UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
--- THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1999
-------------
or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
--- OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
----------- ---------
Commission File Number 0-3021
------
THE ST. PAUL COMPANIES, INC.
------------------------------------------
(Exact name of Registrant as specified in its charter)
Minnesota 41-0518860
------------------------- -------------------------
(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) No.)
385 Washington St., Saint Paul, MN 55102
---------------------------------- ----------
(Address of principal executive (Zip Code)
offices)
Registrant's telephone number, including area code: (651) 310-7911
--------------
Indicate by check mark whether the Registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the Registrant was required to file
such reports) and (2) has been subject to such filing requirements
for the past 90 days.
Yes X No
----- -----
The number of shares of the Registrant's Common Stock, without par
value, outstanding at August 9, 1999, was 226,638,192.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
Page No.
PART I. FINANCIAL INFORMATION ----------
Consolidated Statements of Operations (Unaudited),
Three Months and Six Months Ended June 30, 1999 and 1998 3
Consolidated Balance Sheets, June 30, 1999
(Unaudited) and December 31, 1998 4
Consolidated Statements of Shareholders' Equity,
Six Months Ended June 30, 1999
(Unaudited) and Twelve Months Ended 6
December 31, 1998
Consolidated Statements of Comprehensive Income
(Unaudited), Six Months Ended June 30, 1999
and 1998 7
Consolidated Statements of Cash Flows (Unaudited),
Six Months Ended June 30, 1999 and 1998 8
Notes to Consolidated Financial Statements
(Unaudited) 9
Management's Discussion and Analysis of
Financial Condition and Results of
Operations 22
PART II. OTHER INFORMATION
Item 1 through Item 6 38
Signatures 38
EXHIBIT INDEX 39
PART I FINANCIAL INFORMATION
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Consolidated Statements of Operations (Unaudited)
Three Months Ended Six Months Ended
June 30 June 30
(In millions, except per share ------------------- -------------------
data) 1999 1998 1999 1998
----- ----- ----- -----
Revenues:
Premiums earned $1,412 1,468 2,815 2,966
Net investment income 402 398 797 795
Asset management 85 75 166 146
Realized investment gains 68 136 133 185
Other 31 23 61 52
----- ----- ----- -----
Total revenues 1,998 2,100 3,972 4,144
----- ----- ----- -----
Expenses:
Insurance losses and loss
adjustment expenses 1,013 1,345 2,048 2,408
Life policy benefits 85 62 152 122
Policy acquisition expenses 359 385 699 761
Operating and administrative 251 596 517 876
----- ----- ----- -----
Total expenses 1,708 2,388 3,416 4,167
----- ----- ----- -----
Income (loss) from
continuing operations
before income taxes
and cumulative effect of
accounting change 290 (288) 556 (23)
Income tax expense (benefit) 69 (95) 135 (34)
----- ----- ----- -----
Income (loss) from
continuing operations
before cumulative effect
of accounting change 221 (193) 421 11
Cumulative effect of
accounting change,
net of taxes - - (30) -
----- ----- ----- -----
Income (loss) from
continuing operations 221 (193) 391 11
Loss from discontinued
operations, net of taxes (17) (81) (22) (90)
----- ----- ----- -----
Net income (loss) $204 (274) 369 (79)
===== ===== ===== =====
Basic earnings (loss) per
common share:
Income (loss) from continuing
operations before cumulative
effect of accounting change $0.97 (0.84) 1.81 0.02
Cumulative effect of
accounting change,
net of taxes - - (0.13) -
----- ----- ----- -----
Income (loss) from
continuing operations $0.97 (0.84) 1.68 0.02
Loss from discontinued
operations, net of taxes (0.08) (0.34) (0.09) (0.38)
----- ----- ----- -----
Net income (loss) $0.89 (1.18) 1.59 (0.36)
===== ===== ===== =====
Diluted earnings (loss) per
common share:
Income (loss) from continuing
operations before cumulative
effect of accounting change $0.91 (0.84) 1.71 0.02
Cumulative effect of
accounting change,
net of taxes - - (0.12) -
----- ----- ----- -----
Income (loss) from
continuing operations 0.91 (0.84) 1.59 0.02
Loss from discontinued
operations, net of taxes (0.07) (0.34) (0.09) (0.38)
----- ----- ----- -----
Net income (loss) $0.84 (1.18) 1.50 (0.36)
===== ===== ===== =====
Dividends declared on
common stock $0.26 0.25 0.52 0.50
===== ===== ===== =====
See notes to consolidated financial statements.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(In millions)
June 30, December 31,
ASSETS 1999 1998
- ------ ------------ -------------
(Unaudited)
Investments:
Fixed maturities, at estimated fair value $20,849 $21,056
Equities, at estimated fair value 1,393 1,259
Real estate and mortgage loans 1,531 1,507
Venture capital, at estimated fair value 640 571
Securities lending collateral 1,822 1,368
Other investments 315 373
Short-term investments, at cost 771 982
-------- --------
Total investments 27,321 27,116
Cash 126 120
Investment banking inventory securities 67 107
Reinsurance recoverables:
Unpaid losses 4,113 3,978
Paid losses 190 157
Ceded unearned premiums 285 288
Receivables:
Underwriting premiums 2,435 2,152
Interest and dividends 368 361
Other 204 117
Deferred policy acquisition expenses 1,007 878
Deferred income taxes 1,339 1,193
Office properties and equipment, at cost less
accumulated depreciation of $478 (1998; $405) 531 518
Goodwill 574 592
Other assets 769 746
-------- --------
Total assets $39,329 $38,323
======== ========
See notes to consolidated financial statements.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Consolidated Balance Sheets (continued)
(In millions)
June 30, December 31,
LIABILITIES AND SHAREHOLDERS' EQUITY 1999 1998
- ------------------------------------ ---------- -----------
(Unaudited)
Liabilities:
Insurance reserves:
Losses and loss adjustment expenses $18,486 $18,458
Future policy benefits 4,604 4,142
Unearned premiums 3,342 3,266
-------- --------
Total insurance reserves 26,432 25,866
Debt 1,506 1,260
Payables:
Reinsurance premiums 346 291
Income taxes 258 221
Accrued expenses and other 1,089 1,238
Securities lending 1,822 1,368
Other liabilities 1,085 940
-------- --------
Total liabilities 32,538 31,184
-------- --------
Company-obligated mandatorily redeemable
preferred capital securities of subsidiaries
or trusts holding solely convertible
subordinated debentures of the Company 503 503
-------- --------
Shareholders' equity:
Preferred:
Series B convertible preferred stock;
1.45 shares authorized; 0.9 shares
outstanding in 1999 and 1998 132 134
Guaranteed obligation - PSOP (114) (119)
-------- --------
Total preferred shareholders' equity 18 15
-------- --------
Common:
Common stock, 480 shares authorized;
227 shares outstanding (234 shares in 1998) 2,078 2,128
Retained earnings 3,541 3,480
Accumulated other comprehensive income:
Unrealized appreciation 670 1,027
Unrealized loss on foreign currency translation (19) (14)
-------- --------
Total accumulated other comprehensive income 651 1,013
-------- --------
Total common shareholders' equity 6,270 6,621
-------- --------
Total shareholders' equity 6,288 6,636
-------- --------
Total liabilities, redeemable preferred
securities and shareholders' equity $39,329 $38,323
======== ========
See notes to consolidated financial statements.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Consolidated Statements of Shareholders' Equity
(In millions)
Six Twelve
Months Ended Months Ended
June 30 December 31
------------ ------------
1999 1998
------ ------
(Unaudited)
Preferred shareholders' equity:
Series B PSOP convertible preferred stock:
Beginning of period $134 $138
Redemptions during period (2) (4)
------- -------
End of period 132 134
------- -------
Guaranteed obligation - PSOP:
Beginning of period (119) (121)
Principal payments 5 2
------- -------
End of period (114) (119)
------- -------
Total preferred shareholders' equity 18 15
------- -------
Common shareholders' equity:
Common stock:
Beginning of period 2,128 2,057
Stock issued under stock incentive plans 22 70
Stock issued for preferred shares redeemed 3 8
Reacquired common shares (75) (35)
Other - 28
------- -------
End of period 2,078 2,128
------- -------
Retained earnings:
Beginning of period 3,480 3,720
Net income 369 89
Dividends declared on common stock (114) (223)
Dividends declared on preferred
stock, net of taxes (4) (9)
Reacquired common shares (190) (100)
Tax benefit on employee options and awards 2 7
Premium on preferred shares redeemed (2) (4)
------- -------
End of period 3,541 3,480
------- -------
Unrealized appreciation, net of taxes:
Beginning of period 1,027 846
Change during the period (357) 181
------- -------
End of period 670 1,027
------- -------
Unrealized gain (loss)loss on foreign currency
translation, net of taxes:
Beginning of period (14) (23)
Change during the period (5) 9
------- -------
End of period (19) (14)
------- -------
Guaranteed obligation - ESOP:
Beginning of period - (8)
Principal payments - 8
------- -------
End of period - -
------- -------
Total common shareholders' equity 6,270 6,621
------- -------
Total shareholders' equity $6,288 $6,636
======= =======
See notes to consolidated financial statements.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
Unaudited
(In millions)
Three Months Ended Six Months Ended
June 30 June 30
------------------ ----------------
1999 1998 1999 1998
------ ------ ------ ------
(In thousands)
Net income (loss) $204 $(274) $369 $(79)
----- ----- ----- -----
Other comprehensive income, net of
taxes:
Change in unrealized appreciation (249) (28) (357) 21
Change in unrealized loss on
foreign currency translation (3) (4) (5) -
----- ----- ----- -----
Other comprehensive income (loss) (252) (32) (362) 21
----- ----- ----- -----
Comprehensive income (loss) $(48) $(306) $7 ($58)
===== ===== ===== =====
See notes to consolidated financial statements.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Unaudited
(In millions)
Six Months Ended
June 30
-----------------------
1999 1998
-------- -------
OPERATING ACTIVITIES
Net income (loss) $369 $(79)
Adjustments:
Change in property-liability
insurance reserves 181 351
Change in reinsurance balances (117) (112)
Change in premiums receivable (341) (58)
Change in asset management balances 16 (3)
Depreciation and amortization 69 64
Realized investment gains (133) (185)
Other (79) 3
----- -----
Net Cash Used by
Operating Activities (35) (19)
----- -----
INVESTING ACTIVITIES
Purchase of investments (3,440) (2,288)
Proceeds from sales and
maturities of investments 2,923 2,433
Change in short-term investments 170 16
Change in open security transactions 54 101
Net purchases of office properties
and equipment (73) (52)
Acquisitions - (98)
Other (20) 107
----- -----
Net Cash Provided (Used) by
Investing Activities (386) 219
----- -----
FINANCING ACTIVITIES
Deposits on universal life
and investment contracts 602 181
Withdrawals on universal life
and investment contracts (56) (131)
Dividends paid on common and preferred stock (123) (103)
Proceeds from issuance of debt 286 36
Repayment of debt (41) (194)
Repurchase of common shares (265) -
Stock options exercised and other 22 27
----- -----
Net Cash Provided (Used) by
Financing Activities 425 (184)
----- -----
Effect of exchange rate changes on cash 2 -
----- -----
Increase in cash 6 16
Cash at beginning of period 120 113
----- -----
Cash at end of period $126 $129
===== =====
See notes to consolidated financial statements.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Unaudited
June 30, 1999
Note 1 - Basis of Presentation
- ------------------------------
The financial statements include The St. Paul Companies, Inc. and
subsidiaries (The St. Paul), and have been prepared in conformity
with generally accepted accounting principles. The St. Paul
completed its merger with USF&G Corporation (USF&G) in April
1998. The financial statements for all current and prior periods
in this report reflect the combined accounts and results of
operations of The St. Paul and USF&G.
