assets, liabilities, revenues and expenses, after making adjustments to convert Lloyd's accounting to U.S. GAAP. The most significant U.S. GAAP adjustments relate to income recognition. Lloyd's syndicates determine underwriting results by year of account at the end of three years. We record adjustments to recognize underwriting results as incurred, including the expected ultimate cost of losses incurred. These adjustments to losses are based on actuarial analysis of syndicate accounts, including forecasts of expected ultimate losses provided by the syndicates. Financial information is available on a timely basis for the syndicates controlled by the managing agencies that we own, which make up the majority of the company's investment in Lloyd's syndicates. Syndicate results are recorded on a one-quarter lag due to time constraints in obtaining and analyzing such results for inclusion in our consolidated financial statements on a current basis. Our liabilities for unpaid losses and LAE related to tabular workers' compensation and certain assumed reinsurance coverage are discounted to the present value of estimated future payments. Prior to discounting, these liabilities totaled $866.2 million and $776.2 million at Dec. 31, 1998 and 1997, respectively. The total discounted liability reflected on our balance sheet was $668.6 million and $575.8 million at Dec. 31, 1998 and 1997, respectively. The liability for workers' compensation was discounted using rates of up to 3.5%, based on state-prescribed rates. The liability for certain assumed reinsurance coverage was discounted using rates up to 8.0%, based on our return on invested assets or, in many cases, on yields contractually guaranteed to us on funds held by the ceding companies. POLICY ACQUISITION EXPENSES--The costs directly related to writing an insurance policy are referred to as policy acquisition expenses and consist of commissions, state premium taxes and other direct underwriting expenses. Although these expenses arise when we issue a policy, we defer and amortize them over the same period as the corresponding premiums are recorded as revenues. On a regular basis, we perform an analysis of the deferred policy acquisition costs in relation to the expected recognition of revenues, and reflect adjustments as period costs. ACCOUNTING FOR OUR LIFE INSURANCE OPERATIONS PREMIUMS--Premiums on life insurance policies with fixed and guaranteed premiums and benefits, premiums on annuities with significant life contingencies and premiums on structured settlement annuities are recognized when due. Premiums received on universal life policies and investment-type annuity contracts are not recorded as revenues; instead, they are recognized as deposits on our balance sheet. Policy charges and surrender penalties are recorded as revenues. POLICY BENEFITS--Ordinary life insurance reserves are computed under the net level premium method. A uniform portion of each year's premium is used for calculating the reserve. The reserves also reflect assumptions we make for future investment yields, mortality and withdrawal rates. These assumptions reflect our experience, modified to reflect anticipated trends, and provide for possible adverse deviation. Reserve interest rate assumptions are graded and range from 2.5% to 6.0%. Universal life and deferred annuity reserves are computed on the retrospective deposit method, which produces reserves equal to the cash value of the contracts. Such reserves are 40 not reduced for charges that would be deducted from the cash value of policies surrendered. Reserves on immediate annuities with guaranteed payments are computed on the prospective deposit method, which produces reserves equal to the present value of future benefit payments. POLICY ACQUISITION EXPENSES--We consider anticipated policy benefits, remaining costs of servicing the policies and anticipated investment income in determining the recoverability of deferred acquisition costs for interest-sensitive life and annuity products. Deferred policy acquisition costs (DPAC) on ordinary life business are amortized over their assumed premium paying periods based on assumptions consistent with those used for computing policy benefit reserves. Universal life and investment annuity acquisition costs are amortized in proportion to the present value of their estimated gross profits over the products' assumed durations, which we regularly evaluate and adjust as appropriate. EQUITY-INDEXED ANNUITIES--Interest on our equity-indexed annuities is credited to the equity portion of these annuities annually based on an average gain in the S&P 500 index during the policy year. We purchase one-year options with similar terms as the index component to provide us with the same return on the S&P 500 index as we guarantee to the annuity contract holder. We carry a reserve on these annuities at an amount equal to the premium deposited, plus the increase in the market value of the option purchased based on the S&P 500 index, plus the amortization of the original purchase price of the option. ACCOUNTING FOR OUR ASSET MANAGEMENT OPERATIONS The John Nuveen Company comprises our asset management segment. We held a 78% and 77% interest in Nuveen on Dec. 31, 1998 and 1997, respectively. Nuveen sponsors and markets open-end and closed-end (exchange-traded) managed funds, defined portfolios (unit investment trusts) and individual managed accounts. They also underwrite and trade municipal bonds. They hold in inventory securities that will be sold to individuals or security dealers. Those inventory securities are carried at market value. Nuveen's revenues include investment advisory fees, revenues from the distribution of defined portfolios and managed fund investment products, interest income, gains and losses from the sale of inventory securities, and gains and losses from changes in the market value of investment products and securities held temporarily. We consolidate 100% of Nuveen's assets, liabilities, revenues and expenses, with reductions on the balance sheet and statement of income for the minority shareholders' proportionate interest in Nuveen's equity and earnings. Minority interest of $67.1 million and $63.1 million was recorded in other liabilities at the end of 1998 and 1997, respectively. Nuveen repurchased and retired 0.7 million and 1.8 million of its common shares in 1998 and 1997, respectively, for a total cost of $27 million in 1998 and $55 million in 1997. Our proceeds from the Nuveen repurchases totaled $41 million in 1997. ACCOUNTING FOR OUR INVESTMENTS FIXED MATURITIES--Our entire fixed maturity investment portfolio is classified as available-for-sale. Accordingly, we carry that portfolio on our balance sheet at estimated fair value. EQUITIES--Our equity securities are also classified as available-for-sale and carried at estimated fair value. REAL ESTATE AND MORTGAGE LOANS--Our real estate investments include apartments and office buildings and other commercial land and properties that we own directly or in which we have a partial interest through joint ventures with other investors. Our mortgage loan investments consist of fixed-rate loans collateralized by apartment, warehouse and office properties. For direct real estate investments, we carry land at cost and buildings at cost less accumulated depreciation and valuation adjustments. We depreciate real estate assets on 41 a straight-line basis over 40 years. Tenant improvements are amortized over the term of the corresponding lease. The accumulated depreciation of our real estate investments was $108.4 million and $93.0 million at Dec. 31, 1998 and 1997, respectively. We use the equity method of accounting for our direct real estate joint ventures, which means we carry these investments at cost, adjusted for our share of earnings or losses, and reduced by cash distributions from the joint ventures and valuation adjustments. We carry our mortgage loans at estimated fair value, representing the unpaid principal balances less any valuation adjustments. Valuation allowances are recognized for loans with deterioration in collateral performance that are deemed other than temporary. The estimated fair value of mortgage loans at Dec. 31, 1998 was $629 million. VENTURE CAPITAL--We invest in small- to medium-sized companies. These investments are in the form of limited partnerships or direct ownership. The limited partnerships are carried at our equity in the estimated market value of the investments held by these limited partnerships. The investments we own directly are carried at estimated fair value. SECURITIES LENDING--We participate in a securities lending program whereby certain securities from our portfolio are loaned to other institutions for short periods of time. We receive a fee from the borrower in return. Our policy is to require collateral equal to 102 percent of the fair value of the loaned securities. We maintain full ownership rights to the securities loaned. In addition, we have the ability to sell the securities while they are on loan. We have an indemnification agreement with the lending agents in the event a borrower becomes insolvent or fails to return securities. REALIZED INVESTMENT GAINS AND LOSSES--We record the cost of each individual investment so that when we sell any of them, we are able to identify and record the gain or loss on that transaction on our statement of income. We continually monitor the difference between the cost and estimated fair value of our investments. If any of our investments experience a decline in value that we believe is other than temporary, we establish a valuation allowance for the decline and record a realized loss on the statement of income. UNREALIZED APPRECIATION AND DEPRECIATION-- For investments we carry at estimated fair value, we record the difference between cost and fair value, net of deferred taxes, as a part of common shareholders' equity. This difference is referred to as unrealized appreciation or depreciation. In our life insurance operations, deferred policy acquisition costs and certain reserves are adjusted for the impact on estimated gross margins as if the net unrealized gains and losses on securities had actually been realized. The change in unrealized appreciation or depreciation during the year is a component of comprehensive income. GOODWILL Goodwill is the excess of the amount we paid to acquire a company over the fair value of its net assets, reduced by amortization and any subsequent valuation adjustments. We amortize goodwill over periods of up to 40 years. The accumulated amortization of goodwill was $203.5 million and $153.1 million at Dec. 31, 1998 and 1997, respectively. IMPAIRMENT OF LONG-LIVED ASSETS AND INTANGIBLES We monitor the value of our long-lived assets to be held and used for recoverability based on our estimate of the future cash flows (undiscounted and without interest charges) expected to result from the use of the asset and its eventual disposition considering any events or changes in circumstances which indicate that the carrying value of an asset may not be recoverable. We monitor the value of our goodwill based on our estimates of discounted future earnings. If either estimate is less than the carrying amount of the asset, we reduce the carrying value to fair value with a corresponding charge to expenses. We monitor the value of our long-lived assets, and certain identifiable intangibles, to be disposed of and report them at the lower of carrying value or fair value less our estimated cost to sell. 42 OFFICE PROPERTIES AND EQUIPMENT We carry office properties and equipment at depreciated cost. We depreciate these assets on a straight-line basis over the estimated useful lives of the assets. The accumulated depreciation for office properties and equipment was $405.3 million and $369.4 million at the end of 1998 and 1997, respectively. FOREIGN CURRENCY TRANSLATION We assign functional currencies to our foreign operations, which are generally the currencies of the local operating environment. Foreign currency amounts are remeasured to the functional currency, and the resulting foreign exchange gains or losses are reflected in the statement of income. Functional currency amounts are then translated into U.S. dollars. The unrealized gain or loss from this translation is recorded as a part of common shareholders' equity. The change in unrealized foreign currency translation gain or loss during the year is a component of comprehensive income. Both the remeasurement and translation are calculated using current exchange rates for the balance sheets and average exchange rates for the statements of income. In highly inflationary economies, the functional currency is the U.S. dollar. Monetary assets and liabilities are translated into U.S. dollars using exchange rates in effect at the balance sheet date, whereas nonmonetary balances are translated using historical exchange rates. Revenue and expense accounts are translated using the average exchange rates prevailing during the year for monetary transactions and historical exchange rates for nonmonetary transactions. Realized gains or losses resulting from translation are included in the statement of income. SUPPLEMENTAL CASH FLOW INFORMATION INTEREST AND INCOME TAXES PAID--We paid interest of $71.1 million in 1998, $81.1 million in 1997 and $85.5 million in 1996. We paid federal income taxes of $68.3 million in 1998, $99.3 million in 1997 and $96.3 million in 1996. NONCASH FINANCING ACTIVITIES--The John Nuveen Company issued $45 million of preferred stock in 1997 to fund a portion of its purchase of Flagship Resources, Inc. In December 1997, we issued $112 million of common stock in consideration for our acquisition of TITAN Holdings, Inc. Cash provided from operating activities in 1997 does not include a $104 million portion of a coinsurance contract purchased to cede certain structured settlement annuity obligations (see Note 15 "Reinsurance"). During 1996, we entered into a coinsurance contract with an unaffiliated life insurance company to cede a portion of our block of single premium deferred annuities (the "broker SPDA block"). As part of the noncash transaction, we transferred $932 million of investments and other assets to the coinsurer, and recorded a reinsurance receivable of $964 million. 2. MERGER WITH USF&G CORPORATION On April 24, 1998, The St. Paul issued 66.5 million of its common shares (as adjusted for the May 6, 1998 two-for-one stock split) in a tax-free exchange for all of the outstanding common stock of USF&G Corporation (USF&G), a holding company for property-liability and life insurance operations. This business combination was accounted for as a pooling of interests; accordingly, the consolidated financial statements for all periods prior to the combination were restated to include the accounts and results of operations of USF&G. There were no material intercompany transactions between The St. Paul and USF&G prior to the merger. 43 The following summarizes the results of operations previously reported by The St. Paul and USF&G, and the combined amounts included in the accompanying consolidated financial statements.
YEAR ENDED DECEMBER 31 ---------------------- 1997 1996 ---------- ---------- (IN THOUSANDS) Total Revenues: The St. Paul Companies, Inc....................... $6,219,273 $5,734,156 USF&G Corporation........... 3,403,906 3,497,381 ---------- ---------- Combined.................. $9,623,179 $9,231,537 ---------- ---------- ---------- ---------- Net Income: The St. Paul Companies, Inc....................... $ 705,473 $ 450,099 USF&G Corporation........... 193,866 260,977 ---------- ---------- Combined.................. $ 899,339 $ 711,076 ---------- ---------- Conforming accounting adjustment, net of taxes..................... 29,953 21,626 ---------- ---------- Net income included in accompanying consolidated financial statements...... $ 929,292 $ 732,702 ---------- ---------- ---------- ----------
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 discounted tabular workers' compensation reserves using an interest rate of up to 3.5%. These reserves have an ultimate cost and payment pattern that are fixed and determinable, and accordingly, may be discounted 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 conforming accounting adjustment in the preceding table represents the net reduction in insurance losses and loss adjustment expenses to conform the discounting policies of the two companies with regard to these reserves. We recorded a pretax charge to earnings of $292 million ($221 million after-tax) in 1998 related to the merger, primarily consisting of severance and other employee-related costs, facilities exit costs, asset impairments and transaction costs. We estimated that approximately 2,000 positions would 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, are affected by the reductions. The number of positions expected to be reduced by function include approximately 950 in our property-liability underwriting operation, 350 in claims and 700 in finance and other administrative positions. The reductions will occur throughout the United States. Through Dec. 31, 1998, approximately 1,400 positions had been eliminated, and the cost of termination benefits paid was $78.2 million. We expect to realize annualized pretax expense savings of approximately $200 million as a result of our plan to merge the two organizations, primarily due to the 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." 44 The following table provides information about the components of the charge taken during the second quarter, payments made and the balance of accrued amounts remaining at Dec. 31, 1998.
PRE-TAX CHARGE -------------- (IN THOUSANDS) CHARGES TO EARNINGS: USF&G corporate headquarters....... $ 36,400 Long-lived assets.... 22,835 Software depreciation acceleration....... 9,678 Computer leases and equipment.......... 9,600 Other equipment & furniture.......... 7,700 -------------- Subtotal........... 86,213 --------------
RESERVE PRE-TAX AT DEC. 31, CHARGE PAYMENTS 1998 -------------- ----------- ----------- (IN THOUSANDS) ACCRUED CHARGES SUBJECT TO ROLLFORWARD: Executive severance.......... 89,352 $ (51,939) $ 37,413 Other severance...... 52,200 (26,275) 25,925 Branch lease exit costs.............. 34,150 (105) 34,045 Transaction costs.... 29,676 (29,681) (5) -------------- ----------- ----------- Subtotal........... 205,378 $(108,000) 97,378 -------------- ----------- ----------- Total............ $ 291,591 $ 97,378 -------------- ----------- -------------- -----------
On our Statement of Income, $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 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. We 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 our "parent company and other" segment results. We continue to depreciate this building over its estimated remaining useful life. LONG-LIVED ASSETS Upon consummation of the merger, we determined that several of USF&G's real estate investments were not consistent with our 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, we determined that four of these miscellaneous investments should be written down to fair value, based on our 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 our Statement of Income in "Realized investment gains." The 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. 45 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 segment results: $14.1 million in property-liability investment; $6.2 million in parent company and other; and $2.5 million in life. ACCELERATION OF SOFTWARE DEPRECIATION We 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. COMPUTER LEASES AND EQUIPMENT The technology study also identified redundant computer hardware, resulting 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. 46 3. EARNINGS PER COMMON SHARE Earnings per common share (EPS) amounts are calculated based on the provisions of SFAS No. 128, "Earnings Per Share." Common shares for all periods reflect the impact of the May 6, 1998 2-for-1 stock split.
