SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1994
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 1-5686
The Continental Corporation
(Exact name of registrant as specified in its charter)
New York 13-2610607
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
180 Maiden Lane, New York, New York 10038
(Address of principal executive offices)
(Zip Code)
(212) 440-3000
(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
The number of shares outstanding of each of the issuer's
classes of common stock as of August 8, 1994 is as follows:
55,462,819 shares of Common Stock
Page 1 of 28 Pages
The Exhibit Index is located on Page 26
THE CONTINENTAL CORPORATION
INDEX
Page
Part I- Financial Information
Item 1 - Financial Statements:
Consolidated Statements of Income - Three and
Six Months Ended June 30, 1994 and 1993 3 - 4
Consolidated Balance Sheets -
June 30, 1994 and December 31, 1993 5
Consolidated Statements of Cash Flows -
Six Months Ended June 30, 1994 and 1993 6
Notes to Consolidated Financial Statements 7 - 14
Item 2 - Management's Discussion and Analysis of Financial
Condition and Results of Operations 15 - 23
Part II - Other Information 24
Signature 25
Exhibit Index 26
Exhibit 1 27 - 28
THE CONTINENTAL CORPORATION
Part I - Financial Information
Item 1 - Financial Statements
CONSOLIDATED STATEMENTS OF INCOME
(millions, except share and per share amounts)
Three Months Ended Six Months Ended
June 30, June 30,
1994 1993 1994 1993
Revenues:
Premiums $1,164.8 $1,082.1 $2,268.9 $2,131.3
Net Investment Income 129.1 130.5 251.2 271.6
Realized Capital Gains (Losses) (6.6) 62.5 25.4 83.5
Other Revenues 24.6 28.5 46.4 50.7
Total Revenues 1,311.9 1,303.6 2,591.9 2,537.1
Expenses:
Losses and Loss Expenses 891.3 822.8 1,869.3 1,646.3
Insurance Operating Expenses 367.1 347.8 744.3 685.8
Other Expenses 35.1 35.0 66.0 66.7
Interest on Corporate Borrowings 9.5 15.3 18.3 29.4
Total Expenses 1,303.0 1,220.9 2,697.9 2,428.2
Income (Loss) from Continuing
Operations before Income Taxes 8.9 82.7 (106.0) 108.9
Income Taxes (Benefits):
Current 4.1 13.1 (18.6) 19.9
Deferred (1.1) 1.8 (3.4) 2.3
Total Income Taxes (Benefits) 3.0 14.9 (22.0) 22.2
Income (Loss) from Continuing
Operations 5.9 67.8 (84.0) 86.7
Income from Discontinued
Operations, Net of Income
Taxes - 4.0 - 7.7
Income (Loss) before Net
Cumulative Effect of Changes
in Accounting Principles 5.9 71.8 (84.0) 94.4
Net Cumulative Effect of Changes
in Accounting Principles - - - 1.6
Net Income (Loss) $5.9 $71.8 $(84.0) $96.0
Net Income (Loss) Available
to Common Shareholders $5.8 $71.0 $(84.1) $94.4
See Notes to Consolidated Financial Statements.
(Continued)
THE CONTINENTAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME, CONTINUED
(millions, except share and per share amounts)
Three Months Ended Six Months Ended
June 30, June 30,
1994 1993 1994 1993
Per Common Share:
Income (Loss) from
Continuing Operations $0.10 $1.22 $(1.52) $1.54
Income from Discontinued
Operations, Net of Income
Taxes - $0.07 - $0.14
Net Cumulative Effect of
Changes in Accounting
Principles - - - $0.03
Net Income (Loss) $0.10 $1.29 $(1.52) $1.71
Dividends Declared $0.25 $0.25 $ 0.50 $0.50
Weighted Average Shares
of Common Stock
Outstanding 55,446,008 55,113,707 55,404,678 55,083,578
See Notes to Consolidated Financial Statements.
THE CONTINENTAL CORPORATION
CONSOLIDATED BALANCE SHEETS
(millions, except par values)
June 30, December 31,
1994 1993
Assets:
Investments:
Fixed Maturities Available-for-Sale
at Fair Value (Amortized Cost:
1994-$6,325.3; 1993-$6,615.9) $6,137.6 $6,916.4
Equity Securities Available-for-Sale
at Fair Value (Cost: 1994-$606.4;
1993-$600.0) 710.6 759.1
Other Long-Term Investments at Fair
Value (Cost: 1994-$596.1;
1993-$387.9) 602.2 395.9
Other Short-Term Investments 430.5 1,071.0
Total Investments 7,880.9 9,142.4
Cash and Cash Equivalents 87.9 58.5
Premiums Receivable 1,510.5 1,021.0
Accrued Interest and Dividends 117.6 160.7
Reinsurance Receivables 3,289.5 3,152.9
Prepaid Reinsurance Premiums 352.3 321.5
Reinsurance Recoverable 220.4 329.0
Deferred Policy Acquisition Costs 512.0 494.0
Property and Equipment, Net 454.8 463.5
Deferred Tax Asset 210.2 41.7
Other Assets 617.3 790.1
Net Assets of Discontinued Operations 51.8 84.6
Total Assets $15,305.2 $16,059.9
Liabilities:
Outstanding Losses and Loss Expenses $9,218.8 $9,068.7
Unearned Premiums 2,517.9 2,409.7
Short-Term Debt 223.3 229.1
Long-Term Debt 777.5 774.4
Accounts Payable and Accrued Expenses 79.12 107.9
Accrued Employee Benefits 301.1 308.3
Other Liabilities 542.0 978.7
Total Liabilities 13,659.7 13,876.8
Commitments and Contingencies - -
Shareholders' Equity:
Preferred Stock - $4 par value 0.3 0.3
Common Stock - $1 par value 65.7 65.7
Paid-in Capital 612.1 613.2
Retained Earnings 1,500.8 1,612.5
Net Unrealized Appreciation
(Depreciation) of Investments (100.1) 322.1
Cumulative Foreign Currency Translation
Adjustment (67.8) (61.1)
Common Stock in Treasury at Cost (365.5) (369.6)
Total Shareholders' Equity 1,645.5 2,183.1
Total Liabilities, Commitments and
Contingencies and Shareholders'
Equity $15,305.2 $16,059.9
See Notes to Consolidated Financial Statements.
THE CONTINENTAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(millions)
Six Months Ended
June 30,
1994 1993
Cash Flows From Operating Activities:
Income (Loss) from Continuing Operations $(84.0) $86.7
Adjustments to Reconcile Income (Loss) from
Continuing Operations to Net Cash Provided
from (Used in) Continuing Operating
Activities:
Realized Capital Gains (25.4) (83.5)
Outstanding Losses and Loss Expenses 150.1 (14.8)
Unearned Premiums 108.2 132.8
Premiums Receivable (489.5) (558.0)
Reinsurance Recoverable 108.6 27.7
Prepaid Reinsurance Premiums (30.8) (53.2)
Reinsurance Receivables (136.6) 51.7
Depreciation and Amortization 22.4 21.2
Other-Net (276.0) 151.5
Net Cash Used in Continuing Operating
Activities (653.0) (237.9)
Net Cash Used in Discontinuing Operating
Activities - (4.8)
(653.0) (242.7)
Cash Flows From Investing Activities:
Net Purchase of Property and Equipment (13.7) (20.5)
Cost of Investments Purchased (1,969.5) (3,463.6)
Proceeds from Investments Sold 1,822.1 3,469.1
Proceeds from Investments Matured 442.1 354.9
Net (Increase) Decrease in Long-Term
Investments (208.2) (39.5)
Net Decrease (Increase) in Short-Term
Investments 640.5 (67.1)
Increase in Net Receivable on
Sale of Securities - 2.0
Net Cash Provided from Investing Activities 713.3 235.3
Cash Flows From Financing Activities:
Proceeds from Treasury Shares Sold 3.0 2.5
Dividends to Shareholders (27.7) (28.9)
Issuance of Long-Term Debt - 146.4
Decrease in Short-Term Debt (5.8) (70.2)
Other Increase in Long-Term Debt (0.4) -
Net Cash (Used in) Provided from
Financing Activities (30.9) 49.8
Net Increase in Cash and Cash Equivalents 29.4 42.4
Cash and Cash Equivalents at Beginning of
Year 58.5 111.5
Cash and Cash Equivalents at End of Period $87.9 $153.9
See Notes to Consolidated Financial Statements.