In July 1999, The St. Paul announced an agreement to sell its
standard personal insurance business to MetLife Auto and Home.
The results of the operations sold have been accounted for as
discontinued operations for all current and prior year periods
presented in this report. See Note 9 on page 17 for further
information regarding this sale.
These consolidated financial statements rely, in part, on
estimates. In the opinion of management, all necessary
adjustments, consisting of normal recurring adjustments, have
been reflected for a fair presentation of the results of
operations, financial position and cash flows in the accompanying
unaudited consolidated financial statements. The results for the
period are not necessarily indicative of the results to be
expected for the entire year.
Reference should be made to the "Notes to Consolidated Financial
Statements" in The St. Paul's annual report to shareholders for
the year ended December 31, 1998. The amounts in those notes
have not changed materially except as a result of transactions in
the ordinary course of business or as otherwise disclosed in
these notes.
Some amounts in the 1998 consolidated financial statements have
been reclassified to conform with the 1999 presentation. These
reclassifications had no effect on net income or shareholders'
equity, as previously reported.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Note 2 - Earnings Per Share
- ---------------------------
Earnings per common share (EPS) amounts were calculated by
dividing net income, as adjusted, by the average common shares outstanding.
Three Months Ended Six Months Ended
June 30 June 30
------------------ ----------------
1999 1998 1999 1998
----- ----- ----- -----
(In millions, except per share data)
EARNINGS
Basic:
Net income (loss), as reported $204 $(274) $369 $(79)
Dividends on preferred stock,
net of taxes (2) (2) (4) (4)
Premium on preferred shares redeemed (1) (1) (2) (2)
----- ----- ----- -----
Net income (loss) available
to common shareholders $201 $(277) $363 $(85)
===== ===== ===== =====
Diluted:
Net income (loss) available
to common shareholders $201 $(277) $363 $(85)
Effect of dilutive securities:
Convertible preferred stock 2 - 3 -
Convertible monthly income
preferred securities 2 - 4 -
Zero coupon convertible notes 1 - 2 -
----- ----- ----- -----
Net income (loss) available
to common shareholders $206 $(277) $372 $(85)
===== ===== ===== =====
COMMON SHARES
Basic:
Weighted average common
shares outstanding 226 235 228 235
===== ===== ===== =====
Diluted:
Weighted average common
shares outstanding 226 235 228 235
Effect of dilutive securities:
Stock options 2 - 2 -
Convertible preferred stock 7 - 7 -
Convertible monthly income
preferred securities 7 - 7 -
Zero coupon convertible notes 3 - 3 -
----- ----- ----- -----
Total 245 235 247 235
===== ===== ===== =====
EARNINGS (LOSS) PER SHARE
Basic $0.89 $(1.18) $1.59 $(0.36)
===== ===== ===== =====
Diluted $0.84 $(1.18) $1.50 $(0.36)
===== ===== ===== =====
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Note 3 - Investments
- --------------------
Investment Activity. A summary of investment transactions is presented
below.
Six Months Ended June 30
------------------------
1999 1998
-------- --------
(In millions)
Purchases:
Fixed maturities $2,519 $1,146
Equities 654 820
Real estate and mortgage loans 110 149
Venture capital 107 86
Other investments 50 87
----- -----
Total purchases 3,440 2,288
----- -----
Proceeds from sales and maturities:
Fixed maturities 2,039 1,230
Equities 675 915
Real estate and mortgage loans 78 173
Venture capital 110 43
Other investments 21 72
----- -----
Total sales and maturities 2,923 2,433
----- -----
Net purchases (sales) $517 $(145)
===== =====
Change in Unrealized Appreciation. The increase (decrease) in
unrealized appreciation of investments recorded in common
shareholders' equity was as follows:
Six Months Ended Twelve Months Ended
June 30, 1999 December 31, 1998
---------------- -------------------
(In millions)
Fixed maturities $(787) $203
Equities 85 69
Venture capital 27 45
Life deferred policy acquisition
costs and policy benefits 59 (1)
Single premium immediate
annuity reserves 43 (17)
Other - (16)
----- -----
Total change in pretax
unrealized appreciation (573) 283
Change in deferred taxes 216 (102)
----- -----
Total change in unrealized
appreciation, net of taxes $(357) $181
===== =====
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Note 4 - Income Taxes
- ---------------------
The components of income tax expense on income from continuing
operations before the cumulative effect of accounting change is
as follows :
Three Months Ended Six Months Ended
June 30 June 30
---------------- ----------------
1999 1998 1999 1998
------ ------ ------ ------
(In millions)
Federal current tax
expense (benefit) $ 2 $ (7) $ 14 $ 44
Federal deferred tax
expense (benefit) 59 (93) 105 (93)
----- ----- ----- -----
Total federal income tax
expense (benefit) 61 (100) 119 (49)
Foreign income taxes 6 3 13 10
State income taxes 2 2 3 5
----- ----- ----- -----
Total income tax expense
(benefit) on continuing
operations $69 $(95) $135 $(34)
===== ===== ===== =====
Note 5 - Contingent Liabilities
- -------------------------------
In the ordinary course of conducting business, The St. Paul and
some of its subsidiaries have been named as defendants in various
lawsuits. Some of these lawsuits attempt to establish liability
under insurance contracts issued by those companies. Plaintiffs
in these lawsuits are asking for money damages or to have the
court direct the activities of the company's operations in
certain ways. Although it is possible that the settlement of a
contingency may be material to The St. Paul's results of
operations and liquidity in the period in which the settlement
occurs, The St. Paul believes that the total amounts that it or
its subsidiaries will ultimately have to pay in all of these
lawsuits will have no material effect on its overall financial
position.
In some cases, plaintiffs seek to establish coverage for their
liability under environmental protection laws. See
"Environmental and Asbestos Claims" in Management's Discussion
and Analysis for information on these claims.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Note 6 - Debt
- -------------
Debt consists of the following:
June 30, December 31,
1999 1998
--------------- ---------------
Book Fair Book Fair
Value Value Value Value
----- ------ ----- ------
(In millions)
Medium-term notes $617 $618 $637 $675
Commercial paper 434 434 257 257
8 3/8% senior notes 150 156 150 160
Zero coupon convertible notes 92 97 111 118
7 1/8% senior notes 80 81 80 86
Variable rate borrowings 64 64 - -
Floating rate notes 46 46 - -
Real estate mortgages 15 16 15 16
Nuveen short-term borrowings 8 8 10 10
----- ----- ----- -----
Total debt $1,506 $1,520 $1,260 $1,322
===== ===== ===== =====
A number of The St. Paul's real estate entities are parties to
variable rate loan agreements aggregating $63.8 million. The
borrowings mature in the year 2030, with principal paydowns
starting in the year 2006. The interest rate is set weekly by a
third party, and was 3.8% at June 30, 1999.
Note 7 - Segment Information
- ----------------------------
The St. Paul has seven reportable business segments in its
property-liability insurance operation, consisting of the
Commercial Lines Group, Specialty Commercial, Surety, Specialty
Auto, International, Reinsurance and Investment Operations. (In
July 1999, The St. Paul announced an agreement to sell its
standard personal insurance business to Metropolitan Property and
Casualty Insurance Company in a transaction expected to close
near the end of the third quarter of 1999, subject to regulatory
approval. The results of the operations to be sold have been
accounted for as discontinued operations for all current and
prior year periods presented in this report and are not included
in The St. Paul's segment data). The St. Paul also has a life
insurance segment (Fidelity and Guaranty Life) and an asset
management segment (The John Nuveen Company). The St. Paul
evaluates the performance of its property-liability underwriting
segments based on GAAP underwriting results. The property-
liability investment operation is disclosed as a separate
reportable segment because that operation is managed at the
corporate level and the invested assets, net investment income
and realized gains are not allocated to individual underwriting
segments. The life insurance and asset management segments are
evaluated based on their respective pretax operating results,
which include investment income. The St. Paul does not aggregate
its segments for purposes of reporting segment information.
The reportable underwriting business segments in The St. Paul's
property-liability operation are each managed separately because
each offers insurance products to unique customer classes and
utilizes different underwriting criteria and marketing
strategies. For example, the Commercial Lines Group provides
"commodity-type" insurance products to the extensive, small and
medium-sized commercial markets. It also targets certain large
industry groups, such as the construction industry. By contrast,
the Specialty Commercial segment markets specialized insurance
products and services tailored to meet the individual needs of
specific commercial customer groups, such as doctors, lawyers,
officers and directors, as well as technology firms and
government entities. Customers in the Specialty Commercial
segment generally require specialized underwriting expertise and
claim settlement services.
The tabular information on the following pages provides revenue
and income data for each of The St. Paul's business segments for
the three months and six months ended June 30, 1999 and 1998. In
1999, The St. Paul revised its segment reporting structure to
separately disclose its Surety underwriting operation as a business
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Note 7 - Segment Information (continued)
- ---------------------------------------
segment, which differs from its prior classification as a
component of the Commercial Lines Group. This revision reflects
the distinct nature of this operation, which provides surety bond
coverages (primarily for construction contractors). The Surety
operation is managed and evaluated separately from other
components of the Commercial Lines Group, and is also the largest
underwriter of surety bonds in North America, based on 1997
written premium volume. Segment information for 1998 has been
restated to be consistent with the 1999 presentation.
