-----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, UjSLmCDNptC3RETcHMtIPfppmfvzUEY6RSWTN1GnAFJN5IxsfdW1cQKtSeNZUmYK zzHD65UEclBZgzf6CYkgCA== 0000897430-98-000010.txt : 19980817 0000897430-98-000010.hdr.sgml : 19980817 ACCESSION NUMBER: 0000897430-98-000010 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980630 FILED AS OF DATE: 19980814 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: TIG HOLDINGS INC CENTRAL INDEX KEY: 0000897430 STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331] IRS NUMBER: 943172455 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-11856 FILM NUMBER: 98689448 BUSINESS ADDRESS: STREET 1: 65 EAST 55TH STREET 28TH FLOOR CITY: NEW YORK STATE: NY ZIP: 10022 BUSINESS PHONE: 9728315393 MAIL ADDRESS: STREET 1: 65 EAST 55TH STREET 28TH FLOOR CITY: NEW YORK STATE: NY ZIP: 10022 10-Q 1 FORM 10-Q - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 --------------- FORM 10-Q (X) Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Quarterly Period Ended June 30, 1998 OR ( )TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Transition Period from to Commission File Number 1-11856 ================================================================================ TIG HOLDINGS, INC. (Exact name of registrant as specified in its charter) Delaware 94-3172455 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 65 East 55th Street, 28th Floor New York, New York 10022 (Address of principal executive offices) (212) 446-2700 (Registrant's telephone number, including area code) ================================================================================ Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 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 _____ Number of shares of Common Stock, $0.01 par value per share, outstanding as of close of business on June 30, 1998: 50,955,718 excluding 16,258,097 treasury shares. - -------------------------------------------------------------------------------- TIG HOLDINGS, INC. INDEX TO FORM 10-Q PART I. FINANCIAL INFORMATION Page Item 1. Financial Statements Condensed consolidated balance sheets as of June 30, 1998 (unaudited) and December 31, 1997 ....................3 Condensed consolidated statements of income for the three and six months ended June 30, 1998 (unaudited) and June 30, 1997 (unaudited).. .......................4 Condensed consolidated statement of changes in shareholders' equity for the six months ended June 30, 1998 (unaudited).....................................5 Condensed consolidated statements of cash flow for the six months ended June 30, 1998 (unaudited) and June 30, 1997 (unaudited)...........................6 Notes to condensed consolidated financial statements (unaudited)..............................................7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations......................11 2.1 Consolidated Results...............................................12 2.2 Reinsurance........................................................14 2.3 Commercial Specialty...............................................16 2.4 Custom Markets.....................................................18 2.5 Other Lines........................................................20 2.6 Investments........................................................21 2.7 Reserves...........................................................24 2.8 Liquidity and Capital Resources....................................25 2.9 Year 2000..........................................................27 2.10 Forward-Looking Statements.........................................28 2.11 Glossary...........................................................29 PART II. OTHER INFORMATION Item 1. Legal Proceedings..................................................31 Item 4. Submission of Matters to a Vote of Security Holders................32 Item 6. Exhibits and Reports on Form 8-K...................................33 SIGNATURE ...................................................................34 TIG HOLDINGS, INC. CONDENSED CONSOLIDATED BALANCE SHEETS
June 30, December 31, (In millions, except share data) 1998 1997 - ---------------------------------------------------------------------------- ------------------ ------------------ Assets (unaudited) Investments: Fixed maturities at market $4,006 $3,874 (cost: $3,859 in 1998 and $3,725 in 1997) Short-term and other investments (cost: $187 in 1998 and $316 in 1997) 190 318 - ---------------------------------------------------------------------------- ------------------ ------------------ Total investments 4,196 4,192 Cash 33 18 Accrued investment income 55 56 Premium receivable (net of allowance of: $5 in 1998 and 1997) 536 453 Reinsurance recoverable on paid losses (net of allowance of: $5 in 1998 and $6 in 1997) 115 125 Reinsurance recoverable on unpaid losses 1,733 1,404 Deferred policy acquisition costs 172 155 Prepaid reinsurance premium 159 177 Income taxes 97 140 Other assets 174 147 - ---------------------------------------------------------------------------- ------------------ ------------------ Total assets $7,270 $6,867 - ---------------------------------------------------------------------------- ------------------ ------------------ Liabilities Reserves for: Losses $3,500 $3,459 Loss adjustment expenses 477 476 Unearned premium 761 738 - ---------------------------------------------------------------------------- ------------------ ------------------ Total reserves 4,738 4,673 Reinsurance premium payable 129 61 Funds withheld under reinsurance agreements 527 319 Notes payable 178 122 Other liabilities 345 379 - ---------------------------------------------------------------------------- ------------------ ------------------ Total liabilities 5,917 5,554 - ---------------------------------------------------------------------------- ------------------ ------------------ Mandatory redeemable 8.597% capital securities of subsidiary trust 125 125 - ---------------------------------------------------------------------------- ------------------ ------------------ Mandatory redeemable preferred stock 25 25 - ---------------------------------------------------------------------------- ------------------ ------------------ Shareholders' Equity Common stock - par value $0.01 per share 1,269 1,257 (authorized: 180,000,000 shares; issued and outstanding: 67,572,612 shares in 1998 and 66,955,288 shares in 1997) Retained earnings 299 253 Accumulated other comprehensive income 96 96 - ---------------------------------------------------------------------------- ------------------ ------------------ 1,664 1,606 Treasury stock (16,258,097 shares in 1998 and 15,597,021 shares in 1997) (461) (443) - ---------------------------------------------------------------------------- ------------------ ------------------ Total shareholders' equity 1,203 1,163 - ---------------------------------------------------------------------------- ------------------ ------------------ Total liabilities and shareholders' equity $7,270 $6,867 - ---------------------------------------------------------------------------- ------------------ ------------------ See Notes to Condensed Consolidated Financial Statements.
1 TIG HOLDINGS, INC. CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
Three Months Six Months Ended June 30, Ended June 30, --------------------------- ---------------------------- (In millions, except per share data) 1998 1997 1998 1997 - -------------------------------------------------------- ------------- ------------- -------------- ------------- Revenues Net premium earned $374 $358 $734 $711 Net investment income 60 73 126 148 Net realized investment gain 1 4 3 5 - -------------------------------------------------------- ------------- ------------- -------------- ------------- Total revenues 435 435 863 864 - -------------------------------------------------------- ------------- ------------- -------------- ------------- Losses and expenses Net losses and loss adjustment expenses incurred 246 250 492 502 Commissions and premium related expenses 84 80 163 158 Other underwriting expenses 41 32 78 64 Corporate expenses 16 11 29 19 Interest expense 5 5 11 10 - -------------------------------------------------------- ------------- ------------- -------------- ------------- Total losses and expenses 392 378 773 753 - -------------------------------------------------------- ------------- ------------- -------------- ------------- Income before income tax expense 43 57 90 111 Income tax expense 13 18 27 36 - -------------------------------------------------------- ------------- ------------- -------------- ------------- Net income $30 $39 $63 $75 - -------------------------------------------------------- ------------- ------------- -------------- ------------- Net income per common share Basic $0.57 $0.74 $1.21 $1.41 Diluted $0.56 $0.72 $1.19 $1.36 - -------------------------------------------------------- ------------- ------------- -------------- ------------- Dividend per common share $0.15 $0.15 $0.30 $0.30 - -------------------------------------------------------- ------------- ------------- -------------- ------------- See Notes to Condensed Consolidated Financial Statements.
2 TIG HOLDINGS, INC. CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (Unaudited)
Accumulated Other Total Comprehensive Share- Common Retained Income Treasury holders' (In millions) Stock Earnings Stock Equity ---------------------------------- ------------- ------------- ------------------ ------------- ------------- Balance at December 31, 1997 $1,257 $253 $96 ($443) $1,163 Net income 63 63 Common and preferred stock dividends (17) (17) Common stock issued 10 10 Amortization of unearned compensation 2 2 Treasury stock purchased (18) (18) ---------------------------------- ------------- ------------- ------------------ ------------- ------------- Balance at June 30, 1998 $1,269 $299 $96 ($461) $1,203 ---------------------------------- ------------- ------------- ------------------ ------------- ------------- See Notes to Condensed Consolidated Financial Statements.
3 TIG HOLDINGS, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW (Unaudited)
Six Months Ended June 30, ------------------------------------ (In millions) 1998 1997 --------------------------------------------------------------------- ----------------- ------------------ Operating Activities Net income $63 $75 Adjustments to reconcile net income to cash provided by (used in) operating activities: Changes in: Accrued investment income 1 (4) Premium receivable (83) (37) Reinsurance recoverable (319) (63) Deferred policy acquisition costs (17) (14) Prepaid reinsurance premium 18 14 Income taxes 43 23 Loss reserves 41 (2) Loss adjustment expenses reserves 1 (74) Unearned premium reserves 23 29 Reinsurance premium payable 68 41 Funds held under reinsurance agreements 208 51 Other assets, other liabilities and other 10 (52) --------------------------------------------------------------------- ----------------- ------------------ Net cash provided by (used in) operating activities 57 (13) --------------------------------------------------------------------- ----------------- ------------------ Investing Activities Purchases of fixed maturity investments (1,616) (1,470) Sales of fixed maturity investments 1,232 1,357 Maturities and calls of fixed maturity investments 217 134 Net decrease (increase) in short-term and other investments 129 (5) Other (36) (10) --------------------------------------------------------------------- ----------------- ------------------ Net cash provided by (used in) investing activities (74) 6 --------------------------------------------------------------------- ----------------- ------------------ Financing Activities Common stock issued 10 9 Treasury stock purchased (18) (106) Mandatory redeemable capital securities issued - 125 Common stock and preferred stock dividends (17) (17) Increase in notes payable 56 - Other 1 1 --------------------------------------------------------------------- ----------------- ------------------ Net cash provided by financing activities 32 12 --------------------------------------------------------------------- ----------------- ------------------ Increase in cash 15 5 Cash at beginning of period 18 19 --------------------------------------------------------------------- ----------------- ------------------ Cash at end of period $33 $24 --------------------------------------------------------------------- ----------------- ------------------ See Notes to Condensed Consolidated Financial Statements.