THE CONTINENTAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1: Basis of Presentation
The consolidated financial statements include The Continental Corporation
and its majority-owned subsidiaries (collectively, "Continental").
These financial statements have been prepared in conformity with generally
accepted accounting principles and are unaudited. These interim statements
necessarily rely heavily on estimates. In the opinion of management, all
material adjustments have been made. Certain reclassifications have been
made to the prior years' financial information to conform to the 1994
presentation.
Note 2: Investments
Fixed maturities available-for-sale consist of bonds and preferred stocks,
presented at fair value, that management may not hold until maturity.
Equity securities available-for-sale are comprised of common stocks and
nonredeemable preferred stocks which are reported at fair value.
Other investments are comprised of money market instruments, mortgages
receivable and certificates of deposit, which are reported at amortized
cost; notes receivable, time deposits, federal funds sold and
securities purchased under resale agreements, which are reported at
cost; venture capital investments, which are reported at lower of cost
or market; investments in minority affiliates, which are reported under the
equity method of accounting; and investment in limited partnerships, which
are reported at fair value. These other investments are classified as
short term if their original maturity date is within one year of the balance
sheet date. All investment transactions are recorded on the settlement date.
Realized capital gains and losses on the sales of investments are included
as a component of revenues, based upon the specific identification method.
Provisions for impairments of investments that are considered other than
temporary are reported as realized capital losses. Unrealized gains (net
of related deferred taxes) and losses on investments reported at fair value
are reflected in shareholders' equity.
At June 30, 1994, Continental did not invest in the securities of any issuer,
except securities issued/backed by U.S. or Canadian government agencies,
in excess of 10% of total shareholders' equity.
Note 3: Changes in Accounting Principles
The net cumulative effect of changes in accounting principles is
comprised of the following:
(millions, except per share amounts) Six Months Ended
June 30, 1993
Net Cumulative Effect of the Change in
Accounting for Postemployment Benefits $ (3)
Net Cumulative Effect of the Change in
Accounting for Retrospectively Rated
Reinsurance Contracts 5
Net Cumulative Effect of Changes in
Accounting Principles $ 2
Per Common Share:
Net Cumulative Effect of the Change in
Accounting for Postemployment Benefits $(0.06)
Net Cumulative Effect of the Change in
Accounting for Retrospectively Rated
Reinsurance Contracts 0.09
Net Cumulative Effect of Changes in
Accounting Principles $ 0.03
Note 3: Changes in Accounting Principles, continued
Effective January 1, 1993, Continental adopted SFAS No. 112,
"Employers' Accounting for Postemployment Benefits", Emerging
Issues Task Force Issue No. 93-6, "Accounting for Multiple-Year
Retrospectively Rated Contracts By Ceding and Assuming Enterprises"
and SFAS No. 113, "Accounting and Reporting for Reinsurance of
Short-Duration and Long-Duration Contracts".
In addition, effective December 31, 1993, Continental adopted SFAS
No. 115, "Accounting for Certain Investments in Debt and Equity
Securities", which did not change the way Continental accounts for
investments or have a material impact on its 1993 financial results.
Note 4: Restructuring Charge
In March 1994, Continental's senior management approved plans to
re-engineer the operations of Continental's Agency & Brokerage
division (including home office and field claims and underwriting),
selected operations of Continental's Special Operations division,
particularly its multinational unit, and several corporate staff
divisions, including Human Resources, Corporate Claims, Actuarial,
Finance, and Legal. The locations identified for re-engineering are
Cranbury, New Jersey; New York, New York; Duluth, Georgia;
Chicago, Illinois; Dallas, Texas; Glens Falls, New York; Overland
Park, Kansas; Rancho Cordova, California; Columbus, Ohio; York,
Pennsylvania and certain overseas locations. These re-engineering
efforts will eliminate 680 positions, from a total company
workforce of 12,255 at year end 1993, as well as achieve business-
related expense savings. As of the date of this filing, 199
employees have been notified that their positions have been
eliminated. It is expected that these 680 positions will be
eliminated within one year from the date of the plan's approval.
The re-engineering efforts also include vacating leased space at 27
locations. Continental began vacating leased spaced in June 1994
and will continue to do so through December 1994. As of the date
of this filling, eight of these locations have been vacated.
Continental has also implemented additional cost saving measures in
several employee benefit programs. Included in the re-engineering
plan are severance packages for all affected employees as well as
extended benefits and outplacement counseling for many of them.
Underwriting results for the first six months of 1994 included a
$45 million restructuring charge, including $29 million in expected
severance and related benefits and $16 million in expected lease
vacation and other associated costs.
Note 5: Income Taxes
The provision for income taxes from continuing operations was as
follows:
Six Months Ended
(millions) June 30,
1994 1993
Current Tax Expenses (Benefit):
U.S. Federal $(21) $17
State and Local 1 1
Foreign 1 2
Total Current Expenses (Benefit) (19) 20
Deferred Tax Expenses (Benefit):
U.S. Federal (1) -
Foreign (2) 2
Total Deferred Expenses (Benefit) (3) 2
Total Income Taxes (Benefit) $(22) $22
Note 5: Income taxes, continued
In the first six months of 1994 there was no reduction in income
taxes through the utilization of tax net operating loss carryforwards
and tax credit carryforwards. In the first six months of 1993 a
reduction in income taxes of $2.5 million was recognized through the
utilization of $1.5 million of tax net operating loss carryforwards
and $1.0 million of tax credit carryforwards.
Unused domestic net operating loss carryforwards at June 30, 1994,
available for use in future years on a tax return basis, amount to
$351 million for regular tax and expire at various stages through
the year 2009. There are no operating loss carryforwards available
for use in future years with respect to AMT.
Continental also has a foreign tax credit, general business credit
and AMT credit carryforwards of $31 million, $10 million and $21
million respectively; the foreign tax and general business credits
expire at various stages through the year 2000.
Set forth below are the significant differences between the U.S.
federal income tax rate and the effective tax rates as reflected in
the accompanying Consolidated Statements of Income:
Six Months Ended
June 30,
(millions, except percentages)
1994 1993
% of % of
Pretax Pretax
Amount Income Amount Income
Income (Loss) from Continuing
Operations Before Income Taxes $(106) $109
Statutory Federal Corporate Tax
(Benefit) (37) (35)% 37 34%
Increases (Reductions) in
Taxes Resulting from:
Tax-Exempt Interest (11) (10) (11) (10)
Dividends Received Deduction (2) (2) (3) (3)
Foreign Income at Higher Rates (6) (6) - -
Change in Valuation Allowance 54 51 (3) (3)
Current Alternative Minimum
Tax Benefit (21) (20) - -
Other 1 1 2 2
Total Income Taxes (Benefit) $ (22) (21)% $ 22 20%
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at
December 31, 1993 and June 30, 1994, and the provision for deferred income
taxes under SFAS #109 for the six months ended June 30, 1994 and 1993 are
presented on pages 10 and 11.
A valuation allowance is provided when it is more likely than not
that some portion of the deferred tax asset will not be realized.
