1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 F O R M 10 - Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For Quarter Ended September 30, 1994 [ ] 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 1-6563 SAFECO CORPORATION ------------------- (Exact name of registrant as specified in its charter) Washington 91-0742146 ---------- ---------- (State of Incorporation) (I.R.S. Employer Identification No.) SAFECO Plaza, Seattle, Washington 98185 ---------------------------------------- (Address of principal executive offices) Registrant's Telephone Number, Including Area Code (206) 545-5000 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 62,995,413 shares of no par value common stock were outstanding at September 30, 1994. 2 SAFECO CORPORATION - - - --------------------------------------------------------------- TABLE OF CONTENTS & SIGNATURES Part I - Financial Information* Page --------- Item 1. Financial Statements: Consolidated Balance Sheet, September 30, 1994 and December 31, 1993 3 Statement of Consolidated Income and Retained Earnings for the Quarters and Nine Months Ended September 30, 1994 and 1993 5 Statement of Consolidated Cash Flows for the Nine Months Ended September 30, 1994 and 1993 6 Item 2. Management's Discussion and Analysis 8 Part II - Other Information Item 6. Exhibits and Reports on Form 8-K: (a) Exhibit 27 Financial Data Schedule (b) Form 8-K was not required to be filed for any event during the quarter ended September 30, 1994. * The accompanying unaudited condensed financial statements have been prepared in accordance with the instructions to Form 10-Q. In the opinion of management, they include all adjustments (none of which were other than normal and recurring adjustments) which are necessary for a fair presentation of results for the interim periods. It is suggested that these condensed financial statements be read in conjunction with the financial statements and the notes thereto included in the Company's Form 10-K for the year ended December 31, 1993 which has previously been filed with the Commission. 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. SAFECO CORPORATION ------------------ (Registrant) BOH A. DICKEY --------------- Boh A. Dickey Executive Vice President and Dated November 7, 1994 Chief Financial Officer ROD A. PIERSON --------------- Rod A. Pierson Senior Vice President, Secretary, Controller Dated November 7, 1994 and Chief Accounting Officer -2- 3 SAFECO CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET (In Thousands) - - - -------------------------------------------------------------------- September 30 December 31 1994 1993 ASSETS ------------ ------------ Investments: Fixed Maturities Available-for-Sale, at Market Value (Amortized Cost: $9,420,534) (a) $9,492,905 $ - Fixed Maturities Held-to-Maturity, at Amortized Cost (Market value: 1994-$1,863,501; 1993-$11,965,731) 1,962,046 10,720,976 Marketable Equity Securities, at Market Value (Cost: 1994-$556,781; 1993-$513,138) 914,610 910,252 Mortgage Loans 413,476 402,138 Real Estate (At cost less accumulated depreciation) 473,357 447,797 Policy Loans 51,843 50,488 Short-Term Investments 91,529 109,047 ------------ ------------ Total Investments 13,399,766 12,640,698 Cash 47,347 67,833 Accrued Investment Income 219,979 210,289 Finance Receivables 594,286 547,759 Premiums and Other Service Fees Receivable 420,786 400,873 Other Notes and Accounts Receivable 81,825 75,977 Reinsurance Recoverables 206,847 126,240 Land, Buildings and Equipment for Company Use (At cost less accumulated depreciation) 155,277 149,618 Deferred Policy Acquisition Costs 385,663 367,303 Other Assets 293,459 220,701 ------------ ------------ TOTAL $15,805,235 $14,807,291 ============ ============ (continued) -3- 4 SAFECO CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET (In Thousands Except Share Amounts) (continued) - - - -------------------------------------------------------------------- September 30 December 31 1994 1993 ------------ ------------ LIABILITIES AND STOCKHOLDERS' EQUITY Losses and Adjustment Expense $2,268,454 $2,128,372 Unearned Premiums 889,443 819,385 Life Policy Liabilities 155,793 151,488 Funds Held Under Deposit Contracts 7,759,103 7,229,439 Notes and Mortgages Payable: Credit Company Borrowings ($393,430 maturing within one year) 472,280 427,930 10.75% Notes Due September 1995 200,000 200,000 Other Notes and Mortgages ($18,098 maturing within one year) 279,272 290,505 Other Liabilities 722,683 629,891 Federal and Canadian Income Taxes: Current 18,656 37,963 Deferred (Includes tax on unrealized appreciation of investment securities: 1994-$150,570; 1993-$138,990) (a) 114,463 117,927 ------------ ------------ Total Liabilities 12,880,147 12,032,900 ------------ ------------ Preferred Stock, No Par Value: Shares Authorized: 10,000,000 Shares Issued and Outstanding: None - - Common Stock, No Par Value: Shares Authorized: 150,000,000 Shares Reserved for Options: 1994-2,061,941; 1993-2,182,828 Shares Issued and Outstanding: 1994-62,995,413; 1993-62,931,562 210,657 207,480 Retained Earnings 2,433,655 2,307,322 Unrealized Appreciation of Investment Securities, Net of Tax (a) 283,664 262,157 Unrealized Loss from Foreign Currency Translation, Net of Tax (2,888) (2,568) ------------ ------------ Total Stockholders' Equity 2,925,088 2,774,391 ------------ ------------ TOTAL $15,805,235 $14,807,291 ============ ============ <FN> (a) See Management's Discussion and Analysis - "Other - Footnote" section. -4- 5 SAFECO CORPORATION AND SUBSIDIARIES STATEMENT OF CONSOLIDATED INCOME AND RETAINED EARNINGS (In Thousands Except Per Share Amounts) - - - ----------------------------------------------------------------------------- Nine Months Ended Three Months Ended September 30 September 30 ----------------------- ----------------------- 1994 1993 1994 1993 ----------- ----------- ----------- ----------- REVENUES: Insurance: Property and Casualty Earned Premiums $1,517,223 $1,424,145 $529,234 $493,925 Life & Health Premiums & Other Revenues 209,984 231,870 68,451 74,544 ----------- ----------- ----------- ----------- Total 1,727,207 1,656,015 597,685 568,469 Real Estate 84,220 58,181 30,931 17,154 Finance 38,737 37,541 13,948 12,552 Asset Management 13,130 9,461 5,687 3,262 Net Investment Income 735,927 711,228 249,303 239,306 Realized Investment Gain 24,983 136,874 4,242 56,272 ----------- ----------- ----------- ----------- Total 2,624,204 2,609,300 901,796 897,015 ----------- ----------- ----------- ----------- EXPENSES: Losses, Adjustment Expense and Policy Benefits 1,646,327 1,519,343 570,804 504,818 Commissions 295,657 274,297 105,420 95,869 Proposition 103 Settlement - 40,000 - 40,000 Personnel Costs 165,840 169,628 55,453 57,606 Interest 50,801 44,198 17,670 14,883 Dividends to Policyholders 17,339 14,416 6,469 5,026 Other 200,243 167,590 69,361 54,025 Amortization of Deferred Policy Acquisition Costs 293,615 273,549 101,096 94,957 Deferral of Policy Acquisition Costs (313,022) (294,099) (110,256) (102,719) ----------- ----------- ----------- ----------- Total 2,356,800 2,208,922 816,017 764,465 ----------- ----------- ----------- ----------- Income before Income Taxes 267,404 400,378 85,779 132,550 ----------- ----------- ----------- ----------- Provision (Benefit) for Federal and Canadian Income Taxes: Current 63,689 127,207 17,112 44,178 Deferred (14,872) (22,474) (3,845) (5,418) ----------- ----------- ----------- ----------- Total 48,817 104,733 13,267 38,760 ----------- ----------- ----------- ----------- Income before Cumulative Effect of Accounting Changes 218,587 295,645 72,512 93,790 Cumulative Effect of Accounting Changes: Postretirement Benefits - (15,676) - - Income Taxes - 18,553 - - ----------- ----------- ----------- ----------- Net Income 218,587 298,522 72,512 93,790 Retained Earnings, Beginning of Period 2,307,322 1,993,350 2,392,445 2,141,580 Dividends Declared (90,065) (82,378) (30,868) (28,314) Common Stock Reacquired (2,189) (3,803) (434) (1,365) ----------- ----------- ----------- ----------- Retained Earnings, End of Period $2,433,655 $2,205,691 $2,433,655 $2,205,691 =========== =========== =========== =========== Net Income Per Share of Common Stock: Income before Cumulative Effect of Accounting Changes $3.47 $4.70 $1.15 $1.49 Cumulative Effect of Accounting Changes: Postretirement Benefits - (0.25) - - Income Taxes - 0.30 - - ----------- ----------- ----------- ----------- Net Income $3.47 $4.75 $1.15 $1.49 =========== =========== =========== =========== Average Number of Shares Outstanding During the Period (In Thousands) 62,971 62,863 62,988 62,894 =========== =========== =========== =========== Cash Dividends Paid to Common Stockholders $1.39 $1.27 $0.49 $0.45 =========== =========== =========== =========== <FN> Income per share of common stock is based on the average number of common shares outstanding. Stock options do not have a significant dilutive effect on income per share. -5- 6 SAFECO CORPORATION AND SUBSIDIARIES STATEMENT OF CONSOLIDATED CASH FLOWS (In Thousands) - - - ------------------------------------------------------------------------ Nine Months Ended September 30 ----------------------- 1994 1993 * ----------- ----------- OPERATING ACTIVITIES: Insurance Premiums Received $1,730,935 $1,643,591 Dividends and Interest Received 721,356 687,675 Other Operating Receipts 133,648 92,156 Insurance Claims and Policy Benefits Paid (1,269,183) (1,193,156) Underwriting, Acquisition and Insurance Operating Costs Paid (596,378) (548,111) Interest Paid (54,181) (45,139) Other Operating Costs Paid (75,101) (48,949) Income Taxes Paid (76,470) (125,714) ----------- ----------- Net Cash Provided by Operating Activities 514,626 462,353 ----------- ----------- INVESTING ACTIVITIES: Purchase of: Fixed Maturities Available-for-Sale (1,584,272) - Fixed Maturities Held-to-Maturity (262,546) (2,218,051) Equities (98,908) (93,258) Other Investments (130,009) (97,748) Maturities of Fixed Maturities Available-for-Sale 626,188 - Maturities of Fixed Maturities Held-to-Maturity 52,991 760,394 Sale of: Fixed Maturities Available-for-Sale 562,861 - Fixed Maturities Held-to-Maturity - 730,415 Equities 73,365 125,865 Other Investments 96,622 67,616 Net Decrease in Short-Term Investments 23,362 58,195 Finance Receivables Originated or Acquired (220,595) (197,607) Principal Payments Received on Finance Receivables 161,616 147,721 Other (34,652) (18,532) ----------- ----------- Net Cash Used in Investing Activities (733,977) (734,990) ----------- ----------- FINANCING ACTIVITIES: Funds Received Under Deposit Contracts 731,442 799,218 Return of Funds Held Under Deposit Contracts (482,157) (402,150) Proceeds from Notes and Mortgage Borrowings 38,174 23,950 Repayment of Notes and Mortgage Borrowings (119,395) (47,656) Net Proceeds from (Repayment of) Short-Term Borrowings 119,163 (10,019) Common Stock Reaquired (2,325) (4,008) Dividends Paid to Stockholders (87,520) (79,819) Other 1,483 3,087 ----------- ----------- Net Cash Provided by Financing Activities 198,865 282,603 ----------- ----------- Net Decrease in Cash (20,486) 9,966 Cash at Beginning of Period 67,833 73,122 ----------- ----------- Cash at End of Period $47,347 $83,088 =========== =========== (continued) -6- 7 SAFECO CORPORATION AND SUBSIDIARIES STATEMENT OF CONSOLIDATED CASH FLOWS (continued) (In Thousands) - - - ------------------------------------------------------------------------ Nine Months Ended September 30 ----------------------- 1994 1993 * ----------- ----------- Net Income $218,587 $298,522 ----------- ----------- Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities: Realized Investment Gain (24,983) (136,874) Depreciation and Amortization 28,993 23,082 Amortization of Fixed Maturity Investments (16,270) (17,430) Deferred Income Tax Benefit (14,872) (22,474) Interest Expense on Deposit Contracts 293,490 303,141 Cumulative Effect of Accounting Changes - (2,877) Other Adjustments 8,789 4,341 Changes in: Losses and Adjustment Expense Liabilities 140,082 18,994 Unearned Premiums 70,058 82,170 Life Policy Liabilities 4,305 (120) Accrued Income Taxes (19,307) 3,475 Accrued Interest on Accrual Bonds (32,275) (44,251) Accrued Investment Income (9,690) (4,399) Deferred Policy Acquisition Costs (18,360) (20,550) Other Assets and Liabilities (113,921) (22,397) ----------- ----------- Total Adjustments 296,039 163,831 ----------- ----------- Net Cash Provided by Operating Activities $514,626 $462,353 =========== =========== <FN> * Certain reclassifications have been made to the 1993 amounts to conform to current year classifications. -7- 8 SAFECO CORPORATION - - - ------------------ MANAGEMENT'S DISCUSSION AND ANALYSIS - - - ------------------------------------------------------------------- SAFECO Corporation - - - ------------------ Our net income for the first nine months of 1994 was $218.6 million or $3.47 per share compared with $4.75 for 1993. If we exclude realized gain from investments, which is explained in the next paragraph, our per share income was $3.21 per share, compared with $3.34 per share in 1993. These results for the first nine months of 1994 have been impacted $1.24 per share as a result of the January, 1994 Los Angeles earthquake as discussed below. Third quarter and nine month 1993 results include a $0.41 per share charge related to our California Proposition 103 settlement. During the first nine months of 1994, realized gain from investments was $0.26 per share, compared with $1.36 per share in 1993. The pretax gain from security investments of $25.0 million compares with $128.8 million a year ago. Declining interest rates during 1993 produced calls and redemptions in our bond portfolios resulting in substantial capital gains. As interest rates have risen in 1994, calls and redemptions have decreased significantly. The following summarized financial information sets forth the contributions of each business segment to our consolidated income. Nine Months Ended Three Months Ended September 30 September 30 --------------------- -------------------- 1994 1993 1994 1993 - - - ---------------------------------------------------------------------- (In Thousands Except Per Share Amounts) Income (Loss) before Realized Gain and Income Taxes: Property