4 TIG HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS For the Six Months Ended June 30, 1998 (Unaudited) - -------------------------------------------------------------------------------- NOTE A. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - -------------------------------------------------------------------------------- Basis of Presentation. TIG Holdings, Inc. ("TIG Holdings") is primarily engaged in the business of property/casualty insurance and reinsurance through its 14 domestic insurance subsidiaries (collectively "TIG" or the "Company"). The accompanying unaudited condensed consolidated financial statements include the accounts of TIG Holdings and its subsidiaries and have been prepared in accordance with generally accepted accounting principles ("GAAP") for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. Financial statements prepared in accordance with GAAP require the use of management estimates. In the opinion of management, all adjustments, including normal recurring accruals, considered necessary for a fair presentation have been included. Certain reclassifications of prior year amounts have been made to conform with the 1998 presentation. Operating results for the six months ended June 30, 1998 are not necessarily indicative of the results to be expected for the full year. Operating results for the second half of 1998 could decline from those reported for the first half of the year. For further information, refer to Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations included in this Form 10-Q and TIG's annual report on Form 10-K for the year ended December 31, 1997. Earnings per Share ("EPS"). Basic EPS is calculated based upon the weighted average common shares outstanding ("average shares") during the period. In order to calculate EPS, unallocated Employee Stock Ownership Plan shares and treasury shares are deducted from the outstanding common shares. For diluted EPS, common stock options increase weighted average shares outstanding to the extent that they are dilutive. To obtain net income attributable to common shareholders for EPS computations, the preferred stock dividend is deducted from net income. The following schedule presents the calculation of Basic and Diluted EPS:
Three Months Ended Six Months Ended June 30, June 30, ------------------------------ --------------- --------------- (In millions, except earnings per share) 1998 1997 1998 1997 - ------------------------------------------------- --------------- --------------- --------------- --------------- Numerator: Net income $30 $39 $63 $75 Less: Preferred stock dividends 1 1 1 1 - ------------------------------------------------- --------------- --------------- --------------- --------------- Income available to common stockholders $29 $38 $62 $74 Denominator: Weighted average shares outstanding for basic EPS 51.2 51.8 51.2 52.6 Effect of dilutive options 0.8 1.6 1.1 2.1 - ------------------------------------------------- --------------- --------------- --------------- --------------- Adjusted weighted average shares for diluted EPS 52.0 53.4 52.3 54.7 Basic EPS $0.57 $0.74 $1.21 $1.41 - ------------------------------------------------- --------------- --------------- --------------- --------------- Diluted EPS $0.56 $0.72 $1.19 $1.36 - ------------------------------------------------- --------------- --------------- --------------- ---------------
5 TIG HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS For the Six Months Ended June 30, 1998 (Unaudited) - -------------------------------------------------------------------------------- Investments. Fixed maturities are classified as available for sale, as TIG has no positive intent to hold such securities until maturity, and are carried at market value. Short-term investments are carried at cost, which approximates market value. Market value is principally based upon quoted market prices. Quoted market prices are available for substantially all securities held by the Company. The difference between the aggregate market value and amortized cost of securities, after deferred income tax effect, is reported as unrealized gain or loss as a component of accumulated other comprehensive income directly in shareholders' equity and, accordingly, has no effect on net income. Loss and Loss Adjustment Expense Reserves. The liability for loss and loss adjustment expenses ("LAE") is based on an evaluation of reported losses and on estimates of incurred but unreported losses ("IBNR"). The reserve liabilities are determined using estimates of losses for individual claims (case basis reserves) and statistical projections of reserves for IBNR. Management considers many factors when setting reserves, including: (i) current legal interpretations of coverage and liability; (ii) economic conditions; and (iii) internal methodologies which analyze TIG's experience with similar cases, information from ceding companies and historical trends, such as reserving patterns, loss payments, pending levels of unpaid claims and product mix. Based on these considerations, management believes that adequate provision has been made for TIG's loss and LAE reserves. Actual losses and subsequent developments or revisions to the estimate are reflected in results of operations in the period in which such adjustments become known. Loss Portfolio Reinsurance. Effective January 1, 1998, the Company entered into a loss portfolio reinsurance agreement on a funds held basis for loss and LAE reserves of $265 million related to certain run-off programs. The gain on the cession was deferred and will be amortized into income as losses are paid. Amortization of deferred gain of $2 million and $4 million was recorded as a reduction of incurred losses for the three and six months ended June 30, 1998, respectively. The contract covers 80% of any adverse loss development incurred in excess of $280 million up to a maximum of $343 million. Any additional future benefit from the contract triggered by adverse loss development will also be deferred and amortized into income as the related losses are paid. Funds held bear interest at 1.7% per quarter beginning April 1, 1998. Related funds held interest of $4 million was recorded as a reduction of net investment income for the three months ended June 30, 1998. Treasury Stock. At June 30, 1998, the Board of Directors had authorized the repurchase of up to 18.75 million shares of TIG Holdings common stock. As of June 30, 1998, the Company has repurchased 16.3 million shares at an aggregate cost of $461 million. The Company uses the cost method to record the repurchase of treasury shares. Independent Agents Business Ceding Commission. On December 31, 1997, TIG completed the sale of its Independent Agents personal lines operations, which was principally effected through reinsurance transactions. At close, TIG received a ceding commission in excess of related deferred acquisition costs of $20 million related to the 100% reinsurance of certain Independent Agents business. This ceding commission will be recognized in income during 1998 as the related ceded premium is earned. TIG recognized $8 million and $17 million of pre-tax ceding commissions for the three and six months ended June 30, 1998, respectively. 6 TIG HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS For the Six Months Ended June 30, 1998 (unaudited) - -------------------------------------------------------------------------------- NOTE B. CONTINGENCIES - -------------------------------------------------------------------------------- TIG's insurance subsidiaries are routinely engaged in litigation in the normal course of their business. As a liability insurer, the Company defends third-party claims brought against its insureds. As an insurer, the Company defends against coverage claims. On January 11, 1994, a Los Angeles County Superior Court jury returned a verdict of $28 million for punitive damages against TIG Insurance Company ("TIC") in Talbot Partners v. Cates Construction, Inc. and TIC (the "Talbot Case"). The award arose out of TIC's handling of a surety bond claim on a construction project. On March 28, 1997, the California Court of Appeals reduced the trial court's punitive damage award to $15 million. On July 23, 1997, the California Supreme Court granted TIC's petition to review the Court of Appeals' decision. Management believes that the ultimate liability arising from the Talbot Case will not materially impact consolidated operating results. TIG's Federal income tax returns are routinely audited by the Internal Revenue Service (IRS) and provisions are made in the financial statements in anticipation of the results of these audits. Following a routine federal income tax audit by the IRS, in September 1997, the IRS issued a Statutory Notice of Deficiency for the tax year 1993 and a Revenue Agents Report for 1994 asserting a tax liability of approximately $170 million excluding interest. The IRS's asserted tax adjustments principally relate to the acquisition made by TIG under the Section 338(h)(10) election of April 27, 1993 in conjunction with TIG's Initial Public Offering and primarily generate temporary differences by creating income in 1993 with corresponding deductions in 1993 and future tax years. TIG strongly disagrees with the IRS's position and, on December 11, 1997, TIG filed a Tax Court Petition challenging it. In connection with the Statutory Notice of Deficiency issued by the IRS for the 1993 tax year, TIG made a $40 million advance tax payment in December 1997, that has been reflected as a current tax asset. While the timing of cash tax payments may be impacted, management believes that revisions to TIG's recorded tax liability, if any, arising from the IRS's audit will not materially impact consolidated net income or the financial condition of the Company. On February 12, 1998, a purported class action complaint, naming TIG and two of its executive officers as defendants, was filed in the United States District Court for the Southern District of New York on behalf of persons who purchased TIG common stock during the period from October 21, 1997 to January 30, 1998, when TIG announced its fourth quarter 1997 results. The complaint alleges that TIG violated the federal securities laws by misrepresenting the adequacy of its underwriting and monitoring standards and loss reserves, and that five of its officers and directors sold shares at prices that were artificially inflated as a result of the alleged misrepresentations. Plaintiffs seek unspecified monetary damages, including punitive damages. Management believes that the lawsuit is without merit and it will be vigorously defended. 7 TIG HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS For the Six Months Ended June 30, 1998 (unaudited) - -------------------------------------------------------------------------------- NOTE C. COMPREHENSIVE INCOME - -------------------------------------------------------------------------------- In January 1998, TIG adopted Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("Statement 130"). Statement 130 establishes new rules for the reporting and display of comprehensive income and its components. Statement 130 requires changes in unrealized gains or losses on the Company's available-for-sale securities and foreign currency translation adjustments, which prior to adoption were reported separately in shareholders' equity, be included in other comprehensive income. Prior year financial statements have been reclassified to conform to the requirements of Statement 130. The adoption of this statement had no impact on TIG's net income or shareholders' equity. During the first six months of 1998 and 1997, total comprehensive income was $63 million and $73 million, respectively. The components of comprehensive income, net of related tax are as follows:
Three Months Ended Six Months Ended June 30, June 30, --------------------------- --------------------------- (In millions) 1998 1997 1998 1997 - ------------------------------------------------------ ------------- ------------- ----- ------------- ------------- Net income $30 $39 $63 $75 Unrealized gain (loss) on marketable securities 8 51 - (2) - ------------------------------------------------------ ------------- ------------- ----- ------------- ------------- Comprehensive income $38 $90 $63 $73 - ------------------------------------------------------ ------------- ------------- ----- ------------- -------------
The components of accumulated other comprehensive income, net of related tax, at June 30, 1998 and December 31, 1997 are as follows:
June 30, December 31, (In millions) 1998 1997 -------------------------------------------------- -------------------- -------------------- Unrealized gain on marketable securities $98 $98 Foreign currency translation adjustments (2) (2) -------------------------------------------------- -------------------- -------------------- Accumulated other comprehensive income $96 $96 -------------------------------------------------- -------------------- --------------------
- -------------------------------------------------------------------------------- NOTE D. NOTES PAYABLE - -------------------------------------------------------------------------------- The Company borrowed $70 million on its $250 million revolving line of credit in the first quarter of 1998, of which $55 million is currently outstanding at June 30, 1998. The proceeds of the borrowing were utilized for general corporate purposes. This borrowing bears interest at a floating rate, currently 5.8275%. 8 TIG HOLDINGS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - -------------------------------------------------------------------------------- ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - -------------------------------------------------------------------------------- The following discussion provides management's assessment of financial results for the three and six months ended June 30, 1998 as compared to the three and six months ended June 30, 1997 and material changes in financial position from December 31, 1997 to June 30, 1998 for TIG Holdings, Inc. ("TIG Holdings") and its subsidiaries (collectively "TIG" or the "Company") and presents management's expectations for the near term. The analysis focuses on the performance of TIG's three major operating divisions, Reinsurance, Commercial Specialty, and Custom Markets, and its investment portfolio, which are discussed at Items 2.2, 2.3, 2.4, and 2.6, respectively. Lines of business that have been de-emphasized ("Other Lines") are discussed at Item 2.5. This discussion updates the "Management's Discussion and Analysis" in the 1997 Annual Report to Shareholders and should be read in conjunction therewith. Key industry terms that appear in the Management's Discussion and Analysis and elsewhere in this document are defined at Item 2.11 - Glossary. Certain reclassifications of prior years' amounts have been made to conform with the 1998 presentation. Statements contained in the Management's Discussion and Analysis, and elsewhere in this document that are not based on historical information are forward-looking statements and are based on management's projections, estimates and assumptions. Management would like to caution readers regarding its forward-looking statements (see Item 2.10 - Forward-Looking Statements). 9 TIG HOLDINGS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - -------------------------------------------------------------------------------- 2.1 CONSOLIDATED RESULTS - -------------------------------------------------------------------------------- Overview. Results of operations for the three and six months ended June 30, 1998 and 1997 are presented below:
Three Months Six Months Ended June 30, Ended June 30, --------------------------- --------------------------- (In millions) 1998 1997 1998 1997 - ------------------------------------------------- ------------- ------------- ------ ------------- ------------- Gross premium written $526 $465 $1,118 $933 - ------------------------------------------------- ------------- ------------- ------ ------------- ------------- Net premium written $354 $380 $774 $769 - ------------------------------------------------- ------------- ------------- ------ ------------- ------------- Net premium earned $374 $358 $734 $711 Less: Net loss and LAE incurred 246 250 492 502 Commission expense 74 70 144 137 Premium related expense 10 10 19 21 Other underwriting expense 36 31 70 61 Policyholder dividends incurred 5 1 8 3 - ------------------------------------------------- ------------- ------------- ------ ------------- ------------- Underwriting gain (loss) 3 (4) 1 (13) Net investment income 60 73 126 148 Net realized investment gain 1 4 3 5 Corporate expenses 16 11 29 19 Interest expense 5 5 11 10 - ------------------------------------------------- ------------- ------------- ------ ------------- ------------- Income before tax expense 43 57 90 111 Income tax expense (13) (18) (27) (36) - ------------------------------------------------- ------------- ------------- ------ ------------- ------------- Net income $30 $39 $63 $75 - ------------------------------------------------- ------------- ------------- ------ ------------- -------------
Net income declined by $9 million or 23% in the second quarter and $12 million or 16% for the first six months of 1998 as compared to the corresponding 1997 period. The principal drivers of the decline were increased corporate, commission and other underwriting expenses. Corporate expenses increased due to planned corporate systems and other projects, including Year 2000 initiatives (see Item 2.9). Commission rates increased in all ongoing divisions due to pricing pressures. Other underwriting expenses increased disproportionately to net premium written growth as "start-up" business initiatives are taking longer to achieve targeted volumes due to continuing soft market conditions. TIG reported an underwriting gain for the second quarter and first six months of 1998, despite increased commission and other underwriting expenses, due to ceding commission income arising from the December 1997 sale of TIG's Independent Agents business of $8 million and $17 million, respectively (see Item 2.5). Remaining ceding commission income of approximately $3 million will be recognized in the third quarter of 1998. In addition, increased utilization of aggregate stop loss and other finite reinsurance coverages in all operating divisions provided an additional underwriting benefit of approximately $17 million and $29 million for the second quarter and first six months of 1998, respectively, as compared to the corresponding 1997 periods. The increased utilization of finite reinsurance coverages is partially in response to favorable market conditions and partially to mitigate the inherent financial volatility of a changing book of business. As discussed below, both the sale of the Independent Agents business and increased utilization of finite reinsurance has had a negative impact on investment income. 10 TIG HOLDINGS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - -------------------------------------------------------------------------------- Net investment income decreased $13 million or 18% and $22 million or 15% for the second quarter and first six months of 1998, respectively, as compared to the corresponding 1997 periods. Approximately, $5 million of the year-to-date 1998 decrease is attributable to net assets transferred in December 1997 in connection with the sale of Independent Agents business while approximately $10 million results from increased funds held interest expense resulting from additional utilization of finite reinsurance coverages. The remaining decrease in net investment income is principally attributable to declining market investment yields in 1998. The following could impact earnings during future quarters: Competitive conditions in commercial insurance and reinsurance markets, increased commission pressure, new initiative start-up expenses, continued losses from the Alternative Distribution business unit (see Item 2.4) and the decrease in ceding commissions from the sale of the Independent Agency Personal Lines operations, offset by the net impact of any opportunistic use of finite or other ceded reinsurance which has favorably benefited loss ratios in 1998. As a result, operating earnings for the second half of 1998 could decline from those reported for the first half of the year. Premium. Overall market conditions remain extremely competitive in 1998, which has provided additional leverage to brokers and ceding companies in establishing terms, including commission rates. Oversupply of capital in the insurance industry has resulted in significant downward pricing pressure, making it increasingly difficult for TIG to write business which meets its profitability standards. TIG's marketing focus for all divisions is to develop program business which caters to a specific market niche. The following table summarizes net premium written ("NPW") by division:
Three Months Six Months Ended June 30, Ended June 30, ------------------------------------- ------------------------------------- 1998 1997 1998 1997 -------- --------- --------- -------- -------- --------- --------- -------- (In millions) NPW % NPW % NPW % NPW % --------------------------- -------- --------- --------- -------- -------- --------- --------- -------- Reinsurance $118 33% $139 37% $238 31% $284 37% Commercial Specialty 175 49% 136 36% 419 54% 276 36% Custom Markets 66 19% 40 10% 127 16% 71 9% Other Lines (5) (1%) 65 17% (10) (1%) 138 18% --------------------------- -------- --------- --------- -------- -------- --------- --------- -------- Net premium written $354 100% $380 100% $774 100% $769 100% --------------------------- -------- --------- --------- -------- -------- --------- --------- --------
Consolidated net premium written decreased by $26 million or 7% and increased by $5 million or 1% for the second quarter and first six months of 1998, respectively, as compared to the corresponding 1997 periods, while growth in ongoing operations net premium written was $44 million or 14% and $153 million or 24%, respectively. Growth in ongoing operations net premium written decreased in the second quarter of 1998 from the first quarter of 1998 due to the seasonality of Lloyd's syndicate premium, the buying down of the Managed Compensation business unit's net retention from $1 million to $100 thousand (see Item 2.3) and increased utilization of finite reinsurance coverages. As expected, ongoing operations premium growth was offset in 1998 by a decline in Other Lines net premium written resulting from the sale and 100% reinsurance of TIG's Independent Agents business in December 1997 (see Item 2.5). 11 TIG HOLDINGS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - -------------------------------------------------------------------------------- Statutory Combined Ratio. The following table presents the components of the Company's statutory combined ratio:
Three Months Six Months Ended June 30, Ended June 30, ---------------------------------- ---------------------------------- Statutory ratios 1998 1997 1998 1997 -------------------------------- ----------------- ---------------- ----------------- ---------------- Loss and LAE 66.4 69.7 67.6 70.6 -------------------------------- ----------------- ---------------- ----------------- ---------------- Commission expense 22.8 19.4 21.3 19.2 Premium related expense 3.5 2.7 2.9 2.8 Other underwriting expense 10.3 8.8 9.2 8.4 -------------------------------- ----------------- ---------------- ----------------- ---------------- Total underwriting expense 36.6 30.9 33.4 30.4 Policyholder dividends 1.3 0.9 1.2 1.1 -------------------------------- ----------------- ---------------- ----------------- ---------------- Combined 104.3 101.5 102.2 102.1 -------------------------------- ----------------- ---------------- ----------------- ----------------