Three Months Ended Six Months Ended
June 30 June 30
------------------ ------------------
1999 1998 1999 1998
----- ----- ----- ------
(In millions)
Revenues from Continuing
Operations
Property-liability
insurance:
U.S. Underwriting:
Commercial Lines Group $526 $564 $1,029 $1,155
Specialty Commercial 318 334 679 672
Surety 94 91 184 164
Specialty Auto 56 63 114 120
----- ----- ----- -----
Total U.S. Underwriting 994 1,052 2,006 2,111
International 139 127 260 241
----- ----- ----- -----
Total primary
insurance operations 1,133 1,179 2,266 2,352
Reinsurance 242 263 484 564
----- ----- ----- -----
Total property-liability
premiums earned 1,375 1,442 2,750 2,916
----- ----- ----- -----
Investment operations:
Net investment income 321 331 643 663
Realized investment gains 71 132 132 180
----- ----- ----- -----
Total investment operations 392 463 775 843
Other 27 20 53 42
----- ----- ----- -----
Total property-
liability insurance 1,794 1,925 3,578 3,801
----- ----- ----- -----
Life insurance 110 94 209 184
----- ----- ----- -----
Asset management 86 76 169 149
----- ----- ----- -----
Total reportable segments 1,990 2,095 3,956 4,134
Parent company, other
operations and
consolidating eliminations 8 5 16 10
----- ----- ----- -----
Total revenues from
continuing operations $1,998 $2,100 $3,972 $4,144
===== ===== ===== =====
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Note 7 - Segment Information (continued)
- ---------------------------------------
Three Months Ended Six Months Ended
June 30 June 30
----------------- ----------------
1999 1998 1999 1998
----- ----- ----- -----
(In millions)
Income (Loss) from
Continuing Operations
Before Income Taxes and
Cumulative Effect
of Accounting Change
Property-liability
insurance:
U.S. Underwriting:
Commercial Lines Group $(77) $(349) $(172) $(427)
Specialty Commercial (26) (42) (43) (47)
Surety 13 19 28 33
Specialty Auto - 1 - (1)
----- ----- ----- -----
Total U.S. Underwriting (90) (371) (187) (442)
International (17) (15) (53) (40)
----- ----- ----- -----
Total primary insurance (107) (386) (240) (482)
Reinsurance 6 2 29 16
----- ----- ----- -----
Total GAAP underwriting
result (101) (384) (211) (466)
----- ----- ----- -----
Investment operations:
Net investment income 321 331 643 663
Realized investment gains 71 132 132 180
----- ----- ----- -----
Total investment
operations 392 463 775 843
Other (1) (190) (21) (217)
----- ----- ----- -----
Total property-
liability insurance 290 (111) 543 160
----- ----- ----- -----
Life insurance 9 (33) 28 (14)
----- ----- ----- -----
Asset management:
Pretax income before
minority interest 40 33 77 64
Minority interest (10) (8) (18) (15)
----- ----- ----- -----
Total asset management 30 25 59 49
----- ----- ----- -----
Total reportable segments 329 (119) 630 195
Parent company, other
operations and
consolidating eliminations (39) (169) (74) (218)
----- ----- ----- -----
Total income from
continuing operations
before income taxes and
cumulative effect of
accounting change $290 $(288) $556 $(23)
===== ===== ===== =====
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Note 8 - Reinsurance
- --------------------
The St. Paul's consolidated financial statements reflect the
effects of assumed and ceded reinsurance transactions. Assumed
reinsurance refers to The St. Paul's acceptance of certain
insurance risks that other insurance companies have underwritten.
Ceded reinsurance involves transferring certain insurance risks
The St. Paul has underwritten to other insurance companies who
agree to share these risks. The primary purpose of ceded
reinsurance is to protect The St. Paul from potential losses in
excess of the amount it is prepared to accept.
The St. Paul expects those with whom it has ceded reinsurance to
honor their obligations. In the event these companies are unable
to honor their obligations, The St. Paul will pay these amounts.
The St. Paul has established allowances for possible nonpayment
of amounts due to it.
The effect of assumed and ceded reinsurance on premiums written,
premiums earned and insurance losses and loss adjustment expenses
is as follows:
Three Months Six Months
Ended June 30 Ended June 30
---------------- ---------------
($ in millions) 1999 1998 1999 1998
----- ----- ----- -----
Written premiums:
Direct $1,201 $1,185 $2,375 $2,465
Assumed 580 426 900 764
Ceded (250) (163) (423) (387)
----- ----- ----- -----
Net premiums written 1,531 1,448 2,852 2,842
===== ===== ===== =====
Earned premiums:
Direct 1,256 1,292 2,506 2,680
Assumed 376 344 710 711
Ceded (220) (168) (401) (425)
----- ----- ----- -----
Net premiums earned 1,412 1,468 2,815 2,966
===== ===== ===== =====
Insurance losses and loss
adjustment expenses:
Direct 1,051 1,262 2,009 2,248
Assumed 222 264 496 502
Ceded (260) (181) (457) (342)
----- ----- ----- -----
Net insurance
losses and loss
adjustment expenses $1,013 $1,345 $2,048 $2,408
===== ===== ===== =====
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Note 9 - Discontinued Operations
- --------------------------------
In June 1999, The St. Paul made a strategic decision to sell its
standard personal insurance business. On July 12, 1999 an
agreement was reached to sell this business to Metropolitan
Property and Casualty Insurance Company (Metropolitan) for
approximately $600 million. As a result, the standard personal
insurance operations were accounted for as a discontinued
operation for the second quarter and first six months of 1999,
and prior period results were restated to be consistent with the
1999 presentation. The Specialty Auto line of business, which
was previously aggregated with standard personal insurance to
form The St. Paul's Personal Insurance segment for reporting
purposes, was not included in this sale.
The St. Paul anticipates that this transaction will close near
the end of the third quarter of 1999, subject to regulatory
approval. The St. Paul estimates that it will recognize a modest
gain on this transaction, net of the costs associated with the
sale as well as the estimated loss from operations expected
during the third quarter 1999, which will be recorded on closing.
Proceeds from the sale, to be received on closing, will be used
for general corporate purposes, which may include strategic
acquisitions to augment The St. Paul's existing specialty
insurance and general commercial lines, expansion of specialty
product offerings, and continuation of The St. Paul's common
share repurchase program.
Under the terms of the agreement, Metropolitan will purchase the
Economy Fire & Casualty Company and its wholly-owned subsidiaries
(Economy). Economy's net book value at June 30, 1999
approximates $370 million, including investments and other
assets, loss reserves, unearned premium and other liabilities.
As of June 30, 1999, these balance sheet amounts are included in
the applicable line items of The St. Paul's consolidated balance
sheet. Economy represents a portion of the personal lines business
to be sold.
Additionally, The St. Paul will sell its rights and interests in
those policies constituting the remaining portion of its standard
personal insurance operations and certain related assets. This
business will be transferred to Metropolitan by way of a
reinsurance and facility agreement pursuant to which The St. Paul
will transfer assets, representing the unearned premium on the
inforce policies, of approximately $330 million to Metropolitan.
As a result of the sale, all 1,700 standard personal insurance
employees of The St. Paul will transfer to Metropolitan,
effective on closing. An additional 500 to 600 positions will be
eliminated, commensurate with the expected revenue decline from
the sale. The severance and other costs related to these
terminations will be included in The St. Paul's calculation of
its gain on the sale and recognized at closing.
Note 10 - Cumulative Effect of Accounting Change
- ------------------------------------------------
Effective Jan. 1, 1999, The St. Paul adopted the provisions of
the American Institute of Certified Public Accountants (AICPA)
Statement of Position (SOP) No. 97-3, "Accounting by Insurance
and Other Enterprises for Insurance-Related Assessments." The
SOP provides guidance for recognizing and measuring liabilities
for guaranty fund and other insurance-related assessments. The
St. Paul recorded a pretax expense of $46 million ($30 million
after-tax) in the first quarter of 1999 representing the
cumulative effect of adopting the provisions of the SOP. The
majority of the cumulative effect related to assessments for
workers' compensation second-injury funds, with a lesser amount
related to insurance guaranty funds. Second-injury funds provide
reimbursement to insurance carriers or employers for workers'
compensation claims when the cost of a workers' second injury
combined with a prior accident or disability is greater than what
the second injury alone would have produced. Second-injury funds
are established to help ensure that employers are not made to
suffer a greater monetary loss or increased insurance costs
because of hiring previously injured or handicapped employees.
The St. Paul's total accrued pre-tax expense related to insurance
assessments was $74 million at March 31, 1999, which consisted of
the $46 million first quarter cumulative effect of adopting SOP
97-3 and $28 million of previously recorded liabilities. The
accrual was recorded as follows: $53 million in other
liabilities, $16 million in insurance reserves, and $5 million in
other assets as an offset to deferred premium tax recoverable.
The accrued amounts are expected to be disbursed as assessed
during a period of up to 30 years.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Note 11 - Merger with USF&G Corporation
- ---------------------------------------
On April 24, 1998, The St. Paul issued 66.5 million of its
common shares in exchange for all of the outstanding common
stock of USF&G Corporation, a holding company for property-
liability and life insurance operations.
The St. Paul recorded a pretax charge to earnings of $292 million
in the second quarter of 1998 related to the merger, primarily
consisting of severance and other employee-related costs,
facilities exit costs, asset impairments and transaction costs.
The St. Paul estimated that approximately 2,000 positions would
be eliminated due to the combination of the two organizations,
resulting from efficiencies to be realized by the larger
organization and the elimination of redundant functions. All
levels of employees, from technical staff to senior management,
were affected by the reductions. The number of positions
expected to be reduced by function included approximately 950 in
The St. Paul's property-liability underwriting operation, 350 in
claims and 700 in finance and other administrative positions.
The reductions are occurring throughout the United States.
Through June 30, 1999, approximately 2,100 positions had been
eliminated, and the cost of termination benefits paid was $124
million. The St. Paul expects to realize annualized pretax
expense savings of approximately $210 million as a result of the
merger (as measured against the combined 1997 pre-merger expenses
of The St. Paul and USF&G), primarily due to the reduction in
employee salaries and benefits.
The merger-related charge was determined in accordance with
Emerging Issues Task Force (EITF) Issue No 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other
Costs to Exit an Activity," Statement of Financial Accounting
Standards (SFAS) No. 121, "Accounting for the Impairment of Long-
Lived Assets and for Long-Lived Assets to Be Disposed Of," SFAS
No. 5, "Accounting for Contingencies," and Accounting Principles
Board Opinion No. 16, "Business Combinations."
The following table provides information about the components of
the 1998 charge, payments made and the balance of accrued amounts
remaining at June 30, 1999.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Note 11 - Merger with USF&G Corporation (continued)
- --------------------------------------------------
Pre-tax
Charges to earnings: Charge
- ------------------- ------
(in millions)
USF&G corporate headquarters $36
Long-lived assets 23
Software depreciation acceleration 10
Computer leases and equipment 9
Other equipment and furniture 8
-----
Subtotal 86
-----
Accrued charges subject
to rollforward:
-----------------------
Reserve at
Pre-tax Pay- Adjust- June 30,
Charge ments ments 1999
------- ------ ------ --------
Executive severance 89 $(84) $(2) $3
Other severance 53 (40) 0 13
Branch lease exit costs 34 (5) 0 29
Transaction costs 30 (30) 0 -
----- ----- ----- -----
Accruals subject to rollforward 206 $(159) $(2) $45
----- ===== ===== =====
Total $292
=====
The following discussion provides more information regarding the
rationale for and calculation of certain components of the merger-
related charge:
USF&G Corporate Headquarters
- ----------------------------
After consummating the merger in April 1998, The St. Paul vacated
a significant portion of a building in Baltimore, MD that had
been the site of USF&G's corporate headquarters. Having
developed a plan to lease the space to outside parties, The St.
Paul categorized the building as an "asset to be held or used" as
defined by SFAS No. 121 for purposes of evaluating the potential
impairment of its $64 million carrying value. Based on an
independent appraisal, The St. Paul recorded a $36 million
writedown in its carrying value.
Computer leases and equipment
- -----------------------------
The St. Paul conducted an extensive technology study upon
consummation of the merger which identified redundant computer
hardware. As a result, The St. Paul recorded a $9 million
expense for lease buy-out transactions and disposals of computer
equipment. The expense represented the lease termination fee
obligation (lease buy-outs), calculated as the discounted value
of the remaining computer lease obligations; and the net book
value of redundant computer equipment.