The valuation allowance for deferred tax assets was $136 million at
December 31, 1993. The net change in the valuation allowance for
deferred tax assets was an increase of $90 million, resulting in a
$226 million valuation allowance at June 30, 1994. The $90 million
increase in the valuation allowance resulted primarily from a $46
million increase in unutilized tax net operating loss carryforwards
and a $36 million increase in deferred tax assets attributable to
net unrealized depreciation of investments.
Note 5: Income Taxes, continued
Deferred
(millions) Balance Tax (Expense) Balance
December 31, 1993 Benefit June 30, 1994
Deferred Tax Assets:
Unearned Premium Reserve $ 127 $ 4 $ 131
Loss Reserve Discounting 245 6 251
Adoption of SFAS No. 106 70 - 70
Net Operating Loss Carryforward - 46 46
Tax Credit Carryforwards 73 - 73
Real Estate Basis Differences 47 (2) 45
Allowance for Bad Debts 16 2 18
Capital Leases 15 - 15
Provision for Early Retirement 15 - 15
Unrealized Depreciation of
Investments - 36 36
Other Items 28 2 30
Total Gross Deferred Tax Assets 636 94 730
Valuation Allowance (136) (90) (226)
Net Deferred Tax Assets 500 4 504
Deferred Tax Liabilities:
Deferred Acquisition Costs 154 (5) 159
Accrual for Retrospectively
Rated Premiums 13 - 13
Audit Premiums 43 - 43
Installment Receivables 18 - 18
Other Items 65 4 61
Total Gross Deferred
Tax Liabilities 293 (1) 294
Net Deferred Tax Asset before
Unrealized Appreciation of
Investments 207 $ 3 210
Deferred Taxes on Unrealized
Appreciation of Investments (165) -
Deferred Tax Asset $ 42 $ 210
Note 5: Income Taxes, continued
Deferred
(millions) Balance Tax (Expense) Balance
December 31, 1992 Benefit June 30, 1993
Deferred Tax Assets:
Unearned Premium Reserve $ 112 $ 4 $ 116
Loss Reserve Discounting 269 57 326
Adoption of SFAS No. 106 68 2 70
Net Operating Loss Carryforward - 2 2
Tax Attribute Carryforwards 76 (7) 69
Real Estate Basis Differences 50 (1) 49
Allowance for Bad Debts 22 1 23
Capital Leases 15 - 15
Provision for Early Retirement 14 (1) 13
Other Items 35 (5) 30
Total Gross Deferred Tax Assets 661 52 713
Valuation Allowance (159) 3 (156)
Net Deferred Tax Assets 502 55 557
Deferred Tax Liabilities:
Deferred Acquisition Costs 140 (5) 145
Accrual for Retrospectively
Rated Premiums 13 - 13
Audit Premiums 42 - 42
Discounted Reserves for
Workers' Compensation - (24) 24
Installment Receivables 15 - 15
Other Items 92 (28) 120
Total Gross Deferred
Tax Liabilities 302 (57) 359
Net Deferred Tax Asset before
Unrealized Appreciation of
Investments 200 $ (2) 198
Deferred Taxes on Unrealized
Appreciation of Investments (101) (154)
Deferred Tax Asset $ 99 $ 44
Note 6: Long-Term Debt
In March 1993, Continental completed a public offering of $150
million of 7.25% Notes due March 1, 2003. These Notes (which
provided $147 million of a total $346 million in cash, net of
offering and underwriting costs) were sold under Continental's
shelf registration of up to $400 million of debt securities with
the Securities and Exchange Commission. Continental may sell
additional debt securities (with varying maturities, interest rates
and other terms) under the shelf registration from time to time
over the next twelve months as market conditions warrant. During
first quarter 1993, Continental used $50 million of proceeds from
sales under the shelf registration to reduce parent company
short-term borrowings. In July, 1993 Continental used $282 million
of net proceeds to retire its outstanding 9 3/8% Notes. Depending
on market conditions, Continental intends to register for the sale
of up to an additional $100 million of debt securities.
Continental plans to use the net proceeds from any subsequent sales
to further reduce its short-term borrowings.
Note 7: Preferred Stock
The Series A and Series B preferred stocks are convertible into
common stock at the rate of 2.2 shares of common stock for each
share of preferred stock. The number of common shares reserved for
conversion of these preferred stocks is 118,923.
Note 8: Employee Stock Options and Performance Awards
Continental has a Long-Term Incentive Plan under which it grants
performance awards and issues stock options to key employees. Nine
million shares of common stock, the maximum number of shares which
may be issued under the Plan, have been reserved for issuance.
Continental has granted both incentive stock options and
nonqualified stock options under the Plan. No stock option has
been granted with an exercise price below the market price of
Continental's common stock at the time of grant.
Performance awards are payable in either cash or shares of
Continental's common stock in amounts based on Continental's
performance for four-year award cycles determined by the
Compensation Committee of the Board of Directors. As of June 30,
1994, 724,391 of such shares were reserved for possible payment of
such awards.
The stock options are accounted for as common stock equivalents and
are used in computing earnings per share. Options for 4,485,368
shares (at a weighted average exercise price of $29.72 per share)
were outstanding, of which 3,771,643 were then exercisable. During
the six months ended June 30, 1994, no options were exercised.
Note 9: Discontinued Operations
In December 1993, Continental completed the sale of its premium
financing operations, AFCO Credit Corporation, AFCO Acceptance
Corporation and their Canadian affiliate CAFO Inc., to Mellon Bank
Corporation. Continental realized a $36 million gain from this
sale, net of income taxes. The 1993 results and net assets of these
premium financing operations, which were previously reported in the
Corporate & Other Operations segment, have been classified as
discontinued in the accompanying Consolidated Financial Statements.
Also included in discontinued operations are the traditional
assumed reinsurance and marine reinsurance businesses, as well as,
the indigenous international and international marine insurance
businesses which were discontinued in 1992. As of June 30, 1994,
Continental has sold all of its discontinued entities intended for
sale and will run-off the remaining reserves of these discontinued
insurance operations.
The financial statements reflect the operating results and balance
sheet items of the discontinued operations separately from
continuing operations. Operating results of the discontinued
operations were as follows:
Note 9: Discontinued Operations, continued
Insurance Operations
Three Months Ended Six Months Ended
June 30, June 30,
(millions) 1994 1993 1994 1993
Total Revenues $ 15 $ 55 $ 33 $ 172
Total Expenses 15 56 33 173
Income (loss) before Income
Taxes - (1) - (1)
Income Taxes - - - -
Income (Loss) from
Discontinued Operations $ - $ (1) $ - $ (1)
Premium Financing Operations
Three Months Ended Six Months Ended
June 30, June 30,
(millions) 1994 1993 1994 1993
Total Revenues $ - $ 25 $ - $ 50
Total Expenses - 20 - 40
Income before Income Taxes - 5 - 10
Income Taxes - - - 1
Income from Discontinued
Premium Financing Operations $ - $ 5 $ - $ 9
Net assets of discontinued insurance operations at June 30, 1994 and
December 31, 1993 were as follows:
Insurance Operations
June 30, December 31,
(millions) 1994 1993
Assets
Cash and Investments $ 1,146 $ 1,167
Other Assets 491 528
1,637 1,695
Liabilities
Outstanding Losses and Loss Expenses 1,304 1,346
Unearned Premiums 2 3
Other Liabilities 279 261
1,585 1,610
Net Assets $ 52 $ 85
Note 10. Commitments and Contingencies (Outstanding Losses and Loss Expenses)
Included in Continental's liability for outstanding losses and loss
expenses are gross undiscounted reserves for asbestos-related,
other toxic tort and environmental pollution claims of $272 million
at June 30, 1994 ($270 million at June 30, 1993). Included in
Continental's reinsurance assets are amounts due for
asbestos-related, other toxic tort and environmental pollution
claims of $97 million at June 30, 1994 ($115 million at June 30,
1993). Net losses and loss expenses include charges for
asbestos-related, other toxic tort and environmental pollution
claims of $41 million and $24 million for six months of 1994 and
1993, respectively. The $17 million increase in losses and loss
expenses is primarily due to the recording of reinsurance
recoveries during the first six months of 1993 that applied to
losses and loss expenses incurred in prior years.