The combined ratio for second quarter 1998 increased 2.8 percentage points over second quarter 1997 as increased underwriting and commission expense ratios more than offset a decrease in the loss and LAE ratio. The increase in the other underwriting expense ratio is primarily attributable to start-up costs incurred for new business initiatives and lower net premium written, while the increased commission expense ratio is principally attributable to pricing pressures in all ongoing divisions. The decrease in the second quarter 1998 loss and LAE ratio is due to increased utilization of finite reinsurance coverages and a decrease in retention limits for Managed Compensation business from $1 million to $100 thousand (see Item 2.3). The combined ratio for the first six months of 1998 increased only slightly over 1997 as ceding commission income from the sale of Independent Agents business was also recognized in statutory income for first quarter 1998. As a result, the year-to-date 1998 commission ratio and combined ratio was reduced by approximately one percentage point. - -------------------------------------------------------------------------------- 2.2 REINSURANCE - -------------------------------------------------------------------------------- TIG's reinsurance operations are conducted through TIG Reinsurance Company ("TIG Re") which is based in Stamford, Connecticut. TIG Re operates through a number of business units which employ similar underwriting principles but serve differing market needs: Specialty Casualty, Traditional Treaty, London Branch, a Lloyd's Syndicate, Reverse Flow, Specialty Property, Finite Reinsurance and Facultative. Specialty Casualty emphasizes general liability and professional liability lines. TIG Re is often a lead underwriter in these transactions which are usually structured on an excess-of-loss basis. Traditional Treaty reinsures "standard" property/casualty business. The London Branch focuses on worldwide property exposures, with casualty underwriting having been introduced in late 1996, while a fully integrated Lloyd's vehicle (underwriting syndicate) was introduced in December 1996. Reverse Flow is an alternative distribution mechanism whereby general agents or intermediaries submit program business to TIG Re. TIG Re then works with the reinsurance intermediary to provide a primary insurer to issue the primary policy and then cede a significant portion of the risk to TIG Re. Beginning in the second quarter of 1998, management and reporting of reverse flow business is being transitioned to the Company's Irving, Texas location, principally under the control of its Commercial Specialty operations. Specialty Property covers both domestic and international exposures. Finite Reinsurance provides clients with integrated underwriting approaches to control the volatility of financial results over time. TIG Re maintains eight branch offices dedicated to the marketing and underwriting of direct facultative reinsurance on an automatic and individual risk basis. 12 TIG HOLDINGS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - -------------------------------------------------------------------------------- Premium. The following table summarizes TIG Re's premium production:
Three Months Six Months Ended June 30, Ended June 30, -------------------------------------- -------------------------------------- 1998 1997 1998 1997 ------------------- ------------------ ------------------- ------------------ (In millions) NPW % NPW % NPW % NPW % ---------------------------- --------- --------- -------- --------- --------- --------- -------- --------- Specialty Casualty $41 35% $57 41% $99 41% $112 39% Reverse Flow 24 20% 12 9% 39 16% 31 11% Traditional Treaty 23 20% 32 23% 37 16% 56 20% London Branch & Lloyd's 23 20% 24 17% 48 20% 44 16% Specialty Property 3 2% 17 12% 10 4% 29 10% Finite 5 4% 7 5% 9 4% 24 8% Facultative 11 9% 6 4% 18 8% 11 4% Other (12) (10%) (16) (11%) (22) (9%) (23) (8%) ---------------------------- --------- --------- -------- --------- --------- --------- -------- --------- ---------------------------- --------- --------- -------- --------- --------- --------- -------- --------- Net premium written $118 100% $139 100% $238 100% $284 100% ---------------------------- --------- --------- -------- --------- --------- --------- -------- --------- Gross premium written $139 $156 $280 $312 ---------------------------- --------- --------- -------- --------- --------- --------- -------- ---------
Net premium written declined by $21 million or 15% in the second quarter of 1998 and $46 million or 16% in the first six months of 1998 compared to the corresponding 1997 periods. The decrease in net premium written is due to the non-renewal or reduced participation in several large and unprofitable accounts combined with increased use of reinsurance to manage the Company's net underwriting exposure. During the first seven months of 1998 TIG Re appointed a new Chief Executive Officer, a new Chief Actuary, a new Chief Financial Officer and replaced several senior underwriters. These appointments, and the departure of their predecessors, could impact, positively or negatively, existing producer relationships and the availability of new business opportunities. Underwriting Results. The following table summarizes TIG Re's underwriting results:
Three Months Six Months Ended June 30, Ended June 30, --------------------------- --------------------------- (In millions) 1998 1997 1998 1997 ---------------------------------------------- ------------- ------------- ------------- ------------- Net premium earned $130 $119 $264 $248 Less: Net loss and LAE incurred 87 84 176 179 Commission expense 36 29 73 58 Other underwriting expense 12 10 25 20 ---------------------------------------------- ------------- ------------- ------------- ------------- Underwriting loss ($5) ($4) ($10) $(9) ---------------------------------------------- ------------- ------------- ------------- ------------- Statutory ratios ---------------------------------------------- ------------- ------------- ------------- ------------- Loss and LAE 67.1 70.9 66.8 72.4 Commission 28.6 23.0 29.0 22.9 Premium related 0.5 0.4 0.5 0.3 Other underwriting 9.5 7.2 10.1 6.9 ---------------------------------------------- ------------- ------------- ------------- ------------- Combined ratio 105.7 101.5 106.4 102.5 ---------------------------------------------- ------------- ------------- ------------- -------------
13 TIG HOLDINGS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - -------------------------------------------------------------------------------- TIG Re's underwriting loss for the second quarter and first six months of 1998 approximated the underwriting loss of the comparable 1997 periods. Results for both 1998 periods reflect overall lower program profitability expectations, offset by increased aggregate stop loss reinsurance utilization which improved the statutory combined ratio by approximately 1.9 percentage points for the second quarter of 1998 and 2.3 percentage points for the first six months of 1998. In addition, a favorable arbitration award reduced first quarter 1998 incurred loss and LAE, while second quarter 1998 incurred loss and LAE received a similar unplanned benefit from a novation transaction. The statutory commission ratio increased by 5.6 percentage points in the second quarter 1998 and 6.1 percentage points for the first six months of 1998 when compared to the corresponding 1997 periods. This increase is principally due to a changing mix of business with higher commissions and competitive market conditions. The statutory other underwriting expense ratio increased as a result of spending on new initiatives and lower net premium volume in 1998 compared to the 1997 periods. - -------------------------------------------------------------------------------- 2.3 COMMERCIAL SPECIALTY - -------------------------------------------------------------------------------- Commercial Specialty, based in Irving, Texas, provides specialized insurance products through five main business units: Managed Compensation, Sports and Leisure, Lloyd's Syndicates, Primary Casualty and Excess Casualty. Managed Compensation provides workers' compensation insurance coverages and occupational care management. Workers' Compensation insurance covers medical care, rehabilitation, and lost wages of employees who suffer work-related injuries, and provides death benefits for dependents of employees killed in work-related accidents. The Sports and Leisure unit offers coverages for professional and amateur sports events. Coverages include spectator liability and participant legal liability, including property and liability packages for a variety of entertainment and leisure activities. Commercial Specialty participates in three Lloyd's syndicates which principally write marine, U.K. property and aviation business. The Primary Casualty unit focuses on commercial auto, professional liability, construction, and marine programs. The Excess Casualty unit offers lead umbrella and excess umbrella policies. Premium. The following table summarizes Commercial Specialty's premium production:
Three Months Six Months Ended June 30, Ended June 30, -------------------------------------- -------------------------------------- 1998 1997 1998 1997 ------------------- ------------------ ------------------- ------------------ (In millions) NPW % NPW % NPW % NPW % ---------------------------- --------- --------- -------- --------- --------- --------- -------- --------- Managed Compensation $72 41% $54 40% $188 45% $109 39% Lloyd's Syndicates 14 8% 4 3% 68 16% 24 9% Sports & Leisure 55 31% 48 35% 99 24% 88 32% Primary Casualty 24 14% 23 17% 45 11% 41 15% Excess Casualty and other 10 6% 7 5% 19 4% 14 5% ---------------------------- --------- --------- -------- --------- --------- --------- -------- --------- Net premium written $175 100% $136 100% $419 100% $276 100% ---------------------------- --------- --------- -------- --------- --------- --------- -------- --------- Gross premium written $241 $171 $556 $348 ---------------------------- --------- --------- -------- --------- --------- --------- -------- ---------
14 TIG HOLDINGS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - -------------------------------------------------------------------------------- Net premium written increased 29% for the second quarter of 1998 and 52% for the first six months of 1998 compared to the corresponding 1997 periods. The increase in each respective period is principally attributable to increased production in the Managed Compensation business unit and from Lloyd's Syndicates. The increase in Managed Compensation was primarily due to TIG entering into a strategic relationship in the third quarter of 1997 with a general agent that writes program business and also provides loss management services. This relationship contributed $20 million of premium in second quarter 1998 and $67 million for the first six months of 1998. Also contributing to the increase in Managed Compensation premium for the first six months of 1998 is a better competitive environment in Illinois and growth in Arizona. The increased production in Lloyd's Syndicates is due to increased participation in the capacity of the syndicates from approximately 18% in 1997 to 41% in 1998. Growth in net premium written decreased in the second quarter of 1998 from the first quarter of 1998 due to the seasonality of both Lloyd's syndicate premium (the majority of premium is booked in the first quarter of each year) and workers' compensation renewals (premium writings are greater in the first quarter), and the second quarter 1998 decision to buy down the Managed Compensation business unit's net retention from $1 million to $100 thousand. The change in net retention was made to take advantage of favorable reinsurance pricing available due to soft market conditions. Underwriting Results. Underwriting results for Commercial Specialty are presented below:
Three Months Six Months Ended June 30, Ended June 30, --------------------------- --------------------------- (In millions) 1998 1997 1998 1997 ---------------------------------------------- ------------- ------------- ------------- ------------- Net premium earned $184 $120 $355 $228 Less: Net loss and LAE incurred 115 83 235 159 Commission expense 34 22 65 40 Premium related expense 7 5 13 10 Other underwriting expense 18 13 33 23 Policyholder dividends incurred 5 1 8 3 ---------------------------------------------- ------------- ------------- ------------- ------------- Underwriting gain (loss) $5 ($4) $1 ($7) ---------------------------------------------- ------------- ------------- ------------- ------------- Statutory ratios ---------------------------------------------- ------------- ------------- ------------- ------------- Loss and LAE 62.5 69.2 66.3 69.8 Commission 19.7 18.9 18.9 18.0 Premium related 5.0 3.7 3.9 3.7 Other underwriting 10.5 9.7 8.4 8.8 Policyholder dividends 2.6 2.6 2.3 3.0 ---------------------------------------------- ------------- ------------- ------------- ------------- Combined ratio 100.3 104.1 99.8 103.3 ---------------------------------------------- ------------- ------------- ------------- -------------
Commercial Specialty's underwriting results improved $9 million in the second quarter and $8 million for the first six months of 1998 as compared to the corresponding 1997 periods. The improvement is principally due to benefits realized as a result of changes in the Managed Compensation reinsurance strategy. As previously described, the Managed Compensation business unit's net retention was reduced to $100 thousand from $1 million in the second quarter of 1998. Additionally, in 1998 the Managed Compensation business unit purchased a finite reinsurance treaty that allows the unit to stay competitive with other insurers whose states of domicile allow discounting of workers' compensation loss reserves. These changes improved Commercial Specialty underwriting results by $14 million and $15 million for the second quarter and first six months of 1998, respectively. Unfavorable commission comparisons due to favorable contingent commission adjustments in the first and second quarters of 1997 partially offset the benefits of the new reinsurance facilities. 15 TIG HOLDINGS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - -------------------------------------------------------------------------------- 2.4 CUSTOM MARKETS - -------------------------------------------------------------------------------- Custom Markets division provides personal lines and small business insurance products through three main business units: Non-standard Auto, Alternative Distribution and Small Business. Non-standard Auto provides auto physical damage and liability coverages to higher risk insureds principally through general agents. Alternative Distribution markets personal lines insurance through non-traditional channels, such as direct marketing, and group and affiliation marketing. Small Business provides commercial property, liability, and auto coverages to small business owners through independent agents, primarily in Hawaii, Arizona and California. Premium. The following table summarizes Custom Markets premium production:
Three Months Six Months Ended June 30, Ended June 30, ------------------- ------------------ -------------------------------------- 1998 1997 1998 1997 ------------------- ------------------ ------------------- ------------------ (In millions) NPW % NPW % NPW % NPW % ---------------------------- --------- --------- -------- --------- --------- --------- -------- --------- Non-standard Auto $29 44% $19 47% $55 43% $31 44% Alternative Distributions 21 32% 6 15% 39 31% 7 10% Small Business 16 24% 15 38% 33 26% 33 46% ---------------------------- --------- --------- -------- --------- --------- --------- -------- --------- Net premium written $66 100% $40 100% $127 100% $71 100% ---------------------------- --------- --------- -------- --------- --------- --------- -------- --------- Gross premium written $77 $45 $142 $77 ---------------------------- --------- --------- -------- --------- --------- --------- -------- ---------
Custom Markets net premium written increased $26 million for the second quarter of 1998 and $56 million for the first six months of 1998 as compared to the corresponding 1997 periods. The increased production noted in Alternative Distribution is due to this unit having been formed in late 1996 with limited production in the 1997 periods. The increases noted in Non-standard Auto are principally due to new general agent relationships in California and Texas. 16 TIG HOLDINGS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - -------------------------------------------------------------------------------- Underwriting Results. Underwriting results for Custom Markets are presented below:
Three Months Six Months Ended June 30, Ended June 30, --------------------------- --------------------------- (In millions) 1998 1997 1998 1997 ---------------------------------------------- ------------- ------------- ------------- ------------- Net premium earned $65 $38 $124 $70 Less: Net loss and LAE incurred 51 24 97 45 Commission expense 12 7 24 13 Premium related expense 1 2 2 4 Other underwriting expense 7 5 12 9 ---------------------------------------------- ------------- ------------- ------------- ------------- Underwriting loss ($6) $- ($11) ($1) ---------------------------------------------- ------------- ------------- ------------- ------------- Statutory ratios ---------------------------------------------- ------------- ------------- ------------- ------------- Loss and LAE 78.0 62.7 77.8 63.6 Commission 18.7 18.0 19.2 18.3 Premium related 2.2 5.4 2.0 5.9 Other underwriting 10.3 13.0 9.3 13.3 ---------------------------------------------- ------------- ------------- ------------- ------------- Combined ratio 109.2 99.1 108.3 101.1 ---------------------------------------------- ------------- ------------- ------------- -------------
Custom Markets underwriting results deteriorated $6 million in the second quarter of 1998 and $10 million for the first six months of 1998 compared to the corresponding 1997 periods. This deterioration is principally the result of program start-up costs in the Alternative Distribution unit, which was partially mitigated by an aggregate stop loss reinsurance facility purchased in second quarter 1998. The underwriting loss from Alternative Distribution, net of reinsurance, was $4 million and $10 million for the second quarter and first six months of 1998, respectively, compared to an underwriting loss of $2 million and $3 million in the corresponding 1997 periods. TIG has initiated corrective action by changing the underwriting guidelines and filing for rate increases with respect to the major program in the Alternative Distribution unit. TIG anticipates that all of these filings will be made by the end of the first quarter of 1999, with the major state filings scheduled to be made by the end of 1998. These actions have led to a dispute with the producer of this program, the outcome of which cannot be currently determined. The producer has notified TIG that it has stopped writing new business. In addition, underwriting results for the Non-standard Auto unit deteriorated $4 million and $5 million in the second quarter and first six months of 1998, respectively, compared to the corresponding 1997 periods. This deterioration is primarily due to late reported premium cancellations and an increase in reported property losses in one large state, for which a rate increase was effective July 15, 1998. 17 TIG HOLDINGS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - -------------------------------------------------------------------------------- 2.5 OTHER LINES - -------------------------------------------------------------------------------- Other Lines principally includes the results of Independent Agents personal lines operations which were sold and 100% reinsured effective December 31, 1997, commercial products which have been placed in run-off, and aggregate stop loss reinsurance activity not related to a specific division. Underwriting Results. Underwriting results for Other Lines are presented below:
Three Months Six Months Ended June 30, Ended June 30, --------------------------- --------------------------- (In millions) 1998 1997 1998 1997 ---------------------------------------------- ------------- ------------- ------------- ------------- Gross premium written $69 $93 $140 $195 ---------------------------------------------- ------------- ------------- ------------- ------------- Net premium written ($5) $65 ($10) $138 ---------------------------------------------- ------------- ------------- ------------- ------------- Net premium earned ($5) $81 (9) $165 Less: Net loss and LAE incurred (7) 59 (16) 119 Commission expense (8) 13 (18) 26 Premium related expense 1 2 3 6 Other underwriting expense - 3 1 10 ---------------------------------------------- ------------- ------------- ------------- ------------- Underwriting gain $9 $4 $21 $4 ---------------------------------------------- ------------- ------------- ------------- -------------
The underwriting gain of $9 million in second quarter 1998 and $21 million in the first six months of 1998 is principally due to the recognition of $8 million and $17 million, respectively, of ceding commissions related to the sale of the Independent Agents unit in December 1997 (see Note A to the Condensed Consolidated Financial Statements). Other Lines second quarter 1998 and first six months of 1998 results also include $7 million and $15 million, respectively, of benefit recorded under aggregate stop loss and other reinsurance coverage compared to $7 million and $10 million for the corresponding 1997 periods. Retroactive premium and other miscellaneous adjustments partially offset the benefit of the aforementioned transactions for the second quarter and first six months of 1998. 18 TIG HOLDINGS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - -------------------------------------------------------------------------------- 2.6 INVESTMENTS - -------------------------------------------------------------------------------- Investment Mix. The goal of ongoing investment strategies is to provide TIG with the most advantageous balance of liquidity with the highest possible return over inflation, within corporate credit guidelines and regulatory restrictions and subject to management's risk tolerance. The following chart summarizes TIG's investment portfolio by investment type:
June 30, 1998 December 31, 1997 ----------------------------- ----------------------------- Market % of Market Market % of Market (In millions) Value Portfolio Value Portfolio ------------------------------------- -------------- -------------- --------------- --------------- Mortgage-backed securities $1,237 29.5% $941 22.4% Corporate and other bonds 1,216 29.0% 1,282 30.6% U.S. government bonds 906 21.6% 1,014 24.2% Municipal bonds 647 15.4% 637 15.2% ------------------------------------- -------------- -------------- --------------- --------------- Total fixed maturity investments 4,006 95.5% 3,874 92.4% Short-term and other investments 190 4.5% 318 7.6% ------------------------------------- -------------- -------------- --------------- --------------- Total invested assets $4,196 100.0% $4,192 100.0% ------------------------------------- -------------- -------------- --------------- ---------------
The portfolio gross book yield at June 30, 1998 was 7.1%, as compared to 7.4% at December 31, 1997. The decline in gross book yield is reflective of general market conditions. The weighted average duration of the portfolio increased to 6.1 years at June 30, 1998 as compared to 5.4 years at December 31, 1997 due to a decline in short-term investments. TIG's objective is to maintain the weighted average duration of its investment portfolio between 4 and 7 years. Approximately 30% of TIG's portfolio consists of mortgage-backed securities ("MBS"). AAA rated United States federal government agency mortgages now represent approximately 85% of TIG's exposure to MBS. A risk inherent in MBS is prepayment risk related to interest rate volatility. The underlying mortgages may be repaid earlier or later than originally anticipated, depending on the repayment and refinancing activity of the underlying homeowners. Should this occur, TIG would receive paydowns on the principal amount which may have been purchased at a premium or discount and TIG's investment income would be affected by any adjustments to amortization resulting from the prepayments. TIG's consolidated financial results have not been materially impacted by prepayments of MBS. Additionally, interest rate volatility can affect the market value of MBS. All MBS held in the portfolio can be traded in the public market. Derivatives/Hedges. In the normal course of business, TIG may choose to hedge some of its interest rate risk with futures contracts and/or interest rate swaps. Alternatively, derivative financial instruments may also be utilized to enhance prospective returns. TIG's interest rate swap arrangements generally provide that one party pays interest at a floating rate in relation to movements in an underlying index, and the other party pays interest at a fixed rate. While TIG is exposed to credit risk in the event of nonperformance by the other party, nonperformance is not anticipated due to the credit rating of the counterparties. 19 TIG HOLDINGS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - -------------------------------------------------------------------------------- No futures contracts positions were open at June 30, 1998, or December 31, 1997. There were no interest rate swaps at June 30, 1998 compared to $14 million notional face amount of interest rate swaps at December 31, 1997. Total fair value of derivative positions were approximately $78 million, representing 1.9% of the total investment asset holdings at June 30, 1998 no change from December 31, 1997. All TIG derivative financial instruments were with financial institutions rated "A" or better by one or more of the major credit rating agencies. Investments in TBA's. TIG routinely enters into commitments to purchase securities on a "To Be Announced" ("TBA") basis for which the interest rate risk remains with TIG until the date of delivery and payment. Delivery and payment of securities purchased on a TBA basis can take place a month or more after the date of the transaction. These securities are subject to market fluctuations during this period and it is the Company's policy to recognize any gains and losses only when they are realized. TIG maintains cash and short-term investments with a fair value exceeding the amount of its TBA purchase commitments. At June 30, 1998, there were no outstanding TBA commitments, compared to TBA commitments of $24 million with a fair value of $26 million at December 31, 1997. Unrealized Gains. Net pre-tax unrealized gains were relatively unchanged at June 30, 1998, compared to December 31,1997. The following is a summary of net unrealized gains by type of security.