YEAR ENDED DECEMBER 31 ------------------------------- 1998 1997 1996 --------- --------- --------- (IN THOUSANDS) BASIC Net income, as reported...... $ 89,348 $ 929,292 $ 732,702 Preferred stock dividends, net of taxes............... (8,504) (10,304) (28,893) Premium on preferred shares redeemed................... (4,282) (4,441) (1,033) --------- --------- --------- Net income available to common shareholders.... $ 76,562 $ 914,547 $ 702,776 --------- --------- --------- --------- --------- --------- DILUTED Net income available to common shareholders........ $ 76,562 $ 914,547 $ 702,776 Effect of dilutive securities: Convertible preferred stock.................... -- 5,998 9,478 Zero coupon convertible notes.................... -- 3,143 5,133 Convertible monthly income preferred securities..... -- 8,073 8,073 --------- --------- --------- Net income available to common shareholders.... $ 76,562 $ 931,761 $ 725,460 --------- --------- --------- --------- --------- --------- COMMON SHARES BASIC Weighted average common shares outstanding......... 235,360 230,158 233,340 --------- --------- --------- --------- --------- --------- DILUTED Weighted average common shares outstanding......... 235,360 230,158 233,340 Effect of dilutive securities: Stock options.............. 3,322 4,399 3,089 Convertible preferred stock.................... -- 7,788 9,152 Zero coupon convertible notes.................... -- 2,923 3,263 Convertible monthly income preferred securities..... -- 7,017 7,017 --------- --------- --------- Total.................. 238,682 252,285 255,861 --------- --------- --------- --------- --------- ---------
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 per share for the year ended Dec. 31, 1998, and are therefore not included in the EPS calculation. 47 4. INVESTMENTS VALUATION OF INVESTMENTS--The following presents the cost, gross unrealized appreciation and depreciation, and estimated fair value of our investments in fixed maturities, equities and venture capital.
DECEMBER 31, 1998 -------------------------------------------------------- GROSS GROSS ESTIMATED UNREALIZED UNREALIZED FAIR COST APPRECIATION DEPRECIATION VALUE ------------- ------------ ------------ ------------- (IN THOUSANDS) Fixed maturities: U.S. government...................................... $ 2,672,630 $ 208,471 $ (7) $ 2,881,094 States and political subdivisions.................... 6,113,669 445,483 (331) 6,558,821 Foreign governments.................................. 909,353 70,378 (1,515) 978,216 Corporate securities................................. 6,747,847 375,100 (26,577) 7,096,370 Asset-backed securities.............................. 661,259 26,012 (2,831) 684,440 Mortgage-backed securities........................... 2,791,677 66,212 (571) 2,857,318 ------------- ------------ ------------ ------------- Total fixed maturities............................. 19,896,435 1,191,656 (31,832) 21,056,259 Equities............................................... 941,723 360,576 (43,790) 1,258,509 Venture capital........................................ 389,225 200,969 (18,854) 571,340 ------------- ------------ ------------ ------------- Total.............................................. $ 21,227,383 $ 1,753,201 $ (94,476) $ 22,886,108 ------------- ------------ ------------ ------------- ------------- ------------ ------------ -------------
DECEMBER 31, 1997 -------------------------------------------------------- GROSS GROSS ESTIMATED UNREALIZED UNREALIZED FAIR COST APPRECIATION DEPRECIATION VALUE ------------- ------------ ------------ ------------- (IN THOUSANDS) Fixed maturities: U.S. government...................................... $ 2,754,657 $ 120,750 $ (1,886) $ 2,873,521 States and political subdivisions.................... 6,280,554 419,744 (535) 6,699,763 Foreign governments.................................. 1,118,494 66,586 (23,875) 1,161,205 Corporate securities................................. 6,089,142 287,178 (5,613) 6,370,707 Asset-backed securities.............................. 692,536 14,946 (400) 707,082 Mortgage-backed securities........................... 3,053,327 80,607 (993) 3,132,941 ------------- ------------ ------------ ------------- Total fixed maturities............................. 19,988,710 989,811 (33,302) 20,945,219 Equities............................................... 804,593 267,889 (20,112) 1,052,370 Venture capital........................................ 324,333 156,205 (18,646) 461,892 ------------- ------------ ------------ ------------- Total.............................................. $ 21,117,636 $ 1,413,905 $ (72,060) $ 22,459,481 ------------- ------------ ------------ ------------- ------------- ------------ ------------ -------------
STATUTORY DEPOSITS--At Dec. 31, 1998, our property-liability and life insurance operations had investments in fixed maturities with an estimated fair value of $1.17 billion on deposit with regulatory authorities as required by law. 48 FIXED MATURITIES BY MATURITY DATE--The following table presents the breakdown of our fixed maturities by years to maturity. Actual maturities may differ from those stated as a result of calls and prepayments.
DECEMBER 31, 1998 ------------------------ AMORTIZED ESTIMATED COST FAIR VALUE ----------- ----------- (IN THOUSANDS) One year or less............ $ 895,252 $ 906,956 Over one year through five years..................... 4,459,414 4,686,292 Over five years through 10 years..................... 5,721,337 6,101,179 Over 10 years............... 5,367,496 5,820,074 Asset-backed securities with various maturities........ 661,259 684,440 Mortgage-backed securities with various maturities... 2,791,677 2,857,318 ----------- ----------- Total..................... $19,896,435 $21,056,259 ----------- ----------- ----------- -----------
5. INVESTMENT TRANSACTIONS INVESTMENT ACTIVITY--Following is a summary of our investment purchases, sales and maturities.
YEAR ENDED DECEMBER 31 ---------------------------------- 1998 1997 1996 ---------- ---------- ---------- (IN THOUSANDS) PURCHASES Fixed maturities...... $3,213,663 $3,435,901 $3,077,119 Equities.......... 1,250,453 1,509,774 1,087,951 Real estate and mortgage loans........... 211,263 380,258 291,745 Venture capital... 153,146 97,413 94,891 Other investments..... 100,380 24,065 15,846 ---------- ---------- ---------- Total purchases..... 4,928,905 5,447,411 4,567,552 ---------- ---------- ---------- PROCEEDS FROM SALES AND MATURITIES Fixed maturities: Sales........... 1,098,212 1,705,234 1,096,544 Maturities and redemptions... 2,012,366 1,322,330 1,432,263 Equities.......... 1,340,620 1,478,575 1,353,399 Real estate and mortgage loans........... 338,709 467,684 185,742 Venture capital... 63,894 250,015 118,011 Other investments..... 104,898 4,384 2,957 ---------- ---------- ---------- Total sales and maturities.... 4,958,699 5,228,222 4,188,916 ---------- ---------- ---------- Net purchases (sales)....... $ (29,794) $ 219,189 $ 378,636 ---------- ---------- ---------- ---------- ---------- ----------
NET INVESTMENT INCOME--Following is a summary of our net investment income.
YEAR ENDED DECEMBER 31 ---------------------------------- 1998 1997 1996 ---------- ---------- ---------- (IN THOUSANDS) Fixed maturities...... $1,376,038 $1,405,478 $1,368,654 Equities.......... 16,271 17,357 16,279 Real estate and mortgage loans........... 120,812 112,944 83,994 Venture capital... 297 352 324 Securities lending......... 726 518 769 Other investments..... 21,529 9,348 18,718 Short-term investments..... 76,741 57,915 51,371 ---------- ---------- ---------- Total........... 1,612,414 1,603,912 1,540,109 Investment expenses........ (27,432) (26,107) (27,534) ---------- ---------- ---------- Net investment income........ $1,584,982 $1,577,805 $1,512,575 ---------- ---------- ---------- ---------- ---------- ----------
REALIZED AND UNREALIZED INVESTMENT GAINS (LOSSES)--The following summarizes our pretax realized investment gains and losses, and the change in unrealized appreciation of investments recorded in common shareholders' equity and in comprehensive income.
YEAR ENDED DECEMBER 31 ------------------------------- 1998 1997 1996 --------- --------- --------- (IN THOUSANDS) PRETAX REALIZED INVESTMENT GAINS (LOSSES) Fixed maturities: Gross realized gains....... $ 10,268 $ 36,233 $ 23,033 Gross realized losses...... (21,376) (43,620) (40,037) --------- --------- --------- Total fixed maturities... (11,108) (7,387) (17,004) --------- --------- --------- Equities: Gross realized gains....... 241,407 208,978 239,646 Gross realized losses...... (77,524) (46,412) (31,282) --------- --------- --------- Total equities........... 163,883 162,566 208,364 --------- --------- --------- Real estate and mortgage loans............. 13,883 45,259 (22,137) Venture capital.............. 25,231 212,663 86,011 Other investments............ 9,800 9,947 6,755 --------- --------- --------- Total pretax realized investment gains....... $ 201,689 $ 423,048 $ 261,989 --------- --------- --------- --------- --------- ---------
49
YEAR ENDED DECEMBER 31 ------------------------------- 1998 1997 1996 --------- --------- --------- (IN THOUSANDS) CHANGE IN UNREALIZED APPRECIATION Fixed maturities............. $ 203,315 $ 399,696 $(440,916) Equities..................... 69,009 61,969 27,981 Venture capital.............. 44,556 (154,826) 163,110 Life deferred policy acquisition costs and policy benefits............ (653) (21,171) 53,469 Single premium immediate annuity reserves........... (16,678) (27,411) -- Other........................ (16,765) (1,974) 11,074 --------- --------- --------- Total change in pretax unrealized appreciation........... 282,784 256,283 (185,282) Change in deferred taxes..... (101,205) (89,853) (34,456) --------- --------- --------- Total change in unrealized appreciation, net of taxes.................. $ 181,579 $ 166,430 $(219,738) --------- --------- --------- --------- --------- ---------
6. DERIVATIVE FINANCIAL INSTRUMENTS Derivative financial instruments are defined as futures, forward, swap or option contracts and other financial instruments with similar characteristics. We have had limited involvement with these instruments for purposes of hedging against fluctuations in market indices, foreign currency exchange rates and interest rates. All investments, including derivative instruments, have some degree of market and credit risk associated with them. However, the market risk on our derivatives substantially offsets the market risk associated with fluctuations in interest rates. We seek to reduce our credit risk by conducting derivative transactions only with reputable, investment-grade counterparties. We enter into interest rate swap agreements for the purpose of reducing the effect of interest rate fluctuations on some of our debt and investments. We purchase foreign exchange forward contracts to minimize the impact of fluctuating foreign currencies on our results of operations. We hedge our obligation to pay credited rates on equity-indexed annuity products by purchasing options tied to the S&P 500 index. Individually, and in the aggregate, the impact of these transactions on our financial position and results of operations is not material. 7. RESERVES FOR LOSSES, LOSS ADJUSTMENT EXPENSES AND LIFE POLICY BENEFITS RECONCILIATION OF LOSS RESERVES--The following table represents a reconciliation of beginning and ending consolidated property-liability insurance loss and loss adjustment expense (LAE) reserves for each of the last three years.
YEAR ENDED DECEMBER 31 ------------------------------------- 1998 1997 1996 ----------- ----------- ----------- (IN THOUSANDS) Loss and LAE reserves at beginning of year, as reported................. $18,153,080 $17,888,536 $16,559,200 Less reinsurance recoverables on unpaid losses at beginning of year..................... (3,053,425) (2,867,732) (2,826,942) ----------- ----------- ----------- Net loss and LAE reserves at beginning of year... 15,099,655 15,020,804 13,732,258 Net reserves of acquired companies................ -- 140,710 1,033,443 ----------- ----------- ----------- Provision for losses and LAE for claims incurred: Current year............. 5,874,522 5,720,662 5,567,703 Prior years.............. (270,961) (627,141) (414,138) ----------- ----------- ----------- Total incurred......... 5,603,561 5,093,521 5,153,565 ----------- ----------- ----------- Losses and LAE payments for claims incurred: Current year............. (1,840,328) (1,709,512) (1,864,832) Prior years.............. (3,653,865) (3,453,073) (3,029,833) ----------- ----------- ----------- Total paid............. (5,494,193) (5,162,585) (4,894,665) ----------- ----------- ----------- Unrealized foreign exchange loss (gain).............. (14,916) 7,205 (3,797) ----------- ----------- ----------- Net loss and LAE reserves at end of year......... 15,194,107 15,099,655 15,020,804 Plus reinsurance recoverables on unpaid losses at end of year.... 3,263,814 3,053,425 2,867,732 ----------- ----------- ----------- Loss and LAE reserves at end of year, as reported............... $18,457,921 $18,153,080 $17,888,536 ----------- ----------- ----------- ----------- ----------- -----------
In 1998, we recorded pretax loss and loss adjustment expenses of $250 million to reflect the application of our loss reserving policies to USF&G's loss and loss adjustment expense reserves subsequent to the merger. In the foregoing table, $60.7 million of the charge is reflected in the provision for current year losses and LAE, and the remaining $189.3 million is reflected in the provision for prior year losses and LAE. Prior to the merger, both companies, in accordance with generally accepted accounting principles, recorded their best estimate of 50 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, we obtained the raw data underlying, and documentation supporting, USF&G's Dec. 31, 1997 reserve analysis. Our 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, our 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 segments: Commercial Lines ($196.7 million); Personal Insurance ($35.1 million); and Specialty Commercial ($18.2 million). LIFE BENEFIT RESERVES--The following table shows our life insurance operations future policy benefit reserves by type.
DECEMBER 31 ---------------------- 1998 1997 ---------- ---------- (IN THOUSANDS) Single Premium Annuities: Deferred.................... $1,366,137 $1,373,519 Immediate................... 1,118,586 1,047,744 Other annuities............... 1,031,871 367,475 Universal/term/group life..... 625,683 1,027,312 ---------- ---------- Gross balance............... 4,142,277 3,816,050 Reinsurance recoverables...... 713,975 785,626 ---------- ---------- Total future policy benefit reserves.................. $3,428,302 $3,030,424 ---------- ---------- ---------- ----------
ENVIRONMENTAL AND ASBESTOS RESERVES--Our underwriting operations continue to receive claims under policies written many years ago alleging injuries from environmental pollution or alleging covered property damages for the cost to clean up polluted sites. We have also received asbestos claims arising out of product liability coverages under general liability policies. The following table summarizes the environmental and asbestos reserves reflected in our consolidated balance sheet at Dec. 31, 1998 and 1997. Amounts in the "net" column are reduced by reinsurance.