Most of Continental's environmental pollution claims result from
general liability policies written prior to 1986. Certain
provisions of these policies have been subject to wide-ranging
challenges by policyholders and/or differing interpretations by
courts in various jurisdictions, with inconsistent conclusions as
to the applicability of coverage for environmental pollution
claims. Asbestos-related claims have generally arisen out of
product liability coverage provided by Continental under general
liability policies written prior to 1983. Thereafter,
asbestos-product exclusions were included in general liability
policies. Other toxic tort claims have also generally arisen out of
product liability coverage under general liability policies. These
claims involve a variety of allegations of bodily injury arising
from exposure over a period of time to products alleged to be
harmful or toxic.
Continental does not establish reserves for unreported
asbestos-related, other toxic tort and environmental pollution
claims because of significant uncertainties, which do not allow
liabilities to be reasonably estimated. Such uncertainties include
difficulties in determining the frequency and severity of such
potential claims and in predicting the outcome of judicial
decisions, as case law evolves regarding liability exposure,
insurance coverage and interpretation of policy language. At this
time, the future financial impact of unreported asbestos-related,
other toxic tort and environmental pollution claims cannot be
reasonably estimated, and no assessment can be made with respect to
the ultimate impact thereof on Continental's results of operations
or financial condition in the future although this impact could be
material.
The actuarial profession is addressing environmental liabilities
(e.g., unreported asbestos-related, other toxic tort and
environmental pollution claims) and is in the initial stage of
developing standards, but has not yet scheduled publication of a
discussion draft. Other uncertainties may be clarified through the
debate, extension or modification of the Comprehensive
Environmental Response, Compensation, and Liability Act (Superfund)
in 1994 or 1995. Congress is considering legislation based upon a
modification of the Clinton Administration's proposed Superfund
Reform Act. The legislation would amend Superfund and establish an
environmental insurance fund which would have the authority to make
offers to settle insurance coverage claims for Superfund
liabilities recognizing the intended use of sites. The fund would
be financed by taxes on property and casualty insurance companies.
These developments will continue to be monitored and assessed by
Continental and may enable it to develop a framework to estimate
future costs for these unreported claims.
Note 11: Planned Sales of Subsidiaries
Continental has announced its intention to sell Continental Canada,
a major property and casualty insurer in Canada; and Casualty
Insurance, the leading writer of workers' compensation in Illinois
with operations in neighboring mid-west states and California.
Continental does not expect the sale of these operations to have a
significant impact on its financial position, results of operations
or liquidity.
Item 2 - Management's Discussion and Analysis of Financial
Condition and Results of Operations
Business Operations: Continental's principal business is property
and casualty insurance. These Insurance Operations are comprised of
three segments: Agency & Brokerage Commercial, Agency & Brokerage
Personal and Specialized Commercial. The results of Continental's
non-insurance operations, including investment management, claims
adjusting and risk management, are reported in the Corporate &
Other Operations segment. Insurance Operations generated 98% of
consolidated revenues for the first six months of 1994, including
87% from premiums earned and 11% from investment activities (net
investment income and realized capital gains). In 1993, Continental
sold its premium financing operations, the results of which were
reported as discontinued.
Results of Operations - First six months 1994 compared with first
six months 1993.
Summary: The net result for the first six months of 1994 was an $84
million loss from continuing operations, including a one-time $45
million charge to restructure the field claims operations and
several corporate staff units (see "Restructuring Charge"). The
net result for the first six months of 1993 included $87 million of
income from continuing operations, $7 million of income from
discontinued operations and a $2 million benefit from the
cumulative effect of changes in accounting principles.
Insurance Operations: Insurance Operations had a loss before income
taxes for the first six months of 1994 of $74 million, $205 million
worse than the first six months of 1993. Underwriting results for
the first six months of 1994 were down $144 million and investment
results were down $61 million, including a $54 million decrease in
realized capital gains and a $7 million decrease in net investment
income.
The $144 million decrease in underwriting results was primarily due
to a substantial increase in weather-related losses not officially
designated as catastrophic, a substantial increase in large losses,
an $11 million increase in catastrophe losses, and the $45 million
restructuring charge ($26 million in loss expenses and $19 million
in insurance operating expenses). Premiums earned increased $138
million, primarily due to growth in certain specialty commercial
lines (resulting from both price increases and acceptance of new
risk) and in commercial package business (resulting from price
increases). Losses and loss expenses increased $223 million,
primarily due to the aforementioned increases in non-catastrophe
weather-related losses, large losses and catastrophe losses; the
restructuring charge; inflation in loss costs; and the increase in
the amount of risk accepted. Insurance operating expenses increased
$59 million, primarily due to the restructuring charge, growth in
business written, and a $21 million decrease in servicing carrier
income (which is recorded as a reduction in commission expenses)
reflecting a decrease in the amount of business serviced.
Underwriting results for the first six months of 1994 included
pretax catastrophe losses of $118 million, compared with $107
million in the first six months of 1993. Catastrophe losses for
the first six months of 1994 included $43 million from January snow
and ice storms and $30 million from the California earthquake;
catastrophe losses for the first six months of 1993 included $44
million from the East Coast blizzard.
The insurance segments' premiums earned and underwriting results
for the first six months of 1994 and 1993 were as follows:
(millions)
Premiums Earned Underwriting Results
INSURANCE SEGMENT* 1994 1993 1994 1993
Agency & Brokerage Commercial $ 1,093 $ 1,029 $ (224) $ (123)
Agency & Brokerage Personal 438 420 (59) (36)
Specialized Commercial 738 682 (61) (42)
Total Insurance Operations $ 2,269 $ 2,131 $ (344) $ (201)
* Distinct investment portfolios are not maintained for individual
insurance segments; accordingly, Insurance Operations' investment
results are explained in aggregate below.
The Agency & Brokerage Commercial segment's underwriting results
for the first six months of 1994 were $101 million worse than the
first six months of 1993, primarily due to a substantial increase
in non-catastrophe weather-related losses, a substantial increase
in large losses, a $12 million increase in catastrophe losses, and
the segment's $29 million share of the restructuring charge ($17
million in loss expenses and $12 million in insurance operating
expenses). Premiums earned increased $64 million, primarily due to
price increases in the commercial package line. Losses and loss
expenses increased $134 million, primarily due to the aforementioned
increases in non-catastrophe weather-related losses, large losses
and catastrophe losses; the restructuring charge; and inflation in
loss costs. Insurance operating expenses increased $31 million,
primarily due to the restructuring charge and a $21 million decrease
in servicing carrier income.
The Agency & Brokerage Personal segment's underwriting results for
the first six months of 1994 were $24 million worse than the first
six months of 1993, primarily due to the segment's $13 million share
of the restructuring charge ($9 million in loss expenses and $4 million
in insurance operating expenses) and an increase in insurance operating
expenses. Premiums earned increased $18 million, primarily due to an
increase in the personal package line reflecting price increases
partially offset by a decrease in the amount of risk accepted. Losses
and loss expenses increased $25 million, primarily due to a $4 million
increase in catastrophe losses; an increase in non-catastrophe
weather-related losses; the restructuring charge; and inflation in loss
costs. Insurance operating expenses increased $17 million, primarily
due to the restructuring charge and an increase in underwriting expenses.