Executive severance
- -------------------
Represents the obligations The St. Paul is required to pay in
accordance with the USF&G Senior Executive Severance Plan in
place at the time of the merger. The merger with USF&G qualified
as a change in control under the Severance Plan, which obligated
The St. Paul to make payments to covered employees on the
occurrence of certain triggering events within two years of the
closing of the merger. Such triggering events, which have
occurred, included the employee's involuntary termination without
cause by the company or the employee's termination for "good
reason" which included such factors as diminution of
responsibilities, change in job title, or being required to
relocate beyond a certain distance. In addition, The St. Paul
had an obligation to certain employees who, although not
terminated, had "good reason" to take action which would trigger
payment under the Severance Plan.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Note 11 - Merger with USF&G Corporation (continued)
- --------------------------------------------------
Other severance
- ---------------
Represents severance and related benefits such as out-placement
counseling, vacation buy-out and medical coverage to be paid to
terminated employees not covered under the USF&G Senior Executive
Severance Plan.
Branch lease exit costs
- -----------------------
As a result of the merger, excess space was created in several
locations due to staff reductions in the combined organization.
The charge for branch lease exit costs was calculated by
determining the percentage of anticipated excess space at each
site and the current lease costs over the remaining lease period.
In certain locations, the lease is expected to be terminated.
For leases not expected to be terminated, the amount of expense
included in the charge was calculated as the percentage of excess
space (20% to 100%) times the net of: remaining rental payments
plus capitalized leasehold improvements less actual sub-lease
income. No amounts were discounted to present value in the
calculation.
Transaction costs
- -----------------
This amount consists of registration fees, costs of furnishing
information to stockholders, consultant fees, investment banker
fees, and legal and accounting fees.
Long-lived assets
- -----------------
Upon consummation of the merger, The St. Paul determined that
several of USF&G's real estate investments were not consistent
with The St. Paul's real estate investment strategy. A plan was
developed to sell a number of apartment buildings and various
other miscellaneous holdings, with an expected disposal date by
year-end 1999. In applying the provisions of SFAS No. 121, it
was determined that four of these miscellaneous investments
should be written down to fair value, based on The St. Paul's
plan to sell them. Fair value was determined based on a
discounted cash flow analysis, or based on market prices for
similar assets. The four investments were as follows:
1) Description of Percentage rents retained after sale
investment: of a portfolio of stores to a third
party
Carrying $21.6 million prior to writedown of
amount: $16.6 million, for current amount of
$5.0 million, with $4.3 million held
in the property-liability segment
and $0.7 million held in the life
segment
2) Description of 138-acre land parcel in New Jersey,
investment: with farm buildings being rented out
Carrying $4.9 million prior to writedown of
amount: $2.1 million, for current amount of
$2.8 million, held in the property-
liability segment
3) Description of Receivable representing cash flow
investment: guarantee payments related to real
estate partnerships.
Carrying $4.8 million prior to writedown of
amount: $1.7 million, sold with no further
gain or loss.
4) Description of Limited partnership interests in
investment: three citrus groves
Carrying $4.5 million prior to writedown of
amount: $2.4 million. Two of the
partnership interests have been
exchanged for an investment in a new
partnership, with one of the
original citrus grove partnership
interests remaining. This
partnership is carried at a current
balance of $.6 million, held in
"parent company and other"
operations
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Note 12 - Fourth Quarter 1998 Restructuring Charge
- --------------------------------------------------
In the fourth quarter of 1998, The St. Paul recorded a pretax
restructuring charge of $34 million. The majority of the charge,
$26 million, related to the anticipated termination of
approximately 520 employees in the following operations: Claims,
Commercial Lines Group, Information Systems, Medical Services and
Professional Markets. The remaining charge of $8 million related
to costs to be incurred to exit lease contracts.
As of June 30, 1999, approximately 300 employees had been
terminated under the restructuring plan, and the cost of
termination benefits paid was $18 million. The remaining reserve
related to severance was written down by $3 million, for a
balance at June 30, 1999 of $5 million. Less than $1 million had
been paid related to branch leases as of June 30, 1999. Actions
to take place under this restructuring plan are expected to be
completed by the end of 1999. The St. Paul anticipates realizing
annualized pretax expense savings of approximately $50 million in
1999 (compared with 1997 levels), primarily as the result of the
reduction in employee salaries and benefits.
Note 13 - Subsequent Event - Cost Reduction Program
- ---------------------------------------------------
In August 1999, The St. Paul announced a cost reduction program
designed to enhance its efficiency and effectiveness in a highly
competitive industry environment. The program includes the
elimination of approximately 1,000 additional employee positions,
primarily staff functions, by year-end 1999. These reductions
are separate from positions to be eliminated as a result of the
sale of The St. Paul's standard personal insurance business to
Metropolitan. The St. Paul expects to record a charge to
earnings in the third quarter of 1999, primarily for severance
and other expenses related to the cost reduction program.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and
Results of Operations
June 30, 1999
In July 1999, The St. Paul announced an agreement to sell its
standard personal insurance business to Metropolitan Property and
Casualty Insurance Company. The results of the operations to be
sold have been accounted for as discontinued operations for all
current and prior year periods, and are thus excluded from any
table or discussion of continuing operations.
Consolidated Results
--------------------
The following table summarizes The St. Paul's results for the
second quarter and first six months of 1999 and 1998.
Three Months Six Months
Ended June 30 Ended June 30
-------------- --------------
(in millions,
except per share data) 1999 1998 1999 1998
----- ----- ----- -----
Pretax income (loss):
Property-liability insurance:
GAAP underwriting result $(101) $(384) $(211) $(466)
Net investment income 321 331 643 663
Realized investment gains 71 132 132 180
Other (1) (190) (21) (217)
----- ----- ----- -----
Total property-
liability insurance 290 (111) 543 160
Life insurance 9 (33) 28 (14)
Asset management 30 25 59 49
Parent and other (39) (169) (74) (218)
----- ----- ----- -----
Income (loss) from
continuing operations
before income taxes and
cumulative effect of
accounting change 290 (288) 556 (23)
Income tax expense (benefit) 69 (95) 135 (34)
----- ----- ----- -----
Income (loss) from
continuing operations
before cumulative effect
of accounting change 221 (193) 421 11
Cumulative effect of
accounting change, net of taxes - - (30) -
----- ----- ----- -----
Income (loss) from
continuing operations 221 (193) 391 11
Loss from discontinued
operations, net of taxes (17) (81) (22) (90)
----- ----- ----- -----
Net income (loss) $204 $(274) $369 $(79)
===== ===== ===== =====
Diluted net income (loss)
per common share $0.84 $(1.18) $1.50 $(0.36)
===== ===== ===== =====
The St. Paul's pretax income from continuing operations of $290
million in the second quarter of 1999 represented a significant
improvement over the pretax loss of $288 million in the same 1998
period. The 1998 loss included a pretax charge of $292 million
related to The St. Paul's merger with USF&G, primarily for
severance and other employee-related costs and facilities exit
costs. The 1998 pretax loss from continuing operations also
included a $215 million provision to reflect the application of
The St. Paul's loss reserving policies to USF&G's loss and loss
adjustment expense reserves subsequent to the April 1998 merger,
and a $41 million writedown in the carrying value of deferred
acquisition costs in The St. Paul's life insurance segment.
Excluding these charges, which totaled $548 million, pretax
income from continuing operations totaled $260 million in 1998's
second quarter, $30 million less than the equivalent total of
$290 million in this year's second quarter. Earnings growth in
1999 resulted from an improvement in property-liability
underwriting results and a reduction in expenses due to merger-
related efficiencies, which were partially offset by declines in
the property-liability operations' investment income and realized
investment gains. Through the first six months of 1999, pretax
income from continuing operations of $556 million was 6% higher
than comparable 1998 income of $525 million (excluding the
charges referred to above).
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Consolidated Results (continued)
-------------------------------
The merger-related efficiencies realized in the first half of
1999 primarily resulted from the elimination of duplicate
functions throughout the combined organization, including the
consolidation of corporate headquarters' functions, and the
elimination of approximately 2,100 employees since the
consummation of the merger. By the end of 1999, The St. Paul
expects to realize pretax annualized expense savings of
approximately $260 million (as measured against the combined 1997
pre-merger expenses of The St. Paul and USF&G) as a result of the
merger and the restructuring of its Commercial Lines Group and
Specialty Commercial underwriting business segments in late 1998.
The St. Paul's net income for the first half of 1999 totaled $369
million, compared with a net loss of $79 million in the same
period of 1998, which reflected the impact of earnings charges
recorded in last year's second quarter. Net income in 1999
included a pretax expense of $46 million ($30 million after-tax),
representing the cumulative effect of adopting the AICPA's
Statement of Position (SOP) 97-3, "Accounting by Insurance and
Other Enterprises for Insurance-Related Assessments." The SOP
provides guidance for recognizing and measuring liabilities for
guaranty and other insurance-related assessments.
In June 1999, The St. Paul made a strategic decision to exit the
standard personal property-liability insurance market, and in
July 1999, announced an agreement to sell those operations to
Metropolitan Property and Casualty Insurance Company
(Metropolitan) in a transaction expected to close near the end of
the third quarter of 1999, subject to regulatory approval.
Accordingly, the results of these operations have been segregated
and presented as discontinued operations for all periods
presented in this report. The loss from discontinued operations
reported for the second quarter and first six months of 1998,
respectively, include a $35 million pretax provision to reflect
the application of The St. Paul's loss reserving policies to
USF&G's loss and loss adjustment expense reserves subsequent to
the April 1998 merger, and also reflect the impact of severe
catastrophe losses resulting from several spring storms in the
second quarter of the year.
Under terms of the sale agreement, Metropolitan will purchase the
Economy Fire & Casualty Company (a wholly-owned subsidiary of The
St. Paul) and its wholly-owned subsidiaries, as well as the
rights and interests in those policies constituting the remaining
standard personal insurance operations of The St. Paul. These
rights and interests will be transferred to Metropolitan by way
of a reinsurance and facility agreement pursuant to which The St.
Paul will transfer assets, representing the unearned premium on
the inforce policies, of approximately $330 million to
Metropolitan.
The sale is a strategic move to focus The St. Paul's property-
liability insurance operations on its business and professional
insurance lines. Proceeds from the sale are expected to total
approximately $600 million, and The St. Paul expects to realize a
modest gain upon completion of the sale. The approximately 1,700
employees of The St. Paul directly involved in the personal
insurance business will be transferred to Metropolitan upon the
closing of the transaction. As a result of the sale, The St.
Paul plans to terminate an additional 500 to 600 employees by the
end of 1999 to maintain expenses at a level commensurate with a
smaller revenue base going forward. The severance and other
related costs associated with the elimination of these positions
will be included in The St. Paul's calculation of its anticipated
gain on the sale to be recorded on the closing.