DECEMBER 31 ------------------------------------------ 1998 1997 -------------------- -------------------- GROSS NET GROSS NET ---------- -------- ---------- -------- (IN THOUSANDS) Environmental....... $ 783,000 $645,000 $ 867,000 $677,000 Asbestos............ 402,000 277,000 397,000 279,000 ---------- -------- ---------- -------- Total environmental and asbestos reserves........ $1,185,000 $922,000 $1,264,000 $956,000 ---------- -------- ---------- -------- ---------- -------- ---------- --------
8. INCOME TAXES METHOD FOR COMPUTING INCOME TAX EXPENSE (BENEFIT)--We are required to compute our income tax expense under the liability method. This means deferred income taxes reflect what we estimate we will pay or receive in future years. A current tax liability is recognized for the estimated taxes payable for the current year. INCOME TAX EXPENSE (BENEFIT)--Income tax expense or benefits are recorded in various places in our financial statements. A summary of the amounts and places follows:
YEAR ENDED DECEMBER 31 ------------------------------- 1998 1997 1996 --------- --------- --------- (IN THOUSANDS) STATEMENTS OF INCOME Expense (benefit) on continuing operations.... $(135,635) $ 338,666 $ 150,637 Expense on discontinued operations............... -- -- 401 Benefit on loss on disposal................. -- (35,530) (291,493) --------- --------- --------- Total income tax expense (benefit) included in statements of income... (135,635) 303,136 (140,455) --------- --------- --------- COMMON SHAREHOLDERS' EQUITY Benefit for deductions relating to: Dividends on unallocated ESOP and PSOP shares... (5,880) (3,112) (3,626) Employee stock options and awards............. (6,468) (8,211) (5,623) Expense for the change in unrealized appreciation and unrealized foreign exchange................. 98,538 89,232 31,891 --------- --------- --------- Total income tax expense included in common shareholders' equity... 86,190 77,909 22,642 --------- --------- --------- Total income tax expense (benefit) included in financial statements... $ (49,445) $ 381,045 $(117,813) --------- --------- --------- --------- --------- ---------
51 COMPONENTS OF INCOME TAX EXPENSE (BENEFIT)--The components of income tax expense (benefits) on continuing operations are as follows:
YEAR ENDED DECEMBER 31 ------------------------------- 1998 1997 1996 --------- --------- --------- (IN THOUSANDS) Federal current tax expense............. $ 19,650 $ 281,528 $ 117,035 Federal deferred tax expense (benefit)... (177,433) 23,299 5,174 --------- --------- --------- Total federal income tax expense (benefit)......... (157,783) 304,827 122,209 Foreign income taxes............... 13,740 19,467 22,074 State income taxes.... 8,408 14,372 6,354 --------- --------- --------- Total income tax expense (benefit) on continuing operations........ $(135,635) $ 338,666 $ 150,637 --------- --------- --------- --------- --------- ---------
OUR TAX RATE IS DIFFERENT FROM THE STATUTORY RATE--Our total income tax expense differs from the statutory rate of 35% of pretax income as shown in the following table:
YEAR ENDED DECEMBER 31 ------------------------------- 1998 1997 1996 --------- --------- --------- (IN THOUSANDS) Federal income tax expense (benefit) at statutory rate............... $ (16,201) $ 467,498 $ 346,884 Increase (decrease) attributable to: Nontaxable investment income........... (112,882) (112,420) (96,156) Valuation allowance........ (35,408) (31,657) (106,519) Nondeductible merger expense... 31,036 -- -- Other.............. (2,180) 15,245 6,428 --------- --------- --------- Total income tax expense (benefit) on continuing operations..... $(135,635) $ 338,666 $ 150,637 --------- --------- --------- --------- --------- ---------
MAJOR COMPONENTS OF DEFERRED INCOME TAXES ON OUR BALANCE SHEET--Differences between the tax basis of assets and liabilities and their reported amounts in the financial statements that will result in taxable or deductible amounts in future years are called temporary differences. The tax effects of temporary differences that give rise to the deferred tax assets and deferred tax liabilities are presented in the following table:
DECEMBER 31 ---------------------- 1998 1997 ---------- ---------- (IN THOUSANDS) DEFERRED TAX ASSETS Loss reserves................. $1,048,361 $1,122,326 Loss on disposal of insurance brokerage operations........ 33,036 199,868 Unearned premium reserves..... 181,165 198,124 Net operating loss carryforward................ 459,926 194,267 Other......................... 706,144 555,562 ---------- ---------- Total gross deferred tax assets.................... 2,428,632 2,270,147 Less valuation allowance...... (5,814) (41,222) ---------- ---------- Net deferred tax assets..... 2,422,818 2,228,925 ---------- ---------- DEFERRED TAX LIABILITIES Unrealized appreciation of investments................. 536,334 437,947 Deferred acquisition costs.... 277,624 279,469 Real estate................... 115,051 65,036 Other......................... 300,517 232,683 ---------- ---------- Total gross deferred tax liabilities............... 1,229,526 1,015,135 ---------- ---------- Deferred income taxes....... $1,193,292 $1,213,790 ---------- ---------- ---------- ----------
If we believe that all of our deferred tax assets will not result in future tax benefits, we must establish a "valuation allowance" for the portion of these assets that we think will not be realized. The net change in the valuation allowance for deferred tax assets was a decrease of $35.4 million in 1998, and a decrease of $31.7 million in 1997, relating to our foreign underwriting operations and our provision for loss on disposal of insurance brokerage operations. Based upon a review of our refundable taxes, anticipated future earnings, and all other available evidence, both positive and negative, we have concluded it is "more likely than not" that our net deferred tax assets will be realized. NET OPERATING LOSS (NOL), FOREIGN TAX CREDIT (FTC), AND ALTERNATIVE MINIMUM TAX (AMT) CREDIT CARRYFORWARDS--For tax return purposes, as of Dec. 31, 1998 we had NOL carryforwards that expire, if unused, in 2004-2018 and FTC carryforwards that expire, if unused, in 2000-2003. We have AMT credit carryforwards of approximately $116.7 million 52 which are available to reduce future federal regular income taxes over an indefinite period. The amount and timing of realizing the benefits of NOL, FTC and AMT credit carryforwards depends on future taxable income and limitations imposed by tax laws. The approximate amounts of the NOLs on a regular tax basis and an AMT basis at Dec. 31, 1998 were $1,314.1 million and $908.7 million, respectively. The approximate amounts of the FTCs on a regular tax basis and an AMT basis at Dec. 31, 1998 were $9.9 million and $8.1 million, respectively. The benefits of the NOL, FTC and AMT credit carryforwards have been recognized in our financial statements and are included in our net deferred tax assets. UNDISTRIBUTED EARNINGS OF SUBSIDIARIES--U.S. income taxes have not been provided on $35.0 million of our foreign operations' undistributed earnings as of Dec. 31, 1998, as such earnings are intended to be permanently reinvested in those operations. Furthermore, any taxes paid to foreign governments on these earnings may be used as credits against the U.S. tax on any dividend distributions from such earnings. We have not provided taxes on approximately $194.5 million of undistributed earnings related to our majority ownership of The John Nuveen Company as of Dec. 31, 1998, because we currently do not expect those earnings to become taxable to us. IRS EXAMINATIONS--The IRS is currently examining the USF&G Life Group's premerger returns for the years 1992 and 1993 and USF&G's pre-merger consolidated returns for the years 1994 through 1997. The IRS has examined The St. Paul's pre-merger consolidated returns through 1994 and is currently examining the years 1995 through 1997. We believe that any additional taxes assessed as a result of these examinations would not materially affect our overall financial position, results of operations or liquidity. 9. CAPITAL STRUCTURE The following summarizes our capital structure:
DECEMBER 31 ---------------------- 1998 1997 ---------- ---------- (IN THOUSANDS) Debt......................... $1,260,392 $1,304,008 Company-obligated mandatorily redeemable preferred capital securities of subsidiaries or trusts holding solely convertible subordinated debentures of the Company................ 502,700 502,700 Preferred shareholders' equity..................... 15,576 16,725 Common shareholders' equity..................... 6,620,811 6,591,443 ---------- ---------- Total capital............ $8,399,479 $8,414,876 ---------- ---------- ---------- ---------- Ratio of debt to total capital.................... 15% 15%
DEBT Debt consists of the following:
DECEMBER 31 ---------------------------------------------- 1998 1997 ---------------------- ---------------------- BOOK VALUE FAIR VALUE BOOK VALUE FAIR VALUE ---------- ---------- ---------- ---------- Medium-term notes....... $ 636,913 $ 674,700 $ 511,920 $ 529,000 Commercial paper........ 257,461 257,461 168,429 168,429 8 3/8% senior notes..... 149,708 159,900 149,592 159,060 Zero coupon convertible notes................. 111,333 118,000 106,838 122,307 7 1/8% senior notes..... 79,848 86,000 79,824 82,680 Real estate mortgages... 15,129 15,600 19,900 20,491 Nuveen short-term borrowings............ 10,000 10,000 69,500 69,500 7% senior notes......... -- -- 145,225 145,744 Nuveen notes payable.... -- -- 15,000 15,100 Credit facility......... -- -- 35,000 35,000 Guaranteed ESOP debt.... -- -- 2,780 2,800 ---------- ---------- ---------- ---------- Total debt.......... $1,260,392 $1,321,661 $1,304,008 $1,350,111 ---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
FAIR VALUE--The fair values of our commercial paper, credit facility and short-term borrowings approximate their book values because of their short-term nature. For our other debt, which has longer terms and fixed interest rates, our fair value estimate is based on current interest rates available on debt securities in the market that have terms similar to ours. MEDIUM-TERM NOTES--The medium-term notes bear interest rates ranging from 5.9% to 8.3%, with a weighted average rate of 6.9%. Maturities range from five to 15 years after the 53 issuance date. During 1998, we issued $150 million of medium-term notes bearing an interest rate of 6.4%. COMMERCIAL PAPER--Our commercial paper is supported by a $400 million credit agreement that expires in 2002. The credit agreement requires us to stay below a certain ratio of debt to equity, maintain a stated amount of common shareholders' equity and meet certain other requirements. As of year-end 1998, we had not borrowed any funds under the agreement, and we were in compliance with all of its provisions. Interest rates on commercial paper issued in 1998 ranged from 4.5% to 6.3%; in 1997 the range was 5.2% to 6.8%; and in 1996 the range was 5.1% to 6.6%. 8 3/8% SENIOR NOTES--The 8 3/8% senior notes mature in 2001. ZERO COUPON CONVERTIBLE NOTES--The zero coupon convertible notes are redeemable beginning in 1999 for an amount equal to the original issue price plus accreted original issue discount. In addition, on March 3, 1999 and March 3, 2004, the holders of the zero coupon convertible notes may require us to purchase their notes for the price of $640.82 and $800.51, respectively, per $1,000 of principal amount due at maturity. 7 1/8% SENIOR NOTES--The 7 1/8% senior notes mature in 2005. REAL ESTATE MORTGAGES--The real estate mortgages represent a portion of the purchase price of two of our investments. One $13.2 million mortgage bears a fixed interest rate of 6.7% and matures in November 2000. A second $1.9 million mortgage bears a fixed rate of 8.1% and matures in February 2002. NUVEEN SHORT-TERM BORROWINGS--Short-term borrowings at the end of 1998 and 1997 were obligations of our asset management segment that were collateralized by some of its inventory securities. These borrowings bore a weighted average interest rate of 6.3% and 7.4% at Dec. 31, 1998 and 1997, respectively. 7% SENIOR NOTES--The 7% senior notes matured in May 1998. CREDIT FACILITY--We maintained two committed, standby credit facilities totaling $450 million at Dec. 31, 1997. The facility in place for $200 million expired in December 1998 and the remaining facility will expire in 2002. These facilities require us to maintain a minimum net worth and debt-to-capital ratio. We were in compliance with the provisions contained in these agreements at Dec. 31, 1998 and 1997. INTEREST EXPENSE--Our interest expense was $75.4 million in 1998, $86.1 million in 1997 and $87.2 million in 1996. MATURITIES--The amount of debt that becomes due in each of the next five years is as follows: 1999, $287.5 million; 2000, $13.2 million; 2001, $195.2 million; 2002, $50.6 million; and 2003, $67.3 million. COMPANY-OBLIGATED MANDATORILY REDEEMABLE PREFERRED CAPITAL SECURITIES OF SUBSIDIARIES OR TRUSTS HOLDING SOLELY CONVERTIBLE SUBORDINATED DEBENTURES OF THE COMPANY In 1995, we issued, through St. Paul Capital L.L.C. (SPCLLC), 4,140,000 company-obligated mandatorily redeemable preferred capital securities, generating proceeds of $207 million. These securities are also known as convertible monthly income preferred securities (MIPS). The MIPS pay a monthly dividend at an annual rate of 6% of the liquidation preference of $50 per security. We directly or indirectly own all of the common securities of SPCLLC, a special purpose limited liability company which was formed for the sole purpose of issuing the MIPS. We have effectively fully and unconditionally guaranteed SPCLLC's obligations under the MIPS. The MIPS are convertible into 1.695 shares of our common stock (equivalent to a conversion price of $29.50 per share). The MIPS are redeemable after May 31, 1999, but we may redeem them before then upon the occurrence of certain events. In 1997 and 1996, USF&G issued three series of capital securities. After consummation of the merger with USF&G in 1998, The St. Paul assumed all obligations relating to these capital securities. These Series A, Series B and Series C Capital Securities were issued through separate wholly-owned business trusts (USF&G 54 Capital I, USF&G Capital II and USF&G Capital III, respectively) formed for the sole purpose of issuing the securities. We have effectively fully and unconditionally guaranteed all obligations of the three business trusts. In December 1996, USF&G Capital I issued 100,000 shares of 8.5% Series A Capital Securities, generating proceeds of $100 million. The proceeds were used to purchase $100 million of USF&G Corporation 8.5% Series A subordinated debentures, which mature on Dec. 15, 2045. The debentures are redeemable under certain circumstances related to tax events at a price of $1,000 per debenture. The proceeds of such redemptions will be used to redeem a like amount of the Series A Capital Securities. In January 1997, USF&G Capital II issued 100,000 shares of 8.47% Series B Capital Securities, generating proceeds of $100 million. The proceeds were used to purchase $100 million of USF&G Corporation 8.47% Series B subordinated debentures, which mature on Jan. 10, 2027. The debentures are redeemable at our option at any time beginning in January 2007 at scheduled redemption prices ranging from $1,042 to $1,000 per debenture. The debentures are also redeemable prior to January 2007 under certain circumstances related to tax and other special events. The proceeds of such redemptions will be used to redeem a like amount of the Series B Capital Securities. In July 1997, USF&G Capital III issued 100,000 shares of 8.312% Series C Capital Securities, generating proceeds of $100 million. The proceeds were used to purchase $100 million of USF&G Corporation 8.312% Series C subordinated debentures, which mature on July 1, 2046. The debentures are redeemable under certain circumstances related to tax events at a price of $1,000 per debenture. The proceeds of such redemptions will be used to redeem a like amount of the Series C Capital Securities. Under certain circumstances related to tax events, we have the right to shorten the maturity dates of the Series A, Series B and Series C debentures to no earlier than June 24, 2016, July 10, 2016 and April 8, 2012, respectively, in which case the stated maturities of the related Capital Securities will likewise be shortened. PREFERRED SHAREHOLDERS' EQUITY The preferred shareholders' equity on our balance sheet represents the par value of preferred shares outstanding that we issued to our Preferred Stock Ownership Plan (PSOP) Trust, less the remaining principal balance on the PSOP Trust debt. The PSOP Trust borrowed funds from a U.S. underwriting subsidiary to finance the purchase of the preferred shares, and we guaranteed the PSOP debt. The PSOP trust may at any time convert any or all of the preferred shares into shares of our common stock at a rate of eight shares of common stock for each preferred share. Our board of directors has reserved a sufficient number of our authorized common shares to satisfy the conversion of all preferred shares issued to the PSOP trust and the redemption of preferred shares to meet employee distribution requirements. Upon the redemption of preferred shares, we issue shares of our common stock to the trust to fulfill the redemption obligations. During the first half of 1997, we redeemed all of the remaining outstanding shares of USF&G's Series A Preferred Stock for $200 million cash. COMMON SHAREHOLDERS' EQUITY COMMON STOCK AND REACQUIRED SHARES--We are governed by the Minnesota Business Corporation Act. All authorized shares of voting common stock have no par value. Shares of common stock reacquired are considered unissued shares. The number of authorized shares of the company is 480 million. Our cost for reacquired shares in 1998, 1997 and 1996 was $135.1 million, $128.1 million and $225.0 million, respectively. We reduced our capital stock account and retained earnings for the cost of these repurchases. In December 1997, we issued approximately 2.9 million shares of common stock valued at $112 million as partial consideration for our acquisition of Titan. Also in 1997, we issued 40,976 shares of our common stock valued at $1.7 million, and in 1996 we issued 57,496 shares of our common stock (also valued at $1.7 million), as partial consideration for our acquisition of a Lloyd's of 55 London managing agency. We issued 1.2 million common shares during 1996 for the conversion of USF&G Corporation Series B Preferred Stock. A summary of our common stock activity for the last three years is as follows:
YEAR ENDED DECEMBER 31 ------------------------------------- 1998 1997 1996 ----------- ----------- ----------- (SHARES) Outstanding at beginning of year.... 233,129,721 230,851,306 235,433,487 Shares issued: Stock incentive plans.............. 4,243,354 1,501,532 1,597,983 Conversion of preferred stock.... 204,765 1,223,571 1,310,849 Acquisitions......... -- 2,918,396 57,496 Reacquired shares...... (3,828,062) (3,365,084) (7,548,509) ----------- ----------- ----------- Outstanding at end of year................. 233,749,778 233,129,721 230,851,306 ----------- ----------- ----------- ----------- ----------- -----------
UNDESIGNATED SHARES--Our articles of incorporation allow us to issue five million undesignated shares. The board of directors may designate the type of shares and set the terms thereof. The board designated 50,000 shares as Series A Junior Participating Preferred Stock in connection with the establishment of our Shareholder Protection Rights Plan. The board designated 1,450,000 shares as Series B Convertible Preferred Stock in connection with the formation of our Preferred Stock Ownership Plan. SHAREHOLDER PROTECTION RIGHTS PLAN--Our Shareholder Protection Rights Plan is designed to protect the interests of our shareholders in the event of unsolicited and unfair or coercive attempts to acquire control of the company. Our shareholders own one right for each common share owned, which would enable them to initiate specified actions to protect their interests. We may redeem this right under circumstances specified in the plan. Pursuant to our Shareholder Protection Rights Plan we declared a dividend of one right ("Right") in respect of each outstanding share of our voting common stock held of record as of the close of business on Dec. 19, 1989. The Rights become exercisable if a person or group acquires 15 percent or more of our common stock and upon certain other events set forth in the agreement governing the Rights. Each Right entitles our shareholders to purchase one four-thousandth of a share of Series A Junior Participating Preferred Stock at an exercise price of $46.25. When the Rights become exercisable, the holder of each Right (other than the acquiring person or members of such group) is entitled (i) to purchase, at the Right's then current exercise price, a number of the acquiring company's common stock having a market value of twice such price, (ii) to purchase, at the Right's then current exercise price, a number of shares of our common stock having a market value of twice such price or (iii) under certain circumstances, at the option of our Board of Directors, to exchange each Right (other than the Rights owned by such acquiring person or group), at an exchange ratio of one share of common stock per Right. At the option of our Board of Directors, under certain circumstances, the Rights may be redeemed for $.005 per Right. The agreement governing the Rights is due to expire on Dec. 19, 1999. The Company will allow those rights to expire on that date, if not redeemed earlier. DIVIDEND RESTRICTIONS--We primarily depend on dividends from our subsidiaries to pay dividends to our shareholders, service our debt and pay expenses. Various state laws and regulations limit the amount of dividends we may receive from our U.S. property-liability underwriting subsidiaries and our life insurance subsidiary. In 1999, $295 million will be available for dividends free from such restrictions. During 1998, we received cash dividends of $200 million from our U.S. underwriting subsidiaries. 56 10. RETIREMENT PLANS PENSION PLANS--We maintain funded defined benefit pension plans for most of our employees. Benefits are based on years of service and the employee's compensation while employed by the company. Pension benefits generally vest after five years of service. Our pension plans are noncontributory. This means that employees do not pay anything into the plans. Our funding policy is to contribute amounts sufficient to meet the minimum funding requirements of the Employee Retirement Income Security Act and any additional amounts that may be necessary. This may result in no contribution being made in a particular year. The following tables provide a reconciliation of the changes in the plans' benefit obligations and fair value of assets over the two-year period ended Dec. 31, 1998, and a statement of the funded status as of Dec. 31, for both years.
DECEMBER 31 -------------------------------------------------- PENSION BENEFITS OTHER BENEFITS ------------------------ ------------------------ 1998 1997 1998 1997 ------------ ---------- ----------- ----------- (IN THOUSANDS) Change in benefit obligation: Benefit obligation at beginning of year...................... $ 845,784 $ 770,303 $ 192,434 $ 181,337 Service cost............................................... 30,929 27,897 5,627 5,602 Interest cost.............................................. 58,410 56,422 13,181 13,152 Amendments................................................. -- -- -- 252 Actuarial loss............................................. 113,403 55,298 14,855 9,605 Benefits paid.............................................. (42,933) (56,128) (12,032) (13,568) Curtailment gain........................................... -- (8,008) -- (3,946) ------------ ---------- ----------- ----------- Benefit obligation at end of year........................ 1,005,593 845,784 214,065 192,434 ------------ ---------- ----------- ----------- Change in plan assets: Fair value of plan at beginning of year.................... $ 953,259 $ 793,660 $ 18,612 $ 17,107 Actual return on plan assets............................... 176,203 170,250 3,581 1,505 Employer contribution...................................... 48,407 45,477 12,032 13,568 Benefits paid.............................................. (42,933) (56,128) (12,032) (13,568) ------------ ---------- ----------- ----------- Fair value of plan at end of year........................ 1,134,936 953,259 22,193 18,612 ------------ ---------- ----------- ----------- Funded status................................................ 129,343 107,475 (191,872) (173,822) Unrecognized transition asset.............................. (4,941) (6,756) -- -- Unrecognized prior service cost............................ (12,918) (16,681) (3,592) (3,935) Unrecognized net actuarial loss (gain)..................... 64,346 34,859 11,314 (1,705) ------------ ---------- ----------- ----------- Prepaid (accrued) benefit cost........................... $ 175,830 $ 118,897 $ (184,150) $ (179,462) ------------ ---------- ----------- ----------- ------------ ---------- ----------- -----------
PENSION BENEFITS OTHER BENEFITS ---------------------- ------------------------ 1998 1997 1998 1997 ---------- ---------- ----------- ----------- Weighted average assumptions as of Dec. 31: Discount rate.................................................. 6.25% 7.00% 6.50% 7.00% Expected return on plan assets................................. 10.00 9.25 8.00 9.00 Rate of compensation increase.................................. 4.00 4.50 4.00 3.75
Plan assets are invested primarily in equities and fixed maturities, and included 804,035 shares of our common stock with a market value of $28.0 million and $33.0 million at Dec. 31, 1998 and 1997, respectively. 57 We maintain non-contributory, unfunded pension plans to provide certain company employees with pension benefits in excess of limits imposed by federal tax law. The following table provides the components of our net periodic benefit cost for the years 1998 and 1997:
DECEMBER 31 ------------------------------------------------ PENSION BENEFITS OTHER BENEFITS ---------------------- ------------------------ 1998 1997 1998 1997 ---------- ---------- ----------- ----------- (IN THOUSANDS) COMPONENTS OF NET PERIODIC BENEFIT COST: Service cost................................................... $ 30,929 $ 27,897 $ 5,627 $ 5,602 Interest cost.................................................. 58,410 56,422 13,181 13,152 Expected return on plan assets................................. (97,956) (70,875) (1,675) (1,518) Amortization of transition asset............................... (1,814) (1,814) -- -- Amortization of prior service cost............................. (3,763) (3,765) (343) (346) Recognized net actuarial loss (gain)........................... 5,668 6,883 (69) (74) ---------- ---------- ----------- ----------- Net periodic pension cost (income)........................... (8,526) 14,748 16,721 16,816 ---------- ---------- ----------- ----------- Curtailment gain............................................... -- (8,070) -- (5,553) ---------- ---------- ----------- ----------- Net periodic benefit cost (income) after curtailment......... $ (8,526) $ 6,678 $ 16,721 $ 11,263 ---------- ---------- ----------- ----------- ---------- ---------- ----------- -----------
POSTRETIREMENT BENEFITS OTHER THAN PENSION-- We provide certain health care and life insurance benefits for retired employees and their eligible dependents. We currently anticipate that most of our employees will become eligible for these benefits if they retire while working for us. The cost of these benefits is shared with the retiree. The benefits are generally provided through our employee benefits trust, to which periodic contributions are made to cover benefits paid during the year. We accrue postretirement benefits expense during the period of the employee's service. A health care inflation rate of 6.75% was assumed to change to 6.25% in 1999, decrease annually to 5% in 2002 and then remain at that level. A one-percentage-point change in assumed health care cost trend rates would have the following effects:
1-PERCENTAGE- 1-PERCENTAGE- POINT POINT INCREASE DECREASE ------------- ------------- Effect on total of service and interest cost components............... $ 3,740 $ (3,112) Effect on postretirement benefit obligation....... 33,262 (27,724)
EMPLOYEE STOCK OWNERSHIP PLAN As of Jan. 1, 1998, the Preferred Stock Ownership Plan (PSOP) and the Employee Stock Ownership Plan (ESOP) were merged into The St. Paul Companies, Inc. Stock Ownership Plan (SOP). The plan allocates preferred shares semiannually to those employees participating in our Savings Plus Plan. Under the former PSOP, the match was 60% of employees' contributions up to a maximum of 6% of their salary. This match has been enhanced to 100% of employees' contributions up to a maximum of 4% of their salary plus shares equal to the value of dividends on previously allocated shares. Additionally, this plan will now provide an annual allocation to qualified U.S. employees based on company performance. To finance the preferred stock purchase for future allocation to qualified employees, the SOP (formerly the PSOP) borrowed $150 million at 9.4% from our U.S. underwriting subsidiary. As the principal and interest of the trust's loan is paid, a pro rata amount of our preferred stock is released for allocation to participating employees. Each share pays a dividend of $11.72 annually and is currently convertible into eight shares of common stock. Preferred stock dividends on all shares held by the trust are used to pay this SOP obligation. In addition to dividends paid to the trust, we make additional cash contributions to the SOP as necessary in order to meet the SOP's debt obligation. 58 The SOP (formerly the ESOP) borrowed funds to finance the purchase of common stock for future allocation to qualified U.S. employees. The final principal payment on the trust's loan was made in the first quarter of 1998. As the principal of the trust loan was paid, a pro rata amount of our common stock was released for allocation to eligible participants. The final allocation was made as of Dec. 31, 1997. Common stock dividends on all shares held by the trust were used to pay this SOP obligation. In addition to dividends paid to the trust, we made additional cash contributions as necessary in order to meet the SOP's debt obligation. Starting in the second quarter of 1998, common stock dividends on shares allocated under the former ESOP were paid directly to participants. All common shares and the common stock equivalent of all preferred shares held by the SOP are considered outstanding for diluted EPS computations and dividends paid on all shares are charged to retained earnings. Our SOP expense was reduced by the dividends we paid to the SOP trust that were used to pay the SOP debt obligations. We follow the provisions of Statement of Position 76-3, "Accounting Practices for Certain Employee Stock Ownership Plans," and related interpretations in accounting for this plan. We recorded expense of $7.8 million, $16.6 million and $14.0 million for the years 1998, 1997 and 1996, respectively. The following table details the shares held in the SOP:
DECEMBER 31 -------------------------------------------------- 1998 1997 ------------------------ ------------------------ COMMON PREFERRED COMMON PREFERRED ----------- ----------- ----------- ----------- (SHARES) Allocated......... 7,250,535 324,938 7,128,891 306,624 Committed to be released........ -- 27,809 487,091 17,889 Unallocated....... -- 577,132 -- 631,081 ----------- ----------- ----------- ----------- Total............. 7,250,535 929,879 7,615,982 955,594 ----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
The SOP allocated 53,949 preferred shares in 1998, 41,810 preferred shares in 1997 and 60,803 preferred shares in 1996. The remaining unallocated preferred shares at Dec. 31, 1998 will be released for allocation annually through Jan. 31, 2005. The SOP (formerly ESOP) made its final allocation in 1997 totaling 1,207,254 common shares and allocated 997,430 common shares in 1996. 11. STOCK INCENTIVE PLANS We have made fixed stock option grants to certain U.S.-based company officers and outside directors. We also have made separate fixed option grants to certain employees of our non-U.S. operations. These plans are referred to as "fixed plans" because the measurement date for determining compensation costs is fixed on the date of grant. In 1997 and 1996, we also made variable stock option grants to certain company officers. These were considered "variable" grants because the measurement date is contingent upon future increases in the market price of our common stock. At the end of 1998, approximately 3,700,000 shares remained available for grant under our stock incentive plan. We follow the provisions of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" and related interpretations in accounting for our stock option plans. In 1996, we implemented the disclosure provisions required by SFAS No. 123, "Accounting for Stock-Based Compensation" for our option plans. SFAS No. 123 requires pro forma net income and earnings per share information, which is calculated assuming we had accounted for our stock option plans under the "fair value" method described in that Statement. Since the exercise price of our fixed options equals the market price of our stock on the day the options are granted, there is no related compensation cost. We have recorded compensation costs associated with our variable options and restricted stock awards, and the former USF&G's Long-Term Incentive Program, of $10.4 million, $17.5 million and $14.9 million in 1998, 1997 and 1996, respectively. In connection with the USF&G merger, The St. Paul assumed USF&G's obligations under four stock option plans and its Long-Term Incentive Plan. Exercise prices were based on the fair market value of USF&G's common stock on the date of grant. As a result of the merger, all outstanding options under the stock 59 option plans were vested and converted into options to acquire The St. Paul's common stock. FIXED OPTION GRANTS U.S.-BASED PLANS--Our fixed option grants for certain U.S.-based company officers and outside directors give these individuals the right to buy our stock at the market price on the day the options were granted. Fixed stock options granted under the stock incentive plan adopted by our shareholders in May 1994 may be exercised between one and 10 years subsequent to the date of grant. Options granted under our option plan in effect prior to May 1994 may be exercised at any time up to 10 years after the grant date. NON-U.S. PLANS--We also have separate stock option plans for certain employees of our non-U.S. operations. The options granted under these plans were priced at the market price of our common stock on the grant date. Generally, they can be exercised from three to 10 years after the grant date. Approximately 73,000 option shares remained available at year-end for future grants under our non-U.S. plans. The following table summarizes the activity for our fixed option plans for the last three years. All grants were made at fair value on the date of grant.