The Specialized Commercial segment's underwriting results for the first
six months of 1994 were $19 million worse than the first six months of
1993, primarily due to a substantial increase in large losses partially
offset by a $5 million decrease in catastrophe losses. Premiums earned
increased $56 million, due to both price increases and acceptance of
new risk in certain lines. Premiums earned increased $37 million in
domestic marine, $36 million in specialty casualty, $28 million in workers'
compensation in selected markets, and $10 million in aviation. These
increases were partially offset by a $49 million decrease in customized
financial coverages and a $23 million decrease in multinational business.
Losses and loss expenses increased $64 million, despite the decrease
in catastrophe losses, primarily due to the aforementioned increase in
large losses; inflation in loss costs; and the increase in the amount of
risk accepted. Insurance operating expenses increased $11 million,
primarily due to an increase in business written and the segment's $3
million share of the restructuring charge.
Net investment income for Insurance Operations for the first six months of
1994 was $244 million, down $7 million from the first six months of 1993,
primarily due to the reinvestment of proceeds from sales, redemptions and
maturities of fixed income securities into lower available short-term and
intermediate-term yields. Fixed income securities include short-term
investments, fixed maturities investments and nonredeemable preferred
stock and comprise 86% of Continental's investments.
Realized capital gains for Insurance Operations for the first six months
of 1994 were $27 million, compared with $81 million for the first six months
of 1993. Sales of securities in the fixed income portfolio produced no
net realized capital gains or losses, compared with gains of $54 million
in the first six months of 1993. Sales of appreciated securities in the
common stock portfolio produced $27 million of net realized capital gains
for both the first six months of 1994 and 1993.
Corporate & Other Operations: Corporate & Other Operations had a loss before
income taxes for the first six months of 1994 of $32 million, $10 million
worse than the first six months of 1993. This decrease is primarily due
to an $18 million decrease in investment results (a $14 million decrease
in net investment income and a $4 million decrease in realized capital gains)
and a $4 million decrease in other revenues partially offset by an $11
million decrease in corporate interest expense.
Income Taxes: In the first six months of 1994, Continental recorded federal
and foreign income tax benefits of $22 million and $1 million, respectively,
and state and other income tax expense of $1 million. In the first six
months of 1993, Continental recorded federal, foreign and state and other
income tax expenses of $17 million, $4 million and $1 million, respectively.
The income tax benefits for the first six months of 1994 reflect the period's
operating losses.
Discontinued Operations: In the first six months of 1993, discontinued
premium financing operations had income, net of income taxes, of $7 million.
Results of Operations - Second quarter 1994 compared with second quarter 1993.
Summary: Net income from continuing operations for second quarter 1994 was
$6 million. Net income for second quarter 1993 included $68 million of
income from continuing operations and $4 million of income from discontinued
operations.
Insurance Operations: Insurance Operations had second quarter 1994 income
before income taxes of $26 million, $68 million worse than second quarter
1993. Second quarter 1994 underwriting results were down $5 million and
investment results were down $63 million, including a $66 million decrease
in net realized capital gains and a $3 million increase in net investment
income.
The $5 million decrease in underwriting results was primarily due to
slightly higher losses despite a $5 million decrease in catastrophe losses.
Premiums earned increased $83 million, primarily due to growth in certain
specialty commercial lines (resulting from both price increases and
acceptance of new risk) and in commercial package business (resulting from
price increases). Losses and loss expenses increased $69 million, primarily
due to inflation in loss costs and the increase in the amount of risk
accepted partially offset by the decrease in catastrophe losses. Insurance
operating expenses increased $19 million, primarily due to growth in
business written and an $11 million decrease in servicing carrier income
reflecting a decrease in the amount of business serviced.
Second quarter 1994 underwriting results included pretax catastrophe losses
of $19 million, compared with $23 million in second quarter 1993.
The insurance segments' second quarter premiums earned and underwriting
results were as follows:
(millions)
Premiums Earned Underwriting Results
INSURANCE SEGMENT* 1994 1993 1994 1993
Agency & Brokerage Commercial $ 571 $ 533 $ (55) $ (49)
Agency & Brokerage Personal 211 209 (15) (13)
Specialized Commercial 383 340 (24) (27)
Total Insurance Operations $1,165 $1,082 $ (94) $ (89)
*Distinct investment portfolios are not maintained for individual insurance
segments; accordingly, Insurance Operations' investment results are explained
in aggregate below.
The Agency & Brokerage Commercial segment's second quarter 1994 underwriting
results were $7 million worse than second quarter 1993, primarily due to
higher losses despite a $5 million decrease in catastrophe losses. Premiums
earned increased $38 million, primarily due to price increases in the
commercial package line. Losses and loss expenses increased $40 million,
primarily due to inflation in loss costs partially offset by the decrease in
catastrophe losses. Insurance operating expenses increased $5 million,
primarily due to the decrease in servicing carrier income.
The Agency & Brokerage Personal segment's second quarter 1994 underwriting
results were $1 million worse than second quarter 1993. Premiums earned
increased $2 million, primarily due to an increase in the personal package
line reflecting price increases partially offset by a decrease in the amount
of risk accepted. Losses and loss expenses decreased $1 million while
insurance operating expenses increased $4 million, primarily due to an
increase in underwriting expenses.
The Specialized Commercial segment's second quarter 1994 underwriting results
were $3 million better than second quarter 1993, primarily due to lower
losses despite a $7 million increase in catastrophe losses. Premiums earned
increased $43 million, primarily due to both price increases and acceptance
of new risk in certain lines. Premiums earned increased $22 million in
domestic marine, $18 million in specialty casualty, $14 million in workers'
compensation in selected markets, and $8 million in aviation. These
increases were partially offset by a $24 million decrease in customized
financial coverages and an $11 million decrease in multinational business.
Losses and loss expenses increased $30 million primarily due to the increase
in catastrophe losses; inflation in loss costs; and the increase in the
amount of risk accepted. Insurance operating expenses increased $10 million
primarily due to an increase in business written.
Second quarter 1994 net investment income for Insurance Operations was $125
million, up $2 million from second quarter 1993, primarily due to a small
increase in income from investments other than fixed maturities and equity
securities.
Second quarter 1994 realized capital losses for Insurance Operations were
$5 million compared with realized capital gains of $60 million for second
quarter 1993. Sales of securities in the fixed income portfolio produced
$16 million of net realized capital losses, compared with gains of $34
million in second quarter 1993. Sales of appreciated securities in the
common stock portfolio produced $11 million of net realized capital gains,
compared with $26 million in second quarter 1993.
Corporate & Other Operations: Corporate & Other Operations had a second
quarter 1994 loss before income taxes of $17 million, $6 million worse
than second quarter 1993, primarily due to an $8 million decrease in
investment results, including a $4 million decrease in net investment
income and a $4 million decrease in realized capital gains.
Income Taxes: In second quarter 1994, Continental recorded federal, foreign
and state and other income tax expenses of $1 million, $1 million and $1
million, respectively. In second quarter 1993, Continental recorded federal,
foreign and state and other income tax expenses of $11 million, $1 million
and $3 million, respectively. The decrease in income tax expenses for
second quarter 1994 reflects the period's lower earnings.
Discontinued Operations: In second quarter 1993, discontinued premium
financing operations had income, net of income taxes, of $4 million.
Other Developments
Economic Issues: Price levels in the property and casualty insurance markets
are cyclical and materially affect Continental's underwriting results.
Continental's strategy is to write business in those areas in which
management believes Continental has a competitive advantage. The property
and casualty industry's apparent capacity to provide insurance coverage,
at present, substantially exceeds demand for that coverage. It is not
possible to determine when the insurance markets will permit more adequate
pricing. During the first six months of 1994, Continental's premiums written
(which will be earned ratably over the term of the applicable policies)
increased 6% over the first six months of 1993. The slowdown in growth from
1993's 12% increase in premiums written reflects more competitive pricing
for new business in certain lines and Continental's unwillingness to write
business when management believes that prices are inadequate relative to
loss costs. Continental will continue its efforts to obtain adequate prices;
curtail property writings (particularly commercial and personal package
business in catastrophe-prone areas); selectively increase writings in
certain specialty commercial lines; and reduce expenses (see "Restructuring
Charge" and "Additional Improvements"). Premiums, net income and cash flow
will depend on the degree to which Continental successfully implements its
strategy.