In August 1999, The St. Paul announced a cost reduction program
designed to enhance its efficiency and effectiveness in a highly
competitive industry environment. The program includes the
elimination of approximately 1,000 additional employee positions,
primarily staff functions, by year-end 1999. This new initiative
is separate from the actions associated with The St. Paul's
pending sale of its standard personal insurance operations to
Metropolitan. The St. Paul expects to record a charge to
earnings in the third quarter of 1999, primarily for severance
and other expenses related to the cost reduction program.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Property-Liability Insurance
----------------------------
The following summarizes key financial results by property-
liability underwriting business segment (Underwriting results
are presented on a GAAP basis; combined ratios are presented on
a statutory accounting basis):
% of Three Months Six Months
1999 Ended June 30 Ended June 30
($ in millions) Written ------------- -------------
Premiums 1999 1998 1999 1998
-------- ----- ----- ----- -----
Commercial Lines Group:
Written Premiums 35% $507 543 1,007 1,094
Underwriting Result $(77) (349) (172) (427)
Combined Ratio 114.9 165.6 116.3 139.4
Specialty Commercial:
Written Premiums 20% $264 259 578 540
Underwriting Result $(26) (42) (43) (47)
Combined Ratio 111.1 116.1 109.7 111.3
Surety:
Written Premiums 8% $111 109 214 200
Underwriting Result $13 19 28 33
Combined Ratio 80.5 79.4 79.8 79.1
Specialty Auto:
Written Premiums 4% $58 61 124 134
Underwriting Result $- 1 - (1)
Combined Ratio 99.6 99.1 98.9 98.2
----- ----- ----- ----- -----
Total U.S.
Underwriting:
Written Premiums 67% $940 972 1,923 1,968
Underwriting Result $(90) (371) (187) (442)
Combined Ratio 110.1 139.2 110.1 124.0
International:
Written Premiums 12% $236 158 345 279
Underwriting Result $(17) (15) (53) (40)
Combined Ratio 109.9 110.5 118.1 115.1
----- ----- ----- ----- -----
Total Primary
Insurance:
Written Premiums 79% $1,176 1,130 2,268 2,247
Underwriting Result $(107) (386) (240) (482)
Combined Ratio 109.3 135.8 110.9 122.9
Reinsurance:
Written Premiums 21% $355 318 584 595
Underwriting Result $6 2 29 16
Combined Ratio 90.1 95.4 91.4 95.9
----- ----- ----- ----- -----
Total Property-Liability
Insurance:
Written Premiums 100% $1,531 1,448 2,852 2,842
GAAP Underwriting Result $(101) (384) (211) (466)
Statutory Combined Ratio:
Loss and Loss Expense Ratio 73.7 93.3 74.5 82.6
Underwriting Expense Ratio 32.0 35.0 32.9 35.1
----- ----- ----- -----
Combined Ratio 105.7 128.3 107.4 117.7
===== ===== ===== =====
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Property-Liability Insurance (continued)
---------------------------------------
Overview
- --------
Consolidated written premiums from continuing operations of $1.53
billion in the second quarter of 1999 were 6% higher than
comparable 1998 premiums of $1.45 billion. Premium volume in The
St. Paul's U.S. Underwriting operations declined 3% from 1998's
second quarter, reflecting the impact of competitive domestic
market conditions, and corrective underwriting and pricing actions
implemented in the Commercial Lines Group aimed at improving the
quality of that book of business. That decline, however, was more
than offset by a significant increase in International volume and
growth in Reinsurance premiums. Year-to-date written premiums of
$2.85 billion were virtually level with the same period of 1998,
with an 8% decline in Commercial Lines Group volume substantially
offset by new business growth in the Surety and International
segments.
The consolidated loss ratio, measuring insurance losses and loss
adjustment expenses as a percentage of earned premiums, was 73.7
for the second quarter of 1999, compared with an adjusted loss
ratio of 78.4 in the same period of 1998, which excludes a 14.9
point impact of the $215 million provision to reflect the
application of The St. Paul's loss reserving policies to USF&G's
loss and loss adjustment expense reserves subsequent to the April
1998 merger. Of the 4.7 point improvement over last
year's adjusted second quarter loss ratio, 1.3 points was
attributable to a decline in catastrophe losses, from $79 million
in 1998 to $58 million in 1999's second quarter. The balance of
the improvement over 1998 reflects the effect of profit improvement
initiatives implemented in the Commercial Lines Group. Through the
first half of 1999, the loss ratio of 74.5 was less than one point
better than the adjusted 1998 six-month ratio of 75.2.
The consolidated expense ratio, measuring underwriting expenses as
a percentage of written premiums, was 32.0 for the 1999 second
quarter, an improvement of three points compared with the 1998
second quarter ratio of 35.0. The expense ratio reduction reflects
cost savings realized as a result of the merger with USF&G, and
efficiencies resulting from the restructuring of the Commercial
Lines Group and Specialty Commercial segments in late 1998. That
restructuring resulted in the elimination of approximately 300
positions from these segments during the first six months of 1999.
These positions are separate from those positions eliminated as a
result of the merger with USF&G. The year-to-date expense ratio of
32.9, over two points better than last year's comparable ratio of
35.1, also reflects the merger-related and restructuring cost
savings initiated in 1998.
Underwriting Results by Segment
- -------------------------------
Commercial Lines Group
- ----------------------
The Commercial Lines Group segment includes The St. Paul's Middle
Market and Small Commercial business centers, and several other
business centers providing specialized products and services for
targeted industry groups. Second quarter 1999 written premiums of
$507 million declined 7% from comparable 1998 premiums of $543
million. The reduction was centered in the Middle Market business
center, where a 16% decline in premium volume reflects the impact
of management's initiatives to improve profitability by refusing to
underwrite inadequately-priced business. Small Commercial premium
volume for the quarter of $116 million increased 4% over the
comparable 1998 total of $112 million. Written premiums in the
Construction business center grew 10% over the second quarter of
1998, primarily due to price increases and the effect of
retroactive premium adjustments on prior year business. Year-to-
date premiums for the total Commercial Lines Group segment were 8%
below comparable 1998 levels, with the Middle Markets business
center accounting for the majority of the decrease.
This segment's underwriting loss of $77 million in the second
quarter of 1999 was a significant improvement over last year's
second quarter loss of $349 million, which included $197 million of
the provision to reflect the application of
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Property-Liability Insurance (continued)
---------------------------------------
The St. Paul's loss reserving policies to USF&G's loss and loss
adjustment expense reserves subsequent to the April 1998 merger.
Excluding that provision, the 1999 result was still $75 million
better than last year's loss of $152 million, reflecting progress
achieved through corrective underwriting and pricing initiatives, a
decline in catastrophe losses and ongoing expense reductions. The
expense ratio in this segment improved by over three points over
the second quarter of 1998. The year-to-date underwriting loss of
$172 million was $58 million less than the adjusted 1998 loss of
$230 million.
Specialty Commercial
- --------------------
The Specialty Commercial segment includes the Medical Services,
Custom Markets and Professional Markets business centers, all of
which provide specialized insurance products and services tailored
to meet the needs of specific commercial customer groups. Second-
quarter 1999 premium volume totaled $264 million, 2% ahead of
comparable 1998 premiums of $259 million. Medical Services' volume
grew 10% over the second quarter of 1998, largely due to premiums
on a three-year policy recorded during the quarter. Custom
Markets' written premiums of $81 million were virtually level with
the second quarter of 1998, as an increase in Technology volume was
offset by a decline in Surplus Lines production. Professional
Markets posted a 4% decline in premiums compared with last year's
second quarter, primarily due to a reduction in Public Sector
volume. Year-to-date premiums of $578 million in the Specialty
Commercial segment grew 7% over the same period of 1998, but that
rate was inflated by a first-quarter reporting endorsement on an
existing Medical Services account which generated a premium of $37
million. Excluding that amount, six-month 1999 written premiums
were level with the same period of 1998.
Excluding the $18 million provision (to reflect the application of
The St. Paul's loss reserving policies to USF&G's loss and loss
adjustment expense reserves subsequent to the April 1998 merger)
from the 1998 second quarter underwriting loss, Specialty
Commercial's second quarter 1999 underwriting loss of $26 million
was virtually level with 1998. Medical Services' underwriting
result improved $9 million over last year's second quarter, but the
Technology and Financial and Professional Services business
operation experienced a decline in underwriting profitability. The
1999 year-to-date underwriting loss of $43 million in the Specialty
Commercial segment was driven by Medical Services; Custom Markets
and Professional Markets posted breakeven results through the first
half of 1999.
Specialty Auto
- --------------
The Specialty Auto segment provides personal property-liability
insurance products and services to individuals who are unable to
obtain standard coverage due to their inability to meet certain
underwriting criteria. These operations were not included in the
sale of The St. Paul's standard personal insurance business to
Metropolitan. In an increasingly competitive marketplace for these
coverages, written premium volume of $58 million in the second
quarter was slightly below last year's second-quarter total of $61
million. Year-to-date premiums of $124 million fell 7% short of
the comparable 1998 total. This segment posted virtually break-
even underwriting results for the second quarter and first six
months of both 1999 and 1998.
Surety
- ------
The St. Paul is the largest underwriter of surety bonds in North
America, based on 1998 written premiums. Written premiums in
1999's second quarter of $111 million were virtually level with
second-quarter 1998 volume of $109 million. In the first six
months of 1999, written premiums of $214 million grew 7% over the
comparable 1998 total of $200 million. An increase in contract
surety business, driven by the strong economy in the United States
and Mexico which has fueled new construction activity, was the
chief factor in 1999 premium growth. This segment continues to
produce strong results, posting underwriting profits of $13 million
and $28 million in the second quarter and first half of 1999,
respectively.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Property-Liability Insurance (continued)
---------------------------------------
International
- -------------
The St. Paul's International segment provides commercial and
personal property-liability insurance products and services in
selected international markets. Premium volume of $236 million in
the second quarter grew almost 50% over the comparable 1998 total
of $158 million. Growth was centered in the Lloyd's of London
operation, where The St. Paul has significantly increased its
underwriting capacity on the syndicates that are managed by the
managing agencies that it owns. New commercial business
opportunities in Europe and a large account recorded in Canada were
also contributing factors to the 1999 growth rate. The strong
second quarter premium total pushed year-to-date premiums to $345
million, 23% higher than those for the same period in 1998. The
second quarter underwriting loss of $17 million was slightly worse
than last year's second quarter loss of $15 million but was
significantly better than the first quarter 1999 loss of $36
million. The six-month 1999 loss of $53 million was $13 million
worse than the year-to-date 1998 result, primarily due to
significant losses in Canada and reserve strengthening in the
Global Marine business center in the first quarter.
Reinsurance
- -----------
The St. Paul's Reinsurance segment underwrites treaty and
facultative reinsurance for property, liability, ocean marine,
surety and certain specialty classes of business, and provides
products and services to the alternative risk transfer market.
Premium volume in the second quarter of $355 million increased 12%
over the same period of 1998, primarily the result of new
opportunities in non-traditional business as well as changes made
to The St. Paul's estimates of premiums that have been earned, but
not yet reported, by ceding insurers. Excluding that change in
estimate, which added approximately $20 million to the second
quarter total, premium volume increased 5% over the second quarter
of 1998. Worldwide reinsurance markets remain highly competitive,
driven by excess capacity in primary insurance markets which has
put downward pressure on the demand for and price of reinsurance
coverages. Excluding the impact of the change in estimated
premiums, year-to-date volume fell 10% below the comparable 1998
total. The Reinsurance segment posted a $6 million underwriting
profit in the second quarter of 1999, pushing the year-to-date
profit to $29 million. Underwriting profits in the equivalent
periods of 1998 were $2 million and $16 million, respectively.