WEIGHTED OPTION AVERAGE SHARES EXERCISE PRICE ---------- -------------- Outstanding Jan. 1, 1996... 10,419,127 $20.47 Granted.................... 3,444,162 26.42 Exercised.................. (1,395,719) 18.21 Canceled................... (586,775) 23.62 ---------- ------ Outstanding Dec. 31, 1996..................... 11,880,795 22.60 Granted.................... 3,353,133 34.38 Exercised.................. (2,133,788) 20.07 Canceled................... (557,329) 31.77 ---------- ------ Outstanding Dec. 31, 1997..................... 12,542,811 25.76 Granted.................... 3,693,511 42.65 Exercised.................. (3,663,620) 23.04 Canceled................... (1,428,810) 37.23 ---------- ------ Outstanding Dec. 31, 1998..................... 11,143,892 $30.78 ---------- ------ ---------- ------
The following table summarizes the options exercisable at the end of the last three years and the weighted average fair value of options granted during those years. The fair value of options is estimated on the date of grant using the Black-Scholes option-pricing model, with the following weighted-average assumptions used for grants in 1998, 1997 and 1996, respectively: dividend yield of 3.0%, 2.1% and 2.0%; expected volatility of 18.9%, 20.1% and 22.7%; risk-free interest rates of 5.6%, 6.5% and 6.2%; and an expected life of 5.9 years, 5.4 years and 6.2 years.
1998 1997 1996 --------- --------- --------- Options exercisable at year-end................. 8,078,734 8,174,128 7,186,957 Weighted average fair value of options granted during the year................. $ 8.91 $ 8.88 $ 7.20
The following tables summarize the status of fixed stock options outstanding and exercisable at Dec. 31, 1998:
OPTIONS OUTSTANDING ------------------------------------- WEIGHTED AVERAGE WEIGHTED REMAINING AVERAGE NUMBER OF CONTRACTUAL EXERCISE RANGE OF EXERCISE PRICES OPTIONS LIFE PRICE - - ------------------------ ----------- ----------- ----------- $11.08-20.03............ 1,992,242 3.3 YEARS $ 17.80 20.13-25.38............ 1,849,880 5.9 YEARS 23.67 25.44-29.00............ 2,322,290 6.8 YEARS 26.33 29.81-40.83............ 2,120,164 8.2 YEARS 36.17 41.38-50.76............ 2,859,316 9.1 YEARS 44.05 ----------- ----------- ----------- $11.08-50.76............ 11,143,892 6.9 YEARS $ 30.78 ----------- ----------- ----------- ----------- ----------- -----------
OPTIONS EXERCISABLE ---------------------------- WEIGHTED NUMBER OF AVERAGE RANGE OF EXERCISE PRICES OPTIONS EXERCISE PRICE - - --------------------------- ----------- --------------- $11.08-20.03............... 1,992,242 $ 17.80 20.13-25.38............... 1,849,880 23.67 25.44-29.00............... 2,254,290 26.32 29.81-40.83............... 1,943,664 36.23 41.38-50.76............... 38,658 49.33 ----------- ------ $11.08-50.76............... 8,078,734 $ 26.11 ----------- ------ ----------- ------
VARIABLE OPTION GRANTS In 1997 and 1996, we made variable option grants of 316,200 and 1,650,000 shares, respectively, from our 1994 stock incentive plan to certain of our key officers. One-half of the 60 options will vest when the market price of our stock reaches a 20-consecutive-day average of $50 per share. The remaining options will vest when our stock price reaches a 20-consecutive-day average of $55 per share. The exercise price of each option is equal to the market price of our stock on the grant date. These options may be exercised during the twelve months preceding the Dec. 1, 2001, expiration date provided the stock price targets are achieved. The following table summarizes the activity for our variable option grants for the last three years.
WEIGHTED OPTION AVERAGE SHARE EXERCISE PRICE --------- --------------- Outstanding Jan. 1, 1996.... -- $ -- Granted..................... 1,650,600 29.38 --------- ------ Outstanding Jan. 1, 1997.... 1,650,600 29.38 Granted..................... 316,200 33.56 --------- ------ Outstanding Jan. 1, 1998.... 1,966,800 30.05 Canceled.................... (468,600) 29.38 --------- ------ Outstanding Dec. 31, 1998... 1,498,200 $ 30.26 --------- ------ --------- ------
The weighted average fair value of options granted during 1997 and 1996 is $5.46 and $4.54 per option, respectively. The fair value of the variable options was estimated on the date of grant using a variable option-pricing model with the following weighted average assumptions in 1997 and 1996, respectively: dividend yield of 2.8% and 3.0%; expected volatility of 20% for both years; risk-free interest rate of 6.1% and 5.8%; and an expected life of 4.6 years and 5.0 years. RESTRICTED STOCK AND DEFERRED STOCK AWARDS Up to 20% of the 11.6 million shares available under our 1994 stock incentive plan may be granted as restricted stock awards. The stock is restricted because recipients receive the stock only upon completing a specified objective or period of employment, generally one to five years. The shares are considered issued when awarded, but the recipient does not own and cannot sell the shares during the restriction period. Up to 1,800,000 shares remain available for restricted stock awards at Dec. 31, 1998. We also have a Deferred Stock Award Plan for stock awards to non-U.S. employees. Deferred stock awards are the same as restricted stock awards, except that shares granted under the deferred plan are not issued until the vesting conditions specified in the award are fulfilled. Up to 21,000 shares remain available for deferred stock awards at Dec. 31, 1998. PRO FORMA INFORMATION Had we calculated compensation expense on a combined basis for our stock option grants based on the "fair value" method described in SFAS No. 123, our net income and earnings per share would have been reduced to the pro forma amounts as indicated.
YEAR ENDED DECEMBER 31 ------------------------------- 1998 1997 1996 --------- --------- --------- (IN THOUSANDS,EXCEPT PER SHARE DATA) NET INCOME As reported................ $ 89,348 $ 929,292 $ 732,702 Pro forma.................. 75,983 914,831 721,209 BASIC EARNINGS PER SHARE As reported................ 0.33 3.97 3.01 Pro forma.................. 0.27 3.91 2.96 DILUTED EARNINGS PER SHARE As reported................ 0.32 3.69 2.84 Pro forma.................. 0.27 3.63 2.79
12. COMMITMENTS AND CONTINGENCIES INVESTMENT COMMITMENTS--We have long-term commitments to fund venture capital and real estate investments totaling $117.2 million as of Dec. 31, 1998. We estimate these commitments will be paid as follows: $49.1 million in 1999; $37.5 million in 2000; $22.1 million in 2001; and $8.5 million in 2002. FINANCIAL GUARANTEES--We are contingently liable for financial guarantee exposures ceded through reinsurance agreements with a company in which we formerly had a minority ownership interest totaling approximately $76 million as of Dec. 31, 1998. LEASE COMMITMENTS--A portion of our business activities is carried on in rented premises. We also enter into leases for equipment, such as office machines and computers. Our total rental expense was 61 $88 million in 1998, $92 million in 1997 and $107 million in 1996. Certain leases are noncancelable, and we would remain responsible for payment even if we stopped using the space or equipment. On Dec. 31, 1998, the minimum annual rents for which we would be liable under these types of leases are as follows: $109 million in 1999, $104 million in 2000, $105 million in 2001, $70 million in 2002, $56 million in 2003 and $265 million thereafter. We are also the lessor under various subleases on our office facilities. The minimum rentals to be received in the future under noncancelable subleases is $99 million at Dec. 31, 1998. LEGAL MATTERS--In the ordinary course of conducting business, we and some of our subsidiaries have been named as defendants in various lawsuits. Some of these lawsuits attempt to establish liability under insurance contracts issued by our underwriting operations. Plaintiffs in these lawsuits are asking for money damages or to have the court direct the activities of our operations in certain ways. In connection with our sale of Minet to Aon Corporation in 1997, we agreed to indemnify Aon against any future professional liability claims for events that occurred prior to the sale. Included in our 1997 provision for loss on disposal of Minet was the cost of purchasing insurance to cover a portion of our exposure to such claims (see Note 13 "Discontinued Operations"). It is possible that the settlement of these lawsuits or payments for Minet-related liability claims may be material to our results of operations and liquidity in the period in which they occur. However, we believe the total amounts that we and our subsidiaries will ultimately have to pay in all of these matters will have no material effect on our overall financial position. 13. DISCONTINUED OPERATIONS In December 1996, we decided to sell our insurance brokerage, Minet, and in May 1997, we completed the sale to Aon Corporation. As a result, we accounted for Minet as a discontinued operation in 1997 and 1996. Proceeds from the sale of Minet to Aon were $107 million. The following table summarizes our discontinued operations for 1997 and 1996:
DECEMBER 31 -------------------- 1997 1996 --------- --------- (IN THOUSANDS) Operating loss, before income taxes......................... $ -- $ (18,815) Income tax expense.............. -- 401 --------- --------- Operating loss, net of taxes....................... -- (19,216) --------- --------- Loss on disposal, before income taxes......................... (103,280) (380,036) Income tax benefit.............. (35,530) (291,493) --------- --------- Loss on disposal, net of taxes....................... (67,750) (88,543) --------- --------- Loss from discontinued operations.................. $ (67,750) $(107,759) --------- --------- --------- ---------
In 1996, we recorded a pretax loss of $380 million on the disposal of Minet, which represented the estimated difference between its fair value and carrying value by the time we would finalize the sale. That loss provision encompassed Minet's estimated operating losses through the date of disposal, the realization of previously unrealized foreign exchange losses, pension and postretirement curtailment gains, and estimated selling costs. We also recorded a net $291 million tax benefit in 1996, consisting of a $353 million tax benefit on the provision for loss on disposal reduced by a valuation allowance of $62 million. Our federal income tax carrying value of Minet was substantially higher than our carrying value for financial statement purposes, so the tax benefit was not proportionate to the pretax loss. In 1997, we recorded an additional pretax loss on disposal of $103 million (with a corresponding tax benefit of $36 million), which resulted primarily from our agreement to be responsible for certain severance, employee benefits, future lease commitments and other costs related to Minet. We agreed to indemnify Aon against any future professional liability claims for events that occurred prior to the sale. Since this indemnification relates to claims that had not yet been discovered or reported, it is not possible to 62 estimate a range of the potential liability. The company monitors its exposure under these claims on a regular basis. We believe reserves for reported claims are adequate, but the company still does not have information on unreported claims to estimate a range of additional liability. The company purchased insurance to cover a portion of its exposure to such claims. The insurance covers claims reported three years from the date of sale, with the option to renew the contract for an additional three years. The policy provides $125 million maximum coverage with a $25 million aggregate deductible. 14. ACQUISITIONS In 1997, we acquired TITAN Holdings, Inc. (Titan), a property-liability insurance company located in San Antonio, Texas, for $259 million including assumed debt. Titan specializes in the non-standard automobile and government entities insurance markets. The transaction resulted in goodwill of approximately $151 million, which is being amortized over 40 years. The consideration paid included shares of our common stock, valued at approximately $112 million. As of Dec. 31, 1997, $47 million in cash payments were made to reduce debt and cover certain other acquisition-related expenses. The remaining consideration of $97 million, consisting of cash payments to Titan's shareholders, was subsequently paid in February 1998. In 1997, The John Nuveen Company (Nuveen), our asset management segment, acquired Flagship Resources, Inc., a firm that manages the assets of both its sponsored and marketed family of mostly tax-free mutual funds and its private investment accounts, for a total cost of approximately $72 million, plus as much as an additional $20 million contingent upon meeting future growth targets. Nuveen also acquired Rittenhouse Financial Services, Inc., an equity and balanced fund investment management firm, in 1997 for a total cost of approximately $147 million. These acquisitions added approximately $13.8 billion to Nuveen's assets under management. The cost of these acquisitions was largely composed of goodwill of $213 million, which is being amortized over 30 years. In late 1996, we acquired Afianzadora Insurgentes, S.A. de C.V. (Afianzadora), a surety bond company in Mexico, for $65 million in cash. This acquisition resulted in goodwill of $18 million, which is being amortized over 20 years. In 1996, we acquired Northbrook Holdings, Inc. and its three insurance subsidiaries from Allstate Insurance Company. Northbrook and its subsidiaries underwrite various property-liability commercial insurance products throughout the United States. Our total cost for this acquisition was approximately $193 million, which was provided from internal funds. We recorded goodwill of approximately $71 million that we are amortizing over 15 years. In the Northbrook purchase agreement, we agreed to pay Allstate additional consideration of up to $50 million in the event a redundancy develops on the acquired Northbrook reserves between the purchase date and July 31, 2000. Similarly, Allstate agreed to pay us consideration of up to $100 million in the event a deficiency develops on those reserves during the same time period. Any amounts to be paid by either party will depend on the extent of the redundancy or deficiency and will be determined in accordance with terms described in the purchase agreement. All of these acquisitions were accounted for as purchases. As a result, the acquired companies' results were included in our consolidated results from the date of purchase. 15. REINSURANCE Our financial statements reflect the effects of assumed and ceded reinsurance transactions. Assumed reinsurance refers to our acceptance of certain insurance risks that other insurance companies have underwritten. Ceded reinsurance means other insurance companies agree to share certain risks with us. The primary purpose of ceded reinsurance is to protect us from potential losses in excess of what we are prepared to accept. We report balances pertaining to reinsurance transactions "gross" on the balance sheet, meaning that reinsurance recoverables on unpaid losses and ceded unearned premiums are 63 not deducted from insurance reserves but are recorded as assets. We expect the companies to which we have ceded reinsurance to honor their obligations. In the event these companies are unable to honor their obligations to us, we will pay these amounts. We have established allowances for possible nonpayment of amounts due to us. Additionally, we have been active in the involuntary market as a servicing carrier whereby we process business for a pool but take no net underwriting risk because we are directly reimbursed for the cost of processing policies and settling any related claims. Servicing carrier receivables of $805 million and $710 million associated with this business are included in our balance sheet in reinsurance recoverables on unpaid losses at Dec. 31, 1998 and 1997, respectively. In August 1996, our life insurance subsidiary entered into a coinsurance contract with an unaffiliated life insurance company to cede a significant portion of a block of single premium deferred annuities. As part of the transaction, our life insurance subsidiary transferred $932 million of investments and other assets to the coinsurer and recorded a reinsurance recoverable of $964 million. In December 1997, our life insurance subsidiary entered into another coinsurance agreement with an unaffiliated life reinsurance company whereby it transferred approximately $144 million of investments and other assets to the reinsurer and recorded a reinsurance recoverable of $131 million. For each of these transactions, the difference between the assets transferred for the reinsurance contract and the amount of the reinsurance recoverable was considered part of the net cost of reinsurance, and is recognized over the remaining life of the underlying reinsurance contracts. The reinsurance costs of the coinsurance transactions (net of related deferred policy acquisition cost amortization) were deferred at the inception of the contracts and are being amortized into expense over the remaining term of the underlying reinsurance contracts. These transactions had no material effect on our 1997 or 1996 net income. The effect of assumed and ceded reinsurance on premiums written, premiums earned and insurance losses, loss adjustment expenses and life policy benefits is as follows:
YEAR ENDED DECEMBER 31 ---------------------------------- 1998 1997 1996 ---------- ---------- ---------- (IN THOUSANDS) PREMIUMS WRITTEN Direct.................. $6,077,769 $6,340,767 $6,345,860 Assumed................. 1,400,655 1,502,887 1,589,900 Ceded................... (785,256) (911,117) (901,277) ---------- ---------- ---------- Net premiums written........... $6,693,168 $6,932,537 $7,034,483 ---------- ---------- ---------- ---------- ---------- ---------- PREMIUMS EARNED Direct.................. $6,311,124 $6,528,712 $6,347,572 Assumed................. 1,389,266 1,530,969 1,584,275 Ceded................... (874,610) (898,652) (897,737) ---------- ---------- ---------- Net premiums earned... 6,825,780 7,161,029 7,034,110 Life.................... 118,795 137,071 144,572 ---------- ---------- ---------- Total premiums earned............ $6,944,575 $7,298,100 $7,178,682 ---------- ---------- ---------- ---------- ---------- ---------- INSURANCE LOSSES, LOSS ADJUSTMENT EXPENSES AND POLICY BENEFITS Direct.................. $5,367,878 $4,730,435 $4,539,951 Assumed................. 912,635 1,011,883 1,043,400 Ceded................... (676,952) (648,797) (429,786) ---------- ---------- ---------- Net insurance losses and loss adjustment expenses.......... 5,603,561 5,093,521 5,153,565 ---------- ---------- ---------- Life policy benefits.... 272,756 276,848 312,737 ---------- ---------- ---------- Total insurance losses, loss adjustment expenses and policy benefits... $5,876,317 $5,370,369 $5,466,302 ---------- ---------- ---------- ---------- ---------- ----------
16. STATUTORY ACCOUNTING PRACTICES Our underwriting operations are required to file financial statements with state and foreign regulatory authorities. The accounting principles used to prepare these statutory financial statements follow prescribed or permitted accounting principles, which differ from GAAP. Prescribed statutory accounting practices include state laws, regulations and general administrative rules issued by the state of domicile as well as a variety of publications and manuals of the National Association of Insurance Commissioners. Permitted statutory accounting practices encompass all accounting practices not so prescribed, but allowed by the state of domicile. 64 At Dec. 31, 1998 and 1997, permitted property-liability transactions related to the disposal of certain real property acquired as security increased statutory surplus by $12 million and $20 million, respectively, over what it would have been had prescribed accounting practices been followed. At Dec. 31, 1998 and 1997, permitted property-liability transactions related to the discounting of certain assumed reinsurance contracts increased statutory surplus by $33.7 million and $37.6 million, respectively. At Dec. 31, 1998 and 1997, permitted life insurance transactions related to the release of capital gains related to a coinsurance contract and the related establishment of a voluntary investment reserve increased statutory surplus by $18 million and $23 million, respectively. On a statutory accounting basis, our property-liability underwriting operations reported net income of $196.4 million in 1998, $1.15 billion in 1997 and $759.2 million in 1996. Our life insurance operations reported statutory net income of $24.1 million, $21.0 million and $28.8 million in 1998, 1997 and 1996, respectively. Statutory surplus (shareholder's equity) of our property-liability underwriting operations was $4.7 billion and $4.8 billion as of Dec. 31, 1998 and 1997, respectively. Statutory surplus of our life insurance operation was $201 million and $195 million as of Dec. 31, 1998 and 1997, respectively. 17. SEGMENT INFORMATION We have seven reportable segments in our insurance operations, consisting of Commercial Lines, Specialty Commercial, Personal Insurance, International Underwriting, Reinsurance, Property-liability Investment Operations, and Life Insurance. The insurance operations are managed separately because each targets different customers and requires different marketing strategies. We also have an Asset Management segment, consisting of our majority ownership in The John Nuveen Company. The accounting policies of the segments are the same as those described in the summary of significant accounting policies. We evaluate performance based on underwriting results for our property-liability insurance segments, investment income and realized gains for our investment operations, and on pretax operating results for the life insurance and asset management segments. Property-liability underwriting assets are reviewed in total by management for purposes of decision making. We do not allocate assets to these specific underwriting segments. Assets are specifically identified for our life insurance and asset management segments. GEOGRAPHIC AREAS--The following summary presents financial data of our continuing operations based on their location.
YEAR ENDED DECEMBER 31 ---------------------------------- 1998 1997 1996 ---------- ---------- ---------- (IN THOUSANDS) REVENUES U.S.................. $8,314,641 $8,820,153 $8,544,996 Non-U.S.............. 793,760 803,026 686,541 ---------- ---------- ---------- Total revenues..... $9,108,401 $9,623,179 $9,231,537 ---------- ---------- ---------- ---------- ---------- ----------
SEGMENT INFORMATION--The summary on the next page presents revenues and pretax income from continuing operations for our reportable segments. Amounts for 1997 and 1996 were reclassified to be consistent with the 1998 presentation. The revenues of our life insurance and asset management segments include their respective investment income and realized investment gains. The table also presents identifiable assets for our property-liability underwriting operation in total, and our life insurance and asset management segments. Included in the table are life insurance segment revenues of $47 million, $65 million and $76 million for the years ended Dec. 31, 1998, 1997 and 1996, respectively, related to structured settlement annuities sold primarily to our Commercial Lines segment. 65
YEAR ENDED DECEMBER 31 ---------------------------------------- 1998 1997 1996 ------------ ------------ ------------ (IN THOUSANDS) REVENUES FROM CONTINUING OPERATIONS Property-liability insurance: Commercial lines....................................................... $ 2,614,645 $ 2,912,393 $ 2,775,349 Specialty commercial................................................... 1,446,937 1,441,835 1,416,577 Personal insurance..................................................... 1,392,325 1,302,110 1,335,451 ------------ ------------ ------------ Total U. S. underwriting............................................. 5,453,907 5,656,338 5,527,377 International.......................................................... 333,186 277,778 269,266 ------------ ------------ ------------ Total primary underwriting........................................... 5,787,093 5,934,116 5,796,643 Reinsurance............................................................ 1,038,687 1,226,913 1,237,467 ------------ ------------ ------------ Total underwriting................................................... 6,825,780 7,161,029 7,034,110 Investment operations: Net investment income................................................ 1,306,828 1,323,967 1,236,013 Realized investment gains............................................ 187,871 412,332 271,483 ------------ ------------ ------------ Total investment operations........................................ 1,494,699 1,736,299 1,507,496 Other.................................................................. 59,147 47,732 50,338 ------------ ------------ ------------ Total property-liability insurance................................... 8,379,626 8,945,060 8,591,944 Life insurance........................................................... 393,084 403,821 356,887 Asset management......................................................... 307,535 268,927 232,347 ------------ ------------ ------------ Total reportable segments............................................ 9,080,245 9,617,808 9,181,178 Parent company, other operations and consolidating eliminations.......... 28,156 5,371 50,359 ------------ ------------ ------------ Total revenues....................................................... $ 9,108,401 $ 9,623,179 $ 9,231,537 ------------ ------------ ------------ ------------ ------------ ------------
66
YEAR ENDED DECEMBER 31 ---------------------------------------- 1998 1997 1996 ------------ ------------ ------------ (IN THOUSANDS) INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES Property-liability insurance: Commercial lines....................................................... $ (658,694) $ (90,615) $ (95,375) Specialty commercial................................................... (146,872) 17,956 71,088 Personal insurance..................................................... (175,489) (111,364) (319,071) ------------ ------------ ------------ Total U. S. underwriting............................................. (981,055) (184,023) (343,358) International.......................................................... (67,422) (52,788) (23,432) ------------ ------------ ------------ Total primary underwriting........................................... (1,048,477) (236,811) (366,790) Reinsurance............................................................ 7,349 4,032 17,322 ------------ ------------ ------------ Total GAAP underwriting result....................................... (1,041,128) (232,779) (349,468) Investment operations: Net investment income................................................ 1,306,828 1,323,967 1,236,013 Realized investment gains............................................ 187,871 412,332 271,483 ------------ ------------ ------------ Total investment operations........................................ 1,494,699 1,736,299 1,507,496 Other.................................................................. (322,162) (112,935) (208,002) ------------ ------------ ------------ Total property-liability insurance................................... 131,409 1,390,585 950,026 Life insurance........................................................... 20,747 77,995 (8,250) Asset management......................................................... 103,960 92,617 91,697 ------------ ------------ ------------ Total reportable segments............................................ 256,116 1,561,197 1,033,473 Parent company, other operations and consolidating eliminations.......... (302,403) (225,489) (42,375) ------------ ------------ ------------ Total income (loss) from continuing operations before income taxes... $ (46,287) $ 1,335,708 $ 991,098 ------------ ------------ ------------ ------------ ------------ ------------
DECEMBER 31 ------------------------------------------- 1998 1997 1996 ------------- ------------- ------------- (IN THOUSANDS) IDENTIFIABLE ASSETS Property-liability insurance........................................ $ 32,340,907 $ 31,688,474 30,005,932 Life insurance...................................................... 4,838,690 4,478,236 4,204,400 Asset management.................................................... 504,788 516,690 356,318 ------------- ------------- ------------- Total reportable segments....................................... 37,684,385 36,683,400 34,566,650 Parent company, other operations, consolidating eliminations and discontinued operations........................................... 638,323 675,428 579,586 ------------- ------------- ------------- Total assets.................................................... $ 38,322,708 $ 37,358,828 $ 35,146,236 ------------- ------------- ------------- ------------- ------------- -------------
The $291.6 million merger-related charge is recorded in the following captions of the "Income (Loss) from Continuing Operations Before Income Taxes" section of the foregoing segment table: $142.4 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, other operations and consolidating eliminations. The $250 million provision to strengthen loss reserves is recorded as follows: $196.7 million in commercial lines; $35.1 million in personal insurance; and $18.2 million in specialty commercial. Also included in the life insurance caption is a $41.0 million charge to writedown the carrying value of deferred policy acquisition costs (DPAC). The writedown relates to universal life- 67 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 to be 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 shall be 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. Late in the fourth quarter of 1998, we recorded a pretax restructuring charge of $34.3 million ($22.3 million, or $0.09, net of tax benefit). The majority of the charge, $26.5 million, related to the anticipated termination of approximately 520 employees in the following operations: Claims, Commercial Lines, Information Systems, Medical Services and Professional Markets. The remaining charge of $7.9 million related to costs to be incurred to exit lease contracts. As of Dec. 31, 1998, no employees had been terminated under the restructuring plan. Actions to take place under this fourth quarter 1998 plan are expected to be completed by the end of 1999. The charge is included in the property-liability insurance-- other caption in the foregoing segment table. 68 18. COMPREHENSIVE INCOME Comprehensive income is defined as any change in our equity from transactions and other events originating from nonowner sources. In our case, those changes are comprised of our reported net income, changes in unrealized appreciation and changes in unrealized foreign currency translation adjustments and minimum pension liability. The following summaries present the components of our comprehensive income, other than net income, for the last three years.
YEAR ENDED DECEMBER 31, 1998 ---------------------------------- INCOME PRETAX TAX EFFECT AFTER-TAX ---------- ---------- ---------- (IN THOUSANDS) Unrealized appreciation arising during period................................ $ 460,790 $ 163,507 $ 297,283 Less: reclassification adjustment for realized gains included in net income..................................................................... 178,006 62,302 115,704 ---------- ---------- ---------- Net change in unrealized appreciation...................................... 282,784 101,205 181,579 ---------- ---------- ---------- Net change in unrealized loss on foreign currency translation................ 6,189 (2,667) 8,856 ---------- ---------- ---------- Total other comprehensive income........................................... $ 288,973 $ 98,538 $ 190,435 ---------- ---------- ---------- ---------- ---------- ----------
YEAR ENDED DECEMBER 31, 1997 ---------------------------------- INCOME PRETAX TAX EFFECT AFTER-TAX ---------- ---------- ---------- (IN THOUSANDS) Unrealized appreciation arising during period................................ $ 624,125 $ 218,598 $ 405,527 Less: reclassification adjustment for realized gains included in net income..................................................................... 367,842 128,745 239,097 ---------- ---------- ---------- Net change in unrealized appreciation...................................... 256,283 89,853 166,430 ---------- ---------- ---------- Net change in unrealized loss on foreign currency translation................ (3,284) (621) (2,663) ---------- ---------- ---------- Total other comprehensive income........................................... $ 252,999 $ 89,232 $ 163,767 ---------- ---------- ---------- ---------- ---------- ----------
YEAR ENDED DECEMBER 31, 1996 ------------------------------------ INCOME PRETAX TAX EFFECT AFTER-TAX ----------- ---------- ----------- (IN THOUSANDS) Unrealized appreciation (depreciation) arising during period............... $ 92,089 $ 131,536 $ (39,447) Less: reclassification adjustment for realized gains included in net income................................................................... 277,371 97,080 180,291 ----------- ---------- ----------- Net change in unrealized appreciation (depreciation)..................... (185,282) 34,456 (219,738) ----------- ---------- ----------- Unrealized gain (loss) on foreign currency translation..................... (5,030) 97 (5,127) Less: reclassification adjustment for realized loss relating to discontinued operations.................................................. (22,932) 2,662 (25,594) ----------- ---------- ----------- Net change in unrealized loss on foreign currency translations........... 17,902 (2,565) 20,467 ----------- ---------- ----------- Minimum pension liability.................................................. 100,312 -- 100,312 ----------- ---------- ----------- Total other comprehensive income (loss).................................. $ (67,068) $ 31,891 $ (98,959) ----------- ---------- ----------- ----------- ---------- -----------
69 19. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED) The following is an unaudited summary of our quarterly results for the last three years.