(In millions) June 30, 1998 December 31, 1997 Change -------------------------------------------- --------------------- --------------------- -------------- Municipal bonds $40 $41 ($1) Mortgage-backed securities 5 8 (3) US government bonds 86 73 13 Corporate and other bonds 16 27 (11) Other investments 3 2 1 -------------------------------------------- --------------------- --------------------- -------------- Net unrealized gains $150 $151 ($1) -------------------------------------------- --------------------- --------------------- --------------
Investment Income. The following table displays the components of TIG's investment income and mean after-tax investment yields. The yields include interest earned and exclude realized investment gains and losses. These yields are computed using the average of the end of the month asset balances during the period.
Three Months Six Months Ended June 30, Ended June 30, --------------------------- --------------------------- (In millions) 1998 1997 1998 1997 ----------------------------------------- ------------- ------------- ------------- ------------- Fixed maturity investments: Taxable $61 $67 $122 $136 Tax-exempt 9 8 18 16 Short-term and other investments 2 2 4 3 ----------------------------------------- ------------- ------------- ------------- ------------- Total gross investment income 72 77 144 155 Investment expenses (1) - (1) - Interest expense on funds held (11) (4) (17) (7) ----------------------------------------- ------------- ------------- ------------- ------------- Total net investment income $60 $73 $126 $148 ----------------------------------------- ------------- ------------- ------------- ------------- After-tax gross investment yield 4.9% 5.0% 4.9% 5.0% ----------------------------------------- ------------- ------------- ------------- -------------
20 TIG HOLDINGS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - -------------------------------------------------------------------------------- The $5 million and $11 million decline in gross investment income for the three and six month periods ended June 30, 1998 compared to the corresponding 1997 periods is due to a lower average invested asset base and a lower average yield for the 1998 periods compared to the 1997 periods. The decline in average investable assets is principally due to the transfer of $149 million of investment assets related to the sale of the Independent Agents personal lines operations on December 31, 1997. The decline in investment yield is due to a general decline in market yields. The increase in interest expense on funds held is the result of increased utilization of aggregate stop loss reinsurance in 1997 and 1998. As a result of this increased utilization, funds held interest expense is expected to continue to increase in future periods. Investment Quality. The table below shows the rating distribution of TIG's fixed maturity portfolio:
June 30, 1998 December 31, 1997 --------------------------- --------------------------- Market % of Market % of Standard & Poor's/Moody's Value Portfolio Value Portfolio ------------------------------------------ ------------- ------------- ------------- ------------- (In millions) AAA/Aaa $2,710 67.7% $2,541 65.6% AA/Aa 281 7.0% 261 6.7% A/A 255 6.4% 209 5.4% BBB/Baa 225 5.6% 220 5.7% Below BBB/Baa 535 13.3% 643 16.6% ------------------------------------------ ------------- ------------- ------------- ------------- Total fixed maturity investments $4,006 100.0% $3,874 100.0% ------------------------------------------ ------------- ------------- ------------- -------------
TIG minimizes the credit risk of its fixed maturity portfolio by investing primarily in investment grade securities; however, management has authorized the purchase of high yield, less than investment grade securities up to statutory limitations. The Company's high yield portfolio is comprised of bonds whose issuers are subjected to rigorous credit analysis, including tests of prospective profitability, liquidity, leverage, and interest coverage. This analysis is updated regularly as financial results are released, and bonds are constantly evaluated for their value. The information on credit quality in the preceding table is based upon the higher of the rating assigned to each issue of fixed income securities by either Standard & Poor's or Moody's. Where neither Standard & Poor's or Moody's has assigned a rating to a particular fixed maturity issue, classification is based on 1) ratings available from other recognized rating services, 2) ratings assigned by the National Association of Insurance Commissioners Securities Valuation Office (the "SVO"), or 3) an internal assessment of the characteristics of the individual security, if no other rating is available. The SVO assigns bond ratings for most publicly held bonds. The SVO ratings are used by insurers when preparing their annual statutory financial statements. State departments of insurance use the bond rating data when attempting to determine whether an insurer's holdings are sound. Investments must fit within certain regulatory guidelines of an insurer's domiciliary state in order for an insurer to be licensed to do business in that state. The SVO ratings range from "1" to "6", with "1" and "2" being the higher quality, "3" being medium grade, and "4" through "6" being lower grade obligations. As of June 30, 1998 and December 31, 1997, approximately 88% and 84%, respectively, of TIG's portfolio, measured on a statutory carrying value basis, was invested in securities rated as "1" or "2". 21 TIG HOLDINGS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - -------------------------------------------------------------------------------- 2.7 RESERVES - -------------------------------------------------------------------------------- TIG maintains reserves to cover its estimated liability for losses and loss adjustment expenses ("LAE") with respect to reported and unreported claims. TIG's reserves for losses and LAE totaled $3,977 million and $3,935 million at June 30, 1998 and December 31, 1997, respectively. The process of estimating loss and LAE reserves involves the active participation of an experienced actuarial staff with input from the underwriting, claims, reinsurance, financial, and legal departments. Management, using the advice of loss reserve specialists, makes a judgment as to the appropriate amount to record in the financial statements. Because reserves are estimates of ultimate losses and LAE, management monitors reserve adequacy over time, evaluating new information as it becomes known and adjusting reserves as necessary. Such adjustments are reflected in current operations. The inherent uncertainty in estimating reserves is increased when significant changes occur. Examples of such changes include: (1) changes in production sources for existing lines of business; (2) writings of significant blocks of new business; (3) changes in economic conditions; and (4) changes in state or federal laws and regulations, particularly insurance reform measures. TIG has experienced significant changes in each of these areas during the past several years. The inherent uncertainties in estimating reserves are greater with respect to reinsurance than for primary insurance due to the diversity of the development patterns among different types of reinsurance contracts, the necessary reliance on ceding companies for information regarding reported claims and differing reserving practices among ceding companies. TIG's reserves include an estimate of TIG's ultimate liability for asbestos-related matters, environmental pollution, toxic tort, and other non-sudden and accidental claims for which ultimate values cannot be estimated using traditional reserving techniques. TIG's "environmental" loss and LAE reserves totaled $30 million and $34 million at June 30, 1998 and December 31, 1997, respectively. TIG's environmental claims activity is predominately from hazardous waste and pollution-related claims arising from commercial insurance policies. In connection with TIG's IPO in April 1993, an affiliate of TIG's former parent, Transamerica Corporation, agreed to pay 75% of up to $119 million of reserve development and newly reported claims, up to a maximum reimbursement of $89 million, on policies written prior to January 1, 1993, with respect to certain environmental claims involving paid losses and certain LAE in excess of TIG's environmental loss and LAE reserves at December 31, 1992. At June 30, 1998, the Transamerica affiliate had incurred no liability under this agreement. Management considers many factors when setting reserves, including: (i) current legal interpretations of coverage and liability; (ii) economic conditions; and (iii) internal methodologies which analyze TIG's experience with similar cases, information from ceding companies and historical trends, such as reserving patterns, loss payments, pending levels of unpaid claims and product mix. Based on these considerations, management believes that adequate provision has been made for TIG's loss and LAE reserves. Actual losses and LAE paid may deviate, perhaps substantially, from such reserves. 22 TIG HOLDINGS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - -------------------------------------------------------------------------------- 2.8 LIQUIDITY AND CAPITAL RESOURCES - -------------------------------------------------------------------------------- Liquidity is a measure of an entity's ability to secure enough cash to meet its contractual obligations and operating needs. TIG requires cash primarily to pay policyholders' claims, operating expenses, policyholder dividends, interest expenses and debt obligations. Generally, premium is collected months or years before claims are paid under the policies purchased by the premium. These funds are used first to pay current claims and expenses. The balance is invested in securities to augment the investment income generated by the existing portfolio. Historically, TIG has had, and expects to continue to have, more than sufficient funds to pay claims, operating expenses, policyholder dividends, interest expenses and debt obligations. Cash Flow From Operating Activities. The following table summarizes the significant components of cash flow from operations: Three Months Six Months
Ended June 30, Ended June 30, ---------------------------- --------------------------- (In millions) 1998 1997 1998 1997 ------------------------------------- ------------- -------------- ------------- ------------- Reinsurance operations ($5) $40 $83 $69 Primary operations and corporate 37 25 70 36 ------------------------------------- ------------- -------------- ------------- ------------- On-going operations 32 65 153 105 Run-off (Other Lines operations) (62) (82) (96) (118) ------------------------------------- ------------- -------------- ------------- ------------- Total ($30) ($17) $57 ($13) ------------------------------------- ------------- -------------- ------------- -------------