During the second quarter of 1999, the Reinsurance segment ceded,
under an aggregate excess of loss reinsurance contract, $56 million
in losses, less related ceded premiums of $25 million, for a net
recovery of $31 million.
Investment Operations
- ---------------------
The St. Paul's property-liability insurance operations produced
pretax investment income of $321 million in the second quarter of
1999, 3% below the comparable 1998 total of $331 million. Year-to-
date pretax investment income of $643 million was also 3% below the
1998 six-month total. Negative underwriting cash flows over the
last several quarters (an excess of loss and expense payments over
premium revenues) have resulted in a net reduction in the
underwriting operations' invested assets compared with the same
time in 1998. In addition, merger-related and restructuring
payments of $176 million over the last fourteen months have further
reduced opportunities for growth in the investment portfolio.
Recent investment maturities have also generally been reinvested at
current market yields which are lower than the average yield on the
portfolio. These factors have resulted in a trend of declining
investment income over recent quarters. The St. Paul does not
anticipate substantial improvement in its underwriting cash flow
situation during the remainder of 1999. The pending sale of The
St. Paul's standard personal insurance business, expected to close
near the end of the third quarter of 1999, subject to regulatory
approval, will result in the transfer of approximately $370 million
of net invested assets to Metropolitan, further reducing investment
income in the future.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Property-Liability Insurance (continued)
---------------------------------------
Investment Operations (continued)
- --------------------------------
Pretax realized investment gains in The St. Paul's property-
liability insurance operations of $71 million in the second quarter
of 1999 declined from gains of $132 million in the same period of
1998. Sales of equity and venture capital investments accounted
for the majority of the 1999 total. In last year's second quarter,
The St. Paul took advantage of favorable market conditions to
restructure its equity portfolio, which resulted in an unusually
high level of realized gains. Pretax gains for the first half of
1999 totaled $132 million, compared with $180 million through the
first six months of 1998.
The $17.2 billion carrying value of the property-liability fixed
maturities portfolio on June 30, 1999 included $405 million of
pretax unrealized appreciation in market value. An upward movement
in market interest rates during the first half of 1999 resulted in
a $611 million pretax decline in the unrealized appreciation of the
bond portfolio since the end of 1998. Approximately 96% of that
portfolio is rated at investment grade (BBB or above). The
weighted average pretax yield on those investments was 6.8% at June
30, 1999.
Environmental and Asbestos Claims
---------------------------------
The St. Paul continues to receive claims alleging injuries from
environmental pollution or alleging covered property damages for
the cost to clean up polluted sites. The company also receives
asbestos injury and property damage claims arising out of product
liability coverages under general liability policies. The vast
majority of these claims arise from policies written many years
ago. The St. Paul's alleged liability for both environmental and
asbestos claims is complicated by significant legal issues,
primarily pertaining to the scope of coverage. In the company's
opinion, court decisions in certain jurisdictions have tended to
broaden insurance coverage beyond the intent of original insurance
policies.
The St. Paul's ultimate liability for environmental claims is
difficult to estimate because of these legal issues. Insured
parties have submitted claims for losses not covered in their
respective insurance policies, and the ultimate resolution of these
claims may be subject to lengthy litigation, making it difficult to
estimate The St. Paul's potential liability. In addition,
variables, such as the length of time necessary to clean up a
polluted site and controversies surrounding the identity of the
responsible party and the degree of remediation deemed necessary,
make it difficult to estimate the total cost of an environmental
claim.
Estimating the ultimate liability for asbestos claims is equally
difficult. The primary factors influencing the estimate of the
total cost of these claims are case law and a history of prior
claim development.
The following table represents a reconciliation of total gross and
net environmental reserve development for the six months ended June
30, 1999, and the years ended Dec. 31, 1998 and 1997. Amounts in
the "net" column are reduced by reinsurance recoverables.
1999
Environmental (six months) 1998 1997
- ------------ ----------- ------ ------
(in millions) Gross Net Gross Net Gross Net
----- ---- ----- ---- ----- ----
Beginning reserves $783 $645 $867 $677 $889 $676
Incurred losses 8 9 (16) 26 44 58
Paid losses (21) (19) (68) (58) (66) (57)
---- ---- ---- ---- ---- ----
Ending reserves $770 $635 $783 $645 $867 $677
==== ==== ==== ==== ==== ====
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Environmental and Asbestos Claims (continued)
--------------------------------------------
The following table represents a reconciliation of total gross and
net reserve development for asbestos claims for the six months
ended June 30, 1999, and the years ended Dec. 31, 1998 and 1997.
1999
Asbestos (six months) 1998 1997
- -------- ----------- ------ ------
(in millions) Gross Net Gross Net Gross Net
----- ---- ----- ---- ----- ----
Beginning reserves $402 $277 $397 $279 $413 $304
Incurred losses 3 9 44 13 22 (5)
Paid losses (15) (11) (39) (15) (38) (20)
---- ---- ---- ---- ---- ----
Ending reserves $390 $275 $402 $277 $397 $279
==== ==== ==== ==== ==== ====
The St. Paul's reserves for environmental and asbestos losses at
June 30, 1999 represent its best estimate of its ultimate liability
for such losses, based on all information currently available.
Because of the inherent difficulty in estimating such losses,
however, The St. Paul cannot give assurances that its ultimate
liability for environmental and asbestos losses will, in fact,
match current reserves. The St. Paul continues to evaluate new
information and developing loss patterns, but it believes any
future additional loss provisions for environmental and asbestos
claims will not materially impact The St. Paul's results of
operations, liquidity or financial position.
Total gross environmental and asbestos reserves at June 30, 1999 of
$1.16 billion represented approximately 6% of gross consolidated
reserves of $18.49 billion.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Life Insurance
--------------
The St. Paul's life insurance segment consists of Fidelity and
Guaranty Life Insurance Company and subsidiaries ("F&G Life"). F&G
Life's primary products are deferred annuities (including tax-
sheltered annuities and equity indexed annuities), structured
settlement annuities and immediate annuities. F&G Life also
underwrites traditional life insurance products.
Highlights of F&G Life's financial performance for the second
quarter and first six months of 1999 and 1998 were as follows:
Three Months Six Months
Ended June 30 Ended June 30
-------------- --------------
(in millions) 1999 1998 1999 1998
----- ----- ----- -----
Pretax earnings (loss) $9 ($33) $28 ($14)
Sales (annualized premiums) $312 $71 $616 $151
Premiums and policy charges $38 $26 $65 $50
Policy surrenders $52 $62 $100 $114
Net investment income $82 $67 $153 $132
Life insurance in force $11,044 $10,744
F&G Life's pretax earnings in the second quarter and first six
months of 1999 benefited from growing spread from increased assets
under management and strong product sales, offset by realized
investment losses of $9 million and increased product development
and channel expansion expenses. The pretax loss of $33 million in
the second quarter of 1998 was driven by a $41 million writedown in
the carrying value of deferred acquisition costs, and $9 million of
charges (primarily for severance and writedowns in the carrying
value of investments) related to The St. Paul's merger with USF&G.
Excluding realized investment gains and losses in both years and
earnings charges in 1998, pretax earnings of $37 million for the
first half of 1999 were level with the same period of 1998. After-
tax earnings, however, increased slightly over 1998 levels,
reflecting the impact of F&G Life's adoption of an investment
strategy to allocate 1% of its investment portfolio to tax-favored
investments. These investments generate tax credits that have
lowered F&G Life's effective tax rate.
The significant increase in sales volume in the second quarter and
first six months of 1999 compared with the same periods of 1998
resulted from sales of an equity-indexed annuity product introduced
in June 1998. F&G Life has been the leading equity-indexed annuity
producer in the United States for the past nine months. Sales of
that product accounted for $235 million, or 75%, of total sales in
the second quarter, and $485 million, or 79%, of total year-to-date
sales. Credited interest rates on this product are tied to the
performance of the S&P 500 equity index. Sales of fixed interest
rate annuities in 1999 declined due to the negative impact of
continued low levels of market interest rates on F&G Life's fixed
rate products. The demand for annuity products is affected by
fluctuating interest rates and the relative attractiveness of
alternative investments, particularly equity-based products.
In July 1999, F&G Life announced that it will begin to provide its
products to banks and broker-dealers that specialize in offering
annuities and life insurance directly to consumers. The entry into
the institutional marketplace, which will complement existing
distribution channels, is expected to enable F&G Life to distribute
its products in markets to which it has previously had limited
access.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Life Insurance (continued)
-------------------------
The increase in premiums and policy charges over the second quarter
and first six months of 1998 resulted from an increase in sales of
structured settlement annuities and life-contingent single premium
immediate annuities ("SPIA"). Structured settlement annuities are
sold primarily to property-liability insurers to settle insurance
claims. Sales of structured settlement annuities, annuities with
life contingencies and term life insurance are recognized as
premiums earned under GAAP. However, sales of investment-type
contracts, such as equity-indexed, deferred and tax sheltered
annuities and universal life-type contracts are recorded directly
on the balance sheet and are not recognized as premium revenue
under GAAP. The expansion of the structured settlement program
into The St. Paul's property-liability claim organization led to
the increase in structured settlement sales. The growth in SPIA
sales resulted from an increased emphasis on this product in 1999.
Deferred annuities and universal life products are subject to
surrender by policyholders. Nearly all of F&G Life's surrenderable
annuity policies allow a refund of the cash value balance less a
surrender charge. Surrender activity in 1999 has declined from
1998 levels. Policy surrenders in 1998 reflected surrenders on a
block of single premium deferred annuities ("SPDA") policies sold
through a distributor that ceased doing business with F&G Life in
1997. The decrease in SPDA surrenders in 1999 was partially offset
by an increase in tax-sheltered annuity surrenders.
Net investment income in the second quarter and first half of 1999
grew 22% and 16%, respectively, over the same periods of 1998 as a
result of an increasing asset base generated by positive cash flow.
Asset Management
----------------
The St. Paul's portion of pretax earnings from The John Nuveen
Company (Nuveen) was $30 million in the second quarter of 1999,
compared with $25 million in 1998's second quarter. For the first
half of 1999, The St. Paul's $59 million portion of Nuveen's pretax
earnings was 21% higher than comparable earnings of $49 million in
1998. The company holds a 78% interest in Nuveen.
Nuveen's asset management revenues continue to grow at a strong
rate, accounting for Nuveen's increase in earnings over 1998.
Those revenues totaled $76 million and $149 million for the second
quarter and first six months of 1999, respectively, compared with
$67 million and $132 million in the corresponding periods of 1998.
Total managed assets grew to $59.5 billion at June 30, 1999, a $4.3
billion increase over year-end 1998 and $7.4 billion higher than at
the same time a year ago. The increase was due to new product
sales, particularly managed accounts sold through Rittenhouse
Financial Services, Inc., a Nuveen subsidiary. At the end of June
1999, Nuveen announced the sale of its investment banking division
to U.S. Bancorp Piper Jaffray. The transaction will enable Nuveen
to focus on its asset management business. The transaction is not
expected to have a material impact on the results of Nuveen's
operations.