1998 ---------------------------------------------- FIRST SECOND THIRD FOURTH QUARTER QUARTER QUARTER QUARTER ---------- ---------- ---------- ---------- (IN THOUSANDS) Revenues...................................... $2,324,192 $2,379,681 $2,211,257 $2,193,271 Income (loss) from continuing operations...... 194,678 (273,803) 67,693 100,780 Net income (loss)............................. 194,678 (273,803) 67,693 100,780 Earnings per common share: Basic: Income (loss) from continuing operations.............................. 0.82 (1.18) 0.27 0.41 Net income (loss)......................... 0.82 (1.18) 0.27 0.41 Diluted: Income (loss) from continuing operations.............................. 0.76 (1.18) 0.27 0.40 Net income (loss)......................... 0.76 (1.18) 0.27 0.40
1997 ---------------------------------------------- FIRST SECOND THIRD FOURTH QUARTER QUARTER QUARTER QUARTER ---------- ---------- ---------- ---------- (IN THOUSANDS) Revenues...................................... $2,402,251 $2,493,102 $2,324,290 $2,403,536 Income from continuing operations............. 237,168 288,942 215,172 255,760 Net income.................................... 169,418 288,942 215,172 255,760 Earnings per common share: Basic: Income from continuing operations......... 1.02 1.25 0.92 1.09 Net income................................ 0.72 1.25 0.92 1.09 Diluted: Income from continuing operations......... 0.94 1.15 0.86 1.01 Net income................................ 0.67 1.15 0.86 1.01
1996 ---------------------------------------------- FIRST SECOND THIRD FOURTH QUARTER QUARTER QUARTER QUARTER ---------- ---------- ---------- ---------- (IN THOUSANDS) Revenues...................................... $2,197,076 $2,222,329 $2,347,496 $2,464,636 Income from continuing operations............. 206,633 207,417 155,369 271,042 Net income.................................... 191,043 202,175 169,480 170,004 Earnings per common share: Basic: Income from continuing operations......... 0.85 0.85 0.64 1.14 Net income................................ 0.78 0.83 0.70 0.70 Diluted: Income from continuing operations......... 0.79 0.80 0.60 1.06 Net income................................ 0.73 0.78 0.66 0.66
70 SHAREHOLDER INFORMATION CORPORATE PROFILE The St. Paul is a group of companies providing property-liability and life insurance and reinsurance products and services worldwide. YOUR DIVIDENDS A quarterly dividend of $0.26 per share was declared on Feb. 2, 1999, payable April 16, 1999, to shareholders of record as of March 31, 1999. Dividends have been paid every year since 1872. During those 127 years of uninterrupted dividend payments, total payments have been increased in 67 years. The chart at the lower right contains dividend information for 1998 and 1997. AUTOMATIC DIVIDEND REINVESTMENT PROGRAM This program provides a convenient way for shareholders to increase their holding of company stock. Approximately 48 percent of shareholders of record participate. An explanatory brochure and enrollment card may be obtained by calling our stock transfer agent--Norwest Bank Minnesota, N.A. at 888-326-5102, or contact them at the address below. STOCK TRANSFER AGENT AND REGISTRAR For address changes, dividend checks, direct deposits of dividends, account consolidations, registration changes, lost stock certificates, stock holdings and the Dividend Reinvestment Program, please contact: Norwest Bank Minnesota, N.A. Shareowner Services Department P.O. Box 64854 Saint Paul, MN 55164-0854 Telephone: 888-326-5102 STOCK TRADING The company's stock is traded nationally on the New York Stock Exchange, where it is assigned the symbol SPC. The stock is also listed on the London Stock Exchange under the symbol SPA. The number of holders of record, including individual owners, of our common stock was 24,179 as of March 1, 1999. Options on the company's stock trade on the Chicago Board Options Exchange under the symbol SPQ. ANNUAL SHAREHOLDERS' MEETING The annual shareholders meeting will be at 2 p.m. Tuesday, May 4, 1999, at the corporate headquarters, 385 Washington Street, Saint Paul, Minn. A proxy statement will be sent around March 30 to each shareholder of record on March 11, 1999. FORM 10-K AVAILABLE The Form 10-K report filed with the Securities and Exchange Commission is available without charge to shareholders upon request. Write to our corporate secretary: Sandra Ulsaker Wiese The St. Paul Companies 385 Washington Street Saint Paul, MN 55102 Also available from the corporate secretary is a comprehensive supplement to the annual report. STOCK PRICE AND DIVIDEND RATE The table below sets forth the amount of cash dividends declared per share and the high and low closing sales prices of company stock for each quarter during the past two years.
CASH DIVIDEND HIGH LOW DECLARED --------- --------- --------- 1998 1st Quarter......... $47 3/16 39 5/16 $0.25 2nd Quarter......... 45 3/8 39 15/16 0.25 3rd Quarter......... 43 5/8 28 1/16 0.25 4th Quarter......... 37 1/2 29 9/16 0.25 Cash dividend paid in 1998 was $0.985.
CASH DIVIDEND HIGH LOW DECLARED --------- --------- --------- 1997 1st Quarter......... $35 13/16 28 15/16 $0.235 2nd Quarter......... 40 1/16 32 1/16 0.235 3rd Quarter......... 40 15/16 36 9/16 0.235 4th Quarter......... 42 5/8 39 9/16 0.235 Cash dividend paid in 1997 was $0.925.
71 BOARD OF DIRECTORS H. Furlong Baldwin, 67 DIRECTOR SINCE MAY 1998. USF&G DIRECTOR 1968 TO 1998. Chairman and CEO of Mercantile Bankshares Corporation, a general banking business with offices in Maryland, Delaware and Virginia, and provider of mortgage banking and trust services. Joined Mercantile-Safe Deposit & Trust Company in 1956 and in 1970 was named president of Mercantile-Safe Deposit & Trust and president of Mercantile Bankshares Corporation. Was elected to present position in 1976. Norman P. Blake, Jr., 57 DIRECTOR SINCE MAY 1998. USF&G DIRECTOR 1990 TO 1998. Elected chairman, president and chief executive officer of Promus Hotel Corporation in December 1998. Previously chairman, president and CEO of USF&G Corporation, which merged with The St. Paul in April 1998. Joined USF&G as chairman, president and chief executive officer in 1990. Previously served as chairman and chief executive officer of Heller International and executive vice president-financial operations for General Electric Credit Corporation. Michael R. Bonsignore, 57 DIRECTOR SINCE 1991. Chairman and CEO, Honeywell, Inc., a manufacturer of automation and control systems for homes, buildings, industry and aerospace. Joined Honeywell in 1969 and held marketing and operations management positions until being named to present position in 1993. John H. Dasburg, 56 DIRECTOR SINCE 1994. President and CEO, Northwest Airlines, Inc., since 1990. Joined Northwest as executive vice president in 1989. Before joining the airline, employed by Marriott Corp., where posts included president of the lodging group, chief financial officer and chief real estate officer. W. John Driscoll, 70 DIRECTOR SINCE 1970. President and CEO (retired 1994), Rock Island Company, a private investment company. Joined Rock Island in 1964 as general manager and named president and CEO in 1973. Kenneth M. Duberstein, 54 DIRECTOR SINCE MAY 1998. USF&G DIRECTOR 1996 TO 1998. Chairman and CEO, The Duberstein Group, an independent strategic planning and consulting company. Previously served as chief of staff to President Ronald Reagan, 1988 to 1989; also served in the White House as deputy chief of staff in 1987, and assistant and deputy assistant to the president for legislative affairs from 1981 to 1983. Pierson M. Grieve, 71 DIRECTOR SINCE 1985. Chairman and CEO (retired 1995), Ecolab, Inc., a worldwide developer and marketer of cleaning and sanitizing products, systems and services. Joined Ecolab in 1983 as chairman and CEO. Previously served in executive management positions with several major U.S. businesses. Currently serves as a senior operating executive of Palladium Equity Partners, LLC, a New York private investment firm. James E. Gustafson, 52 DIRECTOR SINCE JANUARY 1999. President and Chief Operating Officer, The St. Paul Companies. Previously served as president and chief operating officer of General Re Corporation, a Stamford, Conn., international reinsurance company. Joined General Re in 1969 as an underwriter. Was named executive vice president in 1991 and president and chief operating officer in 1995. 72 Thomas R. Hodgson, 57 DIRECTOR SINCE 1997. Served as President and Chief Operating Officer, Abbott Laboratories, a global diversified health care company devoted to the discovery, development and manufacture and marketing of pharmaceutical, diagnostics, nutritional and hospital products from 1990 to December 1998, when he retired. Joined Abbott in 1972 and served as president of Abbott International from 1983 to 1990. Served on Abbott board for 13 years, until December 1998. David G. John, 60 DIRECTOR SINCE 1996. Chairman, The BOC Group, a U.K.-based manufacturer of industrial gases and related products, and high vacuum technology. Joined BOC as non-executive director in 1993; named chairman in 1996. Appointed non-executive director of British Biotech plc and vice president and board member of The Prince of Wales Business Leaders Forum in 1996. Has served as non-executive chairman of Premier Oil since March 1998. Previously served 15 years in executive positions with Inchcape plc. William H. Kling, 56 DIRECTOR SINCE 1989. President, Minnesota Public Radio. Founded Minnesota Public Radio in 1966 and has served as president since then. Was founding president of American Public Radio (now Public Radio International) in 1983 and served as vice chairman until 1993. Has served as president of Greenspring Company, a diversified media and catalog marketing company, since 1987. Douglas W. Leatherdale, 62 DIRECTOR SINCE 1981. Chairman and CEO, The St. Paul Companies and Chairman, St. Paul Fire and Marine. Joined the company's investments department in 1972. Named to present position in 1990 after serving as vice president-investments, senior vice president-finance, executive vice president and chief financial officer. Bruce K. MacLaury, 67 DIRECTOR SINCE 1987. President Emeritus (since 1995), The Brookings Institution, a Washington, D.C., public policy research and education institution. Prior to appointment as president of Brookings in 1977, served with the Federal Reserve Bank of New York and as president of the Minneapolis Federal Reserve Bank. Also served as a deputy undersecretary of the U.S. Treasury. Glen D. Nelson, M.D., 61 DIRECTOR SINCE 1992. Vice Chairman, Medtronic, Inc., a world leading medical technology company. Served Medtronic as an outside director from 1980, then joined the company in 1986 as executive vice president. Previously served as CEO of two health care corporations and practiced as a surgeon in a multispecialty group for 17 years. Serves as a clinical professor at the University of Minnesota. Anita M. Pampusch, 60 DIRECTOR SINCE 1985. President, The Bush Foundation, Saint Paul, Minn., since July 1997. Previously served as president, The College of St. Catherine, from 1984 to 1997. Joined the college as a philosophy instructor in 1970, became associate professor three years later and was named vice president and academic dean in 1980. Served one year as acting president of St. Catherine's before being named president. Gordon M. Sprenger, 61 DIRECTOR SINCE 1995. Executive Officer, Allina Health System, a not-for-profit integrated health care system. Assumed current position in 1993 when HealthSpan Health Systems Corporation, of which he was executive officer, merged with Medica. Previously served in executive positions with Abbott-Northwestern Hospital and as president and CEO of LifeSpan, Inc 73 EXECUTIVE OFFICERS Douglas W. Leatherdale, 62 CHAIRMAN AND CHIEF EXECUTIVE OFFICER SINCE 1990. Joined the company's investments department in 1972. Served as vice president-investments, senior vice president-finance, executive vice president and chief financial officer, president and chief operating officer before being named to current position. Fifteen years investment experience, including 11 years as an officer of Great West Life Assurance Company and five years as associate executive secretary for the Lutheran Church in America's Board of Pensions, prior to joining The St. Paul. Reporting to Leatherdale are U.S. Underwriting, International Underwriting, St. Paul Re, Nuveen, Finance and Investments, Legal Services, Human Resources and Corporate Affairs. James E. Gustafson, 52 PRESIDENT AND CHIEF OPERATING OFFICER SINCE JANUARY 1999. BOARD MEMBER SINCE JANUARY 1999. Previously served as president and chief operating officer of General Re Corporation. Joined General Re in 1969 and served in several underwriting positions before being named vice president of the treaty underwriting division in 1978. Named president and chief executive officer of the General Reinsurance Services Corporation in 1987; senior vice president and chief underwriting officer in 1982; executive vice president in 1991; and president and chief operating officer in 1995. Reporting to Gustafson are the U.S. Underwriting operations. Paul J. Liska, 43 EXECUTIVE VICE PRESIDENT AND CHIEF FINANCIAL OFFICER SINCE 1997. Twenty years prior corporate executive and financial management experience including five years with Kraft General Foods and most recently as president and chief executive officer of Specialty Foods Corporation. Reporting to Liska are Financial Controls, Investments, Corporate Audit, Corporate Treasury, Strategic Planning and Development, Corporate Risk Management, Information Systems, Ceded Reinsurance and F&G Life. James F. Duffy, 55 PRESIDENT-ST. PAUL RE SINCE 1993. Joined The St. Paul in 1980 as president of surplus lines and specialty underwriting operations. Named senior vice president in 1984 and executive vice president in 1988. Prior to joining company, 13 years insurance and reinsurance experience, including eight with First State Insurance Company and New England Reinsurance Corporation. John A. MacColl, 50 EXECUTIVE VICE PRESIDENT-BALTIMORE OPERATIONS SINCE APRIL 1998. Previously served as USF&G's executive vice president-human resources and general counsel. Before joining USF&G in 1989, was a partner with the law firm of Piper & Marbury in Baltimore and served as federal prosecutor in the U.S. Attorney's Office in Maryland. Mark L. Pabst, 52 PRESIDENT AND CHIEF OPERATING OFFICER-ST. PAUL INTERNATIONAL UNDERWRITING SINCE 1995. Joined The St. Paul as senior vice president-human resources in 1988. Named executive vice president of Minet in 1992. Sixteen years prior experience in human resources in banking, and five years as naval intelligence officer. Michael J. Conroy, 57 EXECUTIVE VICE PRESIDENT AND CHIEF ADMINISTRATIVE OFFICER OF ST. PAUL FIRE AND MARINE SINCE 1995. Joined company in 1994 as senior vice president-claim. Twenty-nine years prior insurance experience with the Chubb Corporation and with The Home Insurance Company as executive vice president and chief administrative officer. 