The decline in Ongoing operations cash flow for second quarter 1998 compared to 1997 is driven by lower premium collections in the Reinsurance operations due to decreased net premium written. Also, second quarter Reinsurance cash flow was reduced by the return of $13 million of a $75 million deposit received in first quarter 1998 upon finalization of various agreements to assume certain run-off liabilities of another reinsurer. Primary operations and corporate cash flow improved primarily due to increased premium production and collections, which were partially offset by increased paid losses, premium related expenses, operating expenses and corporate selling and administrative expenses. The $20 million improvement in Run-off cash flow is primarily attributable to the expected decline in losses paid. The improvement in both Ongoing operations and Run-off operations cash flow for the first six months of 1998 compared to the corresponding 1997 periods is due to several factors. The Reinsurance operations benefited from the net receipt of $62 million in connection with the assumption of certain run-off liabilities of another reinsurer, while the Primary operations are generating increased cash flow due to increased premium production. Also, contributing to the improvement is the expected decline in Run-off operations losses paid. Partially offsetting these improvements are a reduction in premium receipts in the Reinsurance operations as a result of declining net premium written, increased operating expenses, selling and administrative and debt interest payments, and lower investment income received. Restrictions on Dividends from Insurance Subsidiaries. The maximum amount of shareholders dividends which the insurance subsidiaries can pay to TIG Holdings is limited to the greater of (i) 10% of statutory surplus as of the end of the preceding year or (ii) the statutory net income for the preceding year except that such amount may not exceed earned surplus. Accordingly, the maximum dividend payout to TIG Holdings from its subsidiaries that can be made without regulatory approval during 1998 is $180 million. TIG Holdings received $90 million in dividends from its insurance subsidiaries in the first six months of 1998, as compared to $60 million for the first six months of 1997. Aggregate investments and cash at TIG Holdings were $63 million at June 30, 1998, compared to $39 million at December 31, 1997. 23 TIG HOLDINGS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - -------------------------------------------------------------------------------- Notes Payable. In December 1995, TIG Holdings established an unsecured revolving line of credit with maximum borrowings of $250 million. During first quarter 1998, TIG borrowed $70 million against this facility, of which $55 million remains outstanding at June 30, 1998. In 1995, TIG Insurance Company entered into a five-year $50 million credit facility of which approximately $24 million was outstanding as of June 30, 1998 and December 31, 1997. The facility is a direct financing arrangement with a third-party related to the sale leaseback of certain fixed assets. In addition, TIG Holdings had $99 million of 8.125% notes payable maturing in 2005 outstanding at June 30, 1998 and December 31, 1997. In January 1997, TIG Capital Trust I, a statutory business trust created under Delaware law as a trust subsidiary of TIG Holdings, completed a private offering of $125 million of 8.597% capital securities. TIG Holdings issued $128.75 million in 8.597% Junior Subordinated Debentures to TIG Capital Trust I (including approximately $3.75 million with respect to the capital contributed to the Trust by TIG Holdings). Shareholders' Equity. Shareholders' equity increased by $40 million during the first six months of 1998, primarily due to $63 million in net income and $10 million in common stock issued partially offset by $18 million of common stock repurchases, and $17 million of common and preferred stock dividends. Book value per share increased to $23.60 at June 30, 1998 from $22.82 at December 31, 1997. Excluding the impact of unrealized investment gains, the book value per share would have been $21.69 at June 30, 1998 and $20.90 at December 31, 1997. As of June 30, 1998, the Board of Directors has authorized common stock repurchases of up to 18.75 million shares of TIG Holdings common stock. Under the repurchase plan, repurchases may be made from time to time on the open market at prevailing market prices or in privately negotiated transactions. Through June 30, 1998, 16.3 million shares have been repurchased (24% of total issued and outstanding including treasury shares at June 30, 1998) at an average cost per share of $28.34, for an aggregate cost of $461 million. In February and May 1998, TIG Holdings paid quarterly stock dividends of $0.15 per share, the same as the quarterly dividend rate for 1997. 24 TIG HOLDINGS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - -------------------------------------------------------------------------------- 2.9 YEAR 2000 - -------------------------------------------------------------------------------- The Year 2000 issue relates to the ability or inability of computer systems to properly interpret date information for the year 2000 and beyond. Many existing computer programs, including TIG's, use only the last two digits to refer to a year (i.e. "98" is used for 1998). Therefore, these computer programs may not properly recognize a year that begins with "20" instead of the familiar "19". If not corrected, these computer applications could fail or create erroneous results. The insurance business, by its nature, is date sensitive. Proper processing of core policy and claims data is dependent upon correct policy effective dates, policy expiration dates, endorsement dates, premium payment dates, loss dates, loss report dates, and the like. Inaccurate date processing of policy, claims and other information could have a significant adverse impact on the conduct of TIG's daily business operations and the preparation of accurate financial information. Processing of policies expiring in Year 2000 will begin in the fourth quarter of 1998. TIG believes that the failure to make its systems Year 2000 compliant could result in a material disruption of its operations commencing at the end of 1998. TIG has conducted a review of its core procressing computer systems, including computer hardware and software vendors, to identify and address all code changes, testing and implementation procedures required to make its systems Year 2000 compliant. The Company has instituted a centralized process to facilitate the necessary changes, testing and implementation procedures. While the Year 2000 system remediation project has fallen slightly behind schedule, TIG expects all necessary modifications and testing of its computer systems to be completed by the end of 1998. As of June 30, 1998, TIG had completed the required code changes phase of its Year 2000 system remediation project. The system testing phase is expected to be completed by September 30, 1998 and the user testing phase is anticipated to be completed by December 31, 1998. TIG currently estimates that approximately $5 to $10 million will be expensed for services rendered by outside vendors related to Year 2000 system modifications, of which approximately $3 million has been expensed for those services inception to date. The aggregate Year 2000 system project costs are expected to represent less than 10% of TIG's 1998 information systems budget. Substantially all of the amounts expensed on Year 2000 system modifications have been used for software remediation and testing. To date, TIG's Year 2000 system project has not caused any significant delays in other key information system projects. TIG also has significant business relationships with numerous third parties (other than computer software and hardware vendors discussed above) that impact virtually all aspects of TIG's business including without limitation, general agents and brokers which produce and service policies, third party administrators which provide services such as claims adjusting, banks, general suppliers and facility related vendors. In the event that one or more key third parties are unable to make their systems Year 2000 compliant, TIG's operations could suffer a material adverse impact. Currently, TIG does not have substantive information concerning the Year 2000 compliance status of such entities. TIG has instituted a centralized process to indentify key third parties, request information regarding Year 2000 compliance, assess potential risk based upon responses received, and determine any action required to mitigate potential risks. TIG has commenced mailing initial information requests to key third parties and expects to complete the initial mailing by October 1998. Evaluation of the third party responses and determination of any action required is expected to be completed by March 1999. TIG currently cannot estimate the aggregate costs related to ascertaining third party Year 2000 compliance. Expenses to evaluate third party Year 2000 compliance to date are less than $1 million. In addition, TIG's policyholders may incur Year 2000 related losses. Generally, the type of problems expected to arise from the Year 2000 issue will be business risks rather than insurable risks. However, there is the possibility that TIG's policies may be reformed by judicial decisions, to cover unforeseen liabilities relating to Year 2000 claims. TIG is unable to determine whether Year 2000 claims will be held to have merit or whether such claims will have a material impact on TIG's financial results. To date, TIG has not incurred any losses relating to Year 2000 claims unders its insurance and reinsurance policies. 25 TIG HOLDINGS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - -------------------------------------------------------------------------------- 2.10 FORWARD-LOOKING STATEMENTS - -------------------------------------------------------------------------------- TIG Holdings would like to caution readers regarding certain forward-looking statements in the Management's Discussion and Analysis and elsewhere in this Form 10-Q. Statements which are based on management's projections, estimates and assumptions are forward looking statements. The words "believe", "expect", "anticipate" and similar expressions generally identify forward-looking statements. While TIG Holdings believes in the veracity of all statements made herein, forward-looking statements are necessarily based upon a number of estimates and assumptions that, while considered reasonable by TIG Holdings, are inherently subject to significant business, economic and competitive uncertainties and contingencies, including without limitations: changes in interest rates which could impact investment yields, the market value of invested assets and ultimately product pricing changes in the frequency and severity of catastrophes which could impact net income, reinsurance costs and cash flow increased competition (on the basis of price, services, or other factors) which could generally reduce operating margins regulatory and legislative changes which could increase the Company's overhead costs, increase federal and state tax assessments, restrict access to profitable markets or force participation in unprofitable markets delays in regulatory approvals for rate and form filings changes in ratings assigned to TIG which could impact demand for the Company's products changes in loss payment patterns which could impact cash flow and net investment income changes in estimated overall adequacy of loss and LAE reserves which could impact net income, statutory surplus adequacy and management's decision to continue certain product lines changes in general market or economic conditions which could impact the demand for the Company's products and loss frequency and severity for certain lines of business loss of key management personnel which could impact the development and execution of the Company's business strategy and impact key customer and vendor relationships inability of the Company or third parties with whom the Company has material relations, to address Year 2000 issues on a timely basis Many of these uncertainties and contingencies can affect TIG Holdings' actual results and could cause its actual results to differ materially from those expressed in any forward-looking statements made by, or on behalf of, TIG Holdings. 26 TIG HOLDINGS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - -------------------------------------------------------------------------------- 2.11 GLOSSARY - -------------------------------------------------------------------------------- Catastrophe: An event that is designated to be a "catastrophe" by the Property Claim Service Division of American Services Group, an industry body. It generally defines events which are estimated to cause more that $5 million in insured property damage and which affect a significant number of insureds and insurers. Combined ratio: A combination of the underwriting expense ratio, the loss and LAE ratio, and the policyholder dividends ratio, determined in accordance with statutory accounting practices. A combined ratio below 100% generally indicates profitable underwriting results. A combined ratio over 100% generally indicates unprofitable underwriting results. Facultative Reinsurance: The reinsurance of all or a portion of the insurance coverage provided by a single policy. Each policy reinsured is separately negotiated. Finite reinsurance: Reinsurance that contains an ultimate negotiated limit of risk to the reinsurer with respect to minimum and maximum exposure. This form of reinsurance can be used to mitigate the financial volatility of new programs, or cover exposure to large deductibles under other reinsurance treaties. It can also be used to provide surplus relief or loss development protection. Gross premium written: Total premium for direct insurance written and reinsurance assumed during a given period. Incurred but not reported ("IBNR") reserves: Reserves for estimated losses and LAE which have been incurred but not reported to the insurer (including future developments on losses that are known to the insurer). Incurred losses: The total losses sustained by an insurance company under a policy or policies, whether paid or unpaid. Incurred losses include a provision for claims that have occurred but have not yet been reported to the insurer. Loss adjustment expenses ("LAE"): The expenses of settling claims, including legal and other fees, and the portion of general expenses allocated to claim settlement costs. Loss development: The emergence of actual loss data as compared to estimate for specific accident years and for specific lines of business. Loss and LAE ratio: The ratio of incurred losses and LAE to earned premium, determined in accordance with statutory accounting practices. Loss and LAE reserves: Liabilities established by insurers and reinsurers to reflect the estimated cost of claims payments that the insurer will ultimately be required to pay in respect to insurance or reinsurance it has written. Reserves are established for losses and for LAE, and consist of case reserves and IBNR reserves. Net premium earned: The portion of net premium written in a particular period that is recognized for accounting purposes as income during that period. 