Inflation generally increases the cost of losses covered by insurance
contracts. However, the effect of inflation varies by line of business.
Since the overall rate of inflation has been relatively constant and
historically normal in recent years, such effects have been less significant
than in previous years, except in medical care costs. The medical cost
inflation rate, while now generally decreasing in anticipation of enactment
of a comprehensive health care reform program, is still higher than the
overall inflation rate. Lines of insurance involving medical care costs,
such as automobile, workers' compensation and medical malpractice, comprised
41% of Continental's premiums earned for the first six months of 1994. The
method used by Continental to estimate individual case reserves and reserves
for unreported claims implicitly considers the effect of inflation in the
projection of ultimate costs.
Asbestos-Related, Other Toxic Tort and Environmental Pollution Claims:
Included in Continental's liability for outstanding losses and loss expenses
are gross undiscounted reserves for asbestos-related, other toxic tort and
environmental pollution claims of $272 million at June 30, 1994 ($270 million
at June 30, 1993). Included in Continental's reinsurance assets are amounts
due for asbestos-related, other toxic tort and environmental pollution
claims of $97 million at June 30, 1994 ($115 million at June 30, 1993)
(see "Reinsurance"). Net losses and loss expenses include charges for
asbestos-related, other toxic tort and environmental pollution claims of
$41 million and $24 million for the first six months of 1994 and 1993,
respectively. The $17 million increase in losses and loss expenses is
primarily due to the recording of reinsurance recoveries during the first
six months of 1993 that applied to losses and loss expenses incurred in
prior years.
Most of Continental's environmental pollution claims result from general
liability policies written prior to 1986. Certain provisions of these
policies have been subject to wide-ranging challenges by policyholders
and/or differing interpretations by courts in various jurisdictions,
with inconsistent conclusions as to the applicability of coverage for
environmental pollution claims. Asbestos-related claims have generally
arisen out of product liability coverage provided by Continental under
general liability policies written prior to 1983. Thereafter,
asbestos-product exclusions were included in general liability
policies. Other toxic tort claims have also generally arisen out of
product liability coverage under general liability policies. These
claims involve a variety of allegations of bodily injury arising
from exposure over a period of time to products alleged to be harmful or
toxic.
Continental does not establish reserves for unreported asbestos-related,
other toxic tort and environmental pollution claims because of significant
uncertainties, which do not allow liabilities to be reasonably estimated.
Such uncertainties include difficulties in determining the frequency
and severity of such potential claims and in predicting the outcome
of judicial decisions, as case law evolves regarding liability exposure,
insurance coverage and interpretation of policy language. At this
time, the future financial impact of unreported asbestos-related,
other toxic tort and environmental pollution claims cannot be
reasonably estimated, and no assessment can be made with respect to
the ultimate impact thereof on Continental's results of operations,
financial condition or liquidity in the future although this impact
could be material.
The actuarial profession is addressing environmental liabilities
(e.g., unreported asbestos-related, other toxic tort and
environmental pollution claims) and is in the initial stage of
developing standards, but has not yet scheduled publication of a
discussion draft. Other uncertainties may be clarified through the
debate, extension or modification of the Comprehensive
Environmental Response, Compensation, and Liability Act (Superfund)
in 1994 or 1995. Congress is considering legislation based upon a
modification of the Clinton Administration's proposed Superfund
Reform Act. The legislation would amend Superfund and establish an
environmental insurance fund which would have the authority to make
offers to settle insurance coverage claims for Superfund
liabilities recognizing the intended use of sites. The fund would
be financed by taxes on property and casualty insurance companies.
These developments will continue to be monitored and assessed by
Continental and may enable it to develop a framework to estimate
future costs for these unreported claims.
Restructuring Charge: In March 1994, Continental's senior
management approved plans to re-engineer the operations of
Continental's Agency & Brokerage division (including home office
and field claims and underwriting), selected operations of
Continental's Special Operations division, particularly its
multinational unit, and several corporate staff divisions,
including Human Resources, Corporate Claims, Actuarial, Finance,
and Legal. The locations identified for re-engineering are
Cranbury, New Jersey; New York, New York; Duluth, Georgia; Chicago,
Illinois; Dallas, Texas; Glens Falls, New York; Overland Park,
Kansas; Rancho Cordova, California; Columbus, Ohio; York,
Pennsylvania and certain overseas locations. These re-engineering
efforts will eliminate 680 positions, from a total company
workforce of 12,255 at year end 1993, as well as achieve business-
related expense savings. As of the date of this filing, 199
employees have been notified that their positions have been
eliminated. It is expected that these 680 positions will be
eliminated within one year from the date of the plan's approval.
The re-engineering efforts also include vacating leased space at 27
locations. Continental began vacating leased spaced in June 1994
and will continue to do so through December 1994. As of the date
of this filling, eight of these locations have been vacated.
Continental has also implemented additional cost saving measures in
several employee benefit programs. Included in the re-engineering
plan are severance packages for all affected employees as well as
extended benefits and outplacement counseling for many of them.
Underwriting results for the first six months of 1994 included a
$45 million restructuring charge, including $29 million in expected
severance and related benefits and $16 million in expected lease
vacation and other associated costs.
During second quarter 1994, Continental paid $4 million in expenses
($3 million in severance and related benefits, and $1 million in
lease vacation and other associated costs) associated with its
planned restructuring, which reduced its outstanding liability at
June 30, 1994 to $41 million.
Additional Improvements: In June 1994, Continental announced
additional steps with a goal to improve its profitability and
strengthen the capital base of its domestic insurance subsidiaries.
To improve its profitability, Continental intends to dramatically
curtail its property writings, especially in catastrophe-prone
areas (see "Economic Issues"). Also, to further reduce its
operating expenses, Continental plans to eliminate another
approximately 900 positions. Management believes that its
previously announced re-engineering actions (see "Restructuring
Charge") together with this elimination of another 900 positions
will create annual pretax savings of about $120 million compared
with its reported 1993 expenses. To strengthen the capital base of
its domestic insurance subsidiaries, during the second quarter of
1994, The Continental Corporation contributed $40 million of
capital to its domestic insurance operations. In addition,
Continental has arranged quota share reinsurance on its domestic
personal lines business to lower its premium-to-surplus ratio and
further reduce its exposure to catastrophes (see "Reinsurance").
Continental did not take a charge to earnings in the second quarter
associated with these additional improvements because the
requirements contained in Emerging Issues Task Force No. 94-3 were
not met.
Planned Sales of Subsidiaries: In April 1994, Continental announced
its intention to sell Continental Canada, a major property and
casualty insurer in Canada; and Casualty Insurance, the leading
writer of workers' compensation in Illinois with operations in
neighboring mid-west states and California. Continental does not
expect the sale of these operations to have a significant impact on
its financial position, results of operations or liquidity.
Discontinued Operations: In December 1993, Continental completed
the sale of its premium financing operations, AFCO Credit
Corporation, AFCO Acceptance Corporation and their Canadian
affiliate CAFO Inc., to Mellon Bank Corporation. Continental
realized a $36 million gain from this sale, net of income taxes.
The 1993 results and net assets of these premium financing
operations, which were previously reported in the Corporate & Other
Operations segment, have been classified as discontinued in the
accompanying Consolidated Financial Statements.
New Accounting Pronouncements: Effective January 1, 1993,
Continental adopted SFAS No. 112, "Employers' Accounting for
Postemployment Benefits," Emerging Issues Task Force issue No.