and Casualty Insurance: Underwriting Gain (Loss) $ (73,657) $ (9,339) $(29,075) $ 12,293 Net Investment Income 211,070 208,030 70,891 69,058 Proposition 103 Settlement - (40,000) - (40,000) --------- --------- --------- -------- Total Property and Casualty 137,413 158,619 41,816 41,351 Life and Health Insurance 95,619 93,078 35,841 30,369 Real Estate 7,724 7,170 2,531 2,340 Credit 7,440 7,835 2,961 2,944 Asset Management 4,694 4,377 1,586 1,498 Corporate (10,469) (7,647) (3,198) (2,224) --------- ---------- ---------- --------- Total 242,421 263,504 81,537 76,278 --------- ---------- ---------- --------- Realized Gain (Loss), before Tax, from: Security Investments 25,034 128,810 4,242 54,790 Real Estate Investments (51) 8,064 - 1,482 --------- ---------- --------- --------- Total 24,983 136,874 4,242 56,272 --------- ---------- --------- --------- Income before Income Taxes 267,404 400,378 85,779 132,550 --------- ---------- --------- --------- Provision for Income Taxes on: Income before Realized Gain 40,434 53,439 11,854 14,685 Realized Gain 8,383 51,294 1,413 24,075 --------- --------- --------- --------- Total 48,817 104,733 13,267 38,760 --------- --------- --------- --------- Income before Cumulative Effect of Accounting Changes 218,587 295,645 72,512 93,790 Cumulative Effect of Accounting Changes: Postretirement Benefits - (15,676) - - Income Taxes - 18,553 - - --------- --------- --------- --------- Net Income $ 218,587 $ 298,522 $ 72,512 $ 93,790 ========= ========= ========= ========= Net Income Per Share of Common Stock: Income before Cumulative Effect of Accounting Changes $3.47 $4.70 $1.15 $1.49 Cumulative Effect of Accounting Changes: Postretirement Benefits - (.25) - - Income Taxes - .30 - - ---------- ---------- ---------- --------- Net Income $ 3.47 $ 4.75 $ 1.15 $ 1.49 ========== ========== ========== ========= - 8 - 9 SAFECO CORPORATION - - - ------------------ MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued) - - - ---------------------------------------------------------------------- Property and Casualty Insurance - - - ------------------------------- Property and casualty operations for the first nine months of 1994 produced pretax income of $137.4 million before realized gain from investments, compared with $198.7 million (excluding the $40 million Proposition 103 settlement) for the first nine months a year ago. The third quarter of 1994 produced an underwriting loss of $29.1 million. During the quarter the estimated cost of claims from the January 17 Los Angeles earthquake was increased from $175 to $225 million, before reimbursement from reinsurers. SAFECO's reinsurance covers 90% of losses between $50 and $200 million. Additional earthquake costs recorded during the third quarter were $30.2 million, resulting from the increase in the earthquake estimate of $27.5 million of net losses and an additional $2.7 million that we are paying our reinsurers to fully reinstate our coverage for a second catastrophe event in 1994, should it occur. For the first nine months, the loss from underwriting was $73.7 million, compared with a loss of $9.3 million a year ago. The current year results include $90.0 million in net losses from the earthquake and $23.3 million of reinsurance reinstatement premiums. The combined loss and expense ratio was 104.9 for the first nine months, compared with 100.7 last year. Investment income was $211.1 million, up slightly from a year ago. Personal auto, our largest line, continues to perform well. This line produced an underwriting profit of $47.2 million for the first nine months, compared with $25.3 million for the first nine months last year. Current year loss costs are up approximately 6% over a year ago. Other personal lines, which provide coverage for earthquake, dwelling fire, inland marine, boats and recreational vehicles, were adversely affected by the Los Angeles earthquake described earlier. These lines produced an underwriting loss of $25.4 million for the third quarter and a loss of $85.6 million for the first nine months. By comparison, these lines produced a profit of $20.6 million for all of 1993. In the Consolidated Balance Sheet, the asset Reinsurance Recoverables is higher at September 30, 1994 due to the amounts recoverable by SAFECO from its reinsurers related to the Northridge earthquake. Homeowners produced an underwriting loss of $27.5 million for the first nine months, compared with a loss of $49.9 million for the first nine months of 1993. The improvement in 1994 results is partially due to lower catastrophe losses which were $30.4 million after reinsurance, for the first nine months, compared with $42.4 million a year ago. In addition, results for this line are benefiting from rate increases and continuing