Capital Resources
-----------------
Common shareholders' equity totaled $6.27 billion at June 30, 1999,
down $350 million from the year-end 1998 total of $6.62 billion,
primarily due to a $506 million decline in the after-tax unrealized
appreciation of the consolidated fixed maturity investment
portfolio and significant common share repurchases, which more than
offset The St. Paul's six-month net income of $369 million. The
St. Paul repurchased 8.3 million of its common shares for a total
cost of $265 million during the first half of 1999, for an average
cost of $32.03 per share. An increase in market interest rates
during the first six months of 1999 led to the decline in the
unrealized appreciation of The St. Paul's bond holdings compared
with year-end 1998.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Capital Resources (continued)
----------------------------
Total debt outstanding at June 30, 1999 of $1.51 billion increased
by $246 million over the year-end 1998 total of $1.26 billion,
primarily due to the issuance of commercial paper to finance the
company's common share repurchases. Consolidated debt also
reflects the $64 million of variable rate borrowings entered into
by a number of The St. Paul's real estate entities, and the
February 1999 issuance of $46 million of floating rate notes by a
special purpose offshore entity that is providing reinsurance to a
property-liability subsidiary of The St. Paul. In March 1999, The
St. Paul purchased $33.5 million face amount of its $1,000
principal amount zero coupon convertible notes from note holders
for a total cash consideration of $21 million, which represented
the original issue price plus the original issue discount accrued
to the date of purchase. The St. Paul purchased the notes at the
option of the note holders.
Approximately 41% of The St. Paul's consolidated debt outstanding
at June 30, 1999 consisted of medium-term notes bearing a weighted-
average interest rate of 6.9%. The ratio of total debt to total
capitalization of 18% increased from the year-end 1998 ratio of
15%.
The company anticipates that any major capital expenditures during
the remainder of 1999 would involve further repurchases of its
common shares or acquisitions of existing businesses. At June 30,
1999, The St. Paul had approximately $100 million of capacity to
repurchase additional common shares under the $500 million
repurchase program authorized by the company's board of directors
in November 1998. The St. Paul anticipates that net proceeds from
the sale of its standard personal insurance business will be used
for general corporate purposes, which may include strategic
acquisitions to augment The St. Paul's existing specialty insurance
and general commercial lines, expansion of our specialty product
offerings, and continuation of The St. Paul's common share
repurchase program. There are no major capital improvements
planned for the remainder of the year.
For the first six months of 1999, The St. Paul's ratio of earnings
to fixed charges was 8.06, and the ratio of earnings to combined
fixed charges and preferred stock dividend requirements was 7.29.
For the first six months of 1998, The St. Paul's loss from
continuing operations before income taxes was inadequate to cover
fixed charges by $23 million and combined fixed charges and
preferred stock dividend requirements by $32 million. Fixed
charges consist of interest expense, distributions on capital
securities and that portion of rental expense deemed to be
representative of an interest factor.
Liquidity
---------
Liquidity is a measure of The St. Paul's ability to generate
sufficient cash flows to meet the short- and long-term cash
requirements of its business operations. Net cash outflows from
operating activities totaled $35 million in the first six months of
1999, compared with a net outflow of $19 million in the same period
of 1998. Operational cash flows in both 1999 and 1998 were
negatively impacted by the decline in premium volume and investment
receipts in The St. Paul's property-liability insurance operations,
as well as cash disbursements associated with The St. Paul's merger
with USF&G and the restructuring of the company's commercial
insurance operations. The St. Paul does not anticipate significant
improvement in operational cash flows during the remainder of 1999
due to the expected continuation of the decline in premium volume,
severance payments associated with the elimination of approximately
1,600 employees by the end of the year, and a further reduction in
investment income. On a long-term basis, The St. Paul believes its
operational cash flows will benefit from the corrective pricing and
underwriting actions under way in its property-liability operations
as well as expense control initiatives. The St. Paul's financial
strength and conservative level of debt provide it with the
flexibility and capacity to obtain funds externally through debt or
equity financings on both a short-term and long-term basis should
the need arise.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Market Risk
-----------
Upward movement in market interest rates during the first half of
1999 resulted in a significant decline in the unrealized appreciation
of the bond portfolio since the end of 1998, as discussed in
Property-Liability Insurance - Investment Operations. However, The
St. Paul's portfolio mix, and therefore its exposure to market risk,
has not changed materially from its position at December 31, 1998.
Year 2000 Readiness Disclosure
------------------------------
Many computer systems in the world have the potential of being
disrupted at the turn of the century due to programming limitations
that may cause the two-digit year code of "00" to be recognized as
the year 1900, instead of 2000. The St. Paul is heavily dependent
on its many computer systems, and those of its independent agents
and brokers (The St. Paul "distribution network") and its vendors,
for virtually every aspect of its operations, including
underwriting, claims, investments and financial reporting. Thus,
the "Year 2000" issue involves potentially serious operational
risks for the Company.
For several years, The St. Paul has been evaluating its computer
systems to determine the impact of the Year 2000 issue on its
operations. As compliance evaluation of systems has progressed to
an advanced stage, a shift of emphasis from evaluation to
correction and compliance testing has taken place. The St. Paul
has also been working with vendors and members of its distribution
network in an effort to address Year 2000 issues that such
relationships involve. Finally, The St. Paul has been reviewing
and taking action to address non-systems related issues that may
arise as a result of the Year 2000 problem, including insurance and
reinsurance coverage issues, and it has also been seeking to reduce
the Company's Year 2000-related exposures through the development
of contingency plans.
The following discussion describes The St. Paul's efforts to date
and future plans to deal with the Year 2000 issue. These plans
have been and continue to be updated and revised as additional
information becomes available.
State of Readiness
- ------------------
The St. Paul established a Review Board in the third quarter of
1997 to review the remediation and testing methodology applied to
the hundreds of internally developed and externally sourced systems
used in the Company's corporate headquarters in St. Paul, MN. To
coordinate the Year 2000 remediation efforts, The St. Paul created
the Year 2000 Project Office, which is responsible for the
oversight, coordination and monitoring of Year 2000 efforts
including, among other things, reviewing the compliance status of
information systems in all operating units and subsidiaries, both
foreign and domestic, directing the Year 2000 coordinators assigned
to operating units, and formulating company-wide contingency plans.
Prior to The St. Paul's merger with USF&G in April 1998, a separate
"Y2K Action Committee" was maintained by USF&G, and a comprehensive
program to address each of three identified aspects to the Year
2000 issue (readying USF&G's systems, coordinating with agents and
other third parties with whom USF&G interacts, and managing the
risk of claims from insured parties) had been established. The
Year 2000 program developed by USF&G's Y2K Action Committee has now
been integrated into The St. Paul's overall Year 2000 response.
Information Technology Systems
- ------------------------------
All of The St. Paul's systems, whether internally developed or
externally sourced, are subject to the company-wide comprehensive
testing and compliance standards promulgated by the Company's
Information Services Division (ISD), the oversight and monitoring
of which is the responsibility of the Year 2000 Project Office.
Insofar as internal systems maintained in St. Paul, MN. are
concerned, with few exceptions, Year 2000 compliance was achieved
by December 31, 1998. With few exceptions, initial compliance
validation of all such systems was completed by March 31, 1999.
All subsidiaries not headquartered in Saint Paul, MN or Baltimore,
MD completed initial validation testing of their application
systems on or before June 30, 1999.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Year 2000 Readiness Disclosure (continued)
-----------------------------------------
The Year 2000 Project Office's plan for remediation and validation
of externally sourced systems provides for the Company to work with
the vendors of those systems to ensure that those systems become
Year 2000 compliant at the earliest practicable date. Compliance
testing in accordance with ISD standards takes place as and when
compliant versions and/or affirmations of compliance from vendors
are received. The St. Paul has identified what it believes to be
all of its third-party supplied mission critical systems, and, with
few exceptions, expects to receive Year 2000 compliant versions
and/or affirmations of compliance for each of them, and to complete
the validation process, before September 30, 1999.
Third-Party Service Providers and Distribution Network
- ------------------------------------------------------
The St. Paul relies indirectly on the information technology
systems of its service providers and those of its distribution
network. The Year 2000 Project Office is communicating with the
Company's service providers, including financial institutions
providing custody accounts and other services, its independent
agents and brokers, and other entities with which it does business,
to identify and resolve Year 2000 issues and to determine the
potential impact, where relevant, of the possible failure of
certain of such persons to achieve Year 2000 compliance on a timely
basis. Results of this process are expected to be used in The St.
Paul's contingency planning efforts discussed below.
Nuveen Systems
- --------------
Having started the development and implementation of internal four-
digit date code software and system standards in the early 1980s,
Nuveen's Year 2000 program consists primarily of Year 2000
compliance examination and testing of the software packages and
hardware provided by third parties and of the systems and software
of its service providers. Certification of Year 2000 compliance
and testing of critical third-party hardware and software systems
used in trade processing at Nuveen was completed by the end of the
first quarter of 1999. The remaining certification and testing was
completed in the second quarter of 1999. Nuveen is in the process
of developing contingency plans based upon its examination of the
Year 2000 readiness of its third-party supplied systems and its
service providers. Nuveen believes that the costs associated with
its Year 2000 efforts will not be material to its operations and
financial position.
Embedded Chip Issues
- --------------------
Given the nature of its business, and that of its vendors and the
members of its distribution network, The St. Paul believes that its
exposure to embedded chip Year 2000 issues is minimal (other than
its exposure to possible disruptions in electricity,
telecommunications and other essential services provided by public
utilities that are subject to embedded chip-related disruption).
The St. Paul is, where deemed appropriate, coordinating with
vendors to obtain certificates of Year 2000 compliance for the
embedded computer technology equipment that it uses.
Year 2000 Compliance Program Costs
- ----------------------------------
The St. Paul has developed and implemented plans to address the
system modifications required to prepare for the Year 2000, and
does not expect the planning and implementation costs associated
with Year 2000 efforts to be material to its results of operations,
cash flows or consolidated financial position. Through December
31, 1997, the costs of Year 2000 remediation measures incurred,
including costs incurred by USF&G prior to the merger, totaled
approximately $8.7 million. The St. Paul incurred costs of
approximately $11.3 million in 1998, and it anticipates additional
costs of approximately $6.6 million in 1999.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Year 2000 Readiness Disclosure (continued)
-----------------------------------------
Contingency Planning
- --------------------
During the first half of 1999, contingency plans were developed by
business and staff units, field offices and subsidiary location
teams in accordance with a model that focuses first on restoring
and maintaining infrastructure, and secondly on business
resumption. Individual teams identified their critical processes
and then identified pre-emptive actions to mitigate the potential
impact of a Year 2000 disruption. Teams also developed plans for
reacting to potential threat and duration scenarios. Plans have
been received and assessed across the organization. Each team has
been advised of any required plan modifications and asked to
incorporate the modifications by the end of July. Test plans are
under development and will encompass integrated testing with a
simulated "command center" providing oversight and coordination.