93-6, "Accounting for Multiple-Year Retrospectively Rated Contracts
by Ceding and Assuming Enterprises," and SFAS No. 113, "Accounting
and Reporting for Reinsurance of Short-Duration and Long-Duration
Contracts". The cumulative change to Continental's results for the
first six months of 1993 from these adoptions was a net benefit of
$2 million.
In addition, effective December 31, 1993, Continental adopted SFAS
No. 115, "Accounting for Certain Investments in Debt and Equity
Securities," which did not change the way Continental accounts for
investments or have a material impact on its 1993 financial
results.
Financial Resources and Liquidity
Cash Flow Analysis: Operating activities for the first six months
of 1994 used $653 million in cash and cash equivalents, whereas
operating activities for the first six months of 1993 used cash and
cash equivalents of $238 million. The principal causes for the
increase in cash used by operations were a $327 million increase in
losses and loss expenses paid, the repayment of $188 million of
obligation under reverse repurchase and dollar reverse repurchase
agreements and a $105 million increase in underwriting expenses
paid. These increases were partially offset by a $204 million
increase in premiums collected and a $23 million increase in
investment income received.
Investing activities for the first six months of 1994 provided $713
million in cash and cash equivalents, whereas investing activities
for the first six months of 1993 provided $235 million in cash and
cash equivalents. Increases in investments are reported as uses of
cash and cash equivalents, and proceeds from sales, redemptions and
maturities of investments are reported as provisions of cash and
cash equivalents. The increase in cash provided by investing
activities is primarily due to higher 1994 net sales of securities
as a result of increased cash used by operating activities.
Financing activities for the first six months of 1994 used $31
million in cash and cash equivalents, whereas financing activities
for the first six months of 1993 provided cash and cash equivalents
of $50 million. Increases in borrowings are reported as provisions
of cash and cash equivalents, while decreases in borrowings and
payments of dividends are reported as uses of cash and cash
equivalents. The increase in cash used by financing activities is
primarily due to a $6 million reduction in short-term borrowings in
the first six months of 1994 and the issuance of $146 million of
Notes in the first six months of 1993, partially offset by a $70
million reduction in short-term borrowings in the first six months
of 1993. In addition, dividends paid to shareholders amounted to
$28 million for the first six months of both 1994 and 1993.
As a result of the operating, investing and financing activities
described above, cash and cash equivalents provided by operations
decreased $13 million from the first six months of 1993.
Liquidity: To meet its cash obligations, including claims payments,
operating expenses, interest and principal payments on debt,
declared shareholder dividends and taxes, Continental holds cash
reserves, short-term money market instruments and other fixed
income securities with maturities of less than one year.
In March 1993, Continental sold $150 million of a total of $350
million of Notes (which provided $147 million of a total $346
million in cash, net of offering and underwriting costs)
outstanding under its shelf registration of up to $400 million of
debt securities with the Securities and Exchange Commission.
During 1993, Continental used $282 million of the net proceeds
from these sales to retire its outstanding 9 3/8% Notes due July 1,
1993 and $50 million of net proceeds from these sales to reduce
corporate short-term borrowings. Depending on market conditions,
Continental intends to sell an additional $50 million of debt
securities under its existing shelf registration and to register
for the sale of up to an additional $100 million of debt
securities. It plans to use the net proceeds from these sales to
further reduce its short-term borrowings.
During the first six months of 1994, Continental's insurance
subsidiaries paid it $51 million in dividends. Beginning in 1993,
several states in which these subsidiaries are domiciled have
adjusted the formula which governs the maximum amount of dividends
that they may pay, without prior regulatory approval, to an amount
which effectively equals 10% of policyholder surplus. One or more
of these states could change their dividend payment formula in the
future. Under the restrictions currently in effect, the maximum
amount available for payment of dividends to Continental by its
insurance subsidiaries during the year ending December 31, 1994
without regulatory approval is estimated to be $166 million, in
addition to the $51 million paid during the first six months of
1994. Continental anticipates that dividends from its insurance
subsidiaries, together with cash from other sources, will enable it
to meet its obligations for interest and principal payments on
debt, corporate expenses and taxes in 1994. To the extent that its
insurance subsidiaries do not generate amounts available for
distribution sufficient to meet Continental's cash requirements
without regulatory approval, Continental would seek approval for
additional distributions.
Continental anticipates paying for the remaining charges associated
with its planned restructuring ($41 million) by year end 1994 using
cash flows from operations. Based on its restructuring program,
the remaining costs should be paid over the last two quarters with
any residual amount to be paid in first quarter 1995.
In 1993, Continental entered into a revolving credit facility,
providing for borrowings of up to $150 million from a syndicate of
banks. Funds borrowed through the facility may be used for general
corporate purposes, but Continental intends to use the facility
primarily as an alternative to existing sources of short-term
borrowings. At June 30, 1994, Continental had not borrowed any
funds through the facility.
Investments: Fixed maturities available-for-sale consist of certain
bonds and redeemable preferred stocks that management may not hold
until maturity and which have an average Standard & Poor's rating
of AA (or its Moody's equivalent). Continental's fixed maturities
available-for-sale had a balance sheet fair value of $6,138 million
at June 30, 1994 (compared with a fair value of $6,280 million at
June 30, 1993) and included mortgage-backed securities with a fair
value of $1,292 million and an amortized cost of $1,295 million at
June 30, 1994 (compared with a fair value of $1,257 million and an
amortized cost of $1,233 million at June 30, 1993). Continental's
mortgage-backed securities have an average Standard & Poor's rating
of AAA (or its Moody's equivalent) and an average life of 9.1
years. Continental has an insignificant investment in
collateralized mortgage obligations which put the return of
principal at risk if interest rates or prepayment patterns
fluctuate.
At June 30, 1994, Continental's bond portfolio classified by
Moody's rating was as follows:
Percentage of
Bond
Moody's Rating Portfolio
Aaa 54.3%
Aa 18.2
A 15.5
Baa 7.0
Below Baa 5.0
100.0%
At June 30, 1994, the fixed maturities portfolio included an
immaterial amount of securities, the fair value of which is
expected to be lower than their carrying value for more than a
temporary period; such investments have been recorded in the
accompanying Consolidated Balance Sheets at their net realizable
value.
Continental also maintains an equity securities portfolio, the fair
value of which was $711 million at June 30, 1994. At June 30,
1994, Continental also had a $111 million investment in privately
placed direct mortgages, which are included in the balance sheet
caption "Other Long-Term Investments."
Unrealized appreciation on investments decreased $545 million,
before income taxes, from December 31, 1993. Unrealized
appreciation on fixed maturities decreased $488 million. Unrealized
appreciation on common stocks decreased $48 million, while
unrealized appreciation on nonredeemable preferred stocks decreased
$7 million. Unrealized appreciation on other long-term investments
decreased $2 million. In addition, unrealized appreciation on
investments held by discontinued operations decreased $46 million,
before income taxes, from December 31, 1993.
Continental holds a small amount of derivative financial
investments for the purposes of enhancing income and total return
and/or hedging long-term investments. At June 30, 1994 the total
notional value of these investments amounted to $827 million and
include financial future contracts, financial options and interest
rate swap agreements. Continental does not expect to recognize
material gains or losses related to these investments.
Continental's book value per share at June 30, 1994 was $29.69,
compared with $39.40 at December 31, 1993, reflecting a $7.57 per
share decline in the unrealized appreciation of investments
(primarily due to the rise in interest rates during the first six
months of 1994), the $1.52 per share loss for the first six months
of 1994, a $0.12 per share worsening of the foreign currency
translation adjustment and a $0.50 per share shareholder dividend
payment.