efforts to improve homeowners insurance to value. Commercial lines produced an underwriting loss of $17.6 million for the first nine months, operating at a combined ratio of 104.4. A year ago, the loss was $12.8 million and the combined ratio was 103.6. The combined ratios for both years compare favorably with the industry and are a result of our focus on specific states and efforts to reduce expense and maintain rate adequacy in the face of stiff price competition. - 9 - 10 SAFECO CORPORATION - - - ------------------ MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued) - - - ---------------------------------------------------------------------- Surety continues to experience excellent results for both contract and commercial bond business. The profit for this line was $11.2 million for the first nine months, compared with a profit of $15.4 million for the first nine months last year. Total premiums written for the first nine months increased 8% over a year ago with personal lines up 8% and commercial lines up 9%. Life and Health Insurance - - - ------------------------- Life and health insurance operations produced a pretax profit, before realized gain from investments, of $95.6 million for the first nine months of 1994. This compares with $93.1 million for the same period in 1993. Income for the third quarter was $35.8 million, up from the $29.8 million for the second quarter and $30.4 million for the third quarter of last year. The annuity and pension lines combined nine months earnings were $35.1 million, up from the $26.6 million reported for the first nine months of 1993. The favorable effects of reduced expenses and increased investment income attributable to rising interest rates are the major factors contributing to the excellent earnings in annuity and pension lines. Group insurance earnings were $15.8 million for the first nine months, compared with $21.0 million for the first nine months of 1993. Lower group earnings and premium revenue were primarily caused by competitive pressures and market uncertainty surrounding health care reform. Real Estate - - - ----------- SAFECO Properties' pretax income was $7.7 million for the first nine months of 1994, compared with $7.2 million for 1993. In the Statement of Consolidated Income, the increase in Real Estate Revenues and Other Expenses is due primarily to a higher level of sales of properties held for sale in the first and third quarters of 1994. - 10 - 11 SAFECO CORPORATION - - - ------------------ MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued) - - - ---------------------------------------------------------------------- Credit - - - ------ SAFECO Credit Company reported pretax profit of $7.4 million for the first nine months of 1994 compared with $7.8 million in 1993. New loan/lease production continued at record levels which partially offset the effect of continuing rate competition and increased borrowings costs. Non-affiliate receivables and operating leases reached $631 million at September 30, 1994, a 13% annualized increase from December, 1993. Delinquency experience continued at record low levels with accounts past due 30 days or more less than 1% at September 30th. SAFECO Credit's summarized financial information is as follows (in thousands): September 30 December 31 1994 1993 ---------- ----------- Finance Receivables $ 594,286 $ 547,759 Other Assets 107,753 114,283 ---------- ---------- Total Assets $ 702,039 $ 662,042 ========== ========== Credit Company Borrowings $ 472,280 $ 427,930 Other Liabilities 141,986 150,380 ---------- ---------- Total Liabilities $ 614,266 $ 578,310 ========== ========== Nine Months Ended September --------------------------- 1994 1993 -------- ------ Revenues $ 41,825 $ 40,194 Expenses 34,385 32,359 --------- --------- Income before Income Taxes 7,440 7,835 Provision for Federal Income Taxes 2,272 2,911 --------- --------- Income before Cumulative Effect of Accounting Changes 5,168 4,924 Cumulative Effect of Accounting Changes - 403 --------- --------- Net Income $ 5,168 $ 4,521 ========= ========= Asset Management - - - ---------------- The pretax income from our investment management activities for the first nine months of 1994 was $4.7 million, compared with $4.4 million for the same period last year. Assets under management are approximately $2.5 billion, up from $2.3 billion a year ago. As part of our strategy to increase assets, we launched two new lines of business during the quarter: SAFECO Advisor Series, a mutual fund family that will be distributed through banks and broker-dealers, and SAFECO Trust Company, which will provide trust services to high net worth individuals. Investment Portfolios - - - --------------------- The market value of our consolidated bond