74 Stephen W. Lilienthal, 49 EXECUTIVE VICE PRESIDENT OF ST. PAUL FIRE AND MARINE SINCE AUGUST 1998 AND OF COMMERCIAL LINES GROUP SINCE NOVEMBER 1998. Served as executive vice president and chief underwriting officer of USF&G, and president of USF&G's Commercial Insurance Group. Joined USF&G in 1993 as senior vice president and chief commercial lines underwriting officer. Twenty-one years prior insurance experience at Travelers Insurance. Joseph B. Nardi, 54 EXECUTIVE VICE PRESIDENT OF ST. PAUL FIRE AND MARINE AND PRESIDENT OF SPECIALTY COMMERCIAL SINCE FEBRUARY 1998. Joined company in 1970 and worked in underwriting, legal and marketing positions before being named president of Medical Services in 1982. Also served as president of business insurance operation from 1992 to 1993. Bruce A. Backberg, 50 SENIOR VICE PRESIDENT AND CHIEF LEGAL COUNSEL SINCE 1997. Started with company's legal services department in 1972. Named vice president in 1992, and senior vice president and chief legal counsel in 1997. James L Boudreau, 63 SENIOR VICE PRESIDENT SINCE MAY 1998 AND TREASURER SINCE 1979. Joined company's investment area in 1973 and named senior planning officer in 1976. Twelve years prior experience in the financial services industry with The National Shawmut Bank of Boston and Connecticut General Life Insurance Company. Thomas A. Bradley, 41 SENIOR VICE PRESIDENT AND CORPORATE CONTROLLER SINCE APRIL 1998. Previously served as USF&G's vice president-finance and corporate controller. Before joining USF&G in 1993, was vice president and chief financial officer with Maryland Casualty Company's Commercial Insurance Division. Karen L. Himle, 43 SENIOR VICE PRESIDENT-CORPORATE AFFAIRS SINCE 1997. Started with company's government affairs department in 1985. Named senior government affairs officer in 1989 and vice president-corporate communications in 1991. Six years prior government relations and legislative experience, most recently with Peoples Natural Gas Company. James Hom, 43 SENIOR VICE PRESIDENT-STRATEGIC PLANNING AND DEVELOPMENT SINCE JOINING COMPANY IN 1994. Twenty years prior insurance experience, including eight years in external management consulting. Served in various corporate and line positions with The Home Insurance Company and Hartford Insurance Group. David R. Nachbar, 36 SENIOR VICE PRESIDENT-HUMAN RESOURCES SINCE AUGUST 1998. Previously vice president-human resources and chief of staff-Asia for Citicorp. Fifteen years prior human resources experience with the American Broadcasting Companies, Time Warner, PepsiCo and Citibank. Sandra Ulsaker Wiese, 39 SENIOR CORPORATE COUNSEL SINCE 1994 AND CORPORATE SECRETARY SINCE FEBRUARY 1998. Joined the company's legal services department in 1991 and named officer in 1995. Served as chief of staff of the U.S. Small Business Administration in Washington, D.C. 75 EX-21 13 EXHIBIT 21 Exhibit 21
Subsidiaries of The St. Paul Companies, Inc. State or - - ------------------------------------------- Other Jurisdiction of Name Incorporation - - ---- --------------- (1) St. Paul Fire and Marine Insurance Company Minnesota Subsidiaries: (i) St. Paul Mercury Insurance Co. Minnesota (ii) St. Paul Guardian Insurance Co. Minnesota (iii) The St. Paul Insurance Co. Texas (iv) The St. Paul Insurance Co. of Illinois Illinois (v) St. Paul Fire and Casualty Insurance Co. Wisconsin (vi) St. Paul Indemnity Insurance Co. Indiana (vii) St. Paul Property and Casualty Insurance Co. Nebraska (viii) St. Paul Lloyds Holdings, Inc. Texas (ix) St. Paul Management Services, Inc. Minnesota (x) Seaboard Surety Company New York Subsidiary: (a) Seaboard Surety Company of Canada Canada (xi) St. Paul Insurance Co. of North Dakota North Dakota (xii) St. Paul Specialty Underwriting, Inc. Delaware Subsidiaries: (a) St. Paul Surplus Lines Insurance Co. Delaware (b) Athena Assurance Co. Minnesota (c) St. Paul Medical Liability Insurance Co. Minnesota (d) St. Paul Risk Services, Inc. Minnesota (xiii) Economy Fire & Casualty Co. Illinois (a) Economy Preferred Insurance Co. Illinois (b) Economy Premier Assurance Co. Illinois (xiv) Northbrook Holdings, Inc. Delaware Subsidiaries: (a) Northbrook Indemnity Co. Illinois (b) Northbrook National Insurance Co. Illinois (c) Northbrook Property and Casualty Insurance Co. Illinois (xv) St. Paul Venture Capital IV, L.L.C. Delaware (xvi) St. Paul Properties, Inc. Delaware Subsidiaries: (a) 77 Water Street, Inc. Minnesota (b) St. Paul Interchange, Inc. Minnesota (c) 350 Market Street, Inc. Minnesota (xvii) United States Fidelity and Guaranty Co. Maryland Subsidiaries: (a) Fidelity and Guaranty Insurance Underwriters, Inc. Wisconsin (b) Fidelity and Guaranty Insurance Co. Iowa (c) USF&G Insurance Company of Mississippi Mississippi (d) USF&G Insurance Company of Wisconsin Wisconsin
40 (e) USF&G Insurance Company of Illinois Illinois (f) USF&G Specialty Insurance Co. Maryland (g) USF&G Business Insurance Co. Maryland (h) USF&G Family Insurance Co. Maryland (i) GeoVera Insurance Co. Maryland (j) F&G Re, Inc. Delaware (k) Inner Harbor Reinsurance, Inc. Maryland (l) The Del Mar Co. Delaware (m) Northern Indemnity, Inc. Canada (n) USF&G Small Business Insurance Co. Maryland (o) USF&G Pacific Insurance Co. Maryland (p) USF&G West Insurance Co. Maryland (q) USF&G Founder's Insurance Co. Maryland (r) Charter House Underwriters, Inc. Maryland (s) Afianzadora Insurgentes, S.A. De C.V. Mexico (t) F&G Specialty Insurance Services, Inc. California (u) IMG Holding Company, Inc. Maryland Subsidiary: (i) USF&G Realty Advisors, Inc. Delaware (v) Discover Re Managers, Inc. Delaware Subsidiary: (i) Discovery Reinsurance Co. Indiana (w) St. Paul Syndicate Holdings, Ltd. United Kingdom Subsidiary: (i) F&G Overseas, Ltd. Cayman Islands (x) THI Holdings (Delaware), Inc. Delaware Subsidiaries: (i) Titan Holdings Service Corp. Texas (ii) Victoria Financial Corp. Delaware (xviii) Fidelity and Guaranty Life Insurance Co. Maryland Subsidiary: (a) Thomas Jefferson Life Insurance Co. New York (xix) USF&G Realty, Inc. Delaware (2) The John Nuveen Company* Delaware Subsidiaries: (i) John Nuveen & Co. Incorporated Delaware Subsidiaries: (a) Nuveen Advisory Corp. Delaware (b) Nuveen Institutional Advisory Corp. Delaware (ii) Nuveen Asset Management, Inc. Delaware (iii) Rittenhouse Financial Services, Inc. Delaware (3) St. Paul Re, Inc. New York (4) Camperdown Corporation Delaware
41 (5) St. Paul Capital L.L.C. Delaware (6) St. Paul Venture Capital, Inc. Delaware (7) St. Paul London Properties, Inc. Minnesota (8) St. Paul London Investments, Inc. Minnesota (9) St. Paul Multinational Holdings, Inc. Delaware Subsidiaries: (i) St. Paul Insurance Company (S.A) Limited South Africa (ii) Seguros St. Paul de Mexico, S.A. de C.V. Mexico (iii) Botswana Insurance Company Limited Botswana (iv) St. Paul Argentina Compania De Seguros S.A. Argentina (10) St. Paul Bermuda Holdings, Inc. Delaware Subsidiaries: (i) St. Paul (Bermuda), Ltd. Bermuda (ii) St. Paul Re (Bermuda), Ltd. Bermuda (11) St. Paul Holdings Limited United Kingdom Subsidiaries: (i) St. Paul Reinsurance Company Limited United Kingdom (ii) St. Paul International Insurance Company Limited United Kingdom (iii) St. Paul Insurance Espana Seguros Y Reaseguros, S.A. Spain (iv) Camperdown UK Limited United Kingdom (v) New World Insurance Company Ltd. Guernsey (vi) Lesotho National Insurance Holdings Limited Lesotho (12) USF&G Pegasus Realty, Inc. Maryland (13) F&G International Insurance, Ltd. Bermuda (14) Bosworth Insurance Co., Ltd. Bermuda (15) St. George Reinsurance, Ltd. B.W. Indies (16) Mountain Ridge Insurance Co. Vermont
*The John Nuveen Company is a majority-owned subsidiary jointly owned by The St. Paul, which holds a 65% interest, and Fire and Marine, which holds a 13% interest. The remaining 22% is publicly held. 42 EX-23.(A) 14 EXHIBIT 23(A) EXHIBIT 23A CONSENT OF INDEPENDENT AUDITORS The Board of Directors The St. Paul Companies, Inc.: We consent to incorporation by reference in the Registration Statements on Form S-8 (SEC File No. 33-15392, No. 33-23446, No. 33-23948, No. 33-24220, No. 33-24575, No. 33-26923, No. 33-49273, No. 33-56987, No. 333-01065, No. 333-22329, No. 333-25203, No. 333-28915, No. 333-48121, No. 333-50935, No. 333-50937, No. 333-50941, No. 333-50943 and No. 333-67983), and Form S-3 (SEC File No. 33-33931, No. 33-50115, No. 33-58491, No. 333-06465 and No. 333-67139) of The St. Paul Companies, Inc., of our reports dated March 2, 1999, relating to the consolidated balance sheets of The St. Paul Companies, Inc. and subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of income, shareholders' equity, comprehensive income and cash flows for each of the years in the three-year period ended December 31, 1998, and related schedules I through V, which reports appear or are incorporated by reference in the December 31, 1998 annual report on Form 10-K of The St. Paul Companies, Inc. The consolidated financial statements and financial statement schedules as of December 31, 1997 and for each of the years in the two-year period then ended have been restated to reflect the pooling of interests with USF&G Corporation. Our reports state the consolidated financial statements and financial statement schedules of USF&G Corporation which statements reflect total assets constituting 43 percent as of December 31, 1997 and total revenues constituting 35 percent and 38 percent for the years ended December 31, 1997 and 1996, respectively, of the related consolidated totals were audited by other auditors whose reports have been furnished to us, and our opinions, insofar as they relate to the amounts included for USF&G Corporation, as of December 31, 1997 and for each of the years in the two-year period then ended, are based solely on the reports of such other auditors. Minneapolis, Minnesota /s/ KPMG Peat Marwick LLP March 31, 1999 ------------------------- KPMG Peat Marwick LLP 43 EX-23.(B) 15 EXHIBIT 23(B) EXHIBIT 23B CONSENT OF INDEPENDENT AUDITORS We consent to the use of our report dated February 20, 1998, with respect to the consolidated financial statements of USF&G Corporation for the year ended December 31, 1997 (not included separately herein) included as Schedule VII in The St. Paul Companies, Inc.'s Annual Report (Form 10-K) for the year ended December 31, 1998, filed with the Securities and Exchange Commission. Our audits also included the financial statement schedules of USF&G Corporation listed in Item 14(a) of USF&G Corporation's Annual Report (Form 10-K) for the year ended December 31, 1997 (not included separately herein). These schedules are the responsibility of management. Our responsibility is to express an opinion based on our audits. In our opinion, the financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein. We also consent to the incorporation by reference in the Registration Statements on Form S-8 (SEC File No. 33-15392, No. 33-23446, No. 33-23948, No. 33-24220, No. 33-24575, No. 33-26923, No. 33-49273, No. 33-56987, No. 333-01065, No. 333-22329, No. 333-25203, No. 333-28915, No. 333-48121, No. 333-50935, No. 333-50937, No. 333-50941, No. 333-50943 and No. 333-67983), and Form S-3 (SEC File No. 33-33931, No. 33-50115, No. 33-58491, No. 333-06465 and No. 333-67139), of The St. Paul Companies, Inc., of our report dated February 20, 1998, with respect to the consolidated financial statements and schedules of USF&G Corporation (these financial statements and schedules are not presented herein) included as Schedule VII in The St. Paul Companies, Inc. Annual Report on Form 10-K filed with the Securities and Exchange Commission. /s/ Ernst & Young LLP ---------------------- Ernst & Young LLP Baltimore, Maryland March 31, 1999 EX-24 16 EXHIBIT 24 EXHIBIT 24 POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS, That I, the undersigned, a director of The St. Paul Companies, Inc., a Minnesota corporation ("The St. Paul"), do hereby make, nominate and appoint Sandra Ulsaker Wiese and Thomas A. Bradley, or either of them, to be my attorney-in-fact, with full power and authority to sign on my behalf a Form 10-K for the year ended December 31, 1998, to be filed by The St. Paul with the Securities and Exchange Commission, and any amendments thereto, and shall have the same force and effect as though I had manually signed the Form 10-K or amendments. Dated: February 2, 1999 Signature: /s/ H. Furlong Baldwin ---------------------- Name: H. Furlong Baldwin Dated: February 2, 1999 Signature: /s/ Norman P. Blake --------------------- Name: Norman P. Blake Dated: February 2, 1999 Signature: /s/ Michael R. Bonsignore ------------------------- Name: Michael R. Bonsignore Dated: February 2, 1999 Signature: /s/ John H. Dasburg ------------------- Name: John H. Dasburg Dated: February 2, 1999 Signature: /s/ W. John Driscoll -------------------- Name: W. John Driscoll Dated: February 2, 1999 Signature: /s/ Kenneth M. Duberstein ------------------------- Name: Kenneth M. Duberstein Dated: February 2, 1999 Signature: /s/ Pierson M. Grieve --------------------- Name: Pierson M. Grieve Dated: February 2, 1999 Signature: /s/ Thomas R. Hodgson --------------------- Name: Thomas R. Hodgson 45 Dated: February 2, 1999 Signature: /s/ David G. John ----------------- Name: David G. John Dated: February 2, 1999 Signature: /s/ William H. Kling -------------------- Name: William H. Kling Dated: February 2, 1999 Signature: /s/ Bruce K. MacLaury --------------------- Name: Bruce K. MacLaury Dated: February 2, 1999 Signature: /s/ Glen D. Nelson ------------------ Name: Glen D. Nelson Dated: February 2, 1999 Signature: /s/ Anita M. Pampusch --------------------- Name: Anita M . Pampusch Dated: February 2, 1999 Signature: /s/ Gordon M. Sprenger ---------------------- Name: Gordon M. Sprenger 46 EX-27 17 EXHIBIT 27
7 1,000 YEAR YEAR YEAR DEC-31-1998 DEC-31-1997 DEC-31-1996 DEC-31-1998 DEC-31-1997 DEC-31-1996 21,056,259 20,945,219 20,107,863 0 0 0 0 0 0 1,258,509 1,052,370 823,628 629,450 640,734 406,377 877,998 985,317 1,247,673 27,115,892 25,980,033 24,441,938 119,841 113,175 109,855 157,484 128,422 164,618 878,172 872,460 857,560 38,322,708 37,358,828 35,146,236 22,600,198 21,969,130 21,440,625 3,265,762 3,528,234 3,679,752 0 0 0 0 0 0 1,260,392 1,304,008 1,170,676 502,700 502,700 307,000 15,576 16,725 16,063 2,127,671 2,057,108 1,895,608 4,493,140 4,534,335 3,735,789 38,322,708 37,358,828 35,146,236 6,944,575 7,298,100 7,178,682 1,584,982 1,577,805 1,512,575 201,689 423,048 261,989 377,155 324,226 278,291 5,876,317 5,370,369 5,466,302 1,653,613 1,709,039 1,682,788 1,624,758 1,208,063 1,091,349 (46,287) 1,335,708 991,098 (135,635) 338,666 150,637 89,348 997,042 840,461 0 (67,750) (107,759) 0 0 0 0 0 0 89,348 929,292 732,702 0.33 3.97 3.01 0.32 3.69 2.84 18,153,080 17,888,536 16,559,200 5,874,522 5,720,662 5,567,703 (270,961) (627,141) (414,138) 1,840,328 1,709,512 1,864,832 3,653,865 3,453,073 3,029,833 18,457,921 18,153,080 17,888,536 191,000 0 0
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