Rating Agencies: In June 1994, A. M. Best & Co. affirmed the
financial strength of Continental's domestic insurance subsidiaries
as "A-" (Excellent). However, the companies' rating was placed
under review with developing implications, pending further
evaluation of the companies' capital preservation efforts,
restructuring plans and future business plans (see "Restructuring
Charge" and "Additional Improvements").
Also in June 1994, Standard & Poor's Corporation placed
Continental's domestic insurance subsidiaries' "AA-" (Excellent)
claims paying ability rating and The Continental Corporation's "A-"
senior debt rating on Creditwatch, with negative implications.
Reinsurance: In the ordinary course of business, Continental cedes
business to other insurers and reinsurers. Purchasing reinsurance
enables Continental to limit its exposure to catastrophic events
and other concentrations of risk. However, purchasing reinsurance
does not relieve Continental of its obligations to its insureds.
Continental reviews the creditworthiness of its reinsurers on an
ongoing basis. To minimize potential problems, Continental's
policy is to purchase reinsurance only from carriers who meet its
credit quality standards. It has also taken and is continuing to
take steps to settle existing reinsurance arrangements with
reinsurers who do not meet its credit quality standards.
Continental does not believe that there is a significant solvency
risk concerning its reinsurance claims. In addition, Continental
regularly evaluates the adequacy of its reserves for uncollectible
reinsurance. Continental believes that it makes adequate provisions
for the ultimate collectibility of its reinsurance claims and
therefore believes these net recoveries to be probable.
Continental has in place various reinsurance arrangements with
respect to its current operations. These arrangements are subject
to retentions, coverage limits and other policy terms. Some of the
principal treaty arrangements which are presently in effect are an
excess of loss treaty reducing Continental's liability on
individual property losses, a blanket casualty program reducing
Continental's liability on third party liability losses, a clash
casualty program reducing Continental's liability on multiple
insured/single event losses, and a property catastrophe program,
with a net retention of $50 million in both 1994 and 1993, reducing
its liability from a catastrophic event. Continental also uses
individual risk facultative and other facultative agreements to
further reduce its liabilities.
Effective July 1, 1994, Continental entered into a quota share
agreement to reinsure a portion of its domestic personal lines
business with a major U.S. carrier. From July 1, 1994 through
December 31, 1995, Continental's quota share participation is 50%
of the covered lines. Continental expects to cede premiums related
to this agreement of approximately $300 million per year, through
December 31 1995. This arrangement will help Continental lower its
premium-to-surplus ratio and further reduce its exposure to
catastrophes subject to the agreement's catastrophe coverage limits.
Sale of Premiums Receivable: In December, 1993, Continental sold
$513 million of premiums receivables balances. This sale
accelerated the cash flow from the sold receivables, increasing
cash provided by operations in 1993, but reducing cash by $396
million for the first six months of 1994, when this portion of the
receivables would have been collected. As a result, the balance
sheet caption "Premiums Receivable" at June 30, 1994 is lower by
$117 million than it otherwise would have been. In the event that
the receivables are not collected, Continental's credit risk is
limited to the amount that the purchasers of such receivables hold
as a deposit ($15 million at June 30, 1994).
PART II - OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security-Holders.
At the Corporation's Annual Meeting of Shareholders held on May 11, 1994,
shareholders voted against a proposal to repurchase shares and ratified
the appointment of independent auditors for the year 1994. The results
of these proposals and the election of directors were:
Votes
Votes Against Broker-
For or Withheld Abstentions Non-Votes
Nominations for Director:
Ivan A. Burns 48,528,022 340,466 - -
Alex Flamm 48,490,689 377,799 - -
Irvine O. Hockaday, Jr. 48,526,603 341,885 - -
John E. Jacob 48,499,581 368,907 - -
John P. Mascotte 48,489,517 378,971 - -
John F. McGillicuddy 48,520,197 348,291 - -
Richard de J. Osborne 48,523,872 344,616 - -
Charles A. Parker 48,526,357 342,131 - -
John W. Rowe, M.D. 48,511,353 357,135 - -
Patricia Carry Stewart 48,489,809 378,679 - -
Francis T. Vincent, Jr. 48,495,889 372,599 - -
Michael Weintraub 48,524,970 343,518 - -
Anne Wexler 48,498,679 369,809 - -
Shareholder Proposal Re
Repurchase of Shares 3,108,405 40,685,762 1,378,003 3,696,318
Ratification of
Independent Auditors 48,412,274 328,958 126,924 -
A total of 48,868,488 shares were present in person or by proxy at the
Annual Meeting.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
See the Exhibit Index included herein.
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the period covered by this report.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
The Continental Corporation
(Registrant)
Dated: August 12, 1994 By s\William A. Robbie
William A. Robbie
Vice President and
Chief Accounting Officer
Mr. Robbie has signed this Report on behalf of the Registrant in his capacity
as a duly authorized officer and as the chief accounting officer of the
Registrant.
EXHIBIT INDEX
The following is a list of exhibits hereto required to be filed by Item 601
of Regulation S-K.
Exhibit No.
(11) Statement Re: Computation of Per Share Earnings. Exhibit 1
EXHIBIT 1
THE CONTINENTAL CORPORATION
STATEMENT RE: COMPUTATION OF PER SHARE EARNINGS
(millions, except share and per share amounts)
Three Months Ended Six Months Ended
June 30, June 30,
1994 1993 1994 1993
Income (Loss) from
Continuing Operations $5.9 $67.8 $(84.0) $86.7
Adjusted for:
Preferred Stock Dividends 0.1 0.8 0.1 1.6
Income (Loss) from
Continuing Operations
Available to Common
Shareholders 5.8 67.0 (84.1) 85.1
Income (Loss) from
Discontinued Operations,
Net of Income Taxes - 4.0 - 7.7
Income (Loss) Available to
Common Shareholders before
Net Cumulative Effect of
Changes in Accounting
Principles 5.8 71.0 (84.1) 92.8
Net Cumulative Effect of
Changes in Accounting
Principles - - - 1.6
Net Income (Loss) Available
to Common Shareholders $5.8 $71.0 $(84.1) $94.4
Weighted Average Shares of
Common Stock Outstanding:
Primary 55,446,008 55,113,707 55,404,678 55,083,578
Fully Diluted 55,567,239 55,690,063 55,525,909 55,659,934
(Continued)
EXHIBIT 1
THE CONTINENTAL CORPORATION
STATEMENT RE: COMPUTATION OF PER SHARE EARNINGS, CONTINUED
(millions, except share and per share amounts)
Three Months Ended Six Months Ended
June 30, June 30,
1994 1993 1994 1993
Earnings Per Share:
Income (Loss) Per Common
Share from Continuing
Operations
Primary (1) $0.10 $1.22 $(1.52) $1.54
Fully Diluted (2) $0.10 $1.20 $(1.52) $1.52
Income (Loss) from
Discontinued Operations,
Net of Income Taxes
Primary (1) - $0.07 - $0.14
Fully Diluted (2) - $0.07 - $0.14
Net Cumulative Effect of
Changes in Accounting
Principles
Primary (1) - - - $0.03
Fully Diluted (2) - - - $0.03
Net Income Per Common Share
Primary (1) $0.10 $1.29 $(1.52) $1.71
Fully Diluted (2) $0.10 $1.27 $(1.52) $1.69
(1) Per share amounts are computed on the weighted average number of common
equivalent shares outstanding during the period. Common equivalent shares
include the dilutive effect of stock options and shares which would become
issuable pursuant to performance awards. Dividend requirements on all
preferred shares are deducted from earnings to derive common earnings, upon
which primary per share earnings are based.
(2) Fully diluted per share amounts are computed on the weighted average
number of common equivalent shares outstanding during the period, increased
by the assumed conversion of all convertible securities as of the beginning
of each period. Fully diluted earnings amounts are based on earnings after
deduction of preferred dividends on shares which are not convertible, but
before deduction of dividends on convertible preferred shares.