portfolio was $26 million below amortized cost at September 30, 1994. This compares with market value being in excess of amortized cost by $168 million at June 30, 1994 and $1.2 billion at December 31, 1993. These declines reflect the weakness in the bond market during 1994 as a result of higher interest rates. However, these higher interest rates will benefit our investment income in the future. The market value of our equity securities was $358 million in excess of cost at September 30, 1994. - 11 - 12 SAFECO CORPORATION - - - ------------------ MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued) - - - ---------------------------------------------------------------------- Other - Footnotes - - - ----------------- The following additional footnote disclosures are being made due to the adoption of two new accounting standards in the first quarter of 1994. Employee Benefit Plans ---------------------- SAFECO adopted Financial Accounting Standards Board Statement 112, "Employers' Accounting for Postemployment Benefits", effective January 1, 1994. Adoption had no effect on net income. Investments ----------- In May 1993, the Financial Accounting Standards Board issued Statement 115, "Accounting for Certain Investments in Debt and Equity Securities", which expands the use of fair value accounting for debt and equity securities. As of January 1, 1994, SAFECO adopted the provisions of this statement for investments held as of, or acquired after that date. Statement 115 requires that debt and equity securities be classified as trading, available-for-sale or held-to-maturity. Debt securities that SAFECO has the positive intent and ability to hold to maturity (as narrowly defined by Statement 115) are classified as held-to-maturity and are reported at amortized cost. Debt securities classified as available-for-sale are carried at market value, with changes in unrealized gains and losses recorded directly to stockholders equity, net of applicable income taxes and deferred policy acquisition costs valuation allowance. All marketable equity securities continue to be carried at market value, with changes in unrealized gains and losses recorded directly to stockholders' equity, net of applicable income taxes. Under Statement 115, trading securities are to be carried at market value with immediate recognition in income of changes in market value. Since SAFECO does not have any securities held for trading, the adoption of Statement 115 had no effect on net income. As required by Statement 115, no restatement of prior period amounts has been made. - 12 - 13 SAFECO CORPORATION - - - ------------------ MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued) - - - ---------------------------------------------------------------------- The following reconciliation of Stockholders' Equity from December 31, 1993 to September 30, 1994 shows the effect of adoption of Statement 115 as of January 1, 1994 and the change in net unrealized holding gains (losses) for the first nine months of 1994. (In Thousands) Stockholders' Equity, December 31, 1993 $2,774,391 Net effect of adoption of Statement 115 (1) 640,477 ---------- Stockholders' Equity, January 1, 1994 3,414,868 Net income 218,587 Dividends declared (90,065) Net decreased in unrealized appreciation of investment securities, net of tax and deferred policy acquisition costs valuation allowance (2) (618,971) Other items affecting Stockholders' Equity 669 ---------- Stockholders' Equity, September 30, 1994 $2,925,088 ========== SAFECO had no sales during the first nine months of debt securities classified as held-to-maturity. The decline in the unrealized appreciation of investment securities was due to weakness in both the bond and stock markets as a result of higher interest rates. See note (2) below for the components of the decrease. (1) The net effect of adopting Statement 115 is comprised as follows: Aggregate market value in excess of amortized cost of debt securities classified as available-for-sale, at January 1, 1994 $1,013,117 Deferred policy acquisition costs valuation allowance (27,768) Deferred income taxes, at 35% (344,872) ----------- Net effect of adoption of Statement 115 $ 640,477 ========== (2) The decrease in net unrealized appreciation of investment securities is comprised as follows: Decrease in unrealized appreciation of debt securities, available- for-sale $ (940,746) Decrease in unrealized appreciation of marketable equity securities (39,285) Decrease in deferred policy acquisition costs valuation allowance 27,768 Decrease in deferred income taxes 333,292 ---------- Net decrease in unrealized appreciation of investment securities, net of tax and deferred policy acquisition costs valuation allowance $ (618,971) ========== - 13 -