The St. Paul believes that its most significant Year 2000 exposure
is the potential business disruptions that would be caused by
widespread failure of public utility systems, particularly in the
power generation/distribution and the telecommunication industries.
While the contingency plans The St. Paul is developing will provide
alternative procedures to lessen the impact of short duration
disruptions, prolonged failure of power and telecommunications
systems could have a material adverse effect on the Company's
results of operations, cash flows and consolidated financial
position.
As noted above, The St. Paul indirectly relies on the information
systems of the many components of its distribution network, which
includes thousands of independent agents and brokers. The St. Paul
is aware that some of its independent agents and brokers are
currently Year 2000 non-compliant and expects that a much lesser
number, unknown at this time and expected to consist primarily of
smaller agents, will be non-compliant on January 1, 2000. The St.
Paul believes that Year 2000-related difficulties experienced by
members of its distribution network have the potential to
materially disrupt its business and that such potential disruptions
constitute its second greatest area of potential exposure to the
Year 2000 problem. As part of its contingency planning effort, The
St. Paul has been providing information to members of its
distribution network intended to sensitize them to the Year 2000
issue and to encourage them to take appropriate steps to become
Year 2000 compliant. Although the Company's distribution network
consists of thousands of agents and brokers, the number of
different systems used by the constituent members is far less. For
example, the Company believes that fewer than 20 different types of
agency management systems are used by its property-liability
insurance agents in the United States. Contingency arrangements
are being discussed with distribution network members pursuant to
which the Company may, among other provisional steps, provide data
in alternative formats and institute temporary direct billing
services in the event of a disruption in their individual systems.
The Company notes that the Year 2000 issue by its nature carries
the risk of unforeseen and potentially very serious problems of
internal or external origin. Some commentators believe that the
Year 2000 issue has the potential of destabilizing the global
economy or causing a global recession, either of which could
adversely affect the Company. While The St. Paul believes it is
taking appropriate action with respect to third parties on whose
systems and services it relies to a significant extent, there can
be no assurance that the systems of such third parties will be Year
2000 compliant or that any third party's failure to have Year 2000
compliant systems would not have a material adverse effect on The
St. Paul's earnings, cash flows or financial condition.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Year 2000 Readiness Disclosure (continued)
-----------------------------------------
Insurance Coverage
- ------------------
The St. Paul also faces potential Year 2000 claims under coverages
provided by insurance and reinsurance policies sold to insured
parties who may incur losses as a result of the failure of such
parties, or the customers or vendors of such parties, to be Year
2000 compliant. Because coverage determinations depend on unique
factual situations, specific policy language and other variables,
it is not possible to determine in advance whether and to what
extent insured parties will incur losses, the amount of the losses
or whether any such losses would be covered under The St. Paul's
insurance policies. In some instances, coverage is not provided
under the insurance policies or reinsurance contracts, while in
other instances, coverage may be provided under certain
circumstances.
The St. Paul's standard property and inland marine policies
require, among other things, direct physical loss or damage from a
covered cause of loss as a condition of coverage. In addition, it
is a fundamental principle of all insurance that a loss must be
fortuitous to be considered potentially covered. Given the fact
that Year 2000-related losses are not unforeseen, and that The St.
Paul expects that such losses will not, in most if not all cases,
cause direct physical loss or damage, The St. Paul has concluded
that its property and inland marine policies do not generally
provide coverage for losses relating to Year 2000 issues. To
reinforce its view on coverage afforded by such policies, The St.
Paul has developed and is implementing a specific Year 2000
exclusion endorsement. The Company may also face claims from the
beneficiaries of its surety bonds resulting from Year 2000-related
performance failures by the purchasers of the bonds. As with
insurance policies in general, because surety claims depend on
particular factual situations, specific bond language and other
variables, it is not possible to determine in advance whether and
to what extent Year 2000-related claims will arise under surety
bonds issued by The St. Paul, the amount of any such claims or
whether any such claims will by payable under surety bonds issued
by The St. Paul.
The St. Paul is taking a number of actions to address its exposure
to insurance claims arising from its liability coverages, including
individual risk evaluation, communications with insured parties,
the use of exclusions in certain types of policies, and
classification of high hazard exposures that in the Company's view
present unacceptable risk. The St. Paul does not believe that Year
2000-related insurance or reinsurance coverage claims will have a
material adverse effect on its earnings, cash flows or financial
position. However, the uncertainties of litigation are such that
unexpected policy interpretations could compel claim payments
substantially beyond the Company's coverage intentions, possibly
resulting in a material adverse effect on its results of operations
and/or cash flows and a material adverse effect on its consolidated
financial position.
Impact of Accounting Pronouncements to be Adopted in the Future
- ---------------------------------------------------------------
In June 1998, the FASB issued SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities," which establishes
accounting and reporting standards for derivative instruments and
hedging activities. It requires that an entity recognize all
derivatives as either assets or liabilities in the balance sheet,
and measure those instruments at fair value. In June 1999, the FASB
issued SFAS No. 137, "Accounting for Derivative Instruments and
Hedging Activities - Deferral of the Effective Date of FASB
Statement No. 133," which amended SFAS No. 133 to make it effective
for all quarters of fiscal years beginning after June 15, 2000, and
prohibits retroactive application to financial statements of prior
periods. The St. Paul intends to implement the provisions of SFAS
No. 133 in the first quarter of 2001. The St. Paul currently has
limited involvement with derivative instruments, primarily for
purposes of hedging against fluctuations in market indices, foreign
currency exchange rates and interest rates. The company cannot at
this time reasonably estimate the potential impact of this adoption
on its financial position or results of operations for future
periods.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Impact of Accounting Pronouncements to be Adopted in the Future
(continued)
- ---------------------------------------------------------------
In October 1998, the AICPA issued SOP No. 98-7, "Deposit
Accounting: Accounting for Insurance and Reinsurance Contracts That
Do Not Transfer Insurance Risk," which provides guidance for
accounting for such contracts. The SOP specifies that insurance
and reinsurance contracts for which the deposit method of
accounting is appropriate should be classified in one of four
categories, and further specifies the accounting treatment for each
of these categories. The SOP is effective for fiscal years
beginning after June 15, 1999. The St. Paul currently intends to
implement the provisions of the SOP in the first quarter of the
year 2000. The company cannot at this time reasonably estimate the
potential impact of this adoption on its financial position or
results of operations for future periods.
Forward-looking Statement Disclosure
------------------------------------
This report contains certain forward-looking statements within the
meaning of the Private Litigation Reform Act of 1995. Forward-
looking statements are statements other than historical information
or statements of current condition. Words such as expects,
anticipates, intends, plans, believes, seeks or estimates, or
variations of such words, and similar expressions are also intended
to identify forward-looking statements. Examples of these forward-
looking statements include statements about The St. Paul's
expectations concerning: market conditions and their effect on
future premiums, revenues, cash flow and investment income; expense
savings resulting from the USF&G merger and the restructuring
actions announced in 1998 and 1999; the timing of the closing of
the sale of the standard personal insurance business and its impact
on The St. Paul's earnings; and Year 2000 issues and the company's
efforts to address them.
In light of the risks and uncertainties inherent in future
projections, many of which are beyond The St. Paul's control,
actual results could differ materially from those in forward-
looking statements. These statements should not be regarded as a
representation that anticipated events will occur or that expected
objectives will be achieved. Risks and uncertainties include, but
are not limited to, the following: general economic conditions
including changes in interest rates and the performance of
financial markets; changes in domestic and foreign laws,
regulations and taxes; changes in the demand for, pricing of, or
supply of insurance or reinsurance; catastrophic events of
unanticipated frequency or severity; loss of significant customers;
judicial decisions and rulings; receipt of required approvals and
the satisfaction of the conditions to closing for the sale of the
standard personal insurance business; the pace and effectiveness of
the transfer of that personal insurance business from The St. Paul
to Metropolitan; and various other matters, including the effects
of the merger with USF&G. Actual results and experience relating
to Year 2000 issues could differ materially from anticipated
results or other expectations as a result of a variety of risks and
uncertainties, including the impact of system faults, the failure
to successfully remediate material systems, the time it may take to
remediate system failures once they occur, the failure of third
parties (including public utilities, agents and brokers) to
properly remediate material Year 2000 problems, and unanticipated
judicial interpretations of the scope of the insurance or
reinsurance coverage provided by The St. Paul's policies. The St.
Paul undertakes no obligation to release publicly the results of
any future revisions we may make to forward-looking statements to
reflect events or circumstances after the date hereof or to reflect
the occurrence of unanticipated events.
PART II OTHER INFORMATION
Item 1. Legal Proceedings.
The information set forth in Note 5 to the
consolidated financial statements is incorporated
herein by reference.
Item 2. Changes in Securities.
Not applicable.
Item 3. Defaults Upon Senior Securities.
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders.
Not applicable.
Item 5. Other Information.
Not applicable.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits. An Exhibit Index is set forth as the
last page in this document.
(b) Reports on Form 8-K.
1) The St. Paul filed a Form 8-K Current
Report dated April 30, 1999, relating to the
announcement of its financial results for the
quarter ended March 31, 1999.
2) The St. Paul filed a Form 8-K Current
Report dated July 12, 1999 relating to the
announcement of The St. Paul's sale of its
standard personal insurance underwriting
operations to Metropolitan Property and
Casualty Insurance Company.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, the Registrant has duly caused this report to be signed
on its behalf by the undersigned thereunto duly authorized.
THE ST. PAUL COMPANIES, INC.
(Registrant)
Date: August 12, 1999 By /s/ Bruce A. Backberg
---------------------
Bruce A. Backberg
Senior Vice President-Legal Services
(Authorized Signatory)
Date: August 12, 1999 By /s/ Thomas A. Bradley
---------------------
Thomas A. Bradley
Senior Vice President
and Corporate Controller
(Principal Accounting Officer)
EXHIBIT INDEX
----------------
Exhibit
- ---------
(2) Plan of acquisition, reorganization, arrangement,
liquidation or succession**...................................
(i) Stock and Asset Purchase Agreement Dated as of July 12, 1999
Between St. Paul Fire and Marine Insurance Company and
Metropolitan Property and Casualty Insurance Company......... (1)
(3) (i) Articles of incorporation*....................................
(ii) By-laws*.....................................................
(4) Instruments defining the rights of security holders,
including indentures*.........................................
(10) Material contracts...............................................
(11) Statement re computation of per share earnings**................. (1)
(12) Statement re computation of ratios**............................. (1)
(15) Letter re unaudited interim financial information*...............
(18) Letter re change in accounting principles*.......................
(19) Report furnished to security holders*............................
(22) Published report regarding matters submitted to
vote of security holders*.....................................
(23) Consents of experts and counsel*.................................
(24) Power of attorney*...............................................
(27) Financial data schedule**........................................ (1)
(99) Additional exhibits*.............................................
* These items are not applicable.
** This exhibit is included only with the copies of this
report that are filed with the Securities and Exchange
Commission. However, a copy of the exhibit may be obtained
from the Registrant for a reasonable fee by writing to The
St. Paul Companies, Inc., 385 Washington Street, Saint
Paul, MN 55102, Attention: Corporate Secretary.
(1) Filed herewith.