27 TIG HOLDINGS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - -------------------------------------------------------------------------------- Net premium written: Direct premium written plus premium on assumed reinsurance less premium on ceded business for a given period. Policyholder dividend ratio: The ratio of dividends paid to policyholders to earned premium determined in accordance with statutory accounting practices. Program business: Tailored products developed for a particular industry segment (i.e., sporting events, railroads) or distribution system (i.e., trade associations, affinity groups). Programs are often developed and controlled by managing general agents. Reinsurance: The practice whereby one party, called the reinsurer, in consideration of a premium paid to it agrees to indemnify another party, called the reinsured, for part or all of the liability assumed by the reinsured under a policy or policies of insurance which it has issued. The reinsured may be referred to as the original or primary insurer, the direct writing company, or the ceding company. Reinsurance does not legally discharge the primary insurer from its liability to the insured. Retention; Retention level: The amount or portion of risk which an insurer or reinsurer retains for its own account. Losses in excess of the retention level are paid by the reinsurer or retrocessionaire. In pro rata treaties, the retention may be a percentage of the original policy's limit. In excess of loss reinsurance, the retention is a dollar amount of loss, a loss ratio, or a percentage of loss. Reverse flow business: Alternative distribution mechanism whereby general agents submit program business to a reinsurer. The reinsurer then works with a reinsurance intermediary to provide a primary insurer to the transaction who will issue the primary policy and then cede a significant portion of the risk to the reinsurer. Treaty reinsurance: The reinsurance of a specified type or category of risks defined in a reinsurance agreement (a "treaty") between a primary insurer or other reinsured and a reinsurer. Typically, in treaty reinsurance, the primary insurer or reinsured is obligated to offer and the reinsurer is obligated to accept a specified portion of all such type or category of risks originally underwritten by the primary insurer or reinsured. Underwriting: The insurer's process of reviewing applications submitted for insurance coverage, deciding whether to accept all or part of the coverage requested and determining the applicable premium. Underwriting expense ratio: The ratio of underwriting expenses to net premium written, determined in accordance with statutory accounting practices. Underwriting expenses: The aggregate of policy acquisition costs, including commissions, and the portion of administrative, general, and other expenses attributable to underwriting operations. Underwriting results: The measure of profitability of the insurance operations of an insurer, calculated as the result of earned premium, less losses, loss expenses, and underwriting expenses. Underwriting results is an indicator of a company's underwriting success. Workers' compensation insurance: Insurance that covers medical care, rehabilitation, and lost wages of employees who suffer work-related injuries, and provides death benefits for dependents of employees killed in work-related accidents. 28 TIG HOLDINGS, INC. PART II. OTHER INFORMATION - -------------------------------------------------------------------------------- ITEM 1. LEGAL PROCEEDINGS - -------------------------------------------------------------------------------- TIG's insurance subsidiaries are routinely engaged in litigation in the normal course of their business. As a liability insurer, the Company defends third-party claims brought against its insureds. As an insurer, the Company defends against coverage claims. On January 11, 1994, a Los Angeles County Superior Court jury returned a verdict of $28 million for punitive damages against TIG Insurance Company ("TIC") in Talbot Partners v. Cates Construction, Inc. and TIC (the "Talbot Case"). The award arose out of TIC's handling of a surety bond claim on a construction project. On March 28, 1997, the California Court of Appeals reduced the trial court's punitive damage award to $15 million. On July 23, 1997, the California Supreme Court granted TIC's petition to review the Court of Appeals' decision. Management believes that the ultimate liability arising from the Talbot Case will not materially impact consolidated operating results. TIG's Federal income tax returns are routinely audited by the Internal Revenue Service (IRS) and provisions are made in the financial statements in anticipation of the results of these audits. Following a routine federal income tax audit by the IRS, in September 1997, the IRS issued a Statutory Notice of Deficiency for the tax year 1993 and a Revenue Agents Report for 1994 asserting a tax liability of approximately $170 million excluding interest. The IRS's asserted tax adjustments principally relate to the acquisition made by TIG under the Section 338(h)(10) election of April 27, 1993 in conjunction with TIG's Initial Public Offering and primarily generate temporary differences by creating income in 1993 with corresponding deductions in 1993 and future tax years. TIG strongly disagrees with the IRS's position and, on December 11, 1997, TIG filed a Tax Court Petition challenging it. In connection with the Statutory Notice of Deficiency issued by the IRS for the 1993 tax year, TIG made a $40 million advance tax payment in December 1997, that has been reflected as a current tax asset. While the timing of cash tax payments may be impacted, management believes that revisions to TIG's recorded tax liability, if any, arising from the IRS's audit will not materially impact consolidated net income or the financial condition of the Company. On February 12, 1998, a purported class action complaint, naming TIG and two of its executive officers as defendants, was filed in the United States District Court for the Southern District of New York on behalf of persons who purchased TIG common stock during the period from October 21, 1997 to January 30, 1998, when TIG announced its fourth quarter 1997 results. The complaint alleges that TIG violated the federal securities laws by misrepresenting the adequacy of its underwriting and monitoring standards and loss reserves, and that five of its officers and directors sold shares at prices that were artificially inflated as a result of the alleged misrepresentations. Plaintiffs seek unspecified monetary damages, including punitive damages. Management believes that the lawsuit is without merit and it will be vigorously defended. 29 TIG HOLDINGS, INC. PART II. OTHER INFORMATION - -------------------------------------------------------------------------------- ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - -------------------------------------------------------------------------------- At the Company's annual meeting of stockholders on April 30, 1998, the stockholders elected two director's each for terms expiring at the annual meeting of stockholders in the year 2001. The voting results are as follows: Election of Director for a term expiring in 2001: For Withheld ---------- -------- George B. Bietzel 45,030,267 270,312 George D. Gould 45,035,219 265,360 Directors whose terms continued and the years their terms expire are as follows: Joel S. Ehrenkranz (2000) The Rt. Hon. Lord Moore (2000) William W. Priest, Jr. (2000) Ann W. Richards (2000) Jon W. Rotenstreich (1999) Harold Tanner (1999) The stockholders ratified the appointment of Ernst & Young LLP to serve as independent auditors of the Company for the year 1998. The voting results are as follows: Abstain and Broker For Against Non-Votes ---------------- ----------------- --------------- 45,063,132 103,161 134,286 30 TIG HOLDINGS, INC. PART II. OTHER INFORMATION - -------------------------------------------------------------------------------- ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K - -------------------------------------------------------------------------------- (a) Exhibits: Exhibit 3.1: Amended and Restated Certificates of Incorporation of TIG Holdings as filed with the Delaware Secretary of State on April 16, 1993 (incorporated by reference to Exhibit 3.1 to TIG Holdings' Quarterly Report on Form 10-Q for the quarter ended March 31, 1993, Commission File No. 1-11856). Exhibit 3.2: Amended and Restated Bylaws of TIG Holdings as adopted by TIG Holdings' Board of Directors on May 18, 1993 (incorporated by reference to Exhibit 3.2 to TIG Holdings' Registration Statement on Form S-8, File No. 33-63148). Exhibit 4.1: Certificate of Designation of TIG Holdings relating to the $7.75 Cumulative Preferred Stock of TIG Holdings as filed with the Delaware Secretary of State on April 16, 1993 (incorporated by reference to Exhibit 4.1 to TIG Holdings' Quarterly Report on Form 10-Q for the quarter ended March 31, 1993, Commission File No. 1-11856). Exhibit 4.2: Indenture dated as of April 1, 1995 between TIG Holdings and the First National Bank of Chicago, as Trustee (incorporated by reference to Exhibit 4.2 to Registration Statement No. 33-90594, filed March 24, 1995). Exhibit 4.3: Junior Subordinated Indenture, dated January 30, 1997, between TIG Holdings, Inc. and The Chase Manhattan Bank, as Trustee (incorporated by reference to Exhibit 4.3 to TIG Holdings' Quarterly Report on Form 10-Q for the quarter ended March 31, 1997). Exhibit 4.4: Certificate of Trust of TIG Capital Trust I, dated January 24, 1997 between TIG Holdings, Inc. and The Chase Manhattan Bank, Chase Manhattan Bank Delaware, as Trustees (incorporated by reference to Exhibit 4.4 to TIG Holdings' Quarterly Report on Form 10-Q for the quarter ended March 31, 1997). Exhibit 4.5: Capital Securities Guarantee Agreement, dated January 30, 1997, between TIG Holdings, Inc. and The Chase Manhattan Bank, as Trustee (incorporated by reference to Exhibit 4.5 to TIG Holdings' Quarterly Report on Form 10-Q for the quarter ended March 31, 1997). Exhibit 4.6: Trust Agreement, dated January 24, 1997, between TIG Holdings, Inc. and The Chase Manhattan Bank, Chase Manhattan Bank Delaware, as Trustees (incorporated by reference to Exhibit 4.6 to TIG Holdings' Quarterly Report on Form 10-Q for the quarter ended March 31, 1997). Exhibit 4.7: Amended and Restated Trust Agreement, dated January 30, 1997, between TIG Holdings, Inc., the Administrators named therein and The Chase Manhattan Bank, Chase Manhattan Bank Delaware, as Trustees (incorporated by reference to Exhibit 4.7 to TIG Holdings' Quarterly Report on Form 10-Q for the quarter ended March 31, 1997). Exhibit 4.8: Form of Capital Securities Certificate of TIG Capital Trust I, (included as Exhibit E to Exhibit 4.7). (b) The Company did not file any reports on Form 8-K during the three months ended June 30, 1998. 31 TIG HOLDINGS, INC. SIGNATURES - -------------------------------------------------------------------------------- Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Dated: August 14, 1998 TIG HOLDINGS, INC. By: /s/CYNTHIA B. KOENIG Name: Cynthia B. Koenig Title: Controller (Principal Accounting Officer) By: /s/LOUIS J. PAGLIA Name: Louis J. Paglia Title: Executive Vice President, Chief Financial Officer and Treasurer (Principal Financial Officer) 32 EX-27 2 FDS --
7 (Replace this text with the legend) 0000897430 TIG Holings, Inc. 1,000,000 US Dollar 3-Mos DEC-31-1998 APR-01-1998 JUN-30-1998 1.000 0 4,006 4,006 0 0 0 4,196 33 115 172 7,270 3,977 761 0 0 178 25 0 1,269 (66) 7,270 374 60 1 0 246 0 0 43 13 30 0 0 0 30 0.57 0.56 0 0 0 0 0 0 0
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